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Should my company have a Shareholders' Agreement?

All Australian companies are governed by either a constitution or the replaceable rules contained within the Corporations Act 2001 (Cth) (Act) which sets out matters concerning directors' obligations, shareholders' rights, and how the company is to be managed. So why then would a company need a shareholders' agreement?

The reality is that the stakeholders in most companies have specific objectives or preferences - not all of which are contained in a constitution, and not all of which align with other stakeholders. A well drafted shareholders' agreement should work in conjunction with the constitution to map out those objectives, and meet the stakeholders' agreed needs.

Much like a guide book compliments a map, a shareholders' agreement is a more tailored document which provides greater detail, especially with respect share ownership and shareholder dispute resolution mechanisms, which in the long run deliver cost and time savings when they are more needed.

Ari Armstrong, Maddocks Lawyers

So what is a shareholders' agreement?

A shareholders' agreement is essentially a contract between all the company's shareholders which provides a set of rules which manages disputes, sets out specific rights and obligations of shareholders and directors, and specifically deals with scenarios not generally contemplated by a company's constitution. As such, they can be drafted in any way the shareholders agree, provided any right or obligation included is not contrary to the requirements of the Act.

As the shareholders' agreement is a contract, it can be varied by all the parties to the contract (i.e. the members) at any time by unanimous agreement. Note that this is in contrast to the variation mechanism for a constitution, which requires a special resolutions of members in meeting.

It is important to note that a shareholders' agreement is not the same as a buy/sell (or buy-out) agreement between business owners. A buy/sell agreement is intended to cater for circumstances where a co-owner of a business dies or is otherwise forced to leave the business, and is often put in place in conjunction with insurance policies which provide for payouts to the departing co-owner's estate from the company. A shareholders' agreement can cover these arrangements, but it is broader than this because it also provides guidance for the day-to-day management and control of a company.

What are some examples of how a shareholders' agreement is different from a constitution?

Whilst the Act provides rules dictating how to raise and manage capital and imposes statutory duties on directors, a shareholders agreement enables the shareholders to get more granular on how the company's affairs are to be conducted

Set out below are some topics which are generally dealt with in a constitution on a high level, but which can also be dealt with in more detail in a shareholders agreement:

Topic What a constitution usually says... What a Shareholders Agreement might say...
Directors appointment Directors to provide a consent, declare interests, and then elected by 50% plus 1 vote of the shareholders. Any shareholder with a specified percentage of shares(which can be less than 50%), can appoint and replace a director, who can represent their interests.
Share issues Directors can issue to who they choose, the directors can determine the class of shares, and they can determine the price at which the shares can be issued.

Shares can only be issued to employees or associates of the company, with the consent of other shareholders.

Shares can only be issued according to a particular valuation method.

Shares can only be a particular class.

Sale of company Shares can be sold to third parties, generally after they are offered to other shareholders first.

If a shareholder with a particular percentage of shares wants to sell to a third party, they can compel the other shareholders to sell too on the same terms (drag along).

If a large shareholder has a right to sell their shares to a third party, smaller shareholders can compel the large shareholder to ensure the third party is also obliged to buy the smaller shareholders' shares on the same terms (tag along).

Death of shareholder Shareholder's shares generally are 'transmitted' to the shareholder's estate. Estate then bound by constitution as to what they can do with the shares.

If one shareholder dies, the other shareholders have a right to buy the shares, at a price set up a valuation. They may be given a period, say 12 months, to complete the purchase.

Other shareholders therefore avoid having to be shareholders alongside the deceased shareholder's family/estate.

Forced divestment of shares (say if shareholder leaves employment of company) Not generally dealt with.

Departing shareholder may be obliged to sell shares to other shareholders.

A discount to the price may be applied if the departing shareholder is a 'bad leaver'.

A restraint may be imposed on the departing shareholder.

Do shareholders agreements provide better protection for minority shareholders?

Because a shareholders' agreement can specifically deal with circumstances not contemplated by a constitution, the answer to this question is:

A shareholders' agreement can afford better protection to a minority shareholder, but they need to ask for that protection!

Indeed, it is possible that a shareholders' agreement can provide more rights to a majority shareholder than they may otherwise have (see 'drag along' example above).

If a minority shareholder wants protection that they might not otherwise have under a constitution, they need to think about what is important to them, and negotiate for inclusion of those protections. For example:

  • They may want the document to grant minority shareholders 'tag along' rights as referred to above.

    This would give minority shareholders in the company some comfort that they will not be left behind in certain circumstances.

  • A minority shareholder may want to have a right to appoint a director to represent their, say, 20% interest in the company. Even if that director will be often out-voted, the shareholder they represent will be abreast of how the company is being managed, and better apprised of the company's affairs.
  • They may want the document to include bespoke dispute resolution procedures, which may have a focus on alternative dispute resolution. Under the Act, minority shareholders are only able to bring oppression proceedings against a company, which is a far costlier and potentially more time-consuming process.

Conflict between provisions of the constitution and shareholders' agreement

Potential inconsistencies between the constitution and the shareholders' agreement are usually dealt with by an 'inconsistency clause' in the shareholders' agreement.

For instance, the Cleardocs shareholders' agreement contains a general clause dealing with inconsistencies, and then further pinpoints specific clauses which take precedence over those specific topics in the constitution, specifically those clauses relating to:

  • appointment and removal of directors, secretaries and the chair;
  • the chair's casting vote;
  • any requirement to hold directors' meetings;
  • convening and conduct of directors' meetings;
  • decisions by directors, and how they are made;
  • declaration and payment of dividends;
  • issue, transfer and transmission of shares;
  • creation, issue or transfer of securities relating to the company;
  • creation of encumbrances relating to shares;
  • valuation of shares;
  • classes of shares; and
  • the provisions regarding death, transfer and transmission of shares on death.

More information from Maddocks

For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Tax team.

More Cleardocs information on related topics

You can read earlier ClearLaw articles on a range of company-related topics.

Role of a Company's Constitution and a Shareholders Agreement

Inconsistencies between shareholders agreements and company constitutions

Order Cleardocs packages

 

Lawyer in Profile

Georgia Borg
Georgia Borg
Lawyer
+61 3 9258 3554
georgia.borg@maddocks.com.au

Qualifications: LLB, University of Sheffield, LLM(CL), University of British Columbia

Georgia is a member of Maddocks Commercial team and assists in a variety of commercial and corporate matters for private, public and not-for-profit clients.

Her expertise includes advising on general commercial law, wills and estates law, charities and not-for-profit law along with corporate law.

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