Shareholders’ Agreements

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A Shareholders’ Agreement is an agreement entered into by shareholders of a corporation. Sometimes the agreement is entered into by all the shareholders and other times only some of the shareholders enter into such an agreement. Shareholders’ Agreements serve two primary functions. Firstly, they deal with the management, financing and operation of the corporation and, secondly, they deal with restrictions on transfer or the circumstances upon which the shares of the corporation may be transferred.

MANAGEMENT, OPERATION AND FINANCING OF THE CORPORATION

The organization, financing and management provisions under a shareholders’ agreement will depend on the business deal between the parties and which primary concerns of this business relationship they are attempting to address. For example, the shareholders agreement may address the following:

  • Which of the shareholders will have an active role in the management of the corporation and how control may be exercised by them;
  • Veto rights or supermajority shareholder approval over material changes or significant transactions by certain shareholders who may not play an active role in the day to day management of the corporation;
  • Providing for remuneration for the shareholders who actively manage the business;
  • Providing for repayment of the initial capital investment to the shareholders who financed the corporation.

Shareholders’ agreements may also provide for direction on how the corporation will finance growth including the obligation of the shareholders to contribute further capital to the corporation and/or raising funds through a private lender. Usually any shareholder obligation to fund the corporation would be on a pro rata basis equal to each shareholder’s ownership interest in the corporation.

TRANSFER OF SHARES

Most shareholders’ agreements will typically contain a provision that prohibits any of the shareholders from selling, transferring, assigning and/or encumbering shares without the prior consent of the other shareholders or in accordance with provisions that may be agreed upon in the shareholders’ agreement.

Most shareholders agreements do provide for “permitted transfers” that, for estate planning purposes, allow for the transfer and assignment of shares to a trust, a holding corporation and/or to immediate family members.

There are also several provisions which are drafted in a shareholders’ agreement which are designed to provide an exit strategy where a shareholder no longer wishes to be involved in the corporation. The following provide a summary of some of these provisions:

Right of First Refusal

One of the most common types of exit provisions is where a shareholder is required to offer to sell his or her shares to the other shareholders prior to selling them to a third party. Where a shareholder receives an offer from a third party that he or she is prepared to accept he or she must first give notice to the other shareholders and give the other shareholders a period of time upon which to purchase the exiting shareholder’s shares on the same terms and conditions as the third party offer. Hence, the other shareholders have the option to purchase the shares of the exiting shareholder on those same terms and conditions. If the other shareholders do not which to do so, then the exiting shareholder is free to sell to the third party.

Right of First Offer

A right of first offer is where an existing shareholder delivers an offer to the remaining shareholders that the exiting shareholder intends to sell his or her shares and the remaining shareholders all of his or her shares at a price as is set out in the offer. Failing the purchase by the remaining shareholders of the exiting shareholder’s shares, the exiting shareholder is then at liberty to sell his or her shares to any third party on the same terms and conditions as contained in the offer.

Piggy-back Rights or “Tag-Along” Rights

These provisions require one shareholder, if he or she wishes, to sell to a third party his or her shares on the same terms and conditions that may have been received from the third party offer.

Carry-Along Right or “Drag-Along” Rights

These rights permit an existing shareholder to require the other shareholders to sell their shares at the same price and on the same terms and conditions as the exiting shareholder.

Shot-Gun or Buy-Sell Provision

A shotgun and/or mandatory buy-sell provision is where one shareholder delivers to the other an offer to buy the shares of the other shareholder and an offer to sell his or her shares, each offer containing the same price and terms. The other shareholder then has a choice as to whether to buy or sell.

Puts and Calls

A put is an option to sell and a call is an option to buy. These rights are included in shareholders’ agreements usually to handle a variety of exiting or triggering events. Such events include death, disability, retirement, cessation of employment and any other situation which would require a party to sell his or her shares.

The process of drafting and negotiating the various buy-sell provisions and circumstances upon which shares may be sold requires an understanding of the individuals involved and the nature of the business. The negotiation process itself, which deals with future events, may dredge up potential sources of conflict and disagreement between partners.

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