Much has been written about governance issues in shareholder agreements as well as the ROFR, shotgun, put, call and other buy-sell provisions that such agreements often include. But it’s also worth considering some of the less discussed provisions of a shareholder agreement and how they can sometimes create significant concerns. In this article, we give some reasons why it’s best not to skip too hastily through all those pages of "boilerplate" when negotiating a shareholder agreement.
Voting trusts come up when, as often happens, a majority shareholder wants to treat a group of minority shareholders as a "block" or, alternatively, a management group agrees to act together in order to control the corporation.
For decades now, Canadian law has given carte blanche to the formation of voting trusts. As long ago as 1960, the Supreme Court of Canada declared that shareholders have virtually unfettered discretion to combine their interests and voting powers as they see fit.1 Once formed, however, a voting trust can find itself facing a number of legal issues, two of which are especially important to keep in mind:
(1) Where a voting trust creates a controlling interest in a corporation, the usual corporate law restrictions on the exercise of such an interest – in particular, the "oppression" provisions that are common to most Canadian business corporations regimes – come into play. In other words, where a voting trust that is effectively in the position of a majority shareholder conducts itself in a manner oppressive to a minority shareholder who is not part of the voting trust, the minority shareholder may have a recourse under the oppression remedy. It is essential that shareholders entering into a voting trust of this type understand the legal significance of being in control of a corporation.
(2) The establishment of a voting trust can have tax consequences. Again, the dominant tax consideration in setting up a voting trust is whether the trust acquires control of the corporation. Under Canadian law, an acquisition of control has various tax consequences that can adversely affect both the company and its shareholders.
Arbitration provisions are often included in shareholder agreements in the hope that disputes will be resolved faster, without damaging the parties’ relationship, and in a manner that will ensure that confidential information does not become public. Canadian courts are generally inclined to give effect to the intentions of parties to a commercial agreement wherever possible. Applying this to an arbitration clause in Onex v. Ball, Mr. Justice Blair advised against "putting too fine a distinction on the nuances between words or phrases", adding that "where the language of an arbitration clause is capable of bearing two interpretations, and on one of those interpretations fairly provides for arbitration, the courts should lean towards honouring that option".2
Canadian case law following Onex v. Ball has continued to respect, and has even broadened, the right to arbitration and the powers of arbitrators. However, it should be emphasized that the arbitration clause must have clearly been entered into willingly by the parties3 and that ambiguities resulting from the careless "cutting and pasting" of boilerplate arbitration clauses may lead courts to doubt the genuineness of the parties’ intention.4
Just how broad the powers of an arbitrator can be is a question that has arisen with respect to oppression claims. In Armstrong v. Northern Eyes Inc., an Ontario judge ruled that shareholders can oust the jurisdiction of the court with respect to oppression remedy proceedings by choosing, through their agreements, to arbitrate their disputes. The fact that the dispute settlement mechanism under the agreement does not give the complaining party access to remedies as favourable to it as would have been available under the statutory oppression remedy is not grounds for the courts to take jurisdiction.5 However, the determination of a shareholder’s oppression claim by an arbitrator may be limited by the circumstances. In Deluce Holdings Inc. v. Air Canada, the Court used its discretion to stay the arbitration proceedings in a situation where invoking the arbitration clause was itself oppressive. The Court reasoned that the majority shareholder "visited oppression upon a minority shareholder" and his conduct was found to be unfairly prejudicial and to have unfairly disregarded the interests of the minority shareholder.6
The dismissal of an arbitration clause in favour of judicial process, as occurred in Deluce, will only be repeated under very specific circumstances. The court must find it oppressive to invoke the clause in and of itself. The mere fact that oppressive conduct between the parties existed does not favour the denial of an arbitration process where the parties have agreed to arbitration in a shareholder agreement. Where it is clear that the arbitration agreement was intended to cover the very issues that might otherwise have been dealt with under the oppression remedy, a series of Ontario decisions has held that the courts will generally hold the complaining party to its bargain.7 Although one recent British Columbia case took issue with this view,8 the prevailing approach suggests that the existence of a broad arbitration provision will likely entail that the parties are forgoing their right to pursue an oppression remedy in court.
Third Parties and Privity
Certain provisions in shareholder agreements often create benefits for third parties. Indemnification or insurance rights are examples, as are (more generally) provisions that benefit a related corporation or a purchaser of shares. Liberalizing developments in the law relating to third party beneficiaries – or "privity of contract", as it is also known – have yet to be felt specifically in the area of shareholder agreements, but it is likely only a matter of time before third party rights will also be broadened in this context.
