Shareholders agreement – General overview and important clauses

Shareholders agreement – General overview and important clauses

In most occasions, certain matters regarding the relations between shareholders of a certain company appear unregulated, which may lead to disputes and court proceedings that can prolong the advancement of a company. In more corporate oriented countries which have such a culture developed, non-existence of such an agreement is quite rare, but in other countries it is rarely concluded.

For that reason, it is advisable to conclude a Shareholders Agreement, where any potentially disputable point can be clearly defined and the shareholders are able to know what can they do when such a situation occurs.


About Shareholder Agreement

According to the Law on Companies of the Republic of Serbia a shareholder of the company can conclude a contract in written form with one or more shareholders of the same company, which regulates issues of importance for their mutual relations in connection with the company. Such an agreement is valid only between the shareholders that concluded it.

Basically, such an agreement is not a mandatory one, and it serves as a supplement to Articles of Association of a company which is probably why it is rarely concluded in countries with less developed corporate culture. However, Shareholders Agreement is extremely important, because it can regulate or clarify the provisions of Articles of Association which do not regulate or just generally regulate certain questions. Topics it can regulate fall under the scope and principle of autonomy of will in contract law.

Therefore, such an agreement can cover topics like understanding on how to vote in the assembly, how to regulate rights and obligations of a shareholder when transferring the share or shares of a company to a third party, how to redistribute profits between shareholders who concluded such an agreement, how to solve blockages in decision-making process etc.

Furthermore, a Shareholder Agreement does not have to be concluded with all the shareholders – one shareholder can conclude it with one or more of them from the same company, but if some shareholders were left out of it, the agreement does not apply to them.
This agreement is of great importance, especially for startups since it essentially regulates the points on how the company should be operated and managed, that shareholders are treated in an adequate and fair manner and that their rights are protected, but also who can become a new shareholder of the company. We specifically noted startups because that field is risky and the beginnings are quite stressful, which is why most of the startups are prone to fail and shut down. This agreement brings a necessary clarity into the relations between shareholders making things much easier for everyone involved in the company’s management. This of course does not mean that other companies should not have such an agreement, on the contrary – it is strongly advisable to do so.

Since it can regulate various topics, we shall outline some standard clauses used in this agreement.

Standard Clauses
Some standard clauses used in a Shareholders Agreement are: tag along and drag along rights, pre-emptive rights clause, right of first refusal, good leaver bad leaver clauses, non-competition clause, deadlock resolution clause, dispute resolution clause etc. 

Please note that for the sake of this article, not all clauses are listed. Such endeavor would be almost impossible one because new clauses can and do emerge, and ones currently in existence are so numerous that listing them all would be considered possibly overwhelming for the reader. That is why we strongly advise seeking for a counsel from a legal professional in order to tailor your needs in the best possible way.

Now we shall describe the clauses that we listed above
Tag along and drag along – Tag along clause protects the minority shareholders who do not wish to be in business with unwanted co-owners, should the majority shareholder(s) decide to sell their majority stake in the company. Therefore, this clause provides that if a majority shareholder(s) wishes to sell its stake in the company to a third party, the stakes of minority shareholders must be sold at the same price and terms as the majority one if they choose so (the minority shareholders are not obliged to use this right if they are satisfied with who will be a new co-owner). This is why this clause is also called a “piggyback rights“ one. On the other hand, a drag along clause serves the opposite purpose – to protect the interests of the majority, i.e. it is favorable for the buyer of shares because it can acquire a 100% share in the company. Drag along rights require the minority shareholders to sell their shares to a bona fide purchaser/buyer, on the same terms and conditions, and for the same price as a majority shareholder.

Pre-emptive rights and rights of first refusal – These are anti-dilution clauses, i.e. they protect existing shareholders from the involuntary dilution of their share/stake in the company. Pre-emptive rights grant the initial opportunity to purchase newly issued shares to the current shareholders of a company or the right of first refusal over the sale of existing shares.
In the scenario where a company issues additional, new shares, these shares are initially made available to the company's current shareholders, proportionate to their existing ownership, before extending the offer to potential new investors. This mechanism enables shareholders to maintain their ownership percentage in the company, provided they possess the financial capacity to acquire the newly issued shares.

