A previous blog already addressed shot-gun clauses and two alternative provisions permitting shareholders to force a share transfer that will prove useful when a business relationship deteriorates. When a business relationship ends or is altered due to other external circumstances, it will equally be of great advantage to have a shareholder agreement in place that provides the framework for resolving the relationship or the dispute. While this scenario is often not at the forefront of the partners' minds when they enter into a business relationship, it should be addressed. This entry complements the previous blog by adding two further mechanisms to provide for a resolution of issues in a business relationship by means of a shareholder agreement.
Disability, death, and insolvency of a shareholder
When a shareholder dies, becomes disabled or insolvent, the business partners and/or their families are facing a number of challenges. The corporate aspects of this challenge can and should be addressed in a shareholder agreement to alleviate the difficulty that arises in such circumstances. A shareholder agreement should provide that the remaining shareholders, or the corporation itself, are obliged to purchase the shares previously held by the deceased, disabled or insolvent shareholder. Conversely, his or her personal representative shall be obliged to sell the shares.
Additionally, the shareholder agreement needs to provide for a mechanism to determine the value of the shares and the source of money required to complete the transaction. Reference to the fair market value of the shares leaves room for future debate, hence it may be advisable to set out the method of valuation with more precision. Regarding the source of money required to perform the transaction, life and disability insurance designating the corporation as the beneficiary can provide the means to purchase the shares. A well-drafted shareholder agreement that addresses these point will allow for a smooth resolution of a situation that is challenging on many other levels.
Under the Family Law Act, shares in a corporation form part of a spouses net family property. Therefore, if a shareholder is obliged to make an equalization payment or to pay spousal support, a court may order the shareholder to transfer shares to the other spouse to meet these obligations. The shareholder's business partners may not welcome the forced introduction of a new shareholder, particularly one that already has a strained relationship with the shareholding spouse.
One solution to this problem is to have the spouses of shareholders agree at the time the shareholder agreement is drafted to waive any claims to the shares of the corporation and to waive any right to information concerning the corporation, such as financial documents. Obtaining a certificate of independent legal advise would be advisable to ensure enforceability of such a clause.
Alternatively, the shareholder agreement can provide that the shareholder who is obliged to make payments under the Family Law Act is require to sell his or her shares in the event that a proceeding is commenced against or by a shareholder for spousal support or equalization payment. The shareholder involved in the matrimonial conflict may be provided a chance to proof to the other shareholders that the asserted claims will not affect the shareholdings of that spouse. If the remaining shareholders are not satisfied with the proof or if a shareholder fails to disclose a relevant family law proceeding they are involved with, the other shareholders can exercise their option to buy the shares of that shareholder in the same manner as in the event of a disability. This buy-out option prevents the forced introduction of a new shareholder that may have unwanted business consequences or cause conflict among the shareholders.
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.