A shareholder agreement is first and foremost a contract which must be in writing and must be signed by the shareholders who are party to it. Shareholder agreements are a class of contracts that relate specifically to the relationship between some or all of the shareholders of a corporation and, often (although not necessarily), between those parties and the corporation. While shareholder agreements are specific to each company and its shareholders, most of these documents deal with the same basic issues.
When Should a Shareholder Agreement be executed?
It is always best to implement a shareholder agreement from the beginning. This will force the shareholders to think about rights, obligations, and commitments to set out expectations early on. Many times shareholders have verbal agreements or discussions in passing; this can often be forgotten, disputed or deficient. It is usually more difficult to enter into an agreement later on when progress has been made due to possible issues between shareholders. Once a dispute arises, an agreement will most likely not be entered into which leaves court action as the only avenue to resolve the dispute– this process is usually deficient, time consuming and costly.
What type of rights and procedures do Shareholder Agreements encompass?
A shareholder agreement may attempt to grant rights to the parties with respect to the shares held by them. These rights may include:
- limiting share transfers to the transactions permitted by the agreement and/or providing for certain rights of first refusal on any disposition of shares governed by the shareholder agreement;
- giving existing shareholders a pre-emptive right to purchase shares issued from treasury before they can be issued to other persons or entities;
- giving a shareholder (or group of shareholders) with a significant interest in the corporation approval rights over fundamental transactions such as a sale of the corporation or any of its material assets or the incurring of indebtedness; and
- receiving certain financial and other information regarding the corporation beyond the minimum disclosure obligations of the applicable corporate statute.
Shareholder agreements may also set out rules for the transfer of shares when certain events occur, such as the death, disability, retirement, individual bankruptcy or divorce of a shareholder. An agreement can include detailed provisions governing when a shareholder can or must sell their shares, or what happens to those shares after the individual shareholder has left. These provisions are complex and usually set out mechanisms to manage the transfer, including how the transfer price will be calculated and funded.
Other shareholder agreement provisions may include non-competition clauses, confidentiality agreements, dispute resolution mechanisms and details respecting how the shareholder agreement itself is to be amended or terminated.
Factors affecting the complexity of Shareholder Agreements
- Who are the parties (e.g. voting and non-voting shareholders)?
- What mechanism will be used by the shareholders to elect or appoint board members?
- What mechanisms will exist for shareholders to sell or transfer their shares (e.g. shotgun, put/call, consent sales, auctions, piggy back, drag a long, etc.)?
- What mechanisms will enable a shareholder to be bought out if a dispute arises or if they would like to move on from the business?
- What about compensation for shareholders who become working shareholders/directors?
- What about confidentiality, non-solicitation, and proprietary information provisions? Are these needed?
- How will the agreement be terminated?
- How will the shares of a shareholder be dealt with on death, incapacitation or disability?
Different methods to transfer shares under a Shareholder Agreement.
Here are some of the ways in which share transfers are permitted/restricted:
Consent Sale: a shareholder can transfer their shares after obtaining the consent of a pre-determined number or percentage of other shareholders.
Right of First Refusal: a shareholder who receives an offer from a third party for the purchase of their shares must first offer the other existing shareholders the opportunity to purchase those same shares on terms, for example, that are equivalent to the third party’s offer.
Shot Gun Buy-Sell: a shareholder can name a price at which it is willing to either buy or sell its shares. The offer is then presented to other shareholders who have a specific amount of time to decide whether to accept the offer.
Right to Come Along (Piggy-Back): when a shareholder who sells to a third party, the other shareholders are entitled to have their shares sold on, for example, the same terms to that third party.
Right to Take Along (Drag Along): when a shareholder sells to a third party, the other shareholders are forced to have their shares sold on, for example, the same terms, to that third party.
Option to Purchase (Call Option): this right gives a shareholder/Corporation the option to purchase shares in certain circumstances (these are called Triggering Events) from the Corporation/shareholder.
Option to Sell (Put Option): this right gives a shareholder/Corporation the option to sell shares in certain circumstances from the Corporation/shareholder.
Auction: an auction is a mechanism whereby shares are sold to the highest bidder (or on certain terms of the auction) to third parties.
Shareholders, Share Ownership and the Family Law Act
Many shareholders are concerned that matrimonial conflict may destabilize the shareholdings of a corporation. In some cases, care is taken at the time a Shareholder Agreement is prepared to ensure that the spouse of each participating shareholder produces a waiver of any claims to the shares of the shareholder or a waiver of any right to information respecting the corporation, together with a certificate of independent legal advice. It is, however, frequently not possible to obtain such documentation. An alternative would be to require the sale of the shares of any shareholder in the event an application or proceeding is brought by or against that shareholder under the Family Law Act (FLA). In such an event, the shareholder involved would be required to provide satisfactory evidence to the other shareholders within a fixed period (e.g., 90 days) that the claims being asserted in the proceedings shall not affect, encumber, or interfere with that shareholder’s shareholdings.