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Article:

Shareholder Agreements

24 August 2017

Companies with multiple shareholders including shareholder employees are common throughout the construction industry.  Also surprisingly common are disgruntled shareholders and shareholder disputes.  Accordingly all companies with multiple shareholders should have a robust shareholder agreement tailored specifically to the peculiarities and special features of each company.

Multiple shareholders are very common in the professional services firms supporting the construction industry.  The mature construction companies also frequently have multiple shareholders, many arising from the partnership of two or three key people who combined their varied expertise to create the business but also as the founding shareholders grow their business and plan their ultimate succession, it is now very common for senior management and the up and coming future leaders to take a small shareholding position which can increase over time as they buy out the retiring founders.

With multiple shareholders, disputes amongst the shareholders at some point in the company’s history are almost inevitable.  Many manage to keep their internal disputes out of the public spotlight and for others the difficulties emerge over a few beers on a Friday night.

Shareholder disputes are incredibly disruptive on the business.  The individuals involved are distracted from their business responsibilities, communication within the organisation is invariably destroyed and the distraction from core business means results in a significant reduction in business performance and in some cases business failure.

A carefully drafted shareholder agreement does not prevent shareholder dissatisfaction but it should provide a suitable mechanism to deal with the common issues and should also include appropriate arrangements that allows the exit of at least one of the affected parties.

Some companies have a shareholder agreement put in place by an insurance advisor to deal with handling insurance proceeds on the death or disablement of a shareholder.  Such shareholder agreements are seldom sufficient to deal with all of the matters which should be dealt with in the agreement.

For those companies that have not had a shareholder agreement, the directors and shareholders have learned very quickly that the provisions of the Companies Act and the company’s constitution if it has one are wholly inadequate for resolving disputes or forcing out a non-performing shareholder.

By comparison, one of the first shareholder agreements I was involved in the preparation of was used a few years later when there was a falling out between the two shareholders and within two weeks, the non-performing shareholder was paid a fair value for his shares, was gone and the company was able to continue operations without being adversely impacted by what could have been a drawn out and acrimonious dispute.

One of the first matters to consider is whether the entitlement to be a shareholder is restricted to active employees.  Most directors and shareholders prefer not to be dealing with former employees that no longer work in the business or with the families of deceased employees.  A good agreement will have an arrangement whereby shares are sold when a person leaves the business.

That raises the very challenging question of what the shares are worth.  A lot of agreements provide a process involving valuers and experts which can become particularly expensive as well as drawn out and uncertain.  Where possible, a relatively straightforward predetermined formula that can be objectively applied for certainty and efficiency resolves these issues.

Directors have access to company information but employees and shareholders do not have similar rights.  An agreement needs to ensure that shareholders have access to all the information they need and in particular receive copies of regular financial statements and other financial information which may impact upon them.

I have assisted shareholders who wish to retire from a business and have had no power to get the remaining shareholders or the company to acquire the shares for a fair price.  This is another situation where an agreed formula provides the speed and certainty which the departing shareholder employee deserves.

Shareholder current accounts and funding are a common area of contention.  Best practice is for shareholders to maintain current accounts in proportion to their shareholding percentage.  Often that is difficult and proportions change.  There should be an agreed interest rate payable to those who have contributed more than others.  What about when the company needs funding and can’t get it from its bankers?  Should all shareholders be required to fund any cashflow shortfall?  What if some shareholders are unable to contribute their share?  These difficulties and their solutions need to be planned and properly documented in advance.

Guarantees to bankers, particularly for plant finance or contract bonds, is a further area of stress and inequity.  Should all the shareholders no matter what their size provide a personal guarantee?  Should the guarantees be joint and several or be limited in some manner?  What if the bank will not provide the required funding because a shareholder refuses to sign a personal guarantee?  The major material suppliers also seek personal guarantees from directors and key shareholders.  Should there be an indemnity between the shareholders that if a guarantee is called up, the other shareholders cover their respective portion based on their shareholder percentage.

There is a long list of other features and clauses which should be considered and a multitude of shareholder agreement templates in existence.  Many do not adequately address the various issues which arise of the particular nuances in the construction and professional services sectors.  Each organisation has a different culture, different personalities and unique features and need an agreement that suits their particular circumstance. 

Complications from accidents, sickness, disablement and death are common but infrequently planned for.  If insurance has been arranged it may deal with some of the financial issues but does not deal adequately with the remuneration, shareholding and shareholder current account issues.  Entitlement to employment usually arises directly from shareholding but these events disrupt this.  The usual approach would be to accommodate short to medium term disruption and for a long term event, there should be an agreed process for buying out the shareholding and repaying the shareholder current account.  The impacted shareholder will be in a very weak negotiating position so clarity and fairness are important.  The issues become much more complex when the disruption is caused by the health of a critical shareholder such as one that is primarily responsible for securing additional contracts.  A detailed analysis and strategy should be considered for each shareholder as different situations may require different responses.

Very poor performance of a shareholder in carrying out their employment related tasks is not unusual and is very difficult to deal with.  Company law provides no solutions and more success is obtained using employment law.  There will invariably be a difference of opinion and the matters are usually very subjective.  Dispute resolution clauses in shareholder agreements are seldom adequate for dealing with this issue.  The better solution usually follows the provisions of employment law but it is critical that the shareholder agreement is able to then respond quickly and adequately or a massive disruption can result.  It is worth double checking that all working shareholders actually do have an employment contract.

Confidentiality, restraint of trade and general protection of customers and technology are always an issue if a shareholder departs in circumstances other than out right retirement.  Clauses around these issues need to be particularly robust as do the periods of any restraint.  There can be a conflict between what is in the company’s best interests and restraints that are enforceable under employment law.  A former shareholder that starts approaching a company’s clients even three or four years after departure can cause a huge amount of damage.  Techniques such as delaying final payments for shares as an attempted “good behaviour bond” have their limitations once the required period has passed and the payment made.