The Importance of Shareholder's Agreements in Business Entities
1.?Introduction to Shareholder's Agreements
The shareholder's agreement is a pivotal foundational instrument governing the relationship between shareholders. A shareholder's agreement outlines the rules and regulations that govern the relationship between the shareholders. It identifies the rights and responsibilities of the shareholders within the company. The main objectives of shareholders' agreements include (a) protecting the interests of the different parties to the business; (b) ensuring continuity of the business, particularly in the case of family-owned companies; (c) protecting the shareholders from any subsequent actions of other shareholders, for example, in terms of debt incursion; and (d) dispute resolution.
In the United Arab Emirates (UAE), shareholders’ agreements are regarded as essential contractual tools, particularly given the distinctions between the regulatory environments of mainland UAE and its various free zones. While UAE law does not mandate shareholders’ agreements, their enforceability under general contract law makes them critical for effective governance and risk management.
2.?Key Elements of a Shareholder's Agreement
2.1.?Shareholder Rights and Obligations
The creation of any business idea or entrepreneurial project always involves the interaction or collaboration of different individuals with one another. Within the agreements these people enter into, there is anticipation of the rights and obligations each one may have within the business. All of these subjects regarding the previous issue are dealt with within the shareholders’ agreement because they stipulate what is expected from the shareholder and the unique responsibilities or rights that they may have, where equality and a steady balance between these items always prevail. The articulation of this relationship must be very clear, and it is critical to stipulate some things in a detailed and extensive manner, such as the subject’s access to information or to a certain process, the shareholder’s power to vote and participate in management, and anything else related to information passed on.
Because the rights and obligations are outlined within the agreement, the business requires that the partners be closely involved and the dynamics entail them; thus, it is understood that the obligations of the parties are positive, meaning everything that the shareholder undertakes to do in order to ensure their relationships with the company succeed, which is finality. At the same time, the confirmation of the rights of the shareholders is negative, and it prevents the person from being harmed in their future vitality. This right must be in place so that the shareholder has adequate protection for the continuation of the social relations with the company. With the definition of the aforementioned rights and obligations, one must express everything necessary and possible. This is necessary to increase awareness and avoid any future disagreements and conflicts.
2.2.?Decision-Making Processes
The management of a corporation or business entity is vested with corporate officers and a board of directors for companies. However, the direction and management of a company are controlled by the shareholders. Decision-making procedures should be established to delineate how decisions are to be made, especially those actions requiring shareholder approval, and to ensure a transparent and fair process for all shareholders in order to gain the trust of those shareholders. Some examples of these procedures could be: routine decisions for day-to-day activities that require no shareholder involvement and are left to those officers and/or directors duly elected by the shareholders to control the business; for major decisions, a shareholder resolution would be required whereby a certain percentage of the shareholders are required either by a simple majority or supermajority to approve the action before it can be taken; alternatively, the shareholder agreement could give a specific shareholder or group of shareholders veto rights if such an action is to be undertaken.
It is very possible for the shareholders to come to an impasse, especially where the decision of the shareholders requires a vote with a larger percentage than is owned by any of the disputing shareholders. A shareholder agreement can set forth procedures on what to do in the event a deadlock arises. Resolution could include a suggested forum for resolution, such as mediation or arbitration. This area of the shareholder agreement is significant for companies with equal shareholders due to the potential of a 50/50 vote, often creating an impasse. Understanding the decision-making process of a company is of the utmost importance in ensuring that a harmonious governing structure is in place to ensure the operations function smoothly and in a predictable manner. If there is a concern or risk of impasse or deadlock, the same ought to be addressed in the shareholder agreement to allow the shareholders an option to avoid stalemates when running the business.
In mainland UAE, companies must comply with the Commercial Companies Law, which dictates voting thresholds for key decisions. Shareholders’ agreements can provide additional clarity by stipulating specific requirements for routine versus major decisions, deadlock resolution mechanisms, and veto rights.
In free zones, where common law principles often apply, shareholders’ agreements can incorporate more flexible and bespoke decision-making processes. For example, shareholders may agree to arbitration under DIFC or ADGM rules for deadlock resolution.
