Is It Time To Revisit Your Shareholder Agreement?

Shareholder agreement. Buy-sell agreement. Stock restriction agreement. Whatever it is titled, an agreement between a bank holding company (BHC) and its shareholders is one of the most effective tools available for strategic planning, managing shareholder succession and protecting the organization. And while a significant percentage of BHCs have a shareholder agreement of some sort in place, recent trends, market realities and regulatory expectations are prompting many BHCs to refresh these agreements. 

Fair Valuation
Many shareholder agreements contain a valuation mechanism for determining how covered stock transactions will be priced, but the reasoning behind preferred valuation methodologies can change over time and may be worth revisiting. The right valuation mechanism will balance market realities, shareholder expectations and the BHC’s need to manage capital effectively and fairly. In addition, appraisal rights have become increasingly favored, whether as a starting point for determining fair value or a tool for resolving valuation disputes.

Structural Changes
If the organization has switched from being taxed as an S corporation to a C corporation, or vice versa, it is probably time to update the shareholder agreement. S corporations are subject to specific restrictions on the size and makeup of the shareholder group, and a good shareholder agreement should include appropriate restrictions to protect against transfers of stock to ineligible shareholders. Reciprocally, restrictions designed to protect S corporations can ineffectively and confusingly restrict ownership — and therefore capital raising — options for C corporations.

Shareholder Group Dynamics
Most BHC shareholder rolls look different today than they did 25 years ago. Deaths, retirements, divorces, tax planning, family dynamics and other of life’s inevitabilities have taken their toll, and today’s shareholder group may very well be dealing with a different set of realities. An aging shareholder group may need a shareholder agreement that strategically supports estate planning activities, such as trust or legacy transfers. A closely held, family owned BHC may want to guard against transfers resulting from divorces and deaths or balance rights of first refusal on shares equally among family branches. A BHC owned by business investors may wish to emphasize rights governing major changes in control or the sale of the organization. And every organization has an interest in protecting itself against potential hostility or relationship breakdown. An effective shareholder agreement can help establish transparency, distill collective goals and foster unity among the current shareholder group. 

Regulatory Requirements
Like most things in banking, shareholder agreements for BHCs carry a regulatory asterisk, and shareholder agreement provisions that are permissible for other types of businesses may not be permissible for BHCs. For example, to avoid being deemed a BHC in its own right, a shareholder agreement must meet certain requirements, including terminating within 25 years after its adoption. 

Safety and soundness concerns are also paramount. The Federal Reserve may object to provisions it views as potentially threatening to a BHC’s financial health or stability, such as put options that require a BHC to repurchase a shareholder’s stock, or overly restrictive provisions that might dissuade a future investor from purchasing stock — thereby limiting the BHC’s ability to raise capital in practice. 

If the shareholder agreement includes certain types of provisions — like excessively long or overly restrictive rights of first refusal for stock transfers — the Fed can determine that all of the parties to the shareholder agreement are acting in concert to control the BHC, thereby triggering change in control filings from each of them. Regulation Y includes a handy list of provisions that generally do not raise control issues, and the Federal Reserve has also released guidance — SR 15-15 — summarizing provisions that can raise particular regulatory concerns.

The Federal Reserve requires BHCs to submit their shareholder agreements for review in connection with many routine regulatory filings. These reviews often reveal the need to update shareholder agreements to comply with regulatory requirements. 

The worst time to confront the need to update a shareholder agreement is when regulatory approval for an important transaction hangs in the balance. To avoid complications or delays with filings, BHCs would be wise to review their shareholder agreements and address any issues in advance of submitting them to the Fed.