COVID-19: Some Considerations in the Event of a Shareholder Dispute

The state of health emergency related to the COVID-19 pandemic is a source of concern and uncertainty for many executives and shareholders. However, as we all know, it is easier to be tolerant and pleasant in fair weather[1].

In turbulent times, frustrations and sources of conflict - which we had previously managed to contain - typically tend to arise. Thus, when a company goes through difficult times, relations between its shareholders can deteriorate.

In this time of pandemic, the first recommendation would be to encourage shareholders and managers to try to contain their emotions, and to continue to cultivate and commit to their social values such as solidarity, tolerance and equity. Now is not the time to add to the company's challenges unless it is truly necessary for its survival or growth.

However, if, after careful consideration, a break should prove to be necessary and inevitable, this article will review various considerations that every shareholder should take into account before taking any steps to end his association with his co-shareholders.

Confinement in Shareholding

When a conflict arises between shareholders, which apparently can only be resolved by the departure of one of the parties, the general rule is that, subject to exceptional provisions contained in the company's incorporating act (for example, the right of dissent or the oppression remedy) or in its articles, or to specific provisions contained in a shareholders' agreement:

• a shareholder shall not be expelled from the share capital of the corporation; and
• a shareholder shall not demand that his or her fellow shareholders or the corporation buy his or her shares.

Having realized that he is confined to a shareholding with no real way out could lead a shareholder, disappointed by his association and fuelled by feelings of anger or anxiety, to make untimely decisions.

Considerations to Take Into Account before Exercising Remedies

The Canada Business Corporations Act (hereinafter, the "CBCA") and the Business Corporations Act (hereinafter, the "QBCA") both provide various rights and recourses to the shareholders of a corporation.

One of the main recourses is the rectification of abuse of power or iniquity (ss. 450 QBCA and 241 CBCA), usually referred to as the "oppression remedy". Essentially, this recourse allows the court to intervene when there is a violation of the reasonable expectations of the shareholder causing unjust and prejudicial effects, even if the alleged conduct may prove to be in accordance with the rules of law. The concept of reasonable expectations of the shareholder is at the centre of this remedy. This remedy is also particular because of the impressive battery of power it grants to the court. Indeed, in an application for oppression remedy, the court may make any order it deems appropriate, whether or not it has been requested by the parties.

Moreover, and especially in these times of historic pandemic, the rights of shareholders and the obligations of the corporation must still be assessed in light of the circumstances. A shareholder wishing to terminate his or her participation in a corporation should seriously consider his or her real bargaining power, particularly if he or she is a minority shareholder. Before taking any action, the prudent shareholder should, among other things:

• weigh the costs and delays inherent to the legalization of his conflict and evaluate the real chances of success of his recourse;
• have a fairly accurate idea of the value of his shares; the fact that this exercise is particularly difficult in times of pandemic (and even risky, in some cases) should be taken into consideration;
• receive advice on the scope of the relevant provisions contained in the company's incorporating act, articles and by-laws and, if applicable, the agreement governing relations between the shareholders of the company;
• consider the potential disruption that a legalization of the conflict could cause (will it worry employees, suppliers, customers and bankers?) and measure its effects (negative impact on the value of the shares?);
• have the wisdom and courage to ask himself whether he, himself, might have contributed, at least in parts, to the deterioration of the relationship with his associate(s); if so, this might lead him to consider the attractions of an out-of-court settlement more thoroughly.

At the end of this exercise, the shareholder should be able to identify the parameters of what, if anything, could constitute a reasonable settlement.

The Shareholder Agreement, a Valuable Tool 

The importance of a good shareholders' agreement for each and every shareholder cannot be overemphasized. Drafted in fair weather - that is, before a conflict arises - such an agreement can prove to be an excellent tool for preventing and managing disputes between the company's shareholders.

In the context of a dispute between shareholders, here are certain types of clauses - generally provided for in a shareholders' agreement - that it will be important to scrutinize carefully because they can be drafted in a variety of ways.

Right of First Refusal

This clause generally obliges a shareholder wishing to sell his shares, to offer them beforehand to the other shareholders in proportion to their shareholding in the company.

If the agreement contains such a clause, a shareholder wishing to leave the shareholding could consider using this process before taking another route.

Irrevocable Offer to Sell Shares

This type of clause provides that the shares of a shareholder (the "Offeror") will be deemed to have been offered for sale to the other shareholders (the "Remaining Shareholders"), or to the Company, if the Offeror suffers or commits certain events, most commonly, the death of the Offeror, his bankruptcy or insolvency, his disability or incapacity, the termination of his employment (with possible variations : voluntary resignation with or without notice, dismissal for or without serious reason, etc.), its bankruptcy or insolvency, its disability or incapacity, the termination of its employment (with possible variations : voluntary resignation with or without notice, dismissal for or without serious reason, etc.) or his death, or the termination of the Company's operations, his commission of theft or fraud or his contravention of any of the provisions of the shareholders' agreement (for example, of a non-competition and non-solicitation undertaking).

Depending on the nature of the event giving rise to the irrevocable bid (is it a "friendly" or "unsympathetic" case?), the remaining Shareholders or the Company should or could, as the case may be, acquire the Offeror's shares at the prices, terms and conditions set out in the agreement.

