Think Before Pulling the Trigger: Shotgun Offers Irrevocable, BC Court of Appeal Confirms

In a recent decision, Blackmore Management Inc. v Carmanah Management Corporation[1] (“Blackmore”), the British Columbia Court of Appeal confirmed that once invoked, a shotgun clause contained in a Unanimous Shareholder Agreement (“USA”) cannot be revoked. This case provides an excellent illustration of the risks associated with shotgun clauses.

Shotgun clauses are one of the most well-known share purchase mechanisms found in a USA, and as the name suggests, they can be somewhat of a risky mechanism at that.

To understand why, it is important to know how a shotgun clause works. Let’s imagine a scenario where a makeshift corporation, AB Corp., has two shareholders, Shareholder A and Shareholder B. As is often the case when shotgun clauses are used, the shareholders' business relationship broke down and Shareholder A wishes to force Shareholder B to sell their interest in AB Corp. To do so, Shareholder A delivers an offer to purchase pursuant to the shotgun clause to Shareholder B, offering to purchase all of their shares at a specified price. At that point, Shareholder B has a specified amount of time (the “election period”) to determine how they want to proceed. They can either (i) accept the offer and sell their shares to Shareholder A at the proposed price or (ii) reject the offer and purchase all of Shareholder A’s shares for the same proposed price.

While a simple mechanism at first glance, issues may arise where there is a change in circumstances between the time of the initial offer by Shareholder A and when Shareholder B decides how to proceed. We see an illustration of such a situation in Blackmore.

In Blackmore, Carmanah Management Corporation (“Carmanah”), Blackmore Management Inc. (“BMI”) and Amphitrite Management Inc. (“Amphitrite”) were equal shareholders of First Light Technologies Inc. (“FLT”) and parties to FLT’s Unanimous Shareholder Agreement.

After failed attempts to negotiate BMI’s exit from FLT, Carmanah and Amphitrite resorted to invoking the shotgun clause contained in the USA. In January 2020, they delivered a notice to BMI offering to purchase its 1/3 interest in FLT or, in the alternative, to sell their 2/3 interest to BMI.

The notice stipulated that BMI had 60 days to respond to the offer. When presented with the notice, BMI requested additional accounting records from FLT to help it secure financing. It filed a petition with the court, seeking an injunction to stop the 60-day clock from running until it obtained such records. Eventually, in March 2020, all parties agreed by agreement to suspend the 60-day election period until the injunction application was heard.

However, in a perfect storm of events, two important changes in circumstances occurred during the election period. Firstly, by the latter part of March, the courts suspended all in-person operations due to the COVID-19 pandemic causing the hearing of the application to be delayed and rescheduled for August 2020. Secondly, by June 2020, the parties became aware that FLT’s value had increased “by an amount that was not insignificant”[2].

Once aware of this turn of events, Carmanah and Amphitrite immediately sought to revoke the shotgun offer on the basis that such events have “fundamentally changed the circumstances relating to the shotgun offer”[3]. However, in July 2020, BMI decided to purchase the other shareholders’ interest at the valuation stipulated in the initial notice.

The lower court found that the shotgun offer was revocable. The Court of Appeal reversed such finding and held that the shotgun offer was in fact irrevocable. It based its finding on the plain meaning of the words in the USA, the surrounding circumstances, and the general principles of commercial reasonableness.

In its analysis, the Court of Appeal employed the general principles of contractual interpretation. It first looked at the ordinary meaning of the shotgun provisions in the context of the USA as a whole. In the agreement, the shotgun offer was defined as a compulsory offer and the recipient of the offer was “entitled” to either buy or sell their shares within the election period, which suggested that such offer was locked in and irrevocable.

The Court also looked at the surrounding circumstances and general commercial principles of contract formation. It concluded that both commercial reasonableness and the surrounding circumstances required the Court to interpret the clause as irrevocable within the election period.[4]

The Court explained that such clauses are usually invoked when shareholders wish to terminate their business relationship through a forced sale. Interpreting a shotgun offer as revocable, would go against such an objective of terminating the business relationship.[5]

The Court finally commented that an important feature of a shotgun mechanism is the underlying incentive for each party to make a fair offer based on the market value of the corporation. This fairness-incentive exists because the offeror does not know whether they will be buying or selling their shares at the end of the day. Allowing for a shotgun offer to be revocable would weaken this incentive:

[44] […] To conclude that shotgun offers are revocable absent an agreement to that effect would weaken the incentive for shareholders to make a fair offer.[6]

Moreover, it would unfairly allow an undecided shareholder to test the waters knowing that they can change their mind should a new set of circumstances arise:

[47] […] To conclude the shotgun mechanism could be unilaterally stopped after having been triggered would be to “rescue a party who later regrets contractual arrangements that were carefully designed and accepted”

[48] There is always a risk of market fluctuations during the election period. Parties can mitigate this risk by bargaining for a shorter election period. In this case the respondents agreed to a 60-day election period and further agreed to toll the election period. Sophisticated commercial parties must be taken to understand the market’s risks and uncertainties when entering into contracts [7]

The main takeaway from Blackmore is that a shareholder should evaluate and ensure that they understand the risks associated with initiating the shotgun mechanism. Subject to specific wording in the USA that states otherwise, shotgun offers are likely to be found irrevocable. Once started, the process cannot be halted or reversed.

Secondly, it is important to carefully consider whether shareholders actually want a standard shotgun clause in the USA when it is initially being drafted and, if so, whether they want to personalize its terms.

For example, if shareholders do want the shotgun offer to remain revocable during the election period, they must clearly provide for such flexibility it in the wording of the USA. Likewise, as the British Columbia Court of Appeal stated, if shareholders are concerned with the risks of market fluctuations, they may wish to consider providing for a shorter election period in the USA (or at least not agreeing to an extension without also securing a right to revise their offer). Another option could be to base the purchase price on an arm’s length valuation.

Shotgun clauses are an excellent tool to resolve shareholder disputes relatively quickly, certainly much more quickly than normal litigation. However, they are a blunt instrument which brings significant risk that one of the shareholders could end up significantly “losing out”.

Any of the lawyers from our Corporate Commercial Law Group would be happy to discuss Unanimous Shareholder Agreements and specific provisions such as shotgun clauses.

[1] Blackmore Management Inc. v Carmanah Management Corporation, 2022 BCCA 117 [Blackmore].

[2] Blackmore at para 17.

[3] Blackmore at para 18.

[4] Blackmore at paras 41 and 42.

[5] Blackmore at para 43.

[6] Blackmore at para 44.

[7] Blackmore at paras 47 and 48.