Municipal law, Deborah Curran, spring 2004
Business Associations, Mark Gillen, Spring 2005
This is just an edited/reorganized version of Mark Gillen’s notes (including class notes/examples/etc).
For exam:
1) Five steps for each question (assume reader knows nothing, lay out all basics): a) Identify issue b) State the law i) Generally don’t state a point and then in brackets cite the case unless case is very clear on that point – instead, describe facts, decision and rationale of the case and then compare to current fact pattern c) Apply to the facts and analyze i) Address each and every element even if obvious (e.g. is it a ‘person’) ii) Mention if need additional facts d) Consider policy considerations i) Two steps here:
(1) State the policy and its rational
(2) Apply to the facts ii) Example policy considerations:
(1) Protect reasonable reliance
(2) Avoid unjust enrichment
(3) Assign responsibilities according to least cost avoidance (who can best assess risk and who can best control risk, and if large $’s at risk who should have been more careful)
(4) Consider whether there is a market mechanism that reduces need for courts
(5) Maintain mutual benefit
(6) Provide deterrence
(7) Distributional concerns
(8) Promote full cost pricing
(9) Maintain trust (e.g. public trust in professions)
(10) costs)
Avoid future contracts/deals having to consider every eventuality (transaction
(11)
(12)
(13)
Avoid third parties having to confirm everything
Help struggling businesses survive
Keep credit cheap e) Make a conclusion of likely result
2) Include your rough notes with answer in case run out of time
3) Remember: a) First question for any business: i) Was it incorporated (just because it sounds like it’s incorporated, or a partnership, doesn’t mean it necessarily is: Smith & Sons Co. might be a sole proprietorship) ii) If so, where and how (under which statute, or its own statute, or letters patent, or Crown
Charter, etc)? b) For setting up closely-held corporations , see “Powers of dirs” under Corporate Governance c) People acting on behalf of corporations are agents, so all the agency law applies as far as it’s not displaced by the corporate law d) Check the Act itself for exact wording of sections e) Sole proprietor/partners/corporation can be vicariously liable for employees f) Any form of business can try to get insurance g) Unlimited liability forms of business can try to get limited liability through no-recourse loans
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Contents
Ostensible auth: if no actual auth, still K & 3 rd
party claim v principal if represntatn & reas relianc ......... 17
Breach of warranty of authority: if no actual or ostensible auth, still claim by 3 rd
party v. agent ............... 19
party on contract (unless 3 rd
parties & ‘in common’: not partners if only co-owners or only sharing gross returns ........ 47
parties & ‘in common’: policy considerations (reliance, unjust enrichment, LCA) ............ 51
parties & ‘in common’: cases on partnrship existnce (Lepage, Cox, Pooley, Martin) ........ 54
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3
party constructive notice of restrictd powers unless indoor mgmt rule, limited by BC/CBCA ..... 181
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Cases / Statutes / Articles
A. Salomon v. A. Salomon & Company, Limited ....................................................................................... 105
A.E. Lepage v. Kamex Developments
(1977) 78 D.L.R. (3d) 223, aff’d (1979) 105 D.L.R. (3d) 84n ........ 54
A.G. Can. v. A.G. Man.
, [1929] 1 D.L.R. 369 .............................................................................................. 91
ADGA Systems International Ltd. v. Valcom Ltd. (1999), 43 O.R. (3d) 101 ............................................. 137
Alberta Gas Ethylene Co. v. M.N.R.
