What are Stock Splits / Reverse Splits
This post is the second part on my Stock Splits series. The first part is a comparative table of the law on Stock Splits across some selected US and Canadian jurisdictions and can be read here.
Simply stated a stock split (or forward split) is a corporate action, usually effected by amendment to the articles, to increase by a multiple the number of outstanding shares of a class without altering the equity capital of the corporation. Thus, in a 2 for 1 split of a class of par value shares, the corporation will replace each outstanding shares of that class with 2 new shares of half the original par value. The amount of equity capital stays the same, only the number and the value of each share will change. Likewise, in corporations with no par value shares, the market value of the stock should decrease in a manner inversely proportional to the increase in the number of shares.
A reverse stock split (or share consolidation) is the mirror transaction of a forward split. The number of outstanding shares of a class is reduced by a fraction without altering the equity capital of the corporation. For instance, a 5 to 1 reverse stock split of shares of a given class will result in the corporation replacing each block of 5 outstanding shares of that class by a single share of 5 times the par value. Thus the stated par value (or market value in the case of a corporation with no par value shares) will be increased by the converse of the percentage reduction in the number of outstanding shares.
A bit of Comparative Law: how Stock Splits / Reverse Splits are effected
United Kingdom, Delaware
In jurisdictions with mandatory par value stock (e.g. the U.K.) and jurisdictions that encourage par value stock (Delaware), the corporate action effecting the forward / reverse split will have to set both the multiple by which the number of outstanding shares is increased or decreased and the new par value. This implies that the corporate action will always be effected by amendment to the articles (or, in the case of the UK, by filing a new statement of capital[1]) if only to set the new par value and will also give rise to a class vote of the shares whose par value is affected[2].
Canada, Ontario
Jurisdictions with mandatory no-par value stock (e.g. the CBCA and its progeny; California) and jurisdictions that encourage no-par value stock (MBCA), tend to deal with forward / reverse splits in one of two ways.
The Canada Business Corporations Act (CBCA) and its progeny (e.g. Ontario)
Jurisdictions with mandatory no-par value stock (e.g. the CBCA and its progeny; California) and jurisdictions that encourage no-par value stock (MBCA), tend to deal with forward / reverse splits in one of two ways.
The Canada Business Corporations Act (CBCA) and its progeny (e.g. Ontario) handle forward and reverse splits homogeneously: both presuppose an amendment to the articles approved by a special resolution of the shareholders[3]. Having rejected the notion of par value stock, in theory it should have been possible to subdivide / consolidate shares without going through the amendment process. However, the CBCA considers that a stock split is a “fundamental adjustment in the outstanding share capital of a corporation and may therefore be construed as a matter properly allocated to the shareholders”[4]. The amendment will not give rise to special voting rights by the class of shares that is forward/reverse split unless the rights and privileges attached to the shares are somehow affected, viz. in the event of a reclassification.
Model Business Corporations Act
The Model Business Corporations Act (MBCA), California and Alberta handle forward and reverse splits differentially. The latter are always effected through an amendment to the articles. Forward splits are adopted by the board when the corporation has only one class of shares outstanding[5]; however, they require shareholder approval if more than 1 class of shares is outstanding. The reasons for this is that, as we shall see, reverse splits have the greatest potential of mischief; forward splits in single-class shares corporations are innocuous if performed judiciously; whereas forward splits in multiple-class shares corporations can alter the relative position and privileges of a class.
Because the accounting treatment of share dividends and forward splits in regard to no-par value shares is the same, the MBCA assimilates the two. Forward splits require shareholder approval only in the event that the corporation has more than 1 class of shares: inter-class share dividends will require the special approval of the class of shares to be issued[6] whereas intra-class dividends will require the special assent of the class that is being forward split[7]. The MBCA requires that the articles state the number of shares that the corporation is entitled to issue and assimilates a reverse split to an amendment of the articles reducing the number of authorized shares[8]. Thus, in corporations with only one class of shares, forward splits will be effected by an amendment to the articles according to the procedure set forth in §10.03; and in corporations with more than one class of shares, will give rise to class voting rights for the class of shares that is being reverse split[9].
