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In a previous article, we discussed how negotiations over control or influence over the affairs of the company may result in special voting thresholds for director or shareholder decisions over certain matters. These are commonly known as “reserved matters”.

In this article, we take a closer look at reserved matters in the context of model shareholders’ agreements published by:

1. the United States based National Venture Capital Association;
2. the British Venture Capital Association;
3. the Australian Private Equity & Venture Capital Association; and
4. the SingaporeVenture Capital Association.

What is a reserved matter list and what is it for?

The reserved matters list is a list of actions which the company and, often, its subsidiaries must not undertake without special approval by a requisite majority or from specific persons, usually at the board or shareholder level.

The reserved matters provision mandates an additional level of approval above that required by general law. It provides a form of control or protection for those with a minority stake who may not otherwise be able to veto or influence decisions on those matters if the approval threshold is only that applicable under general law.

These reserved matters are generally actions outside the company’s ordinary course of business. Finalising the list of reserved matters is always tricky. While it is, at heart, a negotiation on which shareholder or groups of shareholders influence these potential actions of the company and its subsidiaries, there are other important considerations:

• It should not paralyse or unduly delay the day-to-day operations of the company and its subsidiaries;
• It should address precisely the legitimate concerns of minority stakeholders so that the veto afforded is not used for collateral purposes or as a result of technical applications.

What are some common reserved matters?

The list of possible reserved matters may potentially be long. Here are some themes common across all four model shareholders’ agreements:

• amending the constitution of the company;
• varying the rights attached to shares, changing the capital structure of the company or paying dividends or making distributions;
• undertaking winding up or restructuring procedures;
• making material changes to the business;
• buying or selling shares, assets or the business or entering into joint ventures or collaborations;
• borrowing money or guaranteeing the obligations of third parties;
• dealing with intellectual property;
• transacting with related parties such as directors, shareholders and joint venture companies; and
• employing or changing the terms of employment of key executives.

What reserved matters are found in some but not all of the model shareholders’ agreement?

Some reserved matters are only included in some but not all of the model shareholders’ agreements, such as:

• approving or amending the budget or business plan;
• appointing or changing auditors or accounting policies or practices;
• conducting or settling litigation or claims;
• making gifts or charitable donations.

Some are more broadly drafted versions of common reserved matters, encompassing them and likely extending further, such as:

• undertaking anything “outside the ordinary course of business”;
• entering into unusual, onerous, material or long term contracts.

It is also interesting to note that some reserved matters may be fashionable for a period and are likely in response to trends prevailing at the time, such as the reserved matter on initial coin offerings. This may not always be a concern and users of model shareholders’ agreements will want to carefully determine if the list is right for them.

Which reserved matters are generally exercised at the board level or at the shareholder level?

Reserved matters are usually drafted as thresholds to be exercised at the board or shareholder level. This is because decisions of the company are usually made at these fora.

Reserved matters at the board level tend to be for matters which the board would ordinarily be able to decide upon as part of its running of the company. Often, the provision would allow a director representing a minority investor to veto certain key decisions. Drafted in this way, a director exercising the special reserved matter veto may still have to be mindful of their general directors’ duties such as to act in good faith and in the best interests of the company.

Reserved matters which are commonly dealt with at the board level include:

• employing and changing terms of employment;
• granting security interests on the company’s assets; or
• incurring financial indebtedness.

Reserved matters at the shareholder level may be for matters which are usually the province of shareholder approval or, sometimes, for matters which may be decided by the board. Shareholder approval in the Singapore context is usually required for matters which are more fundamental for the company or affect shareholder rights.

Before including a reserved matter at the shareholder level, you may want to consider:

• whether the matter is one on which discretion should be tempered with directors’ duties in mind;
• whether shareholders may be more difficult to track down than directors and decisions may be delayed.

As you can imagine, reserved matters which are more common at the shareholder level include:

• amending the constitution of the company;
• varying the rights attached to shares;
• declaring a dividend; an
• winding up the company or other similar actions.

What are some common limitations or qualifications to these reserved matters?

Limitations or qualifications on reserved matters are usually a matter of negotiation reflecting:

• the level of control or influence which the minority shareholders require for their investment and the majority shareholders require for their contributions;
• a desire to ensure that reserved matters vetoes are not used in a manner that is unintended, for example, as leverage in a situation not within the parties’ original intent; and
• a desire to ensure the business is not paralysed and decisions may be made sensibly for its progress.

Here are some common limitations or qualifications to some reserved matters:

• setting monetary limits before approval is required – for example, only incurring debt above a certain specified threshold requires reserved matter approval;
• use of terms such as “material” or “substantial” – for example, only material contracts or material changes to the business require reserved matter approval; and
• allowing actions within the approved business plan or budget – matters approved in the business plan or budget usually do not have to be approved again as a reserved matter.

Conclusion

You should settle the reserved matters list in your shareholders’ agreement with thought and care. A poorly drafted list can result in either insufficient control or influence for minority investors or hamper the day-to-day operations of the company. In the worst case, a poorly drafted reserved matters list could give a party a veto outside of what was intended and be abused as leverage in certain situations.

Read more on our analysis of model shareholder arrangements published by venture capital associations including on:

• our analysis of the differences in the provisions on board-related rights in shareholders’ agreements – 5 key options for board provisions in a SHA
• our analysis of the differences in the provisions on pre-emptive rights in shareholders’ agreements – 5 key options for pre-emptives on transfers in a SHA
• our analysis of provisions on transfer of shares in shareholders’ agreements – 5 key concepts on transferring shares under a SHA
• our analysis of board and shareholder control provisions in shareholders’ agreements – 3 key control concepts for a SHA
• choosing a template agreement – 6 tips for picking a template agreement
• our thoughts on the Singapore model documents – VC model documents for Singapore
• different options for drag-along provisions – 5 key areas in drag-along provisions in a SHA

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fsLAW is a boutique business law firm group providing legal solutions and advocacy for clients in the Asia Pacific region from Singapore. We provide our services through retainers as well as in the traditional way of an hourly or daily rate or fixed-quote for projects.

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This article is provided for general information purposes only and does not constitute legal or other professional advice. Legal services are only provided to clients under an engagement letter which specifies a practice. Other communications do not give rise to a solicitor-client relationship or constitute the provision of legal services.