Most shareholder agreements will address the following core issues with appropriately customized terms: (a) decision making; (b) restrictions on share transfers and ownership of shares; (c) financing; (d) pre-emptive rights; (e) rights of first refusal; (f) mandatory sales of shares; (g) conflict resolution; (h) non-competition, non-solicitation, and non-disclosure; and (i) shareholder exit strategies.
Decision making
- In Ontario, written ordinary shareholder resolutions must be signed by the holders of at least a majority of voting shares.
- A majority threshold can be:
- useful for quickly obtaining shareholder approval for simple matters; but
- problematic for more important decisions, as minority shareholders can be easily outvoted.
- To strike a balance between efficiency and fairness, set out in a shareholder agreement what threshold of approval is required for different types of decisions
- i.e. fundamental decisions may require a unanimous decision by all shareholders, while less important decisions may require a majority vote
Restrictions on share transfers and ownership of shares
- For a business to run smoothly, shareholders must remain amicable and successfully make decisions as a group.
- The addition of an undesirable shareholder can throw off the balance of the existing shareholders and make decision-making more difficult.
- To prevent this, a shareholder agreement should:
- contain restrictions on who can become a shareholder; and
- set out the level of approval required for new shareholders.
Financing
- A shareholder agreement should set out how the corporation will access capital to start up and maintain its business.
- Shareholders might be required to make financial contributions or guarantee loans.
- There might also be consequences for shareholders who fail to fulfil their financial obligations, such as:
- preferential interest rates for shareholders who contribute funds on behalf of non-contributing shareholders; or
- restrictions on declaring dividends until shareholder loans are repaid.
Pre-emptive rights
- When a corporation issues shares from treasury to new shareholders, the addition of new shareholders dilutes the existing shareholders’ voting powers and percentages of ownership.
- A shareholder agreement can protect shareholders from dilution by giving them the first right to purchase new shares, usually at a lower price than what would be offered to third parties.
Rights of first refusal
- A right of first refusal gives existing shareholders the first right to purchase each other’s shares if they go up for sale. This allows shareholders to better control who becomes a shareholder.
- Under a right of first refusal, a selling shareholder may be required to either:
- first, obtain an offer from a third party and then, before accepting, present the same offer to the existing shareholders; or
- offer his/her shares to the existing shareholders first and then, if not sold, offer the shares to a third party on equal or less favourable terms.
Mandatory sales of shares
- Events like death, divorce, and bankruptcy can often lead to the addition of new, undesirable shareholders in a corporation such as ex-spouses and beneficiaries.
- To help prevent this, most shareholder agreements will require a divorced, deceased, or bankrupt shareholder to sell his or her shares back to the corporation or to the other shareholders.
- A shareholder agreement can also require shareholders who are employees of the business to sell their shares back to the corporation or to the other shareholders if they become disabled, retire, or are terminated.
- A shareholder agreement should also contain a mechanism for determining the value of shares in these circumstances.
Conflict resolution
- Every shareholder agreement should contain conflict resolution options to help disputing shareholders avoid litigation, such as:
- mandatory negotiation;
- mediation, and/or
- arbitration.
- These provisions should also specify:
- whether the result or decision that comes from the dispute resolution will be binding on the shareholders; and
- how mediators and/or arbitrators will be appointed.
Non-competition, non-solicitation, and non-disclosure
- Most shareholders of a business will have:
- knowledge of the company’s intellectual property, trade secrets, and business plans;
- relationships with its key stakeholders; and
- access to its customer lists.
- To prevent shareholders from using information or connections to damage or compete with the corporation, a shareholder agreement should include non-competition, non-solicitation, and non-disclosure clauses.
- A non-competition clause prohibits a departing shareholder from starting, working for, or buying into a competing business for a certain period of time and within a certain geographical area after exiting the company.
- A non-solicitation clause forbids soliciting of the corporation’s employees, customers, agents, dealers, or distributors.
- A non-disclosure clause prohibits shareholders from sharing the corporation’s insider information with third parties.
Shareholder exit strategies
- A shareholder agreement should contain strategies for shareholders to exit the corporation if the shareholders cannot resolve a dispute or if a majority shareholder wishes to sell his or her shares to an undesirable new shareholder.
- A shot gun clause forces one or more shareholders to exit the company. One shareholder makes an offer to the remaining shareholder(s) to buy all of their shares at a specific price, and the remaining shareholder(s) must either:
- accept the offer to sell; or
- purchase the offering shareholder’s shares at the same price.
- A drag-along clause allows a majority shareholder who wishes to sell his or her shares to a third party to “drag” the minority shareholders along on the sale, forcing them sell their shares to the same third party. The result is a sale of the whole business.
- A piggy-back clause gives minority shareholders the option to “piggy-back” on the majority shareholder’s sale and sell their shares to the same third party.
Conclusion
A shareholder agreement is not a one-size-fits-all approach to managing corporations and the relationships of the people behind them. The provisions of a shareholder agreement should address the core issues for corporations, many of which are set out in this blog, with provisions that are tailored to the specific needs and circumstances of the corporation and its shareholders.
If you require assistance with preparing, reviewing, or amending a shareholder agreement, please reach out to Jade Renaud at 343-888-8913 or jade@ottawa.law
