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frozen asset

Estate Freeze Litigation Concerns

If you ask the typical accountant about an estate freeze, he or she will tell you that smart people who are in a growth business are well advised to consider an estate freeze in order to defer taxes. In an estate freeze, the owner of the business will take steps to freeze the value of that business today and ensure that the future growth (and any capital gains on it) passes on to the next generation. Arguably, if properly implemented, by taking these steps the present owner can maintain control of the business while deferring the capital gains tax which would otherwise be paid upon the death of the owner on the increase in value. That may be how tax planners see an estate freeze, but there is another side to this question.

We see the estate freeze in an entirely different context. We are litigators. In our practice, which deals with commercial and estate litigation, we see significant litigation risk arising out of estate freezes. Often, these risks are unanticipated when estate freezes are proposed and first implemented. These litigation risks should be brought to the attention of clients prior to implementing an estate freeze.1

Let’s first be more precise about what happens in a typical estate freeze. In his article, entitled ESTATE FREEZES – FACT OR FICTION IN FAMILY LAW2, Timothy G. Youdan3 explains,

There are various ways to achieve an estate freeze but the basic idea is that a person, X, who owns property (typically shares of a corporation) that is likely to increase in value carries out a transaction under which the value of the property is frozen and the future growth in value passes to another person or persons. A typical arrangement would be for X to transfer his shares in Opco to a new corporation, Holdco, in exchange for preference shares of Holdco with a redemption/retraction amount (i.e. the maximum value) equal to the value of X’s Opco shares. Typically, X will wish to have control over Holdco and thus indirectly over Opco. There may be sufficient votes attached to the preference shares to achieve this purpose. However, on redemption these shares, and the votes attached to them, will disappear. Therefore, it is quite common for X also to receive a further class of preference shares with a nominal value redemption/retraction amount but carrying sufficient votes to control Holdco.”

The goal of the estate freeze is to save taxes. In the absence of a freeze the parent would simply own 100% of the common shares of the business. When he dies his estate would have a tax bill of approximately 25% of the increase in value of the business (the capital gain) which, if uninsured, could force the family to sell equity, or even the whole company just to pay the tax bill.

So if a parent implements an estate freeze, but can still maintain absolute control of his company, what could go wrong?

The place to start is the Ontario Court of Appeal case of Naneff v. Con-Crete Holdings et al.4 In Naneff, Natscho Naneff (“Father”) and Ingeborg Gina Naneff (“Mother”) had two children and a successful business. The oldest child was Alex and the youngest was Boris. When this case was heard the children were 36 and 33 years old respectively. Father built the business and by the time of the litigation it had revenue of over $23 million per annum. Father dreamed of his sons coming into the business and eventually taking over. To that end the children worked in the business part time while they were growing up and the parents showered them with gifts. On the advice of their professionals, Father implemented an estate freeze giving the equity in his business to his sons while retaining control through redeemable voting special shares/preference shares.5 Both Alex and Boris came into the business working hard and effectively. But, Alex started leading a lifestyle that gave his parents cause for concern. He was dating a woman whom his parents did not like and as a result of the friction that ensued, Alex was thrown out of the family home and the business.

Alex commenced an application under s. 248 of the OBCA6 seeking relief for oppression. Based on the estate freeze Alex was a minority shareholder. Pursuant to section 248 of the OBCA he was entitled to seek a declaration that his Father’s conduct was oppressive – i.e. that it was unfairly prejudicial to him or that it unfairly disregarded his interests. Section 248(3) gives the court very broad discretion to implement a remedy if it finds oppression. The court can make any order “it thinks fit”. When there is a finding of oppression, a court may even order that the corporation involved be wound up. In the Naneff case, the court made a finding that Alex was oppressed and ordered Father and Boris to acquire Alex’s shares of the companies at fair market value, without minority discount.7  We can imagine Father’s chagrin. He built the business, gifted his son an ownership interest in it and then against his wishes he had to pay out the value of the son’s ownership interest at a time when he actually wanted to financially punish his son. Do you think Father would have liked the opportunity to rethink the decision to implement an estate freeze?

