Two founders of a small technology company decide to incorporate. They split shares equally, shake hands, and get to work. Years later, one founder wants to sell. The other does not. There is no agreement governing what happens. The corporation is functionally deadlocked. The founders go to court. The court, as it has done repeatedly in situations like this, declines to infer any shared intention about what the parties would have agreed had they put their minds to it. The litigation costs more than either founder can afford, and the company they built together is worth considerably less by the time a judge resolves the dispute.
This outcome is not a hypothetical. It repeats itself across Ontario courtrooms with depressing regularity, and it is almost entirely avoidable. A shareholders’ agreement, properly drafted before the dispute arises, provides the legal framework to address exactly these situations. This guide explains what shareholders’ agreements are under Ontario and federal law, why the statutory defaults make them necessary, how the unanimous shareholders’ agreement operates as part of the corporate constitution, what a comprehensive agreement must address, and what legal consequences flow from getting these documents right or wrong.
The Statutory Starting Point: Ownership Without Control
Every corporation in Ontario operates within a legal framework established by either the Canada Business Corporations Act (CBCA) or the Ontario Business Corporations Act (OBCA). Both statutes establish the same foundational principle of corporate governance: the board of directors manages or supervises the management of the business and affairs of the corporation, and the shareholders as such have no direct say in management. Section 115(1) of the OBCA and section 102(1) of the CBCA both vest that management authority in the board, not in the shareholders who own the corporation.
The board is answerable to the shareholders, but directors are not agents of the shareholders. They act under duties owed to the corporation itself, including a fiduciary duty to act honestly and in good faith with a view to the best interests of the corporation and a duty of care in exercising their powers. A director who receives instructions from the shareholder who nominated them to vote a particular way on a board decision is not legally required to follow those instructions if following them would not serve the corporation’s best interests.
For a public company with hundreds or thousands of shareholders, this separation of ownership from management makes sense. For a closely held private corporation with two or three shareholder-founders who are also the company’s active management, it creates a governance structure that was not designed for them. The majority shareholder controls the board, the board controls management, and the minority shareholder’s only meaningful protection against majority overreach is the oppression remedy, which is expensive to invoke and slow to produce results. By the time a court issues an oppression remedy, the business being fought over has typically suffered significant damage.
What a Shareholders’ Agreement Is
A shareholders’ agreement is a contract among the shareholders of a corporation, sometimes joined by the corporation itself, that governs the relationship between the shareholders and regulates aspects of the corporation’s management and share structure that the statutory defaults do not address. It is principally concerned with two things: allocating management control between the shareholders, and establishing the terms on which shareholders may deal with their shares.
Shareholders’ agreements come in two legally distinct categories, and the distinction between them has significant practical consequences.
A non-unanimous shareholders’ agreement, one that does not include all shareholders or that does not restrict the directors’ powers, is enforceable as a commercial contract between its parties. It can govern voting, establish rights of first refusal, mandate arbitration, and address a range of other matters. But it cannot override the directors’ statutory authority to manage the corporation. Where a conflict arises between the agreement and a director’s exercise of management discretion, the director’s statutory authority prevails. Non-unanimous agreements also do not automatically bind subsequent purchasers of shares.
A unanimous shareholders’ agreement operates under entirely different rules, and it is the unanimous form that provides the most comprehensive protection for shareholders in closely held corporations.
The Unanimous Shareholders’ Agreement: Definition and Constitutional Status
Under section 108(2) of the OBCA and section 146 of the CBCA, a written agreement among all the shareholders of a corporation, or in Ontario among all the shareholders and one or more persons who are not shareholders, may restrict in whole or in part the powers of the directors to manage or supervise the management of the business and affairs of the corporation. When an agreement meets this definition, it qualifies as a unanimous shareholders’ agreement and enjoys a fundamentally different legal status from any other contract.
The corporate constitution of a business corporation incorporated under the CBCA or OBCA model is composed of three documents: the articles of incorporation, the by-laws, and any unanimous shareholders’ agreement. What makes this hierarchy notable is that the unanimous shareholders’ agreement does not merely sit alongside the articles and by-laws. It can override them. The very purpose of a unanimous shareholders’ agreement is to displace rules of law that would otherwise apply, including some of the governance rules set out in the OBCA and CBCA themselves. Where the articles conflict with a unanimous shareholders’ agreement, the agreement prevails. The articles do not take priority.
