Ch 16 - The corporate form: operational matters

Corporate liability

A corporation is a legal person in the eyes of the law

• A corporation commits a tort or crime through human agents

2 ways of liability in tort

1. Primary liability: the entity itself commits the tort

2. Vicarious liability: liability for the torts of agents/employees of a company

Identification theory

Establishes when a corporation has primary liability in tort

• This is when the directing mind and will of the organization knew or ought to have known that the corporations actions would cause damage

2 Part test for corporate primary liability (identification theory)

1. Was the wrongful act committed by a “directing mind”?

   • A directing mind is someone who has decision-making authority on matters of corporate policy, not just operational duties (ex: president, ceo, certain managers)

2. If so, ask whether their wrongful action was:

   • Within the field of operation assigned to them (acted within the scope of their duties)

   • Not totally in fraud of the corporation (not done solely to defraud or harm the company, not against the companies interests. if purely done for personal gain, company is not liable)

   • By design or result, partly for the benefit of the corporation (action was intended to, or did benefit the company even if it was also wrongful)

Corporate liability in contract

Whether the corporation is bound by a contract depends on whether the person signing it had the authority to do so (were they an agent?)

• Agents can sign on actual authority or apparent

• Outsiders rely on apparent authority, as they often do not know whether the person signing has actual authority or not

• If a manager of a corporation signs a contract, the corporation can be liable even if that manager did not have signing authority, as long as their role made it seem reasonable to outsiders for them to sign it

• You should try to limit apparent authority to the outside world

Promoter

Someone who acts on behalf of a company before the company even exists

• Often, promoters will sign contracts before the company exists

• Unless the company ratifies and adapts that contract when it exists, then it will not be bound

• Do not sign contracts before the company exists, you will be personally on the hook if the company does not accept the contract

Criminal liability of corporations

A company can be charged for criminal offences committed by “senior officers” which is broader than identification theory (as it includes mid-level managers, not just directing minds)

• Senior officers: directing minds, managers (who may not be a directing mind, but are a senior officer)

• Identification theory was originally used to determine criminal liability (directing minds only), but it was very difficult to prove “beyond a reasonable doubt”

• These liabilities can include: fraud, environmental offences, bribery or corruption, etc

Factors for when a corporation is criminally liable

If a “senior officer” acting in the scope of their authority and intending to at least partly benefit the company:

• Actively engages in unsafe conduct

• Directs others to engage in unsafe conduct

• Knows about unsafe conduct but does nothing or not enough to stop it and injury results (important)

Senior officers are under an obligation to act when they have knowledge that an offence has been or will be committed

• There are stiffer penalties and corporate probation orders for this

Regulatory offences of a corporation

Offences under statutes rather than the criminal code, also called quasi-criminal offences

• The corporation and sometimes even its directors and officers face penalties, including civil liability for damages

• The corporation can face regulatory liability in many areas, including: taxation, human rights, employment standards, consumer protection, unfair or anticompetitive business practices, OHS, environmental protection

Duties of directors and officers and liability

Directors are elected by shareholders to manage or supervise the management of a company

• Business is usually managed by officers, appointed by the directors (president, CEO, CFO)

• Directors are ultimately responsible for activities of officers and other employees

How would it be determined that a company is primarily liable for a violation or tort committed by an employee? (test)

Courts use identification theory, and the 2 part test

2 duties of a director (same as agents)

1. Fiduciary duty: the duty to act honestly and in good faith with a view to the best interests of the corporation, not yourself (avoiding real and potential conflicts of interest)

2. Duty of competence: Must exercise the “care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances”

2 potential conflicts of interest

1. Self-dealing contracts

2. Corporate opportunities

• These can be managed by a director/officer by disclosing the conflict of interest to the company in writing, and not participating in any vote relating to the conflict of interest

Self dealing contracts

When a director or officer enters into a contract with the organization for their own personal benefit, creating a conflict of interest

• They are on both sides of the transaction, they represent the corporation, but they also personally benefit from the contract

• Ex: A director of a company sells their own property to the company at a profit without proper disclosure or approval.
  They’re acting as both seller and corporate decision-maker, which creates a conflict.

Corporate opportunities

When a director or officer takes business opportunities for themselves when they belong to the corporation.

Includes any business, investment, contract, or deal, that:

• Falls within the corporations current or expected line of business

• Would reasonably be of interest or benefit to the corporation

• The corporation has the capacity or financial ability to pursue

• Ex: A director of a real estate company learns of a great investment property through their corporate position. If they buy it personally without first offering it to the company, they may be liable for breach of fiduciary duty.

Personal liabilities of directors and officers

Directors and officers are exposed to a broad range of liabilities relating to the business of the corporation, including:

• Liability in torts and contracts

• Liability for statutory offences (such as the income tax act, must properly submit taxes to avoid the CRA)

Personal liability in tort

Directors/officers may be personally liable for torts they commit, even when acting in the best interests of the company

• This liability arguably imperils the separate existence of the corporation, it is consistent with the tort principle that each person should be held liable for their own torts

• Personal liability is almost certain for intentional torts

Personal liability in contract

Directors and officers are not generally personally liable for the corporations contracts

• The principles of agency apply, however, meaning if they act beyond the scope of their authority, they will be liable

Personal liability in statute

Directors/officers may face personal liability for breaching various statutes

• Some statutes impose potentially serious penalties, not only on the corporation but also on officers and directors for failure to comply

