Escape mechanisms

Going into business with partners is a serious commitment. The relationship between partners is often long-term and entails important responsibilities. Quite often, unfortunately, a partner who is enthusiastic and eager to work at the beginning of the business relationship becomes lazy and uninterested as time progresses and one partner alone ends up shouldering the burden of running and growing the business.
Luckily, there are various contractual mechanisms that you may have drafted into your shareholders agreement, if the business is incorporated, or into your partnership agreement, if the business is not incorporated, to protect you in the event that one of your partners suddenly becomes deadweight.
Let’s overview some of these provisions briefly.

Forced Withdrawal Clause

A shareholders agreement or a partnership agreement may contain a clause that allows the forced removal of a shareholder or partner who repeatedly fails to fulfill his obligations towards the business. Usually, the displeased shareholder must provide written notice to the delinquent shareholder, informing him that his behavior is in contravention of the agreement and that if he fails to improve his performance, he will be forcefully removed from the business. If he does not take heed of this warning, the remaining shareholder has the right to purchase his shares, often at a discount.

Shot-gun Clause

The shot-gun clause is one of the most well-known contractual devices for getting rid of a business partner with whom you cannot see eye-to-eye. The clause is basically an escape mechanism used in the event that the shareholders face a dispute among themselves that they are unable to resolve. One shareholder may offer to buy the totality of the other shareholder’s shares for a certain price. The shareholder who receives the offer will have the option to sell his shares at that price. However, if that shareholder refuses to sell his shares, he must automatically buy the offering shareholder’s shares at the price that was initially offered to him.
The shot-gun clause can be a dangerous weapon, though. For example, if one shareholder knows that the other is in serious financial difficulty, the clause can be used to force the destitute shareholder out of the corporation at a price that is significantly below the market value of the shares.

Drag-along clause

If a hard-working majority shareholder decides that he is ready to sell his interest in the business, the investor considering buying his shares may be turned off by the idea of being stuck with a delinquent minority shareholder. A drag-along clause would enable the majority shareholder to force the minority shareholder to sell his shares to the investor and thus prevent the deal between the majority shareholder and the investor from falling through.

For more information, you may contact Kelly Francis at (514) 802-7736 or at info@kellyfrancisavocate.com.

Disclaimer: This article merely gives readers an overview of the issues discussed therein and is not legal advice. Please do not take action based on this article alone without first seeking the legal counsel appropriate for your specific situation!