Canada: New CBCA Rules And Risks Of Non-Compliance - Register Of Individuals With Significant Control

On June 13, 2019, new provisions in the Canada Business Corporations Act (the "CBCA") will come into force that will require federally incorporated private corporations to maintain a register of all individuals who directly or indirectly exercise "significant control" over the corporation (the "ISC Register"). Reporting issuers (i.e., public companies) will be exempt from these new requirements.

Commentary: It is hard to understate the sea change these new provisions will have relative to the current rules regarding the books and records of a corporation. The rationale for the new provisions is linked to the ever-escalating concerns regarding money laundering, terrorist financing and tax evasion. However, in the generally routine and sleepy world of corporate records and minute books, the new provisions introduce serious punishment for non-compliance, including a fine of up to $200,000, imprisonment for up to six months, or both. Whether you are currently a director, officer or shareholder of a corporation, we suggest you keep reading.

Individuals with Significant Control – 25% Votes, 25% Value or "Influence"

Individuals are considered to have "significant control" over a corporation if they, directly or indirectly, own or control (i) shares that carry 25% or more of the voting rights attached to all of the corporation's outstanding voting shares, or (ii) 25% or more of the corporation's outstanding shares measured by fair market value.

In addition to the 25% "votes" or 25% "value" criteria to identify individuals with significant control, if an individual who has any direct or indirect influence that, if exercised, would result in control in fact of the corporation that individual is also considered to be an "individual with significant control." Two or more individuals may each be considered an "individual with significant control" if they hold their interests or rights jointly or if they exercise their control or direction jointly or in concert with one another.

These provisions will apply to registered and beneficial shareholders as well as individuals who have direct, indirect or de facto control over shares.

Commentary: The new provisions cast the net very broadly. The factual matrix to apply the 25% "votes", the 25% "value" and/or the "influence" test is not as clear cut as one might initially think. Corporations Canada has confirmed that its expectation is that the corporation is to continue to inquire about the "chain of ownership" of its shareholders until it has identified all individuals with significant control or determined that there are not any individuals with significant control over the corporation. This will not only require a corporation to ask for additional information of its shareholders that are individuals, but also inquire about its shareholders that are corporations, partnerships, trusts, etc., foreign or domestic. According to Corporations Canada, these investigations are to continue (e.g., pursue the chain of ownership of its shareholders, and the shareholders of its corporate shareholders) until the corporation has identified all individuals with significant control over the corporation or determined there are none – no small task, which is completely new to corporations in Canada.

Below are a few examples that illustrate how complex the assessment of identifying individuals with significant control can be:

  • Shareholders' Agreement: It is not uncommon for one or more shareholders to have rights under a shareholders' agreement that can impact his, her or its influence over a corporation. A shareholder with 5% of the shares could have director nomination or governance rights that allow for significant influence. Assessing "influence" based on such rights under a shareholders' agreement can be challenging on its own, but what if those rights also require the support of one or more other shareholders or only in certain circumstances?
  • Estate Freeze: Private companies commonly implement an estate freeze where certain shareholders lock-in the value of their shares in the company with (generally non-voting) special shares and allow future growth to accrue to newly issued (voting) common shares. The 25% "votes" and 25% "value" test may not be as straightforward to determine in this case, particularly as the value of the new (voting) common shares increases over time.
  • Limited Partnerships: If the sole shareholder of the corporation is a limited partnership, are both the general partner, based on control, and any limited partner holding more than 25% of the limited partnership considered to be individuals with significant control? If the general partner and/or such limited partner is also a corporate entity, the corporation would have to inquire further up the chain of ownership, and so on.
  • Trusts: If the sole shareholder of the corporation is a trust, are all trustees considered for the purposes of identifying individuals with significant control? What about the beneficiaries of a discretionary trust? Generally, the beneficiaries do not have any rights to the trust property until the trustees make a distribution, so how are the beneficiaries of a trust supposed to be treated when identifying individuals with significant control?
  • Share Pledge: If a significant shareholder of the corporation grants a share pledge to a creditor in order to secure the shareholder's obligations to the creditor, is the creditor holding the share pledge considered to have direct or indirect influence? Does the assessment change after an event of default, even if enforcement proceedings have not been commenced?

