Many people choose to start a business to provide for their families. When these enterprises are successful, money flowing from those companies has the potential to sustain a family for generations – and minimize their tax obligations. When there is a change in directors, shareholders should be assured that business will operate, more or less, like usual. For those who fall victim to material changes, certain remedies exist to rectify the situation.
Family businesses provided income to business owner’s family
In a recent Ontario case, a business owner died in 2020 due to a stroke. He was survived by his wife, Sheila, and three daughters. His daughter, Denise, was the applicant.
The business owner had five different enterprises that were the subject of the dispute. Each of these businesses generated enough revenue to sustain the family’s lifestyle, which included homes on the Bridle Path and in Florida, golf club memberships, and regular luxury vacations. The funds from the businesses also paid for the daughters’ homes even though none of them had ever worked for the companies. The daughters also owned shares in some of the corporations from which they received monthly stipends.
Daughter’s sole income derived from business
One of the businesses, 530 Ontario, owned half of the shares of a commercial rental property. In 2001, the business owner implemented an estate freeze and transferred the shares to his other corporation, DHA. After the transfer, DHA issued the below shares:
- 100,000 Class C non-voting shares at a fixed value of $1.25 million to 530 Ontario. 530 Ontario redeemed these in 2006. DHA provided a promissory note in the full amount with interest at 3 percent per year.
- 240 Class B voting shares to the business owner so he could control DHA as its sole director.
- 100 common voting shares to the business owner, which were subsequently transferred to Denise at no cost. This represented the majority of the future equity growth.
The director had the power and full discretion to issue dividends. Under the articles of incorporation, DHA was permitted to issue an unlimited number of all share classes. Denise, as a shareholder, could not transfer her shares without the director’s consent.
Although the business owner did not issue new shares of DHA, he had been providing a monthly stipend to Denise out of 530 Ontario. Aside from her monthly stipend from 530 Ontario, Denise earned no other income. The business owner was the sole director of DHA until his death.
Daughter’s income changed significantly after father’s death
Upon the business owner’s death in 2020, his Class B shares in DHA and majority interest in 530 Ontario were passed onto his wife, Sheila. From 2019 to 2020, the stipends given to Denise from 530 Ontario decreased by $156,000.
At the same time, the adverse market conditions brought on by the COVID-19 pandemic caused another family business to decline. This business had been providing Sheila with most of her income. In 2019, the daughters removed Sheila as a director of that business and stopped paying Sheila a year later, after their father’s passing. In response, Sheila altered the corporate structure of DHA through a Debt Conversion Agreement. The Agreement converted DHA’s debt owed to 530 Ontario into Class B shares of DHA with a total redemption value equal to a redemption value of nearly $1.3 million. Sheila admitted that this action was done to allow revenue flowing from DHA and the commercial rental property to go to her instead of Denise.
Daughter sought oppression remedy
Denise brought an oppression application under the Ontario Business Corporations Act. The relevant provision, section 248(2), reads:
(2) Where, upon an application under subsection (1), the court is satisfied that in respect of a corporation or any of its affiliates,
- any act or omission of the corporation or any of its affiliates effects or threatens to effect a result;
- the business or affairs of the corporation or any of its affiliates are, have been or are threatened to be carried on or conducted in a manner; or
- the powers of the directors of the corporation or any of its affiliates are, have been or are threatened to be exercised in a manner,
that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer of the corporation, the court may make an order to rectify the matters complained of.
In the leading case of BCE Inc v. 1976 Debentureholders, the Supreme Court of Canada created a two-step test to assess claims brought under this section. First, the court determines if the evidence supports the claimant’s reasonable expectations. Second, the court determines if the evidence that the reasonable expectation was infringed by oppressive conduct. Oppression is defined as carrying “the sense of conduct that is coercive and abusive, and suggests bad faith.”
Daughter had reasonable expectation of continued income
The Ontario Superior Court held that Denise had the reasonable expectation that she would continue to receive her monthly stipend payments, consistent with those received before her father’s passing. She also had the reasonable expectation of benefiting from DHA’s residual value, even after both her parents had passed. These expectations were breached when Sheila implemented the Debt Conversion Agreement.
However, Sheila also had the reasonable expectation that she would continue to benefit from the family’s various businesses, including the commercial rental property, even after her husband’s death. It was also her reasonable expectation that she would continue to make reasonable income into her old age.
In assessing these conflicting expectations, the Court sided with Denise. Sheila ignored Denise’s reasonable expectations and treated Denise’s interest in the companies as trivial. She took no consideration of those interests while entering the Debt Conversion Agreement and implemented changes that affected Denise’s only source of income. Therefore, the Court held that Sheila’s conduct was oppressive.
The Court could not determine what remedy should apply as there was insufficient evidence about the amounts Denise received during the business owner’s lifetime. It also did not have enough information about the amounts needed to meet Denise or Sheila’s reasonable ongoing and current needs. As a result, the parties were directed to exchange further details and return to the Court if they could not come to a reasonable accommodation.
Contact the Lawyers at Campbell Litigation for Help Resolving Shareholder Disputes
Campbell Litigation understands the complex and high-risk nature of business and commercial disputes. Our experienced team represents business owners and other stakeholders in various matters, including estate-related issues and creditor-debtor matters. Richard Campbell has decades of experience in several dispute resolution processes, including mediation, arbitration, and litigation (including trials and appeals).
Our reputation is based on our years of experience and familiarity with the distinctive nature of the Waterloo business community. To find out how we can help you and your business, contact us at 519-886-1204 or reach out online.