7 October 2016 APFF Roundtable Q. 7, 2016-0652971C6 F - Paragraph 251(5)(b) and subsection 256(1.4) -- translation

Principal Issues: (1) Whether a power of attorney to find a prospective buyer for the shares of the capital stock of a corporation held by a departing shareholder is a right under subsection 256(1.4). (2) Whether an automatic redemption by a corporation of shares of its capital stock held by a departing shareholder is a right under subsection 256(1.4). (3) Whether an automatic redemption by a corporation of shares of its capital stock held by a departing shareholder is a right under paragraph 251(5)(b).

Position: (1) Question of facts. In the situation, the power of attorney is not a right to, or to acquire, shares of the capital stock of a corporation. However, a review of the clause, the modalities of the shareholder agreement or any other conventions is necessary to determine whether the power of attorney represents a right to control the voting right of shares of the capital stock of a corporation. (2) Question of facts. CRA's current position is that the fact that a clause of a shareholder agreement provides for an automatic redemption by a corporation of shares of its capital stock is not determinant by itself to determine whether a shareholder has a right to cause a corporation to redeem, acquire or cancel any shares of its capital stock owned by other shareholders under subsection 256(1.4) or paragraph 251(5)(b).

Reason: (1) The law and previous positions. (2) The law and previous positions.

7 October 2016 APFF Roundtable

Q. 7 Special clauses in a franchise agreement and association rules

Under the busienss model for a franchising corporation, it 50% of the voting and participating shares of its franchised companies. The franchisor, through a franchise agreement, ensures high quality standards, exclusive distribution of its products and ensures the sustainability of its distribution network. The shareholder who holds the other 50% of the shares of a franchisee is the person who acts as the day-to-day franchise manager and operates the franchise. In each case, there is an agreement between shareholders to govern the rights of each, including on death, bankruptcy and permanent disability.

The shareholders' agreement contains a clause that applies in the event that the manager determines to leave the manager's position and wishes to dispose of the manager's shares. This clause ensures that the manager will provide a mandate to the franchisor to find an independent purchaser for the shares in accordance with the terms set out in the shareholders' agreement. The purchaser of the 50% shareholding cannot be the franchisor or a person related to the franchisor. Alternatively, the shareholders' agreement would contain a clause providing for the automatic redemption by the franchisee of the shares of the manager wishing to dispose of those shares (this would not be an option to be exercised by the other shareholder but, rather, would be an automatic mechanism requiring no action on the part of the other shareholder).

Subsection 256(1.4) provides that in determining whether a corporation is associated with another corporation with which it is not otherwise associated, consideration must be given to whether a person has a right at any time under a contract, in equity or otherwise, either immediately or in the future, and either absolutely or contingently to shares of the capital stock of a corporation or to control the voting rights. The same principle applies where the person has a right to require a corporation to redeem, acquire or cancel shares held by the other shareholders of the corporation.

Questions to the CRA

(A) Can the CRA confirm that the clause granting a mandate to the franchisor to find another independent shareholder to acquire 50% of the shares should not be a right referred to in subsection 256(1.4) for the purposes of the association rules?

(B) Can the CRA confirm that the clause providing for automatic redemption of the 50% of the shares held by the outgoing manager should not be a right contemplated by subsection 256(1.4) for the purposes of the association rules?

(C) Can the CRA confirm that the clause providing for automatic redemption of the 50% of the shares held by the outgoing manager should not be a right referred to in paragraohg 251(5)(b)?

CRA response to question 7(a)

Subsection 256(1.4) provides in particular that, for the purpose of determining whether a corporation is associated with another corporation with which it is not otherwise associated, where a person, or any partnership in which the person has an interest, has a right at any time under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently, to, or to acquire, shares of the capital stock of a corporation, or to control the voting rights of shares of the capital stock of a corporation, the person or partnership shall, except where the right is not exercisable at that time because the exercise thereof is contingent on the death, bankruptcy or permanent disability of an individual, be deemed to own the shares at that time, and the shares shall be deemed to be issued and outstanding at that time.

