When business partners come together to build a company, they often focus on growth and profitability. But what happens when disagreements arise, a partner wants to exit, or the business needs additional funding? Without a shareholders’ agreement in place, a thriving business can quickly face unnecessary conflicts and legal complications.
We sat down with Chris Yung, a partner at Lenczner Slaght LLP, a boutique litigation firm specializing in dispute resolution, to discuss why shareholders’ agreements are a crucial component of any business.
What is a Shareholders’ Agreement?
The corporate statutes provide only basic governance rules, but a shareholders’ agreement can provide a comprehensive contract that acts as a blueprint for how a corporation is managed. “It guarantees rights to all shareholders, whether majority or minority, and lays out how they can participate in and oversee the corporation,” Yung explains. “This agreement ensures that all stakeholders have a voice in the company’s future.”
Why Every Business Needs a Shareholders’ Agreement
According to Yung, having a well-structured shareholders’ agreement in place helps businesses avoid pitfalls and ensures smooth operations. Here’s why:
- Balanced Decision-Making – Without an agreement, control automatically belongs to the majority owner, leaving minority shareholders with little influence. A shareholders’ agreement helps level the playing field.
- Guaranteed Board Representation – Shareholders can secure the right to be on the board, giving them the highest level of insight into the company’s affairs.
- Clear Funding Arrangements – The agreement defines how the business will be funded and what happens if additional capital is required.
- Structured Exit Strategies – Whether through a buyout, valuation process, or other means, the agreement ensures shareholders can exit on fair terms.
- Effective Dispute Resolution – Instead of public legal battles, the agreement can set out mechanisms like mediation and arbitration to resolve conflicts privately and efficiently.
The Consequences of Operating Without a Shareholders’ Agreement
If no shareholders’ agreement is in place, or a dispute falls outside its scope, shareholders may need to rely on legal remedies. Some of the most common include:
The Oppression Remedy – This protects shareholders from unfair treatment. In Naneff v. Con-Crete Holdings Ltd., a family business dispute arose when a father removed his son from the company, leaving him financially cut off. The court ruled that the son was entitled to have his shares bought at fair value without discount, and he received compensation for wrongful dismissal.
Wind-Up Remedy –Courts can order the dissolution of a corporation if it is “just and equitable” to do so. In Animal House Investments Inc. v. Lisgar Development Ltd., a shareholder sought to dissolve a family business because the relationship had broken down. The court refused, stating that mere disagreements were insufficient grounds unless they resulted in a deadlock.
Derivative Actions –When a company suffers harm but fails to take legal action, shareholders can step in on behalf of the company. In Rea v. Wildeboer, a TSX-listed auto parts manufacturer faced allegations of misappropriation of funds. Shareholders attempted to sue under an oppression remedy, but the court ruled it should be pursued as a derivative action requiring court approval.
Real-World Lessons: Two Case Studies
To illustrate just how critical a shareholders’ agreement can be, Yung shares two cases where the absence of an agreement led to major challenges. While the names and details have been adjusted for confidentiality, these real-world scenarios highlight the risks business owners face without clear agreements in place.
Case #1: The Cash Call Dilemma
ABC Company was thriving. That was, until the pandemic hit. With mounting expenses, the company needed additional capital to stay afloat. A cash call was issued, but the majority shareholders were unable to contribute. This forced the minority shareholders, despite holding only a 30% stake, to cover 100% of the funding, while remaining in the minority. A shareholders’ agreement could have set out a procedure for cash calls and outline that where one shareholder has to “step up” and cover the obligations of another shareholder, they are entitled to increase their shareholding.
Case #2: Ousting the Founder
John Smith spent three decades building his company, bringing in partners along the way. Eventually, those partners, who held a collective majority stake, decided John should step away. Since they controlled the votes, they forced him out of the running of the business, and he was relegated to being a passive investor. A shareholders’ agreement protecting his right to participate could have safeguarded his role in the company,” Yung explains.
Protecting Your Business
For business owners, taking a proactive approach is key. Yung advises:
- Seek Legal Advice – Consult an expert to draft or review a shareholders’ agreement tailored to your business needs.
- Establish Clear Guidelines – Take the time to discuss and document key principles. Ensure all shareholders fully understand their rights, obligations, and exit strategies from the outset.
- Consider Mediation First – If disputes arise, mediation can often resolve issues before they escalate into costly legal battles.
- Pursue Legal Action When Necessary – In cases where mediation fails, legal intervention may be necessary.
“A shareholders’ agreement is an essential safeguard for your business,” Yung concludes. By taking the time to put the right framework in place, business owners can protect their investment, maintain control, and avoid costly disputes down the road.
