What is a Shareholders’ Agreement And Why Does a Company Need One?

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Have you recently set up a new company with friends or family? Do you run an existing long-standing company? Or perhaps you are an accountant or other professional adviser working with a company? Whatever your relationship to a company, having a well-drafted shareholders’ agreement in place can help the business to run more smoothly and ensure any problems can be resolved quickly and effectively.

More often than not when a dispute between shareholders arises, the first question that we ask a client is whether or not there is a shareholders’ agreement in place.

In this article, we cover what a shareholders’ agreement is, why the shareholders need one, what the agreement should cover, when to make one and how the agreement interacts with a company’s articles of association.

Need help with a shareholders’ agreement or any other company and commercial legal matters? Please contact Michael Budd who will be happy to advise.

Key points to know about shareholders’ agreements

  • They are private contracts between shareholders’ and a company
  • Shareholders agreements help to define how the company will be run, as well as shareholders’ rights and responsibilities
  • They can cover matters such as how decisions are made, how shareholder exits will work and how disputes should be resolved
  • Shareholders’ agreements are supplementary to a company’s articles of association and both documents must work effectively together
  • There are many reasons to make a shareholders’ agreement, including helping a business to run smoothly and make it easier to resolve problems, being easier to enforce than the terms of articles of association, defining and protecting rights for specific shareholders or classes of shareholders, protecting confidential information and introducing restrictive covenants for shareholders
  • The terms of a shareholders’ agreement should be tailored to your company, so you should always get specialist legal advice and support for their creation
  • These agreements can be made at any time during a company’s lifecycle but, ideally, before any major issues have arisen that they could have forestalled
  • The interaction between a shareholders’ agreement and articles of association must be carefully considered so they do not conflict and you can maintain overall legal compliance

What is a shareholders’ agreement?

A shareholders’ agreement is a private document that governs the relationship between the company and its shareholders. It protects shareholders’ interests and covers matters from which shareholders may not be protected under general company law.

A shareholders’ agreement can help to define matters such as how the board of directors operates, how key company decisions will be made, shareholders’ rights and liabilities, how the business will be financed, how shareholders can exit the business and how any disputes should be resolved.

A shareholders’ agreement is supplementary to a company’s articles of association. The relationship between a shareholders’ agreement and a company’s articles of association must be carefully considered so that they complement and do not conflict with each other.

Why does a company need a shareholders’ agreement?

There are many different reasons to create a shareholders’ agreement but, in general terms, they help to provide clarity about shareholders’ rights and responsibilities, as well as how different matters should be dealt with. This can help to ensure the smooth running of the business and reduce the risk of costly and time-consuming disputes. If a dispute does occur, a good shareholders’ agreement can also make it easier to find a positive resolution.

A key issue to consider is that there are limits to how enforceable the terms of a company’s articles of association may be as it is a statutory contract to which the normal rules of contracts do not apply. As a private legal agreement between individuals, a shareholders’ agreement can, therefore, offer more options for enforcement if the need arises.

A shareholders’ agreement can also be used to keep commercially sensitive and other confidential information private. This is because a company’s articles of association are a public document, available to anyone, whereas a shareholders’ agreement is a private document, only available to authorised parties. Therefore, it may be desirable to grant different rights to specific shareholders (for example, giving a certain shareholder the right to veto particular decisions) which is better to appear in a private document. It can also be used to protect the rights of minority shareholders. Another consideration is that a shareholder will only be bound by the articles of association for as long as they remain a member of the company. A shareholders’ agreement can, therefore, be used to introduce restrictive covenants such a preventing competition with the company, soliciting or dealing with its clients, and poaching its staff that would remain binding on a member after they left the company.

What should a shareholders’ agreement cover?

Exactly what should be included in a shareholders’ agreement will depend on the company, so it is always important to get specialist legal advice when creating these documents.

Some key matters that are commonly covered include:

  1. Specific rights relating to minority shareholders’ interests.
  2. The transfer of shares from existing shareholders, allowing for pre-emption rights so that any shareholder leaving the company must offer his or her shares to the remaining shareholders and preventing that shareholder from selling to a third party.
  3. Mechanisms for valuing shares of a shareholder wishing to leave the company so that there is no argument at a later stage as to the value of the shares.
  4. Mandatory transfer provisions that deal with matters such as what will happen to a shareholder’s shares if they die, become mentally incapacitated or commit a breach of the shareholders’ agreement.
  5. Mechanisms for how any disputes between shareholders should be resolved.

This list is not exhaustive but provides the type of considerations that ought to be given when setting up a company.

When should you make a shareholders’ agreement?

A shareholders’ agreement can be drawn up at any time during the lifetime of a company. The only time that it may be too late to enter into one is when an issue arises that is not capable of being resolved which could have been resolved had a shareholders’ agreement been entered into in the first place.

If you are starting a company with the intention to have more than one shareholder, then it would be best to create a shareholders’ agreement at the outset. Another time to consider making a shareholders’ agreement is when bringing new shareholders on board.

Unfortunately, many people do not make a formal agreement until after a problem has arisen. In such cases, a shareholders’ agreement may be created to protect the company against future problems once the immediate issue has been resolved.

How does a shareholders’ agreement interact with a company’s articles of association?

All companies are legally required to have articles of association containing rules about how the company will be run. A shareholders’ agreement also covers how the company should be run but is a private contract between the shareholders. Understanding how these documents interact with each other is important and the shareholders’ agreement must be drafted in such a way as to work with the articles effectively.

In an ideal world, your articles of association and shareholders’ agreement would be created at the same time. In reality, the shareholders’ agreement often comes later. Either way, any terms set out in the shareholders’ agreement will need to be in compliance with the terms of the articles of association. As the articles must comply with the Companies Act 2006, ensuring your shareholders’ agreement does not conflict with the articles can be important for overall legal compliance purposes.

How Longmores can help with shareholders’ agreements

If you need help drafting, interpreting or amending a shareholders’ agreement, then the team at Longmores will be happy to advise. We can help to put in place a clear, effective agreement that facilitates effective relationships between shareholders and the company, as well as reducing the risk of shareholder disputes that could harm your business.

Our Company Commercial team can also assist with any other business legal needs you have, while our Business Dispute Resolution team can step in to help with any conflicts you may be facing.

To discuss how we can help you, please contact Michael Budd who will be happy to advise.

Please note the contents of this blog are given for information only and must not be relied upon. Legal advice should always be sought in relation to specific circumstances.