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Company Formation Home Page  >>  UK Limited Company Formations Guide >>  UK Shareholders Agreements

SHAREHOLDERS AGREEMENT. SOME USES OF SHAREHOLDERS' AGREEMENTS:

In a United Kingdom limited liability company it is possible that, in order to obtain some degree of protection of control, the members would wish to bind themselves either to preserve the status quo or to stipulate that should one or more member(s) wish to withdraw from the company, that the other members should have the right to purchase or find purchasers for the shares (i.e. a right of pre-emption of first refusal on the shares), rather than them being sold to an outsider. This particularly important where the voting strength is heavily unbalanced.

If you are setting up a limited company with others one of the many things you should consider is a Shareholder Agreement. This factsheet looks at why you need such an agreement and what such an agreement should contain. If you decide to enter into a business partnership with someone you would no doubt have a partnership agreement to set out who does what, who is entitled to what and so on. But similar rules apply if you are setting up business with someone as a limited company. If you're setting up a limited company with others you will no doubt all own shares in that company and so it's best to have an agreement in place to avoid future misunderstandings and problems in running the business. Shareholders agreements are private arrangements between the shareholders in a company. They deal with the same things often found in partnership agreements.
Finding and Using Information on This Page:  Shareholders Agreement - Contrast with the Articles of Association | Some Advantages of Shareholders' Agreements | Shareholders Agreement - Some Drawbacks | Matters Commonly Included in Shareholders' Agreements | Shareholders Agreement - From £35.00 | 

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Shareholders agreement. Includes clauses on share transfers, new members and breach - all with a plain English explanation. Suitable for use by UK business. Shareholders in privately held companies often perceive their company and its ownership in context of incorporated partnership with pro rate sharing of decision-making, income, obligations and value. As with any contract, legal assistance is essential for your own protection. Because of different circumstances for each business relationship, a standard or off-the-shelf shareholder agreement won't be appropriate to your circumstances. You'll have to craft a custom agreement to fit your specific needs and arrangements. An effective agreement can't be prepared without the help of an expert.
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Shareholders agreements are used because even the smallest business has to operate under the same company rules as much larger ones. In many instances a small limited company is often more like a partnership than a quoted company. Using a shareholders agreement allows the best of both worlds. The company can be run as if it were a partnership with the advantages of limited liability and any other reasons behind forming the company in this way in the first place.

Solicitors here advise on and supply documentation relating to the relationships between shareholders in limited companies and conduct litigation and arbitration arising from disputes between them. It is often prudent for shareholders to document the terms of their agreement. This is often done by the insertion of special provisions in the company's articles of association or by a separate agreement ("shareholders' agreement") between shareholders or by a combination of the two.

Shareholders in private limited companies address issues such as restrictions on the transferability of their shares and the absence of a market for sale of those shares, especially if the shareholder is not in a controlling position. A person acquiring shares in a private company without obtaining control will prudently seek special protection and rights to safeguard his position.

Where the affairs of a company can be demonstrated to have been conducted by the majority shareholders in a manner unfairly prejudicial to the minority shareholders, a right of action for an injunction and damages may be available by way of application to the Companies Court. Our solicitors are experienced in Companies Court litigation.

Here are some uses of shareholders' agreements: to give to a shareholder rights which would otherwise be unenforceable if inserted in the company's Articles - e.g. personal rights (as opposed to rights as a member), such as a right to be appointed as a professional adviser to the company. To regulate the special relationships between shareholders which have nothing to do with the administration of the company - e.g. if one or more shareholders are investing in the company. To protect minority shareholders' rights - e.g. by giving them a power of veto which they would not otherwise enjoy under Company Law. To preserve confidentiality.

Shareholders' agreements, properly structured and funded, are a critical part of any business with more than one shareholder. A well-thought-out agreement provides an orderly way to transfer shares in the business and helps keep the business running smoothly in the face of future events such as death, disability or retirement of a shareholder.

These agreements generally establish a purchaser for the shares of the deceased or existing shareholder, a formula for determining the purchase price of the shares, and a method for funding the purchase. A venture capitalist who does not acquire control with his purchase of company stock will usually require a shareholders' agreement as a condition of funding. Management that sells a controlling interest in its company's common stock normally insists upon a shareholders' agreement to ensure its continued ability to run the company.

Shareholders' agreements can take a variety of forms and can serve a variety of purposes. They are usually in writing and signed by persons who together own at least a majority of the outstanding shares of the company's voting stock. Shareholders' agreements enable a minority shareholder to exercise more control over a company that he would have otherwise. (By voting his minority interest in the company's shares, he would have no control).