The OBCA’s formulation is broader than the CBCA’s in one important respect. Section 108(2) of the OBCA expressly contemplates parties who are not shareholders, meaning a unanimous shareholders’ agreement in Ontario can extend its protections and obligations to a wider group than the shareholders themselves: lenders, key employees, family members, or other stakeholders with a legitimate interest in the corporation’s affairs. The CBCA limits the agreement to shareholders.
Several consequences follow from this constitutional status. First, compliance and restraining orders are available from the courts under section 253 of the OBCA and section 247 of the CBCA where officers, directors, employees, or agents of the corporation fail to follow the terms of a unanimous shareholders’ agreement. This is not available for ordinary commercial agreements: it is a remedy specific to agreements that form part of the corporate constitution.
Second, if reference to the unanimous shareholders’ agreement is made on the corporation’s share certificates, any subsequent purchaser of those shares is bound by the agreement regardless of whether that purchaser was a party to it, regardless of whether they signed it, and regardless of whether they provided any consideration to the other parties. This automatic binding of future shareholders gives the agreement a reach that an ordinary contract does not have and provides a degree of certainty in arranging the affairs of the corporation that is otherwise unavailable.
Third, for income tax purposes, a unanimous shareholders’ agreement has significance that a plain shareholders’ agreement does not. Under the Federal Court of Appeal’s 2013 decision in Canada v. Bioartificial Gel Technologies (Bagtech) Inc., a corporation can qualify as a Canadian Controlled Private Corporation even where more than 50 per cent of its voting shares are held by non-residents, provided a unanimous shareholders’ agreement gives Canadian residents the right to elect more than half of the board of directors. A plain shareholders’ agreement or voting trust cannot achieve this result because neither has the constitutional status of a unanimous shareholders’ agreement. Where CCPC status is essential to the corporation’s tax position, a unanimous shareholders’ agreement may be the only available mechanism to achieve it.
The Agreement as a Contract: Remedies for Breach
Despite its constitutional status, a unanimous shareholders’ agreement is at its core a contract. The Alberta Court of Appeal’s analysis in Sumner v. PCL Constructors Inc. is the leading statement of this principle. The court described the unanimous shareholders’ agreement as a specialized form of contract because of its unusual ability to bind non-parties and to override the constating documents of the corporation, while confirming that the primary source of remedies for its breach is the law of contract, not the oppression remedy or other statutory mechanisms.
The court in Sumner went further. It held that it was an error of law for the trial judge to search for remedies in the oppressive shareholder provisions of the applicable business corporations statute when the parties had treated the unanimous shareholders’ agreement as a contract in their pleadings and had contemplated contractual remedies throughout. Importing oppression remedies without pleading them is not permissible. If statutory relief is sought, it must be specifically pleaded, and the evidence the parties would need to introduce is different from the evidence appropriate to a pure contract claim.
This distinction has direct strategic implications. A party who discovers that a co-shareholder has breached the terms of the agreement must decide before commencing proceedings whether to frame the dispute as a contract claim, an oppression claim, or both. The decision affects the elements that need to be proven, the remedies available, and the evidence required. It also affects limitation periods, procedural requirements, and costs exposure. Making this decision correctly at the outset requires legal advice from counsel experienced in shareholder disputes.
Parties to a unanimous shareholders’ agreement are not limited to the remedies available at common law for breach of contract. The agreement itself can specify additional remedies tailored to the relationship. Common provisions include pre-agreed buy-out arrangements with specified valuation formulas that remove the scope for dispute about price when a mandatory transfer is triggered; liquidated damages provisions that simplify the recovery of a monetary remedy without the need to prove actual loss; and expanded rights to injunctive relief that lower the threshold for obtaining a court order stopping a breach in its tracks. A unanimous shareholders’ agreement may also expressly limit the range of remedies available for certain types of breach, providing a measure of predictability to the consequences of non-compliance.
