Estate Planning Council - Edmonton November 2012 SHAREHOLDER AGREEMENTS ISSUES IN To establish the parties rights and obligations where a shareholder SUCCESSION terminates his/her PLANNING association with the corporation. Gary H. Clark CLU TEP Often it is the most tangible and visible blueprint of a carefully thought out succession plan. The Business Succession Advisory info@clarkandarsenault.com STEP Toronto Page 1 A
Important Dates for Shareholder Agreement Planning 31 December 1971 Capital Dividend Account created for Canadian Controlled Private Corporations (CCPC s ) 01 January 1978 Alberta Business Corporations Act changed to allow AB Corporations to deal in Own Shares. 1985 - $500,000 ($750,000) Capital Gains Exemption for individually owned shares of a private corporation introduced. 26 April 1995 Stop Loss Rules Introduced 01 January2006 Two categories of dividends for private corporations. Eligible & Ineligible STEP Toronto Page 2
BUSINESS SUCCESSION The significant wealth of most individuals is represented by the shares of a private corporation. STEP Toronto Page 3
BUSINESS SUCCESSION Where a Business is to be continued A Unanimous Shareholder Agreement (USA) is a valuable legal document for the protection of the parties. STEP Toronto Page 4
BUSINESS SUCCESSION Alternatives of Business Succession: Sale to other Shareholders Sale to Employees Sale to Third Party Sale or Transition to Family Go Public Wind up Business STEP Toronto Page 5
SHAREHOLDER AGREEMENTS Automatic consideration by individuals joining together as shareholders in a company. The agreement often calls for life insurance to fund the purchase on the demise of a shareholder STEP Toronto Page 6
SHAREHOLDER AGREEMENTS Like Wills Shareholder Agreements are seldom readdressed. No such thing as a Standard Agreement. Where do precedents come from? STEP Toronto Page 7
SHAREHOLDER AGREEMENTS Often not current, or are not constructed in a tax efficient manner. As tax laws change, original agreements are seldom revised to take advantage of new strategies. STEP Toronto Page 8
Stop Loss Quick Review STEP Toronto Page 9
CORPORATE REPURCHASE OF SHARES Prior to April 27 th, 1995: Deceased s estate could be bought out tax free to the extent of the Capital Dividend Account (CDA) The repurchase of shares considered a deemed dividend and by the agreement, is to be elected out of the corporation s CDA. STEP Toronto Page 10
Stop Loss Rules - Introduced April 26 th, 1995. Stop Loss Rules limit the tax free repurchase of shares to 50% of the Deemed Dividend leaving the remaining 50% taxable to the Estate. Without planning, 50% of the CDA could be wasted for the surviving shareholder (s) STEP Toronto Page 11
MISCONCEPTIONS and OMISSIONS Agreements Often Overlook the Stop Loss Rules. Calls for the corporate repurchase of shares of a deceased shareholder without the knowledge of the grandfathered status of shares Fails to recognize the availability of the $750,000 Enhanced Capital Gains Exemption on personally held shares STEP Toronto Page 12
MISCONCEPTIONS and OMISSIONS CALU negotiated for Grandfathered status for shares owned on or before April 26 th, 1995 Shares could be Grandfathered by Agreement Insurance STEP Toronto Page 13
Shares Grandfathered by Agreement A signed agreement was in place prior to April 27 th 1995 calling for the repurchase shares : of Insurance can be added. Agreement cannot be altered or modified STEP Toronto Page 14
Shares Grandfathered by Insurance Corporation named beneficiary of a life insurance policy on April 26th, 1995, and a main purpose was to repurchase shares; An Agreement can be Added, Changed, Rewritten Insurance can be Added, Increased, Replaced STEP Toronto Page 15
Shares Grandfathered by Insurance Shares retain grandfathered status: Shares exchanged for different class (Section 51 ITA) Shares reorganized under internal or external freeze (Section 85 and 86 ITA) Amalgamation of Companies (Section 87 ITA) Proof of Grandfathered must be maintained STEP Toronto Page 16
