So which mistakes do SHAs most often contain?
Term sheet
The term "term sheet" most often denotes a legally non-binding document that is to set out the agreement of the future parties to the SHA on the essential elements of the SHA. It is not, however, mandatory for the conclusion of every SHA to be preceded by the conclusion of a term sheet. In many cases it is far more efficient to devote time to preparing the SHA rather than to drafting a flawless term sheet, which ultimately does not even guarantee that the SHA will in fact be concluded in the future.
Absence of essential provisions
Where too simple an SHA is used, it may fail to take account of all the members' needs, or the SHA may fail to allow for all the eventualities that may arise. It is not easy to determine which provisions of an SHA are essential, or which provisions every SHA must contain. It is always necessary to draft the SHA in relation to the client's specific case, or in relation to their individual needs or the needs of their company.
From practice, however, it can be said that where an investor enters a company and there is the related need to conclude an SHA, it is essential that a proper SHA contain provisions governing a right of first refusal, tag-along, or drag-along, provisions concerning the manner and mechanism for selecting the statutory and supervisory bodies, and the voting rules at the company's general meeting. In some cases it may also happen that the SHA also contains an investment agreement, that is, an agreement by which the investor undertakes to provide the company with an investment (whether in monetary or non-monetary form). In this case, it will be necessary to take this aspect into account within the SHA and to ensure that the SHA also contains the details of the provision of the investment, the deadline for providing it, the manner of providing it, and the consequences of the investor's failure to provide the investment.
Binding nature of the SHA
When concluding an SHA, it is also necessary to bear in mind that the circumstances existing at the time of its conclusion may change over time. The investor or any of the members may decide to leave the company and sell their ownership interest. Every SHA should therefore address the situation of a member leaving the company, which is also linked to the arrival of a new member as the acquirer of the ownership interest. The parties to the SHA should be obliged to ensure that the SHA is also binding on the acquirer of the departing member's ownership interest. Otherwise the SHA should terminate, since without all the company's members being bound by it, it may lose its purpose.
Definitions
It might seem that definitions are an unimportant part of an SHA. This is not always so. For example, a definition of a "Material breach of the SHA" should never be missing from the definitions. With the correct application of this definition in the context of regulating a member's departure as a Bad Leaver, that member can be protected from adverse consequences.
Example:
"The parties to the SHA have agreed that any breach of this SHA by any member of the Company means that the member of the Company is deemed to be a member departing in breach (Bad Leaver)."
The above example represents an inappropriate way of formulating a provision of an SHA. By using a simple definition of a "Material breach of the SHA", it is possible to change the meaning as well as the consequences of the above provision.
Example:
"The parties to the SHA have agreed that a Material breach of this SHA by any member of the Company means that the member of the Company is deemed to be a member departing in breach (Bad Leaver)."
This is not solely a matter of the definition of a material breach. If a member is to be protected, the SHA must be unambiguous, definite and precisely formulated.
Ambiguity and vagueness
Example:
"Member 2 undertakes to provide the company with an investment of EUR 100,000 in the form of assuming the obligation of Member 3 to pay up a contribution to the Company's capital fund."
If you did not find any problem in the above provision, look more closely. By when is Member 3 to provide the investment? When will the general meeting be held to decide on approving the assumption of Member 3's obligation to pay up the contribution to the Company's capital fund? What happens if Member 3 does not provide the investment to the Company? From such a vaguely formulated provision it is not possible to answer a single one of the questions posed.
Non-competition clause
Where legal entities conclude the SHA as members, care must be taken that the non-competition clause does not bind the natural persons standing behind the legal entities as members. These natural persons need not, after all, be a party to the SHA.
The same principle applies to other provisions as well, not only the non-competition clause. It is not possible to impose obligations in the SHA directly on managing directors where they are not a party to the SHA.
Inheritance of the ownership interest
Another case of SHA shortcomings from practice is the exclusion of the inheritance of the ownership interest in the event of a member's death. Excluding the inheritance of the ownership interest is of course possible, but not where the company's members, as well as the parties to the SHA, are legal entities.
Time of concluding the SHA
When concluding an SHA, it is necessary to take the current situation into account, in particular in order to correctly identify the parties to the SHA. An SHA may be concluded by the members of an already existing company or by the future members of a company that has not yet come into existence. It is very important to take this fact into account, because where the party to the SHA is also a company on which the SHA imposes certain obligations, it must be an existing entity. Obligations cannot be imposed on a company that has not in fact yet come into existence at all.
Termination of the SHA
An SHA, like any other contract, may terminate. It does not matter whether this occurred on the basis of an agreement of the members or by the lapse of time, where it was an SHA concluded for a fixed term (this, however, does not happen often). On the termination of an SHA, it is nevertheless necessary to ensure that certain rights and obligations continue even after its termination. As a rule, these are rights and obligations whose nature permits it, such as the duty of confidentiality, claims for damages, or claims for the payment of contractual penalties.
Transfer of the rights and obligations under the SHA to a third party
We recommend excluding the possibility for members to transfer their rights and obligations under the SHA to a third party. The purpose of an SHA is to bind the company's members, not to have the company's members transfer their rights and obligations to any third party. In the event of a change of members, the new member will be bound by the provisions of the SHA on the basis of accession to the SHA, or on the basis of concluding a new SHA.
If you are a member of a company and have signed an SHA, we recommend that you check whether it contains any of the shortcomings mentioned above. If it does contain such shortcomings, it is appropriate to raise with the other members the topic of amending the SHA under the supervision of an experienced lawyer with experience in the field.