A shareholders’ agreement is a legal agreement between the shareholders or stockholders in a company. The agreement regulates the relationship, rights, and obligations of the shareholders. The shareholders’ agreement often supplements the incorporation documents and bylaws of the company. Many companies use them due to many advantages such as:
- Confidentiality: Shareholders’ agreements are more like private contracts and are generally not made public, unlike most corporate constitutional documents
- Flexibility: Parties to the agreement can modify the terms more closely to meet the specific needs of the company and the shareholders
- Lower costs and easier to modify than changing corporate documents
Shareholders’ agreements are sometimes known as “stockholders’ agreements.”
What is the Purpose of a Shareholders’ Agreement?
When there is a relatively small number of shareholders, like in a startup company, it is common for shareholders to supplement a company’s organizational documents with a shareholders’ agreement.
There are numerous reasons why shareholders may want to supplement the constitutional documents of the company with a shareholders agreement:
- A company’s organizational documents are typically available for public inspection, whereas a shareholders’ agreement is a private contact. The terms of a shareholders’ contract are normally confidential between the parties
- Shareholders’ agreements are cheaper, less formal, and easier to administer, revise, or terminate.
- Shareholders might want to provide a way for disputes to be resolved by arbitration or in a state other than the one in which the company is incorporated.
- Shareholders may anticipate that the company will require regular changes to the original arrangements, and it may be wise to have the flexibility to amend the document repeatedly.
- Corporate laws in some countries may not provide enough protection for minority shareholders, who may wish to better protect their interests through a shareholders’ agreement.
- Shareholders may wish to provide formulas for sharing valuation to cut down on disputes over values of shares. Shareholders can work out the details of voluntary or compulsory transfers through a shareholders’ agreement.
- Shareholders’ agreements may provide mechanisms for removing minority shareholders when the company’s preservation is an ongoing concern.
- A shareholders’ agreement may restrict shareholders’ activities and prevent abuse of position and competition.
What are the Basics of a Shareholders’ Agreement?
Shareholders’ agreements are intended to ensure that shareholders are treated fairly and that their rights are protected. Shareholders’ agreements include sections outing the fair and legitimate pricing of shares, particularly when the shares are sold. These agreements allow shareholders to make decisions about what outside parties may become shareholders in the future while providing safeguards for minority positions within the company.
Shareholders’ agreements include a date and the number of shares issued. Percentages of ownership by shareholders are outlined and restrictions on transferring shares. Pre-emptive rights for current shareholders to purchase new shares and maintain current ownership percentages are detailed in the event of a company sale.
How Do Shareholder Agreements Differ from Company Bylaws?
Company bylaws work together with a company’s articles of incorporation to form the legal backbone of the business and govern the business’s operations. Shareholder agreements, however, are optional. These documents are often by and for shareholders. They are created to outline shareholder rights and obligations. Shareholders’ agreements can be especially effective when a corporation has only a small number of active shareholders.
What Do Shareholders’ Agreements Cover?
Shareholders’ agreements are specifically tailored to the needs of the company and the shareholders. They may cover a wide range of legal issues and topics and are crafted through careful negotiation. Shareholders’ agreements may cover subject matter such as:
- Ownership of distribution of shares of stocks and other securities in the company
- Control/management of the company, including the election of a board of directors and meeting votes
- Restrictions on interactions between shareholders and other competing businesses
- Initial contributions to the business
- Definitions of the overall purpose and function of the business
As mentioned, shareholders’ or stockholders’ agreements often vary drastically from company to company. They are also subject to frequent revisions and re-workings.
What Does a Shareholders’ Agreement Draft Look Like?
Startup companies often draft shareholders’ agreements initially to ensure clarification of what parties originally intended as they started the company. If disputes arise as the company grows, written agreements can help to resolve issues by serving as an original reference point.
Entrepreneurs may want to delegate who can be a shareholder; what happens if a shareholder no longer has the capacity to own their shares by becoming disabled, passing away, resigning, or being fired, and who is eligible to become a board member.
Shareholder agreements often include the following sections:
- A preamble, identifying the parties, which are commonly the company and its shareholders
- A list of goals for the agreement
- Details about optional vs. mandatory buying-back of shares by the company in the event that a shareholder forfeits theirs
- A right of first refusal clause, detailing how the company has the right to purchase a selling shareholder’s shares prior to them selling to an outsider
- Notes and calculations about fair price shares
- Potential descriptions of insurance policies
What Are Some Common Shareholders’ Agreement Disputes and Remedies?
Like any contractual document, shareholder agreements can be the focus of various legal disputes and lawsuits. Common shareholders’ agreement disputes include:
- Breaches of agreement terms and provisions
- Conflicts over the scope of shareholder rights and duties
- Partnership creation within the agreement, which is permitted in some jurisdictions
- Conflicts involving one specific term or provision, such as those regarding stock distributions and percentages
Remedies for a shareholders’ agreement dispute can often involve a monetary damages award. This is meant to help compensate a non-breaching party for losses caused by an agreement violation. In many cases, the shareholders’ agreement itself may contain terms indicating how disputes are resolved, such as by lawsuit or arbitration. In such cases, the terms of the agreement will be followed when it comes to dispute remedies.
Do Shareholders’ Agreements Need to Be Registered?
Generally, shareholders’ agreements do not need to be registered in order to be effective. Typically, contract law is more binding over shareholders’ agreements than corporate law. If you have any questions about registration of shareholder agreements, contact an attorney.
What are the Risks Associated with Shareholders’ Agreements?
There are certain risks associated with putting a shareholders’ agreement in place. Using a shareholders’ agreement could constitute a partnership, which can have unintended tax consequences or result in personal liability attaching shareholders to bankruptcy.
When a shareholders’ agreement is inconsistent with the company’s constitutional documents, the efficacy of the parties’ intended arrangement can be questioned by courts.
Should I Hire a Lawyer for Help with a Shareholders’ Agreement?
Shareholder or stockholders’ agreements can often be complex and may involve much negotiating. They can also be highly specific and require careful attention to detail when drafting and reviewing them. You may need to hire a corporate attorney if you need assistance with any shareholder agreement issues.
Your lawyer can help with editing, reviewing, and negotiating an agreement. Also, if you need to file a lawsuit over a shareholder dispute, your lawyer can provide you with professional representation during court proceedings.
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