, [1989] 41 B.L.R. 117 (FTD) Affd [1990] 2 C.T.C. 171 (FCA.) .... 123
American Law Institute (ALI), Principles of Corporate Governance and Structure; Restatement and
Recommendations (Tentative Draft No. 1, 1982) ...................................................................................... 193
Asbury Railway Carriage & Iron Co. v. Riche (1875), L.R. 7 H.L. 653 ................................................... 176
Automatic Self-Cleansing Filter Syndicate Co. Ltd. v. Cunninghame [1906] 2 Ch. 34 (C.A.) ................. 214
Backman v. Canada (2001), 196 D.L.R. (4 th
) 193 (S.C.C.) ......................................................................... 36
Bank of Nova Scotia v. Williams (1976), 12 O.R. (2d) 709 ....................................................................... 118
Barnes v. Andrews 298 F. 614 (1924 S.D.N.Y.) ........................................................................................ 201
Barron v. Potter [1914] 1 Ch. 895 ............................................................................................................. 216
Barwick v. English Joint Stock Bank (1867), L.R. 2 Ex. 259 ...................................................................... 26
Berger v. Willowdale A.M.C. (1983), 145 D.L.R. (3d) 247 ............................................................... 135, 138
Better Off Dead Productions Ltd. v. Pendulum Pictures (2002), 22 B.L.R. (3d) 122 (B.C.S.C.) ............. 139
Black v. Smallwood & Cooper (1966), 117 C.L.R. 52 (High Court of Australia) ..................................... 114
Blair v. Consolidated Enfield Corp. (1993), 15 O.R. (3d) 783 .................................................................. 221
Bonanza Creek Gold Mining v. The King [1916] 1 A.C. 566 (P.C.) ........................................................... 89
Bowater Canadian Ltd. v. R.L. Crain Inc. & Craisec Ltd. (1987), 62 O.R. (2d) 752 ............................... 157
British Merchandise Transport Co. Ltd. v. British Transport Commission , [1961] 3 All E.R. 495 .......... 127
Brown v. Duby (1980), 111 D.L.R. (3d) 418 ............................................................................................. 229
Buff Pressed Brick Co. v. Ford (1915), 33 O.L.R. 264, 23 D.L.R. 718 (App. Div.) ................................. 160
Bushel v. Faith, [1970] A.C. 1099 (H.L.) .......................................................................................... 155, 186
Canada Deposit Insurance Corp v. Canadian Commercial Bank (1992), 97 D.L.R. (4 th
) 385 (S.C.C.) .... 65
Canadian Indemnity Co. v. A.G. B.C. [1977] 2 S.C.R. 504 ......................................................................... 92
Charlebois v. Bienvenue [1968] 2 O.R. 217 (Ont. C.A.) ........................................................................... 227
Chiang v. Heppner (1978), 85 D.L.R. (3d) 487 (B.C.) .............................................................................. 131
Citizens Insurance Co v. Parsons (1881), 7 App. Cas. 96 at 116-17 (P.C.) ................................................ 89
Colonial Building and Investment Association v. A.G. Quebec (1883), 9 App. Cas. 157 (P.C.)................. 91
Conference Board of Canada, Canadian Directorship Practices: A Critical Self-Examination (1977) ... 193
Cooper v. Premier Trust Co. [1945] O.R. 35, [1945] 1 D.L.R. 376 .......................................................... 235
Corkum v. Lohnes (1981), 81 A.P.R. 477 (N.S. App. Div.) ...................................................................... 130
Cox v. Hickman (1860), 8 H.L. Cas. 268 ..................................................................................................... 55
Dixon v. Deacon, Morgan, McEwen, Easson (1989) 41 B.C.L.R. (2d) 180 (B.C. S.C.) ........................... 206
Dodge v. Ford Motor Co., 170 N.W. 668 (1919 Michigan Supreme Court) ............................................. 153
Dominion Sugar v. Warrell (1927), 60 O.L.R. 169 (Ont. C.A.) ............................................................ 63, 64
Duvergier v. Fellows (1828) 5 Bing. 248 Bext, c.5 ..................................................................................... 85
Edmonton Country Club v. Case [1975] 1 S.C.R. 534 .............................................................................. 240
Ernst & Young v. Falconi (1994), 17 O.R. (3d) 512 .............................................................................. 26, 46
Fergusson v. Imax (1983), 43 O.R. (2d) 128 (C.A.) .................................................................................. 153
Fraser v. MNR , [1987] 1 C.T.C. 2311, (1987) 87 D.T.C. 250................................................................... 207
Freeman & Lockyer v. Buckhurst Park Properties (Mangal) Ltd.
