In certain situations, shareholders may find it advantageous to enter into agreements with other shareholders regarding how the company should be run or who will run the company. These agreements, known as “shareholder agreements” or sometimes “vote pooling agreements” or “block voting arrangements” are generally permissible and can pertain to a variety of topics. The specific rules governing shareholder agreements varies from state to state, however most states follow some version of the Revised Model Business Corporation Act (“RMBCA”). Section 7 of the RMBCA states the rules regarding shareholder agreements.
The most common types of shareholder agreements are:
- Voting Trusts: In a voting trust, shareholders agree to transfer their shares to a trust and to appoint a trustee who will be in charge of voting all of the shares controlled by the trust.
- Voting Agreements: A written agreement by which each shareholder that is a party to the agreement agrees to vote his shares in a specific way.
- Management Agreements: An agreement between shareholders to take some specific management action.
Voting Trusts
A voting trust is best understood as a group of shareholders agreeing to delegate voting authority for their shares to a third party, known as the trustee of the voting trust. Voting trusts are written agreements in which shareholders transfer their shares to a trust in exchange for in interest in the proceeds from the trust. Most commonly, a group of shareholders will transfer their shares to the trust in exchange for an interest in the proceeds of the trust that is proportional to the number of shares each transfers. Because their interest in the trust is proportional to the interest of their shares, each party’s financial stake (that is, the amount of money each shareholder will receive from dividend payouts) remains unchanged. The trustee is given the authority to vote the shares and distribute the proceeds from the trust. Often, the trustee is also given directions regarding how to vote the shares of the trust. For example, the trustee can be instructed to “vote the shares of the trust in favor of a member of the Smith family to become a director of the corporation if at least one member of the Smith family seeks to be a director.” Generally, the only proceeds of the trust are the dividends paid to the shares. Under Section 7.30 of the RMBCA, five elements must be present for a voting trust to be validly:
- Written Agreement: All shareholders creating the trust must sign an agreement explaining the terms of the trust. This requirement can also be satisfied if the voting trust is created by the will of a deceased party who leaves the shares to the voting trust (for no longer than the permissible time period) and designates a person or persons who shall have a right to the proceeds from the trust until the trust expires.
- Transfer of Legal Ownership: The creation of a voting trust requires that legal title to the shares is transferred to the trust itself. If an agreement calls for the shareholders to retain ownership of the shares, the agreement cannot qualify as a voting trust.
- Filed with the corporation: The corporation must be given a copy of the trust agreement as well as the name and address of each party with a present beneficial interest (the parties which will receive the proceeds of the trust) in the trust.
- Ten Year Limit: A voting trust is valid for not more than ten years. A trust can be extended for up to ten additional years if all of the parties to the trust agree. If the trust is extended, the new ten year limitation starts at the time of the agreement to extend rather than at the end of the current ten year period.
Voting Agreements
A voting agreement is an agreement between shareholders to vote their shares in a specific way. Instead of delegating voting authority to a third party as is the case in a voting trust, in a voting agreement, each shareholder pledges to abide by the agreement. If the agreement is validly executed, any party to the agreement can sue for specific performance of the agreement if another party refuses to abide by the agreement. If a suit for specific performance is successful, the court will order the parties to vote the shares in accordance with the voting agreement. Unlike voting trusts, voting agreements can be for any duration and do not need to be filed with the corporation. Under Section 7.31 of the RMBCA, a voting agreement is valid if three requirements are satisfied:
- The agreement is in writing.
- The agreement is signed.
- The agreement is not subject to any contractual defenses. Because a voting agreement is a contract between shareholders, the agreement is subject to the normal contractual defenses. If the agreement would be void or voidable under the applicable state’s contract law, the agreement is void or voidable.
Voting agreements offer several benefits when compared to voting trusts. First, voting agreements are easier to enter into and easier to maintain, because they do not need to be filed with the corporation and do not need to be renewed every ten years. Additionally, voting agreements may be less expensive to implement, becauase trustees may charge a fee for their services. Furthermore, owners are allowed to retain complete ownership of the shares under a voting agreement.
Voting agreements also have some disadvantages when compared to voting trusts. Most notably, because a voting agreement is a contract, there is less room for the exercise of future discretion. For example, when the future is unclear, a voting trust can lay out general decision making guidelines for a trustee to follow and have the trustee make the final decision, whereas in a voting agreement, each party will likely make their own choice, possibly defeating the purpose of the agreement. The less clear or more subjective the requirements of the agreement are, the less likely a court is to specifically enforce the agreement. Additionally, because voting agreements can be perpetual in nature, a party that no longer wishes to be bound by a voting agreement may be bound by the agreement perpetually.
Management Agreements
Management agreements are contracts entered into by the shareholders regarding the governance of the corporation. Management agreements can address a variety of topics, including the authorization or paying of dividends, the identity of the corporation’s directors or officers, and the powers of the board of directors. Management agreements are so powerful they can even be used to eliminate the board of directors entirely or give a specific shareholder the power to manage the business. Because of the enormous power of management agreements, RMBCA Section 7.32 severely limits the methods of creating a management agreement. Under the RMBCA, a shareholder agreement can be created in two ways:
- The agreement is made a part of the corporation’s articles of incorporation or bylaws AND all of the shareholders who are shareholders at the time the agreement is made a part of the articles of incorporation or bylaws approve of the agreement.
- All shareholders agree in writing to the management agreement AND the written agreement is filed with the corporation.
Once a valid management agreement is in force, the agreement can be amended or terminated either by an agreement of all of a corporation’s then current shareholders or in accordance with any terms set forth in the agreement. If a corporation “goes public” by listing its shares on a national exchange, any existing management agreements are automatically suspended. RMBCA Section 1.40(18A).
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