What Is the Purpose of a Shareholders’ Agreement?

This column outlines the purpose of a shareholders’ agreement for a corporation’s shareholders. Specifically, this column highlights some very common and practical situations in which a shareholders’ agreement proves very useful.

Asking the question often provides the answer. When business owners consult us as to the necessity and usefulness of a shareholders’ agreement, we ask them the following questions:

• What would happen if a shareholder of your corporation died? Would the surviving shareholders purchase the shares from the deceased shareholder’s estate or would the corporation redeem them directly? The tax consequences will vary depending on the option chosen.
• Is there a mechanism in place to evaluate the value of the shares in the case of redemption?
• Do co-shareholders have a right of first refusal when one shareholder intends to sell his shares to a third party? What is to be done if he sells his shares to a third party without notifying his co-shareholders?
• What is to be done in the event of a shareholder’s disability, incapacity, or bankruptcy?
• What is to be done if a co-shareholder places himself in a conflict of interest or commits theft, fraud, or embezzlement to the detriment of the corporation? How is he to be removed as a shareholder?
• What is to be done in the event of an impasse or conflict between shareholders? Do we necessarily need to go before a court?
• What is to be done if a cash call is required and some shareholders are unable to contribute?
• What is to be done with the shares of an employee who is dismissed for having committed a serious fault or who resigns to work for a competitor?
• How do we ensure the loyalty of our co-shareholders and that a co-shareholder does not one day compete with the corporation?

A shareholders’ agreement will provide the answers to these questions as well as many others. It should be noted that the laws on corporations do not establish specific rules on the manner in which shareholders are to deal with each other, hence the need for a shareholders’ agreement. The agreement will prevent long and costly legal proceedings in the event of a conflict or impasse and will establish the rights and obligations of each shareholder in specific situations that are not provided for in the laws on corporations.

Ultimately, many elements must be taken into consideration in the drafting of a shareholders’ agreement, including taxes and estate planning. It is a fundamental agreement for which the content will vary according to the specific needs of the parties. Every business with more than one shareholder must have an agreement between its shareholders.