What is the difference between a Shareholder and Security Holder Agreement?

There is no difference – Shareholders Agreements are often referred to as Security Holders Agreements (SHA).

They are both one and the same and are written agreements that set out the obligations, responsibilities and rights that a shareholder and a director have to each other and to the Company itself.

The purpose of the SHA is to supplement the company constitution and ensure the efficient, legal and smooth running of the company and how the parties to the SHA deal with each other and most importantly in a transparent manner.

A correctly drafted SHA will ensure that when issues arise, they ae addressed in a proper manner and above all in accordance with the wishes of the parties to the SHA and in the best interests of the company.

A correctly drafted SHA must at a minimum cover the following:

• management and operation of the company
• objects of the company and its purpose
• election and removal of directors
• distribution of profits and the incurring of expenses and liabilities
• transfer and issuing of shares
• dealing with any disputes
• frequency of meetings of the board and shareholders
• decision making and the distinction between that of directors and shareholders
• how to value shares and the process where a shareholder want to exit
• issuing surrounding the death or permanent disability of a shareholder
• warranties of shareholders
• obligations of confidentiality and non-compete provisions

Key Terms in a Shareholders Agreement

Firstly, you will need to understand that a shareholder can be a person, company, or institution that owns at least one share of a company’s stock whereas a director is a natural person who is responsible for managing the company’s business and may exercise all of the company’s powers.

There are many terms that you would be familiar with in a SHA and some not so readily recognisable, so it is worthwhile looking at the key terms in any SHA.

Board

A board is the governing body of a company, whose members are elected by shareholders to set the strategic direction of the company, oversee the management, and protect the interests of shareholders.

Board Meetings

A Board Meeting is a formal meeting of the board of directors of the company held at definite intervals and as required to review the performance, consider policy issues, address major issues and perform the legal business of the board.

Covenants

Often described as restrictive covenants are incorporated into a SHA to prevent the relevant party from acting in a way that might cause damage to the company and the business.

Deadlock resolution clauses

It is always worth remembering no party goes into a SHA with looking for a disagreement resulting in a deadlock and then a dispute.

Therefore, it is important the SHA has dispute resolution mechanisms which allow any deadlock to be resolved so the business does not suffer and/or  the company becomes crippled.

The SHA must define what constitutes a deadlock and the process to follow if this occurs.

In the end a deadlock clauses tend have the result that if it can’t be resolved one party may have to sell their shares to the others so that control changes and the remaining shareholders can pass a vote about the issue the subject of the deadlock.

Directors and their types

• Executive Director: A director who is also an employee of the company and responsible for the day to day management.
• Independent Director: A non-executive director who is not a member of management and free from any business or other relationship that could the independent exercise of their judgment.
• Managing Director: An executive director who sits on the Board, but also has the ultimate authority to manage the organisation on a day-to-day basis.
• Non-Executive Director: Any director who is not an executive (or employee) of the company.
• Representative / Nominee Director: Usually a director appointed by a shareholder usually with a in significant percentage shareholding specified under the SHA to represent their interests on the Board.

Dividends

A dividend is a distribution of profits by a company to its shareholders usual from profits or surplus with any amount not distributed is taken to be re-invested in the business.

Good and bad leavers

These clauses dictate the basis on how a shareholder who wishes to leave the company will do so.

A good leaver clause refers to a shareholder and often one how is an employee leaves in reasonable circumstances or due to circumstances outside their control.

On the other hand, a bad leaver refer to when they leave as a result of misconduct or actions that are contrary to the SHA such as a breach of their contract of employment, gross misconduct or within a certain period defined in the SHA.

Good leavers can but do not need to be mandatory whereas a bad leaver obliges them to sell their shares on exit to the other shareholders and will receive a reduced or nominal value of the shares.

Non-compete clauses

These clause outline in what way and manner a shareholder may carry out activities which may compete or rival their obligations to the company.

The benefit of these clause it that is eliminates any ambiguity and defined the cope of any restrictions.

Whilst these clauses aim to keep company information confidential and reduce competition  the courts require them to be reasonable and unnecessarily broad.

It is imperative advice is sought on the reasonableness of any of these clauses.

Non-disparagement

A non-disparagement clause simply states that you won’t say anything negative about the company or its products, services, or leaders – in any form of communication.

Non-solicitation

A non-solicitation clause is a provision in a SHA prevents employees from ‘soliciting’ or ‘enticing away’ the customers, workers or suppliers of the company for a specified period of time after their employment or tenure ends.

Ordinary resolution

Ordinary resolutions are not specifically defined in the Corporations Act 2001 and need only a simple majority which is normally, more than 50% of votes cast in favour to pass.

Pre-emptive rights and the right of first refusal

This protects shareholders from having their shares in the company being diluted.

The pre-emption right provides that the company must first offer to any existing shareholders any issue of new shares or the first refusal over the sale of existing shares.

Generally, in the case of the issue of new shares they will be offered in the same proportion to the existing shareholding before offered to any prospective new shareholders.

For an existing shareholder when selling their shares, the pre-emption right gives the right of first refusal to the remaining shareholders in their proportionate shareholdings.

Quorum

This is the minimum number of directors or shareholders that must be present at any of its meetings to make the proceedings of that meeting valid.

Reserved matters

Reserved matters are the actions that the company, its directors and shareholders must not do without the explicit approval by at least a certain proportion of specific either the directors or shareholders. The decision is ‘reserved’ for certain people.

They are generally matters that are exceptional rather than the normal day to day matters that don’t require a quick decision.

Resolution

A resolution is a formal way in which a company can note decisions that are made at a meeting of company members. There are two types of resolutions: ordinary and special.

Shares (Securities)

Shares are units of stocks issued by a company that represent ownership.

The most common types of shares are ‘ordinary shares’ and ‘preference shares’ and the rights attaching to them will be set out firstly in the constitution and when there is an SHA in that document.

The SHA will usually specify the specific rights that attach to each class of shares, such as:

• Voting rights: Outlines what particular issues a certain type of shareholder can or can’t vote on
• Dividend rights: Outlines whether a shareholder has rights to a dividend or in what circumstances are entitled to be paid first.
• Liquidation preferences: Where certain classes of shareholders have preference to others when the company goes into liquidation.
• Special rights: Rights for certain classes of shares in preference to others regarding specific issues

Special Resolution

The Corporations Act 2001 requires 75% of the votes cast by shareholders to pass certain resolution. A SHA often requires a special resolution of directors to approve critical business decisions. There is no set rule on what percentage of the directors is necessary to approve a special resolution of directors in a SHA, but it is typically 75%.

Tag along and drag long rights

A tag along right gives a minority shareholder to have their shares purchased at the same price and on the same terms as any majority shareholder who wishes to sell their shares to a third party.

This avoids the circumstance where a majority shareholder who sells their share could leave the minority shareholder with new shareholders who they do not know or do not want to be in business with.

On the other hand, drag along rights require the minority shareholders to sell their shares at the same price and on the same terms as a majority shareholder sells to a third party.

The minority shareholders are compelled to sell and can’t refuse.

Voting

Voting is when a formal expression of opinion or choice made by an individual, body of individuals or body corporate is made and will depend on the class of shares held.

How can FC Lawyers help?

At FC Lawyers we have assisted shareholders and directors with SHA’s in a range of industries and professions and our business and commercial team has over 100 years’ experience assisting clients.

Contact us to for an obligation free discussion to assess your needs and questions.