Introduction

In principle, shareholders cannot be forced to sell their shares. Ownership of shares constitutes private property, and the shareholder retains control over whether and when to sell. Conversely, no one can compel you to sell your shares. This holds true even in situations where personal conflicts arise, and one party wishes to see the other shareholder removed from the company.

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However, there are specific circumstances where forcing a sale may become a possibility, as outlined below:

1. Major Breach of the Shareholders' Agreement

A material breach of the shareholders' agreement can sometimes trigger an obligation for the breaching party to sell their shares, often at a significant discount. In extreme cases, the sale may occur at a token value, effectively forfeiting the shares. Common breaches include sharing business secrets, violating confidentiality agreements, acting disloyally, breaching non-compete clauses, or failing to adhere to governance protocols.

Key Considerations:

• Definition of a Material Breach: Clearly define what constitutes a material breach. Ambiguities can be exploited by stronger shareholders to force an unjustified sale.

  • Consider adding qualifications, such as requiring a breach to remain unrectified within a defined timeframe (e.g., two weeks after notice) or limiting the provision to breaches that cannot be remedied.

    
    

• Funding the Buyback: Enforcing a buyback right can be financially challenging. For example, if the company's valuation is substantial, acquiring even discounted shares may require significant liquidity, which could be difficult in a private company with illiquid shares.

  
  

• Valuation Methodology: Establish a fair and clear valuation mechanism.

  • A steep discount may incentivize opportunistic behavior by stronger shareholders.

  • Conversely, a higher buyout cost may encourage resolution of disputes rather than triggering a forced sale.

    
    

2. Vesting Provisions and Unvested Shares

When shares are subject to vesting, a shareholder who fails to meet the agreed terms (e.g., continued employment) may be obligated to sell back their unvested shares. Such shares are often bought back at nominal value, as they were conditioned on the shareholder fulfilling specific obligations.

3. Sale/Purchase Right: The Shotgun Provision

A shotgun clause is a pre-agreed mechanism designed to resolve deadlocks between shareholders. While it does not directly force a sale, it allows one party to initiate a separation. The triggering party sets a price for the shares, and the counterparty can choose to either sell their shares at that price or buy the triggering party’s shares.

Key Considerations:

• Accurately valuing the shares is critical to avoid unintended outcomes.

• Ensure sufficient funds are available to execute a buy-out if the counterparty opts to sell.

  
  

4. General Call Option

A call option grants one party the right to purchase shares at a pre-determined price or based on an agreed formula. Call options are often used for financial structuring, control mechanisms, or as part of secondary transactions.

Important Points to Consider:

• Review transfer restrictions in the shareholders' agreement to avoid breaching rights of first refusal or other preemption clauses.

• Use call options judiciously, particularly in scenarios like the buyback of shares from departing shareholders.

  
  

5. Drag-Along Rights

A drag-along clause allows majority shareholders to compel minority shareholders to join in the sale of the company under pre-agreed terms.

Key Points to Watch For:

• For the minority: Ensure thresholds for triggering the clause are reasonable, and ensure that the accepted payment is only either cash consideration or shares in a publicly traded company (not e.g. shares in a privately held company since they can prove illiquid).

• For buyers and the majority: Specify whether the clause applies to affiliated buyers and ensure that there is no right of first refusal for other shareholders that can disrupt the transaction after a long and costly negotiation process with some of the shareholders representing a majority.

  
  

6. Exit Triggers and IPO Processes

Certain agreements allow shareholders to initiate an exit process, such as through an IPO or sale. This is often structured with a defined approval threshold and may include an exit committee to oversee the process. Often the clause kicks in after a time period if the company has not already initiated an exit process, when the investors are venture capital firms you often see it coming into play after 5-6 years.

7. Liquidation Rights

While not a direct sale, liquidation involves realizing the company’s assets, distributing proceeds to shareholders, and dissolving the entity. This scenario often arises in bankruptcy or fund-structured investments.

8. Squeeze-Out Provisions

Statutory squeeze-out rights typically allow shareholders holding over 90% of the company to compel minority shareholders to sell their shares. Conversely, minority shareholders may also have the right to force a buyout by the majority shareholder.

Common Applications:

• Delisting a public company.

• Court or arbitration processes often accompany these provisions to ensure fair valuation.

  
  

9. Enforced Pledge, Bankruptcies, and Default

If shares are pledged as collateral and the shareholder defaults, the shares may be sold to recover the debt. Similarly, bankruptcy can result in forced liquidation of shares as part of asset recovery.

For the remaining shareholders this can be problematic as they want to control who comes in as shareholder and they want to ensure that such a person also adheres to the shareholders agreement.

Conclusion

While shareholding is fundamentally a matter of personal property rights, mechanisms such as those outlined above allow for forced sales under specific conditions. These tools must be carefully designed, clearly defined, and fairly applied to balance shareholder interests and prevent misuse. Consulting with legal professionals and crafting detailed agreements can help ensure these provisions serve their intended purposes effectively.

This is not legal advice, only general orientation. If you have further questions please feel free to reach out on katarina.strandberg@stgcommerciallaw.com

Author: Kat Strandberg

Stockholm, 2024-12-06