, [1964] 2 Q.B. 480 (H.L.) .............. 13, 18
Gelhorn Motors Ltd. v. Yee (1969), 71 W.W.R. 526 (Man. C.A.) ............................................................ 130
Gilford Motor Company Ltd. v. Horne, [1933] Ch. 935 (C.A.) ......................................................... 122, 124
Gordon v. The Queen [1961] S.C.R. 592 ..................................................................................................... 36
Grace v. Smith (1775), 2 Wm. Bl. 998 ........................................................................................................ 48
5
Great West Saddlery Co. Ltd. v. The King [1921] 2 A.C. 91, 58 D.L.R. 1 (Ont. P.C.) ............................... 90
Greenpeace Foundation of Canada v. Inco. Ltd. (Feb. 23, 1984, Ont. High Court) ......................... 231, 232
Gregorio v. Intrans-Corp. (1984), 18 O.R. (3d) 527 (C.A.) ...................................................................... 123
Haughton Graphic Ltd. v. Zivot (1986), 33 B.L.R. 125 ............................................................................... 71
Hayes v. Canada-Atlantic & Plant S.S. Co. 181 F. 289 (1st Cir. 1910) .................................................... 189
Howard Smith v. Ampol Petroleum ............................................................................................................ 203
International Power Co. v. McMaster University (sub nom Re Porto Rico Power Co.) [1946] S.C.R. 178
.................................................................................................................................................................... 149
Jacobsen v. United Canso Oil & Gas Ltd. (1980) 11 B.L.R. 313 (Alta. Q.B.) ......................................... 156
John Deere Plow Co. v. Duck ...................................................................................................................... 90
John Deere Plow Co. v. Wharton (1914) 18 D.L.R. 353 (P.C.) .................................................................. 90
Kamin v. American Express Co., 383 N.Y.S. 2d 807 (Sup. Ct., N.Y. County) affd, 54 A.D. ed 654, 387
N.Y.S. 2d 993 ............................................................................................................................................. 204
Kelner v. Baxter (1866), L.R. 2 C.P. 174 (Common Pleas) ....................................................................... 112
Kennerson v. Burbank Amusement Co. 260 P. 2d. 823 (Calif. C.A. 1953) ............................................... 191
Kosmopolous v. Constitution Insurance Co. of Canada , [1987] 1 S.C.R. 2 ...................................... 110, 121
Landmark Inns v. Horeak , [1982] 2 W.W.R. 377 ...................................................................................... 117
Lee v. Lee’s Air Farming Ltd. [1961] A.C. 12, [1960] 3 All E.R. 420 ...................................................... 109
Lloyd v. Grace, Smith & Co.
, [1912] A.C. 716 ............................................................................................ 25
London Drugs v. Kuehne & Nagel (S.C.C.) ............................................................................................... 138
Lymburn v. Mayland , [1932] A.C. 318 (P.C.).............................................................................................. 92
Macaura v. Northern Assurance ................................................................................................................ 109
MacKay v. Commercial Bank of New Brunswick (1874), L.R. 5 P.C. 394 .................................................. 26
Mangen v. Terminal Cabs Ltd.
, 272 N.Y. 676 (1936 N.Y.A.D.) ............................................................... 128
Martin v. Peyton 158 N.E. 77 (1927 N.Y. C.A.) ......................................................................................... 59
McClurg, R. v.
, [1990] 3 S.C.R. 1020 ........................................................................................................ 144
McFadden v. 481782 Ont. Ltd. (1984), 47 O.R. (2d) 134 ......................................................................... 136
McKnight v. Hutchinson (2002), 28 B.L.R. (3d) 269 (B.C.S.C.)................................................................. 43
Medical Committee for Human Rights v. SEC , 432 F.2d 659 (1970) ........................................................ 232
Melvin Eisenberg, The Structure of the Corporation (1976) ..................................................................... 193
Miles v. Clark , English ................................................................................................................................. 39
Montreal Public Service Co. v. Champagne (1916), 33 D.L.R. 49 (P.C.) ................................................. 198
Multiple Access v. McCutcheon (1982), 18 B.L.R. 138 (SCC) ................................................................... 92
Myles Mace , Directors: Myth and Reality (1971) ..................................................................................... 193
Newborne v. Sensolid (Great Britain) Ltd.
