Tailored for Success – Shareholders’ Agreement
What is a Shareholder’ Agreement?
A shareholder’ agreement is a legal agreement between the shareholders of a corporation or between a corporation and its shareholders. It regulates the behaviour of shareholders and outlines certain rights and obligations.1 A shareholder’s agreement is “principally concerned with allocating management control and setting out the terms on which shareholders may sell their interests in the business.”2 Unlike the articles of incorporation and bylaws of a company, a shareholder agreement is optional.3
Why might I want one?
Shareholder agreements are a way to formally set out the expectations of shareholders. They can be used to protect the rights of minority shareholders or restrain their power in certain situations. A shareholder agreement can be used to address potential conflicts between shareholders and require the use of an arbitrator to resolve issues that arise. They can be used to restrict the transfer of shares to control ownership of a company. They can also mandate a valuation mechanism to determining share price for transfers under the agreement. Far from an exhaustive list, this is a small sample of why shareholders might want to implement a shareholder agreement.
The use of a standard form agreement is not advisable. There are different types of shareholder agreements and their contents can range broadly. Below is an overview of the different types and a sample of common provisions. It should be apparent that the agreement needs to be tailored to the needs of the individuals and the corporation in involved.
There are Different Types?
Unanimous Shareholder Agreement
A Unanimous Shareholder Agreement (USA) must be in writing and include all shareholders of a corporation (or of a certain class of shares).4 This is commonly found in owner managed corporations. The purpose is to transfer some or all the powers of the directors to the shareholders. USAs exists under the Canadian Business Corporations Act5 and similar provincial legislation. They can offer certainty to existing shareholders; because if the corporation’s share certificate references the agreement, all future shareholders automatically become a party to the agreement.6 Unlike other shareholder agreements, USA’s are treated similarly to other incorporation documents such as articles of incorporation and bylaws.7 As such, USAs can amend or supersede these documents.
Shareholder agreements that are not unanimous shareholder agreements (USA) are largely explained above, under the heading “What is a Shareholder’ Agreement?”. They are treated as an ordinary contract as opposed to constating documents of a corporation. Unlike USAs, depending on the contents of the document, they do not require unanimous agreement to be amended. New shareholders do not automatically become subject to the agreement by purchasing shares of the company. A provision can be included that requires selling shareholders to ensure purchasers sign the shareholder agreement. This provision does not offer the same certainty as a USA, because if the shares are sold to a good faith purchase who is unaware of the provision, the purchaser will not be bound by the agreement. Unlike USAs the provisions of a shareholders’ agreement cannot amend or supersede other incorporation documents such as articles of incorporation and bylaws.
Example of Common Provisions
The following is a non-exhaustive list of common provisions found in shareholder agreements. The descriptions are superficial, and the intention is to show the array of combinations that can be found in a shareholders’ agreement.
Pre-emptive rights provide current shareholders with the right to participate in future financings.8 The shareholders’ participation can often be direct or indirect.9 The purpose of pre-emptive rights is to prevent the dilution of existing shareholder equity.
Right of First Refusal
“Rights of first refusal require any shareholders intending to sell their shares to first offer them to their fellow shareholders or to the corporation.”10 There are two variations of this provision. One is “hard”, meaning the selling shareholder must acquire an offer from a third party, then provide that offer to the existing shareholders for their consideration. The other is “soft”, meaning the selling shareholder must first offer the shares to the other shareholders, then if not purchased, can offer to third parties. The purpose of a right of first refusal is to allow shareholders to sell their shares while giving the existing shareholders the power to determine who can become owners.
Mandatory Share Sales
These provision “contemplate that in a variety of circumstances – death, divorce, bankruptcy, breach of the agreement – the affected shareholder will be obliged to sell his or her shares back to the corporation or to the other shareholders.”11 The purpose is to prevent people that are not a party to the corporation from becoming shareholders.
