Benefits of Unanimous Shareholders Agreements

While fledgling startups frequently are short of disposable funds to be expended upon legal documents designed to record the expectations and the participation of the principals, serious consideration should be given to some sort of a Unanimous Shareholders Agreement, almost regardless of how extensive.

Regrettably, not all ventures fully succeed or surpass the wishes of their creators and in the event of a dispute or collapse, the costs, whether through litigation or third party intervention, to resolve disputes, often exceed even the economics at stake.

“Shot Gun” clauses offer a tried and true method for dealing with potential battles of interest.

This is a dual-message. First: all business relationships among parties should have a “divorce mechanism”. The second is that “shot gun” clauses offer an expeditious and expedient method to achieve that divorce without the necessity and costs of litigation.

In essence, “shot gun” clauses allow one party to say: “I want either to buy you or to sell to you: same terms; you choose”.

It’s cutting the pie: the other side chooses which “one-half”.

THE SHOT-GUN NOTICE

But here’s the caution: almost all “shot gun” clauses dictate that the shot gun Notice determines the terms of the shot gun. (NOT the Unanimous Shareholders Agreement in which is found the provision for the shot gun clause).

Extreme care must be taken to set out precisely what are the terms triggered on a shot gun clause. It is not infrequent that the underwriters of the business (the startup entrepreneurs) have guaranteed bank loans or possibly leases of premises or third party contracts. The shot gun Notice should expressly state what is to be done with those third party obligations; most usually, that, whoever is the eventual Vendor of shares, is absolved of all of those third party obligations.

The shot gun Notice is the document in which those terms are set out and they must be set out explicitly because that is what the other party is to receive and must match in order to reverse the shot gun.

A clear example: a business operates for a brief period of time and generates significant Canada Revenue Agency unremitted withholdings or HST obligations together with an operating line of credit and a government guaranteed small business loan. One or the other of the shareholders wishes to get out of the venture but wishes to be absolved of all third party obligations. The shot gun Notice must set out exactly what is to be done with those third party obligations. If they are not expressly set out, there is no obligation of a party to eliminate those third party obligations and the departing shareholder may find himself in the position of being a continuing guarantor of the indebtedness due by his former Corporation and former shareholder/partner.

The message and takeaway is:

1. The shot gun Notice must be triggered with absolute certainty of what is required including full specificity of all terms.

2. Frequently, the party ending up purchasing must renegotiate with third parties all third party obligations in order to secure the release of the vending partner. That takes time and third party cooperation and frequently substituted security to satisfy the third party lender.

Winding Down A Business

There are 2 prominent initiatives driving consideration of winding down a corporation:

1. First, retirement/capitalization on investment; sale to third party; or
2. While still operating, a desire to reduce complexity and possibly to merge holding companies with operating companies to result in fewer tax filings and simplification of administration.

These types of initiatives frequently arise from family maturation, change in business plans or maybe even declining business.

But regardless, many enterprises have complex structures of “tiered” corporations frequently determined by estate planning or for the purpose of segregating potential liability. The relevance of these related corporations should be seriously considered before the desire to simplify prevails over better business structure planning.

It’s natural to think of simply “shutting down”. Simple as that may seem, that will not stop government filing requirements, costs to complete tax returns and continual notices from various levels of government, sometimes rather costly as the result of the failure to file.

So we’ve counseled clients to consider amalgamations between and among holding companies and operating entities to result in just one corporation and therefore just one set of filings. Continuing a corporate existence to take advantage of corporate tax rates/income splitting and banking relationships should be considered. It is not infrequent that corporate structures have been established in a multitude of jurisdictions necessitating the bringing of a corporation from one jurisdiction (say, for example, the federal jurisdiction) into the jurisdiction of another company (say, an Ontario company).

One must also assess the effect of an amalgamation relating to liabilities. Remember that whatever were the assets and liabilities of each pre-amalgamation corporation automatically become the assets and liabilities of the post-amalgamated corporation.

