A shareholders’ agreement sets out the rights and obligations of a company’s shareholders and stipulates elements of how the business should be run.
As you might expect, this type of document is critical when it comes to making sure that each shareholder is treated fairly and that stakeholders are aligned in relation to how the company will operate.
In this comprehensive guide, we’ll look more closely at shareholders’ agreements, what they can offer, when they should be used and what to include. This will give you an insight into how beneficial shareholders’ agreements can be and whether you need one.
What Is a Shareholders’ Agreement?
A shareholders’ agreement is essentially a contract between the people holding shares in a company. It documents the relationships between the shareholders and can offer protection to minority shareholders too.
As well as establishing the rights and obligations of company shareholders, the agreement may also include clauses relating to how the business is operated. For example, a shareholders’ agreement may state how future directors will be appointed or which pre-emptive rights are available to existing shareholders as the company grows.
Is a Shareholders’ Agreement Compulsory?
No. A shareholders’ agreement is not compulsory, but it is advisable if the company has more than one shareholder.
A contract between the shareholders gives you peace of mind and ensures that your rights are protected. While it isn’t strictly necessary to have a shareholders’ agreement, a well-drafted document can reduce the risk of shareholder conflicts in the future.
In scenarios where the company undergoes significant structural changes, such as during business sale agreements, having a shareholders’ agreement in place can ensure a smoother transition and protect shareholders’ interests.
Furthermore, a shareholders’ agreement can help to ensure the smooth operation of the company and minimise the risk of shareholder disputes leading to legal action and breach of contract claims. In cases where disputes do arise, having clear terms and conditions in place can often prevent the need for lengthy and costly settlement agreements.
What Happens If There is No Shareholders’ Agreement?
If no shareholders’ agreement is in place, the company’s Articles of Association shall be used to determine governance and operation, in conjunction with legislative regulation, such as the Companies Act 2006.
Every company is required to have Articles of Association. If bespoke Articles are not drafted, Model Articles of Association will be used as a default. The company should be operated in accordance with these Articles and, if necessary, they can be referred upon if a dispute amongst shareholders arises. In these instances, it is crucial for company directors to fulfil their legal responsibilities, ensuring the company adheres to its legal framework and avoiding potential breaches of director duties.
However, a shareholders’ agreement typically contains far more information regarding the rights and responsibilities of shareholders than Articles of Association do. As a result, the Articles of Association may not always be sufficient to resolve a shareholders’ dispute.
If a conflict occurs between shareholders and there is no shareholders’ agreement in place and the Articles of Association do not provide a clear-cut resolution, then mediation, arbitration and/or court proceedings may be required to resolve the issue.
In short, a lack of shareholders’ agreement could lead to unnecessary confusion, costly legal action and major disruption to the company.
Can a Shareholders’ Agreement Override Articles?
Generally, no. In most instances, the Articles of Association will override a Shareholders’ Agreement but a supremacy clause could be used to prevent this.
Both the Articles of Association and the Shareholders’ Agreement should co-exist and provide clear guidance on how the company is run and how the shareholders operate. However, if there are discrepancies between the two documents, then shareholders may reasonably want to know which document should be upheld.
Unless there are specific terms relating to this, the Articles of Association will take precedence over a shareholders’ agreement. However, if a supremacy clause has been incorporated into the shareholders’ agreement, it can supersede the Articles.
It is worth noting that directors who are not party to or aware of a shareholders’ agreement may rely on the Articles, as held in Dear and Griffiths v Jackson [2013].
What Should Be Included in a Shareholders’ Agreement?
This type of agreement should include information and processes relating to shareholders’ rights and obligations, including:
- Company name and information
- Shareholders names, details and shareholdings
- Share capital of the company
- Capital contributions
- Parties to the shareholders’ agreement
- How important company decisions will be made
- Protection of minority shareholders
- How shares are managed in the event of:
- the death of a shareholder
- the retirement of a shareholder
- the bankruptcy of a shareholder
- Confidentiality requirements and/or restrictive covenants
- Conflicts of interest
- Methods of dispute resolution
As you can see, there are many elements that can (and should!) be included in a shareholders’ agreement. In many instances, drafting an agreement will force shareholders to consider potential future scenarios that they have yet to foresee. This enables each shareholder to protect their rights in any eventuality and can help to streamline the management of the company.
