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Charting your company’s future: Key considerations for Shareholder Agreements

If you’re thinking about starting a company, you need to consider how it will be operated and governed. That means determining everything from finances, to management and the future direction of the business. Replaceable Rules, company constitutions and shareholder agreements will help you make some of these choices – but which is the best option for you?

This post examines shareholder agreements, how they operate and what to consider including in yours.

The Corporations Act 2001 and replaceable rules

Under the Corporations Act, company directors must act in good faith and in the best interests of the company. As well as providing these basic safeguards for shareholders, the Act also states that a set of rules – Replaceable Rules – will apply to private companies in specific circumstances.

So what are Replaceable Rules? Replaceable rules are standard rules outlining how a company is to be managed. They deal with director and shareholders’ meetings, issue and transfer of shares, inspection of company books and matters relating to the company’s officers and employees.

If your company was registered before 1 July 1998, and your company Constitution has been repealed since, the Replaceable Rules will apply. The same goes if your company was registered after 1 July 1998. However, if you’re the sole director and shareholder of your company, or if your company Constitution has displaced or modified the Replaceable Rules, they don’t apply.

Company Constitution

A company constitution also outlines how a company is to be managed. It can be adopted either on or after the registration of a company and allows Replaceable Rules to be displaced or modified. However, its value is limited if it isn’t customised to suit the needs of your company.

Shareholder Agreements

A Shareholder Agreement can be entered into on, or after the registration of a company. A written agreement between the shareholders or partners of a business, it can be customised to address matters not dealt with by your company’s Constitution or the Replaceable Rules.

The primary purpose of a Shareholder Agreement is to deal with issues that may arise during the life of your business. By pre-empting specific future events, it determines in advance how those issues will be dealt with. As such, it covers the funding, structure, management and direction of the business, as well as outlining the responsibilities and obligations of the business owners.

If your Shareholder Agreement is inconsistent with your company’s Constitution, the Shareholder Agreement will prevail, as long as it doesn’t conflict with the Corporations law.

What to include in your Shareholder Agreement

An effective Shareholder Agreement is clearly drafted, and operates to resolve issues quickly, with certainty and finality. Here are some of the things you should consider including in yours.

– Director and management structure

Most Shareholder Agreements contain clauses regulating the company’s directors and management structure. This usually means clauses about decision making, rights of shareholders to appoint or remove directors, and the powers of the managing director.

– Capital contributions and company loans

You need to prepare your company for the worst. So your Agreement should include procedures or mechanisms allowing for capital injections when times are slow and/or growth is declining. As this usually involves someone loaning funds to the business, your Agreement should outline that person’s obligations during such times.

Your Agreement should also specify how shareholders will contribute to the working capital of the business. It should also outline the implications for any shareholder who doesn’t contribute in proportion to their shareholding.

– Appointment of Directors

It’s essential you clarify how people can leave or join the company, and whether these movements must be agreed unanimously or by majority or special resolution. These clauses should apply to the appointment of directors, as well as other key company personnel.

– Meetings and voting rights

Board meetings are an essential part of company life. Manage them efficiently by outlining:

• Which matters require board meeting approval
• How meetings must be called
• Procedures for the meeting itself
• The expected level of attendance
• How a quorum can be formed
• When unanimous voting is required
• When a certain percentage of votes will suffice to pass a resolution

You should also include scheduling of regular partners/directors meetings and the level of attendance required.

– Observer rights

Some of your shareholders may only be shareholders. As such, they’re not directors of the company and have no voting rights. Consider giving these people ‘observer rights’ to attend board meetings (or certain parts of those meetings).

– Dispute resolution

It’s imperative your Agreement sets out the consequences for a shareholder who breaches the Agreement, and the process for resolving disputes between parties.

– Deadlock

Deadlock provisions operate when shareholders can’t agree on a course of action. If your company has two shareholders, each owning 50% of the company’s shares, deadlock provisions are essential.

A deadlock can be resolved through:

• Russian roulette – one shareholder buys the other out, or sells their shares
• Mediation – the shareholders agree to mediation or another form of dispute resolution in an attempt to resolve the disagreement
• Texas shoot-out – each shareholder puts in a sealed bid to buy the other’s shares – whoever places the higher bid must then buy the shares
• Deterrence – this fixes a price where one shareholder must buy the other person’s shares at 125% of the market value

Regardless of which method you choose to resolve a potential deadlock, you must specify the method in the Agreement so the deadlock provisions can operate.

– Exit strategies

These include buy-out procedures, sale of shares and share valuation. You should also include buy-sell provisions which set out the rights and obligations of shareholders to buy or sell their shares in specific circumstances. This may include insolvency, disability, death or retirement. You should also include a price or valuation mechanism. You can read more about buy/sell agreements here.

A strong Shareholder Agreement covers all your bases

Some of the situations discussed above may never occur in your business. However, forewarned is forearmed, and it’s best to be prepared. Including these provisions in your Shareholder Agreement will provide your business with much needed stability and security, particularly in uncertain economic times.

About the Author:

Ian Macleod is the CEO of the legal publisher RP Emery and Associates. They provide cost effective legal contract kits for Individuals, SME’s and the legal fraternity.

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