If you are a private company shareholder you hold shares under standard articles of association. Standard articles are automatically downloaded when the company is incorporated. Based on the problems we see in our practice we have summarised some of the most common consequences of having to rely on standard articles if you are a shareholder.
Problems if there is no shareholders agreement
The problems arising if you rely on standard articles will vary depending upon the circumstances and the percentage of shares you hold. If you can control 75% of the voting power you can amend standard articles of association and cure many problems. But, minority shareholders do not enjoy this power.
Impact for minority shareholders
The impact on a minority shareholding if unwanted changes to the standard articles are implemented can be serious and the minority shareholder is stuck with the changes to the articles even if you did not vote in favour.
In limited cases a minority shareholder may be able to rely on protections under the Companies Act. But in practice the provisions for minority shareholders are cumbersome and often of little or no practical help. A minority shareholder will be in a better position if issues are sorted out when the shares are acquired or before problems arise.
Majority shareholders may not be able to sell
A minority shareholder could block your company’s sale. The solution is to include tag and drag along rights in the articles or the shareholders’ agreement. Then all the company’s shares are saleable if the majority want to do a deal.
A typical drag along right enables a majority of shareholders to sell the company. Minority shareholders are dragged into the sale on the same terms. So buyers can acquire 100% of the company.
Tags along rights protect minority shareholders. Minority shareholders may not want to retain their shares in a company under new management and control. Typically, if a majority sell their shares to a purchaser, then the purchaser must offer to buy the minority shareholder’s shares on the same terms.
Shareholders who leave the company can retain shares
Often managers award shares to incentivise people working in the business. However, if an employee or director leaves the company, they retain ownership of those shares. Commercially this may be undesirable, as it dilutes the profits for those who remain.
The articles and or the shareholders’ agreement can deal with leavers. Quite commonly leavers are forced to sell their shares if the directors demand which builds in flexibility.
Departing shareholders free to set up competing businesses
With no protection by way of agreement with the shareholders then any shareholder is free to take your know how and customers and trade on their own account. Restrictive covenants prevent departing shareholders setting up in competition after they sell their shares.
Non compete provisions are best reserved for the shareholders’ agreement as this increases the chances of enforceability.
Every shareholder entitled to equal treatment
Standard articles come with only one class of share which carries equal rights to income, voting and capital. Different share classes enable you to pay different dividends to different shareholders and vary rights to voting and capital. This is popular if different shareholders contribute different amounts to the business. Different share classes can also carry different:
- Voting rights;
- Rights to capital payments on sale or liquidation.
The articles do have to set out the different classes of shares. Fine detail on the payment of dividends on the different classes of shares can be reserved for the shareholders’ agreement.
Deadlock at director and shareholder level
Sometimes when shareholders do not agree, there is stalemate. We add simple dispute resolution clauses to the articles or shareholders’ agreement to resolve deadlocks. For example, it is possible to provide that:
- Disputes are referred to a third party expert or arbitrator;
- Disputes trigger a pre-determined buy-out mechanism. i.e. one side buys the other’s shares a pre-determined price.
- Unresolved disputes cause a winding up of the company up and resultant loss of goodwill.
The solution – implement a shareholders agreement
Any company with two or more shareholders should have a shareholders agreement. A shareholders agreement compliments the articles of association. For example, a shareholders agreement can:
- Define shareholder responsibilities;
- Assist in the company’s smooth running;
- Reduce the chances of shareholder conflict.
Under English Law, shareholder’s agreements enjoy confidentiality. The articles of association are publicly available through Companies House.