7/1/2021
The global COVID-19 pandemic situation caused serious impacts on the world economy, especially in Brazil, affecting companies and enterprises in a very relevant way. The behavior of the consumer community changed dramatically, and companies had to adapt quickly to these changes.
Some markets and areas of operation were heavily suppressed and impaired by the rules restricting commercial circulation and operation imposed by several state governors, and by the behavior of the vast majority of consumers who voluntarily remained in isolation.
At the same time, a number of businesses became successful in this scenario. The pandemic and quarantine restrictions brought big losers but also big winners – especially companies in the technology, computer, e-commerce, transport and delivery, retail markets and supermarkets, and others.
Numerous business opportunities arise during a crisis, especially for disruptive innovations with the application of technology. And new risks arise from new investments and ventures, many of which can be preventively avoided.
A new company – be it a startup, a franchise, or a conventional venture with some market differential – invariably involves people, who will join together as partners in collaboration toward an economic goal. This corporate relationship will be far more complex and extensive than the provisions of a by-law or articles of association can regulate.
And the best way to regulate the relationship between the quotahoders or stockholders of a company is by agreeing on a Stockholders’ Agreement (in the case of a Stock Corporation) or a Quotaholders’ Agreement (in the case of a Limited Liability Company). It is an institute set forth in article 118 of the Brazilian Corporation Law (Law no. 6,404/76), which is widely used nowadays.
Despite its unquestionable importance, many investors and experienced businessmen fail to use it, and start incurring in risks and litigation that could be easily avoided. The importance of the Quotaholders’ Agreement is establish rules, in advance, that will guide the quotaholders’ relationship in the company’s various issues, anticipating what would be a future discussion and thus avoiding disputes and controversies between the quotaholders.
With previously negotiated rules and agreements, many possible disputes that commonly occur in day-to-day business will never exist, resulting in more tranquility and predictability for the company’s operation.
In this sense, many people wonder why to sign a Quotaholders’/Stockholders’ Agreement, and also if it is possible to set forth the clauses in the articles of association/by-laws.
In general, the importance of the Quotaholders’ or Stockholders’ Agreement is enormous, because, as already said, it drastically reduces the possibility of dispute and controversy between quotaholders, and preventively resolves issues of controversy and disputes that commonly occur in the business world. Translated into a more business language: more stability for the company’s management, and fewer events that would deviate the focus from the “core business”, and therefore less expense with disputes and litigation – many of which may result in the company’s annihilation.
The possibility of including the clauses of a quotaholders’ or stockholders’ agreement in the articles of association/by-laws is highly inadvisable.
First of all, the Quotaholders’ or Stockholders’ Agreement will deal with sensitive issues and the personal relationship of the quotaholders or stockholders – therefore, of interest to them and not to third parties, other than the company. The confidentiality of these clauses may prevent third parties from using such knowledge to obtain some advantage in relation to the company or a particular quotaholder.
The Quotaholders’ or Stockholders’ Agreement aims to preserve the common good, putting the company in first place as opposed to the isolated will of one or more quotaholders.
Another reason to avoid including such clauses in the articles of association/by-laws is more practical. The articles of association are a public instrument filed with the Board of Trade and they serve as certificate of organization of the company – and so will be delivered to all parties of an economic relationship with the company, such as banks and financial institutions, customers and suppliers, and governmental agencies, particularly for licenses and permits.
Large volume articles of association/by-laws, with several clauses limiting action by quotaholders and managers, or too many details about the company’s operation may unnecessarily slow down – or even hinder – the company’s relationship with such governmental agencies, or with its customers and suppliers.
Thus, leaner articles of association/by-laws, containing the minimum clauses and rules sufficient for the healthy operation of the company are the most advisable measure.
Understanding the main provisions of a Quotaholders’ or Stockholders’ Agreement
Among the general items of a Quotaholders’ or Stockholders’ Agreement, there are some crucial points that make it a useful and assertive instrument for the company’s operation. And what would be the essential matters that must be included in a Quotaholders’ Agreement?
