The Reynolds Report – October 2020
Feeling a bit like the bar hostess in the film The Blues Brothers who proudly announces, “We have both kinds of music here, Country and Western…,” I can confirm that we do both kinds of work in the Property and Commercial Department at Barrett & Co – Property and Commercial.
This is, in fact, one of the great things about working at Barrett & Co – that I get the chance to do work in both of these areas.
This month, therefore, having concentrated on Commercial Property themes for the last couple of months, I thought it would be an idea to tackle a subject with a Company/Commercial theme – specifically Shareholders Agreements.
Readers will be familiar with the Articles of Association of a company – a document setting out the basic rules on the basis of which the company is run: rules for directors meetings, rules for shareholders meetings, rules for the issue of shares etc. Most newly incorporated companies now make use of the Model Articles for a Company Limited by Shares provided in Regulations issued pursuant to the Companies Act 2006. Bespoke Articles can also, however, be used and many older companies have historical Articles dating back to the time when they were incorporated.
There are nonetheless substantive limitations to trying to regulate the governance of a company through the Articles of Association alone, in particular:
- Statute provides that it is not permissible for the Articles to block the power of a shareholder majority to remove a director of the company; and
- The Articles can be changed by Special Resolution (a resolution supported by 75% or more of shareholder votes).
There are also issues around the enforcement of Articles of Association – what is the remedy in the event of breach? – and the content of Articles is publicly known as they must be registered with Companies House and will therefore appear on Companies House’s website.
To get around these and other difficulties many companies (small and not so small) have ‘Shareholders Agreements’ operating in parallel to the Articles. These are a contract (agreement) between all of the shareholders and, frequently, the company as well.
Frequently Shareholders Agreements are used to:
- Regulate the transfer of shares (usually providing that any shares to be sold must first be offered to the existing shareholders); and/or
- Give a power to a specific shareholder (or group of shareholders) to appoint a director; etc
Shareholders Agreements usually achieve these goals by providing that, as a matter of contract, the parties will exercise their rights in the company (specifically their voting rights) to ensure that the various goals are achieved.
It is also common for Shareholders Agreements to state that certain matters are reserved for ‘Shareholders Consent’ –defined to be the agreement a specified percentage of shareholders – often 80% but sometimes even 100. Reserved matters will frequently include:
- Issuing further share capital;
- Changing the business of the company; and, even
- Moving the Registered Office.
The usefulness of a Shareholders Agreement can be clearly seen in a company where there are four or more shareholders, each holding the same number of shares. In this case each shareholder will hold 25% or less of the shares and, in the absence of a Shareholders Agreement, will not be able to prevent changes to the Articles of Association.
But what about a company with only two shareholders – where each holds 50%? This situation – effectively – makes every decision a reserved matter. The parties either agree or there is deadlock.
Even in these situations, however, a Shareholders Agreement can be useful in particular in relation the transfer of shares (restricting this so that the remaining shareholder is not at risk of finding themselves in business with a different person).
It can also provide for ‘tag along’ and ‘drag along’ rights. These mean, respectively, that where one shareholder finds a buyer for their shares the other shareholder is entitled to require that the buyer also buy their shares at the same price (allowing them to ‘tag along’) and that where one shareholder finds a buyer they are able to compel the other shareholder to sell on the same terms (dragging them along). (These can equally be provided for in the Articles but would then be vulnerable to change if not entrenched.)
Another, more technically complex but equally useful provision can be provision for cross options (on death) backed by life insurance policies. A cross option on death provides that, on the death of one shareholder, the other shareholders have an option to buy their shares at a determined price – and the Executors have a right to require the other shareholders to buy at that price (hence ‘cross options’). These are ‘backed by life insurance policies’ when the company funds life insurance policies for the various shareholders written in trust for the other shareholders. Hence in the event that one of the shareholders dies there is both the entitlement to buy their shares from them and the money to fund that purchase. In this way everyone gets what they – the Executors get money to give to the Beneficiaries and the shareholders retain control of the business.
All of the above are still useful even in a company with only two shareholders (even more so when there are more).
Coming back, then, to the question posed at the start: is it better to have a shareholders agreement or shareholders that agree? The answer is, of course, that it is best to have both. But if you do need a Shareholders Agreement that is something the Property & Commercial Department at Barrett & Co can help you with.