The Benefits of and Advantages of Shareholders Agreements - Case Study Example

Busan Law A2

Shareholders in US Companies are motivated to enter into shareholders’ agreements as a matter of best practice for the same business reasons as in other jurisdictions, namely to set out their respective rights and obligations and to protect their commercial interests. That being said, what are the benefits of and advantages of shareholders’ agreements? Are shareholders’ agreements enforceable? Yes or No, please explain

Introduction

Many legal documents exist currently to help in moderating the link and the relationship that exist between different parties. Further, these legal documents help in defining the relationship in regards to the standards and the rules under which every decision and action is made or taken. Even though there exists no legal requirement to have a formal shareholders agreement, every other company that has more than one shareholder is properly advised to have one. An agreement remains as one of the possible though legally approved arrangements that stands to help in negotiation process between two different parties (Cadman, 2003). Globally, there exist several types of agreements and every document has its own power and affect individuals and countries (Bebchuk, 2005). Therefore, it is without a doubt that individuals need to comprehend the legal basics for them to know the types of agreements that are enforceable in the countries. There are several types of agreements and they include sponsored, services, collaborative or affiliation.

Shareholder agreements play a critical role within companies as it ensures that the running of the company and the responsibilities that are given to the shareholders are well thought of. Further, through the agreements, it is clear and certain on what can be done and cannot be done and the decisions taken either through consensus and through discussion. Therefore, with proper application of the agreement, there is reduction in the potential conflict that is likely to arise between shareholders and ensure that the company runs smoothly and profitably.

Having the agreements in place is usually not a bother to most individuals especially when they are putting up a startup business. Often, it is advised that the shareholder agreement be put in place at the outset as further down the line views are likely to diverge, the current situations are likely to change and resentment are likely to be built between the shareholders hence leading to fractious disagreements in regards to the company needs. This paper seeks to identify the various characteristics and the unique features of a shareholders’ agreement in order to understand the benefits or the advantages of the shareholders’ agreements. While using the US as the case country, the paper expounds whether the shareholders’ agreements are enforceable.

The benefits of and advantages of shareholders’ agreements

A shareholders agreement refers to an agreement or a contract that is between the shareholders in a company. Through the document, stakeholders of a given company are differentiated and identified in the articles of association (Cadman, 2003). Those who support the shareholders’ agreement mainly do so to protect the investments of shareholders and define the quality of the relations that may exist between the shareholders and the company. Even though the shareholders are significant in life of any company and take part in different issues including financial discussions of the companies their duties remains to be unclear or even limited in most organizations. Therefore, as required through the shareholders agreement, there is need to have certain guarantees and clarifications regarding the role that shareholders can play in the company.

Advantages of Shareholders’ Agreement

Promotion of Transparency in Companies

By having the shareholders’ agreement in place, a company is putting across a message of transparency (Cadman, 2003). The company does not in any way have hidden intentions regarding the transactions with the shareholders and investors. Within the shareholders agreements, there are numerous things that are discussed and they include the power of votes and liabilities, which among others affect the individuals (Bebchuk, 2005). Even though most countries have shareholder’s agreement governed by principles of contract law, the document can be improved or still other amendments made to reflect the various corporate values and standards that exist within a company. The agreements will ensure that there is regulation of relationship between the shareholders and explain how the company will be managed. This means that shareholders’ agreement will offer an opportunity for all the shareholders to get the additional rights or even expand on the existing rights. It is necessary that every shareholder agreement be customized to suit a given situation of the company as well as that of the shareholders.

Regulator of Inflows in a Company

Upon properly developing shareholder’s agreement, it can then be used to help in regulation of all the inflows within the company. Further, it can also be used to help in regulation of the different financial decisions that can be made by different individuals who are in the company.

Privacy

One of the reasons for the use and application of the shareholders’ agreement is the privacy with which it brings. It is a private document between the parties that are involved and is often subject to direct restrictions in regards to confidentiality (Cadman, 2003). Nonetheless, the company’s constitution remains a public document that can be accessed by anybody who is a member of the public in the Companies Registration Office. Therefore, constitution in this light remains to be unsuitable way through which matters like internal management matters can be dealt with.

