Shareholders’ Agreements: Understanding the application

Shareholders’ Agreements: Understanding the application

Introduction

A shareholders’ agreement is a contract between your company’s shareholders setting out their rights and responsibilities. This section will help you to decide whether you need a shareholders’ agreement and includes a customisable template that you can use for your company. A shareholders’ agreement can protect your shareholders from common problems, particularly those which affect the sale or transfer of their shareholdings, and therefore who has control of the company.

The importance of a shareholders’ agreement

What is a shareholders’ agreement?

A shareholders’ agreement is a contract between the shareholders of a company. It regulates the relationship between the shareholders and governs how your company is run. For guidance on what your shareholders’ agreement should include and for a template shareholders’ agreement that you can use, see Shareholders’ agreement. Sometimes, a company itself will also be party to a shareholders’ agreement.

Do I need a shareholders’ agreement

If your company has more than one shareholder, although it is not mandatory, it is strongly recommended that you have a shareholders’ agreement setting out the rights and responsibilities of your shareholders as part of your company’s internal management. You may find that a new share investor requires one before investing.

Who produces a shareholders’ agreement?

As a shareholders’ agreement is in place principally to protect your company, you/your company should produce it.

You should, however, think about getting expert legal advice first – a poorly written shareholders’ agreement can cause serious issues – for example, if the agreement conflicts with what your Memorandum of Incorporation say must be done in a given situation, it can be complex and costly to resolve. For access to a specialist lawyer in a few simple steps, you can submit a case into our network of legal practitioners here.

If a new share investor is coming on board, they may insist on producing a shareholders’ agreement themselves. You may need to agree to this if the new shareholder is investing a considerable amount into your company.

What could happen if I do not have a shareholders’ agreement?

Without a shareholders’ agreement in place, you may face disagreements between your shareholders on matters such as:

  • when your board should get shareholders’ approval;
  • whether any important decisions, such as issuing more shares which dilute the power of existing shareholders or purchasing another business, need consent from all or nearly all shareholders;
  • if any shareholder can transfer their shares as they think fit without first offering them to the other shareholders; and
  • when your business is sold and how you go about this.

If your company has adopted the model Memorandum of Incorporation and has no shareholders’ agreement, matters which do not have to be approved by shareholders will be dealt with by your board by default.

What are the benefits to my company of having a shareholders’ agreement?

There are a number of benefits to your company and shareholders in having a shareholders’ agreement, which include:

  • confidentiality – any commercially sensitive information included is not available to the public (unless it aims to override or otherwise vary your Memorandum of Incorporation);
  • the ability to protect shareholders who are not on the board or who hold minority stakes – for example, requiring particular decisions to have the prior approval of any shareholders who hold more than a certain percentage of shares (known as veto rights);
  • controlling shareholders for a time after they have sold their shares, eg by restricting their ability to set up a competing business (known as restrictive covenants); and
  • provisions to facilitate a sale of your company, such as a clause forcing minority shareholders to sell if enough other shareholders wish to accept an offer (known as a drag-along right).

A shareholders’ agreement can only be changed by unanimous agreement of the shareholders who are part of it, so everyone gets peace of mind. In contrast, any rights in your company’s Memorandum of Incorporation can usually be changed by special resolution meaning shareholders who hold an agreement determined per cent or more can change them.

It is easier for a shareholder to enforce their rights under a shareholders’ agreement compared to other routes (e.g. enforcing rights written into your Memorandum of Incorporation), as a shareholders’ agreement is a direct contract between the shareholders of a company.

What does a shareholders’ agreement contain

What should my shareholders’ agreement cover?

Exactly what your shareholders’ agreement should cover will depend on your company’s circumstances and the number and bargaining position of your shareholders.

