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Pre-emption - It's not what you know...

Over a series of weeks Oliver King examines some of the traps and pitfalls of operating within a private limited company structure without the protection of either a shareholders’ agreement or bespoke articles of association. Poor preparation of a company’s constitutional documents can lead to disputes and ultimately the business failing.

A key aspect of any organisation is knowing exactly who you are in business with.

Whilst certain aspects of the model articles and other governing law restrict (although do not necessarily prevent) a company from issuing fresh shares without at least offering them to the other shareholders, there is nothing within the model articles or at law to prevent a shareholder from selling, or even gifting, existing shares to any person.

Any person; a friend, a relative, or even a competitor.

Bespoke articles will almost always cover pre-emption (or the right of first refusal) as standard, which require a shareholder to first offer those shares to all other shareholders at the same price as that offered by the third party.

Where the price offered by the third party is less than the shares are worth, the existing shareholders may have an opportunity to increase their shareholding for a low price, but the articles will also usually utilise a valuation mechanism where the price is too high. An external, independent third party – usually an accountant – will value the shares in question, using pre-determined bases and assumptions, and that will be the price to be paid.

The articles will also usually provide for a deemed offer by a shareholder to sell their shares where certain specified events take place. For example, if a shareholder were to pass away, or lose their capacity to manage their affairs or cease to be a director and/or an employee of the business.

Further, bespoke articles will also usually provide that, where a shareholder does not conduct themselves as they ought to, for example they breach the terms of their contractual relationship (i.e. the shareholders’ agreement or service agreement), fail to pay monies owing to the company, or allow themselves to become bankrupt, their shares are also offered to the other shareholders.

In this regard, the articles may also provide for a variance in the amount to be paid to that shareholder, through “good leaver”/”bad leaver” provisions, so that an outgoing shareholder will not be rewarded for inappropriate conduct.

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