Constitutions and Conflicts: Shareholders Agreements Do Not Always Prevail

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By Warren Scott, Partner

Many shareholders fall into the trap of assuming that an inconsistency clause in a shareholders’ agreement will always be effective in the event of a conflict. As the judgment in Cody v Live Board Holdings Limited [2014] NSWSC 78 demonstrates, it is first important to consider whether there is in fact an “inconsistency” between the relevant clause of the shareholders’ agreement and the constitution.

Summary of Facts

In September 2013, Cody Live Board Holdings Ltd, wanted to raise capital of approximately $1m. To do this, the board issued preference shares to new shareholders for exchange of funds as well as issuing ordinary shares to the existing shareholders.

Constitution – requires any direct or indirect variation of the rights of an existing class of shares to be approved, in writing, by 75% of the holders of that class of share.

Shareholders’ Agreement – requires any decision on the issue of, or grant of rights over, “any shares” or securities in the company to be made by a majority decision of the shareholders. The agreement contained an “inconsistency” clause in the event that where there was a conflict between the shareholders’ agreement and the company constitution, the shareholders’ agreement would prevail.

A shareholder claimed that the issue of shares was invalid because 75% of holders of the shares had not approved the share issue following a variation in the share rights. The shareholder argued that the rights of this class of shares were varied because the issue of preference shares would rank those new shareholders ahead of the current shareholders in relation to certain matters.

The board argued that the share issue was valid because the power to issue the shares was done pursuant to the power granted to them under the shareholders’ agreement. The board claimed that they did not have to comply with the constitution in this event because there was a conflict between the two documents and the shareholders’ agreement stated it would prevail in the event of an inconsistency.

The Court’s Decision: No Inconsistency

The Court noted that a reference to the word “any shares” in the shareholder’s agreement included preference shares, the requirement for a majority resolution of the shareholders under the shareholders’ agreement superseded the 75% requirement under the constitution as there was no “inconsistency”.

The majority resolution required under the shareholders’ agreement was for the purpose of giving the shareholders the power to issue shares while the purpose of the 75% threshold under the constitution was to protect the interests of the holders of specific classes of shares, when a change to their rights was being contemplated. As a result, the power to issue shares under the shareholders’ agreement was subject to the constitution where those shares altered the rights or obligations of the existing class of share.

The issuing of preference shares was therefore invalid.

Lessons Learned

  1. An inconsistency clause within a shareholders’ agreement may not be sufficient to prevail over the constitution in an event of a conflict between the two documents. This is particularly the case between two clauses with separate purposes.
  2. This issue can be avoided by being proactive and amending the company’s constitution to align it with the shareholders’ agreement and by defining what situations will amount to an “inconsistency” in the shareholders’ agreement.

To read the full decision, please click here.

For further information, please do not hesitate to contact us.

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