Business Organizations
INTRODUCTION ...... 9
Main Features of the 3 major Corporate Forms: ...... 9 1. Sole Proprietorship 9 2. Partnerships 9 3. Corporations 9
SOLE PROPRIETORSHIP ...... 10 Registration: 10
PARTNERSHIPS ...... 11 The legal nature of Partnerships 11 Scheme of Partnership Act 11
Formation / Definition of the Partnerships (S. 2-5) ...... 12
Definition of Partnership ...... 12 Test to identify Partnerships 12 1. “Carrying on a Business” 12 2. “In Common” 12 Green v Harnum ...... 12 Cressman et al v Furniss ...... 12 Red Burito...... 13 3. “View to a profit” 13 Backman v R SCC ...... 13 Spire Freezers SCC ...... 13 Sharing of Profits Critical but not essential and not always sufficient for partnership 13 Cox v Hickman – Mutual Agency test for Partnerships ...... 13 Pooley v Driver – rights and behaviour of an alleged partner will determine if they are a partner ...... 13 Factors indicating NO partnership: Co-ownership 14 LePage v. Kamex – No partnership where there was co-ownership ...... 14 Factors Indicating Partnership: Co- Ownership 14 Volzke Construction v. Westlock Foods ...... 14
Agreeing to be a Partner ...... 15 W v. MNR ...... 15 Surerus Construction...... 15 Factors Suggesting a Partnership Relationship 15
The Relationship of Partners to Each other ...... 15 Some of the important default rules 15 Fiduciary Duty 16 Rochwerg v Truster ...... 16 Mohammadamin v Zameni ...... 16 Olson v Gullo ...... 17 Partnership Property 17
Liability of the Partnership to Third Parties ...... 17
Test for Triggering Partnership Liability ...... 17 Ernst & Young v Falconi ...... 17 Dubai Aluminium v Salaam ...... 17 3464920 Canada Inc. v Strother SCC 2007 ...... 18
2 Holding out and Related Liabilities ...... 18 Holding out of Retired Partners: 18
Dissolution of a partnership ...... 19 When mandatory dissolution under the Act occurs 19
Partnership Agreements...... 19 Considerations that should go into drafting partnership agreements ...... 19 a. Name 19 b. Description of Business 20 c. Membership of Partnership 20 d. Capitalization 20 e. Arrangements regarding Profits and their distribution 20 f. Management 20 g. Dissolution 21
Joint Ventures ...... 21 Central Mortgage v Graham ...... 21 Wonsch Construction v Danzig Enterprises ...... 21
Limited partnerships ...... 22 Definition and Liability 22 Limited Partners Rights 22 When Limited Liability disappears 23
Limited Liability Partnerships – s.10, 44.1-44.4 ...... 23 New provisions on limited liability partnerships: 23
Partnership Summary ...... 24 CORPORATIONS ...... 24
Jurisdiction to Incorporate / regulate ...... 24
Incorporation and Organization of Corporations ...... 25 To incorporate you MUST ...... 25 1. File Articles of Incorporation 25 2. Hole a Directors’ Meeting 25 3. Hold a Shareholders’ Meeting 25
Function of Corporate Law ...... 25 1. Corporate Law increases returns by decreasing costs 26 2. Corporate Law decreases shareholder risk 26 3. Corporate Law balances mandatory rules protecting non shareholder Stakeholders 27 Relationship Between Corporate and Securities Law 27
The Nature of the Corporation / Separate legal Existence ...... 28 Salomon v Salomon & Co. corporation is a separate legal entity ...... 28 Kosmopoulos v. Constitution Insurance (1987) SCC ...... 28 Lee v Lee’s Air Farming One can be an employee of their own Corporation ...... 28
3 disregard of the Separate Legal Identity of Corporations ...... 29
Grounds for Piercing the Corporate Veil...... 29 1. Unfairness 29 Wildman v Wildman flagrantly opposed to justice therefore disregard the corporate entity ...... 29
2. Variety of Objectionable purposes for which the court will pierce the corporate veil 29 Big Bend Hotel Fraud therefore disregard corporate entity ...... 29 Preeco I v Bon Street Holdings ...... 29 Gilford Motor Co. v Horne avoiding contractual obligation therefore disregard corporate entity ...... 30 Rogers Cantel v Elbanna Sales avoiding contractual obligation therefore disregard corporate entity ... 30 De Salaberry Improper tax purpose therefore disregard the corporate entity ...... 30 Stubart Opposite to De Salaberry...... 30 Smith -TEST for Agency leading the court to lift the corporate veil ...... 30 Alberta Gas Ethylene v MNR ...... 31 Gregorio v Intrans- Corp ...... 31 Professional Corporations 31
THE PROCESS OF INCORPORATION ...... 32 Items included in the articles: ...... 32 Number of Directors 32 Registered Office (s. 14) 32 Class and Number of Shares 32 Restrictions on issuing, transferring or owning shares 32 Restrictions on the Business the corporation may carry on 33 Other Provisions 33
Incorporation: other details ...... 33
Pre Incorporation Contract ...... 33 Common Law Position ...... 33 Kelner v Baxter ...... 33 Black v smallwood ...... 34 Statutory Reform...... 34 When Does Contract Adoption Occur? 34 Sherwood Design Services Inc. v 872935 Ltd...... 34 s.21 OBCA – Pre-incorporation Statutory reform (what happens if the corporation is not incorporated yet) 35
THE CORPORATION IN ACTION...... 35
Liability of Corporations for crimes ...... 35 1. Common law Absolute Liability Offences 35 2. Common law Strict liability offences: 36 3. Common law Mens Rea Offence 36 R v Waterloo Mercury Sales Ltd...... 36 R v Safety-Kleen Canada ...... 36 Canadian Dredge and Dock STILL GOOD LAW ...... 36 Oger v Cheifscope ...... 37
Criminal Liability Under The Criminal Code ...... 37 Bill c-45 An act to amend the criminal Code (Criminal Liability of Organizations) 37 Criminal negligence crimes s. 22.2 37 Criminal Offences requiring intent or recklessness 37 4 Liability of Corporations in Tort ...... 38 1. Vicarious Liability 38 Bazley v Curry ...... 38 2. Direct Liability 38
Liability of Corporations in Contract ...... 38 Common law rules for corporate liability in Contract ...... 39 Actual Authority 39 SMC Electronics v Akhter Computers Ltd. implied authority is actual Authority ...... 39 Apparent Authority 39 CDN lab supplies Ltd. v Engelhard Industries of Canada Behaviour sufficient for Apparent Authority . 40
Statutory reform on Corporate Liability in Contracts ...... 40
MANAGEMENT AND CONTROL OF THE CORPORATION ...... 40
OBCA provides enhanced roles for shareholders / how they exercise power ...... 41 How Shareholders Exercise their power ...... 41 Shareholder meetings and resolutions 41 Remedies available to shareholders for management misbehavior 44
Directors and how they Exercise their Power...... 44 Director Qualifications 44 Election and appointment of Directors 45 Filing Vacancies on the board s. 124 45 Number of Directors s. 125 45 Directors Meetings 45
Officers ...... 45 Delegation 46 Delegation outside the Corporation – Cannot lose all control 46 Kennerson v Burbank Amusement – case of delegation limits being exceeded ...... 46 Remuneration and Indemnification of Directors and Officers 47 Director Remuneration 47 Radtke...... 47 Director Indemnification 47 Consolidated Enfield Corp v Blair ...... 48 Catalyst Fund General Partner v Hollinger ...... 48 Bennett v Bennett Environmental Inc ...... 48 Cytrnbaum v Look Communications ...... 48 R. v. Bata Industries case ...... 49
Shareholder Agreements- Management and control of Corporations ...... 49 Share Transfer 49 Unanimous shareholder agreement 49 Final issues on Corporate Governance 49
SHARES ...... 50 Terminology 50 Priority structure on dissolution: 51
5 Creation or Authorization ...... 51 Class – Incorporator or Shareholders 51 The basic rights associated with shares s. 24(3) 51 Distinction between Classes and Series of Shares: 52 Issuance of Shares 52 Dividends 52
Solvency Tests – HARD TEST S. 42 ...... 52 Redemption/Retraction/Purchase 53
DUTIES AND LIABILITIES OF DIRECTORS AND OFFICERS ...... 53
Fiduciary Duty ...... 53 “Best interest” of the Corporation 54 BCE Inc. v 1976 Debenture Holders ...... 54
Fiduciary Duty / Breach of Best interests may arises in 3 Scenarios ...... 54 1. Transacting with the Corporation at common law 54
OBCA S. 132 - Statutory Test - when director / officer CAN transact with their own corporation ...... 55 Alternative transaction Saving Provision - s. 132(8) 55 Zysko v. Thorarin ...... 55 Exide Canada v. Hilts ...... 55 Rooney v. Cree Lake...... 56 Repap Case ...... 56 2. Taking corporate opportunities 56 Cook v. Deeks ...... 57 Regal v Gulliver ...... 57 Peso Silver Mines v Cropper ...... 57 Canaero – land mark case ...... 57 Test for whether Appropriation of an Opportunity is a Breach of Fiduciary Duty Canaero 57 3. Fiduciary duty not to compete with a company 58 4. Fiduciary Duties and Take Over Bid Transactions 58 Things Directors can do to defend against a Bid 58
Views on whether defensive measures against takeover bids should be allowed: ...... 58 Free Market View 58 View in favour of defensive measures by directors against takeover bids 59 Other Breaches of Fiduciary Duty 59 DEFENSE: Being Able to Use Reliance as a defence 59 Shareholder Ratification of Breach 59
DUTY OF CARE ...... 60 RE City Equitable Fire Insurance Co. Ltd (1925) ...... 60
Standard of Care ...... 60 Francis v United Jersey Bank ...... 60 Fraser v MNR ...... 61 Peoples v Wise ...... 61
6 Other Duties imposed on Directors and Officers ...... 61
Liabilities of Directors and Officers for Torts ...... 61 Negligence 62 Inducing a breach of contract 62 SHAREHOLDER REMEDIES ...... 62
1. Personal Action...... 63
2. Derivative Action ...... 63 Test for when the Court will allow Derivative Action 63 Procedural Matters ...... 63
3. Oppression Remedy...... 64
The Statutory Scheme ...... 64 Oppression Remedy Provision 241 64 WHO may claim Relief from Oppression: The Complainant 64 Section 245 - The Complainant 64 What can the complainant complain about? 65 What relief is available? 248(3) 65 Interim Costs 65 The Complainants Continued: 65 Cask v Aumon –whether applicants claiming a right to become security holders are complainants ...... 65 Affiliates can also be Complainants under the Oppression remedy 65 Oppression is also available to Creditors and others… 66 The Complainant can also be the majority shareholders, 66 245(b) – director or officer or former director or officer 66 The corporation itself as complainant 66 The SCC in BCE developed a new analytical framework for finding oppression (VD, pg. 432- 33): 67 BCE Explaining the terms of the Oppression Remedy 67 Arthur v. Signum Communications – some examples to show the remedy can be invoked ...... 68 Other Procedural Issues 68
Remedies Available to the court for successful Oppression Applications ...... 69 a. Share purchase 69 b. Liquidation and Dissolution 69 c. Remedies against other oppressing shareholders 69 d. Compliance 69 Other possible oppression remedies 69 Oppression Remedy Framework: 69
Shareholder remedies ...... 70
CORPORATE CHANGES - CBCA ...... 71
Dissent rights ...... 71 1. Amendment of Articles 71 2. Amendment of By-laws 72
Corporate Changes – Changing Jurisdictions ...... 72 3. Continuance (Export of the business to a new jurisdiction) 72
7 Corporate Changes – Business Combinations ...... 73 4. Amalgamation (Long Form) 73 5. Amalgamation (Short Form) 74 6. Sale of Substantially All of the Assets – roughly 90% 75 7. Plan of Arrangement 75
Corporate Changes – Termination of Company’s Existence ...... 75 8. Voluntary Dissolution 75
8 Introduction
MAIN FEATURES OF THE 3 MAJOR CORPORATE FORMS:
1. Sole Proprietorship Both own and manage their business Formation occurs when an individual carries on business with his or her own account SP is the sole owner SP cannot employ self All benefits accrue to SP You are responsible for all contracts, any torts you commit yourself, or committed b employees, and income is taxed to you and you have unlimited personal liability.
2. Partnerships Partners are owners and managers (similar to sole proprietorship in legal form) This is 2 or more persons carrying on business in common with a view to a profit Partnerships Act (PA) S. 2 The characteristics of partnerships include internal relationships with other partners. This is governed by default rules in the PA ss. 20- 31. Partners cannot be employees? All Benefits of partnership accrue to partners All obligations of partnerships are personally attached to the partners regardless of which partner actually commits the partnership to doing it Each partner is responsible for tortious acts of self or employees subject to the Partnerships Law Amendment act for some professional partnerships (often seen in law) Income tax – income is calculated at the partnership level Each partner has unlimited personal liability Liability of partnerships to third parties is governed by the PA ss. 6-19 e Each partner is an agent of the partnership which means that each partner can bind the partnership when acting the normal course of business
How to manage risk of unauthorized obligations? - Legal protections Partnership agreements Law of partnership Limited liability partnerships under the partnership Statute Law Amendment Act - Practical protections Relationships of trust and confidence Opportunities for informal monitoring
3. Corporations Corporations are incorporated under a statute either the Canada business Corporations Act or a provincial act. Like with partnerships, corporations can customize their relationship and structure by augmenting the statutory scheme with agreements and within the corporate constitution No registration of the corporation is required Run by directors and officers Ask yourself… are the shareholders really owners? (NO) Formation: Filing incorporation documents with appropriate government authority
9 Characteristics: Separate legal entity- separate from shareholders It is a juridical person (NOTE: core difference between partnerships, sole Prop. And corporations) The corporation carries on business, owns the property of the business Is solely responsible for obligations of business, contracts, torts and taxes Only entity that is entitled to income from the business (unlike the other two) A person can be a shareholder and an employee The corporation has perpetual existence There is a separation of ownership and management -managed by paid agents who are directors and officers Shareholders DO vote in the directors however it is the directors that appoint the officers.
Key Issues: How do shareholders ensure that management (directors and officers) act in their interest? How do they ensure that there is no negligence? How do they ensure that management interests are placed ahead of personal interests?
In response to these concerns the following items are in place: 1. Controls in the corporate constitution (articles, by laws, and shareholder agreements) 2. Duty of care, fiduciary duty and obligation not to oppress 3. Access to information rights (Bundle of shareholder rights) 4. Shareholder voting (Bundle of shareholder rights) 5. Shareholder remedies (Bundle of shareholder rights)
Sole Proprietorship
Simplest form of business organization Comes into being whenever an individual starts to carry on business on own account without taking steps necessary to use some other form of organization Sole proprietor is the sole business owner and the only person entitled to manage the business. Cannot contract with herself The sole proprietor is exclusively responsible for preforming all contracts entered into in the course of business and is exclusively responsible for all torts committed by her personally in connection with the business and is vicariously liable for all torts committed by employees in the course of employment. All of the sole proprietors personal assets, as well as those contributed to the business may be seized to fulfill the obligations of the business For income tax purposes the income or less from the business is included with the income or loss from other sources in calculating the sole proprietors personal tax liability. Obligations applying to all new businesses apply to all SP’s upon commencement of business- E.g. licenses under Municipal Act; Securities Act; Registered Real Estate Brokers Act
advantage = ease to open a business; disadvantages = risk of unlimited personal liability, difficulty of raising money, it is not possible to divide up ownership of the sole proprietorship so the only method of financing is to borrow money directly.
Registration: s. 2(2) of the Business Names Act (ONBA) Governance of Ontario registration of a sole proprietorship Registration is required if a sole proprietor is using a name other than her own. S. 4 says that a sole proprietor may also register voluntarily. S. 7 If you do not register when you have to you cannot sue to ensure a business obligation in Ontario (and you may be liable for a fine of up to $2000 s.10 These are the sticks to get you to register. It ensures that there is public record which can be relied on by those dealing with SP to identify the individual who is liable for SP’s obligations
10 Partnerships
Common law partnership law codified in 1890. In Canada most provinces base their partnership related statutes on 1890 statute from Great Britain. This means that the statute does not reflect how businesses function today. Note that QC’s partnership law is based on the civil code. There are 2 major categories of partnerships in QC- declared partnerships where the individuals register or there are undeclared partnerships, which are similar to that in the common law.
3 types of partnerships 1. General partnerships (simple) Each partner has unlimited liability (Partnerships act s.6, 10-13) 2. Limited Liability Partnership Same as general except that each partner is only liable for his or her own negligence or that of persons under direct supervision or control 3. Limited Partnerships At least one general partner and one limited partner contribute to partnership. All you are liable for is the amount you invest and the general partners will take the rest of the liability risk amounting to the same amount of risk that would be taken in a general partnership. Used in risky partnerships.
History of limited liability partnerships: Until August 1, 2007, LLP was a general partnership except An individual partner not liable for negligence of other partners or Employees - unless directly supervised by the partner affecting ss. 10 (2-4), 13, 24 and 44 OPA. After Aug. 1, 2007, LLPs will have “full shield” limited liability protection for debts or obligations but liability is enlarged if criminal or fraud involved or knew or ought to have known of negligent or wrongful act. See sec. 10(2), 10(3). Limited liability partnerships are formed by signing agreement designating as Limited Liability Partnership, and registering its name, inc. LLP or s.r.l. under the Business Names Act. There are also requirements set out in ss. 44.1 to 44.4 OPA
The legal nature of Partnerships General and limited liability partnerships must register under the Ontario Business Names Act s. 2(3) The act triggers default rules unless you contract out of them as you structure your partnership. Partnerships should learn how to contract out and make alternate agreements because the act is outdated Partnerships are like a sole proprietorship in that partners themselves carry on business directly Unlike corporations, the partnership is not a legal entity separate from the partners Each partner is liable to the full extent of his personal assets for debts and other liabilities of the partnership business Existence of any partnership depends on the continuing participating of the partners. If a partner leaves the partnership it is terminated. For income tax purposes, the income from the partnership business is calculated at the firm / partnership level, adding up all of the revenues of the partnership and deducting all related expenses. A partnerships assets and liabilities are not separate from each of the partners personal assets and liabilities.
Scheme of Partnership Act – Nature of partnership ss. 2-5 - formation – Relationship of partners to persons dealing with them ss. 6-19 – mandatory – Relationships of partners to each other ss. 20-31 –default rules – Dissolution of Partnership ss. 32-44
11 FORMATION / DEFINITION OF THE PARTNERSHIPS (S. 2-5)
Definition of Partnership S. 2 “relation between persons carrying on business in common with a view to a profit”
Test to identify Partnerships To determine if there is in fact a partnership assess whether: 1. A business is being carried on 2. In common 3. With a view to profit
1. “Carrying on a Business” Business is defined as including every trade, occupation and profession OPA s. 1 “Any ongoing activity or even a single transaction” Thrush v Read The idea of carrying on a business together usually suggests the need for an enduring relationship, but even that factor may be inconclusive of identifying a partnership. Preparation for a restaurant that never opens could be understood as carrying on a business identifying a partnership Kahn v Miah partnership may arise in relation to carrying on a business for a one time limited activity Spire Freezers SCC Principle indicia of carrying on a business together was sharing profits but now that is a rebuttable presumption OPA s.5 a partnership is called a firm, e.g. law firms. Actions against a partnership may be commenced and defended using the firm name, but any judgment can be enforced against the partnership assets and those of the individual partners. A business is less likely to be found a partnership if the people involved are merely passive investors for example, if several people jointly own an apartment building and collect rent their relationship may not be found to be a partnership
2. “In Common” Carrying on bus together, based on some kind of agreement. Agreement may be – written, oral, or implied Whether agreement exists determined objectively- meaning persons may be characterized as Ps w/out their knowledge, even contrary to their express intention. Provisions stating the intention of parties may help clarify the agreement where clauses are not clear Agreement must demonstrate intention to participate in a relationship that fits w/in definition of partnership. Whether Ps describe themselves as such or not in an agreement is not conclusive of a partnership. Nor is express provision denying intention to be Ps (but may help clarify other clauses of the agreement where such clauses not clear) S. 15 OPA states that if you hold yourself out to be a partner you are a partner
Several cases have addressed what is needed to establish the existence of an agreement:
Green v Harnum 2 men buy a fishing boat together, shared profits and borrowed equal amounts to fund the business but there were no formal agreements. The court still held that this was a partnership because of a clear intention.
Cressman et al v Furniss Where a partnership agreement was drafted but not signed there was insufficient evidence of a partnership business based on the terms of the agreement, which contemplated each partner having an ownership interest in an optometry business (here the court seems to be wrong- this is inconsistent case law).
12 Red Burito If it is clear from their actions that the partners were planning to carry on business together the court may find a partnership. The two parties had entered into a letter of understanding which provided that they would incorporate. This never happened though the court still held that it was clear that they were going to carry on business together and did so.
3. “View to a profit” Need not actually make profit—but must have making money as a goal—ie: not for the purpose of carrying out charitable, social, or cultural purposes
Backman v R SCC if only purpose is to take advantage of loss then there is no view to profit in the business
Spire Freezers SCC “Ancillary purpose to make profit suffices for a partnership”. Making profits need not be main or sole intention in order for there to be a view to a profit there just needs to be some intention. Even if you have losses for a long time you might still have an intention to make profit.
