A shareholders’ agreement at outset can avoid messy litigation later

A recent case underscores why it’s crucial to understand what each party’s expectations are and what pre-existing business relationships they bring to the table when drafting a shareholders’ agreement, Toronto business lawyer Anton Katz tells AdvocateDaily.com.

The Commercial List matter involved an applicant and two respondents who were founders and equal shareholders in a business. Prior to being dismissed by his two co-founders, the applicant was the primary point of contact for a client who represented more than half of the company’s revenue. This client grew out of a relationship he had developed over 14 years preceding the founding of the company.

The co-founder was dismissed from the company in 2017, and the circumstances of that dismissal were the basis of the application and counter-application, court documents state. The respondents alleged that they feared the applicant might try to leave the company and take the major client with him.

Meanwhile, the applicant alleged that when he was sick with cancer, the respondents began working together to squeeze him out of the company he helped found and whose continuing success he was so heavily responsible for, the decision states.

Katz, principal of Anton M. Katz Barrister & Solicitor, says the litigation’s focus on the major client underscores the desirability of having a shareholders’ agreement in place, so all stakeholders understand whether something is the property of the corporation.

“The applicant had a long-standing pre-existing relationship that he brought to the company he co-founded. One of the findings the judge had to make was whether that client became an asset of the company,” says Katz, who was not involved in the case and comments generally. “What we see here is that there was no shareholders’ agreement and so the parties could have put the expectations into writing to avoid this.”

If each party’s reasonable expectations are contained in a shareholders’ agreement, then there can be more certainty as to whether a party is subsequently acting in an oppressive manner.

The applicant alleged the respondents convened the first-ever shareholder meeting of the corporation without his proper notice or consent and removed him as a director. Then, wearing their director hats, removed him as an officer and purported to impose the terms of his future employment at their discretion, the judgment states.

“As might have been anticipated, things did not end well,” Justice Sean Dunphy said in the decision.

Katz says while it’s not necessarily a reasonable expectation that a shareholder can be an officer and director forever, the judge frowned on the haste with which the decision to remove the applicant was made.

“It underscores the importance of holding regular shareholders’ meetings — not simply having one to suit a very narrow purpose,” he notes.

The applicant asked for his shares to be purchased by the respondents at a fair market value without discount.

“In my view, this is the only remedy that will fairly repair the harm that has been done,” Dunphy wrote.

Katz says in a typical shareholders’ agreement, parties can negotiate buyout provisions — such as a buy-sell or shotgun clause.

“You wouldn’t typically have a situation where you have a unilateral right to force your shareholders to buy out your shares, which happened in this case,” he says. “Call or shotgun rights are valuable because they can be triggered if a corporation no longer wishes to have someone as a shareholder.”

Ultimately, Katz says roles need to be clearly delineated within a corporation, and a shareholders’ agreement should talk about buyout rights.

“Rather than the uncertainty and expense of litigation, this could have been avoided by addressing these issues head-on in a shareholders’ agreement,” he says. “An agreement could have dealt with the pre-existing client account and the buyout of a departing partner’s shares in a much faster and less uncertain way.”

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