Shareholder Agreements: Helping Business Owners Resolve Disputes Before they Arise

Introduction

Many shareholders operate under the assumption that they and their fellow shareholders are all on the same page with respect to their rights and obligations to one another. However, when a dispute arises shareholders often realize that their expectations and understandings may differ dramatically, and this can lead to the complete breakdown of the shareholder relationship. Taking the time to enter into a shareholder agreement when everyone is in agreement can help eliminate any confusion about the rights and obligations of the shareholders if a dispute arises.

What if I do not have a Shareholder Agreement?

In the absence of a shareholder agreement, the relationship between shareholders will generally be governed by the default rules provided for in the applicable governing corporate law statute where the corporation was incorporated. However, no two groups of shareholders are identical, and these default rules will not necessarily reflect the intentions and expectations of you and your fellow shareholders. By entering into a shareholder agreement, shareholders can adopt a bespoke set of rules that works for their unique relationship.

Operational Control and Fundamental Decision-Making

The default rule under most corporate law statutes is that most decisions to be made regarding a corporation can be decided by a simple majority vote. Critically, this includes decisions as to who is able to serve on the board of the corporation, meaning in the absence of a shareholder agreement a shareholder holding a majority of voting shares will have complete control over the composition of the board. A shareholder agreement can allow shareholders, especially minority shareholders, to protect their right to participate in the management of a corporation.

Corporate law statutes provide that certain fundamental matters, such as amending the articles of a corporation, require a two-thirds resolution of the shareholders. These default rules will not be right for every business, and a key function of a shareholder agreement is allowing shareholders to decide for themselves the percentages of votes required for certain decisions.

Restrictions on Transfer

Regulating how and when shareholders can sell their shares to another individual is an essential function of a shareholder agreement. If any shareholder can transfer their shares at will, their fellow shareholders may find themselves in the unenviable position of co-owning a business with a third party buyer with whom they have no prior relationship. Shareholder agreements will typically restrict the transfer of shares – for example, by providing that no shares can be transferred without the consent of the board of directors or that each shareholder shall have a right of first refusal over the shares of their fellow shareholders.

Selling the Business

In the event that a corporation is being sold to a third party, a shareholder agreement can provide that certain shareholders have the right or the obligation to participate in the sale. Including a drag-along clause allows one shareholder to oblige their fellow shareholders to participate in a sale if they line up a buyer. By contrast, a tag-along provision provides that if one shareholder is selling their shares, all the other shareholders have a right to participate in such a sale. Agreeing on such terms can help ensure that when the time comes to sell your business, all shareholders are treated fairly, and no one shareholder can unduly delay the sale.

A shot-gun clause in a shareholder agreement can force the sale of the business between shareholders. A shareholder triggering such a clause specifies a price per share. The other shareholders can either buy the triggering shareholder’s shares at such price or sell their shares to the triggering shareholder at the fixed price. Including a shot-gun clause can ensure that the shareholders have an exit strategy in the event that the shareholder relationship breaks down.

Conclusion

While shareholders are often on the same page at the inception of a corporation, as time goes on interests may diverge and understandings may change. Taking the time to codify the understandings of the shareholders in a written agreement can help avoid costly and protracted litigation in the future, allowing shareholders to focus their attention on what matters most: the business.