Shareholder agreements and their legal relevance: How they affect the administration and control of the company

Rodolfo Salazar,  March 26, 2024

BLP - In the business world, teamwork is essential. Likewise, when several people come together to invest in and manage a company through shares, they must decide on the company’s direction. Here, shareholder agreements come into play.

A shareholder agreement can be considered the instruction manual that guides company operations. Imagine that several friends decide to play a board game. To ensure everyone plays by the same rules and avoid mid-game arguments, all must read the game manual and agree to follow it. For companies, the shareholder agreement is that manual. Such agreements outline how to make decisions, sell shares, and handle other essential company aspects. They provide clarity and structure to the relationship between shareholders.

Now, one might ask why such agreements are crucial preconditions to investment. The answer is simple: they prevent conflicts and ensure a stable future for the company. Without an agreement, shareholders may become at odds over crucial decisions, such as expanding into a new market or reinvesting profits. These disagreements can lead to costly disputes, which can destabilize the company. By establishing from the outset who makes these decisions and who controls certain aspects of the company, shareholder agreements act as a lifeline, ensuring that the company moves forward no matter what challenges arise.

Main objectives of shareholder agreements

When establishing a company, the role of shareholders is crucial, as they provide the capital and, in many cases, the strategic direction. However, with multiple stakeholders, it is natural that different opinions and visions may arise. Shareholder agreements, in this context, are essential tools to provide a clear path and guidelines to follow, ensuring the proper functioning and sustainability of the company. The main objectives of these agreements are detailed below:

A. Ensure consistent management and administration of the company

A company is similar to a ship in the middle of the ocean that, without clear direction, can drift or, worse yet, capsize in the middle of a storm. Without consistent management and administration, a business may face difficulties or fail. Shareholder agreements establish roles, responsibilities, and clear lines of decision-making, ensuring that all stakeholders share a common vision and that the company has a defined direction.

B. Establish resolution mechanisms for possible conflicts between shareholders

It is natural for disagreements to arise in any relationship, and business relationships are no exception. However, the factor that sets successful companies apart is how they handle these disagreements. Shareholder agreements anticipate conflicts and establish resolution mechanisms to resolve them. These mechanisms may include mediation, arbitration, or even court proceedings, ensuring the resolution of disagreements effectively and efficiently.

C. Protect the interests of minority shareholders

In many companies, there is a distinction between majority and minority shareholders. Without proper protection, minority shareholders may feel left out or be subject to unfair decisions. Shareholder agreements, recognizing this dynamic, incorporate clauses that protect the rights and interests of these minority shareholders, ensuring that their voices are heard and their interests safeguarded.

D. Regulate the transfer of shares and preferential purchase rights

The business world is dynamic, and corporate ownership structures can change over time. Whether through the sale of shares, inheritance, or new investments, stock transfers require guidelines. Shareholder agreements outline the sale or transfer process, establishing, for example, preemptive rights for existing shareholders. Such provisions guarantee an orderly and fair transition, protecting company stability and the interests of all shareholders.

In essence, shareholder agreements establish a structured and predictable framework for the management and control of a company. By clearly defining shareholder roles, responsibilities, and procedures, these agreements facilitate a collaborative and productive work environment, ensuring the company’s success and longevity.

Key aspects that shareholder agreements usually regulate

Shareholder agreements are detailed contracts intended to define the rules of interaction between shareholders. Their purpose is to structure the relationship between all parties and provide a clear framework for making decisions during business activity. These agreements, although varied in their content depending on the nature and needs of each company, usually touch on some essential points:

A. Rules for the sale or transfer of shares

A shareholder may wish to sell or transfer their shares for various reasons, such as financial need or strategic purpose. Rules ensure a smooth transition and protect company interests and those of other shareholders. These may include the right of first refusal, which allows other shareholders to buy the shares before being sold to third parties, or even place restrictions on who may purchase such shares.

B. Preferential acquisition rights or "tag-along" and "drag-along"

These clauses guarantee that if a majority shareholder decides to sell their shares, the minority shareholders can accompany the sale ("tag-along") or, conversely, that if a majority shareholder sells, they can force the minority shareholders to sell as well ("drag-along"). These mechanisms protect and balance the interests of both parties, guaranteeing justice and equity in transactions.

C. Establishment of dividend policies

Dividends are a fundamental reason to invest in a company. Shareholder agreements often define policies on when and how to pay dividends, ensuring that all shareholders receive their fair share of the company’s profits.

D. Appointment and removal of administrators or directors

Leadership is essential to the success of any company. Defining how administrators or directors will be appointed or removed is necessary. Agreements may stipulate processes, criteria, or even predefined lists of candidates.

E. Procedures for making strategic decisions

Not all decisions have the same weight. Some, such as mergers, acquisitions, or significant changes in company management, have profound implications. Shareholder agreements may require special majorities for these decisions, ensuring they invoke due consideration and consensus.

