WHAT IS A CORPORATION?
Posted Sept 14, 2006 (please look for periodic updates)
Introduction
The corporation is the most common form of business organization in
Canada and other countries in the developed world. The corporate form is
used by all types and sizes of business because it provides certain legal and
economic advantages for those forming the corporation.
One way in which the corporate form differs from sole proprietorships and
partnerships is that, unlike the latter, the corporation does not come into
existence merely because individuals or groups start to operate a business.
A corporation comes into existence only when relevant documents are filed
with the appropriate government office under either the federal Canada
Business Corporations Act (CBCA) (RSC 1985, c-C-44) or one of its
provincial counterparts. Once incorporated, the company is bound by the
laws of the jurisdiction in which it was incorporated. The majority of
provinces (including Alberta: see The Business Corporations Act, SA 1981,
c. B -15) follow the federal model of the CBCA, though the effect of the
laws in the other provinces is the same as for companies incorporated in the
federal jurisdiction and the provinces following the federal model.
Under the CBCA and the provincial acts that follow it, the following items
must be filed:
 articles of incorporation
 a name search report on the proposed name of the
corporation
 the fee
These steps are significantly less complicated than in the 19th Century where
a proposed corporation required a specific legislative act for its creation, and
limitation of activity. Also, early corporations frequently had a limited life
span determined by legislation.
Articles of incorporation
These articles set out the fundamental characteristics of the corporation.
These comprise its name, the class and number of shares authorized to be
issued, any restrictions on transferring shares, the names and number of
directors, and any restrictions on the business that the corporation may
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conduct. Once the appropriate documents are filed along with the fee, a
corporation receives a certificate and can commence business.
Fees
The fee for incorporation varies across Canada. In Alberta the fee is $100,
while the fee in Prince Edward Island is $2600, payable annually.
Organizational matters
While a company can start doing business as a corporation upon receiving
certification, other matters must be attended to. Directors named in the
documents of incorporation must meet to pass a resolution to issue shares to
the shareholders. The directors also determine at the first meeting such
matters as:
 what notice must be given of meetings of directors and
shareholders;
 what constitutes a quorum
 who can sign contracts on behalf of the corporation
 what officers the corporation will have.
Such matters are set out in by-laws (or equivalents) and take effect when
approved by directors and shareholders.
Shareholders Agreement
If there are few shareholders, the final organizational step is usually to
establish a contract between the corporation and the shareholders. While the
relevant corporate legislation sets default rules, shareholders are free to
establish different rules, designed to meet their needs. This can include
specifying the matters that need shareholder approval and the degree of
shareholder support that they need. This is discussed later in “corporate
governance”.
Separate Legal Existence
Unlike sole proprietorship or partnership, a corporation has separate legal
existence to that of the individual shareholders, directors or other persons.
The corporation itself carries on business as a legal entity. It owns property,
and incurs liability for breach of contract, torts, or criminal acts. In most
ways, a corporation has the same legal rights, privileges, and powers as a
natural person.
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While shareholders have a bundle of legal rights in relation to the
corporation through their ownership of shares, they do not own the
business carried out, or the property owned, by the corporation. This
differs from sole proprietors and partners, who own the business, possess the
rights of owners and are directly responsible for the liabilities of the
business. Some implications of the separate legal existence of corporations
are:
 a shareholder can be an employee or creditor of the
corporation (see the case Salomon v. Salomon & Co. [1897]
AC 22 (HL).
 The corporation is unaffected legally if a shareholder dies or
withdraws from the business.
 The corporation is treated separately for income tax
purposes. Income or losses that are generated through the
business are attributed to the corporation and are taxed at the
corporate level. On the other hand shareholders are taxed
only when they receive a taxable benefit from the
corporation, such as a dividend. A dividend is a payment of
cash or property to a shareholder by the corporation,
approved by the directors. It is one way that shareholders
receive a return on their investment.
Limited liability
It is often said that shareholders have “limited liability” for the financial
obligations of the corporations. Strictly speaking shareholders have no direct
liability for the corporation’s obligations. The statement that shareholders
have limited liability means that the maximum loss that a shareholder can
incur is the value of the money they transfer to the corporation in return for
their shares.
Creditors, employees, and others can demand to be paid money owed out of
the corporation’s assets but cannot claim payment from the shareholders
personally. If all the corporation’s assets are taken by creditors, the shares
will likely be worthless and in that respect shareholders may lose. That is,
shareholders lose their investment but nothing more.
