It appears unfortunately that the following scenario may not be uncommon. An entrepreneur with a booming business will decide that the time has come to incorporate. Lawyers are hired and “legal formalities” attended to: articles of incorporation are filed, initial directors elected, officers appointed and shares subscribed for. A corporate minute book (often nicely engraved, bound in leather together with a fancy corporate seal) is ordered and put together, properly documenting all of the initial resolutions with all requisite registers and ledgers neatly in place. The world has been blessed with a birth of a brand new legal person. As the case is often with smaller, private corporations, the focus immediately shifts back to actually running the business and accumulating the profits, while the minute book, with time, starts accumulating only a nice layer of dust. Resolutions are not passed or documented, subscriptions for shares are not prepared and multitudes of other “legal formalities” are neglected. The dire consequences of failing to file corporate returns or keep proper corporate records (including a cancellation of the corporation) are beyond the scope of this article. Instead, the focus is on what happens when the minute book is not kept up to date while various sets of circumstances eventually lead to questions or disagreements as to one of the most fundamental aspects of corporate existence: who are the shareholders?

Typically, someone can become a shareholder by either (a) transfer of existing shares from an existing shareholder or (b) subscribing for the new shares. Ultimately, a person becomes a shareholder through a subscription when a contractual relationship is formed between the corporation and that person, and the basic contract law applies. In general terms, to have a valid contract, one party must make an offer which is in turn accepted by the other party, where both parties get something of value as a result of the transaction.

The offer (i.e. subscription) is made by a potential shareholder by making a written application to the corporation to issue a certain number of shares in the corporation. There are no magic words that need to be used to create a valid subscription. Moreover, it appears that a person may make an oral application for a subscription as well. In any case, the offer does not create any obligations until it is accepted by the corporation, and the corporation is free to accept or reject the subscription. A potential shareholder has no right to insist that the subscription be accepted by the corporation, even where the corporation solicits subscriptions in the first place, as in such case, the solicitation is considered a “mere invitation to treat” and is not open for acceptance by the subscriber in order to create a valid contract. Finally, if a subscription does not provide that it is open for acceptance for a specified period of time, it must be accepted within a reasonable period of time, and if not accepted, such subscription lapses.

The acceptance of the subscription is ordinarily documented by a formal resolution of the corporation’s board of directors, as only the board of directors may issue shares and cannot delegate this power. However, it is important to mention that the courts have the power, known as “Oppression Remedy” to intervene in the affairs of a corporation and do whatever is necessary (including issuing of shares), in order to protect a person from or prevent oppressive, unfairly prejudicial conduct of a corporation. A formal board resolution authorizing the issue of shares is not required, and any action on the part of the corporation which in some way demonstrates an acceptance of share subscription will suffice. For example, the acceptance may be demonstrated by (i) acceptance of money tendered in payment of subscription price, (ii) the issue of share certificate, (iii) notification to the subscriber by one of the corporation’s officers or some other authorized person, that the offer has been accepted. A subscriber must receive a notice of the acceptance of the subscription so that he or she knows that the contract has been formed, as without an accepted subscription, a corporation may not make a person a shareholder against his or her will. There are some general rules that govern the issuance of shares. For example, a corporation cannot accept a subscription and issue shares where it would be necessary to exceed the corporation’s authorized capital. Also, the shares may not be issued until fully paid. The onus lies upon the shareholder to prove that he or she has paid for the shares. 

The identification of shareholders is of crucial importance, due to numerous benefits associated with that position, including receipt of dividends and voting at the shareholder meetings.  However, combined with poor record keeping, this issue could potentially result in prolonged and expensive legal proceeding, where all evidence demonstrating the existence of a contract would be scrutinized. The identification of persons who are shareholders may also be important in a liquidation or bankruptcy proceedings, where proper contributories must be determined. In such cases, a person may be estopped from denying that he or she is a shareholder. A “shareholder by estoppel” is a person who has acted and been treated as a shareholder, so as to become subject to the liabilities of a shareholder. The acceptance of a dividend and other forms of participation in the corporation as a shareholder (making part payment for the shares or attending the meetings) are in general sufficient to estop a person from denying that he or she is a shareholder.

In conclusion, although the formal board resolutions and subscriptions, inclusion of the name of a person on the shareholders register, the issue of a share certificates, the payment of dividends, participation in shareholders meetings are obviously evidence that the particular person is a shareholder (and may be sufficient to raise presumption to that effect), none of these steps, on their own, are conclusive of that fact. However, in order to avoid any uncertainty and to avoid spending time and money in analyzing past events in order to determine whether shares were in fact ever issued (or a valid contract ever formed), a corporation must ensure that all of the appropriate steps are taken and corporate records kept up date.

Faruk Gafic practices in the areas of corporate/commercial law, commercial real estate and leasing with McLean & Kerr LLP, a law firm based in Toronto.
The content of this article is intended to provide general information for the reader and is not intended as advice or an opinion to be relied upon in relation to any particular circumstance. For specific applications of the law to a particular set of circumstances, the reader should seek professional advice.