A shareholders' agreement is usually advisable when there is more than one shareholder in a limited company. The provisions of the Companies Act and the Articles of Association are usually not sufficient to cover or regulate the relationship between the company and its shareholders or the relationship between shareholders.
Why a shareholders' agreement is usually drawn up
A shareholders' agreement usually provides for cooperation between the parties in the administration and management of the company and in the conduct and development of the business. This usually provides clarity for the parties as to what the other parties are committed to and how they want to develop the business. The shareholders' agreement also usually aims to safeguard the influence of minority shareholders in the company's activities. However, a shareholders' agreement cannot limit the liability of a shareholder or the company vis-à-vis third parties.
I often come across the question of whether or not they should draw up a shareholders' agreement. On the other hand, many people are not clear about what can be agreed in a shareholders' agreement and what is usually agreed in them. In addition, external financiers or (equity) investors often require a shareholders' agreement between the company and its shareholders as a condition for financing or equity investment. Often, the drafting of a shareholders' agreement also involves amending the company's articles of association and aligning these documents.
Key points of the shareholders' agreement
Below are the main elements of shareholders' agreements, the use and content of which vary significantly depending on the stage of development and ownership of the company. A shareholders' agreement is always drawn up for a specific company and its shareholders, so other matters are usually agreed in addition to the elements set out below.
Parties to the agreement are usually all or some of the shareholders. The company should also be a party to the agreement if all shareholders are involved. Otherwise, the company itself will not be bound by the agreement, which may cause problems in the future.
Aim and objectives of the agreement should be specified at the beginning of the contract as it will help in the interpretation of the contract in case of disagreement. It is also a good idea to include a business plan for the company as an annex to the contract. This will clarify the company's business idea and commit the shareholders to follow it.
On the prohibition on pledging shares should also be provided for in the shareholders' agreement, in order to prevent the transfer of shareholders outside the circle of intended owners. Even if the provision in the shareholders' agreement does not bind the bona fide pledgee, the shareholder who has pledged the shares is in breach of contract and is therefore liable for damages.
Governance and election of the company's institutions should be agreed in the shareholders' agreement, as the provisions of the articles of association usually leave the election of the company's board and managing director to the discretion of the largest shareholders. It is usually agreed that shareholders are entitled to a seat on the board and to specify which board decisions require the consent of all shareholders and which require a qualified majority.
Decision-making by the company's Board of Directors or General Meeting of Shareholders. In general, there is agreement on the exercise of voting rights and, for example, on tightening the majority principle and requiring a larger qualified majority or even unanimity in certain decision-making situations. There is also agreement on influence over the election and remuneration of key personnel and on incentive schemes.
Shareholders' input in the company and the compensation that shareholders receive for their work should be agreed in the shareholders' agreement, so that it is clear to all parties to the agreement who is working full-time in the company and who is more of an investor. The responsibilities of the shareholders for the company's activities are often also agreed. On the other hand, the division of responsibilities between the managing director and the board of directors may also be defined in the shareholders' agreement, within the limits allowed by the Companies Act.
Intellectual property rights (IPR) and know-how and the transfer of these to the company should be agreed. It is generally agreed that any intellectual property rights, patents, utility models, copyrights and other intangible rights, technical know-how and knowledge created or arising in the course of the Company's activities have been and will be created and accrue to the Company and all rights therein will be retained as the Company's rights and protected to the best of the extent permitted by applicable law. Any Intellectual Property Rights arising from all projects and assignments of the Company which have not been agreed to be transferred to the Company's customer shall remain the property of the Company to the extent permitted by applicable law. Similar provisions should and should also be included in employment contracts. The content of this clause varies considerably depending on the company's industry and activities.
On the financing of the company and changes in the share capital is usually agreed in the shareholders' agreement. For start-up companies and companies in which capital is injected, the financial arrangements are agreed in great detail in the shareholders' agreement. At a minimum, it is advisable to agree on the extent to which shareholders are obliged to contribute capital to the company or to lend to or provide security for the company.
On the distribution of the company's assets or used for related-party financing. In general, the principles of asset allocation or the terms of financing to shareholders, such as shareholder loans or guarantees, etc. are agreed upon, as well as the liability of the shareholder, such as the obligation of the shareholder to make additional contributions (paid-up share issue, guarantees, etc.), in case the equity level of the company is at risk, etc.
