5 Common Clauses required in your Shareholder Agreement
by Jason Yong Kok Yew ~ 12 September 2019
Starting a new company with one or more business partners may seem like a rose-tinted glasses affair, but prudent shareholders may want to consider entering into a shareholder agreement (“SHA”).
This is especially so if you are a minority shareholder in the Company. Although the Companies Act, 2016 does provide some form of protection for shareholders (e.g. derivative actions or minority oppression), these may result in protracted and expensive litigation for all parties involved.
When shareholders have entered into an SHA, the Courts will generally give priority to it as the SHA indicates finality in the parties’ intentions as to the nature of their relationship. Without one, it may be more difficult to find a legal basis for a claim, as the Memorandum and Articles of Association (which is now called the Constitution) of the Company may provide insufficient protection.
Here are 5 common clauses in SHAs which may be helpful to protect your rights as a minority shareholder:
1. Shareholders’ Obligations
This is often where parties set out the general niceties of being business partners. For instance, you might see a clause which says “Shareholders are to act in the best interest of the Company”.
However, if each shareholder is bringing something different to the table, this clause can help spell out the specific obligations of each shareholder – e.g. Tony has an obligation to invest RM1,000,000.00 into the Company; Nick has the know-how and the network to obtain the necessary licenses from the relevant local governmental and regulatory authorities; and Steve has decades of management expertise to oversee and implement the various projects of the Company.
2. Reserved Matters
‘Reserved Matters’ are a set number of matters on which the Company will need unanimous voting on to decide. This clause would be especially important to minority shareholders, as it places safeguards against the rights of the majority shareholders (who will most likely be able to outvote everyone else at meetings of the Company). Common examples of Reserved Matters would include a change in the Company’s business, an increase in the Company’s share capital (which would dilute everyone’s shareholding), exercise of borrowing powers (for instance taking on a huge loan from a bank), or creation of encumbrances (e.g. registering a charge on the Company’s assets).
Companies commonly have an uneven number of directors to prevent any deadlock situations. It’s also conventional for a majority shareholder to appoint more directors than a minority shareholder, as they would want to retain control of the Company on an executive level.
Nevertheless, minority shareholders should also insist on the right to appoint at least 1 director of the Company – even though you may not have control of the Company at an executive level, your representative on the Board of Directors would enable you to easily monitor the operations of the Company and safeguard your rights as the minority shareholder.
4. Transfer of Shares
A prudent shareholder would need to make sure that provisions are made in the event another shareholder wants to exit the Company. In lieu of provisions to be contrary, you may find yourself in business with a competitor who bought over your business partner’s shares! If this is important to the parties, it’s possible to set this out explicitly in the shareholders’ agreement.
Another important provision is the purchase price of the exiting shareholders’ shares. Unless the exiting shareholder is willing to part with the shares at the price they initially invested for them (not feasible in many situations), it may be necessary to have some sort of valuation mechanism. However, do keep in mind that valuing a company may not be cost-efficient. Prominent auditing firms in Kuala Lumpur can quote up to six figures, even if the company they are valuing aren’t worth that much!
There are also specialized clauses like rights of first offer, rights of first refusal, drag-along rights, and tag-along rights. However, these may not be necessary (and in fact, they may be rather cumbersome) especially for SMEs.
5. Dispute Resolution
A dispute resolution clause may give shareholders an option to decide how to resolve disputes amongst themselves. For instance, the shareholders’ agreement may contain an arbitration clause, which means that any disputes have to be resolved via arbitration instead of via litigation in the Courts.
However, it should be noted that as a minority shareholder, you should never agree to an arbitration clause unless you fully understand the implications of the same!
Shareholder agreements are both commonplace and may very well serve to safeguard the interests of all shareholders involved, especially minority shareholders. Even if a Company did not start off with a shareholder agreement in place, there is nothing preventing the shareholders from entering into one subsequently. Although it is technically possible to draft your own shareholder agreement (especially if you know specifically what you want from it), we would highly recommend consulting a lawyer or a legal adviser to advise you on the potential ramifications of what goes into a shareholder agreement.