What happens to company shares when a shareholder dies, divorces or leaves?

Most corporate documents are drafted with the expectation that they will never be used in anger, and constitutional documents (a company’s articles of association) are no different. However, when a crisis arises, having made the right preparations can make the difference between success and failure.

One key provision, often overlooked in happier times, is the good/bad leaver clause.

What is a good/bad leaver clause?

Typically included in bespoke articles and shareholders’ agreements (but missing from Model Articles), a good/bad leaver clause requires shareholders to transfer their shares if they cease to be part of the business. It allows the value to be variable depending on the circumstances under which the shareholder leaves.

Who needs one?

A good/bad leaver clause is essential in owner-managed businesses, family companies and where employees are offered shares as a part of an incentive scheme.

What can go wrong without a good/bad leaver clause?

This is a good example of a clause which is included routinely but which nobody ever wants to need. Nevertheless, if a shareholder dies, divorces or is poached by a competitor, it can be extremely damaging for a business if their shares pass into the wrong hands.

Our Corporate and Commercial team has recently seen a number of real-life situations where having a good/bad leaver clause made the difference between allowing a company to carry on trading and facing insolvency. It can also allow a company to continue operating, rather than struggling to find the funds to buy out a stubborn shareholder at an inflated price.

Examples

Critical situations where having a good/bad leaver clause made the difference include:

When a founder dies

A start-up company whose founders each held shares was faced with difficult trading conditions and then the tragic death of one of the founders. Fortunately, the company’s articles contained good and bad leaver provisions which allowed the company to buy back the founder’s shares at market value. This permitted the company to negotiate a sale of all its shares to an investor who was able to secure the company’s future. Without the good/bad leaver clause, the negotiations would have been much more uncertain and his family no better off.

When a shareholder divorces

A family company was run by three brothers who all worked in the business. They had not revised their articles as the business grew, and when one of them was involved in divorce proceedings, his ex-wife was awarded a large number of his shares as part of a settlement. She was not involved in the business, and there was no leaver provision, so the other shareholders could not require her to sell the shares back to the company. The company was left with a shareholder who was entitled to dividends and could block the progress of the business but, unlike the other shareholders, was not actively involved in the business.

Creating a start-up with the right legal protections

We often advise start-up companies and always suggest they include good and bad leaver provisions. These normally include board discretion so that there is enough flexibility to cover unforeseen circumstances, but shares can be valued nominally (e.g. £1 per share) where there is a bad leaver. This allows the company to continue to operate even if cash flow is restricted without a leaving shareholder holding the company hostage.

How to protect your company

A company’s articles of association should be reviewed and updated regularly to ensure that they are fit for purpose. If you would like us to review or revise your company’s articles or shareholders’ agreement, or if you have any concerns about good/bad leaver provisions, we can help.

Contact our corporate and commercial lawyers on 0117 325 2929 or fill out our online enquiry form.