For every corporation, it’s almost inevitable that, at some point, the organization will face a shareholder disagreement or dispute. These conflicts can be highly disruptive and cause significant damage to a business. This blog discusses the important role a robust and well-drafted shareholder agreement plays in both reducing such disputes and resolving them when they arise.
Common shareholder disputes include conflicts and disagreements relating to:
- control and direction of an organization
- material expenditures, mergers, acquisitions or the sale of a business
- the appointment of directors
- the addition of new shareholders and exit of existing ones
- the valuation of shares.
How effectively a dispute can be prevented (or resolved if it arises) often depends on the quality of a company’s shareholder agreement. A shareholder agreement acts like a roadmap for how your company should be run, covering various issues like corporate governance, appointment of directors, dealing with new and departing shareholders, share distributions, valuation of shares, approval of (or potential veto over) material transactions, as well as dispute resolution, including mediation and arbitration clauses.
Without a well-drafted agreement, it can be challenging for shareholders to avoid and resolve disputes when they present themselves over the lifetime of a business. Unfortunately, many companies have shareholder agreements that are not adequately tailored to the business, or they do not have a shareholder agreement at all.
Here are some tips to ensure your shareholder agreements are well-drafted to help reduce shareholder disputes and resolve them when they occur.
Revise your agreement as your company grows
As a company matures, it often outgrows its initial shareholder agreement. This can be a function of the company’s success or growth in particular and sometimes unanticipated areas, or divergence among the company’s existing shareholders’ investment horizons, interests in, or contributions to the business. These developments warrant updating a company’s shareholder agreement to better reflect its current reality as well as the most likely eventualities that it will face.
Start-ups and new businesses often use basic templates for their shareholder agreements. While such templates can be satisfactory during the early stages of a business, they should be revised as a company matures. Disputes often arise because the agreement between shareholders does not include clauses for specific scenarios. These can include tag-along, drag-along and shotgun provisions, rights of first refusal and rights of first offers, among other clauses dealing with sales of shares and exits from the business.
[Read our blog post: Why you should consider a shotgun, tag-along or drag-along clause within your shareholder agreements]
While a contract cannot cover every possible eventuality, it can certainly address a number of the more common ones that are likely to affect a company and its shareholders.
Limit opportunities for impasse
Some early-stage companies believe that unanimity when it comes to shareholder voting is essential – that is, requiring all shareholders to vote in favour of a resolution in or order for it to be passed. They feel that such unanimity reflects the company’s ethos of fairness, equity and of everyone being aligned with its mission.
And, in the early days, when things are running well, it can work. But as the organization grows, differences of opinion are bound to arise. These disagreements can make it impossible to make decisions about the company’s direction if one or more shareholders disagree, leading to an impasse. It is important to consider alternatives to this voting structure, such as a supermajority of two-thirds or three-quarters of the voting shares instead of 100%.
Other alternatives to address such deadlock include buy/sell provisions that allow a shareholder to exit the company and sell its shares according to an agreed upon valuation mechanism.
Needless to say, litigation can be costly, disruptive, time-consuming and damaging to a business. Appropriate dispute resolutions clauses, such as mandatory mediation and/or arbitration, are effective in resolving disputes more quickly than litigation, with fewer disruptions, at a lower cost and without potential negative publicity.
Work closely with your corporate counsel to draft an effective shareholder agreement
If your company is experiencing a period of rapid growth or change, it is worth sitting down with your counsel to revisit your shareholder agreement.
A good corporate counsel will be attuned to the needs of your business and will work with you to understand and address the specific challenges and opportunities the company is facing with appropriate solutions, including the ones discussed above.
If you need help ensuring your shareholder agreement is fit for purpose, we can help. Caravel has a team of 85 qualified and experienced lawyers, including those specializing in contract law. Get in touch with our team today to find out more.