G. Capital Structure
| Author | M.H. Ogilvie |
| Profession | LSM, B.A., LL.B., M.A., D.Phil., D.D., F.R.S.C. Of the Bars of Ontario and Nova Scotia Chancellor's Professor and Professor of Law, Carleton University |
| Pages | 117-126 |
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Extensive provision for the capital structure of banks in Canada was made for the first time in the 1980 Bank Act, again following the lead of the CBCA. Comparison of the Bank Act and the CBCA demonstrates how closely the capital structure of banks is modelled on that of publicly distributed business corporations.338
Banks, like any other business, require a pool of capital to finance their operations and likewise
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draw this capital from several sources, either by borrowing money with an obligation to repay or by selling shares to shareholders, for which there is no obligation to repay. Banks have several potential sources of debt financing, including customers’ deposits, which are loans made by a customer to the bank,339as well as raising debt capital in the capital markets using a trust indenture, for which the Bank Act provides. The sale of shares to the public yields equity financing. Banks also derive operating capital from their banking operations, including earned interest on loans, service charges for the various services they provide to customers, and profits from the exploitation of research and development results in the computer service sector. Debt financing must be repaid first should a bank be liquidated, and equity financing can be repaid only from any assets left over after the creditors’ claims are satisfied.
Like any other business corporation, banks are authorized to solicit equity financing by issuing shares at such times, to such persons, and for such consideration as the directors may determine.340
A bank share is not a proportionate fraction of the assets of the bank but represents a right to receive only a proportionate distribution of the value of the assets after another debt has been repaid in a liquidation. A share is a chose in action and not a chose in possession.
Although the Bank Act itself no longer sets minimum capital requirements for banks, banks in Canada are required to maintain adequate capital and adequate and appropriate forms of liquidity.341
The requirements may be set by the Governor in Council through regulations and by guidelines issued by the Superintendent of Financial Institutions,342who may also direct a specific bank to increase its capital over the minimum set in the guidelines.343
The Superintendent’s valuation of any asset held by a bank or its subsidiaries will prevail over the bank’s valuation.344
Guidelines set by the Office of the Superintendent of Financial Institutions (OSFI) for capital adequacy are taken from the
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new framework for regulatory capital known as "Basle II" because they were developed by the Basle Committee on Banking Supervision. These guidelines set out in very considerable detail the internationally agreed standards for regulatory capital and risk management.345
The reason minimum capital requirements are set is to provide some protection for creditors, depositors, and shareholders in the event of a liquidation of a bank.
Bank shares shall be issued without nominal or par value,346that is, the value of a share shall be the market or sale value of that share on the day of issue. All shares shall be fully paid for in money or, if the Superintendent approves, in property347and may be in a currency other than Canadian dollars.348
Again, following the CBCA, the current Bank Act eschews the earlier Acts, which permitted par value shares and partly paid shares, thereby simplifying the assessment of the actual market value of bank shares. Again, a bank is required to have at least one class of shares designated as common shares, which are non-redeemable and in which the rights of the holders are equal and include the rights to vote at shareholder meetings, to receive dividends, and to receive the remaining property of the bank on dissolution.349
By by-law approved by the shareholders, a bank may issue more than one class of shares,350 and all banks typically do so, setting out the specific attributes attached to these shares in relation to such matters as voting rights, restrictions on their alienation, dividend rights, and so on. For all classes of shares to which voting rights are attached, each share shall carry one vote only.351
Finally, by by-law, a bank may also issue series of shares, that is, in any class of shares, it may issue one or more subdivisions of shares within that class, and each subdivision will have some features common to the class and some distinctive series features.352
The reason for issuing series of shares with special features is to permit the directors to respond to market conditions by issuing shares attractive to a market at any given time so as to raise capital quickly. Since banks are subject to special adequacy and risk requirements not shared with other busi-
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ness corporations, a copy of the by-law proposing the issue of a series of shares must be sent to the Superintendent prior to issue.353
Once shares are issued, the consideration received for those shares is to be added to the stated capital account for each class and series of shares issued.354
The stated capital account must precisely reflect the consideration received for issued shares,355although the consideration may take the form of property or shares of another body corporate exchanged for bank shares as set out in the Act.356
The Bank Act addresses several issues relating to rights, privileges, and restrictions in dealing with shares. First, existing shareholders enjoy pre-emptive rights in relation to new shares in their class of shares should the by-laws so provide.357
Secondly, a bank may issue conversion privileges, options, or rights to acquire securities.358
Thirdly, banks are permitted to purchase for cancellation and to redeem their own shares in certain circumstances designed to ensure that a bank will not thereby become insolvent.359
The stated capital account shall be reduced to reflect these transactions360and may also be reduced generally by a special resolution of the shareholders, provided it is approved by the Superintendent.361
Where money or property is paid or distributed to any person, including a shareholder, as a consequence of a reduction of capital contrary to the Act, a creditor may apply within two years for a court order for re-delivery of the money or property to the bank.362
Conversely, when a "debt obligation" of a bank is converted into shares or a series of shares, a bank shall add the net value to the stated capital account.363
Finally, the Act provides that the directors may declare a dividend in money or property or by issuing fully paid shares or options or rights to acquire fully paid shares.364
The directors must give the Superintend-
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ent at least fifteen days’ notice prior to the day fixed for payment.365
If the dividend is paid by shares, the stated capital account should be amended accordingly.366
Until 2007, the Act provided that the directors may not declare a dividend in two situations: (i) there are reasonable grounds for believing that the self-dealing provisions of the Act are being contravened367and (ii) the payment has not been approved by the Superintendent and the total of all dividends declared in that year would exceed the aggregate of the bank’s net income up to the day in that year set for the payment and of its retained net income for the two preceding financial years.368
The 2007 amendments no longer so provide, so presumably the Superintendent’s approval is now sufficient.
Since the payment of a dividend, especially in money or property but not in a stock dividend, amounts to a reduction in the capital of a bank, the role of the Superintendent is to ensure that the solvency of the bank is protected in any distribution for the benefit of depositors and creditors. The Bank Act, therefore, does not follow the CBCA, section 42, which sets out the criteria that directors of business corporations must follow in deciding whether to declare a dividend. In addition, the jurisprudence on that provision and its predecessors, as well as the common law, does not apply. However, notwithstanding the supervisory role of OSFI, directors who vote for, or consent to, the payment of a dividend contrary to the Act are jointly and severally liable to restore to the bank any amounts paid not otherwise receivable by the bank.369
Directors are equally liable for the redemption or purchase of shares or a reduction of capital contrary to the Act.370
Historically, purchasers of bank shares would have expected to receive paper certificates of considerable artistic merit evidencing their purchase. However, paper certificates have been overtaken by book-based registers in which share ownership is recorded, and share certificates have been assimilated into the general category of "investment securities." Paper share certificates were once regarded as mere evidence of what was recorded in the central securities register, which alone was regarded in law as the definitive record of the shareholder’s investment. The paper certificates were not widely regarded at common
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law as negotiable instruments, although they were often treated as such in commercial practice.371
However, since the 1980 Bank Act, which followed the CBCA model again, paper certificates have been deemed to be negotiable instruments372and freely tradable as such. The Bank Act defines a "security" or a "security certificate" to include any instrument issued by a bank that is in bearer, order or registered form, of a type commonly dealt with on security exchanges, one of a class or a series of shares and evidence of a share in or obligation of a bank.373
The Act contains extensive and detailed provisions relating to the transfer of security certificates, which virtually replicate provisions in the CBCA.374
These deal with such matters as the negotiable...
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