Shareholder Agreements: Features & Importance

By David Gass

A shareholder agreement is an understanding between the shareholders and/or with the corporation, under the law, about various aspects ranging from their duties to their rights, in relation to the company. The shareholder agreement is considered as the basis of a company’s inception and more or less lays the path for its future course. It lays the guidelines about the duties & powers of the board of directors & management.

Essentials of a Shareholder Agreement:

The following are the points/clauses that are considered prudent related to the constitution of a shareholder agreement. And the reasons for having an agreement are:

• To introduce and lay the rights related to the issuance, sale or subsequent distribution of shares, including the rights of pre-emptive rights and first refusal;
• Defining the duties and rights of the management and the employees;
• Guidelines and options for selling and buying the shares (‘shotgun clause’);
• Laying down the guidelines in case of any mis-happenings such as retirement, death, etc., of a shareholder (the agreement should set out what effects it has over the corporation and the other shareholders)
• Deciding the duties / composition of board of directors.
• Deciding on the rights of the shareholders vis-à-vis right to approval for future shareholders
• Chalking out Exit clauses/mechanisms

Vital Points:

These are vital from the point of view of shareholders. The shareholder agreement is to be drafted articulately to minimize future speculation and possibility of any legal entanglement, and smooth functioning/transition of events in the corporation. A foolproof agreement needs to concentrate on the following aspects as well:

• Structure of the company
• Role of the shareholders
• Distinction in the ownership of the shares
• Clearly-mentioned vesting provisions(if any)
• Provision (or lack of it) regarding Stock Pledge
• Demarcating of the quorum (minimum strength of the participants in a meeting to pass a resolution)
• Procedures of handling ownership issues in case of buyouts
• Methodology of dispute settlement
• Voting rights
• Issues related to compensation and remuneration
• Appointment of professional advisors

These above stated points and issues largely cover all the ingredients of a good and professional shareholder agreement. Strict adherence to the details about the said issues culminates into a finely carved out agreement. A serious study of the agreement provides valuable insight into one’s rights and duties with respect to the corporation and other shareholders, the vision of the company and the management and path laid to achieve them. A shareholder agreement should be revised regularly for any amendments (if necessary) and upgrading the issues keeping in mind the current scenario.

Regular professional advice should be sought from expert professionals, such as, tax consultants and legal experts. These advices take care of the botherations that may trouble the company or the shareholder(s) in the future, if ignored at the time of inception. The contents of the shareholder agreement are not bound by the law to be made public; these can be kept confidential or made public as per the consideration of the shareholders. It is in the best interest of the company to have a shareholder agreement to avoid any misunderstanding and any inconvenience resulting out of lack of clarity in dispensing the duties/obligations of the company.

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