Companies occasionally discover – often at inconvenient moments – that someone else believes they are entitled to shares. These “forgotten shareholders” can emerge years later, complicating financings, delaying exits, or triggering litigation.
Forgotten shareholders typically arise where a person claims an interest in a company that was never properly documented, or where key elements of a share issuance – such as consideration – were not clearly established.
These situations tend to originate in informal arrangements. Verbal understandings among co-founders, early employees, or service providers are fertile ground for later disputes. What begins as a casual promise of “a piece of the business” can harden into a claim of legal entitlement, particularly once the company becomes valuable.
What do they want?
The answer depends on the circumstances, but the stakes can be significant. Claimants may seek a declaration of share ownership, a share of historical profits, or other relief under corporate oppression remedies.
In Fedel v. Tan, a 2010 decision, the Ontario Court of Appeal addressed precisely such a dispute. The plaintiff claimed a 40% interest in a business based on a verbal agreement. The defendant later incorporated the business into two companies and issued himself 100% of the shares. Years later, the plaintiff brought an oppression claim asserting a 40% stake. The court ultimately awarded the plaintiff 40% of profits and the value of diverted business opportunities, along with repayment of his financial contributions.
Even where a company successfully defends a claim, the process can be costly and distracting – and may disrupt ongoing transactions.
Forgotten shareholders may demand a wide range of remedies, and the stakes can be significant. They may seek a declaration of ownership in your company, a share of past profits, or any other remedy available under an oppression claim.
Why it matters
- Capital-raising: Investors expect clarity. Uncertainty over ownership can stall or derail financings.
- Exit risk: Buyers typically insist on acquiring 100% of a target’s shares. Any ambiguity can jeopardize a transaction or result in indemnity claims.
- Dispute dynamics: Clear records often allow disputes to be resolved commercially rather than through litigation. Where relationships deteriorate, courts may prefer monetary compensation over restructuring ownership – an outcome that can be far more expensive. In Fedel v. Tan, for instance, the relationship between plaintiff and defendant had deteriorated so much that the judge found it was best to sever their relationship and compensate the plaintiff for his monetary losses. As a result, instead of simply issuing new share certificates, the companies had to come up with cash.
- Regulatory and audit requirements: Corporations are required to maintain accurate shareholder registers and related records. These may be reviewed in audits or by regulators. For more information about maintaining a corporation’s minute book in general, see our blog.
Responding to a claim
There is no single approach; much depends on the facts. In some cases, the issue can be resolved by documenting and ratifying an intended share issuance. In others, a negotiated settlement, potentially involving a buyout and full release, may be appropriate. Where litigation is a possibility, early engagement with counsel is critical.
Past issuances may also carry securities law implications, particularly if required filings were not made on time. Late filings can result in penalties and other complications.
What if you are the forgotten shareholder?
If you believe you may have a claim, here are some possible steps to consider:
- Contact the company to make sure you’re on their shareholder register.
- Ensure your contact details are up to date, so that you receive documents and communications from the company from time to time. For example, you should receive financial statements and an invitation to an annual general meeting of shareholders or annual resolutions to sign in lieu of a meeting.
- Review any shareholder agreements or related documentation that you may be required to sign.
Avoiding the problem
Most forgotten shareholder disputes are preventable. A corporate lawyer can help you properly document the issuance of shares and other securities. A few key principles go a long way:
- Get tax advice early: The structure of a share issuance has tax consequences. Address them upfront.
- Avoid vague promises and casual conversations: Equity should not be offered casually. Even passing conversations can make a lasting impression. As you grow your business, you may be tempted to promise equity in your company to those helping you in the early days. Where appropriate, consider structured alternatives such as stock option plans.
- Define the “slice”: Specify the number and class of shares, not just a percentage. Percentages can become misleading as additional securities are issued.
- Define the “pie”: Clarify which entity is issuing shares. It is important to know what makes up the “business” as some companies place assets such as land, intellectual property, and key contracts into separate companies. Your documentation should clearly define which company is issuing what securities.
- Document all terms: Conditions, vesting, rights, and expectations should be clearly set out in writing. Does the shareholder receive shares right away or only if he or she has stuck with the company for a certain period of time, or met certain milestones? What rights should attach to the securities? Will they expire or mature at a certain date? Consider a unanimous shareholder agreement or a voting trust agreement to reduce the risk of misunderstandings. Whatever the agreement may be, all the terms should be clearly laid out so that the expectations of all parties are managed early on.
- Confirm consideration: Ensure that valid consideration – cash, property, or services – has been received and properly recorded in the board resolution. If shares are being issued for services, certain additional requirements apply: for example, the services must have already been performed, and the unpaid fair value of those services must at least equal the value of shares to be issued.
- Approve properly: Board resolutions should authorize the issuance and comply with governing documents (including any shareholders’ agreement in effect) and applicable law. Check the shareholder agreement to see if any shareholder approvals are required or if any pre-emptive rights need to be waived. There may also be other contractual limitations on issuing shares such as covenants in your bank documents that should be taken into account.
- Comply with securities laws: Securities laws apply to both public and private companies in Canada. Ensure an available exemption applies to your proposed share issuance and make all required filings within prescribed timeframes.
- Maintain accurate records: Update the shareholder register and minute book to reflect each issuance. For federally incorporated companies, additional obligations may apply to individuals with significant control. See our blog about corporate transparency requirements for more information.
- Get advice before responding to a claim: Early missteps can be difficult to unwind, and there may be other more appropriate ways of documenting and rewarding someone’s contributions to a business.
Informal arrangements can be easy to overlook in the early stages of a business. They are much harder to address once value has crystallized. Clear documentation at the outset is not just good governance; it is often the difference between a straightforward transaction and a costly dispute.
