Shareholders' agreements in Kenya

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published on April 5, 2019 | Reading time approx. 7 minutes

 

Shareholders' agreements are, as the name suggests, agreements between shareholders in a company. They are used, in addition to the articles of association, to provide rules to govern the running of the company.

 

 
A shareholders' agreement can be entered into by some or all of the shareholders in a company. It is often the case that it is prepared to bind all the shareholders of the company. In such instances new incoming shareholders will be mandatorily required to accept to be bound by it by signing a deed of adherence. It is however possible for a part of the members of the company to enter into an agreement amongst themselves. For instance minority shareholders may enter their own to secure their interests. Shareholders' agreements are however generally more effective where they bind all the shareholders in the company.

 
A shareholders' agreement as mentioned, is used as a secondary means to the articles of association in order to govern the shareholders' conduct in relation to the running of the company. Articles of association are mandatory for every company and are public documents filed with the Companies Registry. Shareholders' agreements on the other hand are not mandatory and are entered into as needed. They are private contractual documents and need not be filed at the Companies Registry. They tend to provide for the same or similar things though if well drafted they can be distinct yet compatible and complimentary documents. To deal with conflicts between the documents, the parties may agree on which document is to take precedence, which is typically the shareholders' agreement. However in cases where the shareholders' agreement is silent on a particular matter that the company’s articles address, the articles will take precedence and vice versa.

 
A shareholders' agreement may provide for any number of matters the shareholders may desire. It is, after all a contract and parties are free to draw it up any way they please. There are however, certain clauses that feature in a typical shareholders' agreement. In this article, we will highlight what some of these clauses are.

 

Management of the company

Board of directors – Shareholders' agreements contain detailed provisions on the qualifications required for seats on the board. The composition of the board of directors can be a point of contention between shareholders as it determines the level of control shareholders have in the day-to-day running of the company. Where majority shareholders would like to protect themselves from the participation of minority shareholders in the decision making process, they may for instance limit the right to board seats to shareholders with shareholding above a certain specified threshold. Equivalently minority shareholders will seek representation on the board to exercise influence larger than their shareholding to protect their particular respective interests. The shareholders' agreement will also provide for the manner in which board meetings are to be convened and conducted, specifying the number of meetings to be held in a year, the manner in which meetings are to be called and how decisions are to be made.

 
Reserved matters - Shareholders do not have a role in running the day-to-day activities of a company despite being the owners of the company. Decisions about the day-to-day management of the company, such as entering into agreements with customers and suppliers, recruitment and determining the remuneration of staff, is ordinarily reserved for directors and their staff. For shareholders who do not have a seat on the board of directors, it would appear that they have no opportunity to have a say in the goings on in the company. Shareholders may specify certain actions by the company, in the shareholders' agreement, matters that require the approval of the shareholders. Shareholders may, for instance, require that contracts and loans with a value above a certain threshold must be approved by shareholders either by super-majority/unanimous vote.

 

Issuance or transfer of shares

A typical shareholders' agreement will set out in detail provisions controlling the issuance or transfer of shares in the company.

 
Pre-emptive right – This gives existing shareholders the right to purchase any new shares the Company may issue before they are offered to third parties.


Right of first refusal – This requires shareholders of the company seeking to sell their shares to first offer them to existing shareholders. Shareholders seeking to sell their shares may simply be required to first offer their shares to other shareholders to purchase. If they fail to purchase then they will be allowed to offer them to third parties. Alternatively, the shareholder may be required to first procure an offer from a third party and to make an offer to existing shareholders to purchase the shares on the terms and at the price the third party is willing to pay.

 
Drag-along – Drag along rights serve to protect a majority shareholders interests in a future merger or acquisition allowing them to force minority shareholders to sell off their shares to the counterparty at the same price and terms as they had negotiated. This prevents a standoff with minority shareholders, who may want to delay or frustrate such a deal.

