The Law Office of Hutchinson, Thompson, Henderson & Mott

Unanimous Approval By Shareholders

November 18th, 2013

By: Nathan Green

I have written before about the function of a Shareholders Agreement for any company with more than one shareholder.  I noted at the time that there are many important elements of a Shareholders Agreement and today I would like to address one that is often overlooked by clients – the matters which will require unanimous approval by the Shareholders.  This often sounds like legal jargon but it can be vitally important.

Imagine a flower shop that incorporated with a 60/40 ownership.  Let us also assume for the moment that litigating is not a workable option (the oppression remedy is fairly limited in scope and that type of litigation can be extremely expensive).

Now, what mischief could the 60% majority owner of the corporation get up to?  Generally in the corporate setting people are concerned with the direction of the company and its money.

A minority shareholder might be excluded from the board of directors, which in turn would exclude them from appointing officers which in turn would exclude them from all decision making by the corporation.

So if one shareholder wanted to take the flower store online and begin soliciting big corporate accounts and the other wished to keep it as a small local enterprise, the majority shareholder could simply steam roll the minority shareholder and effectively exclude them from influencing the course of the company.

The other mischief has to do with money.  A majority shareholder can influence the board of directors to pay the shareholder an exorbitant salary, issue new shares, declare unequal and large dividends, or encumber the company to finance a risky endeavor.  Regardless of how it comes about the minority shareholder’s revenues from the company and equity in it can be put at risk or modified in unwelcome ways by a majority shareholder.

The take away is that a minority shareholder will be under the thumb of a majority shareholder, especially in the context of a small business where litigation is not a practical option and an emotional connection to the business is involved.  It is also worth noting that this would also apply to situations with more than two shareholders.  If a company had one shareholder with a 40% interest and six with 10% interests the six small shareholders could group together and have as much power as if one person owned 60% of the company.

A well drafted Shareholder’s Agreement offers a practical form of protection by requiring unanimous agreement for certain corporate actions.  The actions requiring unanimous approval could be anything from requiring that all the shareholders must consent to issuing new shares or paying dividends, to making a 60/40 equity position a 50/50 control position.  This simply depends on what the parties can negotiate and agree to (with the aid of their lawyers).

The irony of course is that the people who most often need a Shareholders Agreement, and for whom it would be the easiest to prepare, are often the least likely to get it.  For example an investor who is a stranger to the owners of the flower store may be willing to inject a small amount of capital into the company.  In return he would take a small interest in the corporation and would almost certainly insist on a Shareholders Agreement that requires him to sign off on almost any corporate action.  The Shareholders Agreement in these kinds of transactions is often very contentious because the investor wants a great deal of control and the original owners want the investor to have no control.  But in practice investors usually invest in a company because they liked the way the management operated and felt there was a good probability of a return on their investment if they simply sat back and watched – so the control they want may never be used.

On the other hand two friends going into business together often do not get a Shareholders Agreement done even though it would be a simple matter to negotiate the agreement when they start the business (and the simpler the negotiation the cheaper the document is to prepare).  It is also much easier for friends to decide how to handle hypothetical future events (such as one partner wanting to retire and sell their shares to the other) but when there is the reality of an event, one announcing they want to retire and to be bought out, disputes can easily arise – who should value the company, what criteria will they use, etc.  Two honest partners can look at the same valuation (which estimates the value at between $900,000 and 1 million dollars) and have a real dispute with $100,000 difference.

While a Shareholders Agreement is an expensive, thick, legally complex document the costs of disputes, the unpredictability of them arising, and their devastating effects, make Shareholders Agreements prudent things for any corporation with multiple shareholders to have.