A shareholders' agreement (SHA) is a contract that governs the relationship among a company's shareholders and between the company and its shareholders. It plays a critical role in defining the rights and responsibilities of the parties involved, as well as in providing mechanisms to prevent and manage disputes.
This article offers a high-level overview of what a SHA usually entails, and the key questions parties should consider when negotiating its terms.
While the overall framework and management of a company is in fact governed by such company's articles of association-a statutory document indispensable to the company's incorporation and binding on all current and future shareholders- a shareholders' agreement allows for more tailored arrangements that address the specific needs and dynamics of a particular business or investment. In addition to the matters covered by the articles of association, a shareholders' agreement often incorporates additional provisions—such as restrictive covenants and confidentiality clauses—that may be absent or inappropriate for inclusion in the articles of association. Crucially, unlike the articles of association, which must be filed with the Registrar of Companies and are therefore publicly accessible, the SHA is a private contract, binding only on and accessible to the parties involved.
To avoid conflicts with the articles of association, a SHA typically includes a supremacy clause stating that, in the event of any inconsistency, the SHA's provisions shall prevail over those of the articles of association. However, due to the principle of privity of contract, the SHA only binds its signatories. This means that certain parties who are not signatories (e.g the company's directors) are not bound by the SHA and remain subject to the articles of association. To prevent any issues arising from this duality, shareholders should arrange to amend the articles of association to align their provisions with those of the SHA. Such amendments help ensure consistency and avoid potential conflicts or uncertainties in the company's governance.
A well-structured SHA typically addresses several core areas, each aimed at reducing uncertainty and clarifying the shareholders' expectations. One of the first elements to consider when preparing a SHA is the company's shareholding structure. If different classes of shares exist, the SHA should clearly outline the specific rights and obligations attached to each class, including respective voting rights and dividend entitlements. The SHA will also usually describe the business of the company, thus providing clarity on the company's strategic direction and ensuring that shareholders are aligned on core objectives from the outset. Management of the company is another crucial area. The SHA will likely provide for the composition of the board of directors, including how many directors there will be, who has nomination rights, how vacancies will be filled, etc. It will also define how decisions are made—whether by simple majority, supermajority, or unanimity—and set the quorum requirements for board meetings. Similarly, it is expected to regulate the conduct of general meetings of the shareholders, identifying any reserved matters that require shareholder approval and specifying the necessary majorities and quorum for such decisions. Reserved matters may include significant actions such as amendments to the articles of association, changes to the share capital, and additional matters beyond those already requiring shareholder approval under the Cyprus Companies Law (Cap.113)—such as the approval of major transactions.
A SHA will also typically, include mechanisms to regulate share transfers and allotments, reflecting the practical need to balance exit flexibility with safeguards against dilution and unplanned shifts in ownership. Thus, it will often outline a process under which existing shareholders are granted pre-emption rights in the event of new issuance of shares, ensuring they are given the first opportunity to acquire any newly issued shares. Similarly, it may set out rights of first refusal, allowing current shareholders to purchase shares before they are offered for sale to third parties. Additionally, a SHA may empower the board to block transfers to unapproved buyers, while excluding from such restriction certain transfers—such as those to family members or affiliated entities—as freely permitted. In more complex shareholding structures, it is not uncommon to also include drag-along and tag-along rights. Drag-along rights allow majority shareholders to compel minority shareholders to sell their shares in a sale, enabling the company to be sold as a whole (i.e 100% of its share capital). Conversely, tag-along rights protect minority shareholders by allowing them to participate in a sale by the majority shareholder on the same terms. The SHA may also provide clarity on financial expectations among shareholders by explicitly addressing the company's dividend policy—such as specifying the percentage of profits to be retained for reinvestment or stating whether such matters will be left to the discretion of the board.
Finally, a SHA may contain restrictive covenants that impose specific obligations and limitations on shareholders to protect the company's business interests. These covenants often prohibit shareholders from engaging in activities that could harm the company, such as operating or investing in competing businesses, soliciting or recruiting the company's employees or clients, or improperly using or disclosing confidential or proprietary information. Such restrictions are crucial to safeguarding the company's trade secrets, client relationships, and overall competitive position. These obligations can and they usually do extend beyond the term of share ownership. Even after a shareholder exits the company, the restrictive covenants will typically continue to apply for a defined post-termination period and within a specified geographic area relevant to the company's operations. This post-exit protection is intended to prevent former shareholders from immediately undermining the company's business or capitalizing on sensitive information gained during their involvement. The scope, duration, and enforceability of these covenants are generally carefully negotiated to balance protecting the company's interests while remaining reasonable and legally enforceable under applicable laws.
A shareholders' agreement should be seen as more than just a collection of standard clauses—it serves as a vital framework that reflects the unique dynamics among a company's stakeholders. To be effective, the provisions of a SHA must be customized to the specific needs and structure of the company, as these will vary depending on the shareholding distribution and ownership breakdown. Such factors have a direct impact on the company's governance, shaping elements like the composition of the board of directors, the balance of power between the board and the general meeting, and the majorities required for critical decisions. By proactively addressing key issues like governance, financing, and exit strategies, entering into a SHA encourages shareholders to confront important questions and reach agreement on a number of important matters from the outset, minimizing the potential for conflicts down the road.
It is no exaggeration to say that a SHA, by defining critical issues such as voting rights, transfer restrictions, and exit strategies, serves as the foundation of the relationship between shareholders in a company. A lawyer's involvement throughout the process is therefore essential—not only to ensure that the negotiated terms are carefully tailored to the specific context of the company, but also to safeguard their client's overall interests and address key legal risks associated with the negotiation and drafting of a SHA.
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.