 
Tag-along - Tag along rights protect minority shareholders in a future merger or acquisition giving them the right to be included in a proposed transaction negotiated by another shareholder. It works to the benefit of minority shareholders by giving them an opportunity to benefit from the deal the majority shareholder negotiated (if it was indeed a good deal). It also gives minority shareholders the opportunity to exit at the same time as a majority shareholder and to avoid having to deal with a new shareholder.

 

Anti-dilution protection

Dilution is a reduction in the percentage of ownership a shareholder has due to the issuance or allotment of new shares by the company. To guard against this, shareholders may include anti-dilution provisions in their shareholders' agreement. Clauses on pre-emptive rights can provide some anti-dilution protection as they may be drafted to provide that existing shareholders will have a right to purchase the newly issued shares in proportion to their current shareholding therefore shareholders retain the same percentage shareholding after the new issue.

 
Investors holding convertible preferential shares will also want to protect themselves from dilution in instances where further shares are issued to new investors at a lower price. There are two methods used to protect against dilution in these circumstances namely full ratchet and weighted average. A full ratchet protection will function to change the conversion price to the lower price, so that the existing investor gets more shares to maintain the percentage stake they had originally bought in for. A weighted average protection works in the same way but will factor in the number of new shares being issued, such that the issuance of a small number of shares will alter the conversion price minimally and vice versa.


Deadlocks

Deadlocks in decision-making by shareholders can cripple the operations of a company. Deadlocks can arise for instance, where shareholders with equivalent voting rights take different positions on a matter and none is willing to compromise on their own. It is important to include deadlock provisions in shareholders' agreements especially where the possibility of deadlocks is foreseeable, for instance where there are an even number of shareholders with the same number of shares and voting rights.

 
Deadlocks can be resolved through mediations or arbitrations done by mediators and arbitrators appointed by the shareholders. These of course can fail to resolve the deadlock. Alternative arrangements for the most part involve forcing shareholders to sell off their shares to each other to break the deadlock.

 
In one known as ‘Russian roulette’, one shareholder (A) may make an offer to purchase the shares of another (B) at a particular price. Then B may accept the offer or counter to purchase A’s shares at the price a set. Others involve shareholders making sealed bids to purchase the other’s shares. The shareholder who bids highest is required to purchase the other’s shares.

 

Death of shareholders

The legal title to shares in a company will pass to the shareholders heirs upon their death. The remaining shareholders may want to plan for such an eventuality as it will have consequences on how the business will run. Shareholders may be concerned about having heirs, with whom they have had no developed business relationship, becoming ‘partners’ in the business. This eventuality can however be dealt with in a shareholders' agreement in various ways. One way is to provide that in the case of the death of a shareholder, their personal representatives of the deceased will be required to sell off their shares to the surviving shareholders at an agreed upon price. Further, like in the ‘Russian roulette’ discussed earlier, one can require the personal representatives to purchase the surviving shareholders shares if they do not agree to sell their shares.

 

Non-compete, non-solicitation and confidentiality

Shareholders' agreements will often contain provisions to prevent shareholders, who tend to have intimate knowledge of the business the company is engaged in, from competing with the company. These provisions will for instance prevent shareholders from engaging in business activities similar to that of the company, prevent them from recruiting key members of staff of the company and to require them to maintain the confidentiality of proprietary information they may become privy to and not to use it even after they exit from the company.

 

Financing the company

Shareholders may want to provide for the manner in which the funding requirements of the company will be met. The shareholders may specify, if it is possible, what the expected funding requirements of the company are, what contribution is expected of each shareholder, what alternatives sources of funding the company may use if the requirements cannot be met by the shareholders, amongst other things.

 

Conclusion

Shareholders' agreements really are a product of the negotiations between the shareholders and may contain such further clauses as the parties and the circumstances require. It is important that care and consideration is given to the drafting of the agreements due to the long-term implications of the terms they contain. If well negotiated and drafted they provide a means for shareholders to properly organize their relationship and to gain security and certainty in respect of the differing interests they have in the company.
  

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