Any company having more than one shareholder should have a shareholders’ agreement which sets out the rights and responsibilities of the shareholders. It will provide for the manner in which corporate decisions are to be made, the protection of minority shareholders, operational and financial issues and the situations in which a shareholder may sell his shares.
From the estate planning angle, shareholder agreements will ensure your share interest in a company is protected if you were to die pre-maturely or lose your mental capacity.
Shareholder agreements are often confused with buy-sell agreements. A buy-sell agreement focuses on the buying and selling of shares triggered off by certain life events, e.g. death, disability, critical illness or retirement of the shareholders); and is an appropriate funding vehicle. A buy-sell agreement can be one of the items of a shareholder agreement.
A shareholder agreement, besides dealing with the exit of shareholders as described above, also deals with other important corporate control and financial matters.
Another common misconception is that the Articles of Association of a company is the shareholder agreement. While the Articles of Association of a company does set out the rules governing the management and administration of a company, these are the basic rules as set out in the Companies Act (Cap. 50). A shareholders agreement allows the business owners to establish their own “rules” or terms of engagement as to how to run the business, for example the usage of surplus or dividend policies. The Articles of Association document is governed by the Companies Act, and is a public document, whereas the shareholder agreement is governed by the normal contract law, and is a confidential document only for the eyes of the binding shareholders.
General Content of Shareholder Agreements
Below is the general content of a shareholder agreement:
- Parties to the Agreement
- Business of the Company
- Organisation & Management of the Company
- Composition of the Board of Directors
- Officers of the Company
- Meetings of Directors and Shareholders
- Protection of Shareholders
- Employment of Shareholders or Management Contract with Shareholders
- Signing of Documents
- Proper Books and Records
- Share Capital
- Use of Surplus
- Dividend Policy
- Funding an Inter Vivos (living) buy-out
- Right of 1st Refusal
- Buy-out of shares from deceased shareholder’s estate
- Life Insurance policy to fund buy-out of shares from deceased shareholder’s estate
Here are a few important items in the agreement:
Protection of Shareholders
In order for a shareholder to be protected against the dilution of shares or the change of corporate capital structure or business direction, the agreement may require the unanimous consent of the directors or the shareholders. For example, recently, there was a case where a listed company got hit by an international short-seller, the issue being that the company carried excessive debt. In order to calm the market, the company decided to place a right issue in the market. To prevent such a situation, which has a great material impact on the company’s capital structure, shareholders should be briefed and consent should be sought.
It is also not unusual for a family business to hold on to commercial properties inherited from the founder. The agreement should spell out the conditions through which such properties can be sold or mortgaged, and the purpose for these sales or mortgages.
In the absence of such terms, an unsuspecting shareholder might find that the business crown jewels (i.e. main assets) systematically stripped off by self-serving business partners.
Use of Surplus and Dividend Policy
It is good practice to spell out the guidelines for the use of surplus and the distribution rate of dividends. For example, the surplus can be used for the repayment of bank indebtedness, redemption of preferred shares, repayment of shareholder loans, and declaration of dividends.
Right of 1st Refusal
The right of first refusal is a prohibition against a sale to a 3rd party without first offering to sell the shares to the other shareholders under the same terms and conditions. This is to prevent undesirable 3rd parties from gaining a shareholding in the business, especially in a family holding company.
The right of 1st refusal may require a shareholder, who has received an offer from an arm’s length purchaser, to send a notice to the other shareholders and offer to sell them the shares first.
Buy-out of shares from deceased shareholder’s estate
It is important to establish the valuation of the shareholding and provide an immediate funding to buy-out the shares from the deceased shareholder estate. This is to minimise potential conflicts over the ownership and management dynamics of the company. The funding vehicle should be from the life insurance policy so as not to disrupt the capital structure of the company.