2.3.?Transfer of Shares
Shareholders' agreements usually have special clauses regulating how and when shares can be sold. Some of these clauses provide that if a shareholder wishes to sell his shares, he must first offer them to the other shareholders. This is usually referred to as the pre-emption right or first right of refusal. Sometimes, there will be a delayed pre-emption right to the other shareholders or simply reserved for the directors of the company. Shareholders' agreements for both private and public companies may also provide that shares may not be sold to outside parties without the consent of the other shareholders. It is important because if other shareholders do not want to work with an individual, they should not be forced by that individual. Sometimes they will simply not work well together. Shareholders' agreements may also make provisions to determine the value of the shares for the purposes of transferring. This may be done by reference to the last valuation price of the company, the most recent annual financial statements of the company, by agreement or determination by an auditor, or by any other appropriate method.
It is also important to consider the right to purchase shares by a deceased, insolvent, or divorced shareholder or by his estate, trustee, or liquidator. Some drafting of shareholders' agreements provides that on the death of a shareholder, for example, his shares must first be offered to the remaining shareholders before they are given to the deceased's spouse or estate. This is important because, as a shareholder, you might not always want to be in business with your partner or spouse if the other party in the shares should predecease you. This may cause unnecessary complications because you may end up having co-owners which you did not choose. The agreement might also operate on divorce. Finally, a basic agreement is important to define every party's rights and ensure precise compliance.
The framework of a shareholders' agreement must especially define the transfer or sale mechanism for the shares between the shareholders. Moreover, the sale process must also be handled in line with the act since an instrument that does not comply with a legal framework can lead to disputes and possible rights to the assets.
UAE law imposes restrictions on share transfers, particularly in mainland companies where pre-emption rights for existing shareholders are mandatory. Shareholders’ agreements can expand on these provisions by specifying valuation methods, conditions for transferring shares, and mechanisms to address events such as a shareholder's death or insolvency. In free zones, where the regulatory environment is more flexible, shareholders’ agreements play a crucial role in preventing unauthorized share transfers and maintaining control over the shareholder base.
2.4.?Dispute Resolution Mechanisms
No business is a utopia; it is possible that in any business there are disputes, whether in decisions of the majority judgment with the minority or among all shareholders of an entity. Sometimes these disputes can be fatal to the continuity of the business and destructive to the relationships of the partners behind the business. These conflicts can be created by differences arising from commercial or personal matters among partners, whether they have to do with the business or not. When a dispute arises in which it is not possible for the majority to impose a decision, it can lead to the beginning of a procedure of unnecessary and costly litigation, including stopping the activity of the business. For this reason, the shareholders’ agreement or bylaws of a company must outline mechanisms for resolving disputes. Establishing all possible mechanisms for resolving disputes from the beginning can reduce the possibility that the same members will become parties in lengthy and costly disputes.
The mechanisms provided for the resolution of disputes among the shareholders in case of abuse after a free tender or in arbitration perpetuate the social life and management effectiveness of corporate governance. Indeed, by preventing disputes among the shareholders and securing the final settlement of internal succession and substantial operational remedies, everyone will pay a fair price, which also perpetuates the life of the company, giving it its expected economic utility.
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In the UAE, shareholders’ agreements often include detailed provisions for dispute resolution, ranging from mediation and arbitration to court proceedings. Mainland companies typically rely on the UAE’s civil law system, while free zones such as DIFC and ADGM offer arbitration-friendly environments under common law principles.
3.?Benefits of Having a Shareholder's Agreement
In today’s businesses, a company may have one or more shareholders, making it essential that their relationships are based on respect, order, and harmony. This positive aspect may be obtained by having a shareholders' agreement. A shareholders' agreement ensures that all the shareholders know each other’s expectations and obligations and the shareholders themselves. An important aspect of the shareholders' agreement is its capacity to grasp the terms stipulated in the agreement with respect to the administration and control of the companies.
