Companies are governed, in general, by their constitutional documents - the memorandum of association and articles of association.  The articles of association (normally simply called "articles") set out the rules under which the company is run, including, inter alia, rules for the purchase and sale of the company's shares, rules for shareholders meetings, rules for the appointment and removal of directors and the conduct of directors meetings.  Companies when set up have default articles under the Companies Acts (sometimes referred to as Table A articles, after the part of the Act that sets them out), but these are almost always substituted in whole or  in part by separately drafted articles to suit more closely the company's business.  The articles take effect as a contract between all of the shareholders of the company from time to time.

The sole use of articles to govern a company's affairs and the relationship between its shareholders has a number of disadvantages, including:

PUBLICITY - the articles are filed with the Registrar of Companies and are made available for public inspection.  There are a number of perfectly valid reasons why shareholders would wish to have their agreement kept out of the public gaze, perhaps involving sensitive financial settlements between the shareholders or disclosing aspects of the company's business which are confidential in order to give it a competitive advantage.  Such aspects should be covered in a private document.

UNIVERSALITY - articles generally have equal effect to ALL shareholders.  It is possible to achieve differential effects by setting up different classes of shares, but this is of limited effect and can be very complicated.  It is open to groups of shareholders to agree to take certain actions between themselves and then to record this in a separate agreement.

UNANIMITY - certain agreements regarding the conduct of a company are so crucial that they require complete unanimity to change them.  Articles are changeable at the behest of a 75% majority of the shareholders (this is somewhat qualified where the company has a number of different classes of shares).  Contracts generally require unanimity to amend them.

It is quite common to put shareholders agreements in place to avoid the disadvantages of relying on the articles.  Many agreements govern, for example, what separate groups of shareholders can do independently of the others, provide rights to appoint one of more directors to distinct groups of shareholders, limit the power of the company to perform certain acts without the consent of one or more groups of shareholders and/or provide rules for exit of shareholders (rights of first refusal, provisions for price setting, provisions for compulsory sale if the shareholder ceases to be an employee, provisions on retirement etc).

It is also common in venture capital investments for the structure of the investment to be recorded in an investment agreement, which includes the elements of a shareholders agreement in addition to dealing with warranties, intellectual property rights and other investment specific issues.

VS&H have drafted customised shareholder and investment agreements for a very large number of companies and have broad experience both of the type of clauses that are generally incorporated and how to customise them for specific circumstances.

For further information please contact:

john.davies@vshlaw.co.uk or

martin.jinks@vshlaw.co.uk or

su.knowles@vshlaw.co.uk