A company is the most common form of joint venture to carry on an ongoing business. Corporate entities exist in most countries. A corporate structure generally offers advantages such as: identity; limited liability; more opportunities for financing; continuity in the event of transfers; flexibility of share rights; established laws. Against that, there will be certain additional publicity, formality and compliance requirements.
The most common form will be a company limited by shares (usually a private company, or its equivalent in the relevant jurisdiction, unless a subsequent public offering of shares is contemplated).
Shareholders’ disputes are one of the most common causes of business failures. Shareholders' Agreement is the best way to avoid disputes and offer legal protection for shareholders. It is concluded between the shareholders of the company to (i) define their respective rights and responsibilities, and (ii) organise the management of the said company. It allows shareholders to incorporate express contractual provisions addressing key management issues above and beyond those afforded by statute and corporate law but is not intended to govern the day-to-day operations of a business.
The following table is a quick reference guide to the documents available on DocPro:
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Documents |
When to Use |
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Shareholders Agreement - Equal Shareholdings |
A Shareholders' Agreement suitable for the set up of a relatively simple joint venture - a company with equal shareholding. This agreement is drafted for 2-5 parties and can be in Neutral, Strict or Loose Form. |
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Shareholders Agreement - Unequal Shareholdings |
A Shareholders' Agreement to be entered into upon completion or establishment of the Joint Venture Company with standard clauses for minority protection. This agreement is drafted for 2-5 parties and can be in Neutral Form, or in favour of the Majority / Minority Shareholder. |
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Parental Guarantee to other parties in relation to Shareholders Agreement |
In relation to a Joint Venture / Shareholders Agreement, a guarantee is given by a party's parent to the other shareholders for the party's obligations. |
A well drafted Shareholders Agreement should allow the minority shareholder to:
A minority shareholder will often seek a right to appoint a director to the board of the Company. This should ensure that, although the board may not be involved in day-to-day operations, the minority shareholder is kept fully informed about the Company's business through its appointed director and that it has a voice at board discussions. In the case of a multi-party joint venture, the formula may be that a number of minority shareholders (perhaps aggregating not less than a certain percent of the voting share capital) should, collectively, be entitled to appoint a director. A minority shareholder should consider whether certain additional protections are appropriate in order to ensure that its right to participate in management is not circumvented:
In practice, much will continue to depend in practice on the spirit of the joint venture relationship to ensure appropriate participation by a minority shareholder.
A minority shareholder may wish to have a right of veto over certain major decisions by the Company, such as:
It is necessary to decide whether these matters should be entrenched at the board or shareholder level. Should the unanimous approval or super-majority vote be required of the directors or of the shareholders of the Company? It may be appropriate that decisions on these major matters should be reserved to the parties at the shareholder level with more operational matters being left to the board level. In smaller ventures, decisions at board level will often amount to the same thing and be sufficient. It may not be appropriate for each minority shareholder to have a separate right of veto. In joint ventures where there are a number of joint venture parties, for certain matters to require the approval of a "super majority" of the shareholders (normally 75% to 90% rather than unanimity).
A minority shareholder will wish to ensure that its equity stake in the Company will not be diluted by alterations to the share capital of the Company, including:
Some of the common protections against dilution are:
An alternate protection is to preserve a minority shareholder's equity stake is for it to retain an option to ensure - possibly for a specified period - that it can buy back its full equity stake by subsequently acquiring from the majority shareholder sufficient shares, at current full market or fair value, to take it back to an agreed percentage level.
The board of directors of the Company will declare dividends, and the amount of each dividend distribution. A minority shareholder may wish to ensure that an agreed distribution policy is established at the outset - and, in some ventures, to ensure that profits cannot be diverted in a discriminatory manner to the majority shareholder:
Another approach is to require that the dividend policy should be dealt with in the annual business plan if the minority shareholder has rights of approval over the annual adoption of that plan.
A minority shareholder's rights to information regarding the Company's affairs is limited under Common law. Apart from the right to receive the annual audited accounts, a shareholder has no statutory right to inspect the accounting records of the company nor, as a shareholder, a right to inspect the minutes of board meetings. A minority shareholder should consider seeking the following:
A minority shareholder can find itself locked in the Company without any effective exit route. The following are possible protective provisions to enable an exit for a minority shareholder:
The structure of the Company may lead, and indeed be designed to lead, to the ability of the majority shareholder to exercise rights which assist its own tax planning. Examples could include arrangements (between the Company and its shareholders concerning use of group relief or consortium relief. In most cases, the co-operation of the Company itself will be required before any of these rights can be exercised. The minority shareholder should ensure that these rights cannot be exercised to the prejudice of the Company (and indirectly the minority shareholder) and that provision is made for proper payment to the Company by the majority shareholder for any benefit obtained by it.
