A Co‐Owners' Agreement (COA) for a heavily lopsided bi‐lateral co‐ownership (such as when one co‐owner holds a 75% undivided interest and the other co‐owner holds 25%) should look quite different than a COA for a 50/50% co‐ownership. In the case of the lop‐sided co‐ownership, there is typically a trade off between control and liquidity:
- the majority co‐owner wants to control all decisions, ie. no veto given to the minority coowner; and
- the minority co‐owner is often comfortable with this so long as it has a way to bring an unhappy co‐ownership to an end, either through a buy‐out of the majority co‐owner or through some form of liquidity.
A conventional shot‐gun buy/sell clause will not give a minority co‐owner sufficient protection on this second point because:
- the minority co‐owner may not have the resources to acquire the much larger interest;
- if the majority co‐owner knows of this inability, it may be motivated to trigger the shot‐gun at a deep discount, knowing the minority co‐owner will have no option but to sell‐out at the discount; and
- if both parties want sole ownership of the asset, the majority co‐owner will be in a position to trigger the shot‐gun at an inflated price, willing to pay a premium for the smaller interest, knowing that it will be much more difficult for the minority co owner to justify paying a premium on a majority interest.
So, it would be typical in a COA for a heavily lopsided co‐ownership to have the following variations:
a) if the minority co‐owner doesn't really care if it can be forced out of the investment, so long as it gets fair market value (FMV) for its interest at the time, then it is often willing to forgo the shot‐gun buy‐sell altogether and settle for the following:
- a put: giving the minority co‐owner the right to put its interest to the majority coowner at FMV or at a pre‐determined price. The minority co‐owner may likewise be willing to grant the majority co‐owner a reciprocal call (essentially an option to purchase the minority interest at FMV at any time);
- in addition (though not essential if there is a put and it is binding on subsequent transferees) a tag‐along: forbidding the majority co‐owner from selling its majority interest to a bona fide third party unless it negotiates a similar offer from the third party for the minority interest;
- the majority co‐owner without a call will often want a drag‐along: whereby it can drag the minority co‐owner into a sale to a bona fide third party of 100% of the interests. This prevents the minority coowner from frustrating a sale of the entire asset to a bona fide third party, especially because there is no shot‐gun. The minority co‐owner often wants in return a right of first offer/right of first refusal (RoFO/RoFR) so that it has the option of acquiring the majority interest rather than being dragged into a sale if it thinks the sale is below market.
b) if the minority co‐owner prefers not to be forced out of the investment, if that can be helped (and, in fact, may want to acquire the majority interest if the opportunity arises), then it will often negotiate for the following:
- a shot‐gun at FMV: rather than the triggering co‐owner stipulating a purchase price, the FMV of the entire asset is determined by a professional after the shot‐gun is triggered. Often, the professional is required by the COA to adjust the pro rata allocation of the FMV between the interests to take into account the premium value attached to the majority interest of having control;
- in addition (though not essential if there is a shot‐gun), the minority coowner will frequently request a tagalong. The minority co‐owner often negotiates to add a RoFO/RoFR so that it has the option of acquiring the majority interest rather than tagging along with the sale it thinks is below market or being stuck with a new undesirable co‐owner;
- the majority co‐owner will still often want the drag‐along because a third party purchaser may not be willing to hold open its offer while the majority co‐owner exercises the shot‐gun. The minority co‐owner will often want to add a RoFO/RoFR so that it has the option of acquiring the majority interest rather than being dragged into a sale that it thinks is below market or it just doesn't want to do.
Where there are more than two co‐owners, the above approaches may work to give the majority of the co‐owners the control they require but give the minority co‐owner the liquidity it requires. However, several additional factors may come into play that renders the above approaches unsatisfactory.
Also, the above approaches may work in any of the other forms of lop‐sided joint ventures, such as a partnership, limited partnership or corporation. However, there is legislation applicable to most of those other JV structures (such as minority shareholder rights in the case of corporations) that need to be taken into consideration when drafting the applicable JV agreement, whether it be a partnership agreement, limited partnership agreement or shareholders agreement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.