The company’s constitution is regarded as a statutory contract between the shareholders. It is common in practice for the shareholders to supplement the constitution with a separate agreement setting out their rights and obligations prior to or subsequent to incorporating a company to conduct their business. These agreements are often comprehensive and deal with rights and obligations that are additional to those mentioned in the company’s constitution. Such an agreement is usually referred to as a “shareholder agreement”. The shareholder agreement may be between:
- the company and its members,
- all the members amongst themselves, or
- select members amongst themselves.
There is no fixed rule on the scope of a shareholder agreement. The parties of the shareholder agreement have the freedom to determine what the agreement covers based on their needs. As such, some companies have a simple and streamlined agreement, while others may have a comprehensive agreement with very detailed terms on every aspect of the company’s operations. Generally, a well-drafted shareholder agreement will cover (but not limited to) the following aspects:
- Management of the company
- Who will exercise the management functions of the company?
- The mechanism for which certain decisions are made (e.g. unanimous approval / approval of a specified percentage) to protect the interests of minor shareholders who can potentially be out-voted.
- Dispute/Deadlock Resolution
- In the unfortunate event that dispute/deadlock arises between shareholders, and they are unable to work together anymore, the shareholder agreement can minimise the time and costs of the dispute by dictating who should leave, price of his/her shares and when the sale will take effect.
- Exit strategy
- How can the shareholders sell their shares and how will the shares be valued?
- Disability / death of shareholder
- In the event that a shareholder is disabled, will the company continue to pay a full/reduced salary and for how long? Will the disabled shareholder be required to sell his shares?
- In the event that a shareholder passes away, how will his/her next-of-kin be compensated for the deceased’s interest in the business?
- Non-competition provision
- This will protect the company’s interest by ensuring that the company’s confidential information is preserved and founders are restricted from leaving to join/ start a competitor.
- Return of investment
- What is the company’s dividend policy?
What is the difference between the “statutory” contract and a “shareholder agreement”1 ?
The statutory contract created by a company’s constitution is distinct and separate from any shareholders’ agreement between the parties. The result is that there may be two contracts governing the relationship between the parties. Both contracts are equally binding and have their own legal force. Where there are conflicting provisions on both documents, it is suggested that the conflict will have to be resolved using general principles of interpretation under contract law to decide which should take precedence. This flows from the use of general contractual rules of interpretation in construing corporate constitutional documents by the courts.
There are two key differences between the constitution and a shareholder agreement.
First, the rights and obligations of the statutory contract are inextricably intertwined with membership of the company. A party who ceases to be a member also ceases to be a party to the statutory contract. Conversely, new members who join the company are regarded as parties to the statutory contract. The rights and obligations in a shareholder agreement are personal to the original parties to the agreement and can only be assigned (transferred) pursuant to the rules in contract law.
Secondly, the statutory contract can be amended so long as the procedures for amending of the company’s constitution have been complied with. Under most circumstances, there is no need to obtain the agreement of all the parties involved to the statutory contract to agree to this but only a requisite majority. In contrast, all parties to the shareholder agreement must agree for any amendment to the agreement to take effect.
1 Yeo, Victor C.S., Lee, J., Hanrahan, P., Ramsay I., Stapledon, G. (2015). Commercial Applications of Company Law in Singapore (5th Edition), 5-420.