Sometimes we receive instructions for incorporation that include a request to create shares with a fixed redemption amount and a right to receive unlimited dividends. We generally advise against creating such shares, especially if they are to be used in a freeze, because we are concerned that the fair market value of such a share will not be equal to its redemption amount, especially if the share will be held by a controlling shareholder.
In a typical freeze, Father and Mother exchange their Common Shares of Opco for Opco Special Shares with a fixed redemption amount. Any future growth in the value of Opco’s issued shares is supposed to accrue to the new Common Shareholders (usually the Next Generation). It is also quite common for Father and Mother to retain voting control of Opco so that they can keep an eye on their Special Share investments.
The effectiveness of the freeze depends on the value of the Special Shares being fixed. If the Special Shares share in the growth of the value of Opco, the freeze has not served its purpose because the Next Generation will not be receiving that growth.
In general, the Special Shares used in a freeze will be redeemable and retractable for a fixed amount and entitled to non-cumulative dividends equal to a fixed percentage of the redemption amount of the shares. The share may or may not be entitled to vote. See, for example, CRA advance tax ruling ATR-36 (“Estate Freeze”).
What is the position if Mom and Dad’s Special Shares are entitled to unlimited dividends and Mom and Dad control Opco? In Winram v. M.N.R., [1972] D.T.C. 6187 (F.C.T.D.), Gibson J. considered the liability of an estate for estate tax when the deceased died owning nine of the 1,000 issued shares of a corporation. The issued capital of the corporation consisted of 990 Class B shares, which were participating and non-voting and 10 Class A shares, which were participating and voting. The deceased held nine of the latter shares at his death; his wife held the remaining issued shares. It appears the estate took the position that the nine Class A shares were worth only 9/1000 of the entire value of the corporation. The Minister assessed on the basis that the value of the nine Class A shares was much greater than that. The Minister contended that, because the husband could control the issuer, he could divert dividends to himself and, in effect, take all of the value of the corporation for his own benefit. As a result, the value of his shares was significantly higher than the value ascribed to them by the estate.
The trial judge found in favour of the Minister. First, the judge noted the following about the governance of the corporation:
Until the date of death of the deceased and at all material times prior thereto also, the Articles of Association of the company provided at Article 3 that no share might be transferred except with the consent of the Board of Directors “who (might) . . . in their absolute discretion refuse to register the transfer of any share”; at Article 6 that the holders of non-voting shares did not have the right to vote; at Article 17 as amended that in the case of an equality vote that the Chairman had a second or casting vote; at Article 18 that “a Director interested in any contract or arrangement under consideration may be counted to make up the quorum although he shall not vote thereon”; and at Article 20 that dividends might be declared by ordinary resolution and that “dividends so declared may be equal for each class of share or not equal and dividends may be declared on one class of share without dividends being declared on another class of share”.
The judge’s decision is neatly summarized in the headnote of the case:
The wife of the deceased could not, by wilfully refusing to attend a properly called directors’ meeting, prevent the deceased from transferring the nine class A shares of which he was the owner, or from declaring dividends whereby the company would pay out 910 of the surplus to himself. Even if she did attend such a meeting, the deceased, because of his casting vote, could take these steps. Such action would not have been an abuse of his power in respect of the class B shareholders as they did not have an inalienable right to any part of the dividends declared, nor would it have been a breach of the deceased’s fiduciary duty as a director for he would have also been acting in his capacity as a shareholder and would therefore be free of any constructive trust. Also, any dividends declared on class A voting shares at a properly called directors’ meeting would not have been an abuse by the majority of the class A holders over the rights of the minority of class A holders.
Winram dealt with two classes of shares, both of which were fully participating. Perhaps the court would have arrived at a different conclusion if the shares had been redeemable and retractable for a fixed amount. Moreover, the decision has been distinguished in another case involving similar circumstances (see Shepp v. The Queen, [1999] D.T.C. 510 (T.C.C.)).
But why wonder about the status of Winram? It would seem prudent simply to ensure that the freeze shares have a dividend cap. If the freezor wishes to continue to share in the value of the corporation going forward, it would be better to put an estate “gel” in place or leave the freezor with some portion of the Common Shares.
