Imagine for a moment that you are in business with three other individual shareholders. The four of you may be friends and started the business by investing personal capital and shaking hands. You incorporated the company, and each of you are equal owners of the business. Over the years, the business grows into a profitable venture.

But what would happen if one of the other three shareholders unexpectedly dies? It could be a sudden heart attack or tragic car accident. The how isn’t as important as the fact that this real-life scenario could happen to any business at any time.

If you and your friends had a signed shareholders agreement, it should include one or more forced transfer provisions (i.e. the forced transfer of shares by a shareholder upon the occurrence of death, disability, bankruptcy or divorce/separation) (collectively, “Forced Transfer Provisions”). Forced Transfer Provisions prevent shares from becoming encumbered or being transferred to unsuspecting shareholders (i.e. on death or divorce). What this means is that if the scenario above were to become reality, the corporation (or the remaining shareholders) would have the option, but not the obligation, to purchase the shares of the deceased shareholder in accordance with the terms laid out in the shareholder agreement. (Often this is at fair market value using an agreed upon method of valuation).

Forced Transfer Provisions safeguard the business but also protect the deceased shareholder’s family. For example, if the deceased shareholder was the primary income earner, there will be no more salary, and the surviving family members may be expecting, or perhaps may be relying on the funds from the deceased shareholder’s shares to carry on living the lifestyle that they had come to expect, or perhaps even pay for the basic necessities of life.

Once these provisions have been agreed to, shareholders should also consider funding these “buy-sell” provisions by purchasing life insurance. Companies, or individual shareholders, may purchase life insurance coverage on each shareholder in order to be able to fund the purchase or repurchase for cancellation of the deceased shareholder’s shares (or encumbered shares) in accordance with the shareholders agreement.

No recourse for remaining shareholders

Here’s a look at what could happen if, using this same real-life scenario, the four of you did not have a signed shareholders agreement with Forced Transfer Provisions:

There would be no recourse for the remaining shareholders or for the deceased shareholders surviving spouse/partner. The shares could be tied-up in the estate and then transferred to the surviving spouse, giving that person a 25 percent stake in the business and equal voting rights. Suddenly, as one of the three remaining shareholders, you may find yourself in partnership with someone who knows little about the business operations, day-to-day management and future plans but who is considered an equal in all decision-making processes.

Safeguard shares for other shareholders

Now, let’s imagine a slightly different scenario than the one above. Imagine instead that you are in business with three other shareholders and one undergoes a bitter divorce or breakup of a common-law relationship. As part of the separation process, all net family property is equalized and divided.

Forced Transfer Provisions would safeguard those shares, forcing the shares to be sold to the other shareholders, or repurchased for cancellation by the corporation, thereby preventing the shares from becoming ‘net family property,’ and instead, allowing the cash from the sale/repurchase for cancellation to become net family property. The shareholder would be required to provide adequate proof that the shareholder would retain 100 percent of such shareholder’s shares, or the company would have the option, but not the obligation, to purchase all shares held by the shareholder in accordance with the terms in the shareholders agreement.

Here’s a look at what could happen if, using this same real-life scenario, the four of you did not have a signed shareholders agreement with Forced Transfer Provisions:

You and your business partners could now end up in business with a fifth shareholder — the now hostile ex-spouse — when that shareholder’s shares are divided as part of the family property. As a shareholder, that ex-spouse may receive dividends and have voting rights. It’s not hard to imagine the challenges the business may face in this situation.

The act of simply drafting a shareholders’ agreement, which includes Forced Transfer Provisions as well as a myriad of other provisions to deal with all business and shareholder issues, whether such issues are administrative, or which may cause contention in the future, forces all parties to discuss any and all issues that could arise long before any of those issues do arise. Once an agreement is signed, all shareholders can carry on with the comfort of knowing that a plan is in place to deal with the unexpected.