Shareholders agreements

What the law gives you if you write nothing

Every company has a set of internal governance rules. If you did not adopt a constitution, the replaceable rules in the Corporations Act apply. They are minimal and they were never designed to run a two-owner business.

• Nothing forces a dividend. A majority can leave profits in the company indefinitely while paying themselves a salary.
• Nothing stops a shareholder selling to a stranger. Absent a pre-emptive rights clause, you can wake up in business with someone you have never met.
• Nothing resolves a 50/50 deadlock. Two directors who cannot agree simply stop the company. The remedies are an oppression application under sections 232 and 233, or a winding up on just and equitable grounds under section 461, both of which cost more than the agreement would have.
• Nothing requires anyone to keep working. A founder can stop contributing and keep their shares.
• Nothing values the shares. If someone dies, gets divorced, becomes ill or wants out, there is no agreed price and no agreed method.
• Nothing protects the minority. Members holding 75 per cent can pass a special resolution and change the constitution.

A shareholders agreement replaces all of those defaults with answers you chose.

The clauses that actually get used

In our experience the clauses that get relied on in a real dispute are a short list. Everything else is scaffolding.

1. Reserved matters. A list of decisions that require unanimous or special approval regardless of shareholding: taking on debt, issuing shares, changing the business, selling assets, paying directors, entering related party transactions.
2. Pre-emptive rights. Before a shareholder sells to an outsider, the shares must be offered to the others on the same terms, with a defined process and timetable.
3. Drag along and tag along. If holders of a defined majority accept a genuine offer for the whole company, they can drag the minority in. If they sell, the minority can tag along on the same terms. Without both, a minority can either block a good sale or be left behind in a company owned by a stranger.
4. Compulsory transfer events. Death, permanent incapacity, bankruptcy, a serious breach, or ceasing to work in the business trigger an obligation to sell, usually with a different price for a good leaver and a bad leaver.
5. A valuation mechanism. An agreed method beats an agreed number. Independent expert, defined multiple, or an accountant appointed by the professional body if the parties cannot agree.
6. Deadlock resolution. Escalation to the shareholders, then mediation, then a buy-sell mechanism such as a shotgun clause where one party names a price and the other chooses to buy or sell at it.
7. Restraints and confidentiality. A departing shareholder should not be able to take the customer list with them.
8. Funding. What happens when the company needs money. Who must contribute, what dilution follows if someone does not, and whether shareholder loans rank ahead of dividends.

Constitution or shareholders agreement

They do different jobs and most companies should have both.

The constitution is a public-facing document lodged conceptually with the company's records, binding the company and its members under section 140 of the Corporations Act. It deals with share classes, meetings, directors and the mechanics of running the company.

The shareholders agreement is a private contract between the owners. It can bind people the constitution cannot, such as a founder personally, a spouse, or a holding entity. It can also contain commercially sensitive material, such as valuation formulas and salary arrangements, that you would not want in a company document that a purchaser or a bank will read.

Where they conflict, the agreement usually provides that the shareholders will exercise their votes to amend the constitution so the agreement prevails. Drafting that properly matters, because a provision in an agreement that purports to override the Corporations Act itself will not work.

When the relationship has already broken down

If you are reading this because a co-owner has locked you out of the accounting software, an agreement written now will not fix it. What you have instead is a set of statutory remedies.

Sections 232 and 233 allow the court to make orders where the conduct of a company's affairs is oppressive, unfairly prejudicial, or unfairly discriminatory against a member. The most common order is that one shareholder buy out the other at a valuation. Section 247A allows a member to apply for access to the company's books, which is often the necessary first step when you have been shut out of information.

These applications are Supreme Court proceedings and they are not cheap. Almost every one of them would have been avoided by a buy-sell clause and an agreed valuation method. Read commercial dispute resolution for what the process looks like, and get advice before you send the angry email.