A shareholders agreement is a private contract between the people who own a company. It sets out how the company will be run, who gets to make which decisions, what happens to shares when someone wants out, and how disputes between the owners get resolved. For a business with more than one owner, it is usually the document that most closely reflects the real deal between the founders, because the law's default rules rarely capture that deal.
This article explains how a shareholders agreement operates alongside the two other layers that govern every Australian company: the Corporations Act 2001 (Cth) (the Act) and the company's constitution. It covers the standard components, where the agreement stops, and the situations where a dispute can still arise even with one in place. It is written for owners and directors of small and medium companies, typically proprietary companies, where most of these issues come up.
Who the agreement balances
A shareholders agreement exists because the people behind a company do not all want the same thing. The document has to balance interests that pull in different directions:
- Founders: want to keep control of the business and the decisions that shape it.
- Investors: want to protect the value of their money, usually through a say over major decisions and a clear way out.
- Minority shareholders: want to avoid being outvoted on everything or squeezed out of a company they helped build.
- Directors: run the day-to-day business but are answerable to the shareholders who appointed them.
The shareholders agreement is where these interests get written down and traded off. A founder gives an investor a seat on the board in exchange for capital. A minority shareholder accepts majority control in exchange for a veto over specific decisions. Neither the Act nor a standard constitution does this work, because both are generic. The agreement is the bespoke layer.
Where the rules for running a company come from
Every company is governed by three layers of rules, and it helps to keep them separate.
The first layer is the Act. It contains a set of default provisions known as the replaceable rules. Under s 134 of the Act, a company's internal management may be governed by the replaceable rules, by a constitution, or by a combination of both. Under s 135, the replaceable rules apply automatically to companies registered after 1 July 1998, and to older companies that have repealed their constitution since then. They cover ordinary matters such as how directors are appointed, how meetings are called, and how shares are transferred.
The second layer is the company's constitution, if it has one. A constitution can displace or modify the replaceable rules, because s 135(2) allows the constitution to override them. The constitution is not just an internal document. Under s 140 of the Act, it has effect as a contract between the company and each member, between the company and each director, and between members themselves. That is why the constitution binds everyone who joins the company later, whether or not they have read it.
The third layer is the shareholders agreement. It is not part of the statutory scheme at all. It is an ordinary contract between the shareholders, and usually the company as well. The agreement can deal with anything the parties agree on, including matters the replaceable rules and the constitution do not cover, such as how the shareholders will vote their shares, how deadlocks will be broken, and what happens when one owner wants to leave.
What happens when the agreement and the constitution conflict
Because the agreement and the constitution are separate documents, they can say different things. Which one wins depends on what the inconsistency is about.
The agreement binds the parties who signed it. The constitution binds the company and everyone who becomes a member. Where the dispute is between shareholders about their own rights, such as how they will vote or who they will appoint as director, the agreement generally prevails as between the parties, because people are free to contract about how they exercise their own rights. But where the validity of a company act is in issue, such as whether a board meeting was properly held, the company acts through the Act and its constitution, and the agreement cannot simply override that.
The New South Wales Supreme Court case of Lorebray [2021] NSWSC 1533 shows how real this problem is. The shareholders agreement contained a clause stating that where the agreement and the constitution were inconsistent, the agreement would prevail. The constitution set a quorum of two directors for board meetings, while the agreement contemplated a board of three. When one shareholder refused to appoint its director, the others argued that no board meeting could validly be held without all three. The court held that resolutions passed at board meetings with a quorum of two were not invalid. The agreement could bind the parties to use their best efforts to keep three directors on the board, but it could not change how the company's meetings validly operated. As Black J observed, a clause that says the agreement prevails implicitly recognises the possibility of continuing inconsistency between the two documents.
The practical lesson is not that the agreement is worthless, but that it works best when it is aligned with the constitution. A well-drafted agreement does not contradict the constitution; it sits on top of it, using contractual obligations to achieve what the constitution cannot.
What a shareholders agreement can do
The value of the agreement lies in its clauses. These are the components that do the work.
