Nelligan O'Brien Payne gratefully acknowledges the contribution of Stéphane Serafin, Student-at-Law in writing this article.
If you’re entering into a business relationship with another party, it’s often best to set out the details advance. Regardless of the corporate vehicle you choose – partnership, joint venture, business corporation or other – an agreement can go a long way in securing the proper functioning of that relationship.
One type of clause to consider including is a buy-sell provision, commonly referred to as a ‘shotgun clause’. At its most basic, it allows parties to escape from the business relationship in the event that they are at an impasse. In the context of a business corporation, the clause operates by allowing one party to offer their shares to the other at a specific price per share, which may or may not be set out in advance by the provision. Generally speaking, the shareholder or shareholders receiving the offer must either accept to purchase the shares at that price or sell their own shares to the offering shareholder at the price set out in the original offer.
In other words, a shotgun clause is not something to be contemplated lightly. At a minimum, it means that one shareholder may be able to force another out of a viable business at any moment. As such, while it may be useful to include as a means of resolving an impasse, the clause’s operation may not be restricted to such situations. Of course, specific types of shotgun clauses may be more or less well suited for particular business arrangements.
However, a core difficulty remains where the signatories possess unequal bargaining power – usually because one has more limited means than the other. This issue was clearly at play before the Ontario Court of Appeal in Western Larch Limited v Di Poce Management Limited . In that case, the shotgun clause did not require a party to make offers at market value, nor did it prevent multiple shareholders from making combined offers to oust one amongst them from the business. When a conflict did arise, the parties in agreement – all save one – activated the shotgun clause and made a combined offer to the disagreeing party. As the latter was alone, it possessed more limited means than the other parties combined and was forced to sell its stake in the partnership at below market value.
When considering whether or not a shotgun clause is right for you, care should be taken with respect to the decision in Western Larch. If the party forced out of the business sought relief, it did not find it before the courts. The Ontario Court of Appeal, asked to deal with the fallout from this transaction, considered both the content of the shotgun clause and the validity of the offer made on its basis. With respect to the first issue, the Court noted that the parties, all sophisticated business people, had decided not to require the offers be made at market value and not to prevent multiple shareholders from making combined offers. As such, care should be taken with respect to the terms of any shotgun clause you choose to include in your agreement. You should not expect the courts to intervene on your behalf where you have freely agreed to the inclusion of the clause.
Nor should you expect the courts to intervene with respect to the types of offers made on the basis of a shotgun clause. Considering this second issue in Western Larch, the Court of Appeal nuanced the restrictive interpretation traditionally brought to shotgun clauses, which had required strict compliance with the terms of the clause in the event an offer was made. Instead, the Court held that where the offer presented two alternative modes of payment – one compatible with the clause and the other not – non-compliance would result from the choices of the receiving party. In other words, the offer would only be invalid should the invalid option be chosen. Strict compliance does not mean perfect compliance – the offer remains valid insofar as the compliant option is chosen.
For these reasons, the Ontario Court of Appeal decision in Western Larch should have parties considering a shotgun clause on their toes. The risk of such a clause being used in an undesirable way by another party is very real, and the courts should not generally be expected to intervene. If you are already a party to a shotgun clause, you should instead look to Western Larch as affirming the terms set out in your agreement – for good or ill.