Orr Litchfield
Solicitors and Business Lawyers
Solicitors and Business Lawyers
Shareholders’ agreements are contracts between some or all of the shareholders of a company and, sometimes, the company itself. Their main purpose is to regulate the relationship between the shareholders who are parties to the agreement and the way in which they deal with the company of which they are shareholders.
They may take many different forms depending on factors such as the nature and purpose of the company, the reason for the shareholders’ agreement, the comparative size of the shareholdings of the relevant parties and the roles of the parties in the company.
Neither companies nor shareholders are required to have a shareholders’ agreement. However, they are a useful means of dealing with matters such as the management of the company, board and shareholders meetings, disputes between members, finance, issuing shares, transferring shares, pre-emption rights, rights to information and dividends, confidentiality and restrictive covenants.
A shareholders’ agreement is a private contract and a separate document from the constitutional documents of the company – the memorandum and articles of association – which are public documents.
The articles of association contain rules relating to the management of the company and the separate relationship that exists between the shareholders and the company. It is sensible to make sure that a shareholders’ agreement does not conflict with the articles of association.
The memorandum of association of a company has a limited role in modern companies. However, in older companies it is also sensible to make sure that a shareholders’ agreement does not conflict with it.
There are certain circumstances in which a shareholders’ agreement may cease to be a private document. These include where a shareholders’ agreement has to be filed at Companies House or where it has to be disclosed in the course of legal proceedings.
It is not usually necessary to file a shareholders’ agreement at Companies House. It is a private contract separate from the constitutional documents of the company, which must be registered at Companies House.
The effect of sections 17, 29 and 30 of the Companies Act 2006 is to require a company and its officers to ensure that certain types of resolution or agreement (or, in the case of a resolution or agreement that is not in writing, a written memorandum setting out its terms) are filed at Companies House within 15 days after they are passed or made.
In so far as these provisions relate to shareholders’ agreements, an issue may arise, for example, where (a) a shareholders’ agreement is referred to in the articles of association of the company and the articles are not capable of interpretation without reference to the shareholders’ agreement, or (b) the shareholders’ agreement deals with certain matters that are the same as or very similar to those contained in the articles of association. If the shareholders’ agreement contains wording to the effect that any part of it takes precedence over any provision of the articles of association of the company (for example, in the event of conflict) then that might indicate that the shareholders’ agreement should be registered under the Companies Act 2006. This type of problem can normally be avoided by putting in place properly drafted documents, which do not conflict with each other and adding a provision in the shareholders’ agreement to the effect that the parties will exercise their powers to amend any conflicting provisions in the articles.
A shareholders’ agreement is a contract between the parties who have entered into it. In order to be valid and legally binding, it will need to comply with the usual contractual requirements relating to offer, acceptance, consideration and an intention to create legal relations.
A valid and legally binding shareholders’ agreement will usually grant the signatories numerous rights (for example, with regards to information, voting and buying and selling shares) and impose a variety of obligations (for example, with regards to confidentiality and restrictive covenants).
Importantly, the contractual rights contained in a shareholders’ agreement can be enforced using normal contractual principles. Conversely, it can sometimes be difficult for shareholders to enforce certain apparently similar rights contained in the articles of association of a company as many of these rights need to be enforced by the company itself (which may cause particular difficulties for minority shareholders).
As a shareholders’ agreement is a contract, the remedies available for breach of a shareholders’ agreement are based on contract law. The most common remedy for breach of a shareholders’ agreement is damages but, depending on the circumstances, other remedies (such as an injunction) may be available.
It is usually the case that all of the shareholders in a company are parties to a shareholders’ agreement. However, that is not always the case.
The shareholders who are parties to a shareholders’ agreement may be individuals or other types of legal person, for example, companies. Where companies are involved, it may be necessary to take additional steps in order to ensure that the company does not circumvent certain rights contained in the shareholders’ agreement, such as pre-emption rights.
Some shareholders’ agreements may be between specific classes of shareholders or between groups of related shareholders (for example, families).
The company to which a specific shareholders’ agreement relates may sometimes be a party to the shareholders’ agreement. This is often for defined limited reasons in order to ensure that it remains a private contract and it does not become necessary to file the shareholders’ agreement at Companies House.
Whilst there is no requirement for companies or shareholders to have a shareholders’ agreement at all and shareholders can usually create one at any time, it is good practice for shareholders to put a shareholders agreement in place as early as possible where the relevant company is to be started by or has more than one shareholder. This applies irrespective of the nature, size or business sector of the relevant company.
