We often get asked why you need Articles and a Shareholders Agreement for a private company. In this article we cover some of the key reasons.
All limited companies are required to have Articles of Association (Articles) and are advised to agree a Shareholders Agreement (SHA). In this article we look at the key differences between the two and why both are important for a business.
Why you need Articles and a Shareholders Agreement
Articles are public, a Shareholders Agreement is private
Articles are a public document and a SHA is private. There may be certain rules of your company which you don’t want others to see. For example, within a Shareholders Agreement there is usually a list of things which cannot be done without a certain shareholders consent, i.e. you cannot appoint a director without the founders consent. Also, things such a dividend policy you may wish to keep private.
Amending Articles and a Shareholders Agreement
To amend the Articles you need 75% of the shareholders to agree, to amend a SHA you need all shareholders which have signed up to the SHA to agree.
Articles can be amended to a certain extent but there are certain provisions which you can’t exclude/amend. Shareholders Agreements are governed by contract law so can be drafted as the parties wish; this gives the parties more flexibility in terms of what private agreement they wish to agree.
Breaching the Articles or Shareholders Agreement
If a person breaches the Articles or Shareholders Agreement, different remedies are available. In a nutshell, if Articles are breached this will result in the breaching action being invalid. For example, if pre-emption provisions were breached and a shareholder transferred shares other than in accordance with the Articles, the transfer may be void or the Articles may provide for all rights attaching to the shares to be forfeited. If these provisions were in the SHA, the breach is likely to lead to a remedy of damages which may not be as effective.
Shareholders Agreements cannot be enforced against a liquidator
As a Shareholders Agreement cannot be enforced against a liquidator, this can give rise to problems. For example, if the liquidator does not agree with any valuation formula in the SHA. There is also a question of whether a compulsory transfer provision in a SHA will be enforceable against a trustee in bankruptcy.
Therefore, if you are ok with the transfer provisions being public information in the Articles, it is best to put the share transfer provisions in the Articles.
When a new shareholder joins a company, they will be automatically bound by its Articles but not by its Shareholders Agreement, unless they sign a deed of adherence to the Shareholders Agreement.
If the identity of the shareholders is likely to change frequently it may be more practical for the important provisions to be in the Articles which automatically bind.
Articles often provide some protection to shareholders. However, Shareholders Agreements usually provide further clarity and additional provisions on certain matters for both minority shareholders (e.g. certain decisions to be approved by shareholders) and majority shareholders (e.g. drag along provisions where majority shareholders can force minority shareholders to sell).
Other benefits to SHAs
Shareholders Agreements often provide useful provisions to keep the company running smoothly, such as:
- A dispute resolution process;
- Information rights for shareholders (which are limited under the Companies Act 2006);
- Confidentiality provisions;
- Details regarding what shareholders should do for the company;
- A list of decisions which the directors can make without reference to the shareholders; and
- Which decisions shareholders must approve.
To conclude, the Articles are a legal requirement to have in place and are often sparse on detail, particularly as the company grows.
One of the main purposes of a SHA is to prevent future conflict, the idea being that whilst the parties are not in dispute, they agree the terms on which they will deal with future situations which may be a source of disagreement. In the long term, this should enable shareholders to realise the maximum value from their investment.
We would recommend both Articles and Shareholders Agreement to be drafted at the same time to ensure they dovetail.
We would also recommend that both the Articles and SHA are kept under review annually or when a major change is made such as an investor is brought on board. This is to ensure they remain fit for purpose.
To learn more about Articles and whether they fit your business, please see our previous article ‘Model Articles of Association – are they fit for purpose?’.
If you would like assistance with amending your Articles and/or drafting a Shareholders Agreement, please get in touch below.