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Good leavers and bad leavers

Please note that the information herein is of a general nature and you should not act or refrain from acting on it without professional advice on the specific facts of your case. No liability is accepted by the author or Sykes Anderson Perry Limited in respect of this article. Law is a complex subject and the above is a basic outline only and is intended only as a general guide. Nothing herein constitutes financial advice.

Shareholder agreements usually have provisions dealing with shareholders rights when they wish to sell their shares or when the other shareholders want to remove them. This is often poorly understood by shareholders and can have a major impact on the value of their shares. The provisions are usually put in a shareholder agreement rather than in the company’s articles because the shareholder agreement is a private document whereas the company’s articles is a public document available for all to read.

How can you stop being a shareholder?

In simple terms you can dispose of your shares in various ways.

  • You can gift them to members of your immediate family or put them into trust for your family. This is usually not controversial.

  • You can sell them to other shareholders in the company. This is usually the easiest way but may not get you the best price.

  • You can sell them to outsiders.

  • The company can buy the shares from you.

  • Your shares can be cancelled.

  • You can die and the shares will be transferred to your executors. In some cases the company will have an insurance policy and will end up buying the shares from your executors. This is often the best outcome as your heirs will receive cash and the company will not have to deal with a widow or widower shareholder who has no interest in the business.

Pre-emption rights

Almost all private companies articles have provisions giving existing shareholders a first right to buy shares before they can be offered to outsiders. Even if a company’s articles do not contain pre-emption rights, the shareholders may be able to rely on statutory pre-emption rights. In simple terms you have to offer your shares first to the existing shareholders at the same price as the outsider has offered. Only if the existing shareholders decline to buy can you sell to outsiders. This is the simplest arrangement.

More complex provisions in shareholder agreements will not allow you to sell to an outsider without your shares first being valued often by the company’s auditor. The auditor will fix a fair value which cannot be appealed at which the existing shareholders can buy. For instance you may have an outside offer at £10 per share but the company auditor decides the fair value is £7. The existing shareholders are then given the opportunity to buy at £7. Only if they do not buy can you go ahead and sell at £10.

The company itself may be given the opportunity to buy the shares back either at £10 or £7. If the company has cash say in the form of retained profits this may be worthwhile. It reduces the number of shares on which dividends are paid and increases the value of the other shares.

No problem situations

There is unlikely to be any problem if the other shareholders agree to the sale. Similarly gifts and death are unlikely to be a problem.

On a death, if the company has been paying premiums for the life assurance which pays out on a shareholder’s death, then the proceeds of the policy belong to the company. This is because the company paid the premiums so it receives any pay out. The company has usually claimed a tax deduction on the cost of the premiums. This is why a cross option agreement is usually entered into under which the company can, on a shareholder’s death, require the shareholder to sell the shares to the company and vice versa.

Problem situations

Shareholder agreements often contain a provision under which if you cease to be a director or an employee you have to dispose of your shares say within 6 months. This could arise because you wish to retire or obtain a different job. Normally if you are a “Good Leaver” there is a mechanism under which you can serve notice on the company offering to sell your shares to the company or any of the other shareholders. In this case the procedures outlined above will apply. There may be no fair value to be ascertained by the company’s auditor.

If however you have been dismissed then you are likely to be a “Bad Leaver”. This could also arise if you left as a “Good Leaver” but then broke the terms of restrictive covenants. In these circumstances the company may have a right to cancel your shares and to make no payment to you. In practice most shareholders agreements give you something for your shares say 20% of what you would get as a Good Leaver. This is where disputes are likely to break out. A shareholder may claim that they were constructively dismissed by the others so they could get their shares.

November 2017
David Anderson
Solicitor-Advocate and Chartered Tax Adviser
Sykes Anderson Perry Limited