Estate freezes are a common tool in the estate and tax planner's toolkit. Their purpose, in essence, is to transfer corporately held wealth that has been accrued during one generation's lifetime to another generation in a manner which is usually advantageous from a tax perspective.
Unfortunately, notwithstanding the underlying premise that one generation (usually the children) is receiving something for free from another generation (usually the parents), there are frequently disputes which arise from a gap in expectations as between the parties.
In a recent decision from our British Columbia Court of Appeal: Hui v. Hoa, 2015 BCCA 128 [Hui], one such dispute arose between a mother and her son, in regards to two companies that were originally part of an estate freeze back in the '70s.
- Company 1 was incorporated in 1967 and all of the voting shares were issued to the parents, while 9,990 of the non-voting shares were issued to the son.
- Shortly after, the parents separated and Company 2 was incorporated in 1972. The father was issued all of the voting shares and the son was issued 7,500 of 9,990 non-voting shares.
- The parents divorced in 1975, but subsequently reconciled and spent a great deal of time together.
- Hoping to allay her son's concerns that she would waste Company 1's assets, the mother passed a special resolution in 1981 converting her son's 9,990 non-voting shares in Company 1 to voting shares, giving her son control of Company 1.
- The father died in 1988 and the mother inherited all of the voting shares and 2,490 non-voting shares in Company 2. This left the mother in control of Company 2.
- It was intended that, as part of the estate freeze, the mother would continue to earn income from both companies while she was alive and that the son would inherit both companies upon her death.
- This intention was upheld until October of 2007, when the son exercised his voting control of Company 1 to remove his mother as a director and to prevent her from receiving any further income from that company. This led to the mother removing her son as a director of Company 2 in retaliation.
- Both mother and son commenced petitions in 2008 against each other under ss. 227 and 324 of the Business Corporations Act (BC) claiming shareholder oppression and requesting various forms of relief from the Court, including the winding up of Company 2.
- Was the son's use of his majority shareholder position in Company 1 to remove his mother as a director and to prevent her from receiving income from Company 1 shareholder oppression?
- Was the mother's exclusion of the son from the management and income of Company 2 shareholder oppression?
THE B.C. SUPREME COURT RULING
Both mother and son filed petitions alleging oppression and the Court heard both petitions together. Mr. Justice Ball dismissed the son's petition. He then granted the relief sought by the mother in her petition by making orders for, amongst other things:
- the mother's exclusive management of Company 1;
- the mother's exclusive entitlement to the cash flow generated by Company 1; and
- the son's accounting and repayment to the mother of any monies paid out of Company 1 without the mother's express consent.
Mr. Justice Ball's ruling in favour of the mother was predicated on his interpretation of the case law on shareholder oppression and his belief that the case law stood for the proposition that:
when a parent gives a child shares without consideration to implement a tax freeze that will benefit both the parents and the child, the child cannot then turn around and attempt to seize control via an oppression remedy – even if [the child is] unhappy with how [the] parents are controlling the companies.
[Hui at 26]
Mr. Justice Ball went on to conclude that "oppression cannot be used to give a shareholder something that they never reasonably expected when they received those beneficial shares" (Hui at 26). As such, the son never had a reasonable expectation to control either company prior to the death of his parents. Conversely, Mr. Justice Ball found that the mother did in fact have an expectation as to the control of both companies while she was alive, and his orders reflected such finding.
THE B.C. COURT OF APPEAL RULING
The son appealed both of Mr. Justice Ball's rulings alleging various errors in law and in fact. While the son was ultimately successful in his appeal of Mr. Justice Ball's ruling in respect of Company 1, he was unsuccessful in his appeal of the ruling in respect of Company 2.
Central to the Court of Appeal's decision in overturning Mr. Justice Ball's ruling in favour of the mother, was the error in the lower court's focus on the mother's expectations while ignoring the corporate realities. While it was true that the mother had an expectation of controlling Company 1 and the income therefrom while she was alive under the original estate freeze, the moment she converted her son's non-voting shares into voting shares and gave him control of Company 1, she deviated from the "plan" established by her tax and estate planning advisors, and her expectations of control were no longer valid, since they no longer reflected the corporate reality.
In regards to the other ruling for Company 2, Mr. Justice Chiasson upheld the lower court's decision and found that Company 2 was still subject to an estate freeze, and therefore the son's reasonable expectations as a shareholder had to be reconciled with the reality of the estate freeze, i.e. his interest in Company 2 vested upon the death of his mother and therefore he had no reasonable expectation of control while she was alive.
The oppression remedy is an equitable remedy which springs from corporate law and which the Court is generally hesitant to wield. In order for a shareholder to successfully prove oppression and avail themselves of the various remedies of the Court, a shareholder must demonstrate that their expectations are consistent with the corporate reality and that the non-fulfillment of such expectations constitutes oppressive conduct by another shareholder. Where the corporate structure does not reflect or support the shareholder's stated expectations, which form the basis for the oppression claim, the Court will not exercise its equitable jurisdiction.
Furthermore, where an estate freeze or a similar estate plan has been implemented and a child has received shares gratuitously on the understanding that they will ultimately inherit some or all of the control of the corporation upon the death of one or more of that child's parents, that child cannot then claim shareholder oppression where they are prevented from participating in the management and income of such corporation while that child's parents are still living.
However, and notwithstanding the foregoing general proposition, where a parent modifies an estate plan such that the corporate structure allows for the child's participation in the control of the corporation, then the oppression remedy may well become available for such child, while simultaneously becoming unavailable to such parent, as demonstrated in Hui.
Ironically, had the mother simply left her son's shares as non-voting shares back in 1981, it is unlikely that either petition would have come before the Court. Therefore an additional point to take from Hui, is not to issue voting shares to your children where control of your company may be wrested from you.
Ultimately, as with all complex planning matters, it is recommended that you consult a professional before taking any action.
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.