The question of whether a corporation is otherwise associated with another corporation is a question of fact. The information provided is insufficient to determine whether the franchisor is otherwise associated with the franchisee in the context of the given situation.

Moreover, to determine whether a person has a right at any time under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently, to shares of the capital stock of a corporation, or to acquire them or to control the voting rights, all the facts and circumstances applicable to a situation including the shareholders’ agreement must be considered.

In the given situation, it would be reasonable to conclude that the franchisor does not have a right to the shares in the capital stock of the franchisee owned by the manager is the owner nor to acquire them within the meaning of paragraph 256(1.4)(a) by virtue only of the provision granting a mandate to the franchisor to find another independent shareholder to acquire the shares held by the manager in the capital stock of the corporation.

However, the CRA would need to analyze this mandate clause, the terms of the shareholders’ agreement or any other agreement to determine whether the franchisor has an immediate or future right, conditional or not, to control the voting rights of the capital shares of the franchise company held by the manager.

CRA response to question 7(b) and (c)

Subsection 256(1.4) also provides that for the purpose of determining whether a corporation is associated with another corporation with which it is not otherwise associated, where a person, or any partnership in which the person has an interest, has a right at any time under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently, to cause a corporation to redeem, acquire or cancel any shares of its capital stock owned by other shareholders of a corporation, the person or partnership shall, except where the right is not exercisable at that time because the exercise thereof is contingent on the death, bankruptcy or permanent disability of an individual, be deemed at that time to have the same position in relation to control of the corporation and ownership of shares of its capital stock as if the shares were redeemed, acquired or cancelled by the corporation.

Furthermore, subparagraph 251(5)(b)(ii) states in part that for the purposes of subsection 251(2) and the definition of Canadian-controlled private corporation ("CCPC") in subsection 125(7), where at any time a person has a right under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently, to cause a corporation to redeem, acquire or cancel any shares of its capital stock owned by other shareholders of the corporation, the person shall, except where the right is not exercisable at that time because the exercise thereof is contingent on the death, bankruptcy or permanent disability of an individual, be deemed to have the same position in relation to the control of the corporation as if the shares were so redeemed, acquired or cancelled by the corporation at that time.

The current position of the CRA concerning the interpretation of paragraph 256(1.4)(b) and subparagraph 251(5)(b)(ii) is that the fact that a clause in a shareholder agreement provides for the automatic redemption by a corporation of the shares of its capital stock is not determinative as to whether a shareholder has the right to cause a corporation to redeem, acquire or cancel any shares of its capital stock held by other shareholders.

In the CRA's view, the wording of paragraph 256(1.4)(b) and subparagraph 251(5)(b)(ii) are broad enough to apply to a situation in which a particular person would control the triggering of an event that would require a corporation to redeem, acquire or cancel any shares of its capital stock held by other shareholders. In this regard, the CRA has ruled that a person does not generally control the triggering of an event where a corporation is obliged to redeem or purchase shares of its capital stock held by a shareholder convicted of defrauding the corporation.

The wording of paragraph 256(1.4)(b) and subparagraph 251(5)(b)(ii) also applies to a situation where a particular person would have the right to cause a corporation to redeem, acquire or cancel any shares of its capital stock owned by another shareholder even if the person has no control over the triggering of an event requiring the company to make the purchase.

However, neither paragraph 256(1.4)(b) nor subparagraph 251(5)(b)(ii) would apply if the event in question were the death, bankruptcy or permanent disability of an individual.

Additional information and legal analysis of the automatic redemption clause and any other agreement would be necessary to determine, in the context of a particular situation, if the franchisor has a right, either immediately or in the future and either absolutely or contingently, to require the franchisee to redeem, acquire or cancel shares of the manager in its capital stock.

Guylaine Gladu
(819) 639-3271
October 7, 2016
2016-065297