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What are the essential provisions of a shareholders’ agreement in Canada?

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Following our previous article on the importance of having a shareholders’ agreement in Canada, this article offers an overview of the most common clauses in a “regular” shareholders’ agreement or a unanimous shareholders’ agreement.

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The general provisions of a shareholders’ agreement in Canada


Some of the provisions in a shareholders’ agreement are of a general nature, as they can be used in a variety of circumstances, while others must be used in specific cases. In this section, we detail the general provisions of a shareholders’ agreement in Canada.

Confidentiality and non-competition 

A corporation has to protect its confidential information, clients, and employees. To do so, 3 provisions are instrumental:

  • The confidentiality of information clause,
  • The non-competition clause, and
  • The non-solicitation clause.

A confidentiality clause prevents the unauthorized disclosure of confidential information by a shareholder. Thus, a shareholder upholds a non-disclosure duty in favour of the corporation. Note that the scope of that duty varies when a shareholder holds a position or office within the corporation.

A non-competition clause restricts a shareholder’s ability to compete against the corporation. In practice, this clause is almost always supported by a non-solicitation clause that prohibits a shareholder from soliciting the corporation’s employees or clients for his personal benefit or that of another corporation. These restrictions are determined for a fixed period of time that exceeds the term of the shareholding, and vary according to the degree of the shareholder’s involvement in the corporation. Therefore, a shareholder is bound by these obligations even after the end of his shareholding. For example, a shareholder who is an employee of the corporation will be subject to less restrictive duties than a shareholder who is a director of the corporation.

Mediation and arbitration 

A mediation clause allows parties to solve their dispute by finding a common solution with the help of a third-party, the “mediator”. The mediator referees the discussion between the parties without having the power to make or impose any decision on them. In fact, it is the parties that have to find a solution to their dispute with the guidance of the mediator. Usually, a mediation process is undertaken before resorting to an arbitration or judicial process, and with the objective of avoiding litigation.

In Canada, an arbitration clause allows parties to submit their dispute to one or multiple arbitrators who decide(s) on the outcome of the dispute. The objective of arbitration is to resolve disputes in a timely fashion, to preserve the parties’ relationship, and to ensure the confidentiality of the dispute. The scope of the arbitration process is usually defined within this provision. It is fundamental to understand that, as a general rule, an arbitration provision expressly waives any recourse to courts, and that its decision is final and without appeal which incurs certain consequences that parties have to be aware of.

Pricing of shares, and terms and conditions for the transfer or sale of shares

Independent of the context, when a “regular” shareholders’ agreement or an unanimous shareholders’ agreement discusses the sale or transfer of shares, it should provide how the value of the shares will be determined, and how that sale or transfer will be undertaken.

Who sets the price? There are generally 3 possibilities:

  • The shareholder’s agreement, in advance or reviewed upon a specific period (i.e. yearly)
  • A formula provided for in the shareholders’ agreement, or
  • An independent third-party or the corporation’s auditor or accountant. 

How to determine the share’s price? Commonly, there are 3 ways to go about it:

  • A fixed price – a predetermined amount that does not change in time. 
  • A fair market value price – a price determined at the moment when the sale or transfer occurs, and based on an open market’s evaluation of the value of the share.
  • A book or adjusted book valuation – the book value is a ratio between the market price per share and the book value per share, and the adjusted book valuation sets the value of the share by taking into account the company’s liabilities.

Note that to determine a share’s price in Canada, we recommend you seek the help of a tax specialist or chartered accountant. Furthermore, the event triggering the valuation of shares, whether it is amicable or non-amicable, may determine how the sale price is fixed, and its terms and conditions.

Amendment and termination of a shareholders’ agreement

As a contract, any shareholders’ agreement may be amended or terminated with the assent of all the shareholders subject to the agreement. It is common for a third-party investor to require the amendment of a shareholders’ agreement, or the approval of a new agreement before investing into a corporation.  

This concludes the section on the general provisions of a shareholders’ agreement in Canada. In the following section, we will review the specific provisions of a shareholders’ agreement.


The specific provisions of a shareholders’ agreement in Canada


Six types of clauses are most commonly used in a shareholders’ agreement in Canada. These types are discussed below, but do not constitute an exhaustive list as other provisions may be included in a shareholders’ agreement.

We know that it is difficult to choose and establish the terms of a shareholders’ agreement, which is why Lex Start helps you build your shareholders’ agreement with a lawyer’s help at an affordable price. If you have any questions about this subject, please do not hesitate to book a free phone call with us.

The pre-emption clause

The pre-emption clause contains a pre-emptive right that grants a priority to the existing shareholders of a corporation to purchase new shares that are being issued before being sold on the market. The purchase has to be conducted in proportion to the shares already held in a corporation, and at the same price offered to third-parties. Thus, the pre-emptive right does not increase a shareholder’s ownership stake in the corporation but avoids its dilution. Practically, a pre-emptive right may be used by minority shareholders to restrict the ability of majority shareholders to dilute their shareholding when the corporation issues new shares.

