When setting up a company, the founding shareholders (the “founders”) often ignore the conclusion of a founders’ agreement (the “FA”), or if any, the terms and clauses thereof will be merely simple. This may not cover the resolution of disputes arising under circumstances where the company has experienced a certain period of operation, achieved its prosperity, added new shareholders, or come up with its dissolution. So, which issues will the founders need to clarify in the FA for the limitation of dispensable disputes?
Under a practical view and some regulations of Vietnam’s prevailing laws, BLawyers Vietnam would like to point out 07 issues that the parties in a FA should prescribe strictly and tightly to minimize legal risks arising in the future.
1. Complying with provisions of the contract law
The FA is deemed to become a primary source of references for resolving the relevant conflicts or disputes raised eventually. Thus, the parties need to ensure the legal effect of the agreement herein shall be recognized and protected by law. For this purpose, the establishment of the FA shall comply with the provisions of civil law regarding contracts. Especially, the contents agreed by the parties shall not contradict the law in general and the law on enterprises in particular.
2. Ensuring the consistency between the FA and other legal documents of the company
In fact, there often occur circumstances where the FA may conflict with such legal documents of the company as the charter, resolutions/ decisions adopted at the meetings of the executive boards, or the shareholder councils when these instruments stipulate the same issue. That may challenge the legal effect of the FA when the dispute settlement body needs to decide on an applicable basis to handle the dispute between the parties. In the context where the law does not clearly prescribe the hierarchy of legal effects among these documents, the founders should be more careful in preparing, drafting, and adopting legal documents of the company. In addition, during the operation of the company, the founders need to conduct regular revisions on the contents of the company’s legal documents to ensure their consistency and correspondence with the principles set forth by the FA and the prevailing provisions of law.
3. Ensuring the priority of the founders when the company increases its capital or one founder transfers his/her contributed shares
In practice, the mechanism of transferring shares in the FA usually stipulates some special clauses which purport to protect the positions of the founders against third parties. They may include the following clauses:
- Pre-emption/ pre-emptive right: This clause enables the founders to be prioritized in purchasing the contributed shares of another founder that is intended to be transferred to a third party, or to be prioritized in registering to purchase the shares of additional capital contributions from the company or other transferable securities that the company may issue in the future.
- First-refusal right: Along with pre-emption/ pre-emptive right, this clause enables the founders to consider opportunities or risks arising in business operation prior to deciding whether to execute their priority to purchase the contributed shares of another founder that is intended to be transferred, or when the company increases its charter capital, or the company issues transferable securities in the future. Based on the clause herein, the founders can consider engaging at a specific time in the future, rather than immediately investing and giving commitments to receive the transfer of shares or purchase the capital contribution.
In addition, please note that the FA may provide details of the mechanism of transferring shares, however, it shall still adhere to the relevant principles as prescribed by law. For instance, the prevailing Law on Enterprises has requested that regarding a company limited with two or more members, the offering of transferring contributed shares from one shareholder to the others shall comply with the corresponding ratio of each remaining shareholder in the company and under the same offering conditions. Moreover, the shareholder transferring his/her/its contributed shares shall also give the transferring offer to the existing shareholders in the company prior to sending it out to any third parties and shall transfer his/her/its shares to third parties only under the same offering conditions set forth for the existing shareholders in the company. Regarding a joint stock company, the founding shareholders who own voting preference shares shall not transfer such preference shares to other parties except for certain cases as prescribed by law.
4. The regime for one founder to withdraw his/her shares
During the cooperation, there may exist reasons for which one founder can choose to terminate cooperation with the company or other founders. To guarantee the interests of each party, the FA can specify a mechanism of share withdrawal that corresponds to the attributes of the project and the business lines of the company. Some of the following clauses can be used when building the share withdrawal mechanism for the founders:
- Redemption right: This clause allows the founders to request the company to purchase his/her/its contributed shares. This request may be under the status of forcing the company to purchase or putting it at the discretion of the company. The FA can extend the range of circumstances under which the shareholders are entitled to request the company purchase his/her/its contributed shares, in addition to the circumstances as prescribed by the law on enterprises.
- Call option: This clause allows one founder to request another founder to transfer his/her/its contributed shares under certain circumstances. For instance, when one founder decides to leave the project, the existing founders will request such founder to transfer all his/her/its contributed shares to them.
- Put option: This clause allows one founder participating in the FA to request the other founders to purchase his/her/its contributed shares under certain circumstances, especially when there is one founder violating the commitments and obligations as stated in the FA, or simply because of the failure to achieve the objectives and principles of cooperation for investment set forth in the FA.
- Drag-along right: This clause allows one founder to request the others to participate in the process of transferring his/her/its contributed shares to the third party. In this case, such founder has the right to request the other founders to transfer (partially or entirely) their contributed shares to the third party on the same conditions and terms under which the founder above has transferred its contributed shares. This clause is often proposed by the founder that is a majority founder and aims at forcing minority founders to accept his/her/its transferring the contributed shares to the third party.
- Tag-along right: This clause allows the remaining founders to participate in the transferring of shares conducted by another founder who intends to offer to transfer his/her/its shares to a third party. This clause is often used to protect the minority founders from the sudden share withdrawal out of the company made by the majority founders.
Of note, the establishment of the share withdrawal mechanism above also needs to ensure compliance with the general requirements of the Law on Enterprises regarding the time limit, the method of notification, and the offering conditions for shareholders to request the company or other shareholders to purchase his/her/its contributed shares.
5. Intellectual property ownership
Regarding the clause of intellectual property rights, the parties in the FA shall specify the scope and time limitation of the intellectual properties (the “IPs”) to be used for the cooperation project of the parties. As the tendency of startups is growing, this type of clause is getting more awareness and concentration from the parties in the FAs. Startups in the project always strive to protect their ownership of the IPs of which they are the author or the owner. Meanwhile, investors financially contributing to the project become especially concerned about whether the startups are able to guarantee the ownership of the IPs against third parties and about the exclusivity and competitive advantage of the IPs over their like products and services in the market. Regarding the IPs formed during the implementation of the project, the parties should agree on the disposal of those IPs when the project completes in the future or when one of the parties chooses to terminate cooperation before the expiry date of the project.
6. Non-compete clauses
Regarding the non-compete clause (the “NCC”), the parties in the FA may provide the times and methods for each of the parties not to conduct the activities as/of a competitor against the objective company. The parties should be aware of the clear provision of the scope and time limit of the competition restrictions laid down in the FA. In addition, agreements and commitments prescribed under the NCC in the FA need to comply with the regulations of the competition law to avoid the risk of violations.
7. Clauses for the settlement of conflicts and disputes
It is necessary for the parties in the SA to stipulate the mechanism for settling conflicts and disputes arising from the agreements under the FA. Currently, there have been various mechanisms to resolve disputes arising from the FAs, including alternative dispute resolution (“ADR”) mechanisms such as mediation, arbitration, neutral evaluation, settlement conferences…, or even court trials. The parties in the FAs often prefer ADR mechanisms for their confidentiality. On the other hand, in practice, the parties in the FAs can also expand the range of circumstances where one founder has the right to request the company to purchase his/her/its contributed shares if that founder could not continue to cooperate with the company. This can help conflicts between the founders be promptly resolved before they escalate into disputes requiring the involvement of third parties.
Above are 07 primary issues that the founders of the company should take note of when concluding the FA. A carefully and properly drafted FA could help to balance the rights and obligations among the founders, which will eventually contribute to improving the effectiveness of the operation and administration of the objective company.
Date: 08 September 2022
Writer: My Trang
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