Who decides what: board versus general meeting
By default, the directors run the business. Under the replaceable rule in s 198A of the Act, the business of a company is managed by or under the direction of the directors, and the directors may exercise all the company's powers except those the Act or the constitution requires to be exercised in general meeting.
An agreement typically redraws this line. It lists the decisions that need shareholder approval, such as entering major contracts, borrowing above a set limit, hiring or dismissing a senior manager, or changing the nature of the business. It then sets the level of approval required, from a simple majority up to a unanimous vote. Requiring a supermajority, say 75 per cent, for specific decisions gives a minority shareholder an effective veto without handing them control of everything else.
Appointing and removing directors
Who sits on the board largely decides who runs the company. An agreement can give a founder or an investor the right to appoint a director while they hold a minimum percentage of shares, and can set the process for filling a vacancy. It can also define when a director must go, such as for fraud, for incapacity, or for breaching the agreement, and can require all shareholders to vote their shares to remove that director.
The statutory default supports this. Under the replaceable rule in s 203C, members of a proprietary company may remove a director by resolution and appoint someone else in their place. Because that rule is replaceable, the constitution may vary it, which is another reason the agreement, the constitution and the Act have to be read together rather than drafted in isolation.
Issuing new shares and dilution
A new issue of shares changes everyone's percentage. The Act already contains a default protection for proprietary companies: under s 254D, directors must offer new shares to existing holders in proportion to their existing holdings before issuing them to anyone else. An agreement typically makes this right firmer, with a formal offer process, a deadline for acceptance, and an agreed method for valuing the shares. It can also require a shareholder vote before any issue, so that a majority cannot quietly dilute a founder's stake by issuing shares to themselves or to an ally.
Selling and transferring shares
An agreement controls who can own shares over time. The usual mechanism is a right of first refusal: a shareholder who wants to sell must first offer the shares to the other shareholders pro rata at a price set by an agreed valuation method, such as a formula based on earnings or a valuation by an independent accountant.
The agreement can also include two related rights. A tag-along right lets a minority shareholder sell their shares on the same terms when a majority shareholder sells, protecting them from being left behind. A drag-along right works the other way: when a large majority sells to a third party, they can force the minority to sell on the same terms, which is how a buyer acquires 100 per cent of the company.
These clauses operate inside a statutory framework. If the company refuses to register a transfer, s 1071E of the Act requires it to notify the transferee within two months, and s 1071F allows a transferee to apply to court where the refusal was without just cause. A transfer regime in an agreement should be drafted to work within those rules, not against them.
Dividends
Under the replaceable rule in s 254U, the directors determine whether a dividend is payable and fix the amount, the time for payment and the method of payment. But the Act imposes a hard limit that no agreement can waive. Under s 254T, a company must not pay a dividend unless its assets exceed its liabilities and the excess is enough for the payment, the payment is fair and reasonable to the shareholders as a whole, and it does not materially prejudice the company's ability to pay its creditors.
What an agreement can do is set a dividend policy: a target proportion of profits to distribute, a regular date for declaring dividends, and a method of payment. The directors remain bound by the statutory test in s 254T regardless of what the shareholders have agreed among themselves.
Deadlock and disputes
In a company split evenly between two shareholders or two factions, a deadlock is a structural risk: neither side can outvote the other, and the company can stop functioning. An agreement can provide a deadlock mechanism, such as a mediation and escalation process, a tie-breaking vote, or a buy-out arrangement where one side names a price and the other must either buy at that price or sell at it. It can also set the general dispute resolution path, typically negotiation, then mediation, then arbitration or court.
These clauses matter because without them a deadlocked company has no agreed way forward, and the only option is litigation or an application under the oppression provisions. A deadlock clause agreed while the relationship is still good is far more workable than one negotiated after the breakdown.
Protecting minority shareholders
A minority shareholder in a company controlled by others faces the risk of being outvoted, excluded from information, and diluted. An agreement can respond with information rights, such as access to financial statements and board papers, a seat on the board, a veto over specified major decisions, and preemptive rights over new issues.
