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Shareholders’ Agreement 101 – Do I Need One?

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Why do you need a shareholders’ agreement?

When friends or family members come together to form a company, more often than not, they will not consider the need for a shareholders’ agreement as they tend to rely on mutual trust, respect and confidence. Of course, this generally works perfectly when the business is doing well and profitable, and while the shareholders are receiving their expected return on investment. But what if things turn sour? Whether the business is not doing well or trust and confidence morph into distrust and suspicion, what can shareholders do? In circumstances like these, the shareholders’ agreement comes into play. A well drafted shareholders’ agreement should be able to offer a solution to the parties in most cases. As with any other agreement such as those for sale and purchase, and loan transactions, the importance of a shareholders’ agreement is to safeguard interests of the shareholders and if disputes arise between the parties, there is an agreement they can fall back on setting out clearly what the parties can or cannot do, and shall or shall not do.

What is a shareholders’ agreement?

Shareholders’ agreement is an essential agreement between the shareholders of a company and the company itself. It can be between the company and all or just some of the shareholders; for instance, a company with different classes of shares and holders of different classes of shares might prefer to separately enter into a shareholders’ agreement with the company instead of with holders of all classes of shares. A shareholders’ agreement is used to govern the company’s management and operation and sets out all the rights and obligations between the shareholders and the company. A shareholders’ agreement is particularly important for third party investors investing in an existing company or business or when unrelated parties come together to form a new company.

What terms are to be included in a shareholders’ agreement differ according to the parties’ needs and bargaining power and/or the particular type of business. Still, a typical shareholders’ agreement normally consists of the following terms:

  • the type of business the company will run
  • the management of the company, i.e., the composition of the board of directors and any committees
  • the right of shareholders to nominate directors
  • frequency, procedures for convening and holding board meetings and shareholders’ meetings
  • matters which require simple majority, super majority or unanimous votes
  • specific obligations of shareholders
  • dividend policy
  • issue of new shares and admission of new shareholders
  • transfer of shares
  • anti-dilution mechanism
  • deadlock
  • minority shareholder protection
  • further financing needs of the company
  • non-competition undertaking by shareholders
  • term and termination of the shareholders’ agreement
  • dispute resolutions

If investments are to be made in stages, the shareholders’ agreement would normally include the timetable for capital contribution, share subscription by the shareholders, shareholding structure and other typical clauses in a share subscription agreement.

Minority protection

Where a company has only two shareholders, one of them holds 51% (majority shareholder) and the other one holds 49% (minority shareholder) of the issued shares, the minority shareholder typically has no control over how the company will be managed and operated as the minority shareholder will be out-voted by the majority shareholder at general meetings, assuming all decisions only require a simple majority vote, i.e., >50%, of the shareholders to pass. However, according to the Companies Ordinance (Cap.622, Laws of Hong Kong), certain decisions of a company are required to be passed by special resolutions, i.e., passed by at least 75% of the voting shares. These decisions include the alteration of the articles of association, change of the company’s name, reduction in the share capital of the company, etc., meaning that the majority shareholder in the above case cannot simply pass a resolution by itself to alter the articles of association of the company. In addition to those decisions specified in the Companies Ordinance that must be approved by special resolutions, to protect their interests, the minority shareholder will negotiate with the majority shareholder for other matters to be passed by special resolutions which are not otherwise required so by law. Common examples include capital expenditure above a certain amount, disposal of material assets, change in the company’s principal business, further financing through equity or borrowings or change in dividend policy, etc. 

Often when an investor invests in a business as a minority shareholder, the investor is in fact investing in the experience, expertise and knowledge in the industry and business operation of the company’s management team who are normally the majority or founding shareholders of the company. In case the majority shareholders decide to divest and sell their shares, the investor could also consider selling their shares as there may be uncertainty as to the management, operation and profitability of the business once the company changes hands. Hence, the investor will almost inevitably request a “tag-along right” to be incorporated in the shareholders’ agreement, giving the investor the right but not the obligation to co-sell its shares on the same terms to the prospective buyer of the majority stake. 

A minority investor would normally request a non-competition undertaking from the company and the majority shareholders to oblige them not to engage in any business operations or investment in other businesses that are similar to or in direct competition with that of the company. This is to avoid any negative impact on the profitability of the company. 

