Checklist – Articles of Association and Shareholders Agreements 

Snapshot

We can advise you on how to structure your shareholding structure in a private company or a privately funded company to maximise your return on equity and minimise the financial consequences of commercial disputes, including minority shareholder and director and executive employment disputes. We also advise on director service agreements and executive employment contracts which often interact with the articles of association and shareholders agreement.

There are various areas which may require special protection as explained below.  Please do call us if you have any queries.

The company's articles of association set out all the company's internal rules governing its shares and administration. The shareholders agreement will frequently include terms which are private between the shareholders such as investment and dividend policies and post termination restrictions such as non-competition by a former shareholder or non-solicitation of staff or clients. Shareholder disputes and director employment disputes often arise in relation to breaches under these agreements. Our checklist provides you with the common issues you should consider when drafting articles of association and/or a shareholders agreement for a private company limited by shares. It is recommended that you also consider and review director service agreements and executive employment contracts.

Activities of the Company

• Should the type of activity that the company can be involved in be restricted in any way?

Amending Articles of Association

• Are any provisions of the articles of association of such importance that a resolution passed by more than 75% of the shareholders should be required to change them?  100% of shareholders will be required to amend a shareholders agreement.

Company Secretary

• Does the company want/ want to retain a Company Secretary?

Changing Company name

• Should the articles of association include a special procedure for changing the company's name?

Shares

• Should there be a ceiling placed on the level of authorised share capital? If so should such a provision be subject to a resolution of more than 75% of the shareholders eligible to vote?
• Should the directors' authority to allot shares be restricted?  If so, should any change to that restriction be subject to a resolution of more than 75% of the shareholders eligible to vote?
• If new shares are being issued:-
• Should the company be required to offer those new shares to each existing shareholder – pro rata or otherwise; or
• Should the company be free to issue new shares to a third party without making such an offer to existing shareholders

Shareholder disputes often arise in the context of new shares being issued as existing shareholders seek to maintain the value of their shareholding, which will be diluted by additional issue of shares. Therefore the procedure for the issue of shares must be clearly set out in the articles of association and shareholders agreement.

• Should there be a restriction on the company's ability to do any of the following: 
• sub divide or consolidate share capital
• re denominate share capital
• issue redeemable shares
• purchase its own shares
• purchase its own shares out of capital
• reduce it's share capital
• use the proceeds of a reduction for a distribution. 
• If the company is able to issue redeemable shares, should the articles of association authorise the directors to determine the terms, conditions and manner of the redemption?
• Are all the shares to have the same rights as to voting/ dividends/ return of capital (sale, winding up etc)/ transfer and mechanism for calculating market value of shares on a sale?
• If there is more than one class of shares should specific provisions on variation of class rights be included in the articles of association?

Directors

• Is there a requirement that each director must be a shareholder? 
• If so, must they resign as directors if they cease to hold shares or a required number of shares? Director disputes may arise if their position following the sale of their shareholding in the company is not clearly set out in the articles of association and shareholders agreement. This issue may also be covered in the director service agreement.
• How many directors will be on the board of directors?
• Are directors appointed by specific shareholders?
• What will be the quorum for a directors' meeting?
• Who will have power to appoint additional directors?
• the board; or
• particular shareholder(s); or
• particular percentage of shareholders
• If as a result of death or bankruptcy the company is left with no directors and no shareholders should the articles of association include provisions whereby the personal representative or trustee in bankruptcy has the right to appoint a person to be a director? It is important for the articles of association and shareholders agreement to cover every contingency, including the appointment of new directors in the event of the death or bankruptcy of directors and shareholders.
• How are board resolutions to be passed?
• Consider whether directors should have weighted voting rights.
• What happens if the directors are evenly split on a resolution? Will a chairman of the board have a casting vote?
• How will the chairman of the board be appointed?
• by the board
• by a particular shareholder
• by a particular percentage of shareholders
• How frequently are board meetings to be held?
• Should meetings be called by
• one director
• a given number of directors acting together
• What will be the requisite notice period for board meetings?
• Can attendance at a board meeting be by electronic means?
• Do you want to include a procedure for directors' written resolutions?
• Should the articles of association include procedures for recording directors' decisions?
• Should there be provision for directors to appoint alternate directors? If so, does the appointment of an alternate have to be with the consent/approval of the other directors?
• Should the articles of association include a procedure to apply in the event of a director having a conflict of interest? Director and shareholder disputes may arise in the event of a director having a conflict of interest, therefore a clear remedial procedure must be in place to avoid these disputes.
• Should the articles of association include a provision that prevents directors authorising another director's conflict of interest? If so, do you wish to include an express requirement for the consent or approval of shareholders for such authorisation?
• Where a director has an interest – actual or proposed in a transaction, should he be entitled to attend, be counted in the quorum and vote?
• Should the company have discretion to indemnify directors to the extent allowed by law or an obligation?
• Should the indemnity be extended to cover (a) other officers of the company as well as directors, for example the company secretary and (b) former officers?
• Should the company's option to purchase insurance be extended to cover officers and former officers rather than just directors?

