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Legal aspects of Succession Plans. Presented by: Roy Sommerey, Partner Doak Shirreff LLP Lawyers. The following is presented as general information only and is not legal or tax advice with respect to any specific individual, corporation or transaction. . Succession Plan.

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legal aspects of succession plans

Legal aspects of Succession Plans

Presented by:

Roy Sommerey, Partner

Doak Shirreff LLP Lawyers

The following is presented as general information only and is not legal or tax advice with respect to any specific individual, corporation or transaction.

succession plan
Succession Plan
  • Develop a Plan - Goal Setting – What and Why?
  • Values and Vision – shared or distinct?
  • Plan the Plan – Strategic Planning – How and When and Where?
  • Advisors – Accounting (Tax), Legal, Financial
  • Do the Plan – Implementation
  • Have a Contingency Plan - unanticipated health problems - death - changes of heart
  • The Law and the Mechanics are secondary
  • Interpersonal issues are key
  • Leader’s Character and Leadership style
  • Leader’s Current vision for Company
  • Who are the successors?
  • Do the Successors get along?
  • Education and Preparation
  • If more than one successor, prepare for different roles
  • Financial Returns from continued ownership and operation vs. sale
  • Capable successors (age, education, skills)
  • Willing successors? Too early to tell?
  • Teachable successors? Skills, ability, and motivation to learn
  • Outside skill sourcing? – interim CEO /Advisory Board Members
  • How will outsiders get along with family?
  • Transition plan is necessary for the business to survive
  • Affordability of inter-family purchase or other succession transfer
  • Is transition financially viable to meet everyone’s needs?
  • Failure or dissolution (of family and business) is possible
  • Transition business intact? Transition in parts?
  • Sale to a third party? (management of proceeds the succession business)
  • Willingness - Time, Energy, and Money to succession
  • Founder - Maturity, Experience, Motivation
  • Does Founder really want to stop running things?
  • Successors – Maturity and Confidence Levels
  • Can they do it?
  • Sense of Entitlement vs. Actual Skills and Abilities
  • Can I work with or for my family?
  • Business- key to achieving career and personal goals?
  • Or A distraction or hindrance to personal fulfilment?
generation gaps
Generation Gaps
  • Industrial Generation (after WWII)
    • Self Sacrifice for family and country
    • Respect Authority
    • Accept the World as it is and work with it and for it
    • Be thankful for a Job and Work as long and as hard as it takes
    • Mom at home taking care of things while Dad just works
    • I want my children to be better off than I was
  • Today, Baby Boomers (now mainly in control)
    • Make the world what I want it to be
    • Mom and Dad working and taking care of family together
    • More Self-centered and ego-centric
  • Generation X and very soon, Generation Y
    • Do I have time to do this?
    • Why do I have to do this?
    • When do I get my reward for this effort?
    • My Parents don’t understand or can’t keep up
    • Text, Blog, Face Book, My space – different world
  • Gaps more dramatic as the pace of life quickens
succession documents
  • Family or employees or third parties?
  • Estate Freeze documents
  • Family Trust Agreement (trust deed)
  • Succession buy-sell agreement
  • Shareholder Agreement
  • Share Option Agreement
  • Employment Contracts
  • Vendor Financing Security documents
estate freezes
Estate Freezes
  • Accountant is the architect of the Freeze
  • Lawyer papers the Freeze
  • Clients – do and sign what they’re told to
  • Accountant - CRA filings and reporting to preserve the Freeze
  • Clients pay the bills and move on, focusing on the next project or task trusting all that should be done has been done
it s the tax
It’s the Tax
  • Main goal is to utilize tax advantages
  • $750,000.00 lifetime capital gains (CG) exemption on disposition of shares (past gains)
  • Multiply GC exemptions for family members (future gains)
  • Company may need to take steps to “purify” to qualify shareholders (SH) for CG exemptions
  • Need to get shares to SH who can claim them
  • Canadian Controlled Private Corporation
  • Private (not public) Company owned and controlled by Canadian residents
  • Control – majority vote vs. actual control
  • Shares aren’t all - who or what is really in control?
  • All or substantially all (90%+) assets (by FMV) used in an active business in Canada
  • Look at all assets recorded in company’s books (not reduced by liabilities)
  • Assets must be owned by the company (not a trust)
active business
Active Business
  • Assets actively used in business or associated company’s business
  • Not investment nor personal services business
  • Specified investment business exclusion