A venture capitalist, for example, will almost always insist that management agree to vote its shares so that he will be ensured a seat on the company's board of directors. Sometimes an investor will ask for other types of control as well, such as the right to veto certain important financial decisions made by the directors.

Shareholders' agreements often contain other provisions affecting management and its relationship with its investors. These provisions commonly contain limitations on the manager's ability to sell his shares to outsiders and provide for the disposition of his shares in the event of his death or termination of employment. Shareholders' agreements are also commonly used for estate planning purposes. Management should consider shareholders' agreements carefully. They should have a limited term and, in most cases, should terminate in the event of a public offering of the company's stock or sale of the company. If you have any questions please E-Mail or call us: 0800 081 1510 or +44 (0) 207 637 3881, fax: +44 20 7681 3318.

CONTRAST WITH THE ARTICLES OF ASSOCIATION:

The Articles of Association of a company are the rules governing its internal management and administration. The Articles are governed by Company Law and are binding on all the members of the company. A shareholders' agreement is an agreement between the members of a private limited company which is governed by the normal law of contract. Some matters covered in a shareholders' agreement may equally be incorporated in the Articles of Association - pre-emption rights, for example. However, bearing in mind that the Articles of Association are open to public inspection, it may be more appropriate in some circumstances to deal with matters in a shareholders' agreement for reasons of confidentiality.

Care must be taken in drafting to ensure that the true effect of the provision of a shareholders' agreement is not to alter or amend the Articles of Association. A shareholders' agreement which does so must be registered at Companies House in the same way as a resolution to amend or alter the Articles, thus forfeiting the advantage of confidentiality.

It is common for the company itself to be a party to a shareholders' agreement both to ensure that it is bound by obligations which might otherwise have appeared in the Articles of Association and to oblige the directors indirectly to give effect to the obligations in it.

SOME ADVANTAGES OF SHAREHOLDERS' AGREEMENTS:

Here are some uses of shareholders' agreements: confidentiality - provided a shareholders' agreement is drawn carefully so as not to alter or amend the Articles of Association there is NO NEED to file it at Companies House. Can be altered by simple agreement rather than using the formalities of meetings required by companies' legislation. Can be terminated by simple agreement.

For small private companies shareholder agreements offer a valuable addition to the constitutional regime embodied in the memorandum and articles of association. They have the advantage of relative privacy and cannot (in the absence of provision to the contrary) be modified without unanimous agreement.

The value of such agreements was made apparent in Russell v Northern Bank Development Corp Ltd [1992] BCC 578; [1992] 1 WLR 588 where the House of Lords held that such an agreement, although incapable of fettering the statutory entitlement of a company to increase its share capital, could place curbs on the manner in which members exercised their voting rights within the company when exercising a vote on a capital increase. The practical utility of such an agreement thus received support from the highest court in the land.

The interpretation of a shareholders' agreement was at the fore of the litigation in Euro Brokers Holdings Ltd v Monecor (London) Ltd [2003] BCC 573; [2003] EWCA Civ 105. This case concerned the enforceability of a provision in a shareholders' agreement, made in the context of a joint venture company, requiring a member to sell its shares to the other member in defined circumstances. That question turned on whether the triggering event (a purported board decision) was valid or whether it could be regarded as valid by applying the Duomatic principle (Re Duomatic Ltd [1969] 2 Ch 365) of informal shareholder assent.

Both the judge at first instance (Leslie Kosmin QC) and the Court of Appeal (Pill, Waller and Mummery L.JJ.) agreed that this pragmatic common law principle could operate in the context of a shareholder agreement.

SOME DRAWBACKS:

There may be complications when a member who is signatory to a shareholders' agreement transfers shares: the new member MUST agree to be bound by the shareholders' agreement and the old member released from it - this can be easily overlooked. Shareholders' agreements can become unwieldy if the number of shareholders increases substantially.

All business partnerships start out with good intentions. They vary in form but they have one thing in common - the capacity to go horribly wrong. Disputes can arise between shareholders for many reasons; over business strategy, composition of the board, succession planning and workloads, to name but a few. Shareholder agreements are supposed to take account of such eventualities but who can foresee everything?

"More often than not there is more of the human element to these disputes," says John Reynolds, head of litigation at London law firm McDermott Will & Emery. "Shareholder agreements have basic provisions for areas of possible disputes but often fail to take into account the fact that people change and, as a result, find they have very different ideas about how to move the business on. When you are dealing with disputes between individuals as shareholders, emotions run high."

Family businesses are no more prone to faulty shareholder agreements than any other business, he says but the effects of a falling out can be devastating. "A family business requires the same elements of a shareholder agreement as any other company. It may be far less palatable to contemplate that you will have a mass fall-out with your father or your brother but it does happen," says Mr Reynolds.

