What should be included in a Shareholder Agreement?

A company constitution does not adequately protect
shareholders in the event of a dispute between members.

It is not compulsory to have a properly formulated Shareholder Agreement but it is highly recommended for all companies. When a person is entering into a business relationship by way of a company, they are usually doing so with someone they know and trust. Therefore, often clients will say to us that there is no need for a Shareholder Agreement due to the fact that they trust their business partner, or their business partner is family. However in most instances, disputes arise not because of any underlying dishonesty on the part of a party, but due to circumstances such as:

• both parties having differing but equally legitimate views of what is to occur in a certain circumstance
• where something happens to one of the parties, for example death or disability, and the surviving party must deal with members of the party’s family who may not necessarily have the same business experience or knowledge as the prior party
• when a party is under financial stress.

Therefore, it is advisable to have a Shareholder Agreement entered into initially, when things are good between the parties as all of the relevant issues can usually be discussed amicably, agreed upon and documented. Hopefully such agreements never need to be enforced, however in the event that disputes do arise, the Shareholder Agreement provides a backstop.

Every Shareholder Agreement will need to be individually tailored to the specific needs of the business and shareholders, the number of shareholders, the objectives of the shareholders, funding arrangements and the type of business in which the company operates.

However, there are some basic clauses that every Shareholder Agreement should have:

1. An alternative dispute resolution clause. It is advisable for the parties to try and resolve disputes through an alternative dispute resolution process, rather than initiating Court proceedings. Often these processes take less time, cost less and result in a solution being tailored to the specific needs of the parties, rather than a Court imposed decision.
2. Deadlock provisions. These deal with circumstances where shareholders cannot agree on the management of the company and they set out a procedure to resolve a deadlock if one arises, for example:
   – one shareholder being the chairman and having the casting vote
   – if the deadlock continues over a certain period of time, the company is to be voluntarily wound up
   – a shareholder being entitled to serve notice on another, requiring the other shareholder to buy their shares at a nominated price or based on a formula.
3. Preemptive rights. These impose restrictions on the sale of shares. For example, they may include a right of first refusal to existing shareholders, a right to refuse a transfer of shares to prevent an unwanted party from joining the company or a requirement that the board of directors have to consent to the transfer.
4. Events which trigger a mandatory sale of shares. Examples of such events include a shareholder’s death, failure of a shareholder to contribute capital when required, a shareholder’s insolvency, fundamental breaches of the agreement, an inability to continue working, termination of the employment relationship with the shareholder, loss of professional certification (for example, a Doctor).\
5. Share valuation methods. A Shareholder Agreement should stipulate a method for determining the value of shares to apply in the event of preemptive rights or mandatory sales events occurring. Typical methods of valuation include a fixed priced agreed between the parties, asset-based, expert valuation or a valuation by the board of directors where the directors are not directly involved in the transaction.

Often people don’t see the value in having a Shareholder Agreement prepared. However, where parties do not have one and issues arise, the costs involved in resolving the disputes becomes far greater than the costs that would have been incurred in having a Shareholder Agreement prepared. Further a Shareholder Agreement will avoid the emotional trauma of having to go through a dispute and possibly, the termination of not only a business relationship but also the termination of a personal relationship.

For further information, please contact our Commercial Team.