What Is a Shotgun Clause and How Does It Work in Ontario?

A shotgun clause, sometimes called a buy-sell or Texas shoot-out clause, is a way for two partners to end a deadlock. If you have just received an offer under one, the deadline may already be running.

This article explains how these clauses generally work, what Ontario's Court of Appeal has said about them, the main risks, and how to respond. It is general information and not advice about your agreement.

What a shotgun clause is

In a typical shotgun clause, one shareholder names a price for the shares. The other shareholder then has a choice: buy the first shareholder's shares at that price, or sell their own shares at that same price. The idea is that the person naming the price has an incentive to be fair, because they do not know which side they will end up on.

Shotgun clauses are contractual, not statutory. The legal footing is that, under the CBCA, a lawful written agreement among all shareholders is valid, and a purchaser or transferee of shares subject to a unanimous shareholder agreement is deemed to be a party to it, so buy-sell, drag and shotgun terms bind new holders. If your company is an Ontario OBCA company, the equivalent provisions should be confirmed with a lawyer.

What the Ontario Court of Appeal has said

The leading example in the area is Western Larch Limited v. Di Poce Management Limited, 2013 ONCA 722. The main points for someone holding or receiving an offer are these.

• The offer must strictly comply with the terms of the clause that authorizes it before the offeror can obtain its benefit.
• Strict compliance is not perfect compliance, and the court looks at the parties' commercially reasonable expectations.
• Minor, commercially insignificant defects that damages can remedy did not make the offer unenforceable.
• An offer that included both a non-compliant and a compliant alternative was not invalidated; the court would not enforce the non-compliant alternative but enforced the compliant one.

The court also noted that the partners were sophisticated, advised and had a carefully drafted clause. Because the agreement did not require the price to reflect fair market value, the court did not require the shotgun price to equal fair market value.

Timelines and risks

The agreement sets the response period, how notice must be delivered, how the price is paid and when closing happens. These vary from agreement to agreement, so do not rely on a general rule. In Western Larch, the offer was delivered on December 15, 2009, the recipient was treated as accepting the first alternative by silence, and closing took place on June 14, 2010 with about $33 million paid. A challenge can fail even after a lawsuit is filed.

If you receive a shotgun offer

First, read the clause and the notice side by side. Check whether the notice came from the right person, in the right form, with all required terms, and whether it was delivered the way the agreement requires. The court expects an offer to strictly comply with the clause, but strict compliance is not perfect compliance, and minor, commercially insignificant defects that damages can remedy did not make the offer unenforceable in Western Larch. You should not assume a flaw will save you.

Second, think about both outcomes. Could you afford to buy at that price, and would you be content to sell at it? A fair price for you is one you would accept on either side. If you are not sure, a valuation may help you decide, though the clause may not give you time to get one.

Third, consider tax. The after-tax result of a sale can differ from the headline price, and whether any capital gains exemption applies depends on your situation, so it is worth confirming with an accountant. Whether your shares qualify needs an accountant's review.

What to do next

• Note the date and method by which the offer was delivered.
• Find the response deadline and any deemed-acceptance wording in the clause.
• Collect the shareholder agreement, amendments and any prior valuations.
• Check whether you can finance a purchase, in case you choose to buy.
• Do not stay silent without knowing what silence means under your clause.
• Get advice from an Ontario business lawyer, and an accountant, right away.

If you are thinking of using a shotgun clause yourself, the same care applies: follow the wording exactly, because the benefit of the clause depends on strict compliance.

Frequently asked questions