STOP LOSS RULES PLANNING Shares left to Surviving Spouse Puts and Calls / Roll & Redeem Strategy Deceased shares left to surviving spouse, common law partner or spousal trust on tax free rollover basis Spouse puts shares to the corporation and other shareholders within 120 days. Surviving shareholders and/or corporations have Call option after 120 days. STEP Toronto Page 17
STOP LOSS RULES PLANNING Shares left to Surviving Spouse Puts and Calls/Roll & Redeem Strategy (continued) Deceased s spouse shares repurchased tax free to extent of CDA. Important that deceased has a valid will leaving shares to the spouse. STEP Toronto Page 18
STOP LOSS RULES PLANNING No Spousal Roll Over 50% Solution 50% of shares can be repurchased from a deceased s estate, tax free to the extent of CDA. 50% is taxed as dividend (preserves 50% of CDA for surviving shareholders.) STEP Toronto Page 19
STOP LOSS RULES PLANNING No Spousal Roll Over 100% Solution 50% of shares can be repurchased from a deceased s estate, tax free to the extent of CDA. 50% (balance) is taxed as Capital Gain; (wastes 50% of CDA for surviving shareholders) Who Decides? STEP Toronto Page 20
SHARES OWNED BY HOLDCO (Corporate Shareholder) Tax free repurchase to Holdco to the full extent of CDA No Puts & Calls required Should be a mandatory repurchase Executor or Personal Representative can determine 50% or 100% solution out of Holdco STEP Toronto Page 21
Denille Industries Case STEP Toronto Page 22
DENILLE INDUSTRIES CASE Denille Industries Ltd. v. Island Enterprises Inc., 2012 ABCA 140 (Alberta Court of Appeal) Corporation with three corporate shareholders (40%-40%-20%) who signed a unanimous shareholders agreement A 40% shareholder died and a dispute arose regarding interpretation of the agreement STEP Toronto Page 23
DENILLE INDUSTRIES CASE S. 5.7 of agreement gave estate option to put some or all of its shares to surviving shareholders S. 5.8 gave survivors a call option if option under s. 5.7 not exercised Estate exercised put option with respect to 1 of its 40 shares STEP Toronto Page 24
DENILLE INDUSTRIES CASE One of the survivors attempted to exercise call option regarding 27 of the estate s shares Estate took position that no call option available because put option exercised Estate succeeded at trial STEP Toronto Page 25
DENILLE INDUSTRIES CASE Appellant s arguments: Other terms should be implied, such as duty to sell all shares or to keep shareholdings in same proportion Suggested a duty to use insurance to buy all shares STEP Toronto Page 26
DENILLE INDUSTRIES CASE Court of Appeal findings: No implied duty to sell all shares or keep shares in proportion Plain words of agreement supported estate s position No ability to rectify agreement or fix an error (if there was one) Appeal failed STEP Toronto Page 27
DENILLE INDUSTRIES CASE LESSONS At drafting stage carefully consider alternative buy-sell strategies that would apply on death Optional purchases and sales on death may create uncertainty and cause disputes Mandatory buy-sell funded with life insurance preferable in most cases Any sale on death should usually involve all of the deceased s shares STEP Toronto Page 28
Ribeiro versus Braun Nursery Ltd. Ontario Superior Court 2009 Ribeiro vs. Braun Nursery Ltd. STEP Toronto Page 29
SHAREHOLDER AGREEMENT REVIEW No Capital Dividend Account election stated in agreement on repurchase of deceased s shares. STEP Toronto Page 30
Ribeiro (Estate) v. Braun Nursery Ltd. 2009 CanLII 1149(OSC) Key employee/minority shareholder Corporate-owned life insurance used to pay portion of sale price under shareholders agreement Corporation required to use insurance for buyout but no mention of capital dividend account STEP Toronto Page 31
RIBEIRO CASE: LEGAL ISSUES Estate brought application under Ontario Business Corporations Act Sought oppression remedy - damages equal to additional tax paid (approximately $250,000) Alleged that Corporation acted unfairly in failing to declare capital dividend on purchase of shares STEP Toronto Page 32
RIBEIRO CASE: DECISION Court found that Corporation had fulfilled all obligations under shareholders agreement Also found that deceased could not have reasonably expected Corporation to go beyond wording of the agreement Claim for damages dismissed STEP Toronto Page 33