Another benefit of having a shareholders' agreement is the certainty regarding the dispute resolution method. Thus, the characteristics of a shareholders' agreement encompass an analysis of the general characteristics of the seller, resolution methods of conflict, the principles directly related to the agreement itself, and policyholder interests. A shareholders' agreement takes into consideration the life of the company and not just the shareholders. The rights, obligations, and expectations of the shareholders juxtapose with the life and fate of the company. A potential piece of proof of these prerequisites is the appeal exercised by general shareholders upon the financial market investors. More general arguments or principles also plead for the conclusion of a shareholders' agreement, ensuring the company’s control. Even if the vast majority of companies conclude not to have a shareholders' agreement, this does not mean that the sharing of powers is carried out based on an agreement. In reality, a shareholders' agreement makes it easier for the shareholders to get along because they know what the limits are. Thus, a shareholders' agreement also has a relational justification.
4.?Legal Requirements and Enforceability
Shareholders' agreements or any other documents or contracts that impose obligations on shareholders, govern how a company is run, or set out how certain internal or management affairs are to be conducted are either subject to a special regime in many jurisdictions or are covered by general principles of law applying to contracts. In either case, it is important to ensure these documents meet the requirements of the local systems and are enforceable. In some instances, to ensure compliance with regulatory authorities, the wording of a shareholders' agreement must be crafted so that it does not impose any obligations or restrictions of any kind on shareholders.
Shareholders of a company agree among themselves to govern their mutual relationships and that of the company. Although these agreements are quite common in many parts of the world, they are often overlooked as a necessity in countries where corporate regulations provide the perceived appearance of a carefully crafted balance between corporate affairs, relationships among shareholders, management, and the power of representation of the shareholders. The increasing notoriety of shareholders' agreements is now challenging this line of thought, and shareholders' agreements are now being viewed as essential tools to protect investments and instill confidence in the corporate entity.
The enforceability of shareholders’ agreements in the UAE depends on compliance with the applicable regulatory framework. In mainland UAE, shareholders’ agreements must align with the Commercial Companies Law, which governs corporate governance and shareholder rights. For example, provisions in a shareholders’ agreement cannot override statutory rights or obligations prescribed by the law.
In free zones, shareholders’ agreements benefit from greater flexibility. DIFC and ADGM operate under independent legal systems based on common law, allowing for tailored agreements that address unique business needs. These jurisdictions also provide robust dispute resolution mechanisms and recognition of contractual obligations, making shareholders’ agreements highly enforceable.
5.?Drafting a Shareholder's Agreement
It is essential that a Shareholders' Agreement be tailored specifically to the needs and circumstances of each particular business, and these interests should be fully explored, canvassed, and disclosed to all relevant parties by an independent legal practitioner prior to the drafting of any such document. This would ensure that all pertinent matters have been canvassed, correctly agreed upon, and implemented in the agreed manner or, when possible, avoided. Such matters include drafting relevant checks and balances, voting and exit strategies, time frame for decision-making, restrictions when assigning such shares, etc. In addition, particular consideration and clarification should be given to the four key issues noted above prior to engaging in the exercise of drafting a new Shareholders' Agreement.
In the drafting of such agreements, it is essential that great care and sound advice be taken to avoid ambiguous or imprecise language, which may lead to ambiguity in the drafting itself. Therefore, great care should be taken in the actual drafting to ensure that the provisions are unambiguous. Furthermore, it is imperative that the Shareholders' Agreement be reviewed regularly upon changing circumstances of the parties or any of them, market conditions or otherwise, to confirm that the mutually exclusive interests of the shareholders are kept current. It is also an imperative requirement that any such Agreement and the components thereof are entered into with the consultation and consent of the relevant shareholders so that their ongoing appropriate interrelationships and/or rights may be maintained and remain current at any given time.
In the UAE, shareholders’ agreements are indispensable for fostering trust, ensuring governance, and protecting shareholder interests. Whether operating in mainland UAE or a free zone, businesses must craft shareholders’ agreements that align with the applicable legal framework while addressing the company's and its stakeholders' unique needs. By doing so, they can secure a strong foundation for long-term success and stability.
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