Starting a business requires careful planning and consideration. A failure to allow for unforeseen events or for ways to resolve future disagreements could put your new venture at considerable risk.
The repercussions of failing to plan are clearly illustrated in a case in the Federal Court between co-owners of the popular Grill’d fast food empire. What started out as friends in business has turned into an ugly litigious dispute.
One of the most effective ways of minimising costly business disputes between participants in a company is to seek professional advice early and to have a shareholders agreement prepared by an experienced commercial lawyer.
A shareholders agreement sets out the rights and obligations of each business owner and the processes for resolving disputes and deadlocks. The agreement puts all parties on the same page from the beginning of the relationship and facilitates cost-effective and efficient determination of disputes.
A shareholders agreement is integral to protecting the business and owners from unnecessary delays and losses resulting from a range of events.
What is A Shareholders Agreement?
A shareholders agreement is a private contract made between all shareholders of a company, setting out their respective rights, obligations and liabilities. The agreement need not comply with any set form or procedure, however should be carefully drafted to ensure its validity and enforceability and to cover a range of contingencies.
A shareholders agreement needs the consent of all shareholders and, unless otherwise specified, all existing shareholders must consent to any changes or alterations.
So Why Do I Need A Shareholder Agreement? The Grill’d Case
The case of Bainbridge Grill’d Pty Ltd & Ors v Simon Crowe & Ors before the Federal Court illustrates the potential pitfalls of not having a shareholders agreement in place.
The brainchild of friends Simon Crowe, Simon McNamara and Geoff Bainbridge, Grill’d opened its first restaurant in 2004. Since its founding, Grill’d has spread its wings to over 100 stores Australia-wide and its present value is estimated at $300 million.
In 2011 McNamara exited the business leaving Bainbridge holding 25 percent of the company shares and Crowe the remaining 75 percent.
For various reasons, the relationship between Bainbridge and Crowe became strained and deteriorated to the point that in June 2016 Bainbridge commenced proceedings under the Corporations Act 2001. Bainbridge claimed that he had been denied access to the company’s books and records and that Crowe had breached his director’s duties by using company staff and resources to fund KoKo Black, a chocolate company.
Bainbridge sought an oppression order and the removal of the company’s Chief Financial Officer and Director.
In his counter-claim, Crowe sought an order for the forced sale by Bainbridge of his shareholding on the basis that the relationship had soured to the extent that the continued involvement by both owners in the business would be futile. In his argument, Crowe challenged Bainbridge’s previous decision to invest in Pizza Religion, which he considered a rival of Grill’d.
The battle has been personal and fuelled with emotion between the owners. It has been before the Court several times for various interlocutory and directions hearings, no doubt resulting in considerable expense for both parties.
A central issue to the dispute is the value of the company which, when determined, will inevitably have a significant impact on the resolution of the matter.
The dispute is a bitter one, and until it is resolved, will continue to expend a significant amount of time, emotion and of course finances.
A newly-registered company must adopt a constitution which governs the relationship between the company, its directors and shareholders. The constitution is a contract between the company and each member; a member and other members; and the company officers.
A constitution sets out a company’s objectives, activities and internal administrative matters. Consequently, the rights and obligations formed under a constitution are not necessarily individual rights. The constitution is limited in terms of the personal rights of the shareholders and will generally fall short of protecting a shareholder’s interests in the event of a dispute between the parties.
A carefully prepared shareholders agreement will cover matters not addressed in the constitution and is integral for managing ongoing and future issues affecting shareholders.
What Should A Shareholders Agreement Include?
A shareholders agreement should meet the specific requirements of the company and its shareholders and may include matters of management, confidentiality, and employee contracts and consultancy agreements. The following are common inclusions:
Priority of Shareholder Agreement Over the Constitution
In the event of an inconsistency between the shareholders agreement and the constitution, the shareholders agreement should generally prevail.
Alternative Dispute Resolution
An agreement should include processes to resolve disputes requiring a genuine attempt by the parties to resolve matters or to engage in alternative dispute resolution before commencing formal litigation.
These provisions deal with circumstances where shareholders cannot agree on the management of the company and include:
- Shotgun Clause: Allowing a shareholder to break the deadlock by purchasing the shares of the other shareholder at a nominated price;
- Chairman Clause: Allowing one shareholder to become the chairman with a casting vote; or
- Liquidation Clause: Providing for the company to be voluntarily wound up if the deadlock continues for a set period of time.
These provisions impose restrictions on the transfer of shares. A provision can require exiting shareholders to offer their shareholding to existing shareholders first, before the shares are offered to outside parties.
Drag-Along, Tag-Along Rights
These provisions are aimed at balancing the rights of a majority shareholder and a minority shareholder. Under a drag along option, majority shareholders can require a minority shareholder to join in the sale of shares in the company. Under the tag along option, where a majority shareholder is selling shares in the company, the minority shareholder has the right to join the transaction and sell their minority stake.
Mandatory Sale Events
These provisions set out triggers for the mandatory sale of shares in certain circumstances (for example, a director passes away, resigns or files for personal bankruptcy).
Share Valuation Methods
Methods by which shares are to be valued in relation to pre-emptive rights and mandatory sale events. For example, shareholders agreements often provide for the appointment of an external valuer with set criteria for valuation.
Conflict of Interest and Non-Compete Clause
These provisions prevent the shareholders from investing in or engaging with competing businesses.
Whilst it will be interesting to hear the outcome of the Grill’d case, the matter reinforces some important points.
- The ideal time for a shareholders agreement to be prepared is when the company is first created and there is goodwill between the shareholders.
- It is easier to negotiate terms at the start of a business venture when the parties are amicable, rather than when they are frustrated by disagreements down the track.
- Shareholders agreements should be professionally prepared and tailored to the individual needs of the shareholders and the company as a whole.
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