SHAREHOLDERS' AGREEMENTS - PROVISIONS & CONSIDERATIONS
The provisions suggested in this checklist must be considered in relation to the particular facts in the matter at hand, and augmented and revised as appropriate.
SECTION HEADINGS
1. Date of Agreement
2. Identification of Parties
3. Recitals
4. Interpretation
5. Scope and Nature of Shareholders’ Relationship
6. Conduct of the Affairs of the Company
7. Financing
8. Restrictions on Transfer/Right of First Refusal
9. Compulsory Buy-Out (Roulette or Shotgun Clause)
10. Obligation to Join in a Sale/Piggy-back Rights
11. Obligation to Purchase/Obligation to Sell
12. Indemnification and Discharge of Guarantees
13. Insurance Policies
14. Sale on Death
15. Wills
16. Default
17. Miscellaneous and General Provisions
PROVISIONS & CONSIDERATIONS
1. Date of Agreement
2. Identification of Parties
2.1 The shareholders (generally all, but not necessarily).
2.2 The company (especially if it will be obliged to purchase shares from a shareholder pursuant to the agreement).
2.3 Where a shareholder is a company, consider adding its shareholders as parties to covenant regarding control of the shareholder company.
2.4 Consider including a spouse who may have an interest in the shares and ensuring that a certificate of independent legal advice be obtained with respect to the execution of the agreement by the spouse.
3. Recitals
3.1 General statement of the legal relationship between the parties.
3.2 Company particulars, such as:
.1 Business that will be carried on.
.2 Authorized capital, including a list of shares issued to each shareholder.
3.3 Reasons for entering into the agreement.
3.4 Statement relating the recitals to the rest of the agreement.
4. Interpretation
4.1 Definitions:
.1 Specific definitions (consider setting out in a schedule).
.2 Statement that accounting terms not defined shall have the meaning ascribed to them in accordance with generally accepted accounting principles.
4.2 Choice of law.
4.3 Principles that govern the interpretation of the agreement (e.g., use of the masculine form, insertion of headings for convenience only).
4.4 Schedules, such as:
.1 Definitions (see item 4.1.1).
.2 Escrow agreement (see item 8.1.3).
.3 Life insurance policies (see item 13.1).
.4 Pro forma budget (see item 6.16).
5. Scope and Nature of Shareholders’ Relationship
5.1 Agreement governs dealings.
5.2 No partnership created.
5.3 No shareholder has power to bind any others except as expressly permitted.
6. Conduct of the Affairs of the Company
6.1 Statement that, except as provided in the agreement, the conduct of the company’s business shall be governed by the articles and memorandum.
6.2 Directors:
.1 Number.
.2 Appointment (e.g., each shareholder to appoint one or more nominees, all shareholders to agree on the appointment of a nominee to break any deadlocks).
.3 Resignation.
.4 Filling vacancies.
.5 Removal (i.e., cause for removal, procedure, replacement).
.6 Right of director to appoint an alternate.
6.3 Quorum for the transaction of business:
.1 Number constituting a quorum, and whether a nominee for each shareholder is required to be present.
.2 What happens when there is not a quorum (e.g., adjournment, with whoever attends the adjourned meeting constituting a quorum).
.3 Procedure for breaking a deadlock.
6.4 Directors’ meetings:
.1 Place and time.
.2 Calling a meeting, including notice requirements.
.3 Quorum and voting.
6.5 Shareholders’ meetings:
.1 Place and time.
.2 Calling a meeting, including notice requirements.
.3 Quorum and voting.
6.6 Officers and employees:
.1 Positions.
.2 Duties.
6.7 Major decisions requiring unanimous approval or special approval of the directors or the shareholders, such as:
.1 Sale, lease, transfer, mortgage, pledge, or other disposition of the undertaking of the company or a subsidiary.
.2 Increase or reduction in the capital of the company; issue of additional shares in the capital of the company.
.3 Consolidation, merger, or amalgamation of the company with any other legal entity.
.4 Capital expenditures or commitments exceeding a specified amount.
.5 Leases of company property having a capital value exceeding a specified amount.
.6 Borrowing by the company or a subsidiary which would result in aggregate indebtedness exceeding a specified amount.
.7 Loans by the company or a subsidiary to a shareholder or affiliate.
.8 Contracts between the company and a shareholder or affiliate.
.9 Any transaction out of the ordinary course of business of the company.
.10 Any change in the authorized signing officers in respect of legal documents or any financial institution.
.11 Adoption or amendment of a budget.
.12 Any agreement by the company restricting, or permitting any other party to accelerate or demand payment of company indebtedness upon the sale, transfer, or other disposition by a shareholder of his or her shares or loan.