• Ex: environmental protection legislation, tax laws, OHS

Avoiding risk of personal liability

• Make all decisions informed decisions

• Do what is necessary to learn about matters affecting the company

• Identify problems within the company

• Stay apprised of and alert to the corporations financial and other affairs

• Regularly attend directors meetings (if you miss a meeting as a director and they make a decision, you are still on board with that decision regardless)

• Ensure you receive reliable professional advice

Liability of shareholders

• There is no duty to act in the best interests of the corporation

• You can freely compete with the corporation in which you hold a share

• You are not obligated to attend shareholder meetings, cast a vote, or read the corporations financials

• This is all true unless the shareholder is also a director or officer

When courts make shareholders personally liable

Courts may “lift the corporate veil” sometimes and make shareholders personally responsible for the debts and obligations of the company. They are reluctant to do this, except when they are sure that a company is fake and concealing the true facts

2 part test to make shareholders personally liable

For courts to make a shareholder personally liable, they must show that:

1. There is complete domination and control by the shareholder

2. The corporate form must have been used as a shield for conduct akin to fraud (on test)

Fraudulent conveyances act

If you are shifting assets around to evade creditors, the court has the right to go after those assets regardless of where they end up

Shareholder rights

3 broad categories:

• Right to vote

• Right to information

• Financial rights

These rights are allocated by directors when issuing different classes of shares

Classes of shares

• Common share

• Preferred share

Common share

A share that generally has a

• Right to vote

• Right to share in dividends

• Right to share in proceeds on dissolution (entitled to receive a portion of the remaining assets of a company is the business is dissolved)

Preferred share

Share or stock that has a preference in the distribution of dividends and the proceeds on dissolution

Right to vote (common shares)

Includes the right to:

• Attend one shareholder general meeting each year

• Be given notice of the meeting

• Attend the meeting

• Ask questions

• Introduce motions

• Have a proxy (a person authorized to exercise a shareholders voting rights)

There are situations where regardless of whether your share allows you to vote or not, you can vote. For ex, if the company is merging

Right to information (common shares)

Includes the right to:

• Inspect the annual financial statements

• Apply to the court to have an inspector appointed if it can be shown there is a serious concern about mismanagement

• Inspect certain records, including minute books

• Know whether directors have been purchasing shares of the corporation

Financial rights (common shares)

Includes the right to:

• Receive any dividend declared by the corporation

• Share in the assets of a corporation on dissolution

May include preemptive rights:

• Buy a proportionate share of any new shares issued by the company before they are offered to the public or other investors.

These depend upon whether your shares allow you do to this

Dissatisfied shareholder remedies

If a shareholder is dissatisfied, they may:

• Sell their shares if it is a public company

• Exercise statutory remedies if they do not want to sell their shares

• Selling shares is hard to do if you are dealing with a private company, which is why a shareholder may choose to exercise their statutory remedies

Statutory remedies (test)

Remedies provided for dissatisfied shareholders.

Includes:

• Dissent and appraisal

• Derivative action

• Oppression remedy

Dissent and appraisal

If the company is going to do something big and you dont like it, you have the right to have the company buy you out

• The company has to appraise (assess) the value of your shares to pay you

• Actions by a company to bring this remedy up may include: merging with another company, selling of its assets, etc

• This is not an easy thing to go through

Derivative action

A legal claim brought by a shareholder on behalf of the corporation when the directors or officers fail to act in a situation where action is clearly needed to protect the company’s interests

Ex: A key employee is stealing confidential information, and a shareholder discovers this and informs the board of directors. The directors do nothing, possibly because they’re loyal to the employee or ignoring the problem. The shareholder can ask the court to allow them to bring a claim (or take action) on behalf of the company.

• To get court approval, the shareholder must prove good faith and that you are acting in the best interests of the company

Oppression remedy

When actions or omissions of the corporation or its officers and directors have unfairly disregarded or prejudiced the interests of the shareholders, you can apply for an oppression remedy.

• Directors or officers must be: oppressive, unfairly prejudicial, or unfairly disregard the stakeholders reasonable expectations

• Doesnt just apply to shareholders, but directors and officers, creditors, key employees, etc

• This remedy is very powerful. It ensures the interests of the shareholders are met

• Ex: Bob owns 51%, Sue owns 49%, and they both agree to run the company as equal partners. One day, Bob uses his majority to vote Sue off the board, making himself the sole director and president. Bob then freezes Sue out of management and decision-making. Even though Bob acted legally under corporate voting rules, Sue can go to court under the oppression remedy and say “we had a shared understanding that I would be actively involved in running the business. Bob unfairly disregarded that expectation”

Shareholders agreement

Shareholders can have agreements amongst themselves (contracts amongst themselves, etc)

• MC on test

Unanimous shareholders agreement

Agreement among all shareholders that restricts the powers of the directors to manage the corporation, and gives those powers back to the shareholders.

• All shareholders must sign

• They can all agree what happens to the directors

Corporations paying dividends to shareholders

When it comes to dividends, there is a nuance in the law that you are not allowed to pay dividends to shareholders when you cannot pay the companies bills.

• This includes if it would jeopardize its abilities to pay its own debts and if it would make the company insolvent

• If directors consent to paying dividends and either of these are true, they are personally reliable to restore to the corporation any amount paid

Termination of a corporation

A corporation can be terminated by:

• Winding up: dissolving a corporation

• Lapse: neglect to file an annual report or to follow other reporting requirements

• Court order: shareholder was wrongfully treated and this is the only way to do justice (this is usually in small, privately held corporations)

• Bankruptcy: usually leads to dissolution of the corporation