When estate planning involves corporate shares, particularly in a closely held corporation, it is essential to review the shareholder agreement to see if the transfer of shares is restricted in any way. Shareholders may not be free to gift their corporate shares as they choose in their will due to corporate governance documents.
When a testamentary gift of corporate shares conflicts with the terms of a shareholder agreement, a number of legal questions may arise. Is the testamentary gift invalid or void? Must the estate trustee still attempt to distribute the shares in accordance with the will? And if the gift cannot be completed, what other relief may be available for the intended beneficiary?
Both the Ontario Court of Appeal and the British Columbia Court of Appeal have recently considered these issues, providing useful guidance for estate planners and estate trustees alike.
A Testamentary Gift that Conflicts with a Shareholder Agreement is Not Void
In Frye v. Frye Estate, 2008 ONCA 606, the Ontario Court of Appeal rejected the argument that a testamentary gift of corporate shares should be void because it conflicted with a shareholder agreement.
The shareholder agreement in Frye restricted the transfer of shares by requiring the shareholders to approve share transfers, and also gave the existing shareholders priority rights to purchase shares. Notwithstanding these restrictions, one of the shareholders used his will to leave his shares to his sister, who was also a shareholder.
Writing for the Court of Appeal, Justice Juriansz emphasized that a contractual obligation, such as a shareholder agreement, does not limit a person’s ability to dispose of their property using a will. While a breach of contract may give rise to a claim for damages, the contract will not invalidate the testamentary disposition itself.
Accordingly, a testamentary gift of corporate shares will not be rendered void simply because it conflicts with a shareholder agreement. That said, the shareholder agreement may significantly impact whether – and how – the estate trustee can carry out the transfer.
Implications for Estate Trustees: Trying to Distribute the Gift
If a testamentary gift of corporate shares conflicts with a shareholder agreement, it may not be possible to distribute the gift in accordance with the terms of the will immediately. Justice Juriansz explained in Frye that, under such circumstances, the estate trustee is bound by the terms of the shareholder agreement, and will not be able to distribute the shares to the beneficiary named in the will unless the transfer complies with the requirements articulated in the shareholder agreement.
The court also noted that upon the death of a shareholder, the corporation is required to treat the deceased shareholder’s estate trustee as the registered holder of the shareholder’s shares, as per subsection 67(2) of the Business Corporations Act. This means that the estate trustee is entitled to exercise the deceased shareholder’s rights until the shares are distributed. Moreover, because the estate trustee holds the shares as a bare trustee for the beneficiary named in the will until the shares are distributed, the trustee must exercise any voting rights and other shareholder rights as directed by the beneficiary. In effect, even though the beneficiary may not receive legal title to the shares immediately, the beneficiary may exercise legal control over the shares.
The legal control that a beneficiary may exercise over shares could prove useful, particularly in a case like Frye,where the named beneficiary was also a shareholder in the company. The Court of Appeal held in Frye that the estate trustee was obligated to attempt to carry out thetestator’s intentions by seeking the necessary approvals to distribute the gifted shares in accordance with the terms of the will and in compliance with the shareholder agreement. Obtaining the requisite approvals may be more feasible in a closely held corporation if the beneficiary is already a shareholder, depending on the terms of the shareholder agreement.
Seeking Rectification If the Gift Cannot Be Carried Out
In some cases, unfortunately, a shareholder agreement may make it impossible to transfer corporate shares to a beneficiary named in the will. This occurred, for example, in Simpson v Zaste, 2022 BCCA 208 – a gift of shares included in a shareholder’s will could not be carried out because the shareholder agreement required the shares to be transferred to the shareholder’s surviving business partner at fair market value.
The shareholder’s sons, who would have inherited the shares, sought rectification of the will. The Court of Appeal granted this relief, rectifying the will to give the shareholder’s sons the net value of the shares that could not be distributed to them. Notably, the Court of Appeal did not rectify the will to gift the gross value of the shares to the shareholder’s sons, even though the lower court had granted this relief. Under the shareholder agreement, the purchase price payable by the surviving shareholder was reduced by the value of a life insurance policy payable in favour of the surviving shareholder’s spouse. With this in mind, the Court of Appeal found that the deceased shareholder had intended his sons to receive the shares as they had been encumbered by the shareholder agreement.
To obtain rectification, however, it merits noting that the disappointed beneficiary must also prove that in drafting the will inconsistently with the shareholder agreement, the will-drafter made an error, and that the will does not carry out the deceased shareholder’s intentions. It is also important to remember that rectification is not available simply because a will produces an undesirable or unintended outcome.
Drafting Wills to Take Shareholder Agreements into Account
These cases underscore the importance of carefully reviewing shareholder agreements when drafting a will that disposes of corporate shares, particularly shares in closely held corporations. If a testamentary gift of shares is inconsistent with the terms of a shareholder agreement, the gift may create practical difficulties for the estate trustee, even if the gift is legally valid. In some cases, it may even result in litigation that could have been avoided, had the will-drafter simply ensured that the gift was consistent with the governing shareholder agreement.
Thank you for reading, and have a great day!