A Shareholders Agreement is a binding contract between the Shareholders or Members of a company which sets out the legal relationship between the Shareholders and the Company.
Although Shareholders Agreements are not compulsory under the Corporations Act 2001 (Cth) (Act) the Act does not cover many matters which should be agreed between the Shareholders in relation to issues including the day to day operations of the company, how to resolve disputes between the shareholders and how the exiting of 1 or more shareholders from the company is to be dealt with. It is therefore important to regulate the rights and obligations of Members by entering into such an Agreement.
A Shareholders Agreement will often address:
- How the business will be owned and managed
- How shareholders’ rights are to be protected
- Dispute resolution provisions
- How shareholders may acquire or dispose of shares
- The business plan of the company, accounts and reports and forecasts
- How to resolve disputes between shareholders
- How the company is to be valued upon 1 or more shareholders selling their shares
- The process to be followed when 1 or more shareholders are exiting the business
- Restraints of trade to be imposed on exiting shareholders after they have left the business
Once signed, the Shareholders Agreement is binding on the shareholders and can only be altered by agreement between the shareholders.
This article will discuss 7 of the most important legal clauses to be included a shareholder agreement.
7 Clauses to watch out for in Shareholder Agreements
- Forced Sale Provisions: Require a shareholder to sell their shares, even if they would prefer for them not to be sold. This is often enacted to allow large shareholder to buy out parties in order to avoid a dispute or a deadlock.
- Drag Along Provisions: Allow a major shareholder (or a group of share holders) to drag all other shareholders into a sale without their consent provided everyone receives the same amount per share. Drag along provisions can be used to sell the whole business when the offer is available.
- No Transfers Clause: As the name suggests this is a clause that prevents the shareholder from transferring or selling the share unless consented by all other shareholders. This is a common clause in Privately owned companies where the few shareholders have a working relationship with each other.
- Compulsory Transfers: this clause if included will state the circumstances under which the shares must be sold to the company. The circumstances will vary but may include provisions for sale if the party, becomes insolvent, breaches anti-competition clauses or engages in misconduct.
- Preemptive Rights: This is a clause that benifits minority shareholders as it guarantees that the current shareholders be first in line to purchase any new shares that are issued.
- Approval of Company Decisions: As a share holder you will have the power to weigh in on some decisions that are made by the Company. Different types of decisions will require different levels of consensus among the shareholders to pass them. A simple majority of shareholders (50%) or a special majority of shareholders (75%, or as otherwise defined by the Shareholder Agreement). Many decisions will not require Share holder input at all and can be decided by the CEO or board of directors. It is important that you know what type of decisions the company can make without consulting the shareholders.
- Restraint of Trade Clause: Will there be a restraint of trade clause restraining the shareholders from competing against the company? If so, how long will the restraint last, and over what geographic area?
Legal battles between shareholders can be costly and risky and on many occasions result in the collapse of the business or a forced sale under the control of a Receiver. In order to minimise such drastic scenarios a properly drafted shareholder agreement should be entered into at the outset of the business arrangement.