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Why have a Shareholders Agreement?

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. Law Central Legal recommends you seek professional advice before taking any action based on the content of this Bulletin.

13/09/2018

By Law Central Legal

When a company is incorporated, the company will be governed by the company constitution; the Corporations Act 2001 (Cth); and the common law. In addition to those sources of governance, many shareholders in private companies also choose to adopt a shareholders agreement because of the benefits it confers; even though there is no legal requirement for a company to have a shareholders agreement. Often shareholders agreements are found in Pty Ltd companies where the shareholders are in agreement to run a business enterprise through a company structure.  

A shareholders agreement is a binding contract between the shareholders which sets out their rights, obligations, and the procedures to be followed in certain situations. The advantage of having rights, obligations, and procedures being set out in a shareholders agreement is that in the circumstance of a potential shareholder dispute, the parties have a better chance of avoiding a dispute or resolving their differences as the subject of the potential dispute may be contained and dealt with in the agreement.

Many shareholders find it is prudent to agree on the rules and procedures for governance in advance. Adopting a shareholders agreement will enable parties to address potential governance issues before they arise. If the procedure for certain shareholder events are only considered when they arise; shareholders may find they have a greater vested interest in a specific outcome and find it harder to agree on how it should be handled.

Who does a Shareholders Agreement apply to?

It is important to understand that a shareholders agreement is contractual in nature and therefore will operate quite differently to a company constitution. Once a company constitution has been adopted, it will automatically apply to directors, shareholders, and anyone who becomes a shareholder or director in the future. A shareholders agreement as a contract will only be legally binding on parties who sign the contract. This means it will not be legally binding on people who become shareholders after the shareholders agreement has already been signed. However, this can be remedied by including certain clauses in the agreement.

Most shareholders agreements should contain a clause which requires existing shareholders to ensure any purchaser for their shares will sign a deed of accession. A deed of accession will state that the purchaser of the shares agrees to take on the rights and obligations attached to those shares in the shareholders agreement. Once signed, the purchaser of the shares will be legally bound by the shareholders agreement.

What are common clauses in a Shareholders Agreement?

With shareholders agreements, there is no ‘one size fits all.’ All shareholders agreements should be individually tailored to the situation and the shareholders. The types of clauses you would want in the agreement will also depend on the shareholding you have.

A majority shareholder would want to ensure that most exercises of power are done by a majority vote (“Majority vote” can be defined to be a specific percentage. Normally this would be 51% of the issued share capital). An important clause for majority shareholders is a ‘drag along’ clause. A drag along clause states that if a majority shareholder has a purchaser for their shares on the condition that 100% of the issued shares in the company are sold then the minority shareholders are essentially dragged into the sale even if they do not wish to sell. This can be important for majority shareholders because it maximises their opportunities to sell, without having to negotiate with minority shareholders.

Minority shareholders may have a different agenda in shareholders agreements. Minority shareholders may want most exercises of power to be by a unanimous vote. A unanimous vote means that no exercise of power under the shareholders agreement can proceed without the minority shareholder voting in favour. If a majority vote is required and there is a majority shareholder, the majority shareholder can choose to make decisions without any of the other shareholders consenting.

Another important clause for minority shareholders is a ‘tag along’ clause. A tag along clause will allow minority shareholders to piggy back onto the sale of shares by a majority shareholder. The majority shareholder will be required to notify the minority shareholders of their intent to sell their majority share. If the minority shareholder wishes to ‘tag-along’ to the sale and sell their shares in the same sale, then the majority shareholder must not sell without the minority shareholders’ shares also selling. This can protect minority shareholders from having the company being run by a new party to which they have not agreed.

Other common clauses which are often found in a shareholders agreement include:

Shareholders Agreements and the Company Constitution

Many companies choose to adopt a constitution upon incorporation. If they already have a constitution which governs the shareholders, why do they choose to adopt a shareholders agreement at a later date? Most company constitutions do not contain the practical provisions normally covered in a shareholders agreement. For example, very few company constitutions will feature ‘drag along’ or ‘tag along’ clauses.

The next logical question would be, well why not just amend the company constitution to include the additional clauses you would have included in the shareholders agreement? In some circumstances this may be the most appropriate way to set out additional protections and rights for shareholders. The advantage of this approach is that the company constitution will automatically apply to all future shareholders.

In practice, many companies choose to adopt a shareholders agreement instead of amending the company constitution because of the extra protection afforded to minority shareholders. A shareholders agreement will often state that the shareholders agreement can only be amended by unanimous written agreement of the shareholders. In contrast, section 136(2) of the Corporations Act 2001 (Cth), states that the company constitution can be amended by agreement of 75% of the shareholders. (It should be noted that a company constitution can have a clause which creates additional requirements for amending the company constitution. This is allowed under section 136(3) of the Corporations Act 2001 (Cth).)

Shareholders agreements, as previously discussed, will also contain specific clauses which are not suited to being in the constitution i.e. keyman insurance policies for certain individuals.

Gold and platinum members read on for information on resolving disputes between conflicting company constitutions and shareholders agreements.

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Disclaimer: The content of this Bulletin is general information only. It is not legal advice. Law Central Legal recommends you seek professional advice before taking any action based on the content of this Bulletin.

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