|JAMES D. L. KERR
|TO: Business Clients||FROM: James D.L. Kerr ● Lawyer
Tel 416 485-4254
Fax 416 485-8836
Certified Specialist Civil Litigation
|DATE: May 6, 2002|
|RE: Shareholder Agreements (Ontario Corporations)|
Being in business with
another person is like being married to that person; the relationship will
experience both accord and discord and sometimes that discord will lead to
divorce. During times of prosperity, the
parties to the relationship will be encouraged by the success of the venture to
find mutually acceptable accommodations.
At other times, the parties will seek to enforce their strict rights
and, in that regard, will look to legal principles of general application to
resolve their differences.
Unfortunately, those principles are only of limited assistance; the
governing law does not deal with matters as diverse as limits on the issue
and/or transfer of ownership interests in the business, "buy-outs"
between owners, enforced or otherwise, and the right of a minority owner to
participate in the business both as to management and distribution of profit.
Being in business with another person is like being married to that person; the relationship will experience both accord and discord and sometimes that discord will lead to divorce. During times of prosperity, the parties to the relationship will be encouraged by the success of the venture to find mutually acceptable accommodations. At other times, the parties will seek to enforce their strict rights and, in that regard, will look to legal principles of general application to resolve their differences. Unfortunately, those principles are only of limited assistance; the governing law does not deal with matters as diverse as limits on the issue and/or transfer of ownership interests in the business, "buy-outs" between owners, enforced or otherwise, and the right of a minority owner to participate in the business both as to management and distribution of profit.
Owners, who in the corporate context means the "shareholders", will normally address contingencies not dealt with in the general law by writing their own private law in the form of a contract which, in the case of corporate ownership, is called a "Shareholder Agreement" (Americans refer to such a contract as a "Stockholder Agreement").
A particular type of shareholder agreement which includes all of the shareholders of the corporation and which strips the directors of their powers and transfers those powers to the shareholders is called a "Unanimous Shareholder Agreement"; such an agreement, however, also imposes directors' liabilities on the shareholders and would, accordingly, not be desirable in the case of shareholders who are not participating in the management of the business (so-called "silent partners").
One purpose is a Shareholder Agreement is to restrict or eliminate a shareholder's right to seek redress in the courts from conduct by the other owners which the shareholder considers to be unfair or oppressive. Needless to say, litigation is time consuming and very expensive; it is not uncommon for a shareholder to commence an "oppression" action against the other owners as a means of forcing an issue not by virtue of the righteousness of the shareholder’s position but by virtue of expense which will be incurred to defend the litigation. It is our opinion that the shareholder’s only remedy in the event of a disagreement ought to be the buy-sell mechanism discussed below. Accordingly, we include, in Shareholder Agreements prepared by this firm (and subject to our client's instructions otherwise), a waiver of the so-called "oppression remedy".
Voting Trust: Shareholder Agreements were, historically, first used to impose a "voting trust" on shareholders; that is to say, an obligation that each shareholder would vote to elect each of the other shareholders as a director of the company. Directors are charged by statute with the management of the company and only directors have an absolute right to view all of the company’s records including, and in particular, the books of account. It is fundamental, therefore, that a Shareholder Agreement include a voting trust so that each shareholder will be entitled to attend meetings at which management decisions are to be made and will have full access to the company's books of account.
Quorum: Typically the Shareholder Agreement will
specify the quorum for directors meetings.
By statute, the quorum may not be less than 2/5's or the minimum number
of directors permitted by the Articles of Incorporation.
Historically, corporations were required to have at least a President and a Secretary. This is no longer the case; in fact, corporations are no longer required to have any officers at all. It is, however, the usual practice to designate officers, mainly to facilitate the execution of documents and in particular the signing of cheques. In fact, it is the practice of most banks to require that signing authorities be designated by reference to offices rather than by designating individuals by name.
The corporation's registered
office may be changed by the directors within the municipality specified in its
Articles and may be changed to any place in
Financial Year End:
The selection of and adherence to a fiscal period can have taxation implications for both the corporation and its shareholders. Accordingly, if it is important that the corporation’s year-end not be changed except by unanimous agreement, this must be specified in the Shareholder Agreement.
