Why you need an effective Shareholders Agreement?

A Shareholders agreement provides the rules between shareholders, and their dealings with each other and the company. A shareholders agreement is not registered with the Companies Office, therefore, offers a greater degree of confidentiality. A recent case illustrates the point that the effectiveness or usefulness of a Shareholders Agreement will depend on the time and effort that’s put into it. In the case, the majority shareholders were more or less held to ransom by minority shareholders, which the court held was legitimate in the circumstances.

There are many matters that should be considered when entering into a Shareholders Agreement. Often, there’s more than one way to deal with an issue. Clients are often reluctant to invest time and money to ensure that their Shareholders Agreement will meet their requirements. In that case, they can’t complain if they run into difficulties that could’ve been prevented.

In the case of Dold v Murphy [2020] NZCA 313, the majority shareholders had a client who wanted to purchase all of the shares in the company but a minority shareholder wouldn’t agree to sell their shares unless they were given a premium. Ultimately, the majority bought out the minority shareholder at a premium and then one of the majority shareholders sued the minority shareholder to recover the premium.

Allegations that the minority shareholder had breached many provisions of the Shareholders Agreement, had owed and breached fiduciary obligations to the other shareholders, and had exerted unlawful economic distress on the other shareholders all failed. The Shareholders Agreement could have given drag along rights to the majority, but didn’t.

As noted above, there are many issues that should at least be considered when preparing a Shareholders Agreement. The counsel’s part is to inform their client about the matters. The parties need to know what the issues are and what options there are for dealing with them – how else can they decide what will work for them in their contract? A standard template would never be able to cut the mustard.

Shareholders’ agreements often have an overlap with the provisions of a constitution. However, they usually they cover more sensitive information about company affairs such as the roles and remuneration of the shareholder employees, funding of growth strategies, the dividend policy, rules around compulsory selling of shares in certain circumstances along with dispute resolution provisions.

Provisions of Dispute Resolution

Dispute resolution provisions set out normal mediation and arbitration clauses but, for circumstances where the shareholders simply cannot continue in business together, a ‘Russian roulette’ or ‘shot gun’ clause where each party puts forward a price for the other’s shares and the party who puts forward the highest price then buys the other’s shares at that price gives finality. It’s a fast method for managing the exit of a shareholder where a dispute cannot be sorted out, but it presents some elements of commercial risk.

Some other relevant provisions to consider are rules around shareholder employee’s incapacity, bankruptcy and non-participation, options to purchase shares and how to manage their value, rules around company loans and guarantees, and security given over shares.