Shareholders' agreements

What is a Shareholders' Agreement?

A Shareholders Agreement is an essential, legally binding document for any Canadian corporation, especially those with multiple owners. This private contract, which must be in writing and signed by the participating shareholders, meticulously outlines the rights, responsibilities, and obligations of each shareholder.

Its main objective is to regulate and structure the relationship between shareholders and clarify their commitments to the business. Often likened to a “marriage contract” for business associates, it’s a foundational step towards proper corporate governance. Such documents are integral to the structure, operations, and decision-making processes within the company, making it essential to reference and understand such documents for legal clarity and compliance.

Purpose of Shareholder Agreements

The primary purpose of a shareholder agreement (also known as a shareholders' agreement, which is a legally enforceable document offering advantages such as confidentiality and dispute resolution) is to establish a clear understanding among shareholders regarding the management and operation of the business. It serves to prevent future disputes by anticipating potential conflicts, ensuring that “prevention is better than cure”.

This document clarifies the roles and expectations of those managing the corporation and those in shareholder roles, defining their rights and responsibilities. Ultimately, it’s essential for maintaining positive business relationships and ensuring the company’s operations run smoothly.

Who needs a shareholders' agreement?

A shareholders' agreement is essential for any corporation with more than one shareholder. Whether you are starting a new business venture or managing an existing company, having such an agreement helps establish clear expectations and responsibilities among the shareholders. It is particularly important for small corporations where the relationships among shareholders resemble partnerships, and where disputes can significantly impact the company's operations.

Even in cases where there is only one shareholder, a shareholders' agreement can be beneficial if the corporation anticipates bringing in new investors or partners in the future. Additionally, corporations with key employees who may receive shares as part of their compensation should consider having a shareholders' agreement to outline the rights and obligations of all parties involved.

In summary, any corporation with multiple shareholders, minority shareholders, or plans for growth and investment should have a shareholders' agreement to protect the interests of all parties, prevent future disputes, and provide a clear framework for decision-making and share transfers.

Share Structure and Its Importance

A company’s share structure is critical as it determines the ownership and control of the business, as established in its articles of incorporation. Understanding this structure, including the classes of shares and their associated rights (such as voting, dividends, and property upon dissolution), is vital for making informed decisions about the company’s future.

Shareholder agreements often address the share structure, detailing share classifications, voting rights, and how shares can be transferred. These agreements typically set out the procedures and conditions for share transfer and share sales, including rights of first refusal, pre-emptive rights, and other mechanisms that govern how shareholders can sell or transfer their shares. A well-structured agreement helps maintain control and prevent unwanted changes in the company’s ownership by clearly defining these elements. Different share classes can be created with varied features, including voting, non-voting, or preferential rights to dividends or liquidation.

A capitalisation table is often included as a schedule in shareholders' agreements to clearly delineate ownership stakes and share distribution.

Roles and Responsibilities of Shareholders in a Corporation

As owners of shares, individuals or entities become shareholders, representing an ownership interest in the corporation. The number of shares a shareholder holds determines their voting rights and influence within the company. After paying for their shares, shareholders acquire specific rights, including the ability to vote (if their shares are voting shares), receive a share of profits (dividends), and a portion of the corporation’s property upon dissolution. There are both voting shares and non voting shares; holders of non voting shares generally have limited voting rights but may still attend certain shareholders' meetings and vote on specific fundamental issues as required by law.

They also have the right to attend a shareholders meeting, elect and dismiss directors, and approve fundamental changes. Shareholders exert influence by passing resolutions at these meetings. Ordinary resolutions require only a simple majority and are used for routine decisions, while special or unanimous resolutions are required for more significant matters. As a general rule, certain decisions—especially those involving fundamental changes—require the consent of all the shareholders. A majority shareholder, who owns more than 50% of the voting shares, can significantly influence decisions such as electing the board of directors, making it important to protect minority shareholder rights through shareholder agreements. Through a Unanimous Shareholder Agreement (USA), shareholders can even assume the powers and liabilities of directors, gaining more direct control over corporate management.

Does a 50% shareholder have control?

A shareholder with exactly 50% ownership holds significant influence but does not have outright control over the corporation. Since control typically requires a simple majority vote (more than 50%), a 50% shareholder cannot unilaterally make decisions that require shareholder approval without support from other shareholders. This can lead to deadlock situations where decisions stall due to the equal split in voting power.