Shareholders

• Should a shareholder be authorised to nominate a third party to enjoy that shareholder's rights?
• Might you want the company to be able to communicate with shareholders by placing documents or information on the website?
• Does the company want to set its own deemed delivery periods for documents or information sent or supplied by the company to its members?
• Do you want to reserve to the shareholders a power by special resolution to direct the directors to take or refrain from taking specified action?
• Are there to be specific provisions about what information is to be made available to shareholders (or is this to be left to the directors)?
• Shareholders holding 5% of the total voting rights of all shareholders entitled to vote on a resolution will be entitled to ask for a written resolution to be circulated to shareholders. Do you wish to reduce that percentage?
• Is it intended that use will be made of electronic communications for circulating resolutions to shareholders?
• Are procedures in place to obtain and record the necessary agreements and addresses for electronic communications?
• A circular for a shareholders' written resolution will remain open for agreement for 28 days from the circulation date unless an alternative period is specified in the articles of association. Do you want to specify an alternative period?
• Does the company want to hold annual general meetings?
• Annual general meetings - At least 14 days notice, unless a longer period is specified in the articles of association. Is a longer notice period required?
• What quorum is required for a meeting of shareholders?
• Is the quorum to be based on the number of shareholders/ voting shares held?
• Should the articles of association include provisions governing who may or may not be the chairman at a meeting of shareholders? If a chairman of the board of directors has been appointed, should that chairman also chair a meeting of shareholders?

Permitted Transfers of shares

• Will specified shareholders (eg founders) be entitled to transfer shares freely without any restrictions? Shareholder disputes may arise if the procedure for the transfer of shares is not set out clearly from the outset in the articles of association and shareholders agreement.
• Will shareholders who are individuals be permitted to transfer to a privileged relation (spouse/widow or lineal descendants) or to a family trust? Is approval required and if yes, whose and what %?
• Will shareholders who are corporate entities be permitted to make intra-group transfers? Is approval required and if yes, whose and what %?
• Will transfers of part of a shareholding be permitted?
• Unless there is a Permitted Transfer, will all transfers be required to follow a prescribed Transfer Notice procedure?
• In a Transfer Notice procedure, what parties should be offered shares and in what order?
• Will a seller be able to withdraw an offer to sell shares under the Transfer Notice procedure? If so at what stage?
• Drag Along provisions are useful to protect majority shareholders and enable third party purchasers to take full control of a company. Under a Drag Along provision where one shareholder or a number of shareholders acting together and holding a certain % of shares sells shares to a third party, the remaining minority shareholder(s) must also sell their shares on (substantially) the same terms to the third party. Should a Drag Along provision be included? Minority shareholder disputes may arise if the procedure for transfer of shares by majority shareholders is not clearly set out in the articles of association and shareholders agreement. 
• Tag Along provisions are useful to protect minority shareholders. Under a "tag along"  provision, a shareholder, or a number of shareholders acting together, holding a certain % of shares cannot sell theirs shares to a third party unless it procures that the third party buyer buys the shares of the other shareholders at the same price. Minority shareholder disputes may arise if the necessary protections are not put in place in the articles of association and shareholders agreement. 
• Will there be a compulsory sale of shares upon any or all of the following events?
• the death of a shareholder
• the mental incapacity of a shareholder
• where an individual shareholder becomes bankrupt
• where a corporate shareholder goes into liquidation
• where there is a change of control of a corporate shareholder
• a shareholder committing a material breach of the shareholder agreement
• where a shareholder being an employee or director leaves the employment of the company for any reason

Shareholder disputes may arise if no provision is made for such contingencies in the articles of association and shareholders agreement.

