Once a person owns shares in a company it is very difficult under law to force them to sell their shares to either the other shareholders or the company. The main way to force someone to sell their shares is by recording the terms for when this would arise in a contract. The most common contract to record it in is a company’s memorandum of incorporation (“MOI”), or in a shareholders agreement.
Why Force a Sale
The reasons why shareholders often want to force another shareholder to sell their shares mostly relate to getting rid of shareholders:
- when that shareholder has acted in bad faith (such as breaching a non-compete obligation) or has caused injury to the reputation of the company;
- when that shareholder dies, becomes disabled, or stops being employed by the company – because the company wants only shareholders that are actively involved in the company’s business to own the shares;
- when the control of an entity shareholder changes, such that the persons that originally controlled it no longer do.
The idea is that in a company in which there are only a few shareholders, it is important that the shareholders do not breach the various obligations they have agreed to as shareholders, that the identity of the shareholders remain the same (because the shareholders often chose to invest in a company based on the people who were originally invested in it), and that many of the shareholders are actively involved in growing the company’s business and are not passive investors.
The Deemed Offer Clause
The relevant clause in the contract that records the forced sale terms is often entitled a “Deemed Offer” clause, because when a trigger event occurs, the shareholder to whom the event occurred is deemed to have offered his/its shares in the company for sale to the remaining shareholders.
Examples of Trigger Events
Some examples of common trigger events that result in a Deemed Offer are, if a shareholder:
- Death: dies; or
- Critical Illness / Disability: is declared to be incapable of managing his own affairs, and/or is permanently and totally incapacitated; or
- Termination of Employment: that is a full time employee of the company, leaves the employ of the company for any reason whatsoever; or
- Administration: is deregistered, sequestrated or liquidated, whether provisionally or finally, or placed under business rescue under the Companies Act; or
- Conviction of a criminal offence: who commits a crime prejudicial to the company, or is found guilty of fraudulent or other conduct prejudicial to the company; or
- Fraud or dishonesty bringing a company into disrepute: commits any fraud or dishonesty or carries out business or otherwise acts in any manner which brings or is likely to bring any of the other Shareholders or the company into disrepute;
- Gross misconduct: commits any act of gross misconduct affecting the business or reputation of the company;
- Insolvency: commits an act of insolvency as contemplated in the Insolvency Act, 24 of 1936; or
- Breach of the MOI and/or the Shareholders Agreement: commits a material breach of any of its obligations as set out in the MOI or the Shareholders Agreement, and fails to rectify such breach within 10 business days of any of the other shareholders or the company giving such breaching shareholder/person notice in writing to remedy that breach; or
- Winding Up: receives a certificate from the Master of the High Court of South Africa as contemplated in section 346(3) of the Companies Act (No. 61 of 1973) as amended or replaced from time to time, in respect of the application for the winding up of a Shareholder;
- Change of Control of Company: any Shareholder which is a company, ceases to be ultimately controlled, directly or indirectly, by all or any of the shareholders of such company on the date the company first becomes a Shareholder,
- Change of Beneficiaries of Trust if such Shareholder is a trust:
- if such trust ceases to operate primarily for the benefit of those who are beneficiaries of that trust on the date the trust first becomes a shareholder; or
- is deregistered or resolves to be deregistered or resolves to distribute all or a major portion of the assets of the trust to its beneficiaries or resolves to sell the assets of the trust to any person and distribute the proceeds thereof to its beneficiaries for any reason whatsoever.
The Price of the Shares
The price that the shares will be sold at is often recorded to be at a price that the selling shareholder and the buying shareholders agree on within a set number of days, and failing which, at the fair market value for the shares as decided by the company’s accountant (or by an independent expert – both are commonly used). If the company has a formula to determine the value of its shares that works well for its business, this formula can instead be recorded as the method for determining the share price. The aim is to record a clear and definitive method for arriving at this price within a specific time period, so agreeing on the price does not become disputed and cause delays.
Tailoring the Clause
Of course, this Deemed Offer clause can be tailored to suit the requirements of the specific shareholders of the company. Some ways that the clause can be tailored are as follows:
- penalty price: the clause can record that if the trigger event that caused the Deemed Offer was one which involved bad behaviour by the shareholder (such as a breach of the MOI or shareholders agreement, a breach of a non-compete clause, or being fired as an employee of the company), that the price at which the other shareholders can buy that shareholder’s shares is discounted by a certain percentage from the fair market value of the shares (such as by 50%), or it could even be recorded to be just R1 per share;
- termination of employment variables: to make the trigger of a termination of employment by the company only apply to some of the shareholders, or only apply if the shareholder was a ‘bad leaver’ (i.e. was fired), and not if he/she was a good leaver (i.e. retired or resigned);
- nomination of company as purchaser: that a shareholder who receives the Deemed Offer can nominate the company itself to buy back the shares instead of that shareholder buying the shares.
We believe this is a very important clause to consider including in a company’s MOI or shareholders agreement.