The importance of a shareholders' agreement
by Neil von Bertouch, BBIF LLB GDLP, Principal Solicitor at Moda Law.
7 May 2019
1. The Basics
What is a Company and who is a Shareholder?
An incorporated company is a legal entity and has the same rights as a natural person in that it is capable of entering into contracts, acquiring, holding and selling property and of suing and being sued in its own name (unlike a sole trader or partnership). A company allows the coming together of individuals for a common purpose and is commonly used as the legal structure for the operation of a business in common.
A shareholder is the owner of a share or shares in a company and a member of the company. In exchange for owning a share, a shareholder receives the rights attached to the share, like a right to receive dividends and to vote at general meetings.
What about the company’s constitution and corporations law?
A company’s constitution is a document that sets out the rules that govern the company and the relationship between the company, its directors, officers and shareholders. A constitution replaces, or operates in concert with, ‘replaceable rules’ as set out in the Corporations Act.
The Corporations Act is the principal legislation in corporations law regulating companies, their formation and operation.
What is a Shareholders’ Agreement?
A shareholders’ agreement is an arrangement between the owners of shares in a company as to how they intend to own and operate that company and the rights and obligations of the owners. It is a contractual arrangement between shareholders and only binds the shareholders to it, once agreed to between the shareholders and it will only bind new shareholders if or when that shareholder agrees to be bound by it. The constitution (and/or replaceable rules) automatically apply to directors, officers and shareholders on assuming those roles.
A shareholders’ agreement allows shareholders to adapt and set out their rights, obligations and procedures for the operation of a company generally, and in the event of the occurrence of certain situations arising (such as disputes).
A shareholders’ agreement does not replace a constitution (or the replaceable rules) or the Corporations Act, but operates in conjunction with, and furtherance of them.
2. The Details
Why should you consider a Shareholders’ Agreement?
Giving clarity to operations: Principally, shareholders’ agreements define the rights, obligations and roles of the participants in the company over and above those set out in a constitution or replaceable rules.
It’s a useful, practical exercise: The mere act of preparing a shareholders’ agreement can be a useful exercise for the shareholders to consolidate their objectives for the company and what they want to achieve from the endeavour. As an exercise, it focuses the shareholders in considering how the shareholders will deal with potential future events such as: disputes and what to do with profits.
Being realistic: Starting a new business is a time of optimism, and so it should be. The exercise of preparing a shareholders’ agreement necessarily requires the shareholders to consider the many issues that may arise and to be realistic about how such issues are to be handled These considerations are better made while the parties are optimistic and collegial.
Disputes happen, and they can be expensive: Disputes, from difficulties in agreeing on a business decision to a complete fallout between shareholders, happen. Agreeing to processes to resolve disputes before any dispute arises gives the shareholders a pre-determined process to make decisions and resolve disputes and reduce the need for shareholders to engage in expensive legal proceedings.
Protecting and creating relationships: Many people embark on business relationships with each other on the basis of pre-existing personal relationships: they are friends; family; or colleagues. Shareholders may desire to work with those friends, family members or colleagues, but does that desire extend to working with strangers, other family members or other spouses?
A shareholders’ agreement can serve to protect those relationships by defining the scope of the new business relationship and separating it from the personal relationship, and to protect the business relationship from a breakdown of the personal relationship or the breakdown of outside relationships.
Conversely, shareholders may have no pre-existing relationship. A shareholders’ agreement can serve to form the basis and scope of the shareholders’ newly created business relationship.
What matters do Shareholders’ Agreements deal with?
There is no definitive list of what a shareholders’ agreement should or should not include. Every company is different and its shareholders will have different requirements or expectations of its business, and by extension, of a shareholders’ agreement.
Typically, however, shareholders’ agreements contain some, or all, of the following provisions:
Objectives: setting out the purpose of owning shares in the company and defining the scope of the company’s operations.
Decision Making: establishing a process for the shareholders to make decisions, increasing shareholder participation in decision making, considering the weight of votes, determining which decisions require simple majority, special majority or unanimous assent.
Dispute Resolution Processes and Deadlocks: establishing a process under which disputes and deadlocked decisions are to be resolved.
Capital Raising: setting out the circumstances under which the shareholders would be required to contribute capital and how.
Dividends and Profits: outlining the manner and circumstances in which profits are distributed to shareholders.
Shareholders as Directors: creating rights of shareholders to sit on the board and hold office (or to nominate representatives to the board).
Shareholders as Employees: establishing the right, or obligation, of a shareholder to be an employee (or to nominate an employee) of the company and the consequences if that employment is terminated.
Management: establishing management structures and shareholders’ involvement in such structures.
Moonlighting: controlling shareholders’ ability to work outside of the company’s business.
Restraints of Trade: setting out the rights and restrictions of shareholders to trade in competition with the company, while it is a shareholder and in the event the shareholder sells its shareholding.
Buy/Sell Options: providing shareholders with put and call options to sell or acquire the shares of other shareholders in certain circumstances.
Requirements for Selling Shares: setting out the process by which a shareholder may sell their shares, and to whom they may sell.
Retirement and Death: determining what will happen with the shares of a shareholder who wishes to retire from the company, or in the event of the death or incapacity of a shareholder and how such events will be funded (for example: insurance requirements).
Drag Along and Tag Along: establishing rules under which major shareholders can require minor shareholders to require minority shareholders to sell their shares (usually in the event of a takeover or similar action) and minority shareholders to join a majority shareholder is selling their shares with the sale of a majority shareholding.
Defaults: setting out the consequences to a shareholder who breaches their obligations as a shareholder.
Winding Up and Exit Strategies: setting out the circumstances and manner in which the company is wound up, sold or otherwise ends operations.
When preparing your shareholders’ agreement, consider the advice and recommendations of your solicitor as to what is appropriate to include in your shareholders’ agreement, but don’t be afraid to put to your solicitor your needs and expectations of the document. Nothing needs to be discounted merely because it is not typical of what a shareholders’ agreement ‘usually’ contains. Moreover, ‘usual’ provisions can, and should, be tailored to your needs and expectations.
This article is general commentary only and is not intended as legal advice. You should not rely on the contents of this article without out first obtaining your own legal advice.
You can contact Neil to discuss your corporate legal needs by clicking on this link: contact
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