Creating an effective unanimous shareholder agreement: 7 key topics shareholders should discuss

No matter the number of shareholders in a corporation, a unanimous shareholder agreement (commonly abbreviated to “USA”) is an important tool for effective business operations. USAs protect the rights among shareholders, directors and the corporation itself by among other things, explicitly setting out each parties’ rights, obligations and entitlements to allow for a streamlined co-existence.

This article highlights several key topics for discussion amongst corporations, shareholders, directors and other stakeholders to improve communication and understanding among those parties and their legal advisors as to the important elements when reviewing or assembling an effective USA.

What is a USA?

A USA is a formal written agreement between a corporation’s shareholders that sets out each shareholder’s individual and collective rights and responsibilities. It governs how shareholders interact with the corporation, one another and third parties. Third parties include potential future shareholders, financial institutions, family members of shareholders, customers and suppliers of the business and more. USAs also often address how directors interact with each other, shareholders of the corporation and the corporation itself.

A well-drafted USA helps mitigate risks, minimize disputes, protect shareholder interests and ensure smooth business operations by providing governance mechanisms. These mechanisms specify roles, outline decision-making processes, establish dispute resolution mechanisms and impose restrictions on the transfer of shares to proactively address potential conflicts and issues through pre-established, mutually agreed-upon means.

What happens when there is no USA?

Without entering into a shareholder agreement, shareholders, directors and the corporation will governed by the articles of incorporation, the bylaws of the corporation and most importantly, by the provisions set out in the Corporations Act (Manitoba). Although the Corporations Act (Manitoba) provides a general framework for handling matters among shareholders, directors and corporations, this framework is not as flexible nor as beneficial in some cases as a USA. More critically, it often does not operate the way the parties actually intend.

Key considerations

USAs are not a “one-size-fits-all” solution. In fact, the customizability of USAs allows shareholders to create an agreement specifically tailored to the corporation’s unique needs. Thus, it is crucial for shareholders to identify their mutual interests and anticipate potential issues that could arise during the course of the business. This can be challenging to address, especially for shareholders who are less familiar with corporate governance procedures.

The following is a non-exhaustive list of important considerations that shareholders should discuss before entering into a USA. The purpose of highlighting the topics below is to encourage discussions between shareholders, corporations and their counsel to foster alignment in their corporate governance procedures and to enable corporations to carry on successfully.

1. Roles and responsibilities

One of the first aspects of corporate governance to consider when drafting a USA is who will be responsible for acting and making decisions on behalf of the corporation. These roles include officers, who act on behalf of the corporation by way of any existing employment or contractual arrangement, and directors, who also may act on behalf of the corporation through the management thereof. Comprehensive USAs will address who the existing officers and directors are, how such officers and directors are appointed and removed, and the limitations with respect to such roles in terms of decision-making. By establishing these roles from the outset, potential for conflict is reduced in the future as all of the parties will have an understanding as to their duties and obligations.

Discussion questions:

• Who will be the officers and directors of the corporation?
• How should directors and officers be appointed and removed?

2. Decision-making procedures

The ability to make decisions efficiently and effectively is essential for a corporation to run smoothly. Therefore, a USA should set out the specific decision-making procedures including a determination as to what decisions require consent, and more specifically whose consent must be provided and when. For example, are there decisions that can be made solely by the directors? Are there decisions that can be made by shareholders at a meeting? Alternatively, can a director or shareholder meeting be avoided altogether?

Many USAs have different thresholds for different types of decisions. For fundamental decisions, such as a material change in the nature of the business, major capital expenditures, or a change in authorized or issued shares, shareholders may want to set higher thresholds or ensure that their consent and input is required before such a decision can be made on behalf of the corporation. This will require that these decisions may not be approved by the board of directors alone, and perhaps a proportion of shareholders will need to approve such a decision as well. Careful consideration to the decision regarding proposed thresholds must account for a potential where some or all shareholders may disagree.

Discussion questions:

• What decisions may be made by the directors?
• What decisions require the consent of shareholders?
• What is the threshold for passing a decision of the shareholders or directors?

3. Financing procedures and profit distribution

A corporation will often require additional financing at some point in time. Disputes may arise if the process for obtaining such funding is not clear and agreed to by the shareholders at the outset. Therefore, a well-drafted USA should set out these financing procedures and how relevant decisions and determinations are made, including establishing a sequence of events required to obtain financing from financial institutions, shareholders and other third parties.

Depending on the specific needs of the corporation, shareholders should outline the process for obtaining financing through debt or equity investments, and their respective obligations to provide financing to the corporation, should it be required. On the other hand, there may be times where the corporation experiences surplus profits. In this case, a USA should describe how these dividends will be distributed and how often they will be paid out to shareholders or retained by the corporation.

Discussion questions:

• Can the corporation raise capital by issuing new shares?
• Is there a hierarchy of approaching lenders? (For example, financial institutions, shareholders and third parties)
• Should dividends be distributed to the shareholders or retained by the corporation and who makes these determinations?

