Who is a minority shareholder? Why is there a need for protection? A shareholder is defined under Section 86(1)(a) of the Companies Act, No. 7 of 2007 ("Companies Act"), as a person whose name is recorded in the share register, as the holder of one or more shares in the relevant company. The ownership structure of a company can involve both minority and majority shareholdings. A minority interest is said to be existing where an entity/individual holds less than 50% of the voting rights in the company and a majority shareholding is created where 50% or more of such voting rights are held by an entity / individual.

A minority shareholder would have limited control over decision making matters relating to the company. For instance, decisions requiring approval by ordinary resolution under the Companies Act, would involve a simple majority of 50% + 1 of the voting rights in the company. Alternatively, decisions requiring approval by special resolution under Section 143(1)(a) of the Companies Act, involves a majority of 75% of the voting rights. In both aforesaid situations, the minority shareholder depending on their level of shareholding is usually left with limited influence over decision making in the company. A greater degree of control can be offered through protection of minority interests in a shareholders' agreement.

What is a Shareholders' Agreement?

A shareholders' agreement is a contract between the shareholders of the company that expressly sets out the rights and obligations of the shareholders, and provides guidance in relation to the operation and management of the company. This document can be drafted in a flexible manner based on the consensus reached between the shareholders' in relation to the affairs of the company.

Provisions generally relate to appointment of directors, share issues, dividend policies, exit rights, etc. The terms of such a shareholders' agreement would ultimately depend on the negotiations between the parties and in this connection the commercial purpose of the company, the relative bargaining positions of the respective parties, and applicable laws (for instance ownership restrictions) would be determinative factors.

Enhancing basic shareholder rights

The existence of a shareholders' agreement can help minimise the potential for disputes as the rights and responsibilities of the respective parties can be laid out clearly, including the procedure for dispute resolution. In addition, such agreements may be designed to protect the minority shareholder's rights and interests.

In drafting a shareholders' agreement, a range of contractual protections for minority shareholders can be included. These may range from (but are not limited to): veto rights, put options, anti-dilution clauses, tag along rights, and pre-emptive rights. In the absence of a shareholders' agreement, the potential for disputes increases and the possibility of the majority shareholders taking actions that are prejudicial to the minority shareholders' interests also prevails.

Why have a Shareholders' Agreement when the Articles of Association also exist?

While companies are required to have articles of association, companies are not required by law to have a shareholders' agreement. The articles of association are drafted and filed upon the formation of the company and provides the governance framework for the affairs of the company

The issue with wholesale reliance on the articles of association of the company for minority shareholder protection is that the articles of association can be amended through a special resolution. Thus, a 75% majority of the shareholders could vote to amend the articles which could result in the rights of the minority shareholder being adversely affected.

In contrast, a shareholders' agreement is a contract between the shareholders of the company which can be drafted in a manner that also binds the company and provides protection for the minority shareholders. Further, sensitive commercial terms can be detailed in such an agreement as there is no requirement for filing with governmental departments, thereby remaining confidential between the parties.

Since both documents address aspects of operation and management of the company, it is vital to ensure that there are no conflicting provisions. A standard provision that may be incorporated is that, in the event of a conflict between the shareholders' agreement and the articles of association, shareholders will agree to be bound by the interpretation in the shareholders' agreement and that they will use their voting powers as shareholders to amend the articles of association to remove any inconsistency.

In any event, it is in the best interests of a minority shareholder in particular, to ensure that the articles of association are amended to reflect the terms of the shareholders' agreement.

Terms in the Shareholders' Agreement to help protect minority shareholders

There are several provisions that could be included in the shareholders' agreement to help provide minority shareholders protection. These include:

Veto Rights:

This enables minority shareholders to have veto rights in relation to certain reserved matters such as the issue of new shares, appointment/removal of directors etc. Thus, corporate action that that would likely affect a minority shareholder's interests would require the prior approval of such shareholder.

Put Option:

The inclusion of a put option could provide protection by giving minority shareholders the option to sell the shares according to predetermined formula, upon the occurrence of a specified event. For instance, in the event the put option is linked to a dividend threshold, the minority shareholder may have the opportunity to sell the shares back to the company, when returns are lower that the specified threshold.

Anti-Dilution Clauses:

The inclusion of an anti-dilution clause in a shareholders' agreement provides minority shareholders with the ability to maintain their shareholding percentage in the company. Further, in the absence of an anti-dilution clause, the minority shareholders' face the risk of the value of the minority shareholder's shares declining when new shares are issued at lower valuations. Accordingly, this type of clause provides the benefit of protecting the minority shareholders' share equity whilst maintaining the valuation of such shareholding.

Tag Along Rights:

Tag along rights help the minority shareholder ensure that they are not left behind in a situation where the majority shareholder(s) decides to sell their stake in the company. This is by enabling the minority shareholder(s) to sell their stake at the same price, terms and conditions as those offered to the majority shareholder by the prospective buyer. In the circumstance that this right did not exist, the minority shareholder could be left behind with a minority stake in the company which could be difficult to sell (forcing a sale possibly at less than fair value), as most buyers would want a 100% or a majority stake in the company. These rights also help the minority shareholder ensure that they are not trapped in a company that is controlled by shareholders over whom they have no influence

Pre-Emptive Rights:

The inclusion of pre-emptive rights in a shareholders' agreement could provide any existing minority shareholder with the opportunity to purchase any new issue or transfer of shares in the company concerned. By including such a clause into the shareholders' agreement, the minority shareholder can purchase the shares prior to it being offered to any third parties, which prevents share dilution

Limitations of Shareholders' Agreements

Despite shareholders' agreements providing minority shareholders with considerable protection, the shareholders' agreement also has its limitations. For instance, one such limitation is that it could provide less flexibility for shareholders to deviate from the terms set out in the shareholders' agreement.

Another limitation that arises is in relation to amending the shareholders' agreement. The terms of the shareholders' agreement should be drafted and negotiated carefully, as amendment to a shareholders' agreement would require the consent of all parties, whereas an amendment to the articles of association would not require the same.

This publication is solely for the purposes of general information of our clients and other interested persons. The aim is to provide a general overview of the topic and this should not be construed as legal advice.

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