Sharing of Profits Critical but not essential and not always sufficient for partnership Under legislation, sharing profits alone NOT sufficient to create a partnership OPA s. 3 The focus is on whether there is an interest in how the business is managed to produce profits. If a person is compensated out of revenues she only has a stake in how much the business sells – may not be sufficient to indicate a partnership. If a person is sharing profits, that person must also be concerned with how the business is managed. Agreements to share losses and profits are strongly indicative of partnerships.
Cox v Hickman – Mutual Agency test for Partnerships Facts: C & W were creditors of an ironworks business, appointed trustees; while the business was being operated by the trustees, it became indebted to Hickman; Hickman sued them, alleging that they were partners Rule: Where there is profit sharing but no mutual agency = no partnership The fundamental characteristic of the relationship of partnership is mutual agency. A partnership exists where each person alleged to be in a partnership carries on the business on behalf of the other alleged partners. The case also illustrates the difficulty with drawing a clear line between partnership relationships and creditor relationships. Analy: To find a partnership between cox and wheatcroft the business had to be carried on for the benefit of cox and wheat croft . Here they were simply trustees acting for the benefit of the creditor and the actual principles, which was the iron company. Held: not partners, true relationship found to be debtor & creditor (business not carried on for benefit of C & W as principals). Sharing profits not sufficient to find partnership relationship NOTE: Vanduzer states that the case shows how the same facts may give rise to different interpretations of whether a partnership exists and illustrates difficulty of determining whether a partnership exists even where an individual or creditor is involved in the management of the business.
Pooley v Driver – rights and behaviour of an alleged partner will determine if they are a partner Facts: Partners in manure business agreed to split profits with “Lenders” in accordance with their capital interests. Complex relationship that was expressly designed to ensure that the Lenders were not found to be partners (tried to fit into the equivalent of BCPA s.4(c)(iv)) Rule: in every case, court must decide if, based on all the circumstances, the most accurate characterization of the relationship is one of a partnership, or some other relationship (eg. Debtor and creditor) Held: In looking at the whole relationship between the Lenders and the partnership as described in the partnership & loan agreements, court concluded the Lenders were partners (had interest in capital, had a degree of
13 participation & control unusual for Lenders, etc.) The return to alleged partner depended on profits; simply meant that the sharing of profits in these circumstances does not by itself give rise to presumption of partnership
Profit sharing does NOT always create inference of partnership -Ex.’s s. 3.3 - Repayment of debt out of profits to a lender - Compensation to lender in the form of share of profits or interest rate varying with profits - Employee profit sharing - Annuity to spouse or child of deceased partner - Payment of purchase price for sale of business out of profits - DO NOT CONFUSE THESE WITH REAL PARTNERSHIPS
Note on Creditors May be ongoing payments out of profits each month (s.4 says ok)… Look at initial reason for investment – investing for sake of carrying on the business? Look at how relationship will end – when some fixed amount repaid? Or, if only repaid in full when business ends – may be interpreted as equity investment & so partnership
Factors indicating NO partnership: Co-ownership Co-ownership is a form of tenancy in property law, managed by a trustee, and they get the profits (but not carrying on a business together, as in partnership) Co-Ownership does not in and of itself create partnership even if profits are shared s. 3.1 OPA To create a partnership, something more than simply co-owning property & sharing profits – some active involvement in management or other business activity must exist to find a partnership among co-owners If co owners do cross the line and go into management and did not intend to you may still end up in a partnership agreement To avoid partnership hire a management company instead of trying to do it yourself!
LePage v. Kamex – No partnership where there was co-ownership Facts: Apt. Building, co-owners have invested; individual co-owner signed K with real estate agent, who is now trying to sue “partnership” not just individual Rule: To determine if there is a partnership of co-owners ask: whether the intention of the co-owner was to “carry on business” or simply to provide by an agreement for the regulation of their rights and obligations as co-owners of a property? Rule: Where co-owners want to deal with their individual interests separately, like by exercising a first right of refusal over their own portion of a property, that desire is incompatible with the intention that a piece of property become part of a partnership. Held: Not partners, each co-owner had a “right of first refusal” on their own share.
Factors Indicating Partnership: Co- Ownership Where, in addition to co-ownership and sharing of profits, there is substantial participation in the activities associated with the management of the co-owned property, a partnership will likely be found.
Volzke Construction v. Westlock Foods Ratio: co-owners Involvement in management need not amount to control for courts to find a partnership exists. Use of common bank account (even if only signing authority, agreement to share the costs and profits, common participating in financing the business & dealing with tenants concerns, and talking to eachother as partners were all held to be indicative of a partnership here Held: control of management had an effect on whether partnership a partnership arose.
14 Agreeing to be a Partner Q: Is the case law becoming too vague in identifying what constitutes a partnership?
W v. MNR Rule: Agreeing to be a partner can be enough to find a partnership. Held: Courts have also held that Participation in management or other contribution not necessary to find a partnership. In this case the Court also focused on the fact that the widows had left their deceased husbands capital with the partnership and had not withdrawn it, so indicated an INTENTION to continue the partnership, even though they were “silent or sleeping” partners.
Q: Does the focus on intention give sufficient guidance to lawyers to determine when a partnership exists? Surerus Construction Even stated intention to be partners were not found to be sufficient to find a partnership agreement, as parties had not agreed to when the partnership would commence or their respective contributions.
Factors Suggesting a Partnership Relationship 1. Sharing profits 2. Sharing responsibilities for losses including guaranteeing partner debts 3. Jointly owning property 4. Controlling the partnership business 5. Participating in management 6. Stating an intention to form a partnership in a contract 7. Making government filings showing partnership 8. Access to information request regarding that business 9. Singing authority for contracts and bank accounts 10. Contributing money, services, or property as capital 11. Full time involvement in the business 12. Use of a firm name, perhaps in advertising 13. The firm having its own personnel and address
THE RELATIONSHIP OF PARTNERS TO EACH OTHER Nature of partnership relationship will be specified in the partnership agreement OPA ss. 20-31 default rules to govern parties relation which can be altered by specific agreements The default rules may be displaced by conduct, but conduct must show a clear intention to displace the rules Default rules are archaic and based on an archetypal conception of partnership. Most partnerships use their partnership agreements to contract out of the default rules
Some of the important default rules 1. Each partner shares equally, both in the capital of the partnership and in any profits and must contribute equally to any losses incurred s. 24.1 This seems out of date. Modern partnerships would maybe consider apportioning capital and profits based on how much each partner contributes. 2. Each partner is entitled to be indemnified (if one partner incurs liability, if the other partner is responsible the first can get the money back from the other partner) in respect of payments made or liabilities incurred in the ordinary course of the partnership business or to preserve the business property of the firm s.24.2 This does not seem too out of date because it is a safety valve against he mistake and idiocy of the other partner’s actions. 3. A partner making, for the purpose of the partnership, any actual payment or advance beyond the amount of capital that he or she has agreed to subscribe is entitled to interest at the rate of 5 per cent per annum from the date of the payment or advance. 24.3 NOTE: this is still the case today
15 4. A partner is not entitled, before the ascertainment of profits, to interest on the capital subscribed by the partner s.24.4 5. Every partner may take part in the management of the partnership business s. 24.5 6. No partner is entitled to remuneration for acting in the partnership business s.24.6 7. No person may be introduced as a partner without the consent of all existing partners s.24.7 8. Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners, but no change may be made in the nature of the partnership business without the consent of all existing partners s.24.8 9. The partnership books are to be kept at the place of business of the partnership, or the principal place, if there is more than one, and every partner may, when he or she thinks fit, have access to and inspect and copy any of them. (s.24.9) 10. No majority of the partners can expel any partner unless a power to do so has been conferred by express agreement between the partners. (s.25) 11. Any person who takes an assignment of a partners interest, whether as a purported transfer or for the purposes of taking security for the performance of some obligation of the partner, has no rights as a partner, except to receive the share of the partnership profits to which the assigning partner would otherwise be entitled (s.31) 12. Any partner may terminate the partnership by giving notice to the others (s. 26 & 32) 13. Any variation of the default rules requires unanimous consent (s. 20)
Fiduciary Duty In addition to the default rules, common law says that partners owe each other a fiduciary duty: they must deal with the partnership and partners with the utmost good faith and loyalty and integrity Partners must never put their personal interests ahead of the interests of the partnership Each partner is required to render to each other partner “true account and full information regarding matters affecting the partnership s. 28 Have to account for any and all use of partnership property Each partner has a right to access documents prepared by and for the partnership Dockrill v Coopers Each partner must make full and accurate discloser of activities such that the partnership is fully aware of the nature and significance of the activities but by agreement may exclude things McKnight v Hutchinson
Rochwerg v Truster Facts: a partner in a firm of accountants became a director of one of the firm’s clients. He also purchased 8000 common shares in the client for what was fair price at the time and acquired options to purchase an additional set of shares. The partner disclosed the directorship to his partners and paid the directors fees he received to the partnership. He did not disclose the investment of the shares because he believed it was a private investment. Rule : The precise content of the fiduciary duty is dependent on the facts. Held: The court held that he had to disclose in accordance with the fiduciary duty. He was required to account for the profits NOTE: that you can contract out of having to give up profits of shares and options as long as you disclose that you will be getting them! Negotiate at the outset of the partnership.
Mohammadamin v Zameni Facts: Zameni sold his interest in the partnerships auto parts business and set up a competing business nearby Rule: Partner’s non competition obligation should extend beyond the termination as a part of fiduciary duties Held: He breached his fiduciary duty by not complying with non-competition obligations
16 Olson v Gullo A partner who sold part of the real property owns by the partnership had to pay the profits of the sale over to the partnership based on s. 29(1) as well as the common law principles of fiduciary duties – a partner in breach of his duty and receiving a benefit from the breach must share over the profits from that breach.
Partnership Property Partnership property consists of all property contributed to the partnership and all property acquired on behalf of the partnership. Once property becomes partnership property, it must be held and used exclusively for the purposes of the partnership and in accordance with the terms of the partnership agreement. Ex if someone decides to give their truck for the partnership, even if that individual has legal title to the property, because it is regarded as property of the partnership it cannot be sold because he agreed that it is part of the partnership. An individual partner looses his individual beneficial interest in property contributed to a partnership
LIABILITY OF THE PARTNERSHIP TO THIRD PARTIES Ss. 6-19 govern when partnerships are liable to third parties. These rules are mandatory and cannot be contracted out of like other parts of the act. (READ THESE CAREFULLY!)
Test for Triggering Partnership Liability
Any business conducted by any partner in the usual way of business will trigger responsibility for the partnership as a whole UNLESS the partner had no authority AND the third party dealing with the partners knows of the lack of authority or does not know but believed him to be a partner s.6
Everything turns on “in the usual way of business” Partnerships become liable to third parties when someone who is an agent of the firm enters into a contract on its behalf. Each partner is considered an agent of the firm and of all other partners. There is no partnership liability for acts outside the usual scope of partnership business Partnerships are liable for the obligations torts and wrongful acts or omissions of its agents or employees A partner is not responsible for the liabilities of the firm that arose prior to him becoming a partner Some cases show that even if a partner is acting in a tortious way that might be considered to be in the “usual or ordinary course of business”. This is where things get tricky.
Ernst & Young v Falconi Facts: the estate partner in a law firm was held liable for the acts of another partner who assisted bankrupt clients with fraudulently disposing of their property contrary to the bankruptcy act. The activity was held to be in the ordinary course of the law firms business. The firm gave him authority to do this kind of fraud. The partner here knew he was acting fraudulently as did the firm. Rule: partners may be held liable for Wrongs, including torts and fraud, authorized in the ordinary course of business of the partnership or with authority of all partners s. 11. The court in that case said that the test for whether the activity could be held to be in the ordinary court of business was whther the unlawful acts are the sort that would be within the scope of the partnership if done for legitimate (rather then illegitimate) purposes as seen from the perspective of the overall business partnership.
Dubai Aluminium v Salaam Rule: So long as the dishonest conduct was sufficiently closely connected to acts that the partners were authorized to engage in the conduct may ne regarded as done in the course of business. Held: House of lords held that a law firm partnership was liable for the dishonest acts of one of the partners. Their actions were found to be in the usual course of business. 17 3464920 Canada Inc. v Strother SCC 2007 Facts: A partner in a firm breached his fiduciary duty and the terms of his retainer with a client when he took a direct financial interest in a direct competitor to that client. The court saw this as a conflict of interest that would lead the lawyer not to act as a zealous advocate in accordance with the rules of professional conduct. Rule: Liability of the firm under the partnerships statutes is not limited to common-law torts, the language of the statute include liability for omissions and breach of fiduciary duty. Where a partner goes out on a frolic on his own it does not matter, if the liability happens in the ordinary course of business, all of the partners are liable. (The partner’s act could not be separated from the firms ordinary course of business). Held: Despite the fact that the firm did not know this was going on the court held that the firm was still responsible because the partners act was so closely connected with the business of the firm as to be within the ordinary course of business.
Holding out and Related Liabilities
“Every person, who by words spoken or written or by conduct represents himself or herself or who knowingly suffers himself or herself to be represented as a partner in a particular firm, is liable as a partner to any person who has on the faith of any such representation given credit to the firm, whether the representation has or has not been made or communicated to the persons so giving credit by or with the knowledge of the apparent partner making the representation or suffering it to be made.” S. 15 OPA
If a person is held out, OR is knowingly holding out to be a partner of a firm then that person may be held liable for the obligations of a partnership even though he was never a partner or was not a partner at the time the partnership incurred the obligation s. 15 OPA s. 15, s. 18 & 36(2) May be liable under these provisions even if never were or no longer a partner. This might include use of a persons name in the firm name, on a sign or on the firms invoices or letterhead
Holding out of Retired Partners: RULE: A retired partner is liable to every person who dealt with the firm prior to his retirement for obligations of the firm incurred after retirement UNLESS actual notice of the retirement is given to the person (OPA s.36 (1), UNLESS the person never knew that the retiring partner was a partner (OPA s. 36(3), or UNLESS the partner left the firm because he became insolvent or died (s. 36(3).
Holding out must be with the knowledge of the partner held out Tower v. Ingram must be some type of action by the person to hold themselves out. If they did nothing it is sort of like a limitation on the liability. In this case Ingram, the retired partner had not knowingly suffered himself to be represented as a partner.
To ensure that there is no liability after retirement it is best to put a notice in the gazette
18 DISSOLUTION OF A PARTNERSHIP Under the Act, partnerships are dissolved if: Formed for a fixed period on expiry of the term s. 32 OPA. If not for fixed term, on notice by one partner to all others s. 26. 33(c). If formed for a single adventure or undertaking, on termination of that business s. 32 (b). If there is a death or insolvency of any partner s.33 (a). But partnership agreement can make durability more stable or unstable, e.g. inability of one of the partners to continue partners’ work. NOTE: This is a default rule you want to stay away from: Partnership agreements should deal directly with these dissolution rules and not rely on the default.
When mandatory dissolution under the Act occurs When business of partnership becomes illegal or illegal to be carried on by partners s. 34 Court may order dissolution on a variety of grounds, e.g. mental incapacity of a partner, persistent breaches of the partnership agreement, and residuary power where it is just and equitable to do so (e.g. where majority of partners refuse to allow a partner to exercise her rights to participate in the management of the partnership as she has a right to do (s. 24.5) or irreconcilable differences between partners. These types of events amount to breach of fiduciary duties between partners. Sec. 44 OPA deals with settlement of claims against partnership on dissolution and what occurs with the assets. As with shareholders in a company, debts to creditors paid first, then debts to partners, then return of capital (original contribution that the partners had made). Statutory scheme re partners share can be tailored in a partnership agreement.
PARTNERSHIP AGREEMENTS We have talked about the default rules, the mandatory rules and the liabilities, but much of the time in these types of law will be spent drafting partnership agreements for clients to ensure that their partnership is tailored and takes into account the default rules which will be replaced as decided upon by clients. It is commonplace for partners to enter into partnership agreements, which allow for tailoring of specifics. Through the agreement the partners can provide a structure for operating the partnership where the legislation is silent or where the partners want something different from what it provides Agreements can also be used to respond to mandatory provisions in the OPA, especially those providing for liability to third parties by structuring the relations among partners to address liability (S. 6-19).
Considerations that should go into drafting partnership agreements
a. Name A partnership may carry on business using any name it likes Name should be registered Name constitutes part of goodwill of the business and belongs to the partners. Thus any partner could use the name on dissolution and thus an agreement might consider identifying who the name would “belong to”. The agreement might outwardly allow for the continued use of the name of a dead or retired partner in order to help limit liability for the retired partner The use of a persons name as a part of the firm name with his knowledge constitutes holding out that person as a partner within the meaning of the OPA. Any person held out after they leave the partnership retains liability. Accordingly, if a persons name is going to be used after she leaved the remaining parties of the firm should agree to indemnify her against liability. Such an agreement will not protect her from third parties but it gives her the right to recover any amount she has to pay from her former partners There is no need for such indemnity where there is a deceased partner’s name used in the firm name
19 b. Description of Business Each partner is an agent of the partnership capable of binding the firm to obligations and thus each partners authority as an agent is limited by the nature of the business undertaken The scope of a partners authority to bind the partnership to a third party will be determined by what the partnership actually does rather then by any limit in the partnership agreement. Nevertheless make it clear what activities are considered to be carried on for the benefit of the partnership Directors fees and options should be dealt with here as well and a discussion of how much capital each partner will contribute Ex: In a law firm partnership partners may want to describe that the business includes teaching a law school course or writing papers so any fees received are income for the partnership Ex: a partnership agreement may explicitly list that all partners must put their full attention into the business or have permission of other partners to carry on another business. Permitting activities in the description of business that would otherwise be a breach of fiduciary duty allows the partner to engage in activities without fear of being required to account of all profits A non compete clause may also be included Describing the scope provides the basis for the firm to claim against a partner for liabilities imposed for carrying on activities that that are outside the scope c. Membership of Partnership Default rules talk about all partners consenting to admission and expulsion and retirement leaves to dissolution. OPA says that in the absence of agreement to the contrary all partners have to agree to the admission of a new partner. This requirement is often adapted in partnership agreements and often include criteria for admission of a new partner Amount of capital a new partner has to contribute should be addressed in agreements The expulsion of a partner is prohibited under the default rules of the OPA so many agreements find a way to change this Retirement should not dissolve a partnership so this default rule should be changed as well. d. Capitalization The amount contributed by the partners to the firm is called the firms capital. Default rules say that in absence of a specific agreement to how partners should share capital all partners share equally. Capital contributions and partners’ entitlement to capital should be dealt with in the partnership agreement. e. Arrangements regarding Profits and their distribution Pursuant to OPA, all profits are to be divided equally among the partners. This provision is almost always changed to allocate to each partner a share commensurate with her contribution to the firm. Each partnership must decide what kinds of contributions to take into account and what weight to give to each for the purpose of allocating profits. These contributions might include capital contributions (how much you put in), billable hours worked, hours worked on matters that were not billable but contribute to the firm, or not, fees billed and collected, totally billings to new clients brought in by that partner, total billings and business development Each partners entitlement will change each time the factors are evaluated It is also necessary o decide how the profits would be distributed f. Management The default rules in the OPA provide that all partners are entitled to participate in management and that decisions on ordinary matters are to be made by a majority of partners but decisions relating to the nature of the partnership requires consent of all partners Agreements usually alter the requirements for consent by numerical majority to something that better reflects the power structure of the partnership Reality is that most medium and large firms delegate the management to one or a few people sometimes not even a partner. 20 g. Dissolution Provincial law allows for dissolution of partnerships in a variety of ways Partners often agree to change the many ways that the OPA identifies automatically dissolve a partnership In some agreements dissolution may be precluded altogether and replaced by a provision dealing with withdrawal S. 44 of the OPA can be fleshed out in an agreement
JOINT VENTURES Joint ventures are neither a distinct form of business organization nor a relationship that has legal meaning Joint Venture is a term used to describe a relationship among persons who agree by contract to combine their money, property, knowledge, skills, experience, time and other resources for some common purpose The distinguishing feature of a joint venture is that it is set up for a limited amount of time for a limited purpose or both You can have a joint venture by partnership and by corporation or by contract alone. The legal consequences of joint venture that is NOT a partnership or corporation are NOT clear Main issues of joint ventures = consequences of the relationship outside of the agreement to the relationship EX: a small mineral exploration business may go in on a joint venture by combining resources with a business with financial strength
Central Mortgage v Graham Facts: Central Mortgage initiated a relationship with a builder under which it provided the financing for that company to build some houses to specifications provided by Central Mortgage. The financing was secured by a mortgage on the property in favour of central mortgage. Central Mortgage was consulted during construction and had the right to approve purchases. Graham bought one of the houses from the second company which assumed that he would take on the mortgage payments. He stopped paying the mortgage Rule: In a joint venture with the following characteristics, each party in the joint venture is responsible for all obligations of the joint venture (just as each partner is responsible for all obligations of a partnership). This is a partnership – like liability Contributions by both parties of money, property, skill or knowledge to a common undertaking Joint interest in the subject matter of the joint venture Mutual control and management Arrangement limited to one project Expectation of profit AND Mutual profit sharing Held: Based on the indicia listed, such a relationship can trigger partnership liabilities. This was a joint venture and therefore Central mortgage was liable for the obligations of its fellow venturing company
NOTE: this is the only case to ever find that a joint venture has partnership like characteristics but it is VALID LAW The label of joint venture seems not to actually have any effect other than to create a partnership like relationship.