This means that, in many cases, the founding shareholders of a company should enter into a shareholders’ agreement (often known as a ‘Founders’ Agreement’) at the outset when the company is created. Typically, it will form part of a suite of documents agreed between the founders before incorporation with the majority of the document taking effect once the company has been incorporated.A properly prepared shareholders’ agreement should provide a clear set of rules to regulate the relationship between the shareholders who are parties to the agreement enabling them to focus on building a successful company whilst reducing the risk of future disagreements and disputes between the shareholders. The process will also enable the parties to give full consideration to all relevant issues and ensure, as far as possible, that these are agreed at the beginning.
Where there is a delay in putting in place a shareholders’ agreement, there is an additional risk that some shareholders will not have considered all relevant issues fully at the outset or that they will change their position or expectations in relation to certain aspects of the company over time (without a shareholders’ agreement in place) leaving greater opportunity for future disagreements and disputes between the shareholders. Any such problems will be enhanced where there is a lack of clear rules to regulate the relationship or any disputes between the shareholders (save to the extent that any such issue is dealt with by the articles of association, relevant legislation or common law).
It is sometimes suggested that shareholders may sensibly delay entering into a shareholders’ agreement in order to save financial (or other) resources. However, in view of the time, effort and costs involved in planning and establishing a new company and the potential risks of not putting in place a shareholders’ agreement at the outset, it may be more prudent to put in place an appropriate shareholders’ agreement (as a Founders Agreement). A well-managed and organised business is usually more attractive to a lender or future investor. Whilst an investor is likely to require some changes to any existing shareholders’ agreement as part of any investment arrangements, these may not be significant.
Whilst it is good practice for shareholders to put a shareholders’ agreement in place as early as possible where the relevant company is to have more than one shareholder, there are several scenarios where they are often out in place between some or all shareholders. These include:
This type of shareholders’ agreement may be entered into by the proposed shareholders prior to the formation of the relevant company as part of the overall arrangements between the parties
This type of shareholders’ agreement may be entered into by a limited number of related shareholders, particularly where rules relating to share transfers provide for transfers within family groups without pre-emption rights applying. They are often simply limited to voting rights in order to provide a mechanism to protect and maintain a family’s combined shareholding.
This type of shareholders’ agreement may be entered into by shareholders holding the same class of shares. The reasons and purpose of such agreements are often similar to those for Family Shareholders’ Agreements.
These shareholders’ agreements are often called ‘Investment Agreements’. They are typically a second or third stage shareholders’ agreement created as part of the overall arrangements between the initial shareholders and one or more private or corporate investors when the initial shareholders are raising finance to develop a company. The terms of the shareholders’ agreement and the overall arrangements between the parties are often complex.
The proposed members of a management buy-out (or management buy-in) team (the ‘management team’) may enter into pre-management buy-out agreement, the majority of the terms of which will come into effect as a shareholders’ agreement on completion of the management team. Alternatively, there may be an umbrella agreement between the management team dealing with all of the arrangements to be in place between them including a shareholders’ agreement.
This type of shareholders’ agreement is typically used when existing companies are seeking to combine their assets, knowledge and/or skills for a specific project or purpose. They often have a defined duration.
In many companies, the format of the shareholders’ agreement will evolve over time. In particular, where an initial Founders Shareholders’ Agreement evolves through the addition of new shareholders (particularly in unfunded start-ups) and through one or more rounds of third-party equity investment with several investment shareholders’ agreements.
A company cannot be formed without constitutional documents (in the form of a memorandum and articles of association). Whilst companies can amend their constitutional documents in most respects by following applicable procedures, a company must always have a memorandum and articles of association. These documents are publicly available. All shareholders will be bound by the memorandum and articles of association of the company.
A company does not need a shareholders’ agreement and does not have to be a party to any shareholders’ agreements that are created – although it can be. Shareholders are not required to enter into a shareholders’ agreement but, where there are 2 or more shareholders, it is good practice for the shareholders to put one in place. Save in certain circumstances, a shareholders’ agreement is a private document between the parties to the agreement. Those parties may not include all of the shareholders (for example, in the case of Family Shareholders’ Agreements or Share Class Shareholders’ Agreements).
Whilst the articles of association of a company and a shareholders’ agreement often cover many similar issues, a shareholders’ agreement is more flexible. For example, a shareholders’ agreement may (a) inter-link with other private contracts (such as directors’ service agreements or share option agreements), and/or (b) contain provisions which require a lower or higher proportion of shareholders to determine specific issues or take certain steps compared to the relevant proportion required by the articles of association of a company (for example, in order to amend the articles of association of a company, a special resolution (75% of the voting rights) is required). In addition, the way in which a shareholders’ agreement can be enforced by shareholders is different from the way in which shareholders can enforce compliance with the articles of association of a company.
