Shotgun Clauses in Shareholder Agreements

A shotgun clause (also called a buy-sell clause) is a provision in a shareholder agreement that allows one shareholder to force the sale of another shareholder’s shares when they reach an impasse. 

It works like this: one shareholder makes an offer to buy the other’s shares at a specific price. The receiving shareholder must either sell their shares at that price, or buy the offering shareholder’s shares at the same price.

The name comes from the “shoot or be shot” dynamic:  you make an offer knowing the other person can turn it around on you. This mechanism is designed to ensure fairness because the person making the offer must be willing to accept the same terms they’re proposing.

Here’s the typical process:

Step 1: Trigger the clause

One shareholder (the offeror) sends written notice to the other shareholder (the offeree) offering to purchase their shares at a specific price per share. The offer must comply with the shareholder agreement’s requirements for triggering the shotgun: notice format, delivery method, and any conditions.

Step 2: The offeree decides

The receiving shareholder has a limited time (typically 30-60 days) to choose between two options:

• Accept: Sell their shares to the offeror at the offered price.
• Reverse: Buy the offeror’s shares at the same price per share.

There’s no third option. You can’t negotiate, counter-offer, or simply refuse. You must either sell or buy.

Step 3: Complete the transaction

Once the offeree makes their choice, both parties must complete the transaction within the timeframe specified in the agreement (usually 30-90 days). Payment terms are set out in the shareholder agreement: sometimes full payment upfront, sometimes installments with security.

Step 4: Transfer of shares

The selling shareholder transfers their shares to the buyer, receives payment, and exits the company.

Shotgun clauses solve a common business problem: what happens when shareholders can’t agree and the business is deadlocked?

Breaks deadlocks: When shareholders fundamentally disagree about business direction and can’t work together anymore, the shotgun forces a resolution.

Ensures fairness: The mechanism prevents lowball offers because the offeror risks having to buy at their own price. This self-regulating feature encourages realistic pricing.

Avoids court: Without a shotgun clause, deadlocked shareholders might end up in expensive oppression remedy or dissolution proceedings. The shotgun provides a private solution.

Protects minority shareholders: Even shareholders with less than 50% ownership can trigger the shotgun, giving them leverage they wouldn’t otherwise have.

Certainty: Everyone knows the exit mechanism from day one, reducing uncertainty about how disputes will be resolved.

Despite their benefits, shotgun clauses can create serious problems:

Financial capacity matters: The clause favors the wealthier shareholder. If one shareholder has significantly more money or better access to financing, they can make an offer knowing the other person can’t afford to reverse it. This effectively forces the less wealthy shareholder to sell at whatever price is offered.

Timing advantages: If one shareholder knows the other is going through financial difficulties, divorce, or personal crisis, they can time the shotgun to exploit that vulnerability.

Valuation disputes: Determining “fair value” for a private company is subjective. The shotgun forces a decision before proper valuation, which can result in one party getting a raw deal.

Business disruption: The urgency of shotgun deadlines can force hasty decisions. Shareholders have limited time to secure financing, conduct due diligence, or arrange their affairs.

Even well-drafted shotgun clauses can lead to litigation:

Improper triggering: Disputes over whether the notice was properly delivered, whether trigger conditions were met, or whether the offer complied with agreement terms.

Valuation challenges: Arguments that the offered price was unrealistic, made in bad faith, or deliberately set to exploit financial disadvantage.

Financing failures: One party commits to buy but can’t secure financing by the closing deadline. 

Bad faith allegations: Claims that the shotgun was triggered maliciously, at a vulnerable time, or as harassment rather than genuine desire to resolve deadlock.

Ambiguous terms: When the shareholder agreement’s language is unclear, parties dispute what the clause actually requires.

Courts generally enforce shotgun clauses as written because sophisticated business people negotiated them voluntarily. However, courts may intervene if the clause was triggered in bad faith, with oppressive intent, or in circumstances that make enforcement unconscionable.

If you’re including a shotgun clause in your shareholder agreement:

Be specific: Don’t leave room for interpretation. Clearly define notice requirements, timelines, payment terms, and what’s being purchased.

Consider financial equality: If shareholders have significantly different financial resources, consider modifications like:

• Required third-party valuation before the offer.
• Longer response periods to allow financing arrangements.
• Mandatory financing terms for buyers.
• Prohibitions on triggering during certain vulnerable periods.

Address loans and guarantees: Specify whether the purchaser assumes shareholder loans to the company or personal guarantees for company debts.

Include dispute resolution: Build in arbitration or mediation for disputes about whether the clause was properly triggered.

Set reasonable timelines: Balance the need for urgency against giving parties adequate time to make informed decisions and arrange financing.

Consider circumstances: Maybe prohibit shotguns during the first 3-5 years, during certain business cycles, or while key contracts are being negotiated.

Get legal advice: Shotgun clauses have significant financial and legal consequences. Proper drafting by an experienced business lawyer is essential.

If you’re negotiating a shareholder agreement, carefully consider whether a shotgun clause is appropriate and how to structure it fairly. If a shotgun has been triggered against you, act immediately: the timelines are strict and the financial stakes are high.

Contact Pinto Shekib LLP at info@pintoshekib.ca or 416.901.9984 to schedule a confidential consultation about shareholder agreements, shotgun clauses, or corporate disputes.