Shareholders Agreements

Shareholders Agreements

When a limited company is formed two documents have to be filed at Companies House – the Memorandum of Association and the Articles of Association (the "M & A's"). These two documents are public documents and everyone can have access to them at Companies House. They are generally basic documents with the minimum of detail to comply with the Companies Act 2006. Thus there are many situations that the M & A's do not effectively deal with and it is often necessary and we strongly urge all our clients to enter into a Shareholder Agreement when forming a company with two or more shareholders.

As we all know and ,have had experience of, at some point in our lives there will be situations or circumstances that arise which are unforeseen for example; a person is involved in bad car accident, a person decides to change jobs or something as simple as retirement. All these situations are common everyday situations but the M & A's do not deal with these everyday situations and this is one reason for entering into a Shareholder Agreement.

If, by way of example there are two shareholders in a company and one shareholder holds 75% of the shares (the "Majority Shareholder") and the other holds 25% of the shares (the "Minority Shareholder") then effectively the Majority Shareholder can run the company in his own way providing he adheres to the Companies Act 2006. The best method of protecting the Minority Shareholder is to enter into a Shareholder Agreement with the Majority Shareholder which is a private agreement between the two parties and regulates how each shareholder is permitted to act in relation to their interest in the company.

The general areas that a shareholders agreement will cover are as follows:-

1. Conduct of the company's affairs – this will ensure that the company can not commit to certain types of contracts or employ certain staff or borrow from the bank (the list can be endless) without the consent of either ALL the shareholders or a certain percentage of the shareholders agreeing ( eg 60% of all shareholders have to agree to enter into a certain contract). This ensures that in our above example the Minority Shareholder will not be continually outvoted by the Majority Shareholder if the Shareholder Agreement states that ALL the shareholders have to agree before entering into a certain type of contract and thus the Minority Shareholder will have some effective power within the company.

2. Share transfers – again this will ensure that shareholders cannot sell their shares to third parties without the consent of the other shareholders or provide a mechanism for the sale of the shares if there is an offer to purchase the shares of the company; for example; if there is an offer to purchase the company and the Minority Shareholder refused to sell his shares then the Majority Shareholder would not be able to take the benefit of selling his shares. We deal with this situation by drafting a clause that permits the Minority Shareholder to either buy the shares of the Majority Shareholder at the same price the third party has offered OR the Minority Shareholder also has to sell his shares to the third party at the same price the Majority Shareholder obtains for his shares. The Articles of Association may already have these provisions contained but if not the Shareholder Agreement can deal with these issues.

3. Restrictive covenants – this prevents a shareholder when resigning or leaving the company, for any reason whatsoever, setting up another business or joining another business that will compete with the company for a certain number of years thus protecting the remaining shareholders and the company's business.

4. Events – either good or bad events that happen in a shareholder life such as death, retirement, bankruptcy, mis-conduct. The Shareholder Agreement will make provision that the shareholder involved has to sell his shares to the remaining shareholders – if the event is a "good" event (e.g. death or retirement) then the selling shareholder will receive the market value for his shares. However, if the event is a "bad" event (e.g. fraud, theft or some other form of mis-conduct) then the shareholder will receive a nominal amount for his shares.

(this list is purely indicative of the type of clauses contained in a Shareholder Agreement and is not exhaustive)

Thus by entering into a Shareholder Agreement, all shareholders have an opportunity to shape the way that their company functions and how they can each protect their different interests whilst working together for the good of the company. It is obviously best to enter into a Shareholder Agreement when the company is formed or when a new shareholder joins the company or when there has been substantial investment into the company. Although no – one can predict the future, the signing of a Shareholder Agreement will keep all parties focused upon their obligations towards the company and each other. This helps to give the company security as all shareholders are bound by the terms of the Shareholder Agreement.