Yes. As a rule of thumb, you should consider the same issues when entering into contracts with a spouse, family member or friend as you would when entering into a contract with any other third party. Spouses can separate or divorce. Family members and friends can fall out with each other temporarily or for a longer period of time.
Where the relevant company is to be started by or is to have more than one shareholder, it is good practice for the shareholders to put in place a shareholders' agreement as early as possible. This applies irrespective of the identity of or nature of any relationship between the relevant shareholders.
A shareholders’ agreement should provide a clear set of rules and procedures regulating the relationship between the shareholders who are parties to it and the way in which they deal with the company of which they are shareholders. This should help spouses, family members and friends to work together in a co-ordinated manner and to deal with difficult personal and business issues which may have a direct or indirect impact upon the company.
Whilst a shareholders’ agreement may not prevent arguments between spouses, family members or friends who are co-shareholders, it should provide rules and procedures for dealing with many issues which may arise between them in connection with their company enabling them to resolve issues relating to the company.
A shareholders’ agreement is a contract between some or all of the shareholders of a company and, sometimes, the company itself. Accordingly, as with most contracts, it is usually possible to amend shareholders’ agreements whether by adding to, removing or replacing existing clauses in order to reflect changes in the company, its business, the nature or identity of the shareholders or for other reasons.
You should read any existing shareholders’ agreement carefully as it may contain a procedure for changing some or all of its terms and conditions. By way of example, a shareholders’ agreement may include an approval threshold for all or certain types of alterations.
In the absence of any agreed contractual procedure in the shareholders’ agreement for changing its terms and conditions, it is likely that it will only be possible to vary the shareholders’ agreement by mutual agreement of the parties to the agreement. Accordingly, any changes will require the consent of all parties for the time being to the existing shareholders’ agreement.
It may be that there are some alternative solutions to resolving any disputes that may arise between the parties in relation to a proposed variation or replacement of an existing shareholders’ agreement (for example, by altering the articles of association or buying out other shareholders).
When business owners start a new company, it is often the case that they do not put in place a shareholders’ agreement at all or put in place a relatively simple shareholders’ agreement with a view to discussing and agreeing a more sophisticated agreement in due course. This may be, for example, because they are focussed on practical issues relating to the establishment of the business of the new company and lack the time required to put in place a detailed agreement, a lack of available financial resources or because they consider that the articles of association are sufficient to deal with all or most key issues either initially or generally. Inevitably there are risks in failing to put in place a clear and well thought through shareholders’ agreement.
Even where shareholders do enter into a detailed shareholders’ agreement, it is a good idea to review that agreement (and other key company and commercial agreements and arrangements) from time to time. An agreement between the shareholders to review such documents at regular intervals (for example, when reviewing annual business plans) in a formalised manner is likely to make the review process more acceptable to those involved and mean that the shareholders have in place a shareholders’ agreement which reflects the current business plans and structure of the company and its owners.
There are various circumstances where it is more common for shareholders to carry out a review of their shareholders’ agreement. These include:
(a) When a founder or key shareholder wishes to exit the company;
(b) When the company is seeking external investment;
(c) Where changes are being made to the financial interests of shareholders in the company;
(d) Succession planning;
(e) Untimely illness or incapacity of a shareholder;
(f) When improving the decision making efficiency in the company’s business; and
(g) When resolving disputes
Ultimately, it is usually in the interests of all parties to a shareholders’ agreement to create a clear set of rules that enable them to ensure that the company is managed as efficiently and effectively as possible whilst minimising the risk of legal or other problems arising.
In general terms, a company gets new shareholders in 2 ways. Firstly, when new shares are issued to a third party (for example, to an investor) and, secondly, when existing shares are transferred (whether by sale, transmission, gift or otherwise) to a third party.
Whilst company law requires every company to have articles of association, there is no legal requirement for a company or its shareholders to enter into a shareholders’ agreement. New shareholders will always be bound by the company’s properly adopted articles of association (although, depending on the circumstances, they may seek to renegotiate them). The articles of association of a company are a publicly available document. However, shareholders’ agreements are private documents which, in accordance with usual contractual principles, are only binding on those persons who are parties to them. Accordingly, new shareholders will not be bound by an existing shareholders’ agreement automatically. They will only be bound by an existing shareholders’ agreement where they agree to be bound by it.