What limited liability of shareholders means in practice is that risk of loss is
shifted from shareholders of a corporation to its creditors and others such as
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employees. In the 19th Century, public policy in western countries was
geared to encourage individuals to invest in corporations, in order to foster
economic development. Accordingly, limited liability of corporations (and
no legal liability of shareholders for the corporation’s debts) was created as
an incentive to shareholders to invest in corporate activities.
Exceptions to limited liability
It is noted in more detail below that, as a condition of providing credit, a
creditor may require a personal guarantee from a creditworthy shareholder.
Such a contractual agreement would be binding against the creditworthy
shareholder, in the event that corporate assets were insufficient to pay the
creditor. I am unsure at present how frequently such arrangements are made
in Canada.
Further exceptions are sometimes made by courts to the concept and practice
of limited liability. Judges have been known to “pierce the corporate veil”
and permit a creditor to claim directly against a controlling shareholder if the
corporation has insufficient assets to pay the creditor’s claim. This does not
deny the separate legal existence of the corporation from the shareholders
but allows the court on a case by case basis to grant relief to a creditor
directly against a shareholder.
For example, in Big Bend Hotel Ltd. v. Security Mutual Casualty Co.
(1979) BCLR 102 (SC), Kumar established a corporation for the purpose of
obtaining insurance that he knew would not be provided to him personally.
The insurance company had cancelled an earlier fire insurance policy due to
suspicious circumstances of a fire that occurred in a previous hotel operated
by Kumar. When the Big Bend Hotel corporation experienced a fire, the
insurance company did not pay out, as Kumar had failed to disclose the
previous fire. The fact that the Big Bend Hotel was a separate legal entity
from Kumar did not relieve him of his duty to report the previous fire in the
first hotel operated by him.
Piercing of the corporate veil is typically undertaken by the courts only
when there is fraud, other impropriety, or unfairness. Accordingly, the
person bringing legal action risks legal costs if he, she or it cannot establish
impropriety or substantial unfairness. However, it is the piercing of the
corporate veil is generally the exception rather than the rule as it remains
legal doctrine that society benefits from a law wherein shareholders have a
separate legal existence from the corporations in which they hold shares.
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Are limited liability and the corporate veil good public policy?
While there is evidently a public benefit in encouraging shareholder
investment in bona fide corporations, the case Walkovszky v. Carleton 223
NE 2d 6 (NY CA 1966) illustrates the arguably negative consequences to
society that flows from the use of the corporate form to transfer risk from
one party to another. Carleton operated a taxi business, using a number of
separate corporations, each of which owned two cabs. Carleton owned all
the shares of each corporation and managed each corporation’s business.
Each corporation maintained the minimum amount of accident insurance
coverage required by law - $10,000. Walkovszky was hit by a cab owned by
one of the corporations created and managed by Carleton, and suffered
serious injuries. She sued the corporation that owned the cab and was
awarded damages significantly higher than the amount of insurance provided
by the insurance policy. As the defendant corporation had assets of only two
cars, the plaintiff was unable to obtain the full damages awarded.
At least two questions arise. First, should it be lawful to operate a taxi
business with insurance coverage so far below what might be reasonably
expected as necessary to compensate victims of the company’s negligence.
Second, is this a case where the court should disregard the separate legal
existence the corporation and Carleton?
A further question raised in an article “Limited Liability, Tort Victims,
and Creditors” David W. Leebron Columbia Law Review, Vol. 91, No. 7
(Nov., 1991), pp. 1565-1650 (available on line through the U of L
Library) is whether the legal doctrine of limited liability conflicts with an
underlying principle of tort liability that seeks to discourage persons
including businesses from engaging in activities that expose others to
unreasonable risks. The outcome of the Carleton case illustrates the opinion
raised in the movie The Corporation that corporations are effective
“externalizing” machines, that is, they pass on the risks and costs of doing
business to other members of society. Do you consider the corporation
(effectively Carleton) was justified in his creation of several corporations
with virtually no assets?
Corporate governance
The underlying goal of the rules of corporate governance is to maintain a
balance between providing incentive for entrepreneurs to start and carry on
their businesses, investors to invest in businesses and managers to work for
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businesses. A related concern is how to render the corporation accountable
to investors without imposing on management excessive burdens that will
interfere with their management of the corporation or deter them from
working for the corporation.
