by Claudius Du Plooy

    9 Important Questions About Unanimous Shareholder Agreements

    Private corporations, especially if they are owner-managed, exist in a dynamic business environment. In periods of economic contraction, corporate activity in consolidations increase as companies look for ways to reduce costs and increase competitiveness. In periods of economic expansion some owners look for good opportunities to exit the business, while financial and strategic investors look for good opportunities to invest their liquid capital. As the economy shifts and different opportunities arise, the ownership (shareholder) team of a corporation will face unexpected stresses. To avoid these stresses and reduce the risks associated with each new opportunity, it is critical for the shareholders to have a clear set of rules that apply to them. The agreement used for these rules is called a Unanimous Shareholder Agreement (“USA”).

    What is a Unanimous Shareholder Agreement?

    A unanimous shareholder agreement (“USA”) is a written agreement among all the shareholders of a company that may completely or partially restrict the powers of the directors to manage, or supervise the management of, the business and affairs of the company. In addition to restricting the power of a company’s directors, a USA will often address other important issues. For example:

    • Issuance of shares.
    • Repayment of shareholder loans.
    • Transfer of shares resulting from the death, incapacity, insolvency or the marital breakdown of a shareholder.
    • Purchase and/or sale of shares (e.g. right of first offer, right of first refusal, piggy-back rights and drag-along rights).
    • Process for resolving disputes among shareholders.
    • Shareholder’s right to compete with the company or solicit employees and/or clients away from the company.

    2. How is a USA Drafted?

    To ensure unanimity with respect to a USA, all registered shareholders of all classes, whether voting or non-voting, common or preferred, must be parties to the USA at all times. If a shareholder agreement is not unanimous, it will be treated as a regular commercial contract and, therefore, subject to the articles and by-laws of the company and the provisions of the relevant corporate statute. To avoid confusion, a USA should be consistent with the company’s articles and by-laws. If it is the intention of the shareholders that a USA will govern, consider including a provision in both the by-laws and the USA that in the event of any inconsistency between them, the USA will prevail. A USA also benefits from the “Deemed Party” rule. The rule applies when shares of a company governed by a USA are transferred, the transferee is deemed to be a party to the USA provided a reference to the USA is noted clearly on any share certificate representing the transferred shares. Despite this rule, it is considered good practice to include in the USA that, as a condition of any share transfer, the transferee must agree in writing to be bound by the USA. Purchasers of newly issued shares from treasury should also be required, as a condition of any issuance of shares from the treasury of the company, to agree in writing to be bound by the USA.

    3. How can the USA affect Board Representation?

    Except in the case of a USA where the board is stripped of all of its powers, a shareholder`s influence over the day-to-day issues of a company will generally be manifested through the appointment of nominees to the board of directors. Certain shareholders may be given the right to appoint nominees to the board. If nominees are to be appointed, consider:

    • Under what circumstances is a shareholder’s right to nominate directors reduced or terminated?
    • If the circumstances resulting in curtailment of the right to nominate are remedied, is the right reinstated?

    Directors who are nominees of a particular shareholder are still subject to fiduciary duties to act in the best interest of the company in the first instance, and not the shareholder who nominated them

    4. How can the USA affect Shareholder Governance?

    A shareholder’s approach to the general governance of a company will typically depend on their particular circumstances (e.g. equal partner, angel investor, venture capitalist, institutional investor, etc.). For example, an equal partner in a company may want to exercise control over all decisions affecting a company, whereas, an angel investor may only want a say in major decisions, such as a merger with another company or sale of substantially all the assets of the company.

    Quorum for board or shareholder meetings may not simply be based on the absolute number of directors or shareholders present at a meeting. It may include a requirement that a certain shareholder be present in order for any decisions to be made. In such a case, consider allowing a meeting to proceed with less than the usual quorum requirements after a certain number of adjournments of a meeting in case a particular director or shareholder fails to attend. This will prevent one party from stalling the business of the company simply by not attending board or shareholder meetings.

    A USA might allow for amendments to the agreement by a specified majority of the shareholders. In order to prevent an agreement being amended by the majority without the knowledge of the minority, a USA should provide that all shareholders must agree to any amendment of the USA.

