June 4 – 5, 2008

The Metropolitan Hotel
, British Columbia


Malcolm P. MacPherson


Farris, Vaughan, Wills & Murphy LLP


I.          What is the Utility of a Shareholders’ Agreement?

 (a)        Purpose

 One of the central purposes of a shareholders’ agreement is to govern the management of the business of a company and its fundamental changes, regulate share transfers, and to provide exit mechanisms for shareholders wishing to sell their shares.  Another purpose which is more often than not a core concern when drafting a shareholders’ agreement is the protection of minority shareholder interests.   This is because without the benefit of specific provisions in a shareholders’ agreement, the conduct of the management and affairs of the company will be carried out under British Columbia’s Business Corporations Act (“BCA”), the common law, and the company’s articles.  That is, a majority of the shareholders or any one or more shareholders collectively holding more than 50% of the voting shares of the company will be able to elect the board of directors who, in turn, will appoint the officers of the company.  Subject to the restrictions contained in the BCA and relevant case law, the directors will be free to conduct the affairs of or manage the company as they in their discretion see fit, thereby potentially placing minority shareholder interests in jeopardy. 

 (b)        Facilitation of Communication Among the Shareholders

 A shareholders’ agreement is also an instrument which fills in the gaps between the provisions of the BCA and the articles of the company.  The process of developing a shareholders’ agreement compels the parties to discuss with their professional advisors and to consider important issues which in many cases the shareholders would not otherwise consider, such as the consequences of the manner in which the shareholders’ agreement is drawn up from a taxation perspective.   It also compels the parties to talk to each other, and to set out in writing their understanding of the business agreement with respect to the conduct of the affairs of the company.  The process of discussion also helps to clarify the shareholders’ objectives for the business and, most importantly, to determine whether those objectives are shared.  The solicitor’s role in preparing the shareholders’ agreement, as is the case with all major business agreements, is to learn as much as possible about the client’s objectives, needs, best case thoughts, and worst case fears.  All of this information can be used to turn a form precedent into a living agreement that makes sense to a particular client in its own unique circumstances.  If the circumstances suggest a shareholders’ agreement that may be complex, or if the parties are not sophisticated, it may be advisable to commence the drafting process with a term sheet or list of issues rather than a full draft agreement.  It is often easier for parties to discuss points that are briefly set out in a short term sheet than to review and absorb a more lengthy and dense legal document. 

(c)        Forward Looking Agreement

 Unlike most other business agreements which tend to focus more on describing the terms of a transaction to be completed at a particular moment in time, the main focus of the shareholders’ agreement is to plan for the future by having the shareholders agree at the outset of their business relationship what rules are to govern their relationship in various circumstances.  One of the things that can be difficult for clients during the process of drafting a shareholders’ agreement, of course, is determining what future circumstances should be contemplated in the agreement.  This challenge becomes particularly evident when the shareholders in question are good friends, or when the business in question is in its honeymoon phase.  Accordingly, one of the solicitor’s roles during the drafting process  is to impart to the shareholder the value of planning for potentially dysfunctional circumstances while the shareholders are on good terms.  Although the cost of drafting a shareholders’ agreement can be substantial, it may be a small price to pay, particularly when one considers the costs that could be incurred if a protracted shareholders’ dispute arises and there is no previously agreed method of dealing with the contested issue.

 II.        Client Representation

 Solicitors should be careful to avoid conflicts of interest arising during the course of their drafting of shareholders’ agreements.  Accordingly, solicitors must at a very early stage determine who their client is, and take steps during the drafting process to ensure that should a disagreement among one or more of the shareholders erupt at any time prior to or after the execution of the shareholders’ agreement, they will not be shown to have breached their duty of undivided loyalty.  If asked to represent the interests of the company, for example, a prudent solicitor would want to insist that all of the other shareholders obtain independent legal advice prior to their execution of the shareholders’ agreement. At the very least, a solicitor would want to insert a clause in the shareholders’ agreement advising that all of the shareholders have been urged to seek independent legal advice prior to the agreement’s execution, and have either done so or waived such opportunity.     

