Do I need A Shareholders Agreement?

When investing or doing business in New Zealand there are many ways to ensure the satisfactory resolution of disputes between related parties, a shareholders agreement is one of them. This weeks article “Do I need A Shareholders Agreement?” is by Queen City Law Lawyer Bradley So. Bradley is a Philippine born New Zealander.  He has lived in New Zealand for 16 years and is fluent in English and Tagalog, to read more about Brad click here.Brad-Pic-688x1024
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Simply put, a shareholders’ agreement is an agreement that governs the business relationship of each shareholder in a company. It is similar to a “pre-nuptial” agreement except in a commercial. Just like a “pre-nuptial” agreement, its necessity only arises when there is a dispute or a misunderstanding between the respective parties. A shareholders’ agreement ensures that each shareholder has a clear understanding about the objective of their business venture, their role in the company and what they are contributing to the proposed business. It is intended to protect each party interest if unforeseen circumstances and contingencies arise.

A shareholders’ agreement is NOT the same as a company’s constitution. It does however, go hand in hand as both documents complement each other. Ideally, a company’s constitution should be consistent with the shareholders’ agreement.

Why do I need it? –

To Cater for Specific Needs

There is no legal requirement under the Companies Act 1993 (“Act”) to adopt a shareholders’ agreement or a constitution. Without a shareholders’ agreement and a constitution the Act sets out the base governing rules for the operation and governance of a company in NZ. As the Act has to provide a framework within which companies of all shapes and sizes can operate, it cannot cater comprehensively for the needs of all.

Both documents allow the relevant stakeholders to cater for their specific needs which are outside the scope of the act. In particular, the shareholders’ agreements often seek to balance the needs and vulnerability of minorities against the will of the majority. A company constitution takes effect as a contract between the shareholders and the company and between the shareholders themselves. The constitution may amend or supplement some of the default rules contained in the Act.

However, there are some provisions that are mandatory.

Firstly, a constitution may be altered or revoked by a special resolution of shareholders where a shareholders’ agreement cannot be amended without the unanimous agreement of the
parties unless the agreement says otherwise. This would of course put key stone shareholders in  a difficult position as they may not want the terms of what they agreed upon initially to be changed. Secondly, a  constitution is a public document that is registered on the company register while a shareholders agreement is a private document.

Another layer of protection

agreementWithout a shareholders’ agreement, there are only basic protections available to minority shareholders. Majority shareholders will always have control over the company via the ability to appoint and remove directors and shareholder voting rights in the Act.There is no legal requirement under the Companies Act 1993 (“Act”) to adopt a shareholders’ agreement or a constitution. Without a shareholders’ agreement and a constitution the Act sets out the base governing rules for the operation and governance of a company in NZ. As the Act has to provide a framework within which companies of all shapes and sizes can operate, it cannot cater comprehensively for the needs of all.

Both documents allow the relevant stakeholders to cater for their specific needs which are outside the scope of the act. In particular, the shareholders’ agreements often seek to balance the needs and vulnerability of minorities against the will of the majority. A company constitution takes effect as a contract between the shareholders and the company and between the shareholders themselves. The constitution may amend or supplement some of the default rules contained in the Act. The important point is the only real remedy for a distressed party to seek redress through legal proceedings in the Courts. This will be time-consuming and potentially expensive.

When do I need it?

Here are  few typical scenarios;

1.   Family – Companies taking basic ventures with family members e.g husband and wife will generally not want a shareholders’ agreement as they will view this as unnecessary or costly. In their view, decisions can be made between them by consensus as a matter of course and any issues that arise can be amicably resolved. However, if there is a fall out with the couple, then there will be serious issues arising in terms of relationship property. Accordingly, it will be in their best interest to ensure that the above issues are resolved at the outset either through a shareholders’ agreement or a contracting out agreement.

2.  Passive/Silent partner – if there is one dominant shareholder and one or more silent partner shareholders with only a nominal investment or stake in the company, the silent partner may not want to be involved in the day to day running of the business. They may be content to allow the dominant shareholder to make all necessary decisions. In this instance, the interested parties may not require an agreement in place. However, it would be in their interest to have clear understanding on how the silent partner can exit from the venture at a later stage. A shareholders’ agreement is away to meet this requirement.

3.   A harmonious dynamics like a group of close or well-acquainted individuals where there is a risk of falling out. In this scenario, it is quite clear that shareholders’ agreement will be required. In essence, it will be a matter of judgement as to whether an agreement is necessary and/or appropriate in any given circumstance.

What is covered by a Shareholders’ Agreement?
Such an Agreement commonly includes, inter alia, policies governing the following matters:

(a)Purpose of the Company: What will the business and purpose of the company be? Restrictions on the activities of the company (eg “major activities” involving substantial amounts, or affecting the nature or structure of the company) unless such activities have the unanimous approval of the directors of the company.

(b)The company structure: Includes composition of the capital of the company and apportionment

(c)The appointment of directors: Includes the power of each shareholder to appoint a director or directors, and the authority of such directors when making decisions.  May also cover situations where additional directors are appointed in the event of additional shares in the company being issued to third parties.

(d)Management of the company: Covers the appointment of the company management (eg director, managing director), and requirements on the company management to prepare financial and management reports for the shareholders (eg monthly financial statements to be prepared in accordance with generally accepted accounting principles applicable at the time).

(e) Shareholding restrictions and the transfer of shares: This may include a provision that, if one shareholder dies or wishes to sell its shares in the company, the other shareholder has the first option, on certain terms, to purchase the shares.  Other provisions may include prohibitions on transfers of shares or interests in shares except in certain circumstances, the procedure for the transfer of shares and the procedure for calculating a fair value for the shares.

(f) Adding new parties to the Shareholders’ Agreement, and additional shareholders.

(g)Dividends, and the provision of additional funding by the shareholders: Includes the methods and the proportions in which the shareholders will provide funds to maintain the company, the amount of the profits to be allocated as dividends each year, and a procedure for resolving disputes that arise in respect of these matters.

(h)The rights of shareholders and directors: Includes shareholders’ access to records, and any variations or additions to the statutory powers, rights and duties of shareholders and directors.

(i)Dispute Resolution: For example, a provision dealing with the resolution of disputes involving matters which could lead to substantial injury to the company as a going concern, and which seem incapable of satisfactory long-term resolution by mediation or negotiation.  Such a provision could expressly include disputes such as disagreements over company financing, dividends, or the management and direction of the company, and would provide a mechanism for resolving such disputes.

(j)Non-competition provisions i.e. preventing either shareholder from setting up a business in competition to the company within a prescribed time period and geographical distance from the
company.

(k)Confidentiality: Includes provisions relating to the exposure of company documents, both during the period of the Shareholder Agreement and following the termination of the Agreement.

(l)Duties of the shareholders with regard to the company and each other in the event of the company being liquidated.

(m) Parting of ways: when and how will the agreement terminate or otherwise come to an end?

What happens in the event of default by a shareholder? In what circumstances can or must the

company be liquidated?

Therefore, a shareholders’ agreement is a valuable tool for providing a procedural framework to govern the internal management of a company. For the reasons set out above we consider that a shareholders’ agreement is an important element in establishing, at the outset of a business arrangement, a sound operating platform to enable the future success of the business venture.