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What is a Shareholder Agreement, and how does it function?

If you are forming a partnership with others to do a business, you will hear about Shareholder Agreement, it may also be called as Partnership Agreement, and MOA of the company. This publication is aimed to give businessmen and investors a deep insight about Shareholder Partnership Agreements and MOA’s, and how to negotiate the best terms for your partnership with others.

Introduction – definition of a Shareholder Agreement.

1. Definition

A Shareholder Agreement is a legally binding document between the Shareholders of a company, which defines the relationship between the Shareholders. This specifies that the company’s Shareholders are each partners of the company by the share they hold, having equal rights to their shares as Shareholders. This agreement will specify the functioning of the business, how decisions are made, and how the interests of the Shareholders will be protected. This is significant as the Federal Law No. 5 of 1985 (Civil Code) or the Federal Decree Law No. (32) of 2021 on Commercial Companies does not give requirements for Shareholder Agreements. It is stated that Agreements may either be conducted in writing or orally. Despite this, it is suggested that an Agreement between the Shareholders be made in writing to avoid disagreement on what has been agreed. A Shareholder Agreement sets out the Shareholders’ arrangement, which includes the Shareholder’s understanding of their rights, obligations, representations and warranties under the Shareholder Agreement.

2. Importance of distinguishing from MOA

There are a few important things to pinpoint as to why it is suggested to have a separate Shareholders Agreement. There should be a document specifying the Shareholders’ rights, as these do not appear in detail from the company MOA. The MOA of the company sets out the details of the company, but it does not specify the rights, obligations, or relationships between the Shareholders, which the parties may want to keep confidential from the public. Therefore, the Shareholders’ Agreement and the MOA should be distinguished, as they do not cover the same legal rights. The Shareholder’s Agreement will specify the role of each partner and his obligations to the company, and how the business will be financed by the Shareholder as needed, which are not apparent from the company’s MOA. Hence, a separate Shareholders Agreement will set out these Shareholders’ roles specifically. It can be tailored according to the Shareholders’ needs and include provisions at their discretion within the objectives of the law.

3. Flexibility

Some of the provisions in Federal Decree Law No. (32) of 2021 on Commercial Companies gives more leeway for the Shareholders to tailor the provisions in their Shareholder Agreement the way they see best suit, however, some provisions require precise application as to their meaning in law. The law does not specify all instances the Shareholders may wish to cover in their Shareholder Agreement. To ensure the smooth operation of the company and the execution of the business, it is necessary to ensure that all required Shareholders’ rights and obligations are set out in the Agreement. Once all partners agree on the terms, the Shareholders shall sign the Shareholders’ Agreement. This agreement will also prevent instances of potential disputes between the Shareholders. If the Shareholders’ Agreement specifies the nature and ability to execute the shares during a potential disagreement, it will ensure the smooth operation of the company in such time. If this has not been specified in the Agreement, it will create difficulty in defining the rights of the Shareholders towards their shares as Shareholders during a dispute.

Understanding the nature of the operation of the laws in the Shareholder’s Agreement is essential, as this enables tailoring it to suit the desired execution of the Shareholder’s obligations. It is useful to draw attention to these different reasons for drafting Shareholder Agreements by seeking each in turn. 

Difference between standard MOA and Shareholder Agreement.

It is crucial to distinguish the Shareholder Agreement from other documents, such as the MOA of the company, as these are two different documents.

  • Nature of the Documents

The MOA of the company is a public document that gives a general overview of the functioning of the business and its structure. It acts as the company’s constitution upon which decisions and amendments can be made to the structure of the business. This is because MOA acts as the foundation of the company through which the business is built- it identifies the powers held by the business, but it does not give detailed information on the company’s operation. 

