A Shareholder’s Agreement – Until Death Do Us Part?

Originally published November 13, 2018

While there’s no cheating death, there are certainly steps we can take to help those left behind transition to a life without us.

It could be a life insurance policy, property, bank accounts – all of which require our instructions and preferably stated in a will – on what, and ultimately who, will take over our worldly goods.

While this might sound simple enough, does the same process hold true for a business when one of its shareholder’s dies? What if there were only two shareholders?

What happens then?

To ensure your business continues to run smoothly, a solid shareholder agreement is absolutely vital to avoid costly litigation and uncertainty about who’s in charge.

What Happens When a Shareholder Dies?

Whether expected or unexpected, the death of a key shareholder is a major hurdle for businesses to overcome. Typically, when a shareholder dies, their shares will pass to their surviving spouse (or to their estate). This can lead to uncertainty for any remaining shareholders, resulting in questions about the company’s future:

• Is it appropriate for the surviving spouse to hold an interest in the business?
• Does the surviving spouse want to be involved in the business?
• If not, what should happen to those shares? Can they be redeemed by the company, sold to existing shareholders, or sold to a third party?
• If redeemed by the company or sold to existing shareholders, where will the required funds come from? Is there an adequate life insurance policy in place? How will the price of the business be determined?
• If sold to a third party, who is responsible for finding a buyer?

If the company has a shareholder agreement, all of these questions will be addressed with specific instructions on how to proceed. As a result, the company can seamlessly transition as dictated by the agreement and carry on its day-to-day operations.

What Happens When a Shareholder Becomes Incapacitated?

The permanence and severity of the shareholder’s illness and/or disability can pose another major hurdle for businesses to overcome. If the impacted shareholder is no longer able to fulfill their roles in the business, what happens next? Should they be allowed to hold their ownership interest? And if not, what should happen to their shares?

Similar to the death of a shareholder, these are major issues that are discussed within a shareholder agreement, meant to provide detailed instructions to mitigate these types of unexpected life changing dynamics and ensuring there is a minimal impact on the business.

What Happens When a Shareholder Wants to Retire?

As the Canadian population ages, succession planning is becoming increasingly common. When it comes to a shareholder’s retirement plans, what needs to happen for a smooth transition so that the shareholder leaves the company on good terms?

A well-planned shareholder agreement will tackle this scenario head on by stating the amount of time needed to provide notice for departure, and whether the shareholder can continue to hold on to their shares upon retirement.

What Happens When a Shareholder Becomes Insolvent or Bankrupt?

If a shareholder becomes insolvent or bankrupt, the shareholder’s ownership interest in the business may be transferred to a trustee in bankruptcy. Depending on the level of ownership held by the shareholder, transferring ownership to a trustee may lead to a loss of control of the business. Rather than risking a loss of control, the shareholder agreement should set out the specific steps necessary when a shareholder declares bankruptcy.

What Happens When a Shareholder’s Marriage Ends?

Marital disputes that lead to separation or divorce can have a direct impact on a business. Upon separation or divorce, the non-shareholder spouse may receive rights to view the business’ financial and corporate information. In one of our previous blogs, “Why Do I Need a Valuation?”, we tackle this situation. When the net family property is equalized, the court could order the shareholder’s ownership interest in the business, or its monetary equivalent, to be transferred to the non-shareholder spouse.

To combat these adverse situations, the shareholder agreement could set out a requirement that all shareholders enter into a domestic contract with their respective spouses that excludes the shares from consideration as net family property. Alternatively, the shareholder agreement could stipulate that any equalization of net family property will not be satisfied by the transfer of shares.

What Happens When Shareholders Don’t Get Along?

As discussed in another previous blog, “Why Do I Need a Valuation: Shareholder Disputes”, shareholder disputes happen, but all hope is not lost. Shareholders have options when it comes to resolving their concerns in the best interest of the company. One option is to seek resolution through the courts. While this may be effective, this option is expensive, time consuming, and public.

Alternatively, less expensive and quicker options exist for shareholders that wish to keep their disputes private. Two of the more common options are mediation and arbitration. To ease the dispute resolution, the process should be agreed upon ahead of time through the shareholder agreement.

Key Takeaways

Interpersonal relationships are complex. In businesses with multiple shareholders, where personal livelihood, financial well-being, and business success are dependent on those interpersonal relationships, a lack of structure can be a recipe for disaster. To establish structure, a shareholder agreement should outline how shareholders relate to each other in good times, and what steps should be taken during challenging times.

If you have any questions about creating, updating or reviewing your shareholder agreement, the professionals at Davis Martindale have experience in all areas of accounting, taxation, and advisory services. Regardless of the challenges you and your business face, we have the expertise to assist you with overcoming any obstacles that stand in your way. Give us a call today for a personalized discussion.