Why Courts Will Not Fill the Gaps
One of the most important reasons to have a shareholders’ agreement is that without one, courts will not supply the missing terms. In Corber v. Henry, the Ontario Superior Court confirmed that where there is no unanimous shareholders’ agreement governing an unforeseen dispute, a court will not infer the parties’ shared intention about what they would have agreed had they addressed the issue. The shareholders are left to resolve their dispute under the default statutory rules, which were not designed with their particular relationship in mind.
This is a recurring pattern in closely held corporation disputes. The shareholders share a common understanding of the business arrangement when they incorporate, but that understanding exists entirely outside the legal framework. It is not in the articles, not in the by-laws, not in any document that a court can give effect to. When the relationship sours and the parties are before a judge, each side characterizes the original shared understanding differently. Without a written agreement that documents what was actually agreed, the court has nothing to work with except credibility assessments of the competing witnesses, which is an unpredictable and expensive way to resolve a business dispute.
The lesson is straightforward but worth stating directly: if the shareholders have an understanding about how the corporation will be governed, who will do what, and what happens when things go wrong, that understanding must be reduced to a written agreement to have legal effect. Handshake arrangements among founders have no legal force beyond what general contract law can establish through the uncertain process of reconstructing a verbal agreement after the fact.
The Critical Warning: What Shareholders Take On With Director Powers
The single most significant and frequently misunderstood consequence of a unanimous shareholders’ agreement is the legal liability it can impose on the shareholders who are party to it. This is not a technical footnote. It is a practical risk that every shareholder considering such an agreement needs to understand before signing anything.
Section 146(5) of the CBCA and section 108(5) of the OBCA both provide that to the extent the directors’ powers are restricted by a unanimous shareholders’ agreement, the parties to the agreement who receive those transferred powers assume all the rights, powers, duties, and liabilities that would otherwise rest with the directors, whether those duties and liabilities arise under the corporate statute or otherwise. The directors are correspondingly relieved of those rights, powers, duties, and liabilities to the same extent.
The practical consequences of this provision are far-reaching. Directors of a corporation can be personally liable for up to six months of unpaid employee wages under section 119 of the CBCA and section 131 of the OBCA. Directors are subject to environmental liability under various federal and provincial statutes. They can face personal exposure for unremitted source deductions, HST, and other tax obligations. Directors owe a fiduciary duty to act in the best interests of the corporation, including when doing so conflicts with the interests of the shareholder who nominated them. All of these duties and liabilities attach to the shareholders who assume director powers through a unanimous shareholders’ agreement.
The wage liability exposure deserves particular attention. If the corporation fails to pay its employees and the shareholders are exercising management powers under a unanimous shareholders’ agreement, those shareholders can be personally sued for up to six months of the unpaid wages. This is not a remote or theoretical risk for a struggling business. It is an exposure that can exceed the value of the shareholders’ investment in the corporation.
The fiduciary duty problem creates a different kind of risk. A director has an obligation to act in the best interests of the company, even if that is not in the best interests of the director’s nominating shareholder. A shareholder is entitled to act in their own interest. Where shareholders are exercising director powers under a unanimous shareholders’ agreement, they lose the freedom to pursue their own interests unconstrained. They cannot simply vote in their capacity as shareholders for whatever outcome benefits them most. They are now fiduciaries of the corporation and must consider its best interests when exercising those transferred powers.
For institutional investors, venture capital funds, and other shareholders who owe fiduciary duties to their own investors, this creates a potential conflict between two sets of duties. A fund manager who is also a fiduciary of the portfolio company through a unanimous shareholders’ agreement may face situations where the duty to the fund’s investors and the duty to the portfolio company point in opposite directions. Unlike a director who can resign in a crisis to escape ongoing liability, a shareholder with powers vested under a unanimous shareholders’ agreement cannot easily escape those duties short of selling all of their shares. That is rarely a practical solution.
The better approach, where specific control rights are needed but the full assumption of director powers is not intended, is to structure those rights in the articles, the by-laws, or a non-unanimous shareholders’ agreement. Veto rights that restrict the manner in which directors exercise their powers, without transferring those powers to the shareholders, do not carry director liability. The directors retain their discretion and their accountability. The shareholders can stop the board from taking actions they do not approve without themselves becoming fiduciaries of the corporation.
