The scenario: You’re a 60 per cent shareholder. Your business partner holds the other 40 per cent. And you’ve just found a third party who wants to buy you out.
Does your company have a shareholder agreement in place?
If not, the buyout could lead your partner to claim shareholder oppression, potentially triggering serious liability and forcing costly, disruptive remedies.
“They could be left in the wilderness if they’re now the minority shareholder to a completely different person that they have no formal relationship with,” explains James Wilding, a business lawyer at Perley-Robertson, Hill & McDougall. “One thing your shareholder agreement should specify is whether the third party also has to buy your shares.”
Situations like this illustrate why it’s vital for founders and business owners to establish a shareholder agreement as soon as possible.
What is shareholder oppression?
Shareholder relationships are supposed to run on trust, transparency, and a shared vision. But when trust breaks down, minority shareholders often find themselves sidelined and searching for recourse – which sometimes leads them to allege shareholder oppression under either the Canada Business Corporations Act or the Ontario Business Corporations Act.
Wilding says shareholder agreements are often called the “prenup of business law,” adding that business owners – especially of smaller, privately-held companies – need one in place in case things go south with fellow shareholders.
“It’s extremely important for all founders, especially when bringing in that next generation of shareholders, to set things out in a shareholders agreement as plainly as possible,” he explains, “so they’re protecting themselves and making sure they can continue to run their company as they need to.
“Ideally, a shareholder’s agreement should give the parties the framework for resolving disputes internally. As soon as you have to go to court, everyone loses. Legal fees are going to be eaten up. No one’s going to be happy with the resolution.”
What are reasonable expectations for shareholders?
Shareholder oppression claims are typically made when the claimant believes one or more “reasonable expectations” have been breached by the company or its controlling shareholders. These reasonable expectations can be enforceable even if they aren’t set out in a written agreement.
While every case is unique, courts have identified several situations where shareholders typically hold legitimate expectations deserving of protection, including:
- Participation in management: Courts consistently recognize the right to participate in management as a reasonable expectation.
- Fair distribution of profits: Every shareholder invests with the expectation of receiving a fair economic return, and courts have consistently held that this expectation is reasonable.
- Protection against unfair dilution: Shareholders reasonably expect that their proportionate ownership and voting power will not be undermined through manipulative corporate maneuvers.
- Access to information and transparency: Shareholders have a legitimate expectation of access to accurate information about the company’s financial position, operations, and governance.
Wilding says participation in management – or the expectation by the shareholder that they’ll participate in management, such as a seat at the directors’ table – is one of the most important expectations for business owners to agree upon.
“If push comes to shove, you have no intrinsic right to sit on the board of directors of a corporation,” he explains. “If you get removed from your position as a director, your recourse would be to make a shareholder oppression claim. But there’s certainly no guarantee of success one way or the other – the only way to be certain is to set the actual expectations of the parties in an agreement.”
What business owners can to do protect themselves
The first and most obvious step, says Wilding, is to contact your lawyer and draft a shareholder agreement right away – something he admits most fledgling business owners are wont to do.“If you’re running a startup you don’t necessarily have the most capital, and it’s not the most fun thing to spend money on an agreement,” he says. But such an agreement doesn’t need to be overly complex or costly.
“You just need a basic agreement,” Wilding adds. “And the earlier you can do it, the better. Who manages things on a day-to-day basis? Under what circumstances can we separate if you’re strapped for cash?”
Additional steps companies should take are to always follow corporate due process, such as calling regular shareholders meetings and providing reasonable financial details when requested, along with always communicating significant changes to shareholders.
“One of the most dangerous times for a shareholder oppression claim is when a big change is coming. Make sure that you’re communicating as early as possible, being open and transparent and not surprising people.”
