GMGT 3300: Major Forms of Business Organization in Canada

Liability

• a debt or obligation

• a right that’s recognized by law that can be enforced by a person, by a court process that can result in a court ordered remedy

• i.e. legal liability is a right that’s enforceable by the law for which a remedy may be obtained in court

Sole Proprietorship

• an individual carries on business for their own account without either the medium of an incorporated company, or the participation of other individuals except as employees

• the sole proprietor has unlimited liability, which is a dangerous position to be in

Advantages of Sole Proprietorships

• ability to make all business decisions

• right to all profits

• right to deal with assets without interference

• simple to set up and inexpensive

Disadvantages of Sole Proprietorships

• unlimited liability

  • sole proprietor is liable for all the liabilities of the business and all non-business assets are exposed to creditors of the business

Prophylactic Actions to Protect Yourself

• insurance

  • will pay off if something goes wrong; not cheap but typically necessary

• put your investments in creditor-proof assets (e.g. whole life insurances, RRSPs)

• ensure you have an estate plan to redistribute your property, and if desirable transfer assets to

  • don’t transfer to spouse or child

Agent

• distinguishing feature, they create contractual liability for the principal

• agents usually exist by contract but you have them estoppels

Principal

• enters into an agency contract with parameters

• the agent enters into a deal with a third party

• if the agency contract is functioning properly then the liability exists between the principal and the third party

Agency Law

• the relationship between the principal and agent according to which the principal has authorized the agent to enter into contract with third parties on the principal’s behalf

  • they are created by getting into a contract, either by verbal or written, and clearly define the boundaries of the agency , the matter to which the agent can bind the principal, what kind of contracts they can make

  • remuneration for the agent

Power of Attorney

• happens when someone is chosen to do the bidding of a person incapable to carry out day to day legal tasks

• they get the power of agency which is general or limited, determined by statute

• the agent should be acting in the best interest of the donor while taking care of issues

Ratification

• if an agent exceeds the authority it has to make contracts, then the principal isn’t held liable, but the principal can ratify the contract to dissolve

• if the principal doesn’t ratify the contract made, then the pseudo-agent is held liable for the contract

Agent by Estoppel

• a bar or barrier which prevents a person from denying the truth of certain facts when this person by words or conduct has lead another person to believe that certain facts are true and to act and rely upon these facts

• two categories…

  • apparent authority

  • holding out

Apparent Authority

• the agent has no real authority but appears to have authority to act on behalf of the principal on account of the past matter of transacting business or on account of certain practices in the trade

• similar to partnership by estoppel

Holding Out

• the principal has used words or behaved in a manner that represented the other person as the other principal’s agent

• or the agent says he is an agent and the principal doesn’t do anything to stop it

Agency by Necessity

when the agent enters into contracts with a third party for the benefit of the principal without the consent of the principal, and to limit losses that the principal could experience

Test of Agency of the Principal

the principal in such cases is responsible of the agent, if a mythical reasonable person, could reasonably assume that the agent is acting within the scope of actual authority then the principal is bound by the act of the agent

Duties of the Agent to the Principal

• agent must comply with the contract establishing the agency or they are liable

• agent must be diligent in reprising role

Fiduciary

• a person that’s in the position of the trustee, they have a duty of loyalty to the principal and must be scrupulous and candid to the loyalty of the trustee

• a person having duty created by his undertaking primarily for another’s benefit

Fiduciary Duties

• personal performance; must perform duties, can’t delegate

• agent must be diligent in informing of new developments

• duty to account for financial matters

• complete good faith; bonafides

Bonafides

• faithfulness; you cannot take advantage of a conflict of interest

• cannot take secret commissions

• agent cannot act on behalf of third party and principal at the same time

• agent cannot intercept opportunities of the principal unless the principals grants permission to the agent

Duties of Principal to the Agent

• an agent has the right to be paid by the principal; can be specified in contract, if not then paid by quantum meruit

• reimbursed for expenses

Quantum Meruit

a reasonable fee based on the nature of services, the outcome, and practices of the trade

