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SHAREHOLDER AGREEMENTS TAKE THE ROMANCE OUT OF THE RELATIONSHIP. AND THAT’S A GOOD THING.

Newsletter

by Paul Gidley30.06.20

The closer the relationship, the harder it hurts when things fall apart. This is equally true in romantic and business relationships.

It’s a common story. Friends believe that together they have the makings of a phenomenal money-making venture. Perhaps one has the idea and one has the capital; or one has the skill and one the business know-how. 

They form a company with equal shareholdings, and each take up a directorship. They’re mates, they trust each other, what could possibly go wrong?

What goes wrong is that the drive, passion and commitment needed to start a small or medium enterprise (SME) commonly supercharges shareholder disagreements when expectations are violated. And expectations are violated because often, they’re not articulated.

A cautionary tale

In the case of Carolia Pty Ltd & Ors v Crompton & Ors [2010] NSWSC 549, two couples formed a company to run a property finance business. One of them (a solicitor) had the expectation that his legal firm would be paid to act on behalf of the borrowers. It was his primary reason for involvement. However, the other couple expected to use the most competitively priced legal firm. Tempers were lost, insults were hurled, and the case ended up in court. 

Acting Justice Windeyer noted in his judgement  that sadly, the costs associated with taking the case to court were significantly higher than the amounts in issue. 

Remedies for shareholder disagreements

The courts

The courts have the power to remedy shareholder disagreements in many ways, for example, by ordering winding up or receivership of the company, forcing the selling of shares by and to members, modifying or repealing the company’s constitution or regulating the conduct of the company’s affairs. However, disagreement about how to run a business doesn’t justify action by the courts. Some form of misconduct must be proven, such as breach of duty or behaviour that is unfair or discriminatory against a member or group of members (oppression). 

Alternative dispute resolution

The courts are the place of last resort for shareholder disputes. Shareholders are encouraged to attempt other means to settle their differences such as negotiation, mediation and alternative dispute resolution, even selling the business.

Prevention is better than cure

Shareholder agreements can help prevent shareholder disagreements. 

They are not a legal requirement, so are often skipped. But shareholder agreements can clarify expectations at the very beginning of a business relationship, and, can be a circuit breaker before acrimony and litigation white-ant the business value and performance.

A shareholder agreement describes the relationship between shareholders and how shares are valued and distributed. 

 As well as the purpose (and limitations to purpose) of the company, a shareholder agreement will cover such things as:

  • who and how someone can become a shareholder
  • different types, voting rights and entitlements of shares
  • how new shares are issued, and existing share value protected
  • decision making and delegation
  • scheduling of meetings and access to records
  • share transfer and sale and right of first refusal
  • details regarding dividends, drawings, salaries, and shareholders’ liability to contribute capital if the company is in debt
  • expectations and value of shareholders’ efforts in the company 
  • how set up costs will be covered
  • shareholder divorce, death or disability 
  • confidentiality and non-compete
  • dispute resolution
  • termination

The devil is in the detail

Many elements will be common to all shareholder agreements. But not all. The beauty of a shareholder agreement is the flexibility to customise an agreement for the specific business type. For example:

  • agreed share valuation method when goodwill and shareholder reputation (where a shareholder works in a service business) are essential elements of business’s success 
  • ownership of intellectual property brought to, or developed in, a business 
  • valuation of shareholder efforts where some shareholders work in the business and others are investors 
  • if/how offspring can be brought into enterprises when they reach adulthood

Beware the online template

Your clients could be tempted to D.I.Y an agreement using an online template. But a tailored agreement, drawn up by an experienced business and commercial solicitor, will end up saving much more than the initial outlay if the shareholder relationship deteriorates. 

All tears no cheers

Shareholder fallout always end in tears. They decimate value and render an otherwise viable business insolvent. Profitable businesses are destroyed because there is no way through the acrimony other than the expensive process of appointing a receiver or liquidator - who will in short enforce some commercial sense on the warring parties, usually causing more angst and asset devaluation. No celebrations, except for the solicitors and liquidators engaged to resolve the impasse.

This situation could have been avoided by a well drafted and subsequently executed shareholder agreement. 

Please don’t hesitate to contact Paul, James, Jeff or Scott with any personal or corporate insolvency & reconstruction queries.