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The easiest way to avoid shareholder disputes

Entrepreneurs should consider the protection of shareholders on incorporation of the company – the decreased chance of future disputes will likely far outweigh the one-off expense

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A shareholders’ agreement is a contract entered into between some or all of the shareholders in a company. A shareholders’ agreement regulates the relationship between the shareholders – they are most often used to give protection to the shareholders’ investments in the event that something were to go wrong, and to establish a fair relationship between the shareholders. Unlike a company’s articles of association or special resolutions, shareholders’ agreements are private documents, and cannot be accessed by members of the public on Companies House. This means that is a useful document in which to include confidential information about the operation of the company.

Often, standard articles of association of a company based on the model articles contained in the Companies Act 2006 will not sufficiently safeguard the interests of the shareholders, and the absence of a shareholders’ agreement will mean that disagreements are, if not more likely, certainly less straightforward to resolve. Entrepreneurs may be more concerned with bringing their business ideas to market as swiftly as possible, and less so with the protection of shareholders on incorporation of the company. However, the decreased chance of future disputes will likely far outweigh the one-off expense and limited time taken to draft such an agreement.

Provisions frequently included in a shareholders’ agreement
A shareholders’ agreement is not “one size fits all” and should be tailored to the company and to the specific circumstances of the shareholders. However, listed below are a number of common areas that shareholders’ agreements tend to cover:

  1. Minority shareholders
    Company decisions are generally made by a simple majority of the board of directors. This means that a minority shareholder (meaning they own less than 50% of the shares in the company) will often have little control of the company. There are laws that give some protection to minority shareholders, but enforcement of these would require costly litigation. Instead, a shareholders’ agreement could require that certain decisions require approval of the minority shareholders before they are passed (for instance, varying the share capital of the company or appointing/removing a director). An additional protection that a minority shareholder might seek is a “tag-along right”. Minority shareholders are sometimes concerned that, if a majority shareholder sells their shares to an unknown third party, the minority shareholder may be stuck in a company where they have no control, and with shares that they may not be able to sell. Tag-along rights require that the majority shareholder can only sell their shareholding if the third party offers to buy the minority shareholders’ shares on the same terms. This prevents minority shareholders from being forced to sell their shares for less than the majority shareholder did.
  2. Majority shareholders
    The converse to tag-along rights, majority shareholders might want “drag-along rights” in a shareholders’ agreement. Often, a prospective buyer of a majority shareholding will desire total control of an entity, without any existing shareholders which are unknown entities. It may be a condition of the buyer that they must be able to purchase the total shareholding in one transaction, not just a majority. Drag-along rights allow the majority shareholder to compel the remaining shareholders to sell their shareholdings to the prospective buyer on the same terms as the majority shareholder. This prevents a majority shareholder from being held to ransom by holdout minority shareholders.
  3. Equal shareholders
    Where the shareholders of a company hold equally shareholdings (i.e. 50% each), disputes can arise where there is a disagreement over how the company should be run. Reiterating the above, as company decisions are largely made by a simple majority, if neither side to a disagreement holds over 50% of the votes, then the company will not be able to operate. However, this can be averted by a shareholders’ agreement which contains a dispute resolution provision in the case of a deadlock – for instance, a decision of a third party expert that is binding on all the shareholders. Such a clause is clearly unnecessary where a company has a majority shareholder, which emphasises the importance of tailoring any shareholders’ agreement to the company in question.
  4. Transfer of shares
    Common to majority, minority and equal shareholders alike is a concern that a shareholder could sell its shares to any unknown third party. Private companies often are small companies with few shareholders, who also tend to be directors. A transfer of shares to a new party would mean that the existing shareholders and directors would have to run the business with an unknown quantity involved. Therefore it is quite common to include a provision regulating the transfer of shares such that existing shareholders in the event of a planned transfer, are offered shares first in proportion to their existing shareholdings. This right is often called the right of pre-emption on transfer.

Recent update
The recent decision in United Company Rusal Plc v Crispian Investments Ltd & Anor [2018] EWHC 2415 (Comm) reaffirmed that a court will apply the usual rules of contractual interpretation (by applying the objective test most recently set out in Wood v Capita Insurance Services Limited [2017] UKSC 24) to a shareholders’ agreement. This should give comfort to those drafting shareholders’ agreements that the court will uphold a clearly worded and coherent shareholders’ agreement.

Should you be incorporating a company, or you have read this article and realised that a shareholders’ agreement would assist you and your fellow shareholders, we offer a bespoke shareholders’ agreement drafting service. Do contact a member of our Corporate team – our details are on the side of this page.