Common provisions include :

  • how your business plan and budget is produced, approved and updated;
  • frequency of board meetings and process for calling them and circulating papers;
  • whether any board committees are to be set up (such as audit and remuneration);
  • how your company issues more shares in the future;
  • listing information you have to provide to shareholders such as accounts;
  • an obligation for shareholders to keep business information confidential;
  • anything on which shareholders’ prior approval is needed and what percentage shareholding is enough to approve it;
  • whether shareholders can transfer their shares freely or have to offer them to other shareholders first;
  • provisions forcing a manager or director shareholder to sell their shares upon leaving the company;
  • when majority shareholders can force minority shareholders to sell, and when your minority shareholders can require their shares to be sold;
  • restrictions on shareholders being involved in competing businesses after they leave; and
  • the process for any future sale of your business.

How should I obtain shareholders’ consent, if this is required under my shareholders’ agreement?

This depends on the terms of your shareholders’ agreement. There should be a clause explaining how the consent of a particular shareholder or group of shareholders is to be obtained. You should follow this carefully.

If you use our Shareholders’ agreement, the relevant shareholder (s ) consent can be obtained either by :

  • having the relevant shareholders give consent in writing;
  • holding a board meeting and having the relevant shareholders vote for the matter in question at the board meeting; or
  • circulating a written resolution (either board or shareholder), and having the relevant shareholders vote in favour of the matter in question by signing the resolution.

You should remember that even if shareholders’ consent is required under your shareholders’ agreement to approve a particular matter, this is not always the only thing you need to do. Sometimes you will have to take other steps under company law and/or if your Memorandum of Incorporation says you must. For example, if your shareholders’ agreement requires you to obtain shareholder consent before changing your company’s name, your company will still need to pass a special resolution and file the necessary documents at the CIPC in order to actually change its registered name. In most cases, including if you use our Shareholders’ Agreement, a shareholder consent requirement should be seen as an additional hurdle to overcome to approve a particular decision, rather than one that replaces or overrides the requirements of company law and your Memorandum of Incorporation.

What happens if my Memorandum of Incorporation and shareholders’ agreement conflict with each other?

A shareholders’ agreement should complement, and not conflict with, your company’s Memorandum of Incorporation. The two often interact and so need to be considered together. For this reason they are often produced at the same time. See for example the following template documents:

In practice, if you get a new shareholders’ agreement or change an existing one, you need to change your Memorandum of Incorporation too.

If your shareholders’ agreement overrides your Memorandum of Incorporation or says that it changes them in some way, it will be treated as a change to your Memorandum of Incorporation and you have to file a copy of the relevant parts of the shareholders’ agreement at CIPC.

What provisions should appear in my Memorandum of Incorporation as well as, or instead of, a shareholders’ agreement?

It is better to cover some things in your company’s Memorandum of Incorporation rather than a shareholders’ agreement. For example :

  • something you want to be public knowledge (your Memorandum of Incorporation are publicly available on the CIPC website) e.g. any restrictions on borrowing or share transfers;
  • if you want your directors to be under a legal duty to do something – they are under a legal duty to comply with your Memorandum of Incorporation but are only required to comply with a shareholders’ agreement if they sign up to it; and
  • if you want the effect of not following a rule to be that the action is of no effect. It can be if the rule is in your Memorandum of Incorporation, but if the rule broken is in your shareholders’ agreement the action stands and your remedy is to sue for damages (a much less reliable way of fixing things).

Does my company need to be a party to my shareholders’ agreement?

There is no requirement for your company to be a party to your shareholders’ agreement. If you prefer, it can simply be an agreement between your shareholders. However, it is common to include your company as a party to a shareholders’ agreement. This is so that your company and its board will be legally bound by the agreement, and will have the right to enforce the terms of the agreement if they are broken by a shareholder.

This may seem odd, as your company is not one of your shareholders. However, many provisions of your shareholders’ agreement will have a direct effect on the company (e.g. provisions regarding how certain important company decisions should be taken, or how shares should be issued and transferred).

For example, if your shareholders’ agreement requires an employee-shareholder to give up their shares if they quit or get fired, your company will want to be able to enforce this if they refuse. Similarly, if your shareholders’ agreement requires shareholder consent before the company takes out any loan, but your board of directors approaches a lender without asking, a shareholder might want to be able to stop them.

For these kinds of reasons, it makes sense both from the company’s perspective and the other shareholders perspective, for the company to be a party to the agreement.

