Glenn M. Davis, LL.B, MTI, TEP

In brief

Shareholder Agreements containing buy-sell provisions are mostly prepared with tax effects in mind. But the structure chosen may also have a significant impact on shareholder rights during marriage breakdown or upon death.

Rights to Property

Rights to division of property on marriage breakdown or upon death vary from province to province, and the approaches to calculating rights have changed over time. In the past, assets that were used and enjoyed by the family (called “family assets”) were presumed to be shared equally on marriage breakdown, while assets that were not used by the family were presumed not to be shared. For example, corporate shares themselves are not something that could be used by the family. However, the income the shares generate might be a significant source of family income.

Many provinces have gradually moved to a system of viewing marriage as an economic partnership, valuing assets more generally rather than focussing on use. The value of a business may constitute a large part of a shareholder’s wealth. This means transactions that affect share valuation can have significant effects on property division during marriage breakdown or upon death. Spousal rights on marriage breakdown may also be available to a surviving spouse on death.

Gifts and Inheritances

Sometimes rights are determined by whether the asset was received as a gift or an inheritance. Property that has been inherited is often given special protective treatment under provincial law. Yet the opposite may be true for property that has been purchased or developed by a spouse during a marriage. In this instance, the property may be fully open to claims for sharing. In addition, the growth in value during marriage of an asset owned before marriage may be subject to division on marriage breakdown or upon death. The income an asset generates may also get attention and, sometimes, protection.

Life Insurance Proceeds

Life insurance proceeds are sometimes included in the protected property category, similar to inheritances. But that protection may depend on whether or not the policy was owned by the spouse or by a third-party, such as a parent or trustee.

Sometimes, life insurance is owned on each shareholder by the other shareholders in a Cross-Purchase arrangement. A different approach is the insured Share Redemption arrangement, where the Corporation owns sufficient life insurance to redeem the shares of a deceased shareholder. Depending on the applicable law and the structure chosen, the value of the insurance proceeds may or may not be included in property rights upon divorce or death.

Case Study

Bob and Kevin each own 50% of the shares of Bovek Industries. Their respective shareholdings are each worth $1 million and each owns $1 million of life insurance on the other partner. Kevin is going through marital difficulties and it appears he and his wife will separate. Just when it seemed things couldn’t get any worse, Bob was killed in an accident. Kevin collects $1 million in cash from the insurance. It was clearly intended that Kevin would use the insurance to purchase the shares from Bob’s estate. However he arranges to do that, the value of Kevin’s original shares does not change.

Depending on Kevin’s province of residence, the $1million of insurance proceeds may be exempted from sharing in his subsequent divorce. Any assets he acquires with exempted proceeds may also be exempted if they are considered as being traceable from exempted property. If this were the case, it would mean that the shares he purchases from Bob’s estate are not part of his divorce settlement.

Kevin may need family law advice, as well as tax advice, about the best way to structure his affairs. Suppose that in Kevin’s province, life proceeds are excluded from the marriage breakdown calculation. If it worked to his advantage in his province, and Bob’s estate was agreeable, Kevin might pay for Bob’s shares with a promissory note and liquidate it over time. He will then have a matching liability to the value of his new asset and his overall net worth will not have changed. If his marriage ends immediately after he owns the whole company, it can be argued that the value of his assets should be reduced by the value of the promissory note. The value of the assets that he shares will be limited to the value of the shares he owned before Bob died.

In contrast, if Bob and Kevin had a Share Redemption arrangement in place with Bovek Industries, a different outcome will result. After Bob’s death, the company will use its insurance money to purchase his shares from Bob’s estate and cancel them. Kevin’s shares will now represent the entire value of the company. Overnight, the value of Kevin’s shares will have doubled to $2 million and his property division on marriage breakdown will be subject to sharing on a much larger scale.

Advising Clients

There are many aspects to consider in planning shareholder provisions. Knowing the matrimonial laws of your province can help you better recommend the buy-sell structure and ownership of life insurance in buy-sell planning for your business clients.

Glenn M. Davis, LL.B, MTI, TEP is a Planning Consultant with the Wealth Protection Group of Sun Life Financial