One Class of Shares Nearly Cost Them Control of Their Company

The situation

Iryna and Wei built their mechanical contracting company from a two-person operation into a business doing several million dollars a year in revenue, split evenly between them from the day they incorporated. Wei ran the field side of the business, having spent years as a plumber before starting the company. Iryna, who kept her day job as a court clerk for the first few years while the business found its feet, eventually came on full-time to run operations and the office. Neither of them had touched the company's legal structure since the original incorporation. Like a lot of small Ontario corporations set up quickly and cheaply at the start, the company had exactly one class of shares: common shares, held fifty-fifty, with no distinctions between them.

By the time the company was turning steady profit and had more work than it could staff, they decided to bring in Ying, their long-time operations manager, as a financial partner. Ying had watched the business grow from the inside and wanted to invest roughly $150,000 to help fund two new service trucks and a small expansion into a neighbouring service area. In exchange, Iryna and Wei agreed she would receive a 20 percent stake in the company. It felt like a natural next step, and a rewarding one for someone who had helped build the business.

What the review found

The three of them handled the investment themselves, using a template share purchase agreement one of them found online and the company's existing minute book. Ying's $150,000 went into the business account, and the company issued her new common shares equal to 20 percent of the total outstanding, the same class Iryna and Wei already held. The deal closed. Only afterward, when the company's accountant flagged that the paperwork should probably be reviewed by a lawyer before year-end, did they bring the file to Treadstone Law.

The problem was not the investment itself. The problem was the tool used to make it. A single class of common shares carries one bundle of rights for every shareholder who holds it: equal voting rights, an equal claim on dividends declared to that class, and an equal claim on whatever is left if the company is ever sold or wound up, all strictly in proportion to the number of shares held. That works fine when every shareholder wants the same thing. It does not work when they do not.

What Iryna, Wei, and Ying had actually agreed to, in conversation, was different from what the paperwork gave Ying. The understanding was that Ying's investment entitled her to a preferred return on her money before Iryna and Wei took dividends for themselves, and that she would have a voice in major decisions but not equal voting control, since she was investing capital rather than founding the business. None of that could exist under a single class of common shares. Every dividend declared to that class had to be paid to all holders in strict proportion to their shareholding, with no way to give Ying priority or a different rate. Every shareholder vote gave her the same one-share-one-vote weight as Iryna and Wei, on everything from approving the company's financial statements to amending its articles.

The gap surfaced almost immediately. A few weeks after Ying's investment closed, the company declared a $40,000 dividend to help the owners cover a tax instalment. Because all shares were common shares of the same class, the dividend went out strictly pro rata: Iryna and Wei each received $16,000, and Ying received $8,000, exactly 20 percent. That $8,000 was meant to be Ying's return on her investment eventually, once the company had grown into the expansion her money funded, not a slice of a dividend declared for an unrelated purpose within weeks of her buying in.

What we did

1. Reviewed the minute book and the closed transaction first. The share purchase agreement and the director and shareholder resolutions authorizing the share issuance had already been signed, and the shares had already been issued and paid for. That transaction was done. Our first job was to understand exactly what had legally happened before proposing anything, since undoing a completed share issuance without everyone's agreement is not something a corporation can do unilaterally.
2. Explained the dividend could not be clawed back. The $40,000 dividend had been validly declared and paid to all holders of the one existing class of shares, in proportion to their holdings, exactly as the law required at the time. Ying's $8,000 share was not a mistake in execution; it was the correct result of an incorrect structure. Reversing it would have meant asking Ying to return money she was legally entitled to receive, which was not something the owners were willing to do and not something we recommended pursuing.
3. Proposed a share exchange to create proper classes. With all three shareholders' agreement, we prepared articles of amendment to reorganize the company's share capital into separate classes: a voting common class for Iryna and Wei that preserved their control over the company's direction, and a new class for Ying carrying a fixed preferred dividend rate ahead of any distribution to the common class, along with limited voting rights on fundamental changes only. Ying's existing common shares were exchanged for the new class share for share, matching the economic deal the three of them had actually intended from the start.
4. Structured the exchange to defer tax. A straight cancellation and reissuance of shares can trigger a taxable disposition for the shareholder involved. We worked with the company's accountant to structure Ying's share exchange using a tax-deferred rollover mechanism available under the Income Tax Act for exactly this kind of internal reorganization, so the fix did not create a tax bill on top of everything else.
5. Put a shareholders' agreement in place. The company had never had one. We drafted an agreement covering how future dividends would be declared and to which class, what needed unanimous consent versus majority approval, how shares would be valued and transferred if one of the three ever wanted out, and what happened if the company brought in further investors down the road. This was the piece that would have prevented the whole problem if it had existed before Ying's investment closed.

The outcome

The company's share structure now matches what the three owners actually agreed to. Ying holds a preferred class with a defined dividend priority and limited voting rights; Iryna and Wei retain voting control through their common shares. Future dividends will flow the way everyone intended, and the shareholders' agreement gives all three a clear process for decisions that used to rest on nothing more than a verbal understanding.

The $8,000 overpayment from the first dividend stood. It could not be undone without unwinding a validly paid distribution, and none of the three wanted to reopen that fight over an amount that, weighed against the cost and disruption of a dispute between business partners, was not worth pursuing. Iryna and Wei treated it as the price of moving fast without proper advice: a contained loss, absorbed early, rather than a structural flaw that could have compounded with every dividend the company declared for years afterward. Had the single-class structure stayed in place through a larger distribution, or through a future sale of the business, the same proportional split would have applied to amounts many times larger, with no easy way to unwind it after the fact.

The legal and accounting cost of the fix was a real expense the company had not planned for, on top of the $8,000 already gone. But it was a one-time cost to correct a structure that, left alone, would have kept producing the wrong result every single time the company declared a dividend or held a shareholder vote.

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