A shareholder agreement is an excellent corporate governance tool that can protect minority shareholder interests, safeguard the company’s competitive interests, and regulate ownership and voting rights. Its flexibility allows shareholders to anticipate a variety of situations that the corporation may encounter and to predetermine shareholder and corporate action. A well drafted shareholders agreement ensures the smooth flow of the corporation’s day-to-day business, and provides for the efficient resolution of contentions situations.

Notwithstanding these benefits, there are also precautions to be noted with respect to the liability of shareholders party to a unanimous shareholder agreement (a “USA”) and items that must be addressed when transferring shares subject to a shareholder agreement.

Initial Considerations and Negotiation

Before entering a shareholder agreement, a prudent shareholder (or her lawyer) will ask herself many questions, including: How much influence do I need to protect my investment? How much financial exposure and legal liability can I withstand? Do I need to be able to exit the company on short-notice? Do I want to be able to purchase additional shares or options? Who will manage the company? What will happen if the manager exits the company? Will non-arm’s length transfers for tax-planning purposes be permitted?

Once the shareholder has ascertained what is important to her, she will begin to negotiate the agreement. In many cases, negotiation will be completed amicably and informally between shareholders; in other cases shareholders may request their lawyers to handle the negotiation. Either way, negotiation of a shareholder agreement is not usually a contentious process and most problems that do arise can be resolved through cooperation, communication and creative drafting.

Common Provisions

Some of the more common provisions in shareholder agreements provide for the following effects:

• control and management of the company (i.e. the power for specific shareholders to appoint nominees to the board of directors and the imposition of “super-majority” voting requirements for reserved matters that are of key importance to the parties);
• restrictions on the transfer of shares (i.e. rights of first refusal and piggy-back rights);
• anticipation of involuntary share transfers (i.e. on the death of a shareholder or the division of net family property in matrimonial proceedings);
• protection of the corporation’s competitive interests (i.e. restrictions on a shareholder’s ability to participate in a competing business);
• resolution mechanisms for future disputes between the parties (i.e. the rotation of a casting vote among the parties and mandatory mediation);
• tax planning (i.e. permitting a holding company to hold the corporation’s shares and for the beneficial owner to sell the shares of the holding company to make use of the lifetime capital gains exemption);
• exit alternatives (i.e. put / call options, shotgun clauses and methods for valuation); and
• funding arrangements (i.e. capital call provisions and pre-emptive rights to purchase)

Privacy

A shareholder agreement can also be an effective tool for keeping the relationship between shareholders and the company out of the public eye. A company registered under the Ontario Business Corporations Act RSO 1990, c B.16 (“OBCA”) or under the Canada Business Corporations Act RSC 1985, c C-44 (“CBCA”) must permit its shareholders and creditors, and their agents and legal representatives to examine the general corporate records, including the articles and by-laws, during normal business hours (CBCA s. 21(1); OBCA s. 145(1)). Shareholder agreements, on the other hand, are governed by contract law (as opposed to the federal and provincial legislation), and as such, they are not usually subject to compulsory disclosure.[1]

Liability

If all of the registered shareholders of the company are party to the shareholders agreement, it becomes a USA. Due to its unanimity, a USA is capable of restricting the powers of the directors to manage the business and affairs of the corporation; a restriction of the directors’ power results in those powers being transferred to the shareholders. Once transferred, the shareholders also take on the rights, duties and liabilities of the directors under corporate statutes or otherwise (OBCA s. 108(5); CBCA s. 146(5)). For example, these liabilities could include: liability under the applicable corporations act (i.e. for 6 months wages for employees, for issuing shares for property of insufficient value, or for payment of dividends or acquisition of shares by the corporation in breach of statutory solvency tests); tax liabilities (i.e. for income tax, source deductions, or HST); and liability for amounts under other non-corporate statutes (i.e. Employment Standards Act, Environmental Protection Act, Pension Benefits Act).

The Issue and Transfer of Shares and the “Deemed Party Rule”

Where shares of a corporation governed by a USA are transferred, the transferee is deemed to be a party to the USA, provided that a reference to the USA is clearly noted on any share certificate representing the transferred shares (CBCA ss. 49(8), 146(3) & (4); OBCA ss. 108(4)). If no notice of the USA is given to the transferee, the transferee may rescind the transaction within 30 days of becoming aware of the USA under the CBCA (ss. 146(4) & 49(8)), or 60 days after receiving a copy of the agreement under the OBCA (ss. 108(9) & (10)). The OBCA has a similar provision regarding the issuance of shares from treasury (s. 108(7)); however the CBCA is lacking in this respect, and as such, there should be a condition in the USA or the company’s by-laws that a non-shareholding subscriber agrees to be bound by the USA.

Conversely, shares transferred that are subject to a non-unanimous shareholders agreement, do not automatically bind the transferee to the terms and conditions of the agreement. As such, there should be a condition in the shareholders agreement that before any shares are transferred, the transferee agrees to be bound by it. The same is applicable with respect to a new subscriber of shares issued from treasury.

Conclusion

Good corporate governance is crucial in today’s marketplace. Taking the time to negotiate and draft a detailed shareholder agreement can protect corporate interests; outline exit strategies; provide tax planning devices; and prevent future disputes amongst shareholders. Taking the time to address these items will contribute to the smooth flow of the corporation’s day-to-day operations and provide a solid foundation for growth.

Please do not hesitate to contact Scott Lemke at slemke@lemkelaw.com with any questions or comments.

[1] Both the CBCA and OBCA require the disclosure of a USA to shareholders and creditors, upon their request and attendance at the Corporation’s registered office, or such other place in Ontario designated by the directors (OBCA s. 145(1); CBCA s. 21(1)).