When succession planning in a business and family law intersect, the result can be complicated and confusing.
With family breakdown a common part of many people’s experience these days, should business arrangements take this possibility into account and how do they do so?
Shane Kelford of Howard Ryan Kelford Knott & Dixon in Smiths Falls, Ont., has seen how many family businesses don’t consider the future when clearly they should.
He practises family and corporate law, so he has seen the issue from both sides. “Marriage breakdown can effectively end a family business,” says Kelford.
Those businesses that do address the matter have a few tools at their disposal, although the certainty surrounding them has taken a hit in light of a recent decision that found that a gift of shares under an estate freeze wasn’t excluded from matrimonial property in a subsequent marriage breakdown.
The decision of Superior Court Justice Gary Tranmer at first instance in McNamee v. McNamee sent shockwaves among family, corporate, and tax lawyers.
No one was more surprised than Kelford, who drafted the documentation. Although the Court of Appeal has now reversed the decision, he still finds himself proceeding much more cautiously with what he previously perceived to be black-letter law.
“The primary purpose of an estate freeze is to crystallize the value of the business for tax purposes and to transfer the value of all future growth to the children,” says Kelford.
“As a corollary to that, you should consider how to protect the business in the event of a marriage breakdown. The technique I used in McNamee is very common. In 2007, the business was worth $2 million.
Mr. McNamee Sr. issued preferred shares for $2 million and then issued common shares, which he gifted to his sons. Much to my surprise, my estate plan was challenged in the family law proceedings and we lost at first instance.
Fortunately, the Court of Appeal took a sober second look and said the gift was excluded, so now we are back on track.”
James Eastwood, a partner at Stewart Corbett in Brockville, Ont., who was co-counsel for the appellants, says the appeal decision has certainly calmed fears that an estate freeze is no longer a viable approach to protecting future tax growth and guarding against future family law claims.
His co-counsel Hunter Phillips of the family law boutique MacKinnon & Phillips in Ottawa is also confident. “There is no uncertainty now that the Court of Appeal has restored the original position if the gift is set up the way this one was,” he says.
“In the McNamee case, there was no issue that it was a gift,” he adds. “There was a deed of gift, and clearly no money came from the sons.”
One special feature of the McNamee deal was that the declaration of gift made special mention of the possibility of a future marriage breakdown.
It said that neither the shares nor any increase in their value or income from them were to form part of the net family property in the event of marital breakdown.
It also said the shares were to remain separate property free from the control of the spouse.
“Mr. McNamee Sr. had himself gone through a marriage breakdown, so he was aware of some aspects of the exclusions under Part 1 of the Family Law Act,” says Eastwood.
“The Court of Appeal put sufficient weight on the provisions that they put the entire document verbatim into the judgment. Given the onus is on the spouse arguing for the gift exclusion, it is certainly good advice to do the same.”
Phillips agrees. “The special clauses that referred to marriage breakdown are particularly significant under the Family Law Act.
Assets that are transferred are excluded from the calculation of joint matrimonial property, but you need special wording if the income on that is to be excluded.”
Another tool in the McNamee case was a shareholders’ agreement that restricted the transfer of the shares without the father’s consent. Kelford also recommends the use of a family trust.
“It is commonly accepted that an interest in a family trust is excluded and has no value in family law,” he says.
“The parents have assets they would like to go to the children but wish to protect them from future marriage breakdown, so Mom and Dad become trustees in a discretionary trust.
They control how any assets are distributed and they don’t have to treat the children equally. The child might get nothing or a lot.”
However, Kelford raises the scenario where the son owes the daughter-in-law $200,000 but has no assets except an interest in a discretionary trust.
“Can the court go into the trust to pay her? Academics and commentators have expressed concern that it might happen.
At this point, it’s black-letter law. What’s in the trust is not part of the child’s family assets. But after the McNamee case, I have to give that advice much more cautiously.”