Majority protection

Not only do minority shareholders need a shareholders’ agreement to protect their interests, majority shareholders also have certain interests that require safeguarding. A potential nightmare for a majority shareholder could be when they have found a prospective buyer willing to buy-out 100% of the company but the minority shareholder refuses to sell their shares. What happens next is the entire deal falls through. To avoid this, the shareholders’ agreement should include a clause whereby if the majority shareholder decides to sell all of their shares in the company to a third-party buyer, they will have the right (but not the obligation) to request the minority shareholder(s) to also sell their shares in the company on the same terms. Once requested by the majority shareholder, the minority shareholder(s) will be obligated to sell their shares. Contrary to the tag-along right afforded to minority shareholders, such a right is known as the “drag-along right” of the majority shareholder.

In addition, a majority shareholder would not want any information relating to the business operations, prospects, customers, suppliers, financial information or trade secrets being disclosed to any third party, especially competitors, or shares in the company sold to competitors. Therefore, specific clauses that deal with the use and disclosure of confidential information and on the restrictions on the transfer of shares will need to be incorporated in the shareholders’ agreement to address the majority shareholder’s concerns.

Equal shareholdings

Suppose every shareholder in a company holds the same percentage of shares, for example, there are five shareholders each holding 20%. In this case, where there is no majority shareholder, would any of the majority or minority protection provisions mentioned above still apply? If two or more shareholders join hands and outnumber the rest in terms of shareholdings, arguably there will be a (collective) majority camp against the minority shareholders. What if none of the shareholders can agree on an issue? Circumstances like this is commonly known as a “deadlock” situation, where things come to a standstill and cannot move forward. If a deadlock situation continues, it could seriously affect the continued operation of the business. A well-drafted shareholders’ agreement should have specific provisions incorporated to cater for deadlocks and provide mechanisms to resolve issues. 

Shareholders’ agreement vs Articles of Association

Whether the terms of a shareholders’ agreement will be reflected in the company’s articles of association very much depends on the parties’ wishes. In Hong Kong, the articles of association of a company are public documents and can be searched and obtained for a fee by anyone. If the articles of association of a company is amended to incorporate and reflect terms of the shareholders’ agreement, all such terms incorporated in the articles of association will also become public information. Hence, whether the terms of the shareholders’ agreement will be incorporated in the articles of association and how much of it should be incorporated becomes another area of negotiation between the shareholders and the company. Suppose certain terms of the shareholders’ agreement differ from the articles of association, such as the quorum for a board meeting, and the parties decide not to amend the articles of association to reflect the same, should the shareholders comply with the articles of association or the shareholders’ agreement? To avoid this embarrassing situation, it is always good practice to include a clause in the shareholders’ agreement to the effect that if there is any contradiction or discrepancy between the shareholders’ agreement and the articles of association, the terms of the shareholders’ agreement will prevail.

If you wish to find out more about whether you need a shareholders’ agreement for your company, how to protect your interests, and what terms should be included in your shareholders’ agreement, please feel free to speak to members of our corporate and commercial team.

January 2021

Simon Wong
+852 2186 4848 / +852 9460 9816
simon.wong@oln-law.com
Partner, Corporate & Commercial
Oldham, Li & Nie

Problems for Your Family by Not Leaving a Will

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When someone passes away without having put into place a valid will, the ‘Law of intestacy’ governs the administration and distribution of their estate. In Hong Kong, the two key pieces of this legislation are the Intestates’ Estates Ordinance (Cap. 73) (the “IEO”) and the Non-contentious Probate Rules (Cap. 10A) (the “Rules”).

Before dealing with the deceased’s estate, a Grant of Letters of Administration must be obtained from the Probate Registry. Individuals who are allowed to apply for a Grant of Letters of Administration of the deceased’s estate are those set out in rule 21 of the Rules, in the following order of priority:

1.    A surviving spouse
2.    Children
3.    Parents
4.    Siblings
5.    Grandparents
6.    Uncles and aunts.

Those who are successful in obtaining a Grant of Letters of Administration are the administrators and are empowered to deal with the estate in accordance with the IEO.