Behind the agreement sits a statutory backstop. Under s 232 of the Act, a court may make orders where the conduct of a company's affairs is oppressive to, unfairly prejudicial to, or unfairly discriminatory against a member. The agreement cannot remove that protection, and it should not try to. A clause that attempts to waive a shareholder's right to apply under s 232 is unlikely to prevent a court from hearing the application.
What the agreement cannot do
A shareholders agreement is powerful, but it has clear limits, and it is worth knowing them before relying on the document.
It cannot excuse directors from their statutory duties. Sections 180 to 184 of the Act impose duties of care and diligence, good faith and proper purpose, and prohibit improper use of position and information. These duties are owed to the company and cannot be contracted away. A clause saying that directors may act in the interests of a particular shareholder, or that they are not liable for certain decisions, does not displace them.
It cannot oust the jurisdiction of the court. Provisions that try to make a dispute resolution process final and binding to the exclusion of the courts, or that waive statutory remedies such as the oppression remedy in s 232, will not have that effect. Dispute resolution clauses should be drafted to manage how disputes are handled, not to pretend the statute does not apply.
It cannot bind people who never signed it. The company is bound only if it is a party to the agreement. A new shareholder who joins later is not automatically bound by it, which is why agreements typically require new shareholders to sign a deed of adherence or to execute the agreement as a condition of receiving shares. The constitution, by contrast, binds every member through s 140, which is one of the reasons the constitution cannot simply be replaced by the agreement.
Where things go wrong
The most common failures in shareholders agreements are not dramatic. They are gaps and mismatches that only surface in a dispute:
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Conflict with the constitution: Nobody noticed it at the time, as in Lorebray. The agreement said one thing about the board, the constitution said another, and the company spent time and money in court working out which applied. The fix is to check the two documents against each other before signing, clause by clause.
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A deadlock clause that does not cover the actual deadlock: A mechanism that only addresses deadlock on board decisions is useless when the shareholders themselves cannot agree. The trigger and the scope of the clause need to match the company's real ownership structure.
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A template that does not fit the business: A valuation formula based on earnings is unworkable for a company that holds appreciating assets. A right of first refusal that takes no account of the statutory notice and court remedy provisions in ss 1071E and 1071F can produce a transfer that cannot actually be registered. Drag-along and tag-along rights that were never reconciled with each other can leave a minority shareholder with no practical exit.
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Staleness: Shareholders leave and new ones arrive without signing the agreement or a deed of adherence. Share classes change, the company restructures, and the agreement keeps referring to arrangements that no longer exist. An agreement that does not match the current register of members is a document that will fail when it is needed.
When you need a lawyer to get involved
Because the agreement sits on top of the Act and the constitution, drafting it properly is a matter of fitting the contract to the statutory frame. A commercial lawyer can help at several points:
- Alignment: The lawyer reads the agreement against the constitution and the replaceable rules that apply to the company, and fixes the conflicts before they become arguments.
- Balance: An agreement that starts as one party's template is rarely fair to the others, and a lawyer negotiates the clauses that matter, such as which decisions need unanimity, how shares are valued, and what happens on a deadlock.
- Currency: As shareholders change, the lawyer updates the agreement and the deeds of adherence that bind new members.
It is worth getting this review done before signing. The cost of a deadlock or an oppression dispute later, with both sides in court over what the agreement meant, is far higher than the cost of having the document drafted and checked properly in the first place.
The agreement manages the relationship, not the company
The point that matters most is this: a shareholders agreement does not run the company. The company is run through the Act and the constitution. What the agreement does is bind the shareholders to exercise their rights in a particular way, to vote their shares, appoint directors, and approve or block decisions according to rules they chose themselves.
That is why the agreement is powerful, and why it is fragile. If the agreement and the constitution drift apart, or if a shareholder who joined later never signed it, the document stops matching the reality it was meant to govern. The work that pays off is done before signing: checking the agreement against the constitution clause by clause, making sure everyone who owns shares is a party, and building the deadlock and exit mechanisms the company's actual ownership structure requires. That is where a lawyer earns their fee, and it is considerably cheaper than litigating the gap after a dispute has started.