10 key issues to look out for when drafting shareholders’ agreements

Introduction

It is often said that a balanced shareholders’ agreement is a good start to any joint venture. More often than not, the tone of a shareholders’ agreement is set by the intentions of the majority. Where the investment is made in equal parts, it is essential for certain key issues to be addressed early on to safeguard the investment itself and the ongoing relationship of the parties in the long run. This article highlights 10 key issues that investors should look out for when negotiating terms and drafting a shareholders’ agreement.

Corporate governance

A company is managed by its board of directors, which is entrusted with day-to-day decision-making and burdened with fiduciary duties to act in the firm’s best interests. At the same time, under section 178 of the Companies Law (Cap 113), a director can be dismissed by an ordinary resolution (50% plus one vote) passed at a general meeting of the shareholders (provided special notice has been given under section 136 of the Companies Law). Accordingly, it is important for a shareholders’ agreement to clearly define the extent of the two bodies’ competence so that the company is smoothly run, without unnecessary overlaps in duties. Specific provisions should be included regarding issues including:

  • the appointment and removal of directors;
  • restrictions on the powers of directors;
  • reserved matters;
  • how decisions should be taken; and
  • specific majority provisions to approve certain acts.

Resolution of deadlock situations

A deadlock situation can occur as a result of a dispute between either the shareholders of a company or between the shareholders and the board of directors. A shareholders’ agreement can provide a roadmap for resolving these situations, while ensuring business continuance or a civilised dissolution of a joint venture. When parties are at the early stages of their joint venture, they can agree specific mechanisms on resolving these difficult situations, rather than depending solely on expensive, lengthy and unpredictable litigation as a means of resolution.

Dividends distribution

The shareholders of most companies, being investors, will expect to see a return on their investment. Consequently, a shareholders’ agreement can include a dividend payment policy, adding a degree of certainty over the manner in which the return will be declared, paid and taxed, subject to applicable laws. According to the Companies Law, the model articles of association, the International Financial Reporting Standards and decided case law, dividends are paid only out of profits. It is possible for shareholders to agree a specific dividend policy that extends beyond what a shareholder should receive as per their percentage of share participation.

Restrictions on transfer of shares

Since shareholders like to have some control over who they are doing business with, it is vital that any provisions prohibiting certain transfers of shares or allowing transfers of shares upon fulfilment of certain conditions, as well as any tag-along and drag-along rights, are carefully drafted to meet the parties’ expectations in this regard. Although detailed provisions relating to the transfer of shares are contained in the company’s articles of association, the shareholders’ agreement acts as a supplement in this respect, providing additional contractual rights to the shareholders in the event of a breach.

Confidentiality

Confidentiality clauses are usually found in most agreements since parties entering into a transaction want to ensure that information exchanged between them is not shared with external parties for the protection of their interests. A confidentiality clause in a shareholders’ agreement should clearly state:

  • what information is considered confidential;
  • the period during which the parties wish to keep such information confidential; and
  • what disclosures are permitted.

Dispute resolution and governing law

A shareholders’ agreement should foresee the event of a dispute between the parties and how this should be resolved. The parties should agree:

  • which law shall govern the agreement; and
  • whether disputes should be referred to courts of specific jurisdiction or be dealt through other routes such as mediation or arbitration and under which rules (eg, the London Court of International Arbitration or the International Chamber of Commerce).

Non-competition

If the shareholders wish to prevent the other shareholders from competing with the business of the company, relevant restrictive covenants should be incorporated into the shareholders’ agreement, such as prohibiting the shareholders from setting up competing business within a specific time period and/or specific territory.

Addition of new shareholders

Usually, shareholders want to control who owns shares and is involved in the company – they do not usually want third parties to become shareholders without their consent. On the other hand, the addition of new shareholders may be desirable in certain situations. Therefore, a shareholders’ agreement should include a specific mechanism for the addition of new shareholders based on the parties’ interests.

Funding

A shareholders’ agreement will typically provide how the share capital of the company is composed – that is, how and in what proportions the shareholders are investing in the business. Additional funding may be required during the course of the company’s business – for example, when the cashflow and working capital are insufficient for the company to meet certain business goals. Specific provisions should be included in a shareholders’ agreement as to how and in what circumstances a company can obtain additional funding such as the issue of new shares and external funding.

Exit strategy

A situation may occur where shareholders may want to sell their shares or liquidate the company. A proper exit mechanism should be structured in a way that protects the interests of all parties involved.

Comment

A shareholders’ agreement that provides for many eventualities can serve as a safeguard and protect shareholders. The shareholders’ agreement can:

  • afford to the shareholders rights that would not be enforceable under the articles of association of the company;
  • regulate matters unrelated to the administration of the company; and
  • protect the rights of minority shareholders.

For further information on this topic please contact Stella Koukounis or Chara Paraskeva at Solsidus Law by telephone (+357 22 007700) or email ([email protected] or [email protected]). The Solsidus Law website can be accessed at www.solsiduslaw.com.

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