Good governance, or was I on my high horse??

An area we have considerable experience assisting legal practices with is the transition of partnerships to incorporated legal practices (ILP).

Recently we were engaged to support a partnership of three partners to transition their practice to an ILP. Those of you considering such a venture ought to consider the magnitude of the change, as I am yet to meet a client that has wanted to embark on the process but has not been surprised by how much administrative and operational management incorporation requires.

But back to this partnership's incorporation. In the partnership, units were distributed per the following percentages:

• Partner A – 68% of the units, and
• Partners B and C - 16% of the units each.

As we moved to the new ILP the agreed position of the founding shareholders was to issue the same three members of the new ILP 100 shares according to the same shareholding percentages.

As you would know, a key document of any private company with more than one shareholder is the Shareholder’s Agreement. Being a commercial firm, this practice opted to manage the drafting of this document internally.

Upon my first review, I noted that the sections in the Agreement relating to the governance of the company, as it related to shareholder resolutions, were drafted as follows:

1. Ordinary Resolutions of the shareholder group (which was also the Board): A majority decision, based on voting rights assigned to the number of shares on issue.
2. Special resolutions: A 75% majority, based on voting rights assigned to the number of shares on issue.

I queried this with the managing partner (who would own 68% of the shares on issue) and the conversation proceeded as follows:

Ben Deverson (BD): Resolutions in the Agreement appear to be based on votes cast according to the number of shares on issue, not on votes of individual shareholders: one person = one vote. In a small private company like this, I do not recommend that. On a vote of members present, not shares on issue, a majority would require two of you and a Special Resolution would require all three of you. Personally, I feel the magnitude of some of the Special Resolution matters should require a unanimous decision. With this current wording of the Agreement, you can essentially vote for ordinary resolutions on your own, regardless of the opinion of your other two partners.

Managing Partner (MP): No, that’s how it is. I have 68% of the votes. I don’t want those two voting on and resolving something I don't agree with.

BD: I appreciate that, but that is good governance in small private companies like this. And good governance suggests you should at least have a majority of the people in the Board/Shareholder group approve ordinary resolutions. In a situation where your two business partners disagree with you on an ordinary resolution, will you still go ahead with it regardless?

MP: Yes, of course. It’s my firm.

BD: Well, my advice is that this document should record shareholders as one person = one vote. Not based on shares on offer. At the very least, let’s make any decision requiring your vote, but no one decision can be made by you alone. I also believe some of these special resolutions are of such significance they ought to be a unanimous decision. As a minority shareholder of this business, you can incur additional bank debt without their ok, and make them liable for it.

MP: That’s the way it’s always been. That’s the way it is right now in the partnership.

BD: Regardless of how we eventually structure this document, we need to ensure that one person cannot make resolutions for the shareholder group on their own. This is a private company where your fellow shareholders work and operate every day. According to this document, you can make decisions that may impact them professionally, personally, and financially. If you do that, then frankly, you don’t have a partnership, you have a dictatorship.

MP: Whatever, Ben.

BD: I’m here to advise you and my advice to you is that this is not effective governance. I have seen too many firms implode over issues like this and the result is a major, and expensive, ‘partnership’ dispute. Those disputes take your eye off the ball for months and no one really ever wins. You don’t want that, do you?

If you wish to maintain the position that voting rights are based on shares on issue, I propose that you make ordinary resolutions a 75% majority and Special Resolutions be a unanimous decision. That way the other shareholders can never pass a resolution without you, and you cannot pass a resolution without, at least, one of them.

MP: Ben, you’re not here to advise me. I don’t need advice. You’re here to do what I tell you to do.

END OF CONVERSATION