Some courts have held that joint ventures may have more limited legal consequences. Some courts have held that parties to a joint venture owe each other a fiduciary duty. An aspect of the fiduciary duty is the obligation not to disclose confidential information provided by one joint venturer to the other for the purposes of the joint venture.
Wonsch Construction v Danzig Enterprises Facts: These two parties entered into a joint venture to build and operate an apartment building. Wonsch was responsible for construction and incurred debt to the Bank. Danzig negotiated an assignment of the debt owed, paying the bank significantly less than the full amount owed. Held: The court decided Danzig owed a fiduciary duty to Wonsch, which precluded it from trying to make a profit from dealing in Wonsch’s debt incurred for the purposes of the joint venture.
21 LIMITED PARTNERSHIPS For investors who want to be able to share in partnerships profits but limit their liability for losses. Limited partners are not usually interested in participating in management- they are usually passive investors In Ontario these partnerships are governed by the Ontario Limited Partnership Act (OLPA) Limited partners are only responsible for their limited risk that they put in and the general partners have unlimited liability. There is always one general partner and often several limited partners. Tax motivation bus likely to have losses in early stages of its life. LPs able to deduct these losses against other income. One of the ways the tax law is trying to promote these partnerships, if companies buy expensive equipment, they can write off capital cost depreciation (a percentage of the value of that equipment). This will bring down the tax bracket of the companies.
Definition and Liability RULE: Every limited partnership must consist of at least one general partner with unlimited liability and at least one limited partner with limited liability OLPA s. 2(2) RULE: A declaration must be filed with the registrar appointed under the Business names Act to identify the limited partners OLPA s.3 RULE: The declaration of the limited liability partnership expires after years unless it is renewed. Expiry does not terminate the limited partnership, but an additional fee must be paid for renewal OLPA s.3(3). RULE: The general partner in a limited partnership has all the rights and powers and is subject to the same restrictions and unlimited personal liability as a partner in a general partnership subject to certain additional constraints designed to protect the limited partners OLPA s.8 RULE: Limited partners have certain narrowly defined rights and their liability is limited to the extent of their contribution OLPA s. 9
Limited Partners Rights RULE: Limited partners have a right to share in profits and to have their investment returned OLPA ss. 11 RULE: right to demand and receive return of investment when: OLPA s.15(1) a. Dissolution of the LP’ship b. At the time specified in the p’ship agreement c. On 6 mos notice, if no time specified in PA d. On unanimous consent of all Ps RULE: No return of a limited partner’s investment may occur if there are not enough assets to pay the claims of all creditors OLPA 15(1)
RULE: In addition, Section 10 of the Ontario Act provides that a limited partner has the same rights as a general partner to: 1) inspect the books and make copies, 2) get full and true information regarding the limited partnership and to be given a complete and formal account of the affairs and 3) to obtain dissolution by court order. OLPA s. 10
RULE: A limited partner may transact business with the limited partnership including lending it money but cannot hold a security interest in its assets and cannot receive anything from the limited partnership if its insolvent
RULE: Unlike a general partner, a limited partner may be an employee of the partnership OLPA s. 12
RULE: A limited partners interest is transferable, but the transferee has the full rights of the transferor OLPA s. 18
RULE: A person can be both a limited and general partner OLPA s. 5(1) Governments allow this because it allows for involvement in high risk activities especially people who do not have money or people with mney but no special skills
22 When Limited Liability disappears
Limited Liability disappears if partner: (a) "takes part in the control of the business" [LPA s. 13(1)]; or (b) allows their name to be used in firm name [LPA s. 6(2)] The limited partner can advise (not control) the firm management [12(2)(a)]
Hard to distinguish between giving advice and when in control. In this case the limited partner lost his status when he acted as the manager Houghton Graphics A limited partner actng only in their capacities as directors and officers of a corporate general partner, they are not liable as general partners Nordile Holdings, o BUT will lose his limited liability if he is also the controlling shareholder because as such, he is in control of the general partner (corporation) (Houghton Graphics).
Limited Partners have similar rights to those in the default rules under general partnerships Dissolution occurs if (a) no more general partner (b) no more limited partners (c) the limited partner’s contribution not repaid when required (d) assets are not enough to pay liabilities.
LIMITED LIABILITY PARTNERSHIPS – S.10, 44.1-44.4 After Aug. 1, 2007, LLPs will have “full shield” limited liability protection for debts or obligations but that liability can be enlarged if criminal or fraud involved and the partners knew or ought to have known of the criminal or fraudulent act or omission. See sec. 10(2), 10 (3). This is done by all partners signing an agreement called LLP under the Business Names Act and must be all requirement set out in ss. 44.1 – 44.4 of the OPA The government statute of the profession – LSUC – has to allow this type of coverage to allow the professional associations to operate under LLP’s LLP’s must carry a mandatory minimum amount of insurance. Minimizes risk for partners, but increases risk for clients/creditors. FIRM REMAINS LIABLE- scheme protects Ps from claims against personal assets. Assets of the firm are still available.
New provisions on limited liability partnerships: 10(2)(a) An individual partner not liable for debts or obligations of partnership or another partner arising out of negligence, or wrongful acts or omissions of Other partners or Employees, agent, or representative of the partnership 10(2)(b) Not liable for any other debts or obligations of p’ship incurred while p’ship is LLP
UNLESS: • Act or omission of other partner or employee (not directly supervised) constitutes a crime or fraud (criminal or civil) [10(3)(c)(i)] OR • Partner knew or ought to have known of act or omission and did not take actions to prevent it that a reasonable person would have taken [10(3(c)(ii)]
REMAINS LIABLE for: own negligence or wrongful act or omission [10(3)(a)] that of person directly supervised or controlled by the Partner [10(3)(b)]
23 Partnership Summary 1. Partnership has no existence separate from the partners who comprise it. Therefore partners have unlimited personal liability for the obligations of the partnership business 2. In absence of any agreement to the contrary, partnerships may be dissolved by any of the partners in accordance with the default rules 3. Partnerships come into existence without any formality – it is sufficient if two or more persons begin to carry on business together with a view to profit. 4. The test for this intention = whether the business is being carried on for the benefit of the alleged partners 5. The most significant indicia of such an intention is sharing of profits from the business activity 6. Other important indicia of partnership include management, control of the partnership, and common ownership of property. 7. The relationship of partners to each other is governed by default rules in the OPA unless the parties agree on some other arrangement. 8. The relationship between partners and third parties are governed by a set of mandatory rules 9. In general, all partners are liable for all obligations incurred in the course of the partnership 10. After a person dies or becomes bankrupt he is no longer liable for the obligations incurred afterwards 11. If a partner leaved for other reason he may continue to be liable 12. Persons who are not partner will nevertheless be liable as partners if they are knowingly being held out as partners 13. Partnership agreements alter the default laws of partnerships 14. Joint ventures are not partnerships but may have some lesser partnership like legal consequences 15. Joint Venterurs have fiduciary duty not to put their personal interests ahead of the interests of the venture. 16. Limited partnerships are like general partnerships except that the liability of at least one partner is limited to the amount of money invested in the partnership 17. If a limited partner violates the restrictions of the partnership he loses his limited liability and becomes a general partner.
Corporations
Jurisdiction to Incorporate / regulate
Provinces Carrying on business “within the province” Constitution Act s. 92(11)) o Can apply for license to carry on business in other provinces o OBCA provides automatic licenses Province cannot legislate re status/powers of a Fed Corp, but they can regulate its conduct in prov if: (1) Legislation grounded in s. 92 and (2) consistent with federal legislation (paramountcy) Provincial securities regulation which affects the way things are bought and sold within the province has been upheld as validly enacted and not inconsistent with federal law. Name registration statutes are another example of valid provincial legislation that can affect federal corporations. Such legislation exists in every province and required registration of business names that are different from corporate names.
Canada In addition to power to incorporate corporations doing business under jurisdiction of federal Parliament, e.g. Banking, general power to incorporate found in POGG Parsons CBCA (Canada Business organizations Act) underwent major amendments in 2001. Federal corporations have the power to carry on business in each province Feds cannot legislate re status/powers of a Prov Corp, but can regulate conduct under s. 91 power Can directly affect operations of a provincially incorporated company is legislation primarily in relation to an area of jurisdiction under section 91 EX: federal legislation on privacy PIPEDA now applied to most business organizations in Canada after January 1 2004 unless provinces pass equivalent law.
24 INCORPORATION AND ORGANIZATION OF CORPORATIONS
To incorporate you MUST 1. ***File articles of incorporation under OBCA s. 5 Form 1 (see below) 2. For the Name Search Report 3. Notice of Directors and Notice of Registered Office needs to be filed under CBCA, Number of Directors have to be identified 115(2) 4. Must have Ltd., Inc. or Corp. or French equivalent in the name Fees, have been reduced, cheaper if done on-line. Director under CBCA issues certificate on proper filing. Date on certificate is the birth of the corporation CBCA, sec. 9, OBCA s. 7 Once the corporation is incorporated it may start to carry on business. Unlike a partnership there is NO NEED for a corporation to carry on business. Its existence derives validity from issuance of the certificate under the statute.
1. File Articles of Incorporation Directors and the officers are in charge of the new “person” The articles of incorporation must include the number of directors and an indication of whether this will be a fixed # or a range. The minimum of directors is one. Only 25% of the Directors need to be Resident Canadian’s except where a corporation is carrying on a prescribed activity including uranium mining, book publishing or distribution. If there are less then 4 directors one must be an Resident Canadian S. 105(3) There must be a registered Officer S. 14 and that must be in the articles of incorporation The articles of incorporation must also include the class and number of shares and must identify how the corporation wishes to deal with the rights, privileges, restrictions and conditions The articles must also address whether there will be a limited or unlimited amount of shares The articles must also include whether there will be restrictions on issuing, transferring or owning shares.
2. Hole a Directors’ Meeting Issue shares Appoint Officers Banking Arrangements Draft By-laws (note- s.17 (1& 2) read with s. 15) o S. 17(1) says that a by law does not need to be passed. You do not need to itemize everything. When you file those documents and a certificate of incorporation is issued you have created a “person”. 17(1) warns you about this because you need to know that you have created a new body. o S. 17(2) says that at one level you can have in your constitution of the company restrictions on the type of business you can carry. You cannot do anything against your own by law o S. 17(3) no act of a corporation including a transfer of property to or by the corporation is invalid by reason only that the act is contrary to its articles, o S. 15 - A corporation has the capacity and the rights, powers and privileges of a natural person
3. Hold a Shareholders’ Meeting Approve By-laws Elect/confirm new directors Unanimous Shareholders’ Agreement
FUNCTION OF CORPORATE LAW Corporate law operates to encourage people to invest money in starting, maintaining and expanding business To understand how it operates this way it is important to understand how people make decisions about investing in business. The corporate finance structure holds that people make decisions based on evaluation 25 of the returns expected from the investment and based on an assessment of the risk. Returns may be interest earned on a loan, dividends on shares, an increase in the price of shares. Risks may include the notion That you will still turn a profit despite the risk associated with the returns
Shareholder or stockholder = individual or institution (including a corporation) that legally owns a share of stock in a public or private corporation A corporate stakeholder = that which can affect or be affected by the actions of the business as a whole : public, employees, government, customers, suppliers, creditors, investors
1. Corporate Law increases returns by decreasing costs Like partnership law, corporate law provides default rules that apply to govern the relationship between the corporation and its shareholders in the absence of some other rule being agreed upon by the corporation and its shareholders and expressed in the articles, by laws or shareholder agreements. The availability of these standard form default rules will save the corporation start up and set up money thus increasing the returns to shareholders Corporate law also reduces costs by providing limited liability.
2. Corporate Law decreases shareholder risk a. Through limited liability The most a shareholder can lose is the amount of her investment. The shareholder is NOT directly liable for the debts and obligations of the corporation at all. Only the corporation which is a separate legal person is responsible for the obligations arising out the business it is carrying on. By providing this simple cost effective mechanism to limit shareholder potential losses corporate law reduces the risk associated with investing. This may be contrasted with a partnership n which the maximum loss is all of the partners business and personal assets By capping the risk investment is encouraged Limited liability does not eliminate risks but rather shifts it to other stakeholders such as employees and creditors.
b. Through mandatory rules protecting all shareholders Corporate law reduces the risk of investing in a corporation for shareholders by imposing certain mandatory rules designed to protect shareholders from abuse by management In addition to giving shareholders the power to determine collectively who becomes a director, corporate law imposes standards of behaviour on directors and officers such as their fiduciary duty to act in the best interests of the corporation CBCA S. 122(1)(a) Corporate law facilitates shareholder monitoring of directors and officers by requiring financial disclosure CBCA 155(1) These rules increase expected shareholder returns by preventing directors and officers from enriching themselves at the expense of the corporation or shirking their responsibilities
c. Through mandatory rules protecting minority shareholders There are a variety of mandatory rules to protect minority shareholders from majority and corp’s operate on majority rule. To guard against this risk mandatory rules require shareholder approval by 2/3 majority for what are deemed fundamental changes to the corporation such as the sale of all or most of the property of the corporation 189(3), and give minority shareholders a right to be bought out if they disagree with the outcome of the vote. Minority shareholders are also entitled to seek relief against abuse of the majority s.241
26 3. Corporate Law balances mandatory rules protecting non shareholder Stakeholders There are some corporate law rules which protect stakeholders by shifting risks back to the corporation and its shareholders a. Limits on limited liability Limited liability is a creation of the law designed to encourage entrepreneurship by shifting the risk of business activity from shareholder to other stakeholders. Despite the express statutory grant of limited liability CBCA s.45, the courts have claimed for themselves the power to disregard the separateness of corporate legal personality – power to lift the corporate veil One source of personal liability for managers is torts Regulatory statutes impose personal liability on directors and officers in connection with the failure of the corporation to meet standards set in the regulatory scheme as a way of encouraging management to be more vigilant to ensure that the standards are met.
b. Other rules protecting Non shareholders Stakeholders Shares cannot be issued on credit CBCA s. 245(3). Shares can be issued only for money or value. Corporations have restrictions against them if the company believes it is insolvent. This also helps to protect the stakeholders and if the rules are broken the directors are personally responsible for any payment made in contravention of the rules. Directors may be liable if they act in a manner that is oppressive to or is unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer. CBCA 241(2) Each director and officer has a fiduciary duty to act in the best interest of the corporation and to exercise reasonable care, diligence and skill in discharging the obligations
2 TESTS for director’s duty to non-shareholder stakeholders under sec. 38(3): 1. Corporation is or would be made insolvent (“Solvency Test”) 2. Realizable value of the corporation’s assets would be less than its liabilities and stated capital for all classes of shares (“Capital Impairment Test”)
Note: Under recent amendments to the CBCA, Nov. 24, 2001 financial assistance restrictions in the previous s. 44 CBCA have been repealed. However, Directors and Officers would be subject to their statutory duties of care and fiduciary duties not to abuse their positions to “rifle” the company.
The CBCA Amendments have also changed the rules on indemnification in Section 124. Their scope has been broadened to get rid of certain ambiguities. For example, the amendments expressly permit corporations to indemnify Directors and Officers past and present or other individuals who, at the corporation’s request acted in a similar capacity for another entity, for any civil, criminal, administrative, investigative or other proceeding. The amendments now make it clear that the indemnification can be extended to investigative proceedings and to persons acting at the corporations request as a Director or officer or other similar capacity for a corporation or other type of entity, such as a partnership or trust. The pre-existing limitations on indemnifying individuals who committed illegal acts or acted in breach of their fiduciary duties continue to apply. Similar OBCA amendments in Sec. 136 (1) effective Aug. 1, 2007
Relationship Between Corporate and Securities Law Differences in Purpose • Securities law – regulate markets for publicly traded securities • corporate law – determines nature of corporation, relationships of corporate stakeholders
Scope of Application • Securities law - All business organizations distributing shares in the jurisdiction • corporate law – corporations incorporated under particular jurisdiction
27 Enforcement • Securities law – Active enforcement by public authority • Corporate law – Private enforcement – weak public enforcement
Substantive Law • Securities law – mandatory disclosure of information to market – Registration of securities market participants – Procedures for certain transactions – e.g. takeover bids
• Corporate law – nature of corporation – rights of outsiders dealing with the corporation – allocation of powers between shareholders, directors and officers – including disclosure of information – Decision making process
THE NATURE OF THE CORPORATION / SEPARATE LEGAL EXISTENCE S. 15 (1) CBCA A Corporation has the capacity and, subject to this Act, the rights powers and privileges of a natural person.
Salomon v Salomon & Co. corporation is a separate legal entity Facts: Mr. S wanted to prevent creditors collecting his personal assets so he incorporated his sole proprietorship and made he & his 6 family members shdrs. When business went bankrupt, only the secured creditor (Mr. S himself) was able to recover. Trade creditors claimed fraud & that corp was a disguise. Rule: The separate legal existence of the corporation means that a shareholder may also be a creditor or even a secured creditor of a corporation. Only restriction in Canada is that a corp may not grant a security interest in its assets in favour of a shareholder as security for a loan from the shareholder if the purpose of doing so is to defeat the claims of existing creditors. Held: Mr. S complied with requisite formalities & incorporated—now corp is a separate legal person from the shareholders, even if outwardly no change (same manager, business & source of capital). Separate legal person now stands between creditors & investor even if the investor is also a shareholder. The specific bundle of rights that a shareholder will have will depend on the corporations articles and the corporate statute. Shares represent a claim to the residual value of the corporation after the claims of all creditors have been paid.
Kosmopoulos v. Constitution Insurance (1987) SCC Facts: K was sole proprietor that incorporated as a sole shareholder & transferred his assets to the corp. His insurance was personal & not in corporation’s name. When fire damaged his assets, insurance co refused to pay on grounds that K has no insurable interest in the assets (shareholder doesn’t OWN assets! Rule: The “separate legal entities” principle (and implication that those who choose the benefits of the corporation must also bear its burdens) will not be enforced when it would yield a result opposite to justice. Held: Grant right of insurable interest to sole shareholder, when that interest is substantial enough—SCC made K a trustee of the corporate assets for benefit of the corporation—broadened the insurable interest & K can recover
Lee v Lee’s Air Farming One can be an employee of their own Corporation Facts: Lee died in an accident while at work; his wife wants to collect benefits & sues the corporation where he worked, arguing he was a “worker” w/in Worker’s Compensation Act. Company denies the WC claim and argues that as a controlling (sole) shdr & director of the corp, Lee was not a “worker”—can’t be an employee of yourself Rule: An employee, as director/manager of corp. (and/or as shdr), MAY contract with himself. This self- dealing is a logical consequence of corp’s separate legal personality Note: This is opposite to partnerships where one cannot be an employee of their own partnership 28 DISREGARD OF THE SEPARATE LEGAL IDENTITY OF CORPORATIONS courts sometimes disregard or refuse to accept the separate legal identity & impose liability on the individual in relation to a specific claim AKA lifting/ Piercing the corporate veil
Grounds for Piercing the Corporate Veil
1. Unfairness In many cases there is an element of unfairness in the way the corporation is being used - separate legal personality yields result “flagrantly opposed to justice” NOTE: raise equity issues where they exist Court does not have carte blanche to disregard the corporations personality Transamerica Life insurance Court is more likely to disregard separate personality if doing so results in liability being imposed on another corporation as opposed to an individual De Salaberry
Wildman v Wildman flagrantly opposed to justice therefore disregard the corporate entity Man using his landscaping corporation to avoid spousal/child support payments- controlling when and how he was paid- court held that it would be flagrantly opposed to justice to allow him to use the separate existence of the corp to avoid his family law obligations
2. Variety of Objectionable purposes for which the court will pierce the corporate veil Courts will disregard the corporate identity where there is improper motive/purpose – “motive contrary to public policy” The most common objectionable purpose and therefore reason to lift the corporate veil is fraud. Arises where the shareholder uses the corporation to effect a purpose or commit an act that should could not do on her own without the corporation a. Incorporation for illegal purposes b. Fraud
Big Bend Hotel Fraud therefore disregard corporate entity If a Shareholder uses corporation to effect a purpose or commit an act that she could not effect or commit on her own it is fraud (common circumstance leading to fraud as a basis for disregard for the coproate identity). Operated hotel, it burned down, Kumar made claim on insurance, acquired new hotel and created a corporation to make the application for insurance so that he didn’t have to disclose that he had a fire When this next hotel eventually burned down, insurance company looked at it and said I won’t pay.
Fraud also arises where assets are transferred to a shareholder for the purpose of rendering the corporation incapable of preforming an obligation that is owed to a third party. c. Misrepresentation as to identity of corporation In Order for the court to disregard the separate existence of the corporation to impose liability on a shareholder, however, the fraud must involve misrepresentation regarding the identity of the corporation, not merely some attribute of the corporation or its assets.
