Shareholders’ agreement — Legal glossary

Corporate law · Corporate governance · shareholders’ agreement

Stockholder or shareholders’ agreements are private, comprehensive agreements entered into among a company’s stockholders and the company itself to supplement statutes and organizational documents. A stockholder agreement typically addresses matters relating to corporate governance and the protection of stockholders’ rights.

A stockholder agreement serves different purposes across various contexts. In privately held companies, it governs share issuance, transfer restrictions, and directorships among stockholders. In joint ventures, it defines the rights, duties, and relationships of stockholders, addressing director appointments and distribution policies.

In management buyouts, stockholder agreements often take the form of investment agreements, outlining the commitments of private equity investors and management to subscribe for shares and manage the company’s operations.

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Importance of incorporating a shareholders agreement

Types of standalone agreements for shareholder rights and obligations

Key provisions of shareholders agreements

How shareholders agreement protects shareholders

Drafting a shareholders agreement

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Importance of incorporating a shareholders agreement

A well-defined shareholders’ agreement sets out matters such as the corporation’s duties, corporate governance structure, appointment and removal of managers, exit provisions, inclusion of future stakeholders, and dispute resolution mechanisms.

• A shareholders’ agreement can help achieve the following:
• A well-defined corporate structure
• Profit maximization and prevention of disputes
• Regulate stock transfer
• Establish preemptive rights
• Protect the interests of minority shareholders and provide redress against oppression and mismanagement

An instance of shareholders’ agreements protecting the interests of shareholders can be seen in the case of Southpaw Credit Opportunity Master Fund, L.P. v. Roma Restaurant Holdings, Inc.

The Delaware Court of Chancery held that the board of directors had violated the procedure for issuance of share capital and contravened the joinder provisions provided in the stakeholder agreement. The court upheld the provision of the stockholder agreement, directing that the restricted share capital issuance was null and void ab initio.

Types of standalone agreements for shareholder rights and obligations

Shareholders’ agreements are comprehensive documents that cover contingencies for various situations that may arise in the future. Depending on the intention of the company and its shareholders, a single long-form agreement may be entered into to address different subjects, or stand-alone agreements may be used for each separate matter.

However, standalone agreements must be consistent and harmonious, ensuring that there is no contravention of or conflict with other organizational documents. The types of standalone agreements include:

• Registration rights agreements – Allow investors or shareholders to have their shares registered with the SEC by the company and to sell the shares publicly.
• Voting agreements – Enables shareholders to enter into a voting pact and coordinate their votes to control corporate decisions.
• Buy-sell agreements – Regulate the mandatory purchase or sale of a person’s shareholding in the company upon the happening of the triggering event. These events can range from death, insolvency, resignation, to termination, among others.
• Stock transfer agreements – Provide for the transfer of shares from one person to another, formalizing and documenting the change in ownership of the share capital.
• Confidentiality agreements– Forming an integral part, confidentiality agreements protect the improper usage of the company’s proprietary and classified information by shareholders.

Key provisions of shareholders agreements

Like any other legally enforceable agreement, a shareholders’ agreement can contain various provisions, including boilerplate clauses, principal clauses, and provisions specific to the subject matter.

Depending on state-specific laws, the shareholding pattern, and the structure of a company, in-house or outside counsel can structure the shareholders’ agreement to fit the needs of the various stakeholders.

Governance

Provisions related to governance define and establish rules for managing a company, setting standards of good governance, and protecting the rights of shareholders. In shareholders’ agreements, governance provisions may include:

• Composition of the Board – The board of directors acts as agents of the shareholders, overseeing the management of the company. A shareholders’ agreement may have clauses related to the size, composition, election, and removal of the board and its members.
• Specialized Committees – The formation of audit, remuneration, and nomination committees is often statutorily mandated. The shareholders’ agreement may give a right to a category of shareholders to designate members of these committees.

Stock transfer

To ensure control over who may become a shareholder, shareholders’ agreements lay down specific rules for stock transfers. Key clauses that counsel should consider including are:

• Right of first offer and right of first refusal – This clause ensures that until an existing shareholder has received an offer to purchase the shares of the outgoing shareholder, a third party who is not an existing shareholder cannot buy the shares.
• Tag-along and drag-along rights – Tag-along rights protect minority shareholders by allowing them to participate in the same terms of sale as a majority shareholder selling their shares. Similarly, when a third party may want to acquire the entire company or a significant stake, drag-along rights enable a majority shareholder to compel minority shareholders to sell their entire or a substantial portion of their shares to the third party.

Registration rights

Shares can be transferred through private arrangements or public sale. Registration rights require a company to register its shares with the Securities and Exchange Commission by filing a registration statement. These rights differ depending on the company’s intention to go public.

