Investor Protection & Dual Class Share Structures

The recent initial public offerings (IPOs) of major players in the Canadian market, including Aritzia in September 2016, Freshii in January 2017 and Canada Goose in March 2017, have sparked debate about the use of dual class share structures and whether regulatory reform is necessary in order to ensure adequate investor protection.

Corporate Legislation of Dual Class Share Structures:

Pursuant to section 24(3) of the Canada Business Corporations Act (CBCA),[1] when a corporation has only one class of shares, the rights of the holders of those shares are equal in all respects and include the right to vote at any meeting of shareholders of the corporation; to receive any dividend declared by the corporation; and to receive the remaining property of the corporation on dissolution.

Section 24(4) of the CBCA allows for a corporation to have more than one class of shares (Dual Class Share Structure). The CBCA requires that the rights, privileges, restrictions and conditions attaching to each class of shares be set out; and that the rights to vote, to receive any dividend declared, and to receive the remaining property of the corporation on dissolution be attached to at least one class of shares, but all such rights are not required to be attached to one class.

Although the use of a Dual Class Share Structure is allowed by the CBCA (as well as by provincial corporate legislation, including the Business Corporations Act (Ontario)), securities regulators have imposed some regulations regarding the use of such a structure. For example, the Toronto Stock Exchange (TSX) requires that companies issuing a class of shares with multiple votes have a coattail provision in order to ensure that all investors are treated equally in the case of a takeover[2], and the Securities Act (Ontario) mandates various initial and continuous disclosure requirements for securities issuers.[3]

Pros and Cons of Dual Class Share Structures:

Proponents of Dual Class Share Structures argue that dual classes allow the corporation’s management to focus on the long term success and profitability of the corporation. Further, dual classes may encourage entrepreneur controlled companies to access public capital markets and provide investors the opportunity to purchase shares in companies that they otherwise would not be able to purchase. Allowing this type of structure is in line with the principle of freedom of contract.[4]

Critics of Dual Class Share Structures argue that such structures allow a company to access public capital (which is generally cheaper than private capital) and to continue to control the company without taking on the associated financial risk. Dual Class Share Structures may entrench poor performing management by insulating management from accountability to shareholders for their actions.

Best Practices & Calls for Regulation:

The Canadian Coalition for Good Governance (CCGG) has provided several best practice principles for companies that use a Dual Class Share Structure such as ensuring that the holders of the multiple voting share class have a meaningful equity stake in the company, and that a ratio of voting rights between the two classes of shares should generally not be more than 4 to 1. CCGG further suggests that all reporting issuers that use a Dual Class Share Structures, even those that are not listed on the TSX, adopt a coattail provision and recommends standardizing the form of coattail provisions to be used by these companies.

Some commentators have also suggested that securities regulators consider further regulating the law relating to the use of dual class share structures in order to ensure they are serving their stated purpose, part of which involves providing “protection to investors from unfair, improper or fraudulent practices”.[5] Some suggested areas of further regulation include requiring that companies using a dual class share structure implement sunset provisions, which terminate the superiority of the superior share class at a certain time[6], as well as mandating additional change of control procedures.[7] So continues the duel on dual class shares.