Preeco I v Bon Street Holdings Facts: Two individual defendants acted on behalf of a corporation named Bon street in negotiating the purchase of property. The seller knew that the corporation had assets. Just before the closing of the transaction the individuals changed the name of the corporation and then created another corporation with the same name as
29 the old one but it had not assets. The contract was signed on behalf of the new company with no assets and then defaulted on the contract to buy the property. Reasoning: The plaintiffs claimed that the separate existence of the corporation should be disregarded and that liability for breach of contract should be imposed on the original corporation with the assets or on the individuals involved (this way they could get access to the $). Held: The court in this case maintained the separate existence of the insolvent corporation (did not lift the corporate veil) in an obvious case of fraud holding that the fraud did not relate to the identity of the corporation but only to its assets. The court did however find the individuals liable for fraud. NOTE: Fraudulent representations by a director officer or shareholder that a corporation has sufficient assets to meet its obligations will result in personal liability for fraud for the director, officer or shareholder. d. Avoiding Contractual Obligations
Gilford Motor Co. v Horne avoiding contractual obligation therefore disregard corporate entity Cannot use a corporation to get around a non-competition clause (claim it’s the corporation competing and not you). D had entered into an agreement not to solicit the customers of his former employer. He incorporated a corporation to carry on a competing business and sought to attract the employer’s customers to the corporation. The court imposed non compete on corporation he was working for as well as individual.
Rogers Cantel v Elbanna Sales avoiding contractual obligation therefore disregard corporate entity Court disregarded the separate existence of the corporation to ensure the effectiveness of a non competition obligation outlined in a contract. e. Holding out as sole proprietor f. Improper or illegal tax avoidance Courts have been sympathetic to arguments that the use of a corporation to reduce taxes is an improper purpose.
De Salaberry Improper tax purpose therefore disregard the corporate entity The court disregarded the spate existence of one corporation in a large corporate group. It had been argued that the sale of land by the corporation was an isolated transaction such that the proceeds should be characterized as capital gain. (At the time capital gains were not subject to tax). The court held that when you disregarded the separate existence of the corporation, the sale was part of a business of buying and selling land being carried on by the whole group of corporations under common control so the proceeds were found to be income from business and fully taxed.
Stubart Opposite to De Salaberry This decision signaled that the courts should be less willing to disregard the separateness of the corporate identity in the interest of imposing tax liability even where no business purpose for the corporation is shown, other than minimizing tax liability. In other words, even the sole purpose of minimizing tax should be seen as legit and the corporation should be allowed to maintain its separate identity. g. Corporation is acting as an agent and therefore court will pierce the corporate veil Another basis on which courts have purported to disregard separate corporate personality is by finding that the corporation is merely acting as the agent of another person usually the controlling shareholder. The courts often use language like “sham”, “cloak”, ”conduit” or alter ego” in these scenarios.
Smith -TEST for Agency leading the court to lift the corporate veil The factors for determining if there is extensive control are almost universally cited as those relevant to determining whether agency exists: 1. Were the profits of the corporation treated as profits of the shareholder? 2. Was the person conducting the business appointed by the shareholder? 30 3. Was the shareholder the head and brain of the trading venture / corporation? 4. Did the shareholder govern the corporation and decide what should be done and what capital should be committed to the venture? 5. Did the shareholder make the profits by its skill and direction? 6. Was the shareholder in effectual and constant control?
Alberta Gas Ethylene v MNR The Agency test does not stand for the proposition that one must ignore the separate existence of a subsidiary corporation when the 6 criteria are met. One must ask for what purpose the corporation was incorporated and used and consider the overall context in which the obligation to the third party arose.
Gregorio v Intrans- Corp Held that the policy behind holding a parent corporation liable is to prevent conduct akin to fraud that would otherwise unjustly deprive claimants of their rights. Where the court finds that a subsidiary has been set up for a legitimate business purpose, disregarding the separate existence of the subsidiary is inappropriate. h. Other Factors? Courts are not always clear whether they are relying on principles of fairness, objectionable purpose, or agency as the basis on which they are disregarding the separate legal existence of a corporation. They are often relied on in combination. Court may also rely on lack of respect for the corporate form In Wolfe v Moir an officer of a corporation that operated a roller skating rink was held personally liable for negligence in connection with an injury of a skater. The basis of the finding was that the business was advertised incorporating the officers name, and not the corporations name. This was in contravention of the corporate law in Alberta therefore the corporate veil was lifted.
Consider all factors: In the end, cumulative argument. Use the tools. ARGUING IN FAVOUR of lifting the corporate veil unfair, objectionable purpose, control, lake of respect for corporate form, think capitalization, et ARGUING AGAINST lifting the corporate veil :raise factors useful for your arg.
Professional Corporations Another special form of corporation that does not provide shareholders with full protection against liability is the professional corporation. Ontario permits lawyers accountants and certain other professions to incorporate their professional practice. Most important aspect is that all shareholders in the PC are liable for all professional liability claims against the corporation, but in all other respects are like any other OBCA corporation. To incorporate as a professional corporation in Ontario you must meet the following: 1. All of the used shares of the corporation are owned by one or more members of the same profession 2. All officers and directors of the corporation are shareholders of the corporation 3. The name of the corporation includes the words professional corporation 4. The articles of incorporation provide that the corporation may not carry on business other than the practice of the profession.
31 The process of Incorporation
A corporation may be incorporated by one or more corporations or individuals or a combination of both Individual incorporators CANNOT be any of the following: 1. Less then 18 years of age 2. Of unsound mind as found by a court 3. Have the status of bankrupt Articles = most important documents filed on incorporation. Set out the fundamental characteristics of the corporation: its name, the province or territory within Canada where it is registered, the class, number and characteristics of shares it is authorized to issue, the number of directors, any restrictions on transferring shares and any restrictions on business the corporation may carry on
Items included in the articles:
Number of Directors Minimum one (1) Can be fixed or a range 25% of Directors must be Resident Canadians except where corp carrying on a prescribed activity under CBCA regs, e.g. Uranium mining, book publishing or distribution. If less than 4 Directors, one must be an RC Sec. 105(3) Under the CBCA corporations that have distributed their shares to the public must have 3 directors, at least two of whom are not officers or employees of the corporation. All other corp’s need to have only one.
Registered Office (s. 14) Under the CBCA must identify in the articles the province or territory in Canada location of registered office If there is a change to the office’s location a notice of change of registered office must be filed with the director within 15 days of the change CBCA s. 19(4) Form 3 The registered office of a provincial corporation must be located inside the incorporating province in the municipality or geographic township specified in the articles
Class and Number of Shares The articles define the classes of shares that the corporation is authorized to issue. Set out the Name by which each class of shares is to be identified (e.g. common shares or preferred shares) Articles set out the Rights, privileges, restrictions and conditions (e.g. vote, dividends and entitlement to property of corporation on dissolution) Number - unlimited or maximum amount
Restrictions on issuing, transferring or owning shares
Transfer If no restrictions, shares are presumed to be freely transferable It is commonplace however for corporations with few shareholders to have some kind of transfer restriction in the articles because in such corporations the shareholders have high stakes in the corporation. Each shareholder wants to control who becomes shareholder BUT each shareholder also wants to be as free as possible to sell own shares Transfer usually requires approval of directors or shareholders Restrictions may be imposed on the issuance of shares as well. Issuance pre-emptive rights s. 26 define class of acceptable shareholders in the articles (e.g. Canadian residents) 32 Restrictions on the Business the corporation may carry on Under the CBCA it is not necessary for the corporation to describe the activities in which it will engage. The corporation has all the capacity and subject to certain limitation in the corporate statute, the rights, powers, and privileges of a natural person S. 15 Even where restrictions on business that the corporation may carry on are included in the articles, the rule that ulra vires obligations are unenforceable against the corporation has been largely mitigated. If a restriction is included the CBCA provides that the corporation is forbidden to act in a manner that is contrary to that restriction. As a result, no third party should be prejudiced because the corporation enters into an obligation with the third party that is contrary to the articles.
Other Provisions A variety of other provisions are sometimes put into the articles which might include requirements for super majorities of directors or shareholders to approver certain decisions, limitations on the corporations right to purchase its own shares, or the required notice and location of director’s meetings and the quorum for such meetings. Any provision permitted by the CBCA to be included in a by law may be included in the articles s. 6(2)
Incorporation: other details All jurisdictions charge a fee on incorporation – under CBCA $250, OBCA $360 Once the documents required are properly filed along with the fee being paid, the director appointed issues a certificate of incorporation on the date of the certificate CBCA s.8 The corporation comes into existence on the date of the certificate s. 9 The directors names in the initial registered office address and first board of directors hold office until the first meeting of the shareholders CBCA S. 106(2)
PRE INCORPORATION CONTRACT Difficulty arises where a contract is entered into on behalf of a corporation before the date of its incorporation. Sometimes a person, typically referred to as an agent or promoter, will purport to enter into a contract with a third party on behalf of a corporation that has not yet come into existence. In these circumstances several difficult issues arise: 1. Is the agent liable to preform the contract personally? 2. Is the corporation liable if it adopts the contract after it comes into existence? 3. If the corporation becomes liable, does the agent cease to be liable?
Common Law Position Corporation = NOT liable for the contracts that were made before it came into existence. Corporations = COULD NOT be made liable for contracts it purported to enter into before incorporation by any unilateral act of adoption or acceptance after incorporation For the corporation to be liable there had to be a NEW contract between the newly incorporated corporation and the third party
RULE: If BOTH parties knew that the corporation was NOT in existence a presumption arose that the parties intended that the AGENT would be personally liable for pre-incorporated business
Kelner v Baxter Promoter and 3rd party make a contract of immediate delivery of goods to a company that was not yet incorporated. Court says that if goods are going to be immediately delivered, someone must have realized that they were going to be liable for the delivery. It would be unreasonable for the supplier to expect the delivery to be contingent on the corporation coming into existence. The third party probably expected the agent of the corporation to be liable. 33
RULE: If BOTH parties thought that the corporation WAS in existence there was no presumption that liability lay with the agent and the parties’ intentions had to be determined from all the circumstances.
Black v smallwood In this case both parties believed that the corporation was incorporated. The corporation was not incorporated but the contract entered into was on the assumption that there was a corporation. Here black is suing Smallwood, an agent, as personally liable. Court says that he is not because both parties believed that there was in fact a corporation and that they had not intended for smallwood to be personally liable.
RULE: Where the AGENT knew that the corporation was NOT in existence but the third party believed that there WAS a corporation in existence one might think that no contract could arise because there was no consensus, no meeting of the minds
Statutory Reform The law tried to put more certainty into this area. Key sections s. 21 OBCA & s.14 CBCA Rule: A person/ agent = liable IF the agent who purports to enter into a contract with a third party by, or on behalf of, a corporation and that corporation does not yet exist
Rule: corporation = liable IF a corporation comes into existence and adopts the contract, the corporation is bound by and is entitled to the benefits of the contract and is liable. The agent is NO longer bound by or entitled to the benefits of the contract
Rule: limitation: if corporation is going to Adopt must be within a reasonable time or the agent retains liability. TMD Investments Ltd case waiting one year not reasonable and the agent would remain liable.
Rule: Third party to contact may apply to court for apportionment of liability between agent and corporation (corporation may have assets that the agent does not).
Rule: Third party and the agent may agree in the contract that the agent is not bound by the contract in any event
As a result of the statutory reforms agents now bear the risks of all liability prior to the adoption of a contract UNLESS the agent’s liability is expressly excluded by the agent in which case the risk of non adoption are transferred to the third party.
NOTE: If a corporation is never incorporated it is unclear which rules should apply to determine liability. It has been suggested that the conflict of laws approach be used in these circumstances
When Does Contract Adoption Occur?
Sherwood Design Services Inc. v 872935 Ltd. Facts: a law firm’s client signed an agreement to purchase some real property on behalf of a corporation to be incorporated. This corporation had not yet come into existence!! The client then instructed the law firm to prepare the necessary documents to complete the transaction. A lawyer in the firm, instead of incorporating the company, decided to complete the transaction by using a corporation that had already been incorporated by a partner in a law firm. The lawyer completed the necessary legal documents to transfer title to the shell corporation to his client and permit it to purchase the real property. The initial client decided he did not want to go through with the purchase. The shell corporation was transferred to another client who began to carry on a profitable business through the self-corporation. Eventually, the unpaid vendor, sued the shelf corporation. The vendor all Issue: Was there an adoption of the contract by the shelf corporation? Rule: An authorized action on behalf of the corporation can constitute adoption. If no adoption possibly no liability (Dissent: corp must actually adopt). 34 Held: Court deemed that the contract had been accepted and that the company had been incorporated. Dissent: despite all that, the control of the corporation had not been trasfered to the purchaser so how could it have been adopted if there was no control?
s.21 OBCA – Pre-incorporation Statutory reform (what happens if the corporation is not incorporated yet) The purpose of the statute was to clear up the common law. When it was argued in this case that there is no contract to be fulfilled because there is no meeting of the minds, the judge in this case says forget about it.
S. 21 of the OBCA is imposing a new regime and moving away from the common law. In the circumstances described in s. 21(1), the promoter is personally bound by the contract and entitled to its benefits. Either party can sue on the other’s breach. After incorporation and notice of intention to adopt, s. 21(2) provides that the corporation is bound and entitled to the benefits retroactively to the date the agreement was signed. Thus, the corporation can be liable for any breach on the promoter’s part and can sue on any breach by the third party, regardless of when the breach occurred.
Contracts under s. 21(4) differ from those under s. 21(1) in a few important ways. 21(4) If a promoter enters into an oral or written contract on behalf of a corporation to be incorporated and that oral or written contract expressly provides that the promoter is not bound by the contract or entitled to the benefits thereof, then the promoter is not in any event bound by or entitled to the benefits of the contract. If a promoter expressly states that they will not be bound by the contract or entitled to the benefits thereof you have a get out of jail card.
In some respects this shows a new form of statutory contract law that has been created. New framework for pre incorporation contracts that is outlined in the statute.
The Corporation in Action
Chapter dealing with the liability of the corporation, directors, Officers, for crimes torts and in contract If a corporation does something wrong, if you try to attach liability to them, unlike individuals they can pass on the consequences to other people (like to consumers through higher prices, or if you put them out of business, you are impacting employees and shareholders). There are big policy issues involved on how to impose criminal liability on juridical people (corporations) One of the most important differences between the juridical person and a real person: corporate persons need to act through human agents
LIABILITY OF CORPORATIONS FOR CRIMES Courts and statute have developed rules on the basis of which corporations may be convicted of criminal and regulatory offences
1. Common law Absolute Liability Offences Corporation is liable of an absolute liability offence if the person doing the prohibited act is acting on behalf of the corporation Punishment: Absolute liability offences are not punishable with jail for breach of s 7 of the charter Big M Note: These are almost insignificant now Polution and environmental offences
35 2. Common law Strict liability offences: RULE: corporation strictly liable if: 1. person is doing prohibited act 2. while acting on behalf of the corporation AND 3. due diligence defence by corporation not established.
BoP: Once it was proven that the act was committed, the burden is on the accused to show on the balance of probabilities that it was not negligent, ie that the directing mind exercised due diligence- if not strictly liable Defence: No liability if the person “directing the mind and will of the corporation” (the person who IS the corporation, usually top officials) was duly diligent ((i.e. did corporation take reasonable steps to prevent the act?). Sault Ste. Marie. Due diligence can be established where the prohibited act was not reasonably foreseeable, (ask was it reasonably foreseeable) OR if the accused knew or ought to have known of the hazard, where the accused took all reasonable steps to avoid committing the offence (ask did they take all reasonable steps?).
3. Common law Mens Rea Offence Under old commons law: Most criminal offences require that the accused have intention for a conviction. Identification Theory: criminal liability may attach and the Corporation liable if person doing prohibited act and having requisite mental state is the “directing mind and will of the corporation” Meaning that the person IS the corporation and therefore is guilty.
Directing the mind and will of the corporation person who has control of the area of the criminal act Does the person make policy/implementation decisions in that area (supervisor, manager, executive) Directing mind = When employee has been delegated expressly or by implication, the authority to design and supervise the implementation of corporate poliyc, as opposed to only the authority to carry out such policy A “directing mind will be found” where there is delegation of authority from the directors to officers and then to managers Canadian Dredge
R v Waterloo Mercury Sales Ltd. Liability was imposed on a corporation operating a car dealership. The manager fraudulently caused the odometers on used cars to be turned back. The manager in this case was found to be a directing mind because he had the discretionary power to make policy and supervise its implementation.
R v Safety-Kleen Canada Though driver was corp’s only rep in an area and responded to calls/ had some interactions w/ regulators didn’t have any discretionary authority w/ respect to operation of business- just a driver- Corp not responsible he isn’t directing mind and will of corp CASE LAW APPLIYING IDENTIFICATION THEORY NO LONGER RELEVANT. LOOK AT PARLAIMENTARY WEBSITE!
Canadian Dredge and Dock STILL GOOD LAW Exception: Corporation will NOT be criminally responsible when the directing mind is acting solely in their person interests (1) if the directing mind is acting totally in fraud of a corporation, and (2) the corporation gets no benefit.
Tesco if company takes measures to protect against fraud they could escape liability (UK case)
36 Oger v Cheifscope Court found that a corporation was not responsible for the fraud of 2 individuals who were directing minds of the corporation because all of their actions were for their own benefit. They stripped the corporation of its assets including assets obtained fraudulently. In this case the court held that the directing minds were not acting as the corporation.
CRIMINAL LIABILITY UNDER THE CRIMINAL CODE
Bill c-45 An act to amend the criminal Code (Criminal Liability of Organizations) • The criminal liability of corporations and other organizations no longer depends on a “directing mind” of the organization having committed the offence. No more identification theory. • The physical (actus reus) and mental elements (mens rea) of criminal offences attributable to corporations and other organizations will no longer need to be derived from the same individual. • Class of personnel whose acts or omissions can supply the physical element of a crime (actus reus) attributable to a corporation or other organization will be expanded to include all employees, agents and contractors • For negligence-based crimes, the mental element of the offence (mens rea) will be attributable to corporations and other organizations through the aggregate fault of the organization’s “senior officers” (which will include those members of management with operational, as well as policy-making, authority = senior officers / almost anyone in management). • For crimes of intent or recklessness, criminal intent will be attributable to a corporation or other organization where a senior officer is a party to the offence, or where a senior officer has knowledge of the commission of the offence by other members of the organization and fails to take all reasonable steps to prevent or stop the commission of the offence. • Sentencing principles specifically designed for corporate/organizational offenders will be adopted. • An explicit legal duty will be established on the part of those with responsibility for directing the work of others, requiring such individuals to take reasonable steps to prevent bodily harm arising from such work.
Criminal negligence crimes s. 22.1 • New section 22.2 deals with criminal offences where the requisite “intent” is negligence, namely, criminal negligence causing bodily harm or death. For these offences, an organization will be guilty where:
An organization is a party to an offence if: (1) One of its representatives is party to the offence, OR two or more of its representatives act together so their acts combined make them a party to the offence, AND (2) Senior officer responsible for activities relevant to the offence – departs markedly from the Stand of Care that, in the circumstances, would reasonably be expected to prevent the representative(s) from being a party to the offence.
• Unlike the current law on corporate criminal liability, section 22.1 will permit the aggregation of the acts and omissions and the state of mind of the organization’s representatives and senior officers in fixing organizational liability. In this way, an organization may be guilty of an offence even if no individual within the organization has committed an offence.
Criminal Offences requiring intent or recklessness New section 22.2 will require that a senior officer, acting at least partially with the intent to benefit the organization: a) Acting within the scope of his or her authority, is a party to the offence; b) Acting within the scope of his or her authority, and while having the necessary intent to commit the offence, directs the work of other representatives so that they do the act or make the omission forming the basis of the offence;(25) or 37 c) Knowing that a representative is, or is about to be, a party to the offence, does not take reasonable measures to stop the representative from being party to the offence.
LIABILITY OF CORPORATIONS IN TORT
1. Vicarious Liability Corporation may be vicariously liable where someone acting on behalf of the corp has committed a tort. a. Requires that the There is a master and servant relationship between the person and the corporation (employee/ employer relationship) b. The person committing the tort was acting in the course of his or her employment
Defence of “Frolic of his own”: Employee was not acting in course of employment- on a “frolic of their own” Joel v. Morison
Bazley v Curry Facts: Allegations of sexual assault against the children. Acts were alleged to have taken place outside of the workplace. Held: vicarious liability is generally appropriate where there is a significant connection between the creation or enhancement of a risk and a wrong that accrues from therefrom, even if unrelated to the employer's desires Rule: what is a "significant" connection? Court will consider the following five main factors in assessing significance: 1. The opportunity for the employee or volunteer to abuse his or her power. 2. The extent of the power over the victim that is conferred to the employee or volunteer. For example, is the employee or volunteer expected to act as a parent, or as a supervisor? Is the person in a position to grant benefits? 3. The vulnerability of the victim. For example, are participants young people, mentally or physically challenged? 4. The nature of the employer's activity or enterprise. For example, is the activity part of a day program, a residential program, a treatment program? 5. The degree of intimacy, confrontation or friction in the environment. For example, does the environment allow or condone a degree of intimacy? Is it hostile or secretive? If significant connection then Vicarious liability in Tort.
2. Direct Liability Requires person “directing mind and will of corporation” to commit the tort in such a way that the acts done are the acts of he corp itself Can include intentional torts (Nelitz v. Dyck – No liability, exam of insured, doctor received consent) A. If Manager performed, ordered or procured action constituting the tort, likely to be found liable. No defence to argue that the tort was done for the benefit of company. Corporate veil is not protection.