    5. How can the USA restrict Share Transfers?

    A key feature of many USAs is preventing shares from being transferred to unknown or undesirable parties. This objective must however, be reconciled with the desire of shareholders to maintain liquidity of their shares. The following procedures are common when selling shares of a company governed by a USA:

    • Right of First Offer: A shareholder proposing to sell their shares must first make an offer to sell their shares to the existing shareholders. The offer must be made on the same terms that they are willing to accept from a third party. If the other shareholders do not accept the offer, the selling shareholder is free to sell their shares to a third party.
    • Right of First Refusal: When a shareholder proposing to sell their shares first obtains a bona fide offer from an arm’s length third party that they are prepared to accept, the other shareholders will then have a right to acquire the shares at the same price and on the same terms set out in the third party offer, failing which the selling shareholder may then sell to the third party.
    • Piggyback (Tag-Along) Rights: This right requires a purchaser of a shareholder’s shares to also purchase the other shareholder’s shares on the same terms. Piggyback rights are often demanded by minority shareholders.
    • Drag-Along Rights: This right is the reverse of piggyback rights. Typically, a controlling shareholder(s) requires that minority shareholders sell their shares to a third party to whom the controlling shareholder(s) is selling his/her shares.

    Even if compelled to sell, the transfer of shares should be smooth. A USA should provide detailed transaction mechanics, including time periods for all notices and actions to be taken, as well as details regarding closing dates and procedures.

    6. How can the USA mitigate Involuntary Transfer of Shares?

    Shareholders may want to ensure that unwanted parties do not become shareholders involuntarily as a result of a death of an individual shareholder, a bankruptcy or insolvency of a shareholder in which case a creditor may become a shareholder, or a transfer or disposition of assets in the event of matrimonial proceedings. A USA can mitigate involuntary share transfers by:

    • Requiring approval by the shareholders of such a transfer.
    • Providing that unless a transfer is approved in accordance with the USA, a new shareholder may not vote, receive dividends or exercise any of the usual rights of ownership.
    • Rights of other shareholders to acquire shares transferred involuntarily for a fixed period following such transfer.

    Any of the above alternatives will be most effective if included in a USA because of the “deemed party” rule.

    7. How can the USA affect a Shareholder Exit?

    A USA will often provide for a number of ways for shareholders to exit the company. These may include:

    • Put or Call Options: A Put or Call Option is typically exercisable after a specified period of time or upon the occurrence of a specific event. The obligation to purchase shares under a Put Option could fall to all the other shareholders on a pro rata basis, or just to the company. Events which may trigger a Put or Call Option may include the death, incapacity, bankruptcy of a shareholder, the retirement or termination of employment, or a material breach by the shareholder of the USA.
    • Shotgun Clause: In a Shotgun scenario, a shareholder delivers an offer: (i) to buy the shares of another shareholder; and (ii) an offer to sell their shares to the other shareholder on identical terms. The other shareholder receiving the offers must decide which of the two offers to accept. This occurs most often in cases involving two shareholders each holding 50% of the issued and outstanding shares. Where a company has more than two shareholders, the drafting of a Shotgun Clause becomes much more complex. The uncertainty for both parties typically acts as an incentive to reach a negotiated settlement to any disagreement.
    • Sale to a Third Party: A sale to a third party will be governed by the provisions, described above, restricting share transfer including Right of First Offer, Right of Frist Refusal, Piggyback Rights, and Drag-Along Rights.

    8. How can the USA affect Valuation

    There are several methods that can be used in a USA to determine share price. These include:

    • Periodic Agreement: The parties commit to agree upon a value from time to time, for example on an annual basis.
    • Specified Formula: This could be based upon book value, a multiple of earnings or cash flow, or another appropriate basis for the company.
    • Determination by a Third Party: Parties will often enlist professionals, such as accountants or business valuators to determine share value. In this case, it is important that parties agree in advance to be bound by the independent valuator’s determination.

    9. How can the USA resolve Disputes

    Disputes among shareholders are inevitable and can range from minor disagreements on day-to-day matters to deadlocks at the board or shareholder level. A USA should provide mechanisms for resolving disputes. The following are examples of dispute resolution procedures:

    • Unilateral Decision by One Party: Disputes with respect to day-to-day business matters could be resolved by one party having a casting vote at board meetings.
    • Discussion or Negotiation: Some USAs provide for a formal process to initiate discussions between parties, including a timetable for meetings.
    • Mediation: Parties can agree to undergo formal mediation. Drafting issues can include identifying how the mediator will be selected and the procedures to follow in conducting the mediation. The required procedures for mediation may be incorporated by reference to a statute.
    • Binding Arbitration: As with mediation, the key is setting limits on the process in advance. It will be important to consider the arbitrator’s powers to bind the parties. For example, whether they can only deal with determining monetary damages or whether the mediator will have discretion to tailor the remedies appropriately.
    • Shotgun: Once triggered, one party will end up exiting the company, while the other party will remain.
    • Sale of the Business: This is the most drastic remedy. Both parties will commit to an auction process to sell the entire business. The threat of this remedy can often serve to bring the parties together at an earlier stage.

    These points are not an exhaustive list of the issues a USA could regulate. A USA can be tailored to fit each corporation’s specific needs. For more information please contact us at business@duplooylaw.com.

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