Share transfer provisions: what are they and why do they matter?

You may have already come across share transfer provisions when you first incorporated your company. These provisions are most commonly found in the company’s articles of association and shareholders’ agreements, but also in buyout service agreements and investment agreements. Let’s take a look at what those provisions are and why they are important.

 

What do your Articles say?

Under the Companies Act 2006, shares in private companies are generally freely transferrable, unless: (a) the articles of association impose an effective prohibition on such transfers, or (b) the shareholders have entered into a legally enforceable agreement which prohibits them from transferring their shares. If you have adopted the Model Articles for a private company limited by shares, you need to be aware that the Model Articles do not contain detailed share transfer restrictions or references to circumstances in which the shareholders may be compelled to transfer their shares back to the company or to the other shareholders. It should be noted that the term transfer means any form of disposal and includes selling, gifting, assigning, pledging, charging, or granting any rights over or in respect of the shares.

 

This level of flexibility is greatest when your company has only one shareholder. Cracks start to appear when there is more than one shareholder, the company is raising investment funding, or the workforce expands. If this is the case, you may have to start thinking about introducing restrictions on share transfers by amending your articles of association and putting in place a shareholders’ agreement. It is worth considering the following:

• Who will be your co-owners after the initial incorporation of the company?
• Will outsiders be allowed to have an interest in your company? 
• Should a bad leaver or a good leaver be permitted to keep their shares? 
• How can you appease your investors, if key team members decide to transfer their shares to another shareholder or a third party?
• Should transfers to family members be allowed?
• What about family trusts or controlled legal entities?

 

If you decide to introduce share transfer rules, you will need to balance the scope and extent of those restrictions with the goals that you are trying to achieve. Establishing a reasonable and balanced approach is key to managing the dynamics within your company. Once you are clear as to how to approach this sensitive subject, you will need to amend your articles of association and your shareholders’ agreement to reflect some of the following options.

 

Absolute bar on transfers

 In principle, it is possible to impose an absolute bar on share transfers. If there is an absolute prohibition on share transfers, then the only way shareholders can exit a company is by transferring their shares back to the company. A variety of legal issues arises in the context of absolute bans on share transfers, for example, when a shareholder dies or when the company is unable or unwilling to buy those shares. Absolute bar on share transfers is very rare, with the prohibition being potentially unenforceable and may give rise to unfair prejudice claims.

 

Qualified bar on transfers

Perhaps a more reasonable approach is to place qualified restrictions on transfers. For example, prohibiting the transfer of shares during a specified period of time (so-called “lock-up restrict”) or precluding transfers to competitors of the company would often sufficiently protect the interests of the company, its shareholders, and investors. 

 

 

Pre-emption rights (Rights of First Refusal)

In private companies, pre-emption rights ensure that an outsider cannot join the company, without the existing shareholders having an opportunity to take the place of departing shareholders. In other words, shares cannot be transferred to a potential  purchaser, without such shares first being offered to the existing shareholders (or a specified group of shareholders) at the same price. The ability to accept a pre-emptive offer will largely depend on whether the shareholders can pay the proposed or agreed price for such shares. 

The pre-emption rights on share transfers must not be confused with the pre-emption rights on the allotment of shares. The latter is a statutory right set out in section 561 of the Companies Act 2006 and only applies to the allotment and issue of new shares. There are no statutory pre-emption rights in respect of share transfers. 

 

Permitted transfers

Together with any share transfer restrictions, you can also provide certain carve-outs and specifically allow share transfers in certain circumstances. For example, transfers to immediate family members, family trusts, or controlled entities (for tax purposes) may be allowed upon notice to and without the consent of the board of directors. You may wish to prescribe a formal procedure – with timeline and template forms – allowing such transfers to take place and disapplying any pre-emption rights in those circumstances.  

 

Compulsory transfers

Compulsory share transfer provisions deal with situations where shareholders are required to transfer their shares to other shareholders or the company. These rules apply to shareholders who are officers and/or employees of the company and compel them to transfer or otherwise lose all or a portion of their respective shares, upon the termination of their office or employment. Strictly speaking, compulsory transfer provisions (so called “leaver provisions”) are not restrictions on share transfers but must absolutely be considered when your share transfer rules are being developed. 

Compulsory transfer rules are the most controversial provisions because they often involve negotiations over the percentage of the shareholder’s equity which will be subject to buy-back or forfeiture and how the buy-back price is determined. For example, if an employee shareholder acquired their shares at a low subscription price as part of a company share option plan, the price paid to such a shareholder upon buy-back may be contingent on the circumstances surrounding their departure from the company. 

 

Legal documentation

 Whatever restrictions you choose for your company, to be enforceable they must be properly reflected in your articles of association and your shareholders’ agreement. Remember, your company’s articles of association will automatically bind any new shareholders, but the shareholders’ agreement will only bind those shareholders that have agreed to become a party to it. To minimise practical difficulties and maximise the protection afforded to the company’s shareholders and officers, it is essential that certain provisions in your articles are also mirrored in your shareholders’ agreement. 

We are here to share our knowledge and help you address your legal needs. We regularly deal with shareholder agreements, develop bespoke articles of association and advise organisations of all sizes on share transfer provisions. Please book a call with a member of our expert legal team to find out more and discuss how we can assist.

 

Our insights, articles and guides do not, and are not intended to, constitute legal advice or be an exhaustive review of all legal developments. Although every effort is made to ensure that the information provided in this article is accurate as of the publication date, please be aware that this is area of law may be subject to change. Please seek legal advice before applying the information provided to any specific circumstances, transactions or legal issues.