Relationship property for companies
Shareholders’ agreements are comparable to relationship property agreements (colloquially known as ‘pre-nuptial agreements’), as the objective of each is to establish rules for relationship property – whether it’s in your business or your personal life.
Not all relationships were built to last forever, and even the most stable relationship amongst shareholders may waver. Issues may also arise unexpectedly, such as the death of a shareholder or the need for a shareholder to sell their shares. Planning in advance for these events can pre-empt a dispute, and save some costs for the respective parties.
Unlike a company constitution, a share-holders’ agreement is not registered with the Companies Office and therefore it has a greater degree of confidentiality. Company constitutions generally contain the nuts and bolts provisions to operate the company that are not provided for in the Companies Act 1993.
Shareholders’ agreements often have an overlap with the provisions of a constitution. However, they usually they contain more sensitive information about company affairs such as the roles and remuneration of the shareholder employees, the dividend policy, funding of growth strategies, rules around compulsory selling of shares in certain circumstances along with dispute resolution provisions.
Dispute resolution provisions would include 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 purchases the other’s shares at that price) gives finality. It’s a quick method for managing the exit of a shareholder where a dispute cannot be resolved, but it obviously presents some elements of commercial risk.
Other relevant provisions to include are:
- Options to purchase shares and how to calculate their value
- Rules around shareholder employee’s incapacity, bankruptcy and non-participation
- Rules around company loans and guarantees, and
- Security given over shares.
Susan and Nancy
The case study below illustrates some benefits of a shareholders’ agreement.
Siblings Nancy and Benjamin Button each hold a 50% share in Button Enterprises Limited (BEL); they are the company directors. There was no constitution or shareholders’ agreement. Over the years they have managed their company successfully. Their only trouble seemed to be the poor relationship between Nancy and Benjamin’s new wife, Susan.
Benjamin died unexpectedly, leaving his shares to Susan. At that time, Susan had large debts to pay for their lavish wedding so she desperately needed cash. Nancy wasn’t prepared to issue dividends from the company as she and Benjamin had planned to reinvest the company’s profits for growth.
The relationship between Susan and Nancy soured quickly – Nancy often could not get Susan to sign a ‘special resolution’ required for a company to undertake any ‘major transaction (the Companies Act 1993 requires that at least 75% of shareholders endorse major transactions). As a result, BEL’s profitability, and the shareholders’ working relationship, suffered.
Nancy remains concerned that Susan could simply sell her shares to any third party – who knows who she would be working with then?
A shareholders’ agreement would have helped in the Susan/Nancy situation. It would have improved their working relationship and given Nancy more certainty following Benjamin’s death. The relevant clauses that would have helped Nancy include:
- On the death of a shareholder, their shares must be offered firstly to the existing shareholders
- Life insurance cross-cover for Nancy and Benjamin. This would have provided cash for Nancy to purchase Benjamin’s shares on his death, and
- A clear dividend policy and a policy around reinvestment of profits into maintaining and expanding the business.
The good news is that even if your company is already up and running it’s not too late to establish a shareholders’ agreement. As you can see from the Susan/Nancy situation, a shareholders’ agreement can be invaluable for any company, irrespective of its size or sector in which it operates. It doesn’t need to be complex, and it can be tailored for your company’s specific situation.
It’s just like those who enter into a relationship property ‘pre-nup’, it can pay to set down rules in advance.