Entrepreneurs and investors are rightly concerned about what rights attach to their shares, and what mechanisms are in place to protect those rights. A recent decision of the Ontario Court of Appeal, (Pruner v. Ottawa Hunt and Golf Club, Limited, 2015 ONCA 609 (CanLII)), shines the spotlight on those concerns.

In 1981 JP was admitted as a “fully privileged golfing” member (FPG) of the Ottawa Hunt and Golf Club. He was issued one Class B voting share, and five non-voting Class A shares. Because of a decline in health, he applied 31 years later to become a “senior social” member. He was informed that the Board’s newly adopted policy required him to resign as an FPG member (thus cancelling his ownership of the Class B share) and reapply as a senior social member. JP wished to both continue as a Class B shareholder and change membership categories. He took the matter to court, arguing that “the Board’s newly-adopted policy amounts to a variation or restriction of the rights attached to his Class B share, and that as such, the Board cannot impose such a change unilaterally”. Implicit in this argument is the idea that because in the past JP could have changed membership categories without relinquishing his Class B share, this right attached to him as a shareholder, and no change in Board policy (without a shareholder vote and change of corporate constating documents) could unilaterally strip him of this right.

The letters patent of the corporation (equivalent in function to the articles of incorporation of a business corporation) provided for “5,000 Class B voting shares….with a par value of $10”. The bylaws of the corporation provided that payment of the initiation fee for three categories of membership, which included the FPG but not the senior social member, entitled each such member to one Class B share. The bylaws further provided that when a Class B shareholder ceased to be a member of the club, the club “shall cancel the Class ‘B’ share of that Member”.

The court found that these bylaws made the holding of a Class B share contingent upon the category of membership. The court also found that these bylaws gave the Board the power to implement the policy that required resignation from the club before a former FPG member could apply to become a social member. The policy itself did not affect the voting rights attached to the Class B share.

Because of these bylaws, the right to vote belonged to JP only as the holder of a Class B share, and the right to hold the share attached to his membership category, and not to him personally.

In business corporations, the ownership of a share will not depend on a membership category, but the distinction between the rights attached to the share itself, and the ability of the shareholder to exercise those rights is extremely important.

In business corporations, changes to the articles must first receive shareholder approval. As a result, the minimum features of the shares (voting, dividends, right to participate on liquidation) are contained in the articles. However, the exercise of those rights can be regulated by the bylaws or a unanimous shareholder agreement. For example higher voting majorities can be required for certain types of decisions, or a particular class of shares can have a ‘veto’ right if that class of shares constitutes a certain percentage of the outstanding shares of the corporation.

When purchasing shares, or designing a corporate structure, it is not enough to examine the articles to determine the rights attached to the shares. Careful consideration must also be given to the bylaws and any shareholders’ agreement to determine how those rights may be exercised.

Take away

  • basic rights attached to shares can be found in the articles of incorporation
  • exercise of those rights can be modified by the bylaws or a unanimous shareholders’ agreement

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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