I. Resolutions at Quotaholders or Stockholders Meetings
The company’s operation will be managed by the Directors or Managers, with the limitations imposed by the by-laws/articles of association. These limitations represent the will of the quotaholders to safeguard strategic, high importance or high risk matters to be decided by the quotaholders or stockholders at meetings.
A point of attention concerns the formalities for convening meetings, their form, and the period of advance notice.
It is fundamental to define the approval quorums for each topic, in order to preserve the good progress of the business, without impairing controlling or minority quotaholders/stockholders. It is possible to establish joint voting obligations or even restrictions to the voting rights of one or more quotaholders/stockholders.
II. Company Management
The appointment of directors and managers is, without a doubt, one of the most fundamental issues of a company. Limited Liability Companies’ management is in charge of one or more quotaholders, or a third party that does not necessarily need to be a quotaholder in the business, but must be qualified for such function.
In the case of the Stock Corporations, the management will be performed by an executive board of officers, and a Board of Directors may also be established, which is very common, or many times mandatory, establishing how many officers and directors will be, their qualifications, term of office, dismissal criteria, among others.
III. Responsibilities of Quotaholders and who can work in the business
In new ventures or startups it is very common for partners to be directly involved in the development of the business. Thus, establishing clearly which are the duties of each one, limits to the actions, goals and objectives is essential to avoid future disputes.
Many times there is also the intention of the family to work in the business, and it can be established what are the technical, training or experience criteria for family members to occupy strategic positions in the business, or even common positions.
The main source of dispute regarding partners and family members working in the business concerns the dismissal or resignation, so it is salutary to clearly address what are the chances of dismissal, with or without cause.
IV. Rules regarding the Distribution of Profits and Dividends
Profits or dividends are divided proportionally to the ownership interest, that is, each quota or stock receives the same amount of profits or dividends. In the case of Limited Liability Companies, another form of distribution may be defined in the Quotaholders’ Agreement, such as the disproportionate distribution of profits, and it is essential to point out the criteria for its occurrence and its limits (there is no provision for Stock Corporations).
There are some specific rules that aim at protecting the minority stockholders of Stock Corporations, such as the obligation to pay 50% of the net profit after some adjustments in case of matters not expressly dealt with by rules in the Corporation’s By-Laws, and the prohibition to provide for mandatory dividends lower than 25% of the ascertained profits. The Stockholders’ Agreement can and should regulate the issue of dividend distribution in a fair and clear manner.
V. Right of first refusal in the transfer of stocks or quotas
Other stockholders/quotaholders are entitled to right of first refusal to purchase the stocks or quotas of a stockholder/quotaholder who wishes to sell them, under equal conditions with the potential buyer.
In Stock Corporations, the stocks may be freely sold to another stockholder or to a non-stockholder third party, without the need for any approval from the company and/or from the other stockholders, nor the performance of any right of first refusal of the other stockholders. The Stockholders’ Agreement will be a fundamental instrument to provide for the right of first refusal.
In the case of Limited Liability Companies, the quotas may be freely transferred from one quotaholder to another, without the need for approval of other quotaholders, although they may oppose it if they represent more than one quarter (1/4) of the capital stock. The transfer of quotas to non quotaholders may only be carried out with the agreement of one quarter (1/4) of the capital stock. In this respect, the Quotaholders’ Agreement may establish more or less restrictions for the sale of quotas or the admission of non quotaholders, as well as provide for the right of first refusal.
VI. Potential Exclusion of Quotaholder with Cause
In Limited Liability Companies it is possible to exclude a quotaholder with cause, as long as the articles of association establish a clause to that effect.
However, the detailing of the rules and standards for exclusion, as well as the company’s particularities or personal matters of the quotaholders shall not be included in the articles of association, but shall be detailed in the Quotaholders’ Agreement and kept away from the eyes of third parties foreign to the business.
The clear and accurate definition of the breaches that give rise to exclusion with cause is extremely important to avoid judicial exclusion. Another relevant issue is the definition of the form and criteria for the calculation of the excluded quotaholder’s assets.
