Settling estates involving share transfers can be complicated for Trustees. When a person bequeaths shares of a privately held corporation in his/her Will, what happens when that bequest is inconsistent with the share transfer provisions of a shareholders’ agreement and the transfer restrictions in the corporation’s articles? Which document governs the bequest?
The 2008 case of Frye v. Frye Estate (“Frye”) illustrates the difficulties corporations can face when the provisions of a Will are inconsistent with the shareholders’ agreement governing those shares.
Frye is a case about a father’s wish to provide equally for his children, and what can happen when one or two of those children choose not to honour this wish. George Frye had a private corporation, and on his death he bequeathed his shares equally to his five children: Cheryl, Jack, Donny, Bing and Cam. Donny’s shares were held in trust for him since he was a disabled adult. Bing and Cheryl were the trustees of Donny’s trust. In 1994, Bing sold his shares back to the corporation. This left the remaining four siblings each with 25% of the shares of the corporation. George had wanted the business to remain in the family, and he wanted his children to share equally in the business. The siblings rarely got along.
The Frye siblings entered into a shareholders’ agreement in 1991 which set out, among other things, the procedure to sell their shares, as well as the specific individuals who were required to be part of all decisions in this regard. It also contained a clause outlining the intent and purpose of the agreement, which was to honour the wishes of their father. Further, the Letters Patent of the corporation contained the standard restriction on the transfer of shares, which is a common and necessary provision for privately-held corporations.
Cam passed away in 2002 and bequeathed his shares to Cheryl. As one can imagine with feuding siblings, Jack challenged the validity of the testamentary bequest, arguing, among other things, that the transfer contravened the provisions of both the shareholders’ agreement and the Letters Patent, and was therefore void.
The Superior Court concluded that the share transfer provisions in the shareholders’ agreement and the Letters Patent were broad enough to capture a testamentary bequest, that the bequest to Cheryl was void, and that Cam’s shares were to be sold in accordance with the provisions of the shareholders’ agreement. However, the case did not end there: each of the parties appealed on various grounds.
In respect of the testamentary bequest, the Court of Appeal agreed with the Superior Court that the transfer of shares provisions in the shareholders’ agreement and the Letters Patent captured a testamentary bequest, but the Court of Appeal did not agree with the Superior Court about the effect this conclusion had on the testamentary bequest. The Court of Appeal said that the executors of Cam’s estate (which were Cheryl and a friend of Cam’s) held the shares in trust for Cheryl as bare trustees, meaning that Cam’s estate retained legal title to the shares and Cheryl had beneficial title to the shares. Cheryl could instruct the executors about how to vote the shares, essentially treating the shares as if she owned them, but she did not have legal title to the shares.
The Court of Appeal also said that the share transfer provisions of the shareholders’ agreement and Letters Patent would not be triggered until such time as the estate transferred legal title to the shares. Further, the Court of Appeal said that Cam’s contractual obligations did not affect his ability to make a testamentary bequest, and based on this and a number of other similar statements, appeared to say that a person can do indirectly on death what he/she would not be permitted to do if alive. Jack’s request for leave to appeal to the Supreme Court of Canada was denied, without reasons. As a result, this case remains the current law in Ontario.
This case is fraught with legal issues: tax issues, securities act issues, estate administration issues, potential personal liability of the executors of Cam’s estate, not to mention the contractual issues. From a practical perspective, the parties have been left in limbo.
It is also troubling to think of the implications of this decision on corporations. Securities legislation requires restrictions to be placed on share transfers as one of the conditions a corporation must meet in order to be exempt from the prospectus requirements of the securities legislation; and the shareholders of closely held corporations enter into shareholders agreement that include specific provisions on the sale and transfer of shares for a reason: they want to be able to control who the other shareholders of the corporation are. Following this case could allow a shareholder to essentially transfer his/her shares to whomever he/she wishes, as long as the legal title to the shares remains with his/her estate.
As a business law lawyer, I look at this case with a view to developing strategies to help my clients attempt to prevent this type of situation. Some suggest expanding the definition of ‘transfer’ in shareholders agreements to include gift, bequest, etc. However, in my view, something was missing from the Frye siblings’ shareholders’ agreement. Neither the Superior Court decision nor the Court of Appeal decision mentions any provision of the shareholders’ agreement that dealt with the disposition of a shareholder’s shares on death; this, in my view, is one of the fundamental provisions of a shareholders’ agreement.
What Frye teaches us is that a general restriction on the transfer of shares in a corporation’s incorporating document, together with specific provisions relating to same in a shareholders’ agreement may not be enough. Had the Frye siblings’ shareholders’ agreement contained a provision dealing with dispositions of shares on death of a shareholder, I wonder what the outcome of the case may have been.