Shareholders' agreements: what to provide for before you need it

Why write it early

A shareholders' agreement is only well written when nobody needs it yet. When a new shareholder comes in, a joint venture is set up or a business passes to the next generation, the shareholders' interests tend to coincide: everyone wants the business to grow and nobody is thinking of leaving.

Interests diverge later: when a purchase offer arrives, when a shareholder wants to cash in, when the shareholders cannot agree on a strategic decision. At that point every missing rule becomes a negotiation, conducted from very unequal positions of strength.

The four clauses to consider first all govern the transfer of shareholdings: lock-up, pre-emption, drag-along and tag-along. Before looking at them, however, it is worth deciding where to put them.

Shareholders' agreement or articles of association?

Where a clause sits matters as much as what it says. A shareholders' agreement is a contract between shareholders and binds only those who sign it. If a shareholder sells in breach of a pre-emption right set out in the agreement, the transfer remains valid: the other shareholder is left with a claim for damages, which is often hard to prove and to quantify.

Clauses in the articles of association, by contrast, have proprietary effect: they can be enforced against the company and against third-party purchasers. The articles, however, are public, can only be amended under the rules for extraordinary shareholders' meetings, and are subject to mandatory limits, such as the right of withdrawal and the fair valuation of shareholdings.

In practice a mixed solution is often adopted. The rules on the transfer of shareholdings go in the articles, while governance, confidentiality, penalties and the shareholders' personal undertakings stay in the agreement.

Duration also needs planning:

• in joint-stock companies (S.p.A.) and the companies that control them, agreements may not exceed five years, subject to renewal; if they are open-ended, each party may withdraw on one hundred and eighty days' notice (art. 2341-bis of the Italian Civil Code);
• in listed companies the maximum term falls to three years (art. 123 of the Consolidated Law on Finance, TUF) and agreements are subject to disclosure and publication requirements (art. 122 TUF);
• in limited liability companies (S.r.l.) the five-year limit does not apply on its terms, but it is prudent to set a term anyway, with a renewal mechanism.

Lock-up: stability for a set period

A lock-up prohibits shareholders from transferring their shareholdings for a set period. It is typical after an investor comes in or in the start-up phase of a project, when the identity of the shareholders is an essential part of the deal.

The limits vary depending on where the clause sits and on the type of company:

• in the articles of an S.p.A., a prohibition on transfer can last at most five years from incorporation or from the introduction of the prohibition (art. 2355-bis of the Civil Code);
• in an S.r.l., non-transferability gives shareholders a right of withdrawal, which the articles may however exclude for the first two years after incorporation or subscription (art. 2469 of the Civil Code);
• in a shareholders' agreement, a restriction on disposal is valid if it is kept within reasonable time limits and supported by a legitimate interest (art. 1379 of the Civil Code).

Beyond duration, it is worth defining the permitted transfers from the outset: to subsidiaries, to family holding companies, to heirs. A change of control of a shareholder that is itself a company should also be addressed: without a specific clause, the lock-up can be circumvented by selling the holding company's shares rather than those of the company it owns.

Pre-emption: who joins the shareholder base

A pre-emption right gives the other shareholders the right to buy, on the same terms, a shareholding that a shareholder intends to sell to a third party. It is the most common clause, but also the one most often drafted in general terms. Four points need to be settled.

1. The transactions caught. A clause referring only to a "sale" leaves out exchanges, contributions in kind and gifts. For transfers without a cash price, a method for determining value is needed, usually entrusted to an independent expert.
2. The procedure. The content of the notice to the shareholders (purchaser, price, payment terms, warranties), the deadlines for exercising the right and the allocation between several interested shareholders must all be set.
3. The subject matter. It is advisable to provide that the right must be exercised over the entire shareholding offered, so that the seller is not left with a residual stake the third party no longer wants.
4. Coordination with the other clauses. If the articles also provide for drag-along, it should be made clear whether and how pre-emption applies when the drag-along is triggered, so as not to block a sale of the whole company.

When included in the articles, pre-emption is enforceable against third parties: according to the prevailing view, a transfer made in breach of it has no effect as against the company, and the purchaser cannot exercise shareholder rights. In the agreement alone, by contrast, the only remedy is damages.

Drag-along: selling 100%

With a drag-along, a shareholder who receives an offer for the entire share capital can require the others to sell on the same terms. The clause meets a practical need: a trade buyer or a fund rarely buys a majority stake alongside minority shareholders it does not know.

For the minority, however, a drag-along amounts to a forced sale. This is why notarial practice and the courts accept it as valid only if a fair valuation is guaranteed. The dragged shareholder must receive at least what it would be entitled to on withdrawal, that is, a value determined according to the statutory criteria (art. 2437-ter of the Civil Code for an S.p.A., art. 2473 for an S.r.l.).