All corporations are required, by law, to audit their accounts for the benefit and protection of their shareholders. Audited financial statements are considerably more expensive than the "Notice to Reader" statements common for small businesses. The legislators also recognized that in small corporations the shareholders and the managers were, generally, one-in-the-same and that, accordingly, such protection is redundant. The law therefore permits the shareholders, by unanimous agreement, to exempt the corporation (up to certain limits) from audits. The law contemplates, however, that the exemption will be addressed yearly. A disgruntled minority shareholder wishing to exert financial pressure on the majority can decide, in any given year, to withhold the necessary consent. If the shareholders are in agreement, at the outset, that the corporation's accounts will not be audited, then the Shareholder Agreement should contain a provision to preclude one or more of the shareholders from resiling from that agreement.
Transfer or Disposition of Shares:
It is generally considered important by business owners that some control be exercised over who may become a participant in the business. Depending on how stringent these controls are intended to be, the issue may be address in one of several ways including the following:
(a) A provision that there be no issue of new shares and no transfer of existing shares without the prior consent of all shareholders;
Disposition on Death:
For the same reasons, a need exists to provide for the purchase and sale of a deceased shareholder's interest. The deceased’s estate wishes to extract the deceased's interest in the business so that it may be distributed to those beneficially entitled and the surviving shareholder(s) presumably does not wish to be in business with the deceased's executor. Buy-sells during the lifetimes of the shareholders usually arise in an adversarial context, which is not usually the case where a shareholder has passed away and, accordingly, the moral gloss is dissimilar.
With respect to funding, the preference is to fund the buy-sell by life insurance on the lives of the shareholders. Of course, this will impose a cost and that cost is not tax-deductible. Where the buy-sell is funded by insurance, the Shareholder Agreement should specify who is to pay the premiums (i.e., the company or the individual shareholders) and who is to retain the excess proceeds of the insurance in the event that those proceeds exceed the purchase price of the deceased's interest.
Shareholder Agreements typically have provisions which state that disputes will be settled by arbitration without resort to the courts. The advantage of arbitration is that the parties can pick their own "judge"; that is to say, someone with expertise in the area of dispute. Furthermore, arbitration generally resolves a dispute much faster than the court process. The disadvantage is that arbitration is considerably more expensive in the short term.
It is not unusual to find that an offer has been made to the majority shareholders to sell the business but that the minority shareholders are refusing to sell (possibly, to extract a premium for their interests). This contingency can be treated by including a provision that permits shareholders controlling a specified level of votes to compel a sale of all of the shares of the corporation.
One of the more sensitive and complex areas for consideration is whether a majority of the shareholders can compel further contributions of capital by the other shareholders and, if so, what are the consequences of default. Normally, provisions calling for mandatory contributions of capital provide, ultimately, for the erosion or complete forfeiture of a defaulting shareholder's interest.
If it is intended that the owners should devote their full attention to the business of the corporation, then such should be stated in the Shareholder Agreement.
It is typical to provide that the shareholders shall not compete with the corporation while they are shareholders of the corporation. More complex is the question of competition by a former shareholder. Shareholder Agreements often contain agreements not to compete once a shareholder has ceased to be a shareholder. Such agreements are in restraint of trade and not enforceable unless reasonably limited in scope. The usual limitations involve time and geography. The greater the limitation, the more likely that a court will enforce the non-competition agreement. The real issues are, firstly, the amount of time which will be reasonably necessary for the remaining shareholders to secure the goodwill which they have purchased and, secondly, the true market area of the corporation's activities.
In addition, it is common to include restrictions on the solicitation of the corporation's employees by former shareholders.
Shareholders sometimes wish to include other provisions, particularly provisions relating to the actual management of the corporation's undertaking (for example, mandatory distribution of profit). Virtually anything can be written into a Shareholder Agreement. It is important to remember, however, that the future is often not predictable and that to bind the hands of the directors at the outset may create more problems than it solves.
Independent Legal Advice:
I amnot a tax advisor and do not render, nor will I render in the context of any retainer, advice with respect to taxation matters. I recommend that the parties obtain competent tax advice from their chartered accountants or other tax advisors. My reporting letter to be delivered on the completion of my work will confirm that the parties have either done so or have declined to do so at their own risk.
DISCLAIMER: The foregoing is not intended to be a comprehensive guide to the applicable law. General Client Memoranda and mailings from James D.L. Kerr ● Lawyer are intended to inform clients and acquaintances with respect to current issues that may be of interest to them. Memos are current to the date shown on the Memo. The law is constantly changing, however, and for that reason a Memo may not be completely accurate after it's stated date. Where circumstances warrant, the advice of a lawyer or other qualified professional should be obtained.
© 2005 James D.L. Kerr