19761
COMMENTS – COMMENTAIRES
Controlling the Power to Manage in Closely-Held
Corporations under the Canada Business
Corporations Act
Introduction
Notwithstanding the fact that they have little in common, both
publicly-held and closely-held corporations are, with minor ex-
ceptions, subject to the same rules under the Canada Corporations
Act.” The imposition of a single set of rigid legal principles has
created numerous problems for participants in closely-held cor-
porations, the most difficult of which relate to the control of man-
agement powers. Subsection 86(1) of the old Act, for example, prov-
ides that the affairs of a company shall be managed by a board of
directors. The courts have further held that directors cannot validly
contract as to how they shall vote at future board meetings.2
The conclusion of this syllogism is that the management of cor-
porate affairs cannot be controlled by contract. As a result, pro-
visions in shareholder agreements which purport to regulate such
matters as the appointment of officers and the granting of signing
authority for banking purposes, are of doubtful validity.
The Canada Business Corporations Act 3 contains a number of
provisions which significantly increase the freedom of shareholders
to establish their own rules with respect to the control and
allocation of management powers. The purpose of this article is to
briefly review and comment upon some of the control techniques
which are permissible under the new legislation.
1. The unanimous shareholder agreement
Subsection 140(2) of the new Act permits the restriction of the
management powers of the directors by means of a written agree-
ment among all of the shareholders While the unanimous share-
‘R.S.C. 1970, c.C-32 (hereinafter referred to as “old Act”).
2L.C.B. Gower, The Principles of Modern Company Law 3d ed. (1969), 525.
See also Motherwell v. Schoof [1949] 2 W.W.R. 529, (1949) 4 D.L.R. 812 and
Atlas Development Co. Ltd v. Calof & Gold (1963) 41 W.W.R. 575. There is a
growing debate as to whether this rule applies in the Province of Quebec. See
D. Sohmer Protecting the Minority Shareholder in Letters Patent Jurisdictions
(1971) 31 R.du B. 388, 392.
3 S.C. 1974-75, c.29 (hereinafter referred to as the “new Act”).
4 It should be noted that the holders of shares which do not have voting
rights must also agree.
McGILL LAW JOURNAL
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holder agreement is a welcome innovation, there are certain aspects
of the new Act relating to such agreements which unnecessarily
diminish their utility.
It has been argued that the board of directors is superfluous
for the olosely-held corporation and ought to be dispensed with
entirely where the participants desire to do soY The new Act does
not go this far. Subsection 140(2) only validates restricting the
powers of the directors as opposed to the transfer of those powers.
Thus, while a unanimous shareholder agreement may provide that
directors cannot exercise management powers without the prior
consent of the shareholders, it cannot provide that the shareholders
may act to the exclusion of the directors. Several sections in the
new Act reinforce this conclusion. Subsection 97(1) provides that
management powers are vested in the ,directors “subject to any una-
nimous shareholder agreement” while other provisions vest certain
powers in the directors “unless a unanimous shareholder agreement
otherwise provide[s]”Y The rules of statutory construction dictate
that a different meaning be ascribed to these phrases. Furthermore,
the new Act contains a number of provisions which grant certain
powers specifically to the directors without expressly permitting
any transfer or restriction of those powers by means of a unanimous
shareholder agreement. Examples of these powers are the power to
5 R. Kessler, The Statutory Requirement of a Board of Directors: A Cor-
porate Anachronism (1960) 27 U.Chi.L.Rev. 697.
6 S.98(1) of the new Act for example provides that the directors may make
by-laws “unless the articles, by-laws or a unanimous shareholder agreement
otherwise provide”. A number of provisions in the new Act are based upon
provisions of the New York Business Corporation Law of 1963 and upon
provisions of the Model Business Corporations Act. It is interesting to note
that both clearly permit a transfer of management powers to the shareholders.
S.620(b) of the New York statute validates a provision in the certificate of
incorporation which “is otherwise prohibited by law because it improperly
restricts the board in its management of the business of the corporation, or
improperly transfers to one or more shareholders or to one or more persons
or corporations … all or any part of such management otherwise within the
authority of the board .. .”. S.35 of the Model Business Corporations Act
provides that “the business and affairs of a corporation shall be managed by a
board of directors except as may be otherwise provided in the articles of in-
corporation”. There is some indication that the relevant provisions in the new
Act do not accurately represent the intentions of the draftsmen. Robert
Dickerson, one of the architects of the new Act has stated that the provisions
relating to unanimous shareholder agreements permit the shareholders “even
to assume directly the functions and the responsibilities of the directors”.
