Much like a newly married couple, in the excitement of forming a new company shareholders may not give much thought as to what would happen if they were to fall out. Should relationships unravel, company law that governs disputes is particularly complex and not as well trodden as the case law in relation to divorce. Accordingly, the outcome for feuding shareholders can be convoluted with limited solutions.
Therefore, it would be pragmatic to have a difficult conversation at the outset and settle bespoke articles of association and a shareholder’ agreement. The articles are the constitution of the company, a binding contract between the company and its shareholders. Whereas a shareholders agreement is a contract between the individual shareholders and as such a shareholder may pursue another shareholder on foot of the agreement, should they be in breach of the covenants. Together, the articles and the shareholders’ agreement will be the “rule book” of the company.
The management affairs of the company can be regulated by the shareholders’ agreement. Typically, the directors will have day to day control and can pass a decision on the board by a simple majority, subject to any quorum specified in the articles. However, the shareholders’ agreement can set out reserved matters which require the approval of all shareholders. Reserved matters often include the issue of further shares, changing the articles of association and acquiring or disposing of company property. Setting these out can help engender trust, offers protection and perhaps avoid discord.
A shareholders’ agreement can also establish a mechanism for the permitted sale of shares. This is a central concern for small companies, established by shareholders whose relationship extends beyond the company and who are unwilling to have one party’s shares be sold to an outsider. The agreement can also attend to how the shares are valued and what would happen in the event of the bankruptcy or death of a shareholder.
Where a shareholder and director are also a key employee, the remaining shareholders may not wish for the leaver to continue receiving dividends generated by the remainers hard work. A shareholders’ agreement can help govern this situation by imposing the sale of the leavers shares to the company or the remainers. There can even be provisions for different valuations of the shares in circumstances where the leaver is what is known as a “good leaver” (such as on death or retirement) or a “bad leaver” (such as resignation or dismissal). If included, these provisions equate to a carrot and stick approach, aimed at having well behaved directors.
For further protection, the shareholders’ agreement may include restrictive covenants, where a leaver is restricted from setting up a competing business and approaching employees, clients or suppliers of the company. Wider geographical and time limits can be placed on restrictive covenants within a shareholders’ agreement than those than those in an employment contract, therefore this can be a valuable tool in safeguarding the interests of the company.
Perhaps most importantly the shareholders’ agreement can set out what to do when the shareholders disagree. A deadlock at the board can have a disastrous effect on the company and so it is imperative disputes can be dealt with swiftly. Deadlock provisions may give the chairman a casting vote, refer the matter for mediation, nominate a non-executive director to intervene or the nuclear option of voluntarily winding up the company, if deadlock is not resolved within a time frame. The latter option will at the least focus the shareholders minds during the deliberation period.
Like any relationship, if the parties have surety as to their roles and expectations, the course will be much smoother. A shareholders’ agreement can act as a prenup for a company and have a stabilising effect as a result. Accordingly, shareholders should give due consideration to entering an agreement before walking up the corporate aisle.
Rachel Toner, Solicitor with Worthingtons Solicitors Commercial regularly acts on behalf of shareholders in the drafting and provision of shareholders agreements. For advice please telephone 02890434015 or email RachelToner@worthingtonslaw.co.uk