Jacksons Law Firm corporate and commercial solicitor David Artley offers some important advice to private business owners around the importance of Shareholders’ Agreements…

How important is a shareholders’ agreement? Ask a corporate solicitor about a situation involving a fellow shareholder and the first thing they will ask is if you have a shareholders’ agreement. Every private limited company with multiple shareholders should have a shareholders’ agreement.

Why they are so important? A company is a legal entity, it has a distinct legal ‘personality’, akin to a person. The company can own property, be sued, sue and enter into contracts in its own right. The company owns its assets, and the shareholders own the company. But a company cannot ‘make’ decisions; for that it has its board of directors.

What happens if the company’s interests and the individual directors’ interests conflict? There are two default solutions:

The legal duties on directors to act in the best interests of the company (more a last resort); and the shareholders’ power to define the powers of the directors (better but not ideal).

Shareholders have two main sources of power. First is the articles of association; the main constitutional document of a company. It says what directors can and cannot do and it can be altered only if at least 75 per cent of the shareholders agree. The second is that, by law, directors must ask the shareholders to vote on certain actions, called resolutions.

Resolutions can be ordinary (agreed by more than 50 per cent) or special (agreed by 75 per cent or more).

There are problems with relying on just the default sources of shareholder power, however.

Most obvious? The power to make decisions is linked to how many shares are owned. The owner of 20 per cent has little power against the remaining 80 per cent, but 20 per cent could represent a significant investment needing protection; the company may have difficulty securing investment if it is not protected. Or 50/50 ownership where the two owners vote different ways? Deadlock.

Second problem? The articles of association must comply with the Companies Act 2006, both in what they cover and how they cover it. If the Companies Act says that a special resolution is required, the articles of association cannot say that an ordinary resolution will suffice, for example.

A third? The articles of association are essentially a contract between the company and each shareholder, not between the shareholders. They focus on protecting the shareholders from the company/directors, not protecting the company from its shareholders. They could not stop a fellow shareholder setting up a rival company, for example.

The solution? A shareholders’ agreement – an agreement between the shareholders setting out how they will use the powers and rights as shareholders, enforceable by each shareholder against the others. It is not regulated by the Companies Act so it can cover a far wider range of situations in a very flexible way.

Do you want a different voting threshold for a particular decision? First hold a vote under the shareholders’ agreement (not regulated) and the shareholders must vote to give effect to that decision in the regulated vote, even if they disagree.

Or do you want to prohibit a shareholder from competing with the company? The shareholders’ agreement could require all their shares to be sold to the company if they do, and at a favourable price.

Finally, how do you or your fellow shareholders plan to leave the business? If a takeover offer is received, can you require others to accept it? Or can you prevent them selling shares unless the buyer will buy yours, too? You could have a lot riding on this, and it is good to know where you stand.

Often a shareholders’ agreement is used to solve a problem. A difficult and expensive argument can be avoided by a robust agreement.

Anecdotally, it seems companies with a shareholders’ agreement have fewer arguments in the first place.

Planning for the situations and decisions of the future is best when there is goodwill and calm – a shareholders’ agreement should be one of your first company documents.

David Artley
Solicitor, corporate and commercial, Jacksons Law Firm

 

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