For instance, demand registration rights may create an obligation for the company to register shares with the SEC at the shareholders’ demand to enable selling to the public.

On the other hand, in piggyback registration rights, the shareholders may not demand that the company register the shares. However, when the company registers its shares, all shareholders get the rights to include their personal shareholding on a pro rata basis.

Boilerplate clauses

Although boilerplate clauses are standard in shareholders’ agreements, the language and scope of these clauses differ from company to company. These clauses usually encompass provisions related to succession, assignment, jurisdiction, interpretation, severability, amendment, waivers, and so on.

Information rights

Information rights may be provided in shareholders’ agreements to enable shareholders to inspect the company’s books of account or gain more access to company information, helping them become part of the decision-making process and make informed decisions.

An instance of statutory information right can be found in NYBCL § 624 and DGCL § 220(b), which grant shareholders the right to inspect the company’s books and records in New York and Delaware, respectively.

Joinder agreements

Joinder agreements are designed to bind new shareholders to the existing agreement, ensuring that the incoming shareholders follow the preexisting agreements regarding preemptive rights, transfer restrictions, and so on.

Counsels must ensure that the joinder provisions are well-drafted, with no scope for interpretation or construction that would limit the negotiation and execution of new shareholders’ agreements whenever there is a transfer of shares to a third party.

Termination

Shareholders’ agreements can be terminated upon the occurrence or non-occurrence of a predetermined event. While there is no restriction on a shareholders’ agreement being in effect for an indefinite period, in-house and outside counsels may provide for early termination.

Events of termination include, but are not limited to, the dissolution of the company, listing the shares publicly through an initial public offering, a hostile takeover, and the sale of all or a substantial stake of the company to a third party.

Like other contractual arrangements, a shareholders’ agreement may also be terminated through the mutual consent of the signatories to the agreement.

How shareholders agreement protects shareholders

In most cases, in the absence of a shareholders’ agreement, there are no procedures for regulating the transfer of share capital, the protection of trade secrets and a company’s technical know-how, or dispute resolution procedures.

Counsels should draft comprehensive and well-defined shareholders’ agreements that protect the rights and interests of both majority and minority shareholders.

Majority shareholders

Majority shareholders are better protected than minority shareholders due to their voting power influencing corporate decisions and board appointments. However, there may be instances where their financial interests require protection.

Minority shareholders

A shareholders’ agreement cannot contravene state law or a company’s charter and incorporation documents. However, it can provide additional protection to minority shareholders and establish mechanisms for effective corporate governance.

Most minority shareholders are not involved in the corporation’s decision-making process and lack adequate representation to communicate and enforce their interests. With shareholders’ agreements, minority shareholders can benefit from contractual protection. For instance,

• Higher quorum for management decisions
• Access to information provisions
• Exit strategies

In Lee C. Ritchie versus Ann Caldwell Rupe, the Texas Supreme Court discussed the importance of shareholders’ agreements.

The court stated that where there is no shareholders’ agreement, a minority shareholder with no voting power or contractual rights may not even have any power to resolve disputes or even sell their shares due to the absence of statutory exit provisions.

Drafting a shareholders agreement

A shareholders’ agreement should be modified based on the application of the agreement to the day-to-day business of the company.

When a shareholders’ agreement is entered into, it should contain provisions related to its eventual modifications, amendments, waivers, joinders, and termination, providing a contractual right, as well as the procedure for replacing redundant or obsolete clauses.

This is done to ensure that the shareholders’ agreement is not static and the rights of the majority and minority shareholders can be enhanced through mutual consent. Additionally, a periodic review and amendment of the shareholders’ agreement ensures adequate corporate governance models are adopted.

Fiduciary duty of shareholders

The shareholders‘ agreement must incorporate provisions related to the fiduciary duties of a shareholder to other shareholders.

When drafting shareholders’ agreements, certain aspects of duties towards the company, as well as other shareholders, should be provided to limit instances of fraud and instill a contractual obligation on shareholders to act in the best interests of the company.

Additionally, a final consideration while negotiating and drafting a shareholders’ agreement is to ensure that no elements of fraud, misrepresentation, or contravention of any statutory federal or state law are present.

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Standard documents

• Buy-sell Agreement (General Form): Corporations
• Registration Rights Agreement (Section 4(a)(2) Private Placement Form)
• Stockholders Agreement (Multi-Party; General Form) (DE)
• Stockholders Agreement (Multi-Party; Private Equity)
• Stockholders Agreement (S-Corporation Form) (DE)
• Stockholders Agreement (Two-Party)
• Stockholders Agreement: Joinder Agreement

Checklists

• Stockholders Agreement Checklist