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Shareholder Agreements

Shareholder Agreements

When an investment in shares in a company (other than a company quoted on a stock exchange) is being made, a shareholders' agreement is essential in many cases.

Why you should have a shareholder's agreement?

Shareholders of 'ordinary' shares are the last people in the queue to be paid if a company goes into liquidation. Secured creditors lead the list, then unsecured creditors and those with preference shares. The ordinary shareholder will receive nothing unless the prior claims of the others are met in full.

If a company gets into difficulties, additional funding may be sought from the shareholders and will normally be sought from existing investors in the ratios of their shareholdings.

What is in a shareholder's agreement?

Although the board of directors has day to day control over the operation of a company, a majority vote of the shareholders is, in effect, the ultimate authority in company decision-making. There are many circumstances where both of these general rules will need to be modified, especially when there are minority shareholders with substantial investments to protect. Although the Companies Act 2006 does contain statutory protection to prevent the 'oppression' of minority shareholders and the 'standard' articles of association do contain some protection, these can be modified or overridden by a shareholders' agreement and in practice relying on the Act is often less than satisfactory.

In a company not listed on a stock exchange, having a shareholder's agreement is very much the norm, not the exception.

'Shareholders' Agreement

Where a shareholders' agreement is needed, it will normally contain some or all of the following.

  • A mechanism by which disputes between shareholders can be resolved. This is probably the most important part of a shareholders agreement.
  • Restrictions on the right to issue or transfer shares without shareholder approval.
  • 'Equality of value' clauses which ensure that in the event of a takeover, all shares will be valued equally.
  • Restrictions on the appointment and removal of directors.
  • Restrictions on dividend policy.
  • Restrictions on disposals of shares. Normally these give the existing shareholders a right of pre-emption to buy any shares before they are sold elsewhere.
  • Sometimes there are also restrictions on the nature of business the company can enter into and changing the company's capital structure (for example by mortgaging assets).

Where a dispute between shareholders cannot be amicably resolved, the normal long-stop is for one side to buy out the other. The shareholders' agreement will normally contain a clause which provides how the valuation of shares is to be ascertained (for example, by a binding valuation by an expert) and sometimes will contain a term by which a minority can be forced to sell its shares (this is called a 'drag-along' clause) if a sufficient majority of the shareholders choose to sell their stake in the company. A clause which means any buyer of a majority stake in the company must offer the same terms to a minority shareholder is called a 'tag-along' clause.

Case study 1

When the shareholders of a company fell out, the majority shareholder wished to sell his shares to an outsider. The presence of a shareholders' agreement meant he was required first to offer them to the existing shareholders.

Case study 2

When the principal director of a company which was performing poorly (and eventually ceased trading) lost faith in it, he used that company to make supplies to another company he owned at very low cost or even for free, ignoring completely the wishes and interests of the minority shareholders. They went to court to force him to buy out their shares. Had a shareholders' agreement been in place, the court hearing would not have been necessary

Resources

Companies Act 2006

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