When will the Court Uphold Bad Leaver Provisions?

A shareholders’ agreement commonly includes a bad leaver provision. This protects the company from surrendering the ownership and control to employees who leave the company in a particular way, or shareholders who have committed certain breaches of the shareholders’ agreement. Examples include when the employee or shareholder has committed fraud, dishonesty or gross misconduct. Other examples include a failure to act in good faith or involvement in a conflict of interest against the company.

A bad leaver provision operates as a penalty against the individual who owns the shares. Interestingly, it effectively denies an individual a right to their property. So, when will the courts enforce such provisions?

The Importance of Company Documents

The Court in the English case, Grace v Biagioli considered that the individual’s conduct needs to be against the requirements of the corporate structure or company constitution. What this means is that the main consideration will be the legal documents and agreements between the shareholders, which outlines when the shareholders can and cannot do certain things.

If the Shareholders’ Agreement is unclear on this point, the individual can still argue that equitable principles should protect them. Another way to say this is that it would unfair to allow the provision to succeed after considering the Agreement and the conduct of the shareholder.

What are Bad Leaver Events?

Recently, an Australian Court provided some guidance as to what a bad leaver event entails in Zomojo Pty Ltd v Hurd (No 2). Here, the company’s ‘Plan Information Booklet’ contained their bad leaver provisions. In essence, the provisions stated that if you are a bad leaver, then at Zomojo’s option, you must transfer your shares to Zomojo or its nominee at the value equal to the lower net tangible assets, or, the last arm’s length transaction price.

Hurd was a director of Zomojo and had entered discussions to resign, and sell Zomojo his shares. At the time, the other directors did not know that Hurd  had engaged in ‘bad leaver’ behaviour. He had created a startup company that was pitching a device (a prototype circuit board), the equivalent to the one Zomojo was engaged in producing.

Zomojo sought to recover damages because if they had known this at the time of Hurd was developing this product, they would have been entitled to dismiss him immediately. The Court held that Hurd was indeed a bad leaver within the meaning of the provision, and ordered him to keep all of the profits he made from the sale of his devices on trust for Zomojo.

Key Takeaways

These examples demonstrate that the Courts will first look to the company documents and assess if their description of ‘bad leaver events’ is sufficiently clear. Enforcement depends on the individual’s conduct and the extent of the company’s detriment.

Conclusion

LegalVision can help your company draft a shareholders’ agreement that includes bad leaver provisions. This will ensure your company is protected in the long run. Call us today on 1300 544 755 to get in touch with one of our experienced business lawyers.