An essential contract for small non-offering corporations, shareholders’ agreements define the rights, privileges, liabilities, and responsibilities of each shareholder. These agreements, also known as “unanimous shareholders’ agreements,” offer a framework to govern various aspects of a corporation’s functioning, such as delineating shareholder roles, placing limitations on certain actions, and regulating share transfers. Without a well-drafted shareholders’ agreement, corporations may face difficulties, particularly when disputes among shareholders arise, potentially disrupting operations. This blog post delves into the intricacies of shareholders’ agreements and highlights key factors to consider when formulating one.
Navigating the Common Law Landscape
Before 1975, neither federal nor provincial corporate legislation in Canada addressed shareholders’ agreements, complicating their interpretation and enforcement. The Canada Business Corporations Act first established specific provisions for “unanimous shareholders’ agreements” in 1975. Under common law, no agreement can limit a director’s discretion in managing a corporation due to their fiduciary duty to act in the best interests of the corporation. Consequently, drafting and enforcing shareholders’ agreements can be challenging.
Courts have attempted to strike a balance between the legal principle of unfettered discretion and the notion that shareholders should be permitted to make agreements restricting their discretion as directors. However, without legislative clarification, shareholders’ agreements that fetter directors’ discretion may be rendered unenforceable.
As an alternative to traditional shareholders’ agreements, voting trusts or pooling agreements can be used, allowing shareholders to vote collectively. These agreements are more prevalent in widely held offering corporations, where a trust company or an individual holds shares in trust for several shareholders.
Unanimous Shareholders’ Agreements: A Legislative Solution
Recognizing the need for shareholders’ agreements to limit directors’ discretion in certain situations, the Canada Business Corporations Act introduced unanimous shareholders’ agreements in 1975. Governed by Section 108 of the Business Corporations Act (Ontario) and Section 146 of the Canada Business Corporations Act, these provisions enable two or more shareholders to enter a written agreement specifying the exercise of their voting rights. Additionally, these agreements allow all corporation shareholders to agree in writing to limit, in whole or in part, the directors’ powers to manage or supervise the business. Unanimous shareholders’ agreements are considered vital for small non-offering corporations.
Establishing Board Representation and Officer Roles
Shareholders’ agreements typically dictate the election of certain individuals as board members and officers, as well as the decision-making process among board members. It is essential for shareholders to ensure their intentions are clearly understood, especially in cases where one shareholder wields considerably more power than others.
Effective Management of the Corporation
A well-constructed shareholders’ agreement outlines roles and responsibilities for shareholders in areas such as sales, finance, accounting, and operations. The agreement should also specify individual shareholder authority for corporate representation and contractual obligations. These provisions should be tailored to the unique needs and preferences of the shareholders involved.
Determining the Term of the Agreement
Contracts should include provisions for commencement and termination. Shareholders must establish the intended start and end dates for the agreement’s obligations. If the term is not specified, the contract is considered indefinite and, on its face, perpetual.
Addressing Financial Matters and Financing
The shareholders’ agreement should consider the corporation’s financial matters and financing, addressing the appointment of accountants or auditors, the fiscal year end, and any borrowing restrictions. This is particularly important for small non-offering corporations, as situations may arise where one shareholder is more financially capable than others.
Bankruptcy and Insolvency of a Shareholder
In the event of a shareholder’s bankruptcy or insolvency, provisions must be in place to ensure a mandatory share transfer to remaining shareholders based on pre-agreed terms. This mitigates the risk of interference from third-party trustees or receivers, thus protecting the corporation’s management and operations.
Family Law Considerations
To safeguard the corporation from the impact of a shareholder’s marital breakdown, shareholders’ agreements should address marital dissolution while also respecting the spouse’s rights. This can be achieved through determining fair market value, obtaining independent legal advice, and efficient arbitration methods for disputes involving non-shareholder spouses.
Disability and Death
A comprehensive shareholders’ agreement should include provisions for handling a shareholder’s incapacitation, disability, or death. This may involve allowing the corporation to purchase the shares of the affected shareholder, depending on the circumstances and the preferences of the remaining shareholders.
To protect the corporation and shareholders in cases of share transfer due to events like death or incapacitation, insurance is recommended. This allows shareholders to compensate the heirs, preventing financial strain on the corporation.
Restrictions on the Transfer of Shares
Incorporating a clause in the shareholders’ agreement that prohibits share transfers, except as outlined in the agreement, provides control over membership. Transfer restrictions should be explicitly stated on each share certificate to notify potential transferees.
The shareholders’ agreement should outline allowed share transfers among shareholders, adhering to specific restrictions and requirements. Some common permitted transfers include pledging shares to a lender, transferring shares to a shareholder’s spouse or children, transferring shares to wholly owned corporations or subsidiaries, and transferring shares among shareholders.
Purchase and Sale of Shares: The Right of First Refusal
The right of first refusal provides marketability and control for shareholders looking to sell their shares. It allows a selling shareholder to offer their shares to an outside party while giving remaining shareholders the opportunity to buy the shares at the set price.
Purchase and Sale of Shares: Shotgun Provisions
Shotgun provisions are mandatory share transfer mechanisms that can be used as a last resort for resolving disagreements among shareholders. The initiating shareholder offers to buy all remaining shareholders’ shares or sell all their shares at a set price, resulting in one disagreeing party being removed from the corporation.
Purchase and Sale of Shares – Piggyback Provisions
Piggyback provisions enable majority shareholders to compel minority shareholders to sell their shares alongside the majority’s shares when selling the corporation to a third party. This prevents minority shareholders from halting the transaction.
Incorporating non-competition clauses in shareholders’ agreements can protect the corporation from competition if an active shareholder is removed. These clauses must be reasonable to avoid being deemed unenforceable by courts.
To avoid costly and time-consuming litigation, arbitration clauses should be included in shareholders’ agreements. These clauses enable shareholders to appoint a neutral third party as an arbitrator for dispute resolution, providing a cost-efficient and faster resolution process.
A comprehensive shareholders’ agreement is vital for the success and longevity of small non-offering corporations. By addressing the various aspects mentioned above, shareholders can create a solid foundation that protects their interests and facilitates smooth operations. It is recommended to consult with legal professionals to ensure that the shareholders’ agreement is tailored to the specific needs and circumstances of the corporation and its shareholders.
In conclusion, a well-drafted shareholders’ agreement is essential for the smooth functioning and long-term success of small non-offering corporations. By taking into account factors such as bankruptcy, insolvency, family law considerations, disability, death, insurance, share transfer restrictions, permitted transfers, and various purchase and sale provisions, shareholders can establish a robust agreement that protects their interests and fosters a healthy business environment. Additionally, incorporating non-competition and arbitration clauses can further safeguard the corporation against potential disputes and competition. To ensure the shareholders’ agreement is tailored to the specific needs and circumstances of the corporation and its shareholders, it is highly recommended to consult with legal professionals during the drafting process.