Limited Partnership

• there are certain partners that have limited liability, called limited partners, and you must have at least one general partner

• the worrisome thing is that if a limited partner participates in a manager function, it can convert them into a general partner with unlimited liability

• not utilized as much because the tax advantages were eliminated in the early 90’s

Limited Liability Partnerships

• provides protection for the personal assets of an innocent partner from professional liability claims arising from the negligence or misconduct of another partner, associate, or employee in whose work the innocent partner was not involved

• Partnership Amendment Act makes provision for limited liability partnerships

• Texas saw the first LLP statute in 1991 after claims from law and accounting firms

  • Ontario adopted in 1998 and other provinces followed

• professionals allowed by statute…

  • lawyers

  • chartered accountants

LLP Protections

once registered, a partner in a LLP isn’t liable for…

• debts

• obligations/liabilities of partnership

• another partner

• anything that arises from negligence, wrongful acts or omission, malpractice, or misconduct of another partner, employee, agent, or representative of a partnership occurring in the ordinary course of professional practice

Limitations to LLP

you can lose protection if…

• partner knew of negligence and failed to take reasonable steps

• negligence was committed by an employee, agent, or representative of the partnership for whom the partner was directly responsible in a supervisory role

Partial Shield

protects innocent partners from the negligence, wrongful acts, etc… of others in the firm but doesn’t provide any protection for contractual or trade debts

Full Shield

• the LLP model which extends protection to contractual or trade debts

• only Saskatchewan has this

Corporation

• separate legal entity

• people are more willing to participate in economic activity because their assets aren’t at risk

• agency principles manifest themselves through corporate law

  • they can’t do much by themselves because they are artificial; must act through human agents

• various characteristics

  • limited liability

  • tax advantage

  • management

  • transfer of ownership

  • continuous existence

  • loyalty

  • separation of ownership and management

Separate Entity Principle

• a corporation is a separate person from the investors, and so the investors aren’t responsible for the actions of the corporation

• gives limited liability to the shareholders

• the investors can’t be sued for the entity of the corporation

Limited Liability (Corporations)

• natural consequence of being a separate entity

• means a shareholder is only liable to lose their investment and/or the shares for which they have not paid

• the ability to routinely incorporate in business and have limited liability is one of the most important economic achievements of North American culture

  • it has emboldened investors because they aren’t risking all their assets

  • has generated as much wealth as the industrial revolution

Tax Advantage (Corporations)

• small business tax deduction

  • eligible for tax savings for the corporate tax rate

• capital gains exemption

• estate freeze

  • allows you to pass active shares to your heirs without tax consequences

• individual pension plan (IPP)

  • you can put more into this pension plan than an RRSP with similar tax treatment, and it stays in the company

Management (Corporations)

• shareholders have no authority to participate in management

• their essential right is to elect the board of directors once a year

Transfer of Ownership (Corporations)

transfer of corporations are allowed and your relationship is ended

Continuous Existence (Corporations)

• it’s an artificial entity that can live forever

• if someone dies, the corporation doesn’t have to dissolve

Loyalty (Corporations)

• shareholders don’t hold any loyalty like partners do because they aren’t fiduciaries

• you can have shares in competing corporations as a shareholder

Separation of Ownership and Management (Corporations)

• size of company will affect the type of ownership/management disputes

• if compensation packages are too big for managers in large companies, shareholders get upset because is lowers the growth of the stock and dividends

• in smaller companies, there are few owners and oppression of minority shareholders occurs

Large Companies

• generally publicly traded

• owners don’t have the specific skills to operate and manage the company, so there’s a distinction of managers and owners

• shareholders are interested in capital gains and dividends; managers want salaries, benefits

• the money has to go to one or the other, therefore the two parties are in competition

Small Companies

• generally not publicly traded

• there are owners that are actively participating in management or outright labour of the corporation; the shareholder/management issues are quite different

• problem is oppression of the minority shareholders

  • “locked in a frozen out”

  • they can’t sell their shares except at a very discounted price because nobody wants to pay to take their place, but are frozen out because they have no influence on management

