How leaver provisions work in a shareholders' agreement

What leaver provisions are for

A leaver provision is a clause in a shareholders' agreement that says what happens when a shareholder who also works for the company stops providing services. In many Australian companies, shares are used to reward people for their labour as much as their money. Founders, key employees and contractors are given shares so that the success of the business becomes their success too. That arrangement works while the person is contributing. It becomes a problem when they stop.

If a founder or key employee leaves and keeps their shares, the company ends up with a shareholder who no longer works for it. The shares cannot be offered to the replacement who now does the work, and the departing shareholder keeps an upside they no longer helped create. Leaver provisions fix that problem. They oblige the departing shareholder, the leaver, to sell some or all of their shares to the continuing shareholders or to the company itself.

These provisions are most common in startups, professional services firms and other businesses where ownership is tied to service rather than to capital. They usually sit in the shareholders' agreement and work together with vesting schedules and pre-emptive rights over share transfers. This article explains how the mechanism runs: what triggers it, who buys the shares, how many must be sold, what price is paid, and where the drafting usually goes wrong.

Who is involved

A leaver mechanism has a small cast of players, each with a distinct role:

The leaver: the shareholder who stops providing services and becomes obliged to sell.
The continuing shareholders: the people who usually get the right, or the option, to buy the departing shares.
The company: it may buy the shares itself, or simply register the transfer to whoever does buy them.
The directors: they control registration of the transfer, and the replaceable rules in the Corporations Act 2001 (Cth) give them limited grounds to refuse it.
The valuer or expert: where the parties cannot agree on price, the agreement typically sends the question to an independent valuer whose decision is binding.
A court: if the parties dispute whether a leaver event occurred, what the shares are worth, or whether the leaver must cooperate, the dispute ends up before a court.

The interests do not align. The continuing shareholders want the shares back quickly and at the lowest defensible price. The leaver wants full value and freedom to keep the upside. The company wants the handover to happen without a dispute that disrupts the business. Most of the drafting effort goes into managing those tensions.

What counts as a leaver event

The trigger for the whole mechanism is the leaver event, and the agreement defines it. Most agreements split departures into two categories, with different consequences for each.

A bad leaver event typically includes some or all of the following:

Failure to perform: the shareholder materially fails to provide, or persistently fails to provide in a proper and timely manner, the services they agreed to provide.
Material breach: the shareholder breaches a material term of the shareholders' agreement or a related document such as an employment contract or service agreement.
Harmful conduct: the shareholder knowingly acts, or causes others to act, in a way that is reasonably likely to impair the reputation, value, profitability or goodwill of the company. This commonly covers competition with the business and misuse of confidential information.
Unauthorised disposal: the shareholder attempts to transfer or encumber their shares other than through the process the agreement sets out.

A good leaver event is defined by contrast: the shareholder stops providing services for a reason that is not a bad leaver event. Resignation on agreed terms, redundancy, retirement, ill health and death are the usual examples. Some agreements add a third, neutral category, or specifically direct that death and total disablement are always treated as good leaver events.

The characterisation matters because it drives the price. Whether a departure was a resignation or a dismissal for cause, a redundancy or a termination for misconduct, can be worth hundreds of thousands of dollars. That is why characterisation disputes end up in court. In Chief Disruption Officer Pty Ltd v Michel, in the matter of Laava ID Pty Ltd (No 3) [2022] FCA 1302 (judgment), the Federal Court considered a founder's departure from a company governed by a shareholders' deed with leaver-style forced sale provisions. The dispute concerned allegations that the founder had been forced out as acting CEO, together with oppression claims under s 232 of the Corporations Act 2001 (Cth). The Court was not satisfied the founder had been forced out, but found oppression established in respect of some, though not all, of the share and option issues that followed his departure. The case shows that leaver provisions operate in a world where characterisation disputes and oppression claims are common.