.13 Any amendment to any employment contract made between the company and one of the other parties to the agreement, or a representative of one of those other (corporate) parties.
.14 Employment by the company of any relatives of a shareholder or, if a corporate shareholder, its representative.
.15 Waiver or appointment of auditor.
.16 Other decisions of particular importance having regard to the nature of the company business.
6.8 Where the shareholders will be running the business, consider:
.1 Including employment provisions in the shareholders’ agreement (include provisions regarding expectations as to commitment of time and energy to the business of the company).
.2 Having separate employment or management contracts tied to the shareholders’ agreement so that a default by a shareholder under his or her employment contract would trigger a default under the shareholders’ agreement.
6.9 Shareholder’s duties to the company:
.1 Duty not to compete, during the time he or she is a shareholder and for a reasonable time thereafter, within a reasonable geographic area.
.2 Methods for authorizing exceptions to duty not to compete.
.3 Duty of confidentiality.
6.10 Statement that each shareholder acknowledges that, by reason of his or her unique knowledge of and association with the business of the company, the covenants set out in item 6.9 are reasonable and commensurate with the protection of the legitimate interests of the company, and that it is agreed that the covenants shall be severable and subsist even if the rest of the agreement is terminated.
6.11 Bank and accounts.
6.12 Signing officers.
6.13 Auditor/accountant.
6.14 Books of account, financial statements, accounting principles, provision of periodic financial statements.
6.15 Indemnification of shareholders.
6.16 Pro forma budget (consider attachment as a schedule and inclusion of a statement of intent).
6.17 Consider the application of the above provisions to subsidiaries.
7. Financing
7.1 Initial financial contribution required from each shareholder, distinguishing between subscribed capital (equity) and shareholder loans.
7.2 Mechanisms by which the company may raise additional funds for working capital:
.1 Borrowing from an institutional lender:
(a) Whether the company is required to try to obtain funds in this manner before turning to the shareholders.
(b) Whether the shareholders are required to enter into guarantees of indebtedness of the company (consider a provision that liabilities for guarantees shall be shared pro rata and each shareholder will indemnify the others for his or her share of the amount guaranteed).
.2 Borrowing from the shareholders:
(a) Circumstances in which the company may do this, how the decision is made, and whether there is a maximum amount that may be demanded.
(b) Contribution to be pro rata.
(c) Notice requirements.
(d) Shareholder’s obligation (or option) to advance funds.
(e) Where the shareholder is obliged to advance funds, a provision for failure to do so.
7.3 Whether shareholder loans bear interest and whether they are to be secured (if so, include obligations as to granting priority to other borrowings).
7.4 Provisions regarding repayment of shareholder loans, including whether there is a right to demand repayment or whether company can defer payment, etc.
7.5 Other contributions required of shareholders (e.g., premises, personnel, directing opportunities, trade marks, etc.).
7.6 Distribution of net profit:
.1 Statement that distribution will occur except as prohibited by the terms of debt financing or other agreements, and to the extent permitted by law, after the board has provided (by resolution) for such reserves as are necessary.
.2 Frequency of distribution.
.3 Priorities (e.g., repayment of loans, dividends).
8. Restrictions on Transfer/Right of First Refusal
8.1 Right of first refusal to be offered to the company or the other shareholders, setting forth:
.1 The investment offered for sale, which may be required by the agreement to:
(a) Include, proportionately, preference shares and loans outstanding.
(b) Represent a minimum of a specified percentage of the shareholder’s investment.
.2 The purchase price, which must be within the guidelines set out in the agreement.
.3 The terms and conditions of the sale, including the method of payment, whether the price may be paid over time and, if so, provisions regarding interest on the unpaid balance, security on the unpaid balance (e.g., in the form of an escrow agreement annexed as a schedule), and whether prepayment can be made without penalty.
.4 The prospective purchaser (where there is an offer from a third party). Consider whether it should be a pre-condition that a third party offer has been obtained.
.5 Whether the offer may be accepted in part, or must be accepted in its entirety or not at all.
.6 The length of time the offer is open for acceptance (as set out in the agreement).
8.2 Where an offer is made to the company and the other shareholders as set out in item 8.1:
.1 The secretary shall, upon receipt:
(a) Transmit the offer to each director and shareholder.
(b) Call a meeting of the board to consider the offer.
(c) Instruct the auditors to determine the investment purchase price.
.2 The company has first right to accept the offer, and to the extent that it does so, the shareholders agree to refuse any offers required to be made by the company under any Act (e.g., Company Act, s. 237), the articles, or the agreement.
