city competence
coastal calm
Why your company needs a Shareholders Agreement
Starting a business requires careful planning and consideration. Failure to allow for unforeseen events or to provide a mechanism for resolution of future disagreements could put your new venture at considerable risk.
The repercussions of failing to plan are clearly illustrated in a case in the Federal Court between co-owners of the popular Grill’d fast food empire. What started out as friends in business has turned into an ugly expensive dispute.
One of the most effective ways of minimising costly business disputes between participants in a company is to seek professional advice early and to have a shareholder agreement prepared by an experienced commercial lawyer.
A shareholder agreement sets out the rights and obligations of each business owner and processes for resolving disputes and deadlocks. The agreement puts all parties on the same page from the beginning of the relationship, and facilitates cost-effective and efficient determination of disputes.
A shareholder agreement is integral to protecting the business and owners from unnecessary delay and loss resulting from a range of unforeseen or likely events.
What is a shareholder agreement?
A shareholder agreement is a private contract made between shareholders of a company, setting out their respective rights, obligations and liabilities. The agreement need not comply with any set form or procedure, however should be carefully drafted to ensure its validity and enforceability and to cover a range of contingencies.
A shareholder agreement needs the consent of all shareholders and, unless otherwise specified, all existing shareholders must consent to any changes or alterations.
So why do we need a shareholder agreement? The Grill’d case
The case of Bainbridge Grill'd Pty Ltd & Ors v Simon Crowe & Ors before the Federal Court illustrates the potential pitfalls of not having a shareholder agreement in place.
Grill’d opened its first restaurant in 2004, the brainchild of friends Simon Crowe, Simon McNamara and Geoff Bainbridge. Since its foundation, Grill’d has spread its wings to over 100 stores Australia-wide and its present value is purportedly estimated at $300 million.
In 2011 McNamara exited the business leaving Bainbridge holding 25 percent of the company shares and Crowe the remainder.
For various reasons, the relationship between Bainbridge and Crowe became strained and deteriorated to the point that in June 2016 Bainbridge commenced proceedings under the Corporations Act 2001. Bainbridge claimed that he had been denied access to the company’s books and records and that Crowe had breached his director duties by using company staff and resources to fund KoKo Black, a chocolate company.
Bainbridge sought an oppression order and the removal of the company’s CFO and Director.
In his counter-claim, Crowe sought an order for the forced sale by Bainbridge of his shareholding on the basis that the relationship had soured to the extent that the continued involvement by both owners in the business would be futile. In his argument, Crowe challenged Bainbridge’s previous decision to invest in Pizza Religion, which he considered a rival of Grill’d.
The battle has been personal and fuelled with emotion between the owners. It has been before the Court several times for various interlocutory and directions hearings, no doubt resulting in very considerable expense for both parties.
A central issue to the dispute is the value of the company which, when determined, will inevitably have a significant impact on the final result.
The matter is yet to be resolved amidst a bitter dispute, and until it is resolved, will continue to exhaust time, emotion and of course finances.
Lessons learnt
All companies must adopt a constitution which governs the relationship between the company, its directors and shareholders. The constitution is a contract between the company and each member, a member and other members, and directors.
The constitution sets out a company’s objectives, activities and internal administrative matters. Consequently, the rights and obligations formed under a constitution are not necessarily individual rights. The constitution is limited in terms of the personal rights of the shareholders, and will generally fall short of protecting a shareholder’s interests in the event of a dispute between the parties.
A carefully prepared shareholder agreement will cover matters not addressed in the constitution and is integral in managing ongoing and future issues affecting shareholders.
What should a shareholder agreement include?
A shareholder agreement should meet the specific requirements of the company and its shareholders, and may include matters of management, confidentiality, and employee contracts and consultancy agreements. The following are common inclusions:
Priority of shareholder agreement over the constitution. In the event of an inconsistency between the shareholder agreement and the constitution, the shareholder agreement should be worded so as to prevail over the constitution, or contain express agreement to vary the constitution appropriately.
Alternative dispute resolution. An agreement should include processes to resolve disputes requiring a genuine attempt by the parties to resolve matters or to engage in alternative dispute resolution before commencing formal litigation.
Deadlock breakers. Such provisions deal with circumstances in which shareholders cannot agree on the management of the company, and may include:
- a shotgun clause, allowing a shareholder to break the deadlock by purchasing the shares of the other shareholder at a nominated price;
- a chairman clause, allowing one shareholder to become the chairman with a casting vote; or
- a liquidation clause, providing for the company to be voluntarily wound up if the deadlock continues for a set period of time.
- a provision entitling one shareholder to offer its shares for sale at a nominated price, and if the other shareholder/s do not accept that offer they must sell their shares for that price if requested.
Pre-emptive rights. These provisions 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.
Drag-along, tag-along rights. These provisions are aimed at balancing the rights of a majority shareholder and a minority shareholder. Under a drag along option, majority shareholders can require a minority shareholder to join in the sale of shares in the company. Under the tag along option, where a majority shareholder is selling shares in the company, the minority shareholder has the right to join the transaction and sell their minority stake at such same price.
Mandatory sale events. These provisions set out triggers for the mandatory sale of shares in certain circumstances (for example, a director dies or suffers impaired capacity, resigns or files for personal bankruptcy).
Share valuation methods. Methods 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.
Conflict and non-compete clause. These provisions prevent the shareholders from investing in or engaging with competing businesses.
Future Shareholders
Provision should be included requiring that no share can be transferred to another party unless they first sign a deed of accession agreeing to be bound by the terms of the shareholder agreement.
Conclusion
Whilst it will be of interest to hear the eventual outcome of the Grill’d case if the parties cannot reach some agreement, the matter reinforces some important points.
- the ideal time for a shareholder agreement to be prepared is when the company is first created and there is goodwill between the shareholders.
- it is easier to negotiate terms at the start of a business venture when the parties are amicable, rather than when they are frustrated by disagreements down the track.
- shareholder agreements should be professionally prepared and tailored to the individual needs of the shareholders and the company as a whole.
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 Nicole Downs
Partner Solicitor
(07) 5443 4866 (07) 5443 4866
kwaddington@gwlaw.com.au ndowns@gwlaw.com.au