Shareholder’s agreement is a mechanism which saves the company from losses and protect its interest. Every shareholder agreement has to have the key provisions stated above to create a balance between the shareholder interests and the company’s interests

Team Law Community
May 12, 2021

What is a Shareholder Agreement?

Shareholder’s agreement is a mechanism which saves the company from losses and protect its interest. Every shareholder agreement has to have the key provisions stated above to create a balance between the shareholder interests and the company’s interests. Shareholders are known to be the company's real shareholders. The Shareholder’s Agreement is called an agreement entered into by the corporation and the shareholder specifying the rights and responsibilities. In order to dissolve any disagreement between the owners and the management, a shareholder arrangement is entered into. It also helps secure a shareholder's investment and sets down the rules & regulations for the shareholders and every other company-related entity. Regulating a shareholder arrangement is necessary since not every shareholder is the same. It is important to draw up an agreement taking into account that each person is different and has a different viewpoint on the issues or the subject matter concerned. 

The need for Shareholder Agreement

1. The arrangement operates in accordance with the articles of association of a corporation but can provide shareholders more protection than the articles alone would offer, not less because corporations are often formed easily and inexpensively only with basic articles that do not include any information about shareholder security clauses or specify the limits of their obligations.

2. In compliance with the extensive body of business laws that regulates how a corporation should be managed, a company is generally subject to the regulation. However, any settlement negotiated by the owners should be used in a shareholder’s agreement and can change what would otherwise be the legal situation without it.

3. A shareholder arrangement is a cheap way to mitigate the opportunity for business conflicts between shareholders by clarifying how such decisions are taken and by offering a dispute settlement process and procedures as well.

4. It eliminates cases where changes in the personal circumstances of one shareholder can have an effect on the corporation or other shareholders within the company, safeguarding the financial interest of each shareholder in the company and the rights of the families of the shareholders in the case of the shareholder’s death.

5. The presence of a shareholder arrangement will help to collect funds from banks or creditors and also show other future partners the viability of the group.

Key Elements of Shareholders Agreement

1. Commercial Intent - An investor's economic intent varies from that of others. With minimum setbacks, the investor tries to get full return on his invested money, whereas, the seller wants the capital and wishes to manage the business independently.

2. Terms of the deal - The different types of instruments like equity share, preference share, debenture, hybrid securities, etc. provide for maximization of return on investment. The nature of investment and the ownership of different kinds of securities, help the investor’s to get returns. These are defined terms in the shareholders agreement

3. Exit rights - The purchase option allows for the purchase of the shares of other owners in the event of a violation of terms or default unless settled within a defined period of time. The breach needs to be a material breach which, to the detriment of the investment, changes things radically for the corporation.

4. Representations, warranties and indemnity - The owners and their sponsors shall supply the transaction with representations and promises. They must state the company's true state of affairs and show it to investors in such a way. The investor may claim compensation in the case of a violation of warranty.

5. Dispute Resolution- There is normally a bargaining time set aside to settle the issues resulting from the Shareholder’s Agreement in a co-operative way. But the parties have the option to switch to arbitration in case of failure to do so. In order to cut the financial costs involved, the arbitration venue is typically advantageous for the organization.

Clauses in a Shareholder Agreement

1. Transfer of shares

2. Further issue of shares

3. Quorum

4. Chairman

5. Voting rights

6. Retirement

Steps Involved

1. Designate the parties to the agreement - This section outlines all of the parties to the agreement, including the shareholders that will sign the agreement and the corporation.

2. Set the guidelines - This section specifies the legal meaning of words used throughout the agreement. The agreement should include the agreed upon definitions, relevant to the company’s structure.

3. Explain the structure - Detailing the structure of the company is one of the most important element of the shareholder’s agreement. Depending on the size and type of organization, the shareholder agreement should address the followings:

  • Board of directors-The shareholder agreement should specify: the number of directors; who will be the original directors; how frequently the board will meet; how members of the board are chosen; and whether a majority of shareholders or any other proportion would vote to approve a board member.
  • Officers -The arrangement should define who the company's initial officers are going to be and their names. The amount of pay for the officers can also be outlined in the arrangement.
  • Board -The role of the board and officers in the administration of the organization. The arrangement may, for example, determine who is allowed to manage the banking of the company, accept investments over a fixed sum, allow dividends to shareholders or conduct a loan on behalf of the company.

4. Outlining of procedural rules - Relevant formal guidelines to be adopted by the board and/or officers can also be outlined by shareholder agreements. The rules which include: how and for whom a board meeting may be called; how regularly the meetings must be held; the number of members of the board who are expected to attend the meeting to reach the necessary voting requirement.

5. Establishing observer rights - Any business investors who are not represented on the board of directors may seek the rights of observers. This privilege allows an investor to attend board meetings and to access information restricted to members of the board. Observer privileges, however, do not authorize observers to vote at board meetings.

6. Rights and obligations of shareholders -The shareholder agreement should include a section that specifies the shareholder’s rights and obligations.

7. Setting Corporations Obligations- Investors can request that the company's responsibilities be stated in the shareholder agreement. If you have this clause of the shareholder agreement, make sure you have the agreement signed with the shareholders by a representative of the company.

8. Corporate purchase - A shareholder contract can contain a clause that requires the corporation to repurchase a stockholder shares that expire, become injured, sue for divorce, or become insolvent. This helps the company to retain the shares and eventually sell them for resale to the remaining owners.