Including a Buy-Sell Provision and/or a Restrictive Covenant in Your Shareholder Agreement

HNW Business Law, Employment Law, Shareholder Rights Litigation

A Shareholder agreement should be an essential document for every small operating corporation in New Jersey. These agreements can address every aspect, or at a minimum, many aspects of corporate governance and shareholder rights and relationships in the business, including ownership and voting rights, control and management, and methods of resolving disputes.

Shareholders’ agreements can be simple or complex and each document is often unique to the corporation it is written for. While many shareholders are knowledgeable enough in the ins and outs of their business, they often create a boilerplate shareholder agreement without the assistance of a shareholder attorney, thus lacking key provisions and details that leave many of the shareholders vulnerable.  A buy-sell agreement and restrictive covenant are two of these key provisions.

The shareholder’s agreement is an agreement between consenting shareholders that serves as the main document courts will look to should a disagreement arise in the future.

Buy-sell provisions and restrictive covenants should both be integral parts of a thorough shareholders agreement, particularly in smaller businesses with fewer shareholders. Smaller corporations often elect to establish ownership by issuing shares of stock in the business (or with an LLC, a membership unit). For example, a small corporation with four co-owners will allocate to each member 25 shares of stock totaling 100 shares, thus each has a 25% interest in the business.

What is a Buy-Sell Agreement?

A buy-sell agreement dictates what happens to the shares of a shareholder who wishes to leave the company. Since a departing shareholder wants the right to sell his/her shares, a dispute often arises as to who has the first right to purchase the shares and at what price.  The departing shareholder wants to sell their shares to the highest bidder. This person may be someone the remaining shareholders do not want to be in business with (i.e., the spouse of the departing shareholder). Also, the remaining shareholders who are “buying out” the departing shareholder often think the shares are worth less than the selling shareholder(s) does. With a reasonably well-written buy-sell provision, valuation language settles this dispute beforehand, stating who will buy the shares and the price or formula they will be bought at when the shareholder/member leaves the corporation. If a valuation disagreement results when a shareholder is leaving, the courts will simply enforce the buy-sell provision of the shareholder agreement.

Restrictive Covenants in a Shareholder Agreement

Restrictive covenants are quite useful and beneficial for smaller corporations, licensed professions, and professions involving particularized skills, such as doctors, highly compensated employees, salespeople, engineers, etc. A restrictive covenant defines a geographic area around the business where a departing member is forbidden from working or competing, whether it is with another rival corporation or in their own enterprise. As long as the restrictive covenant is reasonable in space and time, NJ courts will uphold these limitations. The purpose of the restrictive covenant is to prevent a shareholder from leaving the business and stealing clients from the remaining shareholders.

Shareholder agreements can be detailed and comprehensive addressing many different aspects of the business that the everyday shareholder often does not think of. My suggestion is that you consult a shareholder’s attorney before signing any such agreement.  Please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com to make sure you’re protected in your enterprise.  Please ask us about our video conferencing or telephone consultations if you are unable to come to our office.

By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, NJ Shareholder Law Attorney

 

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