‘Cause breaking up is hard to do

Obtaining a divorce can be easier than getting rid of a bad business partner!

On the founding of a business, the partners don’t want to consider 10 different ways to terminate their relationship. After all, they’re preoccupied with the bright prospects for the future. And so it should be.

Their business advisers think otherwise. Lawyers, of course, are trained to focus on risks and dire consequences, however remote. Accountants, being fiscal conservatives, are inherently pessimistic in nature.

As a client of mine once said, “If it was up to the lawyers and the accountants, no business deal would ever be done because the potential risks always outweigh the known benefits.”

Many times, the owners of a new venture (be it a partnership or a corporation) just don’t get around to completing a definitive agreement to govern their holdings and eventualities like death, taxes and disagreements.

Of all the commercial agreements that a lawyer is asked to prepare and negotiate, the shareholders’ agreement is surely one of the toughest.

Why? I think the reasons are: a) the parties don’t want to address negative, remote, potential events; and b) the myriad of alternative legal mechanisms greatly complicates the crystal ball gazing process. The choices are simply overwhelming.

It really is tough to predict the future, and then choose the right solution today, for something which won’t happen for 5, 10 or 20 years, or maybe won’t happen at all!

Negotiating these aspects highlights the differences in the contributions of the owners, present and future, and this can be divisive. As a general rule, the operating shareholder doesn’t fully value the contribution of the investor-shareholder (and vice versa!). This dichotomy can become quite contentious when the long term is discussed.

Some owners believe the Courts will resolve a shareholder dispute for them, or provide quick remedies. Therefore, why bother going to the expense and pain of doing a shareholders’ agreement?

Increasingly, the Courts in Ontario have told shareholders they won’t fix a bad deal, or punish a wayward shareholder, in the absence of a shareholders’ agreement to enforce.

To qualify for relief from the Courts in the absence of a decent shareholders’ agreement, a shareholder must be a victim of corporate wrongdoing which qualifies as “oppressive” or “unfairly prejudicial” under the corporate legislation.

Suffering through a horrible deal, or sharing ownership of the corporation with a nutbar are not sufficient grounds. In fact, in reading the cases, it’s quite amazing just how bad things must get before the Courts will intervene.

For example, a recent case has made it clear that bad management, even really bad management, doesn’t qualify as “oppression” within the meaning of the corporate law.

On the other hand, a partnership is both easily begun and easily ended. Indeed, a partnership can be terminated by the simple act of any one partner. And, the Partnership Act contains a reasonably detailed recipe to follow when things go wrong.

Corporations are different creatures. It is legally possible to be stuck indefinitely with a nuisance minority shareholder, or a greedy majority owner.

If the crystal ball gazing is intolerable for some people, I suggest the shareholders at least sign a short memorandum setting out some basic concepts:

A shotgun buy/sell (which I argue is intrinsically fair).
A right of first refusal if a third party offer is received.
A list of major actions that require 100% (or some lesser %) approval of shareholders (issuing shares, dividends, borrowing).
How to distribute dividends, bonus or salaries.
What happens if one shareholder dies or becomes disabled.

Even a short memo on these items may be better than nothing if a dispute arises later on.  From a litigation lawyer’s point of view, the absence of a shareholders’ agreement is a wonderful thing when a dispute arises.

There certainly are legal machinations which are available, if the spirit is willing and the pocketbook is substantial. The solution can take many months or years, and like a divorce, the process can become very emotional and personal.

In those situations where there is a shareholders’ agreement, it’s surprising how dignified the parties act. It’s as if the existence of the agreement takes the emotional, irrational aspects out of the picture.

And isn’t that the way you’d rather do it?