Legal risks with no shareholders agreement

If you are a shareholder in a private company, there are two main ways to plan for future issues: amending the company’s articles of association and putting a shareholders’ agreement in place.

We summarise below some of the common problems that can arise where a company relies solely on its standard articles or has only a basic shareholders’ agreement.

Problems if there is no shareholders agreement

A shareholders’ agreement can address practical matters such as whether shareholders are expected to work in the business, dividend policy, banking arrangements and dispute resolution. It can also deal with future events, including exits, new investment, veto rights and disagreements between shareholders.

The risks of relying on standard articles alone depend on the company’s circumstances and the rights attached to each shareholding. Minority shareholders may need specific protections, while majority shareholders may want provisions such as drag-along rights to facilitate a sale.

Common risks include:

• Majority shareholders may not be able to sell the business – Without appropriate drag-along provisions, a minority shareholder may be able to prevent a sale of the entire company. Drag-along rights can allow a qualifying majority to require minority shareholders to sell on the same terms. Conversely, tag-along rights can protect minority shareholders by allowing them to participate in a sale by the majority on equivalent terms.
• Employee shareholders – Where employees or directors receive shares as an incentive, they may retain those shares after leaving unless appropriate transfer provisions apply. Leaver provisions in the articles or shareholders’ agreement can establish when shares must be transferred and how they are valued.
• Risks from departing shareholders – A departing shareholder may retain access to valuable business knowledge or compete for customers. Carefully drafted restrictive covenants may help protect the company’s legitimate business interests, although their enforceability depends on their scope and circumstances.
• Lack of flexibility in bringing in new investment – Standard articles may not provide the share classes or rights needed to accommodate different investors. Creating different share classes can allow voting, dividend and capital rights to be tailored to the company’s requirements. The relevant rights must be properly documented, particularly in the articles.
• Deadlock at director and shareholder level – Disagreements between equal shareholders can prevent important decisions and disrupt the business. Deadlock provisions may provide for escalation, mediation, expert determination or a buy-out mechanism. Without an effective resolution process, a dispute can damage the business and, in some circumstances, lead to a winding-up petition.

The solution -  shareholders agreement

A shareholders’ agreement can complement the articles of association and provide a framework for managing the relationship between shareholders. It can:

• Define shareholder responsibilities and expectations;
• Support the effective running of the company;
• Set out rights relating to dividends, transfers and future investment; and
• Reduce the risk of disputes and provide mechanisms for resolving them.

A shareholders’ agreement is generally a private document, whereas the articles of association are publicly available through Companies House. However, confidentiality is not absolute, and disclosure may be required in certain circumstances.

We help companies and shareholders put appropriate arrangements in place to protect their interests, manage future changes and reduce the risk of costly disputes.