Shotgun Clause

A shotgun clause, also called a shotgun buy-sell provision, is an exit mechanism written into a shareholder agreement or another co-ownership agreement, such as a partnership or joint venture agreement. It lets an owner end the co-ownership without anyone else's consent. One owner (the offeror) delivers an offer naming a price, and the other (the offeree) must either sell at that price or buy the offeror's interest at that price.

The clause is one of several pricing tools used in a buy-sell agreement, alongside fixed prices, formulas and independent appraisals. What sets it apart is that no valuator or judge picks the number. Self-interest does the work: an offeror who names a low price risks being bought out cheaply, and one who names a high price risks having to pay it. The Court of Appeal for Ontario has called a shotgun buy-sell provision "the quintessential corporate mechanism for the exercise of shareholder self-interest" (Aronowicz v. Emtwo Properties Inc., 2010 ONCA 96).

The Business Corporations Act (Ontario) (OBCA) does not give shareholders a shotgun right. The right exists only if the owners agree to it, and its terms are exactly what the agreement says.

The steps come from the agreement, but most shotgun clauses follow the same pattern:

1. Trigger. The agreement says who may start the process and when. Clauses often allow it only after a defined deadlock, after a minimum holding period, or when no other sale process is under way.
2. Offer. The offeror delivers a written offer stating the price, usually per share, and the payment terms the clause permits. Some clauses require a deposit or proof of funds with the offer.
3. Election. The offeree has a fixed period to elect to sell or to buy. Many clauses provide that if the offeree does not elect in time, it is deemed to have chosen to sell.
4. Closing. The buyer pays on the terms in the clause. The seller transfers its shares, resigns as a director and officer, and the parties deal with shareholder loans and personal guarantees as the clause directs.

Because the price is usually stated per share, it applies to both sides proportionately. A 30% holder who triggers against a 70% holder must be ready to buy 70% of the company. That is why shotgun clauses suit two equal or near-equal owners best, and why they are usually tied to a shareholder deadlock process rather than offered as a general exit right.

A shotgun expels an owner from a going business without consent, so courts treat it as a drastic remedy and insist on strict compliance. In Western Larch Ltd. v. Di Poce Management Ltd., 2013 ONCA 722, which involved a shotgun in a partnership agreement, the Court of Appeal summarized the rules:

• To be enforceable, the offer must comply strictly with the shotgun provision in the agreement.
• Strict compliance is not perfect compliance. The court looks at the wording of the agreement and the commercially reasonable expectations of the parties.
• An offer that includes a non-compliant alternative is still enforceable if it also includes a compliant one, but the court will enforce only the compliant alternative.
• Defects that are commercially insignificant in context, and that damages can fully remedy, do not defeat the offer.

Earlier, in Zeubear Investments Ltd. v. Magi Seal Corporation, 2010 ONCA 825, the shotgun provision in a unanimous shareholder agreement required at least half the price in cash on closing and the balance by promissory note. The offer demanded full payment on closing, and the court held that the agreement's mandatory payment terms governed. Other cases reviewed in Western Larch held offers unenforceable because the offeror added conditions the clause did not provide for, such as a non-competition covenant or a price discount for loans to be settled separately, and the Court of Appeal confirmed that an equivocal acceptance is not enforceable either.

The lesson cuts both ways. An offeror should mirror the clause exactly and add nothing. An offeree should have the offer checked against the clause before the election period runs.

A shotgun is fair in theory and can be harsh in practice:

• Unequal finances. The owner with cash or ready financing can name a low price, knowing the other cannot raise the money to buy. In Western Larch, the offeree could not finance a purchase and was bought out.
• Unequal information. An owner who runs the business knows its prospects better than a passive owner and can time the offer accordingly.
• No market check. Unless the clause says so, the price does not have to equal fair market value. The Court of Appeal noted that the partners in Western Larch could have required a fair market value price but did not.
• Ganging up. With three or more owners, two may combine to push out a third unless the clause prohibits it.
• Timing. An offer made while the other owner is ill, separating or short of cash can force a sale at the worst moment.

The Court of Appeal has said courts should be reluctant to rescue a party who later regrets contractual arrangements that were carefully designed and accepted. These risks therefore have to be dealt with when the clause is drafted, not argued about after an offer arrives.

The main decisions to settle before signing:

• Who can trigger and when. Only after a defined deadlock, after a minimum holding period, and not while another sale or a lawsuit between the owners is pending.
• Price protection. A floor tied to a recent independent valuation, or a requirement that the offer price meet one.
• Payment terms. Cash on closing or part cash with a secured note, a deposit with the offer, and a financing period long enough for the less liquid owner to arrange a loan.
• What closes with the shares. Repayment of shareholder loans, release of guarantees, resignations and any non-competition covenant, each spelled out in the clause itself.
• Several shareholders. Whether owners can trigger jointly, how each participates pro rata, and how the clause fits with any right of first refusal and drag-along and tag-along rights.
• Alternatives. Some owners prefer an appraisal-based buyout or put and call options.

Our article on essential shareholder agreement clauses places the shotgun among the other exit terms, and the guide to removing or buying out a shareholder in Ontario covers exits where no clause exists. Lamba Law's free shareholder agreement builder lets owners add a shotgun clause and a mediation-then-arbitration ladder and produces a discussion term sheet to review with a lawyer.

Mei Lin and Daniel Okafor each own 50 of the 100 common shares of a Mississauga packaging distributor. Their shareholder agreement lets either of them trigger a shotgun once a deadlock notice has gone unresolved for 30 days. The offeree has 60 days to elect, closing follows 90 days after the election, and the buyer must pay at least 60% in cash on closing with the balance by a secured promissory note over two years. The buyer must also replace the seller's personal guarantee of the company's bank line.

After a deadlock over leasing a second warehouse, Daniel serves an offer at $16,000 per share, valuing each half of the company at $800,000. He adds a condition that Mei sign a three-year non-competition covenant if she sells. Mei's lawyer points out that the clause says nothing about non-competes, so the added condition puts the offer's enforceability at risk. Rather than litigate, they agree that Daniel will withdraw it, and he serves a compliant offer at the same price.

Mei arranged a term loan when the deadlock began. She elects to buy, pays Daniel $480,000 on closing and signs a $320,000 note for the balance. The bank releases Daniel's guarantee once Mei's replacement guarantee is in place.