Photo of Mohamed AmeryBy Mohamed AmeryJuly 10 2017
Litigation

“Shot-Gun” Clauses: Important but draft carefully and use with care

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Shareholders of a private or small company often enter into a unanimous shareholders agreement (“USA”) which places control directly into the hands of those shareholders instead of directors.  A term that features prominently in virtually all USAs is a “shot-gun” (buy-sell) clause.

Under a shot-gun clause, a shareholder (“offeror”) may make an offer to other shareholders (collectively “offeree”) for the offeree to purchase the offeror’s shares at a specified price and within a specified time.  The offeree then has an opportunity to accept the offer and buy the offeror’s shares.  If the offeree passes on that opportunity, the offeror then turns the tables and buys the offeree’s shares at the same price.

The offeree is faced with a straight-forward choice: buy the offeror’s shares or have his shares bought. The shot-gun mechanism is an incredibly useful tool that allows a company to deal with an impasse.  If shareholders are not getting along, any one of them can exercise the clause and set the process in motion.

The beauty of the shot-gun mechanism lies in its apparent fairness and equity. Problems arise, however, when a clause, which by its very nature seems fair and equitable, is in practice a tool for a more resourceful shareholder to effect an unfair deal on one with less means.  For example, if the offeror has more money than the offeree, the former can set a high price that the latter simply cannot pay.  The offeror in that case would then be able under the clause to purchase the offeree’s shares at that price.  Problems also arise when multiple parties are able under the clause to make an offer in unison. Parties need to exert due care to set terms (such as pre-specified prices, formulas, or valuation) to ensure that the clause is truly fair.    

The exercise of a shot-gun clause must be done with due care, as the clause needs to be adhered to strictly.  A significant portion of lawsuits filed in relation to shot-gun clauses arise when the offeree alleges that the offeror did not strictly comply with the clause in exercising it (i.e. in making the offer).

Invitation for Discussion

Our litigation lawyers are skilled in corporate law. If you would like to discuss this blog in greater detail, or any other business litigation matter, please do not hesitate to contact Mohamed Amery or one of the lawyers in the Business Litigation Group at Shea Nerland LLP.

Disclaimer:

Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.

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