Good Leaver/Bad Leaver – Get Me Out of Here

You are a director or employee who owns shares in the company you work for but what happens to those shares when you leave?  You could be in for a nasty surprise if you don’t understand the rules that apply in those circumstances – what you think is a valuable asset may turn out to be worth very little or be very hard to turn into cash.

Sometimes there are no specific provisions in place meaning you will be allowed to retain your shares but more often than not there are compulsory transfer provisions that will require you to offer your shares for sale when you leave.  Often these provide that if you qualify as a “Good Leaver” (leaving due to retirement, death, ill-health etc.), you must offer your shares for sale at an agreed fair value and if you are a “Bad Leaver” (resignation, dismissal etc.), you must offer your shares for sale at the price you paid for them.

Good Leaver/Bad Leaver provisions like these are common and are often quite complex but when the time comes to use them, what works in theory often doesn’t work so well in practice.  As we recover from the pandemic this issue is coming into sharp focus for many companies who are unexpectedly finding more shareholders falling into the Good Leaver category.

Offering to sell your shares is one thing but finding someone to buy them can be more difficult.  The articles of association of the Company will usually provide that when you leave your shares have to be offered to the other shareholders of the Company and/or to the Company itself.  In theory this is a good solution but in practice it can be difficult to implement.  For the company to buy back the shares it needs to go through a statutory procedure and it will need to have distributable reserves (a technical accounting term) in its latest accounts to allow it to do that.  Often this isn’t realistic for early stage companies as they don’t have any such reserves in place.  For the other shareholders to buy the shares they will need access to funds – not a big issue if you are a Bad Leaver as the sums involved are small but it can be problematic if you are a Good Leaver and a significant payment needs to be made by the shareholders.  It is important to remember that while compulsory transfer provisions oblige you to offer your shares for sale they don’t actually force anyone else to buy them.

So if your shares are not bought by the other shareholders or the company after your offer to sell has been made, what happens next?  Are you stuck with your shares with no way of getting rid of them?  The articles may allow you to sell the shares to a third party at the same price they have been offered to existing shareholders within say three or six months, however selling a minority stake in a private company is difficult and finding a buyer is likely to be a challenge.  On the plus side if you retain the shares, you would still remain entitled to receive dividends if any are payable and to get a share of the sale proceeds if the Company was sold.

If you did want to sever all ties with the Company but no one will buy your shares, you could gift your shares back to the Company.  To do that the shares have to be fully paid up and there would need to be a letter from you to the Company setting out details of the gift along with a stock transfer form.  The Company then becomes the owner of the shares once the transfer is entered into its statutory books. 

The gifted shares continue to exist and to have voting and dividend rights.  The Company can then gift or sell the shares to another party or carry out a reduction of capital in accordance with the statutory procedures in order to cancel the gifted shares.  Depending on the value of the gifted shares there may be tax implications for both the gifting shareholder and the Company so where there is any significant value then tax advice should be taken before any gift is made.

Good Leaver/Bad Leaver provisions are very common but while they are great in theory, in reality they are not always very helpful either for the leaver or for the Company, which can find itself stuck with a reluctant shareholder because no funds are available to buy them out.

If you are leaving a company and need advice on what happens to your shares, please contact a member of our Corporate Team.

Disclaimer 
The matter in this publication is based on our current understanding of the law.  The information provides only an overview of the law in force at the date hereof and has been produced for general information purposes only. Professional advice should always be sought before taking any action in reliance of the information. Accordingly, Davidson Chalmers Stewart LLP does not take any responsibility for losses incurred by any person through acting or failing to act on the basis of anything contained in this publication.