Unless shareholders in a company agree otherwise (in either a shareholders agreement or the company’s articles of association) they can transfer the shares they hold to anyone they like whenever they want to.

Whilst this may be acceptable, and indeed a requirement, for companies listed on a stock exchange, it is generally not suitable for private companies that do not have a large number of shareholders. Investors in private companies usually invest on the basis they know and trust the other shareholders. If the other shareholders are free to sell the shares to anyone they like, then the whole basis on which the shareholder invests is undermined. The shares might end up being transferred to a competitor or to a person the existing shareholders simply cannot work with.

Although the law states that any new ordinary shares issued for cash by the company are subject to a pre-emption in favour of existing ordinary shareholders (i.e. the new shares must be offered to existing shareholders first in proportion to their existing shareholdings), this does not apply on the transfer or sale of shares.

A shareholders agreement made between the shareholders of a company can include provisions requiring a shareholder who wishes to sell or transfer his/her shares to offer them to existing shareholders first. An alternative approach is draft Articles of Association to include appropriate transfer restrictions.

It is common for a shareholders agreement to dictate that any shareholder wanting to transfer shares must first offer them to the company itself. This will enable the company to buy back the shares if it is legally able to do so. This avoids the need for the remaining shareholders to find the funds to buy the shares if the company has the cash to buy them. Any shares purchased by the company are usually cancelled.

If the company is unable to buy the shares, then a shareholders agreement can be drafted so that the remaining shareholders have a right of first refusal to purchase them (usually pro rata to their existing shareholdings). In this way the shares can remain within the ownership of the remaining shareholders.

Although the seller is usually free to set a price for the shares, it is common for there to be a mechanism for the company or other shareholders to call for an independent valuation of the company and for the sale price to be based on that valuation if it is less than the price demanded by the seller. The seller would usually be able to withdraw from the sale if he didn’t agree with the valuation.

In the event that the company and the remaining shareholders are unable or unwilling to purchase the shares, the seller may be able to sell them to an outsider (ie someone who is not currently a shareholder of the company). Often it is a condition of any sale to an outsider that the price paid is no less than the price at which the shares were offered to the company and/or existing shareholders.

If the company’s plans envisage a time commitment from shareholders, it would also not be unusual for a shareholders agreement to block any sale by (‘lock-in’) the shareholders for that period of time.

There can be exceptions to these rules in the shareholders agreement so that shareholders are free to transfer shares to (say) family members without being required to offer them to the company or existing shareholders first.

There are also situations where it may be sensible to automatically trigger an offer of a shareholder’s shares. For example where a shareholder becomes dies, ceases to work for the company, disappears, is declared bankrupt, or becomes mentally ill. This is not an absolute requirement for every shareholders agreement, the shareholders should think about what they would want to happen in each of these circumstances.

Finally it is worth considering that if an outside purchaser for a company is found in the future, that purchaser is likely to want to buy all of the shares rather than just a majority.

The shareholders should consider to what extent a minority shareholder (perhaps with only 5 or 10% of the shares) should be able to block that sale. Should the majority be able to force that minority to sell (often called ‘drag along’ rights)?

In the opposite situation where a buyer is found for a majority of the shares and a minority shareholder doesn’t want to be left behind, the shareholders agreement can force the majority to ensure the buyer buys the minority’s shares as well (‘tag along’ rights).

In summary, it can be seen that one of the most important areas for shareholders in a private company to consider are the restrictions that should be imposed on shareholders wanting to transfer shares. A well drafted shareholders agreement can protect shareholders from ending up in business with shareholders they never envisaged having to deal with.

Author Bio: James Quinn wrote the Article ‘Shareholders Agreement: Restrictions on Share Transfers’ and recommends you Google ‘Legal Clarity’ for more information on Shareholders Agreements.

Category: Legal
Keywords: law, shareholders agreement, legal, business, corporation, shareholders