R.W.V. Dickerson, The Canada Business Corporation Act (1975) C.A. Magazine
45, 51.
19761
COMMENTS – COMMENTAIR-ES
change the address of the registered office,7 and the power to
determine to whom and for what consideration shares may be
issued.8 The shareholder must therefore continue to wear both a
director’s and a shareholder’s hat, and the hat-changing ritual will
have to await future amendments before it is finally relegated to
history.
A related problem also results from the fact that subsection
140(2) permits the management powers of the directors only
to be “restrict[ed]”. The right to restrict clearly includes the right
to veto. But it is not clear that the right to restrict includes the right
to initiate corporate action. Thus a provision in a unanimous share-
holder agreement stipulating that certain individuals shall have
signing authority for banking purposes may be invalid, since this
involves a positive act by the directors. The same purpose could
perhaps be achieved by phrasing the provision in the negative so as
to prohibit the directors from granting signing authority to anyone
other than those individuals However, this is precisely the type
of artificial procedure which the draftsmen intended to render un-
necessary.10
The utility of a unanimous shareholder agreement is further
diminished by the provisions of subsection 140(4) which impose
upon a shareholder who is a party to such an agreement, the duties
of the directors to the extent that the agreement restricts the dis-
cretion or powers of the directors to manage the business and
7 Supra, note 3, s.19(3).
8 Ibid., s.28(1).
9 This is reminiscent of the type of drafting which was necessary in in-
junctive proceedings in the Province of Quebec before mandatory injunctions
were introduced in 1966.
10 S.101 of The Ontario Business Corporations Act, 1970, S.O. 1970, c.25,
permits the holder of shares to which are attached at least 10% of the votes
attaching to the issued and outstanding shares of a company, to requisition
the directors to call a meeting of the directors for the purpose of passing
any by-law or resolution, and if such by-law or resolution is not passed within
21 days of the deposit of the requisition, the shareholder may convene a
shareholders’ meeting for the purpose of passing it. A shareholder can thus
ensure the passage of any by-law or resolution by means of a covenant in a
shareholder agreement to vote in favour of specified by-laws or resolutions
in the event that they are placed before them pursuant to the provisions of
s.101. While the procedure is unnecessarily cumbersome, it still provides
shareholders with an effective means of initiating corporate action. The
reason why the new Act does not contain a similar provision may be that
the draftsmen thought that the provisions relating to unanimous shareholder
agreements are sufficient to vest this power in the shareholder. See supra,
note 6.
I McGILL LAW JOURNAL
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affairs of the corporation. Subsection 117(1) states that a director
must act with a view to the best interests of the corporation. The
effect of a unanimous shareholder agreement may therefore be to
prohibit a shareholder from acting in his own best interests when
they do not coincide with those of the corporation, notwithstanding
that such action may not constitute a “fraud on the minority”.”
This can give rise to serious difficulties, particularly with respect
to contracts in which such a shareholder is interested and with
respect to opportunites which interest the corporation but which
are not taken up.
Subsection 115(7) provides that a material contract between a
corporation and one of its directors is neither void nor voidable, if
the director disclosed his interest and the contract was approved by
the directors or the shareholders. Subsection 115(5) prohibits such
a director from voting on any resolution to approve the contract.
This may make director approval impossible to obtain where there
is no quorum of directors in office who are not interested. 2 Further-
more, if the director’s hat is permanently rooted to the shareholder’s
scalp by virtue of subsection 140(4), the interested shareholder
may be unable to approve qua shareholder. The proposition that such
a shareholder may be unable to avoid director characterization is
supported by the provisions of subsection 2(1) which defines a
director as “a person occupying the position of director by whatever
name called”. A disinterested minority shareholder may therefore
have the power to prevent a corporation from entering into a con-
tract with a majority shareholder, notwithstanding the fact that the
contract will not result in his “oppression” or .in his being “de-
frauded”. If, as is often the case, all of the shareholders are in-
terested in the contract, it may also be impossible to ratify the
contract, thereby exposing the shareholders to an action by future
shareholders.