The most recent "exceptions" to the third party beneficiary rule would better be characterized as "relaxations" of the privity concept. This relaxation began in earnest in 1992 with London Drugs Ltd. v. Kuehne & Nagel International Ltd., where the Supreme Court of Canada held that employees should be entitled to benefit from their employer’s contractual limitation of liability right where the limitation clause extended this benefit to them (expressly or by implication) and where the employees are seeking the benefit of the clause with respect to a potential liability arising from their provision of the very services provided for in the contract.9 In 1999, the Court relaxed the rule even further when, in Fraser River Pile & Dredge Ltd. v. Can-Dive Services Ltd. it held that a waiver of subrogation right was enforceable by a subcontractor even though the insured had purported to "waive the waiver" subsequent to the event of loss and even though the subcontractor was acting under a separate contract.
It is important to note that the courts have generally ruled that exceptions to the doctrine of privity can only be used as a "shield" and not as a "sword". Thus, a party has not traditionally been permitted to bring an action by virtue of an exception. Interestingly, however, the sword/shield distinction is not specifically mentioned in the tests outlined in London Drugs or Fraser River.10
In the context of shareholder agreements specifically, there have also been examples of relaxation of the doctrine of privity. In Evanov v. Burlington Broadcasting Inc.,11 the applicant, in furtherance of an oppression application, sought a declaration stating that he was a shareholder of the corporation. Although it dismissed his application, having found that he was not a shareholder, the court ruled that the fact that the shareholder agreement specifically contemplated his becoming a shareholder, together with the fact that correspondence, company minutes and memoranda showed that he had been treated as though he were party to the agreement, satisfied the London Drugs test for relaxing privity.
In light of the recent developments in the law of privity, certain things have to be kept in mind when one is drafting a shareholder agreement. If the contract confers benefits in favour of a third party, then the parties to the contract will be constrained in their ability to amend those terms unless the contract provides otherwise. In Fraser River, for example, the Supreme Court held that the parties could not amend the contract without the third party’s consent once those rights had crystallized. When drafting shareholder agreements, the parties should expressly state each party’s ability to amend the terms of the agreement without the consent of the benefited third party. Otherwise, the parties may be constrained from altering the agreement.
Unanimous Shareholder Agreements
A number of potential problems are specific to Unanimous Shareholder Agreements. The Canada Business Corporations Act, like most of Canada’s provincial business corporations statutes, provides that where all shareholders agree, they (and, if desired, one or more non-shareholders) can enter into a Unanimous Shareholder Agreement ("USA") that may inter alia restrict or remove the powers of the directors to manage or supervise the management of the business – powers that under Canadian corporate law are not otherwise generally subject to alteration. Typically, a USA will proceed to confer directors’ powers on some or all of the parties to the agreement. Those parties then "inherit" the rights, powers, duties and liabilities of the director, to the extent that the directors’ powers have been limited by the agreement. Another thing to keep in mind, as discussed elsewhere in this edition of the M&A Update, is that purchasers and transferees of shares of the corporation are bound by the terms of the USA, subject to a rescission right where adequate notice of the USA’s existence was not given (under the corporations legislation of some provinces, purchasers and transferees are not bound in the absence of notice). It is also significant, for reasons discussed below, that a USA is not merely a contract among shareholders (and often others) but a constating document of the corporation and that it may override shareholders’ dissent rights in the event of an acquisition.
