AGREEMENT BETWEEN SHAREHOLDERS OF PRIVATE COMPANIES

Transcription

1 AGREEMENT BETWEEN SHAREHOLDERS OF PRIVATE COMPANIES DIRECTORS ADVISORY SERVICE FACTSHEET These Guidance Notes offer an outline of the relevant provisions, but they are not comprehensive and should not be relied on as authoritative. Specific advice should be obtained on any particular issues. What is a shareholders agreement? The shareholders (or members) in a private limited company may wish to have a separate agreement between all or some of them governing the way their company is to be run and their respective relationships. When is a shareholders agreement needed? In a small private company there may only be two equal shareholders. There is the obvious potential for deadlock if they fall out and disagree. If there are more than two shareholders and one holds a substantial majority giving overwhelming voting powers, the minority holders (whose financial investments may well be significant) will always be dominated by the single majority holder and may seek protection. How does a shareholders agreement work? The principle of one-share-one-vote may need to be suspended or amended for certain key situations to allow the company to continue to function in a situation of deadlock. The agreement will also set out procedures to be employed to avoid situations disadvantaging minority shareholders. Why not just change the Articles of the Company? To deal with deadlock and oppression of minority shareholders, changes to the Articles of Association would be necessary. Since the Articles of a limited company are filed at Companies House and open to public scrutiny, this may be undesirable to the members of a small company. More importantly, the Articles are the charter for all shareholders, but the shareholders agreement may regulate the way in which only some of the members agree to bind themselves to each other. Additionally, an agreement can, if the parties agree, be changed at any time, whereas the Articles can only be changed by a special resolution requiring a 75% majority of all shareholders entitled to attend and vote at a general meeting.

2 Why is it desirable to have a shareholders agreement When starting up a company or investing in an existing company people do so with serious long-term intent and to build value. To allow a successful business to fail through internal strife is extreme folly, let alone being actionable at law against the company s directors. It is particularly tragic where family companies are concerned. Yet these are the types of shareholders who most frequently fail to consider damage limitation and provide an agreed means of dealing with disputes with the help of a shareholders agreement. Warning! A shareholders agreement whether short or long, simple or complex, must be tailored carefully to the shareholders aims, the company and the situation. Getting the shareholders agreement right is vitally important, and is not a job for well-meaning amateurs trying to save a few pounds on legal fees. Take professional advice at the earliest possible opportunity! Remember, the law also provides that, in some circumstances it can be unlawful for a company, by being a party to a shareholders agreement, to fetter its own powers. Remember, if all of the issues are understood by the shareholders, then getting the right kind of legal assistance and drafting the documentation may not be as expensive as at first thought. What follows below is a checklist of some of the key issues to consider when establishing a shareholders agreement. DEADLOCK Structure of a deadlocked company Where two persons set up a limited company they may each own 50% of the shares. This potentially leads to deadlock as neither has absolute control. If they had incorporated their company with standard, 1985 Act Table A or 2006 Act Model Form Articles unchanged, they would have found that their intentions had been thwarted on several fronts. For example, Articles 50 and 88 in Table A gave the chairman a casting vote at general meetings and board meetings respectively so preventing deadlock. Other standard Articles whether under the 1985 Act or the 2006 Act may also stand in the way of preserving deadlock, particularly those dealing with the rights of appointment and replacing directors to the board. If any director resigns or retires, and if management control is to remain deadlocked, then changes may be needed without which neither party would be able to replace their appointee(s) without the cooperation of the other. Changes to quorum provisions at both general meetings and board meetings will need to be made to ensure that no vote can be taken without equal representation of the shareholders being present. It is also advisable to ensure that a minimum specified period of notice must be given to each shareholder/director of company meetings and board meetings to avoid the element of surprise and, further, appropriate changes 2016 Institute of Directors. All rights reserved. 2