• usual solution is provisions in a shareholders agreement; most important clause is the shot gun clause

Shot Gun Clause

• make an offer to the other party at a price per share and it’s their choice of whether they buy or sell

• not always fair to everyone

  • if one party has no money, can’t realistically buy them out

  • in those cases, the price per share will be determined by someone else so that the undercapitalized will be considered

Piercing the Corporate Veil

• to ignore the separate entity principle

• the courts will do this…

  • taxation situations

  • for the residence of the corporation and the controlling shareholders, i.e. not where it’s formed but where the controlling shareholders reside

  • whether they are an agency or shareholders, but they need a written agreement

  • in certain situations of fraud; they won’t allow the separate entity principle to be an instrument of fraud

Methods of Incorporation

• royal charter corporation

• special act corporation (statutes)

• general (routine) acts

Royal Charter Corporation

• created through the use of the royal prerogative

• historically, the crown used them to create companies for a fee

• aren’t formed anymore because the royal prerogative has been terminated

Special Act Corporation

• for major public works

• this method is still employed in creating crown corporations

• special statutes create these corporations

General Act Corporation

• acts that business or other people can resort to create a corporation according to the procedure laid out

• 3 types of general acts

  • english system of registration

  • letter paten system

  • certificate of incorporation

How to Organize a Company in Manitoba

• do a corporate name search to ensure the name is available

• submit articles of incorporation to the corporations branch

  • including the name of the company, corporate head office, nature of the business, types of shares and their characteristics, the first directors, and the incorporators

• must submit a fee

Articles of Incorporation

• i.e. constitution of a company

• if you want to change it you need a 2/3 majority of every class of shares

• according to the articles there are 3 participants

  • shareholders

  • directors

  • officers

Bylaws

• not entrenched and instead can be changed by a simple majority of shareholders

• initially, the first directors create bylaws but must be ratified by the shareholders at the first meeting

• provides the regulation for general governance…

  • charges board of directors with affairs

  • quorums for director and shareholders meetings

  • notice provisions and votes

  • officers of corporations and duties assigned

  • signing authority

  • fiscal year of corporation

Shareholders

• the investors, purchase shares with money or capital and they have few rights in the corporation

• on an annual basis they are eligible to vote for directors

• they must have the ability to participate in the approval of changes made to the corporation including all of its undertaking or changing/amending the articles of incorporation

• shares are a bundle of rights against a corporation

Directors

• charged with the management of the corporation, they are agents through which the corporation acts

• they exercise the power of the corporation, they adopt the initial bylaws

• the directors annually elect the officers of the corporation

• don’t have to be shareholders

Officers

• run the corporation on a daily basis

• don’t need to be directors

• elected annually

Public Company

• no definition in the corporation act

• can say the company is public if there’s a distribution of shares to the public and they’re involved in sales in the stock market

• defined as not being what is defined as a private company under the security act

Private Company

• defined as a company in whose instrument of incorporation or articles the…

  • right to transfer its shares is restricted

  • the number of its shareholders is limited to not more than 50

  • any invitation to the public to subscribe for its securities is prohibited (i.e. no advertising)

Management and Operation of a Corporation

• agency law plays a role; corporations are artificial entities and must act through human agents

• generally speaking, a corporation is liable for the acts of its agents under the ordinary rules of agency

• an officer of a corporation acting within their usual authority, but without express authority, may bind it to contracts made with third parties

• a corporation may ratify acts made by unauthorized agents on its behalf

Manifestation of Apparent Authority for Corporations

3 major ways…

• the effect of publicly filed documents

• indoor management rule

• pre-incorporation contract

Effect of Publicly Filed Documents

• at one time, the public was deemed to have notice of the contents of filed documents whether they read them or not

• if the documents prohibited either the corporation or one of its officers from carrying out certain acts, a third party could not rely upon what otherwise might be the officer’s apparent authority to perform those acts

• that rule could lead to substantial injustice and has now been abolished by statute

Indoor Management Rule

• at times there are requirements in a corporation’s constitution and governing act that require certain acts to be performed in a specific manner if they are to be valid

• if contracts are invalid, there’s a punishment for people who enter into contracts with the corporation

• what about an innocent party?

