Shareholders Agreements are entered into between Shareholders for a number of reasons – more often than not those reasons are related to what happens to the shares of a company in the event of death, disability, disagreement, and default. This article focuses on one of the tools commonly available in Shareholders Agreements related to resolving (and ending) disagreements between Shareholders known as the “Compulsory Buy-Out” provision – also known as the “Shotgun Clause”.
Generally speaking, a Shotgun Clause will set out the procedure for a Shareholder (we’ll call that person the “Instigator”) to compel another Shareholder (or group of Shareholders) to choose to either sell their shares to the Instigator or to buy the Instigator’s shares at a price set by the Instigator. The manner in which a Shotgun Clause is “triggered” should be set out by the Shareholder Agreement. Typically, it will involve the delivery of a notice by the Instigator to the other Shareholder(s).
In the event a Shotgun Clause is triggered by an Instigator, the Shareholder Agreement will provide time frames and procedures for completing the transaction. The details of how the transaction will proceed (such as when the transaction completes, how the purchase price of the shares will be paid, etc.) will depend on the wording of the Shareholders Agreement. Some versions of the Shotgun Clause limit the ability of the Instigator to set the price of the shares and will set out that the price of the shares will be equal to their fair market value of the shares. This type of Shotgun Clause will typically favour minority Shareholders of a company.
The Shogun Clause is typically used as a “last resort” in cases where there is disagreement amongst Shareholders in relation to the direction or operation of the company. The Shotgun Clause gives the ability of one Shareholder to either take a controlling interest in the company, to obtain a higher percentage of the shares of a company, or to have their shares purchased. The primary advantage of a Shotgun Clause is that it provides certainty by putting in place a procedure and (most importantly) a hard and fast timeframe for resolving potentially devastating Shareholder disputes. This benefits all parties in that it ensures that the Shareholder who values the company most ends up with control of the company while the other is compensated fairly for their interest, all while preserving the value of the company as much as possible.
A Shareholders Agreement does not have to have a Shotgun Clause. In fact, there may be scenarios where Shareholders do not want a Shotgun Clause in their Agreement. In such a case, then there should be other means of resolving disagreements set out in a Shareholder Agreement.
A Shotgun Clause is only one of the tools for resolving disagreements in a Shareholder Agreement and, as the name implies, it is not a particularly elegant way of resolving those disagreements.
The ugly truth about the Shotgun Clause is that the party with the deeper pockets (rich parents, more savings, valuable assets, etc.) will win when the clause is invoked. If the targeted Shareholders are cash-poor, the Instigator could get a steal of a deal on the shares if the Instigator is able to set the price of the shares. As mentioned above, a way to avoid this is to require that fair market value, as determined by an independent valuation, be the minimum shotgun offer.
Ultimately, the best way to avoid the Shotgun Clause is to get along and to have other means in a Shareholder Agreement to resolve a disagreement. However, having a Shotgun Clause can serve as a valuable “last resort” where a disagreement between Shareholders cannot be resolved.
© Linley Welwood LLP. The contents of this article do not constitute legal advice. Readers should seek legal advice in relation to their own specific circumstances.