For businesses that have more than one shareholder, a shareholders’ agreement is an essential document. A good shareholders’ agreement will govern the relationship between the business and its shareholders and can help to navigate through future potential turmoil between the shareholders. When getting into business together, shareholders don’t contemplate the possibility of their relationship with fellow shareholders ever breaking down; without a shareholders’ agreement, if the relationship does break down, the only mechanism to resolve conflicts may be the Court. A good shareholders’ agreement will often circumvent the need for Court intervention as it provides for what happens ‘when’ or ‘if’ shareholders cannot agree and also provides an escape hatch so shareholders have a way out. As such, the shareholders agreement is a benefit to shareholders regardless of their equity interests in the business.
A well drafted shareholders agreement provides guidelines on how the company will operate, sets out the shareholders’ roles and required contributions to the corporation, and often also establishes a mechanism for how shareholders will dispose of their shares. Establishing these guidelines at a time when the relationship between shareholders is harmonious often helps to reduce conflict when issues arise and gives the shareholders some degree of certainty as to how these matters will be dealt with if and when they arise in the future. Additionally, forcing the shareholders to think about operational and other issues when their relationships are harmonious helps gives the shareholders better insight into their ability to get along and work together as shareholders.
Scope of a Shareholders’ Agreement
There is no such thing as a “one size fits all” shareholders’ agreement and each shareholders’ agreement should take into account the specific needs and intentions of the shareholders to whom the agreement will apply. However, there are some key matters which should be addressed in most shareholders’ agreements including:
1. the management and operation of the business of the corporation;
2. the financing of the corporation;
3. what if any restrictions should be imposed on the issuance, transfer or sale of shares;
4. what happens in the event of death or disability of a shareholder;
5. the obligations of confidentiality and agreement not to solicit and/or compete undertaken by the shareholders to each other and to the corporation;
6. mechanisms for dealing with the implications of the Family Law Act on shareholders;
7. the cessation of the involvement of one or more shareholders in the corporation; and
8. a mechanism for dispute resolution.
Many considerations will influence whether and how these matters will be dealt with, including:
1. the type of business and whether it is capital intensive;
2. whether the shareholders will share equally in the equity of the company or will hold a disproportionate number of shares;
3. whether the shareholders’ financial contributions will be equal or disproportionate;
4. the relative bargain power of the shareholders; and
5. whether some of the shareholders will be active in the business while others remain passive.
Minority Shareholders and the Shareholders’ Agreement
Minority shareholders lack voting power and are vulnerable to the will of those shareholders with voting control. Minority shareholders therefore have a special set of concerns which should be addressed in the shareholders’ agreement to give them some security. Ensuring minority shareholders have a role in the management can provide some assurance that the minority shareholder has a voice in the company; if this is not possible, then minority shareholders should at the very least insist on the right to veto or influence major decisions which affect their investment and risks in a fundamental way. Minority shareholders should also ensure a means to sell their investment at a fair price in a variety of circumstances such as death, disability, or if the shareholder ceases to be employed in the business.
Majority Shareholders and the Shareholders Agreement
Voting control does not solve all of the legitimate concerns of a majority shareholder. If the “business deal” at the outset is that the minority shareholders will contribute their share of corporate financing, such a deal will not be enforceable without an agreement or provisions in a shareholders agreement to that effect. More importantly, minority shareholders have a statutory right to block an advantageous sale to a buyer who wants 100% of the business unless there is a shareholders’ agreement which sets out the right of the majority to force a sale when a good offer for the sale of all of the business surfaces.
Regardless of the shareholders’ relative shareholdings in the company, a shareholders’ agreement is a useful tool to protect such shareholders’ rights and protect against unnecessary turmoil amongst business partners. It also provides a degree of certainty that would otherwise not be attainable and may help to keep the focus on the business.
© Morrison Brown Sosnovitch LLP, 2014. All rights reserved.