The forced purchase of shares in the context of shareholders disputes

September 2013

The forced purchase of shares in the context of shareholders disputes

bouton-vers-francais 
Xavier Lafontaine


Shareholder disputes are often settled by an order of the Court for the purchase of the shares of a party. In the case of a dispute between shareholders, the simplest solution appears to be the forced acquisition of shares of one party by the other. This outcome is among the most sought-after remedies by victims of abuse, and one of the most often granted by the courts.

Although it may appear to be a simple solution, a share purchase order is a last resort solution resembling a form of expropriation. Courts are therefore careful to ensure that no other option will suffice to correct the abuse and remedy the situation.

Serious abuse must have taken place in order for there to be a share purchase order. Except for the analysis of the parties’ reasonable expectations, no precise criteria have been established for a share purchase order. Courts have a larger discretion in evaluating the merits of each case.

Courts will not intervene in cases where a shareholder wishes to sell his or her shares but the parties are unable to agree on the conditions of sale. The abuse must also not stem from a simple disagreement by a shareholder over how a company is being managed. Courts have great deference for corporate democracy as well as majority rule decision-making at shareholder meetings or through the board of directors.

Only cases of abusive conduct allow the intervention of the courts, particularly where the abuse:

  • prevents all forms of participation or involvement of a minority shareholder in the company’s decision-making and administrative process
  • eliminates all possible trust towards directors of the company
  • prevents a shareholder from selling his or her shares (to a third party acting in good faith, for example)
  • creates a deadlock that threatens the company’s survival or the continuation of its operations

Thus, when serious abuse does take place, there are undeniable advantages to a share purchase order. It allows a victim of abuse to withdraw from the company with dignity while minimizing the degree of intervention by the courts in the company’s activities. Moreover, it’s often the only solution that ensures the company’s long-term stability.

Before introducing this type of recourse, the shareholder victim of abuse must consider certain factors including, a) the identity of the buyer and the seller, b) the purchase price, and c) the valuation date of the shares.

The identity of the buyer and the seller

In the vast majority of cases, a minority shareholder who has been the victim of improper conduct will wish to have his shares purchased by the other shareholder. A minority shareholder who is also the founder of the company, or who holds an important position within the company, could wish to become the buyer of the shares held by the person responsible for the abuse. Lastly, one of several equal shareholders may wish to either sell their shares or buy those belonging to their co-shareholder.

When the parties cannot agree on who will be the buyer and the seller, a court can consider the following facts in determining the issue:

  • Does the victim of abuse wish to withdraw from the company?
  • Is the person who committed the abuse deserving of staying in the company?
  • Who is the founder?
  • Who is the manager?
  • Who is better suited to manage the company?
  • Who has the financial resources to ensure the company’s survival?
  • Are there circumstances that will maximize the company’s value?
  • Who is responsible for the deadlock?

In some cases, courts will refuse to rule on the identity of the buyer and the seller and will impose (shotgun clause to the parties) or will order the parties to submit sealed bids simultaneously. If a shotgun clause is forced unto the parties, courts may order the party that committed the abuse or the person who best knows the company’s value to commit themselves first.

Courts sometimes prefer to grant purchase options that give the victim of abuse the option to buy the other party’s shares. In the case of a refusal to exercise this option, the person responsible for the abuse may then become the buyer under certain predetermined conditions. If the market for the company is unfavorable to the victim of abuse, the order may simply give him an option to sell his shares once a formal valuation has been completed.

The company, insofar as it meets the solvency ratios required by law, may also be obligated to purchase the shares held by the victim of abuse. The benefit of this solution is that it maintains the pre-existing proportions of shares held by the remaining shareholders. However, it may have an adverse fiscal impact on the seller, who is often the victim of the abuse.

Before seeking an order to acquire shares, the victim of abuse must evaluate the fiscal impact of said purchase and the buyer’s financial capacity to proceed with this type of transaction, while at the same time considering the best and worst case scenarios with regards to the determination of the purchase price.

The share purchase price

The central issue in all recourses seeking a share purchase order is determining the price and the conditions under which the sale will occur.

Courts enjoy a wide discretion over the procedures that will be used to determine the price of shares. They may do one or more of the following:

  • grant a delay to the parties in order to reach an agreement of the share purchase price before ordering the judicial valuation of the company
  • hear expert evidence from the parties, either during the hearing, or subsequently when certain valuation parameters have been set (valuation date, factors to consider or ignore, such as fraudulent transactions or cases of misuse that must be considered connected to the company)
  • name a single expert appointed by the Court to determine the company’s value

Expert evidence, either from the parties or a neutral expert appointed by the Court, is a complex exercise requiring professionals in business valuation and forensic accounting.

In order to avoid unpleasant surprises, it is recommended to suggest a value that one considers fair, rather than let the court choose any valuation method. Because the expert’s report and his testimony are simply his professional opinion, it is vital to ensure that the chosen expert is objective, that his or her method fits well with the reality of the company and the predetermined strategy of case.

Multiple factors must be considered in the expert’s valuation, but most important of all is the share valuation date.

The share valuation date

In determining the value of shares, the first step is often the court’s decision as to the correct valuation date. This will make it possible to choose between various hypotheses presented by the parties’ experts or to give an expert a starting point when the valuation is to be completed at a later date.

The court first asks: Did the abuse have an effect on the company’s value?

If so:

  • the court will favour the date of filing of the proceedings as the valuation date, rather than the date of the judgment, since the valuation should not consider the negative effects of the abuse
  • the valuation date set on the date of filing of the judicial procedures assumes that the victim acted with diligence to institute their recourse
  • the court will be reluctant to take into consideration dates subsequent to the filing of judicial proceedings due to the difficulty of predicting their duration. A second injustice cannot be allowed by permitting one party to profit from value fluctuations resulting from the length of the judicial process
  • the court can, at its discretion, make the valuation date coincide with the date of the judgement, especially in circumstances where the company’s valuation fluctuated favorably over the course of the proceedings due to the overall economic context

If not:

  • the company will be valuated on the most reasonable date in accordance with the circumstances surrounding the matter, taking care:
    • not to deprive the victim of contributions to the company, including those whose full impact have not yet been felt, and
    • not to allow a victim to have access to other shareholders’ profits to which the victim has not contributed

When a court finds the value of the shares to be less on the valuation date than the price originally paid, it may choose to set the sale price at that of the price paid at the time of the initial share purchase by the shareholder who is the victim of abuse.

Lastly, it is vital to determine early in the process which valuation date gives an advantage to the client and to suggest in the proceedings a date that is coherent with the matter’s circumstances and the valuation methods put forward by the valuation expert.

Conclusion

All of these complexities and the uncertainty involved in seeking a share purchase order can often be avoided when the parties have had the good sense to sign a unanimous shareholder agreement that provides for the forced acquisition of shares under certain circumstances. Apart from exceptional circumstances, a court will respect the intentions voiced by the shareholders in these agreements. They avoid the uncertainty surrounding the buyer’s identity as well as the share price. In the worst scenario, the court would intervene to adjust or interpret these shareholder agreements. And, in the best scenario, agreement written in accordance with the expectations of all parties and the specific requirements of the company, the shareholder agreement will serve to discourage or put a stop to abuse that could lead to a shareholder dispute.

This bulletin provides general comments on recent developments in the law. It does not constitute and should not be viewed as legal advice. No legal action should be taken on the basis of the information contained herein.

 

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