Section 146(6) of the CBCA and section 108(5.1) of the OBCA now expressly permit shareholders to fetter their discretion when acting under a unanimous shareholders’ agreement, resolving a debate that previously existed about whether the common law prohibition on fettering of directorial discretion applied to shareholders exercising director powers under a statutory agreement. But the statutory permission to fetter does not relieve those shareholders of the underlying fiduciary duty to act in the best interests of the corporation. That tension remains unresolved in the case law and represents an ongoing area of legal uncertainty for parties to comprehensive unanimous shareholders’ agreements.
Nominee Directors and the Conflict Between Shareholder Interests and Director Duty
In many closely held corporations, each significant shareholder nominates at least one director to represent their interests on the board. This creates a structural tension that a well-drafted shareholders’ agreement needs to address directly: the nominee director’s legal duty is to the corporation, not to the nominating shareholder.
A director must act honestly and in good faith with a view to the best interests of the corporation. That duty does not permit a director to implement the instructions of their nominating shareholder when doing so would not serve the corporation’s best interests. A shareholder, on the other hand, is entitled to act in their own interest and owes no corresponding duty to the corporation or to the other shareholders, subject to the constraints of the oppression remedy. The gap between these two positions is where most nominee director conflicts arise.
The CBCA does not permit directors to contract out of their duties to the company, except through a unanimous shareholders’ agreement. Where a unanimous shareholders’ agreement transfers specific powers from the directors to the shareholders, the shareholders who receive those powers assume the associated duties and liabilities, and the directors are correspondingly relieved of them. This is the mechanism through which the interests of nominating shareholders and the duties of their nominees can be formally aligned: by vesting the relevant decisions directly in the shareholders rather than in the board, the shareholders can exercise those decisions as shareholders, unconstrained by director fiduciary duties, while the directors are formally relieved of responsibility for those matters.
The risk is proportional to the scope of the transfer. The more extensively a unanimous shareholders’ agreement strips powers from the directors and vests them in the shareholders, the greater the shareholders’ exposure to the director liabilities that accompany those powers. The goal is to achieve the appropriate balance: transferring enough authority to the shareholders that they can protect their legitimate interests while retaining enough authority in the directors that the shareholders do not inadvertently take on the full burden of directorial liability.
One practical approach is to reserve specific high-stakes decisions to shareholder approval in the agreement without formally transferring the directors’ general management powers. Requiring shareholder approval for a defined list of reserved matters, such as major financings, dispositions of significant assets, or transactions with related parties, gives shareholders meaningful control over the decisions that matter most without triggering the full liability transfer that a comprehensive vesting of management powers would create.
Professional Corporations: A Special Restriction
Shareholders’ agreements for professional corporations operated by lawyers, accountants, physicians, engineers, or other regulated professionals are subject to restrictions that do not apply to ordinary business corporations. Under section 3.2(5) of the OBCA, a unanimous shareholders’ agreement in respect of a professional corporation is void unless each shareholder of the corporation is a member of the same profession. An agreement or proxy that purports to vest in a non-member the right to vote the rights attached to a share of a professional corporation is similarly void.
This restriction has practical significance where a professional wishes to bring a family member or a business partner into a professional corporation’s governance structure through a unanimous shareholders’ agreement. The non-professional cannot be a party to the unanimous shareholders’ agreement in the professional corporation context. Planning for succession, disability, or death in the context of a professional corporation therefore requires a different set of mechanisms than those available in ordinary business corporations, and the agreement must be drafted with the regulatory restrictions of the relevant profession in mind alongside the corporate law constraints.
Key Provisions: What a Comprehensive Agreement Must Cover
The content of a shareholders’ agreement will vary significantly depending on the size and nature of the corporation, the number of shareholders, whether the shareholders are active or passive, and the long-term trajectory of the business. The following is a comprehensive discussion of the provisions that appear in well-drafted agreements for closely held private corporations.
