Shareholder Agreements

A shareholder agreement is an invaluable agreement entered into between shareholders of a corporation. It is a flexible agreement that can contain a variety of provisions which, in general boil down to two main areas - the management of the corporation and exit of shareholders. In the absence of a shareholder agreement, a corporation would be controlled by its majority shareholder(s), leaving minority shareholders with little to no input in the management and direction of the corporation.

A shareholder agreement should be entered into by the initial shareholders as part of the incorporation process. It should be revisited from time to time to determine whether changes are required, especially when there are changes to the shareholders, such as when the corporation receives funding from an investor.

A shareholder agreement can benefit both minority and majority shareholders. Minority shareholders can be provided with rights, such as the right to appoint or act as a director or the right to approve certain decision making. Majority shareholders can be provided with additional rights, such as the right to repurchase shares from minority shareholders who cease to work for the corporation, limit the extent to which a minority shareholder can sell their shares to third parties and can permit a majority shareholders to compel a minority shareholder to accept an offer for the purchase of all of the shares of the corporation.

The following are a list of the main considerations when drafting a shareholder agreement. These items are, at least, considered in most shareholder agreements.

Management

Shareholder agreements will generally specify which shareholders can elect the directors. This can provide a minority shareholder with some influence over the management of the corporation. In addition, a shareholder agreement can Provide that a specified percentage of shareholders must approve certain corporate action. In this way, minority shareholders can at least have a veto power over important corporate decisions.

Share Provisions

Shareholder agreements generally restrict shareholders from transferring their shares unless they do so in accordance with the agreement. The following are common share transfer provisions which are included in a shareholder agreement:

• Pre-emptive rights: existing shareholders get the right to participate, pro rata, in new share offerings
• Rights of first refusal: existing shareholders get the right to match a third party offer to purchase a shareholder's shares before the shareholder can sell to the third party
• Forced share transfers: on the happening of events such as on bankruptcy, death, disability or divorce
• Drag-along rights: majority shareholder can accept a third-party offer for the sale of all of the shares of the corporation on behalf of all shareholders
• Tag-along (piggy-back) right: minority shareholders can require a third party who intends on purchasing a majority shareholder's shares to also purchase their shares on the same terms
• Buy-sell (shotgun) clause: sets out a mechanism whereby one shareholder will purchase the other's shares in the event of a dispute

Restrictive Covenants

Shareholder agreements will often include a category of provisions called "restrictive covenants" which protect the corporation's business, information and relationships by preventing the shareholders from engaged in specified conduct during a specified period. What is unique about restrictive covenants is that, as they are a restraint on trade, they are only enforced if the provision is reasonable between the parties and with reference to the public interest. Reasonableness is determined depending on the circumstances of the case and with regard to what is necessary to protect the legitimate interests of the corporation.

Common restrictive covenants include the following:

• Confidentiality provisions: require shareholders to keep confidential the corporation's information
• Non-Solicitation provisions: prevent shareholders from soliciting employees and customers of the corporation
• Non-Competition provisions: preventing shareholders from competing with the corporation

Other Provisions

As noted above, shareholder agreements are flexible instruments that can be tailored to the circumstances. While this list is by no means comprehensive, the following are some additional provisions that can be included in a shareholder agreement:

• Reporting and access to information rights for minority shareholders
• Financing provisions either requiring shareholders to fund the corporation and/or setting out default financial terms for any shareholder loans
• Valuation provisions, particularly where the shareholder agreement enables the corporation or a shareholder to purchase the shares of a shareholder
• Dispute resolution provisions
• Repurchase options, such as where an employee-shareholder resigns or is terminated

A shareholder agreement is an invaluable agreement which should be a part of every private corporation with more than one shareholder. It sets a framework for the startup journey by creating the legal framework for corporate management and decision making and by setting out prohibited conduct, as well as the consequences of violating those provisions.