F. Confidentiality and non-competition commitments

Information is power. Shareholder agreements often include clauses requiring shareholders to keep sensitive information confidential and not to compete with the company when they are shareholders and for a defined period after they cease to be shareholders.

These aspects, among others, form the backbone of shareholder agreements, providing a solid and predictable structure for the operation and control of the company. Although they may seem formal and detailed, their main goal is to ensure that all shareholders, large or small, are protected and can work together towards the company’s success.

The legal relevance of shareholder agreements

Besides being tools for internal management and strategic planning, shareholder agreements have undeniable relevance under the law. Private accords between the parties interact with the legal framework and have significant consequences in the world of law. Let’s look at some key aspects:

A. Validity and effectiveness vis-à-vis society and third parties

A shareholder agreement, correctly prepared and signed, is fully enforceable. The signing parties are legally obliged to respect and comply with the terms to which they agree. Regarding society, the agreement dictates the behavior and decisions of the shareholders. Third parties not part of the agreement may sometimes face its effects, especially if it opposes them in public records or involves them in clauses relating to the transfer of shares.

B. Relationship between shareholder agreements and the applicable legal system

While shareholder agreements are private contracts, they do not exist in a legal vacuum. They must be in harmony with current legislation and regulations. For example, they cannot establish practices that oppose company goals or competition law. Such agreements must reflect a thorough understanding of the relevant legal system to ensure their compliance and effectiveness.

C. Consequences of failure to comply with these agreements

Failure to honor a shareholder agreement can have stern legal implications. The consequences can range from monetary sanctions to excluding the defaulting shareholder from company ownership. Furthermore, any shareholder who believes the majority owners infringed his or her rights may seek redress in court. Disputes related to these agreements can be costly and damaging to the company, so all shareholders must be well-informed and committed to compliance.

The nature and scope of shareholder agreements are vast; their legal relevance is undeniable. They serve not only as management and control tools but also as legal safeguards that protect the rights and interests of shareholders. The correct implementation and adherence to such an agreement guarantees smooth business management and a solid and reliable legal framework for all involved.

Recommendations for drafting and negotiating shareholder agreements

Drafting a shareholder agreement is a process that requires meticulousness, foresight, and experience. A competent accord not only defines the rules of the game for the administration and control of the company but also seeks to prevent future conflicts between shareholders and protect the interests of society. Below are some key recommendations to carry out this process successfully:

A. Importance of having specialized legal advice

The first and perhaps most essential recommendation is to seek the help of a corporate law expert. These professionals can identify possible gaps or ambiguities in the text and ensure that the agreement complies with current laws. They can offer perspectives based on experience, anticipating common problems, and proposing proven solutions.

B. Clauses that should not be missing

Although each agreement is unique and adapts to company and shareholder needs, some clauses are usually essential:

– Determination of decision-making bodies and their powers: It is essential to define who has the authority to make decisions in different areas, from daily operations to strategic decisions.

– Rights and obligations of shareholders: These may include the right to receive information, the duty not to compete with the company, and directions on resolving conflicts of interest.

– Conflict resolution procedures: Establish mechanisms, whether through mediation, arbitration, or other means, to resolve shareholder disputes or conflicts.

– Rules on the transfer of shares: Clearly define the conditions under which shares are sold or transferred to avoid misunderstandings and future disputes.

C. Adaptation to local and international regulations on corporate matters

The regulations governing companies can vary considerably from one country to another. If the company has operations in more than one jurisdiction, the shareholder agreement must adhere to the laws of all relevant jurisdictions. Such compliance may require specific adaptations or clauses to the agreement to ensure that it is valid and enforceable everywhere. Failure to comply with this point could result in agreement nullification or inapplicability in some jurisdictions, putting the interests of the company and its shareholders at risk.

By considering these tips and recommendations, companies can draft shareholder agreements that are robust and clear and offer protection and predictability for the future. With adequate preparation and advice, these legal tools can become fundamental pillars for the success and stability of a company.

Shareholder agreements are essential instruments in the business world that, properly structured, have the power to guide the course of a company and ensure its stability over time. These agreements not only define the internal rules for decision-making and business control but also act as protectors of the interests of each shareholder, whether majority or minority. An agreement’s effectiveness lies in its adaptation to the particularities of each company and its alignment with the current legal system.

In an ever-evolving business world, where shareholder relationships can directly influence the success or failure of a company, having a well-crafted shareholder agreement is more of a necessity than a luxury. It is an investment in the future, a preparation for challenges, and a guarantee that, in the face of potential disputes or differences of vision, a framework agreed upon will guide resolution.

Therefore, for any company seeking to prosper in the current corporate landscape, it is essential not only to have a shareholder agreement but to ensure that it is clear, complete, and meets the real needs of the company and its investors. Only in this way will a balance be achieved between business autonomy and flexibility and the protection and legal security that these agreements promise.