The Shareholders’ Agreement

When dealing with a closely held company with more than one shareholder, you will always want to advise the shareholders of the need to consider a shareholders’ agreement. If you are on a joint retainer from all the shareholders to draft the agreement, you should recommend that each of the individual shareholders have the agreement reviewed by an independent lawyer before signing. If you are on a retainer from just one of the shareholders to draft the shareholders’ agreement, then advise the others you are not acting for them and that each should seek independent legal advice.

A shareholders’ agreement can be an effective way to set out the details of how a business will be run. Properly drafted, a shareholders’ agreement can provide clarity for the shareholders around issues such as the roles that each will play in the business, how profits and costs will be shared, how disputes will be resolved and what rights the estate of a deceased shareholder and the remaining shareholders will have in the event of death or disability. Normally the company will be a party to a shareholders’ agreement along with the shareholders because it typically contains provisions which impose obligations between each shareholder and the company as well as among the shareholders themselves. Examples of these are confidentiality and non-competition covenants, obligations on the company to repurchase shares in the event of the death or disability of a shareholder, etc. If the shares of an operating company are themselves held by other holding companies, you might consider also adding the principals of the holding companies as parties to the shareholders’ agreement.

Shareholders’ agreements are important documents and they must be drafted carefully. Clients will often ask for a “simple” shareholders’ agreement (although there may be no such thing), and they may initially balk at the cost that a proper, comprehensive agreement entails. It can be helpful to ask them if they have considered the following issues that have been known to keep litigators busy:

  1. A shareholder is frozen out of participation in management contrary to expectations.
  2. Two shareholders cannot get along but neither can push the other out.
  3. The “entrepreneur” shareholder wants to take a new direction.
  4. The founding parent or siblings cannot get along and have a lot of emotional baggage.
  5. Marriage breakup (resulting in a claim to the shares by the shareholder’s spouse).
  6. A new shareholder enters the company by inheritance.
  7. A shareholder becomes the “odd man out” with others ganging up on him or her.
  8. Someone is steering business to a different entity (“feathering the wrong nest”).

The “honeymoon” phase of a new business venture is the best time to ask crucial questions concerning the nature of the business, including:

  • how long it will continue;
  • the work and participation commitments of the parties (e.g., who will manage and run the business on a day-to-day basis);
  • who is to be a full-time employee and how they will be paid;
  • the expected capital contributions from each party, and whether funds will be advanced as shareholder loans or as capital (i.e., subscription price for shares);
  • the sharing (or not) of responsibility for pledges of personal credit;
  • what issues require approval of all the shareholders regardless of their voting rights;
  • how money will be distributed; and
  • how to unwind the company if the honeymoon turns into a divorce.

Note that the BCA provides that certain provisions governing the conduct of a company’s affairs must be included in the Articles of the company if they are to be effective. Examples include s. 172 (requirements for quorum at a general meeting); s. 125 (directors’ share qualification provision); s. 140(1) (directors’ meetings held by telephone); and s. 77 (right to redeem or purchase the company’s shares). A shareholders’ agreement should therefore always contain a provision requiring the shareholders to amend the Articles so that the Articles are consistent with the shareholders’ agreement in the event of an inconsistency or conflict between the documents.

It is useful to have a dispute resolution mechanism in a shareholders’ agreement, even if it is only a shotgun buyout clause (Ex. Group A demands to end the business relationship. They say to Group B "We will buy your shares for XXX amount." Alternatively, Group B can counter with "No. We will buy YOUR shares for that very same amount." A purpose of this counter-offer option is to try to ensure that those attempting to buy out the other party will offer a fair price, if not a premium). Such a mechanism will result in the separation of the feuding shareholders, and compensation for the departing shareholder. To the extent possible, the mechanism of unwinding should require the recalcitrant shareholder to do as little as possible to make it work. Company law material available on-line and a comprehensive precedent agreement is also available in The British Columbia Company Law Practice Manual (looseleaf, The Continuing Legal Education Society of BC).

Community Discussion

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The objectives of a shareholder's agreement are clear. But why not make all these terms part of the corporation's articles so that there is only one document the shareholder's must comply with?