Death: My favourite topic in a shareholders agreement.
What I like about the death provision is that it is usually not controversial, especially if the shareholders do not have an inkling about who is likely to die first.
Say that Susan and Pamela are 50/50 shareholders in a corporation.
If Pamela dies: (i) Susan does not want to get stuck with Pamela’s husband, or wife, or lover, or children as ‘partners’, since they probably cannot contribute to the business but will be entitled to 50% of the profits; and (ii) Pamela does not want her family eating dog food while Susan is refusing to buy the estate’s shares and at the same time increasing her own salary, never paying dividends and engaging in conduct that limits the value of Pamela’s family’s investment, leaving them only the option of suing.
So, each of Susan and Pamela can easily agree that on Pamela’s death her estate must sell the shares. And vice-versa.
Occasionally someone will want to do things differently. I once had a client who insisted that if he died, he wanted his son (at the time three years old) to inherit his shares and become the other shareholder’s new partner. I told him he was an idiot and if the other shareholder agreed to it, he was also an idiot.
Of course there are some technical things to think about, such as:
1. How will the purchase price be determined? (Usually by a business valuator. Sometimes by a formula.)
2. Will the purchase price equal fair market value? (Probably.)
3. If the deceased was a minority shareholder, will a minority discount apply? (A lawyer for the minority shareholder who does not address this is likely negligent.)
4. Will insurance be used to fund the purchase?
5. If there is no (or insufficient) insurance: (i) will payment be made in instalments? (ii) will interest be paid? (iii) will there be restrictions on how the company will be operated until payment in full? (iv) will there be security?
6. Will the corporation or the other shareholder purchase the shares? There are different tax consequences to each approach and if the corporation is purchasing the shares there may be statutory solvency tests which apply.
7. In Canada, if there is insurance and depending on the structure, the agreement should address the Capital Dividend Account. If it does not, the drafter may be negligent.
Finally, these provisions are tax driven and some tax advisors have been known to come up with technically complex alternatives to the ‘standard’ approaches. Lawyers should get the draft approved by tax experts every single time. Or risk negligence claims. As they prefer.