One classic problem with shareholder agreements that everyone should tackle is the issue of share value when a shareholder wishes to exit, says Tong Bogod, a partner at BDO Stoy Hayward, the accountancy firm. He also cites the issue of minority discount and the fact that many people do not realise that owing 20 per cent of a private company worth £1m does not mean their share is worth £200,000 if they wish to leave.

David Gallagher launched Prime Time Recruitment in 1992. Initially it comprised himself and a non-executive chairman, followed by several more investors and, to date, a total of 16 shareholders.

"We lost a couple of shareholders early on because they felt they were doing more than some of the other shareholders. They were wrong; they simply weren't seeing the full picture across the board."

As the business grew, Mr Gallagher needed to bring in senior executives, who wanted to have equity or a salary package plus share options.

"This was something we had planned for when we drew up the shareholder agreement and we had put some equity to one side: 2.5 per cent of the 3I's [the venture capitalist involved in the business] equity and 2.5 per cent of management equity. Even so, some of the board members saw this as a diluting of shareholder value." He argues that the value that new executives bring to a company can increase its value to shareholders.

Further problems loomed when the buy-out valuation clause of the shareholder agreement was enacted. It set out that shareholders a level down from the main board would receive an amount decreed by a set formula, involving multiples of share value, while for members of the main board the calculation was done by an external assessor. As a result the departing board member gained little value.

Although we are likely to see an increase in insolvency litigation in company cases over the next few years it must be remembered that a significant percentage of company cases coming before the courts involve internecine disputes centred on solvent businesses.

Litigation featuring unfair prejudice petitions pursuant to section 459 of the Companies Act 1985 continues to flow through the courts at a steady rate. Having said that, much of the new case law merely applies principles that are well established. Occasionally a novel application arises.

It is impossible to define with precision what is meant by unfair prejudice. It now seems clear that we are concerned with inequitable behaviour rather than conduct which in common parlance might be said to be unfair (see the comments of Jonathan Parker J. in Re Guidezone Ltd [2000] 2 B.C.L.C. 321 at 355-356. As a test it mutates according to the type of company involved. In Brownlow v. GH Marshall [2000] 2 B.C.L.C 321 it was emphasised that what might be fair in a purely commercial setting might not be so regarded where the company had a strong "family" flavour.

It is now established that exclusion from management may be sufficient grounds for a successful petition - thus in Richards v. Lundy [1999] B.C.C. 786 the removal from office of a director with a 10 per cent shareholding was sufficient to justify a section 459 petition even though he had made no substantial financial contribution to the business; that did not necessarily exclude the notion that the company had been incorporated with a quasi partnership in mind under which all participators would take part in management.

The law is so firmly entrenched here that it is hardly surprising that the Law Commission felt that there should be a rebuttable presumption of unfair prejudice in such exclusion situations.

Inappropriate behaviour by a controller is equally likely to found the basis of a successful petition. In Re Regional Airports Ltd [1999] 2 B.C.L.C. 30 Hart J indicated that self serving behaviour on the part of a controlling shareholder which was designed to further his ulterior interests rather than to benefit the company could justify a conclusion of unfair prejudice.

The most contentious issue concerns the enforcement of participators "legitimate expectations". The House of Lords took a strict view in O'Neill v. Phillips [1999] 1 W.L.R. 1092 and was clearly reluctant to allow the concept to be exploited as extensively as it had been previously (see Palmer's In Company 07/99). On the other hand, the Scottish courts continue to support petitions founded upon this ground. In Anderson v. Hogg 2000 SLT 634 the Court of Session (Outer House) indicated that legitimate expectations could exist outside the parameters of the articles of association and the court should consider whether the parties had been working together informally in a way not anticipated by the formal constitution.

In its latest pronouncement on the subject the Company Law Review (see Completing the Structure URN 00/1335) refused to recommend the statutory reversal of O'Neill v. Phillips (supra) in spite of significant pressure to do so.

Not all petitions under section 459 succeed. Indeed the likelihood is that in the future this failure rate will increase. This is a predictable consequence of what appears to be a less sympathetic approach towards such petitions on the part of the courts. One cannot but hope that improved case management techniques now at the disposal of the courts will weed out the more unpromising petitions at an early stage.

Where an unfair prejudice claim has been established, notwithstanding the guidance offered by section 461 the court enjoys complete discretion as to remedial action. Normally a share buyout will be the preferred option. The court here enjoys great freedom of manoeuvre in determining the most appropriate valuation date for the petitioners shares. In Richards v. Lundy (supra) the date of judgment was identified as the appropriate time for valuation. For example, in Profinance Trust SA v. Gladstone [2000] 2 B.C.L.C. 516 the starting point for a complex valuation case was taken to be the deemed value of the shares at the date of the petition. A similar and flexible approach to valuation was adopted by Pumphrey J. in Re Eurofinance Group Ltd, The Times, July 4, 2000 where the circumstances of the case dictated that the company be valued on a going concern basis rather than solely by reference to its assets.

