Shareholders' Agreement

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An Overview of Six (6) Clauses Frequently Found in Shareholders' Agreements

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In its simplest form, the shareholders' agreement is a contractual way to govern the relationship between two or more shareholders. It must be signed by all shareholders who wish to adhere to it. When new shareholders join a corporation, they must sign the agreement for it to apply to them.

It is common in the business world for shareholders of a corporation to decide to regulate their relationships through a shareholders' agreement. Initially, the content of such an agreement may seem complex and discourage the businesswoman or businessman attempting to understand the various clauses found within. In an effort to simplify, this section will break down the most commonly used provisions to provide a brief summary of their advantages and disadvantages.

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1. Buy-Sell Clauses

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Buy-Sell Clauses are present in the vast majority of shareholders' agreements currently in existence in Quebec. This type of clause addresses fundamental concerns for shareholders of a company.

For example, they can provide for the maintenance of proportional share ownership among shareholders, especially to prevent an undesirable change of control. They can also limit and impose conditions on the transfer of issued shares to ensure that the company retains its closely held issuer status. Thus, they allow for the contractual restriction of a shareholder's right to sell their shares to third parties and subject their sale to predetermined conditions.

There are several types of buy-sell clauses. We will specifically focus on the first refusal clause, the « shotgun » clause, the share valuation clause, the insurance clause, and the depository agent clause. However, please note that these various provisions represent only a portion of what can be contractually provided to limit the purchase or sale of shares. If you have any doubts or want to learn more, do not hesitate to contact us to discuss your situation.

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2. The "Shotgun" clause

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The forced buy-sell clause, better known as the « shotgun » clause, is an effective but drastic way to resolve a potential conflict between two shareholders. It is relevant when the company is controlled by two shareholders who each hold 50% of the voting shares of a corporation.

The primary purpose of this clause is to avoid a deadlock in the management of the company when a significant conflict arises between the shareholders. When well-drafted, the « shotgun » clause allows one shareholder to offer another shareholder to purchase their shares at a specified price. The receiving shareholder must then either accept the offer or make a counteroffer to buy the other shareholder’s shares. In either case, one of the two shareholders will hold the shares of the other following the process initiated using this clause. By providing for the application of a « shotgun » type clause, a simple and effective solution is established to resolve a significant dispute among shareholders while maximizing the value and consideration obtained when selling the shares.

To mitigate undesirable situations and to avoid giving an implicit advantage to the wealthier shareholder, specific terms can be stipulated to govern the application of this clause. For example, a waiting period can be specified before it takes effect, or the less economically advantaged shareholder can be given enough time to secure financing and prepare their counteroffer.

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3. The First Refusal Clause

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The First Refusal Clause is a key element often included in shareholders’ agreements or company bylaws, especially when drafting documents for incorporation. Its primary purpose is to prioritize existing shareholders in share transactions.

When a shareholder intends to sell their shares, this clause requires them to first offer these shares to existing shareholders under the agreement. Typically, the clause mandates that the offer to existing shareholders should either match a third-party offer or be at a price predetermined by the agreement’s terms. Careful drafting is crucial to avoid potential abuses, such as artificially inflating share prices, which could undermine the clause’s effectiveness and fairness.

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4. The Share Valuation Clause

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The Share Valuation Clause is crucial in any shareholders’ agreement, especially in relation to the previously mentioned Buy-Sell Clauses. It is designed to determine the value of shares, either by setting a specific price for each class of shares or by outlining a method to calculate this price. This valuation approach can vary depending on the type of transaction involved.

Clarity and fairness are key in drafting this clause. It should facilitate a valuation process that is not only quick and cost-effective but also immune to disputes, ensuring fairness for both buyers and sellers.

Various methods can be employed for share valuation, such a book value, adjusted book value, earnings value, third-party evaluation, or an agreed-upon value. The chosen method should align with the company’s specific needs and activities, and it may differ from case to case.

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5. The Automatic Buy-Sell on Death Clause and Insurance Clause

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The Automatic Buy-Sell on Death Clause and Insurance Clause is commonly included in shareholders’ agreements to streamline the succession process. It ensures a smooth transition of shares to the surviving shareholders upon the death of a shareholder. Typically, this clause is paired with an Insurance Clause, which is often mandatory and tailored to the specific needs of the shareholders and the nature of the company’s operations.

The purpose of the mandatory Insurance Clause is to guarantee the availability of the funds for the company or surviving shareholders to buy back the deceased shareholder’s shares. This arrangement is crucial for maintaining the company’s stability and preventing financial strain.

There are ways to structure life insurance for shareholders. One approach is for shareholders to take out life insurance policies on each other, with benefits distributed in proportion to their shareholdings. Alternatively, the company itself can insure the lives of all shareholder parties. The choice of method involves complex tax considerations and should be made with guidance form specialized professionals. Our firm collaborates with business partners to ensure these clauses meet your specific requirements and are aligned with our business strategy.

The Automatic Buy-Sell on Death Clause is a provision that is regularly found in shareholders' agreements to simplify the succession process and facilitate the transition among surviving shareholders of the company. This clause is sometimes accompanied by an insurance clause, often mandatory, the content of which will vary depending on the shareholders' imperatives and the company's activities.

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6. The Depository Agent Clause

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The Depository Agent Clause serves a preventive role in shareholders’ agreements. It is designed to tackle potential issues before they arise. This clause involves appointing a neutral third party, the depository agent, to step in under certain conditions outlined in the agreement. The agent’s role is to ensure smooth execution and adherence to the agreement’s terms, particularly when complex situations occur.

This becomes especially vital in agreements with first refusal clauses or mandatory buy-sell provisions, where disputes among shareholders are more likely to emerge. The depository agent, acting impartially, ensures obligations are met without relying on individual shareholders’ cooperation. This helps minimize misunderstandings, interpretive disagreements, and potential conflicts between the parties.

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The Unanimous Shareholders' Agreement

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The Unanimous Shareholders’’ Agreement is a distinct type of arrangement, requiring the signature of all shareholders for it to be fully effective. Once in place, it binds not only current but also future shareholders of the company, even without their direct signature.

Typically, this agreement is used to reallocate certain powers from the company’s directors to its shareholders. It is particularly useful in cases where shareholders wish to have more direct control over specific aspects of the company’s management. In other scenarios, it can simplify the administrative management for a sole shareholder.

This agreement can either be a part of a standard shareholders’ agreement or exist as a standalone document. Given the importance and complexity, it is crucial to ensure careful drafting. Legal advice is highly recommended to ensure the agreement meets your objectives and complies with legal standards.

Of course, this text is intended for informational purposes and constitutes a source of general information that cannot replace legal advice. If your situation requires it, the Bessette Lawyers team will be happy to advise you in your efforts or draft a personalized shareholders' agreement tailored to your vision, your business model, and the considerations of your business partners. We invite you to contact us for more information on this matter.