The ambiguity that can be present in such an assessment, as illustrated in the above examples, is especially concerning in light of the potential penalties to the corporation, the directors, the officers and the shareholders of the corporation for non-compliance.

Penalties for Non-Compliance

Corporations that fail to maintain an accurate ISC Register may be liable to a fine of up to $5,000.

Directors or officers who knowingly authorize, permit or acquiesce in the contravention of the new requirements to prepare and maintain an ISC Register commit an offence and are liable on summary conviction to a fine of up to $200,000, to imprisonment for up to six months, or both.

Directors or officers who knowingly record or knowingly authorize, permit or acquiesce in the recording of false or misleading information in the ISC Register commit an offence and are liable on summary conviction to a fine of up to $200,000, to imprisonment for up to six months, or both.

Directors or officers who knowingly provide or knowingly authorize, permit or acquiesce in the provision to any person or entity of false or misleading information in relation to the ISC Register commit an offence and are liable on summary conviction to a fine of up to $200,000, to imprisonment for up to six months, or both.

Every shareholder who knowingly contravenes the requirement to reply accurately and completely as soon as feasible to a corporation's requests for information in contravention of the new provisions commits an offence and is liable on summary conviction to a fine of up to $200,000, to imprisonment for up to six months or both.

Commentary: Needless to say, but the penalties for non-compliance are draconian and can arise not only for doing something (e.g., authorizing misleading information) but also for not doing something (e.g., acquiescing in misleading information) or not maintaining required information.

Substance of the ISC Register

The ISC Register must contain the following information about each individual with significant control over the corporation:

  • name;
  • date of birth;
  • last known address;
  • jurisdiction of residence for tax purposes;
  • the day on which he or she became or ceased to be an individual with significant control; and
  • a description of how he or she maintains significant control.

The corporation must take reasonable steps to ensure that it has identified all individuals with significant control over the corporation and update its ISC Register at least once a year. However, if a corporation becomes aware of information required to be disclosed in the register it must update the ISC Register within 15 days. Shareholders must reply "accurately and completely as soon as feasible" to any requests from a corporation for the foregoing information, though responsibility remains with the corporation to make a request.

Commentary: Currently corporations are to maintain a shareholders register and shareholder ledgers, but typically, other than the name of the shareholder, the information required for the ISC Register does not form part of the corporation's books and records. Nor has keeping any information about shareholders of the corporation's shareholders as will be required when the corporation has to inquire about the chain of ownership mentioned above. Although compliance will be easier for some corporations, being compliant with these new provisions by June 13, 2019 will be a potential significant and time consuming undertaking for many corporations. In addition, the on-going time and effort required to maintain the ISC Register will be a significant burden for many corporations.

Access to the ISC Register

A corporation's ISC Register will not be publicly available. However, shareholders and creditors will be entitled to access the register in connection with matters relating to the affairs of the corporation. The Director of Corporations Canada will be entitled to access upon request. The 2019 federal budget bill is expected to expand the scope of persons that have the right to inspect a corporation's ISC Register to include any police force, the Canada Revenue Agency (and provincial counterparts) and other investigative agencies (to be prescribed in the future).

Trend Towards Transparency

The new CBCA provisions represent part of a broader trend towards corporate transparency. In December 2017, Canadian Finance Ministers agreed to pursue federal, provincial and territorial corporate requirements for registers of beneficial shareholders in order to prevent the misuse of corporations for tax evasion, money laundering and financing terrorist activities. In November 2018, the House of Commons Standing Committee on Finance released a report that recommended the creation of a "pan-Canadian" beneficial ownership registry of persons with significant control over Canadian corporations in order to combat money laundering and terrorist financing. Accordingly, additional steps towards corporate transparency, such as amendments to provincial corporate statues, are likely forthcoming.

Conclusion

Private CBCA corporations should familiarize themselves with the new requirements in preparation for June 13, 2019 and consider providing notice of the requirements to their shareholders. In addition, corporations should consider creating policies for the creation and maintenance of their ISC Registers in order to ensure compliance.

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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