Although the buyout is the usual outcome of a successful section 459 petition the respondents can be ordered to sell out to the petitioner (for the relevant principles to be applied in this much more difficult situation see the judgment of Jacob J. in Re Planet Organic Ltd [2000] 1 B.C.L.C. 366). The discretion enjoyed by the court in remedial matters extends to offering no relief at all if none is suitable or feasible (see the discussion in West v. Blanchet [2001] 1 B.C.L.C. 795 where the petition was struck out and the point was made that in some instances there may be real financing problems encountered if one 50 per cent shareholder was ordered to buy out or indeed sell out to the petitioner).

The winding up remedy is available as a last resort but the courts are reluctant to grant this remedy. Thus in Fuller v. Cyracuse Ltd [2001] 1 B.C.L.C. 187 the High Court indicated that it was an abuse of process for a minority shareholder to persist with a winding up petition on the just and equitable ground when he had been offered a buyout at a price fixed by an independent valuer. In such circumstances there was another remedy available to the petitioner within the meaning of section 125(2) of the Insolvency Act 1986 and as it was unreasonable for this not to be used the court should strike out the petition. Another good indication of that restrictive attitude to the winding up remedy is manifested in the judgment of Jonathan Parker J. Re Guidezone Ltd [2000] 2 B.C.L.C. 321 where the point was made that unless there was a sufficient degree of unfairness to found a successful section 459 petition then a winding up could not be just and equitable for the purposes of section 122(1)(g). This pronouncement once again shows a divergence of opinion from that taken in the Scottish court of Session (Inner House) in Jesner v. Jarrad Properties Ltd [1992] B.C.C. 807 (which was not referred to by Jonathan Parker J.). Its effect will be to remove from the winding up remedy one of its last remaining aspects of utility. Thus the section 459 jurisdiction now appears to have gained complete dominance in English law.

Shareholder actions at common continue to be few and far between (for a rare successful derivative action see Knight v. Frost [1999] 1 B.C.L.C 364). However the pronouncement of the House of Lords in Johnson v. Gore Wood & Co. [2001] 2 W.L.R. 72 may encourage an increase in such claims. Here it was held that although in general a shareholder cannot sue for loss of shareholding value, where that loss merely reflected an injury done to the company, if the loss suffered by the shareholder could be characterised as truly independent them the action can proceed.

Looking at the position in Scotland the court in Anderson v. Hogg (supra) was at pains to stress that shareholders may enjoy protection at common law or under the inherent jurisdiction of the court and outside the parameters of section 459. It remains to be seen how this possibility will develop in Scotland.

The issue of funding the action is still a major obstacle. Cases where an indemnity from the company might be available are few and far between. Thus, in Halle v. Trax BW Ltd [2000] B.C.C 1020, such an indemnity from the company was deemed to be inappropriate in a dispute involving 50/50 shareholders. However, the possibility of an indemnity is not purely hypothetical. In a test case the courts might offer one, as the analogue insurance company case of Re Axa Equity and Law Life Assurance Society plc, The Times, December 19, 2000 shows. Here Evans-Lombe J. granted a pre-emtive costs order in favour of a policyholder who was performing a service by bringing a test case to clarify the effect of a proposed scheme of reorganisation.

Looking to the future there are likely to be sufficient changes recommended in the final report of the Company Law Review project. On the basis of indications in Completing the Structure (URN 00/1335) the statutory derivation action seems on the cards and the other Law Commission Report No. 246 proposals on Shareholder Remedies (particularly those with regard to section 459 petitions) are likely to receive strong support.

MATTERS COMMONLY INCLUDED IN SHAREHOLDERS' AGREEMENTS:

Provisions covering initial funding and further financing of the company. Warranties and indemnities from existing shareholders to a new shareholder/investor. The appointment of auditors and bankers. Provisions governing the application of funds invested - perhaps by reference to an agreed business plan. Provisions governing any personal guarantees given by a shareholder to third parties dealing with the company. Dividend policies. Rights of first refusal in the event of a shareholder wishing to transfer his or her shares (pre-emption rights).

Compulsory transfer or option arrangements. Covenants not to compete with the company nor to solicit its customers, suppliers, officers or employees. Undertakings of confidentiality. Provisions for protection of minority shareholders (e.g. rights of veto). Mechanisms for dealing with deadlock (for a 50/50 joint venture com