The expression “the more the merrier” is not one typically invoked in the context of a private corporation’s shareholders. There, the more shareholders, the greater the potential for disagreements. One option to mitigate or resolve problems is a Shareholders’ Agreement. A Shareholders’ Agreement is a contract addressing, first and foremost, how the shareholders of a corporation relate to one another. Here are five reasons to consider a Shareholders’ Agreement.
1. Establish how shareholders exercise their voting rights
A Shareholders’ Agreement may set out how the shareholders will vote with their shares. This could involve electing, as a director, a nominee of a particular shareholder. Other corporate changes of a fundamental nature requiring shareholder approval (e.g. changing the capitalization of the corporation) may also be addressed in a Shareholders’ Agreement.
2. Reduce matrimonial conflict problems
Under Ontario’s Family Law Act, shares in a private corporation can sometimes be employed to satisfy equalization or support obligations upon matrimonial breakdown. Thus an individual unfamiliar with the business and affairs of a corporation may be thrust into an ownership position by acquiring shares from their former spouse. This may lead to (predictable) concerns for the other, remaining shareholders. A well-drafted Shareholders’ Agreement can account for this possibility by requiring:
- A shareholder undergoing matrimonial breakdown to sell shares to the remaining shareholders; or
- The signing of an enforceable contract which, among other things, waives any claim on shares from each shareholder’s spouse.
3. Control how shares may be transferred or issued
These provisions provide certain share sale rights to existing shareholders who want to market their shares. One such provision is a right of first refusal. Consider the following scenario:
A and B are shareholders of a corporation. A’s friend, C, has made A an offer to purchase A’s shares. If a right of first refusal were in place, A may be required to first offer A’s shares (on the same terms and conditions as C’s offer) to B before completing a transaction with C. In other words, C’s likelihood of purchasing A’s shares will depend upon whether B is willing and able to acquire those shares. Other provisions in a Shareholders’ Agreement may deal with the conditions under which a corporation may issue shares from treasury, or how the shareholders may transfer shares amongst themselves, or to third parties.
4. Restrict directors’ powers to manage the business and affairs of the corporation
A Unanimous Shareholders’ Agreement (“USA”) is a type of Shareholders’ Agreement which, as the name suggests, includes all of a corporation’s shareholders. It is the only contractual mechanism by which shareholders can curtail directors’ powers to manage the business and affairs of a corporation. A USA empowers shareholders by presumptively affording them “all the rights, powers, duties and liabilities” of a corporation’s directors under Ontario’s Business Corporations Act. Shareholders considering a USA must be careful not to unwittingly assume director-specific liabilities.
5. Provide for a shareholder’s incapacity, death or insolvency
Upon the incapacity, death or insolvency of a shareholder, a corporation’s remaining shareholders may be worried about an unfamiliar third party acquiring the incapacitated, deceased, or insolvent shareholder’s shares. The concern is similar to the issues around matrimonial conflict. A Shareholders’ Agreement can address this problem by giving the remaining shareholders the option to purchase the at-risk shares, and/or compelling the incapacitated, deceased, or insolvent shareholder’s personal representative to sell such shares to the existing shareholders. Amongst other things, consideration needs to be given to: (1) which health circumstances of a shareholder will constitute incapacity; (2) how the purchase of the shares will be financed; and (3) how the shares’ valuation will be ascertained.
It is advisable to have a Shareholders’ Agreement in place before it is needed. Doing so allows shareholders to develop a framework for addressing problems before they arise – and before emotions can overtake all involved.
Contact Lerners LLP today to discuss your Shareholders’ Agreement.