When Shareholders Can’t Get Along (Part 2)

business04In my last blog post, I explained how the shotgun clause can be used to separate shareholders that are no longer getting along. The shotgun clause can be an effective way of avoiding litigation and providing a clean split between the warring parties.

How does the shotgun clause work? Generally speaking, it provides that one shareholder may make an offer to buy the other shareholder’s interest at a price set by the shareholder making the offer. However, the interesting twist is that having made the offer to buy, that shareholder is also deemed to have offered to sell their interest at the same price and on the same terms as the offer to buy. So it is left up to the shareholder receiving the offer to determine whether or not they want to sell their interest or buy the interest of the other shareholder. This has the effect of making the offering shareholder think carefully about the price. If they make a lowball offer, they may end up being bought out at that low price!

Normally, the shotgun clause will stipulate time frames and procedures for completing the transaction, depending on the wording of the shareholder agreement that the parties signed. Once the shotgun clause has been triggered, the time frames will have to be observed. Some shareholder agreements provide for a total time frame of about 45 days to complete the process and others provide for longer terms such as 90 days. I find that once a shareholder has decided to trigger the shotgun clause, the shareholder normally wants to shorten the time frame to get the process over with. This is understandable, but not advisable as a shareholder’s failure to comply with the terms of the shotgun clause may invalidate the shotgun clause or the offer.

How do you actually trigger the shotgun clause? This is done with a shotgun offer that should be drafted by your lawyer. As noted above, it must comply with the terms of the shareholder agreement in order to be effective. Often, I find that the shareholder making the shotgun offer wants to add or delete terms for the transaction. However, the courts have been fairly clear that the offer must not vary from the shareholder agreement. For example, a term amending the restrictive covenant contained in the shareholder agreement cannot be included in the shotgun offer. The terms of the purchase and sale in the shotgun offer should relate only to those terms and conditions that are necessary to completely sever the relationship between the parties and the company.

If you have fired the shotgun or are contemplating firing the shotgun, you have to make sure that the offer is delivered to the other shareholder in strict compliance with the shareholder agreement. This is important because you want to ensure that the time periods set out in the shareholder agreement run when you expect them to. You will have to calculate the key dates and then wait for the other shareholder to make their move. The first key date is the day that the other shareholder has to decide to either sell their interest or buy your interest. If the other shareholder does not respond on that date, then by default they will have opted to sell their interest in the business to you at the price you set. Then there will be a time period to close the transaction.

What should you do during the time periods set out in the shotgun procedure? Since you don’t know whether you will be buying or selling, you should immediately commence some due diligence on the company. If you buy the business from your partner, you need to know exactly what you are getting. Sometimes there are hidden problems that you should find out about before the offer is accepted and you end up with the company. The same applies if the shotgun has been turned on you. In that case you should investigate any actions your partner may have taken without your knowledge.

When a shotgun clause is triggered it is a very stressful time for both parties. However, with good advice you can come out ahead. There are a lot of considerations to be aware of if you wish to trigger a shotgun, or if it has been triggered on you. You need advice from a lawyer who has experience with these situations.

Don Sihota is a partner of the firm and a member of the firm’s Private Company Transaction, Business Succession and Wealth Preservation Groups.
More about Don: Bio | LinkedIn | Twitter
Posted in Legal Contracts, The M&A Process and tagged , , , .