.3 If the offer is not wholly accepted by the company within the time set out in the agreement (which is a shorter time than the time during which the offer is open for acceptance):
(a) The secretary shall so advise the shareholders.
(b) The portion of the offer not accepted by the company may be accepted by the shareholders pro rata within the time set out in the agreement (which is a shorter time than the time during which the offer is open for acceptance).
(c) Acceptance by the shareholders shall be by notice to the secretary, and a shareholder may by such acceptance specify any additional portion of the investment offered for sale that he or she is prepared to purchase if the other shareholders fail to accept the offer.
(d) If any of the shareholders fail to accept the offer, any shareholder who has given notice of his or her preparedness to make an additional purchase may do so, on a pro rata basis.
(e) At the expiry of the specified period, the secretary shall advise the company of the extent to which the offer is still open.
.4 If the offer has not been fully accepted by the shareholders by the end of the specified period, the company is again entitled to accept the offer with respect to the portion still available and, if it does so, the shareholders agree to refuse any offers required to be made by the company under any Act (e.g., Company Act, s. 237), the articles, or the agreement.
.5 Prior to the expiry of the period set out in the offer, the secretary shall advise the offeror whether the offer has been accepted in its entirety, and by whom.
.6 If the offer has not been wholly accepted within the specified time period, the offeror has the right, for a specified period of time, to dispose of the investment to a third party (specify whether this may be to any third party, upon no better terms and conditions than were set out in the offer, or to a particular third party, where the terms and conditions offered have first been offered to the other shareholders and have not been taken up), provided that the third party has entered into an agreement with the company and the shareholders by which the third party is bound by the agreement.
.7 Provisions regarding completion of the sale (including where, when, and how).
.8 Consider including a set-off where the vendor is indebted to the company.
8.3 Whether disposition to an affiliate is authorized and, if so, under what conditions (e.g., that the affiliate will remain an affiliate so long as it holds the investment and, prior to ceasing to be an affiliate, will transfer the investment back to the shareholder; that the affiliate is bound by the agreement).
8.4 A defaulting shareholder is not entitled to dispose of his or her investment pursuant to the above provisions unless prior to or concurrently with the transfer he or she ceases to be a defaulting shareholder.
8.5 Except as provided in the agreement, no shareholder shall dispose of his or her investment without meeting the requirements set out in the agreement (e.g., prior written consent of the other shareholders, or of any other party where such consent is required by an agreement between the company and that party).
8.6 No shareholder shall encumber his or her investment except as provided in the agreement.
8.7 Upon execution of the agreement, the shareholders shall surrender to the company each share certificate, which shall be stamped to indicate that transfer is subject to the agreement. Consider whether shares should be placed in escrow to be dealt with in accordance with the agreement.
9. Compulsory Buy-Out (Roulette or Shotgun Clause)
9.1 A shareholder may make a compulsory offer to the other shareholders to either sell all of his or her investment or buy all of the other shareholders’ investment at the price and on the terms and conditions set out in the offer.
9.2 Notice requirements and limitation periods are as set out in the agreement.
9.3 The shareholders to whom the offer is made have the option of buying (pro rata) or selling, but failure to give notice of the election within the specified time period shall be deemed to be an acceptance of the offer to sell.
9.4 Provisions for handling a situation in which some shareholders elect to sell and some to buy.
9.5 Provisions regarding completion of the sale (including where, when, and how).
9.6 Consider including a set-off where the vendor is indebted to the company or the other shareholder(s).
10. Obligation to Join in a Sale/Piggy-Back Rights
10.1 A shareholder may require the other shareholders to join in a sale of the whole of the business to an outsider, by notifying them of an offer.
10.2 Notice requirements and limitation periods are as set out in the agreement.
10.3 The shareholders to whom the offer is made have the option of buying the investment of the shareholder who gave notice (pro rata) at the offered price, or of joining in the sale of all the investment to the third party.
10.4 Provisions for handling a situation in which some shareholders elect to sell and some to buy.
10.5 Provisions regarding completion of the sale (including where, when, and how).
10.6 Consider including a set-off where the vendor is indebted to the company or the other shareholder(s).
10.7 A shareholder may require that a sale by other shareholders to a third party not be completed unless the third party buys the shareholder’s investment for the same purchase price and on the same terms and conditions.
11. Obligation to Purchase/Obligation to Sell
11.1 A shareholder may require the company or the other shareholders to purchase his or her investment (or the company or other shareholders may require the shareholder to sell his or her investment) in the circumstances set out in the agreement (e.g., retirement from the work force or from active involvement in the company’s business).
