Shareholder agreement helps guide parties in exiting corporation

Like marriage, not all business partnerships will work out, which is why it’s crucial to have a shareholder agreement in place from the start, says Toronto business lawyer Anton Katz.

“There are numerous events that can contribute to the breakdown or reorganization of a corporation,” he says. “A shareholder agreement is essentially a roadmap — it’s a working document that parties can look at and govern themselves in accordance with over the years.”

As important as it is to know how to enter into a business, he says, it’s perhaps equally important to know how to exit a business.

“While a shareholder agreement can be a document that guides parties in terms of decision-making, it can also guide parties in terms of exiting the corporation,” he tells AdvocateDaily.com. “In some respects, it’s like a marriage. If you know from the beginning how things will be handled at the end, it allows for more certainty and predictability. It certainly can go a long way towards avoiding litigation and the associated legal fees.”

There are a multitude of involuntary and voluntary events that can happen over the course of a corporation’s lifespan, Katz notes. Involuntary events can include the death or disability of a partner, a marriage breakdown, or a personal bankruptcy.

Meanwhile, voluntary events can include bringing another partner into the fold or buying out an existing partner.

“With both voluntary and involuntary events, there is likely to be a concern as to who is going to be stepping into the shoes of the other party,” he says. “The shareholder agreement can pre-empt or supersede certain consequences by giving one shareholder either a right or an obligation to buy the shares of the other to prevent a spouse or trustee in bankruptcy from becoming a shareholder.”

Katz explains a common clause to have in the shareholder agreement is a shotgun provision, also known as a buy-sell clause.

“A shotgun is a mechanism, which is maybe best described by using an example. Let’s say you have a corporation worth $100. You have two shareholders, A and B, and each of them owns 50 per cent of the shares. And let’s say A and B are not getting along for whatever reason. It could be a legitimate business dispute or it could be frivolous, but they’re not getting along and no longer wish to work together as shareholders.”

Katz says if there is a shotgun clause, A can offer to buy B’s shares for $50. B, in response, can accept A’s offer and surrender the shares for $50 or B can offer to buy A’s shares for $50.

“In that manner, one person is left in the company at the end of that exchange,” Katz says. “If B sells the shares, then A is the sole owner going forward. If B buys A’s shares, then B is the sole owner going forward.

“It’s equitable because it’s the same dollar amount in both cases. It’s just the identity of the buyer or the seller that is unclear at the start of that scenario,” he adds.

There is also the right of first refusal where, using the same scenario, A asks C — who is not a shareholder in the corporation — to buy the shares for $50. If there is a right of first refusal, then A needs to tell B that he has a prior right to buy A’s shares for the same amount.

“The benefit is it helps with liquidity of A’s investment because in that circumstance, A will sell his shares and the buyer will be either C or his partner B. His investment is thereby made more liquid and he can cash out and get $50,” Katz says. “The benefit to his partner B is that if B does not want to be shareholders with C, then B can buy A’s shares for the same dollar amount.”

Katz recommends shareholders seek specialized legal advice when setting out the agreement.

“Getting advice is well warranted to consider all of the permutations and possibilities and tax opportunities and insurance opportunities that could be considered,” he says.