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How a Shareholders’ Agreement can Protect a Shareholder

(Click for updated PDF version: Legal Guide: Shareholder Agreement)

by: Peter Cusimano, B.Sc., LL.B.

Who Should Read This

This article is intended for anyone who either:

  • owns shares in a private corporation;
  • is contemplating buying shares in a private corporation;
  • in contemplating selling a portion of their shares in a private corporation;
  • is starting a private corporation.

This article does not apply to public corporations, that is, corporations whose shares are traded publicly on a stock market.

This article will be of interest to shareholders of small private corporations and where often some shareholders also act as directors or officers of the corporation. In such a case, the co-operation of all the shareholders is crucial to the success of the business. Although the responsibility of making decisions for a corporation normally is with the directors of the corporation, a shareholder may wish that certain decision making powers be removed from the discretion of the directors and be given to all of the shareholders. This article discusses how a written shareholders’ agreement can protect your monetary investment and thereby work for your business and potentially save you money, aggravation, disappointment, and business failure.

How Shareholders are at Risk

Although most shareholders believe that they were meant for each other and they’ll always get along, situations will almost always arise that the shareholders never contemplated. For example, if the corporation requires additional capital there may be disagreement as to where the additional capital is to come from; or some shareholders may desire a first right of refusal if another shareholder desires to sell his/her shares to a third unknown party. If the shareholders get into a disagreement with each other and there is no written shareholders’ agreement it may be extremely difficult if not impossible to require another shareholder to sell his/her shares. It is possible and legal for shareholders to enjoy the profits of the corporation by way of dividends without having to do any work. As such, the success of your business may be in jeopardy when disagreements between the shareholders or unexpected events occur which cannot be resolved.

In the 1990’s your business requires co-operation of all shareholders in order to be successful and if you do not adequately protect yourself, you may discover that your fellow shareholders have a different philosophy than you with respect to the business. Alternatively, unforeseen events may occur that the shareholders cannot agree on how to resolve. Therefore, unless you have a written shareholders’ agreement in place that deals with these concerns it will be very difficult and very expensive to resolve any disagreements between shareholders. Each party thinks that he/she is right and the other party is wrong.

How to Protect Yourself (and Your Business)

You should hope for the best, but plan for the worst scenarios to occur. If you are conducting business using a corporation a written agreement among the shareholders (called a “shareholders’ agreement”) should be prepared and signed by all the shareholders to help protect your interest as a shareholder and thereby help ensure the success of your business. The Ontario Business Corporations Act permits shareholders’ to enter into a shareholders’ agreement and remove decision making powers from the directors. The use of a shareholders’ agreement can save you money, time, aggravation, and most importantly your business. The result is a greater trust and harmony among the shareholders which is fundamental to every successful small private corporation.

If there is a dispute or uncertainty on how to proceed in a particular situation, the shareholders can refer to the shareholders’ agreement for guidance. In the event that the agreement does not cover the circumstance and the situation cannot be resolved by the shareholders, an arbitration clause can be inserted in the agreement that requires the dispute to be referred to an independent third party.

Although some shareholders believe that asking fellow shareholders to sign a written shareholders’ agreement will spoil the relationship, smart business people know that a good shareholders’ agreement helps to protect their business and all shareholders will feel more comfortable knowing that their respective investment, duties & obligations as shareholders, rights, and benefits are in writing. The agreement will be tailored to the specific requirements of your business and will be written in plain English.

What Your Shareholders’ Agreement Should Include

Your shareholders’ agreement should describe the duties and responsibilities of the shareholders, methods of making shareholder decisions, and ownership of shares. In addition to any specific wishes of the shareholders, your shareholders’ agreement will also include provisions addressing the following issues:

  • Date of the agreement
  • The parties (shareholders and others)
  • Definitions to clarify terms
  • Recitals including purpose and background information
  • Business and affairs of the corporation
  • Control of the corporation; election of directors
  • Signing authority
  • Decision making procedures; where shareholder approval required
  • Financing and additional capital contributions to the corporation
  • Issuance of new shares
  • Ownership of shares
  • Transfer of shares: procedure, right of first refusal, conditional on signing agreement
  • Retirement, divorce, bankruptcy, incompetency, or death of a shareholder
  • Insurance
  • Non-competition
  • Confidentiality
  • Non-solicitation
  • Dispute resolution between shareholders (arbitration and “shot-gun” clauses)
  • Legend to be printed on face of all share certificates
  • General contract provisions
  • Relevant schedules (if any)

How the Law Office of Peter Cusimano Can Help You and Your Business Today

Shareholders should enter into a shareholders’ agreement as soon as possible, especially when all the shareholders are harmonious. If you wait until a disagreement arises, it will likely be too late to get the disputing shareholders to agree. I will meet with you and will prepare the necessary shareholders’ agreement. I will ensure that the shareholders’ agreement contains whatever is required to satisfy any of your specific wishes. In order to protect the legal interests of the other shareholders, each shareholder should consult their own lawyer to review the shareholders’ agreement and to provide independent legal advice. You will find that my agreements are complete, and understandable. Complete and clearer agreements are harder rather than easier to do. If something is not clear to you, I will explain it to you.

Peter Cusimano practices business law in Toronto, Ontario.

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