Shareholders’ agreements form a key part of a company’s legal framework. It can prove particularly important when there are multiple owners involved with the setup of a business.
However, there are instances where one or more parties fail to meet the obligations set out in the agreement. This is known as a breach of a shareholders’ agreement, and it can quickly disrupt operations and strain relationships between shareholders.
Here, our Corporate & Commercial solicitors run through how breaches of shareholders’ agreement may occur and what your legal options are when such a situation happens. We’ll also explore how business owners can take preventative steps to decrease the chances of any breach.
Firstly, let’s start with the definition of a shareholders’ agreement.
What Is a Shareholders’ Agreement and When Are They Used?
A shareholders’ agreement is a legally binding contract that defines how a company is run. As well as outlining the rights and responsibilities of each shareholder, this agreement will dictate how key decisions are made and implemented.
Its importance lies in situations like business transfers or disputes, where there are multiple parties that may have competing interests. A shareholders’ agreement, in theory, should provide a set of rules and guidance that protects these parties from uncertainty and conflict.
Shareholders’ agreements, unlike other documentation like the Articles of Association, are not mandatory. Nor, like Joint Venture Agreements, do they typically govern the wider commercial purpose or structure of a specific project or collaboration between businesses.
Instead, they are privately negotiated and aligned solely with the needs of the shareholders involved.
To discover more about what a shareholders’ agreement covers and why it’s so important, check out our full shareholders’ agreement guide.
What Is a Breach of a Shareholders’ Agreement?
A breach of a shareholders’ agreement occurs when one or more of the parties that have signed the agreement violates its rules in some way. How this happens depends on how the agreement is structured, and what is in its content.
Some common examples of breaches include:
- Making strategic or operational decisions without following the agreed voting thresholds or approval process
- Transferring or disposing of shares in a way that bypasses agreed restrictions or pre-emption rights
- Disclosing or misusing confidential company information in breach of agreed confidentiality provisions
- Acting in competition with the company where restrictive covenants are in place
- Failing to comply with agreed procedures for resolving disputes or deadlock situations
As shareholder agreements are legally binding, a violation of any of the above elements could constitute a breach.
It’s important to remember, though, that in many cases breaches occur not through deliberate action (or inaction), but through simple misunderstandings or poor communication.
What Are the Consequences of a Shareholders’ Agreement Breach?
There are a number of potential consequences that may stem from a breach of a shareholders’ agreement. Just like how the causes of breach itself can vary, so can the type and level of ramifications.
In many cases, the non-breaching shareholders may be entitled to bring a claim for breach of contract, which could result in financial compensation where loss has been suffered. The court may also be asked to enforce the terms of the agreement directly, which requires the breaching party to comply with their obligations.
But that’s not all. Some other consequences may include:
- Loss of voting or control rights, if the agreement provides for suspension in the event of breach
- Forced transfer or sale of shares
- Injunctions or court orders
- Breakdown of shareholder relationships
- Expulsion or exit mechanisms being triggered
In the case of consequences like injunctions or court orders, these seek to prevent further actions that would worsen the breach, as well as pushing towards a resolution.
How is a Breach of a Shareholders’ Agreement Resolved?
There’s no definitive answer for how to respond to a breach of a shareholders’ agreement that can apply to all cases. But, there are a number of steps to take that ensure that all parties have the best chance of finding a solution.
Review the agreement
The first step in resolving a shareholders’ agreement breach is to thoroughly check and review the agreement that was signed. There may be elements within the agreement that relate to disputes or escalation steps, as well as potential remedies.
Taking this step first can provide a clear roadmap for how the issue should be addressed before any further action is taken.
Communication between parties
Beyond reviewing the existing agreement, the first step is open and direct communication between shareholders. As mentioned, some breaches arise from misunderstanding or misinterpretation of the agreement rather than intentional wrongdoing.
If this is the case, discussion can often clarify the issue and prevent any further escalation.
Negotiation
If informal discussion does not resolve the matter, negotiation may follow. This involves the parties attempting to reach a practical agreement.
This could be aimed at correcting the breach, agreeing future conduct, or putting temporary measures in place to stabilise the business while a longer-term solution is considered.
Mediation
Mediation, unlike negotiation, involves an independent third party who helps to facilitate discussions and encourages both sides to reach a mutually acceptable resolution. Mediation is often used to avoid the cost and ultimate disruption that comes hand-in-hand with formal legal proceedings.
Expert solicitors like Talbots Law’s mediation specialists can aid you in pursuing this step, and help you find the resolution you are seeking.
Court Enforcement
If the informal approaches fail to find resolve, legal action is a potential next step. Courts can be asked to enforce the terms of the shareholders’ agreement and require a part to comply with its obligations.
However, it’s worth noting that generally speaking, courts are cautious about becoming involved in ongoing business management and will usually only intervene where necessary.
Damages
Some breaches of a shareholders’ agreement may result in financial loss. In these cases, the innocent party may seek compensation through a claim for damages.
This usually means that the affected party will seek a compensatory amount that returns them to the point they were at had the breach not occurred. Of course, there will need to be sufficient evidence here of the quantity that was lost.
Buy Outs or Exit Mechanisms
Sometimes, continuing the business relationship as before is simply not possible. It’s here that shareholders’ agreements make room for buy-outs or other exit routes for one or more of the parties involved.
This will often be largely focused on which shares will be transferred or purchased, and who will take ownership of assets.
As with all possible resolutions to a violation of the shareholders’ agreement, the primary motive of this is to reduce the amount of disruption to ongoing business operations.
When Could a Shareholders’ Agreement be Terminated?
In the initial creation of a shareholders’ agreement, it is often made clear how and why the agreement could be terminated. Beyond this, it may state what provisions are in place for elements like the transfer of shares.
Where it is deemed necessary, there may be clauses and covenants added that will stipulate that a former shareholder of a business cannot set up a competing business within a certain period of time.
How to Prevent a Breach of a Shareholders’ Agreement?
The best way to avoid the potential consequences of a breach of a shareholders’ agreement is to try and prevent them at source.
One of the best ways to achieve this is by regularly checking and reviewing the agreement to ensure all the information is accurate and up-to-date. Ensuring this will mean there are less grounds for disputes.
In the process of doing this, it’s best practice to maintain strong communication with all relevant parties. This is a great opportunity not just to prevent future conflict but also to remind them of what their duties are to the company.
Get in Touch With Our Shareholders’ Agreement Solicitors
No two businesses operate in the same way, and neither do shareholders’ agreements. At Talbots Law, our shareholders’ agreement solicitors work with you to build an agreement that reflects how your business runs today and where you want it to go in the future.
We’re proud to be a Lexcel-accredited, employee-owned firm, meaning our focus is always on delivering the best outcomes for our clients. With hundreds of 5 star rated reviews on Trustpilot, businesses trust our team for practical support when drafting, reviewing, or negotiating shareholders’ agreements.
If you’d like tailored advice, speak to our Commercial Team on 0800 118 1500, fill out an enquiry form below or get in touch online to arrange a consultation. We’ll help you put the right foundations in place to support your business as it grows.
Disclaimer
The contents of this blog or any other published by Talbots Law cannot be considered as legal advice. You should take no action without prior consultation with a qualified solicitor or legal professional. The contents of this blog refers to the process in England and Wales.
This blog was written by Mike Linford, Head of our Corporate Law Team.