Shareholder Remedies and Conflict Resolution
Shareholder remedies and conflict resolution provisions “ensur[e] there is a solution to a breakdown in the relationship between the various managers of a business.”12 These provisions are typical of owner managed businesses as opposed to growth companies or publicly held companies. They help provide a mechanism for conflict resolution and help avoid litigation. An example of one of these provisions is a shotgun clause.
Non-Compete, Non-Solicit, Non-Disclosure
These provisions “contemplate that, in one capacity or another, the shareholders will take on some or all of the duties of the directors.”13 Their purpose is to ensure that shareholders do not abuse their powers in these circumstances.14
“In general, a well-drafted and considered shareholders’ agreement anticipates reasonably likely future events and provides for methods of dealing with them, which can help avoid or resolve future disputes among shareholders, and ultimately save time, money and the stresses associated with conflict resolution. However, shareholders’ agreements can also result in burdensome conditions, making it more difficult to effect decisions and run a business.”15 The key is to ensure the agreement is well drafted and appropriate for the company and its shareholders. As suggested above, there is a vast array of contents that can be drafted in a shareholders’ agreement. There is no one-size-fits-all and the needs of the parties should be appropriately reflected in the document.
Founders of a company should seek independent legal advice when considering a shareholders’ agreement. “Founders are often not sophisticated and Canadian courts have set aside agreements because they did not receive their own legal advice.”16
For more information on how the BLG Business Venture Clinic can help draft a tailored shareholders’ agreement for your company please contact us at http://www.businessventureclinic.ca/contact.html.
Neil Thomas is a member of the BLG Business Venture Clinic, and is a 2rd year student at the Faculty of Law, University of Calgary.
Prospectus Exemptions in Securities Law
One of the most significant barriers to growing a business corporation is financing. Among other methods, start-up founders may choose whether to secure a line of credit, acquire government subsidies or trade their cash for shares in a corporation. However, these options are restricted to the founders’ capacities of obtaining capital. In order to expand the pool of funds without violating the complex legal rules of expensive prospectus requirements, small business owners may consider offering shares to an exceptional group of friends, family or associates as detailed in the Canadian securities National Instrument 45-106.
Under Canadian securities law, a corporation must file a prospectus, which is a comprehensive legal document that discloses the material facts of an investment offering, prior to distributing its securities to the public. The public requires a prospectus in order to make an informed decision about purchasing respective shares. Such a requirement can be an expensive task, involving many professionals including investment bank underwriters, accountants, financial advisors and legal teams, which creates prohibitive obstacles for budding firms. Recognizing this limitation and driven to encourage small firm growth, the government passed the National Instrument 45-106.
The National Instrument 45-106 is a set of rules that governs all securities’ jurisdictions in Canada — except for Ontario, which permits exemptions under its own legislation not discussed here. Using the exemptions detailed in the instrument, a small firm may seek capital through distributing shares, without filing a prospectus, in certain transactions or to a limited group of investors. These investors include close family members, close business associates, or accredited investors, rich and sophisticated individuals for whom a significant amount of protections provided through securities legislation would be unnecessary. Below are a few examples of the exemptions available using this instrument.
According to section 2.3 of the National Instrument, the prospectus requirement does not apply if an issuer distributes securities to an accredited investor. An accredited investor includes financial institutions, banks, advisors, dealers, trusts, government organizations, or individuals who, alone or with their spouses, own assets exceeding $1,000,000 or $5,000,000 (the latter do not have to sign risk acknowledgement forms), or have net incomes of at least $200,000 in the past two years (or $300,000 with a spouse). A corporation may also fit into this category provided the fulfillment of certain conditions, such as having net assets of at least $5,000,000; however, the exemption does not apply if a corporation was created solely to hold securities as an “accredited investor”.
Family, Friends and Business Associates
Under section 2.5, a corporation may distribute securities to founders, employees, directors, officers, control persons or affiliates, their close family members, their close personal friends or business associates, or respective trusts or estates. The court has determined “close” by asking whether it would be acceptable to use a friend’s, family member’s, or business associate’s bathroom without asking.
