In a
shareholders’ agreement, the
bad leaver clause is the one providing that a
shareholder who leaves the company in circumstances considered wrongful or disloyal will have their shares bought back on unfavourable terms, often well below market value. It is the counterpart of the good leaver clause, which gives fair treatment to a shareholder who leaves on good terms. Together, they organise exits and protect the company against the departure of a founder who would keep a significant stake while no longer contributing or, worse, while actively causing harm.
The logic is sound. But the effectiveness of the clause depends entirely on how precisely it is drafted, and in particular on the definition of what makes someone a bad leaver. This is where most clauses fall short. Either they are too vague and prove unenforceable before a court. Or they are too broad and amount to a disproportionate penalty that the departing shareholder may challenge. In both cases, the clause fails to do its job.
We will look at why defining the managing shareholder’s fault is an exercise in precision, which types of conduct can reasonably be included, which wordings weaken the clause, and how to tie it in with the buy-back price so that it is a genuine deterrent and defensible.
Why the definition of fault is the core of the clause
A shareholders’ agreement is a contract. If there is a dispute over how the bad leaver clause applies, a court will decide, on the basis of the signed text and the facts established. Bad leaver status is not a unilateral choice of the majority shareholders: it is a legal characterisation that must result from the precise terms of the clause applied to the actual circumstances of the departure.
If the clause defines a bad leaver as “any departure resulting from wrongful conduct”, the court will have to interpret what “wrongful conduct” means in the context of the shareholder relationship. That interpretation will be uncertain, and the parties will remain in doubt until the judgment.
The more precise and objective the definition, the more the clause can be applied without litigation. That is the goal.
Precision protects both ways. It protects the remaining shareholders, who can trigger the clause on a solid basis. It also protects the departing shareholder, who knows in advance in which cases their departure will be treated as a bad one and what the financial consequences will be. A mechanism known to everyone ex ante is harder to challenge ex post.
The categories of conduct that make someone a bad leaver
Practice in shareholders’ agreements under French law has gradually settled on a number of categories of conduct that are generally accepted as bad leaver events, provided the drafting is precise enough.
Serious or gross misconduct in performing management duties
This is the most obvious category. A managing shareholder who commits serious misconduct in performing their duties, misappropriates funds, takes decisions deliberately harmful to the company, commits misuse of company assets (abus de biens sociaux) or falsifies accounts cannot reasonably claim a buy-back of their shares at market terms.
Serious misconduct must, however, be characterised and proven. Mere underperformance, a debatable strategic decision or a disagreement about the direction the company has taken do not amount to serious misconduct in the legal sense.
The drafting must avoid approximation. A clause referring to “any serious breach of the director’s obligations” is too general. It is better to list the conduct covered: misappropriation of funds or assets, misuse of company assets, presentation of inaccurate accounts, deliberate decisions causing identifiable harm to the company.
Breach of the commitments in the agreement
A shareholder who breaches an essential clause of the agreement, in particular an exclusivity clause, a non-compete clause during the term of the agreement, or an obligation not to solicit staff or customers, may be treated as a bad leaver if the agreement expressly provides for it.
The link between the breach and bad leaver status must be explicitly set out in the text.
This category is particularly important in tech start-ups, where a founder who leaves and immediately joins a competitor, taking strategic information or team members along, causes real harm that a contractual liability clause alone does not always remedy effectively.
Direct competition during the term of office
Carrying on an unauthorised competing activity while serving as a managing shareholder is a breach of the duty of loyalty that can justify bad leaver status. The drafting must specify what a competing activity means: setting up or acquiring an interest in a company whose business competes directly with the company’s, carrying out an assignment or holding office for a competitor, developing an identical or substitutable product or service in parallel.
Removal from office for just cause
Some agreements automatically treat as a bad leaver a shareholder whose management functions have been terminated for just cause by the company’s competent bodies. This approach has the advantage of clarity: if removal for just cause is decided, bad leaver status follows without further discussion. It does, however, require the removal to have been validly decided and the just cause to be real and documented, which may itself be challenged.
What should not count as a bad leaver
The definition of a bad leaver must be balanced: it must target genuinely wrongful or disloyal conduct, not any departure that does not suit the remaining shareholders.
Underperformance is not a fault. A founder whose results are disappointing, whose strategic vision has not materialised, or whose skills no longer match the company’s stage of development may be leaving in a situation that satisfies no one. But they commit no fault. Treating them as a bad leaver on that ground alone exposes the clause to a serious challenge.
A strategic disagreement is not a fault. Founders who disagree on the company’s direction, on development priorities or on whether to raise funds are not guilty of anything towards each other. The separation may be painful, but it does not justify a financial penalty on the buy-back price of the shares unless it comes with genuinely wrongful conduct.
Resignation for a legitimate personal reason is not a fault. A founder who leaves the company for health reasons, to care for a relative, for major family reasons, or because they have reached a level of personal exhaustion incompatible with continuing their commitment, leaves in circumstances that may warrant good leaver treatment, or at least an intermediate regime. A clause that treats this type of departure as a bad leaver event risks being considered disproportionate.
How the definition ties in with the buy-back price
The definition of a bad leaver is only useful if it is tied to a clearly defined pricing mechanism.
The wider the gap between the bad leaver price and market value, the more precise and robust the definition of fault must be. A buy-back at nominal value, which may mean a loss of several hundred thousand euros for the departing shareholder, cannot rest on a vague characterisation open to interpretation.
Several approaches coexist in practice. Some agreements provide for a single bad leaver price, set at the nominal value of the shares or at a very low multiple. Others provide for a discount on market value, with a percentage that varies according to the seriousness of the fault. Others again set up a graduated mechanism: serious misconduct leads to a buy-back at nominal value, a breach of the agreement leads to a 50% discount, a departure in intermediate circumstances leads to a 25% discount.
This graduated approach is intellectually consistent but complex to draft and apply. The risk is multiplying the areas of uncertain characterisation, with each category becoming a subject of debate. The simplicity of a clear definition of two or three well-delimited categories is often better than a sophisticated scale whose thresholds will be disputed.
The implementation procedure
The bad leaver clause must also organise the procedure by which bad leaver status is decided and implemented. Who establishes the fault? Under what decision-making procedure? Within what period must the decision be notified to the shareholder concerned? Does the shareholder have a right to respond before the decision is made? What is the deadline for exercising the buy-back right once bad leaver status is established?
A clause that does not provide for this procedure is open to a procedural challenge, regardless of the merits. A shareholder who was not heard before being classed as a bad leaver may argue a breach of the adversarial principle in the application of the agreement, even if the facts behind the decision are not in dispute.
What we see in practice
Most of the disputes we handle over bad leaver clauses do not concern situations where the fault is obvious. If a founder misappropriates funds, bad leaver status is generally not disputed. Disputes concern the intermediate situations: a founder who took questionable decisions without informing their fellow shareholders, who had contacts with a competitor without disclosing them, or whose management was negligent without being fraudulent.
In these situations,
the drafting of the clause is decisive. A clause that precisely covers the conduct found will be applied. A vague clause will leave room for a dispute with an uncertain outcome, a high cost and a duration that often exceeds what the shareholders had anticipated.
If you would like to review the bad leaver clause in your agreement, check that it covers the situations you have in mind, or get assistance with a contentious departure, we are available to analyse your case.
