Kevin Landry, Matt Jacobs

Shareholder agreements are a key part of corporate governance. Nova Scotia is unique from other Canadian jurisdictions because the Companies Act (Nova Scotia) doesn’t contemplate ‘Unanimous Shareholder Agreements’ as other corporate statutes such as the Canada Business Corporations Act (“CBCA”) do.

Shareholder Agreements vs. Unanimous Shareholder Agreements (“USA”s)

The differing terminology of a ‘shareholder agreement’ and a ‘Unanimous Shareholder Agreement’ is not inconsequential; both are terms of art with specific (and different) meanings. Jurisdictions normally allow one or the other and the way in which they function affects how they should be drafted.

Valid USAs (under s. 146(1) of the CBCA, for example) override statutory requirements and common law restrictions against limiting discretion of directors and often places such powers directly in the shareholders. Specifically, a USA under the CBCA permits parties to restrict “in whole or in part, the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation”. A valid USA becomes part of the constating documents of the corporation, and importantly, s. 146(3) of the CBCA deems purchasers or transferees of shares subject to a USA to be a party to it. USAs add additional concerns that are not a factor in ordinary shareholder agreements such as the assumption of liabilities ordinarily placed on directors, by the shareholders (for example under CBCA s. 146(5)).

In contrast to USAs a shareholder agreement in Nova Scotia is not a constating document that automatically binds future shareholders. It is an ordinary contract, subject to the articles and memorandum of the company it purports to govern. Shareholder agreements are still effective tools for governing companies in Nova Scotia, despite not being ‘unanimous’. They can accomplish many of the same outcomes as a USA, but must be drafted differently than USAs to be effective.

Why do I need a shareholders’ agreement?

Corporations have basic procedures for things like calling meetings, elections of directors, and shareholder votes outlined in their articles or bylaws (depending on the jurisdiction) and their governing corporate statute (once again jurisdiction dependent). Shareholder Agreements supplement these procedures by augmenting the statutory or common law requirements, or by outlining additional terms not covered by those sources.

Under most Canadian corporate statutes, a majority shareholder will have control of a corporation’s decisions by virtue of voting majority except for decisions requiring ‘special majority’ approval of 66 2/3% of votes.

In situations where no shareholder holds a majority of shares, or even a special majority, it is advisable to enter into shareholder agreements to provide certainty about future decisions, concentrate control of the company, and provide protections to minority shareholders.

Basic Terms

Shareholder Agreements take many forms but most are drafted to consider the following issues, which most corporate shareholders should consider when considering a shareholder agreement:

1. Crystalizing management. In a USA, management responsibilities are explicitly placed in shareholders, where in shareholder agreements, shareholders are normally agreeing to appoint specific directors, not take actions in contravention of the agreement, etc. Regardless, these agreements place decision making power in specific individuals agreed among the parties.

• Allocating board seats and appointing officers. Parties should consider who will be permitted a board seat and be appointed officers. Additional considerations include appointing meeting chairs and dictating tie break measures (important where there are an even number of board members).
• Specifying how directors and officers are removed. Equally important to appointing key positions, is considering how they are removed, and if removed, how a replacement is selected.
• Special quorum or voting requirements. Provisions requiring specific parties to be present for director or shareholder meetings will ensure specific parties (often founders) are always present when decisions are made.
• Special approvals. Instead of just requiring their being present at meetings, founding shareholders and strategic investors may want to include “veto rights” over certain key decisions of the company.

2. Controlling Operations. Agreeing to sensible limitations on corporate actions is an appropriate control measure for companies that are subject to shareholder agreements.

• Limiting dividends or other corporate outlays. Parties should agree up front about outlays of corporate funds, especially where repayment of shareholder loans may need to take priority.
• Future financing. Especially if not raising funds through dilutive equity issuances, many companies have requirements for capital that shareholders will put into the company. Funding obligations should be agreed upon and made clear.
• Setting approval thresholds or vetoes. Corporate statutes will outline thresholds for voting approval of most corporate decisions. For a variety of reasons, it can be desirable to deviate from those thresholds, or to ensure specific parties (often founders or key investors) must approve before major actions are taken (such as selling the company).

3. Restricting Share Transfers. It is desirable, particularly in private companies, to limit who can become a shareholder.

