Minority Report: For Shareholders
Posted on: March 22nd, 2019 by

Minority shareholders in a closely held private company are not gifted with the same powers of foresight that Steven Spielberg granted John Anderton (a.k.a Tom Cruise) and his ‘Pre-Crime’ unit in the 2002 seminal, futuristic crime-drama ‘Minority Report’. Set in the year 2054, the Pre-Crime unit relied upon mutated humans called “Precogs” who had an ability to visualize the future. Essentially, would-be murderers were arrested before they committed the actual crime.

Minority shareholders don’t have this power to ‘pre-tell’ in order to take unilateral ad hoc preventative steps to guard against harm or interference with their interests.  As a result, the task of protecting minority shareholders’ interests falls to the legislature and clever corporate lawyers to draft protections for the minority shareholders from future peril. For example, it is common in oppression remedy cases for the minority shareholder to claim they were excluded from the business and that vital financial information was withheld. Section 140 of the Ontario Business Corporations Act, (“OBCA”) requires that companies “prepare and maintain” certain enumerated documentation including “adequate accounting records” which has been interpreted to include financial statements. Furthermore, section 145 of the OBCA confers that any registered or beneficial owner of shares of a company may examine the records referred to in section 140 during the regular business hours of the company. Essentially, minority shareholders in private companies are entitled to unfettered access to the accounting records of the company. It’s not quite as good as an ability to tell the future, but it’s useful information that can be relied upon when it comes time to vote your shares. The Canadian Business Corporations Act has similar provisions at section 155.

Additionally, most readers of this newsletter will be familiar with the shotgun provision in a shareholders’ agreement. Of less notoriety, but also effective in protecting minority shareholders’ interests, is the tag-along right. A tag-along right, or “piggyback”, is generally a right that is attached to a minority shareholder’s interest. The tag-along right provides a minority shareholder with the ability to veto a sale by the majority shareholder to a potential purchaser, unless the purchaser also agrees to purchase the minority shareholder’s interest as well. The tag-along right protects the minority shareholder from a potential corporate takeover where the purchaser is intent on limiting the existing shareholder(s)’ ability to manage and control the company. Perhaps more importantly, it guarantees that the minority shareholder will not have to become a joint owner with an undesirable third party.

The third-party purchaser may be hesitant to purchase all of the outstanding shares of the minority shareholder who enjoys the tag-along right. Tag-along rights can be drafted to ameliorate this concern, while also affording protection for the minority shareholders, by requiring the purchaser to reduce the amount of purchased shares in proportion to the interests of the party enjoying the tag-along right. For example, say Shareholder A and Shareholder B each own 30% of the company. Shareholder A enters into an agreement with a purchaser to sell her interest in the company, and Shareholder B wishes to exercise her tag-along rights. If the tag-along right is structured as set out above, by exercising the tag-along right the purchaser would be required to purchase 15% of shareholder A’s shares and 15% of Shareholder B’s shares, or 30% in total just as originally contemplated. The party enjoying the tag-along right gets to sell a percentage of her interest and therefore reduce her overall risk.

Finally, section 185 of the OBCA provides that where a shareholders’ resolution is passed which involves a fundamental change in corporate operations, the objecting shareholders are afforded “disserting rights”. In essence, the objecting shareholders (who by definition hold a minority interest) can initiate a dissenting process which leads to their exit from the company after being paid fair market value for their shares. However, this section of the legislation is less effective than a shotgun provision because it only applies to resolutions that requires two thirds of shareholders’ approval to pass, and only those resolutions creating a fundamental change such as:

  • An amendment to the articles of incorporation that remove or change restrictions on the issue, transfer or ownership of shares;
  • An amendment to the articles of incorporation that remove or change any restriction upon the business that the company can engage in;
  • Selling, leasing or exchanging all or substantially all of the company’s property; and
  • Certain other enumerated situations.

The timelines and deadlines for complying with the requirements of section 185 are technical and detailed, so corporate counsel should be engaged to assist with navigating this process.

Majority shareholders have an ability to appoint the officers and directors and, therefore, to indirectly control the company and, as the interests of the majority and minority may not always be aligned, you have fertile ground for sowing the seeds of discontent. As minority shareholders are not blessed with the power to see into the future and change the course of events, like John Anderton and his ‘Pre-Crime’ unit, they need to protect themselves by firstly having a shareholders’ agreement in place containing dispute resolution and ‘shotgun’ provisions and secondly by retaining competent corporate counsel. 

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