California
Similarly to the MBCA, California allows single-class share corporations to implement forward stock splits with sole board approval[10]. Class voting is limited to reverse-splits and, for some reason, explicitly excludes forward splits from the realm of reclassifications that give rise to special voting rights[11]. In any event, forward splits in multiple-class share corporations require shareholder consent.
Alberta
Following the Saskatchewan lead, the amended Alberta Business Corporations Act (ABCA) adds a new section 27.1 on stock splits in the corporate finance section of the statute. For some reason that escapes me it also leaves s. 173 ABCA on fundamental changes unmodified. The confusing effect is compounded by the lack of proper terminological distinction between splits and reverse splits or subdivisions and consolidations. In any event, the net effect seems to be the following:
- where the corporation has only 1 class of shares outstanding, the Board of directors may decide to effect stock subdivisions and consolidations either by Board resolution under s. 27.1(1) ABCA, in which case it will have to notify the shareholders after the fact pursuant to s. 27.1(3) ABCA, or under the traditional process of amendment set forth by s. s. 173(1)(f) ABCA, in which case shareholder approval will be required;
- where, however, the corporation has more than 1 class of shares outstanding, subdivisions and consolidations always require a separate vote by each class of shares outstanding (not merely the classes directly concerned).
Saskatchewan
As we have already noted, shares of a class can be split or reverse split into the same or a different class of shares. In no-par value stock jurisdictions, intraclass forward / reverse splits can in theory be effected without directly varying any of the fundamental rights attaching to shares. Inter-class forward / reverse splits however will always change the rights and privileges of the class that is being forward / reverse split and potentially affect other classes as well. That is why during the 1992 revision of its corporation law, the province of Saskatchewan had amended its then s. 167(1)(g)[12] on amendments to articles of incorporation to remove the reference (still present in the CBCA) to intra-class forward / reverse splits. In its stead it created a new s. 25.1 in the corporate finance section which allowed a corporation to effect intra-class forward / reverse splits by adopting of a special shareholder resolution without amending the articles.
British Columbia
Likely influenced by the history of its corporate law, British Columbia‘s new Business Corporations Act (2002) (BCA) is by and large the most rational as far as forward/reverse splits are concerned. Upon incorporation, the founders file a notice of articles and articles of the company. The notice of articles contains a description of the authorized share structure of the company[13], namely: the classes of shares, the maximum number of shares that it is authorized to issue for each class or a statement that there is no maximum number, the par value of any shares with par value or a statement identifying the no-par value shares as such[14]. The articles will set out most other important information about the company, notably for each class of shares the special rights and restrictions attached to the shares of that class[15].
Section 54 of the BCA empowers a BC corporation to subdivide or consolidate its share capital. If the subdivision or consolidation would render the information on the notice of articles incorrect or incomplete, then the company must effect that change by altering the notice of articles. In other words, if the subdivision / consolidation results in a change in the authorized share structure the company must proceed through amendment. Thus, a company will take this route if it wants to subdivide / consolidate par value shares.
Whenever the subdivision / consolidation would render information on both the notice of articles and the articles incorrect or incomplete, the company must seek shareholder authorization to amend both documents. Any inter-class forward / reverse split (reclassification) will result in such an amendment.
Unless the articles provide otherwise, alterations to the notice of articles and the articles must be authorized by special resolution of the shareholders[16]. Inter-class forward / reverse splits will be subject to special voting rights of the holders of shares of the class whose rights are being prejudiced[17].
Finally, whenever the subdivision / consolidation does not alter the authorized share structure and does not require an amendment to the articles, the company must seek shareholder authorization in the manner set forth by the articles or by special resolution if the articles do not specify another type of resolution. This situation covers any intra-class forward / reverse splits of no-par value shares. Note that the Table 1 model articles do not specify the type of resolution and thus most BC single-class companies will likely proceed in this manner.
