Shareholders Agreements for My Business in Asia

Shareholders Agreements in Asia

One of the most common causes of business failure consists in shareholders’ disputes. It is particularly true when doing business in Asia, where foreign investors will often face cultural differences, local commercial practices and specific legal requirements. Unless pre-determined mechanisms have been settled for their resolution, such disputes can severely affect the viability of any business. Shareholders agreements can help reducing uncertainties and ensuring a fair outcome to potential disagreements.
Legally speaking, a shareholders agreement is a contract concluded between the founders of a company, in order to (i) define their respective rights and responsibilities, and (ii) organize the management of the said company. It is not intended to govern the complete day-to-day operations of a business, but instead addresses certain key issues in that respect. Investors shall bear in mind that shareholders agreements can organize the management of the company they invested in, as well as the management of their underlying subsidiary. This is a useful tool when the company laws and regulations of the country of such subsidiary allow less flexibility in terms of shareholders arrangements (see for instance Shareholders Relationships in China).
Shareholders agreements supplement the articles of association of a company. They shall comply with their mandatory provisions (as required by any given company law), but can freely adjust their non-mandatory provisions. Their content can rely on the framework of a memorandum of understanding or letter of intention (if any), which would have been adopted by the parties at an earlier stage of their cooperation project.
There is no standard shareholder agreement and such a contract will need to be tailored to the circumstances and the parties involved. For instance, founding shareholders who have no plan to issue additional share capital will pursue different goals than founding shareholders willing to raise successive rounds of funding to grow their business. Besides, shareholders’ agreements can be unanimous (i.e. agreed upon by all the shareholders of a company) or reserved to a smaller group of key stakeholders (which is often the case when different categories of shares distinguish between active and passive investors). Last but not least, arrangements adopted in shareholders agreements shall comply with the legal requirements of any given jurisdiction. These might vary substantially from one jurisdiction to another, and it is not recommended to use the same template of agreement for different countries.
Some of the key issues to be addressed in a shareholders’ agreement include the following:

  • Issuance of new shares and anti-dilution rights
Unless prevented from doing so by specific provisions, majority shareholders can generally (legally) decide to dilute minority shareholders by issuing additional shares in the company. This reduces subsequently the shareholdings and powers of these minority shareholders. Anti-dilution rights (also referred to as pre-emptive rights) reduce the efficiency of such a “trick”, by requiring the company to offer any newly issued shares to existing shareholders first, in proportion with their existing shareholdings. 
  • Transfer of existing shares and exit options
Many provisions can be adopted in order to prevent the transfer of shares to undesirable third parties (including competitors). In most cases, shareholders agreements require share transfers to be approved by the company and grant existing shareholders an option to purchase the transferrable shares. Meanwhile, restrictions on transfers generally do not apply if the beneficiary is a wholly controlled affiliate, a shareholder’s family member or to a trust. Some common restrictions on share transfers include the following:
  • Right of first refusal
A right of first refusal offers existing shareholders the opportunity to purchase the shares of any shareholder wishing to sell theirs to a third party (at the same price and under the same conditions as those offered by that contemplated third party). Before selling their shares, the transferring shareholder shall first offer them to the other existing shareholders. If no existing shareholder accepts such offer, the transferring shareholder may transfer their shares to the designated third party, within a prescribed time-frame.
  • Tag-along option
A tag-along option grants the minority shareholders the right to request a joint purchase of their shares by the third party acquiring all or a substantial part of the shares of the majority shareholders. In such case, the majority shareholders shall ensure that the shares of the minority shareholders who raised their tag-along right, will be purchased by the designated third party, under the same terms and conditions as those originally agreed with the majority shareholders. This option enables minority shareholders to leave the company if they don’t want to stay without the exiting majority shareholders or if they don’t want to cooperate with the new substantial stakeholder entering the company.
  • Drag-along option
A drag-along option enables the majority shareholders to force the minority shareholders to leave the company, if they receive a bona fide offer from a third party to purchase the company, which they wish to accept. The drag-along option allows the majority shareholders to sell 100% of the company, free of any minority shareholders.
  • Management of the company
Board of directors 
Usually, a majority of shareholders (51%) can appoint and remove directors from the board. Such power allows effective control of the company. It may not be fair to minority shareholders, especially if they hold a substantial shareholding (up to 49%). Instead, shareholders agreements can grant minority shareholders the right to appoint a director, which enables them to keep some control over the company’s governance. Many other arrangements can be adopted in a shareholders agreement (within the mandatory limits of the company law and articles of association) and include: board composition, notice provisions, quorum requirement, conduct of board meetings, directors’ appointment and removal, appointment of an observer who will attend board meetings without any voting power (often required by an investor who invested substantially in the company), etc.
Important decisions 
More often, the mandatory provisions of any company law require the approval of shareholders on essential decisions, which by nature affect or change the original company set-up. It generally includes decisions dealing with capital increase or decrease, change of registered address, change of denomination, liquidation, etc. However, legal requirements are basic and shareholders may decide which strategic decisions shall be taken by the board and by the shareholders. A detailed list can be adopted in a shareholders agreement. Besides, shareholders can also decide to require a special majority (e.g. 75%) for essential decisions, going beyond any mandatory legal requirement.
  • Non-competition
Business partners often share common and/or complementary skills, which originally justified their collaboration through the incorporation of a company. But what happens when such partners split-up or want to develop parallel activities? Shareholders agreements can provide non-competition and non-solicitation clauses, which define in advance the limits under which such shareholders may carry competitive activities.
  • Dispute resolutions
Sometimes, disagreements between shareholders lead to deadlock situations, where the company is unable to make any decision. It may seriously affect its ongoing business. In order to prevent such deadlocks, shareholders agreements can provide exit strategies, upon which one or more shareholders can be forced to buy out others. In such case, independent expertise or a pre-determined formula is often adopted to determine the value of the shares of the exiting shareholder(s).
Shareholders agreements can include many other provisions, such as dividend policy, information reporting, employees incentive schemes, share vesting, management of a subsidiary, protection of intellectual property rights, competent jurisdiction in case of litigation, etc. The assistance of an experienced legal counsel, qualified in the targeted jurisdiction, is highly recommended to ensure fair protection of the intentions and interest of all shareholders.
February 2016

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