However, particularly in small, closely held corporations with only a limited number of shareholders, the existing shareholders may desire to restrict who may become a shareholder of the corporation to limit the shareholders to persons known to the existing shareholders. There are a variety of ways a shareholder agreement can restrict the transfer of stock, including (i) prohibiting the transfer of stock without the consent of the other shareholders, (ii) providing other shareholders with a right of first offer or a right of first refusal if a shareholder desires to sell or transfer his or her stock, and (iii) prohibiting shareholders from encumbering their stock, such as by prohibiting a pledge of stock as collateral for a loan. When such restrictions on transfer are in place, there are often specified exceptions that would not require the consent of other shareholders or trigger rights of first offer or first refusal, such as transfers to a shareholder’s family trust or to other existing shareholders. Buy-Sell Provisions Shareholder agreements often contain put and call rights and may address the sale of stock upon the death, disability or termination of employment of a shareholder. For example, a minority shareholder may be granted a put right, namely the option to require other shareholders or the corporation to purchase the minority shareholder’s stock at a set price or pursuant to a specified formula, thus giving the minority shareholder a way to exit the corporation. Conversely, a shareholder or the corporation may be granted a call option, giving them the right to purchase the stock of a shareholder at a set price or pursuant to a specified formula. The right to exercise a call option is often triggered by a default by the selling shareholder under the shareholder agreement or another agreement or, if the selling shareholder is an employee of the corporation, by the termination of employment. Similarly, put or call rights may be granted to the corporation or shareholders with the trigger being the death or disability of a shareholder. Such rights may allow a disabled shareholder or the estate of a deceased shareholder to sell the stock so that liquid funds are available, allow the other shareholders or the corporation to prevent heirs or devisees of the deceased shareholder from becoming a shareholder, or allow removal of a shareholder that can no longer contribute to the business of the corporation. Drag-Along and Tag-Along Shareholder agreements can address issues that may arise if the corporation is to be sold through a stock sale. For example, if a majority of shareholders (usually a supermajority) agree to sell their stock as part of a stock sale of the corporation, drag-along rights allow them to force the remaining shareholders to sell their stock on the same terms. This protects the majority by preventing a minority holdout from stopping a stock sale of the corporation. As a protection to minority shareholders, a minority shareholder may be given the right to tag-along with the sale of stock by a majority of shareholders on the same terms. This protects the minority by not allowing the majority to sell their stock at a premium, potentially leaving minority shareholders behind or requiring them to sell at a lower price if they want to sell. 19 California New Car Dealer Quarterly
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