Shareholder Agreements

Shareholder Agreements
– some scenarios in favour of having one

If you are a shareholder in a company with one or more other shareholders, or are about to become one, then please consider the following:

• The default legal position is that once shares are issued to a person, and they are ‘fully paid up’, then:
  • the shareholder will be entitled to receive the correct portion of any dividends declared as well as their percentage capital share value on any exit / sale; and
  • it is very difficult, if not impossible, to force a shareholder to transfer their shares for any reason, and they may simply decide to remain a shareholder if they wish to for as long as they like.
• Given the above, you may wish to consider the following fact scenarios:
  • a shareholder who is also an employee or director, contributing to the business, suddenly resigns or leaves for any reason;
  • a shareholder who is also an employee or director, contributing to the business, suddenly becomes seriously ill or suddenly lacks mental capacity (e.g. through a stroke or car accident) and can no longer contribute anything further to the business in the medium or long term;
  • a shareholder dies and their executor (or beneficiary under their Will) then becomes the shareholder – perhaps with considerable power regarding the company’s business affairs; or
  • a shareholder who is also a director or an executive employee of the business starts acting detrimentally to the wider business interests (e.g. being aggressive or inappropriate to key staff members), possibly because they go through a tough period in their personal life or they start to become aligned to competing interests.
• In each of the above scenarios, without clearly agreed “buy – sell’ provisions in a binding Shareholders Agreement, the remaining shareholders are likely to be left with a continuing shareholder model that is either unworkable or undesirable – potentially dragging the business down if key decisions are unable to be made.  The resulting circumstances can be very tedious and costly.
• In some scenarios, an insurance pay-out can also be very helpful with facilitating a smooth and relatively cost-free shares transfer at that time.
• A registered Constitution, if in reasonably standard form, will not address the above types of issues, and any “rights” held by the remaining shareholders under the Companies Act 1993 (Act) may be costly and uncertain to enforce.  Standard Constitutions usually have sections which govern and control the transfer of shares – but only if a shareholder decides to sell !
• Having clear “buy – sell” rules in a Shareholders Agreement (with terms more favourable to the ‘non-defaulters’) could be a “life-saving” and very cost-effective document to be able to pull out, especially when the other expensive litigation-related options are considered.
• All of the above is on top of the other clear benefits of having a well drafted Shareholders Agreement, including as regards:
  • Board appointment rights, given the Act just requires a simple majority shareholder vote to appoint or remove a director whereas a shareholder holding between 25% and 49% will likely want to ensure they have a Board seat and vote;
  • Future funding, if bank funding is not available then who will fund the cash requirements of the business and on what terms, and might a non-funding shareholder be diluted?;
  • Shareholder cross-indemnities for business-related liabilities (if one shareholder ‘takes the hit’ under a personal guarantee for example), so as to ensure fair and equitable sharing of business liability exposures;
  • Confidentiality & Intellectual Property, so that what belongs to the company following lengthy investment remains with the company and does not ‘walk’ with any shareholder’s departure;
  • Non-Competition Restraints, for an appropriate and enforceable scope and duration; and
  • Dispute resolution mechanisms, to avoid expensive litigation in the context of any shareholder dispute.

Considering the above and other issues at the outset is likely to be far more cost-effective for all parties in the long run.  Without such provisions, remaining shareholders are sometimes forced to pay substantially above value in order to gain agreement with an ‘exiting’ shareholder.  That overpayment portion could have been used as working capital for the business.  All ‘food for thought’.

Sean Lynch

Barrister & Solicitor, Director

If you require any commercial legal assistance, please contact Sean Lynch at sean@lynchandco.co.nz, or ph 09 948 8433. 

The above article is not intended as legal advice because each set of circumstances will differ.  Specific legal advice is required for any particular case.