Measures of Last Resort – The Benefits of Exit Provisions in Shareholder’s Agreements

Sabrina Saltmarsh, B.A. (Hons), J.D.Business Law, Business Litigation, Business Torts | Economic Torts, Civil Litigation, Closely-Held Business Disputes, Commercial, Commercial and Contract Litigation, Commercial Contracts, Corporate Disputes, Family Business Disputes, Non-Compete, Non-Competition Agreement, Non-Solicitation Agreement, Non-Solicitation Clause, Oppression Remedies, Sale of Business Disputes, Shareholder Disputes0 Comments

The benefits of a shareholder’s agreement may not be fully considered when parties are intending to go into business together and become joint shareholders in a corporation. Perhaps the mood is optimistic and none of the participants anticipate that things might sour between them down the road. Sometimes corporations are formed absent such an agreement. However, among other benefits, these agreements become particularly useful in managing risk and guiding shareholders through governance issues and disputes that may arise, efficiently so as to minimize disruption to the corporation’s business.

Absent a shareholder’s agreement, shareholders in a closely held corporation that cannot see eye-to-eye regarding the operation and path of the corporation, may become stuck in a deadlock where decision-making is effectively stifled due to a stalemate between them. Shareholder’s agreements can serve to provide mechanisms to address deadlock, protect the voice and rights of minority shareholders, provide a road map for when shareholders no longer want to be involved in the business and prevent abuses of power or unilateral decision-making on important issues such debt arrangements; voting rights; and controlling the transfer of shares to a new owner.

Even if the dispute or deadlock can’t be resolved by way of the agreement, a shareholder’s agreement offers guidance to a court, if required to intervene, on the intention of the parties regarding how disputes or deadlock should be resolved.

Below are some useful clauses to consider including in a shareholder’s agreement:

1) Shotgun Clauses

Most beneficial in corporations where there are two 50/50 shareholders, a shotgun clause compels shareholders in a corporation to engage in a buy out. It can be triggered in circumstances where directors who are shareholders can no longer work together and this inability is having a negative impact on the corporation.

The offeror triggers the provisions by concurrently making both an offer to buy the offeree’s shares or to sell its own shares to the offeree;

the offeree must decide whether to buy out the offeror, or to sell its shares to the offeror, at the price specified in the buy-sell offer;

if the offeree does not respond by the date in the buy-sell offer, then the offeror may force the offeree to sell its interests to the offeror.

Usually there will be a penalty associated with failure to comply with the offer deadline such as the sale of the shares at a discounted rate.

These types of clause should be drafted carefully and clearly as it is considered a harsh remedy. The execution of such a clause will only be enforced if the clause is triggered in accordance with the terms of the shareholder’s agreement. Once this offer is made it cannot be revoked or altered, it is an automatic trigger of the clause, and will be enforced if the offer is made properly.

The criticism of this type of a clause in a shareholder’s agreement is that it benefits the party with deeper pockets, since they can make an offer that the other party could not afford to pay and essentially force a buy out. The clause can be modified to require that the offer at a minimum must be made in accordance with fair market value as determined by an independent valuation.

2) Right of First Refusal/Right of First Offer Clauses

These types of clauses are useful in protecting the interests of existing shareholders. It protects a first right of existing shareholders to purchase shares of any shareholder who is selling their shares.

3) Piggyback/Tag Along Clauses

This type of clause protects an existing shareholder from being compelled to continue on in the venture with new shareholders. If a third party makes an offer to purchase the shares of a majority or controlling shareholder, the other shareholder can require the third party to also purchase their shares on the same terms. Generally considered to be a beneficial clause to minority shareholders.

4) Drag Along Clauses

This type of clause is a reverse of a piggyback clause and can require a minority shareholder to sell their shares to a purchaser who wants to purchase all the shares of the business, on the same terms and for the same price as a majority shareholder. It enables majority shareholders to take advantage of a good opportunity to sell the business.

5) Put or Call Options

These types of clauses give a shareholder who wants to exit to “put” their shares on the table by giving notice requiring other shareholders to purchase their shares under certain circumstances. Similarly, a call option allows a shareholder to purchase shares under certain circumstances. These clauses usually have triggering events such as the death of a shareholder, incapacity, bankruptcy, retirement, etc.

6) Dispute Resolution Clauses

These clauses may assist shareholders who are in a conflict by setting out mechanisms for resolution such as veto power by one or certain shareholders over certain decisions, mandatory mediation or arbitration.

6) Non-competition Clauses

These clauses are useful in clarifying when and under what circumstances shareholders can carry out or participate in a competing venture to the corporation. The rationale is that controlling shareholders will have prime knowledge about the company’s intellectual property and management systems that are important to the competitive edge of the corporation, which should remain confidential and for the benefit of the corporation. These clauses should be worded carefully as courts often construe them narrowly.

7) Dissolution or Auction Clauses

These types of clause are considered the ultimate remedy and will contemplate under what circumstances the corporation ought to be dissolved or wound up in the event of deadlock between shareholders, or the corporation ought to be sold or auctioned off.

8) Valuation Clauses

These types of clauses assist shareholders interested in exercising their exit rights in determining how shares of the corporation should be valued, either by periodic agreement, a formula or determination by an independent valuator or third party.

9) A Deadlock Resolution Clause

This type of clause is beneficial in defining under what circumstances shareholders may be able to trigger some of the exit clauses of a shareholder agreement such as a shotgun clause. It would serve by defining the circumstances in which a corporation is considered to be in a deadlock.

Are you a shareholder looking for an exit strategy? Do you need assistance with the drafting of a shareholder’s agreement or are you involved in a shareholder’s dispute with or without a shareholder’s agreement? The lawyers at Gilbertson Davis LLP have experience assisting shareholder’s who are embarking on a new business and representing shareholder’s involved in a business dispute.

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About the Author

Sabrina Saltmarsh, B.A. (Hons), J.D.

Practitioner in a broad range of business and civil litigation matters including commercial, real estate and condo disputes. Experienced at all levels of Ontario Courts. Bio | Contact

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