When two or more shareholders consider the terms which will govern their relationship, typically in the form of a unanimous shareholders agreement, they will need to consider whether to include a compulsory buy-sell provision, often referred to as a “shotgun” clause.
Shotgun clauses are intended to provide an efficient breakup of the shareholder relationship in the event the shareholders experience irreconcilable differences. The basic terms of the shotgun clause involve an offer by one or more shareholders to one or more of the remaining shareholders to buy or sell all of the shares owned by a shareholder or shareholders at a stipulated price. The shareholder or shareholders receiving the offer have the option of accepting either the offer to sell or the offer to buy at the stipulated price. Because the receiving shareholder can accept the offer to buy or the offer to sell, the stipulated price should reflect fair value for the shares as an undervaluation in the offer would trigger acceptance to buy the shares at the undervalued price and an overvaluation in the offer would trigger an acceptance to sell the shares at the overvalued price all other things being considered equal.
However, inequalities among shareholders, for example, differences in financial circumstances or differences in abilities to operate the business of the corporation, may result in a shareholder or shareholders having advantages over the other or others in circumstances where a shotgun clause would be applied. Where the knowledge and ability of one shareholder to operate the business of the corporation is limited, he or she may not be able to effectively operate the business in the absence of the other shareholder or shareholders and therefore less likely to accept the offer to purchase shares of the other shareholder or shareholders. Similarly where a shareholder does not have access to funding to purchase shares, he or she may be forced to accept an unfavourable offer to sell to the offering shareholder or shareholders.
The use of a shotgun clause does not guarantee an efficient breakup of the shareholder relationship as it would not be uncommon in circumstances where the relationship has deteriorated to see litigation commenced between or among the shareholders in dispute.
There are also alternatives to the shotgun clause such as an ability of a shareholder to withdraw his or her investment typically at a discount from fair value with payment over an extended period. This alternative is intended to be unattractive to a departing shareholder so as to not put undue financial hardship on the corporation or remaining shareholder or shareholders and is really only effective in circumstances where only one or a limited number of shareholders wish to leave. It is not effective in circumstances where all shareholders have a desire to continue to operate the business of the corporation.
Whether to include a shotgun clause in a shareholders agreement requires thoughtful consideration of the consequences, the circumstances in which the shotgun clause might be used and the relative bargaining power between or among the shareholders in the event the shotgun clause is exercised.