Six reasons to have a Shareholders’ Agreement

November 15, 2019

What is a Shareholders’ Agreement?

A shareholders’ agreement (SHA) is a contract entered into by the shareholders of a company and often the company itself. It regulates the relationship between the shareholders and governs the management of the company. It outlines shareholders’ rights and obligations which therefore provides protection for each shareholder.

Although a SHA is not a legal obligation, its value should not be underestimated. It is often omitted with the view of saving time and money, however the lack of certainty created by not having a shareholders’ agreement in place can often lead to disputes amongst the shareholders which can be costly to deal with.

This article outlines the benefits of a SHA and why it is in the company’s best interest to adopt one from the outset.

  1. Disputes

Despite everyone’s best intentions, day to day running of the company can lead to business disputes between shareholders and directors. Disputes can be time consuming and costly for the company. A SHA is an inexpensive way to minimise any potential for disputes as it provides a framework and procedure for dispute resolution by outlining how certain decisions are to be made. This prevents the use of shareholders relying on draconian measures as a way to settle disputes and ensures that everyone’s attention and focus is on promoting the success and development of the company.

  1. Governs the management of the company

The board of directors usually govern the day to day running of the company and therefore, despite common misconceptions, shareholders have very limited rights in decision making. If drafted correctly a SHA can hold the directors accountable for certain actions and compel the directors to seek the shareholders’ consent in advance of key decisions – this can include amendments to governing documents or the incurrence of large expenditure. This is extremely important in circumstances where directors are not shareholders.

  1. Protection for minority shareholders

A SHA can provide protection for minority shareholders by reserving certain decisions for the unanimous consent of all the shareholders, for example varying the articles of association. This will give the minority shareholders the right to veto and prevent majority shareholders from forcing issues that are not in the minority shareholders’ best interests. In addition, a SHA can also contain “tag-along” provisions. This allows a minority shareholder to “tag along” in a share sale situation where the majority shareholders attempt to sell their shares to a third party buyer. A “tag along” clause gives minority shareholders the right to receive the same price, terms and conditions as the majority shareholders that are selling their shares.

  1. Protection for majority shareholders

A SHA often includes a “drag along” provision to go alongside the “tag along” provision mentioned above. A drag along provision enables majority shareholders to force minority shareholders to join in the sale of a company on the same terms so they do not prevent the deal from going ahead.

  1. Deadlock

During the life of the company it can be expected that shareholders and directors will not see eye to eye on certain matters. The inability to reach a consensus on key matters will result in a deadlock which may bring the company’s business to a standstill. A SHA can mitigate this risk by containing a deadlock provision to facilitate a quick resolution which can include mechanics for the parties to buy each other out. It is very difficult to deal with the resolution of any deadlock through articles of association, and a SHA is therefore advisable.

  1. Control the transfer of shares

In the absence of relevant pre-emption provisions in a SHA or the articles, shares may be freely transferrable. This enables a shareholder to sell or transfer their shares to a completely unknown person or even a competitor. A SHA can provide a mechanism to provide that if one shareholder wishes to transfer/sell their shares, the remaining shareholders have the “right of pre-emption” over those shares. If they do not take up that offer then the SHA would contain a clause requiring the recipient of those shares to enter into a “Deed of Adherence” whereby he/she would be bound by the terms of the SHA. This provides comfort to the other shareholders as it ensures the new shareholder has to act in accordance with the provisions of the existing shareholders’ agreement.

Shareholders’ agreements should be reviewed regularly to check that it still operates in the way the company and shareholders wish it to. Whether you have a shareholders’ agreement in place already that needs reviewed or require one, contact us on 028 9024 3141.

This article has been produced for general information purposes and further advice should be sought from a professional advisor. 

Aimee Donaldson, Solicitor, Corporate & Commercial Team, Cleaver Fulton Rankin, Solicitors.