As a business law firm, and given our volume of incorporations, we are frequently asked to draft shareholders’ agreements. Often, the clients who consult us aren’t sure why they need a shareholders’ agreement, or even what it is. We like to explain it by drawing an analogy with marriage. When you get married, you do it for better or for worse, but you still take precautions by signing a marriage contract. The same applies to a company. When the company has more than one shareholder, it becomes imperative to sign a shareholders’ agreement to ensure that the partnership runs smoothly, and that when one of the shareholders wishes to leave the company, this end takes place as peacefully as possible.
Role and objectives of shareholder agreements
Now that we’ve talked about the importance of the shareholders’ agreement in ensuring stability within the company, let’s go into a little more detail about the role and objectives of such an agreement.
The first important aspect of shareholders’ agreements is the protection of minority shareholders’ interests. In a company, shareholders who hold fewer shares are in a somewhat precarious position, because even though they have shares with voting rights, the weighting of these rights means that they have less influence than the majority shareholders. Certain mechanisms contained in a shareholders’ agreement can ensure that even a minority shareholder has a say in important corporate decisions. Voting agreements, for example, enable minority shareholders to participate in corporate decision-making. This is also the case with approval clauses, which require the approval of minority shareholders for certain important decisions. Ultimately, the aim is to balance the powers of shareholders within the company.
The second important aspect of shareholder agreements is conflict resolution. As entrepreneurs, we generally prefer to wash our dirty laundry within the family, and to avoid judicial tribunals which only rule in accordance with the law, without taking into account the interests of the parties or the company. This is why, in the interests of maintaining a healthy and productive working environment. It is preferable to refer, in the shareholders’ agreement, to alternative dispute resolution mechanisms, such as arbitration or mediation, for conflict management.
The shareholders’ agreement also plays a crucial role in defining the roles of the company’s shareholders, directors and officers. It also determines which issues are the prerogative of shareholders and which are the prerogative of management. It may, for example, stipulate that decisions on certain strategic matters require the approval of more than a majority of the company’s directors, or that certain decisions require additional shareholder approval. In the case of a unanimous shareholder agreement, all powers may even be withdrawn from the Board of Directors and entrusted to the shareholders.
In addition, the shareholders’ agreement can include provisions to foster communication, notably by organizing more frequent meetings and ensuring transparency in the company by providing for regular meetings and periodic reports, thus enabling the company’s performance to be closely monitored.
Finally, one of the roles of the shareholders’ agreement may be to prevent situations of conflict of interest from adversely affecting the interests of the company. These arise mainly when a shareholder’s interests conflict with those of the company. The law does not prohibit a shareholder, unlike a director, from making decisions that favor his or her personal interests over those of the company. We therefore need to ensure that safeguards are in place to protect the company from its shareholders. One way of doing this is to insert a disclosure clause requiring shareholders to disclose any conflict of interest. The most classic conflict-of-interest clause is the non-competition clause, which we will discuss below.
Now that we’ve explored the roles and objectives of shareholders’ agreements, let’s turn to the most essential clauses in these contracts to understand how they give concrete expression to the objectives we identified earlier, with the aim of ensuring cohesion within the company.
Key clauses in shareholder agreements
The right of first refusal
The pre-emption clause, also known as the right of first refusal, is an essential element of shareholder agreements. It protects existing shareholders, whether minority shareholders or not, against dilution of their stake in the company. It grants shareholders who already own shares in the company a right of first refusal in the event that the company wishes to issue new shares, or when a shareholder wishes to issue new shares, or when a shareholder wishes to sell some or all of his or her shares. The existing shareholder therefore has the option of acquiring these shares under the same conditions, before they are offered to third parties. This clause gives the company’s shareholders the opportunity to maintain their shareholding and thus their influence in the company. It is also intended to prevent third parties from joining the corporation’s shareholder base, so as to preserve the existing shareholder structure.
Forced redemption clause (or automatic redemption)
In the life of a company, it is often necessary, or inevitable, for a shareholder to leave in the interests of the company. This situation is likely to create tensions between shareholders. One way of avoiding this situation is to provide for the automatic redemption of shares by the company, or the automatic offer of shares to other shareholders in certain circumstances. These situations generally include the death, disappearance or bankruptcy of the shareholder, or a breach of legal or contractual obligations, or any other event provided for in the agreement. It should be noted, however, that for this clause to be complete, the redemption price of the shares must be stipulated to avoid any conflict situations in this respect. The aim remains to protect the company and the remaining shareholders by ensuring an orderly transition and avoiding potential undesirable consequences.
The non-compete clause
The non-compete clause is an essential part of shareholder agreements, as it protects the company’s commercial interests. In particular, this clause prohibits shareholders from having competing activities or businesses for a given period, in a specific geographical area. The aim is to prevent the leakage of confidential information, know-how or trade secrets that could harm the company. Such a clause provides greater assurance that the shareholder is acting in the best interests of the company, rather than furthering his or her own personal interests or those of a third party, thereby preventing the company from compromising its competitive edge. It is worth noting that, in such a clause, it may be wise to exclude other companies in which the shareholders hold shares at the time the agreement is signed, or companies of which they are employees, in order to avoid any potential conflict.
Drag-along and tag-along clauses
The squeeze-out clause is an essential part of shareholder agreements, allowing the majority shareholder to force minority shareholders to sell their shares in the event of a change of control in the company. This clause guarantees that, should the majority shareholder make an offer to purchase the shares, the total sale of the company will not be hindered by minority shareholders, thus facilitating strategic transactions and offering greater flexibility to potential acquirers.
As a general rule, a drag-along clause is always accompanied by a tag-along clause. The latter protects the interests of the minority shareholder by giving him the right to join in a sale initiated by an offer made to a majority shareholder, by allowing minority shareholders to sell their shares on the same terms as those offered to the minority shareholder. This clause ensures that minority shareholders are not left out of important transactions, and can enjoy the same advantages as majority shareholders. Placed side by side, these shares help maintain a balance between minority and majority shareholders in the event of a change of control.
Shareholders’ agreements play a vital role in ensuring the stability and smooth operation of a company, particularly when multiple shareholders are involved. These agreements protect minority shareholders’ interests, provide mechanisms for conflict resolution, and define roles and responsibilities within the company. Key clauses such as the right of pre-emption, forced redemption, non-compete, and drag-along and tag-along clauses help to maintain balance and fairness among shareholders, while also safeguarding the company’s interests. By addressing these key aspects, shareholders’ agreements help to create a framework for effective corporate governance and contribute to the long-term success of the business.
If you would like to find out more about shareholder agreements, please contact us for an exploratory meeting.
