Why your company must have a Shareholders Agreement
Starting a business requires careful planning and consideration. A failure to allow for unforeseen events or for ways to resolve future disagreements could put your business at considerable risk.
The repercussions of failing to plan are clearly illustrated in a case in the Federal Court between co-owners of the popular Grill’d fast food empire. What started out as friends in business has turned into an ugly litigious dispute.
One of the most effective ways of minimising costly business disputes between participants in a company is to have a shareholder agreement prepared by an experienced commercial lawyer.
A shareholder agreement sets out the rights and obligations of each business owner and the processes for resolving disputes and deadlocks. The agreement puts all parties on the same page from the beginning of the relationship and facilitates cost-effective and efficient determination of disputes.
A shareholder agreement is integral to protecting the business and owners from unnecessary delay and loss resulting from a range of unforeseen or likely events.
What is a shareholder agreement?
A shareholder agreement is a private contract made between all shareholders of a company, setting out their respective rights, obligations and liabilities. The agreement need not comply with any set form or procedure, however should be carefully drafted to ensure its validity and enforceability and to cover a range of contingencies.
A shareholder agreement needs the consent of all shareholders and, unless otherwise specified, all existing shareholders must consent to any changes or alterations.
So why do I need a shareholder agreement? The Grill’d case
The case of Bainbridge Grill’d Pty Ltd & Ors v Simon Crowe & Ors before the Federal Court illustrates the potential pitfalls of not having a shareholder agreement in place.
Grill’d opened its first restaurant in 2004, the brainchild of friends Simon Crowe, Simon McNamara and Geoff Bainbridge. Since its foundation, Grill’d has spread its wings to over 100 stores Australia-wide and its present value is purportedly estimated at $300 million.
In 2011, McNamara exited the business leaving Bainbridge holding 25 percent of the company shares and Crowe the remaining 75 percent.
For various reasons, the relationship between Bainbridge and Crowe became strained and deteriorated to the point that in June 2016 Bainbridge commenced proceedings under the Corporations Act 2001. Bainbridge claimed that he had been denied access to the company’s books and records and that Crowe had breached his director duties by using company staff and resources to fund KoKo Black, a chocolate company.
Bainbridge sought an oppression order and the removal of the company’s Chief Financial Officer and Director.
In his counter-claim, Crowe sought an order for the forced sale by Bainbridge of his shareholding on the basis that the relationship had soured to the extent that the continued involvement by both owners in the business would be futile. In his argument, Crowe challenged Bainbridge’s previous decision to invest in Pizza Religion, which he considered a rival of Grill’d.
The battle has been personal and fuelled with emotion between the owners. It has been before the Court several times for various interlocutory and directions hearings, no doubt resulting in considerable expense for both parties.
A central issue to the dispute is the value of the company which, when determined, will inevitably have a significant impact on the finality of the matter.
The matter is yet to be resolved amidst a bitter dispute, and until it is resolved, will continue to exhaust time, emotion and of course finances.
A newly-registered company must adopt a constitution which governs the relationship between the company, its directors and shareholders. The constitution is a contract between the company and each member; a member and other members; and the company officers.
A constitution sets out a company’s objectives, activities and internal administrative matters. Consequently, the rights and obligations formed under a constitution are not necessarily individual rights. The constitution is limited in terms of the personal rights of the shareholders and will generally fall short of protecting a shareholder’s interests in the event of a dispute between the parties.
A carefully prepared shareholder agreement will cover matters not addressed in the constitution and is integral for managing ongoing and future issues affecting shareholders.
What should a shareholder agreement include?
A shareholder agreement should meet the specific requirements of the company and its shareholders and may include matters of management, confidentiality, and employee contracts and consultancy agreements. The following are common inclusions.
Priority of shareholder agreement over the constitution. In the event of an inconsistency between the shareholder agreement and the constitution, the shareholder agreement should generally prevail.
Alternative dispute resolution. An agreement should include processes to resolve disputes requiring a genuine attempt by the parties to resolve matters or to engage in alternative dispute resolution before commencing formal litigation.
Deadlock breaker.These provisions deal with circumstances where shareholders cannot agree on the management of the company and can include:
- a shotgun clause, allowing a shareholder to break the deadlock by purchasing the shares of the other shareholder at a nominated price;
- a chairman clause, allowing one shareholder to become the chairman with a casting vote; or
- a liquidation clause, providing for the company to be voluntarily wound up if the deadlock continues for a set period of time.
Pre-emptive rights. These provisions impose restrictions on the transfer of shares. A provision can require exiting shareholders to offer their shareholding to existing shareholders first, before the shares are offered to outside parties.
Drag-along, tag-along rights. These provisions are aimed at balancing the rights of a majority shareholder and a minority shareholder. Under a drag along option, majority shareholders can require a minority shareholder to join in the sale of shares in the company. Under the tag along option, where a majority shareholder is selling shares in the company, the minority shareholder has the right to join the transaction and sell their minority stake.
Mandatory sale events. These provisions set out triggers for the mandatory sale of shares in certain circumstances (for example, a director passes away, resigns or files for personal bankruptcy).
Share valuation methods. Methods by which shares are to be valued in relation to preemptive rights and mandatory sale events, for example, shareholder agreements often provide for the appointment of an external valuer with set criteria for valuation.
Conflict and non-compete clause. These provisions prevent the shareholders from investing in or engaging with competing businesses.