Share Structure and Initial Capitalization
The agreement should record the share ownership of each shareholder at inception, including the class, number, and proportion of shares held by each party. Where there are multiple classes of shares with different rights, the agreement should specify the rights, restrictions, and conditions attached to each class. If the corporation is expected to need additional capital from the shareholders, the agreement should address capital call provisions: the circumstances under which shareholders may be required to contribute additional funds, the proportion in which those contributions will be made, and the consequences for a shareholder who fails to respond to a capital call. This last point requires care. Punitive consequences for failing to meet a capital call, such as significant dilution or forced share sales at below-market prices, may constitute high-powered incentives that distort shareholder behaviour in ways that ultimately harm the corporation.
Board Composition and Reserved Matters
The agreement should establish who nominates directors, the minimum and maximum size of the board, quorum requirements, and the voting thresholds applicable to different categories of decisions. The most negotiated element is typically the list of matters requiring unanimous shareholder consent or a supermajority vote, commonly called the reserved matters. Reserved matters typically include issuing new shares or share classes, amending the articles or by-laws, approving any transaction above a defined dollar threshold, taking on significant debt or granting security over the corporation’s assets, entering into related-party transactions, changing the corporation’s business, and approving any exit or change of control transaction. The scope of the reserved matters list reflects the balance of power between majority and minority shareholders. A majority shareholder will want a short list; a minority shareholder seeking protection will want a longer one.
Share Escrow and Vesting
For corporations with multiple founders, share vesting or escrow provisions address a common and serious structural problem. All founders typically receive their shares at or near the time of incorporation, usually at nominal value to minimize immediate tax exposure. One founder then does not work out, or leaves, or the business plan changes and their anticipated contribution becomes unnecessary. That founder retains a large block of shares representing value largely created by the remaining shareholders’ ongoing work. Without a vesting or escrow mechanism, there is no legal basis to recover those shares.
Under a vesting arrangement, the founders’ shares vest over time, subject to continued employment or contribution. Shares that have not yet vested are subject to repurchase by the corporation or the other shareholders at the original issue price if the founder departs before full vesting. A common structure provides for a one-year cliff, after which a defined proportion of the shares vest monthly over a total period of three to four years. Under an escrow arrangement, the shares are placed with an escrow agent and released to the founder as defined milestones are achieved or as time passes. Both mechanisms align the founders’ interests with the long-term health of the corporation and prevent a departing founder from taking significant value that was not yet earned.
Pre-Emptive Rights
Pre-emptive rights give existing shareholders the right to participate in future share issuances on a pro rata basis, preventing dilution of their percentage ownership without their consent. They are common and generally appropriate in agreements for stable, privately held corporations where the shareholder base is not expected to grow significantly. In corporations anticipating outside investment, pre-emptive rights require careful drafting. Sophisticated institutional investors often structure their investments with specific rights carefully calibrated among the members of the investor syndicate. Injecting existing shareholders with broad pre-emptive rights into that structure can make it practically impossible to complete a financing on terms acceptable to the institutional investor. Where pre-emptive rights are included for a growth-oriented corporation, they should be subject to sunset provisions and to express exceptions for institutional financings above a defined threshold.
Rights of First Refusal
Rights of first refusal prevent a shareholder from selling their shares to a third party without first offering those shares to the remaining shareholders or the corporation. They come in two forms. A hard right of first refusal requires the selling shareholder to obtain a bona fide third-party offer and then give the other shareholders the opportunity to match it. A soft right of first refusal allows the selling shareholder to first offer the shares to the other shareholders at a price of their choosing; if the offer is declined, the shareholder may then sell to a third party at no less favourable a price. Hard rights are more protective of the remaining shareholders’ ability to control membership but more burdensome on the selling shareholder, because few prospective buyers will invest the time and cost required to negotiate a purchase they may lose to a matching right. The appropriate choice depends on whether the relevant shares are part of a control block and the degree of damage an inappropriate new shareholder could cause.
Shotgun Provisions
A shotgun provision is a forced buy-sell mechanism for resolving deadlock between shareholders. The initiating shareholder names a price per share and offers to either purchase all of the other shareholders’ shares at that price or sell all of their own shares to the other shareholders at that price. The receiving shareholder must choose within a defined period. Because the initiating shareholder does not know in advance which role they will occupy, the mechanism creates an incentive to set a fair price.
