Why Every Canadian Business Needs a Shareholder Agreement

Why Every Canadian Business Needs a Shareholders’ Agreement

In this article, we’ll cover the following topics:

• Why shareholders’ agreements are useful

• The legal power of shareholders’ agreements

  • The shotgun clause

  • Default provisions

Why are shareholders’ agreements useful?

Shareholders’ agreements are notoriously frustrating documents, mainly because they are long – in some cases, 60 pages long – and loaded with confusing legalese. Yet they are among the most important documents in any business owner’s arsenal, and having competent counsel on your team can help to eliminate some of that confusion.

Don’t believe me? Here’s a story that will change your mind.

A few years ago, my friend and his business partner started a property management company. In the beginning, as they tried to get the business airborne, the work was relentless. Eventually, they started to see some revenue, and it wasn’t long before they landed their first big client – a well-known heavy-hitter in the Vancouver business community who had sold his company for more than $100 million. My friend and his partner, though exhausted, were soaring. 

One day, the client approached one of the partners and asked if they’d like to get involved with one of his projects. It was an attractive offer – a shiny object – and so the partner agreed. 

Over time, the partner became increasingly distracted by this shiny object, so much so that he began to neglect his obligations to his own company. The other partner, who at this point was still focused solely on the success of his own business, was starting to feel like he had been abandoned.

Eventually, it reached a boiling point. My friend decided that the only way forward was to push his neglectful partner out of the company. When he approached me for guidance, the first thing I said was, “show me the shareholder’s agreement.” 

You can probably guess what comes next: there was no shareholders’ agreement. 

At that point, his options were frustratingly limited. I told him, he could maybe send some nasty emails – reminding his partner that he is violating his duties to the company, strongly encouraging him to return to his original standing in the company, and so on. In the end, with no shareholders’ agreement to point to, he just didn’t have a lot of options – and so the dispute was never resolved.

You’d be right to think that sending nasty emails isn’t the best way to resolve disputes like this. The best course of action is to be proactive and   establish a shareholders’ agreement as early as possible, effectively guaranteeing that you never end up in a dispute like this to begin with. 

Now that I’ve persuaded you to establish a shareholders’ agreement, let’s look deeper at a couple of the powers that shareholders’ agreements can grant - powers that would have helped out my friend in the scenario above.  

The Shotgun Clause

In a word, the shotgun clause is an ultimatum. One party in a dispute gives the other party two options to choose from. It might sound something like this: “You can either buy my shares of the company for $50K and take 100 percent of the company, or I’m going to force you to sell your shares to me for $50K and then the company will be mine, and mine alone.”

This tends to favour the party with the deeper pockets - if they’re in a better position to buy out the other party’s shares, they can offer a higher amount.

However, the shareholders’ agreement will include a mechanism for determining a fair value of the shares; if it doesn’t, then the parties likely will never agree on their value, then they’ll both lose value in the company, and then the company will start sinking.

Default Provisions

In a word, default provisions are expectations. If one shareholder fails to meet certain expectations detailed in the shareholders’ agreement – they fail to fulfill specific milestones, they’re fired for cause, etc. – then they can be considered to be in default of the shareholders’ agreement, triggering certain remedies. One of those remedies might be a mandatory buyout at a discount, i.e. forcing the shareholder to sell all of his or her shares at 85 percent valuation. 

As with the shotgun clause, the shareholders’ agreement will likely include a mechanism for determining the fair value of the shares.

When else might a shareholders’ agreement be useful? There are too many scenarios to count. A few that come to mind: a partner wants to voluntarily exit the company, a partner wants to sell all of their shares to a third party, a partner goes bankrupt, a partner commits a felony, a partner gets divorced, a partner dies or becomes permanently disabled. The list goes on and on. 

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