How the forced sale runs, step by step

Once a leaver event occurs, the agreement sets a mechanical process in motion:

Notice: The leaver event is identified and notice is given in the way the agreement requires.
The sale obligation: The leaver is usually deemed to have offered their shares for sale, or the continuing shareholders and the company are given an option to require the transfer. Some agreements use a transfer notice mechanism, under which a defaulting shareholder is taken to have served notice offering all of their shares.
The quantity: The number of shares to be sold is fixed, usually by a vesting schedule (see below).
The price: The price is fixed according to the pricing clause, which distinguishes good and bad leaver events.
The transfer: A proper instrument of transfer must be executed and delivered to the company. This is a statutory requirement: under s 1071B of the Corporations Act 2001 (Cth), a company must only register a transfer of shares if a proper instrument of transfer has been delivered to it, and this applies despite anything in the company's constitution (s 1071B).
Registration: The directors register the transfer. Under the replaceable rules, a transferor remains the holder until registration, and directors may refuse to register in limited circumstances, such as where the shares are not fully paid or the company has a lien over them. Directors of proprietary companies have a broader discretion to refuse registration for any reason.
Payment: The buyer pays the price, usually against delivery of the instrument and registration.
Enforcement if the leaver refuses: The obligation to sell is contractual. If the leaver refuses to sign the instrument of transfer, the buyer's remedy is to apply to a court for an order compelling the transfer. Agreements commonly include an acknowledgement that the sale is specifically enforceable, precisely because a reluctant leaver has to be compelled rather than persuaded.

When the company is the buyer

If the company itself buys the leaver's shares, the purchase is a buy-back and must comply with Part 2J.1 of the Corporations Act 2001 (Cth). Under s 257A, a company may buy back its own shares only if the buy-back does not materially prejudice the company's ability to pay its creditors, and only if the company follows the procedures in that Division (s 257A). Where a buy-back exceeds the 10 per cent in 12 months limit, the terms must be approved by an ordinary resolution of shareholders (s 257C).

There are two practical consequences. First, a company in financial difficulty may simply be unable to buy back shares, because the creditor test stands in the way. Second, shares that a company buys back are cancelled: s 257H provides that a company must not dispose of shares it buys back, and they are cancelled immediately after registration of the transfer (s 257H). So a buy-back cannot be used to move the leaver's shares across to a replacement. If the intention is to put the shares into new hands, the continuing shareholders should be the buyers, or the company should cancel the shares and issue new ones to the replacement.

How many shares the leaver must sell

Most leaver provisions do not require the leaver to sell everything at once. Instead they use a vesting-style schedule under which the proportion of shares that must be sold falls as the shareholder's tenure lengthens. A common shape is:

Up to one year: all shares must be sold.
One to two years: 75 per cent must be sold.
Two to three years: 50 per cent must be sold.
Three to four years: 25 per cent must be sold.
After four years: the shareholder keeps everything.

The schedule rewards loyalty over time. A shareholder who leaves early gives back most of the equity, because the company has had little benefit from their services. A shareholder who stays for the full period keeps their shares, because by then they have earned them. The dates usually run from the date the shares were issued or the agreement was signed, and the schedule is a negotiated point rather than a legal requirement. It is also common for leaver provisions to apply only to service shares, so that shares held by investors are not caught.

What the leaver gets paid

The pricing clause is where the good leaver and bad leaver categories do their real work:

Good leaver: the price is usually the price agreed between the parties at the time, or the fair market value of the shares as determined by an independent valuer.
Bad leaver: the price is typically a discounted price. The discount is a matter for negotiation, and discounts in the range of 10 to 30 per cent are commonly seen in practice. Some agreements go further and fix a nominal price for bad leavers who depart early. In the Laava ID litigation, the emails before the Court described exactly that approach: a founder leaving for any reason in the first two years would be bought out at $1, and a good leaver in the third year would receive fair market value less a 15 per cent discount.