Price, terms and conditions, and procedure are as set out in the agreement (refer, for example, to relevant portions of item 8).
12. Indemnification and Discharge of Guarantees
12.1 Obligation of the shareholders and company, where a shareholder has disposed of all of his or her investment in compliance with the agreement, to use their best/reasonable efforts to have any guarantee or pledge issued or granted by the shareholder discharged or cancelled, and to indemnify the departing shareholder for liabilities arising with respect to such a guarantee or pledge subsequent to his or her departure.
13. Insurance Policies
Caveat: This section of the checklist is very involved with tax legislation which changes regularly. It may be appropriate to consult a tax expert before drafting these clauses.
13.1 Obligation of the company to own and maintain life insurance policies of a specified value on all shareholders and representatives of corporate shareholders (such policies to be listed in a schedule to the agreement). (Or, alternatively, obligation of the shareholders and representatives to own and maintain criss-cross life insurance policies.)
13.2 Obligation of the shareholders to cooperate (e.g., by attending physical examinations).
13.3 Rights of the company with respect to the policies, such as:
.1 To apply any policy dividends to payment of premiums.
.2 To collect death benefits.
.3 No right to modify or impair any rights or values of the policies, or exercise any rights of ownership, except as provided in the agreement or with the prior written consent of the shareholders.
13.4 Rights of the shareholders with respect to the policies, such as:
.1 To obtain information from the insurer regarding the status of the policy on his or her life.
.2 To pay premiums where the company fails to do so, and to be reimbursed.
.3 To purchase the policy on his or her life, at the price set out in the agreement (e.g., cash surrender value), on the happening of specified events (e.g., termination of the agreement during the lifetime of the shareholder).
.4 Apply any dividends received on the policy to premiums.
13.5 Uninsurability provisions.
14. Sale on Death
Caveat: This section of the checklist is very involved with tax legislation which changes regularly. It may be appropriate to consult a tax expert before drafting these clauses.
14.1 Where a shareholder who is an individual dies, his or her personal representatives shall sell, and the company, the remaining shareholders or a combination thereof (due to the application of the stop-loss rule contained in the Income Tax Act) shall purchase, from the estate the investment held by the deceased at death. Where the company is the purchaser, the remaining shareholders agree to refuse any offer required to be made by the company under any act (e.g., Company Act, s. 237), the articles or the agreement.
14.2 Where the representative of a corporate shareholder dies, the shareholder shall sell, and the company or the remaining shareholders shall purchase from the corporate shareholder the investment held by it at the date of the representative’s death. Where the company is the purchaser, the remaining shareholders agree to refuse any offer required to be made by the company under any act (e.g., Company Act, s. 237), the articles or the agreement).
14.3 The purchase price and terms and conditions of payment are as set out in the agreement (include an adjustment of price in the event of suicide).
14.4 Where the purchase is required to be made by the company, and the surplus and capital dividend account is insufficient to authorize the purchase, the parties to the agreement agree to take such steps as necessary to increase the account to an amount sufficient to authorize the purchase.
14.5 Where the purchase is required to be made by the remaining shareholders, it shall be on a pro rata basis.
14.6 The company shall, upon the death of the shareholder or representative, claim and collect the proceeds of the life insurance policy. The proceeds shall be applied as set out in the agreement (e.g., to pay any indebtedness of the company to the deceased, to pay the purchase price, to pay the remaining shareholders who make the purchase). Consider appropriate disposition of excess insurance proceeds.
14.7 Provisions regarding completion of the sale (including where and when).
14.8 At the closing the following shall occur, in the order set out in the agreement:
.1 The purchasers shall pay the purchase price, or a specified percentage thereof, to the vendor, and deliver any documents that may be required (e.g., promissory notes, escrow agreements).
.2 The unpaid balance, if any, shall be paid and secured as set out in the agreement.
.3 The vendor, on receipt of the purchase price or the portion payable pursuant to item 14.3, shall give to the purchasers all share certificates, instruments, conveyances, assignments, and releases as may be reasonably required to complete the sale and to transfer all of the investment.
.4 Where the purchasers are the remaining shareholders, the company shall pay to them a capital dividend equal to the lesser of the purchase price or the proceeds of the life insurance policy (and, in the latter case, the company shall elect to have the dividends payable out of its life insurance capital dividend account pursuant to the provisions of the Income Tax Act).
14.9 Provision for purchase price adjustment to take into account value of investment as determined by Canada Customs and Revenue Agency.
14.10 Provision that agreement shall have no application upon the death of the final shareholder or representative of a corporate shareholder, notwithstanding any other term of the agreement or if the shareholders die within a specified time (e.g., 60 days).