4. Share transfer restrictions and exit strategies

Buying and selling shares are an important part of shareholder relations. As such, shareholders should agree upfront on the rules governing the sale or transfer of shares of the corporation. A USA will outline how shares are purchased and sold, and typically includes provisions that provide additional opportunities for shareholders to increase or decrease their interest in the corporation. The provisions providing these opportunities are described in brief below, including:

• Pre-emptive rights: pre-emptive rights provide existing shareholders with the ability to purchase additional shares of the corporation to maintain their existing ownership percentage in the corporation when new shares are issued by the corporation.
• Right of first refusal: a right of first refusal provides that if a shareholder is approached by a third party to sell their shares, some or all of the other shareholders may have a right to acquire the shares at the price and on the terms set out in the third-party offer.
• Right of first offer: similar to a right of first refusal, a right of first offer provides that if a shareholder intends to sell their shares to a third party purchaser, prior to making any offer to sell, they must approach some or all of the other shareholders first.
• Tag-along rights: a tag-along right provides that minority shareholders may require a third party purchaser of another shareholder’s shares to also purchase their shares on the same terms. This type of term may decrease the marketability of shares for any third party purchaser who intends to only acquire a portion but not all the shares of a corporation.
• Drag-along rights: a drag-along right provides that majority shareholders may require any minority shareholders to sell their shares to a third party purchaser. This may increase the marketability of shares by ensuring a buyer can obtain 100% of the corporation’s shares.
• Optional/mandatory sale or buy-back: Some USAs may have a “put” or “call” option, which may provide that: (a) a shareholder may require the other shareholder or the corporation to purchase its shares (i.e. a “put” option); or (b) the corporation or other shareholders of the corporation may require a shareholder sell its shares (such as a “call” option). This is often one of the most heavily negotiated provisions to determine: whether these rights may exist in a USA, and, if they do exist, the circumstances in which they may arise. Frequently, these options are linked to certain circumstances, including the death, permanent disability and/or bankruptcy of a shareholder or its principal, but there are many opportunities for customization depending on the nature of the relationship between the parties, their shareholdings and the corporation’s business.

Discussion questions:

• What rights should shareholders have when a shareholder wishes to sell or transfer their shares? (For example, right of first refusal, right of first offer, tag-along rights for minority shareholders, and drag-along rights for majority shareholders).
• Should shareholders have the right to maintain their ownership percentage on any subsequent share issuance? (For example, pre-emptive rights).
• What should happen to a shareholder’s shares in the event of their death, permanent disability, or bankruptcy?

5. Share valuation

In the event of a share redemption by the corporation or share purchase by another shareholder, the price to be paid for shares often, their “fair market value” must be determined. Given the typical breakdown of the relationship of the shareholders during any sale or redemption of shares, it is strongly advisable that the shareholders establish an agreeable mechanism for calculating “fair market value” in advance of any sale. This is also often a much deliberated provision in the USA which may be resolved by relying on an agreed-upon formula, or may otherwise be determined by an independent valuator or accountant.

Discussion questions:

• Should the fair market value/purchase price be calculated using an agreed-upon formula, or be determined through a third-party valuator? If so, how is this individual chosen?

6. Dispute resolution mechanisms

Disputes amongst shareholders are sometimes inevitable. Although not all conflicts can be prevented, they can often be resolved by having clear dispute resolution mechanisms outlined in the USA. Having these procedures in place helps prevent business operations from grinding to a halt each time a disagreement arises, and can save the corporation (and its shareholders) valuable time and resources.

USAs often contain alternative dispute resolution clauses, where shareholders must try and resolve disputes through mediation or arbitration before resorting to litigation. Even so, in certain circumstances shareholders may come to an impasse where a relationship has broken down between shareholders, in which case mechanisms such as a “shotgun” buy-sell provision may be necessary to break the deadlock and allow the corporation to continue its business. This clause gives one shareholder the option to offer to buy out the other shareholders’ shares at a specified price. The receiving shareholder(s) must then either accept the offer to sell or buy out the shareholder at the same offered price, effectively resolving the deadlock. We note that the even presence of a shotgun clause will often help facilitate negotiation as there it establishes a minimum resolution in the case that all other means fail.

Discussion questions:

• Should disputes be resolved through mediation, arbitration or both before proceeding with litigation?
• How should irreconcilable differences be resolved? Should a buy-sell be incorporated?

7. Restrictive covenants

Restrictive covenants are often crucial for protecting a corporation’s confidentiality and maintaining competitive advantage. Shareholders should decide which restrictions, if any, should be placed on shareholders both during the time they hold shares and after they depart. Typically, these restrictions will prevent shareholders from divulging confidential business information, competing with the corporation or soliciting its clients. Any particulars of these limitations, such as the extent of the restriction, geographical coverage and length of time of enforcement, should be clearly set out in the USA to ensure that the value of the corporation is protected.

Discussion questions:

• Should shareholders be prevented from competing with the corporation? If so, what is the scope of the non-compete clause? (For example, extent of prohibition, geographical coverage or length of time of enforcement)
• Should departing shareholders be prevented from soliciting clients or employees of the corporation? If so, for how long? Are there any exceptions?

When should a USA be put in place?

Ideally, a USA should be established as soon as shareholders subscribe for shares in the corporation. Having a USA established early on builds a strong foundation to allow the corporation and its shareholders to thrive. However, it is important to also revisit the USA from time to time to make sure it still serves the interests of the corporation and its shareholders.

While a framework exists in the Corporations Act (Manitoba) for governing relationships amongst shareholders, directors and corporations,  the flexibility provided in a USA provides significant benefits in governing relationships between the relevant parties, and becomes more important the more successful a corporation is and with the more shareholders it has.

MLT Aikins Corporate/Commercial and Corporate Governance practice group has extensive experience assisting in the structuring, providing advice in relation to and the preparation of unanimous shareholder agreements. Please contact one of our lawyers to learn more.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.

Share