As investors with a say in all major business decisions, shareholders hold the bulk of power when it comes to how a company is run. The ability of shareholders to work together effectively is vital to a company’s day-to-day operations. When shareholders find themselves in a dispute, it must be resolved as quickly as possible, otherwise the dispute could begin to have a serious impact on the functioning of the business itself. To ensure that a business can continue operating even in the face of a serious shareholder disagreement, companies will sometimes look to put specific protocols in place which may be triggered in the event of an unresolved conflict.
This is where the shotgun clause, otherwise known as the buy/sell clause, comes into play. A shotgun clause is often included in a Shareholder Agreement to provide a path for one or more shareholders to force other shareholders to exit their role in the event of a dispute that cannot be resolved otherwise.
What is a Shotgun Clause?
A shotgun clause is included in a shareholder agreement to provide the parties with a means to dissolve a shareholder’s position by forcing another party to sell their shares. Once triggered, the targeted party will be obligated to sell their shares and exit the company, unless they are able to reverse the purchase.
How is a Shotgun Clause Triggered?
A shotgun clause is triggered when one party provides an offer to another party, in writing, to purchase their shares at a certain price. There are no requirements with respect to the price offered, unless specified in the clause itself. Once the offer is received, the offeree must either accept the offer and sell, or reverse the offer and purchase the shares of the offeror at the same price per share.
The Benefits and Risks of a Shotgun Clause in a Shareholder Agreement
When considering whether to include a shotgun clause in a Shareholder Agreement, it is important to remember that there are both benefits and risks to doing so.
A shotgun clause can be very helpful in the event of an insurmountable dispute or if certain shareholders are unable to work together effectively. When there is conflict that cannot be resolved, it can have a profound impact on the company as a whole. A shotgun clause allows for a fast and effective method for one shareholder, or group of shareholders, to force another shareholder out of the company allowing the remaining shareholders to move forward conflict-free. Without a shotgun clause, the only way to remove someone as a shareholder is by way of a mutual agreement, which can be challenging in an already contentious situation.
However, the risk is that the clause can also be used against the person or group who triggers it. They risk having their offer turned on them if the original target has the means and the desire to purchase their shares and eject them from the company instead. For this reason, someone who wishes to trigger the clause should be sure that the price offered is something they would be willing to accept for their own shares, should it be turned around on them.
The Requirements for a Valid Shotgun Offer
Shotgun clauses, and offers made under such clauses, must adhere to certain requirements in order to be enforceable. In the leading Ontario Court of Appeal case on the validity of shotgun offers, Western Larch Limited et al. v. Di Poce Management Limited et al., the Court described these clauses as a “draconian remedy” since they serve to forcibly expel a person or persons from a viable business venture. As such, courts require that the terms of a shotgun offer must be in strict compliance with the corresponding clause.
In this case, several partners under a Partnership Agreement sought to force out the remaining party, using the shotgun clause in the agreement. This case dealt with partners rather than shareholders, therefore the clause provided that the offerors would pay the exiting partner the full value of their portion of the partnership. The clause offered two payment options:
- The remaining partners would pay the full value of the existing partner’s portion of the partnership immediately, or
- The remaining partners would pay half the value of the partnership immediately, and the remainder would be paid over four years, with interest.
If the exiting partner did not choose between the alternatives, they would be deemed to have chosen option #2. The exiting partner in this case took some time to attempt to gather the financing necessary to reverse the offer and buy the other partners out of the business instead, however they were unsuccessful in their attempt. Approximately two months after they received the offer, they filed a statement of claim challenging the validity of the offer, based on the fact that the offer price was not “fair market value”.
The Court of Appeal noted that an offer pursuant to a shotgun clause must be “strictly compliant” with the clause itself to be valid. Since there was no requirement in the clause that the price offered must be fair market value, the offer did not need to meet that standard.
Given this finding, when considering a shotgun clause as part of a Shareholder or Partnership Agreement, the language of the clause itself is extremely important. The clause will be determinative of any subsequent offers, and so the parties must be aware of how much leeway is provided. Leaving key details, such as valuation, up to chance could end up costing someone considerably in the future.
For Exceptional Representation in Shareholder & Partnership Disputes, Contact the Commercial Litigators at Milosevic & Associates
The Toronto corporate lawyers at Milosevic & Associates have many years of experience defending the rights of business owners, directors, officers, and shareholders and advising them on maintaining the continued success of their ventures. Every member of our legal team is an accomplished litigator with experience in the courtroom and mediations. Our lawyers are exceptionally adept at thinking on their feet and addressing the unexpected, particularly in a corporate law context. Over the years we have seen it all and helped our clients mitigate their legal and financial risks to keep their businesses running smoothly. Our impressive track record speaks for itself. To learn more about how we can assist you, call us at 416-916-1387 or contact us online.