Does this sort of thing happen a lot? We are unware of any statistical analysis. But we have been involved in many disputes concerning estate freezes after the fact, and there are a number of reported cases that should give those considering an estate freeze a moment to reflect. We refer the reader to

  1. Animal House Investments Inc. v. Lisgar Development Ltd.;8
  2. 820099 Ontario Inc. v. Harold Ballard Ltd.;9

When a business person only thinks about tax and not the litigation risks he or she does himself or herself a disservice. By implementing an estate freeze there are new shareholders and stakeholders in the business. The directors now have fiduciary obligations to those shareholders. Minority shareholders have rights and the courts are unafraid to enforce them. The owner of the non-voting growth shares who today is a loving cherubic sixteen year old may one day become the 28 year old ne’er do well who cannot hold down a job. He may become the failed business person whose overwhelming flaws motivate him to take ill-advised actions that hurt the family business. He could marry a spouse who turns him against the family. And those shares gifted to that cherubic 16 year old could one day be the weapon he yields to seek an oppression remedy in Ontario.

Are you sure you want to do an estate freeze?

  1. It is beyond the scope of this article to deal with all the risks of an estate freeze. But those considering the option should consider risks such as: family law issues, 21 year rule issues, insufficient value left for the founder to support his lifestyle after sale of the business, US / foreign tax implications of children emigrating.
  2. Presented at Osgood Professional Development conference, “Recent Developments and Complex Issues in Property and Equalization”, June 5, 2013.
  3. Partner, Davies Ward Phillips & Vineberg LLP
  4. (1995) O.J. No. 1377 (C.A.), rev’g (1993) O.J. No. 1756 (Gen. Div.) (QL).
  5. In this case it appears as if the children subscribed for the equity shares. Query what would have transpired if a discretionary trust was created and it was the trust that subscribed for the equity shares. The two children could have formed part of a group of beneficiaries? Would the court grant an oppression remedy to a beneficiary of a discretionary trust? Possibly not. It that were the case then the risk only kicks in after the trust has been terminated, likely after 21 years.
  6. 248 (1) A complainant and, in the case of an offering corporation, the Commission may apply to the court for an order under this section.  1994, c. 27, s. 71 (33).

    Idem

    (2) Where, upon an application under subsection (1), the court is satisfied that in respect of a corporation or any of its affiliates,

    (a) any act or omission of the corporation or any of its affiliates effects or threatens to effect a result;

    (b) the business or affairs of the corporation or any of its affiliates are, have been or are threatened to be carried on or conducted in a manner; or

    (c) the powers of the directors of the corporation or any of its affiliates are, have been or are threatened to be exercised in a manner, that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer of the corporation, the court may make an order to rectify the matters complained of.  R.S.O. 1990, c. B.16, s. 248 (2).

    Court order

    (3) In connection with an application under this section, the court may make any interim or final order it thinks fit including, without limiting the generality of the foregoing,

    (a) an order restraining the conduct complained of;

    (b) an order appointing a receiver or receiver-manager;

    (c) an order to regulate a corporation’s affairs by amending the articles or by-laws or creating or amending a unanimous shareholder agreement;

    (d) an order directing an issue or exchange of securities;

    (e) an order appointing directors in place of or in addition to all or any of the directors then in office;

    (f) an order directing a corporation, subject to subsection (6), or any other person, to purchase securities of a security holder;

    (g) an order directing a corporation, subject to subsection (6), or any other person, to pay to a security holder any part of the money paid by the security holder for securities;

    (h) an order varying or setting aside a transaction or contract to which a corporation is a party and compensating the corporation or any other party to the transaction or contract;

    (i) an order requiring a corporation, within a time specified by the court, to produce to the court or an interested person financial statements in the form required by section 154 or an accounting in such other form as the court may determine;

    (j) an order compensating an aggrieved person;

    (k) an order directing rectification of the registers or other records of a corporation under section 250;

    (l) an order winding up the corporation under section 207;

    (m) an order directing an investigation under Part XIII be made; and

    (n) an order requiring the trial of any issue.  R.S.O. 1990, c. B.16, s. 248 (3).

