7 September 2018
What however often falls by the wayside, is properly governing the investor’s relationship with his co-shareholders once he has successfully acquired an equity interest in a particular company. It is in this exact context that that the critical importance of a properly negotiated, carefully crafted and tailor-made memorandum of incorporation and shareholders agreement is to be found.
It is near impossible to provide an exhaustive list of the items which are to be dealt with in these documents (which can often be fairly lengthy and complex). This article however attempts to highlight some of the key aspects which should be dealt with by shareholders so as to bring about sound corporate governance, balance control, regulate the relationship amongst the company’s key stakeholders and resolve and mitigate potential disputes.
Prior to delving into any level of detail, there are a few basic concepts which should be grasped. In terms of the Companies Act, 2008 (“the Act”) each company is required to have what is known as a ‘memorandum of incorporation’ (“MOI”). In simple terms, the MOI serves as the company’s constitution. The MOI must be consistent with the Act and, subject to certain exceptions, is void to the extent that it contravenes or is inconsistent with the Act. Shareholders generally have two choices. They can either adopt a standard MOI or a bespoke document. There would be very few instances in which we would suggest the former. “Why?”, you may ask. Well, for one, the Act contains a number of so-called ‘alterable’ provisions (about 52 in fact). These are provisions which may (within certain parameters) be altered in a MOI to suit the needs of the shareholders. This is best explained by way of a practical example:
A, B and C are shareholders in XYZ (Pty) Ltd. Each of A, B and C hold an equal number of shares in XYZ (Pty) Ltd i.e. 33.33%. XYZ (Pty) Ltd owns a single commercial property in a trendy Johannesburg suburb, which A and B are now desirous of causing the company to sell. C, for no good reason other than simply wishing to be obstructive refuses to consent to the sale of the said commercial property. As the Act, requires a company to adopt a special resolution prior to selling the greater part or all of its undertaking, A and B effectively face a stale mate, as the default position in the Act is that such special resolution is to be supported by at least 75% of the voting rights capable of being exercised on the resolution. This is however an alterable provision. Resultantly, the position could quite easily have been remedied had A, B and C at the outset realized that reducing the percentage of voting rights to adopt a special resolution below 66.66% would inhibit an obstructive shareholder from holding the others hostage.
“Well, then where does a shareholder’s agreement fit in?”, you ask. The Act, quite specifically makes provision for shareholders agreements by stating that shareholders of a company may enter into any agreement with one another concerning any matter relating to the company, provided however that such agreement is not inconsistent with the Act or the company’s MOI. Similarly, this is best explained by way of a practical example:
A, B and C (who are coincidently best friends) are shareholders in XYZ (Pty) Ltd. Each of A, B and C hold an equal number of shares in XYZ (Pty) Ltd i.e. 33.33%. XYZ (Pty) Ltd. A unexpectedly dies. A, whom B and C had for a long time suspected had an extra-marital relationship bequeathes his entire estate (inclusive of his shares in XYZ (Pty) Ltd) to his recently fired secretary. B and C are now faced with a scenario in which a disgruntled employee owns a third of the company from which she has just been fired. The scenario is further aggravated by the fact that A, B and C had never drafted or adopted a bespoke MOI. As such they are bound by the provisions of the Act that stipulate that a special resolution is to be supported by at least 75% of the voting rights capable of being exercised on a particular resolution. Not only does the disgruntled employee own a third of the company, but now also possesses the ability to hold B and C hostage in decision-making. This could easily have avoided by drafting a shareholders’ agreement in which each of A, B and C are afforded rights of first refusal on the disposal of shares (or deemed disposal in instances of death) by the others at an agreed purchase price.
“Okay, so what should a good shareholders’ agreement and MOI cover?”, you ask. I’d suggest that, as a minimum, the following items be dealt with:
- The capital structure of the company
- Future funding of the company
- Appointment of professional advisors to the company
- Administrative provisions such as the financial year end, appointment of a public officer etc.
- Dilution of shareholding
- Representation at board level
- The percentage of voting rights required to make various decisions
- Quorums and procedures at meetings
- Restrictions on disposal of shares
- Pre-emptive rights on the issue of new shares
- Rights of first refusal in respect of the sale of shares
- Events and/or circumstances in which a shareholder may be compelled to sell his shares
- The manner in which corporate opportunities are to be dealt with
- Confidentiality and restraint provisions
- Resolution of deadlocks
- The resolution of disputes
As there are a plethora of different scenarios and permutations to be considered, we strongly advise that you consult with an appropriate professional and steer well clear of template or generic documents which do not make any provision for your unique needs.