Shareholders' agreement

Shareholders' agreement

A shareholders' agreement (sometimes referred to in the U.S. as a stockholders' agreement) is an agreement between the shareholders of a company.

In strict legal theory, the relationships between the shareholders (as between themselves) and between the shareholders and the company are regulated by the constitutional documents of the company. However, where there are a relatively small number of shareholders it is quite common in practice for the shareholder to supplement the constitutional document.There are a number of reasons why the shareholders may wish to supplement (or supersede) the constitutional documents of the company in this way:
* a company's constitutional documents are normally available for public inspection, whereas the terms of a shareholders' agreement, as a private law contract, are normally confidential between the parties.
* contractual arrangements are generally cheaper and less formal to form, administer, revise or terminate.
* the shareholders might wish to provide for disputes to be resolved by arbitration, or in the courts of a foreign country (meaning a country other than the country in which the company is incorporated). In some countries, corporate law does not permit such dispute resolution clauses to be included in the constitutional documents.
* greater flexibility; the shareholders may anticipate that the company's business requires regular changes to their arrangements, and it may be unwieldy to repeatedly amend the corporate constitution.
* corporate law in the relevant company may not provide sufficient protection for minority shareholders, who may seek to better protect their position by using a shareholders' agreement
* to provide mechanisms for removing minority shareholders which preserve the company as a going concern. [For example, in many countries, the only remedy where the company is being run in a manner prejudicial to the minority shareholders is a just and equitable "winding-up" of the company, which is the commercial equivalent of the judgment of Solomon. By putting put and call options in a shareholders' agreement, the parties can ensure that a dissenting minority can be bought out at a fair value without destroying the company.]


There are also certain risks which can be associated with putting a shareholders' agreement in place in some countries.
* In some countries, using a shareholders' agreement can constitute a partnership, which can have unintended tax consequences, or result in liability attaching to shareholders in the event of a bankruptcy. [Under English law, a shareholders' agreement is often suggested as an inference of a "quasi-partnership", which entitles disappointed partners to certain shareholder remedies, see "Ebrahimi v Westbourne Galleries Ltd" [1973] AC 360]
* Where the shareholders' agreement is inconsistent with the constitutional documents, the efficacy of the parties' intended arrangement can be undermined.
* Countries with notarial formalities, where notarial fees are set by the value of the subject matter, parties can find that their agreement is subject to prohibitively high notarial costs, which, if they fail to pay, would result in the agreement being unenforceable.
* In certain circumstances, a shareholders' agreement can be put forward as evidence of a conspiracy and/or monopolistic practices. [Although, in each case, this would only be likely if the agreement covered more than one company.]

Common characteristics

Shareholders' agreements obviously vary enormously between different countries and different commercial fields. However, in a characteristic joint venture or business start-up, a shareholders' agreement would normally be expected to regulate the following matters:

* regulating the ownership and voting rights of the shares in the company, including
** Lock-down provisions
** restrictions on transferring shares, or granting security interests over shares
** pre-emption rights and rights of first refusal in relation to any shares issued by the company (often called a "buy-sell agreement")
** "tag-along" and "drag-along" rights ["Tag along" rights refer to the power of a minority shareholder to sell their shares to a purchaser at the same price as any other selling shareholder, ie. if one shareholder wants to sell, they can only do so if the buyer agrees to buy out the other shareholders who wish to sell at the same price. "Drag along" refers to the power of larger shareholders to compel the minority shareholder to sell when a purchaser wants to acquire 100% (or in some cases a majority stake) of the company, ie. a purchaser wishes to buy the company at a high valuation but only if they can purchase the entire issued share capital, and 3 out of the 4 shareholders wish to sell, but the 4th does not, well drafted drag-along rights would enable the 3 shareholders to compel the 4th to sell their share at the same price.]
** minority protection provisions [For the normal position in relation to minority rights, see for example, "Foss v Harbottle" (1843) 2 Hare 461]

* control and management of the company, which may include
** power for certain shareholders to designate individual for election to the board of directors
** imposing super-majority voting requirements for "reserved matters" which are of key importance to the parties
** imposing requirements to provide shareholders with accounts or other information that they might not otherwise be entitled to by law

* making provision for the resolution of any future disputes between shareholders, including
** deadlock provisions [In a joint venture, "deadlock" refers to the parties being unable to agree on a key matter. If there are only two key parties, this can deadlock the vehicle, and leave it wallowing.]
** dispute resolution provisions

In addition, shareholders agreements will often make provision for the following:
* the nature and amount of initial contribution (whether capital contribution or other) to the company
* the proposed nature of the business
* how any future capital contributions are to be made
* the governing law of the shareholders' agreement [Whilst this is often the same as the law of the company's incorporation, it is sometimes chosen deliberately to be different to allow a more flexible law of contract to overcome perceived limitations in the corporate law of the company's jurisdiction.]
* ethical practices [It is not uncommon to see shareholders' agreements between parties from developed countries and parties from emerging markets which provide that the company shall not engage in corrupt practices. Although in many countries it may be considered normal for local business to bribe officials to facilitate the conduct of business, many Western countries impose severe penalties on business who engage in corrupt practices abroad, and so Western investors often seek to ensure that their partners do not engage in anything which could breach such legislation in the Western investors' jurisdiction. See for example the Foreign Corrupt Practices Act in the U.S.A.] or environmental practices
* allocation of key roles or responsibilities


In some countries, shareholders' agreement are required to registered to be effective or binding, however, this is not normally the case. Indeed, it is the perceived greater flexibility of contract law over corporate law that provides much of the "raison d'être" for shareholders' agreements.

However, where a shareholders' agreement is not publicly filed, and is not perfectly consistent with the other constitutional documents of the company, questions inevitable arise where there is a conflict between the documents. Although the laws of every country are different, in general most countries tend to treat such conflicts as follows:
* as against outside parties, only the constitutional documents regulate the company's powers and proceedings.
* as between the company and its shareholders, a breach of the shareholders' agreement which does not breach the constitutional documents will still be a valid corporate act, but it may sound in damages against the party who breaches the agreement.
* as between the company and its shareholders, a breach of the constitutional documents which does not breach the shareholders' agreement will nonetheless usually be an invalid corporate act.
* characteristically, courts will not grant an injunction or award specific performance in relation to a shareholders' agreement where to do so would be inconsistent with the company's constitutional documents.


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