The issuer may choose to distribute offering memorandums through the required form of section 2.9 in lieu of a full prospectus. A corporation may issue shares to certain qualifying investors in Alberta without a prospectus, provided that:
While using an Offering Memorandum may widen the group of potential investors, this exemption carries the same level of disclosure and liability as issuing through a prospectus.
The private issuer exemption applies to companies that have restrictions from trading securities in the open market without the director’s approval, that don’t have more than 50 shareholders, and that don’t report to any Securities Commission. Under these circumstances, a company may distribute securities to those connected to the firm, such as directors, officers, employees or control persons, their close family members, their close friends or business associates, or accredited investors. Furthermore, unlike the exemptions above, private issuers are not required to publicly report each distribution.
In conclusion, the National Instrument 45-106 provides opportunities for small companies to raise funds through share distribution under certain circumstances without the expensive prospectus requirement. If your organization is looking to make use of the opportunity or has questions regarding details of securities law, please do not hesitate to contact a caseworker at the BLG Business Venture Clinic.
Nick Konstantinov is a member of the BLG Business Venture Clinic, and is a 3rd year student at the Faculty of Law, University of Calgary.
Business and Product Liability
Many businesses operate by producing and selling various products. However, as the manufacturer of a product a business may open itself up to certain legal claims if a customer is injured by their product. What follows are some considerations for product manufacturers regarding product liability.
What is your Liability for Injuries Resulting from a Product?
Start-ups may encounter claims from customers who were injured by faulty or defective products. The burden lies with the customer to prove that but for the product being faulty or defective in some way, they would not have been injured. If this is successfully established by the customer the manufacturer of the product will be held liable for the injury of the customer. While this situation may be avoided through heightened quality control measures and adequate product testing, there are circumstances when an injured customer may bring forward a claim even if the product was functioning properly.
Duty to Warn
The manufacturer of a product must provide sufficient warnings regarding the risks of using their products. If there were not sufficient warnings provided, a customer may still sue a manufacturer even if the product was functioning properly and the injury resulted from the normal use of the product. The extent of the warning required hinges on two factors:
How Can a Manufacturer Defend Themselves from an Injury Claim?
The Injury was not a Result of the Product
In the event that a customer has chosen to bring a claim due to being injured by a manufacturers’ product, there are certain defenses available to the manufacturer. For one, the manufacturer may contend that a separate and distinct event was the cause of the injury. For example, if an individual is injured in a car accident because their breaks failed, this would indicate that the manufacturer may be liable for the injury. However, if it is determined that the breaks failed because of an error made by the customer’s mechanic then this may absolve the car manufacturer of liability. This is because the injury was a result of the negligent mechanic, and not any fault on the part of the manufacturer in manufacturing the vehicle.
The Customer Assumed the Risk of Injury
A manufacturer may also defend themselves by suggesting that the injured customer was aware of issues with the product. This is because the customer was aware that the product was altered or defective in some way, and still chose to operate it despite the heightened risk of injury. An example of this would be a customer choosing to use a knife even after knowing that the blade was faulty. If the blade were to snap and injure the customer the manufacturer may raise the defense that the customer assumed the risk when they chose to use the faulty or defective product.
The Customer Used the Product Negligently
Another possible defense that a manufacturer may raise is that the customer was injured because they used the product negligently in a manner that it was not meant to be used. For example, if an individual chooses to stand on a laundry hamper in order to change a light bulb and is injured because the hamper topples over, the manufacturer may argue that the injury was a result of the customers’ negligence. This is based on the customer using the hamper in a manner that that it was not meant to be used, and the argument that but for the misuse, the customer would not have been injured.
The bringing forward of a claim by an injured customer is subject to a statutory limit. This means that a claim by an injured customer can only be brought forward within a specific period of time once the injury has occurred. This period varies from province to province, but in Alberta it is generally within 2 years of the time the injury occurred. Additional information regarding limitation periods can be found in the Alberta Limitations Act.
Richie Aujla is a member of the BLG Business Venture Clinic, and is a 2nd year student at the Faculty of Law, University of Calgary
Blog posts are by students at the Business Venture Clinic. Student bios appear under each post.