Protection of Minority Shareholders Shareholder agreements can help safeguard minority shareholders’ rights and interests, such as by including provisions that prevent majority shareholders from making decisions that disproportionately benefit the majority shareholders at the expense of minority shareholders. In close corporations, this is especially important as the risk of majority shareholders exploiting their position is higher. As discussed in the following list, some topics a shareholder agreement may cover in this regard are preemptive rights, the right to appoint a director, dividend policies, supermajority approval requirements for certain matters and tag-along rights. • Preemptive Rights: To protect shareholders against dilution of their holdings in the corporation, a shareholder agreement may grant the corporation’s shareholders the right to have the first opportunity to purchase shares in the corporation’s future stock issuances. • Board of Directors: Bylaws typically specify the number of directors a corporation may have, and a shareholder agreement could specify who will serve on the board or give certain shareholders the right to designate a director. For example, sometimes a minority shareholder who does not hold enough shares to select a director by vote may be given a right to designate a director. A shareholder agreement may also specify when such a shareholder would lose the right, such as if their ownership percentage falls below a certain threshold. • Dividends: A dividend policy setting forth, among other things, when and under what circumstances dividends must be paid, can be included in a shareholder agreement to give minority shareholders some certainty as to payment of dividends. • Super Majority Approval: A shareholder agreement could require a super majority vote for approval of certain actions or transactions. For example, a shareholder agreement could require super majority approval, such as a two-thirds vote, for the sale of the corporation’s stock or all or substantially all of the assets of the corporation, for the issuance of additional stock, or to take specified actions outside of the scope of the corporation’s normal day-to-day operations. • Tag-Along Rights: Tag-along rights are another means of protecting minority shareholders, and this is discussed under the Drag-Along and Tag-Along heading of this article. Confidentiality If there is a need for shareholders to keep certain information confidential, such as trade secrets and proprietary business information, including customer lists, a shareholder agreement can set forth the confidentiality obligations of shareholders. Non-Compete and Non-Solicitation State and federal laws often limit or restrict non-competition and non-solicitation provisions. However, even where such laws exist, there may be exceptions allowing a non-compete provision in connection with the sale of a business, including the sale of stock of a corporation, or restricting solicitation that would use the corporation’s intellectual property. When admitting a new shareholder to a corporation, whether such provisions are appropriate or permitted should be considered and could be included in a shareholder agreement to the extent allowed. Deadlock Particularly if there are two 50% shareholders or another combination of shareholders where there is a possibility of a deadlock due to a 50-50 vote, the shareholder agreement may contain a provision on how such a dispute would be resolved. Common approaches to deal with deadlock include designating a third party to cast a tie-breaking vote outside of legal process, requiring arbitration or allowing one shareholder to buy out another shareholder. Delegation of Management Rights; Simplified Corporate Procedures When permitted, a shareholder agreement may transfer the powers of the board of directors to shareholders so that they can manage a corporation directly, and it may, in other ways, simplify corporate procedures by removing formalities such as requirements to hold director and shareholder meetings. For example, a California close corporation, meaning a California corporation whose articles of incorporation include a provision that all of the corporation’s issued stock may not be held by more than 35 shareholders and the statement “This corporation is a close corporation,” may contain such provisions. In very small, closely held corporations where management practices are often informal, this can be an important part of a legal compliance strategy as the shareholder agreement can set forth corporate requirements that comport with how the corporation will actually be run. S-Corporations If a corporation is an S-corporation, a shareholder agreement can contain provisions to help ensure that S-corporation requirements stay satisfied. The previous issues are illustrative of important matters to consider when determining whether to enter into a shareholder agreement and what to include in it. However, there is no one-size-fits-all approach. Each jurisdiction has its own laws that may limit which and to what extent the foregoing issues can be addressed and when default statutory rules for corporations can be varied by a shareholder agreement. Moreover, whether certain minority or majority protections are appropriate for a particular group of shareholders will vary depending on the totality of the circumstances, and there are other issues that could be addressed in a shareholder agreement that are not discussed above. Accordingly, it is important to consult with 20 California New Car Dealer Quarterly
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