What happens if you don’t have a shareholder agreement in Ontario?

But as the business grows, the relationship between shareholders can become more complicated. Someone may want to leave. One founder may be carrying more of the workload. The owners may disagree about money, strategy or bringing in an investor. In a 50/50 company, even a single unresolved disagreement can bring important decisions to a standstill. That is when the absence of a shareholder agreement starts to matter. A shareholder agreement lets you decide in advance how major decisions, exits, disputes and changes in ownership will be handled — before you are trying to negotiate those issues in the middle of a conflict.

What is a shareholder agreement?

A shareholder agreement is a contract between some or all of the shareholders of a corporation that establishes rules for their relationship with one another and, depending on the agreement, the governance of the business.

It can address issues such as:

• how important business decisions will be made;
• which decisions require unanimous or enhanced shareholder approval;
• what happens if shareholders cannot agree;
• whether and how shares can be sold;
• whether the other shareholders have a right to buy those shares first;
• what happens if a shareholder dies, becomes disabled or stops working in the business;
• how a shareholder can exit;
• how the price of their shares will be determined;
• how new shareholders can be brought in;
• expectations around employment and involvement in the company;
• confidentiality and intellectual property; and
• how disputes will be handled.

Unanimous shareholder agreement

The Ontario Business Corporations Act also recognizes a particular type of agreement known as a unanimous shareholder agreement, or USA. A USA can go further and restrict, in whole or in part, the directors’ powers to manage the corporation. Where it does, the shareholders can assume corresponding rights, duties and liabilities ordinarily held by directors. Not every shareholder agreement is a unanimous shareholder agreement, and the distinction can have meaningful legal consequences.

What happens if there is no shareholder agreement?

The short answer is that the corporation continues to operate under the rules that otherwise apply to it. For an Ontario corporation, the Business Corporations Act provides much of that legal framework. For example, subject to a unanimous shareholder agreement, the directors are responsible for managing or supervising the management of the corporation’s business and affairs.

But corporate legislation cannot anticipate the personal and commercial bargain between two or three particular founders. It does not know that you agreed one founder would work full-time while another kept their day job. It does not know that you expected to have the first opportunity to buy your co-founder’s shares if they ever left. It does not know that both of you assumed a departing founder would no longer own 50% of the business. Unless those expectations have been properly documented elsewhere, enforcing them can become considerably harder.

The age-old scenario: a 50/50 disagreement can turn into a deadlock

Consider two founders who each own 50% of a company and are its only directors. For five years, they agree on almost everything. Then one wants to borrow $500,000 to expand the business. The other thinks the expansion is too risky. Or one wants to sell the company. The other wants to keep growing it. Or the relationship has deteriorated so badly that they can no longer agree on basic decisions.

When each person has equal control, there may be no obvious way to break the tie. That is a deadlock. A shareholder agreement can set out what happens if the owners reach that point. For example, it might require the shareholders to try mediation first, give one shareholder the option to buy the other out, or create another agreed process for resolving the dispute. Without that kind of agreement, there may be no simple path forward. Ontario law can provide remedies in serious cases, including where a shareholder has been treated unfairly. But court proceedings can be expensive, slow and unpredictable. It is usually much easier to have a process agreed in advance than to figure one out after the relationship has already broken down.

In practical terms, having no shareholder agreement can mean:

• There is no automatic buyout right if someone wants to leave. A shareholder cannot necessarily force the other owners to buy their shares simply because they want out.
• Leaving the business does not mean giving up your shares. A founder who resigns, stops working or is terminated may still remain a shareholder unless there is another legal basis requiring a transfer of their shares.
• There may be no agreed way to resolve a deadlock. In a 50/50 company, the shareholders or directors can reach a point where neither side can obtain the approval needed to move an important decision forward.
• There may be no agreed valuation method. If one shareholder is eventually bought out, the parties may have to negotiate from scratch over what the shares are worth and how that value should be determined.
• You may not have a contractual right to buy another shareholder’s shares before they are transferred. Any restrictions already contained in the corporation’s articles still matter, but rights such as a right of first refusal are typically created expressly rather than assumed.
• There may be no tag-along or drag-along rights if the company is sold. That can make a future sale more complicated where some shareholders want to sell and others do not.
• Death or incapacity may not trigger a planned buyout. If a shareholder dies, their shares do not simply disappear. Without an agreed succession or buy-sell mechanism, ownership may pass through their estate and the remaining shareholders may have no pre-agreed process for purchasing those shares.
• The statutory rules govern where the shareholders have not agreed otherwise. Depending on the issue, the Business Corporations Act, the corporation’s articles and by-laws will determine who has authority to make decisions and what approvals are required. For example, directors ordinarily manage or supervise the management of the corporation, while certain fundamental transactions require shareholder approval.
• If the relationship breaks down badly enough, the parties may have to rely on legal remedies rather than a contractual exit process. Depending on the circumstances, that can include an oppression application or other court proceedings. A court may have broad powers to address unfair corporate conduct, but litigation is a very different solution from having an agreed buyout or dispute-resolution mechanism in place from the outset.

