Introduction to Shareholders’ Agreements
Definition
A shareholders’ agreement is a contract made between two or more members of a company to govern their relations and determine certain aspects of the company’s management and shareholding.
This agreement complements the company’s statutes, specifying elements not necessarily included in the statutes. Typical content of a shareholders’ agreement includes voting rights, restrictions on share transfers, management rights, financial commitments and contributions, dividend and distribution policies, and dispute resolution mechanisms. (See the article “Shareholders’ Agreement: Definition, Types, and Duration” for more details.)
In Italy, shareholders’ agreements generally have a maximum duration of five years for members of limited liability and share companies, but they can be renewed or terminated with a 180-day notice if no specific term is set. For other types of companies, if a term is not fixed by the parties, each party can withdraw with a 180-day notice. It is important to note that as a contract, the creation, content, and effects of a shareholders’ agreement are subject to the rules and limits of contract law under the civil code. Any modification of the agreement requires unanimous consent of the signatories.
Failure to comply with a shareholders’ agreement can lead to various consequences, depending on the terms set by the signatories and the severity of the breach. The main consequence is financial, in the form of a penalty or liquidated damages. A breach by a signatory may also result in a loss of trust among the partners, potentially harming business management and leading to the exclusion of the shareholder which is in default or even the dissolution of the company.
Difference Between Corporate Bylaws and Shareholders’ Agreement
In Italy, corporate bylaws are official documents governing the formation and operation of the company, filed with the Business register and accessible to the public. They include details such as the company name, registered office, business purpose, share capital, company duration, management structure, rules for calling and holding general meetings, and dissolution and liquidation procedures. Key differences between bylaws and a shareholders’ agreement include:
- Disclosure: Bylaws are public. As an example, they are filed with the Trade and Companies Register in France and Registro delle Imprese in Italy, while the shareholders’ agreement is confidential (except in some cases like listed companies) and not filed.
- Content and Purpose: Bylaws cover fundamental and mandatory aspects of the company, whereas the shareholders’ agreement is flexible and addresses specific and personal aspects of relationships between partners/shareholders, varying by company type and its specifics (SARL, SA, SAS, etc.).
- Modification: Bylaws require a formal decision by the extraordinary general meeting and must be refiled, a lengthy and costly process. In contrast, a shareholders’ agreement can be modified by simple unanimous agreement between the parties without public formalities.
- Scope: Bylaws are mandatory for all shareholders and third parties, while the shareholders’ agreement binds only the signatories.
- Confidentiality:Bylaws are publicly accessible, while the shareholders’ agreement is confidential between signatories.
In summary, corporate bylaws set the legal and structural foundation of a company, while the shareholders’ agreement addresses specific and often more sensitive issues, providing greater flexibility and confidentiality.
Reasons to Adopt a Shareholders’ Agreement
A shareholders’ agreement is crucial for structuring and securing relationships within a company. It provides a clear legal framework to manage various situations that may arise during the company’s life. Key reasons to adopt such an agreement include:
Prevention and Management of Conflicts Among Partners:
The agreement plays a vital role in preventing and managing conflicts. It clarifies each party’s expectations, defines decision-making processes, and establishes mechanisms for resolving disagreements. By anticipating potentially contentious situations, the agreement can avoid costly disputes and maintain cohesion within the company.
Regulation of Share Transfers:
The agreement governs share transfers by setting specific rules on how shares can be sold or transferred. This may include preemption clauses, giving other partners the right of first refusal to buy shares put up for sale, or restrictions to prevent undesirable third parties from entering the company’s capital. This protects the stability and balance of shareholding.
Protection of Minority Shareholders’ Interests:
Minority shareholders can be vulnerable to decisions made by majority shareholders. A shareholders’ agreement can include specific clauses to protect their interests, such as veto rights on significant decisions or special exit conditions. This ensures that minorities retain a voice and are not excessively disadvantaged.
Defining Shareholders’ Responsibilities and Rights:
The shareholders’ agreement may clearly define the responsibilities and rights of each shareholder, including not only financial aspects like dividend distribution but also roles within the company’s management, non-compete obligations, and participation in general meetings. By establishing these parameters from the outset, the shareholders’ agreement fosters smoother business management and a shared understanding of expectations. In summary, a shareholders’ agreement is an indispensable tool for any company, whether new or established. It provides a structure for internal governance, protects each shareholder’s rights, and ensures more predictable and fair management of the company.
Key Elements of a Shareholders’ Agreement
The key elements of a Shareholders’ Agreement depend mainly on the goals of the parties and the purpose of the agreement. Generally, you can find clauses aimed at:
- Regulating the transfer of the shares and protecting shareholders’ interests, (as an example, through pre-emption and tag-along drag-along clauses)
- Introducing special rules for company’s decisions and/or exit mechanisms and conflict resolution among shareholders
Pre-emption and Tag-Along/Drag-Along Clauses
Pre-emption, tag-along, and drag-along clauses are essential components of a shareholders’ agreement designed to regulate the transfer of shares and protect shareholders’ interests.
Pre-emption Clause: This grants one or more signatories of the agreement a priority right to purchase shares that another shareholder wishes to sell, thereby preventing the entry of unwanted new shareholders.
Tag-Along Clause: This mechanism protects minority shareholders when one or more majority shareholders decide to sell their shares. It gives minority shareholders the right to join the sale and sell their own shares under the same conditions as the majority shareholders. This allows minorities to benefit from the same selling opportunities and avoids leaving them with shares in a company that others wish to exit.
