The Enforceability and Effectiveness of Typical Shareholders Agreement The Enforceability and Effectiveness of Typical Shareholders Agreement Provisions By the Corporation Law Committee

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    The Enforceability and Effectiveness of Typical Shareholders Agreement Provisions

    By the Corporation Law Committee of the Association of the Bar of the City of New York

    Table of Contents I. Board of Directors .................................................................................... 1155 A. Shareholders Nomination and Election of Directors ........................... 1155

    1. Certain Legal Principles .................................................................. 1156 2. Drafting Considerations .................................................................. 1157

    B. Removal of Directors .......................................................................... 1157 1. Certain Legal Principles .................................................................. 1157 2. Drafting Considerations .................................................................. 1158

    C. Filling Board Vacancies ....................................................................... 1158 1. Certain Legal Principles .................................................................. 1159 2. Drafting Considerations .................................................................. 1159

    D. Board Size, Quorum, and Voting. ........................................................ 1159 1. Legal PrinciplesBoard Size .......................................................... 1160 2. Drafting ConsiderationsBoard Size .............................................. 1160 3. Certain Legal PrinciplesQuorum Requirement ............................ 1160 4. Drafting ConsiderationsQuorum Requirement ........................... 1161 5. Certain Legal PrinciplesVoting Requirement ............................... 1161 6. Drafting ConsiderationsVoting Requirement ............................... 1161

    E. Limiting the Powers of the Board of Directors ..................................... 1161 1. Certain Legal Principles .................................................................. 1162 2. Drafting Considerations .................................................................. 1162

    F. Board Committees .............................................................................. 1163 1. Certain Legal Principles .................................................................. 1163 2. Drafting Considerations .................................................................. 1164

    G. Board Observer Rights ........................................................................ 1165 1. Certain Legal Principles .................................................................. 1165 2. Drafting Considerations .................................................................. 1165

    H. Indemnifi cation .................................................................................. 1165 1. Certain Legal PrinciplesIndemnifi cation of Directors Generally .. 1165 2. Drafting ConsiderationsIndemnifi cation of Directors Generally .. 1166 3. Certain Legal PrinciplesMultiple Indemnitors ............................. 1167

  • 1154 The Business Lawyer; Vol. 65, August 2010

    4. Drafting ConsiderationsMultiple Indemnitors ............................. 1167 II. Corporate Opportunities ..................................................................... 1167 A. Certain Legal Principles .................................................................. 1168 B. Drafting Considerations ................................................................. 1169 III. Appointment and Removal of Offi cers ................................................. 1169 A. Certain Legal Principles .................................................................. 1169 B. Drafting Considerations ................................................................. 1170 IV. Special Voting Rights ........................................................................... 1170 A. Certain Legal Principles .................................................................. 1170 B. Drafting Considerations ................................................................. 1171 V. Information Rights .............................................................................. 1171 A. Certain Legal Principles .................................................................. 1172 B. Drafting Considerations ................................................................. 1172 VI. Transfer Restrictions ............................................................................ 1172 A. Transfer Restrictions Generally ....................................................... 1172 1. Certain Legal Principles ............................................................. 1172 2. Drafting Considerations ............................................................ 1177 B. Right of First Refusal/Right of First Offer ........................................ 1178 1. Certain Legal Principles ............................................................. 1178 2. Drafting Considerations ............................................................ 1179 C. Mandatory Sale Provisions .............................................................. 1180 1. Certain Legal Principles ............................................................. 1180 2. Drafting Considerations ............................................................ 1181 D. Drag-Along Rights .......................................................................... 1182 1. Certain Legal Principles ............................................................. 1182 2. Drafting Considerations ............................................................ 1184 E. Tag-Along Rights ............................................................................ 1185 1. Certain Legal Principles ............................................................. 1185 2. Drafting Considerations ............................................................ 1186 VII. Mechanisms for Resolving Deadlock . ................................................... 1188 A. Certain Legal PrinciplesDelaware Law ........................................ 1188 B. Certain Legal PrinciplesNew York Law ....................................... 1189 C. Drafting Considerations ................................................................. 1190 VIII. Preemptive Rights . ............................................................................... 1191 A. Certain Legal Principles .................................................................. 1192 B. Drafting Considerations ................................................................. 1193 IX. Amendments and Termination of Shareholders Agreements ................ 1195 A. Certain Legal Principles .................................................................. 1195 B. Drafting ConsiderationsAmendments ......................................... 1195 C. Drafting ConsiderationsTermination ........................................... 1195 X. Governing Law of Shareholders Agreements ........................................ 1196 A. Certain Legal PrinciplesChoice-of-Law ....................................... 1196 B. Certain Legal PrinciplesGoverning Forum .................................. 1198 C. Drafting Considerations ................................................................. 1200 XI. Conclusion .......................................................................................... 1202

  • Enforceability and Effectiveness of Typical Shareholders Agreement Provisions 1155

    Agreements among two or more shareholders of a corporation are commonly used in connection with private equity and venture capital investments, joint ventures, and other corporate transactions. A shareholders agreement typically grants rights to those shareholders who are party to the agreement that are above and beyond the rights that are inherent in the shares that they own, and is intended to ensure that those shareholders obtain the benefi ts of the addi-tional rights that they bargained for when making their investments. For ex-ample, shareholders agreements may allocate among certain shareholders rights to designate the individuals who will serve on the companys board of directors, grant certain shareholders special voting rights, ensure that certain shareholders have preemptive rights if the company issues additional equity securities, and/or provide rights to limit or participate in transfers of shares by other sharehold-ers, among other things. Although freedom of contract is the legal principle that governs many provisions contained in a typical shareholders agreement, there are numerous legal considerations that will affect their enforceability and effectiveness.

    The Corporation Law Committee of the Association of the Bar of the City of New York has prepared this Report to highlight many of these legal consider-ations, with a goal of providing guidance to practitioners drafting these agree-ments. Many matters addressed by shareholders agreements are governed by, and must comply with, the corporation law of the state of incorporation. Because so many corporations are incorporated in Delaware or New York, this Report will focus primarily on legal considerations arising under shareholders agreements for companies incorporated in these states. If a corporation has been formed in another state, it will, of course, be necessary for the lawyer drafting the sharehold-ers agreement to consider the applicable provisions of the corporation statute of the relevant state. Shareholders agreements are most commonly entered into by shareholders of privately held corporations, so this Report generally discusses agreements among shareholders of a private corporation (un