Disclaimer: The information contained in this article is general in nature and does not constitute legal advice. Please contact the Law Office of Jeff J. Li, or another experienced business lawyer if you are concerned about your business law issues.
By Catherine Tian and Jeff Li
When a corporation has more than one shareholder, unexpected events and conflicts may arise. At some point of time, a shareholder may want to quit, or “kick” another shareholder out of the business. A shareholder may also become a party in an acrimonious family lawsuit, become disabled, or even die. These conflicts or events may lead a corporation to disfunction, or even dissolution in some cases. To control these risks, one may want to enter into a shareholder agreement.
What is a Shareholder Agreement?
Shareholder agreements are a class of contracts that relate specifically to the relationship between some or all of the shareholders of a corporation and often, although not necessarily, between those parties and the corporation. The Ontario Business Corporations Act (OBCA) permits:
- a written agreement between two or more shareholders that sets out the manner in which voting rights attributable to the shares held by each party to such agreement shall be exercised; and
- a unanimous shareholder agreement (USA), which is a written agreement among all of the shareholders of a corporation that restricts, in whole or in part, the powers of the directors to manage the business and affairs of the corporation.
A USA is distinct from other shareholder agreements in that it must initially be signed by all of a corporation’s shareholders. It is also the only contractual mechanism by which the powers of the directors to manage the business and affairs of the corporation can be restricted. For any corporation subject to a USA, the OBCA provides that a shareholder who is a party to the USA has “all the rights, powers, duties and liabilities of a director of a corporation, whether arising under this Act or otherwise”. This attribution of duties and liabilities has broad application and could include, for example, a director’s liability to employees for unpaid wages. Care must be taken in drafting USA provisions to ensure that the shareholders do not unknowingly acquire liability that would ordinarily vest in directors. The implications for shareholders who acquire directorial liability are potentially expansive and severe pursuant to both the common law and various statutes.
Care should also be taken when drafting shareholder agreements to avoid creating conflict with the existing terms of the corporation’s articles or by-laws. Where conflict does exist, some USAs provide that the shareholders shall vote to amend the articles and/or by-laws in order to eliminate any such conflict.
Disability or Death of a Shareholder
A shareholder may become disabled or even die unexpectedly. A shareholder agreement may provide proactive measures in dealing with such situations. Most often, when a shareholder dies or becomes disabled, his/her shares will be purchased by the remaining shareholders on a pro-rata basis, at a price to be determined following a pre-set formula.
Matrimonial Proceedings involving a Shareholder
Many shareholders are concerned that matrimonial conflict may destabilize the shareholdings of a corporation. Under the Ontario Family Law Act (FLA), shares in a corporation generally form part of a spouse’s net family property. Therefore, in order to satisfy equalization or support obligations, a court could order a spouse to transfer shares in a corporation to the other spouse. This could result in unwanted business consequences and/or cause friction with the other existing shareholders who may object to the forced introduction of a new shareholder who has no connection to the operations of the corporation.
In some cases, a shareholder agreement is prepared to ensure that the spouse of each participating shareholder provides a waiver of any such claims to the shares of the shareholder. It is, however, often not possible to obtain such documentation. An alternative would be to require the sale of the shares of any shareholder in the event an application or proceeding is brought by or against that shareholder under the FLA. In such an event, the shareholder involved would be required to provide satisfactory evidence to the other shareholders within a fixed period that the claims being asserted in the proceedings shall not affect, encumber, or interfere with the rights and obligations of that shareholder. Should the remaining shareholders not be satisfied with the evidence provided or should the shareholder fail to disclose his/her involvement in an application under the FLA, the corporation or the remaining shareholders have the right to purchase those shares, pro-rata, for a value set in the same manner as it would be set in the event of the death of a shareholder.
Apart from dealing with these unexpected events, a shareholder agreement will play a vital role in the event of shareholder conflicts. We will discuss this in more detail in our next article: How to Regulate Shareholder Conflicts with a Shareholder Agreement.