Anonymised, illustrative composite. The same defective-consideration question as the founder's-own-note file beside this one, except this note came from the founder's arm's-length former business partner, not from the founder himself — and the same statute that voids one note treats the other as valid property.
At a glance
A buyer was acquiring all 2,200 issued shares of a CBCA-incorporated industrial-cleaning equipment distributor for $5,800,000. One director held 900 shares, subscribed for in 2015 at $410,000. Diligence turned up the subscription file: rather than paying cash, the director had arranged for a former equipment supplier — a company that had, coincidentally, owed the corporation roughly $410,000 on a settled dispute over defective inventory — to issue a promissory note to the corporation for that amount, in substance funding the director's subscription, in exchange for the director's personal guarantee of the note and a modest fee. Buyer's counsel, having seen the near-identical fact pattern fail on an unrelated deal earlier that year where a founder's own note had invalidated a share issuance, flagged the file for the same defect.
CBCA s.25(3) requires that a share not be issued until the consideration for it “is fully paid in money or in property or past services,” and s.25(5) narrows what counts as “property” for that purpose: “property does not include a promissory note, or a promise to pay, that is made by a person to whom a share is issued, or a person who does not deal at arm's length, within the meaning of that expression in the Income Tax Act, with a person to whom a share is issued.” The earlier deal's defect turned on the first branch — the subscriber's own note is never property, full stop. This file turns on whether the second branch reaches the supplier: is a former trade creditor who agreed to fund the subscription in exchange for a guarantee and a fee “a person who does not deal at arm's length” with the director.
The disputed block was 900 of 2,200 shares, or roughly 41%, worth $2,378,000 of the $5,800,000 purchase price on a pro-rata basis. If the note failed s.25(5)'s test, the 2015 issuance was never valid, the 900 shares had never come into existence, and every vote cast and dividend paid on them since 2015 sat on the same defective footing — the identical downstream exposure the earlier, genuinely defective file carried. Confirming arm's length status turned on the relationship itself, not the dollar figures: corporate registry searches, the supplier's own shareholder register, and the settlement agreement underlying the original trade dispute, none of which showed any family relationship, common control, or contractual tie between the supplier and the director beyond the guarantee arrangement itself.
Section 25(5) draws the line at two specific categories, not at the identity of whoever happens to write the cheque: a note from the subscriber, or a note from “a person who does not deal at arm's length” with the subscriber, using the Income Tax Act's own meaning of that phrase. A note from a genuine stranger to the subscriber — someone who deals with them only at arm's length — is not excluded by the subsection at all, and therefore falls back into s.25(4)'s ordinary rule that the directors may accept property whose value is the “fair equivalent” of what the corporation would have received for cash. The supplier's guarantee fee, its separate commercial relationship with the corporation, and the absence of any control, family or contractual connection to the director all pointed the same way: an arm's-length counterparty who happened to be persuaded to fund someone else's subscription is still an arm's-length noteholder, and s.25(5) simply does not reach that note.
Treating this note the same way as the earlier, genuinely defective founder's-own-note file would have meant unwinding a validly issued 41% block for no reason connected to the actual statute — reissuing shares that were never actually invalid, renegotiating a purchase price allocation that did not need adjusting, and potentially delaying closing over a diligence flag that resolved, on inspection, in the seller's favour. The cost of treating every promissory-note subscription as automatically suspect, without checking whose note it actually was, is not a legal exposure — it is a wasted diligence budget and a needless renegotiation.
The tell was that the earlier file's shorthand — a note funded the subscription, therefore it is an s.25(5) problem — was doing more work than the statute actually authorises. Section 25(5) is not a blanket rule against note-funded subscriptions; it is a rule about two specific relationships. The one-line diligence flag that triggers the right question is never “was this note-funded,” but “who wrote the note, and what is their relationship to the subscriber” — a question this file's answer resolved in the corporation's favour and the earlier file's resolved against it, on the same subsection.
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