The Importance of a Shareholder Agreement

The recent takeover bid of Arsenal FC by Stan Kroenke has been the cause of much discussion within the British media. Whether you are a supporter of the takeover or not, the story serves as a useful reminder to companies about the devolution of shares. This may be of particular concern for small to medium size businesses that are in essence a family business.

In accordance with the Companies Act 2006 the articles of association form the statutory contract between the shareholders and the company. Anyone who purchases shares in the company is deemed to accept the terms of the statutory contract. This statutory contract is different from a normal contract in that it is subject to limitations. To note a few:

• A court cannot imply any terms to the contract
• The contract cannot be set aside on the grounds of misrepresentation, undue influence or mistake;
• The contract can be varied with considerably less than unanimous consent.

All the above are of concern to the minority shareholder who may find themselves in a weak position. Without any additional protective provisions the minority shareholder may be powerless to stop the majority from changing the companies articles and in essence unilaterally amending the terms of the statutory contract to which the minority shareholder is a party.

The most common method of regulating the rights and duties of the shareholders in a private limited company is through the use of a shareholders agreement. The agreement typically governs the affairs of the company and can amend the statutory contract to provide greater protection, for example, by ensuring decisions to amend company articles or the company name can only be made by a unanimous vote as opposed to a special resolution which only requires a 75% shareholder approval.

It is important that any shareholders agreement is consistent with the company’s articles. To not be so would cause confusion and it is likely that the latter agreement will prevail. This could mean the statutory contract overrides the shareholders agreement if it was entered into prior to the formation of the company.

A well drafted shareholders agreement should provide shareholders with additional comfort that key managerial decisions will be restricted to a unanimous vote. In particular shareholders may prefer to limit the company’s ability to proceed with the following:

• engage in any type of business other than that agreed, or to make or permit any material change in that business;
• acquire share or loan capital in any other company, form a subsidiary, amalgamate or merge with another company or enter into partnership or a joint venture with any other party;
• amend the company business plan or the company’s accounting policy;
• close down the business or any part of it;
• dispose of all or a material part of the business or assets of the business, including shares in a subsidiary company, whether by a single transaction or a series of transactions.

Whilst a shareholder agreement provides a shareholder with certain security it is important not to simply view this document with an inward perspective as on occasions the agreement needs to be attractive to external parties such as investors whose capital may be needed to successfully develop the company.

Shareholders may take legal advice on deadlock provisions to avoid stifling the company’s progress. Whilst the majority of legal advisers would urge their shareholder clients to compromise and resolve their differences where possible, the deadlock provision provides the company with security that where decisions cannot be made by a majority then the dissenting party can be bought out thus preserving the company and enabling it to move forward. To have an agreement that allowed minority shareholders to entrench and obstruct company decisions is to be avoided at all costs.

Our final thought goes back to the opening of this article relating to the devolution of shares. Shareholders leave, retire and in the case of Danny Fiszman, pass away. Small and medium sized companies and in particular family run companies would wish to ensure the exiting shareholder was not free to dispose of his shares to any person he/she so chooses. Shareholders should therefore consider including restrictions as to whom shares can be transferred to. Rogue children or estranged spouses could prove particularly detrimental to the performance of a business. In addition a shareholder could include a right of pre-emption in the Agreement. Continuing shareholders can therefore ensure they have a first right of refusal to any shares to be transferred, which may be of particular importance if the exiting party was a key contributor to the business. To have silent investors who bring nothing to the day to day running of the company should be avoided.

If you would like any further information or legal advice in relation to anything discussed in this article please contact Daniel Ball in our Commercial department on (01354) 602884 or email