16 June 2020
Not All Shareholders Agreements Are Created Equal
By: Laurie Propeck
If you are operating a small or medium-size business with some partners, there is a good chance that you have entered into, or thought about entering into, a shareholders agreement. As you may know, a shareholders agreement is a contract used to manage relationships among shareholders of a corporation (restrictions on transfer of shares, exit rights or obligations, future financing commitments, etc.), and to outline certain management rights and procedures (appointment of directors and officers, votes on certain decisions, information rights, etc.).
However, you may not be aware that a unanimous shareholders agreement (a USA) is a particular type of shareholders agreement that serves specific purposes and, as we will see below, that has important legal consequences.
Description of a USA
A USA has two basic characteristics, failing which it is not a unanimous shareholders agreement within the meaning of corporate laws: (i) it must be signed by all shareholders, current and future, whether they hold voting or non-voting shares and (ii) it must withdraw or restrict the powers of a corporation’s directors who normally have the power of managing the corporation’s business and affairs and to take major business decisions.
Pursuant to a USA, such powers of the board can be restricted in a direct way by withdrawing either the entirety of the powers of the board or by only withdrawing certain specific powers. Typically, all the powers of the board are withdrawn in situations where a corporation is owned by very few shareholders who are in line amongst each other about the way to govern and manage the activities of the corporation. In such cases, it is not rare to see that the shareholders will require that decisions be taken unanimously amongst them. With regards to situations where solely specific powers are withdrawn from the board, this frequently occurs in cases where, for example, an important third-party investor invests a large sum of money in the corporation and requires in exchange to be given a veto right on specific decisions he considers important and which are normally taken by the board.
Instead of withdrawing some or all of the powers of the board, the shareholders can also restrict said powers in a more indirect way by determining that certain decisions taken by the board or/and to be approved by the shareholders will require more than the standard majority vote rule required by Canada’s and most of the provinces’ business corporations statutes. Typically, this avenue is taken in situations where a corporation has a larger number of shareholders which have different interests in the business. In this case, shareholders could determine, for example, that certain decisions shall be made by special majority (i.e. more than 50%).
It is important to keep in mind that specific legal consequences arise from entering into a USA, such as the following: (i) where the powers of the board are withdrawn either fully or in part, shareholders will then hold said powers and assume the responsibilities and liabilities of the directors related to such powers towards the corporation and third parties; (ii) Quebec law requires that any corporation doing business in Quebec (whether incorporated under Quebec law or not) discloses the existence of a USA with the Enterprise Registrar; (iii) where the powers of the board are withdrawn and exercised by the shareholders, the names of the shareholders exercising such powers also need to be disclosed with the Registrar; and (iv) while in many cases the provisions of a USA will be enforceable against third parties, the shareholders should bear in mind that they may be compelled to provide a copy of the USA to certain third parties (such as the corporation’s creditors).
Typical Provisions in Shareholders Agreements
Even though every shareholders agreement is very specific to each situation and therefore very different from a case to another, there are certain types of provisions commonly found in most shareholders agreement, it being a USA or not.
Most shareholders agreements will likely have provisions pertaining to governance and decision making. Such provisions may determine the size of the board, quorum, frequency of meetings of the board and the way directors are elected. A typical provision often includes the right to a specific shareholder or a group of shareholders to appoint one or more director(s) to the board.
Most shareholders agreements will also include a section pertaining to restrictions and obligations related to shares transfers such as: (i) restrictions on share transfers in order to allow transfers only in specific and pre-determined ways; (ii) pre-emptive right to prevent shareholders’ ownership to be diluted when new shares are issued; (iii) a right of first refusal giving shareholders the option to purchase shares from another shareholder who wishes to sell his shares; (iv) tag along right, which allows minority shareholders to require a third-party buyer to also purchase their shares; and (v) drag along right, which allows majority shareholders to oblige minority shareholders to sell their shares to a third party who wishes to buy all of the shares of the corporation.
A variety of other provisions can be included, some of them which can relate to the following subjects: (i) dispute resolution provisions setting out, for example, mandatory negotiation, mediation or arbitration in case of dispute; (ii) non-compete and non-solicitation clauses restricting specific shareholders ability to compete with the corporation and often to solicit employees and clients from the corporation and which are generally delimited to a specific territory and period of time; (iii) financing clauses which generally determine things such as the corporation’s annual budget and if certain or all shareholders are expected to contribute in financing the corporation; and (iv) exit provisions such as put, call and shotgun mechanisms that determine the conditions under which certain shareholders may sell their shares of the corporation.
As you can see, shareholders agreements need to be carefully drafted at the onset of the creation your business to avoid future painful problems. KRB’s corporate group members are used to deal with shareholders agreements in a number of contexts and can help you navigate through this stage to ensure you are duly protected, of course, but also ensure that the terms of your shareholders agreement adequately reflect your legal and business needs.