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Shareholders Agreements: Prevention is better than the cure

by Published on

Chris Morgan - Website Photo
Chris Morgan — Solicitor — Corporate & Commercial Team

One aspect of the company’s formation which often gets overlooked, however, is the preparation of a Shareholders Agreement. Although not essential, a Shareholders Agreement can be very useful, as they are intended to regulate the relationship between the shareholders. For example, they can commit the shareholders to the company for a period of several years to prevent the disruption of the company while it finds its feet. It could also regulate a shareholder’s position on exiting the company to prevent that shareholder taking their expertise, and more importantly, the company’s clients or business, elsewhere, or from forming a competing business. These are, however, merely a small number of possible uses.

Often, individual shareholders are known to each other before entering into business together, therefore a Shareholders Agreement is frequently considered unnecessary. However, a Shareholders Agreement does not just cover conflicts between shareholders; it can also cover non-contentious issues such as what happens to the company on the sudden death of a shareholder or how existing shares may be disposed of or new shares allotted. Consequently, notwithstanding the prior relationship of the parties, a Shareholders Agreement can have far reaching advantages.

Shareholder Agreements are intended to supplement company legislation and fine-tune the rules governing each individual company. Company legislation applies to all companies, from Barclays Bank plc to ‘the company who owns the shop on the corner’. Clearly, therefore, it is not meant as a rigid framework for all companies but provides a skeleton around which the body of a company can be built.

The key principle behind a Shareholders’ Agreement is that prevention is better than the cure. It is an unfortunate fact of life that relationships are made and broken, whether through disagreements or events beyond the parties’ control. The same is true in business. Accordingly, the legal costs of a solicitor in drafting a well-structured Shareholders Agreement at the outset, or once a company has been incorporated, is far more economical than litigating a shareholder dispute later or spending hours involved in paperwork. Indeed, a court has the power to wind up a company if it deems this to be the fairest way to deal with an issue, meaning the company ceases to exist and cannot continue to trade. Consequently, the goodwill the company has built up vanishes and the business must once again be built from scratch. The best way to avoid this rather draconian ‘solution’ is to use a Shareholders Agreement to provide a mechanism for resolving matters and not to rely on the courts.

A word of caution, however: a Shareholders Agreement cannot provide for every possible eventuality throughout the life of a company. Circumstances change, for example, companies can grow, becoming wealthier and changing ownership or even becoming listed on the stock exchange. Therefore, if you have a Shareholders Agreement, you must review it regularly with a view to updating it as necessary.

Samuel Phillips Law Firm offers a full range of company and business services. Please contact Chris Morgan, a solicitor in the corporate and commercial department, on 0191 255 0206 or at chrismorgan@samuelphillips.co.uk for more information or to arrange a meeting.

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