  • Rental or investment income - need 5+ full time employees
  • No excess cash or deposits (not used or needed to finance the business), marketable securities, life insurance, loans to others, passive income
  • Separate qualifiers for Qualified Farm Property and shares in the family farm corporation or partnership – farming business in Canada
why freeze
Why Freeze?
  • Presumes dealing with appreciating assets or business
  • Stop growth in Parent’s hands and shift future growth to Children/Family Trust
  • Crystallize or lock in the present value of business
  • Future Income and Capital Gains to new shareholders
  • Multiply available Capital Gains Exemptions
  • Capital gain to Parent is deferred – redeemable preferred shares
  • Capital Cost payable to Parent by debt instrument
  • One size does not fit all
  • Transfer individually owned assets to Holdco
  • Transfer shares in operating company to Holdco
  • Transfer shares in operating company into a new operating company (preferred shares back to old operating company, common shares in new operating company to children/trust)
  • Typically all use a s. 85 ITA rollover to defer tax triggered on transaction
basic structure
Basic Structure
  • Identify assets involved
  • Establish the Fair Market Value of the Assets
  • New Company – Holdco
  • Issue Common shares (growth shares) in Holdco to family members or family trust
  • Transfer assets or Opco shares to Holdco
  • Receive Preferred Shares in Holdco (amount of the capital gain) –redeemable over time (taxable proceeds)
  • Receive Promissory Note (debt) for capital cost of assets transferred to Holdco
divide business
Divide Business?
  • Butterfly Reorganization
  • split the business into separate ownership and management segments
  • One or more shareholders owns a new company owning a division of the business
  • Remaining shareholders (relative position unchanged) with the balance of the business in original or another company
  • 2 Companies cannot be “related” when done
  • Cannot use Butterfly to cash out a shareholder, barter assets between companies, sell to third party, etc.
  • Hoops and traps (ITA)
family trusts
Family Trusts
  • Income splitting during life
  • Succession – Incapacity and death
  • Control vested in Trustees – choose your successors wisely
  • Voting directions to Trustees on how to vote in certain circumstances
  • Buys time to discover best leader(s) in the family
  • Leaders can receive voting shares over time from Trust
the trust
The Trust
  • Separate Legal Entity (legal and tax purposes)
  • Settlor (establishes the Trust)- can’t be trustee or beneficiary
  • Trustee(s) –usually the founder(s)
  • Beneficiaries – Family – lineal descendants, spouses (?)
  • Property in the trust – the “coin” , the Freeze shares (Opco), subsequent additions
  • Purposes - income distribution & capital distribution & business succession & helping those behind less able to manage $
who runs it
Who runs it?
  • Trustees can be beneficiaries
  • Power to remove and replace beneficiaries
  • Trustees decide distributions to beneficiaries –“discretionary”
  • Ability to choose trustees, remove, replace
  • Person entitled to choose Trustees – Settlor, initial Trustee, etc.
  • If more than one Trustee, decisions must be unanimous unless you specify otherwise
  • Management Issues – Sharing authority between trustees
how is it run
How is it run?
  • Management -- Trust Agreement (Deed)
  • Mechanism for succession
  • Receiving assets – consent of Trustees
  • Investment authority - Trustees
  • Distribution (discretion) - Trustees
  • Protector – consent required to distribute - removing and replacing Trustees or Beneficiaries
who benefits
Who benefits?
  • Beneficiaries
  • “ Issue” = lineal descendants present and future
  • Children, Grandchildren, Great-Grandchildren
  • Spouses – not usually included but can be
  • Extended Family, Employees, Friends (unusual)
  • With authority in Trust Deed, a beneficiary be removed and returned by the Trustee
  • Divorce, bankruptcy, disappearance
  • Trustees – power
tax again
Tax (again)
  • Taxation of a Trust - Individual for Tax purposes
  • Income can be retained and taxed in Trust (max individual rates)
  • Income can be distributed and taxed in hands of adult beneficiaries (splitting)
  • Prohibit beneficiaries under 18 to receive any distributions to avoid “kiddie tax” – max rate tax
  • Capital distributions tax free
main differences
Main Differences
  • Split income to Beneficiaries
  • Deduct income distributions (paid or payable) to beneficiaries
  • Deemed to dispose of all assets every 21 years – needs planning to pass threshold and bear burden or wind up in advance
  • No personal exemptions or marginal tax rates unless a testamentary trust
shareholder agreements sha
Shareholder Agreements (“SHA”)
  • Boundaries and Expectations
  • Company Management Style
  • How will we want to do business
  • Entry and Exit of Shareholders
  • Dispute resolution
