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After incorporating your company, you will need to turn your attention to the different legal obligations that are involved with running a company. One of which is having a company constitution and a shareholders agreement. However, does your company need both, or neither? This article will set out the relationship between your company’s constitution and shareholders agreement.

What is a Company Constitution?

When running your company, you need a formal set of rules that govern the internal management of your business. These can be in the form of:

  1. a company constitution;
  2. the replaceable rules as set out in the Corporations Act 2001 (the Act); or
  3. a mixture of both the constitution and the replaceable rules.

The replaceable rules are a basic framework for a company’s constitution that you can modify to suit your business’ needs. However, you could also choose to simply adopt the rules as your company’s form of internal governance.

There is no prescribed form that a written constitution should take. Instead, this will depend on what your shareholders decide are the needs of the business. Typically, a company constitution will address the day-to-day matters and management. This includes:

  • the appointment, powers and removal of directors;
  • the organisation and calling of directors meetings;
  • issuing shares and the rights of shareholders depending on their class of shares; and
  • conflict resolution.

A company’s shareholders can adopt a constitution by a special resolution. This requires the agreement of at least 75% of the votes cast.

What is a Shareholders Agreement?

A shareholders agreement is an agreement between either:

  • all the shareholders and the company; or
  • the shareholders within a particular class of share (e.g. preference shareholders).

Shareholders invest in the business by providing money in return for part ownership in the company (shares). A shareholders agreement aims to protect the shareholder’s investment and establish ways that the shareholders can work together to grow the business.

The content of a shareholders agreement depends on the circumstances of a company. However, some standard clauses that are usually found in an agreement include the:

  • relationship between the directors of a company and the shareholders;
  • rights and ability to issue new shares;
  • payment process and calculation of dividends;
  • transfer of shares either to other shareholders or third parties outside of the company; and
  • method of dealing with deadlocks and disputes.

Specific terms of the shareholders agreement will depend on multiple factors. However, there are some additional points that you should consider, including:

  • the nature of the business
  • the potential for growth;
  • future third-party financing; and
  • any other matters particular to the industry.

Technically speaking, you should enter into a shareholders agreement once your company has more than one shareholder. Therefore, even if the shareholders are made up of friends and family, you should still enter into an agreement.

Conflicts Between Shareholders

Conflicts can arise between minority and majority shareholders. A minority shareholder is one who does not exert control over a company. In contrast, a majority shareholder almost always exercises control over:

  • the company;
  • its internal management;
  • the board of directors; and
  • other fundamental business matters.

A minority shareholder may want to include provisions in the shareholders agreement that protect their right to participate in the decision-making process.

Conversely, majority shareholders look to include provisions which give them the flexibility in making decisions for the company without the minority shareholders having input. Therefore, these issues will need to be considered during the drafting of the shareholders agreement.

How Does a Constitution and Shareholders Agreement Work Together?

At first glance, a shareholders agreement and a company constitution look to provide similar functions regarding the rights and obligations of individuals within the company. So, why does your business require both documents? There are many reasons why a company has both, including that:

  • a shareholders agreement is confidential between the relevant shareholders and the company, whereas a company’s constitution may be publicly available;
  • a shareholders agreement is typically more cost-effective and easier to enter into as it doesn’t require a special resolution to be effective and enforceable (unlike a constitution); and
  • the shareholders of a particular class may wish to enter into a private arrangement between themselves and need a shareholders agreement.

Key Takeaways

When opening a company, you should consider whether you need both a company constitution and shareholders agreement. A company constitution governs the internal management of your business. In comparison, a shareholders agreement guides the relationship between shareholders. If need assistance with reviewing or drafting your company constitution or shareholders agreement, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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