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Commercial Contracts

Shareholder Agreements and Director Service Contracts

Relationships between shareholders and directors are central to how a business operates, yet they’re often governed by little more than informal understanding, particularly in the early stages of a company’s life. As a business grows, or as circumstances change, the absence of clear, well-drafted agreements can leave shareholders and directors uncertain of their position and exposed to disputes that could otherwise have been avoided.

What a Well-Drafted Agreement Achieves

A well-drafted shareholder agreement or director service contract does more than record intentions on paper, it gives a framework for how the business is actually run. It sets out how decisions are made and by whom, how disagreements between shareholders are resolved, and what happens if someone wants to leave, is unable to continue, or passes away.

It protects minority shareholders through special mechanisms, while giving all parties clarity around the transfer of shares, valuation, and exit routes. For directors, it defines roles, responsibilities, and remuneration, manages exposure to personal liability, and ensures that restrictive covenants and termination provisions are enforceable rather than merely aspirational.

Taken together, a well-drafted agreement reduces the likelihood of disputes arising in the first place, and where disagreements do occur, gives the parties a clear and pre-agreed route to resolving them without the business being destabilised in the process.

For more information, please read our page on Understanding Shareholder Agreements.

Protecting Minority Shareholders

Minority shareholders can find themselves in a vulnerable position, particularly where a company’s articles of association leave decision-making largely in the hands of majority shareholders. Without specific protections in place, a minority shareholder may have little say over key decisions affecting the business, limited ability to influence the direction of the company, and few options if they wish to exit.

A well-drafted shareholder agreement can address this by giving minority shareholders veto rights over significant decisions, such as issuing new shares, taking on additional debt, or changing the nature of the business, as well as anti-dilution provisions to protect their percentage stake. Tag-along rights can also ensure that if a majority shareholder sells their shares, minority shareholders have the opportunity to sell theirs on the same terms, rather than being left holding a stake in a business under new and potentially unwanted ownership.

Governing the Majority

Just as minority shareholders need protection, majority shareholders benefit from provisions that allow the business to move forward without being held hostage by a small minority stake. Drag-along rights are a key example, allowing majority shareholders who agree to sell the business to compel minority shareholders to sell their shares on the same terms, rather than allowing a single holdout to block a transaction that the majority consider to be in the best interests of the company.

Shareholder agreements can also set out clear thresholds for decision-making, distinguishing between matters that require only a simple majority and those, such as changes to the company’s constitution or the issue of new shares, that require a higher level of approval. Where shareholding is more evenly balanced, agreements should include mechanisms for resolving deadlock, whether through a casting vote, an independent chairperson, or a pre-agreed process such as a buy-sell arrangement, so that disagreement between shareholders does not bring decision-making to a standstill.

What Your Agreement Should Cover

While every shareholder agreement and director service contract should be tailored to the business it relates to, certain issues tend to arise across most companies and are worth considering from the outset. The sections below set out some of these key areas in more detail.

Duties & Responsibilities

A clear definition of the director’s role,  reporting obligations, and day-to-day responsibilities, going beyond the general statutory duties under company law to set out specific operational, financial, or strategic expectations relevant to the business.

Remuneration and Incentives

Salary, bonuses, commission, profit share, pension, private medical cover, and other benefits. For shareholder-directors, remuneration must be structured to align with the shareholder agreement and any investment arrangements in place.

Termination & Garden Leave

Notice periods, typically three to twelve months for senior directors, garden leave provisions preventing a departing director from working elsewhere during their notice period, and good leaver / bad leaver provisions linked to any share incentive arrangements.

Restrictive Covenants

Post-termination restrictions preventing a director from competing, poaching staff or clients, or soliciting the company’s business relationships for a defined period after they leave. Restrictions must be carefully drafted to be enforceable, overly wide covenants may be struck down by the courts.

Confidentiality

Directors have access to highly sensitive business information. Unlike employees, the duty of confidentiality is not necessarily implied by law, it must be expressly set out, along with provisions for the return of company property and devices on termination.

Intellectual Property

Clear provisions addressing ownership of IP created by the director during their appointment, particularly important in technology companies, founder-led businesses, and any company preparing for investment or sale where IP ownership will be scrutinised.

Share Options and Incentives

Where directors receive share options, equity grants, or participate in an EMI or other share incentive scheme, the service agreement must align precisely with those arrangements, including what happens to options on termination.

Conflicts of Interest

Directors owe a statutory duty to avoid conflicts of interest. The agreement should include a clear framework for managing, disclosing, and obtaining approval for any external interests, directorships, or activities that could conflict with their obligations to the company.

Shareholder Agreements and Director Service Contracts

How Shareholder Agreements and Director Service Contracts Work Together

In many businesses, particularly owner-managed companies and SMEs, the shareholders and the directors are the same individuals. In these circumstances, the two documents must be drafted in a coordinated and consistent way to avoid conflicts. 

  • The shareholder agreement may give shareholders the power to appoint and remove directors, the director service contract must reflect the notice requirements that flow from this. 
  • Good leaver / bad leaver provisions in the shareholder agreement must align with the termination provisions in the service agreement to produce a coherent outcome on exit. 
  • Share option arrangements must be reflected consistently in both documents. 
  • Restrictive covenants in the service agreement may need to be mirrored or supplemented by equivalent provisions in the shareholder agreement to be fully effective. 
  • Any reserved matters requiring shareholder consent should be considered alongside the operational authority granted to the director under the service agreement. 
  • Dividend policy in the shareholder agreement may interact with the director’s remuneration structure, particularly where salary and dividends are used in combination. 
  • Where the company has articles of association that have been amended, all three documents must be read together to identify any inconsistencies. 
  • On any future sale or investment, buyers and investors will scrutinise all of these documents, inconsistencies can delay or derail transactions. 

FAQ’s

Yes, but shareholder agreements can generally only be amended with the unanimous consent of all parties, which means every signatory must agree to any change. This is one of the key distinctions between a shareholder agreement and articles of association, which can be amended by a special resolution of 75% of shareholders.  

The requirement for unanimity means that once an agreement is in place, it provides a robust and stable framework that minority shareholders can rely on.

Articles of association are a public document filed at Companies House that set out the basic constitutional rules for running the company. A shareholder agreement is a private contract between shareholders that supplements the articles.  

It can cover matters that articles cannot, including personal obligations, confidentiality, and deadlock provisions, and its terms are confidential. For most businesses, both documents are needed, and they must be consistent with each other.

They can be, but only if they are carefully drafted. The courts will not enforce a restriction that goes further than is reasonably necessary to protect a legitimate business interest. This means restrictions must be proportionate in scope (what activities are prohibited), geography (where the restriction applies), and duration (how long it lasts).  

Blanket or poorly worded restrictions are regularly struck down. It is essential that any restrictive covenants are tailored to the specific role and level of seniority of the director concerned.

Non-executive directors typically do not have service agreements, instead they are usually engaged under a letter of appointment or a contract for services. This reflects the fact that NEDs are generally self-employed and are paid a fee rather than a salary. However, the letter of appointment should still address key matters including time commitment, fees, confidentiality, conflicts of interest, and duration of the appointment.  

We regularly advise on NED appointment terms for both companies and individuals taking on board positions.

This is one of the most common and contentious situations that arises in owner-managed businesses, and one of the strongest reasons for having robust documentation in place from the outset. Without a carefully drafted shareholder agreement and director service contract, a removed director may retain their shares, and the rights that go with them, while having no further involvement in the business.  

The shareholder agreement should include provisions that address this scenario clearly, including compulsory transfer or buyout mechanisms.