  • Ignored while everyone agrees
  • Pulled out in case of dispute or conflict
  • Best to build when everyone agrees
parties to sha
Parties to SHA
  • Company
  • Shareholders (SH) - Individual or Corporate or Family Trust
  • If corporate SH, need to link corporate SH to the Company
  • Individual personally guarantees covenants of corporate SH
  • Unauthorized change of control or management of Corporate SH is a default under SHA
  • Ability to assign individual SH interest to new Holdco – subject to signing on to SHA
  • Share structure and rights and restrictions in Articles
  • Common Shares and Preferred Shares
  • Voting Shares and Non Voting Shares
  • Participating - Dividends and proceeds on Dissolution)
  • Non-Participating – No dividends or proceeds on dissolution
Voting Shares – Meetings of Shareholders.
  • Elect the Directors and Officers
  • Waive Audit
  • Changes to Articles of the Company
  • Deal with major dispositions of the undertaking of the Company
  • Not – Day to Day management of the Company
Necessary to Link active shareholdings to daily management
  • Each active SH has representative director on the board
  • Directors – unless otherwise agreed, one director one vote
  • SH vote not equal to director vote
  • Directors have weighted votes based on SH’s vote
Not all directors may be SH
  • Advisory board Members/outside CEO
  • Not all SH may be family – employee SH
  • Inactive shareholders – no representative director
  • Right to sit at director meetings but no vote
  • Still vote at a Shareholder Meeting?
  • Fiduciary Duties - like a Trustee
  • Best interests of Company
  • No private profit for business opportunities from Company
  • Financial duties and Liabilities – To Shareholders
  • Under Statute – CRA remittances, unpaid wages, etc.
directors meetings
Directors Meetings
  • In person, video conference, internet conference, phone, email, texting
  • Quorum – how many is enough? 51%, 60%, 75%?
  • If no Quorum, adjourn to same place and time 2 days, 4 days, 7 days?
  • Default if failure to vote according to agreement
  • Simple Majority Vote or something greater?
  • Simple Majority, one of whom must be SH “A”
  • Record and circulate minutes?
sh financing
SH Financing
  • SHL contributions
  • Do they bear interest, or interest free?
  • Interest rate set in SHA or by directors?
  • Only excess or disproportionate SHL bear interest?
  • Security for SHL – GSA on Company assets
  • Repayment – restricted - special resolution termination of agreement, dissolution of company
bank financing
Bank Financing
  • Bank Financing - first or last resort?
  • Must Subordinate SHL to Bank Financing
  • Must personally guarantee Bank Financing?
  • Proportionate obligation
  • Indemnify if Bank collects disproportionate contribution
cash calls
Cash Calls
  • Cash Calls – Applications for further SHL
  • Board approval – Everyone advances within x (30?) days
  • Failure to advance is default
  • Others can fill in and financial consequences to defaulting party
  • Others get paid back first, with interest
  • Distributions to defaulting SH diverted until situation rectified
equal pay
Equal pay?
  • Rewarding effort and results
  • Compensating Varying degrees of Effort
  • Salaries, Dividends, Bonuses
  • Employment Contracts with Directors in separate management positions – fixed salary
  • Different Roles – abilities, confidence, motivation
  • Board Discretion on Bonuses and Custom Dividend Yielding
share transfer
Share Transfer
  • Family, Employees, Business Associates?
  • Transferring Shares --- when is it OK and how is it done?
  • No Transfer if a Defaulting SH
  • No Transfer to someone who is not a party to the SHA
  • Prohibition on any transfer (or encumbering) except according to SHA
  • No recognition of SH unless shares acquired according to SHA
  • Right of First Refusal - less applicable in family
  • Before Third Party Sale, must first offer to sell to existing shareholders.
  • Same Terms as that intended for third party
  • Mechanism for forwarding offers and acceptance of RFR Offers
  • A SH can buy shares not acquired by another SH in the RFR process
  • Only one RFR process triggered at one time
affiliates holdco
Affiliates (Holdco)
  • Transfer by SH to Affiliates - Holding Company or Trust owned and controlled by a SH
  • Accommodate personal tax and estate planning
  • Affiliate must be controlled by SH and remain that way
  • No transfer or encumbering of Affiliate by SH
  • Affiliate must sign SHA
  • Personal Guarantees and Indemnities of SH continue.
draw along
Draw Along
  • Less applicable re family – prohibit sales outside family
  • Draw Along Rights – Third party sale
  • Sale by x% Majority SH(s) with minority objecting or refusing to cooperate
  • Majority can compel minority to sell
  • Failing cooperation by minority, majority can transfer minority shares and pay money into trust
piggy back
Piggy Back
  • Piggy-Back Rights - Third Party Sale