The rules of corporate governance in Canada involve the distribution of
power and responsibility of directors, officers, and shareholders as set out in
the Canadian Business Corporations Act (CBCA) and most provincial
statutes in Canada.
There is a legal distinction between the owners and managers of a
corporation. By a majority vote, the shareholders elect a board of directors
to manage the corporation. At subsequent shareholder meetings, directors
can be replaced by directors newly-elected by the shareholders. It should be
noted that shareholders can be directors and directors can be shareholders.
The directors typically appoint officers and delegate to them responsibility
for managing the corporation. The directors not the shareholders have the
authority to monitor and supervise officers’ management of the
corporation’s business. Unlike partners, shareholders are not agents of the
firm. However, in small corporations, shareholders may also be directors and
officers. In large corporations, directors are unlikely to own all the shares
but often do hold some. Large corporations typically have thousands of
shareholders. Officers can also be shareholders.
Legal Obligations of the Management of the Corporation
Standards of behaviour are imposed by statute on management to ensure
accountability of the corporation to shareholders. Such standards include
fiduciary duty and duty of care. Consideration is given to the procedures
available to the shareholders to enforce the standards.
Obligations of the corporation to its creditors, employees and to the general
public also exist in the law of contracts, torts, various regulatory statutes
(such as bankruptcy, environmental and employment laws), and the Criminal
Code of Canada. These laws may impose penalties on management or on the
corporation or impose a duty to compensate an injured party or order the
corporation to cease some activity.
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Duties and Responsibilities of Directors
A director has a duty to conduct the affairs of the corporation in the best
interests of the corporation. Courts have traditionally interpreted the best
interests of the corporation as synonymous with the best interests of
shareholders. This is not always the case but the interests of shareholders
must be considered by management (the directors) as paramount. The duty
of directors is defined in law as “fiduciary” demanding actions of utmost
good faith to serve the interests of the corporation and not one’s personal
interest where such interests diverge. The CBCA s. 122(1) (and various
provinces) also imposes a duty on directors a statutory duty to exercise the
powers and duties of their office honestly with the care and skill of a
reasonably careful and prudent person in similar circumstances.
The fiduciary duty means for example that a director is precluded from
engaging in any activity that might permit the director to make a profit at the
corporation’s expense. The director must not use the corporation’s name to
obtain a personal benefit, nor use his or her position in the corporation for a
personal profit that rightfully belongs to the corporation.
A director may engage in transactions with the corporation but care must be
taken to avoid conflict of interest. As a rule a director must disclose to the
other directors his or her interest in a contract or property of the corporation.
He or she must refrain from voting or discussing the matter at a directors’
meeting. In Ontario the law requires shareholders’ approval of corporate
contracts in which a director has an interest.
A director’s potential conflict of interest does not prevent his or her
addressing the matter at a shareholders’ meeting if he or she is a shareholder.
However, the action of a shareholder at such a meeting cannot be fraudulent,
illegal, or oppressive to other shareholders who may oppose a decision
related to a director’s conflict of interest.
Nevertheless, if a director does not act illegally, fraudulently or oppressively
in such matters, his or her shareholding may be sufficient to enable the
shareholders’ vote to pass in favour of the director’s business with the
corporation. In North-West Transportation v. Beatty, (1887) 12 App. Cas.
589, a director/shareholder entered into an agreement with the corporation to
sell it a steamship. At the shareholders’ meeting to consider ratification of
the contract, the director voted in favour, thus allowing the deal to go
through. The court upheld this outcome and stated:
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The general principle applicable to such cases is well established.
Unless some provision to the contrary is to be found in the charter
or other instrument by which the company is incorporated, the
resolution of a majority of the shareholders duly convened, upon any
question with which the company is legally competent to deal, is
binding upon the minority, and consequently upon the company,
and every shareholder has the perfect right to vote upon any such
question, although he may have a personal interest in the subject matter
opposed to, or different from, the general or particular interests of
the company.
If a director/shareholder has a particular advantage as an insider over a
mere shareholder in doing business with the corporation is it
appropriate that his vote should be decisive in ratifying the contract
that benefits him?
A director should not contract with third parties on matters that might be of
interest to the corporation. If a director bought a property that the
corporation might have an interest in buying the courts this would be a
violation of his duty to the corporation. A court might remedy this by
invoking the doctrine of corporate opportunity and rule that the property
was bought by the director in trust for the company.