The points to negotiate are:

• the threshold that triggers the right, expressed as a percentage of share capital or as a qualified majority;
• the minimum price and the form of consideration, preferably cash;
• the independence of the purchaser, to rule out transactions with parties related to the majority shareholder;
• the warranties required of the dragged shareholders, usually limited to title to the shares and the absence of encumbrances.

There is one more reason to provide for it from the start: whether a drag-along can be introduced by majority vote into existing articles is a contested question. Negotiating it later, with a deal on the horizon, is much harder.

Tag-along: exiting alongside the controlling shareholder

A tag-along is the mirror image of a drag-along. If the majority shareholder sells its stake, the minority shareholders are entitled to sell to the purchaser as well, on the same terms. The minority thus avoids ending up with a new controlling shareholder it did not choose, and shares in the control premium paid by the purchaser.

Here too the details make the difference:

• the trigger: the clause may apply only on a transfer of control, or on any transfer above a certain threshold;
• the extent: a full tag-along, for the minority shareholder's entire stake, or one proportionate to the stake sold by the majority shareholder;
• refusal by the purchaser: it must be decided whether in that case the seller cannot complete the deal, or must itself buy the minority's shares;
• warranties: as a rule the minority shareholder gives them in proportion to its stake and up to the price received.

Other clauses not to forget

Rules on the transfer of shareholdings are not enough on their own: disputes between shareholders often arise from day-to-day management. This is why the agreement should also deal with other matters.

Governance. The agreement establishes who appoints the directors, which matters require unanimity or a qualified majority, and what periodic information the shareholders who do not manage the company receive. It may also provide for a voting syndicate, with prior consultation between the parties before each shareholders' meeting.

Deadlock. In 50:50 companies deadlock is the main risk. The first remedy is an escalation procedure between the shareholders' senior management; if that fails, exit mechanisms are needed. The best known is the "Russian roulette" clause: one shareholder names a price and the other chooses whether to sell or buy at that price. Lower courts have upheld its validity, and the mechanism pushes whoever triggers it to propose a fair price.

Departure of working shareholders. When a shareholder also works in the business, it is worth regulating what happens if that relationship ends. Good leaver and bad leaver clauses give the other shareholders a call option, at a price that varies with the reason for leaving. They should be accompanied by non-compete and non-solicitation covenants, within the limits of duration and scope set by law (art. 2596 of the Civil Code).

Making the agreement effective: penalties and arbitration

An agreement that can be breached without serious consequences is worth little. Since the ordinary remedy is damages, it is worth reinforcing it with a few tools.

• Penalty clause. It liquidates the damage in advance and dispenses with proof of loss (art. 1382 of the Civil Code). It must be carefully calibrated, because the court may reduce it if it is manifestly excessive (art. 1384 of the Civil Code).
• Call option on breach. The other shareholders may buy the defaulting shareholder's stake at a predetermined price, often at a discount to market value.
• Arbitration. Disputes between shareholders lend themselves to arbitration, which is faster and confidential. Arbitration clauses in the articles of association are now governed by the Code of Civil Procedure (art. 838-bis et seq.), which since 2023 has replaced the regime of Legislative Decree 5/2003. The agreement and the articles must designate the same forum, so that a single dispute does not end up before different tribunals.

In general, the agreement and the articles should be drafted together and read against each other. Inconsistencies between the two documents are one of the most frequent sources of litigation.

Questions to ask before signing

A good shareholders' agreement is not born of mistrust between shareholders: it is a way of putting in writing, with a cool head, what each expects of the others. Before sitting down at the table, it is worth answering a few questions.

1. Which rules must also apply to third parties, and should therefore go in the articles?
2. How long do the shareholders commit to stay, and which transfers remain free in any event?
3. Who has a pre-emption right, over which transactions and at what price?
4. Who can force a sale of the whole company, on what terms and at what minimum price?
5. Can the minority exit alongside the controlling shareholder?
6. Who appoints the directors and which decisions require everyone's consent?
7. How is a deadlock broken?
8. What happens if a working shareholder leaves the business?
9. What are the consequences of breaching the agreement, and who decides disputes?

Answering these questions while relations are good costs a few hours of discussion. Doing so in the middle of a dispute costs far more, in time, money and relationships.

Consistency with the articles of association

An effective agreement must work together with the articles: some provisions are better protected if they are also reflected in the articles, while others are best kept confidential between the parties. The choice depends on the shareholders' objectives and the degree of confidentiality they want.

The Firm is available to review existing agreements or to draft tailor-made ones.