Legal Challenges of Companies (Part 2) 2023/2024 Session 3 PDF

Legal challenges of companies Part 2 2023/2024 Sequence description 01 Shareholders agreements 02 Classes of shares SHAREHOLDERS AGREEMENTS Legal Challenges of Companies 2023/2024 Company Law Memorandum of Association and Articles of Association ‘Memorandum of association’ legal statement signed by...

Legal challenges of companies Part 2 2023/2024 Sequence description 01 Shareholders agreements 02 Classes of shares SHAREHOLDERS AGREEMENTS Legal Challenges of Companies 2023/2024 Company Law Memorandum of Association and Articles of Association ‘Memorandum of association’ legal statement signed by all initial shareholders or guarantors agreeing to form the company ‘Articles of association’ written rules and regulations regarding how the company should be governed, owned and managed. Legal Challenges of Companies 2023/2024 Company Law Shareholders agreements  Agreement between the shareholders of a company the contents of which are determined by the shareholders themselves.  The agreement governs the rights and obligations of shareholders vis-à-vis the company and other shareholders (shareholder to shareholder relationship and shareholder to company relationship).  Generally, it is a private document between the parties to it (particularly important where the intricate details of the company’s operation are provisions that the company and its shareholders may not wish to be made publicly available).  Unlike the Articles, it does not need to be registered. Legal Challenges of Companies 2023/2024 It is simply a contract No particular formalities It only binds by force of contract law only on the parties to the agreement Legal Challenges 2022/2023 Company Law It should complement the company’s articles of association a company’s Articles of Association will  manage and oversee the internal affairs of the company / corporation  provide for the rules and regulations regarding how the company should be governed, owned and managed  drafting the company’s articles of association is required by law (unlike shareholders’ agreements)  the articles of association are a public document Legal Challenges of Companies 2023/2024 Company Law The articles of association govern a variety of areas, including:  Share classes and the rights attached to each of them  The procedures involved in the issuance and transfer of shares  General and board meeting procedures  Appointment and removal of directors  Rights and duties of directors Legal Challenges 2023/2024 Company Law  Shareholders’ agreement provide additional provisions in order to improve the relationships between the shareholders  In other words, a shareholder agreement is a more specific and detailed version of the company’s articles of association  Shareholder agreements typically govern the following areas: the protection of minority and majority shareholders, dispute resolution, share sale or purchase, issuance and transfer of shares, rights and duties of company directors, decision-making processes, etc. Legal Challenges of Companies 2023/2024 Company Law Sale of Shares / Control of Transfer The sale of shares can occur for various reasons. To prevent potentially undesirable third parties from acquiring shares in a company, a mechanism can be included in the shareholders’ agreement in order to control the sale of shares in the following situations:  a shareholder willing to dispose of shares ;  the death / illness / bankruptcy of a shareholder;  a proposed sale of the entire company, where not all shareholders are in agreement, etc. Legal Challenges of Companies 2023/2024 Pre-emptive rights Shotgun Key clauses Drag along Tag along Legal Challenges 2022/2023 Company Law Pre-emptive rights  A pre-emptive right is a right of existing shareholders in a corporation to purchase existing or newly issued stock before it is offered to others. The right is meant to protect current shareholders from dilution in value or control.  The general rule is: existing shareholders can exercise their pre-emptive rights only pro-rata (equal to the value owned).  It allows the shareholder to maintain a certain percentage of ownership in the company as more shares are issued.  In other words, before a company can issue shares (typically common shares) to the public or third parties, the shareholders having pre-emptive rights can purchase a certain number of shares to avoid having their ownership percentage diluted.  Having pre-emptive rights does not obligate a shareholder to buy shares every time a company issues additional shares to the public. Legal Challenges 2023/2024 Company Law EXAMPLE Best Corporation Inc has issued 1,000 shares to 5 shareholders (each having 200 shares) giving each shareholder 20% stock ownership. If the company were to issue another 1,000 shares to new investors, without pre-emptive rights, the current shareholders’ stock ownership percentage will dilute to 10% (200 shares over 2,000 shares). With pre-emptive rights, the shareholders have the option to purchase 200 additional shares out of the 1,000 new securities issued so they can maintain their 20% stake in the business. Legal Challenges 2023/2024 Exercise Exercise - CASE ANALYSIS (A) John, Marc, Mary, and Helen own 2,500 common shares giving them a 25% stake in the business. They also have pre-emptive rights should the company issue additional common stocks in the future. At some point in time, the company’s board of directors decides to issue an additional 100,000 common stocks to raise capital to expand their operations. Before the company can issue the shares to the general public or third parties, John, Marc, Mary and Helen have to decide if they will exercise their pre-emption rights or not. To exercise their shareholder pre-emptive rights, each shareholder can purchase an additional 25% of the common stock the company intends to issue. In other words, each shareholder can purchase up to 25,000 shares in the new investment round. Let’s assume that John and Mary exercise their option to buy 25,000 each while Marc and Helen do not. Since Marc and Helen did not exercise their pre-emptive rights, the company sold the remaining 50,000 shares to Jack as a new investor. Question: how will be the proportion of ownership in the company? Legal Challenges of Companies 2023/2024 “Drag-along” and “Tag- along” rights “drag-along” and “tag- along” rights empower majority shareholders to force the other shareholders to sell their shares to third party buyers, or minority shareholders to force their connection to a share sale by a majority shareholder in order that the whole company can be sold as one transaction. Legal Challenges of Companies 2023/2024 DRAG ALONG A drag along provision allows the majority shareholder(s) to require the minority shareholder(s) to sell their shares. This