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THE SHAREHOLDERS AGREEMENT: The most important agreement of your Company!

First and foremost a contract, a shareholders agreement has all the ingredients thereof, for it to be binding and legal.  There is an offer and acceptance, consideration, capacity, and above all a bona fide legal purpose. They (shareholders agreements) are a class of contracts relating specifically to the relationship between some or all of the shareholders of a corporation and, possibly, between those parties and the corporation. In addition to falling under the common law regime of contracts, some, but not all, shareholders agreements are dealt with in the Ontario Business Corporations Act (OBCA) or Canada Business Corporations Act. Shareholders agreements as per Section 108 of the OBCA can deal with any one or both of the following:

  1. A written agreement between two or more shareholders can decide on the exercise of voting rights attributable to the shares held by each of them; and
  2. A unanimous shareholders agreement (USA) is a written agreement among all of the shareholders of a corporation restricting, in whole or in part, the powers of the directors to manage the business and affairs of the corporation.

A USA is also deemed to exist when a person owns all the registered, issued and outstanding shares of a corporation.

Functions

A shareholders agreement is typically an agreement meant to deal with voting rights. Signatories to the agreement have consented to vote their shares in a particular manner and/or to provide for proxies which would allow the shares to be voted in a particular manner. There could also be attempts to grant other rights to the parties in respect to the shares held by them, like limiting share transfers to the arrangements permitted by the agreement and/or providing for certain pre-emptive rights, like rights of first refusal on any disposition of shares governed by the shareholder agreement.

The provisions of the corporation’s articles of incorporation offer the guidelines to all rights granted in a shareholder agreement. Say, the articles will provide for a certain number for the board of directors, a restriction which could not be supplanted by any provision in a shareholders agreement.

The difference of a USA from other shareholders agreements stems from the fact that it has to be initially signed by all of a corporation’s shareholders. It also happens to be the only contractual mechanism by which the powers of the directors to manage the business and affairs of the corporation can be controlled.

A USA controls:

  • The manner in which the directors manage the business and affairs of the corporation;

and may also control:

  • The manner in which all shareholders may vote their shares;
  • The manner in which all shareholders may transfer or otherwise dispose of their shares;
  • Mandatory transfers in the event of disability or death; and
  • Dispute resolution in the event of conflict.

All Ontario corporations subject to a USA, the OBCA  provisions apply and give a shareholder who is a party to the USA all the rights, powers, duties and liabilities of a director of the corporation, whether arising under this Act or otherwise including any defences available to the directors to the extent the USA restricts the powers of the directors.

There is a broad application of this attribution of duties and liabilities including, for instance, a director’s liability to employees for wages. Care is to be taken in drafting USA provisions to ensure that the shareholders do not unknowingly acquire liability that would ordinarily vest in directors with respect to certain aspects of the management and supervision of the corporation’s business. The consequences for shareholders who acquire directorial liability are potentially expansive and severe according to the common law and various statutes.

Common provisions of a USA

The USA is the most comprehensive shareholders agreement that is prepared for a corporation and its shareholders. There are many forms of shareholders agreements, none of them a prototype, but most of them deal with some or all of the matters given below.

The Parties

Unless all the shareholders are party to the agreement, the USA is not effective. Normally, the corporation is also a party to the agreement. A USA stipulates how the management of the business and affairs of the corporation by the directors is to be restricted and the agreement could therefore mandate certain matters, like that a particular bank will be the banker of the corporation and would require that certain actions can only be taken with the consent of the shareholders or a particular majority of the shareholders, say, while issuing additional shares.

Share Transfers

To control the issuance and transfer of shares within the corporation and among its shareholders is the principal objective of most shareholder agreements, including a USA.  This is done by prohibiting share transfers and issuances except as specifically permitted by the agreement. Thereafter, common mechanisms known as “shotgun” clauses and rights of first refusal are used to control transfers.

Shotgun Clauses

It is a mechanism used to sell the shareholder’s own shares or acquire the shares of any other shareholder. In the common shotgun/buy-sell arrangement, the triggering shareholder fixes the price per share for a purchase of another shareholder’s shares, or for the sale of the triggering shareholder’s shares, in a notice that is delivered to the other shareholder. It can be an offer to buy, or an offer to sell. It is for the recipient to buy the shares of the shareholder who has given the notice, or sell the recipient shareholder’s own shares, at the price per share fixed by the “offer”. A shotgun or buy-sell provision works equitably when each of the parties has sufficient financial capacity to exercise a purchase under the shotgun. When the parties are not of equal financial capacity, this type of clause works unfairly against the party of limited means. To try to limit such possible unfair dealings, some agreements provide a specific time delay before any shareholder can use the shotgun/buy-sell provision. Another measure is the inclusion of a “penalty” clause. If the purchasing party fails to complete the share purchase according to the applicable clause, a penalty is invoked to allow for the sale of the shares of the defaulting shareholder at a significant discount.

Rights of First Refusal

Such rights are often used in shareholders agreements and provide a shareholder with the right to purchase the shares of another shareholder who has received a written offer from an arm’s length third party to purchase that shareholder’s shares. Considering that the shareholder is willing to accept, the purchase would be made on the same terms and conditions as set out in the arm’s length offer to purchase. Right of first refusal may appear harmless, but it is a significant restriction on the right of any shareholder to dispose of his or her shares to a third party. Actually, it is very difficult to sell shares subject to a right of first refusal without help from the shareholders who benefit from the right of first refusal in the sale process. Nobody wishes to be third parties so as to allow rights of first refusal to run their course.

Piggyback

It is a meaningful mechanism for the protection of minority shareholders. The piggy-back clause contains provisions which require a selling shareholder to obtain a genuine offer in writing from a third party. Such third party is to offer a fixed price per share for not only the shares of the selling shareholder, but also the shares of all minority shareholders. The piggyback clause therefore gives those minority shareholders the option to sell their shares at the same price per share, and on the same terms, as the selling shareholder.

Mostly, when a piggy-back clause is used, it is intended to provide minority shareholder protection and to apply to a majority shareholder selling his or her shares. Otherwise a piggyback clause may apply to all shareholders such that any selling shareholder must first obtain a third party offer which would allow all other shareholders to sell their shares at the same price per share, and on the same terms, as the selling shareholder.

Although there are many other clauses, techniques and strategies to be used when drafting perhaps the single most important agreement of your company, without a seasoned and well experienced lawyer to do just that, you are almost guaranteed to be faced with hurdles and problems in dealing with shareholder issues, cashing-out, exiting, transferring shares, running the business, choosing investors, obtaining financing, and much more.  Contact the Lawyers at Levy Zavet PC the next time you need to setup a corporation and draft the Shareholders Agreement.

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