The enforcement standard for shotgun provisions was addressed by the Ontario Court of Appeal in Western Larch Ltd. v. Di Poce Management Ltd.. To be enforceable, a shotgun buy-sell offer must comply strictly with the shotgun provision in the authorizing agreement. However, strict compliance is not perfect compliance. A court will find compliance sufficiently strict and enforce a shotgun offer that contains elements of non-compliance that are commercially insignificant in the particular factual context and that can be fully and fairly remedied by damages.
Shotgun provisions require careful thought before inclusion. They are blunt instruments. A financially stronger shareholder can use the mechanism to force out a cash-poor co-shareholder by naming a price the latter cannot match on the buying side, leaving the weaker shareholder no choice but to sell at a time and price not of their choosing. Where shareholders have significantly different financial resources, this imbalance should be addressed in the agreement, either by restricting access to the shotgun mechanism to specific triggering events or by building in protections for the economically weaker party.
Tag-Along and Drag-Along Rights
Tag-along rights protect minority shareholders when a majority shareholder proposes to sell their interest to a third party. They give the minority the right to participate in the sale on the same terms and at the same price, ensuring that when control changes hands, minority shareholders are not left trapped in a corporation now controlled by a party they never agreed to be in business with.
Drag-along rights work in the opposite direction. They give the majority the right to require the minority to sell their shares alongside the majority when a defined triggering event occurs, typically when shareholders holding a specified percentage of the outstanding shares have approved a proposed sale or exit transaction. Most exit transactions require substantial majority approval, and in many structures the consent of essentially all shareholders is needed for a clean acquisition. A minority shareholder who refuses to participate can make an otherwise attractive transaction impossible to complete. Drag-along rights prevent this outcome. The triggering threshold, typically set between 60 and 75 per cent of outstanding shares, should be high enough to require genuine majority support for the transaction but low enough to prevent a small group of dissenters from blocking a sound exit.
Mandatory Transfer Provisions
The agreement should address what happens when a shareholder’s personal circumstances change in ways that could affect the corporation’s membership. The four standard triggers are death, permanent disability, bankruptcy or insolvency, and marital breakdown.
On the death of a shareholder, absent a mandatory transfer provision, the shares pass to the deceased’s estate. The corporation may find itself in business with heirs who had no prior role in the business and may have conflicting interests. A mandatory buy-out mechanism triggered by death, funded by life insurance proceeds, ensures the corporation can acquire the shares at a fair price while providing the estate with liquidity.
On permanent disability, the agreement should specify a clear and measurable condition for triggering the disability buy-out. The threshold between temporary illness and permanent incapacity is rarely obvious, and an ambiguous provision generates disputes at the worst possible time.
On bankruptcy or insolvency, the shares pass to a trustee in bankruptcy unless the agreement contains a mechanism for their mandatory purchase. A mandatory transfer provision on bankruptcy gives the remaining shareholders or the corporation the right to buy the affected shareholder’s interest from the trustee before the shares end up with an unrelated party.
On marital breakdown, shares can become subject to family property claims by a non-shareholder spouse. Courts have generally been willing to honour transfer restrictions in the divorce context by imposing a constructive trust rather than forcing a direct transfer, requiring the shareholder to hold and manage the shares for the benefit of the ex-spouse until a liquidity event produces proceeds that can be distributed. But the agreement should not rely on judicial discretion to manage this risk. Spousal consent provisions executed at the time of signing, pre-agreed valuation mechanisms, and defined buy-out procedures are the appropriate tools.
Valuation
Any provision requiring or permitting one shareholder to buy another’s shares requires a mechanism for determining the price. Formula-based valuations, such as a multiple of EBITDA or a book value calculation, are common but almost always inadequate. A formula calibrated to the business at one stage of its development will produce distorted results at another. Book value consistently undervalues businesses whose primary assets are intangible, such as client relationships, technology, or goodwill. Earnings multiples fail to capture future cash flows in a growth business.