RIBEIRO CASE: FINAL COMMENTS Not clear from judgment whether failure to refer to capital dividend account was intentional or a drafting omission Usual advice is to make specific reference to how capital dividend account is to be used Parties intentions should be made clear in wording of agreement STEP Toronto Page 34
2007 Shareholder Agreement Reviewed Nov. 2012 1- No $750,000 Enhanced Capital Gains Exemption Advantage (Double Up) Overlooked. 2- No Capital Dividend Account Election on Deemed Dividend (Life Insurance). 3- No Plan Around Stop Loss Rules Causing Unnecessary Tax 4- Any Shortfall on the Repurchase of Shares Taxable as a Dividend. (27.71% Ineligible / 19.29% Eligible) STEP Toronto Page 35
2007 Shareholder Agreement Reviewed Nov. 2012 5- Default Provisions Could Cause Association of Companies Result: sharing of $500,000 Small business limit. 6- Life Insurance not excluded in Valuation Formula 7- Corporations Accountants to Establish Business Value When Shareholder s Can t Agree Creates a Conflict of Interest for Accountant. 8- Life Insurance to be owned by Operating Company. Consider Alternate Ownership Structure STEP Toronto Page 36
Shareholder Agreement Review OTHER ISSUES STEP Toronto Page 37
SHAREHOLDER AGREEMENT REVIEW Dividend Election Agreements do not specify from which dividend pool the a dividend is to be elected Alberta Eligible Dividend ------ 19.29% Ineligible Dividend ---- 27.71% Capital Gain ------------ 19.50% Consider a Cross Purchase on any shortfall (be aware of 84.1 ITA) STEP Toronto Page 38
COMBINED TOP MARGINAL TAX RATES for Individuals - 2012 STEP Toronto Page 39
SHAREHOLDER AGREEMENT REVIEW Default Provisions Can Cause Association of Companies where a shareholder has an interest in another Corporation STEP Toronto Page 40
SHAREHOLDER AGREEMENT REVIEW Shareholders can be associated under options arising upon: Partial disability Receivership Breach in terms of the Agreement Shares attached under Matrimonial Property Settlement Retirement Loss of employment No association issues upon: Death Permanent Disability Bankruptcy STEP Toronto Page 41
SHAREHOLDER AGREEMENT REVIEW Optional versus Binding Purchase Upon Death Heirs have option to retain shares or sell. STEP Toronto Page 42
SHAREHOLDER AGREEMENT REVIEW LIFE INSURANCE 1- Many agreements assume the corporation to be the owner and beneficiary (Opco) A withdrawing shareholder entitled to acquire insurance on own life for CSV or portion of term premium. Transfer must occur at FMV. STEP Toronto Page 43
SHAREHOLDER AGREEMENT REVIEW LIFE INSURANCE 2- Often life insured owns insurance on own life with the corporation named as beneficiary. No penalty for owner for redirecting insurance away from its intended use when death occurs. No restriction on policy s assignment Consider: Name Corporation Irrevocable Beneficiary Purchase price reduced by amount of insurance intended to fund the purchase or for which the owner was reimbursed STEP Toronto Page 44
SHAREHOLDER AGREEMENT REVIEW FAMILY Business to Remain in Family Control Tax liability Need of Unanimous Shareholder Agreement Insuring potential beneficiaries STEP Toronto Page 45
COMMON STRUCTURE Mom Dad Trustees Preferred Shares FMV $16 M Common Shares Holdco Trust Opco Opco Opco Beneficiaries STEP Toronto Page 46
BUSINESS SUCCESSION OTHER ISSUES American Citizen ( Dual Citizenship) Shareholder or American spouse considerations Shareholder Loans not identified as part of Shareholder interest Often not insured STEP Toronto Page 47
ADDING FLEXIBILITY TO THE AGREEMENT Notwithstanding the foregoing, the parties may choose an alternate method of buyout which they agree is advantageous to all parties Such election must take place within sixty (60) days of the death or disability of a Principal If no such agreement has been reached by the sixty first (61st) day as an alternative method of buyout, this agreement as outlined aforesaid will stand STEP Toronto Page 48
Questions Importance of Shareholders Agreement Structure and Review Among the Advisory Team Gary H Clark CLU TEP Clark&Arsenault Advisory info@clarkandarsenault.com STEP Toronto Page 49