Company law is generally suited to the situation where the shareholders in a public company are separate from the board of directors, and comprise a number of holdings where no single shareholder or group of shareholders have control. In such cases the directors, having the necessary expertise, are brought in by the shareholders to manage the business of the company on their behalf. Even if the directors have shares in the company, they are likely to be motivated to act in the best interests of the shareholders as a whole rather than representing the interest of the largest single shareholder.
This is not necessarily the case in private companies. Generally, in smaller private companies there are usually few shareholders, and the shareholders are often the directors in the company. This is when a shareholders agreement becomes helpful because the minority shareholders, the majority shareholders, and those holding shares equally want to ensure that their rights are protected, usually in ways which are not covered in the articles of association of the company.
Minority or equal shareholdings
A large number of shareholders’ agreements are designed to contain provisions intended to protect the minority shareholders (i.e. any person(s) with less than 50% of the issued share capital in the company) or those with equal shareholdings (i.e. 2 shareholders holding 50% each of the shareholding or a company with 3 shareholders who all hold 1/3 of the shares each).
A minority shareholder in a private company is a particularly vulnerable person. This is partly because there tend to be much fewer shareholders in a private company. This means it is more likely that control of the company will be held by one or two persons. There is generally no market for the shares of a private company, and a shareholder who is unhappy at the way a company is being run does not have the option of selling those shares. The concentration of control in one or two shareholders can lead to abuse of power, even where no single shareholder holds a majority.
For example, without a shareholders agreement a shareholder who is also a director could be removed from his position as director, by a mere 50% of the other shareholders voting him out. This gives him very little security, and would leave him with a shareholding in a company in which he no longer has any management rights.
Minority or equal shareholdings
Newco limited is a company with three shareholders A, B & C (A – 20 shares; B – 35 shares and C – 45 shares). They are all directors of the company. In addition to their salaries, the directors, as shareholders, receive annual dividends.
If A and B in the future no longer wish to deal with C for any reason, or for example, decide unreasonably that they no longer wish to work with him and they want to remove C as a director; they are able to do this. They can do this by passing (as shareholders) an ordinary resolution (a resolution requiring a majority of more than 50%).
Despite C holding the largest shareholding, he cannot prevent the passing of that resolution. C has lost his right to participate in the management of the company. C has no right to require A or B to buy his shares and no one outside the company is likely to be interested in acquiring them from him.
There are now remedies in the Companies Act which attempt to prevent such unfair conduct towards a minority shareholder, but these remedies are not certain and can prove extremely costly. It is far better to prevent the situation arising in the first place. This is where a minority protection shareholders’agreement and minority protection articles of association could be used.
Majority shareholders’ agreements
Shareholders’ agreements are not just designed for those shareholders who hold less than 50% of the shares in a company. In many cases such agreements are drafted for the majority shareholder.
The majority shareholder may wish to curb the powers of the directors if he does not have a majority representation at board level, or if he does not take an active part in the running of the business.
In the alternative, the majority shareholder may not want to include any minority protection provisions but may want to be able to ensure that if a buyer for the company comes along he can sell all the shares in the company, forcing the other shareholder(s) to sell their shares. This would stop him being held to ransom by a minority shareholder. He may also wish to consider appropriate non-competition and confidentiality covenants and provisions requiring financial input from other shareholders.
Articles of Association
As has been previously mentioned if a Shareholders agreement does not exist, then any disputes between shareholders/ directors will have to be settled by what is contained within the articles of association.
The articles of association (“the articles”) are one of the two constitutional documents of a company. The articles set out the rules as to how a company is run; for example: setting out the division of power between the shareholders and directors and the rights which each will have.
The shareholders’ agreement gives a contractual remedy if its terms are broken; whereas articles may prevent the event happening in the first place.
Some of the problems with having no shareholders agreement and just relying on the standard articles of association are as follows:
This is why it may well be preferable to have detailed provisions in the shareholders’ agreement to cover such issues.