What is a Shareholder Loan Agreement?
A Shareholder Loan Agreement is essentially an agreement between shareholders of a corporation and the corporation itself to document any loans made to the corporation by the shareholders. A lender, such as a corporation, lends money to a borrower, like shareholders, in return for an interest and repayment at a later date. Shareholders can structure a Corporation in many ways, including having different "classes" of shares with various rights assigned to them, which can include to repayment of shareholder loans. In a Shareholder Loan Agreement, a corporation, a lender, may want to ensure that funds loaned to it by shareholders are paid back before funds loaned to the corporation by third parties. Such Shareholder Loan Agreements must be documented in writing as well.
If a corporation does not enter into a written agreement with shareholders , there could be issues surrounding if a shareholder’s loan in fact exists or not. A Shareholder Loan Agreement is crucial for record-keeping at a Corporation if there are amounts owed to shareholders. It can also create issues with Canada Revenue Agency in the fact that Shareholder Loan Agreements must be properly documented in order to obtain the tax consequences of making a loan to a corporation.
Having a written lending agreement in place protects both the shareholders involved and the corporation. The agreement sets out all the details of the lending agreement including key stipulations. For example, the purpose of a loan agreement is to ensure that the loan is documented in writing. The shareholder will have a written record to show any taxes owing on interest received. The corporation will have a written record to show any taxes owing on the interest deduction claimed. Upon sale of the Corporation there will be no ambiguity in how the loan is settled. Shareholders will know how much money they will be receiving under the loan agreement as part of the sale.
Essential Elements of a Shareholder Loan Agreement Template
A shareholder loan agreement template will generally specify important facts such as the parties involved, the loan amount, interest rate, repayment terms, and conditions of default. Details such as how any improvement will be compensated, using which valuation method, may also need to be included within the document.
The most straightforward methodology for determining the loan amount in a shareholder agreement is based on the person’s current level of ownership in the form of shares. The formula can be as simple as a set percentage of the interest held, such as 10 percent, or it could be more nuanced, involving a multiple of what they could have received if they were to have sold their shares quickly or by market price.
Interest rate specifications within a shareholder loan agreement template may be complicated. For example, the rate of interest on the loan can fluctuate in order to be at or below the "applicable federal rate," or AFR. The AFR is adjusted on a monthly basis, and will depend upon term of the loan, whether it is a short-term or long-term loan, and the given prevailing interest rates. Amortization of the payments may be required, or could simply entails interest-only payments over the term of the loan.
As with other forms of commercial debt, repayment terms should be fair to both parties to the agreement. In the event of default or forbearance, the agreement would ideally specify whether there is a deficiency judgment, whether loan fees are due, or whether an extension of time is offered. The nature of the enforcement process is often required, specifying whether the loan is secured by the shares and whether there is the right to foreclose on them, or otherwise liquidate the shares in any way deemed appropriate.
Advantages of Utilising a Template
When starting a company, there are a number of agreements that will need to be drafted. A Shareholder Loan Agreement should also be executed whenever a shareholder in the Company loans the Company money. Rather than drafting each of these agreements from scratch, using a template for a Shareholder Loan Agreement can prove helpful. A template for a Shareholder Loan Agreement ensures that you include the relevant information in a loan agreement for a specific loan. If there are terms that won’t be included in the loan, you simply have to take it out of the template when you utilize it. There is no need to start from the beginning and worry about whether you forgot to include key terms. For the same reason, a template on a Shareholder Loan Agreement for your Company will save you time. Templates take into account the most important terms needed in an agreement, including: Using a template means that you won’t forget to include these terms and others that should be a part of each and every agreement you draft. Using a template also makes it easier to ensure that you are in compliance with legal requirements when making a loan between the Company and its shareholders. This is a very unique category of loans, and there are certain requirements that must be met to ensure that the loan is treated as a bona fide loan, rather than a gift by the Internal Revenue Services. If you aren’t familiar with the terms that must be included in loan agreements, you may not be able to comply with the law. If you are using a template, it is a lot easier to create a loan agreement that is in compliance with the law because you know what terms are absolutely necessary in the agreement. You can then create an agreement that satisfies both your business needs and legal needs. Lastly, a template can make it much easier to ensure consistency in the loan agreements that you draft. For some people, this is important because keeping track of the loans you make and ensuring that you are complying with the law requires creating formal documentation for your records.
Downsides and Precautions
When drafting or using a shareholder loan agreement, a few risks and things to consider are as follows:
Common Pitfalls
1. Terms and Payments
The issue is often that the parties simply don’t take the time to agree on the terms of repayment. An agreement should include specific dates on which principal and interest payments are to be made. If the agreement does not have a clear schedule outlining payments and they are being made on a continual basis, there is a risk that they may be deemed dividends as opposed to loans. If the shareholder loan is ever disputed in court and the terms are scattered throughout many different documents, it may become difficult to prove the true intention of the parties.
