Key Provisions of Shareholders Agreements

A shareholders’ agreement is a legal document entered into by the shareholders of a California corporation. Unlike the bylaws of a corporation which are required by the California Corporations Code and are often required to be disclosed to governmental agencies and/or to third parties in connection with certain transactions, a shareholders’ agreement is a private contract among the corporation’s shareholders. The content of shareholder agreements vary depending upon the requirements of the specific shareholders; however, they generally focus on corporate governance and share ownership issues.

The following are key provisions generally addressed in shareholders agreements of California corporations:

• Representation on board of directors – for any election of directors of the corporation, the shareholders may agree in advance to vote their shares to elect certain designated persons, such as an executive officer of the corporation or individuals designated by one or more significant shareholders
• Restrictions on transfer of shares of stock – such restrictions assure that shares will be held only by the existing shareholders or transferees permitted under the agreement.
• Rights of first refusal – if a shareholder desires to transfer shares to a third party, the selling shareholder must first notify the corporation and offer to sell the shares to the corporation and/or the other shareholders of the corporation.
• Permitted transfers – a shareholder may be permitted to transfer shares to (i) a third party with the written consent of the corporation and/or the other shareholders, provided that the transferee becomes a party to the shareholders agreement or (ii) without such a written consent, if the transfer is to a revocable trust for estate planning purposes and such shareholder is the sole trustee of the trust empowered to vote or otherwise deal with the shares in any manner.
• Optional purchase of shares in the event of a shareholder’s death, disability or termination of employment with the corporation – a departing shareholder may be required to tender his shares for purchase by the corporation and/or the other shareholders on certain terms, which may include (i) fixing the purchase price at an agreed value or otherwise providing for an appraisal of the fair market value of the shares and (ii) specifying whether payment for the shares will be made in a lump sum or in installments over a period of time.
• S Corporation election – to preserve any S corporation election made by the corporation, provision may be made that any transferee of shares must be a qualified S corporation shareholder and to file in a timely manner the required consent to the election.
• Tax distributions – for S corporations, provision may be made to require the corporation to make distributions in amounts sufficient for the shareholders to pay federal, state and local income taxes on the net distributive share of income, losses, deductions and credits that have passed through to the shareholders under IRC §1366.
• Covenant not to compete – in order to preserve the goodwill of the corporation, the agreement may require that a selling shareholder not compete with the business of the corporation for a period of time in the territory in which it then operates.
• Dispute resolution – in the event that any dispute arises among the shareholders, the agreement may provide for mediation and/or arbitration in lieu of court proceedings.
• Spousal consents – in order to assure that the community property or other joint interest of a spouse or domestic partner of a shareholder does not hinder the operation of the agreement, the spouse or domestic partner may be required to consent to the terms of the agreement.

While the California Corporations Code provides the basic legal framework for corporations, a shareholders’ agreement can fine tune the corporation’s operations and governance to the requirements of its shareholders. The attorneys at Poole Shaffery are experts in the formation and operation of corporations, limited liability companies and other legal entities and look forward to the opportunity to be of assistance in tailoring your legal entity to your specific situation.