USE A SHAREHOLDERS AGREEMENT TO PROTECT YOUR ESTATE
Most business owners know the importance of having a will to
organize their financial affairs and control what happens to the estate. Many
may not appreciate the important role of a properly drafted shareholders
agreement in an effective estate plan. If you are not the sole shareholder in
your company, and especially if the other shareholder is not your spouse, the
shareholders agreement can ensure there is a market for the shares, provide
liquidity for your investment and avoid disputes.
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A shareholders agreement is simply a contract between two or
more shareholders of a corporation, setting out the rights and obligations of
the parties. It can deal with any issue that is of importance to the various
shareholders. The agreement should deal with certain major issues such as
management and control of the company, financing required for its operations,
and the transfer or sale of shares. For the protection of your estate, it should
provide for the purchase and sale of your shares by the surviving shareholders
of the company.
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Shares in a private company are personal property. As such
the shares would pass to your estate and be dealt with by your last will and
testament. In the absence of a shareholders agreement and subject to any
specific provisions in the articles of the company, the shares would pass to a
beneficiary named in your will. This may sound ideal until you consider the
converse: in the absence of a shareholders agreement, the surviving shareholders
of the company are not required to buy the shares from your estate.
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Your estate may have a significant need for cash to pay
various testamentary expenses and estate debts. As well, under the provisions of
the Income Tax Act, the shares are deemed
to be sold on your death and the estate has to recognize capital gains taxes. If
you are the sole income earner in the family, then your family may have a sudden
need for cash to replace your income. If the shares represent a significant
portion of your estate, there may be a compelling need to sell the shares in
order to provide for your family.
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To protect against the potential problems outlined above, a
shareholders agreement can provide for a compulsory sale of the shares. All the
shareholders would agree, in advance, that on the death of any one shareholder,
the surviving shareholders must purchase the shares. On behalf of your estate,
you agree that the estate is bound to sell the shares to the surviving
shareholders. Your will would also reflect this agreement. This will ensure that
there is a market for the shares.
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Obviously there is a risk that the surviving shareholders and
the company may not have the funds required to purchase the shares in the event
of the sudden death of a shareholder. Mortgaging the company assets in order to
buy the shares could impose a crushing debt load on the company thus
jeopardizing its continued viability. For these reasons it is normal to require
that the lives of the shareholders be insured. The amount of the insurance must
be sufficient to pay out the purchase price which is the fair market value of
the shares at the relevant time and will have to be adjusted from time to time.
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It is possible that the insurance proceeds will not be
sufficient to pay the purchase price. As such, the shareholders agreement should
provide how the possible shortfall will be paid. As well consider if any
security for the unpaid portion of the purchase price will be provided and by
whom.
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Another important consideration is taxes. Since the shares
are deemed to be disposed of on your death, there will be tax consequences that
your estate must deal with. If you have available any capital gains exemptions,
then some of the deemed gain can be sheltered. It is important that the purchase
and sale of the shares be structured in such a way as to permit your estate to
use any capital gains exemptions available.
Revenue Canada may disagree with you as to the fair market
value of the shares. A properly drafted shareholders agreement should provide
for a price adjustment clause that effectively deals with the various
contingencies that might arise.
With a shareholders agreement in place, there is a market for
the shares that would pass to your estate. The insurance proceeds provide the
needed liquidity. Potential disagreements, and expensive litigation, between the
estate and the surviving shareholders are avoided. To ensure that your estate is
protected, consult an experienced solicitor about preparing a shareholders
agreement.
If you have any questions on the issues discussed above, or on any legal issue in general, please
contact Sucha S. Ollek at: info@e-law.bc.ca.
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