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Unanimous Shareholders’ Agreements: Key Considerations & Terms

Published:

October 21, 2016

Author(s):

• The Corporate & Business Team

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Updated August 19, 2024.

All shareholders – whether in a startup, a small or large business or a family-owned business – can benefit from a unanimous shareholders’ agreement. A unanimous shareholders’ agreement (a.k.a. a “USA”) is a written agreement among all (not just some) of the company’s shareholders. It defines the relationship, rights and obligations among the shareholders themselves and between the shareholders and the company and documents their agreement on matters related to the company’s management and operation, financing, organization and the transfer of shares – and addresses potentially contentious issues before problems arise. Without one, the relationship is governed by the applicable corporate legislation (provincial or federal), but that legislation doesn’t necessarily address everything the shareholders might want to govern their relationship or do so in the way they would choose. The best bet: take control and negotiate a unanimous shareholders’ agreement. Here are the key practical considerations and terms of unanimous shareholders’ agreements to consider.

3 Key Practical Considerations

Here are three key practical considerations about unanimous shareholders’ agreements to keep in mind.

Timing. Particularly for new companies, deciding when to spend the money to put a USA in place isn’t always easy. However, if a USA isn’t put in place at an early stage there’s an increased risk of disagreements or deadlocks among initial shareholders with no clear mechanism to efficiently resolve them. Also, professional investors will likely want to see a USA in place before they consider financing the company. If you’re a shareholder in an existing business that doesn’t have a USA, all isn’t lost. Shareholders can enter into a USA at any time, and while the process for putting a USA in place for a mature company might be more complicated because there are likely more stakeholders involved, the benefits of doing so are substantial. And remember: a USA should be a living document. As the business and its shareholders evolve and change over time, so does the shareholders’ agreement to ensure it continues to reflect the needs of both the company and the shareholders. So, plan to review and, as appropriate, revise the shareholders’ agreement both regularly and when significant business changes occur.

Minority Shareholder Rights.  Canadian corporate law is designed to protect minority shareholders. Accordingly, just because a shareholder owns more than 50% of the company doesn’t mean they can make decisions that disregard minority shareholders’ interests.   However, a properly crafted USA will contain provisions that clearly delineate the rights of minority shareholders so company decision-making isn’t unduly affected by minority rights.

Independent Legal Advice. Shareholders’ agreements have long-term ramifications. Each shareholder should have a complete understanding of the terms of the agreement and the company should therefore afford each an opportunity to obtain independent legal advice.   Failing to give shareholders the time and space to seek their own legal advice can put the integrity of the USA at risk.

7 Key Shareholders’ Agreement Terms

Here are seven key unanimous shareholders’ agreement terms to consider including  in your USA.

1. Management & Operations

Address the key aspects of the company’s management and operations.

• Appointment of Board of Directors. Specify the number of directors and set out how directors are elected or appointed, including the power of certain shareholders to designate board nominees.
• Restriction on Director Powers. USAs can restrict or remove certain director powers and place them in the shareholders’ control so certain company actions can only be completed with shareholder approval.
• Distribution of Profits. If shareholders have certain expectations about dividends or other payouts, set them out in the agreement.
• Meeting Procedures. Deal with the procedure at shareholder meetings, particularly for meeting quorums. Requiring two levels of quorum avoids letting a shareholder effectively veto decisions by refusing to attend – and thus defeat the quorum. For example, a quorum for the first meeting requires 2/3 of the shareholders, and the next meeting after a failure to meet quorum sets a lower level (e.g. 50%) for a quorum.
• Special Approvals. A USA can require a higher than simple majority level of shareholder approval (such as three-quarters, two-thirds, or unanimous) for certain fundamental changes such as: the sale of assets outside the ordinary course of business; change of business; borrowing in excess of certain amounts; major capital expenditures; amalgamations; winding-up; and revising the company’s articles.

2. Pre-Emptive Rights

Pre-emptive rights allow each existing shareholder to avoid dilution of their ownership stake in the company. If a company decides to issue new shares, a pre-emptive right allows the existing shareholders (or those that hold a minimum portion of them) to buy those newly issued shares before anyone else does. Importantly, the price offered to the existing shareholders can’t exceed the price for which the company offers the shares on the open market. If the company wants to lower its price, it must first offer the shares to the existing shareholders and the process starts over again. The shareholders’ agreement also typically sets out the procedure to use a pre-emptive right.

