A Guide to Shareholder Agreements

A company’s internal management is usually governed by the company’s constitution. A company’s constitution is usually drafted in a standard format and does not provide protection for the company’s shareholders in the event of a dispute between them or where issues, not covered by the constitution, arise.

Such disputes or issues can be resolved by having a shareholder agreement. Whilst the Corporations Act 2001 (Cth) does not require a company to have a shareholder agreement, having one may be beneficial as a shareholder agreement sets out how disputes and deadlocks are to be resolved. It is an effective tool which assists shareholders in resolving disputes or issues quickly, with certainty and finality, thus avoiding the cost of litigation.

What is a shareholder agreement?

A shareholder agreement is a private contract made between all the shareholders of a company, setting out the rights, obligations and liabilities of each shareholder. Such agreements do not have to comply with any set form or procedure. However, the shareholder agreement must be drafted and signed by each shareholder so as to ensure that the agreement is valid and enforceable. Unless otherwise specified, any changes or alterations to a shareholder agreement will need the consent of all existing shareholders of a company.

Do I need a shareholder agreement?

All proprietary companies must provide a constitution upon incorporation and it might be assumed that a company constitution is sufficient to address the rights and obligations of shareholders.

However, a company constitution is usually limited in scope and is focused on setting out the company’s objectives, activities and internal administrative matters. A standard company constitution will not protect a shareholder’s interests in the event of a dispute between the parties or where issues, not covered by the constitution, arise.

In contrast, a shareholder agreement can be an extremely useful legal document for managing any issues affecting shareholders, which are not covered by the constitution.

It is not compulsory to have a shareholder agreement but it is highly recommended for all companies, particularly smaller, privately held companies where there might be a close relationship between the shareholders and management.

When a company is created and there is goodwill between the shareholders, a shareholder agreement might not seem necessary. However, it is easier to negotiate a shareholder agreement at the start of a business venture when issues can be discussed amicably, rather than when parties are frustrated by disagreements down the track.

What to include in a shareholder agreement

For a shareholder agreement to be useful it needs to be customised to meet the specific requirements of the company and its shareholders.

Listed below are some common provisions contained in most shareholder agreements:

1. Priority of shareholder agreement over the constitutionIn the event of any inconsistency between the shareholder agreement and the constitution, the shareholder agreement prevails.
2. Alternative dispute resolutionIt is prudent for any shareholder agreement to contain alternative dispute resolution (ADR) processes such as mediation, conciliation or arbitration to assist parties in resolving their disputes before any formal litigation is commenced.
3. Deadlock breakerThese provisions deal with circumstances where shareholders cannot agree on the management of the company. They can include:
   • A shotgun clause, which works by allowing a shareholder to break the deadlock by purchasing the shares of the other shareholder at a nominated price.
   • A chairman clause, which allows one shareholder to become the chairman and have the casting vote; or
   • A liquidation clause, which provides that the company is to be voluntarily wound up if the deadlock continues for a set period of time.
4. Pre-emptive rightsThis imposes restrictions on the transfer of shares. A provision can require exiting shareholders to offer their shareholding to existing shareholders first, before the shares are offered to external parties.
5. Drag-along, tag-along rightsThese provisions are aimed at balancing the rights of a majority shareholder and a minority shareholder. Under a drag along option, majority shareholders can require a minority shareholder to join in the sale of shares in the company. Under the tag along option, where a majority shareholder is selling shares in the company, the minority shareholder has the right to join the transaction and sell their minority stake.
6. Mandatory sale eventsA provision which sets out triggers for the mandatory sale of shares in certain circumstances (for example, a director passes away, resigns or files for personal bankruptcy).
7. Share valuation methodsIt is prudent to set out the method by which shares are to be valued in relation to pre-emptive rights and mandatory sale events. For example, shareholder agreements often provide for the appointment of an external valuer with set criteria for the share valuation.

Conclusion

A shareholder agreement is best prepared when a company is first incorporated, when there is goodwill between the parties and there have not been any disputes or disagreements about the management of the business.

It is a useful document, setting out the rights, obligations and liabilities of the shareholders and how risks and disputes are to be managed or resolved in the future.

A shareholder agreement should be professionally prepared as it needs to be drafted clearly and concisely and tailored to the particular needs of the shareholders and company.

If you or someone you know wants more information or needs help or advice, contact Frichot and Frichot today or complete the form below to request an Introductory Consultation.