UK company law developed to meet the requirements of public companies and was only later adapted for smaller businesses. This has many implications, one of which is that shares are presumed to be freely transferable. A shareholder can sell or give away shares to anyone unless the company's articles impose an effective restriction, or the shareholder has agreed not to transfer them or to deal with them in some other way in a binding contract.
In any company with two or more shareholders it is essential that appropriate share transfer provisions are included in the company's articles or in a shareholders' agreement. There should be clear rules to cover all three methods of disposal: a sale of the shares, a gift and what happens to the shares in the event of a shareholder's death. The potential death of a shareholder is an important matter that isall too often overlooked.
Default positions
Companies are often set up with whatever articles the providers supply as standard. Companies formed since 1st. October 2009 will usually have articles based on the Model Articles, which provide that the directors may refuse to register a transfer of a share (article 26(5)). Older companies will have articles based on Table A, which has had no share transfer restrictions in it since 1981, but it has been commonplace for such a provision to be included as a modification to Table A. The directors' discretion option is discussed further below.
Typical provisions
Transfer provisions are many and various, and practically anything can be drafted, but the following clauses (or combinations of these) are commonly used:
Directors have a discretion to refuse any transfer
Many companies have this by default. In many cases it is not the ideal option, as it has serious limitations that are not always apparent.
The decision to refuse must be made by the directors collectively, not by an individual director. As a directors' decision, each director will have one vote on the resolution, regardless of the number of shares held. To refuse a transfer under such a provision, the directors must be capable of passing a valid collective resolution. This will not be the case if they are deadlocked or inquorate. For example, in a two person company, if one of them proposes to transfer his shares, the other cannot stop the transfer as s/he cannot pass a resolution to that effect.
The discretion to refuse a transfer is not a power given to the shareholders. This may be very important if the directors and shareholders are not exactly the same people.
Directors who exercise the power to refuse must notify the transferee as soon as practicable and in any case within two months, and must provide reasons for refusing, even if the articles say to the contrary (Companies Act 2006, s. 771).
Consent of all members
A very simple rule which is effective for many situations, is that no share can be transferred without the consent in writing of every shareholder. It is entirely appropriate in many small private companies and is effectively the same as usually applies in a partnership. It may be less appropriate as the number of shareholders increases as it will give every shareholder a power of veto over what may be a perfectly reasonable transfer.
Pre-emption provisions
Typically, these provide that shares must be offered to existing shareholders in proportion to their present shareholdings. This is usually to be at a fair price (to be agreed or with a mechanism for valuation), but may be at a fixed price, and may include a timescale for payment of the purchase price. Where there are different classes of shares the provisions may be more complex as to which shareholders can benefit. Such provisions are very common.
Family provisions
Some articles allow shares to be transferred freely to family members (as defined) while transfers to anyone else are subject to a restriction (e.g. shareholders' consent, pre-emption, etc).
'Russian roulette'
This term is often used to describe an arrangement sometimes used where there are just two shareholders, such as in a joint venture. It can be a means for resolving complete deadlock between the parties. It provides that one shareholder can give notice to the other that he offers to buy all the other's shares at a stated price. The other shareholder then has a choice, either to sell the shares at the price in the notice or to buy the first shareholder's shares at the same price. This obviously places a burden on the first shareholder to get the price right. It is only appropriate where both parties have the resources to buy out the other.
Drag along and tag along
A drag along clause says that if the holders of a particular majority of the shares want to sell them to someone who wants to buy the whole company, the other shareholders must sell their shares at the same price. This stops a minority shareholder from blocking a sale or holding out for a higher price (because they may otherwise hold the equivalent of a ransom strip in relation to land). The majority required to serve such a notice tends to vary from a simple majority to, perhaps, 90%, depending on the circumstances within any particular company.
A tag along clause says that if the majority sell their shares the minority shareholder(s) are entitled to sell theirs on the same terms. Drag along and tag along clauses tend to be included together, but can be included separately.
Rules for if a shareholder dies
Unless the company's articles provide to the contrary, the provisions on share transfer apply also when a shareholder dies (which is called "transmission" of the shares). If the articles have no restrictions on transfer, or they are impossible to enforce, a shareholder can leave the shares by will (or if there is no will, they will follow the rules of intestacy). Similarly, if the articles say the directors have a discretion to refuse to register a transfer, this will also apply when a shareholder dies, as will any other restrictions.
It is very important that shareholders agree what is to happen to the shares if a shareholder dies, and that they ensure that the agreement is reflected in both the company documents (either the articles or a shareholders' agreement) and the shareholder's will. If this is not done, the dependants of a deceased shareholder can be left in a distressing, and possibly very expensive, muddle when also having to deal with all the other issues arising when someone dies.
Cross options
These are usually connected with life insurance policies taken out on the shareholders' lives with the proceeds held on trust for the other shareholders. If a shareholder dies, the other shareholders get the insurance money but must use it to buy the deceased shareholder's shares. The terms of the articles (or, more usually, of a separate cross option agreement or shareholders' agreement) require the proceeds to be used in that way and specify how the shares are valued, etc. It is a useful provision for ensuring that the owners of a successful company can pass on the value of their shares in it.
Other variations
Share transfer provisions can be tailored to meet particular circumstances. These may arise to specify different rules for specific shares or classes of shares, or to name particular family members to whom shares can be transferred, etc.
In the articles or in a shareholders' agreement?
Share transfer provisions can be included in the company's articles or in a shareholders' agreement. If a shareholders' agreement is required for other reasons it would be usual to include share transfer provisions in it (unless they are already adequately stated in the articles). There are some advantages in including them in a shareholders' agreement. Such an agreement is not registered at Companies House, and so the provisions are not available to be inspected by anyone who is not a party to them. A provision in the articles can be altered or removed by a special resolution (requiring 75% of the votes) whereas a shareholders' agreement can be changed only with the agreement of all the parties to it. On the other hand a shareholders' agreement can be altered without the statutory formalities of passing a special resolution and registering it, so making amendment simpler. If share transfer provisions are included in a shareholders' agreement it is important to make sure that they are compatible with any provision in the articles.
Final comment
Most shareholders in most small companies do not want another shareholder to be able to pass on his or her shares without their consent, perhaps admitting a complete stranger into the company. For that, there must be a valid restriction on share transfers in place, and this should be tailored to meet the requirements of the directors and shareholders in each case.