The appropriate approach is to require the appointment of an independent, credentialled business valuator when a mandatory transfer is triggered, with reference to the most recent arm’s length transaction price as a starting benchmark if one exists. The Canadian Institute of Chartered Business Valuators sets out three levels of valuation engagement: calculation, estimate, and comprehensive. A comprehensive valuation provides the most certainty but also the greatest cost. The agreement should specify which level is appropriate for which type of transaction and allocate the cost of the valuation between buyer and seller. Deadlock provisions addressing what happens when the parties cannot agree on a valuator are also worth including.
Confidentiality, Non-Competition, and Non-Solicitation
Active shareholders in a closely held corporation acquire detailed knowledge of the business: its clients, pricing structures, competitive strategies, supplier relationships, and operational methods. The agreement should contain provisions protecting the corporation against a departing shareholder using that knowledge to compete against it. Confidentiality provisions protect against the disclosure of proprietary information during and after the shareholder’s involvement in the business. Non-solicitation provisions prevent the departing shareholder from approaching the corporation’s clients, employees, or suppliers. Non-competition provisions restrict the departing shareholder from carrying on a competing business for a defined period in a defined geographic area.
Courts will enforce these covenants if they are reasonable in scope, duration, and geographic reach. A non-competition covenant that restricts a departing shareholder from carrying on any business anywhere in Canada for ten years will not be enforced. A covenant tailored to the specific competitive activities of the corporation, limited to a geographic area where the corporation actually operates, and of a duration proportionate to the legitimate interest being protected, has a meaningful prospect of enforcement. Generic template language copied without adaptation to the specific business is the most common cause of unenforceability.
Financial Governance
The agreement should address the appointment of accountants or auditors, the approval process for annual budgets, borrowing authority and the thresholds above which board or shareholder approval is required before taking on debt or granting security, and dividend policy. Dividend policy is a particular source of conflict in owner-managed businesses where some shareholders are employed by the corporation and compensated through salary, while others are passive investors who depend on dividends for their return. An agreed-upon dividend policy prevents the majority from retaining earnings indefinitely at the expense of passive shareholders.
Information Rights
All shareholders of a private corporation have certain statutory rights to access financial information, but the scope of those rights is limited. A shareholders’ agreement can expand those rights substantially, requiring the corporation to provide shareholders with regular financial statements, management accounts, budgets and business plans, and other information relevant to their investment. For minority shareholders with no representation on the board, access to timely and reliable information is the foundation on which all other rights depend. Without information, a minority shareholder cannot identify breaches of the agreement, assess whether the corporation is being properly managed, or make informed decisions about their investment.
Arbitration and Dispute Resolution
Shareholders’ disputes are damaging in two directions simultaneously: they harm the business being fought over, and they are expensive to resolve. An arbitration clause channels disputes to a private process that is faster, less public, and generally less expensive than court litigation. The clause should specify the applicable arbitration rules, the number of arbitrators and the process for their selection where the parties cannot agree, the seat of the arbitration, and whether the arbitrator’s award is final and binding on all parties. It should also address whether interim relief, such as an injunction to stop a threatened breach, can be sought from the courts pending the arbitration, which is typically appropriate to preserve where speed of relief matters.
Term, Amendment, and Termination
Most shareholders’ agreements for closely held corporations are indefinite in duration. The agreement should specify what events bring it to an end, whether those events include the corporation’s initial public offering, the reduction of the shareholder group to one person, the sale of all or substantially all of the business, or the unanimous agreement of all parties. The amendment formula is equally important. The OBCA permits the parties to specify how the agreement is to be amended, and a simple majority amendment clause can create situations where the majority can unilaterally alter terms designed to protect the minority. Provisions requiring supermajority or unanimous consent to amend key protections are an important safeguard for minority shareholders.
The Growth Company Problem
The standard unanimous shareholders’ agreement designed for an owner-managed business is often poorly suited to a corporation that plans to grow rapidly, raise capital from outside investors, and eventually pursue a sale or IPO. The same features that provide protection in a stable, static corporation become obstacles in a dynamic environment.