The actual control a 50% shareholder has depends on the corporation’s share structure and any shareholder agreements in place. If the remaining shares are widely dispersed, the 50% shareholder may effectively control the company by influencing smaller shareholders. However, if the other 50% is held by a single shareholder or a cohesive group, the 50% shareholder’s influence is balanced. Shareholder agreements often include provisions to address such deadlocks and clarify decision-making processes for evenly split ownership.

Decision Making in Shareholder Agreements

Effective decision-making is a cornerstone of any successful company, and a well-drafted shareholder agreement is essential for establishing how decisions are made. The agreement should clearly define the roles of the board of directors, the chief executive officer, and other key members of the management team in the decision-making process. Typically, routine business matters are decided by a simple majority vote, while more significant issues—such as amending the articles of incorporation or approving major transactions—may require a two-thirds majority or even unanimous consent.

Protecting minority shareholders is a critical aspect of the decision-making framework. The shareholder agreement should include provisions that ensure minority shareholders have a voice and are treated fairly, preventing the majority from making decisions that could harm their interests. By setting out these rules in a written agreement, companies can minimize the risk of future disputes and ensure that all shareholders understand how decisions will be made, fostering transparency and trust within the organisation.

Drafting an Agreement – Things to Consider?

Drafting a comprehensive shareholder agreement involves meticulous planning, particularly when a corporation has multiple shareholders or is seeking new investors. While each agreement is unique, most cover fundamental issues. Key components typically include the initial ownership breakdown, rules for issuing new shares, board composition, decision-making processes, dividend policies, provisions for confidentiality and non-competition, and governance of the company's operations, including the duties and responsibilities of the parties in managing the company's activities.

It should also include exit strategies, mechanisms for dispute resolution, and procedures for amending the agreement itself. The agreement outlines shareholders rights, privileges, and obligations, helping to manage relationships and prevent disputes among shareholders of the company. Given its complexity, legal advice is essential to create a tailored agreement that protects all shareholders of the company’s interests. It should be reviewed regularly, ideally every 1-2 years or when significant corporate changes occur. Establishing a comprehensive agreement is especially important at the start of a new business venture.

Who makes the shareholder agreement?

A shareholders' agreement is created by the shareholders themselves, often with the help of legal professionals, to ensure it meets legal requirements and protects everyone's interests. Typically, it is drafted when the corporation is formed, but can be created or updated later as needed. All shareholders must agree and sign the document, making it a key part of how the company is governed.

Regulatory Requirements and Corporations Canada

In Canada, shareholder agreements operate within the framework set by the Canada Business Corporations Act (CBCA). The corporation’s articles of incorporation, filed with Corporations Canada, formally establish the corporation's share structure and set out the corporation's internal rules and legal parameters. The CBCA specifically recognizes certain types of shareholder agreements, notably Pooling Agreements and Unanimous Shareholder Agreements (USAs).

A Unanimous Shareholder Agreements (USAs) allows all shareholders to restrict or remove the powers of the directors and transfer them to the shareholders, though this also transfers corresponding liabilities. Any significant changes to share classes or rights outlined in the articles require an amendment approved by a special resolution of shareholders. In certain circumstances, shareholders may be entitled to vote separately as a class or group on such amendments. The CBCA recognizes several types of resolutions, including ordinary resolutions, special resolutions, and unanimous resolutions.

Competing Interests Among Shareholders

In any business venture with more than one shareholder, differing goals and priorities can lead to competing interests. A comprehensive shareholder agreement is vital for managing these dynamics and maintaining a productive business relationship. The agreement can include mechanisms such as the right of first refusal, which gives existing shareholders the opportunity to purchase shares before they are offered to outside parties, helping to prevent one shareholder from gaining disproportionate control of the company.

Other provisions, like a shotgun clause, can provide a fair process for resolving deadlocks or disputes between shareholders. By addressing potential conflicts and outlining clear procedures for resolving them, the shareholder agreement helps ensure that all shareholders, whether majority or minority, are protected. This proactive approach supports the long-term stability and success of the company, allowing shareholders to focus on growing the business together.

Transfer of Shares

Shareholders have the right to transfer their shares and the rights attached to them. However, shareholder agreements often include restrictions on share transfers to allow shareholders to control who can become an owner in their corporation. In small corporations, these restrictions can be tailored to control ownership changes and protect the company's interests. Common restrictions include the right of first refusal, which gives other shareholders the opportunity to purchase shares before they are offered to other parties. Other parties may be involved in share transfers, especially when shares are sold to third parties.

