What is a Shareholder Agreement?

As a shareholder, you may be familiar with the general rights that you have in a company. However, you may be in a situation where other shareholders have asked you to sign a shareholders’ agreement. Put simply, a shareholders’ agreement is an additional contract between you and other shareholders of a company. It contains additional terms that are not otherwise binding under company law, such as the permanent right to be one of the company’s directors. This article will explain the general purpose of a shareholders’ agreement and consider some common terms in shareholder agreements. 

Your (Limited) Rights as a Shareholder 

When you become a subscriber to a company upon its incorporation (i.e. you are a founding shareholder), you enter into a special kind of contract. Under this contract, you owe certain limited obligations to:

• the other shareholders of the company; and 
• the company itself. 

In turn, these shareholders and the company owe you certain obligations. 

These reciprocal obligations are usually set out in your company’s articles of association. However, since these obligations are limited by a special kind of contract that company law controls, you and the other shareholders are limited in how you can alter your obligations. 

An Example

Suppose you want a permanent right to serve as a company director and be a shareholder. When the company is incorporated, you and the other shareholders agree to this and insert a term in your company’s articles of associations to this effect. Later, there is a disagreement between you and the other shareholders and they exercise their rights to remove you as a director. You may argue this is unlawful because there is an express term in the company’s articles preventing exactly this. However, company law holds that the special contract that exists between you and the other shareholders only extends to each of you in your capacity as a shareholder. 

Expanding Your Rights Using a Shareholder Agreement

A way you can expand your limited rights as a shareholder is through a shareholders’ agreement. You can think of a shareholders’ agreement as an additional contract between you and the other shareholders in a company in your personal capacities. In other words, you simply owe obligations to your other shareholders. However, this agreement does not extend to the company itself. 

Some terms you may find in a shareholders’ agreement include:

• the requirement for all shareholders to consent to certain processes, such as issuing new shares or changing the business’ name;
• restrictions on shareholders’ ability to change the company’s articles; 
• restrictions on how much the company can borrow without the shareholders’ consent;
• how you will share profits through dividend payments; 
• the method of resolving disputes should they arise; and 
• agreements not to compete with the company you have shares in.

An Example

Let us return to our previous example, but suppose you had a shareholder agreement in place this time. One of the terms says that you have a permanent right to be a director. With this shareholders’ agreement, the other shareholders can still exercise their rights as shareholders to remove you as a director because company law will not restrict this right. You would still have no claim against the company or the other shareholders as shareholders. However, you could sue the shareholders in their personal capacity in this case. This would not allow you to become director again, but you may be entitled to recover damages for the breach of the agreement. 

Other Considerations

Shareholder agreements can provide additional protection, especially for minority shareholders. While a shareholders’ agreement does not create a cause of action against the company itself, it can encourage shareholders to stick to their promises because they can be held personally liable. Hence, you should keep in mind the following considerations when dealing with a shareholder agreement. 

1. A Shareholder Agreement is Not a Public Document

Your company’s articles of association are public documents that anyone can inspect by visiting Companies House. On the other hand, shareholder agreements are not public documents. Consequently, there is no obligation to disclose them to any public member, even if they request them. 

The practical effect is that you could create provisions that would be enforceable without making these provisions known to the public.  A common example is not specifying the rights attached to different classes of shares in your company’s articles. Instead, your shareholder agreements can have a provision that achieves the same effect. 

2. Shareholders Not Party to the Shareholder Agreement

You should be aware that it is possible to be a company shareholder and not a party to the shareholders’ agreement. This is commonly an issue when a founding shareholder later sells their shares to a third party, and there is no legitimate reason why this person cannot become a shareholder. This person would not be under an obligation to sign the shareholders’ agreement. 

3. Parties to the Agreement That Are Not Shareholders

The law does not prevent a third party from being a party to the shareholders’ agreement, even though they are not actual shareholders. However, in practice, there are few circumstances where this would benefit the third party. 

Key Takeaways 

Company law governs the rights shareholders have as shareholders in the company. If you try and create certain rights that are not connected to your rights as a shareholder, the law will not give them any effect. This can create problems if you want to restrict how other shareholders vote or act. Nevertheless, you can get around this by creating an additional contract called a shareholders’ agreement. This will bind each shareholder to certain terms in their personal capacity. You can sue them for damages if they breach a term in the agreement. 

If you need help drafting a shareholders’ agreement, our experienced corporate lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today at 0808 196 8584 or visit our membership page.

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