1 While the issue of which breaches of fiduciary duty are ratifiable is
fraught with uncertainty, as a general rule it appears that a breach may be
ratified unless it involves an appropriation of the company’s assets by the
majority at the expense of the minority. See S.M. Beck, “An Analysis of Foss
v. Harbottle” in J. Ziegel (ed.), Studies in Canadian Company Law (1967),
vol.1, 545, 572; “Corporate Opportunity Revisited”, vol.2, 193, 233; Northwest
Transportation v. Beatty (1887) 12 A.C. 589 (ratification permitted); Cook v.
Deeks [1916] 1 A.C. 554 (ratification not permitted).
12 S.98(4) of the old Act provides that a director of a private company can
vote in respect of a contract in which he is interested where there is no
quorum of directors in office who are not so interested. The new Act contains
no similar provisions.
1976]
COMMENTS – COMMENTAIRES
In Equity, a director is prohibited from appropriating “to himself
property or opportunities, the chance for which came to him because
of the position he occupied”.13 However, as a general rule, a breach of
this fiduciary duty may be ratified by the shareholders.’ 4 As in-
dicated above, subsection 140(4) may have the effect of making such
approval impossible to obtain.
The new Act should have contained a provision which would
make it clear that the imposition of the duties of a director on
shareholders who are parties to a unanimous shareholder agreement,
does not deprive them of any ratification rights which they would
otherwise have had. The remedy against oppression provided by
section 234 is sufficient to protect a minority shareholder against
abuses of such rights.
It should be noted that agreements between shareholders of
companies incorporated under the old Act may constitute unanimous
shareholder agreements when such corporations are continued under
the new Act. The shareholders would then be subject to the pro-
visions of subsection 140(4).
Another criticism of the unanimous shareholder agreement pro-
visions is that the unanimity requirement, which is intended to
protect minority shareholders, can be circumvented. Subsection 6(2)
provides that the articles may set out any provision permitted to
be set out in a unanimous shareholder agreement, and paragraph
167(1) (n) permits the articles to be amended so as to set out
such a provision by means of a special resolution. A special resolution
however can be passed by a two-thirds majority of the votes cast
by the shareholders who voted in respect of the resolution. The use
of the articles instead of unanimous shareholder agreements for
restricting the powers of the directors may also be encouraged by
the fact that subsection 140(4) only imposes -the duties and liabili-
ties of directors on shareholders who are parties to unanimous
shareholder agreements. If the articles are so used, the only danger
to the shareholders would be that they may be characterized as
directors under subsection 2(1), and therefore be subject to the
duties and liabilities of directors qua directors.
Since an agreement requires two or more parties, the unanimous
shareholder agreement provisions cannot apply to one-man cor-
porations. Even if the new Act permitted the transfer of managerial
powers to the shareholders by means of such agreements, a sole
13Beck, “Corporate Opportunity Revisited”, supra, note 11, 206.
14Regal (Hastings) Ltd v. Gulliver (1942) 1 All E.R. 378, 389, per Lord Russell
of Killowen.
McGILL LAW JOURNAL
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shareholder would be denied the right to do so by means of a
unanimous shareholder agreement. The transfer of powers would
have to be effected by means of a provision in the articles or by
transferring a share to a “dummy” and entering into unanimous
shareholder agreement with him. There is no reason why a sole
shareholder acting alone should be denied the convenience of using
a unanimous shareholder agreement for this purpose.
Although the unanimous shareholder agreement is not as flexible
a device as many had hoped it would be, there are a number of
provisions in the new Act which will permit it to play an important
role in the control of management powers.
Subsection 6(3) sanctions high vote requirements for director
and shareholder action in the articles or in a unanimous share-
holder agreement. Such requirements can provide effective protec-
tion without depriving shareholder-directors of their ratification
rights.15
Paragraph 149(1) (c) requires ,directors to place before the share-
holders at every annual meeting any information respecting the
financial position of the corporation and the results of its operations
required by the articles, the by-laws or any unanimous shareholder
agreement. Section 240 provides that this requirement may be en-
forced by means of a compliance order. Compulsory disclosure will
often deter abuses in the exercise of management powers, parti-
cularly when such abuses may result in an application under
sections 232 or 234 of the new Act.