B. If Manager has general responsibility for the area in which the action constituting the tort takes place and no knowledge or involvement, liability unlikely
LIABILITY OF CORPORATIONS IN CONTRACT Liability of a corporation in Contract is generally based on the doctrine of agency- Corporation is the principal, acts through a number of agents Sales people, purchasing clerks, and others may all be considered agents A corporation is liable for contracts entered into by agents on its behalf with either actual or apparent authority to bind the corporation
38 Must balance: • Corporation’s interest in avoiding liability for unauthorized acts of agents Corps don’t want to be held liable for obligations incurred on their behalf that they haven’t authorized Corporation wants to make sure there is prior approval before held legally responsible Corporation in general s complicated enterprise with lots of people with authority to act
Common law rules for corporate liability in Contract
Rule: A corporation is liable for contracts entered into by agents on its behalf with actual OR apparent authority to bind the corporation. (Definitions of actual and apparent authority below)
Exceptions: Rule: Where an agent has no connection at all with the principle and makes a contract on behalf of the principle, the principle is not liable and cannot be bound by a contract. Rule: Where an agent falsely represents that he has the authority he MAY be liable for breach of warranty of authority or fraudulent misrepresentation but the principle is NOT liable Rule: An agent can only bind a corporation where they have some authority to do so. Said differently, an agent cannot bind the corporation UNLESS it has actual authority or apparent authority. The following types of authority are sufficient to enable an agent to bind a corporation
Actual Authority Person dealt with has actual authority to enter into the K. Articles, by-law, Statute, USA, any delegation based on them. Also includes employment Ks and may include implied from authority given to them.
SMC Electronics v Akhter Computers Ltd. implied authority is actual Authority The court held that a person with the job title “director of sales” had the implied authority to conclude a significant arrangement with another supplier based on the fact that entering into such an agreement on behalf of the corporation was reasonably incidental to a job with this title. A third party dealing with an agent may be completely ignorant of the existence of the persons actual authority but any agreement entered into by that person is binding if it fell within his or her actual authority. RULE: Actual authority may not only be authority expressly given, but also implied from position held.
Apparent Authority This authority is created where someone represents to a third party, on behalf of the corporation, that the person the third party is dealing with has authority to bind the corporation. It is the authority of the agent as it reasonably appears to the third party. In this case actual authority of the agent may or may not exist. The representation can be express or implied.
1. Representation creating apparent authority may be express or implied by conduct Freeman & Lockyer e.g. Appointing an agent to a position is representation that agent has authority usual for that position (sometimes called “usual authority”) Express would be letter from president saying person x has authority Acquiescing in agent’s exercise of authority may be representation that person has authority Representation must be made by person with authority to make it . Apparent authority works well to protect interests of 3rd parties but challenges where corp says that person who gave representation didn’t in fact have actual authority to do that and in that case—apparent authority may not be made out
2. Person who has apparent authority must have been given that apparent authority by a person who has actual authority in that area of activity
39
3. There must be reliance on the apparent authority. If so- Corp can’t argue against apparent authority. NOTE: Estoppel : Corp can’t argue that person w/ apparent auth didn’t have actual auth. Essentially estoppel.
CDN lab supplies Ltd. v Engelhard Industries of Canada Behaviour sufficient for Apparent Authority SCC considered what behaviour of an employee constituted a representation creating apparent authority Facts: cook had arranged to have his employer, CDN lab supplies, and purchase platinum from Engelhard. Cook received the platinum and then sold it back to Engelhard as used platinum, pocketing the money. Cook had no authority to buy platinum in the first place. In litigation Engelhard claimed that CDN lab supplies had cloaked cook with apparent authority through a representation by Snook (a purchasing agent) who had directed CDN lab to cook. Issue: was the contract enforceable? Held: SCC held that Snook’s conduct amounted to a representation that Cook had authority to act on behalf of the corporation in relation to the platinum contracts so the contracts were binding.
Statutory reform on Corporate Liability in Contracts Corporate Liability in Contract - Statutory Reform - OBCA ss. 18, 19 BUT OBCA prohibits corporations from raising certain defects in authority
S.19 OBCA provides denials that the corporation may not asset in the event that they think there is a contract defect. The provision says that 3rd parties can assume internal procedures are being followed with regards to contracts. Corporation cannot raise defects specified in s. 19 to deny authority UNLESS person knew or ought to have known by reason of person’s position with or relationship to corporation of the defect
S. 17 CBCA provides that no person is deemed to have knowledge of any document relating to the corporation “by reason only” that the document has been filed with the director and so is a matter of public record.
S. 18 CBCA codified constructive notice rules regarding apparent authority and enhanced the ability of third parties to enforce contractual claims against corporations. Section 18 denies the corporation the ability to rely on certain kinds of defects in the agent’s authority. This makes it easier for 3rd parties to succeed in their claims against corporations. Section 18(d) codifies the common law rule that says that if a corporation makes a representation to a third party by holding someone out as a director, officer or agent, the corporation cannot deny that the person is duly appointed or that she has the authority customary or usual for such a director, officer or agent The balance of section 18 deals with specific situations in which the corporation cannot rely on defects in actual authority to defeat claims by third parties. The main purpose of these provisions is to ensure that corporations cannot escape their obligations to their parties because of internal corporate restrictions on authority or their failure to follow their own procedures. All of the provisions of S. 18 are subject to a qualification: third parties dealing with a corporation cannot benefit from these protections if they are aware of the defect in authority of the person they were dealing with or they ought to have known of the defect in authority due to their relationship to the corporation.
Management and Control of the Corporation
Basic legal Structure: Directors: top level of corporate governance appoint officers and delegate to then some management power. They also manage and supervise management of business and affairs of the corporation. They are not supposed to run the day to day management- they set the strategy and direction of the corporation and allow the officers to exercise the delegated powers to run the company on a day to day basis OBCA s. 115
40 Officers: Exercise power to manage delegated by the directors OBCA S. 133
Shareholders: Are the residual claimants to the assets of the corporation. Their only power is to elect directors, vote on proposals made to them, have limited scope of power to initiate corporate action, they can get information and seek relief against management in certain situations. Shareholders’ control over who the directors are is intended to help create accountability of the directors to the shareholders. Shareholders are NOT the owners of the corporation and VD says that shareholders have a passive voice.
OBCA PROVIDES ENHANCED ROLES FOR SHAREHOLDERS / HOW THEY EXERCISE POWER There are some specific situations in which the OBCA requires shareholder approval: 1. Amendment of articles ss. 168, 170 2. Bylaws s. 116 3. *Sales of "all or substantially all of the assets of a corporation" s. 184(3)) requires special resolution (2/3) 4. Amalgamation s. 176) requires special resolution by shareholders 2/3 of voters entitled to a vote 5. Continuance (s. 181) requires special resolution by shareholders 2/3 of voters entitled to a vote 6. Going private transactions (s. 190) requires special resolution by shareholders 7. Dissolution (s. 207) requires special resolution by shareholders 2/3 of voters entitled to a vote
Note: depending on how a company has structured its share holdings, certain classes of shares will required those share themselves to vote separately and they have a veto right.
The CBCA also provides for an active role for shareholders in two ways: 1. Proposals: shareholder can have matters put in the agenda for discussion at shareholder meetings, including making, amending or repealing bylaws CBCA s. 137 and 103(5)), OBCA s. 99
2. Unanimous Shareholders’ agreements (USA’s): Shareholders can assume all power of the board of directors, completely altering the allocation of powers as between directors and shareholders if they unanimously agree CBCA s. 146, OBCA 108
How Shareholders Exercise their power
Shareholder meetings and resolutions To exercise their power to vote shareholders must act collectively usually done by having a meeting where shareholders vote on matters decided by them For small businesses – shareholders can sign a resolution instead of having a meeting.
2 Types of Meetings : Annual and Special s. 96(5) Annual meeting – Must occur at least every 15 months 94(1)(a) At an annual meeting : 1. There is an election of directors. 2. Consideration of the minutes of earlier meetings. 3. The receipt of financial statements and auditor reports 4. reappointment of an incumbent auditor
Special Meeting deal with anything other than those 2 areas of business are special meetings- these can be called by the shareholders themselves
41 Calling meetings / place of meetings Directors’ responsibility to call meetings 94 Shareholders w/ at least 5% of the shares can requisition a meeting 105(1) o If the directors don’t call a meeting w/in 21 days, shareholders can call it themselves 105(4) and can have their expenses reimbursed 105(6) Court may requisition a meeting upon application of a director or shareholder entitled to vote 106 Place of meetings is specified in the by-laws. If not in bylaws then in Canada at location specified by directors s. 93 Telephone meetings are common in corporations with few shareholders
Notice of meetings Max notice period for a meetings is 60 days and min notice period for a meeting is 21 days 95 Notice must go to each shareholder entitled to vote, each director and the auditor of the corporation 96 Shareholders who are entitled to notice are those who appear in the shareholders register on the “record date”. 95(2)/(3) Small corporations If you are at the meeting—deemed to have gotten notice 98
Proxies and Proxy Selection Proxy = other attends on behalf of shareholders OBCA s.109 The proxy must be in writing and signed by the shareholder – it may be revoked at any time Proxy has all of the power of a shareholder at a meeting but authority is limited to that conferred by the terms of the proxy agreement If a new matter is to be voted on and was not identified in the notice of meeting the proxy cannot vote For Corp’s that have more than 50 shareholders, management must send shareholders a “management proxy circular” and a form of proxy CBCA s.148, 149, 150 Form of proxy lists the matters to be voted on If a shareholder fails to indicate on the form of proxy how her shares should be voted the defaults is that the shares are voted in favour of managements proposals A management proxy circular must include the following categories of information: 1. A description of shareholders rights to appoint a proxy and the procedure 2. Transactions with insiders of the corporation, significant shareholders etc 3. Disclosure regarding principle shareholders holding more than 10% of the issued shares 4. Details about the directors who are proposed for election 5. Details about any special business to be dealt with at the meetings Note: in 2001 amendments to the CBCA permitted greater scope for shareholders to communicate without triggering these proxy circular requirements. Rules about proxies and proxy solicitation may be enforce in the same way as other shareholder rights: a shareholder may seek a court order directing that rules be followed, or may apply to a court to restrain the distribution of a proxy circular that contains untrue statements of material facts. Notices and proxies can be sent electronically with consent Proxy’s are often given to management so all votes are from within and that leads to total control by management
Shareholder Proposals Normally directors set meeting and s. 99 Allows shareholders to put issues on the agenda They may add items relating to the creation, amendment and repeal of by-laws and amendment of articles Any shareholder entitled to vote may submit a proposal of any matter they wish to discuss Proposals are not binding on the corporation if approved – they are more like advice to management Proposals may include nominations for the election of directors only if signed by the Shareholders of not less than 5% f the shares entitled to the vote To be eligible to submit a proposal a shareholder must: hold voting shares equal to at least 1% of the total of voting shares, OR shares worth at least $2000 at the close of business son the day before it is submitted AND have held the shares for at least 6 months prior to the date of submitting the proposal The corporation may require proof that these requirements are met
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5 grounds for refusing to circulate proposals: 1. The proposal not submitted at least 90 days before the anniversary date of the last annual meeting 2. If the proposal is for the purposes of enforcing a personal claim or redressing a personal grievance or does not relate to the business in any way 3. If the proposing shareholder made another proposal in the last 2 years and then failed to show at the meeting 4. If it was substantially the same proposal as one in the last 5 years and did not get support last time 5. If the right to make a proposal is being abused 6. If it was primarily for the purpose of promoting general economic, political racial religious or social causes
2001 CBCA Amendments establish new eligibility criteria for shareholder proposals. To be eligible to submit a proposal, a person: Must be a registered or beneficial owner of a prescribed number of shares of the corporation (currently set in the regulations at least 1% of the total number of voting shares of a corporation or the number of voting shares equal at least $2,000 of the fair market value of such shares). Whether this is a feasible threshold depends on the size of the company and its number of outstanding shares. Must have owned the shares for a prescribed period (currently set in the regulations at six months). Under CBCA Amendments (s. 137 (5) b.1) Corporations under may only reject proposal on the basis that the proposal does not relate in a significant way to the business or affairs of the corporation. This amendment may allow greater shareholder activism to get issues on to the floor of the meeting including those which had previously been cast out as being made on general, economic, political etc grounds, if they can be interpreted to relate in a significant way to the business or affairs of the corporation.
g. Conduct of Meetings / Quorum OBCA s. 97 rules regarding chairing a meeting Meetings are conducted by parliamentary rules unless bylaws provide otherwise At the meeting a shareholder can discuss any topic with respect to which she could have submitted a proposal OBCA s. 99(1)(b). Shareholders have a right to discuss items on the agenda which can be terminated if it is being abused Discussions at meetings are opportunities for shareholders to engage in management Meetings can be conducted electronically if bylaws allow The majority of shares entitled to vote, represented in person or in proxy at the meeting constitute a quorum unless the by-laws provide otherwise OBCA s. 101 By laws often state that 2 shareholders = a quorum h. Voting Voting is by majority s. 97(a) by show of hands or can be by ballot 103(1) Votes can be dealt with electronically or by telecommunication Different types of shares get different voting rights. Some shares have much more voting rights and some are called dual class shares.
Shareholder Access to Information The CBCA requires a corporation to provide shareholders with access info about the corp, including info about past meetings of SHs and financial records, to assist them in monitoring directors and officers and holding them accountable Every shareholder is entitled to one copy of the articles, by laws and unanimous shareholders agreements free of charge OBCA ss. 140,141, 145 Every shareholder is entitled to a list of shareholders, the shareholder registry ss.100,146 Additional rights to information include the right to requisition meetings and to ask questions and the right to have inspectors and auditors appointed s. 149(6) The corporation is also required to make certain limited disclosures to the public, which shareholders may take advantage of s. 154
43 Right to have investigation: Apply to court for an order to have an investigation of the corporation or any of its affiliates (where “appears” to have been fraud or oppression) 105 Shareholders have rights to public filings - Stuff filed with director of the act, stuff filed with securities acts
Differences in Theory and Practice Practice: do shareholders really have any say in major corporate decisions like the election of directors? Shareholders can put forward ideas in the circulars to be voted on. A vote does not really mean a vote- in Canada there is plurality voting, as opposed to majority voting. Under the present system when you go to a meeting shareholder can vote for a director or withhold their votes. Directors only need one vote to be elected. Withheld votes do not count. Canada wants companies to move to majority voting proceedings. This system would include withheld votes working against the running director. Under the previous CBCA provisions, a corporation may hold a shareholder meeting outside Canada if all the shareholders entitled to vote at the meeting agree. Under the amendments a corporation may hold a shareholder meeting outside of Canada without having to seek the consent of the shareholders entitled to vote at the meeting if the meeting is held at a place specified in the articles of incorporation, S. 132 (2). The CBCA Amendments allow shareholder meetings to be held by a means of a “telephonic, electronic or other communication facility” that permits all participants to communicate adequately with each other during the meeting if the corporation’s by-laws so provide, S.132(4). A person participating in a meeting by such means is deemed to be present under the Act. Unless the by-laws declare otherwise, a person participating electronically, can also vote electronically. Corporations whose shareholders are spread out across the world will definitely want to take advantage of these provisions by amending their by-laws. In addition, electronic delivery of relevant documentation, including proxy material by way of electronic means is now permitted, unless the by-laws provide otherwise and is in accordance with any relevant regulations, S. 252.4 Summary so far: there is significant difference between what is in theory and what is in practice.
Remedies available to shareholders for management misbehavior Dissolution s. 207 – shareholders can approve dissolution and can also apply to court for this Derivative action: right to bring action an behalf of the corporation, with permission of the court for breach of duties by directors s. 246 Right to seek relief from Oppression s. 248 – mother of all remedies Right to seek an order requiring Compliances. 253- if they find out something is not being done in correspondence with the articles they can use this to get the corporation to comply with provisions. Bernie Ebbers Situation.
DIRECTORS AND HOW THEY EXERCISE THEIR POWER
Director Qualifications A person is qualified to be a director if she is: S. 118,119 1. At least 18 2. 25% of the directors need to be Resident Canadians (resident Canadian is defined to include Canadian citizens ordinarily resident in Canada and a permanent resident within the meaning of the immigration act). 3. Must be of sound mind as far found by a court in Canada 4. Cannot be bankrupt 5. Must be an individual – a corporation CANNOT be a director
Directors need not hold shares Director ceases to hold office by becoming disqualified.
44 Election and appointment of Directors (s. 119,120,121,122) The first directors of a corporation are those listed in the initial registered articles At the first meeting of shareholders, and at east subsequent annual meeting at which an election is required, shareholders must elect directors. Election of directors is a simple majority vote Can elect for fixed term, but term cannot extend beyond 3rd annual meeting following the election [119(4)] But stay until replaced (even if extends past timelines) [119(7)]
Filing Vacancies on the board s. 124 A vacancy on the board may occur for a variety of reasons: a director may resign, be removed or become disqualified or die If a quorum remains in place, the remaining directors may fill the vacancy by appointing a new director for the unexpired term. If no quorum the vacancy cannot be filled s.124 NOTE: Articles may say otherwise. May require that vacancies be filled by shareholders. As long as quorum of directors still remain in office directors can appoint interim directors until next annual meeting. IF no quorum remaining: Directors MUST call a special meeting to elect a new board
Number of Directors s. 125 One restriction on the # of directors = if the corporation has made a distribution of its shares to the public and those shares remain outstanding and are held by more than one person, the corporation must have three directors, at least of who whom are not officers or employees of the corporation The number of directors must be specified in the articles of incorporation S. 125(4) If you have a range the shareholders can set the number within the range by a special resolution [125(3)] If you’re offering corp- have at least 3. But normally a corp on that scale will have a lot more.
Directors Meetings
Place s. 126(1)/ (2) OBCA, majority. must be in Canada Notice (s. 126(8), (9), (10)) a Bylaws must stipulate under CBCA = Default rule is 10 days of notice under OBCA : May be waived Quorum There must be quorum to conduct a meeting s. 126(3) – and may participate by telephone 126(13) Dissent by Director s. 135 If present at meeting deemed to assent unless dissent, one can request that the dissent be recorded in minutes, that written notice to Secretary at meeting or immediately afterwards if they choose to dissent, or send a dissent by registered mail or delivery it to the officer of the corporation immediately after the meeting is adjourned. If did not attend meeting – assent deemed within 7 days of finding out about a resolution s. 135(1). NOTE: This is an ironclad MANDATORY rule. They are trying to avoid people on the board from saying that they are not responsible for the decisions made because they were not at the meeting like was done by Bernie Ebbers of World Com. (The unethical out is to say you did not know that there was such a resolution). Signed Resolutions are permitted and will be effective wen last director approves s. 129
OFFICERS Very little in Corporate statute that deals with officers Nothing in the CBCA that addresses what duties officers of a corporation should have. 45 Most corporations have officers called “president” and “secretary” “CEO” and “CFO”, “vp” & “Treasurer”. As a matter of practice these people have the most power- they manage the day to day business of the company and their power to do so is delegated by the directors. They are appointed by the directors OBCA s.133
Definition = In 2001 CBCA has introduced a definition of officer: “Officer means an individual appointed as an officer under s. 121, the chairperson of the board of directors, the president, a vice president, the secretary, the treasurer, the comptroller, the general counsel, the general manager, a managing director of a corporation, or any other individual who preforms functions for a corporation similar to those normally preformed by an individual occupying any of those offices… (CBCA s. 2(1))
This definition clarifies that officers are hold certain titles or preforming certain functions. All who fit this definition will be subject to the duties imposed on officers (note this is different from employees who do not have fiduciary duties like directors and officers do). OBCA has a similar definition of officer – OBCA s. 1.1 Directors can be officers but do not need to be A person may hold two or more offices The legal relationship created by appointing a person as an officer is distinct from any employment relationship that the person may have. The distinction is important at termination – an officer can always be removed whereas, an officers employment contract, by contrast, ay be terminated only with just cause and reasonable notice.
Delegation Directors have plenary authority, officers only have authority to the extent that it has been delegated to them by the Directors s. 127(3) Usually offices set out in by-law officers are there, names are there and directors appoint people to fill those officers and delegate responsibilities to described in by laws Directors can delegate all of their power to officers subject to two limitations: 1. they cannot delegate the power and responsibility to SUPERVISE the management of the business and affairs of the corporation. 2. They cannot delegate the specific powers listed in s. 115(3) of the CBCA and s. 127(3) of the OBCA relating to decisions regarding shares, including the power to issue shares, declare dividends on shares and to purchase or redeem shares.
Delegation outside the Corporation – Cannot lose all control To what extent can a corporation delegate to third parties like management companies? This is not dealt with in the legislation but it is permitted
RULE: You CAN delegate to third parties BUT when you delegate outside, can’t do it in such a way that completely sterilizes the board must have “capacity and tools to supervise”
Kennerson v Burbank Amusement – case of delegation limits being exceeded Board delegated all control over the only asset it was responsible for managing- a theater. It attempted to transfer control over booking, personnel, admission prices, salaries etc… to Kennerson with the only condition of having to occasionally report to the board. Rule: The power of the directors had been completely sterilized and so the delegation was found to be non enforceable because you CANNOT completely sterilize the power of the officers.
46 Remuneration and Indemnification of Directors and Officers
Director Remuneration Amount Set by Directors s. 137 - typically delegated re: officers and employees Conflict of Interest re: directors own remuneration is addressed s. 132(5)(a)), but increasing chance, courts may find excessive salaries oppressive to the shareholders. The statute says that there is no conflict of interest with this.
