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In brief - Replaceable rules don't cover all relevant governance issues

New companies and start-ups that only rely on the Corporations Act 2001 for regulation may leave themselves exposed to other uncertainties around new shareholders, minority shareholders' voting rights, and, most importantly, funding requirements.

Shareholders' agreements should detail the company's management and control

Shareholders' agreements are essential tools for ensuring that relationships in closely held companies are conducted on appropriate terms, while also providing protection for shareholders in more widely held companies.

In our March 2016 article Shareholders' agreements for new companies and start-ups, we addressed why shareholders' agreements are important for new companies and start-ups, the basics around company ownership and management and how having a well-drafted agreement can help to manage disputes, including a list of items that might be included in your shareholders' agreement.

In this follow-up article, we look at how failing to enter into a shareholders' agreement appropriate for the nature of a given company can result in unwanted new shareholders becoming involved against the wishes of existing shareholders, disenfranchisement of minority shareholders, and an inequitable bearing of ongoing funding requirements.

Corporations Act and replaceable rules may not be enough to ensure good governance

The Corporations Act 2001, which regulates all Australian companies, defines the rights and obligations of shareholders, company directors and officers, and imposes a basic structure pursuant to which shareholders appoint directors to manage companies without further agreement. Many companies regulate their governance using only the provisions of this Act and informal arrangements. The Act contains certain provisions directed at regulating some of the uncertainties, called replaceable rules, but they generally do not go far enough to address all relevant issues.

Where a company’s shareholders want greater certainty as to the implementation of a certain business plan, composition of management and the management of desired short- and long-term objectives, a shareholders' agreement can be useful to provide all shareholders comfort as to the company’s direction and management.

By way of example, the Corporations Act places no limit on a shareholder selling its shares to someone else, even if the buyer is someone with whom the other shareholders do not wish to associate or to have a say in the composition of the board.

Shareholders' agreement may ensure more equality and voting rights

Setting rules in a shareholders' agreement to create more certainty as to mutual rights and responsibilities is very useful when a company is held by few shareholders who work together closely in circumstances similar to business partners, because it is flexible enough to provide for a partnership-like relationship among shareholders, ensuring equal say in things and preventing new persons coming into the business without consent of the other shareholders.

It also benefits companies with more diverse shareholders, setting standards that passive shareholders can rely on and allowing passive or minority shareholders access to the board or veto rights over certain important decisions.

The company may be included as a party to shareholders' agreements. The purpose is to ensure that each individual shareholder obtains rights against the company that it can enforce itself. Such rights usually pertain to access to books and records, maintenance of accounts and maintenance of directors' and officers' insurance.

Funding requirements may be addressed by private equity and shareholders' obligations provisions

An appropriate shareholders' agreement is an essential element of provision of private equity funding. They are critical when existing shareholders wish to attract additional investment from third parties, who will want structural certainty around mutual rights and responsibilities as a condition of their cash coming in.

Shareholders' agreements can provide mechanisms for ensuring the availability of working capital, to be provided under set circumstances by shareholders. This can be important where there is a risk that some shareholders may not want to provide necessary funding.

Care needs to be taken to ensure that funding mechanisms do not create an obligation on shareholders to provide funds to a company that can be enforced by an external administrator, as this can negate the benefits of limited liability. However, when properly drafted, funding provisions can create equitable mechanisms for sharing funding obligations among shareholders.

This article contains summary information and is not intended as legal advice for your business. Please consult your legal professional in relation to your specific requirements.

This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2024.

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