Clauses Relating to the Establishment of the Sale Price of the Shares and the Terms of Payment Thereof

The inclusion of clauses establishing the sale price of the shares as well as its payment terms is essential if only to enable the execution of the irrevocable offer clause mentioned above. These clauses may be drafted in different ways and use different methods of assessing the value of the shares (fixed price, book valuation, adjusted book valuation, fair market value, etc.); in this period of pandemic, even more attention shall be paid to the planned method of valuation and its effects shall be measured.

The sale price of shares will generally be reduced when the transaction is triggered by the occurrence of a "non-sympathetic" event. The payment terms shall be realistic, taking into account the interest of the buyers and the interest of the seller. This is one of the clauses in a shareholders’ agreement that must be carefully thought out with the help of the company's tax specialists and auditors.

Shotgun Clause

The shotgun clause, often referred to as a "forced sale", "Russian roulette" or "ultimatum clause", is present in some shareholders' agreements.

Briefly, the purpose of the shotgun clause is to terminate the participation of one or more shareholders in the shareholding of the company. Thus, the principle of the shotgun clause is as follows : a shareholder offers his shares for sale to the other shareholder at a price he determines himself; the other shareholder chooses whether, at that price, he buys the shares of the Offeror... or sells his own! Therefore, the initiator of the process has the advantage of choosing the "timing" of the initiation of the process as well as the price at which the shares will be traded. The other shareholder, for his part, will have the advantage of deciding whether, at that price, he will be buyer or seller.

Sometimes poorly drafted and/or misunderstood and misapplied, such a clause can produce an unexpected result. While it may seem to be an effective means of resolving shareholder disputes, it should be handled with care. Some authors even go so far as to suggest that such a clause, despite its apparent usefulness, should not be systematically included in shareholder agreements because of the risks involved in its exercise.

On the other hand, the shotgun clause does not necessarily ensure the settlement of the dispute : its interpretation and application may itself be a source of conflict.

Mediation and Arbitration Clauses

It is also possible that the shareholders' agreement contains certain clauses that will apply in the event of a conflict between shareholders. Mediation and arbitration clauses (the latter sometimes also called "arbitration clause") are to this effect.

Through the mediation clause, the parties acknowledge that before resorting to the arbitration process or the traditional judicial process, they will attempt to resolve their dispute with the help of a third party called a "mediator". The mediator is a sort of "companion" and his status does not give him the power to impose any decision on the parties; his role is essentially to help the parties find the solution to their problem on their own.

Through the arbitration clause, the shareholders undertake to submit to one arbitrator (or three, depending on the wording of the clause) any dispute of which the clause defines the nature. Often, the dispute is about the interpretation, application or performance of the provisions of the shareholders' agreement; however, only a review of the arbitration clause will help to define its scope. The decision of the arbitration tribunal will then be final and without appeal, the parties expressly waiving recourse to the courts for any dispute subject to the arbitration clause. This clause may grant more or less generous powers to the Arbitration Tribunal.

The advantage of arbitration as a means of dispute resolution would (but not necessarily!) be that it would be quicker and less costly than going to court. It also allows the parties to maintain the confidentiality of the process and to choose the arbitrator who will ultimately settle their dispute. On the other hand, shareholders must be aware of the consequences inherent in the fact that the arbitrator’s decision will be final and without appeal. In short, such a clause will be included in the agreement if the shareholders believe that its advantages outweigh its disadvantages.

To conclude on the shareholders' agreement, it is appropriate to recall the importance of updating it from time to time so that its content is at all times in harmony with the ever-changing reality of the corporation and its shareholders.

Reasoned Negotiation, Mediation and Arbitration

In the event that there is no shareholders' agreement or that the agreement is incomplete or imperfect, it will obviously always be possible for the shareholders to agree on a method of amicable settlement adapted to the circumstances. Remember the adage : "The worst settlement is worth the best lawsuit"; even if it should not be applied to the letter... it still offers food for thought! Interest-based negotiation and, where appropriate, mediation should be considered.

As opposed to positional bargaining, interest-based negotiation encourages the parties to adopt a more detached approach that seeks to identify the reason for the impasse, which is an obstacle to settlement. This way of negotiating leads the parties to try to reconcile individual and common interests, while being creative and open to various options for solutions.

If it proves impossible to resolve the dispute amicably, the parties shall themselves determine how to end their partnership, for example, by agreeing on a shotgun process adapted to their reality and which they will then have designed with their advisors "in full awareness of the facts".

The parties could also agree to submit their dispute to the final ruling of an arbitrator who will inspire confidence and who will be entrusted with a broad enough arbitration mandate and generous powers to enable him or her to definitively settle all disputes between the parties, including the power to order one of them to sell his shares – and to the other to buy them - at the prices, terms and conditions he or she will determine.

When tensions or disputes arise between shareholders, it is important that each shareholder remains calm and acts only after careful consideration, guided by his or her personal interest, but also taking into account the interests of the company. Ideally, it will also be necessary - as much as possible - for the protagonists to ensure that civilised relations are maintained between them in order not to unnecessarily compromise desirable settlement approaches.

Pandemic or not, these recommendations, which call on the parties to exercise prudence and wisdom, are applicable to any conflict situation between shareholders.

For 25 years, BCF's mission has been to support local businesses. We know the issues facing entrepreneurs. The members of our team have recognized expertise in disputes between shareholders or partners, acting as strategic advisors, mediators or arbitrators, or as litigators before the courts or arbitration tribunals.

[1] This article was written with the collaboration of Guy Plante, Jules Turcotte, Stephan Charles-Grenon, Isabel Pouliot and Marie-Michelle White.