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The Shareholders Agreement

SHAREHOLDERS AGREEMENT. SOME USES OF SHAREHOLDERS' AGREEMENTS:

In a United Kingdom limited liability company it is possible that, in order to obtain some degree of protection of control, the members would wish to bind themselves either to preserve the status quo or to stipulate that should one or more member(s) wish to withdraw from the company, that the other members should have the right to purchase or find purchasers for the shares (i.e. a right of pre-emption of first refusal on the shares), rather than them being sold to an outsider. This particularly important where the voting strength is heavily unbalanced.

If you are setting up a limited company with others one of the many things you should consider is a Shareholder Agreement. This factsheet looks at why you need such an agreement and what such an agreement should contain. If you decide to enter into a business partnership with someone you would no doubt have a partnership agreement to set out who does what, who is entitled to what and so on. But similar rules apply if you are setting up business with someone as a limited company. If you're setting up a limited company with others you will no doubt all own shares in that company and so it's best to have an agreement in place to avoid future misunderstandings and problems in running the business. Shareholders agreements are private arrangements between the shareholders in a company. They deal with the same things often found in partnership agreements.
Finding and Using Information on This Page:  Shareholders Agreement - Contrast with the Articles of Association | Some Advantages of Shareholders' Agreements | Shareholders Agreement - Some Drawbacks | Matters Commonly Included in Shareholders' Agreements | Shareholders Agreement - From £35.00 | 

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Shareholders agreement. Includes clauses on share transfers, new members and breach - all with a plain English explanation. Suitable for use by UK business. Shareholders in privately held companies often perceive their company and its ownership in context of incorporated partnership with pro rate sharing of decision-making, income, obligations and value. As with any contract, legal assistance is essential for your own protection. Because of different circumstances for each business relationship, a standard or off-the-shelf shareholder agreement won't be appropriate to your circumstances. You'll have to craft a custom agreement to fit your specific needs and arrangements. An effective agreement can't be prepared without the help of an expert.

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Shareholders agreements are used because even the smallest business has to operate under the same company rules as much larger ones. In many instances a small limited company is often more like a partnership than a quoted company. Using a shareholders agreement allows the best of both worlds. The company can be run as if it were a partnership with the advantages of limited liability and any other reasons behind forming the company in this way in the first place.

Solicitors here advise on and supply documentation relating to the relationships between shareholders in limited companies and conduct litigation and arbitration arising from disputes between them. It is often prudent for shareholders to document the terms of their agreement. This is often done by the insertion of special provisions in the company's articles of association or by a separate agreement ("shareholders' agreement") between shareholders or by a combination of the two.

Shareholders in private limited companies address issues such as restrictions on the transferability of their shares and the absence of a market for sale of those shares, especially if the shareholder is not in a controlling position. A person acquiring shares in a private company without obtaining control will prudently seek special protection and rights to safeguard his position.

Where the affairs of a company can be demonstrated to have been conducted by the majority shareholders in a manner unfairly prejudicial to the minority shareholders, a right of action for an injunction and damages may be available by way of application to the Companies Court. Our solicitors are experienced in Companies Court litigation.

Here are some uses of shareholders' agreements: to give to a shareholder rights which would otherwise be unenforceable if inserted in the company's Articles - e.g. personal rights (as opposed to rights as a member), such as a right to be appointed as a professional adviser to the company. To regulate the special relationships between shareholders which have nothing to do with the administration of the company - e.g. if one or more shareholders are investing in the company. To protect minority shareholders' rights - e.g. by giving them a power of veto which they would not otherwise enjoy under Company Law. To preserve confidentiality.

Shareholders' agreements, properly structured and funded, are a critical part of any business with more than one shareholder. A well-thought-out agreement provides an orderly way to transfer shares in the business and helps keep the business running smoothly in the face of future events such as death, disability or retirement of a shareholder.

These agreements generally establish a purchaser for the shares of the deceased or existing shareholder, a formula for determining the purchase price of the shares, and a method for funding the purchase. A venture capitalist who does not acquire control with his purchase of company stock will usually require a shareholders' agreement as a condition of funding. Management that sells a controlling interest in its company's common stock normally insists upon a shareholders' agreement to ensure its continued ability to run the company.