3 should be made to protect shareholders/directors who are overseas at the time the notice is given. The undesirability of absolute deadlock Managing any business involves a fair amount of arguments and disagreements; most will be capable of resolution by compromise, and some actions will simply be shelved due to a lack of agreement. However, the possibility that irreconcilable differences of a serious and terminal nature may, one day, arise. If and when a serious dispute arises, it might be the case that the company is turning over millions of pounds and employing many people, including the shareholders themselves whose livelihoods depend upon the continuation of the business. There are three elements that need to be considered. Firstly, the need to avoid the paralysis of deadlock wherever possible; secondly, the need to be able to resolve the deadlock where avoidance has not been achieved; and thirdly the need to provide for a means of termination upon an unresolved deadlock. This is where the shareholders agreement comes into play as an overlay of the changes mentioned above to the standard Articles, and to set out in a detailed way the arrangements to be made for establishing, operating, maintaining and perhaps closing the company. Avoidance and resolution of deadlock Formal agreements providing that parties should use all reasonable efforts to work with each other may not be easy to operate or enforce. A well-drafted shareholders agreement should contain provisions defining the nature of the business carried on by the company, provide that the parties create and develop a strategy for pursuing the business (often by reference to a business plan incorporated into the agreement) and that they should meet regularly to monitor progress and review new opportunities. These provisions in a formal contract might focus minds more than if no agreement exists and give an innocent party reason for action if the other refuses to attend to his or her responsibilities. If however the parties do fall out and reach the point of deadlock, there is no possibility at law for one to sue the other simply because consensus has not been achieved. The questions of avoidance and resolution of deadlock in a shareholders agreement, therefore, tend to merge together. Given that disagreements cannot always be avoided and deadlock follows, the agreement should include provisions setting out the procedure for their resolution. By itself, company law provides for no other resolution than the liquidation of the company and this may simply not be a satisfactory or economic solution for either party. Moreover, under company law and under certain other legislation it could lead to claims against directors for mismanagement. So, what are the possible ways to deal this? The Chairman: The agreement can provide for an alternating arrangement as to which party acts as chairman of the company and the board. Retaining the chairman s casting vote is, of course, required. If each takes it in turn to be chairman every six or twelve months hopefully some arguments you win and some you lose Institute of Directors. All rights reserved. 3

4 Alternatively an independent father figure can be appointed chairman with the retained casting vote, but only if a suitable individual can be agreed! Arbitration, Mediation or Conciliation: These are methods of either adjudicating upon disputes or providing professional assistance to the parties to find an acceptable compromise. Alternative Dispute Resolution ( ADR ) is another. The agreement may provide a contractual obligation to use one method to resolve a deadlock. Supervisory Board: Most relevant to larger companies. The shareholders delegate upwards through the shareholders agreement many of the key decision-making processes to a wholly or partly independent board. Termination where deadlock is unresolved If it is not possible to resolve a deadlock and no agreement exists there is little alternative but to petition the court for winding up on the grounds that it is just and equitable. Consequently a shareholders agreement should provide a process to force the parties to take a last hard look at whether a solution cannot be found. Examples include provisions that: a deadlock must be shown to exist after a process of board meeting, followed by extraordinary meeting of the company at which no resolution has been passed because of an equality of votes, and the deadlock remains unresolved after pursuing all mediation, conciliation, arbitration or ADR open to the parties, and causing the parties to file any Statutory Declaration (as required by insolvency legislation) which may be applicable in regard to the affairs of the company, and convening an extraordinary general meeting for the purposes of declaring the continuing existence of deadlock and resolving (as a mandatory obligation upon each party under the shareholders agreement) to place the company in members voluntary liquidation. However, irreconcilable deadlock is often a race against the onset of insolvency and some lawyers would recommend that the agreement should provide for a creditors voluntary liquidation as an alternative in these circumstances. Artificial deadlock A very important provision in the shareholders agreement will be to make it quite clear that neither party is to be responsible for creating an artificial deadlock. What this means depends very much upon the way in which the term artificial deadlock is defined. The following example..is a deadlock caused by either Shareholder, or its appointees on the Board, voting against a proposal the approval of which is required to enable the Company to carry on the Business properly and efficiently in accordance with the general trading principles set out in this Agreement will put a huge onus on the parties to show very good cause indeed why they have not been able to agree, if one or other of them is not to end up on the wrong side of a breach of contract action Institute of Directors. All rights reserved. 4