 III.       What is a Unanimous Shareholders’ Agreement?

 (a)        Origins of the USA

 The unanimous shareholders’ agreement, often referred to as a “USA”, is a specific type of shareholders’ agreement.  As its name indicates, this type of agreement requires unanimous agreement among all of its shareholders.  The concept of the USA was first recognized in the Canada Business Corporations Act (“CBCA”), and has since been incorporated into provincial corporation statutes.  The CBCA defines a USA as a written agreement among all the shareholders of a corporation that restricts in whole or in part the powers of the directors to manage or supervise the management of the business and affairs of the corporation.    

 (b)        BCA Section 137

 In Section 137 of the BCA, there is a provision which is analogous to the CBCA’s Section 146 which regulates the usage of the USA, albeit without reference to the concept of unanimity.  Section 137 provides that the articles of a company may transfer, in whole or in part, the powers of the directors to manage or supervise the management of the business and affairs of the Company to one or other persons.  Some important differences which set Section 137 apart from Section 146 include:


(i)                 Section 146 only permits a transfer of powers from directors to shareholders, whereas Section 137 permits a transfer of such powers from directors to one or other persons (this, for example, opens up the possibility of transferring such powers to another company);  and

(ii)               to enable a transfer of powers from directors to shareholders to occur under Section 137, the ability to transfer such powers must be specifically incorporated into the articles of the company, which is not a requirement found in Section 146.

 IV.       Advantages and Drawbacks to Using a USA

 (a)        Advantages

 There are many advantages to using a USA (or the BCA’s analogous provision), some of which include:

 (i)                 pursuant to Section 146 of the CBCA, a share transferee is automatically bound by such transfer, even if such transferee has not explicitly agreed to be bound to such transfer of shares, provided that a reference to the USA is noted in a conspicuous manner on the share certificate;

(ii)               it provides a means of contracting out of or varying many of the obligations under the BCA and the CBCA; and

(iii)             it can make it more difficult for third parties to enforce claims against directors to the extent that the authority of the directors is limited by the USA.

 (b)        Drawbacks

While there are few potential drawbacks to using a USA (or the BCA’s analogous provision), some of the more important ones worth considering include:

(i)                 confusion can ensue if the division of powers between shareholders and directors is not clearly delineated, of if the division is not adhered to; and

(ii)               to the extent shareholders take on the powers of the directors within it, such shareholders assume the liabilities of the directors.

 V.        The Interrelationship of the Articles of a Company and the Shareholders’ Agreement

 (a)        Mirroring of Shareholders’ Agreement Provisions in the Articles

 The extent to which the articles of a company and the provisions of a shareholders’ agreement should mirror each other is largely dependent on shareholder preference, circumstance and strategy.  Some of the more important reasons why solicitors mirror clauses in the articles of the company that would otherwise ordinarily appear in the shareholders’ agreement include:

 (i)                 wanting to lessen the likelihood of potential conflicts of interpretation arising between the documents;

(ii)               wanting to grant additional “constitutional” protection to certain provisions set out in the shareholders’ agreement, in case a portion or the whole of the shareholders’ agreement is, at a future date, invalidated by a court; and

(iii)             wanting to ensure that shareholders who potentially receive shares in the company, but who are not a party to the shareholders’ agreement, are nevertheless bound by one or more of the provisions appearing in the shareholders’ agreement that they would otherwise be bound to, had such shareholders been a party to the shareholders’ agreement.

 (b)        Articles are Available for Public Inspection

 There are, however, some instances where mirroring provisions found in the shareholders’ agreement in the articles of the company may not be appropriate.  For example, the fact that the articles of a company are available for inspection by the public may raise privacy concerns for many shareholders.  Accordingly, shareholders wishing to keep certain aspects of their shareholders’ agreement private would want to refrain from mirroring these in the articles of the company. 