Shareholders' agreements can take a variety of forms and can serve a variety of purposes. They are usually in writing and signed by persons who together own at least a majority of the outstanding shares of the company's voting stock. Shareholders' agreements enable a minority shareholder to exercise more control over a company that he would have otherwise. (By voting his minority interest in the company's shares, he would have no control).

A venture capitalist, for example, will almost always insist that management agree to vote its shares so that he will be ensured a seat on the company's board of directors. Sometimes an investor will ask for other types of control as well, such as the right to veto certain important financial decisions made by the directors.

Shareholders' agreements often contain other provisions affecting management and its relationship with its investors. These provisions commonly contain limitations on the manager's ability to sell his shares to outsiders and provide for the disposition of his shares in the event of his death or termination of employment. Shareholders' agreements are also commonly used for estate planning purposes. Management should consider shareholders' agreements carefully. They should have a limited term and, in most cases, should terminate in the event of a public offering of the company's stock or sale of the company. If you have any questions please E-Mail or call us: 0800 081 1510 or +44 (0) 207 637 3881, fax: +44 20 7681 3318.

CONTRAST WITH THE ARTICLES OF ASSOCIATION:

The Articles of Association of a company are the rules governing its internal management and administration. The Articles are governed by Company Law and are binding on all the members of the company. A shareholders' agreement is an agreement between the members of a private limited company which is governed by the normal law of contract. Some matters covered in a shareholders' agreement may equally be incorporated in the Articles of Association - pre-emption rights, for example. However, bearing in mind that the Articles of Association are open to public inspection, it may be more appropriate in some circumstances to deal with matters in a shareholders' agreement for reasons of confidentiality.

Care must be taken in drafting to ensure that the true effect of the provision of a shareholders' agreement is not to alter or amend the Articles of Association. A shareholders' agreement which does so must be registered at Companies House in the same way as a resolution to amend or alter the Articles, thus forfeiting the advantage of confidentiality.

It is common for the company itself to be a party to a shareholders' agreement both to ensure that it is bound by obligations which might otherwise have appeared in the Articles of Association and to oblige the directors indirectly to give effect to the obligations in it.

SOME ADVANTAGES OF SHAREHOLDERS' AGREEMENTS:

Here are some uses of shareholders' agreements: confidentiality - provided a shareholders' agreement is drawn carefully so as not to alter or amend the Articles of Association there is NO NEED to file it at Companies House. Can be altered by simple agreement rather than using the formalities of meetings required by companies' legislation. Can be terminated by simple agreement.

For small private companies shareholder agreements offer a valuable addition to the constitutional regime embodied in the memorandum and articles of association. They have the advantage of relative privacy and cannot (in the absence of provision to the contrary) be modified without unanimous agreement.

The value of such agreements was made apparent in Russell v Northern Bank Development Corp Ltd [1992] BCC 578; [1992] 1 WLR 588 where the House of Lords held that such an agreement, although incapable of fettering the statutory entitlement of a company to increase its share capital, could place curbs on the manner in which members exercised their voting rights within the company when exercising a vote on a capital increase. The practical utility of such an agreement thus received support from the highest court in the land.

The interpretation of a shareholders' agreement was at the fore of the litigation in Euro Brokers Holdings Ltd v Monecor (London) Ltd [2003] BCC 573; [2003] EWCA Civ 105. This case concerned the enforceability of a provision in a shareholders' agreement, made in the context of a joint venture company, requiring a member to sell its shares to the other member in defined circumstances. That question turned on whether the triggering event (a purported board decision) was valid or whether it could be regarded as valid by applying the Duomatic principle (Re Duomatic Ltd [1969] 2 Ch 365) of informal shareholder assent.

Both the judge at first instance (Leslie Kosmin QC) and the Court of Appeal (Pill, Waller and Mummery L.JJ.) agreed that this pragmatic common law principle could operate in the context of a shareholder agreement.

SOME DRAWBACKS:

There may be complications when a member who is signatory to a shareholders' agreement transfers shares: the new member MUST agree to be bound by the shareholders' agreement and the old member released from it - this can be easily overlooked. Shareholders' agreements can become unwieldy if the number of shareholders increases substantially.