Canada: The Second Opinion: Unanimous Shareholder Agreements and De Jure Control

A Commentary on Recent Legal Developments by the Opinions Group of McCarthy Tétrault LLP

The "de jure" control of a corporation can be important in several legal contexts.  Traditionally, the test employed to assess de jure control was whether the controlling party owned a sufficient number of shares to elect the majority of the board of directors.  However, since Duha Printers (Western) Ltd. v. Canada, [1998] 1 S.C.R. 795, courts have recognized that de jure control may also be influenced by a unanimous shareholder agreement ("USA").  This has given rise to uncertainty over what provisions in a USA can affect the de jure control analysis.

In Canada v. Bioartificial Gel Technologies (Bagtech) Inc., 2013 FCA 164, the Federal Court of Appeal addressed this issue, and took a broad approach to the relevance of USAs.  The case concerned whether Bagtech, a private company incorporated under the Canada Business Corporations Act ("CBCA"), was a "Canadian-controlled private corporation" under s. 125(7) of the Income Tax Act ("ITA") so as to qualify for an investment tax credit.  Under the relevant definition in the ITA, a widely held private corporation such as Bagtech is not Canadian-controlled if its shares owned by non-residents would give a single person control were they held in the aggregate.  During the relevant years, between 62% and 70% of Bagtech's voting shares were held by non-residents.  As a result, the Minister of National Revenue issued reassessments contesting its entitlement to the tax credits.

Bagtech objected on the basis that its USA contained clauses allowing Canadian resident shareholders to appoint a majority of its directors during most of the relevant period.  The Minister argued that those clauses should not be viewed as part of the USA for the purposes of the de jure control analysis.  The Minister accepted that other portions of the USA, which contained clauses restricting the powers of Bagtech's directors, could be treated as components of the USA under the de jure test pursuant to Duha.  However, because ss. 2(1) and 146(1) of the CBCA only define a unanimous shareholder agreement as one "that restricts, in whole or in part, the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation", the Minister argued that a clause which does not restrict the directors' powers, but concerns instead the election of directors, does not form part of a USA.

In support of this argument, the Minister noted that the business corporations legislation of some jurisdictions (e.g., Alberta) specifically states that a USA can include clauses relating to the election of directors, but that no such provision is included within the CBCA.  As well, the Minister observed that s. 145.1 of the CBCA, which was enacted after Duha and permits pooling agreements between shareholders, demonstrates Parliament's intention that shareholder voting agreements be treated as simple contracts rather than USAs, even though they are still binding on shareholders.

The Minister's argument was unanimously rejected by the Federal Court of Appeal, which affirmed the result in the Tax Court below and found Bagtech was Canadian-controlled based on the director election provision in the USA.  Gauthier J.A. held that once an agreement qualifies as a USA pursuant to s. 146(1) of the CBCA, by including a clause that restricts the managerial or supervisory powers of directors, then any clause within it relating to the election of directors must also be taken into account when considering who has de jure control of the corporation.  In other words, the Court of Appeal refused to view a USA as a severable document for the purposes of the de jure control analysis, even when it is made under legislation like the CBCA which does not expressly permit the inclusion of clauses within it that relate to the election of directors.  Gauthier J.A. found this approach was mandated by Duha, which despite finding that the director election clause in the USA there did not actually restrict the shareholder's right to appoint the majority of directors, nevertheless accepted that to determine de jure control, "one must consider... any specific or unique limitation on either the majority shareholder's power to control the election of the board or the board's power to manage the business and affairs of the company, as manifested in... any unanimous shareholder agreement".

Gauthier J.A. reached this conclusion despite acknowledging the existence of academic commentary and obiter remarks by the Tax Court judge below that USAs should be severable for de jure control purposes.  However, in response to the argument that it would be anomalous for a director election clause within a USA to affect de jure control, when the same clause within a simple voting agreement could not have this result, Gauthier J.A. stated:

... Clearly, clauses regarding the election of the board of directors can have a crucial impact on a majority shareholder's ability to effectively control a corporation. In order to avoid creating uncertainty for taxpayers, the SCC concluded that such clauses should not be taken into consideration when simply included in private agreements between shareholders. In seeking to strike a fair balance between these two concerns, it is logical that the special nature of USAs, which are constating documents, and the fact that USAs are easily accessible... make a difference. It is not unusual in tax law to obtain a different result by using one form rather than another. (para. 58)

In light of Bioartificial, parties should give careful consideration to director election clauses in USAs when assessing de jure control.  Such clauses may be relevant even to companies governed by the CBCA or other business corporations statutes which do not expressly permit their inclusion in USAs.

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