What is considered as Breach of a shareholder agreement?

A shareholders’ agreement is a written consent or contract reached between company and some or all of its shareholders. It deals with all aspects ranging from relationship between the parties, personal rights and obligations of the shareholders.. The aim of shareholders’ agreements in South Africa is to regulate and record the relationship between shareholders and the Company, and the relationship amongst the shareholders themselves Together with the company’s articles of association a shareholders’ agreement creates internal “rules” upon which companies working mechanism is decided.

But Shareholder Agreement is unable to guarantee that there always exists consensus of all stake holders involved. There is always a likelihood of breaches   to be committed by shareholders (minority/majority) or the directors.

Following are some common examples of shareholder disputes, generally involving issues of control, use of assets or strategy:

• Shareholders reservations on director’s performance.
• Profit dividend sharing mechanism.
• Minority shareholders claim of “unfair prejudice” by majority shareholders.
• Ambiguities related to financial data communication to shareholders.
• Failure to inform shareholders of meetings and/or exclusion from meetings.
• Breach of any existing shareholders agreement or the articles of association.
• Hegemony of few dominant shareholders undermining the rights of other shareholders.
• Conflict of interest claims
• Departing shareholders(death of shareholder, new ventures, disqualification pertaining to shareholder agreement clauses in case of conviction or been declared defaulter)

In buildup to such breaches, minority shareholders always end up at receiving end. Only sensible formulation of a shareholder agreement leads to a pragmatic solution for them. Because always remember in order to cut down on legal costs you need to address your weaknesses in your relationship with the new partner.

When and why it happens

Problems arise because of

1. Nonexistence of shareholder agreement, either because you trust your new partner too much or you find yourself too much engulfed in setting up new business, hence compromising on key documentation formulation which helps you setup working mechanism for the company. Despite of strong relations still business relations are found fraught enough to crumble on issues pertaining to distribution of profits to hiring of kin’s.
2. No shareholder agreement means no legal documentation to prove your existence in the company. Being a minority shareholder without documentation backing gives rise to majority shareholder hegemony. Role of directors cannot be ruled out as well, and if they are shareholders as well you are asking for more trouble.
3. Transfer of shares also can be termed as a reason. In case of existence of shareholder agreement there are mechanisms to be followed. Otherwise foul practices can be anticipated against the will of other shareholders.
4. Legally the new Companies Act now maintains that any provision of a shareholders’ agreement that is inconsistent with the Act or with the company’s Memorandum of Incorporation (MOI), being the primary constitutional document of a company under the Act, is void to the extent of such inconsistency (Section 15(7) of the Act), on 1 May 2011.

How much damage that can cause to parties?

Any dispute itself is detrimental for a new company. In its inception years if a company goes through legal disputes then there is no hope for it to survive, considering high costs involved in legal procedures. But for case study sake, minority shareholder’s immediate damage can be dismemberment from the company; pertaining to nonexistence of shareholder agreement. But it depends on case to case. In case of human capital investment in the company there can be irregularities in valuation of your efforts. On monetary grounds because of legal costs and investments put into the business, company is bound for losses.

Penalties, if any for breaching a contract

That again depends on shareholder agreements that is signed between the members. In case of breach of any clause of the agreement, damages are prescribed. According to these damages every member is bound to compensate or else legal procedures will be adopted for recovery of dues. These damages can be in the form of monetary penalties or disassociation from the firm.

How comprehensive agreements can prevent such situations

The parties to the shareholders agreement may decide which aspects they wish to include in the agreement. In terms of South African law, any relationship, interest or obligation relating to the company of which the shareholders have an interest may be included in a shareholders’ agreement, provided always that such matter does not conflict with the Act or the company’s MOI. It may, for example, be preferable for information which the shareholders wish to keep out of the public domain to be dealt with in shareholders’ agreement. Normally following clauses are included in the document

• Definitions.
• Relationship of parties
• Directors.
• Proxy votes.
• Company’s obligations.
• Actions for which shareholders’ consent is required.
• New intellectual property.
• Confidentiality.
• Exit strategy.
• Transfer of shares and right of pre-emption.
• Procedure after transfer.
• Transfer of shares on death or incapacity.
• Shareholder’s continuing obligations.
• Restrictions on shareholder after transfer.
• Conflict with the articles.
• Breach of this agreement.
• Agreement is divisible.
• Notices and service.
• Dispute resolution.
• Waiver.
• Jurisdiction.

But all that needs to be formalized beforehand. Line of business needs to be clarified so as to avoid any inconvenience at your end no matter if you own the company or are just a small part of it. Key is that you must be safe legally.