A standard company constitution will not always protect
shareholders in the event of a dispute between members. This is
where a shareholders' agreement, regulating the rights and
obligations of shareholders, can help avoid the uncertainty of
costly court litigation. While it is not compulsory under the
Corporations Act, a considered and properly formulated
shareholders' agreement is highly recommended for all
So, what should you include in a shareholders'
Every shareholders' agreement should be individually
tailored because every company is different. The specific
provisions of each shareholder agreement should take into account
the number of shareholders, the objectives of the shareholders, the
funding arrangements, and the nature of the business or industry in
which the company operates. However, there are also some basic
clauses that every shareholder agreement should have.
Alternative Dispute Resolution
As a pre-requisite to any court proceedings, it is advisable for
all parties to try resolve their disputes through an alternative
dispute resolution (ADR) process stipulated in the
shareholders' agreement. These processes generally take less
time and cost less money than proceedings in a court. ADR may
include mediation, arbitration or conciliation. Note that a
provision in a shareholders' agreement to resolve disputes
through an ADR process will not preclude a court from hearing the
dispute at a later date.
Deadlock provisions deal with circumstances where shareholders
cannot agree on the management of the company. The
shareholders' agreement should set out a procedure to resolve a
deadlock if one arises. There are a number of procedures that can
be used to resolve deadlocks, including:
Shotgun clause – enables a shareholder to serve notice on
another shareholder requiring the receiving shareholder to buy
his/her shares at a nominated price. If the receiving shareholder
chooses not to buy those shares, he/she must sell his/her shares to
the initiating party at the same nominated price.
Chairman clause – enables one of the shareholders to
become the Chairman in the event of a deadlock and have the casting
vote on the dispute.
Liquidation clause – if the deadlock continues for a set
period of time, all the company's assets will be sold and the
company will be wound up voluntarily. The shareholders equally
share in the expenses of liquidating the business. This solution is
generally a last resort where there is no alternative other than to
Pre-emptive rights impose certain restrictions on the transfer
of shares. Pre-emptive rights may include:
Right of first refusal – provides existing shareholders
the first opportunity to purchase the shares from another
shareholder of the same company before the shares can be offered to
parties outside the company.
Right to refuse transfer – the Board will have the
discretion to refuse to register a transfer of shares to prevent
unwanted parties from joining the company.
Board consent to transfer – a shareholder wishing to
transfer his/her shares will have to obtain the consent of the
Board to transfer shares or transfer shares to certain
Mandatory Sale Events
The shareholders' agreement should specify certain
fundamental changes in circumstance which will trigger a mandatory
sale of that member's shares. Examples of such events
A shareholder's death
A shareholder's insolvency / bankruptcy
Certain fundamental breaches of shareholders'
Temporary or permanent disability
Cessation of employment
Loss of professional certification (where this is required
because the company trades, for example, as a doctor's surgery
or a law practice).
Share Valuation Methods
The shareholders' agreement must stipulate a method for
determining the value of shares in relation to pre-emptive rights
and mandatory sale events. Typical share valuation methods
Fixed price – price agreed by the shareholders.
Assets based – the value of the net assets divided by the
current number of shares.
Expert valuation – usually, valuation by an
Board valuation – those directors who are not directly
involved in the transaction value the shares.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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