Shareholders Agreements: The Background and Benefits

August 22, 2016

Business Services

Shareholders Agreements: The Background and Benefits

Background

Historically, it has always been the case that the so called “constitution” of a company (of which the articles of association are most important) forms a contract between all the shareholders of the company.

Section 33(1) of Companies Act 2006 enshrines this in statute and, in effect, creates contractual relationships with powers of enforcement in a situation between shareholders where they would not usually exist. The ambit of section 33 of the Companies Act is that it enables one shareholder to claim against another shareholder for certain matters effecting his or her membership rights. These are specific membership rights such as the right to vote, right to attend meetings and the right to a dividend should the company decide to declare one.

It is possible to amend the model articles used on incorporation but the changes that can be made are limited and generally only involve giving the directors additional powers to issue shares, disallowing any personal interest a director may have in a matter on which he is to vote or lengthening the notice required for meetings.

Case law has established that a number of important company matters that effect shareholders cannot be dealt with in the articles such as the right to be a director itself or clauses that effect the rights of a minority shareholder from being overruled at will on significant matters by majority shareholders.   The rights protected by section 33 of the Companies Act are pitched at a minimum level and so it is important for shareholders of a company to consider whether or not these rights are sufficient and whether they should enter into a contract  with each other specifying how they will behave towards each other in greater detail and clarity. Such a document if prepared is known as a shareholders agreement and is a document best drafted by a solicitor well versed in company law matters.

Benefits

The benefits of a shareholders agreement are both legal and practical.

In the practical sense, the main benefits of a shareholders agreements are:

  1.  That it shows a company has thought things through carefully and shows a proactive rather than a reactive approach to business. As such, it can be useful raising finance from banks or other creditors when used in connection with a business plan as such organisations will be impressed that shareholders have prepared such a document. Many companies do not have one and rather like a person without a will or prenuptial agreement will rue the day one was never drafted when problems arise that require certainty as far as possible  as to what will happen going forward.
  2. The other practical advantage of having a shareholders agreement is that it is not discoverable by a search at Companies House, so in a sense, remains private and confidential behind the shareholders. Articles and resolutions and annual returns are discoverable but a shareholders agreement does not go on the register.

Legal benefits amongst others can be as follows:

  1. It can cover matters personal to shareholders including such personal rights as being appointed as a director or the protection of minority shareholder rights.  (see above.) This type of provision could not be enforced if placed in the company’s articles.
  2. It can help protect minority shareholders. Most matters concerning the company can be implemented if 75% or more of the voting shareholders wish that to happen. In a shareholders agreement minority shareholders can protect their position by such clauses as there has to be a higher percentage or even unanimous agreement if additional debt is to be raised by the company above a set figure, if the articles themselves are to be amended further or if the business is to be sold or put into liquidation on a voluntary basis.
  3. A clear dividend distribution policy can be set out within the framework of the agreement to avoid possible disputes further down the line.  
  4. Disputes between shareholders can be provided for with references to arbitration and/ or mediation avoiding prohibitively expensive legal action.
  5. Agreement can be reached on how a departing shareholder is to be dealt with on what terms and what happens if there is deadlock in terms of decision making between shareholders.  Again such disputes could possibly be referred out to arbitration and / or mediation to save costs and damage to internal relations.

It is not permissible to put anything in a shareholders agreement that would be a breach of the law for example specifiying in the agreement that the company did not need to keep accounts as required and minutes of board meetings for at least 10 years.

Properly and competently drafted a shareholders agreement does provide certainty and is an essential document to have in place before a company starts out on its life in business.

posted by Stevyn Jackson | August 22 2016