The Importance of an Updated Shareholders’ Agreement or Operating Agreement
A shareholders’ agreement is an agreement between all of the shareholders of a company and the company itself that governs the operation of the company. An operating agreement is an agreement among the members of a limited liability company (“LLC”) and the LLC that addresses the relations between the members and how the LLC will conduct its affairs. Every company with more than one shareholder or member should have a shareholders’ agreement or operating agreement. The following are key provisions in a shareholders’ agreement and an operating agreement:
A shareholders’ agreement and an operating agreement dictates the steps to be taken in the event of the death or disability of a shareholder or member.
- Succession Planning
Shareholders’ agreements and operating agreements provide owners of a company with the option to: (i) sell his/her ownership in the company to a third party; (ii) transfer or sell his/her ownership in the company to other to other shareholders or members; or (iii) transfer all or a portion of his/her ownership in the company to family member or key employee.
Generally, shareholders or members have access to valuable intellectual property, trade secrets, or other information that is confidential to the company. A shareholders’ agreement and operating agreement containing confidentiality provisions is the best way for a company to ensure that the shareholders’ or members will keep the company’s information confidential during the life of the shareholders’ agreement and operating agreement and post termination.
Notwithstanding the shareholders’ or members best intentions, disputes are likely to occur during the day to day operation of the company. Without a shareholders’ agreement and operating agreement, disputes can end up in court, be costly to the litigants and cause damage to a company’s reputation. To avoid expensive litigation, a shareholders’ agreement and operating agreement typically contain an arbitration provision to resolve a dispute. Arbitration is held behind closed doors and the process can be streamlined to make it cost efficient to the shareholders’ or members and/or company.
- Restrictions on Transferring Ownership
Without provisions that restrict the transfer of shares or ownership interest, a shareholder or member can freely transfer his/her shares or membership interest to any individual, including involuntary transfers to creditors and spouses in divorce. This can result in shares or membership interest being owned by a competitor or an individual unfit to serve in any capacity at the company. A shareholders’ agreement and operating agreement can prevent this potential issue by requiring unanimous consent of all the shareholders or members prior to transferring any shares or membership interest.
- Majority Owner Protection
This provision is designed to protect majority owners. A “drag along” provision enables majority owners to force a minority owner to join in the sale of the company. The majority owner is required to give the minority owners the same price, terms and conditions as any other sellers.
- Minority Owner Protection
A shareholders’ agreement and an operating agreement provides protection for minority shareholders or members by reserving certain decisions. For example, the ability for the company to issue further shares or membership interest, which can only be made with the unanimous consent of all the shareholders or members. This provision allows minority shareholders or members veto rights and ensures that they cannot be taken advantage of by the majority shareholders or members.
A shareholders’ agreement and an operating agreement may also contain a “tag along” provision, which states that in the event the majority shareholders or members sell their shares or membership interest to a third party buyer, the buyer would be required to offer to purchase the minority shareholders’ shares or membership interest on the same terms as the majority shareholders or members.
A shareholders’ agreement and an operating agreement outlines the voting rights of the owners. The agreement can provide for majority, supermajority or unanimous consent for certain actions taken by the company. For example, the agreement may call for unanimous consent by all owners for the admission of a new shareholder or member. The voting provision in the agreement can be very flexible in order to meet the need of every company.
If you have any questions related to this topic and how it may affect you, our Business Law & Commercial Real Estate group may be able to help. To reach one of our Business Law & Commercial Real Estate attorneys please call our office at 617-951-3100.