Subparagraph 207(1)(b)(i) permits a court to order the liquid-
ation and ‘dissolution of a corporation if it is satisfied that a una-
nimous shareholder agreement entitles a complaining shareholder
to demand dissolution of the corporation after the occurrence of a
specified event and that event has occurred. Subsection 207(2)
permits a court on application for dissolution to make an order
under section 234. The specified event need not involve oppressive
15 Quaere: Does a high vote requirement alone constitute a restriction of
the powers of the directors? If it does not, then an agreement containing
such a requirement may not be a “unanimous shareholder agreement”. (See
s.140(2) and the definition of “unanimous shareholder agreement” in s.2(1).)
This would nullify the effect of a high vote requirement in a shareholder
agreement. If shareholders wish to benefit from the unanimous shareholder
;agreement provisions without having to contend with the problems resulting
from the imposition of directors’ duties and liabilities, it is suggested that the
agreement provide for a nominal restriction of the powers of the directors.
A provision, for example, which prohibits the directors from borrowing more
than $5,000,000 without the shareholders’ consent should suffice.
19761
COMMENTS – COMMENTAIRES
nor unfairly prejudicial behaviour. The mere fact, for example, that
the salary of one shareholder-employee has been Oncreased without
a corresponding increase in the salary of another shareholder-em-
ployee would entitle the latter to apply for a dissolution, if a un-
animous shareholder agreement so provides. The application could
also ask for an order under section 234 increasing the salary of the
applicant as an alternative to dissolution.
2. Non-unanimous shareholder agreements
In many cases a minority shareholder may constitute the balance
of power in a closely-held corporation. Where, for example, the
percentage of total votes controlled by A, B, and C, is 45%, 45%,
and 10%, respectively, an alliance of A and C or of B and C will
effectively control the corporation. Both A and B will usually desire
protection against attack by such an alliance, but they may not
want to pay the price which C may exact as consideration for enter-
ing into a unanimous shareholder agreement. Since A and B are
prohibited from fettering their discretion qua director in the ab-
sence of unanimity, they must protect their interests by controlling
their powers qua shareholders. 16 A shareholder agreement between
A and B can give each a veto power over director action by providing
that each will exercise his right to vote so that one-half of the board
consists of A’s representatives and the other half of B’s represen-
tatives. Where, however, the “controlling” group consists of more
than two shareholders, this approach is not satisfactory, since the
directors representing one can always be out-voted by the repre-
sentatives of the others. The new Act contains a number of provisions
which will assist shareholders in this predicament. These provisions
increase the power of the shareholders -and thereby expand the scope
of non-unanimous shareholder agreements.
a) The power to make by-laws
Subsection 98(5) gives shareholders the power to make, amend
or repeal by-laws. 17 By employing this new power, parties to a non-
unanimous shareholder agreement can, provided that they control
a majority of the votes, exercise significant control over the directors.
They can, for example, pass by-laws restricting the power of the
’16 See supra, note 11.
17 Under the provisions of the old Act, only the directors can adopt or alter
by-laws. See ss.94 and 95 of the old Act; Kelly v. Electrical Construction Co.
(1908) 16 O.L.R. 232; and Stephenson v. Vokes (1896) 27 O.R. 691.
McGILL LAW JOURNAL
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directors to borrow,”8 to appoint officers, 9 to fix the remuneration
of directors, officers and employees” and even vest in the share
holders the exclusive power to make by-laws.2 1 They can also pass
a by-law increasing the number of directors required to constitute
a quorum at any meeting of directors 2 2 If a director’s presence is
necessary to constitute a quorum, he can make it difficult for the
other directors to transact any business to which he objects. 23 The
disclosure of desired financial information can be ensured by means
of a by-law requiring such information to be placed before the
shareholders at annual meetings.2 4
b) The power to amend articles
Section 167 provides that the articles of a corporation are amend-
ed by special -resolution. Subsection 2(1) defines a special resolution
as a resolution passed by a majority of not less than two-thirds of
the shareholders who voted in favour of that resolution. 5 The power
to amend the articles can accordingly be regulated by a non-unani-
mous shareholder agreement between shareholders controlling two-
thirds or more of the votes attached to the issued shares. Subsection
6(3) permits the articles to provide for a high vote requirement for
shareholders’ and directors’ meetings, thereby providing the parties
with a veto power over corporate actions. Another important pro-
vision which can be included in the articles is a provision giving
the shareholders pre-emptive rights. This will protect the parties to
a non-unanimous shareholder agreement against dilution of their
voting strength and equity, and is discussed in more detail below.
