INSIGHTS: Put it in writing: Tools to protect and enforce minority shareholder rights (Part 2)

The Importance of a Shareholders’ Agreement

In the previous issue of Commercial Insights, we wrote about the utility and importance of a shareholders’ agreement in protecting the rights of a minority holding, as illustrated by the recent case of SDW2 Pty Ltd v JLF Corporation Pty Ltd & Ors[1] in the Supreme Court of Queensland.

That case demonstrated how a shareholders’ agreement regulating the conduct of the shareholders enabled a minority shareholder (Shareholder 1) to protect his position as a director of the company’s three subsidiaries. Shareholder 1 prevented Shareholder 2, holding 74%, from acquiring a further 14% of the shares from Shareholder 3 to increase its holding to 88% which was critical in its ability to establish the ‘special majority’ (over 85%) which would be necessary to remove Shareholder 1 as a director. In doing so, Shareholder 1 also managed to increase his own holding from 8% to 96% by acquiring the shareholding of both Shareholder 1 and thereby giving himself the Special Majority and protecting directorships of the subsidiaries.

The case underscores the importance of protecting the rights of a minority shareholder by way of contract. Without the option rights in the shareholders’ agreement, Shareholder 1 would not, in the event of anti-competitive behaviour by other shareholders, have a contractual right to exert control over the ownership of the company or otherwise restrain anti-competitive conduct of other shareholders, other than by utilising the minority shareholder oppression provisions in the Corporations Act.

A shareholders’ agreement is a separate contract

A shareholders’ agreement is a private contract between the shareholders of a company under which they agree to regulate their rights as owners and shareholders of the business.

It is distinct from the company’s constitution which is regulated by the Corporations Act. In the absence of a shareholders’ agreement, minority shareholders are at risk that, pursuant to the constitution, the majority of shareholders constituting 75 percent or more of voting rights, may amend the rights of all shareholders.

If there is a conflict between the shareholders’ agreement and the constitution then it is common for the terms of the shareholders’ agreement to provide that the terms of the shareholders’ agreement prevails.

A shareholders’ agreement, is an enforceable contract agreed between all shareholders and which can generally only be varied with the consent of all parties. Therefore, it operates to protect shareholders by creating contractual rights particularly in the case of minority shareholders.

It can deal with a range of issues relating to ‘control’ for example upon the transfer or issue of shares by giving existing shareholders an equal right of pre-emption or an option to purchase the shares of an existing shareholder.

The Shareholders’ Agreement

A shareholders’ agreement is an important tool which can be used by the owner/shareholders to regulate and control the ownership of the company and management of the directors.

Importantly, it is a contractual mechanism which can be utilised to protect shareholders interests. In this regard, its terms can also deal with a range of other matters such as:

• shareholder exit strategy and events of death or incapacity of a shareholder
• entry of a new shareholder and share issues
• non-compete and restraint of trade
• non-dilution of shareholder interests
• dividend distribution policy
• directors meeting procedures, rights to appoint directors and operating procedures and approvals
• events of default giving rise to share transfers and right of pre-emption
• dispute resolution

Even though there are ‘generic’ or ‘boilerplate’ terms which can be instituted in a standard shareholders’ agreement, the document should be thought of as a specific contract which forms the basis and which services the operational needs of the business and should thus reflect the commercial ownership requirements of the shareholders.

It is therefore to the advantage of the shareholders and the business that a shareholders’ agreement is specifically tailored to satisfy specific expectations and requirements of the shareholders.

Should you require assistance or advice on the preparation of a shareholders’ agreement, strategies regarding ownership and control of your business or protection of shareholder’s rights such as a minority shareholding or anti-dilution of a majority shareholding, please contact our Corporate Advisory Principals Mark Fitzgerald or Georgina Odell.

[1] [2017] QSC 001 (16/7342)

This article does not constitute legal advice and does not give rise to any solicitor/client relationship between Meridian Lawyers and the reader. Professional legal advice should be sought before acting or relying upon the content of this article.