5 MINORITY PROTECTION Why may minority protection be needed? The general effect of company law is that decisions are made by those with majority voting rights. Those with only minority voting powers have very little protection against an abuse of their minority position. The law recognises this problem for small shareholders. Where a complete breakdown of relations occurs, a just and equitable winding up may be ordered in favour of a petitioning shareholder. Other examples where minority shareholders can sue for relief include instances where the action of the majority is wrongful (e.g. illegal or beyond their powers as stated in the Articles of the company), or constitute a fraud or oppression against the minority. However these remedies may not always be easy to enforce and are unlikely to be sufficiently comprehensive to meet the needs of minorities in small/medium sized companies who may well have invested considerable sums in the business concerned. A minority shareholder is going to be much better off if he or she is given some clear rights, either under the Articles or in a shareholders agreement. Legal action may still have to be taken to enforce those rights but it is far less likely with properly amended Articles and/or an agreement. Kinds of minority protection The kinds of minority protection can be grouped into positive rights and negative rights. A shareholders agreement will usually combine both types of rights. Some examples are: Positive rights (a) (b) (c) (d) (e) (f) The right to appoint directors: often given to those with a significant minority holding. Share linked rights: sometimes significant minority holders may be able to insist that no quorum can exist at a general meeting of the company that does not include their presence. Rights to information and visit: shareholders without a board seat may seek a right of access to information (including management accounts) and for the shareholder or representative (e.g. an accountant) to inspect the records and make and take copies of relevant documents. Right to appoint an observer at the board: a useful addition to the inspection right under (c) above. Right to require proper conduct of the business and non-competition: all shareholders will want to ensure their investment is as safe and secure as possible and will, therefore, want the right to ensure that appropriate insurances (maintained at an adequate level) are in place. Also they will want to ensure that they are all bound to each other to act in good faith and not to allow competing external interests to conflict with that duty. Rights in regard to share transfers: a shareholders agreement will provide that shares cannot be transferred without all other shareholders consenting or 2016 Institute of Directors. All rights reserved. 5

6 (g) (h) without a process (known as pre-emption ) applying. Such provisions may be lengthy and complicated. Key employment and other contracts: the terms of key employment contracts (e.g. a CEO s service agreement) and other important contracts with third parties (e.g. a patent licence without which a substantial part of the business would not be able to operate effectively) are candidates for agreement among all the shareholders. Consortium relief: where applicable (i.e. the company is a member of a consortium for tax purposes), minority shareholders will want to see consortium relief rights included in the shareholders agreement. Negative rights All shareholders (including those with positive rights) may be given negative rights or vetoes. They will be content in general for the company to operate under the care and control of its board of directors, subject only to the shareholders having a contractual right to say no on some issues. The veto rights may be individual or majority based. Most controlling shareholders will resist the idea that every minority shareholder will have an individual veto (where for example a holder of 8% of the shares can block the will of the 92% majority) and a preface to the veto list may be used such as The Shareholders shall exercise all rights available to them in relation to the Company so as to procure (so far as they are able) that the Company does not without the prior written consent of the holders of not less than 85% of the voting rights in the Company The list of veto rights (a) (b) (c) (d) No changes to the nature of the business may be extended to cover the start of new activities not carried on at the date of the agreement. No changes in the share capital to protect minorities from dilution. However there may be a proviso that no shareholder can object solely on the grounds of dilution to the issue of new shares to parties investing in the company at the invitation of the board. No steps to liquidate the company save in the case of insolvency. No sale of the business or its assets including land and property save in the ordinary course of business or perhaps by reference to a definition of material or substantial assets. (e) No acquisition of companies, businesses or assets, including land and property save in the ordinary course of business and, sometimes if entering into joint ventures. (f) (g) (h) (i) No making of loans or giving guarantees subject to an exemption for ordinary course of business transactions e.g. granting credit to customers. No transactions with connected parties e.g. management or other contracts with shareholders or other business(es) with which they are associated, otherwise than at arms length. No transfer of shares except in accordance with the rules for pre-emption rights set out in the shareholders agreement or Articles. No borrowings often subject to a stated limit and usually with exceptions like finance leases, hire purchase, etc Institute of Directors. All rights reserved. 6

