How to handle shareholder disputes: common causes and solutions

How to resolve management and operational disputes using a shareholders agreement

Having a shareholders agreement can help by spelling out the rights and obligations of the shareholders in the management and operation of the business and how to resolve disputes among shareholders.

The agreement should capture each shareholder’s rights, responsibilities and obligations in the management and operation of the business, making it easier to establish when one shareholder is in violation of the terms of the agreement. That would be difficult to do if these provisions are not agreed upon in writing. Having an agreement in place can set the stage for negotiations to try to resolve the disputes in a mutually agreeable manner.

What are the exit options?

Exit options come into play if the shareholders decide that they need to end their business relationship. If all are in agreement, shareholders can buy each other out, bring in an outside person to buy out one or more shareholders, or sell the entire business.

It may also be difficult to agree on the procedure and evaluation methodology of selling the shares of one or more shareholders to another shareholder or an outside person. A shareholders agreement can spell out all exit options, typically by providing a mechanism for the sale of shares, such as the procedure and evaluation methodology.

• The “shotgun” clause

A common share buy-sell mechanism in a shareholders agreement is a “shotgun clause”, which forces one of the two shareholders to sell to the other at the designated price (shareholder A can either buy out the interest of shareholder B at the designated price, or at the option of shareholder B – sell the stake of shareholder A to shareholder B for that same designated price). What is the impact of having a shotgun mechanism in a shareholders agreement?

First, it encourages shareholder A to make a fair offer to shareholder B in coming up with the designated price because shareholder B can turn around and buy out shareholder A for that same price. Second, knowing that one of the parties can leverage a shotgun mechanism to their advantage can potentially encourage negotiations before triggering the clause, in the hope of avoiding having the offer backfire on the shareholder triggering this mechanism.

A shotgun clause can also be taken advantage of when shareholder A knows that shareholder B is experiencing financial difficulties and triggers a shotgun buyout using an unfair price, potentially forcing shareholder B to accept an offer for a low price.

• Valuation

Another common method to agree on the price of shares is through a valuation by a professional business valuator. Sometimes shareholders can agree on appointing one valuator, while other times each party can retain its own valuator in the hope of trying to reach an amicable resolution based on the different valuations.

• Selling the business

Other than having a set procedure for buying out each other’s shares or valuating the business, in the absence of an agreement by the parties, one resolution (not necessarily the best one) can be to sell the entire business. But even selling the entire business may not resolve all aspects of a shareholders disputes. If there are disagreements over each shareholder’s entitlement to the proceeds from the sale (because of the types of allegations discussed at the top of the article), disputes will have to be somehow resolved even after selling the business.

What is the legal oppression remedy?

As noted earlier, even with a shareholders agreement in place, exit options do not always help bring a full resolution to the dispute. Shareholders can agree on some elements but not all aspects of the disputes.

This can relate to allegations of unfairly taking advantage of controlling positions, different or objectionable valuation methodologies, misappropriation of funds or entitlement to proceeds from a sale, among others.

Mediation can help try to resolve the dispute. Alternatively, shareholders will have to resort to court or to binding arbitration, depending on whether the shareholders agreement requires binding arbitration. Parties may also mutually agree to resolve their dispute by binding arbitration.

Typically, the allegations by the claimant shareholder will be based on an oppression remedy, which is a broad legal remedy under the provincial or federal (if the corporation is federal) Business Corporations Act. 

Under an oppression remedy, the aggrieved shareholder is required to show that the conduct of the other shareholders is oppressive to his or her interests, by being unfairly prejudicial or unfairly disregarding his or her interest in the company. The aggrieved shareholder is required to prove with evidence what their reasonable expectation was in relation to the management, operational or financial aspects that are in dispute, and bring evidence establishing that their reasonable expectation was violated by conduct that was oppressive, unfairly prejudicial, or that unfairly disregarded their interest.

Court decisions have ruled on many types of circumstances that can amount to oppressive conduct by a majority shareholder or a shareholder in control of the business, including the following:

• mismanaging the company’s affairs or financials;
• misappropriating company assets;
• paying out excessive remuneration to controlling shareholders or directors;
• making decisions that benefit a select group at the expense of others;
• diluting the minority shareholder’s rights by creating new share in the company without their consent;
• denying access to, or failing to disclose, corporate information to the minority shareholder,
• failing to consult the minority shareholder on important decisions or repeatedly failing to observe the minority shareholder’s rights, or
• engaging in any act that violates the expectations of fairness that shareholders, directors, or officers might reasonably have.

The oppression remedy provides the aggrieved shareholder with the right to seek a wide range of types of relief. If a court or arbitrator finds that oppressive conduct has taken place, it can impose a broad range of remedies and orders to regulate the conduct of the corporation’s affairs in the future, or even dissolve the corporation in extreme cases, as well as some or all of the following remedies (depending on what the circumstances require):

• production of accounting and other records or audit of the company;
• appointment or removal of directors;
• purchase of the shares of the oppressed shareholder by the corporation or other shareholders;
• sale of company assets;
• in exceptional circumstances, liquidation and winddown of the company, and
• awarding compensation and other damages to the aggrieved shareholder.

Conclusion

Resolving shareholders disputes can involve many elements in dispute and exit procedures, some of which can be factually complex based on the alleged wrongs, such as financial issues, mismanagement, preferential treatment, reasonable expectation of shareholders, the nature of the business, etc.

Parties to a shareholders dispute would be wise to seek opportunities for a fair resolution to their dispute, preferably before commencing legal proceedings, but certainly also during legal proceedings. The work involved by the litigation counsel representing either side to the dispute, whether in seeking a negotiated resolution or bringing or defending legal proceedings, will involve assessment of the nature of the aggrieved conduct, the reasonable expectation of the parties, the required evidence to prove or defend against the allegations, the financials of the business, and the available legal options, among other things.

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The information contained in this article is provided for informational purposes only and does not constitute legal advice. Readers should not act on this information without seeking professional legal advice from a lawyer experienced in this area. The content in this article may not reflect the most current legal developments, and the application of law can vary in different provinces and territories. As such, the information in this article is not guaranteed to be complete, correct, or up to date. The author and the publisher of this article disclaim all liability for any actions taken or not taken based on any or all of the contents of this site.

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