Shareholders’ Agreements: the ultimate insurance policy?

As litigators, often the first question we ask when instructed on a dispute between shareholders is whether there is a shareholders’ agreement in place. The answer to that question is rarely ‘yes’. But it should be.

A shareholders’ agreement is a contract between a company’s shareholders that governs their rights and obligations. It sits alongside the company’s Articles of Association in framing certain aspects of how the company should be run, such as the procedures for retirement, issuing new shares and selling shares as well as dealing with other important issues such as restrictive covenants.  It is often of particular relevance in disputes between shareholders and protecting the rights of minority shareholders.

It is the ‘pre-nup’ of the corporate world, giving parties certainty over what would happen in the event not only of a fall out between shareholders but, equally, in the event that one shareholder simply wishes to exit the business and go their own way.

As with marriage, nobody goes into business expecting to fall out but the reality is it does happen. It could be because of a serious act or omission by a shareholder (excluding another shareholder from management or using the company’s funds as though it were their own bank account). Or it could be something far more mundane such as a mere difference of opinion on the company’s direction of travel, a breakdown in a personal relationship (such as a separating husband and wife) or, quite simply, because there is no longer the desire to work together.

Whatever the reason, the best time to negotiate and agree the terms of a shareholders’ agreement is not when the relationship has already soured but as early as possible.  That said, much like planting a tree, if not yesterday then the best time is today - the shareholders will still benefit from an agreement no matter what stage the company is at and it’s invariably a case of better late than never.

What do I include in a shareholders’ agreement?

There is no statutory requirement for what should be included in a shareholders’ agreement.It is up to the parties to decide between themselves what provisions they wish to include and what eventualities they wish to cover off. But, generally, covering off what would happen in the event of a disagreement between shareholders would be sensible. Doing so might even help settle disputes before they escalate or can, at the very least, mean that any disputes cause far less disruption to the business.

The sort of provisions that might help to avoid disputes include:

• Clarifying the extent to which shareholders will be involved in the management of the company.
• Specifically identifying certain decisions that cannot be made by the directors without first obtaining approval from shareholders, such as ones relating to expenditure above a certain value.
• Requiring a unanimous decision between shareholders when it comes to particularly important decisions that could prejudice the interests of a minority shareholder, such as issuing new shares.
• Providing for what should happen if a third party expresses an interest in purchasing shares in the company, for instance prescribing ‘tag along’ or ‘drag along’ rights.
• Prescribing pre-emption rights or imposing restrictions on a shareholders’ ability to freely transfer its shares, which may be particularly important where it is envisaged that a company will be run by its shareholders, for instance in family companies, and the shareholders wish to preserve that setup.
• Stipulating how any deadlock can be broken, such as when the company is managed by director-shareholders each with a 50% interest, whether it be appointing a chairperson or providing for an independent third party to be appointed as a director, to avoid deadlock stalling the company.
• Restrictive covenants to limit the ability of a departing shareholder to be able to cause harm and damage to the company e.g. their ability to work for a competing business, to set up in competition, to poach employees or to solicit customers and suppliers.

How will a shareholders’ agreement be used in the event of a dispute?

Articles of Association rarely stray far beyond the Model Articles, a basic set of ‘rules’ that are completely silent on what will happen in the event of a deadlock or dispute between shareholders or directors.

That is where a shareholders’ agreement will come in. It is open to the parties to negotiate any number and manner of provisions within a shareholders’ agreement, including what will happen when there is deadlock at board level (where the directors are also shareholders) or in the event of a dispute between shareholders.

Those provisions can be aimed at avoiding or mitigating disputes (such as those above) or they can give the shareholders certainty over what will happen if the dispute ultimately proves intractable – such as requiring the sale and purchase of a party’s shares in the event of a dispute in line with a prescribed valuation mechanism. Without a shareholders’ agreement, getting to the point of there being a sale and purchase of shares to exit an aggrieved shareholder can be a hugely expensive and protracted exercise – with one, it can be as straightforward as both sides to the dispute following steps that have been agreed long in advance.

Do I really need a shareholders’ agreement?

It is rarely, if ever, the case that the existence of a shareholders’ agreement complicates what happens in the event of a dispute. Whilst there can be different interpretations of provisions in any agreement, the simple fact that there is an agreement will almost certainly give more direction to shareholders in the event of dispute than having to fall back on the Articles of Association, the Companies Act or even case law and the analogous decisions of judges.

What is more, a shareholders’ agreement isn’t exclusively confined to dealing with disputes – any number of provisions can be agreed by parties about how meetings are conducted, how communication takes place between shareholders, what documentation will be provided to shareholders, what rights shareholders have, what will happen in the event that a third party tries to buy the company and in many other circumstances.

If you are in the process of setting up a business, or even if you are established in business, we recommend you and your fellow shareholders talking to us about putting an agreement in place. Just like with a pre-nup, talking to your fellow shareholders does not mean you are contemplating a fall out – far from it, it is about agreeing a commercial arrangement at a time when you are working well together so that you all know what would happen if, for any of many possible reasons, there comes a time for people to go their separate ways.

Ultimately, it is about providing certainty and helping shareholders to know what happens in case of a particular set of circumstances arising and, as is so often the case, prevention is cheaper than the cure.

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We are here to help. If you would like to discuss your options for putting in place a shareholders’ agreement, for updating an existing shareholders’ agreement or if you are facing issues with a fellow shareholder, director or the company itself, please speak to one of our Commercial Dispute Resolution experts.