Forgotten Shareholders

Self-isolating? You might not be as alone as you thought. Forgotten shareholders can make for unwanted company in your company.

June 4, 2020

If you have a little extra down time on your hands these days, it’s a good idea to check that your corporate records are up to date and ensure that you are not forgetting any shareholders!

A forgotten shareholder can arise when someone believes they have a claim to shares in a company, but their piece of the pie (and any necessary requirements of a purchase of shares, like payment of consideration) is not properly documented.

Impressions – and misconceptions – of share entitlement can be easy to create. Verbal conversations with co-founders, employees, and service providers, especially if not further documented in writing, are prime breeding grounds for misunderstandings and can give rise to serious legal issues when they surface later on (often after the publication of good news, like a sale of the company). You may have forgotten about these conversations over the years but be aware, these claimants can resurface at any time, demanding the shares they believe they were promised in your company.

What do they want?

Forgotten shareholders may demand a wide range of remedies depending on the circumstances. They may seek a declaration of ownership in your company, a share of past profits, or any other remedy available under an oppression claim.

For example, in Fedel v. Tan, 2010 ONCA 473, the plaintiff built up a business with the defendant based on a verbal agreement that the plaintiff would own 40% of the business and the defendant would own the remaining 60%. The defendant then unilaterally incorporated the business into two companies and issued to himself 100% of each company’s shares. Years later, the plaintiff sued the defendant in court under the oppression remedy by claiming that he had a 40% stake in both companies as together they made up the business that he helped build.

The court awarded the plaintiff 40% of profits and 40% of the value of business opportunities that the defendant had improperly caused their companies to transfer to himself, along with the return of all of the plaintiff’s financial contributions to the business.

Even if you successfully defend a claim, litigation can take a significant toll on a company’s finances (and management’s attention), and can derail other transactions along the way.

Why should I care?

• Capital-Raising. Potential investors often want to know the capital structure of your business, and you should be able to confidently tell them who owns what.
• Successful sale of your business. The buyer of a business typically wants to be certain that they are buying 100% of the shares.  If this is not the case, a sale could fall through or the seller could be sued or asked to indemnify the buyer. Even an indemnity may not offer complete protection: in Hayat v Raja, 2016 ONSC 6805, a court ordered that a recently sold corporation was jointly liable with its seller to repay loans to an undocumented shareholder, even though the seller had previously agreed to indemnify the buyer against the shareholder’s claims. The buyer’s newly acquired company may therefore have lost some value as a result of its joint liability for such loans.
• (Possibly) simpler solutions to disputes. Good record-keeping often makes updates easier and discourages litigation and the costs of relationship breakdown. In Fedel v. Tan, for instance, the relationship between plaintiff and defendant had deteriorated so much that the judge found it was best to sever their relationship and compensate the plaintiff for his monetary losses. As a result, instead of simply issuing new share certificates, the companies had to come up with cash.
• Audits and other government requirements. An audit may require you to produce shareholder records. Under certain corporate statutes, a company is also required to keep accurate records of key shareholders in its minute books for reference by certain regulatory bodies from time to time.

How do I address a claim by a forgotten shareholder?

Much depends on the nature and timing of a claim, and what exactly is in dispute. Sometimes it’s just a matter of documenting and ratifying a prior share issuance that the parties had always intended to happen. Other times, you might consider entering into a settlement agreement documenting the details and confirming the receipt of appropriate consideration. A settlement agreement can also be used to buy out a shareholder’s interest and obtain a comprehensive release of future claims.

Where a claim raises the prospect of litigation, it’s always wise to speak with litigation counsel to better understand your options and prepare a response.

Past issuances of securities can also raise regulatory filing considerations. This is particularly the case if the company is no longer considered a “private issuer” under securities laws and must file reports within certain periods of issuing securities, or else face late fees and other consequences.

What if I am the forgotten shareholder?

If you’re not sure of your shareholder status, contact the company to make sure you’re on their shareholder register. You should also ensure your address and other contact information in the company’s records is up to date, so that you receive documents and communications from the company from time to time. For example, you should receive financial statements and an invitation to an annual general meeting of shareholders. Even small, private companies must hold an annual general meeting or get 100% of the shareholders to sign certain resolutions once a year. Typically, you would also need to sign on to a shareholder agreement.

How do I avoid a forgotten shareholder claim?

A corporate lawyer can help you properly document the issuance of shares and other securities. Here are some steps we frequently advise you take:

• Always get tax advice. The importance of tax advice cannot be overstated, so before you take steps to issue any securities of your company, speak with a tax professional.
• Don’t promise a slice of the pie. As you grow your business, you may be tempted to promise equity in your company to those helping you in the early days. Instead, consider an employee stock option plan under which you can reward employees with an option to purchase shares over a period of time as opposed to receiving equity right off the bat without any conditions attached.
• Define the “slice”.  Once you’re ready to negotiate a share issuance, clearly state the number and kind of securities to be issued. Defining ownership in percentages can lead to confusion if a company issues additional securities over time.
• Define the “pie”. Is the shareholder acquiring shares in just a parent company or in related entities as well? It is important to know what entities make up the “business” as some businesses place assets such as land, intellectual property, and key contracts into separate companies. There may be other companies set up to do business in other jurisdictions like the United States. Your documentation should clearly define which company is issuing what securities.
• Document conditions, expectations and arrangements. Does the shareholder receive shares right away or only if he or she has stuck with the company for a certain period of time, or met certain milestones? What rights should attach to the securities? Will they expire or mature at a certain date? Consider a unanimous shareholder agreement or a voting trust agreement to reduce the risk of misunderstandings. Whatever the agreement may be, all the terms should be clearly laid out so that the expectations of all parties are managed early on.
• Confirm the consideration received. In exchange for issuing shares, the issuer must receive consideration in the form of cash, or in property/past services. The consideration given should be documented in the board resolution.
• Prepare a board resolution authorizing the share issuance. A board resolution should comply with statutory requirements for documenting the issuance of shares, as well as the articles, by-laws and any shareholder agreement in force. Check the shareholder agreement to see if any shareholder approvals are required or if any pre-emptive rights need to be waived. There may also be other contractual limitations on issuing shares such as covenants in your bank documents that should be taken into account.
• Ensure compliance with securities laws. Securities laws apply to both public and private companies in Canada. Ensure you have an appropriate exemption for the issuance of securities, and file any required reports within prescribed timeframes.
• Cross-reference the changes in your minute book. A company’s shareholder register should be updated to reflect the issuance of any new shares and list all the current shareholders. Additional obligations apply to securityholders with significant control if the company is federally incorporated. Check out our blog on Tracking Controlling Shareholders for further information.
• Seek advice early on. If a forgotten shareholder knocks on your door, speak with a lawyer before acknowledging or agreeing to anything. There may be other more appropriate ways of documenting and rewarding someone’s contributions to a business.

Share ownership can be a very exciting idea, and even passing conversations can make a lasting impression on people that you may have forgotten about. But beware: when your pie is looking freshly-baked, hungry shareholders may pop up to claim a slice!