, [1953] 1 All E.R. 708 (C.A.) ................................................ 113
Nordile Holdings Ltd. v. Breckenridge (1992), 66 B.C.L.R. (2d) 183 (B.C.C.A.) ...................................... 72
Ooregum Gold Mining Co. Ltd. v. Roper [1892] A.C. 125 (H.L.) ............................................................ 163
PCM Construction Control Consultants Ltd. v. Heeger , [1989] 5 W.W.R. 598 ....................................... 140
People’s Department Stores Inc. v. Wise
(2002), 244 D.L.R. (4 th
) 564 (S.C.C.) .............. 202, 203, 210, 213
Pooley v. Driver (1876), 5 Ch. D. 458 ......................................................................................................... 57
Rafiki Properties Ltd. v. Integrated Housing Development Ltd. (1999), 45 B.C.L.R. (2d) 316 ................ 139
Re Barsh and Feldman (1986), 54 O.R. (2d) 340 (Ont. H.C.) ................................................................... 224
Re Brazilian Rubber Plantations and Estates Ltd.
, [1911] Ch. 425 .......................................................... 200
Re Canadian Javelin Ltd. (1977) 69 D.L.R. (3d) 439 (Que. Sup. Crt.) ..................................................... 226
Re Canadian Pacific Ltd. (1990), 68 D.L.R. (4 th
) 48 (Alta. C.A.)............................................................. 150
Re Canadian Tractor Co. (1914), 7 W.W.R. 562 (Sask S.C.) ................................................................... 160
Re Cardiff Savings Bank , [1892] 2 Ch. 100 ............................................................................................... 200
Re City Equitable Fire Insurance Co. Ltd.
, [1925] Ch. 427 (C.A.) ................................................... 201, 208
Re Fort [1897] 2 Q.B. 495 ........................................................................................................................... 65
Re Introductions Ltd. [1970] Ch. 199 ........................................................................................................ 178
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Re Marshall (1981) 129 D.L.R. (3d) 378 .................................................................................................. 220
Re Morris Funeral Service Ltd. (1957) 7 D.L.R. (2d) 642 (Ont. C.A.) ..................................................... 224
Re Opera Photographic Ltd. [1989] 1 W.L.R. 634 (Ch.D.) ...................................................................... 223
Re Paramount Publix Corp.
, 90 F. 2d 441 (1937, U.S. Court of Appeal, 2d Circ.) .................................. 197
Re Routley's Holdings Ltd. [1960] O.W.N. 160 ......................................................................................... 225
Re Royalite Oil Co.
, [1931] 1 W.W.R. 484 (Alta. App. Div.) ..................................................................... 92
Re Smith and Fawcett ................................................................................................................................. 202
Re Thorne v. New Brunswick (Workmen’s Compensation Board) (1962), 33 D.L.R. (2d) 167 (N.B.C.A.)
...................................................................................................................................................................... 37
Re United Canso Oil and Gas Ltd. (1980), 41 N.S.R. (2d) 282 ................................................................ 221
Re Varity Corp. and Jesuit Fathers of Upper Canada (1987), 59 O.R. (2d) 459, affd (1987), 60 O.R. 640
(C.A.) ......................................................................................................................................................... 232
Read v. Astoria Garage (Streatham) Ltd.
, [1952] 1 Ch. 637 ..................................................................... 199
Reference Re the Constitution Act (1991), 80 D.L.R. 4 th
431 (Man. C.A.) ................................................. 92
Reid Murray Holdings Ltd. v. David Murray Holdings Proprietary Ltd. (1972), 5 S.A.S.R. 386 ............ 179
Ringuet v. Bergeron , [1960] S.C.R. 672 .................................................................................................... 238
Rochwerg v. Truster (2002), 23 B.L.R. (3d) 107 (Ont. C.A.) ...................................................................... 42
Roydent Dental Products Inc. v. Inter-dent Int'l Dental Supply Co. of Canada [1993] O.J. 708 .............. 132
Ruben v. Great Consolidated Fingold, [1906] A.C. 439, 75 L.J.K.B. 843 ................................................ 148
Said v. Butt [1920] 3 K.B. 497 ................................................................................................................... 135
Sanford v. The Queen, [1996] 1 C.T.C. 2016 (T.C.C.) .............................................................................. 209
Saskatchewan Economic Development Corp v. Patterson-Boyd Mfg. Corp. [1981] 2 W.W.R. 40 .......... 125
SEC v. W.J. Howey Co.
