Anonymised, illustrative composite. The purchaser bought every share and every asset. What it could not buy was the right to seat whichever four people it liked on the board.
At a glance
A US-listed industrial services group agreed to buy all of the issued shares of a federally incorporated Canadian company operating three service depots in southern Ontario. Price was $23,400,000, all cash, on a cash-free debt-free basis. The buyer had done this eleven times in the United States and once in Mexico. It had not bought a Canadian corporation before.
The closing agenda was the group’s standard one. Among the deliverables: resignations from all five incumbent directors, effective on closing, and resolutions appointing four replacements — the group’s chief operating officer, general counsel, VP of finance and head of field operations. All four live and work in Ohio.
Canadian counsel flagged the board slate nine days before closing. The target is a Canada Business Corporations Act corporation, and s.105(3) says that, “Subject to subsection (3.1), at least twenty-five per cent of the directors of a corporation must be resident Canadians. However, if a corporation has less than four directors, at least one director must be a resident Canadian.”
This is the point most buyers miss, and it is a point about units. Section 105(3) constrains the board. It says nothing about who owns the shares. Acquiring 100% of the equity gives the purchaser the power to elect every director it wants; it does not give it the power to elect four directors none of whom is a resident Canadian. The constraint survives the acquisition intact and applies for as long as the corporation stays federal.
With a four-person board, twenty-five per cent is one director — four is the smallest board on which a single Canadian satisfies the test. On the five-person board the group’s US subsidiaries run, one of five is twenty per cent, so the requirement would have been two. Board size is a lever on the residency count, and it moves in steps of four.
The buyer’s first answer was that its Canadian CFO, eleven years in Mississauga, would take the fourth seat. That answer was wrong. Section 2(1) defines a resident Canadian as an individual who is “a Canadian citizen ordinarily resident in Canada”, a Canadian citizen abroad in a prescribed class, or “a permanent resident within the meaning of subsection 2(1) of the Immigration and Refugee Protection Act and ordinarily resident in Canada, except a permanent resident who has been ordinarily resident in Canada for more than one year after the time at which he or she first became eligible to apply for Canadian citizenship”. The CFO was a permanent resident who had been eligible to apply for citizenship for a little over three years and had never got round to it. The exception in paragraph (c) took him out of the definition entirely.
Section 105(3) sets the composition rule at twenty-five per cent. Section 105(3.1) raises it: where a corporation engages in an activity in Canada in a prescribed business sector, or is required by federal legislation to attain or maintain a specified level of Canadian ownership or control, then “a majority of the directors of the corporation must be resident Canadians”. The prescribed sectors are a short, closed list in section 16 of the Canada Business Corporations Regulations, 2001: “the prescribed business sectors are (a) uranium mining; (b) book publishing or distribution; (c) book sales, where the sale of books is the primary part of the corporation’s business; and (d) film or video distribution.” Industrial services is not on it, so twenty-five per cent was the number here. On a book distributor the same deal would have needed a majority-Canadian board, which for a foreign acquirer is a different proposition altogether.
Section 114(3) is where a defective board stops being a paperwork problem. Directors “shall not transact business at a meeting of directors unless… at least twenty-five per cent of the directors present are resident Canadians” — and for a s.105(3.1) corporation, a majority of those present. A four-person all-Ohio board could hold a meeting; it could not do anything at it. Every post-closing resolution the buyer had scheduled — approving the new banking authority, the intercompany services agreement, the officer appointments — sat behind that sentence.
Be precise about what does not rescue this. Section 116 provides that “An act of a director or officer is valid notwithstanding an irregularity in their election or appointment or a defect in their qualification.” That cures a defect in one director’s qualification. It is not a licence for a board to transact business in the face of the s.114(3) prohibition, which is directed at the meeting.
The fix took an afternoon. The general manager of the Ontario operation — a Canadian citizen ordinarily resident in Burlington, and the one person on the payroll the buyer actually wanted in the room — took the fourth seat, and the three Ohio nominees took the others. The closing went ahead on the original date.
The buyer also asked the obvious follow-up: can we make this go away permanently? It can. Ontario’s Business Corporations Act once carried a resident-director requirement in s.118(3); that subsection was repealed by 2020, c. 34, Sched. 1, s. 5, in force 5 July 2021, and an OBCA corporation now has no residency requirement for its directors at all. Continuing the target into Ontario removes the constraint rather than managing it, and continuance is a well-worn route — but it is a filing, shareholder approvals and new constating documents, not something to do in the nine days before a closing.
Not a fine, and not an invalid share transfer. The cost is that the board cannot function. In the week after closing it needed to authorise a new $6,000,000 operating facility, appoint signing officers and approve the transition services agreement with the parent. The lender’s conditions included a certified copy of the authorising directors’ resolution, and a resolution passed at a meeting held in breach of s.114(3) is not a certificate a lender’s counsel signs.
Section 114(4) offers a narrow escape where the required Canadian director is absent: business may still be transacted if “a resident Canadian director who is unable to be present approves in writing, or by telephonic, electronic or other communication facility, the business transacted at the meeting”. It presupposes you have one. A board with none cannot use it.
The tell was in the closing agenda, not the diligence report: when the resignation-and-appointment list for a Canadian target contains no Canadian, a US closing checklist has been copied across a border. The second tell cost more time — an assumption that a long-settled permanent resident counts. Residency is a defined term with an express carve-out, and the carve-out is aimed at exactly the profile most buyers reach for first.
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