If the minority shareholder considers that the majority shareholder or any of its directors is in breach of any obligation to the Company (including, for example, breach of other ancillary contracts or breach of warranty under any asset transfer agreement at the time of forming the Company), the minority shareholder needs to ensure that the Company's right of claim cannot simply be blocked by the majority. Common solutions are:
Other possible protections which a minority shareholder may seek in any particular case include undertakings that the majority shareholder will ensure that:
Once the protections for the minority shareholder have been agreed, the next question is whether they should be set out in the Joint Venture Agreement or in the Company's Articles of Association or both. This issue will depend on a mixture of practice, drafting style, practitioner preference and legal considerations. There following are some of the implications from case law, Russell v Northern Bank Development Corporation Limited [1992] 1 WLR 588 (HL):
(a) If the Company is a party to a shareholders' agreement which contains terms which fetter the Company's exercise of its statutory powers (e.g. a term requiring more than a special resolution to change the company's name or alter its articles of association), these terms will be void as against the Company but enforceable as a voting agreement between the other parties if the terms which restrict the Company can be severed. If the terms cannot be severed then the provisions may be ineffective, even between the shareholders.
(b) In relation to a shareholders' agreement, provisions which would otherwise "offend" could be included if the Company is not a party to the agreement (or, at least, not a party to the "offending" provisions).
(c) Provisions in the articles relating to the same matters (e.g. any attempt to require a super-majority for a shareholders' resolution on a particular matter, being a majority higher than that required under statutory corporate law for that resolution) can no longer be regarded as enforceable against the Company or valid if contained in the articles of association. The preferred legal course is that minority veto rights should be established either (i) in the articles of association on the basis that they are established as class rights or (ii) by including them in the shareholders' agreement (taking account of the effect of the Russell decision).
(d) Rights normally attaching to shares (such as rights to appoint directors, dividend and voting rights) should be in the articles of association.
(e) Positive obligations on a majority shareholder (e.g. undertakings by the majority shareholder to provide information or access rights to the minority) usually appear solely in the shareholders' agreement.
(f) Whether minority veto rights should appear in the articles and be established as "class rights" or be dealt with solely in the shareholders' agreement (taking account of the Russell decision) is debated between practitioners. There is a balance of considerations. Minority veto rights will usually take the form of an undertaking by the other party(ies) to use all respective votes and powers (including to procure that its appointed directors exercise their respective rights and powers) to ensure that the requisite action does not take place without the relevant minority shareholder's consent. Where the party giving the undertaking does not have a majority shareholding, the undertaking will usually be given only "so far as it is able" or on a "best endeavours" basis. Therefore, in the case of a multi-party joint venture where no single shareholder has a majority position, there is a stronger argument that veto rights should be established as class rights in the articles.
Fulham Football Club [2011] EWCA Civ 855 (CA)
The question of whether shareholders can, by contract, restrict their statutory rights to petition for unfair prejudice has been a matter of controversy. The difficult question is: how far would an agreement to arbitrate restrict a member’s statutory right to seek relief for unfair prejudice? The Court of Appeal decision in Fulham Football Club (1987) Ltd v Richards [2011] EWCA Civ 855 (CA) sheds some light on the subject.
The Football Association took a non-voting share and the 20 football clubs one share each in a company formed at the instigation of Premier League (consisting of 20 football clubs). Its business was managed by Sir David. The 20 football clubs were bound by the rules of the company as well as the Football Association, which contained widely drawn arbitration clauses.
The dispute arose out of a battle between Fulham Football Club Ltd and Tottenham Football Club Ltd for securing the transfer of striker Peter Crouch. Fulham Football petitioned for unfair prejudice, complaining that the chairman Sir David, had acted unfairly in facilitating a player’s move to Tottenham, in preference to a bid put forward by Fulham. It sought an injunction restraining Sir David from participating in future player transfer negotiations, or an order removing him as the director.
The Court of Appeal upheld the shareholders’ agreement to arbitrate, and stayed the unfair prejudice petition.
Patter LJ held, first, that the statute did not exclude unfair prejudice disputes from arbitration. More important is his conclusion that, the dispute relating to alleged breaches of the company’s articles or a shareholders’ agreement was generally arbitrable (at [77]). This is because it was an essentially contractual (internal) dispute which did not ‘engage third party rights’ (at [41]), or affect ‘public interest’ (at [50]).