Agreements also address transfers when certain events occur, such as death, resignation, bankruptcy, or divorce. When these certain events occur, the shareholder's shares, including his or her shares, are often required to be transferred to the remaining shareholders or back to the corporation, potentially at fair market value. The purchase price for shares transferred due to certain events is often determined by an independent appraiser to ensure fairness. In some buy-sell mechanisms, shares may be bought or sold at the same price or a stated price as specified in the agreement. Pre-emptive rights are often included, giving existing shareholders priority to purchase newly issued shares to maintain their ownership percentage.

Dispute Resolution and Applicable Law

A robust shareholder agreement is crucial for handling conflicts and deadlocks efficiently. It outlines processes for resolving disputes, such as mandatory mediation and arbitration clauses, which can help avoid lengthy and costly court battles. Parties are expected to act in good faith during dispute resolution and in fulfilling their obligations.

For situations of stalemate, a shotgun clause is a legal mechanism that allows one shareholder to initiate a forced buy-sell process, providing a structured method for resolving disagreements or exit scenarios. In this process, the initiating shareholder offers to buy the shares of the other party at a specified price, or sell their own shares to the other party at the same price.

Agreements can also mandate that shareholders agree by a higher shareholder approval threshold for significant decisions than required by the CBCA, protecting minority shareholders from being prejudiced by majority actions. When tag-along or drag-along clauses are included, these provisions are designed to have the same effect for all shareholders, ensuring fairness in the treatment of both majority and minority interests. The agreement also specifies the governing law and jurisdiction applicable to any disputes.

How Financing and Investment Strategies Can be Defined in A Shareholders Agreement

Shareholder agreements are instrumental in defining the financial provisions and capital requirements of a corporation. They typically detail initial capital contributions and can outline ongoing funding mechanisms, such as requiring shareholders to contribute additional funds pro rata if other financing is unavailable.

The agreement also sets out dividend policies and profit-sharing rules, ensuring transparency in how earnings are distributed. Dividend decisions are often influenced by current market conditions to ensure sound financial practices.

When a corporation attracts significant investment, particularly from institutional investors like BDC, the existing shareholder agreement may need to be amended to reflect the new investment’s value and specific investor protections, such as liquidity preference for preferred shares. These provisions are vital for the company's financial stability and growth.

What are Possible Exit Strategies for Shareholders?

Planning for the eventual exit of shareholders is an important aspect of any shareholder agreement. The agreement should outline the various exit strategies available, such as the right of first refusal, drag-along rights, and tag-along rights, to ensure that all shareholders are treated fairly when someone decides to sell their shares. Establishing a method for determining the fair market value of shares is crucial, as it protects both the selling shareholder and those remaining in the company.

In addition, the agreement should address what happens in the event of a shareholder’s death, retirement, or incapacity, providing a clear process for the transfer or purchase of shares. By including these exit strategies, the shareholder agreement helps prevent disputes, maintains control of the company, and ensures a smooth transition for all parties involved. This level of planning is essential for protecting each shareholder’s investment and the ongoing success of the business.

Termination of Shareholder Agreements- How it Work?

There are several circumstances under which a shareholder agreement may be terminated, such as the sale of the company, the departure or death of a shareholder, or the resolution of a major dispute. It is essential that the shareholder agreement itself contains clear provisions for termination, including notice requirements, the process for settling outstanding obligations, and methods for resolving any final disputes.

In Canada, the Canada Business Corporations Act(CBCA) provides a legal framework for the termination of shareholder agreements, but having specific terms in the agreement ensures that all shareholders understand their rights and responsibilities when the agreement ends.

By addressing termination procedures in advance, shareholders can avoid future disputes and maintain a positive business relationship, even as the company’s circumstances change. This foresight helps protect the interests of all shareholders and supports the long-term health of the company.

Is It Recommended to have Non-compete and Non-solicitation Clauses in a Shareholder Agreement?

Yes, non-compete and non-solicitation clauses can be included in a Shareholder Agreement. They help protect the company if a shareholder leaves, but they must be reasonable in scope, duration, and geography to be enforceable. Non-competes restrict competing businesses, while non-solicitation clauses stop poaching of clients, suppliers, or staff. These clauses are common, but should be tailored carefully to protect legitimate business interests.

What Are the Limitations of a Shareholders' Agreement

It cannot override the law or the company’s constitution (articles of incorporation). If there’s a conflict, statutory rules or the articles usually prevail.

It binds only the parties who sign it, so new shareholders won’t automatically be bound unless they agree to it.

It remains private between shareholders, no public authority.