Shareholders Agreement

A company is made with the support of many shareholders which can be said as the true owners of the company. This relation is necessary to be made binding and for that purpose, what is requisite is a shareholder’s agreement. This is an agreement between the shareholders and the company describing all the obligations and rights relating to the relation between them. 

Shareholders' agreement is a part of the proper planning that is absolutely essential for the success of any business. Some have plans that are well written for operating their business, and very few have any effective plans to deal with the issues that might arise between shareholders. A business having multiple shareholders must ensure that the company has a properly structured shareholders agreement that would protect everyone’s interest. 

There is never a substitute for corporate governance and to implement this shareholder’s agreement, the best time is when the business is high and good, everyone including shareholders are happy and shall not wait for the three D’s, that is, Death, Disability or Divorce. 

To simplify, a shareholder’s agreement is that contract which administers the relationship between the shareholders. Structured properly, it would not cause any barrier in the regulation of a company’s operations even if the relationship fails or in the event if one party leaves the company. A well-drafted agreement would be efficient and an effective mechanism for a succession of business to the next generation or any other party. If not planned properly, this would impact the ability of shareholders to realize value on their shares. And if planned properly, the company will continue to run smoothly in any circumstance of disability, death or retirement of a shareholder. 

• Different Authority

There is distinction of authority from the shareholders agreement. The respective rights and liabilities of the shareholders are underlined from the shareholders agreement. Moreover, the authority is well defined in the shareholders agreement.

• Shareholders Agreement can be Amended

The shareholders agreement can be amended as per the requirement of the shareholders. However, for this a special resolution has to be passed by the shareholders. Majority of vote of the shareholders is taken for this form of resolution.

• Protection to Minority

There is delineation between minority shareholders and the majority shareholders. Hence their respective rights and liabilities are separated.

• Control over the Company

By having the shareholder's agreement, there can be some form of control over the affairs of the company. The authority of the company can be established by the shareholders.

• Provides Basic Restrictions

Specific forms of provisions related to the transfer of shares would be mentioned in the shareholders agreement. For the transfer of shares there will also be a restriction on the transfer. Specific consent related to such transfers would also be dealt with in the shareholders agreement.

Properly structured shareholder’s agreement includes the determination of future and current ownership of shares, proper transition for the departure of a shareholder, restrictions on transfer or ownership of the shares, a market (or value) for share transfers, protection of interests of minority shareholders and dispute resolution.

Shareholder agreement has been entered into to resolve any dispute between shareholders and the company. We cannot guarantee that nothing will ever go wrong and in such a situation when there is no certainty, such agreements will help us to resolve disputes if possible and to maintain a healthy relationship between shareholders and the company. It also helps to protect the investment made by the shareholder and imposes the rules and regulations of shareholders and any other party affiliated with the company. It is important to manage the shareholder agreement because not all shares are the same. The agreement should be written in such a way that everyone is different and has a different opinion on the topics or issues involved. And whether they can agree or disagree.

• The proportion in which shareholder will hold the shares.
• Different classes of shares for different categories of shareholders (that consist of founder, majority and minority shareholders).
• Whether there are any shares recently issued in the market and whether the already existing shareholder would get any privilege of priority in issuance of such shares.
• Whether the board of directors are capable of stopping issuance of new shares or transfer of shares.
• The rules in regards of transfer of shares.

Shareholder’s consent

It contains such cases and situations in which the shareholder's consent to a number of matters. For example, the shareholder's approval will be based on the issues mentioned below:

• Whenever a member i.e. a manager, any member of the board of directors is appointed, or the shareholders' approval will be issued.
• Whenever a financial statement is written or shares are being distributed.
• When a company wants to amend an organization's articles.
• When you enter the merger or filling of the crumbs.
• When the company is dissolved.

 An example of a permit section is as follows:

“Where this Agreement provides that, any transaction or any issue that require approval, consent or agreement by any shareholder then such approval, consent or agreement may be granted, subject to such conditions and terms as such that the shareholder may enforce and any such breach of these terms and conditions by any person subject thereto ipso facto shall be deemed to be a breach of this Agreement.”

Dispute Resolution

It would be quite modest to say that there are no potential conflicts while investing in a company. Therefore, the company should also be prepared for such events. An argument is not just about conflicts within it and also means arguing with a rival company or a competing company.

To resolve disputes with shareholders, companies often opt out of court proceedings such as mediation or conciliation between the company and the shareholders.

An example of a dispute resolution clause is as follows:

“All the disputes arising between the partners on the effect or interpretation of any clause of this agreement or some other differences arising out of the partners, which cannot be resolved collectively, shall be referred to arbitration of ___ or any other arbitrator nominated by the parties in writing. The decision of such an arbitrator will be binding on the parties.”

Right to the first refusal

This right basically protects the company and its existing shareholders from the sale of shares to a competing company or to those persons with whom the company does not have a good relationship. When some shareholders wish to sell their share, the clause in the shareholders' agreement must stipulate that the shareholders wishing to sell their shares must demonstrate the right to match the offer received from a third party. This is known as the right to initial refusal.

Rights of Buy-Out

Shareholder agreement must include a condition of the purchase rights which is when the shareholder is found to be unable to work due to certain major events namely; death, disability, bankruptcy or dissolution of a marriage, the company or existing shareholders may purchase the shares of the shareholder. It includes a clause called “expulsion” in which existing shareholders can dismiss anyone with undesirable shares and retrieve his or her shares.

Drafting of Shareholder Agreement

• One needs to understand the need for a shareholder agreement including why it is important to create a balance between shareholder interests and company interests.
• Do not make the terms vague, but keep them accurate that interrupts the translation of words. Extensive translation creates problems over time.
• Specifically, list the rights and obligations of both parties – i.e. shareholders and the company.
• Remember that there is a high probability that the shareholder may want to leave - the clauses relating to that process should be clearly stated.
• The stages of dispute resolution should be clearly defined especially in the following points - how to resolve disputes, dispute resolution area, powers and functions etc.
• The limits for the transfer of shares must be clearly defined and the same procedure must be set.

Piggyback Provision

Smaller shareholders may be offered the opportunity to sell their shares to a third party at the same price and conditions as the majority shareholders. The reverse-piggyback clause would make more shareholders to force smaller shareholders to sell their shares to a third party in the additional condition that the buyer should acquire all the company’s shares.

Shotgun provision

This is a quick and effective way to resolve situations where shareholders can no longer work together. Usually, one shareholder sends a promise to buy all the remaining shares held by another shareholder; the shareholder receiving the offer will then choose to sell his shares or buy the shares of the shareholder who did so at the same price as the terms provided.

This provides an incentive for the creative shareholder to make the appropriate contribution as they may be forced to sell at the same price and on the same terms. On the other hand, it can also allow a wealthy shareholder to take advantage of a low-income shareholder.

The use of this provision is usually the last resort to settle disputes.

Fair market value compared to discounted price

Including a method that will be used to inform the shareholder’s shares of moving shares in various circumstances (death, disability, retirement, etc.) can provide the shareholder (and his or her estate) with peace of mind. 

Without an agreement, there can be costly disputes or unnecessary financial burden on the business. In some cases, the fair market value should be used to determine how much a moving shareholder earns.

In some cases, a discounted price may be appropriate (such as the expected departure of the shareholder). There are a variety of stock options to make sure that a qualified professional is used when making this condition and informing the business.

A shareholder agreement is a way to save a company from losses and protect its interests. Each shareholder agreement must contain the essential provisions mentioned above to create a balance between the interests of the shareholders and the interests of the company.