We are often approached by clients to draft a “shareholders’ agreement” for their Company. This is a good idea and clients are often prompted by their accountant or financial adviser to have such an agreement in place. However, that is only half the story. We also must consider (in this context) the Articles of Association of the Company (“Articles”).
Whilst there are overlaps between shareholders’ agreements and Articles, they are different and both need to be fit for purpose for a private company with two or more shareholders.
What Is the Difference Between a Shareholders’ Agreement and Articles of Association?
A Shareholders’ Agreement is a contract, which, if breached, would result in a claim for damages for breach of contract. There are also possibilities for applications to Court for Injunctions (to stop someone doing something in breach of contract) or Specific Performance (to require them to do something they are not doing but should be). Such applications are expensive and 100% success can never be guaranteed, even with seemingly obvious cases.
A Shareholders’ Agreement is necessary where a shareholder is seeking to compete with the company or trying to poach staff or customers. All shareholders agreements between private individuals who work in the relevant business should contain provisions restricting shareholders from acting in this way.
Restrictions on management decisions are also important. Whilst shareholders individually need to have protection from poor management decisions by the Board, the decision makers also need to ensure they have the backing of a majority of shareholders for their decisions. Ideally, this should ensure that the Board is not held back by a difficult minority shareholder who only considers their own position rather than the general good of the company and/or other shareholders.
All private limited companies must have a set of Articles under the Companies Act 2006 (“the Act”). If none are specifically adopted then the Articles will be those set out in the Act as the “default” Articles. The basic nature of these default Articles means they are often inadequate for the specific reasons we are often asked to address.
“Default” articles principally deal with the holding of Board and Shareholder meetings and administrative matters to ensure compliance with the Act, but do not deal with complicated share arrangements or procedures where a shareholder ceases to work in a business. They are usually inadequate when dealing with the transfer or issue of shares.
What Are the Differences and Why Do They Matter?
We often come across problems where there is a Shareholders’ Agreement in place but the Articles of Association are standard “default” Articles as the client may only have a breach of contract claim.
Sometimes we are presented with a situation where there is a potential or actual shareholder dispute but there is no shareholders agreement in place and the Company has “default” Articles. In order to put the necessary new documents in place all shareholders must sign a Shareholders’ Agreement for it to be completely effective, whereas new Articles of Association can be adopted by the approval of shareholders holding 75% of the voting shares in the company.
This clear gap can be taken advantage of by a disruptive minority shareholder if both documents have not been properly established prior to them becoming disruptive.
Similarly, if a shareholder deals with their shares in breach of a Shareholders’ Agreement, the remaining shareholders may be left only with a damages claim; this may be either useless to them or will require expensive and time-consuming litigation to resolve.
However, whilst disputes can never be fully avoided, expensive litigation can be avoided by having properly drafted Articles which have proper procedures for the transfer or issue of shares and which work together with the shareholders agreement to protect the Company and the majority of its shareholders. If procedures in the Articles are not followed, the legal position is much more easily dealt with than a breach of a shareholders agreement, as the wrongful behaviour will be invalid.
Private limited companies with two or more shareholders should have both a shareholders agreement and properly drafted and tailored Articles to ensure both the running of the business and the management of minority shareholders.