Shareholders’ Agreements in Canada
Corporate law is an important aspect of entertainment law because many entertainment businesses choose to incorporate. Often, a business will choose to incorporate after it has reached a certain point in its growth; this may relate to an increase in its personnel numbers or in its output capacity. For a more detailed discussion on incorporation, including why a business should incorporate, we recommend you read our blog Corporate Law: Why, When & How to Incorporate Your Entertainment Business.
Upon incorporation, a business will have incorporators and directors. One of the first activities of the corporation’s directors is to issue shares.
A person who has shares issued in their name is a shareholder. Shareholders are not owners of corporations however a shareholder’s broad rights to control the direction of a corporation are often likened to ownership.
What is the Role of a Shareholder?
Shareholders elect directors, they may have a right to receive profits, they confirm or reject by-laws of the corporation, and they confirm or reject major corporate activities such as mergers or acquisitions. Shareholders often enter into a shareholders’ agreement to define the terms of the relationship among the shareholders. This blog provides information about the three key parts of a shareholders’ agreements.
Is a Shareholders’ Agreement Required?
No, a shareholders’ agreement is not required but it can be very useful. A shareholders’ agreement, like most other legal contracts, is a document that can help to prevent or resolve disputes between the contracting parties – in this case, the shareholders.
This is because a shareholders’ agreement clarifies the rights and obligations that each shareholder has to the others as well as to the corporation. It also protects the corporation and shareholders.
For example, a shareholders’ agreements may protect a minority shareholder who has no day-to-day decision-making power because they can always be outvoted by the majority shareholder(s). A shareholders’ agreement can change this situation.
What are the Main Components of a Shareholders’ Agreement?
Key parts of a shareholders’ agreement set terms on the transfer of shares (or restrictions on the transfer of shares), define the decision-making powers of its shareholders and directors, set out what happens when certain events affect a shareholder, and provide a dispute resolution process.
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Transfers of Shares
A shareholders’ agreement will set out restrictions on the right of the shareholders to sell their shares in the corporation. This is important in a closely held private corporation, in which each shareholder wants to know and control who the other shareholders are. Typically, a shareholders’ agreement will prohibit a shareholder from selling their shares to a third-party without the permission of the other shareholders.
In this way, the other shareholders can control who becomes a shareholder and, where relevant, maintain the status quo with respect to majority and minority shareholders.
Common Share Transfer Provisions:
Right of First Refusal
Before a shareholder can sell their shares to a third-party, they must first offer those shares to the other shareholders who may purchase the shares in a quantity that is pro rated to their current ownership.
Drag-Along Rights
A majority shareholder that sells their shares to a third-party has the right to force the minority shareholders to sell their shares as well.
Tag-Along Rights
If a shareholder sells their shares to a third-party the other shareholders have the right to force the third party to buy their shares on the same terms.
Pre-Emptive Rights
If the corporation issues new shares the existing shareholders may purchase a pro rated number of the new shares, maintaining their ownership percentage of the total outstanding shares.
Shotgun Clause
One shareholder may offer to buy the shares of another shareholder at a set price; the second shareholder can either accept to sell their shares at the set price or purchase the shares of the offering shareholder at the same price.
Decision-Making
How decisions are made among shareholders may be set out in a shareholders’ agreements. How many votes does each shareholder have? What types of matters require a simple majority vote? What matters require more than a simple majority (i.e., 2/3, 3/4 or unanimous votes)? What constitutes quorum for shareholders’ meetings?
These sections are important in addressing minority and majority shareholder dynamics. For example, a corporation in which one shareholder is the principal source of funds may require that shareholder’s approval of some or all decisions, even if that shareholder is in the minority.
Another aspect of decision making relates to the directors of the corporation. How are the directors chosen? Does the corporation have a minimum or maximum number of directors? Does each shareholder have the right to elect one director?
Events Affecting a Shareholder
It can be important in a closely help private corporate to set out what will happen when there is a change in the nature, status, or capacity of a shareholder. For example, a shareholders’ agreement will often provide for the death of a shareholder.
Are the shares inherited by the shareholder’s next of kin or does the corporation redeem them (buy them back and cancel them). Similarly, there may be provisions governing the permanent incapacity of a shareholder or providing for a shareholder that ceases to be an employee of the corporation, or that is subject to family law proceedings.
Resolving Disputes
One of the key objectives of a shareholders’ agreement is to prevent and resolve disputes between shareholders. For this reason, there is typically a section devoted specifically to dispute resolution. For example, if a vote of the shareholders on an issue results in a tie the agreement may provide that a particular shareholder has a tie-breaking vote or that a third party, such as an arbitrator, determines the issue.
Conclusion
The relationship among shareholders can be complex from an emotional, business, and legal standpoint. A shareholders’ agreement – to clarify and codify the obligations and rights of the shareholders – can be a strong tool to ensure that it functions effectively and in the best interests of the shareholders and the corporation.
For further information about shareholders’ agreements and corporate law, we encourage you to visit our website or contact one of the Edwards Creative Law lawyers.
© 2023 Edwards Creative Law, LLP – Updated to August 15, 2023
Edwards Creative Law is Canada’s Entertainment Law Boutiqueâ„¢, providing legal services to Canadians, and international clients who partner with Canadians, in the Film & Television, Music, Video Games and Apps, Publishing and Literary industries.Â
* This blog is for general informational purposes only and is not to be construed as legal advice. Please contact Edwards Creative Law or another lawyer, if you wish to apply these concepts to your specific circumstances.
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