SHAREHOLDERS' AGREEMENT
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A shareholders' agreement (unanimous shareholders agreement) is a contract amongst the corporation's shareholders (owners), which is potentially the most significant legal protection that a shareholder can rely upon to advance their interests in the corporation and optimize the realizable return from their investment in the corporation's future, while providing an operational framework for the corporate entity's management (decision-making) and operations.
A shareholders' agreements typically deals with some or all of the following issues: (i) governance, particularly how to resolve deadlocks on major decisions; (ii) operational issues, such as imposing limits on the decision-making authority of shareholders working in the day-to-day management of the corporation; (iii) how and subject to what conditions shares can be transferred to other shareholders or outside of the corporation; and (iv) what happens when major events occur, i.e. a need to raise additional capital, the receipt of an offer to purchase from third parties, a shareholder ceasing to be an employee, and the death or disability of one of the shareholders.
Due to the flexibility associated with shareholders agreements, arising from the manner in which they are negotiated and drafted, it is crucial that a shareholder have personal legal representation to ensure that their interests are adequately represented and protected within the shareholders agreement. Far too many shareholders have allowed inadequate or inappropriate shareholders' agreements to be foisted upon them, and thereby lose invaluable rights and protections that could have otherwise been attained through a properly negotiated shareholders' agreement.
The importance of a shareholders' agreement stems from its ability to override the default rules of corporate law and the corporation's bylaws, offering a tailored and clear framework for operation, as it:
A. Defines Decision-Making and Governance
A shareholders' agreement allows shareholders to create a custom governance structure, which often limits the powers of the board of directors and grants them directly to the shareholders.
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Avoids Deadlocks: It specifies voting thresholds for important decisions (e.g., requiring 75% or even 100% approval instead of a simple majority). This prevents a majority shareholder from making unilateral decisions and protects minority interests.
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Clarifies Roles: It clearly outlines which decisions must be made by the shareholders, the directors, or the officers, reducing confusion over management authority.
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Electing Directors: It can specify the process for electing and removing directors and officers, potentially guaranteeing a board seat to a minority shareholder.
B. Manages Share Transfers and Exit Strategies
Share transference and exit strategies are perhaps the most critical function of a shareholders' agreement, as it controls who owns the company and how shareholders can buy or sell their stake.
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Share Transfer Restrictions: It prevents shareholders from selling their shares to an unwelcome outside party by imposing restrictions like a Right of First Refusal (existing shareholders get the first chance to buy the shares) or requiring consent from other shareholders.
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Valuation: It pre-determines a method for valuing shares (e.g., upon a shareholder's death or retirement), avoiding potentially contentious and expensive disputes when a buyout is necessary.
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Buy/Sell Mechanisms: It provides clear procedures for mandatory buyouts upon certain "triggering events" like death, disability, or bankruptcy. Common mechanisms include:
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Shotgun Clause: A mechanism to resolve deadlocks where one shareholder offers to buy the other's shares (or sell their own) at a specific price, forcing the other to either buy or sell at that price.
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Drag-Along Rights: Allows a majority to force a minority shareholder to sell their shares in a sale to a third party, ensuring the buyer gets 100% control.
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Tag-Along/Piggyback Rights: Allows minority shareholders to join a majority shareholder's sale on the same terms, protecting them from being left behind.
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C. Provides Dispute Resolution
Disagreements between shareholders are a leading cause of business failure. A shareholders' agreement provides a mechanism to handle these conflicts outside of costly and public litigation.
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Mandatory Resolution Steps: It can require parties to attempt mediation or arbitration before resorting to court action.
D. Protects Minority Shareholders
In the absence of a shareholders' agreement, a majority shareholder often has near-absolute control. The shareholders' agreement is essential for providing protection to those with a smaller stake.
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Veto Rights: It can grant a minority shareholder veto rights over specific, critical actions (e.g., incurring major debt, changing the business scope).
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Guaranteed Information: It can guarantee access to specific financial or operational information.
Providing strategic legal advice and direction to corporate business owners engaging in commercial activities in Alberta, as they strive to optimize the corporation's legal structure to their financial advantage, while minimizing their legal exposure. Contact our law firm at Chris@NeufeldLegal.com or 403-400-4092 to schedule a confidential initial consultation for your new business enterprise.