Canadian incorporation: make sure you pay for your shares

One of the major differences between the Canada Business CorporationsAct (CBCA) and the Quebec Business Corporations Act (QBCA) is that the CBCA prohibits the issuance of shares that have not been fully paid for in money, property or services. To this effect, section 25(3) of the CBCA states:

"The shares may not be issued until they have been fully paid up either in cash or in goods or services rendered, the fair value of which may not be less than the sum of money which the company would receive if payment were to be made in cash.

This rule applies even if the amount to be paid for the subscription of shares is minimal, for example for a total consideration of $100. In such a case, one might be inclined to neglect to pay the cost of issue of the shares; however, it is important to respect the legal obligation to pay the full consideration for the subscribed shares before they are issued. Payment can be made by cheque or in cash (if the consideration is in cash), and the deposit of the amount in the company's bank account will serve as proof that the shares have been paid up and that the share issue is valid.

What happens if the shares have not been fully paid? If someone wishes to raise a breach of the law by the company, it will need to be someone with an interest in the matter. It is possible, for example, that a dispute may arise between the shareholders of the company and the issue of payment for the shares may be raised. The validity of the share issue could also be raised by the tax authorities in some cases.

Several judicial decisions have been rendered in Canada concerning the problem of shares issued without having been fully paid. In Natural Stone International Inc. v. Castonguay, 2007 QCCQ 10250, the Court of Quebec affirmed that the resolution to issue the shares had no effect because the shares had not been paid for:

"[18] Thus, the plaintiff's resolution, dated September 14, 2002, would have no effect since it states that it is issuing 34,000 shares to the defendant, whereas it is a fact that these shares were never paid for either in money or by the transfer of materials."

The issue was also raised in Alberta in Pearson Finance Group Ltd. v. Takla Star Resources Ltd. 2002 ABCA 84. Instead, the Alberta Court of Appeal rejected the "doctrine of nullity" and held that non-payment of shares does not automatically nullify the share issue:

"[21] What is more, a doctrine of automatic nullity would give the court no power to adjust the remedy to the harm done, or to distinguish between the innocent (including the company) and the guilty. Nullity is like a hand grenade in a confined space. It sends a blast and shrapnel in all directions, endangering the person pulling the pin and mere bystanders, as much as the intended target. It cannot be aimed, and can scarcely be lobbed.

The Court considered that automatic nullity would be an inappropriate remedy in cases where the issue price is minimal (e.g. $1), and furthermore that nullity of the share issue might not be in the company's interest.

In order to avoid any risk in the face of these different trends in case law, it is strongly recommended to follow all the formalities of the law and to ensure in all cases that the subscribed shares are fully paid for at the time of their issue.