The clause of first refusal 

In Canada, this clause provides a right of first refusal (also known as “ROFR”) that benefits the existing shareholders to the detriment of third parties wishing to purchase shares of the corporation. The right of first refusal divides itself in two categories: either a “soft” or “hard” right of refusal. 

When a third-party offers a shareholder to buy his or her shares, that shareholder has the duty to notify the other shareholders of the offer. The notice has to specify the price and the terms of the offer, and has to allow the other shareholders to buy these shares for the same price and under the same terms: this is the “hard ROFR”. Thus, the non-selling shareholders have the right to match the offer received by another shareholder to avoid having an external party come into the corporation. 

Similar to a ROFR, the “soft ROFR”, which is also known as the right of first option (and “ROFO”), aims to protect the rights of existing shareholders at the expense of a purchasing third-party. The “soft ROFR” forces the selling shareholder to first offer his or her shares to the remainder of the shareholders before selling on the market. Conversely, these shareholders have the right to purchase the shares in proportion to their shareholding. If they decline to exercise that right, the selling-shareholder becomes entitled to sell the shares to a third-party.

Tag-along clause

This provision grants a tag-along right (also known as the “piggyback right”) that arises when a shareholder sells part or all of the shares to a third-party, and allows another shareholder to “tag-along” and sell in the same proportion the shares owned in the corporation. This is a way-out from the corporation for the shareholders who do not elect to purchase the seller’s shares under the right of first refusal or do not own such a right. In this case, the third-party has to purchase the original seller’s shares, and the shares of the shareholders who decide to exercise their tag-along right.

For example, a first shareholder sells 25% of his or her shares to a third-party. A second shareholder, by using a tag-along right, may require the acquiring third-party to buy 25% of his or her shares as well. Thus, the third-party has to buy-out both the initial 25%, and the additional 25% imposed by the tag-along shareholder.  

Drag-along clause

The drag-along right arises when a third-party offers to buy-out a majority shareholder of a corporation. It aims to facilitate this sale by allowing the selling-shareholder to offer 2 options to the remainder of the shareholders: either to sell their own shares to the acquiring third-party, or to approve the sale. This right grants an important advantage to a majority shareholder.

Option clause

An “option” comes into effect with the occurrence of an event, and may grant a right or impose an obligation on parties to sell their shares. There are two types of options: the “put”, and the “call” options. 

The put option grants a right to a shareholder to sell back his or her shares to the corporation, or to other shareholders at a fixed date or upon the occurrence of a specific event. The sale price can be predetermined or determined using a formula expressly mentioned in the shareholders’ agreement. The shareholder has the right to determine whether or not it exercises this option.

The call option forces a shareholder to sell back his or her shares to the corporation, or to other shareholders. This is an obligation; meaning that the shareholder has no choice but to sell the shares when a specific circumstance arises. A common example is upon the breach of a shareholder’s agreement, in which case the shares can be acquired at a discount. In any other event, the sale price of the shares is commonly determined by the fair market value or a specific formula.

Shotgun clause

The shotgun provision, which is an example of a “buy-sell” provision, represents the Armageddon of all clauses. It is to be used with caution as it terminates the shareholding of one or multiple shareholders.

In Canada, this provision allows a shareholder to purchase the shares of another one, or the remainder of shareholders. Also, the provision specifies the price and the terms of the sale. Following the use of the shotgun clause, shareholders to whom such a clause is opposed, have two options:

  1. Sell their shares in accordance with the offer received, or
  2. Buy the shares of the offeror-shareholder for the same price, and under the same terms of the offer.

 From a practical standpoint, a shotgun provision may be used to resolve what is known as a “deadlock”, that is to say a situation in which shareholders disagree about the affairs of the corporation and want to be bought-out. To put it simply, this provision buys-out or sells-out one or multiple shareholders for the benefit, or to the detriment of another shareholder or the remainder of shareholders. 

Another common example of a “buy-sell” provision arises following the death of a shareholder. In such a context, a corporation that has contracted a life insurance policy on the deceased shareholder and has set itself as the beneficiary, will have the option to buy-out the deceased’s shares using the policy to avoid having an undesired member of the estate integrate the corporation.  

This wraps-up the most common provisions of a shareholders’ agreement in Canada. Nonetheless, a shareholder agreement varies depending on the parties involved and the subject matter covered. Therefore, it may provide for rights other than those mentioned above.


Conclusion


To conclude, remember that:

  • An “regular” shareholders’ agreement or a unanimous shareholders’ agreement may contain a number of general and specific provisions in order to accomplish their objectives.
  • You are not alone: Lex Start is here to help you protect the interests of your corporation, and the rights of shareholders without compromising your budget by providing affordable and personalized legal services.  

We hope that this article has provided a better understanding of the most common provisions of a shareholder agreement. For more information in regard to this or about the incorporation process, contact us.

 

Mihai Gheorghe Cioc
Legal editor