While business ventures invariably begin with a sense of goodwill between parties, disputes between business owners are unfortunately all too common. This rang true for the owners in thecase of Campbell v Backoffice Investments Pty Ltd.[1] Beginning as two co-directors with equal voting power, their relationship quickly broke down, ending in an ugly litigious dispute over claims of oppressive conduct. While disputes are hard to avoid completely, having a well-structured and clear Shareholders Agreement can minimise the risks of disputes and give you a pathway out when a dispute is irreconcilable.
While a company’s constitution is a significant document (setting out the company’s purpose or objectives, detailing the rules that manage the relationship between directors and shareholders, and establishing the basic rights attached to classes of shares and meetings of shareholders) the constitution can be limited in scope. A number of unaddressed issues (described below) can be fully realised through the implementation of a Shareholders Agreement. While it is not required by law, the Shareholders Agreement acts as a legal contract between the shareholders outlining the rights, obligations, and expectations of the shareholders as amongst themselves. Part of the benefit of a Shareholders Agreement is that it forces the shareholders to openly discuss their expectations for their investment in the company and allow the parties to pre-agree matters which might otherwise be a source of dispute if left unresolved.
Whether your company requires a Shareholders Agreement will depend on its ownership structure. If you are the sole shareholder, a Shareholders Agreement is unnecessary. It is only once you look to bring on external investors that implementing a Shareholders Agreement proves valuable. It is beneficial to construct the Shareholders Agreement during this early stage when there have not been any disagreements about the management of the business and there is goodwill between the parties. The key issues to be considered and documented are:
1. Decision-Making
It is prudent to clarify the allocation of the different types of decisions amongst the board and the shareholders. Generally, shareholders have a very limited role in the decision-making of a company (having entrusted the board with the power to make decisions affecting the day-to-day operations of the company). At law, shareholders have the power to amend the Constitution, to elect or remove directors as well as an auditor, to inspect the company’s records, to vote to change the nature or ownership structure of the entity, and to voluntarily wind up the organisation.
Yet, when you become a shareholder you might also expect to have a say in whether the business is sold or whether the company incurs significant debt (for example). Setting out clearly what “fundamental” decisions need a secondary form of approval by the shareholders helps manage the expectations of the parties. You, as shareholder, might also wish to change the percentage of approval required. For example, relatively minor day-to-day company decisions may require only an ordinary majority vote of directors, but decisions affecting the core business of the company (such as a sale or a change in strategic direction) could require approval by a special resolution (75%) or a unanimous decision of directors and the shareholders.
2. Restraints of Trade
Shareholders are in a unique position to access company and business information. In order to protect that information for the benefit of all shareholders, imposing obligations relating to restraints of trade can be important. Not all shareholders work in the business or are directors, and hence not all shareholders are automatically bound by the duties of confidentiality and loyalty at common law and in the Corporations Act. Hence, including restraints where a shareholder is restricted from using information gained from their capacity as a shareholder to form or fund a competing business can help ensure the success of the business and a level playing field for all shareholders.
3. Pre-emptive Rights and Restrictions on Transfers of Shares
Shareholders have the right to transfer shares without the consent or involvement of other shareholders. Yet, at the start of a business relationship you would have gone to great lengths to determine who are the right people for you to go into business with. To ensure existing shareholders are not placed at risk or stuck in a tightly held business with complete strangers, the Shareholders Agreement can provide clauses that ensure share transfers remain “in house” through pre-emptive rights. Obligations to first sell to the existing shareholders, and then rights to approve incoming shareholders can help manage the ongoing business relationships of the shareholders. These clauses might look like first rights of refusal, price valuation mechanisms (so you have pre-agreed how both the business and shares should be valued) and the right (or obligation) to buy or sell in certain circumstances (death, permanent or total disability); such clauses can work to resolve the issues created upon a shareholder’s departure.
4. Dispute Resolution
Finally, no matter the initial goodwill of parties in the beginning, conflicts can arise between shareholders. It is important to have a pre-agreed dispute resolution process in place so that disagreements do not disrupt the entire operation of the business, and the dispute is resolved in a timely and fair manner.
Ideally, your Shareholders Agreement can be drafted and filed away, never needed because the business and the parties are working well together. If, however, you ever get caught up in a conflict, you’ll be glad you’ve got a safety mechanism in place.
For peace of mind when it comes to your rights, duties, and obligations as a shareholder, please get in touch with the Business & Commercial team on 02 6274 0999 to discuss further.
First published on 29 June 2023.