Wearing Different Hats: Takeaways from Mikelsteins v Morrison Hershfield Limited

This story was originally published by Law360 Canada, (www.law360.ca) a division of LexisNexis Canada.

By: Charlie Kim, Matthew McGuigan and Sarah Hooper

In an effort to incentivize and retain key employees, employers often reward key employees with an option to acquire shares in the employer corporation. As a condition to exercising the option, the employees are typically required to enter into a unanimous shareholders’ agreement (“USA”).

The 2021 Ontario Court of Appeal (“ONCA”) case of Mikelsteins v Morrison Hershfield Limited (“Mikelsteins”) shed light on the interplay between an employer’s obligations to employees upon termination and the rights afforded to the employee-shareholder under the USA. The ONCA held that the employee-shareholder was not entitled to his share rights (including “bonus” payments) as part of his pay in lieu of notice following his termination. In light of Mikelsteins, employers should both consider the factors that could influence a Court’s ruling and ensure that the obligations of each party flowing from termination are clearly set out in the USA.

Mikelsteins v Morrison Hershfield Limited 

Factual Background 

Mr. Mikelsteins received written notice that he was being terminated without cause after working for Morrison Hershfield Limited (“MHL”) for over 30 years. While employed, he was granted the option to purchase shares in MHL’s parent corporation subject to Mr. Mikelsteins entering into an existing shareholders’ agreement (the “Shareholders’ Agreement”) with the corporation and its shareholders. Mr. Mikelsteins subsequently exercised this right and purchased the shares. Under the Shareholders’ Agreement, shareholders were entitled to receive a yearly share “bonus” for each share they owned. It also required terminated employee-shareholders to transfer all of their shares back to the corporation within 30 days of being notified of termination.

The initial trial decision, later overturned by the ONCA, concluded that Mr. Mikelsteins’ “termination date” was the date following his 26-month reasonable notice period. Therefore, he was entitled to his share “bonus” for 26-months after his termination as part of his pay in lieu of such notice.

ONCA Decision

The ONCA overturned the trial decision. The Court found that Mr. Mikelsteins’ capacity as an employee was entirely distinct from his capacity as a shareholder of MHL’s parent corporation. Therefore, the rights that were attached to his shares were to be analyzed from his capacity as a shareholder. The Court emphasized two key factors in making this finding:

(i)            Mr. Mikelsteins purchased the shares with his own funds as opposed to receiving the shares as a form of employment compensation; and

(ii)           The share “bonus” payments were actually dividends rather than an employment compensation payment, as the share “bonus” was not tied to Mr. Mikelsteins’ job performance, but rather, was paid to each shareholder and was tied completely to the corporation’s financial performance.

In reviewing the Shareholders’ Agreement, the Court reasoned that on its plain wording, the transfer date had passed and therefore, Mr. Mikelsteins was no longer entitled to his rights arising from his ownership of the shares. Therefore, the ONCA held that Mr. Mikelsteins was not entitled to payment of his share “bonus” in lieu of notice of termination.

Key Takeaways

The Court’s decision in Mikelsteins highlights two important takeaways for employers intending to offer their key employees shares in the employer corporation:

(1)          Employers should be cognizant of the factors that the ONCA considered in Mikelsteins to find that Mr. Mikelsteins’ rights arising from the shares were not tied to his capacity as an employee. Two key recommendations for employers’ consideration are:

1. employees should purchase the shares with their own funds rather than receiving the shares as a form of employment compensation; and
   
   
2. any “bonuses” paid on the shares should not be tied to the employee’s individual job performance, but rather, should be tied solely to the corporation’s financial performance so that they may be viewed as dividends rather than employment compensation.

(2)          Employers should ensure that the applicable USA is well-drafted and particularly, that each party’s obligations upon termination are clearly set out. A well-drafted USA will alleviate uncertainty and clearly establish the expectations of the parties involved. 

Drawing on over 15 years in business law in Ontario, Charlie Kim is a Partner in the Business & Transactions Group at Robins Appleby LLP. He counsels private equity firms, business owners, and lenders, and is active in the Korean Canadian Lawyers Association. He has authored legal articles on shareholder rights and corporate governance.

Matthew McGuigan is an Associate in the Business & Transactions Group at Robins Appleby LLP, where he practices as an Ontario lawyer. He advises on mergers and acquisitions, financing, and shareholder arrangements in Canadian and cross-border contexts. With a dual JD/HBA from Western and Ivey, Matthew applies a strong business lens to legal solutions and contributes to industry publications.

At Robins Appleby, we have been providing legal advice for over 70 years to entrepreneurs, businesses, financial institutions, and foreign companies operating in Canada. Located in Toronto's financial district, our firm is trusted by clients to help solve critical, time-sensitive issues. We offer a wide range of legal services including business and transactions, affordable and social housing, litigation and dispute resolution, commercial real estate development, tax law, employment law, and estate planning.