Radtke Decision the court held that where a director had decided upon his salary unilaterally he had an obligation to ensure that his salary was fair Policy re: Remuneration Issues associated with the conflict faced by directors setting their own pay depend on the scale of the corporation. The smaller the corporation the more implications, the more difficult it can be.As the scale of the corporation increases the shareholders are more greatly affected by salary choices. The payment of large salaries to directors diminishes the residual claim to the corporations assets represented by the shareholders shares.
Director Indemnification Indemnification against liabilities incurred for directors and officers– Need to balance - encouraging competent people to become directors and officers with imposing liability where directors and officers involved in improper conduct The indemnification scheme in OBCA s. 136 and CBCA s. 124. The scheme allows for Indemnity for costs or expenses reasonably incurred in respect of civil, criminal investigative or administrative action to which made party because is or was director or officer
Mandatory Indemnity: A corporation MUST indemnify Directors and Officers for any costs or expenses reasonably incurred in connection with defence of any action in which he was involved because of his association with the corporation or other related entity if the individual:
fault or did not omitted to do anything that the individual ought to have done 136 (4.2)(a) 2. Complied with fiduciary duty 136(2) 3. In civil, criminal or administrative proceedings had reasonable grounds to believe that his or herconduct was lawful Benett
Discretionary Indemnity: a corporation MAY still indemnify the individual for the same costs and expenses as they see fit even where a director or officer has not met #1 above.
The scheme seeks a balance to permit protection for responsible officers and directors and the encouragement of becoming directors, but also to deny indemnification in circumstances where directors are engaged in improper conduct. For these to apply the directors and officers CANNOT have committed illegal acts and CANNOT have acted in breach of fiduciary duties This shows that statutes are piling on indemnity protections for directors and officers.
Note: The CBCA 2001 Amendments have also broadened the scope of the CBCA s. 124 indemnification provisions to get rid of certain ambiguities. For example, the amendments expressly permit corporations to indemnify Directors and Officers past and present or other individuals who, at the corporation’s request acted in a similar capacity for another entity, for any civil, criminal, administrative, investigative or other proceeding. The amendments now make it clear that the indemnification can be extended to investigative proceedings and to persons acting at the corporations request as a Director or officer for a corporation in partnership with the indemnifying corporations or other type of entity, such as a partnership or trust. The amendment also permits corporations to advance defense costs. N.B. 2007 OBCA AMENDMENTS HAS FOLLOWED SUIT.
47 Consolidated Enfield Corp v Blair Facts: SCC addresses availability of indemnity in this case. Blair was the president and a director of Consolidated Enfield Corporation. At the annual meeting, a group of nominees stood for election, including Blair. CDN Express Ltd., a major shareholder, nominated a candidate to replace Blair as director. On the basis of the votes that candidate would have been elected but Blair, before the meeting, had been advised by legal counsel that CDN’s votes against him were invalid and that he as chair had to make a ruling about the results of the vote. Blair made moves to ensure his election. In a later legal proceeding the court held that CDN’s vote HAD been valid and so Blair was not re-elected. Blair sought that he be indemnified for his legal costs in connection with the proceedings. Held: He was granted indemnification Rule: Where a person has relied on legal advice in good faith the court will likely conclude that the director complied with their fiduciary duty thus creating a space for consideration of indemnification.
Indemnification agreements- where on assigning the appointment of an officer there is also an agreement that is signed if that person is involved in litigation. Increasingly, companies are trying to get out of these by claiming that there was a conflict of interest
Catalyst Fund General Partner v Hollinger A partner was denied indemnification for costs incurred in defending an action to remove him. The court determined that he was subject to a number of conflicts of interest and therefore was not upholding his fiduciary duties In this case the conflict was so bad, they also got kicked out of the board. Here Conrad black decided to give over 1 million dollars as a loan to a company he controlled. He managed to do that because 3 directors approved it, one of which was his wife. When they were sued by an institutional shareholder by court said that the loan was in conflict, not allowed and he was kicked off the board.
Note: Some courts are less draconian in terms of insisting on purity of directors seeking indemnification:
Bennett v Bennett Environmental Inc Facts: Announced K publicly, dispute btw him and gov about how big K was, didn’t disclose dispute, when it was resolved he announced it and share price fell. OSC said you should have disclosed dispute, shouldn’t have waited until it was resoled. B said he thought he would win. Entered into settlement w/ OSC, agreed to pay fine and agree that it was material fact he should have disclosed. Issue: Did B have reasonable grounds to believe that he did not have an obligation to disclose that there was a dispute thus making his conduct lawful? Rule: Where there is an honest belief and good faith one has fulfilled his fiduciary duty and conduct is lawful Held: The court allowed for indemnification.
Cytrnbaum v Look Communications Facts: Following a successful proxy contest at its parent corporation, Look Communications Inc. (Look) sued a number of its former directors and officers for alleged self-dealing related to the sale of Look’s key assets in 2009. The former directors and officers in question (the Applicants) brought an application for a declaration that Look was required to advance their legal costs pursuant to Look’s by-laws and indemnification agreements. Stole 20 Mil in assets of the corporation itself. Rule: it must consider whether the requirements for indemnification were met, and in particular consider whether the presumption of good faith had been rebutted. You have to come to court on the presumption that the directors acted in good faith. Held: In this case, because the corporation had established a strong prima facie case that the directors and officers acted in bad faith, the Court denied advancement of indemnity under section 124(4) of the Canada Business Corporations Act, R.S.C. 1985, c. C44, (CBCA).
48 Directors and Officers Insurance This insurance covers anything indemnification does not. Directors can vote for coverage of such insurance protection (132(5)(b) – whenever directors meet and they are deciding an issue of self interest they should not vote in that meeting with the exception of insurance where they are allowed to vote. Conflict of Interest - addressed 132(5)(b)) Policy issue: if you do both indemnification and insurance are you protecting directors too much? Insurance for benefit of director or officer may be obtained against any liability in capacity as director or officer so long as fiduciary duties met There is concern that indemnification and insurance can undermine regulatory goals unless courts can forbid indemnification and imposing personal liability to promote compliance
R. v. Bata Industries case courts will be reluctant to give directors too much protection but on appeal it was decided that there is no limit to the amount of indemnification + insurance to be had.
SHAREHOLDER AGREEMENTS- MANAGEMENT AND CONTROL OF CORPORATIONS Under the CBCA shareholders are expressly permitted to contract regarding how they will vote. Shareholders may even assume the powers of the directors. Prior OBCA, CBCA provisions: cannot bind how will vote as directors Ringuet v. Bergeron BUT CBCA, OBCA Amendments indicate Shareholders in a USA can bind themselves, s.146 (5) CBCA, s. 108 (5.1) OBCA General preference for keeping the share structure simple because there is a cost of drafting specialized share provisions, because shareholders are often reluctant to have their agreements to become a matter of public record and because shares with customized provisions are more difficult to sell. One limitation is that shareholders may not be contract-requiring directors to vote in a certain way. Directors have fiduciary duties and their decision making discretion cannot be restricted so as to prevent them from being able to fulfill their fiduciary duties. This applies even when directors and shareholders are the same person. This constraint does NOT apply to USA’s involving CBCA corporations. Where shareholders have taken directors powers under a USA, they can bind their discretion as to how they exercise them
Share Transfer Problems with share transfer is value is tied to individuals who are shareholders Valuation becomes difficult, especially where there is no market Freedom to sell versus control over who become shareholders Certain provisions have to go in to shareholders agreements in order to account for share transfer. ADR clauses can be included in shareholder agreements
Unanimous shareholder agreement CBCA permits decision making power to be transferred from the directors to the shareholders though a Unanimous Shareholder Agreement s. 146 A USA under the CBCA MAY restrict “in whole or in part the powers of the directors to manage or supervise the management of the business and affairs of the corporation” A shareholder who is party to such an agreement has “all the rights, powers, duties and liabilities of a director whether they arise under the act or otherwise” note: In Alberta all shareholder agreements are USA’s In an effort to avoid uncertainty, shareholders’ agreements frequently contain a provision that says whether or not it is intended to be a USA.
Final issues on Corporate Governance
Corporate governance- what do shareholders really value? - http://www.youtube.com/watch?v=s5Eoy988728
49 Shareholder value thinking which possesses the business world today is causing corporate melt downs like BP Oil. They want to get their share price up a.s.a.p., and in the quest to raise share price companies are doing what BP did and make other poor decisions, they reduce expenditures on research and development. In the quest to raise share price companies are manipulating the law itself. Focus on share price is preventing corporation from doing their best for investors as a class over time Corporations are independent legal entities –they are not owned by shareholders Shares are contracts between shareholder and corporation that gives shareholder limited rights We think that shareholders should get all the money left over after the directors etc are paid. Problem is that the way we understand shares is not accurate. Shareholders are not owners of firms. They enter contracts with firms In reality, shareholders do not get a penny unless directors decide to declare a dividend- they have to wait to get profits from the company if the directors want there to be. Pressure on directors to maximize shareholder value has no basis in law- directors do not owe duties to shareholders. These notions are all dicta. In US and Australia, judges don’t make directors maximize shareholder value. As long as directors are not lining their own pockets, it’s up to the board to decide what the corporation ought to do and this is reflected in corporate charters themselves. Despite the fact that we are telling directors to maximize shareholder value- it does not seem to be helping and in fact it may be hurting.There is a lack of evidence that corporations that are run in accordance with maximizing shareholder value are actually helping the shareholders. Sometimes dual capitalization leads to them outdoing firms that have the “one share one vote” model By looking at performance of independent companies we are looking at the wrong thing. By embracing the ideology of shareholder value and encouraging corporate directors to raise share price we are making it harder for the corporate sector to produce long-term returns for investors. Fishing with dynamite example Our theory of what makes business work does not seem to be working. Shareholder value is going wrong because we don’t understand what shareholders are – shareholders in her opinion are a fiction. Shareholders are people, with interest in quantus stock, tomorrow and ten years from now. We are not just interested in short-term rise in share price, they are also interested in long term relationship with the labour force.
Shares
Three Principles that guide shares: 1. Creditor should always be put first 2. Equal treatment for each class of shares 3. Otherwise, the Acts do not really care how corporations share.
Terminology
1. Shares: a bundle of right against a company. Although a share is personal property, the claim it represents in the corporation is neither a property right in the corporations assets not is a proportionate ownership interest in the corporation itself.
2. Debt: You pay off your debts first to the creditor on the dissolution of a corporation. Debt obligation is an obligation in contract to pay back money.
3. Equity: contractual interest in a company that is acquired through articles of incorporation and rooted in the statutes of business Corporations.
50 Priority structure on dissolution: a. First a corporation has to pay off the secured creditors (Secured Bank Loans), b. Then you can pay off the equity c. When there is a residual left over only AFTER paying off the creditors – the preferred shares get paid out first AND d. Then the residual is paid out to the common share holders
4. Preferred Shares: class or series of shares that has a first right or some preferred right to access, or receive access to the residual value over another class of shares.
5. Common shares: class that is entitled to the residual value of the assets
6. Class: Type of shares
7. Series: Subsection of class
8. Dividends: payment of profit
9. Liquidation rights: right of a shareholder to receive some portion of the residual value of the assets of the company after paying off debt to the creditors.
10. Redemption/ retraction: mechanic by which the company buys back your shares from you to make sure that someone is getting return
11. Stated Capital: notional account that the statute uses for the purposes of limiting the situations in which companies can pay dividends and buy back their stock. This notional account that tracks or calculate the collective value of consideration that a company received in respect of a class of specific shares. Different stated Capital for each class of shares.
CREATION OR AUTHORIZATION All references here are CBCA
Class – Incorporator or Shareholders If you are creating a class of shares include a description of that bundle in your articles s.6.1 and then you can always amend the articles of incorporation to amend the share structure s.173(1) The incorporator defines the initial share capital. Once you have the corporation in place and have organized its initial share capital you need shareholder approval if you are going to change the structure. Shareholders almost always have to be involve in creating new bundles of rights Exception- Directors can create series s.27(1). Shareholders can pre-authorize the board to create series of the same class of shares and then shareholder approval is not needed. You have to tell the world how the shareholders agreed to deal with the shares- there is a filing requirement in place in order to put this on record.
The basic rights associated with shares s. 24(3) a. To vote at any meeting b. To receive dividends declared by the board of directors c. Receiving of residual value on liquidation
51 Distinction between Classes and Series of Shares: 27(3) you can make a bunch of distinctions about series of the same class in terms of voting, and dividends etc. BUT YOU CANNOT say in the articles that series “A” will have a priority over series B with respect to dividends or liquidation preference All shares of the same class must have the same priority in relation to receiving dividends and return of capital even if they are in different series within the same class. Bundle of rights, by common law, run with those shares themselves. In other words, the rights stay with the share not with the shareholder. The idea is to allow the shares to retain their characteristics even when they are transferred or sold. If share rights seem to run with the individual rather then the share then it is not an enforceable condition of a right. Rights run with the shares, not the shareholders.
Issuance of Shares Shareholders generally approve the creation and authorization with one exception (series) Boards of directors issue the shares 3 types of consideration that a board can issue shares for: Money, property or past services S. 25(3) There is NO rule that says that the board must issue the shares for their fair market value. They just have to be in one of the 3 aforementioned forms of consideration. If the board can fund a business reason for it the board can issue shares for less then share market value. In doing so the board MAY be exposing itself to a breach of fiduciary duty. You must issue fully paid and non assessable shares – you cannot promise to pay later for shares that your receive today. Only fully paid shares can be issued (s. 25(2)).
Dividends Boards right ad obligation to declare dividends. First the dividend must be declared. To do that the board passes a resolution to declare a dividend. Then, the board pays the dividends (S.42) First principle is creditors first. So what is the mechanism that the statute uses with respect to dividends and buying back stock? It uses a solvency test** A corporation MUST past the Solvency test to award dividends.
SOLVENCY TESTS – HARD TEST S. 42
2 elements of the solvency test 1. Going concern test- the company has to be in a position after paying the dividend to continue paying its liabilities as it comes due- paying the dividend cannot interrupt the regular operations of the business. You can’t declare a dividend or buy back stock without satisfying this test. This is a current test for accounting purposes.
2. Balance sheet test – in every solvency test after declaring the dividend or buying back stock, your assets have to be greater then your liabilities. You cannot bankrupt yourself by taking the corporate action. It is under the balance sheet test where the board would have to look at the hard and easy parts of the test.
NOTE: Hard test always applies to Dividends. The key fact is where the rights to purchase are located- in the articles within the share terms themselves or outside and negotiated ad hoc. If within it’s the easy test if its contractual and beyond then it’s the hard test.
NOTE: the difference between the hard and easy solvency test is that certain solvency tests add “plus the stated capital of your assets”. After declaring a dividend your assets have to be greater than not only your liabilities but also your stated capital of all of your classes of shares. Assets must be greater then liabilities plus stated capital.
NOTE: in easy test: the assets must be greater then liabilities plus the liquidation preference shares.
52
Hard solvency test applies to: Dividends (s.42) and it applies to a contractual right (one that isn’t mandates by the articles themselves) to purchase shares between a shareholder and the company (s.34(1)).
Easy solvency test applied to: S. 36 where the share provisions are written and greed to within the articles of incorporation.
Redemption/Retraction/Purchase the board makes a decision to buy back or redeem shares 34, 35, 36, sections that deal with times that a company wants to buy back shares from its shareholders. The key distinction between these sections is the difference between what section 34 is and what 36 is. The difference is where the sections say the shareholder get their rights to their shares. If there is a preexisting negotiated redemption rights negotiated into the articles then section 36 applies, if the pre- negotiated right is in a contract then section 34 applies. It is slightly easier for a company to meet a solvency test where section 36 applies- where the rights are in the articles of incorporation.
In practice, share terms focus on three things: CONTROL (voting, director rights) LIQUIDITY (DIVIDENDS, PAYMENTS ON LIQUIDATION, REDEMPTION) EXCHANGE (RIGHT TO CONVERT BETWEEN CLASSES OF SHARES)
Managing these interests as between common and preferred rights
Duties and Liabilities of Directors and Officers
Directors and officers are subject to a fiduciary duty to act honestly and in good faith with a view to the best interests of the corporation” as well as a duty of care to “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances”.
1. Fiduciary Duty - to act “honestly and in good faith with a view to the best interests of the corporation” OBCA s.134(1)a.
2. Duty of Care - to “exercise the care diligence and skill that a reasonably prudent person would exercise in comparable circumstances” OBCA s. 134(1)b. (debate over whether this is objective or subjective standard)
3. Oppression Remedy - creates substantive standard of behaviour as well as process for shareholders to obtain reliefOBCA s. 248
FIDUCIARY DUTY
Duty to act “honestly and in good faith with a view to the best interests of the corporation” s.134(1)a.
General standard of behaviour imposed on directors and officers in relation to their dealings with and on behalf of the corporation Includes a duty to act honestly Requires directors and officers not put their personal interests ahead of the interests of the corporation In most cases in which there is a breach of fiduciary duty the fiduciary has made some profit or received some advantage at the expense of the corporation This duty is owed to the corporation but is not directly enforceable by shareholders 53 “Best interest” of the Corporation The fiduciary duty is owed to the corporation rather then to the shareholders It is also not enforceable directly by the shareholders although there is a movement towards giving them more power to enforce the duty when the corporation does not
BCE Inc. v 1976 Debenture Holders RULE: 1) Corporation may take interests of stakeholders into account to figure out best interest of corporation Best interests defined as “good corporate citizen” but must resolve in the best interest of the corporation. 2) While the interests of shareholders and other stakeholders often will be coextensive with the interests of the corporation, where they conflict, the duty is to the corporation. 3) Business Judgment Rule: Courts reviewing actions of fiduciaries should defer to their business judgment., if it is a matter of business judgment before them.
NOTE: Here we are moving towards a system where they look at the whole group of stakeholders but cannot promote the interests of one group of stakeholders or shareholders over others. Held: The court held that the specific content of the duty would depend on the situation Fiduciary cannot put his or her interests ahead of the interests of the corporation – this can be coextensive with other interests of shareholders and stakeholders but the duty to the corporation itself comes first. Remedy: fiduciary must account for profits made in breach of duty - eliminates incentive to breach the duty in the first place. This can be enforced at the insistence of shareholders through derivative actions – on behalf of the company.
Fiduciary Duty / Breach of Best interests may arises in 3 Scenarios 1. Transacting with the corporation / self dealing director and officer contracting in personal capacity with corporation they are director of. 2. Taking corporate opportunities for oneself high level management—make decision about what opportunities that corporations should pursue 3. Competing with the corporation conflict of interest 4. Takeover bids
1. Transacting with the Corporation at common law Transacting with ones own corporation can lead to conflict of interest and then to a breach of ones fiduciary duties. Ex: A person is seeking to sell goods to a corporation of which she is a director. As director she wants to pay the lowest price possible. As the seller she is looking to make money. Immediate conflict leading to difficulty of maintaining fiduciary duty
Rule: fiduciary not allowed to enter transactions in which he or she has or can have a personal interest conflicting or which possibly may conflict with the interests of those he or she is bound to protect. Contracts involving conflicts of interests are voidable, regardless of whether good or bad K. Aberdeen Railway v Blaikie Bros. Important to recognize that fid duty includes any sort of scenario where there’s a possibility of conflict
Rule: Doesn’t matter if interest is direct and beneficial or indirect and as a trustee, these transactions where a director sells or transacts with his or her own corporation are voidable. Transvall
These absolute rules were adopted because courts do not want to decide when the conflict is so serious that it should be prohibited and because courts do not want fiduciaries to have to decide when he or she is in a sufficiently serious conflict and should not participate in a transaction.
54 Note: This absolute rule was TOO STRICT and it was found that some transactions with fiduciaries were desirable. This led to statutory reform.
OBCA S. 132 - Statutory Test - when director / officer CAN transact with their own corporation Scheme to save transactions between fiduciary and their own corporation
132(1) A director or officer of a corporation who: (a) is a party to a material contract or transaction or proposed material contract or transaction with the corporation; or
(b) is a director or an officer of, or has a material interest in, any person who is a party to a material contract or transaction or proposed material contract or transaction with the corporation, shall disclose in writing to the corporation or request to have entered in the minutes of meetings of directors the nature and extent of his or her interest.
Only applies in relation to “material contract or transaction” with corporation where fiduciary either: • The other party OR • Is the Director or officer or acting as such in a corp. which is a party to such a contract or transaction or • Has a material interest in the other party
The transaction is saved and NOT voidable and there will be NO accounting of profits IF: A. there is notice to the corporation of the nature and extent of the interest (the notice can be general) B. There is approval by the directors of the transaction going through C. The transaction is fair and reasonable. (S. 123(7))
Alternative transaction Saving Provision - s. 132(8) Transaction not voidable if Transaction fair and reasonable 132(7) Approval by directors not in conflict 132(5) Fiduciary acting honestly and in good faith 132(8) Interest disclosed to shareholders 132(7) Transaction approved by special resolution (2/3) of shareholders – much more difficult to achieve here – and Fiduciary not liable to account for profits if same requirements met 132(8)
Note: There is no definition of a material contract or transaction Note: Overall: if you don’t comply strictly w/ statute, go to common law. Common law says no conflict allowed- if any conflict, voidable
Case law seems to be expanding the definitions quite broadly. Note relatively recent case law that seems to suggest that the threshold of materiality depends more on what is likely to affect a fiduciary’s ability to act in the best interests of the company than a financial interest.