  • RBB v. Turquand

RBB v. Turquand

• ratio was that in the absence of notice of the irregularity or of suspicious circumstances, everything which appears regular on its face may be relied upon by an outsider and will bind the company

• “suspicious circumstances” depends on the facts of each case

• it’s a danger to know too much about the internal aspects of the organization; if you notice the irregularity and say nothing about it, then the contract can be invalid

Pre-Incorporation Contract

• a corporation cannot ratify a pre-incorporation contract, i.e. a contract made in the name of a corporation before it comes into existence

• the individual who purported to contract on behalf of the corporation couldn’t be held to the contract either, since the intention was to contract with the corporation

• based on provincial statutes…

  • the corporation is bound by the contract and is entitled to the benefits thereof as if the corporation had been in existence at the date of the contract and had been a party thereto

  • a person who purported to act in the name of or on behalf of the corporation ceases to be bound by or entitled to the benefits of the contract

Director’s Duties

• duties of the directors are owed to the corporation, not the shareholders

• they have authority, but no restrictions on authority; consequently so long as the directors were acting appropriately to the corporation then they were protected

• common law duties revolve around 2 things…

  • care and skill

  • good faith (bonafides)

Care and Skill

• a director is bound to exercise reasonable care and that means they cannot be negligent in carrying out duties

• no greater diligence is required of a director than is required of the average person

• accountants or lawyers are subjected to a higher standard; if you’re a professional on a board you’re expected to conduct yourself with a greater degree of carefulness

Good Faith (Bonafides)

• disclose an interest in contracts with the company

  • you should disclose the interest before the board and not act in any discussions or voting

• interception of corporate opportunity

  • you have to act in the best interest of the corporation/client, and don’t take what’s not yours

Gatekeeper Liabilities

• the attempt to control wrongdoing of companies by making the directors liable through duties

• some of these duties are owed to a series of individuals depending on the statutes (approx. 400), e.g. shareholders, employees, creditors

• potential liabilities…

  • remitting EI, CPP, GST/PST, income taxes

  • debts that are liable to employees up to 6 month’s worth

Minority Shareholder Protection

methods include…

• derivative action

• oppression remedy

• unanimous shareholer agreement

Derivative Action

• a shareholder can sue the board of directors in the name of the company for the wrong done to the company, i.e. bringing the action in good faith

• seldom used because the courts require very high costs deposited in advance and as a result few shareholders are willing to do this

Oppression Remedy

• more common method

• appeal to the court that they have been oppressed and unfairly treated and are entitled to a remedy; i.e. an application of the court, not a trial

• the judge can choose the remedy and there’s no limitations to it given by the court

• possible remedies include…

  • court can dissolve the company and disperse the capital on their own means

  • court can order the forced purchase of shares

Amendments to Help Shareholders (1970s)

• disclosure of company affairs

  • entitled to the financial statements and documents of record

  • if you have 5% shares you can apply to the court for an inspector

• notice of shareholder’s meetings to attend

• minimum of 5% to requisition a shareholder’s meeting

• gave shareholders the right to vote to make a change and only to do it by a special voting majority, more than 2/3

• proxy votes were allowed and made it permissible for shareholders to have other people vote for them; this has given managers more control because they get the proxies

Unanimous Shareholder Agreements

• ensure special majorities for certain actions to occur (e.g. taking on loans, issuing new shares)

• board of director elections and determines the duties of the directors

• share control clause (e.g. shot gun clause)

Criteria for Selection of a Business Entity

• limited liability and the nature of the business

  • if there are substantial risks that are uninsurable you should incorporate

• tax planning

• desirability of perpetual existence

• estate planning

• number of proposed proprietors

• relationship of proposed proprietors

• borrowing requirements, available terms, and relationship of proposed lenders

• available government grants

• employee ownership

• costs

• flexibility of structure

• applicable government requirements

  • e.g. only lawyers and CPAs can have an LLP