The Unanimous Shareholder Agreement And Its Importance

Answer

A unanimous shareholder agreement (USA) is a contract among all shareholders of a company that restricts the powers of the directors to manage the business, transferring those powers, in whole or in part, to the shareholders. This crucial document is often used by KWB and other businesses to define the rights, responsibilities, and relationships among shareholders, preventing future disputes and ensuring the smooth operation of the company. It can cover a wide range of issues, including share transfers, decision-making processes, and dispute resolution mechanisms, providing a clear framework for governance.

What is a Unanimous Shareholder Agreement (USA) and Why Does KWB Care?

If you haven’t reviewed your Unanimous Shareholder Agreement (USA) recently, here are 3 excellent reasons why you should do so:

1.  In 2006, the Federal Budget introduced a second dividend rate. Corporate earnings in Alberta, up to $500,000 are taxed at 14%; when a dividend is paid to an individual shareholder this “ineligible-dividend” is taxed as high as 40.40% (in 2016). Corporate income above $500,000 is taxed at 25%; when a dividend is paid to an individual shareholder and elected out of the General Rate Income Pool this “eligible-dividend” is taxed at 31.71% (in 2016). Your USA should address the type of dividends that are to be paid out in various circumstances because if it doesn’t you could be in a situation similar to the example below.
2. Individuals who owned shares of a CCPC prior to April 26, 1995 may be able to benefit from “grandfathering” under the Stop-Loss Rules; this would allow for the tax-free transfer of shares, dramatically improving the value to the deceased Shareholder’s estate. What is alarming is how often this grandfathered status is overlooked when Shareholder Agreements are written, Succession Plans are changed, or when new life insurance is purchased.
3. If grandfathering is not available, planning around the stop-loss rules can take place tax-free if the deceased shareholder has a surviving spouse to whom shares are transferred under a valid will. This planning can “double-up” the available $800,000 capital gains exemption.

In the case of a USA written prior to 2006, there will be no direction as to who should benefit from the eligible dividend rate (if available). Let’s look at John Smith and Paul Jones, two equal shareholders in ABC Manufacturing Corporation. Both partners are active in the business. Paul becomes disabled and is unable to work. The Shareholder Agreement between the parties states “a deceased shareholder will be entitled to dividend income while disabled for 24 months. Would Paul prefer to be paid from the 31.71% dividend pool or the 40.40% dividend pool? Which dividend pool do you think John wants to use? Could this become the first of many issues if John and Paul have to come to terms on a disability buyout scenario?

We have only to look as far as the Ribiero v. Braun Nursery case of 2009 presented in the Ontario Supreme Court to stress the importance of understanding the consequence of not being current, and knowing what the USA says. 

A key employee and minority shareholder (Ribiero) was insured for $1,000,000 by the corporation (Braun Nursery) for the repurchase of shares should death occur. Upon the death of Mr. Ribiero, the life insurance proceeds were paid to the corporation. There was a $1,000,000 credit to the corporation’s Capital Dividend Account, which could then be paid out tax free. Braun Nursery did not elect to pay a Capital Dividend to buy back the shares from the estate; rather, they paid a taxable dividend to the estate for the shares. This resulted in a tax bill of approximately $250,000 to Ribiero’s estate.

The Estate subsequently brought application under the Ontario Business Corporations Act seeking “oppression remedy” for damages equal to the tax that was paid. They alleged the corporation acted unfairly in failing to declare the dividend a “capital dividend” on the purchase of the shares.

The Court found that the Corporation had fulfilled all obligations under the Shareholder Agreement. The Court also found that the deceased could not have reasonably expected the Corporation to go beyond the wording of the Agreement. The claim was dismissed. This case as well as all cases that have been brought before the Courts teaches us several key lessons that should be considered for both old and new Agreements.

Not only is there complexity in the development of a thorough Shareholder Agreement and constant changes to the Income Tax Act which planning often revolves around, but there are also constant changes to the life insurance products that are used to create the funding to allow the shares of a deceased Shareholder to be acquired.

Since 2008, the Life Insurance Industry has been re-pricing, or eliminating, insurance products due to both the low interest rate environment and new accounting rules in Canada. There have been premium increases to some products while other products, such as Term Life Insurance, have continued to see the lowering of premiums due to competitive pressures. This premium reduction has created the opportunity for business owners to significantly reduce (20%-50%) their long-term costs of funding the requirement of the Shareholder Agreements. An insurance advisor with experience and knowledge in business succession and estate planning can have a significant impact on the development and maintenance of a solid Business Succession Plan. 

For more detailed information please call KWB at 780-466-6204 or email us by clicking here.

This article was provided by Brad Arsenault of Clark&Arsenault – The Business Succession Advisory. Brad has over twenty years experience working with Insurance and Investment Advisors throughout Western Canada. He can be reached at Brad@ClarkandArsenault.com or click here to  visit his website