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 do this is through a deemed offer clause in the contract.
Why force a sale?
The reasons why shareholders may want to force another shareholder to sell their shares mostly relate to the removal of shareholders, explains Abigail Reynolds, Corporate and Commercial Law Attorney at Reynolds Attorneys. This could be due to:
- That shareholder acting in bad faith (such as breaching a non-compete obligation) or causing injury to the reputation of the company;
- The 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 does.
“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,” says Reynolds.
The only way to force someone to sell their shares is by recording the terms for when this would arise in a contract and most common contract to record it in is a company’s memorandum of incorporation (MOI), or in a shareholders agreement. “The relevant clause is known as the deemed offer clause,” explains Reynolds, “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.”
Some examples of common trigger events that result in a deemed offer include death; critical Illness or disability; termination of employment; administration issues; conviction of a criminal offence; fraud or dishonesty bringing a company into disrepute; gross misconduct; insolvency; breach of the MOI and/or the shareholders agreement; winding up; change of control of company; and change of beneficiaries of a trust.
There are a few ways that a deemed offer clause can be tailored to suit the requirements of the specific shareholders of the company:
- Penalty price: If the trigger event was one which involved bad behaviour by the shareholder, 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.
- The trigger of a termination of employment by the company can apply to only 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.
It’s important to consider including the above in your company’s MOI or shareholders agreement to protect both the shareholders as well as the company itself.