A shareholders’ agreement is an agreement entered into between all or some of the shareholders in a company. It regulates the relationship between the shareholders, the management of the company, ownership of the shares and the protection of the shareholders. It will also govern the way in which the company is run. It may be usual to combine the use of a shareholders’ agreement with a specifically drafted set of articles of association for your company. A minority shareholder protection clause is a clause for inclusion in a joint venture shareholders’ agreement incorporating a list of matters in respect of which the minority shareholder has veto rights. It is designed to offer some protection to the rights of a minority shareholder. In this article, the minority shareholder protection clause, we take a look at the process involved and the options open to you.
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Why do you need a shareholders agreement?
A shareholders agreement is designed to protect the shareholders’ investment in the company. If drafted correctly, it should set out the terms of a fair relationship between the shareholders and the manner in which the business is run. It describes the mechanism involved in carrying out operations and sets out the process of dispute resolution if the shareholders are in conflict. It should be an agreement that you create while you are on good terms to explain exactly what you want to happen should the worst happen.
Is it essential to have a shareholders agreement?
The simple answer is no. When you incorporate your company you must allocate shares to people, and you must also issue articles of association. Often most people will just use the model articles of association, which are a standard form of some rules to govern the company, however, these are far from comprehensive and many people who are relying on these when something goes wrong soon find that they are not adequately protected.
How can the rights of minority shareholders be protected?
The Shareholders Agreement is the best form of legal protection for a minority shareholder. By incorporating certain express contractual provisions in the Shareholders Agreement, the minority shareholder can be protected by contractual rights beyond those afforded by statute and corporate law. The Companies Act does give all shareholders certain basic rights. But rights afforded to minority shareholders under the Companies Act are very limited. The way to enhance minority shareholder rights is via the articles or a shareholders’ agreement. Within the confines of a private company, a minority shareholder has the right to vote on major decisions and election of directors, the right to participate in meetings, the right to receive dividends and the right to inspect company records that are relevant to the shareholder’s interests.
What rights do minority shareholders have?
Unless specific amendments were made at the time of the company’s incorporation within the articles of association or shareholders agreement, it is most likely that as a minority shareholder, your rights will be confined to those in the Companies Act 2006. The extent of your rights will depend upon the number of shares you own in the company which are as follows:
If you own a 5% shareholding, you can call a general meeting, require the circulation of a written resolution to shareholders (in private companies), require the passing of a resolution at an annual general meeting (AGM) of a public company and apply to the court to prevent the conversion of a public company into a private company;
If you own a 10% shareholding, you can call for a poll vote on a resolution.
If you own more than a 10% shareholding, you can prevent a meeting from being held on short notice.
If you own a 15% shareholding, you can apply to the court to cancel a variation of class rights, provided such shareholders did not consent to or vote in favour of, the variation.
If you own a 25% shareholding, you can prevent the passing of a special resolution.
What are the key elements of a shareholders’ agreement?
There are a number of elements to consider when creating a shareholder’s agreement. It is better to ensure the agreement is robust and covers as much detail as possible. This will ensure that all parties know where they stand from the start and will eliminate any potential friction caused by uncertainty later down the line.
Even with the best will in the world, it will be highly unlikely that the agreement will cover every single thing in detail. Further, whatever level of detail the agreement goes into, it must accord with company law.
Restrictions on changing the nature of the business. The business may well evolve over time. This could be as a result of reacting to market conditions by changing the products or services being offered or where or how the business operates. Some changes are relatively straightforward whereas others can prove to be more problematic. The process for changing the nature of the business should be set out within the agreement.
Terms regulating the raising of capital to avoid diluting existing shareholdings. At some point in the future, it may be decided that an injection of capital is required by the business in order to flourish. However, this will have the effect of diluting existing shareholdings and as such, the precise terms setting out the mechanism for this need to be included in the agreement.
Restrictions on the disposal of shares. There are a number of ways in which shares can change hands. The other shareholders can control, to some degree, to whom the shares are transferred and what role the new member plays in the company by setting the rights and powers on transfer. However, provisions that prevent the transfer to certain specific classes of people may prove to be problematic.
Managing changes in the roles shareholders play. The directors of the company manage the company and report to the shareholders. The agreement can specify the role a director can play or the limits of his authority. It should also reflect what happens when a member wants to be more or less active in the day to day management of the company. It is also important to include the rights to appoint and remove directors and also the terms to protect minority shareholders so that, for example, unanimous shareholder approval is required for certain company decisions. Identify who will make decisions – shareholders or directors. A good shareholders agreement should set out the decisions a shareholder-director may and may not make without agreement from others.
Include a business plan. Setting out the business plan in a shareholders’ agreement may help to ensure that all shareholders are aligned with the direction in which the business is heading. Additionally, a description of the proposed terms of the exit strategy can be helpful although it can be quite difficult to predict future events that would trigger an exit event.
Include restrictive covenants to prevent a former shareholder from setting up in competition. One of the shareholders may decide that he can set up in competition. This can often happen if he/she has also worked in the business. There may be linked employment issues in competition that are covered by the employment contract, but a shareholders agreement should also include provisions for competition.
Set out the dividend policy. This should state how and when dividends are to be paid and also include if any shareholders are to waiver their rights to dividend payments.
Settling shareholder disputes. Unfortunately, shareholder disputes can and will arise. They can easily become protracted diverting focus and resources away from the business. Consequently, setting out a mechanism for dispute resolution is a sensible thing to do.
Protection for a minority shareholder
Minority shareholders can be further protected beyond their basic rights by making amendments to the company’s articles of association and shareholders agreement.
These changes may include enabling those with minority shareholdings to have a say in who is appointed as a director, expanding the range of matters which require the agreement of all shareholders, and being able to consent to board resolutions.
Wherever possible, such changes should be made pre-emptively, before any disputes have arisen, and due to the fact that at least 75% of shareholders have to back such as change, this is unlikely to occur in the midst of a disagreement.
Adding changes to the company articles or shareholders agreement that afford greater protection to minority shareholders can ensure a great deal of cost, stress, and wasted time is avoided at a later date, in the event of a dispute.
How do you terminate a shareholders agreement?
You can terminate a shareholders agreement in one of three ways.
The first way you can terminate a shareholders agreement is by mutual agreement. This is when all of the shareholders decide that they no longer want to comply with the agreement due to various reasons. The reasons can be from dissolving the company, selling their shares in the company or the company itself or it can be deciding to leave the company. In a well-drafted shareholders’ agreement, these provisions should be included.
Secondly, the shareholders’ agreement may automatically be terminated if there has been a breach in the agreement by any of the shareholders. When this occurs the shareholders’ agreement will be terminated unless there are clauses in the agreement that sets out some form of mediation.
Thirdly, a shareholders agreement can be terminated if one of the shareholders want to leave the company. In this case, there will be certain provisions in the shareholders’ agreement to map out what should happen in this scenario.
How we can help
We have a proven track-record of helping clients set up shareholders’ agreements for businesses of all types. There can be an array of issues to take into consideration and we will guide you through all the necessary legal due diligence in a comprehensive and timely manner and support and advise you with all the negotiations. We firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.
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It is important for you to be well informed about the issues and possible implications of a shareholders’ agreement. However, expert legal support is crucial in terms of ensuring a positive outcome to your case.
To speak to our Corporate solicitors today, simply call us on 0345 901 0445 or click here to make a free enquiry. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.
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