A shareholders’ agreement is a private contract between the shareholders of a company under which they agree to regulate their rights as owners and shareholders of the business.
It is distinct from the company’s constitution which is regulated by the Corporations Act. In the absence of a shareholders’ agreement, minority shareholders are at risk that, pursuant to the constitution, the majority of shareholders constituting 75 per cent or more of voting rights, may amend the rights of all shareholders.
If there is a conflict between the shareholders’ agreement and the constitution then it is common for the terms of the shareholders’ agreement to provide that the terms of the shareholders’ agreement prevails.
A shareholders’ agreement is an enforceable contract agreed between all shareholders and which can generally only be varied with the consent of all parties. Therefore, it operates to protect shareholders by creating contractual rights particularly in the case of minority shareholders.
It can deal with a range of issues relating to ‘control’, for example, upon the transfer or issue of shares by giving existing shareholders an equal right of pre-emption or an option to purchase the shares of an existing shareholder.
Minority shareholder oppression
The recent case of SDW2 Pty Ltd v JLF Corporation Pty Ltd & Ors  QSC 001 (16/7342) in the Supreme Court of Queensland demonstrates the utility and importance of a shareholders’ agreement in protecting the rights of a minority holding.
The dispute involved shareholders of Custodian Funds Management Group Limited (CFMG). CFMG’s principal business was to hold interests in and to raise funds to support the businesses of its subsidiary entities that provided property development, syndication and asset-backed income stream investment opportunities for investors located throughout Australia.
The plaintiff, Shareholder 1, who was a shareholder in CFMG, sought an interlocutory injunction to restrain CFMG from holding certain meetings and restraining another shareholder from casting votes on particular resolutions on the basis of an alleged breach of the option rights in a shareholders’ agreement, which permitted Shareholder 2 to acquire the shares of other shareholders and which had not been afforded to Shareholder 1.
The shareholders’ agreement provided that upon an ‘Event of Default’ by a shareholder, the non-defaulting shareholders would have an option to acquire the defaulting shareholder’s shares.
Shareholder 1 alleged that five events of default had occurred including that Shareholder 2 was in breach of a non-compete prohibition in the shareholders’ agreement which provided that each shareholder and its affiliates must not compete with CFMG or do business with its customers and each shareholder.
Accordingly, the breach by Shareholder 2, gave rise to an option right for Shareholder 1, as a non-defaulting shareholder, to acquire the shares of the defaulting shareholders.
In the interim, Shaw Investment (‘Shareholder 3’) had sought to transfer its shares to Shareholder 2 in contravention of the shareholders’ agreement.
Shareholder 1 commenced proceedings which alleged that a transfer of shares by Shareholder 3 to Shareholder 2 was void, and that it (Shareholder 1) was therefore entitled to purchase the shares of Shareholder 2 and Shareholder 3 as both had breached the shareholders’ agreement.
The case primarily considered whether there was a ‘prima facie’ case for the purposes of interlocutory relief and whether the application ought to be refused because there is no relevant threatened infringement of the rights of Shareholder 1.
The shareholders’ agreement provided that Mr Watson, who controlled Shareholder 1, and was a director of CFMG’s three subsidiary entities, could only be removed from the three subsidiary entities’ boards by way of a resolution of a ‘Special Majority’ of shareholders which, though commonly 75%, was 85% of the ordinary shareholders in CFMG.
CFMG had called a meeting of shareholders for the purpose of removing Mr Watson.
Shareholder 2 intended to remove Mr Watson from the board and to control the company, and sought to increase its holding to 88% by acquiring the 14% interest held by Shareholder 3.
On the other hand, Shareholder 1 intended to retain Mr Watson on the various boards in the group and sought to increase its holding by commencing proceedings seeking an order to permit it to acquire the combined interests of Shareholder 2 and Shareholder 3 as a result of their default under the shareholders’ agreement. As a consequence, if successful, Shareholder 1 would then increase its holding to 96% and acquire control of the company.
Bond J found that there was a prima facie case that there is a real risk of harm to the value of the option rights of Shareholder 1 (‘SDW2’) as a result of the actions of Shareholder 2 (‘JLF’) to the following effect:
“I am satisfied that SDW2 has established a prima facie case that the purported acquisition by JLF of Shaw Investments’ 14% shareholding of CFMG was void and that JLF threatens to exercise a voting entitlement which there is a prima facie case that it does not have. That voting entitlement would be critical in JLF’s ability to establish the special majority which would be necessary to remove Mr Watson as director.”
The case underscores the importance of protecting the rights of a minority shareholder by way of contract. Without the option rights in the shareholders’ agreement, Shareholder 1 would not, in the event of anti-competitive behaviour by other shareholders, have a contractual right to exert control over the ownership of the company or otherwise restrain anti-competitive conduct of other shareholders, other than by utilising the minority shareholder oppression provisions in the Corporations Act.
Should you require assistance or advice on the preparation of a shareholders’ agreement, strategies regarding ownership and control of your business or protection of shareholder’s rights such as a minority shareholding or anti-dilution of a majority shareholding, please contact our Corporate Advisory Principals Michael Bracken or Mark Fitzgerald.
See Part 2 of this article which was published in Commercial insights – November 2017.