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.
Blog posts are by students at the Business Venture Clinic. Student bios appear under each post.