    Idem

    (4) Where an order made under this section directs amendment of the articles or by-laws of a corporation,

    (a) the directors shall forthwith comply with subsection 186 (4); and

    (b) no other amendment to the articles or by-laws shall be made without the consent of the court, until the court otherwise orders.  R.S.O. 1990, c. B.16, s. 248 (4).

    Shareholder may not dissent

    (5) A shareholder is not entitled to dissent under section 185 if an amendment to the articles is effected under this section.  R.S.O. 1990, c. B.16, s. 248 (5).

    Where corporation prohibited from paying shareholder

    (6) A corporation shall not make a payment to a shareholder under clause (3) (f) or (g) if there are reasonable grounds for believing that,

    (a) the corporation is or, after the payment, would be unable to pay its liabilities as they become due; or

    (b) the realizable value of the corporation’s assets would thereby be less than the aggregate of its liabilities.  R.S.O. 1990, c. B.16, s. 248 (6).

  7. See paragraphs 41 & 42 of the OCA decision which rejected the trial judges remedy.

    41     It is my opinion that paragraph 9 of the trial judgment, which provides for the sale of the appellant companies on the open market as a going concern, cannot be sustained. In its place, I would order that the appellants acquire Alex’s shares of the companies at fair market value fixed as of the date of his ouster, December 25, 1990. It is conceded on behalf of the appellants that it would not be fair to apply a minority discount to the market value of Alex’s shares. I agree and would order that there be no minority discount when fixing the fair market value of his shares. Alex is also entitled to pre-judgment interest on the value of his shares as provided in the Courts of Justice Act from December 25, 1990.

    42     In the event that the parties cannot agree upon the value of the shares or to having the value of them fixed in some other way, I would direct a new trial restricted to fixing the value of Alex’s shares in the appellant companies as of December 25, 1990. In my view the costs of such a new trial ought to be in the discretion of the judge presiding at it

  8. (2007) O.J. No. 3879 (S.C.J.), aff’d (2008) O.J. No. 2240 (Div. Ct.) (QL).
  9. (1991) 3 B.L.R. (2d) 113 (Ont. Ct. (Gen. Div.)). In her article, “When an Estate Freeze Goes Awry” which is available on line, Margaret O’Sullivan explains, “Harold Ballard (“HB”) froze his estate in 1966, and gave his three children non-voting common shares of his holding company, while retaining voting control….. A deterioration in family relations occurred, and HB wished to reacquire his children’s shares. … his third child, William Ballard (“WB”) refused his father’s offers to purchase his shares…. The corporation was re-organized and a share issue occurred to finance the purchase of the children’s shares, and to ensure HB’s control over the operating company, Maple Leaf Gardens. As a result, WB was “frozen out”. WB brought an action to nullify the re-organization on the basis that it was oppressive conduct. The court held that in effecting the re-organization, the directors had acted for an improper purpose, that they acted only in the interests of the majority shareholder, and that they did not consider the interests of the minority shareholder. As a result, it set aside the re-organization.”

Charles Wagner and Gregory Sidlofsky

The authors of this blog is Charles Wagner and Gregory Sidlofsky. Charles is a Certified Specialist in Estates and Trusts and partner at Wagner Sidlofsky LLP. Gregory is a Certified Specialist in Litigation by The Law Society of Upper Canada and partner at Wagner Sidlofsky LLP.

This Toronto office is a boutique litigation law firm whose practice is focused on estate and commercial litigation.

This blog is not intended to serve as a comprehensive treatment of the topic. It is not meant to be legal advice. Every case turns on its specific facts and it would be a mistake for the reader of this blog to conclude how it might impact on the reader’s case. Nothing replaces retaining a qualified, competent lawyer, well versed in this niche area of practice and getting some good legal advice.
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