After obtaining the Grant of Letters of Administration and having arranged for the funeral of the deceased, the administrator should first collate all the assets of the deceased and settle any debts and expenses. After that, the administrator should distribute the estate to the beneficiaries in accordance with section 4 of the IEO, with the table below illustrating some examples of entitlement under section 4 of the IEO.

Order of Entitlement When There is No Will

 Surviving RelativesStatus of Other RelativesEntitlement Arrangement
1.SpouseNo issue* of the deceased, parent, full sibling or issue* of full sibling All to the surviving spouse
2.Spouse and issue* of the deceasedOther relatives immaterialThe surviving spouse takes the personal chattels, HK$500,000 and half of the residuary estate. The other half is held on statutory trust** for the surviving issue*.
3.Spouse and one or more of the following relatives, namely:
parent or
full sibling or
issue* of full sibling 		 The surviving spouse takes the personal chattels, HK$1,000,000 and half of the residuary estate. The other half is held for the surviving parent(s) or on statutory trusts for the surviving full sibling(s).
4.Issue* of the deceasedNo spouseAll to the surviving issue* on statutory trust. 
5.Parent(s)No spouse, no issue* of the deceasedAll to parent(s)
6.Full siblingsNo spouse, no issue*, no parentAll to full siblings on statutory trusts**
7.Half siblingsNo spouse, no issue*, no parent, no full siblingsAll to half siblings on statutory trusts**
8.Grandparent(s)None of the aboveAll to grandparent(s)
9.Full uncles and auntsNone of the aboveAll to full uncles and aunts on statutory trusts.
10.Half uncles and auntsNone of the aboveAll to half uncles and aunts on statutory trusts.
11.None of the above relatives All to the Hong Kong Government as unowned property.
    
*Issue in succession law means the descendant of a person, such as children and grandchildren.
**For details on statutory trusts, please refer to the IEO

Despite the prescribed entitlement under the IEO, beneficiaries of an estate may sometimes redistribute their entitlement through a Deed of Family Arrangement executed by all beneficiaries and setting out the agreed redistribution of the deceased’s estate. Do note though that the redistribution through a Deed of Family Arrangement may attract stamp duty. 

While the law prescribes a specific priority for the distribution of an intestate’s estate and may leave certain wiggle room for beneficiaries to alter their entitlement, it would certainly be useful to make a valid will to ensure your estate will be inherited exactly as planned. 

If you have any questions or would like to obtain further information on our probate and estate planning services, please contact one of the members of our Probate and Estate Planning team, who are listed here: https://oln-law.com/probate-estate-planning.  

This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances.

January 2021

OLN Lawyers Contribute to Lexis Nexis on Start up Sale & Purchase

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Sharing their knowledge and expertise on Start up Sale and Purchase Agreements, Partners Anna Chan and Victor Ng have contributed to the ‘Hong Kong Encyclopedia of Forms and Precedents’ by LexisNexis Second Edition, 2020 Reissue. This is Hong Kong’s only collection of precedents which covers all the key areas of commercial law and general practice.

Please click here for more information.

Hong Kong’s broken court system is in urgent need of repair as Covid-19 exposes cracks

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This opinion article by Gordon Oldham was originally published in the South China Morning Post on 28 December 2020. 

In November, President Xi Jinping reiterated his call for “staying on the path of socialist rule of law with Chinese characteristics” and that all members of China’s legal community must “ensure loyalty to the party, the country, the people and the law”.

These comments further fuelled debate in Hong Kong about the integrity of its judicial independence. Yet Hong Kong’s extensive legal community is watching how the situation evolves while totally ignoring the elephant in the courtroom. Hong Kong’s court system is broken. The time it takes to get a civil matter in front of the courts, including matrimonial proceedings, is ridiculous. Justice delayed is justice denied.

Our court system resembles a much-admired vintage Rolls-Royce which still leads with its iconic lady, the rule of law. But, unfortunately, the leather is shabby, the paintwork hasn’t been touched up for decades, the engine needs a complete overhaul and the electronics are sub-par, to say the least.