18 Supra, note 3, s.183(1).
“) Ibid., s.116.
20 Ibid., s.120.
21 Ibid., s.98(1).
22 Ibid., s.109(2).
23 S.109(5) permits the by-laws to provide that a notice of a meeting of
directors must specify the purpose of the business to be transacted at the
meeting. By causing such a by-law to be passed, a director who opposes certain
proposed director actions can use this notice to determine which meetings
to avoid. In the absence of such a by-law, no purpose need be specified in
notices of meetings of directors. M.L. Fraser and S.L. Stewart, Company Law
of Canada 5th ed. (1962), 615.
24 Para.149(1) (c).
25Under the old Act, supplementary letters patent are initiated by by-law,
and since by-laws can only be made by the directors, the shareholders do not
have the power to initiate amendments to letters patent.
1976]
COMMENTS – COMMENTAIRES
c) The power to remove directors
Section 104 authorizes the shareholders to remove any director
from office. A majority of the shareholders could provide in a non-
unanimous shareholder agreement for the removal of any director
who does not comply with the instructions of that majority. This
threat may be sufficient to induce the directors to do the share-
holders’ bidding.
d) Pre-emptive rights and share transfer restrictions
Since a shareholder agreement is only binding on the parties to
it”‘ the issue or transfer of shares to non-parties can undermine the
protection which the agreement is intended to afford.
The parties to a unanimous shareholder agreement can prevent
the issue of shares to non-parties by providing that no shares shall
be issued by the directors without the unanimous consent of the
parties to the agreement. The parties to a non-unanimous share-
holder agreement can secure similar protection by providing for
pre-emptive rights in the articles. Section 28 gives statutory sanction
to the administrative practice of permitting the articles to provide
that no shares shall be issued unless they have first been offered
to existing shareholders in proportion to their holdings of the shares
of the class being issued. The protection provided by a pre-emptive
right however, is not as complete as that provided by the right to
veto the issue of shares. Paragraph 28(2) (a) states that shareholders
have no pre-emptive rights in respect of shares to be issued for a
consideration other than money. As important as this statutory
exception is, the fact is that a pre-emptive right is useless if a share-
holder does not have the means or the liquidity to pay the price at
which the shares are offered.2
7 Parties to a non-unanimous share-
holder agreement would accordingly be well advised to supplement
pre-emptive right provisions with high vote requirements in the
articles and perhaps with high quorum requirements in the by-
laws. This would permit each party to veto any proposed share issue.
Subsection 140(3) provides that a transferee of shares subject
to a unanimous shareholder agreement is deemed to be a party to
2 6 This is subject to the exception provided by s.140(3), which makes a
unanimous shareholder agreement binding on a transferee of shares subject
to the agreement.
27 Ss.13(15) and 44-46 of the old Act permit the issue of partly-paid shares,
so that the pre-emptive right provisions in the letters patent can provide for
liberal terms of payment. S.25(3) of the new Act provides that shares cannot
be issued until they are fully paid.
McGILL LAW JOURNAL
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the agreement, provided that the security certificate transferred to
him contains a reference to the fact that the certificate is sub-
ject to such an agreement. Parties to a non-unanimous shareholder
agreement must, however, rely on share transfer restrictions to pre-
vent the erosion of the protection provided by the agreement through
transfers of shares to non-parties. Paragraph 6(1)(d) requires
such restrictions to be set out in the articles. If the original articles
do not contain adequate restrictions, section 184 may deter any
necessary amendment, since it permits a dissenting shareholder to
compel the corporation to purchase his shares at their “fair value”
in the event of such an amendment.