In the context of an existing shareholder desiring to sell its shares in the company, pre-emption rights function as a priority for the remaining shareholders, i.e. as a first refusal. Essentially, these rights grant the remaining shareholders the opportunity to acquire the shares being sold first, aiming to preserve the original shareholder composition and restrict external parties from obtaining shares in the company.

Typically, when a shareholder intends to sell its shares, he/she is obliged to present the same terms agreed upon with the potential buyer to the remaining shareholders before proceeding with the sale to the prospective buyer.

Good leaver and bad leaver - When a shareholder decides to exit the company, the conditions under which their shares are sold and the amount they will receive for their shares will be determined by the inclusion of "good leaver" and "bad leaver" clauses in the agreement. These clauses specify the terms and valuation criteria for the sale of the departing shareholder's shares.

A good leaver would be someone who leaves the company because of redundancy, ill health, resignation and other circumstances, but (as the name suggests) did not make the breach of an agreement and respected the achieved arrangements. Such a shareholder can, but does not have to sell its shares on departure. This right is usually tied to employees who are also the shareholders of the company, so the end of their engagement does not have to mean also the selling of shares. If the shares will be sold, then the leaver will get a market value of shares on the day of departure, i.e. the worth of the shares is calculated on that specific day.
A bad leaver would be a shareholder who departs from the company on bad terms or circumstances (they breached the agreements and contracts, are indebted to the company, or acted on gross misconduct etc.). Such a leaver is obliged to sell his shares on exit to the other shareholders and will then get simply the nominal value of the shares.

Non-competition clause - Non-competition clauses serve to provide clarity regarding the timing and manner in which a shareholder can engage in competitive activities both while they are a shareholder of the company and after their tenure. These clauses eliminate any uncertainty by specifying the actions that are allowed and prohibited, as well as defining the extent and duration of these restrictions.

Deadlock resolution clause – it is sort of a "peace treaty" for shareholders. It outlines what should happen if shareholders can't agree on a decision, and everything comes to a standstill. It's a way to prevent the business from getting stuck when there's a disagreement. Typically, it suggests steps like mediation, arbitration, or even a buyout where the party sells its shares to remaining shareholders, so the control can change and business can keep moving forward instead of being stuck in a deadlock. 

Dispute resolution clause – as in many agreements, this clause can serve as a solution to a dilemma how to resolve the ongoing conflicts or misdemeanors between the shareholders. Such clauses usually provide for the competent court or even arbitration to solve the existing issues.


Consequences
The Shareholders Agreement is valid only between the shareholders who concluded it and is not publicly announced or registered in a commercial register, thus the logical question arises – what happens if some party/shareholder to the agreement decides not to abide by it.
The only thing left is to initiate the adequate proceedings against such a shareholder in which the performance of the agreed-upon obligations by the defaulting party is required. This can lead to further expenses, delays and, ultimately, devaluation of a company since these proceedings may take some time to complete. Therefore, a contractual penalty is also a viable option, enhancing the loyalty to the agreement.

Final Remarks

Bearing in mind all of the above, the Shareholders Agreement (even though not mandatory) is an essential tool in ensuring the progress of the company, especially a startup.

It can regulate various questions from the management of a company, decision-making process, all up to the admission of new shareholders. However, the autonomy of will is not unlimited – it is limited by provisions of the Law on Companies on the content of the Articles of Association, which is why it is considered a supplement to Articles of Association.

However, this agreement is valid only between the shareholders and is not registered in the commercial register, so various confidential information can be regulated by it without disclosure to third parties, making it a perfect option to keep the trade secrets away from the public, which are of essential value for competitiveness of the company. Such an agreement must be also concluded in written form.

With all the advantages listed out, a Shareholders Agreement must become a part of corporate folklore of each and every country because it ensures progress of the company and, in the bottom line, the society as a whole.

Contact: Aleksandar Čermelj, Senior Associate at IVVK in cooperation with Lexquire

E-mail: aleksandar.cermelj@ivvk-lexquire.rs 

04/10/2023

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