Change Happens – Updating Your Shareholder Agreement

Life takes all kinds of twists and turns. For business owners, the last thing you need is to be caught unprepared. People often take reasonable measures to counter the uncertainties of life – building up emergency cash reserves, having adequate insurance policies, and creating a last will and testament. However, for business owners, having a thorough and up-to-date shareholder agreement is one of the most effective ways to navigate change in your business. Below are some key questions that a shareholder agreement should consider:

What Happens if a Shareholder Passes Away?

Whether expected or unexpected, the passing away of a key shareholder is a major hurdle for businesses to overcome. Typically, when a shareholder passes away, their shares will pass either to their surviving spouse (or to their estate) and many questions will arise:

• For remaining shareholders, is it appropriate for the surviving spouse to hold an interest in the business?
• Does the surviving spouse even want to be involved in the business?
• If not, what should happen to the shares? They could be redeemed by the company, sold to existing shareholders, or sold to third parties.
• 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?

The shareholder agreement should answer all these questions so that if the unfortunate situation occurs, expectations are already in place.

What Happens if a Shareholder Becomes Incapacitated?

Depending on the permanence and severity of the incapacity, shareholder 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 should happen? Can they continue to hold their ownership interest? Or if not, what should happen to the shares? Similar to the death of a shareholder, major decisions need to be made upon the incapacitation of a shareholder. This should be contemplated by the shareholder agreement.

What Happens if a Shareholder Wants to Retire?

As the Canadian population ages, succession is inevitable. And as business shareholders age, change will be coming. If active in the business’s management, how much retirement notice should the shareholder provide? What happens to the retiring shareholder’s shares? Can they still own an interest in the business even if they are no longer actively involved in management? Rather than scrambling to find a solution, having an adequate shareholder agreement in place should set the expectations.

What Happens if 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 losing control, the shareholder agreement should set out what actions are to take place should a shareholder consider declaring bankruptcy.

What Happens if a Shareholder Undergoes a Marital Dispute?

Unfortunately, marital disputes are common in our society. And if that marital dispute leads to a separation or divorce, it can have a direct impact on the business. Upon separation or divorce, the non-shareholder spouse may receive rights to view the business’s financial and corporate information. When the net family property is equalized (refer to our earlier blog: Why Do I Need a Valuation? Family Law) the courts may order the shareholder’s ownership interest in the business, or its monetary equivalent, be transferred to the non-shareholder spouse. To combat these adverse situations, the shareholder agreement should 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 if Shareholders are Fighting?

As discussed in a previous blog (Why Do I Need a Valuation? Shareholder Disputes) shareholders don’t always get along. If disputes arise and resolution can’t be reached, shareholders don’t need to continue in their discontent. One option, although expensive, time consuming, and public, is to seek resolution through the courts. 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.

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 are to relate to each other in the good times, and what steps should be taken during the bad times.

At Davis Martindale, we never want our clients to be caught unprepared. If you are considering creating, updating or reviewing your shareholder agreement, give us a call. We’d love to get you started on the right foot.