There are admittedly certain savings and tax benefits, but at the same time before simply proceeding, serious consideration should also be given to the liability component of the effect of amalgamation.
We’d be pleased to assist you in your consideration.

Franchise Leases

Most franchise operations involve either the franchisor holding a lease and subletting to a franchisee (for obvious control purposes) or the franchisee itself directly leasing space with direct liability to a Landlord.
Either way, the franchisor always seeks control over the location in the event the franchisor seeks to enforce its rights following a franchisee default.

So, for franchisees, here are your issues:

1. Who controls the location?
2. Can you operate any other business on the site in the event the franchise agreement is revoked or discontinued or the franchisor ceases to operate?
3. If the franchisor controls the lease, who controls the renewals if any?
4. What about personal liabilities either of the franchisor in its capacity as both the holder of the intellectual property of the franchise as well as the holder of the real estate?
5. Who owns the improvements located in the premises? (machinery, equipment)

It’s not easy to differentiate the relationships, but if you are a pending franchisee, don’t lose sight of the fact that the lease is as important and sometimes even more important than the franchise agreement.

Sale of Assets vs. Shares

Clearly one of the most fundamental issues for business vendors is the alternatives of an asset or a share sale.

For a moment, and setting aside the tax implications, a sale of assets has considerably fewer issues for a purchaser compared to purchasing shares.  For example, on a purchase of shares, all of the liabilities of the corporation whose shares are purchased become the liabilities assumed by the purchaser (not directly, but the liabilities do not go away).

In a share acquisition, the vendor is actually the shareholder whereas in the case of an asset purchase, the vendor is the corporate entity.

It is probably economically understandable that there would be a different price point for purchasing shares as opposed to assets:  In the case of purchasing shares, the vendor shareholder may well have a capital gains exemption and effectively receives more money into his pocket on a share sale than for an asset sale at the same price.  In the case of an asset sale, as above, the vendor is the actual corporation and may be faced with either recaptured depreciation or capital gains tax or both, but in any event the asset sale gives rise to taxes on the purchase price payable by the corporation.

Until late March 2017, an asset purchase and sale in Ontario had to comply with the provisions of the Bulk Sales Act which itself was a nuisance.

However, that statute was eliminated in Ontario late March 2017 (as it had been eliminated in all the other provinces and territories of Canada quite some time earlier).

Application for “Probate” – Part II

In a recent matter, the issue of an Application for Probate (technically, an “Application for the Appointment of an Estate Trustee with Will”) involved some extraordinary complications given that the Deceased died in the United States where he had resided for some lengthy period of time leaving only an asset in Ontario generating significant revenues for the Estate well into the future.  However, as the Deceased, in his Will, had designated his spouse (also in the U.S.) to be his Personal Representative, the complexity related to the appropriate Application for Probate in Ontario.

In Ontario law, Ontario assets are not subject to the authority of any foreign jurisdiction or any foreign Personal Representative or Executor.   Ontario assets requiring Probate, require that Probate to be in Ontario.  In this case, the desire of the Deceased’s family was to have the Ontario revenue-generating asset not subject to Canadian withholding taxes as would occur if the money were to be forwarded to the Widow in the United States.  Instead, the family sought to have one of the children, a Beneficiary and a resident of Canada, apply for the appointment Order which would result in a Canadian residency of the Estate for the purposes of the Ontario asset.

In the usual case, the Application to deal with the Ontario asset by the U.S.-resident Widow would be made by the same Personal Representative (Executrix) as was appointed in the foreign jurisdiction (called an “Ancillary Appointment”).

But not so fast in this case.  If the Widow were to make that Application in Ontario, the revenue stream to the Estate in the U.S. would be subject to the 25% Canadian withholding taxes.  In the case as presented, that was potentially $250,000 per year in taxes, enough of an incentive to consider alternatives.

An Application was filed on behalf of the Canadian resident Beneficiary after the Widow renounced in the U.S. (resigned, leaving no Personal Representative anywhere). The Application was rejected by the Court on the basis that there had been “Probate” in the U.S. and either the Widow should seek Probate in Ontario or if the Canadian Beneficiary Applicant were to be appointed, there would have to be good reason for that Court Order beyond simply the wishes of the Applicant or even the family.

