Why You Should Have a Shareholders’ Agreement (That Includes Terms Regarding Employee Shareholders)

Why You Should Have a Shareholders’ Agreement (That Includes Terms Regarding Employee Shareholders)

Greg Dobney
Posted July 3, 2019 Category: Individuals/Families

A recent blog post by Andrew Sapiano, one of the firm’s resident corporate lawyers, highlighted some of the reasons that a shareholders’ agreement is advisable.  Andrew noted that a shareholders’ agreement would include provisions dealing with a number of matters, including what happens in the event a shareholder withdraws from the corporation, either voluntarily or in the event of death, disability, divorce or other ‘life events’.  In cases where a shareholder may also be an employee of the corporation, a shareholders’ agreement can set out what will happen with the employee-shareholder shares when the employment relationship is terminated.  A recent decision of the Ontario Court of Appeal, Mikelsteins v. Morrison Hershfield Limited, demonstrates just how important a separate shareholders’ agreement can be when dealing with a shareholder that is an employee.

Mr. Mikelsteins was an employee of Morrison Hershfield Limited (“MHL”).  Through a benefit made available to him in his employment with MHL, Mr. Mikelsteins had the opportunity to purchase shares in MHL’s parent corporation.  Mr. Mikelsteins purchased a number of these shares and, as part of their purchase, had entered into a shareholders’ agreement. The shareholders’ agreement entitled Mr. Mikelsteins (among others) to receive a “share bonus” on an annual basis and it also set out terms upon which shares would be repurchased on upon termination of employment with MHL. 

After about 31 years of employment, at the age of 57, Mr. Mikelsteins’ employment with MHL was terminated without cause.  He received written notice of termination advising him that his employment was terminated effective immediately.  The shareholders’ agreement included a term that, in essence, deemed Mr. Mikelsteins to have sold his shares back to the company thirty days following the notice of dismissal.  In accordance with this term of the shareholders’ agreement, MHL paid Mr. Mikelsteins the “Fair Value” for his shares as of thirty days following the notice of dismissal.  Since Mr. Mikelsteins no longer held the shares as of the deemed repurchase date, he would no longer receive the share bonus.

Mr. Mikelsteins brought an action for wrongful dismissal, claiming common law reasonable notice.  The trial judge found that Mr. Mikelsteins was entitled to a common law reasonable notice period of 26 months. 

In addition to claims for salary, performance bonuses and benefits, Mr. Mikelsteins sought compensation for the increase in the value of his shares to the end of the notice period and for payment of his share bonuses that would have occurred during the notice period.  Working from the basic principle that an employee should be placed in the same financial position that they would have been in had appropriate notice been given, the trial judge found that the shareholder benefits were an integral part of Mr. Mikelsteins’ employment compensation package and that the terms of the shareholders’ agreement did not oust Mr. Mikelsteins’ common law entitlements.  That is, the trial judge found that Mr. Mikelsteins was entitled to compensation for the increase in value in his shares during the 26-month notice period and for his annual share bonuses that would have been payable during that same time period

However, MHL successfully appealed these findings to the Ontario Court of Appeal.  The Court of Appeal noted that the share bonuses were, in effect, dividends and were not related to a shareholder’s contributions as an employee.  The Court held that Mr. Mikelsteins received his shares pursuant to the shareholders’ agreement and it was the shareholders’ agreement (and only the shareholders’ agreement) that determined Mr. Mikelsteins’ rights with respect to those shares; the common law claim for a breach of the employment contract did not apply to Mr. Mikelsteins’ entitlements regarding his shares.  Under the shareholders’ agreement, the termination of employment (and not the end of a notice period) was the triggering event for the repurchase of shares.  Those shares were repurchased in accordance with the terms of the shareholders agreement and Mr. Mikelsteins had no entitlement to any share bonus that would have arisen during the notice period, as he no longer owned those shares. The Ontario Court of Appeal’s decision highlights a subtle but important distinction between entitlements arising as an employee and rights arising in a related but different capacity under a separate agreement.  It also underscores the importance of having a shareholders’ agreement and the effectiveness of including terms relating to what will happen when a shareholder’s employment relationship with the company ends.

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Greg Dobney
Posted July 3, 2019 Category: Individuals/Families

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