.............................................................................................................................. 170
See v. Heppenheimer , 61 A. 843 (1905 N.J. Court of Chancery) .............................................................. 160
Sherman & Ellis v. Indiana Mutual Casualty 41 F. 2d. 588 (7th Cir. 1930) ............................................. 190
Shindler v. Northern Raincoat Co. Ltd. [1960] 2 All E.R. 239 ................................................................. 198
Shlensky v. Wrigley 237 N.E. 2d 776 (1968 Ill. C.A., 1st Cir.) ................................................................. 204
Smith v. Van Gorkom , 488 A.2d 858 (1985) .............................................................................................. 205
Smith, Stone and Knight Ltd. v. Birmingham Corporation , [1939] 4 All E.R. 116 ................................... 122
Soper v. The Queen , 97 D.T.C. 5407, (1997) 149 D.L.R. (4 th
) 297 (F.C.A.) ............................................ 208
Southern Foundries (1926) Ltd. v. Shirlaw ................................................................................................ 199
Sparling v. Caisse de dépôt et Placement , [1988] 2 S.C.R. 1015 ...................................................... 110, 143
State Ex. Rel. Pillsbury v. Honeywell Inc.
, 191 N.W. 2d 406 (1971 Minnesota Supreme Crt) ................. 234
Sukloff v. A.H. Rushforth & Co [1964] S.C.R. 459 ...................................................................................... 66
Tato Enterprises Ltd. v. Rode (1979), 17 A.R. 432 (Alta. Dist. Ct.) ......................................................... 132
Thompson v. Meade (1891), 7 T.L.R. 698 ................................................................................................... 15
Tower Cabinet v. Ingram , [1949] 2 K.B. 397 .............................................................................................. 63
UPM-Kymmene Inc. v. UPM-Kymmene Miramichi Corp.
, (2002), 214 D.L.R. (4 th
) 496 ......................... 209
Verdun v. Toronto Dominion Bank , [1996] 3 S.C.R. 550 .......................................................................... 231
Walkovsky v. Carlton, 223 N.E. 2d 6 (1966) ............................................................................................. 128
Wall v. London and Northern Assets Corporation , [1898] 2 Ch. 469 (C.A.) ............................................ 220
Webb v. Earle (1875), L.R. 20 Eq. 556 ...................................................................................................... 150
Westbourne Galleries ................................................................................................................................. 224
Westcom Radio Group Ltd. v. McIssac (1989) 45 B.L.R. 273 (Ont. Div. Crt.) ......................................... 117
Will v. United Lankat Plantations Co. [1914] A.C. 11 (H.L.) ................................................................... 150
Wiltshire v. Sims (1808), 1 Camp. 288 ........................................................................................................ 14
Wolfe v. Moir (1969), 69 W.W.R. 70 ......................................................................................................... 133
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Introduction
Business provide goods/services, funds for assets, ‘stakeholders’ (eq inv,mgers,cred), law for others
1) Broad definition of business = provision of goods or services a) Includes for-profit and not-for-profit (others limit definition to for-profit) b) Broad definition includes: i) Non-profit societies and charitable foundations ii) Government activities/organizations, municipal corporations
2) To provide goods or services typically necessary to obtain funds to acquire assets (e.g. inventory, equipment, land, machinery, transport, buildings, etc.)
3) Broad definition of stakeholders = anyone affected by the activities of a business a) Equity investors (who provide the funds to acquire the assets and who agree to share in the assets of the business on wind-up only after the creditors have been paid off) b) Creditors (who also provide funds used in the acquisition of assets and so, in a sense, are also investors (‘lender investors’)). Major creditors (e.g. bank loan) often have an influence on how the business is run c) Managers (conduct, or oversee, the day-to-day operations of the business). In some businesses the equity investors are the managers, in others separate managers. d) Employees e) Customers or consumers (e.g. buy product indirectly from retailer) f) Suppliers (will often be creditors as well. E.g. 2/10 & 30 means if pay within 10 days can take 2% off the bill, otherwise must pay within 30 days). g) Competitors h) Local community (business may an important supplier of jobs, support other businesses, e.g. local retail stores support employees, environmental impacts and other dangers) i) Broader community (e.g. affected by general economic activity, acid rain, global warming, etc).
