Carscallen Blog

How a well-drafted USA can prevent shareholder disputes and deadlock

Posted by Carscallen LLP on Jul 30, 2019 8:30:49 AM

Written by Sean R. MacLachlan.

For business owners, a unanimous shareholder agreement (commonly referred to as a USA”) that is drafted by an experienced corporate lawyer and tailored to the specific needs and objectives of your business can prevent a number of potential problems by anticipating and providing for issues before they may arise. A well-drafted USA can also save shareholders time and money by helping to avoid costly litigation in the event of disagreement and/or deadlock.

A USA is a written agreement between shareholders that is most commonly recommended for any closely-held corporation with two or more shareholders. Most USAs are signed by all shareholders in a company at the commencement of the term of the agreement and bind all future shareholders.

Where there are two or more shareholders in a company, it is important that a USA include provisions that address dispute resolution procedures available to shareholders in the event of future disagreements, as well as provisions that can prevent or mitigate shareholder deadlock in the case of disagreements.

Dispute Resolution

A properly drafted USA should include a provision for dispute resolution. This can prevent costly and often unnecessary litigation down the road and save shareholders time and money in the event of future disagreements. A well-tailored dispute resolution provision can also help prevent shareholder deadlock. Typically, a USA will provide for mediation or arbitration in the event of shareholder disagreement and/or deadlock. Sometimes, a dispute resolution clause may provide for a casting or veto vote to certain shareholders on key issues. 

Right of First Refusal

A right of first refusal (or “ROFR”) typically provides for existing shareholders to have the first opportunity to match a bona fide offer that a selling shareholder receives from a third party to purchase his or her shares, on the same terms as the bona fide offer from the third party. A ROFR prevents a shareholder from selling his or her shares after receiving a bona fide offer, unless they offer the shares to existing shareholders first. One advantage for existing shareholders is the chance to buy the shares instead of the third party and avoid having a new and unknown shareholder to contend with.

Right of First Offer

Similar to a ROFR, the right of first offer requires a selling shareholder to offer his or her shares to the existing shareholders in a company before the selling shareholder can offer to sell his or her shares to third parties. As with the ROFR, if the other shareholders in the company are unable or unwilling to accept the offer, the selling shareholder is then permitted to sell his or her shares to third parties.

Shot gun

The “shot gun” provision provides for a worst-case scenario situation under a USA. However, it is a useful clause to include in the event of relations between shareholders souring to the point of requiring the removal of a shareholder from the USA, and in order to prevent shareholder deadlock. 

Under a “shot gun” clause, a shareholder can offer to either: (1) sell his or her own shares to an existing shareholder or shareholders, or (2) offer to purchase the shares of an existing shareholder or shareholders, for the same terms and conditions and at the same price as the shareholder’s offer to sell his or her own shares. The other shareholder or shareholders can decide whether to buy or to sell their shares based on the terms and the price offered by the offering shareholder.

The consequence of a shareholder triggering the “shot gun” clause is that at least one of the shareholders will sell their shares and cease to be a shareholder.

A “shot gun” clause can be complicated in the event of three or more shareholders under a USA, and a “shot gun” offer being made to multiple shareholders. A well-drafted “shot gun” clause is therefore key, and must anticipate and provide for the particular circumstances of the individual corporation as well as the number of shareholders.

Buy-sell

“Buy-sell” is similar to the “shot gun” clause. Certain events will automatically trigger a “buy-sell” provision under the USA, where some or all of the shareholders or the company itself, must or may purchase all of another shareholder’s shares (and that shareholder is usually obligated to sell or otherwise dispose of all of his or her shares in the company).

Some of the events leading to an automatic “buy-sell” under a USA include the disposing/selling shareholder’s: fraud, death or disability/mental incapacity, bankruptcy or insolvency, termination of employment or ceasing to be an employee with the company, and/or breach of the USA.

“Piggyback” or “Tag-along” and “Drag-along”

Other provisions that can be included in a USA include the “piggyback” or “tag-along” provision, and a “drag-along” provision. These clauses, respectively, allow non-selling shareholders to either “tag-along” with a third party offer to buy shares, or allow a selling majority shareholder to “drag-along” non-selling shareholders on an offer to purchase shares.

Whereas “piggyback” or “tag-along” rights are generally drafted to protect minority shareholders, drag-along” rights are drafted to protect majority shareholders.

 

Carscallen LLP’s Corporate Expertise

Whether the foregoing provisions should be included in your company’s USA is a determination that should be made with an experienced corporate lawyer based on the specific facts relevant to your business. There is a significant advantage to having a USA that is precisely tailored to your business by providing piece-of-mind that many issues of dispute that may arise between shareholders may be addressed without time consuming and costly litigation. 

Carscallen’s experienced corporate lawyers can help you draft a USA that anticipates and provides for the long term needs and objectives of your business and shareholders. Carscallen is committed to understanding your business needs and offering timely, targeted legal advice that helps meet your requirements. With the practical experience to advise on every aspect of business law and commercial transactions, we work with you to get deals done. Please feel free to contact any member of our Corporate and Commercial Transactions group if you have any questions about USAs or any other business issues.

Contact Corporate & Commercial Transaction  <https://carscallen.com/our-expertise/corporate-and-commercial-transactions/?area_of_law=corporate-and-commercial-transactions>

 

*This update is intended for general information only on the subject matter and is not to be taken as legal advice.

Topics: Corporate Expertise

Subscribe to our blog to be notified when another blog is released.