A shareholder agreement is your first line of defence

A shareholder agreement is always useful, even when the business is running smoothly and the shareholders are getting along. It records the owners’ expectations while everyone is on the same page and provides a clear framework for how the company will be managed, how decisions will be made and what happens if circumstances change.

A shareholder agreement is particularly useful where:

1. A co-founder wants to leave the business

A founder decides they are ready to move on, but they still own 40% of the company. Can they simply sell their shares? Does the other shareholder get the first opportunity to buy them? How will the shares be valued? A shareholder agreement can set out the exit process in advance, including transfer restrictions, buyout rights and valuation rules.

2. One shareholder stops contributing to the business

Two founders each own 50%, but after a few years one stops working in the company while the other continues running it full-time. Leaving the business does not automatically mean giving up your shares. A shareholder agreement can explain what happens when a working shareholder resigns, is terminated or otherwise stops participating in the company.

3. Shareholders disagree on a major decision

One owner wants to take on financing. The other does not. One wants to hire aggressively. The other wants to preserve cash. Neither can move forward without the other. For closely held and particularly 50/50 companies, a shareholder agreement can establish a process for dealing with deadlock before disagreement brings important decisions to a halt.

4. Someone wants to sell their shares to someone else

Your business partner tells you they have found someone willing to buy their shares. You may not want to find yourself in business with a stranger. A shareholder agreement can restrict share transfers and give existing shareholders rights such as a right of first refusal, allowing them an opportunity to purchase the shares before they are sold to someone else.

5. The company is being sold

Suppose a buyer wants to purchase the entire company, but one minority shareholder refuses to sell. A shareholder agreement can include drag-along provisions that, in certain circumstances, allow the required majority of shareholders to compel the remaining shareholders to participate in the sale. It can also include tag-along rights, which can give minority shareholders the opportunity to participate where another shareholder sells their stake.

6. A new investor or shareholder is coming in

Bringing another owner into the company changes the dynamics of the business. Who gets voting rights? Which decisions require everyone’s approval? Can the new shareholder sell their shares later? A shareholder agreement gives the owners an opportunity to establish those rules before the new shareholder comes on board.

Two founders had a $90 million business, but no shareholder agreement

In the Ontario Superior Court of Justice case Vastis v. Kommatas, 2022 ONSC 1366, two individuals went into business together in 1984, and each owned 50% of the companies, and both were directors and officers. Over the next 35 years, they built a substantial business involving gas stations and a driving range, with corporate land holdings eventually worth more than $90 million.

Despite the size and value of the business, they never finalized a shareholder agreement.

What happened when the founders’ relationship broke down

When their relationship eventually broke down, there was no agreed process for one shareholder to exit or buy out the other. The dispute ended up in the Ontario Superior Court, where both shareholders accused the other of oppressive conduct. The court ultimately concluded that their relationship was irreparably fractured and ordered the companies to be wound up and their assets sold through a court-supervised liquidation.

The value of a shareholder agreement

The lesson is not that every shareholder dispute ends this dramatically. It is that once a 50/50 relationship breaks down, negotiating an exit can become much harder. A shareholder agreement gives the owners an opportunity to pre-emptively decide how disputes like a deadlock, buyout or departure will work.

I’m being asked to sign a shareholder agreement

If you have been asked to sign a shareholder agreement, it is worth understanding exactly what you are agreeing to before you do. The agreement may affect your voting rights, ability to sell your shares, what happens if you leave the business, and even the circumstances in which you can be forced to sell.

The lawyer who drafted the agreement may be acting for the company or another shareholder, rather than for you personally. Align Counsel provides Independent Legal Advice (ILA) to shareholders who want their own lawyer to review the agreement, explain the key terms in plain language, and flag provisions that may warrant further discussion or negotiation before signing.

Align Counsel — shareholder agreement lawyers

Whether you are starting a company with a co-founder, adding a new shareholder or realizing that an existing business has outgrown its original arrangements, a well-drafted shareholder agreement can create clarity around ownership, decision-making, exits and unexpected changes before they become expensive disputes.

At Align Counsel, we help Ontario founders and growing businesses put shareholder agreements in place that reflect how the business actually operates and how its owners want to make decisions, transfer ownership and plan for the future. We can also review an existing agreement or help identify gaps in a company’s current corporate arrangements.