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Handshake Hell – Business Partner and Equal Shareholder-Director Disputes in Ontario

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Handshake Hell – Business Partner and Equal Shareholder-Director Disputes in Ontario

For every client that hopes to set up a company, I have one client hoping to get out of a company. Business breakups can be messier and uglier than divorces. Many business partners set up their company on nothing more than a hope and a handshake. Often, they lacked funds at the onset of their business to properly document their business relationship. Alternatively, founders thought a dispute was unlikely due to their close personal relationship to their business partners who is often a friend or family member. In either case, there is now a successful business, a dispute that is unlikely to be resolved, and little or no documentation to determine how the dispute should be resolved. Depending your business structure, there are options available for you. In Ontario, business structures with multiple owners are typically either a Partnership or a Corporation.

Partnership Disputes

If no company has been incorporated and there is a relation that subsists between persons carrying on a business in common with a view to profit, there is likely a partnership in existence. If there is a partnership, the provisions of the Partnerships Act (Ontario) would govern the relationship between the business partners. Some provisions of the Partnerships Act (Ontario) can be varied by a partnership agreement, which is a contract between partners that lists the rights and responsibilities of the partners. Although typically written, a partnership can be an oral agreement, and would deal with the following matters:

  • Firm Name;
  • Term of Partnership;
  • Percentage and/or Amount of Contribution to Capital;
  • Division and Distribution of Partnership Profits;
  • Management of the Partnership;
  • Retirement, Bankruptcy, or Death of Partner
  • Ownership of Intellectual Property;
  • Sale and Valuation of a Partnership interest;
  • Obligation/Option to Purchase of a Partnership Interest;
  • Expulsion of a Partner;
  • Voluntary Withdrawal of a Partner;
  • Dissolution of a Partnership;
  • Admission of a New Partner;

Without a partnership agreement, the following provisions are some of the Partnerships Act (Ontario) that should be considered in a partnership dispute:

  • Partners equally share in the capital and profits of the business and contribute equally towards the losses (Section 24(1))
  • Partners are bound to render true accounts and full information of all things affecting the partnership to any partner or the partner’s legal representative (Section 28)
  • Every partner must account to the firm for any benefit derived by the partner without the consent of the other partners from any transaction concerning the partnership or from any use by the partner of the partnership property, name or business connection. (Section 29)
  • Every partner may take part in the management of the partnership business (see s. 24(5) of the Act).
  • Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners, but no change may be made in the nature of the partnership business without the consent of all existing partners. (Section 24(8))
  • Consent of all the partners is required for the variation mutual rights and duties of partners, and the introduction of new partners (Section 20 and Section 24(7))
  • Partners have a duty not to compete with the firm (Section 30)
  • No majority of the partners can expel any partner (Section 25)
  • A partnership is dissolved if entered into for an undefined time if a partner gives notice to the other partners of the intention to dissolve the partnership (Section 32)
  • Death or insolvency of a partner results in the dissolution of the partnership (section 33(1))
  • At the option of the other partners, a partnership may, a partnership be dissolved if any partner suffers that partner’s share of the partnership property to be charged (Section 33(2))
  • A partnership is dissolved if the partnership’s business becomes illegal (Section 34)
  • On application to the court by a partner, the court can dissolve a partnership (Section 35)

Resolving a Partnership Dispute

If a dispute arises among partners, it is important to try to resolve the matter responsibly which would most likely entail a negotiated resolution. Such a negotiated resolution could involve one party buying the other out or the dissolution of the partnership.  A negotiated resolution is useful in preserving the business, limiting legal costs, and saving time.

If there is a partnership agreement, the dissolution of the partnership would occur in accordance with the partnership agreement. Partners would need to carry out the terms of dissolution in this partnership agreement in good faith. In the absence of a partnership agreement, a partner can give notice to the other partners of the intention to dissolve the partnership. Such a decision should not be made lightly, and one should seek legal advice before giving such a notice.

Lastly, partners owe fiduciary duties to each other under common law meaning that each partner must place the interests of the partnership ahead of a partner’s private interests. Thus, upon a dispute arising partners should not steal customer information, clear out bank accounts, or defame one another. Rather, a partner should work to preserve the business to the best of their abilities and seek immediate legal assistance. A partner who breaches their fiduciary duties could face legal action.

Dissolving a Partnership

When dissolving the partnership, it is important to do so in a fair and responsible manner. After the dissolution of a partnership, the other rights and obligations of the partners continue despite the dissolution and each partner can bind the firm so far as is necessary to wind up the affairs of the partnership and to complete transactions started but not completed before the dissolution. The accounting of partnership dealings is to be kept open after dissolution and assets of the partnership ought to be divided between the partners in proportion to their ownership shares in the original partnership.

Former partners continue to owe limited fiduciary duties to one another, mainly the duty to ensure that ongoing transactions are completed, and the assets of the partnership are realized for the benefit of all the partners. Moreover, a partner that takes property for their own benefit following dissolution, such as equipment or client lists, could be liable to their partners as assets of the partnership belong to all the partners. As such, equipment, client lists, and other partnership property, should be divided fairly among the partners. Following dissolution, except as constrained by these limited continuing obligations or by an agreement, former partners are free to compete with one another.

Disputes among Equal Shareholder Directors

One of the most difficult and common business disputes is a business dispute among founders who are equal 50/50 owners (shareholders) and directors of the company. When a dispute arises among equal shareholder directors deadlock ensues which will likely ruin the company unless corrective action is taken.

