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8 Strategies to Avoid or Resolve Shareholder Disputes

Published:

October 30, 2024

Author(s):

• David Wallace

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Disputes between shareholders of a corporation, and shareholders and their corporation, are stressful and complicated, and often attract (negative) publicity. Regardless of the outcome, any such dispute irreparably harms the reputations of all involved – including the corporation. But there are strategies to avoid such disputes or if not, then to resolve them without going to arbitration or litigation. Here’s a look at the duties of shareholders to the corporation and to each other, and eight strategies to avoid or resolve shareholder disputes.

Shareholders’ Duties 

Share capital represents the instrument symbolizing and crystallizing the legal relationship between a corporation, an entity distinct from the persons composing it, and its shareholders. Shareholders are the owners of the corporation – but it’s also helpful to understand that shareholders are not:

• Trustees for one another.
• Under any fiduciary duties to the corporation, unlike directors.
• Prevented from competing with the corporation or taking opportunities that the corporation could have pursued, unlike partners or directors.

Shares provide income and capital entitlements to shareholders and an array of other negotiated and statutory rights, to be used by shareholders as they see fit. Shareholders vote in respect of their shares and exercise those voting rights for their own personal advantage. So, shareholders should expect other shareholders to exercise their voting rights in their own self-interest. But this doesn’t mean shareholder action is completely unchecked. While the general concept is that shareholders do not, as a matter of status, owe fiduciary obligations to their corporations or to each other, there are exceptions to this general rule.

Duties & Obligations to the Corporation. If, through a Unanimous Shareholders’ Agreement (USA), shareholders usurp the rights, powers and duties from directors, the shareholders (including minority shareholders) incur all of the liabilities of directors. This is codified in many modern corporate statutes. To the extent shareholders contractually seize such directors’ duties, the shareholders incur the directors’ fiduciary duties and duty of care to the corporation. Where a shareholder has “contractually acquired” these obligations, shareholders can no longer vote in their own self-interest but must instead vote selflessly and in the corporation’s best interests (as a director would be obligated to).

Duties & Obligations to Other Shareholders. The general concept that shareholders don’t owe duties or obligations to each other becomes implicitly nuanced in the context of a closely-held company, and explicitly amended in the context of a unanimous shareholders’ agreement (USA), where all shareholders of a corporation are a party to the agreement, or a shareholders’ agreement (SHA), where less than all of the shareholders of a corporation are a party to the agreement.  A USA or SHA creates contractual (for Nova Scotia companies) and quasi-statutory (for Canada Business Corporations Act or “CBCA” corporations) relationships and expectations among the shareholders that are a party to it, and among such shareholders and the corporation. The obligations created by such contracts are self-explanatory. But what’s more interesting is how the broad remedial nature of the statutory oppression remedy and the special expectations of shareholders in closely-held, private corporations work together to create equitable obligations among shareholders. What does this mean? Shareholders in closely-held corporations might expect employment, a management position or a dividend to be an essential part of their shareholder bargain. Yet for many reasons, these terms might not be explicitly written into a Unanimous Shareholders’ Agreement or a Shareholders’ Agreement. However, courts have time and again recognized that, in the context of a closely-held corporation, such “unwritten” expectations may still be “reasonable”. So when such unwritten but reasonable expectations are breached, courts use the statutory “oppression remedy” to “read in” equitable terms to fill any apparent contractual gaps after the fact.

8 Dispute Avoidance & Resolution Strategies

What can shareholders do to limit the risk of a dispute – and of a court ultimately “reading in” certain equitable terms into the shareholder bargain?

All Shareholders. There are two key strategies all shareholders can employ to avoid the risk of shareholders’ disputes arising at all.

1. Implement a Well-Drafted USA or SHA. Your most valuable tool to combat potential disputes is a well-drafted shareholders’ agreement that addresses the major sources of conflict and how such conflicts will be resolved. Ideally, the Unanimous Shareholders’ Agreement or Shareholders’ Agreement should be negotiated and entered into by the shareholders of a company immediately upon incorporation, when no conflict exists.

• Stakeholder Interests. Minority shareholders in close corporations have brought several oppression actions claiming their interests as shareholders, employees, directors, officers, creditors, or any combination of these, have been unfairly prejudiced. This highlights the importance of drafting the shareholders’ agreement at the outset with an idea of all of the different stakeholders you’ll be dealing with and ensuring you consider all their interests.
• Regular Revisiting. The arrangements among individuals in a closely-held company are dynamic. Shareholders come and go. Ownership interests change. The board turns over. It’s crucial that the shareholders’ agreement continually reflect the changing circumstances. Consider the shareholders’ agreement a “living tree” and proactively revisit it often at regular intervals. For example, proactively revisit and sign off on a valuation schedule (a schedule that sets out the corporation’s value) annually.

