Closely Held Organizations

Closely Held Organizations In a private company, the shareholders, directors, officers and employees are often all the same people • From their point of view, distinctions amongst these roles are blurred, and for most of the year, don’t matter • In a public company, a change in ownership does not directly affect the day to day operations of the business o In a private company, a change in ownership can fundamentally change the operations of the business • If a controlling shareholder sold his or her shares to someone new, it is as if they are retiring o Does the new shareholder have the business skills, honesty, energy and interest the ‘exiter’ had? o A new shareholder could bring a surplus of cash, to be used to grow the business, or, lead to disaster if they control the board but do not fit with the company’s mission statement / business plan • Small businesses start up because the founders work well together and have complementary skills and talents • Consider whether the new shareholder is just investing money, or wants to actively participate in the business For a start-up business, the founders need to agree on: (1) Control (2) Sharing of profits • A solicitor’s goal is to pro-actively prepare appropriate 1) articles, and 2) a shareholders agreement, so that any transition from shareholder to shareholder can be managed effectively Restrictions on transfer When we discuss the “rights and restrictions attached to a class of shares”, RoT are an example of a restriction We place RoT in the Articles at the beginning (when incorporating) in order to: (1) prevent the intrusion of undesirable business associates, (2) preserve the relative interests amongst the owners (fractions), (3) resolve deadlock (tie-breaker) • Alternatively, or in combination, we can create a shareholders agreement that governs the rights and restrictions for shareholders Sample provision: Consent required for Transfer of Shares No share may be sold, transferred or otherwise disposed of without the consent of the Directors and the Directors are not required to give any reason for refusing to consent to any such sale, transfer or other disposition Types of restrictions on transfer: 1. Absolute restrictions = not valid if lasting indefinitely • Could be valid for a set period of time (if reasonable and necessary in the circumstances ~5 year max) • Found in shareholders agreements 2. Consent restrictions • No transfer is valid unless approved by directors, or shareholders, or proportion of both • Used almost universally in private companies; appears in default Table 1 Articles (in BCA regulations) • Refusal is generally assumed to be bona fide + in interests of corp, but have been rejected by courts • Binding on executors, trustees in bankruptcy (if someone wants to give shares in a will – overridden) 3. First Option restrictions (Baron: equitable and practical) • If a shareholder wants to sell his share, he must first offer them to the other shareholders • Price and procedure set by shareholders agreement (valuation formula, method they need to take) • May be triggered by a specific event (eg. retirement) 4. Buy-out Arrangements • Similar to First Option restrictions, but mandatory (must buy-out shares when someone leaves) 5. Buy-sell Arrangement • Upon the death of a shareholder, that deceased shareholder’s estate will sell those shares to the remaining shareholders at a specified price (generally when shareholders are also heavily involved) • Company will already have purchased life insurance polices on each of the shareholders, so that the company will have the funds available to pay the deceased’s estate for the shares Note: classifications/titles are less important than the actual wording of the restrictions in the Articles or in a SA Re Smith & Fawcett Ltd [1942] F: articles of S&F provided that directors can refuse to register any transfer of shares in ‘absolute and uncontrolled discretion’; son, as executor for his dead father, claimed to have 4,001 shares; directors refused to register his shares unless he would sell 2,000 to a director at a certain price, and only then would they register remainder to him A: there is nothing in principle or in authority to make it impossible to draft such a wide and comprehensive power to directors to refuse to transfer • The question is simply whether, on the true construction of the particular article, the director are limited by anything except their bona fide view as to the interests of the company o The article is drafted in the widest possible terms, and I decline to write into that clear language any limitation other than one that is implicit in law’, that they must maintain their fiduciary duty o if there is no mala fide behaviour and are following rules of articles – no breach of fiduciary duty C: the refusal of transfer could stand Case v Edmonton Country Club [1974] F: Articles of public company were altered to give directors of club unfettered power to restrict transfer on shares • another alteration required shareholders of the club to pay annual club fees whether they were playing or not SCC: mandatory fees for shareholders offends the basic principle of limited liability and is ultra vires Dickson (majority): Directors are allowed to refuse a transfer if that power comes from clearly stated articles • it is a very common restriction on shares, and although the right to transfer shares is one of the incidents of share ownership, the right is not absolute – a restriction is not repugnant to ownership of shares, but is one of the original incidents attached to them by the contract contained in the articles (also no evidence of mala fide) Laskin (dissent): the company has effectively turned itself into a private club despite its incorporation as a public co • if a company is unwilling to establish criteria upon which to enable a measure of reasonable exercise of discretion, it ought not to be permitted to have the cover of incorporation as a public company • Act does not expressly confer power to restrict shares – just says they are transferable as provided in articles o Need to have some standard accepted to make it amenable to judicial control Shareholder agreements (pooling agreements - section 175) • Agreements amongst shareholders as to the manner in which they will vote their shares are lawful (Ringuet) • In small businesses, shareholders are typically also directors, or have other roles in the business • Must be for a lawful purpose: • Directors cannot contract how they will vote as Directors • if Directors are also shareholders, they may sign a shareholders agreement and use their rights under that agreement as shareholders, but the agreements cannot be used to fetter discretion of directors • Shareholder Agreements are often planned in phases; we modify and replace them when new shareholders invest or old shareholders retire • Sometimes a corporation is party to a shareholders agreement • What else is in a shareholders agreement: 1. Parties: who are the shareholders? (people/partnerships/etc.) • What classes/rights, # or % of shares, purchase price (shares/loan) 2. Transfers • Restrictions? Are there any types of transfers that are permitted? • Buy-sell provisions, triggering events (retirement/death/going public), Valuation formula 3. Management – who will be Directors? • Self-appointment, or, right to appoint a certain # of board members 4. Finance/budget – plans to borrow money? Who will guarantee the loan? 5. Confidentiality 6. Non-compete and non-solicit 7. Dispute Resolution Ringuet v Bergeron [1960] F: group of people made shareholders agreement that they would acquire 50 shares of a company (which would give them control of it), and then that they would vote themselves into BoD in different capacities, and agreed to vote unanimously in all meetings, providing a penalty for breach of contract I: is this agreement contrary to public order or legality? A: there is nothing illegal or contrary to public order in an agreement to unite upon a course of policy or action and upon whom the directors they will elect • The fact that an agreement may potentially involve a detriment to minority shareholders does not render it illegal and contrary to public order • Courts are hands-off with contracts between shareholders - they can pool their votes if they wish to • Just because someone is a director, does not mean they cannot have an SA if they are a shareholder Common share structure: • Class A voting, participating without par value • Class B non-voting, participating without par value • Class C voting with $1 par value – 100 maximum outstanding – good way to allocate voting rights without affecting any other rights (depending on how much someone has invested)