If a company has a single shareholder then no shareholders’ agreement will exist. In such circumstances, it is usually commercially sensible for the parties to agree the terms of a shareholders’ agreement (and any other appropriate agreements) before a new shareholder subscribes for new shares or existing shares are transferred to a new shareholder.
Where there is an existing shareholders’ agreement, that agreement will typically set out detailed provisions relating to the issuing of new shares by the company and as on how a shareholder may transfer its shares to another existing or new shareholder. These provisions will supplement any provisions contained in the articles of association of the relevant company.
(a) New shares issued to new shareholders
Where there is an existing shareholders’ agreement in place when a company issues new shares to a new shareholder, the new shareholder will often be required to enter into a ‘Deed of Adherence’ (sometimes called a ‘Deed of Accession’) with all of the existing shareholders (and sometimes the company) as a condition to the company registering the proposed new shareholder in the company’s register of members. The result should be that the new shareholder will be bound by the existing shareholders’ agreement.
It may be that the changing share ownership structure or the circumstances necessitate that all parties to the existing shareholders’ agreement will need to negotiate a new shareholders’ agreement with the new shareholder (for example, where there is a substantial new investor).
(b) Existing shares transferred to new shareholders
Similarly, where there is an existing shareholders’ agreement in place when an existing shareholder transfers some or all of its shares in the company to a new shareholder, the provisions of the existing shareholders’ agreement will often require a new shareholder to enter into a Deed of Adherence with all of the existing shareholders (and sometimes the company) as a condition to the share transferor completing the transfer of any shares to a transferee and to the company registering the proposed new shareholder in the company’s register of members. Once again, the result should be that the new shareholder will be bound by the existing shareholders’ agreement.
Deeds of adherence (sometimes called ‘deeds of accession’) are often used as a simple, time and cost-efficient method of binding new shareholders to an existing shareholders’ agreement. They may be used either where a company issues new shares to a new shareholder or where existing shareholders transfer some or all of their shares in the company to new shareholders.
Shareholders’ agreements are usually reasonably lengthy documents which deal with a range of management, operational, financial and other issues relating to the company in addition to setting out various rights, obligations and liabilities of the shareholders.
Where the parties do not require the existing shareholders’ agreement to be changed as part of the process of the company obtaining new shareholders, the new shareholder will simply execute a deed of adherence pursuant to which the new shareholder agrees to be bound by the obligations in the existing shareholders’ agreement whilst also being able to enforce the terms of the shareholders agreement against the company’s existing shareholders.
The format, terms and conditions of a deed of adherence may vary depending on factors such as the ownership structure of the company and the form of the existing shareholders’ agreement. The existing shareholders’ agreement may contain a standardised format of the deed of adherence to be used when the company obtains new shareholders.
The steps that shareholders are required or ought to take in order to change the terms and conditions of an existing shareholders’ agreement are likely to be dependent on factors such as the existence of any procedure for changing the relevant terms and conditions in the existing shareholders’ agreement (for example, any approval threshold), the reason for the proposed changes and the nature and extent of any proposed changes.
Typically, once the shareholders have determined which changes are required, they will either:
(a) Enter into a deed of variation pursuant to which specified existing clauses will be altered or removed and/or new clauses added; or
(b) Enter into a completely new shareholders’ agreement, which will usually replace the existing shareholders’ agreement in its entirety.
It is more common to use a deed of variation where relatively few changes are being made. Where the shareholders intend to make a significant number of changes, it is usually simpler to enter into a completely new shareholders’ agreement. The shareholders may also consider that it is more practical from an administrative perspective to have a single document rather than 2 or more documents – a shareholders’ agreement and one or more deeds of variation.
It may also be necessary to assess whether (or the extent to which) any of the proposed changes may give rise to any other legal issues (for example, any change of ownership clauses in any contracts).Probably! The legal issues which shareholders need to consider are likely to include a variety of issues which are common to shareholders of most companies as well as a number of specific issues which relate to the relevant company, its business and the parties involved in the company
Companies are often set up by a small group of owners, all of whom intend to play a role in managing the business of the company. Depending on the circumstances, it may be that they own (or are to become owners of) equal or unequal numbers of shares in the company and are (or are to become) executive directors of the company. In such circumstances, the parties should consider the constitutional documents of the company and the directors’ service agreements in addition to the shareholders’ agreement.
We will be able to help you identity, prepare and put in place the documents which you require in your specific circumstances.
If you would like more information about shareholders' agreements or would like to discuss an existing or potential shareholders' agreement, please email us at enquiries@orrlitchfield.com, complete an Enquiry Form or call us on +44 (0)20 3126 4520 or +45 38 88 16 00.
