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Considerations for Preparing Shareholders’ Agreements and Partnership Agreements

Initiating the process and a plan to be followed.

By Martin K. Zeidenberg | Partner | Garfin Zeidenberg LLP

The point of this paper is to essentially summarize many of the main considerations in the preparation of a Shareholders’ Agreement, to protect each of the parties entering into this common form of business relationship when one owns shares of a private corporation.

One of the important areas in operating your Corporation is the area of decision-making. Depending on the number of shareholders participating and the percentage of shares owned by each shareholder, you must consider whether certain decisions require unanimous approval or merely approval of the majority of the shareholders. Often when
drafting a Shareholders’ Agreement, major decisions such as selling the business or winding up the business or amending the Board of Directors might require unanimous decision-making. Many of the decisions that are made on a day to day basis, could perhaps require only a majority vote of either the board of directors or the shareholders.
As well, in a Shareholders’ Agreement, the directors have the right to essentially delegate the decision-making to the shareholders in areas where the decision-making is normally made by the Board of Directors.

Another area of concern involves the situation where one of the shareholders might decide at some point not to remain involved with the other shareholders. In that situation, the Agreement can include a mandatory shotgun buy-sell arrangement, whereby any shareholder has the right to give the other shareholders notice that the
initiating shareholder is willing to sell his or her or its shares, and then the remaining shareholders have the option to agree to either buy the initiating shareholder’s shares or sell the shares that they own to the initiating shareholder, in either case at the price per share stated in the first offer submitted by the initiating shareholder. This is a mechanism that essentially allows a disgruntled shareholder to either own the company completely or be bought out entirely by the other shareholders. Alternatively, in many Shareholder Agreement situations, the shareholders choose not
to include any type of mandatory shotgun buy-sell arrangement, but simply leave the issue of a disgruntled shareholder to be dealt with by the shareholders from time to time when the situation arises, although there is no provision then to force any of the shareholders to act in a certain manner, and any decision-making with respect to the
disgruntled shareholder merely becomes a product of an Agreement that the parties would enter into at the appropriate time. Often, if shareholders are not all in a financial position where they would equally be able to buy out one or the other, the shareholders might wish to include no provision in which a forced or mandatory buy-sell arrangement would be required.

In the event a shareholder is permanently disabled, it would be, if desirable, prudent to have the Agreement include a provision that the disabled shareholder would be required to sell his or her shareholding interest in the Corporation either to the Corporation or to the other shareholders, at an agreed upon value. Such an arrangement can be funded
with a form of disability insurance.Similarly, upon death, the Agreement should include a provision that the Corporation would be required to repurchase from the Estate of the deceased shareholder the shares held by the deceased at an amount to be agreed upon from time to time and to be included in the Shareholders’ Agreement. The amount of that purchase price would be funded by life insurance purchased by the Corporation on the life of each of the shareholders. If the Corporation buys the shares of the deceased from the Estate of the deceased, the purchase price to the extent payable out of insurance proceeds is essentially received tax-free by the Estate, provided premiums are charged back to the shareholders personally, and the surviving shareholders then continue to operate the Corporation without concern that the family of the deceased would be involved in the business.

In order to carry out a proper buy-sell on death arrangement, two extremely important decisions or functions must be undertaken. Firstly, the shares of the Corporation must be valued at this time, and that valuation must be looked at periodically from time to time. Secondly, the value of the purchase price must then be appropriately life insured
on each shareholder’s life, and obviously, the value of the Corporation and the amount of life insurance to be purchased would bear a direct relationship. Although one would not wish to over-insure the life of each shareholder, one must keep in mind that as the shareholders age insurability becomes more of a problem, and in certain situations it is advantageous to acquire more insurance today than might necessarily be needed today, and allow the value of the Corporation to grow into the amount of the insurance essentially.

As an adjunct of the life insurance arrangement, you would likely wish to maintain a form of key man insurance component, so that in the event of the death of a shareholder, some value of insurance proceeds would remain in the Corporation to assist the Corporation to replace the deceased shareholder, at least for some period of time.
The Shareholders’ Agreement can also include a first right of refusal clause with respect to any third party offers that any shareholder might receive. In effect, if a shareholder receives an offer for that shareholder’s interest in the business, the other shareholders would have the right to match the terms of such offer and buy out the interest of the
shareholder originally receiving that offer. This would prevent any of the shareholders from marketing his or her shares to a third party that the other shareholders would not find acceptable essentially as a partner.

In the event of any personal bankruptcy of a shareholder, the Agreement should include provision to give guidance as to the value of the shares of the bankrupt shareholder, and allow the other shareholders to buy back the shares of the bankrupt shareholder from the Trustee in Bankruptcy.

The Shareholders’ Agreement would also include provision to govern situations where loans are required from the shareholders by the Corporation to ensure that all shareholders are treated equitably.

This paper only touches the surface of issues to be considered and each Shareholders’ Agreement needs to be tailored to meet the needs and circumstances of all members of the corporation. But let’s start the discussion to protect yourself and your family members.

Contact Martin Zeidenberg by email at mkz@gzlegal.com or by phone at 1.416.642.5402.

Practice Areas: Wills & Estates, Estate Administration, Trusts, Corporate Commercial

© Martin Zeidenberg, 2021

This item is provided for general information purposes only and is not intended to be relied upon as legal advice. Informed legal advice should always be obtained about your specific circumstances.

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