In contrast, the Shareholders’ Agreement is a private document between the Shareholders, giving private information about the company’s operation and specifying the obligations of Shareholders.  It is only available to the Shareholders of the company. It sets out a specific description of the Shareholders’ roles and contributions to the business, either monetary or in-kind, paid or without consideration, operation of the business, including terms of financing the company through shareholder loans and restructuring of shares to pay the finance made by Shareholders. Moreover, it can include confidential clauses for the company’s intellectual property, business data, and business operations, including shareholder details, a non-compete clause, and non-solicitation for clients or employees for existing Shareholders.

  • Bindingness of the Agreements

The MOA of the company is only binding on Shareholders within their capacity as Shareholders against a third party dealing with the company. Whereas the Shareholder’s Agreement is binding between the Shareholders only, establishing precise obligations of the Shareholders and their proportion of shares against each other. This cannot be established in the MOA of the company, as it is a public document, setting out the definition of the limitations and scope of the company by establishing the business it engages in, its objectives, future ventures, the scope of its resources, and limitation of the Shareholders to the value of their shares. It does not detail the strategies with respect to the obligations of the Shareholders.

  • Flexibility of Shareholder Agreement

A Shareholder Agreement gives the possibility to set out the terms and rationale of the Shareholder’s duties more precisely, giving the Shareholders flexibility to specify their aim and purpose with the business according to its strategic aims. Shareholders’ Agreement allows this by tailoring the provisions to suit the aim and purpose of the business. It also gives the possibility to change the obligations of the Shareholders under the Shareholder’s Agreement if they see suit. This can usually be done in the annual general assembly meetings, where the Shareholders collectively agree to meet on a specific date, where they can vote and discuss anything they wish to bring up, whether it is a concern or feedback. The Shareholders’ Agreement can be drafted according to the Shareholders’ needs, including clauses to fit the Shareholders’ purpose in the company and for business operations according to the relevant law. Therefore, it is necessary to draft this Agreement.

Why do partners sign Shareholder Agreements?

Partners sign Shareholder Agreements to protect the interests of the Shareholders in the activities the company engages in, including, but not limited to:

1. Minority and Majority rights

For instance, setting out the rationale of minority and majority Shareholders’ rights in the Shareholder Agreement will protect the interests of both. This way, a structured and detailed day-to-day model can be constructed for the company’s functioning. This model is important to form, as the law does not state all the necessary rights and obligations for Shareholders in the operation of the company. It is significant to ensure that the specific needs of the Shareholders are met in the company.

2. Shareholder’s role during a dispute

A Shareholder Agreement should give guidance to the Shareholders on their role in the company’s day-to-day activities. It should include a clause stating the procedures for the Shareholders during a potential disagreement between them by outlining how such instances would be overcome. This can be done by including common reasons for disagreement and how these will be executed. This ensures the smooth functioning of the business in times of dispute without disturbing the functioning of the company. Thereby, the Shareholders’ Agreement also protects the shareholders and the business by specifying the rights and obligations of the Shareholders and their roles. This is one of the main reasons why partners sign Shareholder Agreements.

How do the laws operate in a Shareholder Agreement?

  1. Binding laws

It is crucial to be mindful of how the law provisions on Shareholders sit with the Shareholder Agreement. Federal Decree Law No. (32) of 2021 on Commercial Companies specifies provisions binding on Shareholders, which shall be included in the Shareholder’s Agreement. These laws are mandatory for the Shareholders of a company and shall hereby be added to the Shareholder’s Agreement due to their binding nature. These laws must be incorporated according to their meaning. Such rights include voting rights and the distribution of profits. According to Federal Decree Law No. (32) of 2021, a Shareholder shall have all rights to its share, including the i) right to obtain its proportion of profits and assets of the company in a time of liquidation in alignment with its share value, ii) to attend general assembly meetings, and vote on its decisions under the laws and articles of association of the company. Shareholders can also check the books of the company. These are mandatory rights that must be complied with by the company and its Shareholders.