Shareholders’ Agreements in Practice: An Example
If A, B and C decide to create a new company together, for example, they may be eager to get the ball rolling and excited to embark on their new venture. To facilitate this, A contributes £20,000 and is allocated a 20% shareholding, B contributes £25,000 and receives a 25% shareholding, while C puts £55,000 towards the new business and becomes a 55% shareholder and all shareholders are named as company directors.
As the company becomes increasingly successful, however, disagreements between A, B and C occur. As the majority shareholder, C is able to make decisions regarding the company’s operation, despite A and B’s combined holding of 45%.
Without a shareholders’ agreement to rely on, A and B are unable to prevent C from controlling the company, subject to legislative remedies or clear breaches of the Articles. Even in the event that C breaches regulations or the company’s Articles, A and/or B will be forced to issue legal proceedings to resolve the issue, if an informal remedy is ineffective.
With a shareholders’ agreement in place, however, A and/or B can protect their position as minority shareholders and set out specific procedures for company decision-making to prevent C from having free rein over company operations. Furthermore, if a dispute does arise, the steps for dispute resolution laid out in the agreement can negate the need for costly legal action and instigate a swift and cost-efficient resolution.
Can a Shareholders’ Agreement Be Amended?
Yes. If all of the shareholders agree to the amended, then a deed of variation can be drafted or signed to this effect.
If the original agreement does not cover all eventualities or a shareholder’s position changes, for example, it may be appropriate to amend the shareholders’ agreement. This ensures that the rights and interests of each shareholder can be maintained or adjusted based on their position, while providing clarity for all involved.
Do All Shareholders Have to Sign a Shareholders’ Agreement?
No. Shareholders can choose to enter into a shareholders’ agreement or can decline to do so. As is standard with any contract, each party is free to decide whether or not to agree to the proposed terms.
Although it is possible to have a shareholders’ agreement in place without all shareholders being signatories, this may prove unsatisfactory in practice. If a shareholder is unwilling to sign the agreement, it may indicate that they are unwilling to abide by the proposed terms in the document. If so, this is likely to lead to disputes arising in the future.
To prevent this, it is preferable for a shareholders’ agreement to be signed by all shareholders. Indeed, the process of drafting this agreement is an opportune time for shareholders to discuss any disagreements and come to an amicable resolution.
How Much Does a Shareholders’ Agreement Cost?
The cost of a shareholders’ agreement can vary depending on the length and complexity of the document.
A very complex shareholders’ agreement will naturally take longer to draft and will, therefore, incur slightly higher fees than a more concise document. Despite this, a comprehensive shareholders’ agreement that is professionally drafted can save a significant amount of funds in the long-term, particularly if a costly litigation process can be avoided with reference to the agreement.
Are Legal Fees for Shareholders’ Agreements Tax Deductible?
Not always.
The cost of a shareholders’ agreement is not usually tax deductible in relation to a company’s corporation tax liability.
Legal fees can be tax deductible against corporation tax if they relate to a company’s normal trading activities. This typically relates to employment matters or lease renewals, for example. As a shareholders’ agreement is considered to benefit the shareholders and is entered into by individual parties, it is not usually considered to be part of a company’s normal trading activities and does not, therefore, qualify as tax deductible against corporation tax.
However, the issue of the tax deductibility of legal fees is not always clear cut and it is advisable to seek bespoke legal advice and/or revenue advice before submitting your company’s accounts.
How to Draft a Shareholders’ Agreement
There are templates available that can help you draft your own shareholders’ agreement – but beware of doing this!
A shareholders’ agreement can be one of the most important documents you’ll ever sign, so it’s worth seeking professional legal assistance when drafting the document.
It’s easy to assume that all companies operate in the same way and that a basic shareholders’ agreement will be sufficient in all cases but this is far from the truth. By working with our corporate and commercial legal team to create a bespoke shareholders’ agreement, you can ensure that the document provides guidance and certainty in all instances and protects the rights and interests of all shareholders.
To find out more, contact our team today on 01276 680000 or send us a message.
