In the fifth part of our series on “Introduction to shareholder’s agreement”, we present to you clauses on Voting Rights
A shareholder agreement has the power to limit the possibility of an oppressive conduct and provide a fair resolution of shareholder disputes with Voting Rights clauses.
A voting right is the right of a stockholder to vote on who will make up the board of directors and on matters of corporate policy, including decisions on issuing securities, initiating corporate actions and making substantial changes in the corporation’s operations. It is common for shareholders to voice their vote by proxy by mailing in their response.
Cumulative voting allows minority shareholders to amass their votes to accomplish greater power in the selection of directors. Depending on the distribution of shares, cumulative voting can give a minority shareholder with a fairly substantial interest to ensure a place on the board.
Shareholders may assign their rights to vote to another party without giving up the shares. The person or entity given the proxy may vote without consulting the shareholder. In certain extreme cases, a company or person may pay for proxies as a means of collecting a sufficient number and changing the existing management team.
Two people pool their complimentary talent, skills and resources to create a start up with an equally distributed shareholding pattern. In due course, disagreements materialise and decisions cannot be made. The startup becomes deadlocked. Although operations continue, the deadlock hinders performance. Growth is muted whilst profitable opportunities are lost.
A well-drafted shareholders agreement will usually have a deadlock resolution clause that sets out the framework to resolve such impending dispute. An appropriate dispute resolution and deadlock provisions can resolve the problem and avoid an untimely demise of the start up. There are a number of mechanisms that can be adopted to resolve deadlock:
- Auction: In an auction, the initiating party will inform the other(s) its intent to acquire their shares. The receiving party has to decide within a certain period and either assent or counter with an offer to buy the initiating party’s shares. If the other party also wishes to buy, both parties will participate. It works when the parties are of equitable financial strength.
- Buy Out: It involves quick buy-out of a shareholder by the other parties. It is more likely linked to the non-performance by a party, thereby giving the non-defaulting parties the right to acquire the defaulter’s shares. The buy-out is at a price evaluated by reference to a pre-determined formula.
- Put and Call: A Put option enables a shareholder to require another shareholder to purchase its shares at a certain price. Put options may be beneficial for a minority shareholder who believes certain events may weaken its position. A Call option allows a shareholder to compel the other shareholder(s) to sell their shares. Call options may be preferred by a majority shareholder who wants to take a certain course of action which may otherwise be impeded by a minority shareholder. The agreement should clearly specify at the outset the timing, trigger, process, and price to exercise the option.
- Liquidation: The parties may wish to provide for a regime that requires the shareholders to liquidate the company in the event of a deadlock and to share the costs and expense of so doing. However, liquidation may not be attractive if a large element of the value of the business is “goodwill” and depends heavily on its continuing as a going concern.
Selection of a mechanism should be relevant to the context, i.e. appropriate in the prevalent circumstances. It is recommended to invest considerable time initially to consider the terms of a shareholder agreement that deal with a deadlock. This way a resolution can be reached quickly without a prolonged dispute, allowing the startup to progress.