Does a shotgun clause require, as a term and condition of the acquisition and sale of shares, that the parties subject to the shotgun clause amend, terminate, and execute agreements at closing of the share acquisition and sale? We argue that, subject to the language of the shotgun provision, a shotgun clause can require the amendment, termination, and execution of agreements at closing of the share acquisition and sale.
Background: Shotgun Provisions
A shareholders’ agreement is an agreement that is typically entered into between two or more shareholders of a private corporation. It regulates the relationship among the shareholders and the corporation. While not typical, some shareholders’ agreements include what is called a “shotgun provision”.
A shotgun provision is a draconian measure that typically works as follows:
A shareholder that is party to the shareholders’ agreement triggers the shotgun provision by offering (via a shotgun clause) to another shareholder that is also party to the shareholders agreement (i.e. the target shareholder), to either
(1.) buy the target shareholder’s shares of the corporation at a set price and on any terms and conditions prescribed by the shareholders agreement or
(2.) sell to the target shareholder such offering shareholder’s shares in the corporation at the same price and on the same terms and conditions contained in the offer to buy.
The target shareholder then either accepts (1) the offer to sell the target shareholder’s shares to the offering shareholder at the set price and on the terms and conditions contained in the offer to sell, or (2) the offer to buy the offering party’s shares on the terms and conditions contained in the offer to buy.
In either situation, once the shotgun provision has been triggered and the share acquisition and sale has been completed, one shareholder will remain a shareholder of the corporation and the other party will cease to hold shares of the corporation; the shareholding relationship between the parties will end.
The shotgun clause that triggers the shotgun provision must be drafted/issued in compliance with the terms of the shotgun provision that is contained in the shareholders’ agreement. A shotgun provision will prescribe what is to be included, and what may not be included, in a shotgun clause in order for such clause to trigger the shotgun provision and to therefore require the forced acquisition and sale of shares of the corporation.
A typical shotgun provision will require that the shotgun clause set forth the proposed purchase price. It may also include parameters around what additional terms and conditions to the acquisition and sale may be included in the clause. If the shotgun clause is not issued in accordance with the shotgun provision, then the shotgun provision has not been triggered and no forced share acquisition and sale must occur.
If the shotgun clause is issued in accordance with the shotgun provision, then the shotgun provision has been triggered, and the forced share acquisition and sale must occur in accordance with the price, terms and conditions that are out in the shotgun clause.
Thought Experiment: Shotgun Clauseto Require the Amendment, Termination and Execution of Agreements
Given the above, this article proposes to conduct the following thought experiment.
If the shareholders’ agreement that contains the shotgun provision provides that the shotgun clause may contain, in addition to the price for the shares, those additional “terms and conditions” to the share acquisition and sale as are deemed appropriate by the offering shareholder, and if the shotgun provision fails to provide any parameters around what those terms and conditions may be, then can the shotgun clause include any or all of the following and still validly trigger the shotgun provision?
- Contract Amendment: A requirement that the target shareholder agrees to deem certain sections of a contract amended. For example, can the offering shareholder require that the shareholders’ agreement (that sets forth the shotgun provision at issue) is deemed amended such that any non-competition provision contained in the shareholders’ agreement that restricts the behaviour of the offering shareholder, and which favours the target shareholder, is of no further force or effect? If so, then, for example, the offering shareholder would have the ability to unilaterally terminate unfavourable non-competes in connection with issuing a shotgun clause.
- Contract Termination: A requirement that the target shareholder agrees to deem a specific contract terminated and of no further force or effect. For example, can the offering shareholder require that an agreement that is favourable to the target shareholder and that is unfavourable to the offering shareholder is terminated and of no further force or effect? If so, then, for example, the offering shareholder would have the ability to unilaterally terminate unfavourable contracts in connection with issuing a shotgun clause.
- Contract Execution: Finally, a requirement that the target shareholder enter into a separate, standalone contract with the offering shareholder on specified terms and conditions. For example, can the offering shareholder require that the target shareholder enter into a share purchase agreement with the offering shareholder under which (1) the offering shareholder is to receive fulsome representations, warranties and indemnities typically contained in a share purchase agreement, and (2) the target shareholder is to acknowledge and agree to the terms of (a) the contract amendment and (b) contract termination, in each case, as set out above? If so, then, for example, the offering shareholder would have the ability to unilaterally force the execution of contracts with terms favourable to the offering shareholder and unfavourable to the target shareholder.
The Ontario Court of Appeal has provided us with some guidance. In Western Larch Ltd. v Di Poce Management Ltd., 2013 ONCA 722, the ONCA said that in order for a shotgun provision to be validly triggered, the shotgun clause must “strictly comply” with the terms of the shotgun provision.
The ONCA clarified in this case that strict compliance did not mean perfect compliance – instead, the strict compliance standard would be satisfied if the shotgun clause was “sufficiently compliant”, and sufficient compliance would be satisfied and determined after a review of the language contained in the shotgun provision and the shareholders agreement, as well an analysis of the commercially reasonable expectations of the parties given the facts of the case. Western Larch remains good law, as several recent decisions have upheld its ruling across a number of provinces:
- 2235512 Ontario Inc. v 2235541 Ontario Inc., 2016 ONSC 7812
- Costello v Redcity Creative Agency Inc., 2019 ABQB 600
- Best v Darling et. al., 2020 NBQB 104
Analysis / Conclusion
In our thought experiment, the shotgun provision provides only that the shotgun clause must include a purchase price, as well as any “terms and conditions” as are deemed appropriate by the offering shareholder.
Assuming the existence of such a shareholders agreement, when the shareholders of the corporation signed the shareholders agreement that set forth its shotgun provision mechanics, the shareholders, we argue, agreed and intended to provide each shareholder with discretion in setting out the desired “terms and conditions” of any share acquisition and sale occurring under the shotgun provisions – the language of the shotgun provision provided as such based upon a technical reading. Moreover, if the words of the shotgun provision provide for broad discretion in allowing any offering shareholder to set out the shotgun notice terms and conditions, then the parties to the shareholders’ agreement, we argue, agreed, intended and expected that a shareholder exercising his/her/its shotgun rights may wish to use the shotgun notice to (1) amend an agreement, including the amendment and removal of any non-competes that bind the offering shareholder, (2) terminate an agreement, including those agreements that are unfavourable to the offering shareholder and favourable to the target shareholder and (3) force the execution of contracts on terms that are favourable to the offering shareholder and unfavourable to the target shareholder. Had this outcome not been a commercially reasonable expectation, then, we argue, that the parties to the shareholders agreement would have included parameters around the terms and conditions that may be included in a shotgun notice. Having failed to do so, the parties agreed to and expected the outcomes set forth in our thought experiment.
Given the power that could be provided to shareholders under a shotgun provision, care should be taken when drafting the terms of a shotgun provision.
Note that this articles does not constitute legal advice and the arguments made herein are subject to the specific language of the shotgun provision and the shareholders agreement generally, each of which varies significantly on a case by case basis.
Feel free to reach out to the author if you have any questions.
Jonathan Lin is a Partner with the Business Law Group at Harrison Pensa. Jonathan has a diversified corporate and commercial law practice, focusing on mergers and acquisitions, securities, corporate finance, private equity, banking and corporate governance.
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