Whether incorporated federally under the Canada Business Corporations Act or Provincially under the Ontario Business Corporations Act, shareholders to a corporation will often want to enter into an additional agreement amongst themselves to address matters beyond the corporation’s bylaws and articles of incorporation. This is why shareholders enter into a shareholder agreement or unanimous shareholder agreement. This blog post will explain the benefits of entering into a shareholder agreement and the typical issues your shareholder’s agreement should address when doing business in Ontario.
The benefits of entering into a shareholder agreement
A shareholder agreement may be used in a variety of circumstances including where there are two shareholders with ownership of the corporation’s shares split 50/50, where there is a majority and minority shareholder, where a larger group of shareholders have equal or unequal shareholdings in the corporation, or where the parties are using a corporation to enter into a joint venture. No matter what the relationship between these parties, typically, the shareholders have spent considerable time discussing their objectives and goals for the corporation both as individuals and a group. The primary benefit of entering into a shareholder agreement is to document those goals and objectives and provide clear evidence of the shareholder’s intentions and obligations as the business grows and expands. A properly drafted shareholder agreement addressing governance of the corporation, finance, and the sale and transfer of shares will help prevent any future misunderstandings and disputes that can result in costly corporate litigation taking time away from the growth and success of the business.
Five Things Your Ontario Shareholder Agreement Should Include
Your shareholder agreement should address the role of the shareholders in the governance of the corporation including the power of individual shareholders or holders of a class of shares to appoint directors to the corporation. While the articles of the corporation will contain provisions dealing with the appointment of directors (such as maximum and minimum numbers that need to be elected) a shareholder agreement typically addresses these issues in much more detail. For example, in a shareholder agreement certain shareholder’s may be entitled to elect one or more directors who will serve as that shareholder’s nominee. The shareholder agreement can also provide for how vacancies are to be filled or how directors are to be removed. The power to influence governance of the corporation is very important because the board may make decisions relating to the corporation that are not specifically reserved for the shareholders under the corporate bylaws or articles.
The Canada Business Corporations Act and Ontario Business Corporations Act require shareholder approval for certain significant matters that materially affect the corporation (such as a sale of substantially all of the corporation’s assets or the amalgamation of the corporation with another entity). However, shareholder agreements or unanimous shareholder agreements usually want to provide for matters that will require a super-majority of votes or unanimous shareholder approval. If the shareholders hold different classes of shares you will want to decide whether some shareholders (such as preferred shareholders) have special voting rights. You may also want to determine if the holders of certain classes of shares will vote together on a class-by-class basis i.e. if there are preferred shareholders they will often want to vote separately from the common share holders on specific matters. All of these issues can, and should, be addressed in a shareholder agreement.
Restrictions on Shareholder Rights
Other matters that a shareholder agreement will usually address are provisions that actually function to remove rights from shareholders that are important to protect the interests of the group. For instance, shareholders can agree to abide by confidentiality and non-disclosure provisions to protect the corporation’s trade secrets or client base. Another restriction could be on shareholder’s ability to compete with the corporation in other similar ventures. Your shareholder’s agreement may also carve out who the restrictions apply to. For instance, it may be more appropriate to prevent certain shareholder’s that are more actively involved in the management and day-to-day business operations of the corporation from competing as opposed to casting a blanket net over shareholders that have little involvement in the corporation’s operations.
One of the fundamental concerns your shareholder agreement will need to address to prevent disputes are pre-emptive rights such as when and how shares can be transferred. Are shareholders allowed to transfer their interests in the corporation’s shares to a family trust, affiliate, immediate family members or only other shareholders? Are shareholders entitled to tag-along rights (the right of a shareholder to participate in another shareholder’s sale of their equity) or drag-along rights (forcing minority share holders to sell their shares when a majority of shareholders agree to a sale of their equity)? Other considerations that can be classified as pre-emptive rights are whether shareholders are permitted to encumber their interest in the shares for instance by using the shares as collateral for a loan agreement or whether shareholders are offered a right of first refusal if another shareholder wants to sell their equity. Addressing shareholder’s pre-emptive rights will go a long way in streamlining the sale or transfer of shares for both the exiting parties and the remaining shareholders.
In addition to the considerations already raised in this post, there are other standard provisions that the shareholders will need to address For instance, what events will lead to the shareholder agreement being terminated? What jurisdiction’s laws should be used to govern the enforcement of the agreement? Do the parties want to agree to alternative dispute resolution provisions such as private arbitration or mediation to avoid having to take each other to court to resolve disputes? What steps do the shareholder’s need to take in the event they want to amend the shareholder agreement? As you can see, there are numerous considerations the shareholders will need to reach a consensus on to give coherence and efficiency to the agreement and therefore prevent disputes.
Shareholder agreements are typically complex and lengthy documents. However, the time spent drafting a comprehensive shareholder agreement is well spent in avoiding the alternative, a complex and lengthy legal dispute. If you need a shareholder agreement or unanimous shareholder agreement for your Ontario business, Supply Law offers flat fee contracts drafted by an Ontario contract lawyer.