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Competing contracts?

Feature Articles

Cite as: December 2011 85(12) LIJ, p.50

The issue of whether a shareholder agreement can take precedence over a company's constitution has implications for lenders with security interests over shares. 

By Michael Duffy

Lawyers are increasingly being asked to draft shareholder agreements for their small business clients. Such agreements have developed as a means of governing relationships between shareholders in joint venture and other arrangements and in closely held proprietary and family companies.1 They tend to deal with succession issues, special rights of founding shareholders, pre-emption rights on disposal of shares, arbitration of disputes and other matters that might not normally be expected to appear in the company’s constitution.2

One purpose for which shareholder agreements have been popularised by commercial lawyers has been as a means of avoiding litigation, and in this regard they appear to have had some success. Yet, commercial relationships being as potentially fraught as other human relationships (family law comes to mind), they have also begun to appear with more frequency in the courts and have therefore become of interest to litigation lawyers.

Shareholder agreements also raise some interesting conceptual questions, not the least of which has been the relationship between the shareholder agreement and the company constitution (which pursuant to s140 of the Corporations Act 2001 (Cth) has the status of a statutory contract between shareholders), and this has also led to academic interest. In that regard, the courts appear to be adopting views that respect the company constitution yet go some way towards accommodating and giving effect to the shareholder agreement.


Its statutory basis may suggest that the constitution or statutory contract should prevail over a shareholder agreement to the extent there is a conflict. This is based on the simple proposition that the legislature is supreme and can override contract and common law so long as it does so expressly and within its constitutional powers. It is also based on the related proposition that a company is a legal person with a statutory right to change its constitution, and that seeking to override this contractually may be problematic.3

On the other hand, the unanimous nature of a shareholder agreement may seem to give it a moral force or authority that the majoritarian status of the company constitution (which can be adopted or amended by 75 per cent of votes cast)4 may seem to lack. Advocates of shareholder agreements have been known to criticise company constitutions as entrenching this “tyranny of the majority”.5

Shareholder agreements, by contrast, require unanimity – which can be protective of minority rights, though potentially inefficient for decision making where unanimity cannot be achieved.

Bailey’s case6 is the High Court’s main foray into the area, and in that decision a shareholder agreement was triumphant over the company’s constitution. The High Court allowed for the possibility that a shareholders’ contract might be changed by changes to the constitution (if the parties intended that this would be the case),7 but found in the case before it that an implied contract between the shareholders and the company had not been changed by changes to the constitution.

The facts of the case were that Bailey was a doctor and member of the NSW Medical Defence Union. He was entitled by his membership to indemnity from the union for medical negligence. In 1977 there was an alteration to members’ rights in the articles to give discretion to the union to refuse indemnity to former members or deceased members. In 1980 Crawford sued Bailey for medical negligence. Bailey died in 1985 and his estate sought indemnity from the union. The union relied on the change of its articles to refuse indemnity. The High Court granted indemnity based on an implied agreement between members and the company that had survived the alteration to the articles.

The decision is perhaps exceptional in allowing a shareholder contract to be implied and to then override the express statutory shareholder contract, and its rationale has been debated.8 The rationale may be simply that the justice of the case warranted it, though it has also been suggested that the case shows some judicial concern about majoritarian alterations of the statutory contract that alter the status quo.9

Secrecy and notice to third parties

One notable feature of shareholder agreements that differentiates them from company constitutions is their potential for secrecy. While the constitution must be filed with ASIC10 and becomes, in that sense, a public document, the shareholder agreement is a private document which need not be filed.

The distinction may be somewhat academic in many cases, since the shareholders will all have notice of its contents by being parties to it. Yet problematic situations may arise – not so much in relation to shareholder notice (except in the rare cases where a shareholder for some reason is not a party to the shareholder agreement), but in relation to third party notice. While third parties (including creditors, employees, customers and other stakeholders) may have theoretical access to the company constitution,11 they will usually not have access to the shareholder agreement. This may become significant where the shareholder agreement is different from the constitution, and particularly where the shareholder agreement may have effects on the rights of third parties. This is what occurred in the 2010 South Australian Supreme Court decision of Elders Forestry Ltd v BOSI Security Services Ltd & Ors (BOSI).12

BOSI involved complex facts, in which a term of the company constitution provided that if there was inconsistency between the company constitution and the shareholder agreement then the shareholder agreement would prevail. Kourakis J noted that a wide construction of that provision would infringe s136(2) of the Corporations Act, which provides that a company may modify or repeal its constitution by a special resolution. He noted that a wide construction would allow the constitution to be modified, not by special resolution but by amendment of the shareholders’ deed (at [76]).

