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Shareholders’ Agreement: Not Legally Binding However Crucial for UAE Startups

Shareholders’ Agreement: Not Legally Binding However Crucial for UAE Startups


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Under UAE Federal Law No. 5 of 1985 (Civil Code), contracts may either be in written or verbal form and do not need the Shareholders’ Agreement (SHA) mandatorily. However, for the avoidance of any future dispute about the agreed terms and conditions between the parties, proper documentation of an SHA in written form is often recommended for UAE startups.

As the startup population in the UAE continues to grow exponentially, besides having in place their Memorandum of Association (MoA) and Article of Association (AoA), they must strongly consider entering into an SHA at the time of company formation in Dubai UAE.

How SHA differs from AOA and MoA?

The SHA often called a stockholders’ agreement is an arrangement amongst the shareholders that describes how a company is to be operated and outlines shareholders’ rights and obligations. The agreement also documents the information about the management of the company including all protections and privileges of the shareholders.

Unlike the MoA and AoA define the fundamental objectives, rights and responsibilities of directors and shareholders of the company, the SHA keeps the focus solely on the protection of shareholders’ rights and fair treatment.

What makes SHA crucial?

The SHA is not for public record and is privately agreed upon amongst the shareholders. Following are some reasons which make the SHA crucial

Crisis Prevention
The SHA offers crisis prevention under certain circumstances and helps mitigate potential disputes through appropriate SHA frameworks that provide solutions for the effective handling of future disputes. SHA can be used for contingency planning and risk mitigation as and when necessary.

The unanimity of Purpose and Responsibilities
The SHA helps in bringing unanimity of purpose and responsibilities and creating a mission statement for the business enterprise. It arouses positive feelings and mindsets, provides a basis for strategies for attaining the defined objectives and resolves divergent views amongst the shareholders.

Protection of Interests
As a startup grows and expands, the ownership and management of the company may also change because of the takeover. The SHA can help protect shareholders’ interests by provisioning takeovers, M&As etc. and mitigating future risks and conflicts if any.

Facilitates Share Transfer
SHA documents the ownership of shares which is the single most vital element of a business. As all the terms and conditions of future issuance of shares, caps on % shareholding, share transfers, and mandatory shareholders’ voting on such matters are all documented in the SHA, it facilitates the share transfer process without creating conflicts amongst the shareholders safeguarding founders from losing control over their company. Both majority and minority shareholders’ interests are addressed in the SHA with provisions of their rights and obligations.

Resolves Disputes
A dispute resolution framework, once properly and correctly documented can offer the greatest advantage to all the shareholders as it can help resolve disputes between them amicably thus ensuring the highest level of business effectiveness of a company.

What key clauses UAE startups must include in the SHA?

A properly documented SHA must include the following key clauses.

Applicability and Purpose
This clause defines the applicability of SHA and outlines the objectives and purpose of this document as the scope. This needs to be reviewed and revised periodically as the company grows and expands.

Management and Operations
Appointment and removal of directors including other key top-level managerial positions e.g. Chairman, Managing Director etc. are addressed in this clause.

Exit Clause
This clause outlines conditions under which a founder shareholder can opt for a buyout and exit the company.

Capital Contribution
Capital contribution by individual founders is addressed in this clause along with their obligations. Shareholding %age is normally decided in proportion to this contribution.

Profit Sharing
This clause outlines the profit distribution policy of the company detailing how the PAT or net profit is going to be shared amongst shareholders.

Transfer of Shares
This clause safeguards the company’s control by restricting the transfer of shares to unwanted third parties.

Critical Decisions
This clause defines the role of investors and lists critical events and circumstances requiring only important members and not dormant investors. The manner of participation is also addressed in this clause.

Pre-Emptive Rights
This clause needs the company to offer the new shares to the existing shareholders first and in the proportion of current shareholding.

Anti-dilution Clause
This clause provides existing investors with the right to maintain their %age of shareholding by purchasing a proportionate number of new shares when new shares are issued in future.

Deadlock Resolution
This clause documents procedural steps in the event of any deadlock situation concerning an agreement over any decision-making in the company and steers it to an amicable resolution.

Dispute Resolution
It is the last option available to the shareholders however often preferred over the deadlock resolution that affects the company more adversely. This clause documents the procedure to be followed to resolve any dispute that may ensue between shareholders.

The Takeaway

A company locked in internal conflicts becomes unproductive and is destined to fail. This is why even though not legally binding, the SHA is receiving increased attention from the new generation of entrepreneurs.

Startups in UAE are increasingly aware of the intrinsic value of this document providing clarity on the rights, liabilities and responsibilities of the shareholders to mitigate the risk of any potential disputes that may arise from time to time and can jeopardize the future of the company.

The essence of SHA lies in its flexibility as this document can be tailored to meet the requirements of unique and specific circumstances of individual startups. SHA essentially documents the relationships of shareholders and the company sets out the rights and privileges of shareholders and builds the foundation of how the company is incorporated and managed.

As the AoA document is legally binding, it is always held in preference and always supersedes the SHA. Hence while drafting the SHA, startups must be mindful and ensure that SHA is in perfect alignment with the AoA document and all its terms and conditions leaving no dispute over any conflicting points or clauses in the two documents.

The professional team of a reputed business consultants firm can advise and assist prospective startups, willing to a business set up in Dubai UAE on the key provisions to be included in a shareholders’ agreement on all the legal, financial and operational matters.

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