Shareholders Agreements, also sometimes called a Security Holders Agreement (SHA) are a written agreement between the shareholders of a company and sets out in a transparent manner the obligations, rights and responsibilities shareholders and directors have to a company and to each other to ensure its efficient and effective management.
One of the issues the SHA must deal with is how a shareholder will exit the company, whether it is voluntarily or as a result of being dismissed, including how their shares are transferred.
The terms Good and Bad leavers are used to describe the mechanism when a shareholder will leave the company.
What is the difference between a Good and a Bad leaver?
Good leaver provisions
These are generally provisions in the SHA where a shareholder leaves the company for a fair or what is often referred to as a ‘good’ reason.
It could be due to:
- Dismissal – whether constructive or unfair
- Illness or injury
- Unfair dismissal
- Voluntary resignation
- Winding up or deregistration of the company
If this provision is enacted the shareholder will be required sell back their shares to the company in the first instance.
It is important when drafting a SHA that consideration is given to how the price for the shares will be calculated, how the shares will be divided amongst the remaining shareholder/s or the mechanism to sell to a third party.
Bad leaver provisions
These provisions, as the name implies, is when a shareholder leaves the company on unfavourable or unreasonable grounds including misconduct.
Often this occurs when a director is dismissed.
Other examples of this are when a shareholder:
- Becomes bankrupt
- Commits an act of misconduct
- Commits a fraud
- Damages the reputation of the company, the directors or the shareholders
- Fails to meet the requisite standards expected of a shareholder, or if they are also a director, in carrying out their duties
How is the value of shares determined if a good or bad leaver results in the shares having to be sold?
In the case of a private company, it can be often difficult to determine the value of the shares.
It can be very subjective and lead to significant disputes when these provisions are enacted.
To avoid a dispute the SHA should (and if the shareholder is also a director even their employment contract or service contract) clearly outline the methodology to calculate the value of the shares.
I always strongly recommend that an agreed formula should be determined and clearly outlined in the SHA.
If a formula cannot be agreed upon then I recommend an independent third party such as a qualified accountant be engaged to carry out the exercise.
In many instances it is agreed that the company accountant will undertake the valuation if they have the requisite skills.
Generally, the remaining shareholder(s) will seek to buy the shares, but if that is not possible then the company could arrange for the shares to be sold to a third-party investor as long as any rights to the remaining shareholder(s) have been complied with.
In practice a Good leaver will be at fair market value as at the date of the provision being exercised.
It is generally paid at the time of leaving but there is scope to retain a proportion of the purchase price to ensure the person does not exhibit any bad leaver behaviour.
On the other hand, the purchase price for a bad leaver’s shares is generally discounted and will be at a lower price.
I have seen instances where it can be between 50 to 80 per cent of their fair market value in an SHA for Bad leavers.
How can FC Lawyers help with Shareholders Agreements and Security Holders Agreements?
FC Lawyers have a very experienced and expert team of corporate lawyers who have significant experience in drafting Shareholders Agreements and Security Holders Agreements.
Contact our team today to discuss your needs.
The information provided in this article is for general information and educative purposes in summary form on legal topics which is current at the time it is published. The content does not constitute legal advice or recommendations and should not be relied upon as such. Whilst every care has been taken in the preparation of this article, FC Lawyers cannot accept responsibility for any errors, including those caused by negligence, in the material. We make no representations, statements or warranties about the accuracy or completeness of the information and you should not rely on it. You are advised to make your own independent inquiries regarding the accuracy of any information provided on this website. FC Lawyers does not guarantee, and accepts no legal responsibility whatsoever arising from or in connection to the accuracy, reliability, currency, correctness or completeness of any material contained in this article. Links to third party websites or articles does not constitute any endorsement or approval of those sites or the owners of those sites. Nothing in this article should be construed as granting any licence or right for you to use that content. You should consult the third party’s terms and conditions of use in relation to any third-party content. FC Lawyers disclaims all responsibility and all liability (including liability for negligence) for all expenses, losses, damages and costs you might incur as a result of the information being inaccurate or incomplete in any way. Appropriate legal advice should always be obtained in actual situations.
Prefer to get in touch?
With offices in Brisbane, Sunshine Coast and Sydney, our team is well equipped to provide both advice and support across a broad range of legal areas.