On top of all this, the courts are chronically ill-equipped to cope with Covid-19. The closure of Hong Kong courts from February-April during the first wave of infection affected nearly 20 per cent of the annual caseload, an estimated 90,000 cases. The courts resumed but with intermittent restrictions until this fourth wave. The courts remain open but with enhanced social-distancing measures, which will once again reduce the number of hearings and tribunals.

The human cost of these extended court delays and logjams to our society is extraordinary. Consider divorcing couples: before the pandemic, they were waiting up to nine months for a hearing due to the serious backlog in the family courts. Now, with court closures and social-distancing measures, there are additional delays, causing further suffering for these families, especially children, in the already painful process of divorce. 

Jarndyce versus Jarndyce, a fictional court case created by Charles Dickens in Bleak House, concerned a High Court matter over a sizeable inheritance, which went on for so long that it survived through three generations. It eventually concluded in favour of the plaintiffs, but as the whole estate had, by then, been entirely devoured in legal fees, the exercise proved futile. This was Dickens’ criticism of the long drawn-out and expensive nature of the court, in which he advises any would-be plaintiffs: “Suffer any wrong that can be done you rather than come here!”

These are wise words in any jurisdiction – avoid court if you can and settle the matter. But it is especially pertinent if we look at Hong Kong’s broken court system. A plaintiff bringing a claim to the High Court today may have to wait for up to 18 months for a hearing. Even with a successful judgment, the enforcement of the ruling is far from certain.

The High Court in Admiralty. Hong Kong is not only among the top 10 per cent most expensive jurisdictions for litigation, but also among the slowest 20 per cent. 

This isn’t just the case for plaintiffs. There are many defendants with claims against them which transpire to be without merit, but only after they have spent significant amounts on legal fees and waited forever to defend against them. For plaintiffs, it is distressing to learn that, despite a meritorious case, they will come before the court only after the defendant has had the time to dispose of any assets or otherwise plead poverty.

Even with a successful judgment, the enforcement is far from certain and may well double the time the whole process takes. Throw into the mix the appeal process, which can double once again the time a party is in court and it’s hardly surprising that the legal system in Hong Kong is a source of much angst and exasperation for both lawyers and the general public.

This state of affairs has nothing to do with the impressive quality of our judges. Our judiciary does a wonderful job and we owe them our full support. It is simply a result of the lack of support staff and judges, and the prevailing ingrained, anachronistic ways of doing things. Examples of these include the lack of e-filing and the centuries-old habit of coming to court with a multitude of box files where an iPad would suffice.

To obtain a wider perspective, OLN Oldham, Li & Nie recently undertook a survey of litigation processes in 54 jurisdictions across the globe through Globalaw, an international network of law firms that it helped create.

Of these 54, it was found that Hong Kong was not only among the top 10 per cent most expensive jurisdictions for litigation, but also among the slowest 20 per cent. Hong Kong is rightly proud of its legal system, but like a lovely old Rolls-Royce, we are very expensive, slow and in desperate need of an overhaul.

Other jurisdictions have shown a willingness to adopt technology to strengthen the efficacy of their court systems and this has served them well through the pandemic. For example, England has been using videoconferencing and telepresence solutions in their court systems for years. Singapore has had paperless courts since 2000, enabling them to operate throughout the pandemic with the use of the e-filing system.

In Hong Kong, we urgently need to double down on our efforts and sharpen our focus to undertake the repairs necessary for the court system. We must completely renovate the infrastructure of our legal system to stop it from continuing to impede the efficacy of our courts so they work for the benefit of members of the public, not lawyers.

If we want to be proud of our legal system, let’s start with overhauling the court system. We live in the 21st century, not alongside Dickens.

Gordon Oldham is senior partner at OLN Oldham, Li & Nie – Solicitors. He is a veteran Hong Kong lawyer and businessman.

Estate Planning: Untold Insights about preparing for our loved ones

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(This article was published in the January 2021 Issue of Localhood: https://www.localhood.org/single-post/preparing-for-our-loved-ones-estate-planning-the-untold-insights)

To most people, what matters is not their own wellbeing but their loved ones’. Whilst it may not be difficult to provide for that during one’s lifetime, it may be virtually impossible to do so when one is gone. It is therefore important to plan ahead to make sure that the loved ones are well taken care of in case of an eventuality.

