Shareholders’ Agreement: What Should Be Included in a Shareholders’ Agreement

What is a shareholders’ agreement, and how does it differ from the articles of association?

The shareholders’ agreement is a contract under the law of obligations that exists alongside the articles of association. It establishes rights and obligations solely between the shareholders concerned and is effective only between them (inter partes). The articles of association, by contrast, form the basis of the company under company law and are binding on anyone who joins the company (inter omnes). 

This fundamental difference gives rise to three practical consequences:

Firstly, publicity. The articles of association are filed with the commercial register and, since the register was digitised, are accessible to everyone. Under Section 53 of the German Limited Liability Companies Act (GmbHG), amendments require a shareholders' resolution certified by a notary and registration. The shareholders’ agreement, on the other hand, is not included in the register file and remains confidential. In practice, this is precisely the most common reason for omitting certain provisions from the articles of association: remuneration structures, vesting conditions or exit provisions are intended to remain hidden from the public, competitors and future negotiating partners.

Secondly, the question of precedence in the event of a conflict. If the articles of association and a supplementary agreement conflict at the corporate level, the articles of association take precedence. A resolution that contravenes the articles of association is open to challenge under company law. A resolution that merely contravenes the contractual agreement remains valid for the time being and, at most, gives rise to claims under contract law. Anyone wishing to ensure that a provision is absolutely safeguarded at the corporate level must therefore incorporate it into the Articles of Association and sacrifice confidentiality.

Thirdly, flexibility. In principle, the agreement can be amended without any registration procedure, provided that no statutory or contractual formal requirements apply. However, amendments may require unanimity or defined majorities and must remain consistent with the Articles of Association and the shareholding structure. This makes it a flexible instrument, particularly in investor and joint venture structures. New shareholders must, however, join the company effectively. There is no automatic binding effect solely through the acquisition of shares.

What should a shareholders’ agreement contain?

The content depends on the specific circumstances, so it varies considerably between a two-member family-owned limited liability company and a start-up with several investors. Nevertheless, a standard set of provisions has emerged.

Vesting. A founder’s or manager’s shares are linked to their continued employment. If they leave the company before the end of the vesting period, they must transfer back a portion of their shares or offer them for purchase, with a distinction being made between a ‘good leaver’ and a ‘bad leaver’. Vesting clauses thus contain obligations to transfer shares, which is significant in terms of form.

Tag-along and drag-along. The tag-along right allows a minority shareholder to sell their shares on the same terms if the majority shareholder sells. Conversely, the drag-along right obliges the minority to sell their shares alongside the majority in the event of a sale by the majority, so that a purchaser can acquire one hundred per cent.

Restrictions on the transfer of shares. The transfer of shares is subject to the consent of the company or the co-shareholders, or to pre-emption rights. However, a restriction on the transfer of shares with corporate effect must be included in the articles of association (Section 15(5) of the German Limited Liability Companies Act (GmbHG)). Only contractual rights of tender and pre-emption may be established in a supplementary agreement.

Non-compete covenants. Shareholders, in particular managing directors, undertake not to compete with the company during and after their involvement. Such prohibitions are valid, but only within the limits set out in Section 138 of the German Civil Code (BGB) and competition law: they must be specific in nature, limited in geographical scope and duration, and, as a rule, valid for a maximum of two years after the termination of the contract.

Protection against dilution. Investors safeguard themselves against the economic dilution of their shareholding in subsequent financing rounds, for example through the right to acquire additional shares at par value in the event of lower valuations (anti-dilution).

Deadlock mechanisms. For deadlocked situations in which two equally powerful factions cannot reach agreement, the agreements provide for dissolution procedures. In ‘Russian Roulette’, one shareholder offers the other the choice of either buying the other’s shares at a price they specify or selling their own shares at that price. The other party chooses which option to take. A related mechanism is the ‘Texas Shoot-out’, in which both parties submit sealed bids and the highest bidder takes over.

Beyond this standard set of provisions, shareholders’ agreements frequently regulate voting ties, the appointment of the managing director and supervisory board, rights to information and approval, rules on the appropriation of profits, as well as call and put options for entry and exit.

So-called ‘reserved matters’ are of particular importance. They determine which measures may not be decided upon solely by the managing directors or majority shareholders. Typical issues include the budget, major investments, financing, acquisitions, the disposal of significant assets, transactions with related parties, capital measures and the appointment of the managing director. Thresholds and decision-making deadlines should be set in such a way that the protection of minority shareholders does not lead to a deadlock in day-to-day business.

Deadlock clauses must be tailored to the specific shareholder structure. ‘Russian Roulette’ and ‘Texas Shoot-out’ mechanisms can provide a clear mechanism for separation where the parties have comparable financial strength, but may lead to a one-sided outcome where the parties are economically unequal. It is often more balanced to escalate matters through the managing director, the advisory board and mediation, and only then to resort to a buy-out or sell-out mechanism.

Does a shareholders’ agreement have to be notarised?

In principle, a shareholders’ agreement may be concluded in private form. However, in the case of a GmbH, Section 15 of the German Limited Liability Companies Act (GmbHG) often applies. Both the transfer of a share and the obligation to transfer a share must be notarised. In particular, vesting and leaver clauses with an obligation to retransfer, drag-along obligations, and call and put options are subject to this formal requirement. In addition, binding obligations to offer shares for sale and to purchase shares, certain rights of first refusal or takeover rights, and obligations to transfer shares in the event of a deadlock or a breach of contract may also be relevant.