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- For example, imagine a company with three shareholders: A, B, and C. A owns 60% of the shares, B 30%, and C 10%. If A and B find a buyer willing to purchase their shares, the tag-along clause allows C to sell their 10% of shares to the buyer on the same terms as A and B. This ensures that C can also benefit from the sale and receive a fair price for its shares.
Drag-Along Clause or ‘Forced Sale Obligation’: Conversely, when a majority shareholder (or a group of shareholders representing a predetermined majority) decides to sell their shares to a third party, the drag-along clause allows them to require minority shareholders to also sell their shares under the same conditions (fair sale price and identical terms). The primary goal of this clause is to ensure a complete sale of the company, which is often more attractive to potential buyers who prefer to acquire 100% of the shares rather than just a portion.
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- For example, suppose a company has three shareholders: A, B, and C. A owns 60% of the shares, B 30%, and C 10%. If A finds a buyer interested in purchasing 100% of the company, the drag-along clause would allow A to compel B and C to sell their shares to the buyer on the same terms.
To draft effective drag-along and tag-along clauses, it is crucial to precisely define the rights and responsibilities of both majority and minority shareholders during the sale of shares. The drag-along clause typically allows majority shareholders, usually those holding at least 75% of the shares, to require minorities to sell their shares in a sale. The transaction terms must be the same for everyone. It is also necessary to include a notification process and outline consequences for minority shareholders if they refuse to sell.
The tag-along clause, on the other hand, ensures protection for minority shareholders by allowing them to join in a sale initiated by the majority. They should be able to sell their shares on the same terms as the majority, with a clear notification procedure. Both clauses should comply with local regulations and include mechanisms to ensure a fair and well-structured sale.
Rules for Major Business Decisions
The shareholders’ agreement might define the rules for making crucial decisions within the company. This may include strategic decisions such as approving the annual budget, appointing or removing executives, or approving expansion plans. Some of these decisions may require a qualified majority or unanimity, which protects minority interests and ensures consultation before making decisions with significant impact.
Applicable Law and Dispute Resolution Mechanisms
Generally, parties from different countries should indicate the law applicable to their shareholders’ agreement, a law that may differ from the law of incorporation of the company.
It is essential to include in the agreement mechanisms for resolving disputes that may arise between shareholders. These mechanisms may also include mediation and arbitration. These clauses help avoid lengthy and costly legal battles, ensuring a quick and fair resolution of conflicts.
Voting Rights and Dividend Distribution
The agreement should clarify the voting rights of each shareholder, particularly in cases of unequal share distribution. It may also provide special voting rights for certain categories of shares or specific decisions.
Additionally, the terms for dividend distribution should be defined, specifying the conditions under which profits are distributed or reinvested in the company. These provisions are crucial for preventing misunderstandings and frustrations regarding profit-sharing.
Benefits of Having a Shareholders’ Agreement
A shareholders’ agreement offers numerous advantages for the effective management of a company. Firstly, it provides clarity and transparency in shareholder relations. By clearly defining the rights, duties, and roles of each shareholder, the agreement helps prevent misunderstandings and facilitates decision-making. This transparency fosters a trustful and collaborative environment.
Secondly, the agreement ensures greater stability and security for investors. By setting rules on share transfers and decision-making, it protects the interests of all shareholders, whether they are the majority or minority. This predictability is reassuring for investors who then have better visibility of the company’s future.
The shareholders’ agreement also facilitates capital raising. By structuring internal relationships and protecting each party’s interests, it makes the company more attractive to potential investors.
Finally, the agreement helps reduce the risk of legal conflicts. By establishing procedures for resolving disputes, such as mediation or arbitration, it avoids lengthy and costly court battles. This strengthens the company’s internal stability and protects its longevity.
Case Studies and Practical Examples
We drafted several shareholders’ agreements for companies in the EU. Thanks to the shareholders’ agreement, a judicial dispute between two shareholders in a small to medium-sized enterprise (SME) in a car component sector, was avoided.
The shareholders’ agreement detailed the dispute resolution procedures and the conditions under which each shareholder could leave the company, including specific economic and time-related conditions. This allowed all parties to assess the benefits of a negotiated settlement, instead of a judicial action. The settlement allowed our client to reobtain sole control of the company by repurchasing part of the shares at a lower price. This solution helped to preserve the company’s business, expertise, and client base.
We assisted several clients in drafting shareholders’ agreements that could preserve their rights in the company’s management and decision making even in situations not always covered by law.
Tips for Drafting a Shareholders’ Agreement
It is advisable to consult legal experts to ensure that the agreement complies with the applicable law and protects the shareholders’ interests. The agreement should be customized to meet the shareholder objectives, considering also the needs of the company, its structure and share distribution. Additionally, periodic reviews of the shareholders’ agreement are necessary to adapt it to changes in the business and to prevent future conflicts.
Conclusion
In conclusion, a shareholders’ agreement is not just a legal tool but a true safeguard for the stability and survival of a business. This document not only clarifies relationships between shareholders but also anticipates and prevents potential conflicts that could threaten the cohesion and management of the company. By providing a clear structure for decision-making, share transfers, and protection of shareholder rights, the shareholders’ agreement strengthens trust and transparency within the company. Furthermore, it plays a crucial role in securing investments and enhancing the company’s attractiveness in the market. Thus, for many businesses, adopting a well-designed shareholders’ agreement is not just prudent but essential.