15. Wills
15.1 As an alternative to items 13 and 14, where the shareholders are all natural persons, consider a provision that each shareholder shall make and maintain a will providing that the others will inherit his or her shares. (Note: if the will is later changed, it is not likely that it will be set aside on the basis of the agreement.)
16. Default
16.1 Circumstances that constitute a default, such as:
.1 Failure to carry out obligations under the agreement after the other shareholders have made a written demand that the failure be cured.
.2 Failure to defend assiduously a proceeding affecting possession or management of the shareholder’s investment after the other shareholders have made a written demand that the failure be cured.
.3 Bankruptcy, commission of an act of bankruptcy, the appointment of a receiver or receiver-manager with respect to the shareholder’s assets, or an assignment for the benefit of creditors or otherwise.
.4 Change in control of a corporate shareholder.
.5 Termination of employment of a shareholder, or a representative of a corporate shareholder, who was employed by the company.
.6 Incapacity (as defined in the agreement).
.7 Retirement (see also item 11).
.8 Failure by a shareholder to meet technical or administrative qualifications imposed by a regulatory body or association as a prerequisite to practice a particular profession as a shareholder/employee of the company.
16.2 Consequences of default (indicate if consequences differ for different types of default; indicate alternatives), such as:
.1 Winding-up of the company under the articles (annex the agreement to the articles (Company Act, ss. 267-269)).
.2 Other parties may waive the specific default.
.3 Other parties may pursue any remedy available in law or equity.
.4 Other parties may take such actions as may reasonably be required to cure the default, in which case expenses shall be recoverable as provided in the agreement.
.5 Implementation of a buy/sell procedure, whereby:
(a) The defaulting shareholder is deemed to offer to sell all or a part of his or her investment to the company or the other shareholders.
(b) The purchase price is determined as set out in the agreement (e.g., a discounted value for specified types of default).
(c) The terms and conditions and procedure are as set out in the agreement (refer, for example, to relevant portions of item 8).
.6 Where the default consists of failure to make a loan to the company as required under the agreement (see item 7.2.2), additional remedies may be provided to the non-defaulting shareholders, such as:
(a) Recovery of loans made to the company.
(b) Right to elect not to make the loan without being held to be in default.
(c) Right to make the loan on behalf of the defaulting shareholder and be entitled to reimbursement from the defaulting shareholder and from the company out of any funds owing to the defaulting shareholder; this may bring the defaulting shareholder out of default, if requirements set out in the agreement are met.
17. Miscellaneous and General Provisions
17.1 Addition of further shareholders contemplated. Consider annexing the form of agreement to be executed by new shareholders.
17.2 Interest rate on any funds required to be paid to other shareholders (except default loans under item 16.2.6).
17.3 Circumstances which will terminate the agreement, such as:
.1 The company goes into bankruptcy, has a receiving order made against it, or makes a proposal to its creditors.
.2 Written consent of the parties.
17.4 If a shareholder disposes of all his or her interest in compliance with the agreement, then he or she is bound by only the rights and obligations which arose pursuant to the agreement prior to the disposition.
17.5 Execution of further assurances.
17.6 Entire agreement.
17.7 Amendments may be made by unanimous written agreement.
17.8 Severability of invalid provisions.
17.9 Time of the essence.
17.10 Failure to insist upon strict performance of any provision of the agreement shall not prevent a subsequent violation of the agreement from having the effect of an original violation.
17.11 Notices:
.1 Addresses for service.
.2 Prepaid registered mail, or other arrangement.
.3 Deemed date of receipt.
17.12 Arbitration.
17.13 Choice of law.
17.14 Choice of forum.
17.15 Execution and delivery in counterparts.
17.16 Binding on heirs and executors and assignment.
17.17 Titles.
17.18 Remedies cumulative.
17.19 Consider including general provisions that would apply to any share transfer, such as standard representations and warranties (e.g., title, no encumbrances), and standard terms relating to closing arrangements, payment of purchase price, interest, security or escrow for purchase price paid over time, prepayment of purchase price, default on payment, indebtedness, resignations, non-competition clauses, restrictive covenants, consents of third parties, etc.
17.20 Consider including a general provision restricting the application of provisions in the agreement respecting share transfer where a change in control of the company would require the consent of third parties (e.g., lease) or would trigger adverse tax implications, such as a deemed year end, loss of Canadian-controlled private company status, etc. Alternatively, include provisions requiring the company to obtain such third party approvals.
17.21 For a reporting company, consider adding a pre-emptive right such as that contained in the Company Act, s. 41.
17.22 Schedules (if any).