Canada: No Transfer Means No Transfer!

Last Updated: October 26 2010
Article by Bryan Haynes

Previously published in the Canadian Lawyer magazine.

In Frye v. Frye Estate, the Ontario Court of Appeal held that a bequest of shares was valid, notwithstanding that such bequest was clearly contrary to the explicit terms of a unanimous shareholder agreement and letters patent. The decision (wrongly) emasculates broadly drafted share-transfer restrictions, reducing them to near meaningless effect.

Four siblings equally inherited the shares of a family business on the death of their father. All of the siblings entered into a shareholder agreement. The agreement contained a "family consensus" provision as follows: "The fixed purpose and intent of [the father] was and is to preserve the Frye group as a family business and for all his children to share equally therein." The agreement contained provisions typically found in shareholder agreements restricting the transfer of shares including a covenant not to "sell, assign, transfer, grant options in respect of, or otherwise deal with" the shares otherwise than in accordance with the terms of the agreement.

The letters patent included a provision that "the right to transfer shares in the company shall be restricted in that no share shall be transferred without the express sanction of the Board of Directors. . . ." One of the siblings passed away leaving a will directing the executors to transfer his shares to one of his siblings, to the exclusion of the others.

Both the Superior Court and the Court of Appeal (rightly) held that the transfer restrictions contained in the shareholder agreement and letters patent were broad enough to catch transfers by testamentary dispositions. However, the courts departed on the effect this had on the bequest. The Superior Court held that the bequest was void and ordered the estate to sell the shares in accordance with the terms of the shareholder agreement. The Court of Appeal held that the bequest was valid and that the executors held the shares as bare trustees for the beneficiary until such time as consent to the transfer of legal title was obtained, however long that may take. Meanwhile, the executors must exercise all rights associated with the shares as the beneficiary directs.

The Court of Appeal held that the transfer restrictions would only be triggered when and if legal title is transferred to the beneficiary. The decision inappropriately withers down broadly drafted transfer restrictions to merely mean that a transferee's name cannot be entered on the register of shareholders without prior consent. However, share transfer restrictions are clearly intended to have more meaningful effect than this, particularly in family businesses and other closely held corporations. Otherwise, unauthorized transfers indirectly accomplish the same result as authorized transfers.

The Court of Appeal justified its decision in part by stating "contractual obligations do not constrain a person's ability to bequeath property by means of a will." This statement is far too sweeping. Although it is true that the validity of a contract to make a will or to refrain from revoking a will is determined by the law of contracts, the making of a will does not therefore necessarily mean that contractual obligations can simply be ignored. If a gift cannot legally be made during a lifetime, there is no reason to permit such transfer at death, whether by will or otherwise. In Pennfield Oil Co. v. Winstrom, it was held that a will could not supersede specific transfer restrictions.

Share-transfer restrictions are not simply obligations binding contracting parties, but constitute encumbrances on the shares themselves. A transferee of shares does not acquire greater rights than a transferor is able to convey. Restrictions on share transfers constitute part of the constitution of a company, elevating their importance to something greater than mere contractual obligations. In Duha Printers (Western) Ltd. v. Canada, the Supreme Court of Canada held that "the USA is a corporate law hybrid, part contractual and part constitutional in nature." The result therefore is that a transfer contrary to such provisions not only constitutes a breach of contract, but the transfer itself is either void ab initio or voidable.

Whether a transfer of an equitable interest in shares is valid in the face of share-transfer restrictions has been widely deliberated in the case law, with disparate and incompatible results. The decision in Hunter v. Hunter, affirmed by the House of Lords, supports the common- sense principle that a valid sale of shares can only be concluded by following the share-transfer procedures set out in the articles and that the beneficial interest could not be sold separately from the legal interest. Although public policy sanctions unauthorized transfers in limited circumstances where transfer restrictions would otherwise unreasonably interfere with the rights of third parties, such third parties naturally acquire subject to the same restrictions.

Following Frye, the surviving siblings henceforth disproportionately controlled, and benefited in, the family business, contrary to the family consensus and shareholder agreement and contrary to the reasonable expectation of the parties. None of the siblings could have expected to disproportionately benefit from the family business. The testator, as well as the beneficiary, was well aware of the transfer restrictions. What justification can there be for a rule that protects a person's ability to do something in death which he or she could not have legally done while alive?

Bryan Haynes is a partner and co-chairman of the commercial transactions practice group at Bennett Jones LLP. This column expresses the opinions of the writer, not his firm, and does not constitute legal advice.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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