A father’s transfer of common shares to his son as part of an estate freeze was intended as a gift to avoid inclusion in the son’s net family property in the event of marriage breakdown. However, the son’s unfamiliarity with certain details of the freeze threatened in later matrimonial proceedings to undermine the father’s efforts.
The case of McNamee v. McNamee, 106 O.R. (3d) 410 (C.A.) provides some insight into how estate freezes might be structured in order to accomplish not only creditor proofing and tax minimization but also exclusion from the equalization regime under the Family Law Act.
In the McNamee case, the founder of a concrete trucking company when undertaking an estate freeze transferred 500 common shares in the company to each of his two sons, one of whom was subsequently involved in matrimonial proceedings. Unknown to that son, a declaration of gift was executed by the founder at the time which provided that neither the shares, nor any increase in their value, nor any income from them, were to form part of the son’s net family property in the event of marital breakdown, and that the shares were to remain the son’s property free from the control of his wife. The son mistakenly thought that he and his brother had each become one-third owners of the company along with their father, whereas the father in fact retained control of the company by holding 20,000 voting preference shares in the company.
The trial judge in the matrimonial proceedings held that the shares had not been transferred to the son by way of gift, and that the son’s wife was therefore entitled to half of their value. In allowing the son’s appeal of the trial decision, the Court of Appeal nonetheless ordered a new trial to be conducted to decide the issue of whether the wife had an interest in the shares by reason of unjust enrichment and constructive trust. While the Court of Appeal found that the shares were transferred as a gift, it held that the trial judge should first have assessed the wife’s claim to a beneficial ownership interest in the shares before determining whether they should be included in the equalization scheme provided under the Family Law Act.
The Court of Appeal’s description of the purpose and structure of the estate freeze (at para. 11) is as follows:
In 2003, [the founder] reluctantly yielded to the advice of his accountant and lawyer to implement a corporate estate freeze in order to protect the business from creditors and as a means of limiting the impact of taxation in the event of his death. This was accomplished by folding the business into a holding company, 1518006 Ontario Limited (“Holdco”), and fixing the value of the business at $2 million for purposes of the freeze. That value was to accrue to [the founder] Mr. McNamee Sr., but the future growth in value would be reflected in common shares of Holdco to be issued to [the son] Clayton and his brother (subject to controls that Mr. McNamee Sr. was to retain). To give effect to the freeze, Mr. McNamee Sr. transferred his only common shares in McNamee Concrete Ltd. to the newly created Holdco in exchange for 20,000 voting preference shares valued at $2 million. He then subscribed for 1,000 common shares for $1 and transferred 500 of those common shares to each of his sons.
The father’s reasons for maintaining control were described by the Court of Appeal (at para. 13) as follows:
Mr. McNamee Sr. insisted that he was to retain control of the business – he did not think his sons were “ready yet” to take over – and he was adamant that no one would get the shares he had transferred to his sons without his approval. He had gone through a divorce himself and was determined that neither the shares nor any income from them were to become part of any community of property if his sons’ marriages broke down. As a result of these concerns, there were some unusual features to the estate freeze. First, Mr. McNamee Sr. retained full control by ensuring that his preference shares be voting shares (in the normal estate freeze, the preference shares maintained by the former principal are non-voting). Secondly, his voting preference shares entitle him to take unlimited dividends from the company at any time, thus enabling him – should he wish to do so – to denude the company of any equity or retained earnings in the future (also an unusual feature).
To reinforce the father’s control of the business, a shareholder agreement was put into place, described by the Court of Appeal (at para. 15) as follows:
Subsequent to the implementation of the estate freeze, the appellant and his brother and his father executed a unanimous shareholders’ agreement. This agreement provides that in the event a common shareholder retires or leaves the employ of the company, his or her common shares are to be converted into fixed-value non-voting preferred shares of the corporation, having a redemption value equal to the fair market value of the shareholder’s common shares on the final date of employment by the corporation
In holding that the father’s transfer of the common shares was a gift, the Court of Appeal found that the father intended to transfer the shares gratuitously, while the freeze was his ultimate motivation or purpose. It held that a donor’s intention does not have to be inspired by affection, respect, charity or similar impulses. A gift of the shares took place and the son took title to them, even though the father could later affect the value of the shares, or even though there were unknown strings attached to the transfer, or even though the son was mistaken about the percentage of his voting interest in the company.
The power of the father to affect the value of the son’s shares, or the potential conversion of those shares to non-voting shares if the son left the company, were disregarded by the Court of Appeal (at para. 44) as follows:
The fact that the donor could affect the value of the shares at any given time reflects the nature of the estate freeze in question. It has no bearing on whether the shares as transferred were or were not a gift. The shares could be of no value, of limited value or of substantial value. As it turned out, they were of substantial value – $418,200 – when it counted. The appellant received what he received, and the donor irrevocably transferred the shares for what they were. That the unanimous shareholders’ agreement calls for the conversion of the appellant’s common shares into fixed-value preference shares, should the appellant retire or leave the company is of little significance in this respect. Such a provision is a common protector for shareholders in closely held corporations against the consequences of another shareholder leaving but still retaining unwanted leverage through potentially mischievous voting rights. It has nothing to do with whether or not the shares were transferred and received as a gift.
Although the Court of Appeal held that the trial judge should have determined the claims of ownership of the shares before determining the exclusions under the Family Law Act, and thereby ordered a new trial to make such a determination, the McNamee decision is nevertheless a useful reminder that the gift of the common or “growth” shares from a founder to his children on an estate freeze if properly structured should succeed in removing those shares from possible future calculations of net family property on marriage breakdown.
However, the decision should caution secretive company founders who prefer to implement an estate freeze without keeping their children adequately informed about the transactions taking place. If the son had been given copies of all of the documents used to implement the freeze, including the undisclosed declaration of gift, the trial may have resulted in a different decision.
