Shareholders Agreements

A shareholders agreement is a contract amongst the shareholders of a company and usually the company itself. A shareholders agreement may include provisions relating to any of the following matters:

(a)  management of the company;

(b)  loans and contributions;

(c)  share issuances;

(d)  share transfers;

(e)  optional buy-outs;

(f)  compulsory buy-outs; and

(g)  defaults by shareholders.

Management

The directors of a company have the responsibility of managing or supervising the management of the company. Absent an agreement establishing some other arrangement, shareholders holding more than 50% of the voting shares of a company can elect the directors of their choice leaving minority shareholders with little or no influence over the business affairs of a company. A shareholders agreement can dictate the manner in which directors are elected. For example, a shareholders agreement could grant each shareholder the right to nominate one director. A shareholders agreement could also give shareholders a greater voice as to how the company is run by requiring shareholder approval or unanimous director approval before certain decisions are made. A shareholders agreement could also include provisions relating to financial records (e.g. designation of accountants and auditors), banking, dividends and insurance (e.g. asset and key-personnel policies).

Financing

Directors may have several options available to them for obtaining additional funds for the operations of a company. A shareholders agreement could restrict or otherwise limit the available sources of funding. For example, a shareholders agreement could limit the ability of a company to look to its shareholders for contributions by requiring the company to first seek adequate financing from a lending institution. A shareholders agreement could also deal with the issue of compulsory shareholder loans. For example, a shareholders agreement could make shareholder loans a requirement in certain circumstances or provide a mechanism for determining the rights of the shareholders who make loans when other shareholders do not.

Share Issuances

Shareholders will often want the ability to protect their percentage of ownership of a company. A right of first refusal that applies to future share issuances is often included in a shareholders agreement for that purpose. A right of first refusal gives existing shareholders the right to acquire a portion of any shares a company may issue in the future based on their proportionate shareholdings at the time. This right is intended to provide shareholders with some assurance that they will at least have the opportunity to maintain their percentage of ownership in the future by acquiring additional shares if necessary. Another way to provide this type of anti- dilution protection is to include a restriction on future issuances that requires the approval of all shareholders before a company may issue shares in the future.

Share Transfers

In a closely held company, the shareholders often play an active role in the management of the company as directors, officers and/or employees and view each other more as partners than shareholders. Not surprisingly, most shareholders in closely held companies prefer to have some say as to who becomes a shareholder. A shareholders agreement could include rights and restrictions that give shareholders greater control over who becomes a shareholder. For example, a shareholders agreement could give shareholders the right to purchase the shares of a shareholder who wants to sell shares. A shareholders agreement could also give purchase rights to shareholders or the company to prevent shares or an interest in shares from being held by non-shareholders as a matter of law, such upon death, divorce or bankruptcy. Sometimes life insurance is obtained for the purpose of having the company purchase the shares from a shareholder's estate in the event of a death.

A shareholders agreement could also include draw-along rights and piggy-back rights. A draw-along right usually gives a majority shareholder the right to require a minority shareholder to sell all of the minority shareholder's shares to a non- shareholder who is willing to buy the shares of the majority shareholder. A piggy- back right usually gives a minority shareholder the right to prevent the sale of a majority shareholder's shares to a non-shareholder unless the non-shareholder also purchases the minority shareholder's shares on the same terms.

Optional Buy-outs

A shareholders agreement could also list events that may give shareholders the right to buy out another shareholder if any of the events were to occur.

Usually the events relate to another person acquiring an interest in a shareholder’s shares by operation of law or as a matter of right. For example, a shareholder’s spouse may acquire an interest under the Family Relations Act if they go through a legal separation or divorce and the shares are considered to be a “family asset”. Another example is a creditor who takes the assets of a shareholder, which includes shares, if the shareholder goes through financial difficulties and is unable to pay the creditor what is owed or goes into bankrupcty. Another example is the death of a shareholder which will result in the shares passing to the shareholder’s estate and being distributed in accordance with the shareholder’s will. Often shareholders want some control over who becomes a shareholder. These examples involve a transfer of the shares or an interest in the shares of a shareholder that is outside of the shareholder’s control. A buy option provides a way for the other shareholders to control who may be a shareholder by allowing them to buy the shares from the spouse, creditor or estate.

Another event that is commonly included in a shareholders agreement for a closely held company is the end of a shareholder’s involvement in the company’s business, e.g. as a director, officer, employee or consultant. Sometimes the original intention amongst shareholders is that they will contribute to the business in some capacity. If a shareholder is no longer willing or able to make his/her contribution then the other shareholders may want the option of buying out the shareholder. For example, a shareholder may become mentally or physically unable to perform as originally contemplated as a result of a permanent disability or a shareholder may decide to leave the business for some reason.

Compulsory Buy-outs

In a closely held company, at some point shareholders may decide to go their separate ways. Perhaps they no longer get along or may be they simply have a difference of opinion in terms of the direction they want to take the business. A shareholders agreement could provide a mechanism whereby shareholders have the ability to get out or force another shareholder out of the company if they are unable to otherwise agree on an appropriate exit strategy at that time. For example, a shareholders agreement could enable a shareholder to approach another shareholder and offer to sell the shareholder's shares to the other shareholder at a certain price/share or at fair market value or, if the other shareholder refuses, to require the other shareholder to sell the other shareholder's shares to the shareholder on the same terms. This is commonly called a shotgun clause.

Defaults

The usual remedies available to parties when a contract is breached (e.g. money damages) are available if a shareholders agreement is breached but a shareholders agreement could also give non-breaching shareholders additional rights. For example, a shareholders agreement could give non-breaching shareholders the right to purchase the shares of a shareholder who breaches the agreement at a discounted price.