What does a shareholders agreement cover?

A shareholders agreement is a great idea to have in place within any company to ensure that the company can run smoothly and profitably with minimal conflict and confusion between the shareholders.

Generally, a shareholders agreement will cover the following points.

• Shareholder rights and obligations including dividend distribution policies
• The management and operation of the company
• Who can appoint directors
• Voting rights and the issue of new shares
• The options available to shareholders if another shareholder leaves the company
• How to restrict competition with the business, ie restraint of trade for directors and/or shareholders

Shareholder rights and obligations including dividend distribution policies

In most company structures, shareholders are entitled to a share in the company’s earnings or profits. So in order to distribute a share of the company’s profits or earnings to shareholders, a company can pay a dividend to these shareholders. While most companies pay dividends twice a year, a company may pay more or less frequently and even pay special dividends in relation to the profits earned from a particular event.

It is important to note that shareholders do not have a legal right to receive dividends under Australian law and companies are not required to pay a dividend from profits and earnings. For example, some companies may choose to reinvest profits and earnings back into the business. However, if dividend distribution policies are included within a shareholders agreement then all parties to this agreement will be bound to the distribution policies.

The management and operation of the company

Shareholders agreements can also be very useful in setting out shareholder rights and obligations in relation to the operation of the company. How a company is managed and operated tend to feature in the initial clauses of a shareholders agreement due to its importance. Certain agreements may even set out the individual roles and duties of various executives of the company for extra clarity.

Who can appoint directors

When reviewing your shareholders agreement, it is a good idea to get a thorough understanding of clauses relating to the appointment of directors. Shareholders are usually given the power to vote in or elect directors. However, the weightage of a shareholder’s vote will depend on the percentage of shares that the shareholder holds within the company.

Since the directors effectively control the company along with the shareholders, it is necessary for these clauses to be set out clearly. It is also useful to have the director’s duties and procedures regarding board meetings to also be set out in the agreement.

Voting rights and the issue of new shares

It is essentially a right of a shareholder to vote on matters regarding the appointment of directors, company policies and procedures and other matters relating to company finances. The voting rights of shareholders often extend to making decisions regarding the issuing of securities, changing the corporation’s operations and splitting stock. It is common for shareholders to be able to exercise these voting rights during general meetings organised by the company.

The options available to shareholders if another shareholder leaves the company

Since a company has its own legal entity, it will continue to exist even if shareholders pass away, sell their shares or leave the company. For this reason, there are usually procedures detailed within shareholders agreements that describe the options available to shareholders if another shareholder leaves the company. For example, most shareholders agreements should incorporate provisions relating to the buy-out or sale of a shareholder’s shares. Clauses should also be included that outline what will happen if a shareholder passes away or if he/she decides to terminate their particular involvement in the agreement.

When drafting a shareholders agreement, it is always a good idea to consider the possibility of shareholders selling their shares or leaving the company. These are realistic possibilities and if a shareholders agreement effectively deals with these situations early on then confusion and conflicts can be avoided when such situations arise in the future.

How to restrict competition with the business, ie restraint of trade for directors and/or shareholders

Issues regarding restraint of trade are not usually covered within the Company Constitution so it is useful for a shareholders agreement to cover these policies. Restraint of trade clauses are usually incorporated into a shareholders agreement to protect the goodwill of the company and prevent employees or partners who leave the company from competing with the company’s business or taking the company’s clients. The goodwill of a company and client relationships are very important for all businesses so restraint of trade clauses are very popular to include within shareholder agreements.

Courts will usually only uphold a restraint of trade clause if it is reasonable in the circumstances. To know if a restraint of trade clause is reasonable you should consider whether the clause:

• displays a genuine interest in protecting the interests of the company
• restraints trade for a time period that is necessary in the circumstances
• restraints trade within a geographical are that is not too wide considering the circumstances
• does not restrict former employees or partners to the extent that they cannot continue to work in their professional fields at all

Conclusion

While most shareholders agreements will cover the general points discussed above, your agreement should reflect the unique needs of your particular company. Therefore if you are getting ready to draft a shareholders agreement for your company or you are reviewing an existing shareholders agreement then it is a good idea to seek legal advice to ensure that you understand the consequences of the clauses in the agreement.