How partnership and shareholder agreements can save your business

December 17, 2020

How partnership and shareholder agreements can save your business

Synopsis
2 Minute Read

Help ensure your business survives by putting a strong partnership or shareholder agreement in place to provide direction and avoid disputes.

Insight
Progress Insight Tax Services

A partnership agreement or unanimous shareholder agreement (USA) may not be top of mind for many business owners who operate in a partnership or corporate structure. But the lack of either may be detrimental to the survival of a business, whether it’s an arm’s length or family-owned business.

If a partnership agreement doesn’t exist or lacks key clauses, or if there is no USA, either party can drag their feet during a dispute, thereby disrupting the operations of the business or the transition of the business to the surviving partners or shareholders in the event of a death. 

Both partnership and shareholder agreements are contracts that gives the parties direction in the event certain situations affecting the ownership group or operational matters become an issue. The agreements are a “play-book” detailing the procedures to follow when certain events occur, such as the death of a partner and when partners or shareholders cannot continue to work together.

Common Provisions

Typical provisions common to both partnership and shareholder agreements include:

  • Rules relating to the transfer of party interests, imposing restriction in certain situations
  • Rules pertaining to decisions that require special or unanimous approval of the parties
  • Rules to deal with party disputes such as a shotgun clause*
  • Rules to deal with insurance requirements for key personnel;

*A shotgun clause protects the partners or shareholders against one party low-balling the other party on a buy-out. In the event one party low balls the other, the other party can then turn the table and buy-out the first party with the offer made.

Partnership Agreements

Within partnerships, even though an oral partnership agreement can be used, there is no proof that key clauses will exist. Certain events such as admission or exit of partners will cause the partnership to windup prematurely, resulting in a fair market disposal of the partnership assets.

Therefore, it is important to have a solid partnership agreement in place. Typical provisions written into a partnership agreement include:

  • A continuation clause to ensure the partnership doesn’t wind up upon admitting or removing partners;
  • Rules to ensure all partners must be resident of Canada otherwise adverse income tax consequences will occur; hence, the agreement should prohibit the sale of a partnership agreement to a non-resident of Canada;
  • Guidance on how the income of the partnership will be allocated amongst the partners.

A partnership agreement can also provide direction on the buy-out or redemption of a retired partner’s interest in the partnership.

Unanimous Shareholder Agreements

A USA can provide direction on the buy-out or redemption of a retired shareholder’s interest in the corporation. In family-owned scenarios, a USA can provide a mechanism on how the parents are to be bought out. This may include a repayment schedule and direction when payments cannot be made to the parents due to poor operations for that year. A USA can also be an effective tool in succession planning, especially if corporate-owned life insurance policies are involved in the plan.

Death and Disputes

A common concern for business owners occurs on the death of a partner or shareholder. In many situations, the surviving partner or shareholder may not be willing to continue running the partnership or corporation with the spouse of the deceased partner. A partnership agreement or USA will provide guidance on this matter. 

Identifying the need for a partnership agreement or USA often occurs when the partnership or corporation doesn’t have one, or in the case of an oral agreement, no evidence of key clauses and there is conflict amongst the parties resulting in a stalemate. This conflict may result in costly legal fees to settle the dispute. Having a partnership agreement or USA for your business, either family-owned or arms’ length owners, will ensure the business will continue to operate in times of dispute and difficult economic conditions.

For more information, contact your local MNP Business Advisor.

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