Introduction

A shareholders’ agreement is a supplement to the company’s constitution and generally regulates the shareholders’ rights and the company’s management and operation policy. There is no legal requirement to have a shareholders’ agreement in place. However, if one is not in place shareholders in private companies are more likely to run into trouble and increased potential for a dispute due to the lack of clarity of obligations.

The provisions of non-compete clauses are one of the key issues that shareholders should take into consideration at the drafting of a shareholders’ agreement.

This article will provide you with an insight into non-compete clause in a shareholders’ agreement, possible implications of the agreement and the benefit of legal advice.

Non-Compete Clause In A Shareholders’ Agreement

A shareholders’ agreement is best made at the commencement of a new business venture. A shareholders’ agreement is a binding contractual arrangement between shareholders and it is advisable to enter into an agreement as the agreement clarifies the rights and entitlements of each party with respect to issues such as initial shareholdings, management of the company, appointment of directors, obligations of shareholders in the operation of the company, rights and obligations on transfers of shares and how shares are valued.

One issue to be clarified in the agreement is when and how a shareholder may compete with the company during their involvement with the company or after their involvement with the company. A clearly expressed non-compete clause in a shareholders’ agreement can remove potential uncertainty and ambiguity.

Incorporating a non-compete clause in a shareholders’ agreement may prohibit or limit shareholders/directors from engaging in competition with the company during their involvement with the company and/or for a period after their shareholding with the company has terminated.

Most shareholders of a business will have detailed knowledge of the company’s intellectual property such as trade secrets, business plans as well as relationships with key stakeholders and access to customer/client lists. A non-compete clause in the shareholders’ agreement is designed to protect and benefit all the shareholders by preventing any of the owners from using the company’s intellectual property to start a rival business or contribute to a direct competitor.

A majority shareholder looking to grow the business by bringing in new partners will want to incorporate a non-compete clause to protect the value they have built in the business and its long-term prospects. Likewise, anyone buying out shares of the majority shareholders will want to ensure the former owner cannot set up a competing business upon their exit.

When preparing non-compete clause in the shareholders’ agreement, it is important to specify clearly and narrowly the commercial activity that is considered competitive. Setting up a new company and offering the same goods or services would clearly be competing in nature. Substitute goods or services may be less clear unless expressly and unambiguously defined.

The shareholders’ agreement should also clearly articulate the nature of the company’s business so that activity that is competing can be easily identified.

Possible Implications

If the shareholders in your business have or are thinking about including a non-competition clause in the shareholders’ agreement to prevent shareholders from competing with the business after they sell their shares then careful drafting will be required to make sure that the clause is reasonable in the circumstances and therefore enforceable.

Non-compete clause that go too far in restricting either the types of business activities the former shareholder can conduct, or the place or time, during which the former shareholder can start a competing business, may not be upheld. Courts are very mindful to not allow trade to be unfairly restricted and agreements that have this effect are enforced very strictly and narrowly.

Similarly, if the shareholders require the approval of a third party such as a lender before they can sell their shares, a Court may consider the time limitation to be potentially infinite and find the clause unreasonable. Such a clause may operate as an unfair restraint of trade.

It is also important to remember that an express acknowledgment by the party to the agreement as to the reasonableness of the agreement will not necessarily safeguard the agreement against a finding of unreasonableness. Such a clause may be given some weight by the Court in its assessment of the restrictive agreement. However, it is not decisive to a Court’s ability to find that a clause is still unenforceable.

The drafting of an enforceable non-compete clause can be a complex part of the shareholders agreement. At the time it is drafted it is common that the shareholders are in good relationships with each other. At the time it is sought to be enforced that is often not still the case.

Need For Seeking Legal Advice

A shareholders’ agreement should cover all aspects of the relationship and the mechanics by which the company is to be operated. The agreement should also protect the interest of the parties to the agreement and also that of the business and should also outline dispute resolution provisions in the event of any disagreement between the parties.

 

You should seek legal advice while drafting the non-compete clause, because a properly drafted clause prohibits shareholders from competing with the company while they are owners in the company and for a short period after they have left the company. This protects the value of the company.

 

In a small company, customers deal closely with the shareholders. A non-compete clause prevents an influential shareholder or former shareholder from attracting customers away from the company. A shareholder that leaves the company may also possess confidential information that can be used to advantage against the company.

 

Owen Hodge Lawyers can help you to have a clear understanding of the entire procedure in regard to shareholders’ agreement and can assist you through the process considering your best interest.

 

We can also draft, revise and structure new and existing agreements, tailoring them to meet the requirements of your business and particular circumstances.

Feel free to contact our team at Owen Hodge Lawyers on 1800 770 780 to get advice on shareholders’ agreement and for any kind of assistance regarding the same.

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