Shareholders’ Agreements in Family Businesses

Erdem & Erdem Law Office | View firm profile

Introduction

Family businesses, in the simplest definition, are companies in which the company shares, or the authority to manage the company, belongs to various members of a family. The most significant issues that must be addressed in these companies are institutionalization, and the prevention or minimization of the effects of disagreements between family members on company activities. In ensuring the institutionalization of the company, it is not always sufficient for family members to be aware of their duties and responsibilities in the company and to comply with them in good faith, and legal instruments that have a binding effect and sanctioning power over the relevant family members become necessary in most cases. In this regard, one of these instruments is the shareholders’ agreements.

Why Do Families Need a Shareholders’ Agreement?

In family businesses, an agreement that sets the rules for the conduct and management of the company’s activities is most often needed in the second generation, when the number of the family members who are shareholders tends to increase. In this agreement, the mutual rights and obligations of the shareholder family members regarding the company are established. This is intended to prevent conflicts that may arise between the shareholders from the very beginning, by complying with predetermined principles and procedures, such as, for example, how a decision will be adopted on an important issue for the future of the company, or how the company shares may be transferred to other family members or to third parties and, ultimately, to ensure the long-term sustainability of the company.

In the absence of a shareholders’ agreement, the rules set by the applicable law are sometimes inadequate and uncertain, and sometimes slow, in resolving disputes between family members. Maybe more importantly, when setting the general rules, it is not possible for the applicable laws to take into account the relevant family dynamics and the unique values of a given family.

Which Issues are Regulated in Shareholders’ Agreements?

Although the content of shareholders’ agreements varies from family to family, and from company to company, certain provisions are common in practice. Like every agreement, these agreements start with a general purpose clause, and by providing information about the history of the relationship, as well as by revealing the current shareholding structure as of the date of signature. The issues regulated thereafter shall be explained under each main heading below. After the regulation of these issues, the agreement usually ends with confidentiality, applicable law and dispute resolution method, prohibition to transfer, and similar standard provisions.

Share Capital and Share Groups

It is usual practice to grant shares from different groups to various family members who are shareholders in the company, considering the amount of their shares in the company, their role in the management of the company, the efforts they have put in, and continue to put in to the business, and the capital they contributed to the company. These share groups are particularly effective in determining the management style and dividend distribution policy of the company, as well as in regulating share transfer restrictions.

In addition, upon a decision for any capital increase, the statutory pre-emptive right is frequently repeated in the shareholders’ agreements in order to prevent dilution of the existing shareholders and impairment of their rights. Within the scope of this right, regulations specific to share groups are generally included.

Corporate Governance

One of the most significant issues for the functioning of a family business is how the company will be managed and how important decisions will be adopted that might concern all of the shareholders, and maybe even all of the family members. Therefore, it is usual to set aggravated quorums in general assembly meetings. For example, in accordance with the Turkish Commercial Code No. 6102[1] (“TCC”), the fact that the resolutions which amend the articles of association can be adopted at general assembly meetings, where at least half of the company’s capital is represented or other general assemblies can be convened with the presence of the holders of the shares that meet at least one-fourth of the capital, and even if these quorums are not reached in the first meeting, the fact that no, or a lesser, quorum is required in the second meeting, is insufficient to protect the interests of the shareholders, especially in companies where the capital is distributed among many family members.

For this reason, a certain quorum is stipulated in the shareholders’ agreements for ordinary meetings, and a higher certain quorum for meetings where more significant issues will be discussed. Resolutions to be adopted on restructurings, such as mergers, spin-offs and changes of type, public offering, issuance of privileged shares or removal of privileges, and changing the dividend policy, are examples of such significant resolutions.

In order to prevent meeting these quorums with the participation of only a certain portion of the family, provisions requiring the participation of certain percentages from each share group are also frequently included in shareholders’ agreements. These provisions that are explained for the meeting quorums may also sometimes be regulated in terms of the decision quorum, together with the meeting quorum, and sometimes only in terms of the decision quorum.

The above explanations for general assembly meetings are also applicable for the resolutions to be adopted by the board of directors. Similarly, provisions can be established that require the resolutions on certain issues to be adopted by an aggravated quorum, where it is mandatory that certain members are among them. Another issue regarding the board of directors is the privilege to nominate candidates for the board of directors. The shareholders’ agreements usually include provisions to protect the managerial rights of various family members, such as which groups of shareholders are entitled to nominate candidates and how many, the required qualifications for the members, and the fact that the board of directors cannot validly convene unless at least one of the members nominated by a certain group is present.

Another pillar of corporate governance is the representation of the company. Issues such as the representation of the company by those including certain members of the board of directors, the necessity of a board resolution taken in advance for the representation of the company on certain issues, how the limited representation powers and the form of signature matrix will be set, and the establishment of committees to report to the board of directors in certain areas, are dealt with under the heading of representation.