"Fair market value" is an objective standard, and that is a drafting trap in itself. In MMAL Rentals Pty Ltd v Bruning [2004] NSWCA 451 (judgment), the NSW Court of Appeal held that fair market value does not involve determining what is just and equitable between the parties, and that the word "fair" still has work to do in removing impediments to bargaining between them. The expert evidence in that case ranged from $59,000 to about $6 million, which shows how much turns on the valuation methodology.

The leading Australian example of a valuation clause failing is Network Ten Pty Ltd v TX Australia Pty Ltd [2018] NSWCA 312 (judgment). The TXA shareholders' agreement deemed a defaulting shareholder to have offered all of its shares for transfer, with the price to be agreed or determined by the company's auditor acting as an expert. The auditor's report set out a range of valuation scenarios but did not fix a single price, and the non-defaulting shareholders adopted the lowest scenario, which valued the shares at nil and saw them transferred for $1 each. The NSW Court of Appeal held that the report had not determined the price at all: the expert process had failed. The lesson is simple. If the agreement sends the price to an expert, it should tell the expert how to value, and the expert must actually arrive at a price.

Where the mechanism tends to bite

The edge cases are where leaver provisions usually fail in practice:

Characterisation disputes: The difference between good and bad leaver can be a difference in price of hundreds of thousands of dollars, and both sides know it. If the definitions are loose, the dispute goes to court and the mechanism stops working.
New shareholders: A shareholders' agreement binds only the parties to it. A company's constitution, by contrast, binds the company and all of its members: s 140 of the Corporations Act 2001 (Cth) gives it effect as a contract between the company and each member, and between members (s 140). If the transfer restrictions that make leaver provisions work sit only in the agreement, new shareholders must be brought in as parties. If they sit in the constitution, note that a modification made after a person becomes a member that imposes or increases restrictions on transferring their existing shares does not bind that member unless they consent in writing.
Death and incapacity: Leaver provisions often extend to the estate of a deceased shareholder, so that personal representatives are obliged to sell. Transfers by personal representatives are expressly permitted under s 1071B.
The company cannot fund the buy-back: If the company is the buyer, the creditor test in s 257A can block the purchase, and the continuing shareholders may not have anticipated having to fund it themselves.
Tax: A leaver who sells shares generally faces capital gains tax on the disposal. Where the shares were acquired under an employee share scheme, the employee share scheme tax rules apply instead, and the interaction with a discounted buy-back should be checked with an accountant or tax adviser.
Misaligned definitions: If "termination for cause" in an employment contract does not match "bad leaver event" in the shareholders' agreement, a person can be a bad leaver under one document and a good leaver under the other.

When a lawyer makes the difference

The drafting stage is where leaver provisions are won or lost. A lawyer's role at that point is to make the definitions precise, to fix the pricing mechanics and the valuation criteria, and to make sure the leaver provisions work with the constitution, the employment contracts and the employee share scheme documents. It is also the point at which new shareholders can be required to accede to the agreement, so that the restrictions survive changes in the register.

A lawyer becomes essential again when the mechanism is actually triggered. Characterising the departure, challenging or defending a valuation, resisting or advancing an oppression claim, and enforcing a reluctant leaver's obligation to transfer are all tasks where the cost of getting it wrong is measured in the value of the shares, not the cost of the advice. The two NSW Court of Appeal decisions discussed above both arose from valuation clauses that the parties thought were fine. The Federal Court litigation in Laava ID ran for years over a founder's departure.

The question to ask before you sign

Leaver provisions only work if two things are clear enough to survive contact with reality: when a leaver event occurs, and what the leaver gets paid. If the agreement cannot produce an answer to both questions without a fight, it will deliver a court case instead of a handover. Before you sign, ask what would happen if a founder resigned tomorrow, whether the valuer would know how to value, and whether the definition of bad leaver would cover the conduct that actually worries you. The answers are cheaper to fix now, while the relationship is still good, than they are after the departure.