Not every provision with an economic connection to shares automatically requires notarisation. Purely voting agreements, rights to information or duties of conduct may, in principle, be agreed without any formal requirements. The decisive factor is whether a legally binding obligation to transfer or acquire a specific or identifiable share in a limited liability company (GmbH) has already been established.

If the required form is not complied with, the obligation in question is, in principle, void. A subsequent transfer of shares in the required form may cure the defect in form pursuant to section 15(4), second sentence, of the GmbH Act (GmbHG), but does not provide protection during the preceding phase in which the transfer is to be enforced. In addition, section 139 of the German Civil Code (BGB) must be observed. Depending on the structure of the contract, the invalidity of a single provision requiring formal compliance may affect other parts or, in extreme cases, the entire agreement. A severability clause aids interpretation but does not replace a valid notarised arrangement.

In practice, there are three options.

• The entire shareholders’ agreement is notarised. 
  
• Provisions requiring specific formalities are bundled in a notarial deed and coordinated with a privately drawn-up agreement.
  
• Share-related mechanisms are – where appropriate – incorporated into the articles of association or a separate option and transfer instrument.
  

Which option is appropriate depends on confidentiality, costs, the need for amendments and the desired effect under company law. In any case, a purely privately drawn-up agreement should be checked for share-related obligations requiring specific formalities before it is signed.

How does a shareholders’ agreement protect minority shareholders?

For minority shareholders, the agreement supplements the statutory rights to information, to challenge decisions and minority rights with protection tailored to their shareholding. Of particular importance are qualified majorities and approval requirements for key decisions, ensuring that the minority is not outvoted in the event of capital measures, amendments to the articles of association or the sale of the company. In addition, there are rights to information and oversight, the right to appoint a member to the advisory board, co-sale rights in the event that the majority stake is sold to a third party, and protection against dilution.

It is crucial to determine which provisions belong in the Articles of Association and which in the Shareholders’ Agreement. A veto undertaking based solely on the law of obligations does not automatically prevent a resolution at the level of company law. For particularly important approval requirements, it may therefore be necessary to enshrine them in the Articles of Association or the rules of procedure. In addition, provisions should cover dilution, access to information, related-party transactions, shareholder loans, distributions and exit arrangements. The effectiveness of such protection depends on the interplay between these provisions, their form and their enforcement.

How does one enforce a shareholders’ agreement?

The fact that the agreement is based on the law of obligations does not render it ineffective. Sufficiently specific voting obligations can be enforced through the courts. The Federal Court of Justice has already recognised, in its well-known decision BGHZ 48, 163, that the obligation to vote in a specific manner can be enforced by means of an action for performance requiring the casting of a vote. In such cases, a final judgement may, subject to the statutory requirements, replace the declaration owed under Section 894 of the Code of Civil Procedure (ZPO). In urgent cases, interim relief may be sought to prevent a resolution that is in breach of the agreement from being passed.

An important reinforcement arises where all shareholders are bound by the agreement. In such cases, a resolution that contravenes the ancillary agreement may, under certain circumstances, even be challenged directly, as the corporate law and contract law frameworks coincide in this instance. If, on the other hand, only individual shareholders are bound, the breach at the resolution level has no legal consequences and merely gives rise to claims between the contracting parties. This distinction should be made deliberately when drafting the agreement, as it determines the scope of the protection.

As actions for performance and interim injunctions take time, a robust agreement should also include sanctions that take effect automatically. Contractual penalties can sanction a breach and facilitate enforcement, as it is not necessary to quantify the full specific loss at the outset. They are often combined with sell-out obligations, so that a shareholder who repeatedly breaches the contract can ultimately be forced to withdraw. The triggers, the amount and the proportionate relationship to the breach must be appropriate and unambiguous. Lump-sum or disproportionate penalties create new risks to the agreement’s effectiveness.

Finally, the issue of termination forms part of the agreement’s validity. In the case of long-term or open-ended agreements, termination must be expressly regulated. Without robust provisions on the term and termination, the agreed protection may be called into question. As a rule, the term is therefore linked to the duration of the shareholding and ordinary termination is excluded, leaving only extraordinary termination for good cause.

How is the shareholders’ agreement linked to the dispute between the shareholders?

A shareholders’ agreement does not prevent conflicts, but it can set out their consequences and the decision-making process in advance. The vast majority of disputes that later end up in court relate precisely to the issues that a good agreement regulates in advance: the appointment and removal of the managing director, deadlock at the shareholders' meeting, the exit of a dissenting shareholder and the valuation of their shares. Anyone who settles these issues from the outset with clear mechanisms – that is, with a deadlock resolution mechanism as well as rules on withdrawal and valuation – shifts the dispute from open legal proceedings to a procedure agreed in advance.

If no such agreement exists, or if it is incomplete, the conflict is resolved under general company law, i.e. through challenges to resolutions, removal for good cause and the redemption of shares. We deal separately with how such a dispute is then conducted – in particular, the removal of the managing director and interim legal protection regarding the position on the board – in our article on the removal of the managing director. Preventative planning does not replace every legal dispute. However, it establishes clear responsibilities, assessment criteria and exit routes, and can thereby significantly reduce the duration, costs and financial damage caused by a dispute.