Legal Implications of Promissory Notes for Share Issuances in Alberta

Author: todd-strang posted in: Business Law + Corporate Commercial

In the intricate landscape of corporate reorganization, the use of promissory notes as consideration for the issuance of shares can appear to be an attractive strategy. This method can facilitate the creation of paid-up capital and cost basis in shares without the immediate need for cash transfer. However, in Alberta, this practice is fraught with legal challenges and potential pitfalls. In this blog, we discuss the legal ramifications of using promissory notes for share issuances in Alberta and explore the permissible alternatives within the province.

Alberta Business Corporations Act (ABCA) Restrictions

The Alberta Business Corporations Act (ABCA) imposes stringent restrictions on the issuance of shares for promissory notes. Specifically:

• Section 27(3): This section mandates that a share of a corporation shall not be issued by the corporation until the consideration for the share is fully paid in money, property, or past services that are not less in value than the monetary equivalent.
• Section 27(5): This section explicitly states that a promissory note or a promise to pay made by a person to whom a share is issued, or by a person who does not deal at arm’s length with that person, is not valid consideration for the share.

These provisions mean that issuing shares of a subsidiary corporation to a non-arm’s length party in exchange for a promissory note is not permissible under the ABCA—or, rather, that such an issuance would not actually occur until the financial consideration that the promissory note represented was paid in full. If a share issuance in exchange for an unpaid promissory note were to occur, it could be challenged or invalidated by a court, leading to significant legal and financial repercussions.

Potential Consequences of Invalid Share Issuance

If a share issuance is nullified, several adverse consequences could arise:

• Tax Implications: Nullification could affect the characterization of payments from the corporation to the purported shareholder. Payments that were initially classified as dividends eligible for dividend tax credits or deductions under section 112(1) of the Income Tax Act could be reclassified, leading to reassessment and potential tax liabilities.
• Director Liability: Directors who consent to the issuance of shares for invalid consideration could be held personally liable. Under Section 118(1) of the ABCA, directors who vote for or consent to such a resolution are jointly and severally liable to the corporation to make good any deficiency.

Permissible Alternatives in Alberta

Given the restrictions under the ABCA, it is crucial to explore permissible alternatives for creating paid-up capital and cost basis in shares within Alberta:

1. Issuing Shares for Property: One viable option is to issue shares in exchange for property other than promissory notes. This property must be of equivalent value to the shares being issued to comply with Section 27(3) of the ABCA.
2. Issuing Shares for Cash: Another straightforward method is to issue shares for cash. The corporation can then lend the cash back to the subscriber if necessary. This approach ensures compliance with the ABCA while achieving the desired financial structuring.
3. Issuing Shares for Past Services: Shares can also be issued in exchange for past services rendered to the corporation. These services must be valued at an amount not less than the monetary equivalent of the shares to meet the requirements of Section 27(3).

Selling Shares Post-Issuance

While the ABCA restricts the issuance of shares for promissory notes, it is important to note that selling shares to another party after issuance can be done with a promissory note. This transaction is considered a contractual agreement between the parties involved and does not fall under the same restrictions as the initial issuance of shares.

Promissory Notes and Share Issuance: Key Takeaways

In conclusion, while using promissory notes as consideration for share issuances in Alberta presents significant legal challenges, there are permissible alternatives within the province. Issuing shares for property, cash, or past services are viable options that comply with the ABCA. Additionally, selling shares post-issuance with a promissory note remains a contractual possibility. Ensuring compliance with all relevant legal provisions and producing thorough documentation is essential to mitigate risks and defend the validity of the share issuance.

KMSC Business Lawyers Can Help

For further guidance and to explore the best strategy for your specific situation, consulting with legal professionals experienced in corporate law and tax implications is highly recommended. Contact KMSC Business Lawyers and let us help you navigate the strategy that is best for you.