1.1. Distribution of profits

Article 243 specifies the Shareholders’ distribution of profits; it states that the Company’s General Assembly shall determine the net profit percentage to be distributed to the Shareholders after deducting the statutory and voluntary services. According to the law guidelines, a Shareholder is entitled to his share of profits, which prevents the Shareholders from excluding any of the partners from receiving their profits; this law is non-negotiable and must be executed as stated in the law. Depending on the discretion of the General Assembly, the company’s AOA may commence distribution on an annual, semi-annual, or quarterly basis.

1.2. Equal voting rights

Article 180 (1) of the Federal Decree Law No. (32) of 2021 on Commercial Companies grants all Shareholders equal voting rights. The weight of the vote is subject to the value of the share. For example, if the share value is 5% of the company’s shares, the weight of the vote by this share is 5%. The number of votes received by each share towards a decision will contribute according to the share value. This way, the law granting equal voting rights to the Shareholders will be complied with. However, the majority Shareholders, e.g. those holding 40% and 50% of the company’s shares, will have the ultimate weight on decisions based on their share value and the number of shares in the company.

1.3 Tailoring of voting rights

To ensure that the rights of the minority Shareholders are secured, the Shareholder Agreement could include specific clauses granting the minority Shareholders the right of a proportion of the profit from the sale of a deal related to the decision made by majority Shareholders so they can exist on the same terms. Accordingly, if the company is sold upon receiving a good offer price for it, the Shareholders’ Agreement can include a clause that specifies such a transaction to grant the minority Shareholders the right to have a proportion of the profit of the sale. This way, minority Shareholders’ rights are included. These rights are called tag-along rights. However, this is restricted for not having weight in a decision on such a transaction; the rights of the majority Shareholder to enforce such sale transactions are called drag-along rights. These rights are non-binding, as they can be added and tailored to the Shareholder’s Agreement to suit the Shareholders’ preferences. Other laws with such a non-binding nature are pre-emption rights, the right to grant loans over shares and the right of first refusal. Although these rights can be tailored, the amendments must still be within the objectives of the law and in alignment with any related binding law provisions.

2. Non-binding rights: Preemption rights

Preemption rights are specified in Article 77 of the Federal Decree Law No. (32) of 2021 stating that the partner specified in the Shareholder Agreement is granted the right to be offered a share first upon its sale before offering it to others. This right is usually granted to the partner(s) holding most of the shares in the company, giving the exclusive possibility to purchase the share. Upon rejecting the offer to purchase the share, it will be subject to being offered to any of the other Shareholders in the company. This right is non-binding. However, partners usually want to include this, as it prevents the sale of the company’s shares to whoever.

3. Granting loan for shares

Another non-binding right is granting loans for shares. It is up to the Shareholder’s discretion to mortgage its shares, pending the partners’ and company’s approval. Loaning shares is a temporary grant of the transfer of ownership of the share to the lender, who then gains interest in the shares. If the loan is unpaid, the shares can be sold. In the UAE, both free zones and mainland allow the grant of loans over shares; the rules for executing such transactions may differ. Therefore, these should be sought from the specific freezone or mainland where the company is formed and included accordingly to the Shareholder Agreement. The possibility of tailoring some of the Shareholders’ rights and restrictions in the Shareholder’s Agreement will result in the fair execution of the business’s day-to-day operations. It is significant to state these in writing, as they are not all specified in the law. Hence, they will only become binding if included in a Shareholder Agreement.

Conclusions

To conclude, the purpose of the Shareholder Agreement is to ensure that all the rights that the Shareholders are subject to and may be eligible for, are included in the Agreement, thereby ensuring the smooth execution of the rights and obligations during the company’s operations. It is noteworthy to pinpoint the importance of drafting the Shareholder Agreement to prevent or resolve any conflict between the company’s Shareholders: It will ensure a straightforward division of the company’s assets to its Shareholders.

Lastly, it must be remembered that this document shall be distinguished from the company’s MOA, as it covers different rights and obligations.

 

Nour Attorneys and Legal Consultants can help you to understand more about shareholder agreements.

Jasmine Dear

Legal Consultant 

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