Good Leaver / Bad Leaver Provisions in Shareholders Agreements: Ensuring Fairness and Clarity

Good Leaver / Bad Leaver Provisions in Shareholders Agreements: Ensuring Fairness and Clarity

 

One of the most overlooked yet critical aspects of a shareholders agreement is the inclusion of Good Leaver / Bad Leaver provisions . These clauses address what happens when a shareholder leaves the company—whether in good terms or in bad terms —and how their shares should be handled. Without clear guidelines, disputes can arise over the valuation of shares, the terms of buyback, and the fairness of the process. This article delves into why these provisions are essential, how they work, and what to include in your shareholders agreement to ensure smooth transitions.

Why Good Leaver / Bad Leaver Provisions Are Important

Shareholders often play multiple roles in a company—they may be investors, employees, or even founders. When a shareholder leaves the company, their departure can have significant implications for the business, including:

1. Ownership Dilution : If a departing shareholder retains their shares, it could lead to ownership dilution or misalignment with the company’s goals.
2. Unintended Beneficiaries : Without clear rules, shares could pass to unintended beneficiaries (e.g., family members) who may not share the same vision for the company.
3. Valuation Disputes : Determining the value of shares upon departure can become contentious, especially if there’s no pre-agreed mechanism in place.
4. Operational Disruption : A poorly managed exit can disrupt the company’s operations, create uncertainty among remaining shareholders, and in a lot of SME companies, closing down of the company.

Good Leaver / Bad Leaver provisions provide a structured framework for handling these scenarios, ensuring that the company and its remaining shareholders are protected while treating departing shareholders fairly.

What Are Good Leaver / Bad Leaver Provisions?

These provisions classify departing shareholders into two categories based on the circumstances of their departure:

1. Good Leaver

A “Good Leaver” is a shareholder who departs under circumstances deemed acceptable or beyond their control. Examples include:

• Retirement
• Death or permanent disability
• Mutual agreement between the shareholder and the company

In such cases, the departing shareholder is typically treated favorably. Their shares are usually bought back by the company or other shareholders at fair market value or a predetermined price.

2. Bad Leaver

A “Bad Leaver” is a shareholder who departs under unfavorable or voluntary circumstances. Examples include:

• Termination for cause (e.g., misconduct, breach of shareholders agreement, competing with business of the company)
• Breach of non-compete or confidentiality obligations

In these cases, the departing shareholder is often penalized. Their shares may be bought back at a discounted price (e.g., cost price, nominal value, or a percentage of fair market value) or forfeited entirely.

Key Components of Good Leaver / Bad Leaver Provisions

To ensure clarity and enforceability, Good Leaver / Bad Leaver provisions should address the following elements:

1. Definition of “Good Leaver” and “Bad Leaver”

Clearly define the circumstances that qualify as a Good Leaver or Bad Leaver. Ambiguity in these definitions can lead to disputes, so specificity is crucial. For example:

• Good Leaver : “A shareholder who ceases to be employed by the company due to death, permanent disability, or redundancy.”
• Bad Leaver : “A shareholder who is terminated for cause, including but not limited to gross misconduct, fraud, or breach of confidentiality.”

2. Valuation Mechanism

Specify how the value of shares will be determined for both Good Leavers and Bad Leavers. Common approaches include:

• Fair Market Value : The shares are valued based on an independent appraisal or a pre-agreed formula (e.g., earnings multiples).
• Discounted Value : Bad Leavers may receive a reduced price, such as 50% of fair market value or the original purchase price.
• Nominal Value : In extreme cases, Bad Leavers may receive only the nominal value of their shares (e.g., RM1.00 per share).

3. Buyback Process

Outline the process for buying back shares from departing shareholders, including:

• Who has the right to purchase the shares (e.g., the company, existing shareholders, or a combination).
• The timeline for completing the buyback (e.g., within 30 or 60 days of departure).
• Payment terms (e.g., lump sum or installment payments).

Benefits of Including Good Leaver / Bad Leaver Provisions

1. Protects the Company’s Interests : By ensuring that shares are not transferred to undesirable parties, these provisions help maintain alignment with the company’s goals.
2. Provides Certainty : Shareholders know upfront how their shares will be treated upon departure, reducing the risk of disputes.
3. Encourages Long-Term Commitment : Bad Leaver penalties discourage shareholders from leaving prematurely or engaging in harmful behavior.
4. Facilitates Smooth Transitions : A clear process for handling share buybacks ensures minimal disruption to the company’s operations.

Conclusion

Good Leaver / Bad Leaver provisions are a vital component of any shareholders agreement, providing clarity and fairness in situations where a shareholder departs. By clearly defining the circumstances of departure, the valuation of shares, and the buyback process, these provisions help protect the company’s interests, encourage long-term commitment, and minimize disputes.

When drafting these clauses, it’s essential to seek legal advice to ensure they are tailored to your company’s specific needs and compliant with applicable laws. With well-crafted Good Leaver / Bad Leaver provisions in place, you can ensure that transitions are handled smoothly, allowing the company to focus on growth and success.