Don't just shake on it
A shareholders' agreement (SA) can be a critical planning tool if you share ownership of your private company. Such agreements typically list the various rights and obligations of the shareholders to each other. They also provide for what happens to the shares of a particular shareholder when that person wants to sell his or her shares, becomes disabled or even dies.
Tax planning often goes hand in hand with SA structuring. For example, the ability to use the tax-free death benefit associated with a life-insurance policy can provide an effective way to "buy out" a deceased shareholder's shares upon death. In addition, shareholder agreements are often designed to allow a selling shareholder to use part or all of the $750,000 lifetime capital gains exemption on the disposition of qualifying small-business corporation shares.
It's critical, however, for SAs to contemplate what happens on death. If they're silent, the wishes of a deceased shareholder could end up in court. For example, take a recent case from Ontario involving Cheryl Sylvestre and Jack, Donny, Bing and Cam Frye, the five children of George Frye, who died in 1991, leaving the shares of his private company to his children equally.
The five siblings signed an SA in 1991 (confirmed by a second agreement in 1994), which declared their intention was to preserve the company as a family business, and for all of the children to share equally in it. The SA contained a clause that required any sibling who wanted to sell his or her shares to first offer them to the company. If the company didn't want the shares, they would then be made available to individual siblings on a pro rata basis. The SA further stated that the shares could only be sold to a third party after the first two offers were declined.
According to court documents, the Fryes "feuded constantly over the years over control of the business." In 1994, Bing sold all of his shares back to the company, which left his siblings owning 25% each. When Cam died in April 2002, he left all of his shares to his sister Cheryl. Jack sued, arguing, among other things, that the SA prohibited Cam from transferring his shares to Cheryl through his will. While the trial judge found the gift to be "null and void," this was overturned upon appeal, as the Appeal Court concluded that the SA could not prevent Cam from leaving his shares to whomever he wanted via his will. Had the Fryes' SA specifically dealt with the presumable inevitability of death, perhaps a different, less fractious outcome would have resulted.