Shareholder Agreements –

Often overlooked, always needed.

If a closely held corporation has more than one shareholder, then the shareholders need a shareholder agreement.  However, in the excitement of setting up a new corporation, this fact is often overlooked.  I cannot count the number of times that I have heard “but we don’t need one, we’re (1) the best of friends or (2) close relatives”.  Unfortunately, best friends and close relatives often become the worst of enemies, especially where money is involved.  Without a shareholder’s agreement, a major shareholder disagreement will result in an impasse, at best, and expensive litigation at worst (shareholder litigation is not that different to a divorce in terms of expense and wasted emotions).  This is especially the case where there are only two shareholders, each of whom own 50% of the corporation’s issued stock.

So, what should a shareholder do?  The answer is simple, and in case you haven’t guessed it already, it’s the negotiation and signing of a shareholders’ agreement.  What does a shareholder agreement do?  Well, to begin with, it addresses the following issues that are often forgotten or overlooked when people set up a corporation:

·    What happens if one shareholder wants to sell his or her shares to a third party?  In the absence of a shareholders’ agreement, the shareholder can sell them without restriction (except to the extent that federal or state securities laws might restrict the sale).  Typically, a shareholders’ agreement will require the selling shareholder to offer the other shareholder(s) a right of first refusal on his or her shares.

·    What happens if a shareholder dies?  In the absence of a shareholder’s agreement, the shareholder’s estate (and probably, thereby, his or her spouse or children) will now own the shares).  While the other shareholders may have gotten along with the deceased shareholder, they might not care for the shareholder’s spouse or children.  A shareholders’ agreement will typically provide for the corporation (or the other shareholders) to have the option to purchase the deceased shareholder’s shares for a pre-determined or appraised value.  This purchase might be paid for by life insurance on the shareholder’s life.

·    How can a minority shareholder ensure that he or she will be elected to the board of directors?  In the absence of a shareholder’s agreement, the majority rules.  However, a minority shareholder can negotiate a requirement in the shareholder’s agreement that each shareholder shall vote his or her shares to elect him or her to the board of directors.

·    How can a minority shareholder ensure that the majority shareholder(s) will consult him or her in the event of a major decision affecting the corporation?  Once again, in the absence of a shareholder’s agreement, the majority rules.  However, it is quite common for a shareholder’s agreement to contain a provision that requires a super-majority (or even unanimous) vote for certain major decisions.

·    What if a corporation has two shareholders, each of whom owns 50% of the issued shares, and there is a major disagreement/impasse?  In the absence of a shareholder’s agreement, the shareholders will have to apply to a court for the judicial dissolution of the corporation – not a preferred alternative, by any means.  However, a shareholder’s agreement can provide for impasses to be subjected to binding arbitration/decision making by a third party (whom both parties trust).

The above list of issues is not exhaustive, but it does provide a good illustration of the overlooked (but important) issues that a shareholders’ agreement can address.  If you are a shareholder in a closed corporation, or are about to become one, don’t forget your shareholder’s agreement!