Shareholder Agreements

Published in Business Law, Tim Brown

One of the most important things you can do when you set up a new company or acquire an existing company is to adopt a shareholder agreement.

What is a shareholder agreement?

A shareholder agreement is a legal contract between the shareholders of the company which sets out the rights, obligations and responsibilities of the shareholders and largely governs the ownership structure and management of the company. It is also the first port of call when things go wrong, so it can include dispute resolution provisions, a process to be followed when a shareholder wants to exit the company and a mechanism for valuing the company’s shares.

It is not compulsory to have a shareholder agreement but many companies opt to have one. Shareholder agreements are flexible – the shareholders can choose what they want to include in the shareholder agreement and it can be amended over time.

Constitution or shareholder agreement?

Many companies have a constitution, which is another form of governing document. It is not compulsory for a company to have a constitution. Some companies have neither a shareholder agreement nor a constitution, some have both and some have one or the other. There will generally be some overlap between the two documents, however, there are some important distinctions between the two.

Firstly, a company’s constitution is a public document which anybody can view via the Companies Office website, whereas a shareholder agreement is a private confidential document among the shareholders. Any sensitive company information regarding trade secrets, funding, management responsibilities and so on should be recorded in a shareholder agreement and not the constitution for that reason.

Secondly, a shareholder agreement will generally not bind a company’s directors as they are not parties to the contract (while some persons may be both shareholder and director, this is not always the case). However, a constitution (together with the Companies Act 1993 (“Act”)) imposes duties and obligations on directors.

And thirdly, the Act allows some of its provisions to be modified or negated by a company’s constitution (but not shareholder agreement). For example, a company may hold up to 5% of its own shares but only if the company’s constitution expressly permits the company to do so.

Some companies may require a constitution in order to modify certain provisions of the Act and a shareholder agreement to record sensitive information or processes that have been agreed by the shareholders. If you require both, try to ensure there are no inconsistencies between the documents, however, a provision in a shareholder agreement will usually take precedence over a conflicting provision in a constitution.

Key clauses

Below are some key clauses that you should consider including in your shareholder agreement:

  • Ownership structure: who are the initial shareholders? Are there planned changes in ownership (e.g. succession planning)?
  • Funding: How has start-up capital been sourced? How will the company raise funds in the future when required – bank finance, capital from shareholders, shareholder advances?
  • Profit share: how will profits be distributed among shareholders? When will dividends be paid?
  • Directors: who are the directors? How can directors be appointed or removed? What are their responsibilities? Will they be paid director fees?
  • Management responsibilities: who will contribute to the management of the business?
  • Voting: will unanimous shareholder consent be required for certain very important decisions? Will anybody have a casting vote if there is a deadlock?
  • Transfer of shares: are there pre-emptive rights or other restrictions on the transfer of shares?
  • Valuation: how will shares be valued?
  • Exiting the company: how much notice is required if a shareholder wants to leave? How can a defaulting shareholder be removed from the company?
  • Restraint of trade/non-compete: what restrictions are there on a departing shareholder?
  • Dispute resolution/deadlock: what is the process for resolving disputes between shareholders or deadlock – mediation, arbitration, buy-out at fair value, liquidation of company?
  • Death/incapacity of a shareholder: what is the process when a shareholder dies or can no longer work in the business? Will the company have life insurance in place for the shareholders in order to pay a deceased shareholder’s estate for his/her shares?

Conclusion

Any company with more than one shareholder should seriously consider having a shareholder agreement. The best time to put one in place is right at the outset (before the company has been formed or before you invest into an existing company), however, if you have an existing company without a shareholder agreement, you can adopt one at any time (before something goes wrong!). We recommend that you regularly review your shareholder agreement and amend it as and when required.

DISCLAIMER: The content of this document is general in nature and is not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.

Tim Brown has specialised in business/commercial law for over 13 years. Tim is an expert in all business law matters, including establishing new businesses, buying and selling existing businesses, restructuring and succession planning, commercial contracts, capital and debt funding, corporate governance and compliance.

For further information and advice on shareholder agreements, please contact Tim.



Tim Brown (LLB, BCom)
Director / Solicitor

First Floor Conway Building
188 High Street
PO Box 576
Rangiora 7400

tim@conwaylaw.co.nz
www.conwaylaw.co.nz