 VI.       Key Provisions and Considerations in Shareholders’ Agreements

 (a)        Rights of First Refusal

 Rights of first refusal offer shareholders a fair amount of control over who can purchase shares of the company, while still allowing sufficient liquidity to shareholders who want to sell their shares.  There are two basic types of rights of first refusal, often referred to as “hard” or “soft” rights.  A hard right of first refusal requires the selling shareholder to have obtained an offer from a prospective purchaser before being required to offer the shares to the other shareholders, and usually requires that the third party be identified in the notice.  This, of course, is advantageous to those remaining shareholders wanting to know, and have control over who they let into the company.  One of the problems with hard rights of first refusal, however, is that exiting shareholders may find themselves having trouble locating willing purchasers.  This is because some prospective share purchasers will be put off by the thought of knowing that their offer to purchase shares can be undone, and may not bother to make an offer at all, thereby shrinking the pool of potential share purchasers available to the selling shareholder.  By contrast, a soft right of first refusal allows the selling shareholder to offer their shares to the other shareholders first without first having entered into an agreement with a prospective third party purchaser.  It is commonplace, in such situations, for there to be a requirement that shares sold to third parties must be sold for, at the very least, what they were offered to the other remaining shareholders for.  From the perspective of a shareholder looking to sell their shares, a shareholders’ agreement containing a soft right of first refusal is clearly advantageous.

 (b)        Piggyback/Tag-Along Rights

 Where a particular provision results in the ability of a shareholder to sell his or her shares in the company, it is not uncommon for the other shareholders to have the right to “piggy-back” or “tag-along” in such sale by selling their own shares to the applicable share purchaser on the same terms and conditions.  Inserting such a right in the shareholders’ agreement has the advantage of making minority shareholders feel more comfortable that they will be able to exit at the same time as a majority shareholder potentially exits.  On the other hand, from the point of view of the exiting majority shareholder who has found a party to purchase his or her shares, it will be important to secure the agreement of any potential share purchaser to buy not only his or her shares but the shares of all other shareholders who wish to potentially exercise these rights.  As such, this provision may narrow the pool of potential share purchasers.

 (c)        Drag Along Right

 Shareholders’ agreements sometimes contain a “drag along” provision such that an exiting shareholder is entitled to force the other shareholders to sell their shares to its purchaser on the same terms and conditions.  Such a provision improves the marketability of a shareholder’s shares in circumstances where there may be potential share purchasers interested only in purchasing all of the shares of a corporation.  Typically, the drag along right applies only after the shareholder being dragged has had the prior opportunity to be a purchaser of the exiting shareholder’s shares.

 (d)        Shotgun/Roulette Clause

 The “shotgun” or “roulette” provision typically allows one shareholder to offer the price and other terms under which it is prepared to either purchase or sell its shares.  The other shareholders then decide whether, under such terms, they wish to either purchase the shares of the party invoking the procedure or instead sell their own shares to such party.  The thinking behind the use of such a provision is that the invoking party will have an incentive to be fair in selecting the price and other terms, as it will not be clear whether the other shareholder(s) will choose to be a purchaser or a seller.  If shareholders are of relatively equal strength, this type of clause does not favour one shareholder over another.  However, if the instigator has significant financial resources and the other shareholder does not have similar resources, the option of the remaining shareholder to buy at the offered price may in fact be of no use.  In such a circumstance, the instigator will in all likelihood be in a position to force the other shareholder to sell out, frequently at a price that does not reflect fair value.  One way of potentially overcoming this inequality of access to resources, however, is for a solicitor to build sufficient time into a shotgun provision to allow a potentially weaker shareholder to source sufficient financing, thereby leveling out the playing field between the shareholders.