2. Accounting
As mentioned above, it is important to keep track of where the money is coming from and going to in the corporation’s books. If accounting fails to properly record the shareholder loan or incorrectly categorizes a payment to a shareholder (as a dividend instead of a loan or vice versa), it may lead to expensive rectifications.
3. Director Resolutions
While the terms of the agreement can be between the corporation on the one hand, and the shareholder on the other, the corporation’s directors may also need to approve the loan. In such cases, approval will need to be obtained from the board of directors, either by way of board resolution or in the meeting minutes, or else the loan will not be valid. This may present a risk particularly in the event that the board of directors changes and persons who were not privy to the shareholder loan become directors and seek to terminate it.
4. No Interest Accrual
Many times, shareholders will agree to not charge interest on the loan. Given that the lender-shareholder is likely furthering their own investment in the corporation by loaning funds, an argument can be made that charging interest would be contrary to the purpose of the shareholder loan and that interest should not accrue. It is quite common for shareholder loans not to accrue interest, however, in the absence of a provision to the contrary in the shareholder loan agreement, interest may accrue. Alternatively, as discussed below, parties can agree to defer interest payments until the end of the term by means of the shareholder loan agreement.
5. Future Loans
It is important to have the terms of all future loans clearly defined and contained in the shareholder loan agreement. This should ideally be done by way of an additional clause, which states that the Shareholder Loan Agreement includes all future amounts and terms of any further loans to the corporation by its shareholders. Otherwise, without a clear new agreement on the terms of a prospective loan, the new loan may be viewed as a gift, thereby having negative tax implications.
Mitigating Risks
The best way to mitigate risk is to make sure to always appropriately categorize all payments to and from a shareholder to the corporation. The first step to accomplishing that is to create a comprehensive shareholder loan agreement that accurately reflects the requirements of the Income Tax Act (ITA). This is particularly true for publicly held corporations who have shareholders from outside of Canada, as taxation issues may arise under the ITA as a result of failure to draft repayment terms sufficiently in the shareholder loan agreement.
Customising Your Template
The shareholder loan agreement template is drafted to be in compliance with general laws governing loans made to shareholders. However, a reader may be wondering whether he or she needs to change the agreement and what changes should be made. There are three distinct types of changes that fall under the category of customization: adding, deleting, and modifying the content. Adding is the process of inserting additional information without removing anything. Deletion is quite the opposite, and involves removing part or all of the existing information. Modification is a hybrid process, meaning that portions of a previous version remain while other parts are replaced by a new version. An individual is required to customize the agreement in accordance with his or her specific interests . For example, if a lender is keen on having an interest rate lower than the standard, a loan agreement modification will be needed. A borrower that desires to pay a lower rate after two years (also known as a step down interest rate schedule) will likewise require a custom modification. Most businesses engage in specific activities or practices that separate them from average small or mid-sized businesses. Such enterprises need to make specific modifications that reflect their overall operations when completing a shareholder loan agreement for that particular organization. The needs of a large international business are vastly different from a local one and as such warrant a different agreement, tailored specifically to accommodate.
Legal Considerations and Adherence
The legal implications of shareholder loans can be significant, as the terms of the loan agreement can impact both corporate operations and shareholder relations. For example, the terms of the loan may impact the distribution of corporate profits among shareholders or the amount of control certain shareholders exert over the company. The rights and obligations established in the loan agreement may also have implications for bankruptcy or other creditor issues.
Section 109 of the Business Corporations Act (BCA) requires that a corporation shall not make a loan, guarantee or provide security for a loan to a director or a shareholder unless the special resolution and consent of shareholders is obtained. Despite the legal protection for the corporation, there can be considerable risk in giving advantage to one shareholder over another. A simple difference in interest rates may create dispute among shareholders. Additionally, shareholder loans may create tax liabilities for the corporation and the shareholders. Before proceeding with any shareholder loan, the corporation should obtain legal advice. Legal advice should include considering the shareholder relationship, not just the corporate structure. In deciding whether to proceed with a loan to a shareholder it may be necessary to look at the larger picture, such as:
Sources for Trustworthy Templates
For many businesses, using a template agreement is the fastest way to go about legally binding a shareholder loan. However, there is a lot of variation in these templates depending on their source. This can leave the business with a document that is either not particularly useful or not legally binding, and in some cases both.
The easiest route for most businesses is to use a company formation service. These services will often have access to a well-written suite of documents, with the necessary provisions written into each one. They may not be as easily customizable as a standalone document, but they can greatly reduced the amount of detail that the business has to define about its own .
Companies can also access templates through an employment attorney or tax attorney. Both of these fields regularly use these kinds of contracts, and so should be able to provide a contract that meets your demand. There’s no person more likely to know exactly what clauses need to be included and how to articulate those clauses than an attorney.
Relying on software tools is another popular method for acquiring shareholder loan agreement templates. Online software programs will provide a question and answer format to help you define everything necessary for the document. At the end of this process, you’ll receive a document that’s ready to sign. Just as with a legal office, you’ll be able to access templates for other contracts as well.
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