Whether an agreement is a USA is generally considered a question of fact rather than of the intentions of the parties. Thus it is important to bear in mind that agreements among shareholders may sometimes unintentionally cross into USA territory (so to speak), resulting in significant potential liabilities. There is no specific percentage or extent to which the powers of the directors must be restricted to qualify as a USA. Courts generally look at a variety of criteria, including:
- Restrictions on the corporation issuing shares;
- Restrictions on the transfer of shares other than those in the articles;
- An agreement to act and vote, as shareholders, directors and officers, to give effect to the shareholders agreement;
- Entitlement to bring observers to meetings of the board of directors;
- An agreement to cause directors meetings to be held;
- Specification of the voting required for decisions of the board of directors;
- Establishment of a quorum for the meeting of directors; and
- Requirements for the consent of all shareholders for any articles of amendment.12
Also worth remembering is that an amalgamation will bring any USA relating to one or other of the amalgamating corporations to an end, unless the amalgamation agreement specifically provides for its survival.13 In Sportscope Television Network, an Ontario court ruled that a USA is a constating document and that the amalgamation provisions of the OBCA require any amalgamation agreement to set out "such other details as may be necessary to perfect the amalgamation and to provide for the subsequent management and operation of the amalgamated corporation." Mr. Justice Blair went on to state that because "the unanimous shareholder agreement is one of the constating documents of a corporation, and not merely a contract amongst its shareholders, it is reasonable to conclude…that the unanimous shareholder agreement, if any, which is to govern the exercise of the powers of directors in the newly amalgamated corporation, should be stipulated in the amalgamation agreement too."14
In Re Systemcorp A.L.G. Ltd.,15 Mr. Justice Farley considered whether dissent rights still exist in cases where there is a USA in place. In that case, IBM had made an offer to acquire all of the shares of the corporation. Under the USA, if an offer were to be accepted by two-thirds of the shareholders, then all of the shareholders would have to sell their shares on the terms of the offer. IBM’s offer was approved by the required number of shareholders, but there was a question as to whether dissent rights were required to be included in the transaction. The dissent right is at the discretion of the court and Farley J. determined that in the circumstances – a unanimous shareholder agreement, a cash offer, the lack of a controlling shareholder or shareholder group and a bona fide arm’s-length negotiation of the transaction – they should not be given. His reasons focussed on the fact that all of the shareholders had signed the USA: "All shareholders", he wrote, "have by their being bound by the USA agreed that they have placed their trust in the wisdom of the specified majority who have agreed to accept such an offer."16
1 Alpine Drywall & Decorating Ltd. v. Minister of National Revenue,  S.C.R. 223; Ringuet v. Bergeron,  S.C.R. 672.
2 Onex v. Ball (1994), 12 B.L.R. (2d) 151 (Ont. Gen. Div.), at para. 24.
3 Munro v. Munro Concrete Products Ltd. (2005), 13 B.L.R. (4th) 64 (Ont. S.C.J.) at para. 18.
4 Thompson General Hospital v. CSL Hospital Services Ltd.,  M.J. No. 495 (Man. Q.B.) at para. 21.
5 Armstrong v. Northern Eyes Inc. (2000), 48 O.R. (3d) 442 (Ont. Div. Ct.); aff’d (2001), 107 A.C.W.S. (3d) 360 (Ont. C.A.).
6 Deluce Holdings Inc. v. Air Canada (1992), 12 O.R. (3d) 131 (Ont. Gen. Div.).
7 Woolcock v. Bushert (2004), 50 B.L.R. (3d) 85 (Ont. C.A.), Kassem v. Secure Distribution Services Inc. (2004), 43 B.L.R. (3d) 277 (Ont. S.C.J.), Butt v. Express Plus Inc. (2004), 42 B.L.R. (3d) 189 (Ont. S.C.J.) and T.J. Whitty Investments Corp. v. TAGR Management Ltd. (2004), 47 B.L.R. (3d) 311 (Ont. S.C.J.).
8 Cut & Run Holdings Ltd. v. Booze Bros. Holdings Ltd. (2005), 2 B.L.R. (4th) 14 (B.C. S.C.), para. 53.
9 London Drugs Ltd. v. Kuehne & Nagel International Ltd.,  3 S.C.R. 299 (S.C.C.).
10 Two recent Nova Scotia decisions could be interpreted as suggesting that, where the intention to confer rights on a third party is clear (notably in the case of many indemnities),the third party may be able to directly enforce its rights. See MacNeill v. Fero Waste and Recycling Inc. (2002), 23 B.L.R. (3d) 297 (N.S. S.C.), rev’d in part (2003), 32 B.L.R. (3d) 167 (N.S. C.A.); Orlandello v. Nova Scotia (2005), 256 D.L.R. (4th) 21 (N.S. C.A.).
11 Evanov v. Burlington Broadcasting Inc. (1997), 29 O.T.C. 102 (Ont. Gen. Div.).
12 See, for example, Sportscope Television Network Ltd. v. Shaw Communications Inc. (1999), 46 B.L.R. (2d) 87 (Ont. Gen Div.) and White v. True North Springs Ltd. (2001), 205 Nfld. & P.E.I.R. 181 (Nfld. S.C.T.D.).
13 Sportscope Television Network, note 12 above.
14 Ibid., para. 34.
15 Re Systemcorp A.L.G. Ltd. (Bankruptcy) (2004), 50 B.L.R. (3d) 163 (Ont. S.C.J.).
16 Ibid., para. 6.
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.