VII. Company Evaluation Criteria
Often the sale of a company is a positive situation, with gain for the selling quotaholders. However, this is not always the reality, and there may be a sale at a value lower than the investments made, or even lower than the price charged by the market.
The definition of clear criteria and specific methodology for the company’s evaluation in a liquidity event (sale) of the entirety of the business or only of its control is a very important measure to avoid disputes or judicial controversy between the quotaholders.
VIII. Tag-along Right and Obligation
Tag-along right and obligation clauses are very common in a Quotaholders’ or Stockholders’ Agreement and are intended to protect quotaholders/stockholders in connection with the sale of equity interests or stocks. The tag-along right and obligation are commonly referred to by two expressions in English:
“Tag-along” means the right of joint sale, whereby in the event of a sale of equity interest to a controlling stockholder (50% +1), the minority stockholders will now have the right to sell their interests under the same conditions and price per quota or stock;
“Drag-along” means the obligation of joint sale, whereby the controlling stockholder or the one with the largest stockholding has the right to oblige the minority stockholders to sell their stocks to the same buyer, under the same conditions and price per quota or stock.
IX. Succession due to death or divorce
The death of a quotaholder of Limited Liability Companies implies the liquidation of its quotas, that is, the heirs will not join the company, unless otherwise determined in the articles of association or in the Quotaholders’ Agreement.
In the case of the property settlement by reason of divorce subject to the total or partial community property ruling, the quotas of a quotaholder may be divided with the spouse, and in this case it is desirable that the Quotaholders’ Agreement already establishes if the spouse may or may not join the company, and in case he/she cannot join, what is the form of liquidation of his/her participation and ascertaining of assets.
In the case of Stock Corporations, the heirs will receive the ownership of the deceased stockholder’s stocks, or the spouse will receive his/her shared portion in case of divorce, and, due to the nature of this corporation, a prohibition of transmission of stocks is not applicable.
However, it is possible to establish put and call options related to certain events and situations.
X. Non-Compete and Non-Solicitation
In order to prevent partners, officers or managers, and directors from competing with the company, whether in their own name or in favor of third parties, it is very common to insert such prohibitions in the Quotaholders’ or Stockholders’ Agreement, extending the term of the obligation to periods subsequent to the partner, manager or director’s removal from the company.
For example, they may not participate in, manage, or render services to another company whose line of business will be the same as that of the company in question, subject to the penalty provided for in the Quotaholders’ or Stockholders’ Agreement in case of non-compliance.
The non-solicitation creates the obligation of not hiring, by itself or for the benefit of third parties, employees, agents, partners, directors or managers of the company, subject to the penalties established in the Quotaholders’ or Stockholders’ Agreement, in case of breach.
XI. Dispute Resolution
The last relevant issue that must be included in a Quotaholders’ or Stockholders’ Agreement concerns the resolution of disputes, in case the quotaholders/stockholders cannot reach an amicable agreement on their differences.
It is highly recommended to institute an arbitration agreement to solve disputes, by reason of the great advantages of arbitration judgments, such as confidentiality, expeditious procedure, and specialized judges resulting in high technical quality of decisions, among others.
In case the arbitration is not indicated, for economic reasons or due to the small size of the enterprise, the Quotaholders’ or Stockholders’ Agreement can regulate a pre-litigation procedure that stimulates the quotaholders/stockholders to reach an agreement, or at least obliges the parties to expose in a clear and formal way, accompanied by supporting documents, their complaints and grievances, prior to the filing of any lawsuit.
It is remarkable that a Quotaholders’ or Stockholders’ Agreement takes into account numerous particularities of the company, its operation and the relationship of its quotaholders/stockholders. Given its complexity, it is essential that Quotaholders’ or Stockholders’ Agreement be written by professionals with enough experience in legal and business issues related to the organization and operation of companies.
Our Corporate team has broad experience and legal knowledge to clarify doubts and assist in the preparation of this fundamental instrument for the protection of companies.
Authored by: André Staffa Neto
