A deemed offer clause is one of the important clauses that are commonly included in a company’s memorandum of incorporation (“MOI”) or shareholders agreement. It records various trigger events which, once one occurs, automatically deem the shareholder to which it has occurred to have offered all of its shares in the company for sale to the remaining shareholders. That offering shareholder has no say in the offer to sell its shares. The offer arises automatically, and the terms regarding the price for which the shares are sold, the timing around the payment of that price and the transfer of ownership of those shares, are all detailed in the clause.
Some of the more common trigger events that are recorded in the deemed offer clause relate to when a shareholder commits a material breach of the MOI or shareholders agreement, when a shareholder goes insolvent when a natural person shareholder dies or becomes incapacitated, when a natural person shareholder’s employment agreement with the company is terminated for any reason, and when the ultimate control of a juristic entity shareholder changes.
In this article, we focus on that last-mentioned trigger event relating to when the ultimate control of a juristic entity shareholder changes. This trigger event will arise when, for example, the identity of the majority shareholder changes in a shareholder that is a company, the identity of the majority member changes in a shareholder that is a close corporation, or the beneficiaries change in a shareholder that is a trust.
We recently saw the impact of not including this change of control trigger event in a deemed offer clause. One of our clients was able to utilise this fact to its advantage. This client (“the Client”) was a company itself and owned a large percentage of the issued shares in another company (“Company A”). Company A’s MOI did not include a change of control trigger event (we were not involved in drafting it!). If the Client wanted to sell its shares in Company A, it would first have to offer them to the remaining shareholders of Company A due to the pre-emptive rights clause that was included in Company A’s MOI, plus, if was then able to offer its shares to sale to an outside purchaser, it would need the approval for the sale from the board of directors of Company A. For various reasons it did not wish to offer its shares to the remaining shareholders, and it was not sure it would get the board’s approval for a sale an outside purchaser either.
Due to there being no change of control trigger event, the Client’s own shareholders were able to sell their entire shareholding in the Client itself to a third-party buyer without triggering a deemed offer of Company A’s shares in Company A to the remaining shareholders of Company A, and without requiring the approval of Company A’s board. There was nothing that Company A or its remaining Shareholders could do about this sale. Without having any say in the matter, Company A’s remaining shareholders and board had to accept the identity of the new shareholder of the Client as a large indirect shareholder in Company A. You can imagine the discomfort this would create in more closely held private companies where the shareholders want to know who they are investing and doing business alongside.
So, a warning: carefully consider whether or not the MOI or shareholders agreement of the companies in which you own shares should include a change of control deemed offer trigger event. Of course, the trigger event can be drafted in various ways, and apply only to some shareholders but not others, and a clause can also be added that exempts transfers of shares intra-group from triggering that deemed offer.