Shareholders Agreements – a cautionary tale for limited companies

Jordans Solicitors’ Susan Lewis discusses a recent Case Study, involving Shareholders Agreements and limited companies.

Whenever a new limited company is set up, we always advise our clients to enter into a Shareholders Agreement. Some do, but many don’t. It is probably one of those tasks which people think they will get around to doing at some point, a little bit like making a will.

No matter when you set up your limited company, it is always a good idea to consider having a Shareholders Agreement in place to protection your legal position within the company. Shareholders Agreement was be entered into at any time once a company has been incorporated. 

What is a Shareholders Agreement?

A Shareholders Agreement is a contract between each of the shareholders and the company about how certain steps and actions within the company and in relation to the shares will be conducted.

Where a company will have more than one shareholder and especially whenever there will be a majority and minority shareholding, and where one or more shareholders are not also a director of the company, a Shareholders Agreement is an essential legal protection for everyone’s personal position within the company. 

A Case Study 

To illustrate the importance of having a Shareholders Agreement in place, the following case study should serve as a cautionary tale.

We acted for a client who was a minority shareholder in a small family business. 

As the business was set up for the family, no one believed there was any reason to have a Shareholders Agreement drawn up. It was considered to be an unnecessary expense which the business could do without incurring at the time. 

There were three family members involved: a parent, a son and the son’s spouse. All three were directors but the parent subsequently stepped down as a director leaving the other two to run the business. The parent however continued working for the business.

All three family members were shareholders however the shares were not held equally. As two of the shareholders were married (and likely to support each other when decisions were being made) this situation called out for a Shareholders Agreement to be drawn up to regulate the relationship between the three parties, especially for the benefit of the parent who was no longer a director of the company and was the minority shareholder. 

A short time later, a rift between the three began. The situation worsened and a solution was required. The minority shareholder stopped working for the business, leaving all the work to be carried out by the two directors. They quickly became disgruntled by the situation as the third shareholder was still entitled to receive dividends for his shares, despite not working in the business. Discussions began between the three, however a price could not be agreed for the directors to buy out the third shareholders’ shares. A stalemate situation was created. 

The minority shareholder could not be forced to sell his shares to either the other two directors or to a third-party buyer unless he was happy with the price being offered for his shares. As a way to work around this restriction, the two directors decided to explore a sale of the business’ assets instead to a third-party. This would not require the minority shareholder’s consent. They also explored the possibility of selling the assets of the business to a new company which they set up so they could, in effect, continue to run an identical business, but without the involvement of the third shareholder. Again, this did not need the minority shareholder’s consent. 

With either of these courses of action, the minority shareholder would be left owning shares in a company which had ceased to trade and no longer owned any assets from which to earn any income. The proceeds of sale from the sale of the assets would be distributed to the three shareholders in proportion to the shares they owned but the minority shareholder could not stop this from happening or challenge the value being paid for the assets, without taking expensive court action against the two directors. 

Why have a Shareholders Agreement? 

In this case study, a Shareholders Agreement would not have stopped the parties falling out. No document can do that. However, a Shareholders Agreement would have given the minority shareholder protection to be consulted and involved in the process of selling the assets of the business. This may have helped to break down the fears and worries the minority shareholder had around this arrangement. It may have also helped the parties to have more sensible and focused discussions around reaching an amicable solution for one of the parties to buy out the other party’s interest in the company. As it was, the minority shareholder felt the majority shareholders’ tactics were underhand and designed to cheat him out of money he felt he was entitled to receive. 

Whilst there was a remedy available to the minority shareholder, this would involve issuing a claim at Court and asking the Court to intervene and remedy the situation. Litigation is always expensive and uncertain and preventing situations escalating to litigation is always a far better option. In this case, a Shareholders Agreement would have put the minority shareholder in a strong position to veto the directors’ decisions if he did not feel they were in his best interests. From there, he would have been in a position of strength to negotiate with the directors. As it was, they were able to present him with a ‘fait accompli’ where the onus would then have been on him to litigate the situation if he had deep enough pockets to do so. 

The moral of this case study is that ‘prevention is better than cure’ by having a suitable Shareholders Agreement drawn up if there are more than one shareholder in the business and if there are majority and minority shareholdings, or if any shareholder is not also a director of the business. 

Jordans Solicitors – Expert Company & Commercial Solicitors 

If you need Company & Commercial Legal Advice in relation to this topic, or anything else in relation to your business, then get in touch with the team here at Jordans Solicitors. 

Just call 033 0300 1103 or fill-in our Request A Call Back form by clicking the link below.