Can minority shares be diluted to force the holder out before a sale?

Dilution means the corporation issues new shares, so each existing share becomes a smaller part of the whole. Whether that can be done to a minority holder depends on the corporation’s own documents and on the statute it was formed under. Under the Canada Business Corporations Act (CBCA), section 25(1) says that, subject to the articles, the by-laws, any unanimous shareholder agreement and section 28, shares may be issued at such times, to such persons and for such consideration as the directors determine. Ontario’s Business Corporations Act and Alberta’s Business Corporations Act govern corporations formed under them, and the other provinces run their own acts.

What can stand in the way of an issue

Directors do not have a free hand. Under CBCA section 28(1), if the articles so provide, no shares of a class may be issued unless they are first offered to the holders of that class, in proportion to their holdings, at the price and on the terms on which they are to be offered to others. Section 28(2) then excludes shares issued for a consideration other than money, as a share dividend, or on the exercise of conversion privileges, options or rights previously granted. Ontario’s Act has a pre-emptive rights provision that applies if the articles or a unanimous shareholder agreement provide for it, and Alberta’s Act has its own. If the articles contain no such right, section 28 gives the holder nothing. CBCA section 25(3) adds that a share cannot be issued until the consideration is fully paid in money, property or past services of at least the fair equivalent of the money.

The directors’ duty and the oppression remedy

CBCA directors and officers must act honestly and in good faith with a view to the best interests of the corporation. Separately, section 241 lets a complainant ask a court for an order where an act or omission of the corporation, the way its business is carried on, or the way the directors’ powers are exercised is oppressive or unfairly prejudicial to, or unfairly disregards, the interests of any security holder, creditor, director or officer. Ontario’s equivalent is section 248 of its Act, and Alberta’s Act has its own provision. A holder who believes a share issue was timed to shrink their stake ahead of a sale can ask a lawyer whether it meets those words.

What a court can do

Under CBCA section 241(3), the court may make any interim or final order it thinks fit. The Act’s examples include restraining the conduct, directing an issue or exchange of securities, varying or setting aside a transaction, and directing the corporation (subject to the payment limit in section 241(6)) or another person to purchase a security holder’s securities. Whether a particular dilution meets the test is a question of facts and of the court’s judgment, not something the statute answers in advance.

What to check first

A minority holder who plans to sell can read how a minority stake is sold. Before any dispute, these are the questions to put to a corporate lawyer:

• Which statute governs the corporation, federal or a province’s own.
• Whether the articles or a unanimous shareholder agreement give existing holders a pre-emptive right.
• What the by-laws and any shareholder agreement say about who must approve a share issue.
• When shares were issued, to whom, and what was paid for them.