The Shotgun Clause—Should You Include it in Your Shareholders Agreement?
A Shotgun Clause is one of many clauses that can be included in a shareholders agreement. Despite its benefits, it is also the most dangerous of all shareholder agreement clauses. That is why it is this clause, more than any other, that elicits much confusion as to whether it is worth the risk of including. The article below will explain everything you need to know about the shotgun clause, which will help you decide whether you want to include it in your shareholders agreement.
What is the purpose of the shotgun clause? Its purpose is to provide one party to the shareholder agreement the means to exit the corporation or force another shareholder to exit a corporation – in essence, dissolve the partnership that exists. It is important to note that this clause is the only clause in a shareholders agreement that can force out a partner without a triggering event, such as death, divorce, or disability. Without the shotgun clause, there is no other mechanism to force out a shareholder; there is only exit by agreement of both parties.
But is it recommended?
There’s a reason why it is called a ‘shotgun’ clause. As the name implies, when pulling the trigger, you run the risk of ‘shooting’ yourself. Here’s how it works: any shareholder at any time can choose to serve the other shareholder with a notice that states “I intend to buy you out at x price per share.” The amount per share can be any amount under the sun and may have no relevance to the shares’ true valuation.
The receiving shareholder then has a short period of time to decide whether to sell his or her shares to the offering shareholder and exit the corporation, or turn the offer around and force the exit of the offering shareholder at that same price. In that instance, the receiving shareholder will purchase the offering shareholder’s shares at that price per share and force the offeror’s exit. Hence the name shotgun clause – the offeror was intending to buy-out his partner; however he has now been forced out of the corporation.
Result of Operation of the Shotgun Clause
Thus, when serving the shotgun notice, the offering shareholder will either be buying out the receiving shareholder, or the receiving shareholder will be buying out the offering shareholder, forcing his exit from the corporation. The offering shareholder has thus “killed” himself and caused his own exit from the corporation. When employing the shotgun clause, you will never know the result of the operation of the clause and it is therefore an unpredictable and dangerous clause to rely on.
Inequality of Financial Bargaining Power
Generally, it is not recommended to insert the shotgun clause in a shareholders agreement where parties have inequality of bargaining power. Where one is wealthier than the other, the wealthier shareholder can offer a price per share above its valuation, undoubtedly forcing the exit of the receiving shareholder since the receiving shareholder would not be able to gather sufficient funds to return the offer on him.
But, not so fast! There are clever ways for shareholder’s with less bargaining power to up the ante. There was a case where one partner believed that his wealth would undoubtedly give him a stronger bargaining position. He triggered the shotgun clause thinking that there was no way that the minority shareholder would be able to come up with the money to buy him out.
After receiving the shotgun offer, the minority shareholder approached the company’s competitor and offered to team up, using their combined wealth, to buy out the shares of the offering shareholder. The result was that the majority shareholder was bought out, losing his lucrative family business. Litigation ensued but the offering shareholder lost. He had pulled the shotgun trigger and there was nothing preventing the receiving shareholder from raising funds on the free market–even from a competitor.
Should You Include it?
This story illustrates the dangers of a shotgun clause. While there is some rationale for it, it is wise to consult a corporate lawyer to discuss how to best protect your rights with a shareholders agreement. Generally, we do advise to insert a shotgun clause where we are within the stronger bargaining position or where we are the majority shareholder. As stated, this is the only mechanism to force a shareholder’s exit from the corporation, whereas all other clauses require either a triggering event outside of the control of the parties or agreement of both shareholders.
If you’d like to discuss whether a shotgun clause is right for you, contact us. We’re Here to Help™.
-Shira Kalfa, BA, JD, Partner and Founder
Shira Kalfa is the founding partner of Kalfa Law. Shira’s practice is focused in corporate-commercial and tax law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law. Shira graduated from York University achieving the highest academic accolade of Summa Cum Laude in 2012. She graduated from Western Law in 2015, with a specialization in business law. Shira is licensed to practice by the Law Society of Ontario. She is also a member of the Ontario Bar Association, the Canadian Tax Foundation, Women’s Law Association of Ontario, and the Toronto Jewish Law Society.
© Kalfa Law 2021