Insider trading by directors (also officers and shareholders owning 10% or
more of the shares of a corporation) is illegal. A director may lawfully buy
and sell shares of the corporation and retain any profit. However, if directors
use information obtained by virtue of their position in the corporation, and
the information is used to the detriment of others, they may be liable to
compensate others who suffer losses as a direct consequence of the
directors’ actions. Most jurisdictions require monthly reporting by directors
on their personal trading of shares. This is made available to the public as a
deterrent to insider trading. It is unclear to me how successful this is. It is a
fairly heavy burden to establish that trading was the result of insider
information. It is also difficult to establish that losses of others were directly
caused by the insider trading. It is also open to insiders to share information
with privileged outsiders.
It is notable that insider trading appears not to be criminal. One wonders
why? If I recklessly or intentionally wreck your car, I am required by law to
compensate you and to answer criminal charges. Is insider trading a similar
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incursion on the property of others worthy of criminal charges? Note the
burden of proof in a criminal charge is much higher than the burden in civil
cases.
Another case testing the extent of fiduciary duty is Canadian Aero Service
Ltd. v. O’Malley et al. (1973) 40 D.L.R. (3d) 371. Directors of a company
resigned and later used information obtained as directors of the company to
establish a new corporation. Although the actions and benefits occurred after
their resignation from the company the defendants were held to be in breach
of their fiduciary duty. Once more, they were not charged or convicted of a
crime.
Case summary from Willes “Contemporary Canadian Business Law” (7th
edition) p. 297; see also Financial Post Sept. 19, 2000.
“Glen Harper, the former CEO of Golden Rule Resources Ltd., was sent to
jail yesterday, albeit for only six hours. Mr. Harper was handed two
concurrent one-year sentences and fined nearly $4 million for insider trading
offences, marking the first time in almost a decade regulators have secured
jail time for the offence. But by the afternoon, he was free on bail, pending
an appeal. He was to return to his Calgary home where he was ordered to
reside as part of the conditions of his release.
Mr. Harper was found guilty of hiding poor soil sample results at the same
time he was selling millions of dollars of Golden Rule shares for his own or
his immediate family’s personal gain. In addition to jail time, Mr. Harper
received on of the heftiest fines ever imposed on an individual.
From January 3, 1997 to May 6, 1997, Mr. Harper sold shares for $4 million
and made stock options for $1 million, while covering up samples that
suggested the company’s gold find in Ghana was not as promising as had
been suggested.
Note The Superior Court of Ontario dismissed Mr. Harper’s appeal, but
reduced the length of the prison sentence and reduced the amount of the fine.
See report of discipline hearing of Mr. Harper’s professional association at:
http://www.apegga.org/whatsnew/peggs/Web01-04/discipline_harper.htm
Who and what are being protected in the prosecution of insider trading
offences?
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Directors may be personally liable to the public. Environmental laws may
penalize not only polluting corporations but directors of the corporation. In
Ontario, in Regina v. Bata Industries Ltd. Bata, Marchant and Weston
(1992) 9 O.R. (3d) 329 the company allowed toxic waste to leak into the soil
and ground-water. The directors owed a duty of due diligence and were
required under the statute to prove they were not negligent in the escape of
the poison. Only one director was successful in doing so. The others were
fined.
The importance of the Bata case is discussed at :
http://www.ns.ec.gc.ca/enforcement/due_diligence.html as shown below.
The term "all reasonable care" is synonymous with "due diligence".
In the historic ruling on R. v. Sault Ste Marie, Dickson J. (as he then was)
created the class of strict liability offences. In that ruling he defined these strict
liability offences as:
"Offences in which there is no necessity for the prosecution to prove the
existence of mens rea; the doing of the prohibited act prima facie
imports the offence, leaving it open to the accused to avoid liability by
proving that he took all reasonable care. This involves consideration of
what a reasonable man would have done in the circumstances. The
defence will be available if the accused reasonably believed in a
mistaken set of facts which, if true, would render the act or omission
innocent, or he took all reasonable steps to avoid the particular event."
([1978]2 S. C. R. 1299, (1978), 40 C. C. C. (2d)353 at 373,374.)