The message:  each Estate has its own particular quirk yet all Probate Applications are fixed in forms prescribed by Court Rules.  Squeezing a “square box” particular Estate into the Court required “round hole” forms is never easy, extremely time consuming and not always successful.

We strongly recommend careful planning for the administration of an Estate before obtaining Court Orders, in any jurisdiction, which can be binding on other Courts.

Application for “Probate” – Part I

At its simplest, “Probate” involves a Court Order appointing someone as the “Executor” (now called an “Estate Trustee”) of an Estate. Usually the Applicant is named in a Will, but if there is no Will, then the Applicant may be any person not disqualified under current jurisprudence. The objective of the appointment of an Executor (again, now, the Estate Trustee) is to carry out the wishes of the Deceased under his Will if he had one and to administer the Estate and its distribution.

Seems simple. But not always. The procedure for the Application is regulated under Court Rules and precision as well as completeness is mandatory. As in many other areas of Court processes, what is acceptable, however, in one Court office may not be acceptable in another.

The Application must also be accompanied by payment of the “Probate Fees”, now called “Estate Administration Tax” (“EAT”). This tax is calculated at $5 per thousand dollars of the value of the Estate up to $50,000 and $15 per thousand dollars of the value of the Estate above $50,000.

Now, the hard realities. The EAT is paid at the time of the Application by the Applicant before any of the Estate is distributed. Same for the legal fees arising from any legal assistance used to prepare and file the Application.

The Court Order may be delayed weeks or even longer for its delivery, making reimbursement of the Applicant’s payment of the EAT (and legals) relatively burdensome. Bank loans may be necessary but the Estate’s assets are not “security”, as they don’t belong to the Applicant/borrower.

Further, the Court may reject the Application or request either further information or a Court attendance – more time and money.

All of these issues (and most importantly, the amount of the EAT) are strong incentives for early planning, the use of effective Wills and, as much as possible, elimination or reduction of the value of the Estate that requires Probate before it occurs (and here it is worth pointing out that not all Estates require Probate).

There are several techniques available to legal counsel in estate planning. We would be pleased to share some of these with you.

Residential Tenancies

Residential tenancies are a combination of a business relationship and a personal tinderbox.

The Tenant occupies the Landlord’s personal property over which the Landlord considers its interests paramount.  And the Tenant is vested with certain rights of exclusive possession and use.

Normally, the relationship is governed by the Residential Tenancies Act or by way of a Lease Agreement, the latter, usually provided by the Landlord.  And usually the Tenant just signs it.

But given the overlay of the Residential Tenancies Act (the “Act”), all residential tenancy leases are also bound by the law of Ontario.

A few of the events of potential conflict between the Landlord and the Tenant arise with respect to:

1. Who does what for maintenance/repairs/breakdown of equipment/snow removal/grass cutting and a host of other issues?
2. What happens when the Tenant wishes to move out — or doesn’t, leaving the Landlord with the potential of having no rental stream for a period of time after the Tenant unexpectedly moves out?
3. The Landlord wishes to sell.
4. Access to the premises while the Tenant lives there.

And there are a ton of other issues.

In almost every case, either the Act or the lease provides direction to a situation.

But, more particularly, the relationship between the Landlord and the Tenant is a human relationship which admittedly has a business connotation, but it is still a human relationship and is fraught with all of the issues of personal orientation (and personal confrontation).

There are some simple solutions.

1. Be sure there is a Lease.
2. Be sure the Lease sets out who does what.
3. Even if you agree on numbers 1 and 2, the Act still applies.
4. Even if you agree on 1, 2 and 3, common sense should prevail.
5. Lastly, if you ignore 1, 2, 3 and 4 above you will most assuredly spend money on lawyers which, without doubt, is non-revenue producing and a pain to endure and all too frequently takes longer for resolution than any of the parties might have anticipated.