The existence of a carefully thought-out shareholder’s agreement can go a long way to avoiding costly and time-consuming litigation. Shareholder agreements can set out the terms for various transactions in advance, determine how shareholders and directors are appointed, and a variety of other issues that will be faced by most shareholders over a corporation’s lifetime. Without an agreement in place, the potential for disputes among the shareholders increases, which can result in the need to take every matter to court for determination. A shareholder’s agreement provides certainty, consistency and saves time and money for the corporation and its shareholders over time.
Court Orders Share Transaction as Remedy for Oppression
DS and EM were shareholders in a private Canadian investment company called Pier 21. DS was the majority shareholder. EM successfully advanced a claim of oppression against DS and Pier 21 and the court ordered the defendants to purchase EM’s shares at fair market value. The shares were assessed at $39.3 million dollars and were held in EM’s holding company. Although the shares were to be purchased by the defendants, the mechanism for doing so had not been pre-determined through a shareholder agreement, as the parties had not entered into one.
The method of the transaction, depending on how it was carried out, would have a significant impact on the parties with respect to tax implications and other matters. As a result, the parties were required to litigate the mechanism for the sale.
How Would a Shareholder Agreement Help?
One of the issues that always arise in these types of disputes is the resulting tax liabilities following the ordered transaction. Given that each party would prefer the method most favourable to themselves, the choice then falls to the court to resolve the deadlock.
In the case at hand, the Court had the following options for resolution:
- DS, alone or through a holding company, purchases the shares of EM’s holding company, which owned all of EM’s Pier 21 shares;
- Pier 21 purchases the shares from the holding company and cancels the shares in the process;
- DS, alone or through a holding company, purchases the Pier 21 shares from EM’s holding company.
Each option would have resulted in a different tax liability for EM, as follows:
- $768, 468;
EM advanced option number one as the best as it would “preserve the integrity of the original tax planning.” Of course, this was also in EM’s best interest from a tax perspective and was also tax neutral for the defendants.
DS advocated for option number two as there was concern that owning the holding company’s shares might entangle the defendants in issues and problems with other security investments EM’s holding company may have been invested in.
The Court sided with the defendants and ordered that option two be utilized. The reason it did so was that the best evidence of EM’s “reasonable expectations” when buying the shares was her method of doing so, i.e. through a holding company. This structure had been of benefit to EM in the past when it allowed her to sell some of her holdings back to DS.
Further, there was no evidence led by EM that she had a reasonable expectation of preserving the original tax planning. Equally, there was no evidence led by EM to show her reasonable expectation of a transaction process that would minimize her tax consequences on such a sale to the exclusion of all other factors.
As a result, EM was stuck with an additional tax bill of $81,000 and the expense of any necessary steps dealing with the impact on her holding company.
Parties Should Set Out Expectations in an Agreement in Advance to Avoid Confusion and Conflict
How much easier things would have been for both parties had they entered into a shareholders agreement to protect themselves. Setting out reasonable expectations is much more convincing when done before a dispute arises. An agreement on the mechanism for any future sales or dispositions, and their tax consequences, would have saved a great deal of expense and time for all parties, even if the result was the same.
For Guidance on Shareholder Matters and Representation in Related Disputes Contact Milosevic & Associates
The Toronto corporate lawyers at Milosevic & Associates have many years of experience defending the rights of business owners, directors, officers, and shareholders and advising them on maintaining the continued success of their ventures. Call us at 416-916-1387 or contact us online for a consultation.