Contact: Phillipa Hobbins; Clarkslegal LLP (Reading, England)
A shareholders’ agreement is a private contract entered into by some or all of the shareholders of a company to regulate the affairs between them. It gives rise to contractual obligations between the parties therefore the usual contractual remedies will be available in the event of breach. There are certain matters which are usually always covered by the shareholders’ agreement and which are often the subject of negotiation between parties.
Scenario
XYZ Ltd has two founding shareholders (the “Founders”) who decide to give 20% of XYZ Ltd to Mr B. The Founders are old friends with Mr B and have decided to bring him on board as a Director to help drive XYZ Ltd so they can look to sell within 5 years. To begin with all goes well, however after 18 months Mr B stops putting in the effort and begins to not turn up to the office or meetings. Things deteriorate more and then the Founders discover Mr B has entered into a financially damaging contract with a supplier, spent £25,000 of XTZ Ltd’s funds on a new car and has set up his own company and is diverting very good business opportunities to his new company. Mr B is now refusing to attend board meetings or to comply with the directions of the Board.
Potential Outcomes:
No shareholders’ agreement
Leaving aside any potential claim the Founders may have on behalf of XYZ Ltd for breach of Directors Duties (Companies Act 2006) in regards to Mr B’s behavior; with no shareholders’ agreement in place the Founders may only take the following action:
- Dismiss Mr B as an employee
- Remove him as a Director (by an ordinary resolution at a meeting (and not by written resolution) so as to ensure the director`s right to be heard. Special notice is required)
Mr B is no longer an employee of XYZ Ltd and is no longer a Director; however he is still a shareholder (and a fairly substantial one). The effect of him still involved in XYZ Ltd could be finically disastrous for the Founders. The Founders now need to negotiate to buy his shareholding and Mr B is fully aware that the Founders unable to force him to sell his shares. As such he continues to receive dividends (on the back of the Founders hard work) and can potentially harm any future sale by demanding better terms of sale for his shares making a buyer decide not to buy XYZ Ltd.
Finally as a potentially parting shot, Mr B is free to sell his shares to whomever he likes, including one of your competitors.
If a shareholders’ agreement was in place
This could vary depending on the agreed terms in the shareholders’ agreement. However an example could be:
Removal as Director:
- Dismiss Mr B as an employee
- Remove him as a Director pursuant to the statutory procedure
Removal as Shareholder:
- Potential sale to a competitor against your wishes
Shareholders’ agreements sometimes include provisions requiring any employee shareholders who cease to be employed by the company to offer their shares for sale to the remaining shareholders. The price at which the shares must be offered for sale (whether market value or at a discount) usually depends on whether the departing employee shareholder is a good leaver or a bad leaver. For example, a shareholder may be a bad leaver where he has resigned within a minimum period of time after being issued shares or he has been dismissed in circumstances in which he is guilty of fraud, dishonesty or gross negligence.
In the scenario above Mr B would be forced to offer his shares to the Founders.
- Competing with XYZ Ltd:
Clauses protecting the competitive interest of a company are very important, particularly in a niche business area. The shareholders’ agreement can include restrictions on shareholders soliciting employees of the company and being involved in a competing business, such as in this case. It may also include restrictions on dealings with key suppliers and customers of XYZ Ltd.
In the scenario above Mr B would be in breach of contract. The most common remedy for breach of the shareholders` agreement is damages; however an injunction may be available at the discretion of the court.
- Potential to harm a future sale?
A shareholders’ agreement and Articles of Association will contain “Drag-along rights” (usually accompanied by tag-along rights).
A drag-along right provides the majority shareholder(s) the right to force a minority shareholder(s) to join a transaction and sell their shares and the same time and under the same conditions.
In the scenario above Mr B would be forced to sell his shares and would not be able to negotiate different terms.
