BRACHER RAWLINS | Why do we need both a shareholder agreement and articles of association?

Starting a company? If so, one of the first steps required under the Companies Act 2006 will be to agree your articles of association, but do you also need a shareholder agreement? If your company has two or more shareholders, it may be prudent to consider having a shareholder agreement drawn up at the same time, or as soon as possible afterwards.

‘The articles of association are the first written rules about running the company, and as a legal requirement they are sometimes given minimum attention in order to get the company registered,’ explains Clare Birch-Palmer, a Trainee Solicitor in the corporate and commercial team. ‘However, the articles may not deal with how some key decisions should be made, or may not provide sufficient protection for shareholders in some situations as the business grows. So, entering into a separate private contract is recommended.’

Clare outlines the benefits of a shareholder agreement and explains how this can operate alongside your articles of association.

Purpose of articles of association

The articles of association are a mandatory requirement of setting up a company and their purpose is to define the infrastructure of the company, such as its structure, roles of its key personnel, and rules and regulations for the company to abide by in the course of its operation. It is the default document for this purpose.

The articles are also a public document which is filed at Companies House.

The articles address shareholder rights to some extent, such as how to transfer or buy shares. They also incorporate broader corporate matters such as the holding of board meetings, director duties and rights, share allocations and other statutory provisions.

Standard articles do not address issues such as shareholder exit strategies, dividend policies, or how voting rights would work.

When setting up a company, there are two options: you can elect to adopt the standard articles (an off the shelf document essentially) or to have bespoke articles of association drawn up.

It is possible to address any gaps in the standard version within bespoke articles, however this will still be a public document, as your articles of association will be on record at Companies House.

If you wish to protect sensitive information or negotiate terms confidentially, a shareholder agreement would provide a more private and discreet document.

Purpose of a shareholder agreement

The shareholder agreement is a private contract between the shareholders and the company. Typically, the shareholder agreement would include clauses and provisions either not found in, or not adequately addressed in, the articles of association.

Examples of provisions which shareholder agreements extend to typically include:

exit strategies available to existing shareholders;
death of a shareholder;
dispute resolution mechanisms;
rights of majority and minority shareholders such as ‘tag along’ and ‘drag along’ rights in case of a buyout of the company;
dilution protocols if the company takes on further external investment;
changes to how shareholder resolutions can be decided (for example, percentages required to pass a resolution, or which events warrant a special resolution or an ordinary resolution); or
dividend policy – while this is available in the articles, the shareholder agreement may be a better place to detail this for privacy or more complex solutions.

Can you have one without the other?

It is entirely possible to have the articles without a shareholder agreement but not vice versa. So, how does a shareholder agreement sit side by side with your articles of association?

A shareholder agreement can operate in one of three ways. It can sit alongside, supplement, or supersede the articles of association.

Where a provision or concept is already addressed in the articles of association but does not go far enough, or requires more bespoke detail, this would be a great demonstration of how the shareholder agreement would work alongside the articles to expand and secure specific areas of concern for shareholders. The dividend policy is a key example of this.

Where the articles of association are silent on aspects of how shareholders’ rights obligations are expected to work, the shareholder agreement would seek to supplement the articles, and in this case provide more robust legal infrastructure to the business owners. For example, the articles may be silent on drag along or tag along rights afforded to shareholders in the case of a share sale, and a shareholder agreement would set these out in detail to mitigate against a future dispute.

Finally, where there is a conflict between what the articles of association normally provide and how the shareholders perceive that clause needs to work operationally or in the interest of the business, the shareholder agreement can serve to supersede or override the articles. However, this can only occur if there is a supremacy clause included in the shareholder agreement.

Legal expertise in drafting such a clause and other protective provisions is necessary to ensure the articles and shareholder agreement both work as they are meant to, without inadvertently giving rise to problems of enforceability or misinterpretation.

In the case of both documents, regular audit and updating is also recommended to ensure they keep working together optimally as your business evolves and grows.

Further shareholder agreement considerations

There are often many reasons why shareholder agreements are not considered important at the time a company is set up. These include:

cost of drafting a shareholder agreement;
not considering the future possibility of investment in the business;
starting a business with friends or family and not perceiving a dispute as a real or big risk; and
the business operation may have been straightforward initially, and complexity was not expected at the time of set up.

Essentially, the shareholder agreement can extend protections for shareholders without compromising the articles of association. The benefits of having a shareholder agreement, in most cases, far outweigh the reasons for not having one. However, each business case is unique and so professional advice should be taken as to what would make most sense for your particular operation.

How we can help

The articles of association provide a statutory backbone to how a business should, among other things, administer its shares, and director and shareholder positions. A shareholder agreement has the benefit of confidentiality and can be used to iron out areas of possible dispute; address sensitive policies like dividend distribution and exit routes; as well as balance the competing interests of majority and minority shareholders.

Our team of experts can work with you to understand your business at startup or scaleup stage in order to help you put in place and keep updated all the required corporate documents to best protect you and your business.

For further information, please contact Clare Birch-Palmer in the corporate and commercial team on 0207 400 1559 or email clare.birch-palmer@bracherrawlins.co.uk.