Gardner Leader

Greg Humphreys, a partner in the Commercial Team at Newbury Solicitors Gardner Leader, is keen to ensure that his clients carefully consider the benefits of a shareholders’ agreement, before its absence causes them significant additional headaches (and wasted costs).

A recent case which he was involved in illustrates the benefits of having a shareholders’ agreement in place. 

The matter concerned the acquisition of a local business by a limited company.  The limited company was funded by subscriptions for shares by two shareholders. One of the shareholders, the investor, also funded the company with loans.  The shares in the company were owned equally by the investor and the other party involved, who we’ll call ‘the Delinquent.’  The investor did not intend to become involved in the detailed running of the business and the Delinquent was appointed as the sole director.  The parties did not enter into a shareholders' agreement in relation to the business of the company. 

The Delinquent then used the business to fund his own lifestyle and other businesses in which he was involved.  No detailed arrangements were agreed that required the Delinquent to report on a regular basis to the investor in respect of the state of the business, and there were no limits placed on the authority of the Delinquent to bind the Company.  The inevitable result was that the company could not cope with the drain on its resources and insolvency proceedings were commenced. 

So, what lessons can be learnt from this example?  Notwithstanding that duties of directors have now been codified in the Companies Act 2006, the fact is that a suitably drafted shareholders' agreement may have given the investor early warning of problems and substantially greater controls and rights.  Possible solutions, which could be incorporated in a shareholders' agreement, include: 

·    placing limits on the authority of the director to bind the company.

·    introducing regular reporting to the shareholders.

·    granting the investor a veto in respect of certain decisions of the company.

·    providing for the forced sale of shares in the event of a breach of the shareholders’ agreement.

·    granting the investor the option to acquire the other party’s shares for a price to be determined in accordance with a pre-agreed valuation mechanism.  

The investor did not have any of these additional protections and , as such, the Delinquent's actions remained undetected for far longer than would otherwise have been the case. Furthermore, it was more difficult to deal with the Delinquent and extricate him from the business once his wrongdoing had been discovered.  It may be the Delinquent would have succeeded in his wrongdoing in any event, but the fewer the controls that were imposed on him, the more likely he was to be successful.

It is difficult for parties to consider the worse case scenario when they are starting a new business. However, much like Wills and partnership agreements, it is necessary to do so to ensure that there is not significant time and money wasted should the venture not proceed exactly as planned.  A shareholders' agreement should therefore be considered at an early stage.