Last but not least, it is also necessary to discuss the auditing of the company. Although the company is not subject to an independent audit in accordance with the TCC, the shareholders may prefer to have the company to be audited by an internationally reputable independent auditing firm each year.

Financial Matters

In particular, shareholders may wish to regulate a minimum distribution policy in the shareholders’ agreement, rather than leaving the issue as to how the company’s profits will be distributed, and whether or not any financial rights will be granted to the members of the board of directors, and to what extent, completely to the discretion of the general assembly, which is entitled to adopt different resolutions each year. In connection with this issue, share groups may be also granted privileges in dividends.

Another issue regulated in this context is the company’s financing policy. If the company is in need of financing, a policy can be determined as to whether such need will be met from shareholders – through capital increase or shareholder loan – or from third parties, such as banks, and the board of directors of the company can be directed to act within the framework of this policy.

Share Transfer Restrictions

Some of the most important issues for family businesses are the share transfer restrictions. Family members do not want the shares of their family business to be acquired by third parties, especially without their knowledge or consent. Since the marital property provisions shall apply between the spouses in the event of new people joining the family, and the inheritance provisions shall apply in case of death, it is important to regulate these issues separately.

In order to prevent such disposals without the involvement of other family members who hold shares in the company, issues such as that the share transfers are subject to the approval of the board of directors, under which circumstances the board of directors is obliged to not grant approval, shareholders who intend to transfer their shares, or who get an offer for such a transfer, must first offer their shares that are the subject of the possible transfer to other existing shareholders, as well as the features of this offer and the approval process are regulated, in detail, in shareholders’ agreements. Transfer restrictions can be regulated differently, or in a different priority order, for various share groups. In this context, the valuation method of the company and, therefore, of the relevant shares, are also clearly determined.

Breach of the Agreement and Contractual Consequences

The consequences of a shareholder’s breach of its obligations are regulated in shareholders’ agreements. In particular, non-compliance with the provisions regarding share transfer restrictions is made subject to separate and more significant sanctions. The most important of these sanctions are the other shareholders’ right to purchase the shares of the violating shareholder, as well as the penal clause.

Can’t these Issues be Regulated under the Articles of Association or the Family Constitution?

The answer to this question is partly yes, and partly no. Firstly, according to Article 340 of the TCC, the articles of association may deviate from the provisions of the TCC only if expressly permitted by law. In such a limited system, it is not possible to regulate under the articles of association a share transfer restriction other than the important reasons stipulated under Article 493 of the TCC, or the purchase and sale sanctions for violations. In addition, it is quite usual that family members do not prefer to regulate all of the details of the shareholding relationship among them in the articles of association, which is a public document. Therefore, even when it is possible to regulate the content in the articles of association, shareholders’ agreements are still necessary to regulate confidential matters among family members.

On the other hand, there is no legal obstacle for the family constitution to regulate the matters included in the shareholders’ agreement. As a matter of fact, the contents of the family constitution and the shareholders’ agreement have diverged from each other due to continuing practices, and due to the purposes thereof. Both agreements are sui generis agreements that are not regulated under the law and enjoy the principle of freedom of contract. However, in practice, as set forth above, shareholders’ agreements contain binding provisions that have sanctioning powers; whereas, family constitutions mostly include ethical and moral rules, as well as non-binding provisions regulating the relations of family members between each other. While shareholders’ agreements are legal texts that are intended for companies in which family members hold the shares, and to which only the shareholder family members are party, all family members who wish to take part in this relationship, whether a shareholder or not, become party to the family constitution and, thus, the scope of the family constitution extends beyond the family business matters. For this reason, in practice, two separate legal relations – albeit interrelated – namely, the family constitution and the shareholders’ agreement, are established for these regulations, which have different parties and different binding effects. The main elements of family constitutions will be discussed in a separate article.

Conclusion

Family members who are shareholders in family businesses need a shareholders’ agreement that will regulate their relations with the company and with each other, and that will prevent or quickly resolve any disputes that may arise, especially as the family expands. Although the content of this agreement may vary by virtue of the principle of freedom of contract, issues, such as corporate governance, representation, method for adoption of important decisions, dividend distribution and financing policy, and share transfer restrictions, are frequently regulated. Thus, through this binding agreement, family members have the opportunity to regulate the issues that cannot be included in the articles of association, or that they do not want to regulate due to confidentiality concerns. Therefore, in addition to family constitutions, shareholders’ agreements are of great importance for family businesses.


(Authored by Ecem Cetinyilmaz and first published by Erdem & Erdem on May 2021)

[1] TCC (Official Gazette, 14.02.2011, No. 27846) entered into force on 01.07.2012.

More from Erdem & Erdem Consultancy Ltd