Zysko v. Thorarin Material interest need not just be a financial interest to allow for self dealing but anything more than a de mininimus interest may allow a person to justify self dealing if the directors approve it
Exide Canada v. Hilts Implies that personal relationships could trigger the material interest in another party that would lead to an ability of a fiduciary to do self-dealing.
55 Rooney v. Cree Lake – Resources Corp decision on pg. 351 which focuses on what is fair and reasonable and therefore allows self dealing to occur. Both the substance and process by which the insider dealing takes place will be examined. So the termination of a management contract that would require compensation of more than 50 % of the corporation’s asset would not be regarded as fair . – Other courts have held that if an insider is a party to the negotiation of the contract and done in undue haste would also not be regarded as fair and reasonable.
If Statutory Requirements not met, it’s a breach of Fiduciary Duty, and 132(9) Shareholder remedy: may apply to court to set aside K and/or get accounting for profits So no need for Derivative Action
You cannot avoid this section by writing it into your corporate by laws. s. 134(3) Note provisions re timing of disclosure pg. 348 & S. 132 (2), (3) for dirs & officers and extent of details required for disclosure. Although no precise provision, the detail must be sufficient for corporation to know costs, profits and in my view what economists call opportunity costs, e.g. what is the corporation missing in terms of other possible contract terms with other possible suppliers or terms of compensation deals with senior officials see
Repap Case Facts: Steven berg was a NY lawyer. REPAP was a failing paper company. This guy was the largest individual shareholder and he teamed up with the largest institutional shareholder to try to push through a compensation package for himself. He tried to call himself CEO, requested a base salary of 420 000, a 5 year renewal term, a signing bonus of 25 million shares and a pension bonus of 8 years and also a great termination benefit. This amounted to a 25 million dollar package. He tried to press the other CEO and president to submit the package to an independent consultant. The consultant was not given enough time to find out it was a failing company. She was also not told that the last board rejected the package. The first board which did not approve it resigned in horror. They were replaced by a second board which were cronies of this guy and did not know that the first board rejected this. The second board had 5 minutes to make a decision and fund in this guys favour. Once the shareholders heard about this they tried to kick him out of the company. New Board kicked him out of the company. Rule: If you are going to argue the business judgment defence (which they tried to do here) you have to have exercised your business judgment. Rule: To fulfill duties as a director need to take steps to prevent action by a company that is oppressive and refraining from voting or resigning is not enough. Rule: To uphold the standard of care a director must also make informed and reasoned decision. Rule: PROCESS followed by the board was inadequate. Failed to discharge duty of care by not upholding the requisite standard. Held: He breached his general fiduciary duty to act in good faith of the company. Did not uphold the standard of care. Excessive compensation can lead to a breach of fiduciary duty where the Director (in this case also the Chairman and largest individual shareholder) inappropriately oversees his own contract, by not making sure the corporation received independent legal representation in negotiating its terms and by requesting “types and amounts of compensation that he knew or ought to have known were not in the best interests of Repap, a company which he believed was on the brink of bankruptcy.” Note: should have had independent legal consultation, there should have been time for the board to make appropriate decisions. This is all true especially in the face of the business judgment defence where the directors said who is the court to step on the business judgment decisions.
2. Taking corporate opportunities What is at the core of the this category is where a fiduciary tries to take the opportunities that should only belong to the corporation Where there is some impediment to the corporation obtaining an opportunity, the courts have held that it is nevertheless can belong to the corporation with the result that the fiduciaries cannot exploit it themselves. Greatest issue is determining when the opportunity belongs to the corporation. 56 Cook v. Deeks Rule: If corporation is actively seeking an opportunity - belongs to corporation Where a corp is negotiating for an opportunity and has a reasonable prospect of getting it, there is no question that the corp has strong interest in the opportunity and a fiduciary is prohibited from exploiting it for her own benefit.
Regal v Gulliver Facts: They acquired the knowledge for acquiring the opportunity in their position as a director. Rule: It is irrelevant that there is impediment-preventing corporation from taking advantage of opportunity – the Directors still cannot take the corporate opportunity that should only belong to the corporation. Rule: This case also stood for the proposition that if you acquire the opportunity in your capacity as a director you cannot take the opportunity even if the director thinking that what they did was in the best interest of the corporations Note: This decision is nuts because the company itself could not take the opportunity anyways so then why punish the directors for taking it? The company could have borrowed the money so that there would be no hint of personal interest in the whole thing.
Peso Silver Mines v Cropper Rule: Interest of the opportunity ceases when the opportunity is rejected. According to this case once the corporation rejected the opportunity it became open for the taking. If they are still considering it, it still belongs to the corporation - (Peso)
Canaero – land mark case Facts: Canero was in the business of mapping. O’Malley, the president and the Vp were assigned to Guyana and were asked to contract to map the country. After working on the project for some time they resigned and incorporated Terra- another company. Subsequently the government of Guyana asked for bids to map the country and terra proposal was accepted over Canaero’s. Canaero sued the P and VP alleging that they had breached their fiduciary duty to the corporation by taking the benefit of a corporation Rule:
Test for whether Appropriation of an Opportunity is a Breach of Fiduciary Duty Canaero
Rule: To determine if appropriation is a breach of fiduciary duty ask: 1. How closely is the opportunity connected to the corporation? a. How mature was the opportunity? b. How specific was the opportunity? c. how significant was project to the company? d. Was the contract public or private?
2. What is the relationship of the Fiduciary to the Opportunity? Factors: a. What is the position of the fiduciary? b. What is the connection between the fiduciaries responsibilities and the opportunity c. Knowledge acquired as a fiduciary d. Use of fiduciary’s position e. If fiduciary terminated - how long ago and in what circumstances f. Is the fiduciary full time or part time? g. What is the scale of the corporation
57 Note: 2 facts that annoy business people – it was not a specific contract; it was similar but not identical. 2- it was part of a bidding process so the old company could have won it but they didn’t. Policy: what is to stop directors from going into this company and learning all about it, ditching the company, starting another on their own and stealing the contract out from under their original company.
3. Fiduciary duty not to compete with a company
General Rule: Fiduciaries cannot compete directly or indirectly with their company if they do it is a breach of fiduciary duty
Can quit and compete -BUT cannot use fiduciary position and opportunities it affords to develop the opportunity THEN quit to take the opportunity Canaero. It would be contrary to competition law to say that they can never quit and compete. After quitting- cannot use confidential information or solicit customers of old company. BUT you can use skills experience and personal goodwill to compete There is no absolute requirement against directorship in two competing companies the question in Canada is whether the director can act in the best interests of both companies – if they can they can act for both Abbey Glen
4. Fiduciary Duties and Take Over Bid Transactions In a takeover a bidder will go to the shareholders to push out the directors should defensive measures where directors try to stop the takeover be allowed?
Things Directors can do to defend against a Bid 1. Directors issue a lot of shares to someone they know won’t tender into the bid (sometimes called a “white knight”) 2. Could sell off assets so that they’re not available. Selling “crown jewels” of the corp. Sometimes complex arrangements to get them back in some circumstances. 3. Most common: Poison Pill. Also called a shareholders rights plan. Amendment to articles introduced providing that if takeover bid made. (reduced price option not available to bidder). So what is happening is that you’re creating prospect that a whole bunch of new shares will be issued, and bidder will have to buy not only shares already issued, but all these new shares. So cost is substantially increased. a. Always a right of directors to waive the pill. b. Often, idea is that threat that pill could be used gives directors ability to negotiate, or more time to go find other bidders.
Views on whether defensive measures against takeover bids should be allowed:
Free Market View No. Directors should not be allowed Fiduciary issues: The directors acting in self-interest to save their own jobs If these types of “poison pills” are allowed to take place, market cannot manage corporate management. Prohibition of Free Market is consistent with common law as we have discussed o Consistent w/Aberdeen Railway o Courts are unwilling to intervene with business decisions. o They do not want to get into certain conflicts. Free market theory in the US is often ignored o Microsoft trying to take over Yahoo at huge premium.
58 View in favour of defensive measures by directors against takeover bids Directors ought to be able to defend against takeovers in some circumstances Think, if defensive measures are in the best interest of the corporation Teck Corp This is becoming more and more common in Canada Example: o Hedge funds go around the world looking for companies to takeover o Goal is to make quick profit through asset stripping. In some situations there might be a duty to stop the takeover Olympia But as per Peoples, sometimes a director can have the best interest of the corp in mind in trying to stop the takeover, but simultaneously director might have a self-interest that is benefitted on an ancillary basis. In Producer’s Pipeline Court said directors should be able to act as long as: o in bona fide what they believe to be best interests of shareholders; o what they’re doing is proportionate to the threat; o they have obtained prior shareholder approval; o that shareholder choice is not pre-empted (shareholders ultimately get to decide whether to sell) None of this provides clear guidelines
Pente Investments Management Rule: Focused on Process that was followed. Court asks if: 1) Board has acted reasonably and in good faith (not perfectly) 2) Board made informed judgement and took reasonable steps to avoid acute conflict of interest If so will defer to business judgement (business judgment rule) of board regarding what did in response to bid
To move towards acknowledging the defensive measures of directors against takeover bids reasonable efforts to avoid conflicts of interest should be taken. Courts do not want to get into second guessing business decisions but business needs to show they were reasonable.
Other Breaches of Fiduciary Duty Fiduciary duties are always emerging EX: the Repap case where the director can set their own wage by law (s132(5)) – but duties will still arise Also – favouring majority shareholders over minority. Frank Stronarch
DEFENSE: Being Able to Use Reliance as a defence Corporate law typically allows directors to be absolved of a breach of FD if they have properly relied on financial statements or reports of a person whose profession lends credibility to a statement made by the person. OBCA – can rely on the information and advice from EMPLOYEES CBCA - is more restrictive: must be SOMEONE WHO IS A PROFESSIONAL
CBCA 123(4)limited defence for breach of FD if relying on others in good faith that Financial statements of corp represented to him by an officer or in a written report by corp auditor to reflect fairly on the finances of the corporation Report of a person whose profession lends creditability to a statement made by the person 373 o Defence is limited to only these situations 373 o You still need to use judgment on whether or not to rely on the report.
Shareholder Ratification of Breach At common law cured fiduciary breach – shareholders could absolve fiduciaries of the consequences of a breach of fiduciary duty by voting to approve to ratify it. Under OBCA and CBCA this has NO EFFECT EXCEPT: 1) In accordance w/ 132(8)- Transactions with the corporation 59 2) Taken into account by court for the purposes of deciding: o To order dissolution of the corporation [207] o If an action is oppressive [248] o To grant permission to commence derivative action [249]
DUTY OF CARE Must use the “care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances” 134(1)(b)
1. Reasonably Prudent person (objective) BCE 2. Comparable Circumstances (subjective) [Take into account: experience of person, position they hold on board, kind of expertise they have (lawyer, accountant, etc)]
RE City Equitable Fire Insurance Co. Ltd (1925) o There is a certain level of incompetence that will breach the duty of care o Sets the common law standard very low
SCC – confirmed that the duty is not an obligation owed exclusively to the corporation, it represents a standard of behaviour to be observed in relation to creditors and other stakeholders as well Peoples Department store. Expands the tort notion of to whom the duty is owed.
In 2007 OBCA amended o Now despite the BCE case, the duty of care is only owed to the corporation in Ontario. o NOTE: the CBCA fiduciary duty still owed to many stakeholders
STANDARD OF CARE Subjective standard - Standard of care is highly dependent on the facts. Requirements: o Cannot set duty lower than statutory standard o Cannot be delegated Fraser o Minimum standard of competence Francis
To uphold the standard of care a director: Must attend meetings S135 Is enetitled to have a limited reliance on others S. 135 (4) – in Repap context (business judgment rule) Cannot set the duty lower that the statutory standard S. 134 (3) CANNOT delegate the standard Must maintain a minimum standard of competence or resign, especially when on key committees o A director must keep himself informed about the business and affairs (does not require a detailed inspection of the day to day). o Must maintain some general familiarity with the financial status of the corporation through review of financial statements. To maintain the standard the director must be informed and act if there is a problem disclosed
Francis v United Jersey Bank Rule: Every director owes a minimum standard of competence. Can’t be a “dummy” director.
60 Fraser v MNR Rule: Delegation of duties does not affect or lessen the required standard of care. Despite delegation of responsibilities, F still has the obligation to meet a minimum standard of care in relation to that aspect of the corporation’s business. Should have called directors meeting, ensured there was a discussion, solution designed, instituted monitoring.
Q: If accused of Breach of the standard of Care what does an innocent director have to do? A: Initiate Lawsuit- Derivative action- s. 246- in extreme circumstances where problem clearly identifiable. Get independent legal advice • Business judgment urle would likely apply in this case • If alleged breach relates to a business issue, courts unlikely to second guess where in good faith and based on reasonable grounds o Was what did within the range of reasonably available alternatives? • Court Will look at process – was decision made with o Adequate information and consideration o Advice of professionals (REPAP)
Peoples v Wise Single transaction can trigger duty of care and breach of fiduciary duty. Facts: Companies trying to merge. Their assets are a mess. So one company would only buy inventory from North America, the rest would buy from the rest of the world. Ultimately, one of the companies went bankrupt. Creditors go after the board. No bad faith here, but they relied on one person for the decision, VP Admin and Finance who was appointed to both companies merging. Liquidator noted there was no reason to do this. Issue: Was there a breach of the standard of care and the duty of care? Rule: Duty of care can be extended even to creditor. Reinforces view that CBCA is a much broader statute here than the OBCA. Court notes it is not a business expert, even if there is a bad decision made here, unless you can show it was a really STUPID decision, not going to be able to show a breach of the duty of care or fiduciary duty. Held: If they acted in the best interest of the corporation and even though it ended up being a terrible decision there is nothing which would indicate they were acting in bad faith. This was the only way they thought they could save the company. Court allows them to say they had not breached duty of care. Remedy: SCC also notes that reliance is not available here. The person relied upon was not a properly qualified accountant thus reliance is not allowed here
OTHER DUTIES IMPOSED ON DIRECTORS AND OFFICERS CBCA and OBCA Employee wages up to 6 months o Directors can be liable for 6 months’ worth of employee wages s.131
Under s.130 (OBCA) or 118 (CBCA) – a Director is personally liable if: o They make dividend or other payments where solvency and capital impairment test not met o They pay unreasonable commissions in connection with the issuance of shares s.37 o They pay improper indemnity s. 136 o Oppressive payments are s. 248 o Issuance of shares for under value s. 23 In each case the directors have to repy the corporation any amount paid out where these requirements are not met. Note: reliance may be available here as a defence to liability under CBCA s. 122(1)
LIABILITIES OF DIRECTORS AND OFFICERS FOR TORTS Reduces value of limited liability especially in small companies where managers are also the sole shareholders
61 General Rule Common Law: If manager or directors, performs orders or procures action constituting the tort, including negligence misrepresentation, the director or manager will likely will be found liable. . Not a defence to argue tort done for benefit of company . Not protection from corporate veil. . If Manager has general responsibility for the area in which the action constituting the tort takes place and no knowledge or involvement, liability unlikely
Negligence Liability also depends on the “ degree” and “ kind” of “ personal involvement”. Does manager have a duty to the victim (relationship to the victim?)
RULE: Manager has a duty to the victim where the manger (Berger – Employee slips on ice): . Was responsible for the area in which tort was committed, . Was aware of the danger . Could have removed the danger and did not
Note: Berger had been criticized in that it imposes personal liability on an indiv really only on basis of his personal position (in the corp). Only link btw indiv who was found to have duty and victim was based on the position in the corporation (other than specific knowledge of danger)]
RULE: Director held personally labile for negligent misrepresentations (NBD Bank – director had personal relation with bank; Canada v. Dofasco)
Note: In Both Dofasco and NBD, person found to be negligent had some direct personal role in connection with the actions. Takes it a bit outside of the Berger example
Inducing a breach of contract In nearly every sector, when companies are in contracts, ie for supply, there is negotiation on price. Price of inputs goes up and down. o Sometimes you need to break a contract, pay the damages, move on and save money. o In theory the supplier could sue the manager or director for inducing breach
RULE: If a servant acts in a bona fide way to breach a contract on behalf of a corp, not liable Said v Butt RULE: Not liable (application of said v Butt) where acting “under the compulsion of a duty to the corporation McFadden (Managers and directors cannot act in their own interest)
The question is whether McFadden is always applicable o Sometimes the director and manager is tied to the best interest of the company o “Compulsion of duty not available to other torts”
Shareholder Remedies
Types of Shareholder Remedies: 1. Personal Action (Never used) 2. Derivative Action 3. Oppression Remedy 4. Others a. compliance 62 b. rectification of records c. investigation d. dissent and appraisal e. dissolution
Shareholder remedies are mechanisms provided in corporate statutes to ensure that the shareholders receive the benefit of their entitlements especially because they do not have contractual rights against the corporation Shareholder remedies do not just protect legal rights but they can provide relief where shareholders’ economic and other interests have been affected or unfairly treated.
1. PERSONAL ACTION . Action where the issue is relevant only to the specific shareholder. . IE: Notice of meetings, voting rights. . There are very few personal rights specific to a given shareholder . Usually where problems arise here it is in the context of a much larger situation . Per Goldex Mines (405) . Cannot seek relief if injury is merely incidental to injury to the corporation. . This hardly ever used b/c it is usually part of a larger issue.
2. DERIVATIVE ACTION Action on behalf of corporation by shareholder with permission of court for corporate wrongs REMEMBER – Can only use to claim for identified injury to corporation You have to establish some breach of an obligation to the corporation.
Old Rule - Foss v. Harbottle – only corporation could sue for injuries to it. Shareholders could not, except in ltd situations. Old rule abolished s. 246
Test for when the Court will allow Derivative Action
Court will permit derivative action if three (3) conditions met: 1. not less than 14 days notice given to directors and directors will not bring action or diligently prosecute, or defend/discontinue action 2. Shareholder acting in good faith 3. Action appears to be in the interests of the corporation (s. 246)
OBCA 2007 amendments no notice required if all Directors are also defendants. SCC in Peoples v. Wise: Where corp. is insolvent, creditors may be proper complainants to bring a derivative action Derivative Action can only be used for identified injury to the company itself.
Procedural Matters Shareholder approval may be taken into account but it is not determinative on whether or not a derivative action may proceed. This eliminates the rule in Foss v Harbottle s 242(1) CBCA Application cannot be stayed, discontinued or settled without leave of the court s242(2) CBCA o Want to avoid settlement outside of court. This way companies could avoid the PR mess / legal fall out. o Prevents “strike suits” 63 Shareholder cannot be requested to give security for costs in the proceedings (242(3)) o Security for costs is a major barrier to justice in Canada. Interim costs may be awarded to an impecunious shareholder (s242(4)) which is routinely awarded, but not if there are doubts re the merits and subject to repayment if suit unsuccessful. Failure to give 14 days notice is not fatal if it is obvious that directors would refuse to act Once the court has given permission for the action, they can provide any remedy they want. NOTE: Case law principles (408-09) o Shareholder need not specify legal basis or facts they are relying on. Need general information regarding nature of the claim. o Good faith requirement means no frivolous or vexatious application or tactical suits. o Requirement that the action appear to be in the interest of the corporation, a low threshold test. o Oppressive Remedy
3. OPPRESSION REMEDY Most open ended common law remedy in the world The essence of the oppression remedy is a claim about the behaviour by the corporation budd v Gentra The oppression remedy has expanded that conduct by a corporation, its affiliates and their respective directors gives rise to a claim for relief and what remedies may be sought The main intended beneficiary of the oppression remedy was minority shareholders but it is also available to stakeholders and the court can allow anyone it thinks is a proper person to bring an oppression action
The Statutory Scheme The key provisions in the CBCA governing the oppression remedy are: 238, 241, and 242 CBCA 238= who gets to complain using the oppression Remedy / complainant CBCA 242 = deals with interim costs and other procedural issues CBCA 241 = substantive standard for oppression remedy
Oppression Remedy Provision 241 241. (1) A complainant may apply to a court for an order under this section. (2) If, on an application under subsection (1), the court is satisfied that in respect of a corporation or any of its affiliates: (a) Any act or omission of the corporation or any of its affiliates effects a result, (b) The business or affairs of the corporation or any of its affiliates are or have been carried on or conducted in a manner, or (c) The powers of the directors of the corporation or any of its affiliates are or have been exercised in a manner That is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer, the court may make an order to rectify the matters complained of.
WHO may claim Relief from Oppression: The Complainant Oppression is not just a shareholder remedy, The courts have allowed it to include those who have securities in the company like creditors, employees and even the corporation itself, as well as previous shareholders are allowed as well This explains corporate law notions about to whom corporate managers are responsible In this way this remedy is an important enhancement in the position of creditors and other non shareholder stakeholders seeking relief from corporate conduct
Section 245 - The Complainant (a) a registered holder or beneficial owner, and a former registered holder or beneficial owner of a security of a corporation or any of its affiliates; check def of security, s. 1.1. OBCA. (b) a director or officer or a former director or officer of the corporation or any of its affiliates;
64 (c) any other person whom a court determines is a proper person to make an application. Ontario Securities Commission may apply for relief if an offering corporation (s. 248(1)) But then look at definition of security in the definition section 1- includes debt obligations
What can the complainant complain about? Acts or omissions of directors or corporation or affiliates which are or threatens to be: o Oppressive to o Unfairly disregard, or o Unfairly prejudice the interests of the complainant in the corporation (s.248)
What relief is available? 248(3) Huge list of relief available – hard to think of anything that is excluded. This is why this remedy is regarded as so expansive that it can eat up any other potential remedy that is out there. Interim costs can actually be awarded to afford plaintiffs the ability to start the remedy
Interim Costs a P seeking relief from oppression may apply for an award of interim costs Courts are cautious about making these orders because in an oppression remedy the Complainant is only seeking relief for him or her self rather than for the benefit of the corporation as is the case in a derivative action Interim costs will only be awarded if financial difficulty is so high that the complainant cannot go forward with litigation without an award for interim costs. Need to show a prima facie case or one case went even further to say that you only have to show an arguable case that even has a chance of success to get interim costs to pursue this remedy. This has been allowed to help the underdog minority shareholder get retribution against the corporation.