When starting a business, founders will commonly incorporate their business to benefit from the many advantages of incorporation. When incorporating their company, they structure the company so that the founders both become directors and equal shareholders.  Ideally, the founders would complete a shareholder agreement which is a document that specifies the rights and regulations of shareholders in a corporation. A shareholder agreement typically includes dispute resolution provisions or a buy-sell clause (shotgun clause) which is an exit provision that allows a shareholder to offer a specific price per share to purchase the shares of the other shareholder. Unfortunately, many equal shareholder founders to not complete a shareholder agreement.

A Negotiated Resolution is typically the Best Option

Without a shareholder agreement in place, the most effective corrective action available in an equal shareholder director dispute is likely a negotiated resolution. This resolution may involve one shareholder buying out the other, the corporation completing a share buyback, or both shareholders agreeing to voluntarily dissolve the corporation.  When one shareholder buys out the shares of the other, a share purchase agreement must be completed. Alternatively, a corporation could complete a share buyback which would result in bought back shares being cancelled and one shareholder holding all outstanding shares.

When negotiating a resolution, it is helpful to realistically value the company. Often one party will demand an amount for their shares that they would never pay for their partner’s shares. For example, should a company be worth $100,000.00, one partner would demand $50,000.00 for their shares despite the fact they would not pay $50,000.00 for their partners shares. Such a demand is unreasonable as it does not take into consideration transaction costs or liquidity discounts. Even worse are situations where one partner is only interested in selling their shares and would not consider buying their partners shares. As there is likely only one potential buyer for the shares, the selling party is unlikely to receive fair market value for the shares which may be discounted to an almost nominal price due to a liquidity discount.

Thus, when dealing with such a dispute without a shareholder agreement, even though there may not be a buy-sell clause (shotgun clause) in place, parties should operate as if one is in place. First, the parties should agree on a valuation for the company. This valuation could be completed by the parties or by a retained professional. Parties should then extend to one another offers that they would consider accepting if they received that offer from the other party. Throughout the dispute it is important to remember that directors of a corporation owe fiduciary duties to the corporation meaning they are subject to a duty to act honestly, in good faith and with a view to the best interests of the corporation. Moreover, unless required to do so under an agreement, such as a shareholder agreement, no party is required to buy the shares of another.

Voluntary Corporate Dissolution

In a voluntary dissolution, a corporation can be dissolved only when its property has been distributed and its liabilities have been discharged. Once the liquidation process is completed, you can apply for a certificate of dissolution.  Such a dissolution would require the consent of both the directors and could be part of a negotiated resolution. There are two ways to have a corporation dissolved: (1) liquidation before starting the dissolution process, and (2) starting the dissolution process before the liquidation process. For liquidation before starting the dissolution process, shareholders must pass a special resolution authorizing the directors to distribute any property and discharge any liabilities in accordance with the articles of the corporation and the requirements under the Canada Business Corporations Act (“CBCA”) or the Business Corporations Act (Ontario) (“OBCA”).  For starting the dissolution process before the liquidation process, if the corporation will cease carrying on business while it is in the process of liquidation, it can apply for a certificate of intent to dissolve. Shareholders must authorize the liquidation and dissolution of the corporation by special resolution.

When a certificate of intent to dissolve is issued, the corporation must cease to carry on its activities except to the extent needed for the liquidation. It must also:

  • notify creditors of its intent to dissolve;
  • give notice of the intent to dissolve in each province in Canada where the corporation is carrying on activities;
  • perform all the acts required for the dissolution, such as: collect the corporation’s property, dispose of the property that is not to be distributed in kind to shareholders, and discharge all the corporation’s obligations;
  • distribute the corporation’s remaining property among the shareholders.

Court Ordered Corporate Dissolution

Should no agreement be reached, a shareholder can commence a court application to dissolve the corporation. This should be treated as a last resort as this process is lengthy and costly. Normally, this process is not available when the company is insolvent which would ordinarily proceed under the Bankruptcy and Insolvency Act. If the company is not insolvent, pursuant to Section 241 of the CBCA and similar provisions in the OBCA, a party can apply to a court which can order one or more of the following:

  • an order restraining the conduct complained of;
  • an order appointing a receiver or receiver-manager;
  • an order to regulate a corporation’s affairs by amending the articles or by-laws or creating or amending a unanimous shareholder agreement;
  • an order directing an issue or exchange of shares;
  • an order appointing directors in place of or in addition to all or any of the directors then in office;
  • an order directing a corporation or any other person, to purchase shares of a shareholder;
  • an order directing a corporation or any other person, to pay a shareholder any part of the monies that the shareholder paid for shares;
  • an order varying or setting aside a transaction or contract to which a corporation is a party and compensating the corporation or any other party to the transaction or contract;
  • an order requiring a corporation, within a time specified by the court, to produce to the court or an interested person financial statements;
  • an order compensating an aggrieved person;
  • an order directing rectification of the registers or other records of a corporation; or
  • an order liquidating and dissolving the corporation.

Deadlock in the corporation’s governance is grounds for a court ordered dissolution. In deadlock situations, meaning situations where the decision-making process within a corporation cannot function and there is no realistic prospect of it being repaired, courts have the power to involuntarily windup a corporation. Such a remedy would likely be used if an indefinite dispute arose in a two director-equal shareholder corporation. Moreover, such a process can be used to buy out a shareholder, resolve a deadlocked board, and even purchase 50% of a company.

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