Greater Binding Effect

Often the constitution binds the shareholder in his or her individual capacity. Nonetheless, the shareholders’ agreements can be used to give the rights and impose obligations on shareholders like binding an individual in their capacity as a director or as a creditor or agent. At the end, one has to be keen and careful in imposing obligations on a party within his capacity as a director within the context of the duties that are owed by the director to the company.

Benefits to Minority Shareholders

Several benefits exist that accrue to the minority shareholders in regards to the shareholders’ agreements. Apart from the extra rights, which are rightly identified in the agreement, and the information that relates to the company, minority shareholders are likely to be the members of the board of directors over time or even introduce some issues regarding new share that can be held high by all the parties concerned. Also, through the help of tag along rights, the minority shareholders have the capacity to purchase the various shares that are sold by a different shareholder at some set prices for purchase without incurring extra costs or even need to have more requirements. The protection of the rights is also one of the significant advantages that remain.

Benefits to Majority Shareholders

Given that this is a group of shareholders with the most number of shares, it is undoubted that many benefits accrue to them. The agreement is flexible hence giving the shareholders a chance to meet new goals and the requirements of any party at a particular time. The other benefit is the drag along clause, which outlines the possibility for a majority shareholder to buy shares from various distinct shareholders and set very affordable prices to all parties within the agreement. Usually, the investors and all the concerned parties that are under the shareholder’s agreement, and those interested by the options that are given, can easily get the answers in this type of document and be provided with some sort of privacy, assurance of resolving disputes, and extensions of the period of agreement. Even though there is comprehensive information contained in the agreement, the information is never within the public domain as it remains just for the parties within the agreement.

Through the shareholders’ agreement, there is ease in regulation of company structure and the role of the employees among other aspects. Through the agreement, one can easily remove or appoint directors of the company who are seen not to meet the regulations and the set standards of the company as well as the restrictions that need to be considered when the company undergoes some given changes.

Are shareholders’ agreements enforceable?

Shareholders agreements are enforceable within the law as it sets the condition under which shareholders can work, relate with the company and be signed.

Often, just like any other covenant, there are set conditions under which the shareholders’ agreement can be signed. Through signing of the shareholder’s agreements, clarity is made concerning the relations that exist between shareholders and the company in which the shareholders invest. Having clear relation defined ensures that in case of any issue or misunderstanding then appropriate legal measures can be taken. Taking up appropriate legal measures is a pointer towards enforceability of the shareholders agreement.

Rights of First Refusal

Shareholders agreement is enforceable as it sets the right of first refusal. Through the right of first refusal, the holder is granted the right to purchase the shares of another shareholder in case the shareholder needs to sells his or her shares to a third party. This only means that the transferring shareholder is mandated to sell the shares to the holder of the right if the first refusal. Just in case the transferring shareholder breaches the obligation then it is obvious that the holder of the right of first refusal will most certainly be in a position not to demand certain specific performance. This is mainly informed by the fact that the shares at stake will have to be transferred most likely to a third party that will make certain performance almost unaccomplished within legal realms. Owing to this, the holder of the right of the first refusal will have nothing else but to claim for compensation from the transferring shareholder.

At times, the right of first refusal has always been confused with statutory pre-emptive purchase right. The difference is clear as the latter gives the current shareholders the right and the ability to buy the new issued shares in case there is an increase in the capital pro-rata of the shareholdings. In case the right is infringed and then the newly issued shares are transferred to some third parties, the shareholders are at liberty to demand the specific performance in a manner that the shares, which will be transferred to third parties, will be regarded as not admissible in a court of law.

Through the right of first refusal as contained in the shareholders agreements ensures that the company as well as the shareholders gets the chance to buy any shares that shareholders may be interested to sell. The right of first refusal (a “ROFS”) require that a shareholder and the buyer of the shares that he or she is willing to sell make an agreement on the terms and the prices that the shares are sold. On the other hand, the right of first offer, abbreviated as “ROFO” sets condition that the selling shareholder to first get offers from the other shareholders or even a corporation. In case the shareholder selling aims at getting higher offers from a third party or parties, the can opt to do so though the party cannot sell the shares to a third party at a price considered to be lower or even that are seen to be less favorable to the selling shareholder as compared to those that are offered by the other shareholders or corporations. Even though both can be enforced, the ROFO is usually preferred to the selling shareholder given that knowledge that the other shareholders or even the corporation will have.