• Is there a distinction between good and bad leavers?  For example, if an employee or director ceases to be employed for a "good reason" the good leaver receives 'fair market value' for his shares whereas bad leavers receive par value or price paid on subscription if higher.  Determining the position in advance will cut down on the risk of a shareholder dispute, disputes by directors and employee disputes.
• Will shares on death of shareholder be allowed to transfer to the estate?
• Will beneficiaries be permitted to exercise the same rights as the deceased shareholder had or will the rights attaching to such shares be limited? Shareholder disputes with a deceased shareholder's estate may arise and therefore the nature and extent of the rights attaching to their shares and passing to their estate must be provided for in the articles of association and shareholders agreement.
• Do you wish to include cross options on death? A cross option involves the surviving shareholder having an option to purchase shares from the estate of the deceased shareholder in a given time period. Will insurance be obtained to provide a fund for the purchase of the shares, by the surviving shareholder?
• Is market value upon sale of the shares to be determined
• failing agreement of the parties, by an independent expert
• Who appoints independent experts?
• Who pays for the independent expert? Seller? Seller and Company?
• Are there specific accounting principles which the expert should apply when determining fair value?
• by a pre determined formula?
• Is allowance to be made for the discount arising on disposal of a minority interest?
• How long should the purchaser be given to pay for the shares?

Disputes/ deadlock

Directors

• Where there is a deadlock/inability to agree at board level, will the chairman have the casting vote?
• Will independent non-executive directors be appointed to decide the outcome of management deadlock?
• Will any matter on which the board are unable to agree be sent to the company shareholders for resolution?

Effective dispute settlement provisions are necessary to prevent and reduce the risk of shareholders disputes and directors' disputes.

Shareholders

• Will deadlocks be dealt with on majority vote by members representing more than a given percentage of the total voting rights?
• Will there be specific deadlock provisions which provide for a transfer of shares if there is a deadlock?
• Will there be a specific right to call for liquidation of the company after a specified period of deadlock?
• If any dispute arises in connection with a shareholders agreement do you wish to include a provision that the parties will attempt to settle the dispute by mediation (eg in accordance with the Centre for Effective Dispute Resolution - Model Mediation Procedure)?
• Should the agreement set out a procedure for initiation of mediation by ADR Notice
• Should the parties in dispute be prevented from commencing court proceedings or arbitration until the mediation process has concluded?

Shareholders Agreement specific provisions

Shareholder approval

• Is shareholder approval required for specific activities? If yes what %?
• Admission of new shareholder
• Formation of subsidiaries
• Loans/borrowing/mortgages/guarantees above specified limits
• Capital expenditure commitments above a certain level
• Acquisition/disposal of the whole or a material part of the assets or business

Will Restrictive Covenants be required?

• Restrictions on shareholders competing with the company both whilst they are shareholders, and once they are no longer shareholders.
• Include prohibition on carrying on a business in the UK (or elsewhere as relevant) the same as or competing with that of the company?
• Include prohibition on soliciting or endeavouring to entice away from or discourage from dealing with the company any person who was a customer or potential customer?
• Include prohibition on soliciting or endeavouring to entice away from the company an employee, agent, independent contractor or consultant of the company?
• Include a prohibition on revealing any confidential information regarding the company
• For what period should the restrictions be in place after a shareholder has ceased to be a shareholder in the company?

Shareholder disputes may arise if existing or previous shareholders abuse their privileged position and access to the company's confidential information for their own personal benefit and gain, therefore restrictive covenants must be clearly and widely drafted.

Dividends

• Are there to be specific provisions on/restrictions about, distribution of profit (or is this to be left to the directors)?

Capitalisation/ funding obligations of shareholders

• Will any of the shareholders be obliged to make further investment in the business (through subscription for further shares and/or the making of loans to the company)? If  yes
• will the shareholders  participate equally in the financing of the company or
• will the investment/funding obligations be borne pro rata to the shares held by the shareholders?
• will shareholders be expected to provide personal guarantees for the company's liabilities (for example, bank overdrafts)?

Shareholders and directors disputes may arise with respect to shareholder liabilities, including the provision of company finance, therefore these obligations must be comprehensively stated in the shareholders agreement.

Conclusion

The specific choice of terms in articles of association and shareholders agreements will give rise to a range of legal, commercial and financial implications. We advise companies as well as individual directors and shareholders, including minority shareholders on the best options for minimising the financial consequences of commercial disputes. We can also advise on director service agreements and executive employment contracts which often interact with the articles of association and shareholders agreement. We take the time to understand the business and your specific needs and expectations, providing you with a timely and cost effective service.

Please note: The points in this 'checklist' are to highlight some of the issues that companies and shareholders may want to address when preparing / reviewing articles of association and shareholders agreements etc. It is not intended to be comprehensive or to be a detailed outline of all matters to be taken into account, and it should not be acted upon without first taking specific legal advice.

Click here to read our article on Shareholder Voting Powers.