Shareholders’ agreement key to resolving conflict, impasse
By AdvocateDaily.com Staff
Although a shareholders’ agreement is like insurance — and most businesses are hoping they will never have to rely on it — the best time to put this document in place is when all parties are thinking equitably, and there is no money at stake, says Vancouver corporate lawyer Jonathan Reilly.
As Reilly, founder of English Bay Law Corporation, explains, because shareholders’ agreements are administrative in nature and expensive to put together, some small companies either choose not to put them in place, or they wait until there are stormy waters ahead to see what can be done.
“At that point, it’s difficult or impossible,” he tells AdvocateDaily.com.
Essentially, says Reilly, shareholders’ agreements act as prenuptial contracts for businesses and are a valuable tool for setting out processes to solve problems later on, and preserving business and family relationships.
“They have a little bit of coverage of how everything is going to work while things are just coming along and a lot of detail about what’s going to happen in the event of death or disagreements, mandatory or voluntary sale, that kind of thing,” he says.
A typical shareholders’ agreement will include a brief description of the business, outline what the authorized capital is and who holds it, as well as a chapter on how the company is to be governed, who’s entitled to appoint directors or to be represented on the board of directors and sets out how decisions are going to be made, including a process for approving a budget or linking expenditure authorizations to the budget.
“How complicated those rules are or whether there are any rules on that, the world is your oyster. There’s no requirement for any rules on those issues, and they can be as simple or as complicated as the shareholders agree. That’s true for the whole agreement — it can be as simple or as complicated as the shareholders decide,” says Reilly.
Another typical area on a shareholders’ agreement concerns the voluntary or involuntary removal of shareholders.
“So, a shareholder wants to go — are they allowed to sell their shares? To whom are they allowed to sell their shares? Anybody who will buy them, or do they have to offer them to existing shareholders first and in that process, if the existing shareholders don’t want them, are they then free to offer them to anybody at any price, or are they stuck? And again, there’s a lot of flexibility,” says Reilly.
In the case of involuntary departures, such as when a shareholder has become impossible to work with, Riley says the agreement will address the question of whether the other shareholders can force them out of the business and if so, whether they can force the acquisition of their shares and at what price.
The shareholders’ agreement can also include a price-setting mechanism for other situations, he adds, such as divorce, bankruptcy, or a buy-sell scenario where there are two shareholders, and the relationship has broken down.
Shareholders’ agreements can also be used to try to govern what can happen to a corporation in an estate circumstance, says Reilly.
“If your estate plan is to give the shares of the company to a group of people, then while you’re still the sole shareholder, you can put rules in place for who can have those shares, say, for instance, to keep them within a family. The bottom line is that those rules can be changed, but you could put rules in place that make it either difficult to change those rules, or it sets expectations that people might actually live by,” he says.
“It may give the testator some peace of mind that what they would like to happen has a better chance of happening. It is by no means a guarantee,” adds Reilly.
Ultimately, in situations where a shareholders’ agreement is not in place, the consequences can be dire both for the business and to the relationships of those involved in the company.
“I’ve had more than one client in my practice who has wound up with an even number of shareholders and a 50/50 disagreement — half the shareholders think one way and half think another way. The disagreement progresses to the point where they can’t even agree on the most basic things, and when that happens, the business can no longer function,” he adds.
On the non-business side, Reilly says absence of a shareholders’ agreement could result in broken relationships.
“The shareholders’ agreement will lay out a process that gets you a decision that maybe leads to an involuntary departure, and there may be hard feelings over that. There is a greater chance that either the hard feelings will be avoided or that the hard feelings can be gotten over if everyone can point to an agreement and say ‘well, we didn’t like it, but we did agree to it.’
“Whereas, if there’s no way to do that, you can spend a lot of money in mediation or some other process and never restore those relationships. And in small companies, those relationships are generally family and friends,” he says.
“So, the worst consequence, if you don’t have a shareholder’s agreement, it means you don’t have any resolution to impasse. And if you don’t have any resolution to impasse, eventually the business will die. And depending on the nature of the business, it may die quickly, or it may die slowly, but it will die,” says Reilly.