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The Importance of Shareholders’ Agreements for Private Corporations

Jillian-Casual small pic for website-onwhiteWhen incorporating a corporation with other individuals or purchasing shares in an existing corporation as a way of partnering in business with others, taking the time to negotiate a Shareholders’ Agreement is always strongly advised. A Shareholders’ Agreement is a highly valuable document that not only sets out the current organizational structure of a corporation but also ensures that the shareholders of a corporation are in agreement as to how various issues will be dealt with should they arise.

Among the many issues that may be addressed in these types of agreements, some of the main ones are as follows:

  1. Corporate Affairs

Generally, one of the first things a Shareholders’ Agreement will address will be the operation and control of the corporation – who will the Board of Directors consist of, who will hold the officer positions of the corporation and what duties/ responsibilities will those individuals have. A Shareholders’ Agreement will also outline those decisions that will require unanimous approval of the Board of Directors and of the shareholders of the corporation in order to ensure that no one individual director, officer or shareholder will have the power to make major corporate decisions without the knowledge and consent of the other directors or shareholders. Unanimous consent is often required for the following:

  • Any action that may result in a material change in the nature of the business;
  • The declaring of dividends;
  • The issuing or selling of any new shares in the capital stock of the corporation;
  • The increasing or decreasing of the capital of the corporation or altering in any way its capital structure;
  • The selling, transferring, assigning or charging of any shares in the capital of the corporation or redeeming or purchasing for cancellation any such shares;
  • The selling or disposing of the whole or a substantial part of the business or the assets of the corporation; or
  • The instituting of proceedings for the winding up, reorganization, amalgamation or dissolution of the corporation.
  1. Death of a Shareholder

If one of the shareholders should die, a Shareholders’ Agreement will often stipulate that the corporation shall purchase and the executor of the deceased shareholder’s estate shall sell all of the deceased shareholder’s shares in the corporation as at the date of his/her death. Once the corporation has purchased the deceased shareholder’s shares, these shares are generally then cancelled by the corporation so that the shareholding percentages of the remaining shareholders remains unchanged. Often, this type of transaction will be scheduled to take place within a few months of the deceased shareholders’ death in order to minimize any potential disruption to the carrying on of business by the corporation. Provision is usually made that between the date of death of a shareholder and the closing of the purchase and sale transaction that the parties are only to cause or permit to be done things within the ordinary course of the business of the corporation. Thus, the executor of the deceased shareholder’s estate would be prevented from doing anything out of the ordinary course of business during the period of time it would take to complete the purchase and sale transaction. Generally, it is also advised that a corporation take out life insurance policies on all of its shareholders in order to ensure that upon the death of any shareholder, the proceeds of the deceased shareholder’s life insurance policy will be available to the corporation to ensure that at least part, if not all, of the necessary funds will be available to the corporation for the purchase of the shares.

  1. Buy/Sell Provision in the Event the Shareholder Relationship Breaks Down

A Shareholders’ Agreement may provide for the occurrence of a breakdown in the relationship of the shareholders of a corporation and the process they can go through in order to discontinue their business relationship. If the buy/sell provision of a Shareholders’ Agreement is triggered by one of the shareholders, this shareholder must be equally prepared to either purchase all of the shares of the corporation held by the other shareholders or to sell all of their shares in the corporation to the other shareholders. When this provision is triggered the shareholder triggering the provision (the “Offeror” in this instance) will deliver notice to all the other shareholders of the corporation. The Buy/Sell notice will outline the fair market value of the shares and contain both an offer to purchase all of the shares of the corporation owned by the other shareholders on specific terms and conditions as well as an offer to sell all of the Offeror’s shares to the other shareholders proportionately on the same terms and conditions. Upon receipt of a buy/sell notice, the decision making power shifts into the hands of the other shareholders, who will have a limited amount of time to decide which option they would like to choose. Hypothetically, if there are two remaining shareholders in the corporation then any one or both of them may decide to purchase the Offeror’s shares. If one of the remaining shareholder’s chooses to purchase the Offeror’s shares while the other remaining shareholder chooses to sell his/her shares, then the remaining shareholder who chose to purchase the Offeror’s shares will also be required to purchase the other remaining shareholder’s shares, thus becoming the sole shareholder of the corporation in the process. If all the remaining shareholders jointly fail to choose either option within the specified time period, they will all be deemed to have accepted the first offer, being to sell all of their shares to the Offeror so that he/she would become the sole shareholder of the corporation.

  1. Incapacity of a Shareholder and Events of Default

A Shareholders’ Agreement also generally provides for a number of situations, the occurrence of any of which would require a shareholder to sell his/her shares to the other shareholders of the corporation. If any of the events provided for are triggered, the shareholder triggering the event will be deemed to have offered his/her shares to the other shareholders of the corporation in their proportionate share on the day before the triggering event took place so as to prevent an outside individual or corporation from gaining access or control of the shares. Triggering events often include the situation where:

  • due to the mental incapacity/incompetence of a shareholder, the Public Guardian and Trustee would take control of the shareholder’s estate and begin making decisions on the incapacitated shareholder’s behalf;
  • a shareholder becomes injured, either mentally or physically, and as a result is unable to carry out his/her normal functions/duties as a director of the corporation;
  • a shareholder becomes subject to a petition in bankruptcy or insolvency which is not rectified within a specified period of time or the shareholder enters into an arrangement or assignment of the benefit of his/her shares to creditors in order to settle a debt owed;
  • a shareholder involuntarily transfers his/her shares in the corporation to a creditor in total or partial satisfaction of any debt, obligation or other liability. This provision often includes the situation where a judgment by a court is made against a shareholder which may indirectly transfer the shareholder’s rights to his/her shares in the corporation to a creditor; or
  • a shareholder going through a divorce becomes subject to a direct or indirect court order that would affect his/her rights to his/her shares in the corporation.

While shareholders can at times be reluctant to spend the time and incur the expense of negotiating a Shareholders’ Agreement, this document enables the shareholders of a corporation to make adequate provision at the outset of their business relationship for the potential occurrence of various situations to ensure that the business of the corporation will continue to run seamlessly when faced with certain internal corporate challenges.

As a part of the Lancaster, Brooks & Welch Corporate and Commercial team, Jillian Ali assists clients in all aspects of their business legal needs. She may be contacted at 905-641-1551.

 

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