Do You Need a Shareholder Agreement?
Starting or owning a business with a partner can be very exciting. These ventures force partners to focus on the financial projections, financial results, and organization and management of the day to day operations. These issues are fundamental, but the partners (or shareholders) also need to understand that no business is free from contentious issues within the corporation. While corporations started by a family, friends, or even long-time associates may run smoothly, you should never assume that problems cannot arise. These are the cases where shareholder agreements come into play.
What is a Shareholders Agreement?
A shareholder agreement is a contract between the shareholders and, in some situations, between the shareholder(s) and the corporation to structure the relationship amongst them. A unanimous shareholder agreement has the same features as described above, but it restricts the power of the directors explicitly to manage the corporation.
The Business Corporations Act (Ontario) (see S. 108 (2) and (5)), the Business Corporations Act (Québec) (see S. 213 and S. 214) and the Canada Business Corporations Act (see S. 146 (1) and (5)) each provide that where a unanimous shareholder agreement exists, a shareholder who is a party has all the rights, powers, duties, and liabilities of the directors to the extent that the agreement restricts the powers of such directors to manage the business of the corporation.
Matters to be Covered in a Shareholder Agreement
As shareholder agreements can take many different forms and each can address many various issues. It’s critical that each shareholder agreement is tailored and negotiated to meet the needs and interests of all parties involved. You will find below a short and non-exhausting list of matters that could or should be covered in a shareholder agreement:
(a) Share Transfer: A shareholder agreement should provide that no shares be transferred without compliance with a number of mechanisms. To name a few:
- Right of First Refusal: a shareholder who receives an offer from a third party to purchase his/her/its shares must first allow the existing shareholders the right to match such offer prior to selling to any third party. This mechanism allows the existing shareholders the option to prevent a third party purchaser from becoming a shareholder and exercising control over the corporation in the future; or
- Buy/Sell or “Shot Gun” Provision: this provision allows one shareholder to offer the other shareholders a price and establish the terms under which he/she/it is prepared to either purchase the other shareholder’s interests or sell his or her interest to the other shareholders. It is then up to the other shareholders to decide whether they wish to either buy the offered shares or sell their own shares on the same terms and conditions presented. This provision can be very useful in the event of a shareholder dispute where the relationship between the shareholders has broken down and one party wishes to exit.
(b) Financing: this provision deals with how the corporation will be financed at the outset and if and how additional financing shall be dealt with;
(c) Dividends: this provision deals with how the corporation will remunerate its shareholders;
(d) Management: this provision deals with how the corporation will be governed with respect to a wide range of matters requiring shareholder decisions. The right for each shareholder to nominate a director is a good example;
(e) Employment: this provision deals with the terms on which a shareholder will be employed in the corporation, how changes in employment should be addressed, how confidential information shall be dealt with, and to what extent a shareholder will be allowed to compete against the corporation after his or her departure;
(f) Dispute Resolution: this provision deals with how deadlocks amongst shareholders can be resolved. A common mechanism in a shareholder agreement is to limit the dispute resolution process to mediation or binding arbitration which is not public and could be a considerably less expensive alternative than seeking restitution through the courts.
(g) Death or Incapacity: in the event of the death or incapacity of one of the shareholders, the corporation, the surviving shareholders, or the shareholders that are not hindered may automatically purchase the shares in accordance with the conditions and procedures often pre-established in such provisions in the shareholders’ agreement. This type of clause prevents the deceased shareholder’s heirs from becoming shareholders themselves during such events or, in the case of the incapacity, prevents the legal representatives to act for a shareholder in any corporate decision after a period of time as agreed between the parties.
The above list is intended to provide a brief overview of the content a shareholder agreement can include and should outline whether or not a shareholder agreement is necessary in your case.
In conclusion, keep in mind that a well-drafted shareholder agreement should define each party’s expectations with clear rules that describe the relationship amongst the shareholders and provide some mechanisms designed to be able to address some of the possible contentious issues that could arise in the future.
Should you have any further questions about a shareholder agreement, we would be glad to provide you with further information.