Shareholders in a private or closely held corporation frequently enter into agreements with one another to decide the manner in which the company will be governed and controlled. Termination of an existing shareholders' agreements can arise either voluntarily, when certain predefined conditions occur, or involuntarily, when one or more of the corporation’s shareholders seek to squeeze out another.
Common Provisions of Shareholder Agreements
Most shareholder agreements contain provisions that restrict the transferability of the shares of the company to third parties. Such transfer restrictions may require that the departing shareholder offer the company a right of first refusal on his shares. Often a shareholders' agreement will contain a mandatory buyout or redemption provision that obligates the corporation to purchase the departing shareholder’s stock. Shareholders' agreements may also provide that some or all of the shareholders are entitled to employment with the company at a specified salary.
Typically, most shareholder agreements provide that upon the occurrence of certain specified events, the shareholder agreements are automatically terminated. These conditions often include death of a shareholder; instances where the company is bought out by another corporation; the dissolution of the company; bankruptcy; and a planned initial public offering (IPO) of the company’s stock.
In some cases, the relations between one or more of the shareholders in a closely held corporation may deteriorate to the point that most of the stockholders may seek to force out the shareholder or terminate his employment agreement with the company. Disputes may also arise between shareholders as to the strategic initiatives or future business plans of the company or about. They might disagree about what portion of earnings should be retained as opposed to distributed to shareholders in the form of dividends. When an individual shareholder's agreement is involuntarily terminated, it affects the mandatory redemption or buyback provisions of the shareholder agreement.
Since there is no public market for the stock of closely held corporations, questions of how to value the departing shareholder’s stock may frequently arise. In some cases, the agreement will provide for valuation methodology, such as a percent of current as well as future earnings or the current book value of the company; in other cases, the agreement may provide that a corporate appraiser will value the shares. If the shareholders' agreement is silent on the manner of valuation and the departing shareholder feels that his shares have not been redeemed for a fair value, litigation may result.