Shareholders' Agreements

Their purpose

A shareholders’ agreement is a private document between shareholders containing terms agreed to by the shareholders. Their purpose is to ensure that issues which can potentially arise within a company are identified in advance and mechanisms are provided to address them, facilitating the efficient operation and management of the company, thereby avoiding costly disputes in the future.

They can be used to deal with matters that are personal to the shareholders and provide clarity and certainty relating to the governance of the company.

As they are a private contract between shareholders, they are not mandatory.

How shareholders’ agreements differ from the Articles of Association

On the formation of a company, shareholders are required to adopt and file Articles of Association (the Articles) at Companies House, which makes them a public document capable of being viewed by any interested party. Articles can be either a standard set of default articles prescribed by company law (known as the Model Articles), or bespoke articles prepared by a company which are tailored to meet its specific needs. A vast majority of UK companies use the Model Articles as they are provided by the government and can be automatically adopted.

Articles are the company’s constitutional document and regulate the company’s internal affairs. In their simplest form - which in essence is the form of the Model Articles - they cover the basic requirements for enabling a company to function on a day-today basis by outlining rights and restrictions on shareholders, the powers and responsibilities of directors, prescribing procedures for holding directors’ and shareholders’ meetings, granting a general authority to issue shares of different classes and to vary those rights, dealing with pre-emption rights on the issue of shares, imposing limited restrictions on the transfer of shares, and prescribing procedures for declaration and payment of dividends.

The Articles are regulated by company law and create a legally binding contract between the company and the shareholders. They do not, however, contain provisions which are personal to the members, nor detailed provisions on aspects of governance of the company.

Entering into a shareholders’ agreement will enable shareholders to extend the scope of the articles to deal with matters that are personal to them to safeguard and define their rights and provide a mechanism for dispute resolution, and also set out specific governance and procedural matters to cater to the requirements of the company.

Being a private contract, shareholders’ agreements are not required to be filed at Companies House, thereby allowing shareholders to retain the privacy and confidentiality of its provisions.

The company will be bound by the shareholders’ agreement only if the shareholders choose to make the company a party to it. The decision would depend on whether the shareholders wish to impose direct obligations on the company (and the directors, indirectly). Where direct obligations are imposed on the company through a shareholders’ agreement to which it is a party, the company then becomes legally bound to give effect to those obligations.

This is useful to shareholders as otherwise, the shareholders would only be able to procure that those obligations are given effect to. This method is also useful if shareholders wish to impose restrictions on the company that they do not want to appear in the Articles, for example, limits on borrowings by directors or caps on their salaries. Care must be taken to ensure those obligations on the company do not fetter the exercise of statutory powers of the company, as if they do, those terms will not be effective. If the company is not made a party to the agreement, in the event issues arise due to a variance of opinion or disputes with management, the shareholders will have wider scope to deal with those issues as they will not be deemed as fettering the statutory powers of the company.

Care must also be taken to ensure the shareholders’ agreement does not contain provisions that contradict any matters contained in the Articles, for if they do, the relevant provisions in the Articles will prevail.

Matters that are typically dealt with in a shareholders’ agreement

• Company law and the Articles vest the management of companies in its board of directors. Articles may not contain detailed processes or mechanics on management and governance unique to each company. A shareholders’ agreement can be used to provide for matters regarding directors and management, such as:
  • the appointment and termination of directors, including determination of their remuneration
  • procedures for holding directors’ meetings, including notices of those meetings, voting and quorums 
  • mechanisms to deal with deadlock situations at directors’ meetings. These can occur when the board is evenly split on important decisions and cannot find a resolution, which can then lead to disruptions in the company’s operations. Deadlock provisions will assist in resolving such stalemates, ensuring the company operates smoothly
  • allow for directors or other key members of management to hold shares as part of their employment, along with mechanisms and procedures for transferring those shares when directors leave their employment (such as Good Leaver Bad Leaver provisions), and methods to value those shares.

 

• Where the shareholders are not members of the board of directors (as is the case in owner-managed companies), the shareholders can:
  • impose limits on the authority of directors by requiring shareholders consent in relation to key corporate actions, which also allows for greater participation by them in the management of the company
  • provide for a right to appoint themselves to the board.

 

• Shareholders are granted rights and powers by the Articles and the law, but being of a general nature, they are not tailored to meet specific requirements of shareholders. Clearly defined rights and obligations can be included, such as the following:
  • mechanisms to overcome deadlock situations at shareholder-level meetings set out defined dividend policies outlining special rights on dividends and as to how and when they are paid. These will be especially helpful as the default position in the Articles is that dividends are declared and paid according to each shareholder's holding of shares
  • restrict the ability of shareholders to freely deal with and transfer their shares by, for example, defining the types of transfers that are permitted (Permitted Transfers), so that all shareholders have equal protection and stability in their shareholding positions
  • grant priority to existing shareholders to either accept or refuse an offer for the sale of shares before they are offered to a third (Pre-Emption Rights)
  • compel majority shareholders wishing to sell all or part of their shares to a third party, to procure that the buyer makes a similar offer to the minority shareholders on the same terms. This is a protection afforded to minority shareholders to avail themselves of the opportunity to join in the sale where they would not otherwise be able to find buyers for small percentages of shares (Tag Along Rights)
  • enable majority shareholders wishing to sell their shares to also force the minority to sell on the same terms, allowing the buyer to thereby acquire full ownership and control of the company (Drag Along Rights). This will be useful in preventing minority shareholders from objecting to or blocking the sale of the company where the majority deem the market conditions or the state of the company prevalent at the time are conducive to selling and realising a profit (for example, due to the profitability of the company at the time, potential for growth and expansion that may be attractive to buyers, or to prevent further loss-making if such is the case)
  • provide for eventualities such as death, incapacitation, divorce etc. of a shareholder, disagreements between shareholders, or events such as certain financial targets being satisfied or reaching a certain date, by allowing a shareholder to require the other shareholders to buy his interest (Put Options), or enabling the others to require a shareholder to sell his shares to them, on the occurrence of any of those events (Call Options)
  • enable the shareholders a right to preserve their current shareholding split without their share value being diluted, by making it compulsory for the directors to give priority to existing shareholders in a new allotment of shares by offering them first to the existing shareholders before they are allotted to third parties (Anti-Dilution Provisions)
  • imposing restrictions on the conduct of shareholders both during their time as shareholders and for a stated period after they have ceased to be shareholders, in respect of competing with the business, soliciting clients, customers and suppliers, and poaching employees. This will be relevant to companies of all sizes due to the financial impact resulting from loss of business through losing clients or customers, or losing key members of staff
  • imposing restrictions on shareholders in relation to using confidential information of the company. This is of relevance where a shareholder is or has been a member of the board of directors or held any other key position and been privy to business and trade secrets
  • include provisions that allow shareholders to sell their shares and exit the company, allow for growth and expansion of the company by enabling new investors to invest in the company, or where the shareholders determine thatthe company is at a stage where it has accumulated sufficient value, enable the company to be sold and the shareholders to make a return on their investments
  • new shareholders acquiring shares in the company can be required to sign a of adherence to be bound by the terms of the shareholders agreement
  • provide dispute resolution mechanisms for shareholders to resolve disputes.

How we can help

• With our experience in drafting shareholders’ agreement and practical experience in dispute resolution, we understand the areas where disputes can potentially arise.
• As we deal with companies of various sizes, we understand what is of relevance to your company and will advise accordingly.
• We will consider your business objectives and draft your shareholders agreement with your objectives in mind.