10 Points to consider before drafting a shareholder or partnership agreement.
Shareholder and Partnership Agreements are essential legal documents that define the structure and governance of a business. While companies and partnerships differ slightly in form, the principles guiding their agreements are largely similar. These documents help establish how shareholders or partners interact with each other and the business, and they play a crucial role in preventing and resolving disputes.
Without clear provisions, disagreements can occur whether about decision-making, ownership changes, or exits and can escalate and be costly to the business. Therefore, it is important to carefully consider what to include in these agreements to ensure smooth operations and protect all parties involved.
1. Shareholders Agreements Are Not Articles of Association
Whilst both documents may cover similar topics, Articles of Association are public and legally required under the Companies Act 2006. In contrast, a Shareholders Agreement is a private document that offers more flexibility and confidentiality.
2. Agreements Can Be Amended
Although these agreements are ideally drafted to be comprehensive from the outset, they can include provisions that allow for future amendment, especially if there are structural or ownership changes.
3. Articles of Association Usually Take Precedence (with Expectations)
Every limited company in England and Wales is required to have articles of association. Shareholders agreements, while sharing similar content, do not have this legal requirement. Company articles tend to build upon the relevant conditions of the Companies Act. However, a shareholder agreement can include any provisions. Typically, Articles take precedence over all other documents pertaining to a Company. An exception to this rule is when the relevant agreement includes a “supremacy clause”.
4. Handling Breaches of Agreement
If an individual or corporate party violates provisions within a shareholder’s or partnership agreement such as restrictive covenants, this would constitute a breach of the agreement. A well-drafted agreement would allow other parties the right to bring forward a claim against the defying party. This would consist of an outline of how breaches are to be dealt with, such as transfer of their interest, financial remedy and even removal of the party from the agreement and thus involvement within the business.
5. Minority Protection
Those holding a minority share can have limited control over company/partnership decisions. An effective agreement can ensure that critical decisions require the approval of all shareholders/partners. Such decisions may include issuing new shares, appointing or removing directors or changing main business operations. Additionally, a “tag-along” provision can mandate that if majority shareholders receive an offer for their interest, the same offer must be extended to all shareholders/partners. This will allow the minority shareholder/partner to also benefit from the sale equally.
6. Majority Protection
Majority shareholders/partners are expected to have the greatest level of control over the business. These parties may then worry about lack of control in the events which require unanimous approval such as sale of the company. An example protection can be that of drag along provisions which stipulate that upon a sale by majority interest-holders, minority interest-holders will also be sold on the conditions as any the other seller.
7. Post Exit Provisions
A party selling all of their shares and exiting the business can pose a risk to the company or partnership due to the knowledge and access to client base. Therefore, typically leaver provisions are used stipulating the restrictions imposed on existing parties. This can include time restrains from contacting any clients and employees which can typically range from 12- 24 months and can also extend to working within the same industry.
8. Deadlocks and Disputes
Disputes between shareholders/partners, such as disagreements over business strategy, can lead to deadlock, halting progress. Agreements should include mechanisms like mediation, arbitration, or buy-out options to resolve such impasses.
9. New Shareholders or Partners
The agreement should clearly define the process for adding new shareholders/ partners, including approval requirements, share allocation, and responsibilities. This protects existing members and ensures transparency.
10. Death of Shareholder
There should be adequate provisions upon the death of a shareholder/partner. This will vary for all businesses, however for example remaining parties may wish not to lose control within the business by shares passing to the bereaved relatives. Options to deal with this may include automatic share transfers, buy-back rights, or rights of first refusal. This helps maintain business continuity and prevent disputes with heirs or third parties.
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