2. Document Decisions. Shareholders wear many hats in a private company: shareholder, employee, director, officer, creditor, or any combination of these. While the line is certainly blurred in private companies, your fundamental rights, duties and obligations differ, sometimes substantially, depending on what hat you’re wearing.

• Identify Your Hat. Drill down about your obligations when wearing each hat.
• Create a Clear Record. And when making decisions, document your decisions and be clear about which hat you’re wearing in making the decision. It’s important to note that just because the requisite shareholder approval for a particular decision has been met, that doesn’t necessarily bar an oppression claim. And even poor documentation isn’t fatal. It’s unlikely a court will consider technical breaches as oppressive on the face of it if the breaches have no adverse consequence of substance. Courts have held that “sloppy paperwork” in and of itself isn’t oppression; overlooking ‘corporate formalities’ isn’t the kind of unfair conduct the oppression remedy deals with.
• Business Judgment Rule. Creating a clear record allows directors and/or shareholders to better take advantage of a defence: the Business Judgment Rule. When shareholders restrict directors’ powers they gain all the directors’ rights, powers, duties and liabilities – including any applicable defences – including the Business Judgment Rule. Courts tend to be reluctant to second-guess a board’s / shareholders’ honest and informed business decisions and recognize a situation could look very different before the fact, in a boardroom, than after the fact, in a courtroom. In practice, the availability of the business judgment rule is often a function of the process the individuals followed in reaching their decision, rather than of an analysis of the merits of the board’s decision. Therefore, to maximize the degree of protection the business judgment rule affords, try to ensure you can prove you were well-informed. And the best way to do this is to ensure decisions are well documented, making it clear they were the result of honest and thorough deliberation.

Obviously, the hope is that you have a well-drafted USA or SHA that clearly and definitively lays out everyone’s expectations and incorporates mechanisms and levers for you to pull and use in the face of a dispute respecting those expectations. But, of course, there may not be a Unanimous Shareholders Agreement or Shareholders’ Agreement – or if there is, it might not sufficiently address the dispute at hand. But before embarking on litigation or arbitration to resolve the dispute, there are some statutory tools you can implement to compel compliance or get the other party’s attention to come to the table to negotiate or reach a settlement.

Minority Shareholders. If you don’t have the votes to block a particular action, you don’t have the votes. But there are statutory ways to slow the majority down and force them to the table to negotiate.

3. Requisition a Shareholder Meeting. Under most corporate statutes, shareholders that meet certain minimum requirements may requisition the directors of the corporation to hold a shareholders meeting. Under the Canada Business Corporations Act, directors aren’t required to call the meeting if it clearly appears that “the primary purpose is to enforce a personal claim or redress a personal grievance against the corporation or its directors, officers or security holders” or “the purpose of the meeting does not relate in a significant way to the business or affairs of the corporation.”

4. Make a Shareholder Proposal. Under most corporate statutes, shareholders who meet certain minimum requirements are entitled to submit a proposal to the company to be considered at the next shareholder meeting. Notably, under most corporate statutes, directors aren’t required to include such a proposal in the notice/circular if it clearly appears that “the primary purpose is to enforce a personal claim or redress a personal grievance against the corporation or its directors, officers or security holders” or “the proposal does not relate in a significant way to the business or affairs of the corporation.”

5. Appoint an auditor / Don’t Waive the Requirement to Appoint an Auditor. Shareholders at each annual general meeting must appoint an auditor. The shareholders of a corporation (including non-voting shareholders/members) can unanimously resolve to not appoint an auditor. Absent the audit being done to unearth wrongdoings, this strategy is really about adding another burden for the majority to handle.

6. Dissent to fundamental changes in the corporation. If there are fundamental changes in the corporation, a shareholder has the right to dissent to those changes and require the corporation buy back their shares at a fair value agreed upon with the corporation – without resort to the court.

Majority Shareholders. On the other hand, if you have the votes, you’re uniquely positioned to implement a couple of specific strategies.

7. Advance Notice By-Law. Require shareholders who wish to nominate directors to give notice of their intentions well in advance of a shareholder meeting. For example, an advance notice by-law could require that before a nominee can stand for election, the supporting shareholder must provide the corporation with at least 30 days’ notice of the proposed nomination. The by-law could require disclosure of certain information, in particular information that would need to be disclosed if the corporation included the nominee in its proxy materials, about the nominee in advance of the meeting.

8. Enhanced Quorum Provisions. Enhanced quorum provisions represent another tool available to corporations seeking to frustrate or prevent shareholder activism. Enhanced quorum provisions increase the quorum requirement to a higher percentage, such as 70%, where shareholders are voting on a contested election of directors.

Please contact your McInnes Cooper lawyer or any member of our Corporate & Business Law Team @ McInnes Cooper to discuss how we can help you avoid or resolve shareholder disputes.

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