Anonymised, illustrative composite. Three CBCA sections govern a corporation buying its own shares and each measures against a different denominator. Reading across from one to another is how this goes wrong.
At a glance
An Ontario industrial-distribution business incorporated federally was held 60/40 by two unrelated shareholders, and a buyer wanted the whole company. The exiting 40% holder's tax position was materially better if the company bought his shares back, so the plan was the familiar hybrid: the corporation would redeem the 40% for $2,000,000 and the buyer would purchase the remaining 60% for $3,000,000. See selling your shares to your own company.
The company drew a $2,600,000 facility to fund the buy-back leg. Nobody involved thought this was unusual, because it is not.
A corporation buying its own shares passes through a statutory gate that a buyer purchasing the same shares does not. The tax analysis and the corporate-law analysis are answering different questions, and the deal was structured entirely on the first.
What made the gate bite was a transaction eight years old and irrelevant to everything else in the file: an estate freeze that had exchanged the founder's growth shares for $1,900,000 of redeemable preferreds. Stated capital records what was paid in for shares. It is not cash, it does not fall when the business does badly, and nothing in a buy-back reduces it.
Before the draw: realizable assets $3,700,000, liabilities $1,200,000. The company drew $2,600,000, taking assets to $6,300,000 and liabilities to $3,800,000. Redeeming for $2,000,000 takes assets to $4,300,000, with liabilities unchanged at $3,800,000.
Stated capital of all classes: $1,900,100 — the freeze preferreds at $1,900,000 plus $100 of common. So the s.34(2)(b) comparator is $3,800,000 + $1,900,100 = $5,700,100, against $4,300,000 of realizable assets. The company fails by $1,400,100.
It passes limb (a) without difficulty. Cash flow covers the new facility, the covenants have headroom, and every supplier is paid on terms. Every conventional measure of solvency says yes. The provision says no, and it says no because of a number that has nothing to do with the company's ability to pay anyone.
Section 34(1) permits a corporation to purchase or otherwise acquire shares issued by it, subject to s.34(2) and its articles. Section 34(2) then provides that a corporation “shall not make any payment to purchase or otherwise acquire shares issued by it if there are reasonable grounds for believing that” it is or would become unable to pay its liabilities as they become due, or “the realizable value of the corporation's assets would after the payment be less than the aggregate of its liabilities and stated capital of all classes”.
Now the correction that decided the file. It is commonly said that s.34(2) and s.36(2) impose the same test. They do not. Section 36(2)(b) forbids payment where “the realizable value of the corporation's assets would after the payment be less than the aggregate of (i) its liabilities, and (ii) the amount that would be required to pay the holders of shares that have a right to be paid, on a redemption or in a liquidation, rateably with or before the holders of the shares to be purchased or redeemed, to the extent that the amount has not been included in its liabilities”. There is no stated capital in it. The second limb counts only what is owed to shares that rank equally with or ahead of the ones being bought.
On this balance sheet the difference is decisive. Had the $2,000,000 been paid to redeem the freeze preferreds — the most senior class, with nothing ranking ahead of or rateably with them — the s.36(2)(b) comparator would have been $3,800,000 of liabilities and nothing more, against $4,300,000 of assets. The company would have passed. Same corporation, same day, same $2,000,000, opposite answer, because a different class was being bought and therefore a different subsection governed.
Section 36(1) reinforces rather than removes the gate, which is the other half of the misreading. It permits a corporation, “Notwithstanding subsection 34(2) or 35(3), but subject to subsection (2) and to its articles”, to redeem redeemable shares “at prices not exceeding the redemption price thereof stated in the articles or calculated according to a formula stated in the articles”. It swaps which test applies and adds a price ceiling. It is not an exemption from any test.
There is a third gate, because deal teams reach for it. Section 35(1) permits an acquisition — notwithstanding s.34(2) — to settle or compromise a debt or claim, to eliminate fractional shares, or to fulfil an option or obligation to buy shares owned by a director, officer or employee. Its own limitation in s.35(3)(b) uses yet another denominator: liabilities plus “the amount required for payment on a redemption or in a liquidation of all shares the holders of which have the right to be paid before the holders of the shares to be purchased or acquired”. Three sections, three denominators — and only s.34's mentions stated capital.
The redemption leg was abandoned. The buyer purchased 100% of the shares directly, and the exiting shareholder took a capital gain rather than the deemed dividend the hybrid was built to produce. The price was re-cut by $85,000 to share the tax difference between the parties, and the $2,600,000 facility was replaced with acquisition debt at the buyer's vehicle.
Reducing the stated capital first was raised and dropped: it is its own corporate step, with its own approvals and its own creditor-protection test, and it could not be done inside the closing timetable. See paid-up capital for the related but distinct tax concept — stated capital and paid-up capital are not the same number.
Paying anyway is not a quiet option. Section 118(2) makes directors who vote for or consent to a resolution authorising “a purchase, redemption or other acquisition of shares contrary to section 34, 35 or 36” jointly and severally, or solidarily, liable to restore the amount to the corporation. Section 118(4) then lets a director who has paid apply to compel the recipient shareholder to hand the money back, and s.118(5) lets the court order exactly that. So the exiting shareholder's exit is not clean either — and s.118(7) allows two years from the date of the authorising resolution to commence the action.
The practical consequence for a vendor is that a certificate from the directors that the s.34(2) test is met is not a courtesy. It is the document that says whether the money he is about to receive is his to keep.
A hybrid buyout structured by the tax adviser and never routed past corporate counsel, in a company carrying preferred shares from an old freeze. The freeze is the tell: it is the commonest way a small private company acquires a large stated capital figure, and stated capital appears in the s.34 test and in no other measure anyone in the deal is looking at.
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