What to Consider when Placing Restrictions on Share Transfers

When drafting articles of incorporation, there may be some restrictions you may want to place on shares or even the business. This article seeks to outline some of the most common types of restrictions, and why it could be favourable to enact some of them.

Should I Place Restrictions on my Share Transfers?

It depends. In some cases it is necessary to place restrictions on shares. For example, if you want your corporation to remain privately held it is important to place restrictions on the sale of shares. The nature of your shares and who holds those shares will determine whether or not your corporation is public or private. A simple clause in the articles of incorporation can restrict share transfers so that the corporation remains private. This is done by restricting the sale of shares to only approved parties.

A common restriction on sale shares may look something like this:

“No shareholder shall be entitled to sell, transfer or otherwise dispose of any interest in the share or shares of the capital of the Corporation without the prior approval of the directors of the Corporation expressed either by resolution passed by the votes of a majority of the directors present at a meeting of the directors or by a written instrument signed by a majority of the directors.”

How to Stay on the Right Side of Security Legislation

In order to comply with securities legislation it is important to restrict share transfers. If a corporation has no intention of selling shares to the public, the corporation should limit their share transfers. Corporations who do sell shares to the public are subject to extra requirements under provincial securities law, unlike corporations who do not sell to the public.

In order to avoid being subject to the additional requirements, the corporation’s securities, (excluding non-convertible debt securities), must be:

  • Subject to restrictions on transfer that are contained in the issuer’s articles of incorporation, bylaws and/or unanimous shareholder agreements or security holders’ agreements;
  • Beneficially owned, directly or indirectly, by not more than 50 persons, not including employees and former employees of the issuer or its affiliates, provided that each person is counted as one beneficial owner unless the person is created or used solely to purchase or hold securities of the issuer in which case each beneficial owner or beneficiary of the person, as the case may be, must be counted as a separate beneficial owner; and
  • Distributed to persons described in securities legislation or regulations. For example, approved people are those who are at non-arm’s length with the corporation, such as directors, officers, employees, family and friends.

To remain recognized as a non-distributing corporation, one should consider inserting a provision that restricts the sale or transfer of shares, and adding another provision that restricts the transfer of the corporation’s securities in the articles of incorporation. There are special rules for professionals who incorporate as a professional organization. They must have a provision that restricts the sale of shares, and the professional corporations must be legally owned, beneficially owned, directly or indirectly, by one or more members of the corporation. Additionally, all officers and directors of the corporation must be shareholders of the corporation. You should consult with legal counsel or other professional advisers to consider the impact of securities legislation on your corporation.

Tax Benefits to being Designated a Canadian Controlled Private Corporation

There are many tax benefits to being designated a Canadian Controlled Private Corporation (CCPC) such as the small business deduction, refundable investment tax credits, and capital gains exemption for qualified small business corporation shares. Corporations can maintain their CCPC status by restricting their shares. A common approach, is to enact a restriction where share transfers require director’s approval. Through this set-up the directors have the ability to maintain the status of the corporation as private.

Should I Place Restrictions on my Business?

While most companies do not restrict what business activities the corporation may carry on, there are certain circumstance where restrictions either need to be or should be included.

Professionals such as physicians, dentists, psychologists, accountants, social workers and lawyers are limited when they incorporate. If one of these listed professionals incorporates to practice their profession, their articles of incorporation must include a provision that states that the corporation may not carry on a business other than the practice of the profession. Another restriction is that the corporation cannot borrow funds to purchase investments such as shares in other corporations. However, the professional’s corporation may carry out activities related to the profession, including investment of their profits earned by the corporation. Therefore, professionals can incorporate to carry on their profession and they can invest any surplus earnings from the corporation, but they cannot borrow funds to invest through their corporation. (see OBCA s. 3.2(2).)

In theory, a corporation may choose to restrict their business activities. They may do so, in an attempt to maintain the integrity of the business by focusing on one sector. However, in reality most corporations will not add a restriction on the type of business the corporation can carry out.

Drafting the Articles of Incorporation is a crucial consideration for any DIY drafter. You can use Clausehound.com‘s incorporation templates to ensure that your incorporation process is as easy and cost effective as possible! When drafting your Articles of Incorporation, you will want to consider the information in the following blogs:

Coming Soon!

  • Part 5 – What to consider when selecting the corporation’s share attributes?
  • Part 6 – What type of restrictions should be in place?
  • Part 7 – Other Important Information
  • Part 8 – What’s else should I consider before developing my business?

For more information, check out these blog posts:

Written by Erin.