3. High vote and high quorum requirements
As indicated above, the new Act authorizes high vote and high
quorum requirements for meetings of directors and shareholders.28
Such requirements can provide protection for the shareholders of a
closely-held corporation which is as effective as that provided by a
28 Supra, note 3, ss.6(3), 109(2) and 133(1). There appears
to be no
Anglo-Canadian jurisprudence with respect to high vote provisions in the
articles or by-laws of a corporation. It has been argued that by-laws in
letters patent jurisdiction are legislative in nature, so that the common
law prohibition against a director fettering his discretion does not extend
to a fettering of discretion by by-law as opposed to contract. See Sohmer,
Protecting the Minority Shareholder in Letters Patent Jurisdictions, supra,
note 2, 407. There is American jurisprudence to the effect that such by-laws are
invalid in the absence of statutory authority. In the case of Benintendi v.
Kenton Hotel, 294 N.Y. 112, 60 N.E. 2d 829 (1945), the New York Court of
Appeals held invalid by-laws requiring unanimity for shareholders’ resolutions,
unanimity for the election of directors and unanimity for directors’ resolutions.
It would be more difficult to characterize a high quorum provision as
an illegal fettering of discretion. The jurisprudence indicates, however, that
quorum provisions will be disregarded where it can be established that the
failure to attend a meeting or the leaving of a meeting, had, as its object,
the prevention of the formation of a quorum or the loss of a quorum. See
In re Copal Varnish Co., Ltd (1917) 2 Ch.349; Re Hartley Baird Ltd (1955) 1 Ch.
143; Hofer et al. v. Hofer et al. (1968) 65 D.L.R. (2d) 607; T. J. Winram Estate v.
M.N.R. [1972] C.T.C. 193; Gearing v. Kelly, 11 N.Y. 2d 201, 182 N.E. 2d 391 (1962);
cf. Fairgreen Investments Ltd v. M.N.R. [1972] C.T.C. 2446. The consistent
refusal of a director to attend meetings would probably constitute a breach
of duty, and it may be that such a breach could be restrained by an injunction.
The Quebec Court of Appeal has upheld contempt of court convictions against
two municipal counsellors who disobeyed an injunction to refrain from acting
together with a view to preventing a municipal council meeting from being
held for want of a quorum; see Bourque and Farineau v. Chartier et al.,
Quebec Court of Appeal, District of Montreal, no.14,646, September 10, 1973 (un-
reported). High quorum provisions are nevertheless an effective first line of
1976]
COMMENTS – COMMENTAIRES
unanimous shareholder agreement. As appears to be the case with
the unanimous shareholder agreement, a high vote requirement
cannot provide a shareholder-director with the power to initiate
corporate action. It also appears that the shareholder-director is
prohibited by the provisions of section 117 from exercising his veto
power at directors’ meetings when his own interests are in conflict
with the interests of the corporation.
In order to -deprive the directors of the power to appoint a third
party to fill a vacancy which results from the death or incapacity of
one of the shareholder-directors on the board, thereby removing the
protection provided by a high vote requirement, either a high quorum
requirement for directors’ meetings should be required or the
articles should stipulate that vacancies can only be filled by the share-
holders 9
4. Cumulative voting
The shareholders of a closely-held corporation may want to grant
a minority shareholder the right to be represented on the Board of
Directors without giving him a veto power. The usual techniques
for accomplishing this are provisions in shareholder agreements
whereby the shareholders covenant to elect to the board a re-
presentative of the minority and the creation of a special class of
shares, the holders of which have the right to elect a specified number
or percentage of directors. Departmental practice30 permits the use
of a third technique, cumulative voting, and section 102 sanctions
this practice. Cumulative voting is a more cumbersome technique
than the others, and it is not anticipated that provision for it will
be made in the articles of many closely-held corporations.
5. Non-voting shares
Subsection 13(17), and sections 104 and 105 of the old Act were
interpreted by the Department as requiring that preferred share-
holders must have some right to vote. The policy was that, at the
very least, such shareholders had to be entitled to vote in the event
that no -dividends were paid for two consecutive years. Many closely-
held corporations do not pay dividends regularly to preferred share-
defense since an obstructionist purpose must be proved and such proof may-
be difficult to make unless there are repeated acts of absenteeism.
29 Supra, note 3, ss.106(2) and (4).
0 Department of Consumer and Corporate Affairs, Corporations Branch
(Canada).
