What Founders Need to Know about Shareholders’ Agreements
Shareholders have only limited rights and obligations in respect of a company limited by shares (Aktiengesellschaft). Their main obligation is to put in the paid-up capital. In return, they will receive a financial share of the company’s profits. They will also have the right to be informed about certain matters and, depending on the shareholding, a right of co-determination.
The law leaves some room for maneuver in how articles of association can be structured. Unlike with a limited liability company (GmbH), it is though not possible to impose shareholder obligations that go beyond the requirement to make a capital contribution.
So that specific needs can be met in some cases, individual or all shareholders may conclude a shareholders’ agreement. This can be freely structured and amended prior to or at any time after the company is formed.
Potential content of a shareholders’ agreement
When it comes to the content of the shareholders’ agreement, the principle of contractual freedom applies, although some mandatory legal requirements must be observed.
The following agreements are permitted:
Voting right commitments: Individual shareholders or groups of shareholders enter into agreements on voting on general meeting resolutions and elections.
Seats on the board of directors: Shareholders guarantee each other representation on the board of directors if their shareholding reaches a certain size.
Restrictions on selling: Selling shares to non-shareholders is restricted or prohibited.
Pre-emptive rights, and purchase and selling rights: If certain conditions are met, shareholders are granted the right to purchase shares from or sell shares to other shareholders at predefined conditions.
Co-selling rights and obligations (tag-along and drag-along): If a controlling majority shareholder sells their shares, minority shareholders are entitled (tag-along) or obligated (drag-along) to a co-sale.
Dividend payments: Contractual agreements on dividend policy.
Non-compete clauses: This may have to be contractually agreed as the law does not provide for a fiduciary duty or a non-compete clause for shareholders.
Safeguarding contractual agreements
A contracting party may demand from other parties either actual performance of their contractual obligations or, if a breach of contract occurs, damages. Additional safeguards are often needed as a shareholders’ agreement has no binding effect on the company itself and actual performance is effectively unenforceable, for example after votes have already been cast in breach of contract.
Although the contractual penalty cannot prevent a breach of contract, it is an effective preventive measure against breaches.
The defined penalty payment exempts the claiming party from proving a specific damage, and this simplifies the process of enforcing a claim for compensation.
To prevent conduct in breach of contract regarding disposal of shares or voting restrictions before it happens, the shares of the bound shareholders may be deposited jointly, or a representative may be appointed to exercise shareholder rights vis-à-vis the company.
An imminent breach of contract can also be prevented by applying to the courts for an interim measure. But the legal bar for this is high and it is often difficult to achieve in practice.
As technology progresses in areas such as company shareholding rights (ledger-based securities) and the associated participation rights, we will see ever more tech-driven solutions to ensure compliance with contractual obligations. Some that spring to mind are “smart” shareholder agreements that are structured as computer protocols and so automate performance of contracts and prevent breaches.