  • Sale by x% Majority SH(s) not extended to minority SH
  • Minority can compel buyer to buy minority shares on same terms
  • Sale can’t happen unless minority bought out
  • Shotgun – Mandatory Buy-Sell
  • Divisive
  • Knife that cuts both ways
  • Deliver offers to buy and sell at same price
  • Recipient has option to decide which one to choose (do I buy or do I sell)
  • Favours the financially stronger party (I can’t buy, so I’ll have to sell)
  • Auction process
  • Party puts interest up for sale.
  • Price determines by auction between the remaining SH
  • Rarely Seen or Used in formal context
death of sh
Death of SH
  • What is your family’s role in company when you die?
  • Buy and Sell Option on Death of a SH (or representative of corporate SH) optional or mandatory?
  • Open to working with the brother-in-law or sister-in-law?
  • What do you want for your spouse and children?
  • Caution on mandatory buyout from estate - lose tax free redemption of shares from spousal rollover with shares redeemed from spouse or spousal trust using capital dividend.
  • Remedy - give the estate or company an option to initiate the buy-sell arrangement from your estate
life insurance
Life Insurance
  • Purchase on Death - Can you afford it?
  • Life Insurance or Financing
  • Company redemption or purchase by other shareholders
  • If SH purchase, insurance $ must get to SH – capital dividend s. 83 and 84 ITA
  • Co uses insurance money to redeem shares –
  • Tax traps – get advice on structure.
Other Buy and Sell Options
  • Voluntary withdrawal from Company
  • Permanent Incapacity (defined)
  • Financial Incapacity – Insolvency, Bankruptcy
  • Divorce
Notice to exercise
  • Division and Apportionment if some SH exercise and others don’t
  • Determination of Price – Discount?
  • Cash down, terms?
  • Closing procedure
can i come back
Can I come Back?
  • Buy-Back options
  • Its over with and I’m ready to come back
  • Divorce resolved
  • Discharged from Bankruptcy
  • Same price plus costs?
  • Interest?
  • Terms?
sha default
SHA Default
  • Family vs. Business Associates
  • Breach of SHA not remedied after notice
  • Seizure of shares by creditor and failure to defend
  • Insolvency
  • Change of control of SH except by death or incapacity
default remedies
Default Remedies
  • Waive or forgive default
  • Injunctions or other court related relief
  • Implement Shotgun
  • Special terms as to price and payment
  • Payments to defaulting SH suspended
  • Can’t Vote on some or all decisions
  • No sale or transfer except to other SH
  • Seller’s interest -Shares, SHL, unpaid bonuses
  • Fair Market Value or discount?
  • By Agreement –reach agreement within x days
  • By fixed periodic determinations of FMV – doesn’t accommodate short term fluctuations
  • By formula – easy or complex, but cannot anticipate all future business and economic developments
  • By appraisal (CBV) – one if agreed or average of two etc. – Who pays?
  • Discount on Default/ Bankruptcy/Divorce – business may be weaker without all aboard or when resources used to buy
terms on sale
Terms on sale
  • All cash or Terms
  • Security for unpaid Seller (promissory note, escrow agreement, security agreement, etc.)
  • Set off if Seller’s debts to Company or other SH
  • Apply purchase price to discharge lien on Seller’s shares
  • Right to prepay
  • Right to accelerate demand on default by Seller
  • Permanent or Temporary?
  • For my and my family entirely?
  • Future involvement as consultant/employee
  • Possibility of future return?
  • Non-Competition restrictions - N/A if driven out by shotgun?
  • Confidentiality provisions
  • Breach Remedies – injunctions, damages, etc.
where s the
Where’s the $
  • Shareholder Compensation
  • Defined or discretionary or combo
  • Specified agreement on the calculation and division of company profits
  • Mandatory distribution of retained earnings on formula, etc.
  • Budgeting and Calculation of future reserves in setting amounts available for distribution
  • Employment Contracts
can t agree
Can’t Agree?
  • Conflict Resolution – win-win possible?
  • Engage third parties to help resolve the conflict
  • Mediation - $ - non-binding attempt to resolve
  • Arbitration - $$- on any matter in dispute?
  • some things really should not be disputable
  • Court - $$ to $$$$$ -nature of the problem and the character and wealth of the combatants
Termination of SHA
  • Unanimous Agreement
  • Company Insolvent and dissolved
  • If terminated, right to receive money under SHA survives termination
sha review
SHA Review
  • Mostly forgotten until there is a dispute
  • Preserve relevancy to situation
  • Company evolves
  • Human relationships are not static
  • All mature and evolve, either for the better or for the worse
  • Family, Business, and SH relationships are rarely static
thank you
Thank You
  • Thank you for Coming and for Listening

Roy Sommerey, PartnerDoak Shirreff LLP Lawyers200 – 537 Leon AveKelowna, BC V1Y 2A9(250)