In US, the rights of first refusal are enforceable and a case in point is the Delaware and New York courts that have held that both ROFRs and ROFOs can be enforced in instances when deemed reasonable (Visentini, 1997). The courts usually apply strict rules and principles when interpreting ROFRs and this lead to narrow interpretation to help ascertain the intent of the parties to some reasonable extent of certainty.

The Drag-along and Tag-along Rights

Usually, there are certain practical challenges and limitations when enforcing the drag-along and tag-along rights in specifics. Through the drag-along clauses, shareholders can drag along the reluctant shareholder in case there is an exit and a buyer who has the capacity wishes to get more than the stake of transferring the shareholder. Nonetheless, “tag-along” clauses are designed in a way to protect the minority shareholders in case the majority shareholder opts to remove himself or herself from the corporation. Through this, a clear framework exists through which the minority shareholders can be bought. The drag-along and tag-along rights dictate that the minority shareholders have the right to be brought out though on pro-rata basis along with the majority shareholder.

It is these exit rights that are known to include both drag-along and tag-along rights and they are regulated under the laws of US hence making the execution easy. If there is a dispute that exists between the shareholders, the courts will have to render a given performance decision, though it will give monetary compensation to remedy the drag-along or tag-along rights that are related to the breaches. Given the ease in enforcement, there is no need for the US courts to seek for alternatives unless it is considered necessary. Some of the alternatives can be delivery of the share certificates that have blank endorsement to help secure enforcement, as this is one of the alternatives that are used within some of the jurisdictions.

Call Options and Put Options

To be enforced, the shareholder agreement has call options and put options that dictate the terms for selling and acquiring the shares (Gillan & Starks, 2007). Through the call option, the shareholder can easily sell the shares while for the put option; the shareholder is guided on ways of acquiring the shares. The exercise of the call or put option is often dictated within a given tome or occurrence of a given event. Usually, most of the shareholders mainly want to have a call option right, while for the minority shareholders prefer to have a put option right to help in strengthening the various exist rights from the company.

This aspect of the shareholders agreement is enforceable in law courts in U.S. In case of breach of call option or put options, shareholders have a right to demand certain defined performance. The particular performance will be to ensure that there is transfer of shares by the breaching shareholder to the other shareholder that is exercising a call option. When enforcing, it is required that the shareholder exercising a call option has to declare the readiness to pay the total value of the shares that have to be transferred. In regards to the put option, the specific performance is the paying the value of the shares that have to be transferred. Usually, the shareholder that exercise the put option need to declare the readiness to ensure transfer of the shares. In theory, the courts in US are at liberty to offer certain performance decision unless it is granted that there is some form of legal impracticality.

Also the execution of a given performance decision on a call option is achievable as guided by the execution and bankruptcy law. The bankruptcy law regulates the execution of decisions that need to deliver the moveable assets. When this happens, the execution officer requires that the debtor deliver the various moveable assets that are under consideration to the required execution office within a defined period. In case there is a failure in the execution, office clerk takes over the moveable assets that are under query by force.

For the instances of joint stock Corporation where the shares are represented by share certificates, the given performance of a call option is realized through delivery of the share certificates (Enriques & Volpin, 2007). In case the breaching party does not opt to volunteer to deliver the share certificates, the execution office clerk has the powers and mandate to take them over forcefully. Specific performance of a put option is relatively easy given that involves the payment of the value of the shares (Bebchuk, 2005). Upon having a given specific performance decision, the execution office will send payment order to the breaching party and order payment and in case there is a failure the assets of the party can then be attached.

This paper has indeed proved that shareholders’ agreement remains to be an essential factor for US companies and shareholders just like other jurisdictions. The paper has set out the various rights and obligations that help in protecting the commercial interests. Indeed, it is through these rights and obligations that the shareholders’ agreements can be enforced (Cadman, 2003). Further, the paper has exploited the benefits of and advantages of the shareholders’ agreements. To prove the enforceability of shareholders’ agreement, the paper has covered some of the provisions that are contained in the shareholders’ agreements. Some of the elements covered include share transfer provisions, tag-along and drag-along rights, the share transfer provisions and preemptive rights among other provisions. Even though it is widely acknowledged that the freedom of contract is the legal principle that governs most of the provisions to some extent, several legal considerations exist that affect the enforceability of the shareholders’ agreement.