Shareholder agreements

Shareholders’ Agreements – how do they work?

Without a shareholders’ agreement, there’s always the potential for disputes between the shareholders. Well-constructed agreements are designed to pre-empt disputes and set out appropriate ways for them to be addressed.

Too often, people set up companies with friends and relatives without protecting their interests … until it’s too late.

Shareholder agreements for minority or equal shareholdings

Many shareholders’ agreements are designed to protect minority shareholders or those with equal shareholdings (i.e. two shareholders holding 50% each).

A minority shareholder in a private company is especially vulnerable. There is usually no market for the shares of a private company. If you’re a shareholder who’s unhappy with the way a company is being run, you don’t have the option of selling your shares.

For example, as director, you could be removed from this position by a mere 50% of the other shareholders voting you out. This gives you very little security. You could end up being a shareholder with no management rights … unless you’re protected by a shareholders’ agreement.

Majority shareholders’ agreements

Shareholders’ agreements can also be useful for majority shareholders.

As the majority shareholder, you may have sound reasons to curb the powers of other directors who are also shareholders.

For example, you may want to ensure that, if you want to sell your shares in the company, the other shareholder(s) are obliged to sell theirs too. This would prevent you from being held to ransom by a minority shareholder. You may also wish to think about appropriate non-competition and confidentiality covenants and provisions that require financial input from other shareholders.

Articles of Association – aren’t they sufficient for preventing disputes?

If you just rely on standard articles of association, the following kinds of problem can arise – all problems that you can avoid through carefully worded shareholder agreements -  

• A director can be removed by 50% of the shareholders
• In law, articles of association can’t make promises about a company’s actions. A shareholders’ agreement can.
• All major executive decisions by the directors are made by a majority. Even though they may be a majority shareholder, a single director could be outvoted.
• Even if the articles are made to protect shareholders, they can be amended by a 75% majority, in which case they could take any protection away from a minority shareholder.
• When deadlocks occur, it can be very difficult to resolve them using articles of association.

What kind of issues will a shareholders’ agreement resolve?

Here are just a few instances –

• changing the salary of any directors
• entering substantial business contracts
• commencing legal proceedings
• deciding on the company’s dividend policy
• considering what percentage of the profits should be paid to the shareholders
• allowing the company to act against, for example, a misbehaving director – which may not have otherwise been possible if that person was the majority shareholder and controlled the board.
• Providing restrictive covenants on the shareholders, preventing them from competing with the business of the company.
• Obliging shareholders to provide further funds to the company if the company requires it and specifying the form in which this funding is to be provided.
• When the shareholders have given a guarantee for the company’s liabilities, and obligations and those guarantees are called upon to be satisfied, the shareholders will split the cost according to their respective shareholdings.
• To agree who the auditors and bankers should be, where the registered office is to be and what the accounting reference date of the company should be.
• What should happen if any shareholder wants to sell their shares? This deserves a section all of its own …

What if a shareholder wants to leave the company and sell their shares?

Let’s look at a few possible scenarios that a formal agreement would help avoid or resolve -

1. What if a shareholder sells his shares to another individual whom the other shareholders deem unsuitable? A shareholders’ agreement could allow shares to be offered first to the remaining shareholders.
2. Would the remaining shareholder(s) be forced to buy the shares of the outgoing shareholder? What if they don’t want to or can’t afford to?
3. If the shareholders refuse to buy the shares, there can always be a provision that the shares are then offered to the company who must buy them back.
4. Could the shares be sold to a third party? This is usually preferable to having an unhappy shareholder on board, ‘locked in’.

How a shareholder agreement can help resolve a ‘deadlock’ scenario

If there’s a stalemate between shareholders or directors in any respect, then the shareholders’ agreement can come into its own. It can provide for bringing in an independent expert to review the situation and advise on a course of action which the shareholders are then obliged to follow. Such deadlock provisions can be particularly helpful where there are only two shareholders holding 50% of the shares each.

Can a shareholder agreement help in the event of the death of a shareholder?

What if

• The surviving shareholder(s) wish to buy the shares of the deceased shareholders, but the executors of that person may not wish to sell them? For example, a widow might demand involvement in the running of the business or insist on being appointed as a director.
• The executors of the deceased shareholder’s estate want to sell the shares to the remaining shareholders, who can’t afford it, forcing the shares to be sold elsewhere?

A shareholders’ agreement can help in these situations by obliging shareholders to take out life insurance where the proceeds of the policy would automatically pass to the surviving shareholder(s). Known as a ‘cross option agreement’, this could then oblige the surviving shareholder(s) to use the proceeds to purchase the shares from the inheritors of the deceased shareholder, who would be bound to sell them.

Here to help

Shareholders’ agreements can prove absolutely vital for the smooth, harmonious running of a business. Don’t leave things to chance or to shareholders’ goodwill and common sense. Talk to an expert.  You don’t have to spend time and money on visiting a solicitor.  We’re experts in Shareholder Agreements, and we’re here to help.

Find out more. Call us on 0116 473 6133 or send us an email.

About our CEO

Our founder and the CEO of METTLaw, Sheikh Najam, is an experienced international lawyer and holds the following qualifications. He is a:

• Law graduate with BA Hons (Law) from Coventry University, England.
• Graduate of the 'Postgraduate Diploma in Legal Practice' from Staffordshire University, England.
• LLM in International Law from the University of London.
• MCIArb member of the CIArb (The Chartered Institute of Arbitrators).
• International Mediation Institute's IMI Qualified Mediator.
• TEP member of the Society of Trust and Estate Practitioners (STEP).

Sheikh has been exhaustively trained to deal with complex contracts, businesses, estates, and civil disputes, both domestic and cross-border.