What is the difference between a founders’ agreement and a shareholders’ agreement?

A founders’ agreement is just another description or title for a shareholders’ agreement. Both documents will contain similar provisions to those described prior, and regardless of the title used, will generally have the same legal effect. 

The term ‘founders’ agreement’ is often used to describe an agreement between the founding shareholders of a company, commonly entered into before any fundraising or external investment. However, such an agreement could equally be titled a shareholders’ agreement, and contain exactly the same provisions.

How to change a shareholders’ agreement

When can I enter into a shareholders’ agreement?

A shareholders’ agreement can be entered into at any time during a company’s life-cycle. There is no need for it to be entered into on the date a company is incorporated, or on the date any new shares are actually issued.

If you use our template Shareholders’ agreement, once it has been signed by all parties, it will regulate the relationship between your company’s shareholders from that date forward. It will not apply retrospectively to previous decisions or conduct, but it will apply to all future decisions and company matters.

Does my company need to approve a shareholders’ agreement?

If your company is a party to your shareholders’ agreement, it will need to approve the agreement before entering into it, and will need a presentative from the company to sign on it’s behalf. For guidance on how your company should approve a shareholders’ agreement, please look through our process guides. 

Conversely, if your company is not a party to your shareholders’ agreement, no company approval of the agreement is required, as it will be a private agreement between the shareholders. This question is also dealt with in the section titled ‘Does my company need to be a party to my shareholders’ agreement?’

How should my company approve a shareholders’ agreement?

If your company needs to approve your shareholders’ agreement, the way in which it does so will depend on what your articles of association say. In most cases, including if your company has the CIPC model articles, you will need board approval for your company to enter into a shareholders’ agreement. You may also need separate shareholder approval for other things commonly done at the same time as signing a shareholders’ agreement e.g. issuing shares or making changes to your Memorandum of Incorporation.

If you use Shareholders’ agreement, you will need to also adopt the matching Articles of association for shareholders’ agreement. You will also need to :

  1. Pass a board resolution, using either:
  • Board minutes approving shareholders’ agreement and new articles if you want to convene a board meeting;
  • Written board resolution approving shareholders’ agreement and new articles if you want to approve it on paper; or
  • Sole director resolution approving shareholders’ agreement and new articles;
  1. Have your shareholders pass a special resolution approving the new articles (use Shareholder written resolution amending a company’s articles of association for this); and
  2. Send a filing copy of your shareholder resolution to the CIPC.

Can I change my shareholders’ agreement after it has been agreed?

Maybe, as long as you (or your company) are one of the parties to the agreement. However, unless your shareholders’ agreement allows you to do so with less than 100 per cent consent, you will need to obtain the unanimous consent of all shareholders who are parties to amend or replace your shareholders’ agreement. Unanimity will even waive any procedural requirements imposed by the agreement itself.

It is best practice to get written confirmation from all the shareholders as to the exact change desired, to avoid any ambiguity or dispute later on (even though, strictly speaking, unanimous consent to vary a shareholders’ agreement does not have to be expressly stated unless required by the agreement). Unless the agreement says otherwise, there is no need for a formal signed document but it is generally considered best practice and recognition thereof makes for a sound business entity.

Can I change my shareholders’ agreement without having to get consent from each party to it?

Yes, if your shareholders’ agreement has a provision in it allowing you to amend it by something less than unanimous consent (e.g. by majority consent ). No if the agreement does not allow this.

You are likely to come across a provision allowing changes with less than unanimous consent in a shareholders’ agreement which has lots of parties, particularly where it is not practical to have to obtain unanimous consent for all changes. These provisions should have an associated action which is contained within the shareholders’ agreement.

Can I add future shareholders to my shareholders’ agreement?

Your shareholders’ agreement will only fully bind shareholders who are a party to it. It will not automatically bind future shareholders, so you must ensure that incoming shareholders expressly agree to be bound by your shareholders’ agreement. This is usually done by having them sign a document agreeing to be bound by your shareholders’ agreement, sometimes called a deed of adherence.