The core idea of an association is the organizational integration of individuals, uniting to achieve a common goal. However, this collective interest does not prevent the emergence of disagreements. It can be extremely difficult to anticipate all the obstacles that shareholders and partners may have to face. Additionally, unresolved conflicts may jeopardize the survival of the company.
Shareholders’ (or partnership) agreements enable the implementation of mechanisms that can facilitate the resolution of potential conflicts. By putting into writing the common objectives of the association, shareholders’ agreements can furthermore prevent the occurrence of disagreements and allow a much more flexible approach compared to modifying the statutes of an association.
Shareholders’ agreements often include the following clauses:
- Rights and restrictions on the sale of shares to third parties or to other shareholders
- The right of first refusal and how to exercise it
- Right of exemption
- Drag-along rights
- Tag-along rights
- Non-competition clauses
- Confidentiality obligations
- Corporate governance rules
- Dividend policy
- Liquidated Damages
- Applicable law & forum-selection clause
It is important to carefully draft the shareholder agreement as it is an essential document regulating the rights and obligations amongst shareholders.
Rights and Restrictions on Sale of Shares
In general, shareholder agreements define the shareholder group i.e. they specify to whom and under which conditions the company’s shares may be sold.
Small and medium-sized businesses typically foresee that shares can only be sold to current shareholders or only with the consent of all other shareholders.
It is also important to ensure that the new shareholder agrees to be subjected to the shareholder agreement in place at the time of purchase.
Right of First Refusal
The right of first refusal grants shareholders a preemptory right of purchase in the event of a sale of shares to a third party. The association’s statutes regularly provide for this right.
One of the central elements in most shareholder agreements is the priority rights of acquisition i.e. in which order shareholders get to exercise their right of first refusal. This kind of clause is sometimes found in the association’s statutes, but it merely acknowledges the principle. Incorporating it into a shareholder agreement thereby regulating it in more detail provides all parties with greater security.
Right of first refusal clauses grant other shareholders the right to buy the shares of the company if a shareholder wishes to sell his shares. Consequently, the shareholder wishing to sell his shares must offer to sell his shares to the current shareholders before attempting to sell them to a third party.
The purchase price can be determined freely. It is usually the current market value, a negotiated amount at the time of purchase, a contractually pre-determined amount, or related to the price that was offered by a third party.
Right of Exemption
The right of exemption allows a shareholder to buy the shares of another shareholder in the cases provided for in the agreement, for example:
- Upon the death of one of the shareholders
- In the event of incapacitation of one of the shareholders for an indefinite period
- In the event of bankruptcy or bankruptcy proceedings against one of the shareholders
- In the event of the issuance of a declaration of insolvency against a shareholder
- In the event of serious or repeated violations of the shareholders’ agreement or other obligations arising from the employment contract
- In case of violation of the rights of exemption or first refusal provided for in the shareholders’ agreement
- In the event of termination of the shareholders’ agreement
Companies with a limited circle of shareholders generally provide for a right of exemption in the event of termination of employment. Thanks to such clauses, all shareholders are actively involved in the company.
The exercise of the right of exemption is situational. For example, in the event of a breach of the shareholders’ agreement, the price of exercising the right of exemption is typically lower than in the event of the retirement of a shareholder/partner.
Minority shareholders do not necessarily want to remain involved with the company in the event of a change of majority shareholder. Thus, the shareholders’ agreement may provide for an exit right. Such clauses allow minority shareholders to sell their shares under the same conditions as the majority shareholder if they have not exercised their right of first refusal.
The shareholders must determine the percentage of the share being sold to a third party for tag-along rights to be triggered. For example, it may be made dependent on the number of shareholders or the percentage of ownership involved.
The sale to the third-party buyer is then made under the same conditions as those agreed upon between the selling shareholder(s) and the third-party buyer.
In the event of a sale, the purchaser may wish to hold the company in its entirety. This is often the case when companies are acquired by international groups or investors.
Such clauses force (all) other shareholders to sell their shares under the same conditions to the third-party buyer.
Here again, the shareholders must determine the percentage of the share being sold to a third party for drag-along rights to be triggered. It may be 51% or a larger majority. It is understood that the other shareholders can exercise their right of first refusal in order to avoid being forced to sell their shares.
Small and medium-sized businesses generally want to prevent their shareholders from being involved (as a partner or employee) with competitors. It is therefore quite common to see non-competition and non-poaching clauses in shareholders’ agreements.
To be valid, it is important to clearly define the scope of the clause. A clause worded in an overly broad manner may be considered unreasonable and thereby unenforceable by the courts.
In order to allow shareholders to be aware of sensitive company information, it is important to include a confidentiality clause in a shareholders’ agreement. This clause prohibits shareholders from revealing information to third parties without the express written consent of the company or other shareholders.
The clause should define the type of information that is considered confidential. It is generally accepted that information that falls into the public domain is no longer protected and may be shared with anyone.
Corporate Governance Rules
Shareholders may wish to organize the composition of the board of directors or management. Founding partners or minority shareholders may be particularly interested in sitting on the board of directors.
The shareholders’ agreement may also include rules regarding the remuneration of shareholders in their capacity as employees or as directors of the company. Salaries may be a fixed amount or variable, considering the company’s result i.e performance-related compensation.
Minority shareholders may wish to ensure that the company pays dividends regularly and that they are based on annual profits and cash flow. The agreement may thus foresee that a fixed amount or a percentage of the annual profit is set aside for dividend payments.
In the event of a violation of the shareholder agreement, the other shareholders may want to seek damages from the shareholder in breach.
In order to avoid controversy, the shareholders’ agreement may provide restitution in the form of a liquidated damages clause. Such a clause predetermines the amount that must be paid in the event of a breach of the agreement. It is necessary to note, that a judge may reduce the amount if deemed excessive.
Applicable Law & Forum Selection
Generally, the applicable law and proper forum are determined by where the association is headquartered or has its seat. However, shareholders may wish to implement compulsory or optional mediation as a precursor to potentially unnecessary litigation. Mediation may enable the parties to find practical solutions with the help of a mediator.
Alternatively, in order to prevent the dispute from being brought before regular courts that are open to the general public and thereby safeguarding the confidentiality of matters discussed, the shareholders may elect arbitration as a more suitable method of dispute resolution.
Thanks to our proven expertise in drafting shareholders’ agreements combined with the valuable experience gained resolving conflicts in absence of such agreements, THEVOZ Attorneys is able to assist you in by providing you with tailor-made shareholders’ or partnership agreements – no matter the level of complexity.