McGILL LAW JOURNAL
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holders. The occasional controlling shareholder suddenly found him-
self being outvoted because the preferred share voting rights had
been triggered as a result of non-payment of dividends. Subsection
24(4) of the new Act removes this trap by permitting the creation
of non-voting shares. 31
6. One-man corporations
Subsection 97(2) reduces the minimum number of directors to
one for corporations the securities of which are not or were not
part of a distribution to the public. Since nominee directors are no
longer necessary, problems relating to the control of their powers
will no longer be encountered.
7. Arbitration
The new Act contains several provisions which will facilitate the
use of arbitration as a technique for resolving disputes as to the
exercise of management powers. A unanimous shareholder agree-
ment can provide that a veto of director action by a party to the
agreement can be overridden by the decision of a third party arbitra-
tor. Subsection 140(4) necessarily implies that the arbitrator would
not be subject to the duties and liabilities of the directors. Paragraph
6(1)(e) permits the articles to set out a minimum and maximum
number of directors. A shareholder agreement, even a non-unanimous
one, can accordingly provide that in the event of a dispute between
the parties as to director action, a third party arbitrator shall be
elected as an additional director until the dispute has been resolved 2
In this case, the arbitrator would of course be subject to the duties
and liabilities of directors, a fact which may make it difficult to
induce a person to accept the role of arbitrator.
3’S.125(1) of the Income Tax Act, S.C. 1970-71-72, c.63, grants a small
business deduction to Canadian-controlled private corporations. S.125(3) of
the Income Tax Act provides that members of an associated group of corpora-
tions may share the small business deduction but that the full deduction
may not be claimed by each of them. Under s.256 of the Income Tax Act,
“control” is the test for determining “association”. In the case of Lou’4
Service (Sault) Ltd v. M.N.R. [1967] C.T.C. 315, several corporations were held
to be associated on the ground that control can be imputed to the holders
of redeemable preferred shares, which, because of non-payment of dividends,
carried the right to vote. This trap will also be removed by s.24(4) of the
new Act.
=The third party need no longer be a shareholder to be a director, ibid.,
s.100(2).
19761
COMMENTS – COMMENTAIRES
8. Buy-sell and stock-retirement agreements
Most shareholder agreements contain buy-sell provisions for use
in the event of the death of a shareholder or in the event of irrecon-
cilable disputes as to the exercise of management powers. These
provisions contemplate the purchase of one shareholder’s shares
by one or more of his fellow shareholders. The use of stock-retire-
ment arrangements whereby shares are purchased by the corporation
is prohibited under the old Act as a result of the decision in Trevor
v. Whitworth.3 3 Sections 32 and 33 of the new Act remove this
obstacle, and section 38 contains a number of specific provisions
relating to such arrangements.
Section 184 may deter an amendment which may in many cases
be necessary to give effect to the “buy-sell” provisions which most
shareholder agreements contain. The customary charter share trans-
fer restriction provides that no shares may be transferred without
the prior approval of the directors. Any covenant by the directors
to approve a transfer in accordance with the “buy-sell” provisions
may constitute an illegal fettering of discretion. Since shareholders
are free to fetter their discretion, the difficulty can be avoided by
amending the articles so as to require shareholder approval instead
of director approval. Section 184 however, provides a right to dissent
not only where restrictions are added or removed, but also where
they are changed.
Conclusion
The draftsmen of the new Act were sensitive to the fact that a
large proportion of federally incorporated companies -are closely-
held. Among their objectives were the abolition of useless formali-
ties, the provision of new and expanded remedies for the resolution
of disputes, and an increase in management flexibility.
The provisions which seek to implement this last objective
significantly expand the freedom of the participants in closely-held
corporations to tailor the power structure in accordance with their
desires. The new Act, however, does not permit as much flexibility
as it should. The shareholder-director dichotomy is meaningless in
the context of most closely-held corporations and the unanimous
shareholder agreement provisions should have permitted the direc-
tors to be dispensed with entirely. At the very least, the new Act
should have been drafted so as to clearly permit a transfer of
management powers to the shareholders.
David H. Sohmer*
33 (1887) 12 A.C. 409.
* B.C.L. (McGill), LL.B. (Dalhousie), of the Montreal Bar.
