Private Companies: The importance of a Shareholders’ Agreement

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Jacksons Law Firm corporate and commercial solicitor David Artley offers some crucial advice to private business owners around the importance of Shareholders’ Agreements…

There is an easy way to find out how important a shareholders’ agreement is: call a corporate/commercial solicitor and ask for advice about dealing with a situation in your company involving another shareholder.

Their first question will be “do you have a shareholders’ agreement?”. If you operate a business though a private limited company with joint shareholders, you should have a shareholders’ agreement.

To understand why they are so important it is helpful to understand how the law sees a company, the documents which govern it and the interplay between them. A company is a legal entity, in many ways similar to a person; it has a distinct ‘personality’. This means that the company can own property, can be sued, can sue and can enter into contracts in its own right. The company owns its assets and the shareholders own the company.

What a company cannot do, of course, is make decisions; for that it has its board of directors. This introduces a tension between what may be the best outcome for the company and what may be the best outcome for the individuals acting as directors. To deal with this, the law has two mechanisms: it places duties on directors to act in the best interests of the company and it gives shareholders the power to define the powers of the directors.

The first way the shareholders exercise this power is through the articles of association. This is the main constitutional document of a company; it is where the directors get their power to act in the name of the company. It sets out what they can and cannot do and it can be altered if the 75% or more of the shareholders agree. The second way is that the law requires directors to ask the shareholders to vote to approve certain actions, called resolutions. Resolutions can be ordinary (those holding more than 50% of the shares must agree) or special (those holding 75% or more of the shares must agree).

So far, so good. We have a company being operated for the benefit of the shareholders and they have the power to hold those running the company to account. There are problems with relying on just these provisions, however.

Most obvious is that the power to make decisions is linked to how many shares are owned. If you only own 20% of the shares there is very little you can do to get your voice heard if the remaining 80% of the shares want to take a different route. 20% could represent a significant investment which you want to protect, and the company may have difficulty getting that investment if it is not protected. What about 50/50 ownership where the two owners vote different ways? Deadlock.

Second is that the content of the articles of association is governed by the Companies Act 2006. They can only regulate what the law allows them to regulate in a company and only within the boundaries the law allows. If the Companies Act says that a special resolution is required, the articles of association cannot say that an ordinary resolution will suffice, for example.

The third is linked to the second. The articles of association are essentially a contract between the company and each shareholder, not between the shareholders. They govern how the company is operated for the benefit of all the shareholders; the focus of which is to protect the shareholders, not to protect the company from the shareholders. They cannot, for example, prevent your fellow shareholder setting up a rival company.

It is here that a shareholders’ agreement comes in. It is an agreement between the shareholders setting out how they will use the powers and rights which attach to their shares and it is enforceable by each shareholder against the other shareholders. It is not regulated by the Companies Act so it can cover a far wider range of situations and it can be very flexible.

For example, if you want a different voting threshold for a particular decision it could require a vote is held beforehand and the shareholders then have to vote to give effect to that vote, no matter if they disagree. Or it could prohibit a shareholder from competing with the company while still a shareholder, perhaps even require all shares to be sold if the shareholder tries to compete.

One way shareholders’ agreements are often used is to set out what will happen when the founders want to sell up and realise their investments. If a takeover offer is received, can you require others to accept it? Or can you prevent them selling their shares unless the buyer will buy yours, too? You could have a lot riding on this, and it is good to know where you stand.

Often, though, we come across shareholders’ agreements where there has been some problem. Without one you can end up in a very difficult and expensive argument, but a well drafted agreement can set out a clear route to peace. Anecdotally, it seems as though companies with a shareholders’ agreement have fewer shareholder arguments in the first place.

Planning for the situations and decisions of the future when there is goodwill and calm is a fantastic way of ensuring the long term success of your business and, ultimately, of you.

David Artley
Solicitor, corporate and commercial, Jacksons Law Firm