• Setting permitted transferees. Parties should consider if transfers to any specific parties are immune from any stated transfer restrictions in the agreement (such as from a shareholder to their wholly owned holding company).
• Binding future shareholders. Particularly in jurisdictions where USAs are not permitted, parties should consider how future shareholders will be bound by the shareholder agreement. Specifically, parties should consider if evidence of such an agreement to be bound will be a prerequisite to approval for a transfer, and if there is a specific form of assumption agreement the new party must sign.
• Subject to board approval. Shareholders should consider what level of shareholder or director approval is needed in order to transfer shares of the company and whether any party has a veto. Given that shareholder agreements are common in private companies, placing restrictions on transfers to ensure compliance with commonly used prospectus exemptions (such as the Private Issuer exemption in National Instrument 45-106) are also key discussions.
• Involuntary transfers. Shareholders should discuss how involuntary transfers (typically divorce, death, incapacity, or bankruptcy of a shareholder) are handled to avoid situations where new, and potentially undesired, shareholders gain shares in the company.

4. Anti-dilutive measures. Ownership and control are the crux of most shareholder agreements. Handling these issues, particularly when the company will be issuing additional shares, is an important consideration.

• Considerations for dilution. Depending on the needs of the company, it may become necessary to dilute the current shareholders’ interests by selling new shares to raise funds for the organization. This is very common in some types of “start-up” companies where it may take multiple months (or years) to generate positive net income. If it is likely that the organization will need to raise funds in this fashion to continue operating, the method of how the current shareholdings will be diluted should considered.
• Pre-emptive rights. Especially in companies expecting dilution through future capital rounds, it is important to discuss provisions that would allow shareholders to maintain their respective holdings by giving them a right to purchase specified amounts of new issuances by the company.   
• Right of first offer/right of first refusal. These clauses require shareholders to offer shares to other shareholders first before transferring shares of the company to a third party.

5. Employment Issues. Until a company has standalone agreements in place with each employee, it can be advantageous to put general provisions accounting for intellectual property and non-competition in the shareholder agreement.

• Intellectual property transfers to company. Particularly in owner managed companies, specific provisions transferring key intellectual property of the shareholders into the company should be considered if there has been no other specific transfer of Intellectual Property in a standalone agreement.
• Confidentiality and non-compete. Unless standalone agreements have been completed, blanket provisions as to confidentiality and non-competition or non-solicitation are important considerations for shareholders given the insider information any of them would have in the company.
• Employee stock ownership plan (“ESOP”) and stock options. ESOPs and stock options can provide employees in some companies (especially start-up companies with no available free cash flow) the opportunity to participate in the growth of the company in addition to, or in the place of, receiving a salary or bonus. Depending on the goals of the organization, this should be contemplated as a way to pay employees appropriately for the services they provide, as well as used as a way to retain key individuals.

6. Contemplated Exits. Planning ahead for liquidity events and other exits is crucial to ensuring parties understand their obligations in those situations, whether or not the exit is voluntary.

• Shotgun clause. Although taking many subtly different forms, shotgun clauses are made to handle the uncomfortable eventuality where parties may want to force someone out of the business involuntarily. Ordinarily, they proceed by allowing one party to offer to buy all the shares of another at a price specified by the offeror, with the recipient of the offer having the option to sell, or alternatively buy, the shares of the offeror on the same terms. Parties should consider provisions to allow for a fair exit in such circumstances.
• Tag along rights. Normally for the benefit of minority shareholders, these provisions are activated if there is an offer to purchase a specified amount of the company (normally a majority stake at minimum) and allow other shareholders to sell their shares on the same terms to avoid being minority shareholders with a new majority shareholder.
• Drag along rights. Similar to tag along rights, but normally to benefit majority shareholders, these provisions are also activated if an offer has been made to purchase a specified amount of the company (normally a majority stake). If such an offer is made, other shareholders can be forced to sell on the same terms as the offer.

7. Other Considerations. Shareholder agreements often contain terms specifying a variety of boilerplate provisions.

• Valuating shares. The value of shares, particularly in a private company, is difficult to gauge and costly to have estimated professionally. Agreeing to a valuation method can help avoid future disputes, particularly if parties become adverse.
• Indemnity for directors. Indemnifying provisions for shareholders, or persons serving as directors in USA jurisdictions, are commonplace given the statutory liabilities placed on directors under Canadian corporate law statutes.
• Settling disputes. Like many commercial agreements, deciding upon a course of action for settling disputes outside of court is desirable for business efficacy, cost, and privacy.
• Accounting and reporting to shareholders. Particularly in jurisdictions where waiving audit requirements is possible, outlining how financials are prepared and provided to shareholders is important to consider since private companies do not have the same disclosure requirements as reporting issuers.

This update is intended for general information only. If you have questions about the above, please contact the authors.

Click here to subscribe to Stewart McKelvey Thought Leadership.