Shareholders Agreement - what they are and why you need one

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24 June, 2020

Owning a company on your own is great, it means you have ultimate control over any decision which the company makes, without having to consider what anyone else thinks. However, as soon as a company is owned by more than one person, things become a little more complicated. The more shareholders of a company the more opinions and therefore, the greater the risk of conflicts arising regarding the management of the company. It is inevitable that not all shareholders will agree all of the time, making decision making more difficult at times and in some extreme cases, shareholders have been seen to petition for the winding up of a company, where there is a deadlock situation and a decision cannot be reached by the shareholders.

This is where a Shareholder's Agreement (SHA) comes into play. A SHA is an essential document for any company owned by multiple shareholders - regardless of the relationship of the parties (even family owned companies would benefit from such an agreement). A SHA will include various provisions relating to the management of a company and decision making, amongst other things and provides an extension to the company's articles of association (Articles), which are not always particularly detailed when it comes to the practical day to day management of a company.

Some of the key provisions which can be covered in a SHA include (but are not limited to):

  • How key decisions must be made and what should happen in the event of a deadlock situation - both at board level and during shareholder meetings;
  • The process for preparing and agreeing business plans and budgets;
  • How directors are appointed, which can include provisions allowing each shareholder to appoint a maximum number of directors;
  • Specific dividend policies;
  • Provisions relating to the transfer of shares and mechanisms to assist shareholders remove a shareholder who may not be acting in the best interests of the company, or who has acted in a way which is inconsistent with company's Articles - which can be particularly important for reasons detailed below further; and
  • Restrictive covenants which shareholders may be subject to whist a shareholder and for a period of time after they cease to be a shareholder.

Unlike a company's Articles, which are publicly available at Companies House, a SHA is a private agreement that only the shareholders will have sight of. This is particularly attractive to shareholders who want to include specific details relating to the running of the company, but which cannot be available to the public - such as a specific dividend policy or details relating to key business decisions which may be confidential.

Another benefit of a SHA which we often see shareholders needing advice on is in relation to "Compulsory Transfer" provisions, which allow shareholders to serve notice on a shareholder who may have done something wrong. This is particularly important when there is a shareholder dispute as neither statute nor the Model Articles, provide such a mechanism to shareholders to remove another shareholder.

COVID-19 impact

COVID-19 has added a further obstacle for companies and shareholders who may need to make important decisions about a company quickly to keep up with the current, uncertain economic climate.

With COVID-19 very much still having an impact on businesses and developments being announced almost every day, it is vital that shareholders understand how decisions can be made and who must consent to certain decisions, before the company can take action. If you have a SHA in place already make yourself familiar with the decision-making process to ensure that this is still adhered to when making quick decisions in response to COVID-19. Also, consider if your existing SHA should be amended to include processes to follow in emergency situations including, what to do if a shareholder is not able to participate in such a process. If you do not have a SHA in place, consider how your Articles currently work and whether these provide you with sufficient protection or whether you should now look to enter into a SHA.

Another impact COVID-19 may have on a company is if a shareholder tests positive for COVID-19 and is admitted to hospital or, subsequently dies. Whilst it is not something which anyone wants to consider, a SHA can provide details on what happens next making the process regarding shares a little easier for all involved. It is usually the case that on death, the deceased shareholder's representative(s) will inherit the shares in the absence of a SHA. This can be problematic for the remaining shareholders as well as for the deceased shareholder's estate, for the following reasons:

  • The remaining shareholders will likely want to retain control and avoid any incoming shareholder taking the place of the deceased shareholder as a result of inheritance - particularly if they have no business background or experience. In addition, the person inheriting such shares may not want to be involved in the company. Therefore, maintaining continuity of ownership is critical to the remaining shareholders who would usually seek to purchase the shares of the deceased shareholder. Provisions can be included in the SHA to set out what would happen to shares in the event of death - one common approach is for a Cross Option Agreement to be entered in to at the same time as the SHA, giving the remaining shareholders an option to purchase the deceased's shares for an agreed value.
  • Accountancy advice should also be sought by the individual shareholders as to how this should be structured to ensure the most tax efficient route is adopted for all involved on the event of death. The shares could be liable to inheritance tax (IHT) therefore advice on the application of business property relief can be obtained and the SHA/Cross Option Agreement can be drafted to incorporate such accountancy advice.

If you are a shareholder of a company that currently does not have a SHA we would always recommend that you enter in to a SHA to protect the interests of the company and all its shareholders, and reduce the amount of avoidable disputes that are not covered by the Articles. A SHA will help maintain a better working relationship between the shareholders as the 'rules' that govern their relationship are consolidated. If you have a SHA we can carry out a review of the same and provide you with advice on how you could update this. We can offer fixed fee packages for the review or preparation of a SHA.

For more information contact Rebecca McCann in our Corporate department via email or phone on 0333 207 1140. Alternatively send any question through to Forbes Solicitors via our online Contact Form.

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