The rolled-over founder negotiated approval rights over hiring and capital spending. Under section 146(5) he took a director's liabilities with them, without ever joining the board.
At a glance
A private equity sponsor bought an industrial services business and asked the founder to roll part of his proceeds into the new holding company. He rolled 22%. Because 22% buys no control, his counsel did the obvious protective work and negotiated a unanimous shareholder agreement containing three reserved matters: no capital expenditure above $250,000, no borrowing above $1 million, and no hiring or dismissal of the general manager, in each case without his approval. He took no board seat. He consulted two days a week and had no involvement in payroll, banking or remittances.
Every other rollover mechanic is about what the seller gets. This one is about what the seller assumes. A unanimous shareholder agreement is not an ordinary shareholders' agreement: the statute treats the transfer of a management power as a transfer of the office's liabilities along with it. The founder had negotiated hard for the third reserved matter — control over who ran the business day to day — and it was the one that put him in front of the employees when the company failed in year three.
Forty-one employees were owed $488,000 in unpaid wages and accrued vacation pay at the date of the assignment. The sponsor's three directors had resigned six weeks earlier, which on these facts did not help them: s.119 attaches to debts for services performed while a person was a director, not to who holds office when the claim is made. The employees' counsel nevertheless went first at the person still connected to the business and still solvent.
The claim settled at $214,000 — 44% of the wage pool — because the scope question below was genuinely open and because the statutory preconditions in s.119(2) had to be satisfied before anyone could recover at all. The founder's rolled equity was worth nothing by then. He paid the settlement from the cash portion of his original sale proceeds.
Subsection 146(5) of the Canada Business Corporations Act is the provision, and its opening words are the whole analysis: “To the extent that a unanimous shareholder agreement restricts the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation, parties to the unanimous shareholder agreement who are given that power … have all the rights, powers, duties and liabilities of a director of the corporation, whether they arise under this Act or otherwise … and the directors are relieved of their rights, powers, duties and liabilities, including their liabilities under section 119, to the same extent.”
This is not a deeming provision that makes a shareholder a director. That is the misreading, and it is the wrong unit twice over: it overstates the founder's exposure and understates the directors', because the relief is symmetrical and measured by the same words. The transfer runs only to the extent the agreement restricts the board, and only to the party given that power. A veto over capital expenditure transfers whatever a director's duties are in respect of capital expenditure. Whether a veto over hiring and dismissing the general manager carries the corporation's payroll obligations with it is arguable, and it was argued.
What is not arguable is the liability at the end of it. Section 119(1) provides that “Directors of a corporation are jointly and severally, or solidarily, liable to employees of the corporation for all debts not exceeding six months wages payable to each such employee for services performed for the corporation while they are such directors respectively.” Section 146(5) names s.119 expressly, so at least that liability unquestionably travels. Section 119(2) gates it — the corporation must have been sued and execution returned unsatisfied, or a claim proved in liquidation or bankruptcy within six months — and s.119(3) bars a claim brought more than two years after the person ceased to be a director.
Source deductions are a live exposure and not a settled one, and it is worth being exact about why. Subsection 227.1(1) of the Income Tax Act makes “the directors of the corporation at the time the corporation was required to deduct, withhold, remit or pay the amount” jointly and severally liable with it. The Act does not define director in s.248(1) — every occurrence of the word in that section was read for this file and none of them is a definition — so whether a unanimous shareholder agreement party is caught turns on the general law and on s.146(5)'s own words whether they arise under this Act or otherwise, not on a definition in the taxing statute. The due diligence defence in s.227.1(3) is available, and s.227.1(4) bars proceedings “more than two years after the director last ceased to be a director of that corporation” — a limit whose starting point is itself unclear for someone who was never appointed and never resigned.
The founder settled and the sponsor's directors contributed nothing, on the footing that s.146(5) had relieved them to the same extent. The lesson the sponsor took was about drafting rather than about risk appetite. Reserved matters that operate at the shareholder level — approving a sale of the business, a new share issuance, an amendment to the articles, a change in the nature of the business — are consents on matters that are already shareholders' business. They do not restrict the directors' powers to manage, so they do not engage s.146(5) at all. Reserved matters that operate at the management level — capex, hiring, borrowing — do. Most rollover protections can be rebuilt at the first level with very little loss of protection, and the redraft on this sponsor's next three deals took an afternoon.
Where a management-level veto is genuinely necessary, the answers are an express indemnity, D&O cover extended by name to unanimous shareholder agreement parties, and — cheapest of the three — a standing monthly confirmation that payroll and source deductions are current, which is also the evidence a due diligence defence needs.
A board seat would have cost him nothing extra. He had refused one on counsel's advice, specifically to avoid directors' liability, and the refusal bought him the liabilities without the information rights, the D&O cover or the minutes a director would have had to defend himself with. Declining the seat while keeping the management vetoes was the worst available combination.
The tell is the phrase unanimous shareholder agreement on a document whose schedule of reserved matters reads like a delegation of authority policy. Dollar thresholds for spending, hiring approvals and borrowing consents are management powers. If they sit in a unanimous shareholder agreement, the person holding them has a director's liabilities in respect of them, however few days a week he attends.
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