The amendment and termination problem is significant. Because every shareholder is a party to a unanimous shareholders’ agreement, any amendment to its terms arguably requires unanimous consent. As the corporation grows and brings in new shareholders, many of whom may be passive investors unengaged in the details of the agreement, obtaining unanimous consent to update its terms becomes increasingly difficult. A sophisticated institutional investor who arrives years after the agreement was first signed will want different terms than those negotiated between the founding shareholders. The difficulty of modifying the agreement to accommodate them can make a financing structurally impossible.
The shotgun provision creates a related problem in a growth context. Applied to a mixed group of active founders and passive investors, many of whom lack the financial resources to exercise the buying role, a shotgun mechanism does not produce rough justice. It produces an outcome where wealthy shareholders can force less financially capable co-shareholders to sell at times and prices not of their choosing.
Perhaps most significantly, a unanimous shareholders’ agreement that is not carefully scoped can inadvertently create an impractical decision-making structure for a growing business. As the number of shareholders increases, requiring shareholder approval for management decisions through the mechanisms of a unanimous shareholders’ agreement introduces the inefficiency of large-group deliberation into decisions that need to be made quickly. Canada’s corporate legislation provides no specific procedural framework for shareholder decisions made under a unanimous shareholders’ agreement, unlike the detailed notice, quorum, and voting rules that govern directors’ meetings. The resulting procedural vacuum compounds the inefficiency.
Corporations in the growth stage should generally favour plain shareholders’ agreements over unanimous shareholders’ agreements, using voting agreement mechanics and carefully scoped veto rights rather than the formal transfer of director powers to shareholders. This approach provides the protections needed by the shareholders without the liability exposure, amendment inflexibility, and procedural complications that attend the unanimous form.
A final caution on this point: both the CBCA and the OBCA provide that any written agreement among all the shareholders of a corporation that restricts, in whole or in part, the directors’ powers to manage the business is a unanimous shareholders’ agreement within the meaning of the statute, regardless of whether the parties intended that result. An inadvertent unanimous shareholders’ agreement carries all the consequences of an intentional one, including the assumption of director duties and liabilities by the shareholder parties. Growth companies whose counsel are using familiar precedents without fully analysing whether the agreement they have prepared qualifies as a unanimous shareholders’ agreement are exposed to exactly this risk.
Enforcing a Shareholders’ Agreement
When a shareholder believes the agreement has been breached, the available remedies depend on what has been breached and by whom.
Where the breach involves conduct that also falls within the scope of the oppression remedy under section 248 of the OBCA or section 241 of the CBCA, the aggrieved party has a choice of proceeding under contract law, under the oppression provisions, or both, but they must plead the basis on which they are seeking relief clearly from the outset. The evidence required, the remedies available, and the strategic dynamics of the litigation differ significantly between a pure contract claim and an oppression application.
Where the breach involves non-compliance with the terms of a unanimous shareholders’ agreement by a director, officer, or other person bound by the agreement, a compliance or restraining order under section 253 of the OBCA is available. This remedy allows the court to compel compliance or restrain non-compliance without the aggrieved party needing to establish that the non-compliance also constitutes oppression. The availability of this remedy is one of the practical advantages of a unanimous shareholders’ agreement over a plain shareholders’ agreement.
Where the agreement contains an arbitration clause, most disputes must be initiated through arbitration rather than through the courts. The courts retain jurisdiction to grant interim relief, such as an injunction preventing a threatened breach from occurring or continuing while the arbitration proceeds, but the merits of the dispute will be resolved by the arbitrator.
Limitation periods are a critical practical consideration. Ontario’s basic two-year limitation period under the Limitations Act, 2002 applies to most breach of contract claims arising from shareholders’ agreements, running from the date the aggrieved party knew or ought to have known that a breach had occurred. Missing the limitation period extinguishes the right to pursue the claim regardless of how clear the breach may be.
A well-drafted shareholders’ agreement is one of the most important documents a private corporation will ever have. A generic agreement or one copied from a precedent without adaptation to the specific circumstances of the corporation and its shareholders creates risks that may not be visible until a dispute has already erupted. Our shareholders’ agreement practice advises shareholders and corporations on drafting, reviewing, amending, and enforcing shareholders’ agreements, as well as on shareholder disputes arising from their breach. Contact our business law practice to discuss your situation.