On dividends and dividend policy should be agreed in the shareholders' agreement. It is common practice, especially in start-up companies, to agree that the company will not pay a dividend in the first few years of operation and that in future dividends will be paid out as a percentage of the annual profits or distributable profits.
New shareholders joining the company and the conditions and procedures by which this is possible may be agreed in the shareholders' agreement. If the shareholders' agreement is drawn up in a situation where new shareholders are joining the company, the arrangement must take into account the relations between the new shareholders and the existing shareholders and the relations of both parties with the company itself.
Non-competition and confidentiality. In general, shareholders agree not to compete with the company and not to become shareholders or otherwise operate in a company that competes with the company. A confidentiality undertaking regarding information relating to the company and its activities is usually included in the shareholders' agreement. These must be confirmed by a contractual penalty.
Withdrawal of a shareholder from the company and the procedures it requires should be agreed in the shareholders' agreement. In general, the possibility of transferring shares in the company to shareholders other than the existing shareholders is also restricted.
Sale of shares. The procedures to be followed when the company's shareholding or control is to be transferred to an external buyer must also be agreed in the shareholders' agreement. It is usually agreed that the board of directors or some shareholders may negotiate the sale of the company's entire shareholding and that if a certain number of shareholders (2/3 or 4/5 etc.) are in favour of the sale, the other shareholders are obliged to sell at the same price per share and under the same conditions. Similarly, minority shareholders are usually protected by a right of prior sale, i.e. they have the right to sell their shares to the buyer at the same price and on the same terms as the shareholders who have sold control.
Redemption clause. The redemption procedure and the redemption price must always be agreed in the share agreement. These arrangements usually also include a redemption clause in the articles of association and a consent clause for the acquisition of shares, as well as a possible right for the company to redeem its own shares. The price of the shares to be redeemed should be clearly defined or a clear formula should be established for calculating the redemption price. In general, I have recommended a procedure whereby a calculation basis is agreed and, in case of disagreement, an independent CPA determines the price according to the calculation basis provided and the parties agree to this result. Using fair value alone will certainly lead to a protracted dispute.
Dispute resolution mechanisms and liability for damages should be agreed in the shareholders' agreement, for example through arbitration or other quick and non-public procedures.
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Breach of the shareholders' agreement
The general principles of contract law apply to the shareholders' agreement. The most important of these is the principle of freedom of contract. This means that such agreements are in principle binding on the parties. A breach of contract is a breach of contract. This in turn may give rise to liability for damages and the right to terminate the shareholders' agreement.
Contractual penalty. For example, when it is very difficult to quantify the potential damage resulting from a breach of a voting agreement, the parties often agree on a contractual penalty, which is in the nature of a pre-agreed compensation. As a general rule at least, the party in breach of contract must pay the agreed penalty, even if the injured party cannot prove the exact amount of damages. It may also be agreed whether the contractual penalty is the final compensation or whether other damages can be claimed in addition to the contractual penalty on the basis of the normal criteria for damages.
The contractual penalty clause typically aims to have a deterrent effect and usually works quite well as such. However, in the event of a breach, the clause may become a difficult object of dispute to interpret. The need for litigation may be reduced if the triggering of the penalty clause requires a materiality or other threshold of the breach of contract and the party in breach must give immediate notice of the breach. This may also allow the breaching party a short period of time to remedy the breach.
Model contracts and drafting a shareholders' agreement
There are many model agreements, guidelines and checklists for drawing up a shareholders' agreement. However, shareholders' agreements are always drawn up for the individual needs of each company and its owners, so they are never suitable for signature as such. Instead, they are useful when used correctly. They provide different options for organising the relationship between the company and its shareholders, and also help when drafting the agreement and negotiating the agreement to remember what should be included in the agreement.
Shareholders' agreements always agree on significant financial values and are usually intended to be long-term, so special attention should be paid to their drafting and at least the assistance of a competent lawyer should be used to finalise the agreement.
The article was written by Jari Sotka, MBA. If you have any questions on this topic, please call Jari on 010 299 5090. The initial assessment is free of charge.
The author has worked as a lawyer and advocate for more than 25 years, focusing throughout his career on preventing and solving legal problems for small and medium-sized enterprises.