Shareholder Agreements regulate the legal ownership rights of shareholders in a corporation.
There are three documents required to properly form a corporation: (1) the Articles of Incorporation (required to be filed with the California Secretary of State), (2) Bylaws, and (3) a Shareholder Agreement.
Because the Articles of Incorporation are filed with the Secretary of State and are difficult to amend, they are typically brief (often no more than a page or two) and govern only the core governing principles of the corporation along with required information such as the name, address, corporate purpose, agent for service of process, and total number and class of shares authorized to be issued of the corporation.
The Bylaws are kept by the corporate Secretary. Bylaws are relatively easier to amend, and consequently provide much more detail about how the corporation will be managed such as when, where, and how annual meetings will be conducted, the number and election of directors, whether a majority, supermajority, or unanimous vote may be required for particular business decisions, among others. In the absence of such provisions, default statutory and case law rules are applied.
The most important and most negotiated formation document, especially for privately-held corporations, is the Shareholder Agreement. The California Corporate Coderestricts what shareholders and directors may provide in the Articles of Incorporation of Bylaws. The concern is that a minority shareholder might nonconsensually become disenfranchised via the Bylaws. In contrast, courts routinely uphold a shareholder’s freedom to contract away its rights via a Shareholder Agreement, freely negotiated into and for which the shareholder receives some benefit for its bargain.
A common provision in Shareholder Agreements relates to the restrictions on the transfer of shares, such as the right of first refusal for other shareholders to purchase at the current fair market value a pro rata share of the stock of a departing shareholder. These transfer restrictions prevent the remaining shareholders from becoming business partners with a stranger, or even a party hostile to the interests of the business. Shareholder Agreements also frequently include non-compete and non-solicitation restrictions, rules on how to distribute profits, rights to employment for one or more shareholders, ownership rights to intellectual property, and other provisions to effect the intents of the shareholders in the management of the corporation.
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