The role of a Shareholders' Agreement in corporate governance

In the dynamic landscape of business, where investment opportunities are set, legal protection amongst both natural and legal persons in their capacity as investors is crucial. Corporate governance serves as the foundation upon which businesses build trust, accountability and sustainable growth. A corporate governance framework essentially outlines the roles and responsibilities among stakeholders hence guiding decision-making processes and ensuring alignment with set principles and compliances.

There are several ways through which corporate governance can be implemented in a legal entity. In this legal update we will focus primarily on a Shareholders’ Agreement as a form of corporate governance and analyse its importance. 

General Overview

A Shareholders’ Agreement is a legally binding contract between the shareholders of a company and, in some cases, the company. A Shareholders’ Agreement can be used in situations such as in:

• a private limited company with multiple shareholders to set out, amongst other things, terms governing the relationship between the parties. 
• a joint venture to deal with the ongoing relationship of the joint venturers as shareholders in the joint venture company.
• a management buyout transaction, the investment agreement is sometimes known as the shareholders' agreement and evidences the commitment of both the private equity provider and the management team to subscribe for shares in the new company. 

Despite the above option where a Shareholders’ Agreement can be used, it is important to note that a Shareholders’ Agreement is optional, therefore it is not mandatory to have one in place. 

We have delved into some of the important roles played by a Shareholders’ Agreement and set out the reasons why as an investor you should always consider having one in place. Please note that these are only some of the benefits.

Supplements the Articles of Association of a company (the Articles)

Every company will normally have Articles which govern the day-to-day management of the company as well as the relationship between shareholders. However, in addition to the Articles, it is advisable to have a Shareholders’ Agreement as it provides benefits that are normally not provided by the Articles.

One of the main differences between a Shareholders’ Agreement and Articles is linked to the fact that a company is a product of a statute. Given this, there is a comprehensive body of law that governs how a company should run and the Articles must comply with these laws. Based on this, a Shareholders’ Agreement can contain almost any arrangement whereas the articles must comply with company law.

Furthermore, from content perspective, a Shareholders’ Agreement is a simple contract between all or some of the shareholders and therefore can deal with all aspects of the relationship between the parties if required, including the personal rights and obligations of shareholders (for example, how they will exercise their voting rights). The Articles, however, can generally only take effect as a contract between the shareholders in their capacity as members and so cannot deal with matters which are personal to the members if this could be seen as fettering the company’s statutory powers.

Confidentiality

The Articles are public documents which are registered at Companies Registry, and they are open to public inspection. On the other hand, Shareholders’ Agreements are rarely publicly registered. Therefore, they are not available to the public. A Shareholders’ Agreement is a private document and as such, there is no legal obligation to file it with the Registrar of Companies, ensuring that the contents remain confidential. This allows shareholders to agree on terms which are sensitive to the parties and parties would like to keep them confidential. 

Control of transfer of shares

Imposing restrictions on the transfer of shares is a common practice in a Shareholders’ Agreement in order to safeguard the relevant company from unwanted changes in ownership. These restrictions may include provisions on pre-emptive rights, tag-along rights, or rights of first refusal, ensuring that changes in ownership are subject to shareholder approval. By maintaining control over the transfer of shares, the Shareholders’ Agreement protects shareholder interests and preserves the stability of the relevant company.

It is possible to include such restrictions in the Articles, however it is common for Articles to only include pre-emptive rights which is only one of many restrictions which can be important to the shareholders. A Shareholders’ Agreement can contain more restrictions such as tag along, drag along, lock in period, compulsory transfer and even valuation mechanisms. The reason why these are normally found in the Shareholders’ Agreement goes back to the confidentiality nature of the Shareholders’ Agreement.

Protection of minority shareholders

In many business ventures, minority shareholders often face the risk of being marginalised or overlooked since the business operations of most companies follow the majority decision. A well-crafted Shareholders’ Agreement can serve to protect minority shareholders. One of the ways is through the provisions that require unanimous approval for certain decisions. As long as one shareholder disagrees, the decision will not be approved, regardless of that shareholder stake in the company. It is also possible to protect the minority in other ways, for example, by provisions in the Shareholders’ Agreement giving a minority a contractual right of veto over certain decisions.

Minority shareholders protection is also achieved through how a Shareholders’ Agreement can be amended. A Shareholders’ Agreement can generally only be amended by the agreement of all the parties, whatever the size of their shareholding. The Articles can generally be altered by special resolution (requiring a majority of at least 75 per cent of votes cast). It may be that a minority shareholder has insufficient shares to block the passing of a special resolution but if the issue is covered in the Shareholders’ Agreement the minority shareholder will also have to agree to it for the Shareholders’ Agreement to be amended. 

Regulates management of the company

The corporate governance structure of a company vests authority in the board of directors to manage its affairs. However, there are circumstances where the shareholders may feel that certain critical decisions should not rest solely on the discretion of the directors, especially where the directors have no financial interest as the shareholders, leading to potential misalignment of interest. In such cases, a Shareholders’ Agreement is paramount to set specific decisions that require shareholder approval. 

Succession planning

This involves preparing for the transfer of ownership and management of the company in situations such as the retirement, disability, or death of the shareholders. A Shareholders’ Agreement outlines procedures for transferring shares to successors or heirs of the shareholders, ensuring a smooth transition of ownership and management responsibilities. It may designate successors or heirs who will inherit or acquire the shares of a deceased or incapacitated shareholder and establish mechanisms for valuing the shares and determining the purchase price. 

Disputes Resolution

In the event of disputes among shareholders, a Shareholders’ Agreement establishes mechanisms for resolution, such as negotiation, mediation, arbitration, or even litigation if necessary. By providing structured methods for resolving conflicts, a Shareholders’ Agreement minimizes the likelihood of shareholders resorting to costly and time-consuming litigation. Instead of immediately pursuing legal action, shareholders are encouraged to follow the agreed dispute resolution procedures, which can save both time and resources. 

Conclusion

A Shareholders’ Agreement plays a pivotal role in corporate governance by defining relationships among shareholders, directors, and the company. It safeguards minority shareholders, controls share transfers, regulates management decisions, facilitates succession planning, and prevents former shareholders from competing. Additionally, it establishes dispute resolution mechanisms, promoting harmony and efficiency within the corporate environment. Ultimately, having a Shareholders’ Agreement is not just desirable but imperative for businesses operating within Tanzania and other jurisdictions. 

Further it is important to avoid conflicts between the Shareholders’ Agreement and the Articles. Either document can prevail depending on the intention of the parties. However, it is common to provide that a Shareholders’ Agreement will prevail, and this will be enforceable as between the parties.