In private companies, particularly family or founder-led businesses, property structures and investment vehicles, shareholders commonly fund the company through loans rather than equity contributions. As a result, a shareholder may own a relatively small percentage of the shares in a company but have a substantial loan claim against it. In those circumstances, a significant portion of the shareholder’s value would sit not in the shares themselves, but in the shareholder loan account.

The founder may have also established various personal rights and entitlements for themselves in the company’s constitutional documents – director appointment rights, vetoes on material transactions and corporate actions, and so forth. These would be along the lines of “For so long as Ms X is a shareholder, she has the following list of rights …”.

This distinction becomes important where it is not expressly addressed in the transaction, as the transfer of shares and the treatment of shareholder loan accounts and other rights are legally separate steps.

Unless the company’s memorandum of incorporation (MOI) or shareholders’ agreement provides otherwise, a shareholder can transfer their shares while retaining their loan claim against the company. A shareholder may therefore exit the company entirely from an ownership perspective, while remaining a creditor of the company. Conversely, a purchaser may acquire the shares expecting to step into the full economic position associated with that interest, only to find that a material portion of the value remains with the seller.

The position is seldom hidden. Shareholder loans are typically reflected in the company’s financial statements and are usually identified during due diligence. The difficulty is more subtle: parties often focus on the mechanics of the share transfer and assume that the loan position will follow as a matter of course. They may likewise assume that the other rights of the seller also follow the shares, but this can be a complicated and fact-dependent question which turns on inter alia the nature of those rights, contractual restrictions (if any) on their assignment and the so-called delectus personae principle, namely, that rights granted specifically to a person by name, by virtue of their special characteristics, might not be capable of cession (despite the general rule in common law that rights can be freely ceded).

The consequences tend to emerge later, when the commercial implications begin to play out. For example, when funding or distribution decisions are constrained by the existence of a significant claim held by someone who is no longer a shareholder. Similarly, a dispute may arise as to whether it is the outgoing or incoming shareholder who is vested with certain rights under the constitutional documents. What was understood as a clean exit, can, in practice, leave an ongoing financial relationship in place.

For this reason, private company MOIs and shareholders’ agreements typically include what are often referred to as “linked transfer” provisions. These provisions are intended to ensure that the economic position follows the equity position and require that a transfer of shares is accompanied by a pro rata cession of the shareholder’s loan claim. By way of illustration, a shareholder disposing of 30% of their shares would be required to cede 30% of their loan account to the purchaser as part of the same transaction. The placement of this provision also matters. While the shareholders’ agreement creates contractual obligations between the shareholders, the MOI provides the company with a clearer basis to administer and enforce the transfer process. Aligning the two documents reduces the risk of inconsistency and improves enforceability. Whilst the ‘stapling’ of shares and loan claims has for decades been a commonplace (but by no means universal) provision found in many constitutional documents, not enough attention is given to the assignability of other rights of the seller. 

What appears to be a straightforward share transfer can, therefore, have very different commercial consequences depending on how the shareholder loan account and other rights are treated. The detail is crucial, and where it is overlooked, the outcome may not reflect a clean exit.