A Shareholders Agreement is a written contract between some or all shareholders of a corporation. It establishes the structure of the relationship, defines expectations, and creates the rules for governing the business and relationships. We understand that that entrepreneurs typically endure long, busy days filled with many tasks and meetings. As a result, it is not uncommon to see business owners unintentionally overlook the importance of a shareholders’ agreement once the corporation is established. This article will highlight a few of the benefits of a shareholders’ agreement, and why we almost always recommend that we one be implemented for a corporation.
Absent a shareholders’ agreement, in the event of a dispute the shareholders, legislation will help govern corporate affairs and resolve any disputes. For example, according to the Act, directors are elected by ordinary resolution of the shareholders. If one shareholder has more than 50% of the votes, this majority shareholder has the power to determine who can sit on the board. As one can imagine, this situation may not work for all private corporations, as it can bestow a great deal of power and control to one shareholder. Since businesses are not “one size fits all”, appropriate tailoring ought to be made at the outset.
A Shareholders Agreement will establish who will be elected to the board of directors, or a provide a mechanism for electing the directors. The process outlined in the shareholders’ agreement typically involves all shareholders. It is not uncommon in small, closely held private corporations to grant all shareholders the right to sit on the board through the shareholders’ agreement, or the right to nominate a representative.
A Shareholders Agreement will also typically prevent the transfer of shares unless specifically authorized under the agreement. Absent an agreement, two-thirds of the shareholders/directors could, for example, issue shares by ordinary resolution to themselves without requiring the permission of the remaining one-third shareholder(s)/director(s). Through a shareholders’ agreement, a corporation may, for example, require that consent of all directors be obtained prior to approving a transfer of shares. There are other mechanisms to control the transfer of shares, and shareholders may wish to insert specific clauses, like a “Right of First Refusal” clause, a “Buy-Sell” clause, among many others.
Shareholders’ agreements can establish a method of valuing the Corporation’s shares. Typically, the parties spell out the exact method of obtaining the share’s fair market value. This type of clause can be especially important when a minority shareholder wishes to sell its shares. Absent this agreement, it can be difficult for the minority shareholder to sell its shares to a third party, and therefore a majority shareholder will be the likely purchaser of its shares. As one can imagine, the majority shareholder has an interest in keeping the share price low. Therefore, to avoid potential conflict, shareholders should spell out the mechanism for valuation in advance.
In the event of a dispute, the parties will have agreed upon a dispute resolution mechanism. It is usual to find Arbitration or Mediation Clauses in Shareholders’ Agreement. This clause provides that, in the event of a dispute (either generally or in defined circumstances), the parties will select an arbitrator or mediator and proceed to the selected alternative dispute resolution. This will prevent private disputes from becoming public through the court system, and allows for a quicker resolution of a dispute.
Through a Unanimous Shareholders’ Agreement (USA), the shareholders take away power from the directors to manage the affairs of the corporation. In other words, the shareholders can give themselves greater power, while restricting the powers of the directors of the corporation. According to the Business Corporations Act (Ontario) and the Canada Business Corporations Act, where a USA exists, a shareholder who is a party to the USA has all the rights, powers, duties and liabilities of the directors to the extent that the USA restricts the powers of the directors to manage the business of the corporation. The shareholders can determine in advance which decisions are so important that they require unanimous shareholder approval prior to proceeding with a transaction.
The agreement will typically also dictate how shares will be transferred upon certain events, such as a death, disability, resignation from the company, bankruptcy or divorce. It can dictate that in these events, the shares must be transferred to the remaining shareholders instead of, for example, a spouse or other family member of the shareholder. Shareholders can also decide how they wish to obtain the funds necessary to run the business. The rules can spell out exactly how the capital is to be obtained, how each shareholder is to contribute, how and when guarantees are to be given, and the penalties for a failure to comply.
There are many other provisions that can be agreed upon by shareholders in advance. We recommend sitting down with a corporate lawyer to discuss the many provisions that will help structure and govern your corporation as it grows. Conduct Law is an Ottawa based business law firm with locations in Ottawa, Barrhaven, Kanata and Winchester. Our professionals are experienced business lawyers who can help with corporate, estates, commercial real estate, or implementing corporate structures that assist with tax planning, whether as an operating corporation, holding corporation, partnership, family trust, testamentary trust, or many other types of legal entity depending on your legal corporate requirements.