Covenants of the stockholder: Overview, definition, and example
What are covenants of the stockholder?
Covenants of the stockholder refer to specific promises or agreements made by a stockholder (or shareholder) within a corporate context. These covenants are often outlined in the corporate charter, bylaws, or stockholder agreements and define the rights, duties, and obligations of the stockholder. They can address various aspects of the stockholder’s behavior, including how they can transfer their shares, participate in corporate governance, or even the conditions under which they may have to sell or buy shares. Covenants may also include limitations or restrictions on stockholder actions to protect the company and other shareholders.
Why are covenants of the stockholder important?
Covenants of the stockholder are important because they help ensure the smooth functioning of the company by setting clear expectations and obligations for stockholders. These covenants help maintain control over the ownership and governance of the company, protect the interests of other shareholders, and create a framework for dispute resolution or enforcement of rights.
For companies, covenants can provide stability by limiting the potential for unwanted changes in ownership or control, especially in closely-held businesses or startups. For stockholders, these covenants define their rights and responsibilities, which helps avoid confusion or disputes in the future.
Understanding covenants of the stockholder through an example
Let’s say that a small business has three founding stockholders. As part of their stockholder agreement, each stockholder agrees to a covenant that limits their ability to sell their shares to outside parties without first offering them to the other stockholders. This ensures that the ownership of the company stays within the group of founders, preventing outside investors from gaining control.
Another example might involve a company that has agreed to a covenant where stockholders must vote in favor of certain corporate actions, like mergers or acquisitions, for the company to proceed. In this case, the covenant might ensure that key decisions cannot be made without the approval of a majority of stockholders.
Example of a covenants of the stockholder clause
Here’s how a covenants of the stockholder clause might appear in a stockholder agreement:
“Each Stockholder agrees not to transfer, sell, or otherwise dispose of any shares of the Company without first offering such shares to the other Stockholders on the same terms and conditions. Furthermore, each Stockholder covenants to vote their shares in favor of any action that is necessary for the Company to comply with applicable law or in the best interest of the Company’s continued operations.”
Conclusion
Covenants of the stockholder play a vital role in managing the relationship between stockholders and the company, as well as among stockholders themselves. These covenants ensure that all parties understand their rights and obligations and that the company is protected from unwanted changes in ownership or control. For stockholders, these covenants provide clarity about their responsibilities and the scope of their actions within the company. By incorporating well-defined covenants into shareholder agreements, businesses can create a stable and predictable environment for growth, governance, and decision-making.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.