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Shareholders’ Agreements: How to Ensure a Smooth Exit

Caveat Legal

At the start of their relationship, shareholders are usually aligned on their vision for the company and are excited to see what the future holds for the business. However, circumstances can change very quickly and in the event that shareholders cannot work together to move the company forward, the remedies contained in a shareholders’ agreement on how to resolve a deadlock, and, if needs be, how to enable a shareholder to exit the business, can be critical.

Importantly, a shareholder dispute is different from a shareholder deadlock. A dispute will usually arise in connection with the interpretation or implementation of the shareholders’ rights and obligations under the shareholders’ agreement. Such a dispute would then typically be resolved through the dispute resolution mechanisms provided for in the shareholders’ agreement, such as mediation or arbitration.

On the other hand, a deadlock between shareholders usually arises where the shareholders are unable to pass a resolution requiring shareholder approval, whether because there is an even split of votes on the particular resolution (i.e. no majority of votes can be achieved) or because the resolution repeatedly fails to obtain the percentage of voting rights required for its adoption, in either event the result is that the resolution fails, often leaving the business paralysed as to how to continue or which direction to proceed. However, the shareholders’ agreement can also include other grounds that would constitute a deadlock, such as failure by the shareholders to achieve a quorum at shareholder meetings, the failure of the shareholders to agree on matters that are essential to the functioning of the company, such how to implement the company’s business plan, or where one shareholder wishes to sell its shareholding but the other shareholders decline to follow their pre-emptive rights and a third party purchaser for the shareholding cannot be found or is not approved by the other shareholders to take up the shares.

A well drafted shareholders’ agreement will include carefully considered mechanisms to break or address a deadlock that are appropriate for and tailored to the shareholders’ circumstances. Typical mechanisms to address a failed resolution include that the resolution in question be deferred for a certain period, following which the shareholders are required to re-consider the resolution; a chairperson or nominated shareholder be given a casting vote; or the resolution be referred for determination by an independent third party elected by the shareholders or by a nominated third party.

Should these mechanisms fail, the shareholders’ agreement could cater for a shareholder’s exit (without having to find a third party purchaser) by including a “Russian Roulette” clause, in terms of which a shareholder may issue a notice offering to either buy or sell the other shareholders’ shares for fair market value or at a fixed price and the other shareholders can then elect to either buy the offering shareholder’s shares or sell their shares at that price, or a “Texas Shootout” clause, in terms of which the shareholders submit sealed bids to an “auctioneer” (a third party non-shareholder) and the shareholder who makes the highest bid must buy the others’ shares at that price. Both the “Russian Roulette” and the “Texas Shootout” remedies should always be carefully considered, taking into account each shareholder’s particular circumstances and financial positions, particularly as they may compel a shareholder to buy or sell his or her shares unwillingly.

Lastly, the shareholders’ agreement should also include a stipulation as to whether a deadlock (or failure to resolve a deadlock) should constitute a ground for the winding-up of the company. This should obviously be relied upon as a last resort but may at times be the only available and sensible remedy if the relationship between the shareholders has disintegrated to the extent that the business cannot continue.

On entering into a shareholders’ agreement, it is essential for the shareholders to consider their options for exiting the business should the shareholder relationship sour – failure to do so could lead to unnecessary pain and expenses down the line, and possibly to the failure of the business and the loss of the time and money invested by the shareholders into it.

Sarah Van Zyl

Sarah has a BA (Law and Psychology) and LLB (cum laude) from Wits. She was admitted as an attorney in 2010 after having completed her articles at ENS and is a qualified solicitor in England and Wales (non-practising). Sarah practiced as an associate in ENS’ corporate commercial department before going in-house at Investec Bank plc in London. She joined Caveat in 2018, specialising in corporate and commercial work.

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