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Shareholder Agreements

As a tax and corporate lawyer with a practice involving family-owned businesses in Canada, I am constantly surprised by how many companies which are owned by various family members, are not governed by a legally binding shareholder agreement. In my experience, there are normally two reasons for this. The first is that the family believes that all business issues can be resolved amicably 'in the family' and legal agreements are not required. Alternatively, when the business started, it may have been very small and the shareholders believed that it was not worth the time or effort to enter into a shareholder agreement. As the business grew, a shareholder agreement was still not a priority. Sadly, I have seen many family businesses ruined because of management or ownership disputes between shareholders which could have been resolved without arguments or litigation if there had been a properly drafted shareholder agreement.

A shareholder agreement is a legally binding document which sets out the rights and obligations of the shareholders of a company. The agreement would normally cover the management of the company, including details relating to the board of directors (number, ability to name nominees and a description of the duties of the directors), how officers will be appointed along with banking arrangements including signing officers. The agreement should also set out how major business decisions will be made, including the sale of a substantial portion of the assets, issuance of further shares, changes in the nature of the business carried on by the company and the entering into of major contracts. As well, there should be a method to determine the hiring and remuneration of employees, including shareholder employees and family members.

Frequently the shareholder agreement will also set out a policy regarding the distribution of company profits as well as how financing will be arranged for the company, including whether shareholders can be required to make compulsory loans to the company or to personally guarantee company loans. In addition, the agreement could deal with future marital disputes of shareholders, possibly requiring each shareholder to enter into a marriage contract which prohibits the shareholder's spouse from making a claim on the shares of the company. If appropriate, reference can also be made to an Advisory Board and/or a Family Council.

One of the most difficult issues to resolve in a shareholder agreement is whether shareholders have a right to transfer their shares to others (e.g., children) and when will shareholders be required to sell or buy from another shareholder. For example, what happens if a shareholder is incapacitated, dies or otherwise ceases to be an employee of the company? Who decides whether such shareholder retains his or her shares or is required to sell to active participants in the business? In addition, a properly drafted shareholder agreement will provide when shares can be transferred to outside third parties. The agreement may contain a right of first refusal which provides existing shareholders with a first option to acquire shares if a shareholder wishes to sell to an outside party and 'carry along' rights which permit a majority shareholder to force minority shareholders to sell their shares if the majority shareholder wishes to sell all of the company.

The shareholder agreement should also set out a mechanism to deal with disputes between shareholders. For example, if there is a major dispute, can one shareholder force the other to sell or acquire shares? Perhaps a 'shotgun' provision would be included in the agreement. This would permit one shareholder to set a price for his or her shares and provide the other shareholder with a right to either buy such shares or sell his or her own shares at such price. The agreement could also provide for mediation and/or binding arbitration in the event of a dispute.

It is also usual for the shareholder agreement to include insurance provisions which provide funding in the event of death and/or disability so that the sale and purchase of shares between family members can be funded on a tax effective basis.

Provisions dealing with non-competition and confidentiality should be considered. For example, if a family member decides to leave the family business or is forced out of the family business, can he or she immediately compete with the family business and use confidential information, such as client lists? As can be seen from a review of these issues, a shareholder agreement involves numerous decisions and can be quite complex and time consuming. However, a properly drafted agreement should help a family business continue for many generations and eliminate disruptive family disputes.

Jules Lewy may be reached at jules.lewy @ fmc-law.com

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