7 (j) No capital expenditure subject to a stated limit (or as already committed in an agreed business plan). (k) No long-term and/or exclusive agency or distributorship agreements/assignments or exclusive licences of intellectual property to tie the company in to important commercial arrangements which may turn out to be detrimental to its long-term interests. (m) No service agreements, senior employee contracts or material changes to any already agreed key employment contracts with long notice periods may be mentioned in shareholders agreements, and included in the list of veto rights. (n) No consultancy or like agreements (o) No leasing agreements for land or property and including finance leasing arrangements involving large sums. (p) No change in the auditors or accounting policies including bank signatories on cheques, etc. (q) No litigation other than between the company and the veto holder. The lists above are not exhaustive and are provided for guidelines only, as circumstances differ from company to company. In some cases they might not be needed at all. OTHER COMMON PROVISIONS IN SHAREHOLDERS AGREEMENTS Pre-emption rights Those who invest in private companies usually want some say in how the company s ownership structure is to change after they have taken up their stake. It is customary to find (in the Articles) detailed provisions dealing with the issue of new shares and the transfer of existing shares. Firstly, this stops a shareholder s stake in the company being eroded or diluted at least without first being given the opportunity to take part in any new issue of shares, or to pick up a proportional number of any shares which an existing member wishes to sell. These are known as pre-emption, tag along and drag along rights, and are particularly important in small/medium sized companies. Secondly, the owners of a small business are unlikely to want a new shareholder foisted upon them. In the case of the death of one of their number, for example, they could find that the deceased s shares pass by way of inheritance to a person entirely unsuited to play a part in the business. It is therefore vital that provisions regarding the disposal of a deceased member s shares have been inserted in the Articles or shareholders agreement, possibly also supported by appropriate insurance policies to finance a buyout of the deceased holder s shares. Termination of the agreement Apart from when a deadlock arises, there are other circumstances when the need to close the company will arise. This may happen by consent, e.g. on a public flotation, or it may be that one of the shareholders has broken the terms of the shareholders agreement to such a material degree that the others want the party in breach expelled from the company. The agreement should provide that the shares of a party who is in serious breach and who has failed to remedy the breach after being served by the others 2016 Institute of Directors. All rights reserved. 7

8 with a notice to do so, will be subject of a forced sale to them under the pre-emption rights often at an arbitrary price well below the market value of the shares at the time of the breach. Loan Finance and Guarantees The agreement may provide shareholders with a preferred route for raising future funding of the business. For example, if only some of them are likely to be able to raise funds in the future, they may include a provision for bank borrowings to be sought first for normal working capital requirements. Directors of new companies may be asked to provide personal guarantees on credit sought by the company. If so, directors/shareholders may have to put their personal assets at risk and the agreement may include obligations to ensure that not one of them is left holding more than his share of the liabilities under any guarantees and that counter-indemnities will be provided by the others in proportion to their shareholdings. Non-competition restrictions Undertakings not to carry on competing activities both during and after the end of employment are common in the service agreements of the key employees of companies. Similar non-competition restrictions may appear in agreements between shareholders. Provisions of this kind are susceptible to challenge in the courts, even when drawn up professionally. Therefore it is doubly important, when drafting a shareholders agreement, to seek professional advice to ensure that the legitimacy of the whole agreement is not threatened by badly drafted restrictions. This Factsheet is one of a series produced by the IoD Directors Advisory Service. It is intended as a general introduction to the subject, and is not a definitive guide. If you would like specific advice, please contact the Directors Advisory Service on , businessinfo@iod.com. The service is free and is exclusive to members of the IoD. 116 Pall Mall, London SW1Y 5ED April Institute of Directors. All rights reserved. 8