Longmore LJ agreed, adding that there was no public policy reason to strike down an arbitration agreement in relation to disputes about ‘the internal management of a company’ (at [98], [99]). Here, Fulham did not seek a winding up order. The agreement would not affect the interests of third parties or the general public. On this view, the Court of Appeal concluded that the agreement was valid.
Can a shareholders’ agreement remove or restrict the statutory right to petition for a winding up?
Fulham Football Club (1987) Ltd v Richards [2011] EWCA Civ 855 (CA) gives some comfort for the view that shareholders’ agreements to arbitrate corporate disputes are generally enforceable so long as they do not affect third parties or go against public policy. What about an agreement not to petition for winding up? In Fulham Football, Patten LJ had opined, obiter, that the same principle would probably apply (at [86]). The arbitration agreement would, in his Lordship’s view, operate as ‘an agreement not to present a winding-up petition unless and until the underlying dispute had been determined in the arbitration’ (at [86]).
This dictum was endorsed by the Hong Kong court in Re Quiksilver Glorious Sun Licensing Limited [2014] 2 HKLRD 759. Quiksilver (a subsidiary of a US listed company) and Glorious Sun (a Hong Kong listed company) were two equal shareholders in two joint venture companies. They entered into a joint venture agreement providing for arbitration of ‘any controversy arising under or relating to this Agreement’ (Cl. 14.4). The joint venture was not developing. Quiksilver offered to buy Glorious’s shares, or sell its shares to Glorious Sun to which Glorious agreed but the parties could not agree on the terms. Arbitration had been underway in California. When Quiksilver sought to wind up the companies on just and equitable ground in Hong Kong, Glorious applied to stay the proceedings.
Harris J upheld the arbitration agreement and stayed the winding up petitions. He held that the substance of the dispute was essentially shareholders’ disputes which did not affect third party rights, and therefore the case was arbitrable. Three main points emerged.
(1) Insolvent and solvent winding up of companies. First, Harris J drew an important distinction between winding up on ‘insolvency’ ground and winding up on ‘just and equitable’ ground: the former invokes a class right that engages the statutory regime for the liquidation of companies for the benefit of all creditors, whilst the latter would normally involve solvent company in that a shareholder must demonstrate a ‘sufficient interest’ in the winding up (see Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32), section 179(1)), and that it would normally involve shareholder disputes that did not affect third parties. Therefore, a just and equitable winding up, he insisted, did not involve a class right that could only be determined by the court.
In more general terms, the judge clearly reinforced the broad rule that an arbitration agreement which restricts members’ statutory rights to petition for winding up is enforceable, so long as it does not affect third parties. This was the uncertain principle in Best Floor [1999] VSC 170 where the Australian court, without drawing a line between solvent and insolvent winding up, refused to stay a winding up petition on the ground that it would have the effect of ‘obviating the statutory regime for the winding up of a company’ (at [18]).
(2) Arbitration Ordinance. Putting aside the ‘class right’ point, question arose as to the applicability of section 20 of the Arbitration Ordinance which requires ‘a court before which an action is brought’ to refer the parties to arbitration. It is clear that winding up proceedings were not an ‘action’. Harris J relied heavily on Fulham where the Court of Appeal stayed an unfair prejudice petition notwithstanding that the provision of UK Arbitration Act left open the possibility of a challenge to a stay on the ground of arbitrability. He agreed with Pattern J in Fulham that ‘action’ (‘legal proceedings’ in the equivalent UK provisions) included a petition, adding that the difference in wording between the Arbitration Ordinance and the equivalent UK provisions were immaterial (at [21]).
(3) Subject matter and the relief granted. Even though an arbitrator cannot make a winding-up order, nevertheless Harris J held that the question of whether a shareholder’s conduct was consistent with the terms of a shareholders’ agreement and the determination of the facts and matters which found a petition to wind up a company were clearly arbitrable (at [14]).
Class rights include any rights conferred on a particular class of shares in contrast to one or more other classes. They may also, importantly in the joint venture context, include rights conferred on a shareholder by name under the company's articles even though they are not attached to a particular class of shares identified as such. Company law generally includes certain protections for the members of a class against any change in the rights attaching to shares of that class.
An alternative approach, in circumstances where it is considered not appropriate to establish class rights, is for a minority shareholder to protect its position by having "weighted voting rights" on particular matters. This method has been used to ensure that a minority shareholder's appointee as director cannot be removed by the majority shareholders. This appears to be a technique capable of general application to entrench rights of a shareholder under Common law.