is usually triggered in a takeover offer. Obligation Example: a bidder would like to buy the entire company. The majority shareholder(s) holding more than 50% of the company agree to sell their shares. Therefore, in this situation, the majority shareholder(s) can “drag along” the remaining minority shareholder(s) and require them to sell their shares. Accordingly, the bidder can purchase the entire company. To protect the minority shareholders, the drag along provision will usually require the majority shareholder(s) to ensure that the minority shareholder(s) is able to sell the shares on the same terms and conditions Legal Challenges of Companies 2023/2024 TAG ALONG Right Tag along rights are also known as 'co-sale rights’ and are the inverse of drag along rights. When a majority shareholder sells their shares, a tag along right will entitle the minority shareholder to participate in the sale at the same time for the same price for the shares. The minority shareholder then 'tags along' with the majority shareholder's sale. Tag along rights are usually worded to state that if the tag along procedures aren't followed then any attempt to buy shares in the company is invalid. Company Law Legal Challenges 2023/2024 Advantages - Control over decisions - Protection of rights Disadvantages - Difficulty in liquidation Example: company A is being bought by investor B, who is offering a certain price for X number of shares. When the investor is informed that he/she has to buy additional shares, which would be the minority shares, he might waive the price. Legal Challenges of Companies 2023/2024 Shareholders agreements Shotgun clause A shotgun clause is a special provision that may be included in a shareholders’ agreement to force a shareholder to sell their stake or buy out an offering shareholder. It is a mechanism of last resort where shareholders cannot settle a dispute by discussion and negotiation and it results in a forced sale of shares. The shotgun clause will set out the procedure for the shareholder (the “Instigator”) to compel the other shareholder (or group of shareholders) to choose to either sell their shares to the Instigator or to buy the Instigator’s shares at a price set by the Instigator. The manner in which a shotgun Clause is “triggered” should be set out by the shareholders’ agreement. Legal Challenges of Companies 2023/2024 Shareholders agreements Shotgun clause Example Under the clause, one party, P1, offers either to buy the shares of the other party, P2, or to sell P1's own shares to P2 at a specified price. P2 can either accept the offer to sell, or reverse it and become the purchaser at the same price. The aim is to induce the party wanting to trigger the process and terminate the relationship to offer a fair price. It always runs the risk of reversal. CASE STUDY – FACEBOOK Video: https://www.youtube.com/watch?v=mOMUe26X3mo&t=80s Legal Challenges of Companies 2023/2024 Exercise New Shares and Pre-Emption Rights The Facebook case: Eduardo Saverin and Mark Zuckerberg Using the information and reference, research the corporate process used by Zuckerberg (and others) in order to explain what happened. 1. Describe, as much as you can, the legal steps used. 2. What was the consequence of those actions? 3. Were issuing shares, pre-emption rights and dilution of votes and fiduciary duty involved? How and why? 2 Legal Challenges of Companies 2023/2024 CLASSES OF SHARES Legal Challenges of Companies 2023/2024 Ordinary shares Non-voting ordinary shares Preference shares Redeemable shares Multiple voting shares Legal Challenges of Companies 2023/2024 ORDINARY SHARES (Common type of shares) o They carry one vote per share o They are entitled to participate equally in dividends o If the company is insolvent, share equally in the proceeds of the company's assets after all the debts have been paid o Some companies create different classes of ordinary shares (e.g. 'A' ordinary shares, 'B' ordinary shares, etc.). This is done to create some difference between the different classes, e.g. to allow the directors to pay different dividends to the holders of the different share classes, or to distinguish between the shares so that different rules apply for share transfers, etc. Legal Challenges of Companies 2023/2024 Preference Shares (preferred treatment over the ordinary shareholders)  They typically carry a preferential right to a fixed amount of dividend, expressed as a percentage of the nominal (par) value of the share.  Preference share are often non-voting  They are sometimes redeemable.  They may be given a priority on return of capital on a liquidation. Legal Challenges of Companies 2023/2024 Non-voting ordinary shares  Non-voting shares carry no rights to vote as a member whether on written resolutions or at general meetings.  Such shares are widely used to issue to employees, so that some of their remuneration can be paid as dividends, which can be more taxefficient, or to confer an interest in the value of a company, without any right to vote.  Preference shares are often non-voting (but not necessarily). Legal Challenges of Companies 2023/2024 Redeemable shares Shares issued on terms that the company will, or may, buy them back at some future date. The redemption date may be fixed, or at the directors' discretion or on the happening of a specified event. The redemption price is often the same as the issue price (but not necessarily) Shares given to employees are often made redeemable, so that if the employee leaves the company, the shares can be taken back, perhaps at their nominal value. Preference shares are often redeemable, but do not have to be. Legal Challenges of Companies 2023/2024 Multiple voting shares As an exception to the general rule, under which the number of votes attributed to each share must be directly proportional to the percentage of the capital it represents (principle of one share, one vote), in some countries companies have the right to issue multiple voting shares. Multiple voting shares give the right to more votes than is warranted by the amount of capital represented by these shares. For example: France and Italy double voting rights Sweden, Finland multiple voting rights Legal Challenges of Companies 2023/2024 Liquidation If a company is insolvent (i.e. it can no longer pay its debts when they fall due) ordinary shareholders will rank last when receiving any amounts from the company. When a company enters into a formal insolvency process their creditors are ranked with differing priorities in regards to repayments. Secured creditors (e.g. Banks that hold a fixed charge on assets, etc.) will receive payment first, followed by unsecured creditors (customers, suppliers, etc..) and then preferential shareholders, followed by ordinary shareholders. Thank you for your attention! Any questions?