agreements and bylaws

Minority shareholders through agreements and bylaw

Shareholder Agreement: Protecting minority shareholders through agreements and bylaws.

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Shareholder Agreements

Protecting the Minority Shareholder by Agreement

Minority shareholders may protect themselves contractually. In Ritchie v. Rupe, the Texas Supreme Court wrote: “Shareholders of closely-held corporations may address and resolve such difficulties by entering into shareholder agreements that contain buy-sell, first refusal, or redemption provisions that reflect their mutual expectations and agreements.”  A shareholder agreement may define respective management and voting powers, the apportionment of losses and profits, the payment of dividends, and shareholders’ rights to buy or sell shares from or to each other, the corporation, or an outside party.  However, shareholder agreements are relatively rare, and truly fair and comprehensive ones that solve future problems not anticipated at the founding of the company are rarer still. The dissenting opinion in Ritchie aptly noted: “[f]rom a relational standpoint, people enter closely-held businesses in the same manner as they enter marriage: optimistically and ill-prepared.”  Because closely-held corporation owners are frequently linked by family or personal relationships, there is often an initial atmosphere of mutual trust that makes that contractual protection seem unnecessary.

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Shareholder Agreement

The Statutory Shareholder Agreement

Section 21.101 of the Texas Business Organizations Code provides a mechanism for shareholders to modify the corporate structure or governance by means of a shareholder agreement. Shareholders may even agree to terms that are inconsistent with the Code. The specific areas in which shareholders may contact under the statute are as follows:

(a) The shareholders of a corporation may enter into an agreement that:

(1) restricts the discretion or powers of the board of directors;

(2) eliminates the board of directors and authorizes the business and affairs of the corporation to be managed, wholly or partly, by one or more of its shareholders or other persons;

(3) establishes the individuals who shall serve as directors or officers of the corporation;

(4) determines the term of office, manner of selection or removal, or terms or conditions of employment of a director, officer, or other employee of the corporation, regardless of the length of employment;

(5) governs the authorization or making of distributions whether in proportion to ownership of shares, subject to Section 21.303;

(6) determines the manner in which profits and losses will be apportioned;

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(7) governs, in general or with regard to specific matters, the exercise or division of voting power by and between the shareholders, directors, or other persons, including use of disproportionate voting rights or director proxies;

(8) establishes the terms of an agreement for the transfer or use of property or for the provision of services between the corporation and another person, including a shareholder, director, officer, or employee of the corporation;

(9) authorizes arbitration or grants authority to a shareholder or other person to resolve any issue about which there is a deadlock among the directors, shareholders, or other persons authorized to manage the corporation;

(10) requires winding up and termination of the corporation at the request of one or more shareholders or on the occurrence of a specified event or contingency, in which case the winding up and termination of the corporation will proceed as if all of the shareholders had consented in writing to the winding up and termination as provided by Subchapter K;1

(11) with regard to one or more social purposes specified in the corporation's certificate of formation, governs the exercise of corporate powers, the management of the operations and affairs of the corporation, the approval by shareholders or other persons of corporate actions, or the relationship among the shareholders, the directors, and the corporation; or

(12) otherwise governs the exercise of corporate powers, the management of the business and affairs of the corporation, or the relationship among the shareholders, the directors, and the corporation as if the corporation were a partnership or in a manner that would otherwise be appropriate only among partners and not contrary to public policy.

The provisions of the statutory shareholder agreement substitute in for the legal obligations imposed by corporate law. Therefore, officers and directors violating the governance requirements of a shareholders’ agreement may be subject to ultra vires or breach of fiduciary duty claims and to the mandamus power of the courts, as opposed to being merely liable for breach of contract. However, the operation of the shareholder agreement may not be used to impose personal liability on a shareholder for corporate acts, where such liability would not otherwise exist.

The statutory shareholder agreement must be made unanimously by all shareholders at the time of the agreement and recorded in writing either in the certificate of formation or in bylaws approved by all shareholders or in a separate written agreement that is signed by every shareholder and is made known to the corporation. The shareholder agreement may only be amended by vote or agreement of all the shareholders at the time of the amendment (unless the initial agreement provides otherwise). All shareholders’ agreements in effect prior to September 1, 2015 are subject to a ten-year expiration, unless a different period was specified in the agreement. All agreements entered into after September 1, 2015 are not subject to any automatic term or duration, except where the agreement contains such a provision. Section 21.103 requires conspicuous notices of the existence of the shareholder agreement to appear on the front and back of the share certificate. Failure to comply with the notice provisions does not affect the validity or enforceability of the agreement itself, but a purchaser who does not have knowledge of the existence of the shareholder agreement may rescind the purchase if the corporation fails to comply with the notice provisions—provided that the action to enforce the right of rescission is commenced not later than the 90th day after discovering the existence of the agreement or 2 years after the purchase.

Shareholder Agreement

The Non-Statutory Shareholder Agreement

Section 21.101 of the Code provides that the provisions governing the statutory shareholder agreement do not prohibit or impair any other agreement between two or more shareholders or between the corporation and one or more of its shareholders. Such a non-statutory shareholder agreement would be valid or invalid based on ordinary principals of contract law and would be subject to challenge if their terms were inconsistent with the ordinary corporate law. Likewise, even unanimous agreements that do not comply with section 21.101 are likely to be unenforceable to the extent that they constrain the exercise of discretion by the board of directors.

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Implied-In-Fact Shareholder Agreement

Texas law recognizes contracts that are expressly made, either in writing or orally, and those that arise by implication from the actions of the parties and facts and circumstances evidencing an intent to form a contract. "Our courts have recognized that the real difference between express contracts and those implied in fact is in the character and manner of proof required to establish them." The terms of an implied shareholder agreement are determined from all the surrounding circumstances, including the statements and conduct of the parties, industry customs and standards, course of dealing, etc. For example, if all the shareholders understood from the outset of the enterprise that all the shareholders would participate and have a voice in management, that all would be employed by the corporation so long as they owned their stock, and that all profits would be fairly distributed by means of increases in salary and bonuses, then these mutual expectations would become contractual rights and interests incident to stock ownership, just as if they were expressly provided for in a written shareholder agreement.

The most common agreements, express or implied, that become problematic in shareholder oppression scenarios are an agreement that all shareholders will participate in management and/or an agreement that all shareholders will be employed by the corporation. The agreement of employment presents extremely difficult issues and is dealt with separately. Other agreements, such as participation in management, sharing and payment of profits, limitations on personal benefits and salary are generally enforceable. The question will always be one of proof. Was the shareholder agreement made and sufficiently definite in its terms to be enforced? Even under the shareholder oppression doctrine, courts rarely held that merely making the same compensation or election of directors decisions repeatedly, even over extended periods of time, established an agreement to continue to do so regardless of circumstances.

Download a copy of Hopkins Centrich Law CLE Paper, Shareholder Agreements as a Mechanism for Dealing with Shareholder Oppression, presented at the Texas Bar's 2020 Essentials of Business Law Course.