In this article, Daksh Gautam, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses the key provisions of a Shareholders’ Agreement.
What is a Shareholder’s Agreement?
Shareholders are considered to be the true owners of the company. An agreement entered between the company and shareholders describing the rights and obligations is called the Shareholder’s Agreement. You can learn more about such types of agreements and the practical application of laws related to mergers and acquisition, by working in a law firm or by doing M&A courses.
Why do we need a Shareholder’s Agreement?
Shareholder’s agreement is entered in order to dissolve any dispute between the shareholders and the company. We can’t be sure that nothing will ever go wrong and in such case where nothing is certain, such agreements help us in dissolving the disputes if it occurs and to maintain a healthy relationship between the shareholders and the company. It also helps to protect the investment made by a shareholder and lays down the rules & regulations for the shareholders and any other party related to the company. It is essential to regulate a shareholder’s agreement because not every shareholder is same. An agreement has to be drafted keeping in mind that every person is different and has the different opinion on subjects or matter concerned. And that they may or may not agree with each other.
Key Provisions in the Shareholder’s Agreement
A Shareholder’s agreement consists of the following basic provisions:
- In what proportion a shareholder is going to hold the shares?
- Will there be the different class of shares for different category of shareholders (comprising of minority, majority & founder shareholders)
- If there are the new issue of shares in the market should the existing shareholders get the privilege of getting those shares first?
- Can the board of directors stop the issuance of any such share or can they stop the transfer of shares?
- What are the rules for transferring of shares?
Consent of Shareholders
It comprises of such circumstances and situations where the consent of shareholder in majority matters. For example, consent of a shareholder will be taken in the matters mentioned below:
- Whenever a member i.e.; manager, any member of the supervisory board is appointed, or is to be dismissed consent of shareholders is a must.
- Whenever drafting a financial statement or distributing the dividend.
- When the company wants to amend the articles of association.
- When entering into amalgamation or filing for bankruptcy.
- When dissolving the company.
An example of a consent clause is as follows:
|“Where this Agreement provides that any particular transaction or matter requires the consent, approval or agreement of any Shareholder such consent, approval or agreement may be given subject to such reasonable terms and conditions as that Shareholder may impose and any breach of such terms and conditions by any person subject thereto shall ipso facto be deemed to be a breach of the terms of this Agreement.”|
It will be really modest to say that there will be no disputes that may arise while investing in a company. Therefore, the company has to be prepared for such events as well. A dispute not only means disputes within it also means the dispute with the rival company or competitive company.
To resolve issues with shareholders, companies normally opt for out of court settlements such as arbitration or conciliation between the company and shareholders.
An example of a dispute resolution clause is as follows:
|“All disputes arising between the partners as to the interpretation, operation, or effect of any clause in this deed or any other difference arising between the partners, which cannot be mutually resolved, shall be referred to the arbitration of…………failing him to any other arbitrator chosen by the partners in writing. The decision of such an arbitrator shall be binding on the parties”|
Restrictions against transfer
A shareholder’s agreement comprises of such rules where the shares can’t be easily transferred and for which a written consent has to be taken by the existing shareholders. This is not applied in case of death of a member as shares are transferred to the family i.e.; legal representatives/heir.
Right of first refusal
This right basically protects the company and the existing shareholders from sales of stocks to a competitor company or such parties with whom the company doesn’t have friendly relations. When some of the shareholders wish to sell their share, a clause in the shareholder’s agreement should state that the shareholders who wish to sell their shares have to show the right to match an offer received from a third party. This is known as the right of first refusal.
The Shareholders’ agreement must include the clause of buy-out rights which states that when a shareholder is found incompetent due to certain major events i.e.; death, disability, bankruptcy or marital dissolution, the company or existing shareholders in such case can buy the shares of such shareholder. It also includes a clause called as “expulsion” where the existing shareholders can expel any undesirable shareholder and acquire his/her shares.
Things to be kept in mind while drafting a Shareholder’s Agreement
- One needs to understand the need of a shareholders’ agreement including why is it necessary to create a balance between shareholders’ interests and company interests.
- Do not make the terms ambiguous, but keep it precise which limits the terms’ interpretation. Wide interpretations cause problems in the long run.
- Clearly, list out the rights and obligations of both parties – i.e. shareholders and the company.
- Keep in mind that there is a high possibility that a shareholder might want to leave – clauses regarding such process should be clearly laid out.
- Dispute resolution clauses should be clearly defined especially on the following points – mode of dispute resolution, place of such dispute resolution, powers and duties etc.
- Restrictions on transfer of shares should be clearly defined and the process for the same should be laid out.
The above are just a few points to be kept in mind. For a detailed analysis, contact a professional who might help you draft the same.
Shareholder’s agreement is a mechanism which saves the company from losses and protects its interest. Every shareholder agreement has to have the key provisions stated above to create a balance between shareholder interests and the company’s interests.