4) Primary focus of this course : a) For-profit activities b) RE: stakeholders i) Primarily about legal framework that governs the relationships between the stakeholders in particular forms of business association ii) Primarily between equity investors and managers , and (to a lesser extent) relationships with creditors (lenders and suppliers) iii) Concerns of other stakeholders are the subject of other law courses. E.g.:
(1) Employees – Labour (employment) law
(2) Consumers – Contract law, tort law, sale of goods and consumer protection law
(3) Creditors – Contract law, bankruptcy law, fraudulent conveyances
(4) Competitors and suppliers – Competition law
(5) Society at large – Environment law, tax law, tort law, criminal law, etc. iv) Some suggest that such other stakeholders should have more of a say in the management of a business
Agent, sole prop, partnshp, corp, biz trust, co-op, society, unincorp assoc, JV, franchs, mult contrct
1) The following lists various arrangements among persons (both real and legal) as to how they can associate to carry on a particular business activity.
2) Each can be described according to investors & liability, agents & employees, management, legal status, lifespan, taxes
3) Can be cost-effective to organize cooperative activities in such ways (contrast with multiple contracts below)
4) Agency
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a) The person carrying on the business (the principal ) may grant another person (the agent ) legal authority to conduct various aspects of the business on his or her (or it’s) behalf and so affect their legal relationship with 3 rd
parties . b) Very common. E.g. when buy coffee from Maria (employee of UVic) have entered into contract with UVic (Maria acting as agent of UVic).
5) Sole Proprietorship a) Description/investors: Single equity investor (referred to as the sole proprietor) has legal title to
(i.e. owns) assets of business and has ultimate management authority (directly manages, or at least oversees, management of the business) b) Agents and employees: Sole proprietor may engage agents and may hire employees (e.g. hire manager and give authority to enter into contract to buy supplies) c) Creditors: Will usually obtain some funds on credit (e.g. bank loan) so will be one or more creditors , who therefore have an interest or stake in the business and so may want to put some management constraints on how the sole proprietor manages the business. d) Legal Status: Not a separate legal entity ( sole proprietor personally liable ). So sole proprietor owns business assets; contracts personally with creditors, employees, suppliers, and customers; and if torts occur in carrying on the business then sole proprietor is personally liable for damages
(either directly or vicariously). e) Continued existence: Sole proprietorship essentially comes to an end on death of the sole proprietor, though may be continued for a time in the administration of the estate after the sole proprietor’s death, but once the assets of the estate have been distributed neither that sole proprietor nor his or her estate will be carrying the business – there will be a new sole proprietor and thus a new sole proprietorship
6) Partnership a) Where persons act in common with a view of profit they are considered to be partners i) E.g. see joint venture between two corporations below ii) Contrast with unincorporated association for non-profit activities below. b) More than one equity investor (each referred to as a partner). Normally each has some say in how the business is managed (i.e. management decision-making authority normally dispersed ). c) The partners may conduct business through agents and they may hire employees , though a partner cannot be an employee (and may again give authority to managers to act as agents) The partners may manage the business directly themselves or they may hire a manager or management team and limit their role to overseeing the management of the partnership business. Agency relationships are a very important element of partnership law since, unless otherwise provided , the partners themselves are considered to be agents for each other . d) Partnership will normally borrow funds so usually one or more creditors (who have stake in business and so major creditors may impose constraints on the way the partners manage the business). e) Not a separate legal entity ( partners are personally liable ). Assets of the business owned by the partners. A “partnership” cannot enter into contracts with other persons, rather all the partners do so. Partners themselves responsible either directly for their part in the commission of a tort that arises in the conduct of the business or vicariously if employee. f) Under common law and under several partnership statutes, the relationship between the partners comes to an end on the death or bankruptcy of any one of the partners . A partnership may be reconstituted thereafter, and there may be statutory or agreed-upon provisions for its reconstitution, but the partnership that existed before the death or bankruptcy of a partner no longer exists.
