Restrictive Covenants in Shareholder Agreements: What They Are and Why They Matter

Shareholders agreements are a common tool used by companies to govern the relationships between their shareholders. These agreements can set out rules for how the company will be run, how decisions will be made, and how disputes will be handled. One important aspect of many shareholders agreements is the inclusion of restrictive covenants, which are clauses that limit the actions that shareholders can take.

What are restrictive covenants?

Restrictive covenants are clauses in a shareholders agreement that restrict the actions that a shareholder can take. These clauses might prevent a shareholder from selling their shares without the agreement of the other shareholders, or from starting a competing business. Restrictive covenants can be particularly important in closely held companies, where shareholders may have a significant say in how the company is run.

Why are restrictive covenants important?

There are a number of reasons why companies might choose to include restrictive covenants in their shareholders agreements. Some of the most common reasons include:

1. Protection of company interests: Restrictive covenants can help to protect the interests of the company by preventing shareholders from engaging in activities that could harm the business. For example, a covenant might prevent a shareholder from selling their shares to a competitor who could use that information to gain an advantage over the company.

2. Encouraging long-term commitment: By restricting the ability of shareholders to sell their shares, restrictive covenants can encourage long-term commitment to the company. This can help to ensure that shareholders are invested in the long-term success of the business, rather than simply looking to make a quick profit by selling their shares.

3. Establishing clear expectations: Restrictive covenants can help to establish clear expectations about how shareholders will behave. This can help to prevent disputes or misunderstandings down the line, as all parties are clear about the limitations on their actions.

How can restrictive covenants be enforced?

If a shareholder breaches a restrictive covenant in a shareholders agreement, there are a number of remedies that may be available. These can include:

1. Injunctions: If a shareholder has breached a restrictive covenant, the other shareholders may be able to seek an injunction against them. This would prevent the shareholder from taking the action in question, and would be enforced by the court.

2. Damages: The other shareholders may also be able to seek damages from the breaching shareholder. This could include compensation for any losses suffered as a result of the breach.

3. Termination: In extreme cases, a shareholder who breaches a restrictive covenant may have their shares terminated. This is a serious punishment, and is typically reserved for only the most serious breaches.

In conclusion, restrictive covenants can be an important tool for companies looking to protect their interests and establish clear expectations for their shareholders. They can help to encourage long-term commitment, and can be an effective way of preventing disputes or misunderstandings. However, it`s important for companies to ensure that their restrictive covenants are reasonable and enforceable – if they are too broad or unreasonable, they may not be upheld by the court.