What do you do if you hold shares in a private company that you no longer want? Divesting shares in a private company can be more challenging than divesting shares in a public company.
For the average shareholder looking to divest, the shareholder essentially has two options: (1) transfer the shares to a third party, or (2) transfer the shares back to the corporation. The aim of this article is to help readers understand the importance of evaluating their exit strategy and understanding the obligations that come with being a shareholder prior to investing in a company.
Review key corporate documents
A shareholder looking to divest should review the company’s governing documents, including the articles of incorporation, by-laws, and the shareholders’ agreement (if one exists), to see what rights and restrictions are provided in respect to sales and transfers of shares.
ARTICLES OF INCORPORATION
The articles form the company and also set out the share terms and transfer restrictions.
Share Terms – If there is more than one class of shares, the articles must set out the rights, privileges, restrictions and conditions attached to each class of shares, including any retraction or redemption rights. Both of these rights involve the corporation buying back its shares, however, they differ in terms of who initiates the action. Retraction rights are initiated by the shareholder, and redemption rights are initiated by the company.
It is important to note that both retraction and redemption rights are typically bound by certain conditions before they can be exercised, such as satisfying the solvency tests (the company must prove that its assets are sufficient to meet all its obligations, ensuring that the company remains stable and solvent after these transactions take place).
Transfer Restrictions – The articles may also contain restrictions on the transfer of the company’s shares. The shareholder should review these to ensure a sale or transfer they are contemplating is permitted.
Therefore, the shareholder should review the articles to determine if it contains (1) redemption and/or retraction rights and what conditions are attached to those rights, and (2) any transfer restrictions.
SHAREHOLDERS’ AGREEMENT
A shareholders’ agreement allows the shareholders to agree on matters outside of the articles, bylaws and governing statute and, in some cases, assume the powers of the directors. It can also offer exit strategies to shareholders and often includes specific conditions that govern the transfer of shares. Some clauses dealing with share transfers include:
- Shot-gun clause: this allows a shareholder to offer their shares to another shareholder at a specific price, who must then either buy the shares or sell their own shares at the same price.
- Right of first refusal clause: this gives existing shareholders the chance to buy shares before the owner can sell them to an outside party.
- Call option clause: this gives a shareholder the right to buy shares from another shareholder at a predetermined price within a certain time frame.
- Put option clause: this gives a shareholder the right to sell their shares to another shareholder at a set price within a specified period.
- Tag along clause: this ensures that if a majority shareholder sells their stake, minority shareholders can join the transaction and sell their shares under the same terms.
- Drag along clause: this allows majority shareholders to force minority shareholders to join in the sale of the company.
Entering into and being familiar with the shareholders’ agreement can empower shareholders with the knowledge about their rights and potential exit strategies, enabling them to make informed decisions about their investment in the company.
Review the applicable legislation
Shareholders contemplating an exit from their investment should not overlook the importance of familiarizing themselves with the relevant legislation that governs the company, including the Business Corporations Act (Ontario) (the “OBCA”), the Canadian Business Corporations Act (the “CBCA”) and the Ontario Corporations Act (the “OCA”).
These pieces of legislation contain specific provisions that allow for a company to repurchase its shares under certain conditions. For example, under section 185(4) of the OBCA and section 190(3) of the CBCA, shareholders who dissent to certain corporate actions have the right to demand the company to repurchase their shares at fair market value. There is a similar provision in section 116 of the OCA.
Furthermore, under section 33 of the OBCA and section 37 of the CBCA, it may be possible for a shareholder to gift their shares back to the company. It’s worth noting, however, that if there are outstanding liabilities, such as unpaid amounts on the surrendered shares, a gift may not be possible unless specific conditions are met.
What’s next? Can I walk away from my shares?
All of the above assumes that the shareholder is able to locate the company’s minute book and the company’s counsel. But what are the shareholder’s options if they can’t locate these or if the above options do not exist or apply? Unfortunately it appears the shareholder may be stuck with their shares.
Generally, the OBCA and the CBCA outline the rights and responsibilities of shareholders and the formal procedures for share transfers, implying that shareholders must follow legal processes to alter their share ownership rather than simply walking away from their shares. As discussed, a company’s governing documents further define the process and often provide restrictions for share transfers. Therefore, a shareholder cannot simply “walk away” without formally transferring the shares; they will still be legally considered a shareholder and will retain the responsibilities and rights associated with those shares.
Key lessons & conclusion
Holding shares in a company can come with significant responsibilities, especially if a shareholder has entered into other agreements that bind them to certain obligations with no straightforward exit. For instance, as a shareholder, you might have committed to providing an indemnity or guarantee under the shareholder’s agreement, committed to contributing funds to the company, or agreed to pay certain fees, such as those related to being a member of an association or social club. These commitments can become burdensome if the shareholder wishes to dispose of their shares and the governing documents fail to provide a straightforward means to do so.
Shareholders must evaluate their exit strategy and understand any potential obligations that come with being a shareholder prior to investing in a company. The fact that a shareholder cannot easily exit their investment highlights the importance of having careful foresight and strategic planning when acquiring shares in a private company. It is important for the shareholder to be aware of the potential long-term commitment and complexities that such investments involve.
Should you have any questions, please feel free to reach out to a member of Miller Thomson’s Corporate group.