The law generally states the default position in the absence of any estate planning (e.g. the Intestates’ Estates Ordinance in Hong Kong stipulates that the primary heirs are one’s spouse and children), but it is increasingly common for people to tailor-make their own contingency arrangements. Different tools and devices may be deployed to that end, and a general understanding of the features of different devices is essential to finding the most suitable solution in the circumstance.

1. The various devices

(1) By Will

If you have ideas on how to distribute your assets, you may make a will and set out your preference. You may designate the inheritee(s) of your estate and the executor(s) who will be handling the distribution of your assets (which will only take effect upon eventuality). Two witnesses are needed to witness your signature of your will and the witnesses cannot be the beneficiary of your estate. 

(2) By Trust

You may set up a trust by transferring the legal ownership of your assets to a “trustee” who will manage the assets on your behalf for the benefit of the designated persons as “beneficiaries”. Different types of trust can be set up for different purposes, and the powers of trustee may vary depending on the types of trust. Generally, a trustee may decide how and when the trust assets are managed or distributed. 

Trusts are becoming increasingly popular among wealthy families to protect their wealth and pass it on to the next generation. They are often used where the beneficiary may not be in a position to make good use of the gift (e.g. minor/disabled children). 

(3) By transfer during lifetime (also known as “Inter-Vivos Transfer”) 

If you have already made up your mind on how your assets should be distributed, the most straightforward way is to make the transfer during your lifetime. The transfer may simply be done by way of gifts.

2. Which device is the best?

There is no one-size-fits-all solution when it comes to estate planning. The above devices come with their own advantages and disadvantages. For example: 

(1) It usually takes a few months (at least) to obtain a probate grant to administer one’s estate, whilst generally, a trustee may at his discretion vest trust assets in a beneficiary. 

(2) Expenses in administration of trusts are generally higher than in administration of estate.

(3) Inter-vivos gifts are binding and may not be revoked once delivered with intention to make gifts.

It should also be borne in mind that these devices are not mutually exclusive – you may mix and match them as you please to achieve your objectives. 

3. Dispute risks

Whatever device(s) to use, no one wants his/her plan to be derailed. Any risks of challenge to the validity of the device(s) in place by disgruntled dependants need to be managed.

As a general rule, the longer a device has taken effect during one’s lifetime, the less likely it will be successfully challenged when one is gone. Therefore, inter-vivos gifts are relatively least challenged, followed by trusts and then wills. Probably with this in mind, the ultra-rich have recently demonstrated strong preference to divide up their assets among families during their lifetime, even though “abdication” is the consequence.

Estate planning not only gives you peace of mind that your loved ones are protected during a time of extreme stress and grief, but also provides an opportunity for you to reflect upon your priorities. Bespoke estate planning involves a deep understanding of one’s wishes and family situation. It is recommended that guidance and advice from experienced professionals be sought, especially where assets across multiple jurisdictions are involved. 

January 2021

OLN achieves strong rankings in Legal 500 Asia Pacific 2021

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OLN has once again been endorsed by Legal 500.

In the Hong Kong section of its Legal 500 2021 Asia Pacific directory, OLN is ranked for these two practice areas:

  • Intellectual property
  • Labour and employment

With our lawyers recommended as followers:

Legal 500’s commentary included:

Intellectual Property:

‘Well-established independent Hong Kong-based firm Oldham, Li & Nie provides ‘concise and accurate advice‘ to local SMEs, China-based corporates, and multinational entities on brand protection throughout Greater China. Team head Vera Sung’s broad IP offering includes expertise across trade mark, patent, and copyright matters, enabling her to provide effective advice to many international clients seeking to preserve and protect their brand throughout the region.’ 

Labour and Employment:

‘Anna Chan not only well-versed across a range of contentious matters but also well-placed to structure corporate tax-efficient remuneration packages, by virtue of her ancillary tax advisory expertise.’

The Legal 500 Asia Pacific 2021 is now available to view online. You can see the full results at:

https://www.legal500.com/firms/30993-oldham-li-nie/30842-hong-kong-hong-kong/?layout=asia-pacific&token=d9d71f53ac6572f267a067cd8f62ee64