Shareholder Agreement Clauses And Company Insolvency
This guide focuses on why a shareholder agreement is relevant in the event of insolvency and the roles it plays to safeguard the interest of shareholders.
But first – what is a shareholder agreement exactly?
A shareholders agreement is a document which outlines their status and rights in a company.
It has a significant function of formulating the framework structures by defining the shareholders’ responsibilities of a company, its processes of decision making and control of disputes.
A shareholder agreement is a private contract, not compulsory but highly recommended. It is not the same as the memorandum – or articles of association, both required when registering a company.
What are the purposes of a shareholder agreement?
The specific contents of a shareholder agreement can vary significantly by company. A shareholders agreement can regulate key aspects such as:
- Share ownership rules
- Shareholders’ protection of rights
- Management and running of the company
For example, a shares section should cover any restrictions on the ability to sell or transfer shareholdings, who may own the shares and/or be a shareholder in the company.
The agreement should contain several provisions to outline the management of company affairs as well as the handling of conflicts or important situations. It can serve as a contractual solution to issues and problems in a way that articles of association cannot.
The best shareholder agreements anticipate disagreements and specify how to address them.
As another example, in a previous article we’ve covered how to resign as a company director. In some cases, on resignation, a director is obliged to sell their shares in the company – but it depends on the shareholders agreement.
Shareholder agreements and insolvency
To mitigate the risk of insolvency – or other adverse situations – there should be certain provisions in the shareholder agreement.
Such provisions are useful in case the company and/or shareholders face financial problems or available funds are not enough to further the company’s development. The agreement may contain procedures to follow in the event of insolvency.
For instance, if the business becomes insolvent, directors need to avoid any risk of wrongful trading. Under the Insolvency Act 1986, a business cannot continue to trade while insolvent as creditors’ interests must come first.
Having a well-written shareholder agreement in place, clarifying what to do in the event of insolvency, can help prevent this scenario. For example, some shareholders may not be fully aware of changes to normal company director duties in insolvency.
In the event of insolvency
One potential option for an insolvent company is a Company Voluntary Arrangement (CVA). It would allow the business, via an insolvency practitioner, to continue trading while paying back creditor debts.
- In this scenario, creditors and shareholders need to consider the proposal.
- At a creditor meeting, which creditors and shareholders need at least 14 days’ clear notice of, they will vote on whether to approve the CVA with at least 75% of voting creditors needing to agree.
However, if the business will not be able to pay back its debts, an alternative solution is required. In this case, shareholders will need to consider closing the limited company.
- To close an insolvent limited company with debts, they need to arrange a Creditors’ Voluntary Liquidation (CVL).
- Again, a resolution must pass and if 75% of shareholders – by value of shares – agree to wind up the company, it goes into the liquidation process with immediate effect.
Shareholder rights are an important aspect to address with the agreement during insolvency proceedings.
The agreement should protect shareholders’ rights by detailing how their shares will be managed and how their interests will be safeguarded. This includes ensuring that shareholders are treated fairly and that their rights are upheld throughout the insolvency process.
When a company goes into liquidation, there is an order of preference for who gets their investment back first.
The first priority is to repay all secured unsecured and preferential creditors – then after that, shareholders if funds still remain. In insolvency, preference share owners have priority over holders of ordinary stock.
Final thoughts: Company insolvency and the shareholder agreement
A shareholders agreement is a vital tool for managing a company, especially when facing the possibility of insolvency. It defines the roles, responsibilities, and rights of shareholders, providing a clear framework for managing the company and addressing financial difficulties.
Ensuring that the agreement is comprehensive, up-to-date, and regularly reviewed helps protect the interests of all parties involved and supports effective management during challenging times.
Understanding and implementing a shareholder agreement effectively can make a significant difference in how a company handles financial distress, ultimately contributing to its stability and resilience.
To find out more about the implications for businesses around insolvency, take a look at the other articles on the Hudson Weir blog. Recently we covered what inside IR35 means and the implications of illegal dividends in insolvency.
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