What sorts of evidence will be accepted by the courts as being valid examples
of due diligence? In the case of R. v. Bata Industries Ltd. (1992, Unreported),
Judge Ormston of the Ontario Provincial Court sets out a useful checklist:
" I ask myself the following questions in assessing the defence of due
diligence:


Did the Board of Directors establish a pollution prevention "system".
Was there supervision or inspection? Was there improvement in
business methods? Did he exhort those he controlled or influenced?
Did each Director ensure that the Corporate officers have been
instructed to set up with a system sufficient within the terms and
practices of its industry of ensuring compliance with environmental
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



laws, to ensure that the officers report back periodically to the Board of
the operations of the system, and to ensure that the officers are instructed
to report any substantial non-compliance to the Board in a timely
manner?
The Directors are responsible for reviewing the environmental
compliance reports provided by the officers of the corporation but are
justified in placing reasonable reliance on reports provided to them by
corporate officers, consultants, counsel or other informed parties.
The Directors should substantiate that the officers are promptly
addressing environmental concerns brought to their attention by
government agencies or other concerned parties including shareholders.
The Directors should be aware of the standards of their industry and
other industries which deal with similar environmental pollutants or
risks.
The Directors should immediately and personally react when they have
notice the system has failed."
Defences Related to Due Diligence
i.
Reasonable Mistake of Fact
This defence goes to the mental element of a crime and so is available
for both strict liability and mens rea (intentional, reckless or negligent)
offences. "In the strict liability context, the defendant's mistake must not
only be honest, but (using an objective standard) must also be
reasonable. To state the test another way, to establish lack of fault the
accused must establish that he or she was honestly mistaken on
reasonable grounds..." (1992), 2 J.E.L.P. 214, at 215).
ii.
Officially Induced Error
Also known as "mistake of law", this defence is to be distinguished from
mistake of fact. This defence may be available if information or advice
is provided by a person responsible for administration of the law which
leads the defendant to believe that the law does not apply to their
particular situation.
1.
2.
3.
the actor must advert to his legal position
the actor must seek legal advice from an official
that official must be one who is involved in the administration of
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4.
5.
6.
7.
the law in question
the official must give erroneous advice
the erroneous advice must be apparently reasonable
the error of law must arise because of this erroneous advice
the actor must be innocently misled by the erroneous advice - that
is, he or she must act in good faith and without reason to believe
that the advice is erroneous
(R. v. Johnson and Wilson (1978(, 78 N.B.R. (2d) 411(Prov. Ct.); R.
v. Imperial Oil Ltd. (August 12, 1988) (Man. Prov. Ct.) [unreported],
summarized in (1988), 6 W.C.B. (2d)11.)
iii.
Abuse of Process
Abuse of process is not, technically-speaking, a defence at all but rather
it relies on the court's inherent jurisdiction to halt proceedings before it
feels that the judicial process is being improperly used. The decision to
abandon proceedings is taken when it is clear that prosecutorial powers
are being used in an unfair, oppressive or vexatious manner.
In the context of environmental prosecutions, the "defence" has
occasionally been raised when charges have been laid despite some type
of understanding or agreement between the defendant and the
government that no prosecution would commence, so long as the
defendant followed a negotiated schedule for reducing discharges.
The singling out of one individual or company over others is not, in and
of itself, an abuse of process. The case law on abuse of process suggests
that a successful abuse of process motion would involve evidence that
the defendants had relied in good faith on the authorities and had
suffered some prejudice as a result of unfair dealings by the authorities.
R. v. Simon (January 24, 1992), file no. 1178/90 (Ont. C.A.)
[unreported] and R. v. Jordan Station Wholesale Florist Ltd. et al
(November 5, 1991) (Ont. CT. Prov. Div., McGowan J.) [unreported]
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The foregoing legal opinion appears to indicate that corporate directors and
officers have challenging responsibilities to prevent harm to persons outside
the corporation. The efficacy of such legal obligations depends as always on
willingness to comply voluntarily with the rules, and the extent to which the
supervising authority monitors and enforces compliance. In The Corporation
one commentator noted that the decision to comply was often a business
decision based on assessment of the risk and cost of prosecution against the
cost of compliance.
Is there a danger that the ideologies of the primacy of self-interest and
of the corporate bottom line as the measure of societal wealth will
render it virtually impossible to protect the environment and those who
inhabit it by legal prohibitions on corporations?
Is there also a concern that the dependency of investors on the survival
of a corporation renders it problematical to impose fines on
corporations that might precipitate its demise?
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