 (e)        Puts/Calls

 Other types of liquidity provisions commonly found in shareholders’ agreements are “puts” and “calls.”  A put is a right available to a particular shareholder to require the corporation or another party to buy its shares.  By contrast, a call allows the corporation or some other party to purchase a particular shareholder’s shares.  Puts and calls are typically used in connection with departing employees who have a small number of shares, on the insolvency or default of a shareholder, and in connection with stock option plans.  These provisions generally require that the applicable shares be valued pursuant to an agreed formula so that the proceeds of sale resulting from the put or the call can be determined and paid.  A put or call may also be the liquidity mechanism on the death or disability of a shareholder, or on the occurrence of deadlock, instead of the options already discussed in this paper.  Any provision of this nature will require that the agreement provide a mechanism for the applicable shares to be valued for purposes of determining the purchase price that is payable.  In some cases, the shareholders agree to regularly value the corporation and the per share value so that value can be more easily determined on an exit.  It will be useful to obtain tax and accounting advice in performing the valuation calculation.  It may also be advisable to include a special purpose dispute resolution mechanism to deal solely with determination of value. 

 (f)        Funding Considerations

 A company will require access to capital in order to grow.  This may require that the shareholders agree to contribute more equity in the future by means of further share subscriptions.  Generally, the shareholders will wish to have equal rights to subscribe for more shares so that they are not diluted.  In addition to such pre-emptive rights, in some cases the shareholders also agree that in circumstances where it is determined as a governance matter that the corporation needs more equity, the shareholders will be obligated to invest more equity.   While it is possible that the proceeds of share subscriptions and general operating revenues will fully finance the company, typically a company will also require access to some sort of debt financing.  If such debt financing is to come from the shareholders, the relevant terms need to be set out in the shareholders’ agreement.  If debt financing is to come from banks and third parties, guarantees may be required and, in such circumstances, the shareholders should provide for a sharing of liability thereunder.  To the extent that the financing needs of the company impose contractual obligations on the shareholders to either advance funds or provide guarantees, the shareholders’ agreement will need to deal with the consequences of a particular shareholder’s failure to meet its obligations.  Possible consequences include the ability of the other shareholders of the company to purchase the defaulting shareholders’ shares at a discount to the value thereof. 

 (g)        Life Insurance

 To fund the buy-out of the deceased’s investment in the company, either by the company or the remaining shareholders, the company is often required or advised to maintain life insurance on the lives of each of the shareholders.  Often, this insurance is required by a financial institution as part of the security package for financing made to the company.  This said, in order for the insurance to accomplish the intended purpose of completely funding the buy-out of the deceased shareholder’s investment, the amount of insurance proceeds available must be no less than the purchase price of the deceased shareholder’s interest.  For this reason, insurance should be maintained in minimum amounts directly related to the estimated buy-out value of each shareholder’s investment in the company.  Insurance policies should be periodically reviewed to ensure that they are still adequate for this purpose.  It is quite common for shareholders’ agreements to have provisions advising that if a shareholder dies, the shares of such shareholder will be offered to the company or the remaining shareholders on a pro-rata basis, with the purchase monies being funded through the insurance proceeds.  One of the advantages of inserting such a provision in a shareholders’ agreement, from the perspective of the remaining shareholders, is that it protects them and the company from having to deal with unknown persons such as, for example, beneficiaries or executors.

 (h)       Default

 All shareholders’ agreements give rise to obligations of the shareholders of the company, which gives rise to the possibility that one or more shareholders may default in the performance of those obligations.  There are many instances of potential default, some of the more commonly cited ones being:

 (i)                 the bankruptcy of a shareholder;

(ii)               the physical or mental incapacity of a shareholder;

(iii)             the cessation of a shareholder’s employment with the company; and

(iv)             the failure of the shareholder to provide financing.

 While there is no right or wrong way to draft potential penalties which are triggered by such instances of default, common sense dictates that breaches which have a greater potential negative impact on a company and its shareholders ought to trigger more severe penalties.  Such potential penalties run the gamet from the loss of certain rights of the defaulting shareholder, to the requirement that the defaulting shareholder must sell their shares.  Whenever drafting such provisions, solicitors should exercise caution to avoid setting up potentially ambiguous or vague triggers that could invite mischief from shareholders looking to increase their shareholdings.  For this reason alone, many solicitors avoid drafting lengthy sections contemplating instances of shareholder default with corresponding penalties, opting instead to use other dispute resolution mechanisms such as the shotgun provision to cure serious instances of shareholder default.   

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