The Complainants Continued: 245(a) - registered, holder and beneficial owner of a security – includes: Present and former and person with claim to be issued securities (Cask v Aumon) – even if there is a dispute about if a shareholder is a shareholder even those people can come within the definition of being a shareholder for the oppression remedy. Even where claim to beneficial ownership of securities disputed. Beneficial ownership is defined to include ownership through any trustee, legal representative, agent or other intermediary The goal here is to identify shareholders / owners of any series or share
Cask v Aumon –whether applicants claiming a right to become security holders are complainants This case held that applicants with a contractual claim to be issued shares which was being denied, were beneficial owners of securities in the corporation for the purposes of CBCA 238(a) which is the same as 245(a). The court held that the meaning of beneficial owner should be interpreted broadly. The case also held that if a person was entitled to complainant status under 238(a) the persons interests were deserving of protection under 241(2).
A majority shareholder can commence an oppression remedy as well.
Affiliates can also be Complainants under the Oppression remedy Complainant status extends to an interest in “affiliate” of the “corporation”: Affiliate of a corporation means another corporation which: 1) Controls the corporation, OR 2) Is controlled by the corporation OR 3) Is under common control with the corporation (s. 2(2)-(5)) 65
There is one catch with affiliates: if you are an affiliate can only claim relief under s. 248 in respect of injury to interest in “ the corporation” (this is tough because affiliates are subsidiaries of the corporation and therefore you cannot claim oppression against your own affiliation but you are removed from the corporation that is causing the problem. The way to deal with this is to change the pleadings to say that the actions that took place in the corporation had implications for his interest in the affiliate company) Moriarity
Oppression is also available to Creditors and others… 245(a) - registered holder and beneficial owner of a security includes: “Security” includes “debt obligation” s. 1(1) “Debt obligation”: means bond, debenture, note or other similar obligation s. 1(1). Has been interpreted as limited to debt of kind that can be registered – e.g. a bond First Edmonton, but non-registered creditors, e.g. trade creditors can be discretionary complainants. Applicable only to creditors at the time of oppression? Devry, no standing because remedy was claimed before the creditor became a judgment creditor, but contra, Levy-Russell Ltd courts have expressed sympathy to an involuntary creditor who could not negotiate contractual protections against oppressive
First Edmonton Place Oppression action by Creditor Tests: Should permit oppression action by creditors where 1. Acts of management constitute fraud (e.g. Prime, Canadian Opera). Court order directly against controlling sh/holder. 2. Breach of underlying expectations of orig. relationship (e.g. alleged oppressive act is not something that creditor could reasonably have expected and would not have been able to protect self against) not the case with lessor in First Edmonton Place,
The Complainant can also be the majority shareholders, Majority shareholders too, also oppressed by acts of Directors, officers etc. Hui confirmed in Repap, Even though orthodox view is that the oppression remedy was designed to protect minority shareholders. This view upheld recently by the Ontario Court of Appeal in the Repap decision which also upheld the decision of the lower court on both the use of the oppression remedy and the “business judgment rule”
245(b) – director or officer or former director or officer Only interests as director or officer – not as employee Naneff VD, pg. 422 but to contrary, Murphy which held that directors as employees can also use the remedy Catch all phrase 245(c) - any other person court determines is proper person. Creditors are most successful Royal Trust says that the courts should not turn all civil actions into oppression cases -Study quote pg. 424 that relates to creditors!
The corporation itself as complainant There was never any intention for the corporation to be seen as a complainant but now there are cases that say that the corporation can trigger the remedy itself in a situation where one individual (probably the majority shareholder) has committed the oppressive act and in that case there are cases where the rest of the corporation can gang up on his and use this remedy against him. = Kredl, Fiber, Dylex VD, pgs. 428-9 ). Is it limited to where all the shareholders other than resp. joined as plaintiffs
Policy / Practical note on the Oppression Remedy’s development: Practical reason why this remedy could take over as the major catalyst for litigation in corporate law: Procedures are expensive and take a long time. There are however some that are very fast- like starting something by application. Opresstion remedy allows you to start by way of application which is a huge procedural advantage. The remedies are also much broader than contractual remedies. They range and include orders for restitution from controlling shareholders as in Canadian Opera and Prime Computer. This may even lead to them replacing fiduciary duty actions. The SCC has said that what you should be doing is establishing a breach of fiduciary duty and then call on that breach to support your oppression remedy arguments. 66 Grounds for using the Oppression Remedy Section 248 – Grounds compare with S. 241 of CBCA 1) A complainant may apply to a court for an order under this section. 2) If, on an application under subsection (1), the court is satisfied that in respect of a corporation or any of its affiliates (a) any act or omission of the corporation or any of its affiliates effects a result or threatens to effect a result; (b) the business or affairs of the corporation or any of its affiliates are, have been or are threatened to be carried on or conducted in a manner; or (c) the powers of the directors of the corporation or any of its affiliates are or have been or are threatened to be exercised in a manner • that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer of the corporation, the court may make an order to rectify the matters complained of.
Before landmark decision in BCE Place, the courts were interpreting this very broadly. Protects reasonable expectations and interests of shareholders - not just strict legal rights see quote from Harold E. Ballard Ltd decision pg. 431 and Westfair Foods Ltd, pg. 431-32. Proving Bad faith is typical but not required. Significant difference between OBCA and CBCA- OBCA includes threatened behaviour – behaviour that is likely to happen in the future. CBCA only deals with past actions.
The SCC in BCE developed a new analytical framework for finding oppression (VD, pg. 432- 33): 1. Reasonable expectations within a company play a fundamental role in the oppression remedy. 2. First, examine whether there is evidence to support the existence of reasonable expectations claimed by plaintiff. 3. Are such reasonable expectations breached by conduct that is oppressive, is unfairly prejudicial or unfairly disregards the interests protected by the remedy? 4. While all stakeholders have reasonable expectations to be treated fairly, what would be reasonable expectations depends on certain factors (see next slide). 5. Remedy stage.
Indicia of what could be regarded as reasonable expectations: (VD, pgs 432-434): 1. Commercial Practice- What are normal practices for that sector? 2. Nature, size and structure of the corporation – with small or closely held corp. more likely to have reasonable expectations of the corp. and its governance. 3. The relationship between the parties, past practices, agreements, e.g. USAs, public disclosures. But past practices may legitimately change for valid commercial reasons as long as the legal rights not violated- the company could counter and say that those expectations have changed and so they should not be expected anymore. 4. Whether complainants could have protected themselves. This, in my view, was the deciding factor in the BCE case. 5. The fair resolution of conflicting stakeholder interests in an equitable manner arising out of fiduciary duty and commensurate with duties as responsible corporate citizen.
BCE Explaining the terms of the Oppression Remedy Paragraph 92 – originally oppression was anything that was not fair dealing. But the court says that it is wrong to give the remedy that name because there have been other terms added to the remedy like “unfairly prejudice” and “unfairly disregards”
Paragraph 93 – by adding those two concepts to the original definition of oppression those indicate something falling short of bad faith. 67
Unfair prejudice – conduct LESS offensive then bad faith like squeezing out a minority shareholder, failing to disclose related party transactions, or changing the corporate structure drastically to alter debt ratios, Adopting a poison pill to prevent a takeover bid, paying dividend without a formal declaration which could get the directors into trouble, preffering some shareholder with management fees and paying management fees than are higher then the norm. There is the higher category of bad faith and this lower catgory of unfair prejudice.
Unfair disregard- least serious injury of the three. Lesser culpability on the part of the directors. EXAMPLES INCLDE FAVOURING A DIRECTOR BY FAILING TO PROPERLY PROSECTURE CLAIMS, IMPROPERLY REDUCING A SHAREHOLDERS dividend or failing to delivery property belonging to a claimant.
Other case law interpretations of Statutory language: Note that reasonable expectations may not be only those at the start of the shareholder relationship, as they may change with the circumstances, see Westfair Foods Ltd case, VD, pg. 432. Expectations may even be based on public pronouncements and investment agreements. Finding of bad faith is not required, though such a finding would be highly persuasive to a court in finding oppression, see Brant Investments Ltd, VD, pg. 435.
SCC is trying to create more substance for this remedy: Before the SCC in BCE, Courts moving to a very broad standard of “fairness” in determining whether there was oppression and not focusing on what is the meaning of the individual phrases in the section e.g. “unfairly prejudicial” or “unfairly disregards”. In the Westfair Foods case,, pgs 436 the judge warns that the standard must be based on values that have gained wide acceptance as principles adopted in precedent, not the judges’ sense of what is fair. Does this provide sufficient guidance to legal advisers? Issues that could be most contentious, excessive executive compensation, conflicts of interest. Note parags. 92-94 of the BCE decision. Does it clarify the situation
Arthur v. Signum Communications – some examples to show the remedy can be invoked concrete indicia of oppressive conduct laid down in prior case law of what the SCC in BCE would view as evidence of conduct to be oppressive, unduly prejudicial or unfairly disregarding the interests of the complainant? 1. no valid corporate purpose for the transactions that management is getting into? 2. failure to act arms-length in the transaction 3. was there clearly a lack of good faith on the part of Directors 4. was there an attempt to discrimination between shareholders that benefit majority to the exclusion or detriment of minority 5. was there a lack of adequate and material disclosure to the minority shareholders 6. was there a plan or design to eliminate minority shareholders
Other Procedural Issues Personal and derivative claims could be folded into oppression claims VD, pg. 437) The SCC in BCE confirmed that oppression remedy can be used for breach of fiduciary duties but still need to show oppressive, unfairly prejudicial or unfairly disregards a protected interest, VD pg. 439. Interests protected – need not be interests of complainant, but note conflicting caselaw, see VD, pg. 440-41. Though typically are interests of complainant Interests of beneficial owner or contractual claimant included, see Csak, VD, pg. 440. Note that oppression is available even for oppressive action under shareholders agreements, although courts reluctant to do so where terms of the USA are implemented according to its terms even though unfairly. Oppression remedy can be brought even for the smallest shareholder –but if you are going to go into a USA add an arbitration clause to help keep the oppression remedy out of court – arbitrator may or may not use the remedy.
68 REMEDIES AVAILABLE TO THE COURT FOR SUCCESSFUL OPPRESSION APPLICATIONS S. 248(3) – list of remedies is very long a. Share purchase Unlimited flexibility to fashion remedy to correspond to specific acts of oppression CBCA s. 241(2) &(3) If an oppressed minority has lost confidence in the corporation or controlling shareholders, case law indicates that courts willing to order buy out of dissenters, Loveridge Holdings & Redekop, Note however, the court is reluctant to order buy outs especially if the company is not in a financial position to do so, may force the courts to order the “capital punishment” remedy, namely dissolution. If oppression can be cured by ordering a mandatory compliance with the Act instead of buy out, courts may opt for compliance order rather than buy out Jackman v. Jackets Enterprises Inc, b. Liquidation and Dissolution Courts reluctant to use this “capital punishment” oppression remedy. Only when forced to do so when the parties relationships have completely broken down. Courts prefer other flexible remedial measures in s. 248(3). Note that in one case Rivers v. Denton, , Court ordered dissolution but postponed it for thirty days to see if parties could work out their problems. c. Remedies against other oppressing shareholders This is a truly innovative remedial power under modern corporate law statutes. See cases where courts have ordered damages against shareholders who have participated in corporate actions, which have caused oppression to creditors. Usually, the shareholders have stripped the company of the assets needed to pay the creditors Tropxe, note 201 VD, pg. 449. Courts have called this a drastic remedy though. Courts are also prepared to order shares of oppressed shareholders to be bought by the controlling shareholders, Lajoie d. Compliance Courts have been ready to order compliance with corporation’s articles, by-laws, statutory obligations under the oppression remedy even though a separate compliance remedy exists under CBCA, s. 247 and OBCA s. 253.
Other possible oppression remedies i. Orders directing the amendment of by-laws and the replacement of management Trmlpczy, ii. Appointment of receivers Kanata iii. The amendment of shareholders agreements Mazzota, iv. The creation of a pre-emptive right to buy shares as proposed by the Dickerson Committee.
Oppression Remedy Framework: 1. Is there a legit Complainant?(s. 245) 2. Were there reasonable expectations? (Assess indicia from BCE and Arthur v Signum) 3. Are such reasonable expectations breached by conduct that is a. oppressive, b. is unfairly prejudicial c. or unfairly disregards the interests protected by the remedy? 4. Should the oppressors have taken reasonable steps to prevent this? 5. Assess whether the use of the remedy is going too far towards replacements for commercial law 6. If the oppression remedy appears available suggest remedies!
69 SHAREHOLDER REMEDIES 1. Compliance Orders (s. 253), VD, pg. 451 You can get those who are violating constitutional documents to comply with them. This is a summary process so it is fast and cheap. Who - Complainant or creditor What - breach of Act, Regulations, articles, bylaws or USA Against corp, director, officer, receiver etc. Summary procedure – not suitable if complex issues of fact or law, e.g. fiduciary duties, Goldhar
2. Rectification of Records Rectification of records OBCA s. 250, 266, CBCA, s. 243. Usually concerns correcting info on company’s register re shareholders. Critical as regards giving notice of meetings and awarding of dividends, so courts can restrain the calling or holding of any meeting or payment of any dividend until records are rectified, CBCA, s. 243. Shareholders can seek expeditious summary application to get information rectified. Need to be quick as info in the registers and records are proof of what they disclose in the absence of any contrary evidence, CBCA, s. 257.
3. Investigations ss. 161-167 OBCA and CBCA allows a court to order investigation on the application of a security holder or Director where there is evidence of fraud, dishonesty and oppressive conduct
4. Winding up ss. 191 – 244 Termination of the Corporation Process: Sell assets, Pay liabilities,– Pay out balance in accordance with entitlements in share provisions May be voluntary, part of an oppression remedy or by court order (s. 207). General ground: Just and equitable to do so, criteria can not be defined exhaustively, but includes: - No longer possible to carry on business, e.g. has become illegal - Justifiable lack of confidence in the management, e.g. due to fraud or deliberate violations of corporate constitution - Deadlock situations where main and equal partners in business unable to agree, so corporation is unable to act
70 Corporate Changes - CBCA
Certain things are not fair to change without getting a higher level of approval.
Type and Description Is Shareholder % Class Additional Steps Approval Simple Vote DISSENT required? Is there majority RIGHTS a statutory or 2/3 of Springing requirement? votes cast votes= You can dissent and in person where non you will get bought or by proxy voting shares out by the company at FMV calculated as actually get of the day voting rights immediately prior to the approval that triggered the dissent right
Most changes in Always If you are 3 situations where File form of articles of 1. Amendment of 173(1) will require going to be doing anything dissent votes amendment with Articles shareholder 2/3 that prejudices apply: appropriate authorities. approval approval of an existing a votes cast class of shares 190(1)(a) – where Shareholders can 27, 173(3) do not then you are transfers approve subject to right require shareholder triggering a restrictions on the of board to withdraw approval to amend class vote. In shares are added, amendment if there are the articles. that case the changed or sufficient number of prejudiced removed – you get dissents. 173(2) a dissent right with 27 – where you class must have previously have 2/3 this proposed authorized the boar agreement and change. dto create a new the total series then the classes affects 190(1)(b) – you directors can do also must have get a dissent right that on their own 2/3 when a and shareholders do agreements. corporation not need to approve decides to affect (they have pre Even prejudiced or any amendment to approved) business non voting class shares restrictions – 173(3) – don’t need shareholder get a chance to vote 175(5) 190(2) – wherever approval when you the class vote are changing your springing voting rights. applies to corporate name prejudice (ie. from a numbered 176(1) – where s.176) name to something prejudicing shareholders get a else. existing class dissent right when of shares??? applies to class voting shares
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The board can 50% of No No Note that by-law is 2. Amendment of amend at any time votes cast effective at the time By-laws and it is in effect at the passed by board, but immediately. S. 103 following remains subject to meeting shareholder approval (these sit in your The board has to (s.103). minute book) have the Easier to amend your shareholders No filing required. by-laws then articles “confirm, reject or amend” the changes at the next meeting.
If the board did this and things were in effect between meetings those decisions hold true.
CORPORATE CHANGES – CHANGING JURISDICTIONS
Type and Description Shld Approval % Class Dissent Additional Steps Vote
Yes (188(5)) 2/3 No spate Yes (190(1)(d)) File application for 3. Continuance (because class vote permission, evidence of (Export of the Springing voting it’s a big shareholder approval, and s. business to a new rights for this - All deal) 188(10) legal opinion that shareholders get a shows that leaving that jurisdiction) vote if they want it statutory framework is (188(4)) substantially similar to the CBCA. Ie: changing from CBCA to Director issues notice of OBCA or vice versa, a acceptance to proposed change in the governing jurisdiction, and issues law that governs your certificate of corporation discontinuance.
tax, business combination reasons
72 CORPORATE CHANGES – BUSINESS COMBINATIONS Type and Description Shld Approval % Class Dissent Additional Steps Vote
Yes, whether or 2/3 of the Depends Yes (190(1)(c)) First step usually a 4. Amalgamation (Long not rights to vote total votes (183(4)) “merger” or “business Form) (183(3)) cast combination” 183(3) Class vote is agreement. In order to amalgamate both required if, by must be under the same amalgamation Address any statute. This is the number 1 you would be continuance issues. reason why continuance is prejudicing used. ANY existing Provide creditor notices, class if changes if required. A Co./B Co. are unrelated, affect share ie. not in subsidiary or classes in the Shareholders approve affiliate relationship way that they and companies enter into would in the amalgamation amendment of agreement (182(1)), ie. articles. the agreement A Co. B Co. implementing the Applies if 176 business deal. would require if proposed File articles of AB Co. change included amalgamation and in articles of declarations and obtain amendment certificate. A Co./B Co. shareholders receive shares of newly If you are not May provide “trap-door” formed AB Co. changing the for directors to drop out priority of deal prior to structure only completion (183(6)). Effect of amalgamation - rely on 183(3) see 186 and think of “two (2/3 of ALL streams” analogy affected) if you are changing The companies are the priority combines and you get to structure then decide how to recreate the 183(4) (2/3 of share structure – the statute EACH affected does not decide. + 2/3 of All)
73 No N/A N/A N/A Provide creditor notices, 5. Amalgamation if required. (Short Form) File articles of amalgamation and Vertical declarations and obtain You have a subsidiary- if certificate. you combine that is a vertical amalgamation (nothing is really changing)
A Co. 100% B Co.
↓
A Co.
Condition to do a short form amalgamation is company A must own 100% of the other companies shares.
ALSO make sure all companies that are subject to amalgation are subject to the same statute (if not they have to export it first)
Horizontal Company a owns 100% of B and C and you are combining B & C it is a horizontal
A Co.
100% 100%
B Co. C Co.
↓
A Co.
100%
BC Co.
74 Generally NO 6. Sale of Substantially Yes, whether or 2/3 of separate class Yes- dissent May provide trap-door – All of the Assets – not rights to vote VOTES vote rights apply. shareholders can roughly 90% (189(6)) CAST authorize board not to There are proceed if there is springing votes substantial dissent. 189(6) No filings required. Only class votes if a class is affected differently upon sale (in practice this never happens) (189(7))
7. Plan of Arrangement Yes, prescribed Generally Generally yes, Generally yes, Prepare business by court 2/3, but but within but within combination agreement. (192(4)) within court’s court’s discretion allows companies to do court’s discretion and and generally Initial procedural order something that the statute discretion generally follows the imposed by the court. may not provide for- allows and follows the statute them to go to court and generally statute Complete matters have a court approved follows the prescribed by the court’s process to get corporate statute procedural order, action done. meetings, etc.
Allows court to override the Final order approving amalgamation procedure arrangement issued by where the companies are in the court. different jurisdictions
without having to do File articles of continuance. arrangement and obtain
certificate. Mostly used for US
exemptions
CORPORATE CHANGES – TERMINATION OF COMPANY’S EXISTENCE
Type and Description Shld Approval % Class Dissent Additional Steps Vote
Yes, other than 2/3 Yes No Can proceed under 210 8. Voluntary under 210(1) (210(2)/(3)) (simple) or 211 (more Dissolution complex) Voting rights Spring votes as 1. File statement of intent to apply whether or well in these Note: if you have not extended by situations dissolve, if required. incorporated a company articles and nothing came of it (210(2)/(3)) Carry out wind up and there were no activities, realize shares- then the initial assets, notify directors can dissolve creditors. pay without shareholder liabilities, file tax approval 210(1) returns.
2. File articles of dissolution
75 NOTE THE DIFFERENCE BETWEEN: THE VOTES CAST (either 50% of 2/3) Springing votes – when classes that don’t have voting rights get voting rights Class votes – when a prejudice occurs the class that is prejudiced gets a class vote
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