Accountant and client crunching numbers

COVID's economic impact creating new risk and new opportunities in shareholder agreements: lawyers

Jonathan Zepp & Charlie Kim interview with Canadian Lawyer Magazine | July 22, 2020

With COVID-19’s unequal distribution of pain and prosperity, terms in many shareholder agreements have been thrown off and may have created new risk for some shareholders and new opportunities for others, and lawyers say agreements may need to be redrafted with this once-in-a-generation event in mind.

While typically drafted for normal business cycles, events such as COVID-19, the 2008 economic crisis or 9/11 can throw a wrench in shareholder agreements, which can be in place for decades, says Jonathan Zepp, a partner in the business law group at Robins Appleby LLP, in Toronto.

The agreements are drafted with consideration to the involved parties’ relative advantage or disadvantage over others, says Zepp. A COVID-like crisis can dramatically alter these dynamics. The pandemic has plummeted many business valuations and dried up cash-flow and access to capital, with businesses being impacted to differing degrees, or not at all, he says.

The current economic downturn may create opportunities for some shareholders and challenges for others, depending on how their financial position has been impacted and what rights are in their agreement, says Charlie Kim, also a partner in Robins Appleby’s business group.

“The relative rights of the parties are dictated by a shareholders agreement that was not drafted thinking about COVID-19,” adds Zepp. “And people will have to live with that if they're in a circumstance where you have an opportunistic shareholder who is now going to take advantage of the fact that the other shareholder cannot practically participate equally in one of the provisions in the shareholders agreement.”

Many agreements have a provision called a shotgun clause. When a shareholder triggers this clause, they are making simultaneous offers, both to sell their shares and to buy their partners,’ for the same price. The other shareholders are forced to either buy or sell, at that price.

“The idea is that the mechanism is to keep everyone honest, given that you can buy out or you can be bought out at the same price. When you are drafting these kinds of provisions, you think of fairness. And at that point in time, it seems fair because all the shareholders may be in the same financial position,” says Kim.

“Given COVID-19 and how its impacted different investors and shareholders differently depending on the shareholder’s diversified portfolio and what industries they may be in, it may create unforeseen opportunities for one shareholder and risk for other shareholders,” says Kim.


A shareholder with diversified income, who is hungrier for more of the company may take the opportunity to use a shotgun clause to buy-out a shareholder who is low on cash and cannot match the offer.

Lack of liquidity is a reality for many shareholders in the current economic climate, which may affect another shareholder provision: the right of first refusal, says Kim. Through a right of first refusal, if a shareholder gets an offer to sell, they cannot until they have offered to sell their shares to the other shareholders at the same price as the offer. Amid the pandemic, a strategic investor, who wants to deploy capital with less competition in the market, may make an offer to a shareholder. If the economic downturn has left the other shareholders low on cash, they may not be able to match the offer and buy-out the seller.

“The consequences of not being able to do that is that the shareholders may be stuck with a new business partner, that, quite frankly, they are not keen on,” said Kim, in a recent video on the firm’s website.

“Or, even worse, if the offer is to purchase all of the issued and outstanding shares and the shareholder receiving the third-party offer exercises the drag-along provision, that could force other shareholders to sell their shares, even if they have no interest in exiting the business.”

Corporations may also want to weather the pandemic’s storm by holding on to capital and setting limits on bank loans or other externally funded debt but may also want to raise funds to get through these tough times, said Kim. This could impact shareholders if a capital call is in place, through which the business raises capital via shareholder loans. Shareholders in a better financial position may be able to answer the call, while the cash-strapped will go into default, which may result in the loss of voting rights and other consequences.

The lower business valuations that have resulted from COVID’s economic devastation will also rearrange shareholder agreements, said Zepp in the video. Shareholder agreements will have a formula which determines the value of the company – either by past performance or future, anticipated performance. The agreement may also stipulate the valuation be determined by a third-party.

The problem is, the valuation is always measured by performance, which is hard to weigh in a pandemic, said Zepp. How are pre-pandemic and post-pandemic performance levels evaluated? Is a recovery expected? How do government programs impact valuations? Practicality is necessary in drafting, because you cannot prepare for everything, said Zepp.