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A Guide to Shareholder Agreements
A company constitution is usually drafted in a standard format which is not tailored to the particular circumstances of a business or venture, and does not provide protection for shareholders in the event of a dispute between them, or where issues arise not covered by the constitution.
A shareholder agreement, which clearly outlines the agreement between the parties (and procedure to be followed in the event of dispute), can be an effective tool for avoiding or limiting the cost of litigation.
A shareholder agreement may set out up front how disputes and deadlocks are to be resolved, and may allow shareholders to resolve issues which arise - quickly and with finality.
What is a shareholder agreement?
A shareholder agreement is a private contract made between all the shareholders of a company, setting out the rights, obligations and liabilities of each shareholder. Such agreements do not have to comply with any set form or procedure, but should be drafted so as to ensure that the agreement is clear, valid and enforceable.
A shareholder agreement requires the consent of all shareholders to be bound and, unless otherwise specified, all the existing shareholders must consent to any changes or alterations.
Do I need a shareholder agreement?
All proprietary companies are deemed to have a constitution upon incorporation. It might be assumed that a company constitution is sufficient to address the rights and obligations of shareholders, but the deemed form (and in fact most standard company constitutions) are usually limited in scope and focused on setting out the company’s objectives, activities and internal administrative matters. A standard company constitution will not protect a shareholder’s interests in the event of a dispute between the parties or where issues arise not covered by the constitution.
In contrast, a shareholder agreement can be an extremely useful legal document for managing any issues affecting shareholders which might arise in the future and are not covered by the constitution,.
It is not compulsory to have a shareholder agreement but it is highly recommended for all companies, particularly smaller, privately held companies where there might be a close relationship between the owners (shareholders) and management.
When a company is created and there is considerable goodwill between the shareholders, a shareholder agreement might not seem necessary. However, it is easier to negotiate a shareholder agreement at the start of a business venture when issues can be discussed amicably, rather than when parties are frustrated by disagreements down the track.
What to include in a shareholder agreement?
For a shareholder agreement to be useful it needs to be customised to meet the specific requirements of the company and its shareholders.
Listed below are some common provisions which most shareholder agreements should contain.
Primacy of shareholder agreement over the constitution - in the event of any inconsistency between the shareholder agreement and the constitution, you want the shareholder agreement to prevail, and this may require provision whereby the shareholders and directors agree to take such steps as are necessary to amend the constitution.
Alternative dispute resolution - to avoid the cost and uncertainty of litigation, it is often advisable that parties be required to try and resolve their disputes through alternative dispute resolution, before any formal litigation can be commenced.
Deadlock breaker - such provisions deal with circumstances where shareholders cannot agree on the management of the company. They can include:
A shotgun clause - which works by allowing a shareholder to break the deadlock by purchasing the shares of the other shareholder at a nominated price.
A chairman clause - which allows one shareholder to become the chairman and have a casting vote; or
A liquidation clause - which provides that the company is to be voluntarily wound up if the deadlock continues for a set period of time.
Pre-emptive rights - which impose restrictions on the transfer of shares. A provision can require exiting shareholders to offer their shareholding to existing shareholders first, before the shares are offered to outside parties and set a mechanism for determining the price.
Drag-along or tag-along rights - provisions which are aimed at balancing the rights of a majority shareholder and one or more minority shareholders. Under a drag along option, majority shareholders can require a minority shareholder to join in the sale of shares in the company. Under a tag along option, if a party (perhaps the majority shareholder) is selling shares in the company, the other (perhaps minority) shareholder has the right to join the transaction and sell their minority stake at the same price as the first shareholder achieves.
Mandatory sale events - a provision which sets out triggers for the mandatory sale of shares in certain circumstances (for example, a shareholder dies, is divorced, resigns as director or files for personal bankruptcy).
Share valuation methods - it is prudent to set out the method by which shares are to be valued in relation to pre-emptive rights and mandatory sale events. For example, shareholder agreements often provide for the appointment of an external valuer with set criteria for valuation.
Conclusion
A shareholder agreement is best prepared before the parties enter upon a venture, when there is goodwill between the parties and there have not been any disputes or disagreements about the management of the business.
It is a useful document, setting out the rights, obligations and liabilities of the shareholders, and how risks and disputes are to be managed in the future.
A shareholder agreement should be professionally prepared as it needs to be tailored to the particular needs of the shareholders and company, but will usually contain some of the key provisions set out above.
If you or someone you know wants more information or needs help or advice, please contact us on (07) 5443 4866 or email kwaddington@gwlaw.com.au.
Ken Waddington
Partner
(07) 5443 4866