3. Rights of First Refusal

Rights of first refusal provisions (ROFRs) protect shareholders – but can deter third party purchasers because the process can be complicated. Generally, a ROFR requires a shareholder that receives an offer from a third-party purchaser to give notice of the offer to the other shareholders. The other shareholders then have the right to match the third party offer within a certain time. If none do, the shareholder who received the third-party offer can sell their shares to the third party. There are two variations of an ROFR.

• “Hard” Right of First Refusal. This is a right of first option: it requires a shareholder(s) to receive a bona fide offer from a third party before offering the shares to other shareholders on the same price and terms. If other shareholders refuse, the offering shareholder can proceed with sale of their shares to the third party in accordance with the offer terms.
• “Soft” Right of First Refusal. This is really a right of first offer: it permits a shareholder to sell their shares to a third party after offering the shares to the other shareholders. The sale to the third party must be on the same price and terms offered to the other shareholders and generally requires disclosure of the terms of the third-party sale.

A right of first refusal can include special rights for majority and/or minority shareholders when a third party wants to enter the mix.

• Tag-Along Rights. This allows other shareholders to “tag-along” with the shareholder that is selling to the third party. Generally, the tag-along shareholder(s) can only sell a maximum of the same percentage of shares as the first shareholder; for example, if the shareholder that received the original offer is selling 10% of its shares, the tag-along shareholders can only sell a maximum of 10% of their shares.
• Drag-Along Right. If a third party offers to buy the controlling shareholder’s or shareholders shares (however the agreement defines the controlling shareholder), the drag-along right allows the controlling shareholder to force all other shareholders to either: sell their shares; or approve the resulting change of corporate control. As a result, a drag-along gives the controlling shareholder(s) great power: it effectively ensures that the controlling shareholder(s) can’t be stopped from divesting their shareholdings when they receive a legitimate third-party offer.

4. Put / Call Provisions

The agreement can permit the company to compel shareholders to sell shares back to the company (a “call”) and can permit shareholders to compel the company to buy shares (a “put”), usually in specified “triggering” circumstances. Common triggering circumstances include breach of the shareholders’ agreement, cessation of employment, voluntary retirement and marriage breakdown.

5. Shotguns

A shotgun clause is intended to break a deadlock between shareholders. It can be an effective means of resolving shareholder disputes – but can be a dangerous game since an unfair price can open the process to abuse by affluent shareholders. There are both single shareholder shotguns and multiple shareholder shotguns.

• Single Shareholder Shotgun. This shotgun applies when there are only two shareholders. One shareholder gives the other shareholder concurrent offers: an offer to sell shares of the company (or of a corporate shareholder) and an offer to buy the other shareholder’s shares of the company (or their corporate shareholder). The receiving shareholder chooses which to accept – the sale offer or the purchase offer – within a fixed time period. If the receiving shareholder doesn’t choose, they’re deemed to accept the sale offer.
• Multiple Shareholder Shotgun. This shotgun applies when there are more than two shareholders. One shareholder gives all other shareholders concurrent offers to sell their shares and to purchase all of the receiving shareholders’ shares. Each receiving shareholder must decide to buy the offering shareholder’s shares (or a portion of them if other shareholders also decide to buy) or to sell their shares. The result can be some shareholders selling and others buying. If, however, any shareholder decides to buy then the offering shareholder must sell their shares.

6. Share Valuation

The agreement can address share valuation. This can help avoid valuation disputes among shareholders, particularly important in a private company setting where there is no public market that establishes the company’s value. A valuation clause provides that shareholders are required to periodically (e.g. annually or bi-annually) determine the value of shares and sets out how the valuation will be made. There are two main approaches to valuation.

• Business Valuation. The company is valued by an independent business valuator according to the terms of valuation set out in the shareholders’ agreement.
• Fixed Formula. This could be specified as a multiple of corporate earnings, the book value of the company’s assets, or another established method of business valuation.

7. Additional Terms

Shareholder agreements typically also include additional provisions that address other key aspects of the business, including:

• Provision for the company’s accounting, including preparation of the company’s financial statements & budgets.
• Officer and Director indemnity and company insurance requirements.
• Signing authority for banking and contracts.
• Dispute resolution mechanisms for shareholder disputes. Shareholders often prefer “private” dispute resolution mechanisms like mandatory arbitration because court litigation can be expensive and time-consuming and court records are generally available to the public.
• Acknowledgement the shareholder has had the opportunity to seek independent legal advice (ILA).

Please contact your McInnes Cooper lawyer or any member of our Corporate and Business Law Team @ McInnes Cooper to discuss negotiating and drafting a unanimous shareholders’ agreement that’s right for you.

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