Though Kourakis J accepted that the terms of a constitution may be expressed by reference to an external document, it was not permissible to give that reference an ambulatory operation (i.e. a power to alter) if its effect was to modify the constitution by an unconstitutional process. He suggested that a change to the shareholders’ deed may effectively alter the rights and obligations of the company and its members even though the constitution was not changed (at [77]). This practical effect would last as long as there was “an identity between the members of the company and the parties to the shareholders’ deed”, but he stated this would not be the case if there was a shareholder/member who was not a party to the shareholders’ deed. In that situation, his Honour said, the deed could not bind such a person (at [78]).13

In the case before him there were no shareholders who were not party to the shareholder agreement. It is not stated, but seems to be implicit in the judgment, that a unanimous change to the shareholder agreement was not seen as altering rights by an unconstitutional process.

In relation to shareholders versus creditors, Kourakis J took a generous view of shareholder rights created by a constitution or shareholder agreement (in that case pre-emptive rights of a member to purchase another member’s shares) versus the rights of a subsequent chargee creditor of those same shares. He appeared to do this not so much by reference to principles of notice (a constitution filed with the regulator has some basis for imputing notice to third parties whereas a shareholder agreement, in the absence of actual notice, probably does not)14 but by reference to the constitution/statutory contract defining the nature of the property (the shares) and the rights inherent in that property (at [108]).

The terms of the shareholder agreement giving pre-emption rights thus became an incident of ownership of the shares (and therefore a proprietary right). In this regard he followed Whelan J in Rathner v Lindholm,15 but went further and applied this precedent not just to a company constitution but also to a shareholder agreement (at [129]). He did this because he did not wish to deny the shareholder agreement the same legal effect as was given to the constitution under s140 in circumstances where all shareholders and the company were party to the shareholder agreement.

The decision also suggested that the burden of such provisions on one shareholder (and the incidental benefit to another shareholder) may also be binding on a subsequent chargee of the shares, as the subsequent chargee takes the shares subject to those burdens (at [127]). Kourakis J’s decision also appeared to rely on the characterisation of the interest of the subsequent registered chargee as equitable rather than legal (and therefore not subject to indefeasibility). This was so notwithstanding that the charge gave a right to become a registered proprietor of the shares on registration of share transfers.


There appears to be a trend by courts to seek to give effect to shareholder agreements. As contracts that tend to be made between sophisticated investors, they fit into the area of commercial contracts, which the courts have tended to uphold, rather than the area of “consumer protection”, which sometimes characterises the approach to retail investors in public companies.

There is also a willingness to give shareholder agreements at least equal standing with the constitution/statutory contract, notwithstanding the latter’s statutory fortification. The decision in BOSI may also be of considerable additional interest to lenders due to its attachment of rights and duties under a shareholder agreement as incidents of ownership of the shares. The decision went in favour of the shareholder with pre-emptive rights to the shares under the shareholder agreement and against the chargee of the shares. This appears to have implications for lenders with security interests over shares as it may affect the nature and quality of that security.

Michael Duffy lectures in corporations law and trusts in the Department of Business Law and Taxation at Monash University.

1. Shareholder agreements have no real role in listed public companies, as constantly changing ownership makes such an agreement problematic (and usually a practical impossibility).

2. See Paul Faure, “Drafting shareholder agreements”, paper presented at Legalwise seminar “Essential Elements for Effective Shareholder Agreements”, Melbourne, 10 September 2010.

3. See Russell v Northern Bank Development Corporation Ltd [1992] 3 All ER 161.

4. Sections 136(2) and 9 Corporations Act 2001 (Cth).

5. A Elson, “Shareholder agreements: a shield for minority shareholders of close corporations” (1967) 22 Business Lawyer 449.

6. Bailey (as executrix of the estate of the late Dr Harry R Bailey) v New South Wales Medical Defence Union Ltd; New South Wales Medical Defence Union Ltd v Crawford (1995) 18 ACSR 521.

7. Bailey, note 6 above, at [14].

8. See M Whincop, “A relational and doctrinal critique of shareholders’ special contracts” [1997] 19(3) Sydney Law Review 314.

9. Whincop, note 8 above. The judicial suspicion of majoritarian alterations to the statutory contract is also demonstrated in the seminal High Court case of Gambotto & Anor v WCP Limited & Anor (1995) 182 CLR 432, where constitutional alterations to allow compulsory acquisition of shares were tempered by the Court with requirements that the acquisitions were for a proper purpose and also fair in all the circumstances.

10. Section 136(5) Corporations Act 2001 (Cth).

11. Whether any of these parties would actually look at the constitution is another matter. Nevertheless, the law traditionally gives credence to various forms of notice (such as the law notices of newspapers) as a form of procedural fairness, and clearly places considerable focus on public registration of mortgages, charges and other instruments. On the other hand, the abolition of the ultra vires doctrine in relation to corporations may be partly due to an acceptance by the legislator that third parties did not read objects clauses of corporations before entering into contracts with them.

12. [2010] SASC 223.

13. Though in the result the shareholders’ deed did affect the rights of a non party.

14. The question of notice is somewhat blurred on the facts as set out in the case report. It appears to be confused by the fact that there were at least two charges/mortgages held at different times by the mortgagee/chargee that appear to have covered essentially the same property.

15. [2005] VSC 399; (2005) 194 FLR 291.


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