7) Limited Partnership a) A type of partnership (i.e. more than one equity investor ) that has one or more “ limited partners ” whose liability is limited to the amount of their investment, and at least one “ general partner
”
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whose liability is not limited. So if employee creates a tort, and damages not covered by insurance, then limited partners only liable up to their investment but general partners may lose their personal assets (house, car, etc). b) Limited partners have limited stake in the business (i.e. only amount of their investment, with no risk to their personal assets) which if small likely means their management involvement is less important to them (and so typically exercise less control over business management). The law governing limited partnerships typically constrains the involvement limited partners can have in the business (to avoid 3 rd parties getting the wrong impression i.e. that they are personally liable). c) Otherwise limited partnership is similar to partnership in terms of having creditors, agents and employees d) Also similar to partnership in that limited partnership is not a legally recognized separate entity .
So once again contracts between the “partnership” and others are, unless otherwise provided, contracts between those others and all the partners , both limited and unlimited partners. Creditors have claim against all partners as individuals. The partners (both general and limited) also own the assets of the partnership business. However, as noted, the liability of the limited partners is limited to the amount of their investment.
8) Limited Liability Partnership a) Note different to Limited Partnership above. b) Relatively recent creation in response to concerns about the increasing scope of liability in large partnerships, particularly professional partnerships (e.g. one of 150 lawyer partnership, one of other lawyers creates huge liability, you are liable even though you had nothing at all to do with it
– for example, see Ernst & Young v. Falconi ). c) Alberta, Ontario, Saskatchewan, and Quebec have legislation permitting these types of partnerships (B.C. is looking into it and will likely have it soon, and already allows law firms to incorporate as PLC). i) The BC Partnership Amendment Act, 2004 , S.B.C. 2004, c. 38, will come into force on
January 17, 2005 , enabling a BC partnership and a foreign partnership to register as a limited liability partnership or an extra-provincial limited liability partnership. d) The model in those provinces is to allow professional partnerships (e.g. doctors, lawyers, accountants and engineers partnerships) to form a limited liability partnership under the legislation in which partners are not liable for the acts of their fellow partners or employees unless they were personally involved or personally supervising or directing the activity that caused the loss. e) Must put LLP after name. f) Otherwise they function as ordinary partnerships. As with ordinary partnership, the limited liability partnership would not be recognized as a separate legal entity .
9) Corporations a) See unincorporated associations below for three ways to create a corporation b) Unlike all previous (sole proprietorships and partnerships), corporation recognized as a separate legal entity (it is a legal person ). i) Thus it is the corporation that contracts with others and is liable in the event it breaches those contracts ii) It can borrow from others and buy supplies (i.e. corporation can have creditors ) iii) Corporation can be liable criminally or (vicariously) for torts arising from carrying on the business conducted through the corporation iv) The corporation (not the equity investors) owns assets of the business. c) A corporation has no physical existence so it cannot negotiate contracts or conduct business without the assistance of human beings. i) Thus a corporation must act through agents (e.g. managers) ii) As a separate legal entity the corporation can hire employees (although it would do so through its agents ).
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d)
With the corporation recognized as a separate legal entity it’s existence is potentially perpetual . i) Shareholders can become bankrupt and die and it will not affect the continued existence of the corporation (it is the corporate person that carries on the business, and enters into contracts etc. which continue even if shareholders do not) e) Must put indication after name (e.g. Ltd ). f) Requires one or more equity investors (will normally have several). i) Many jurisdictions around the world require a minimum number of equity investors in a corporation (e.g. five or seven). ii) In Canada, corporate statutes generally allow for corporations with only one equity investor (a case from the 1890’s found that seven shareholders, where one held 20,000 and the others held only 1, was acceptable, thus allowing for de facto single shareholder, and in response Canada allowed a single shareholder) g) The equity investors in for-profit corporations are typically referred to as shareholders and their interests are usually divided into shares. i) These shares consist of bundles of legal rights that investors can assert primarily against the corporation (a share is a promise by the corporation to do something in exchange for the $’s from the shareholder – i.e. there is a contractual relationship between shareholder and corporation, and shareholder owns a ‘chose in action’ to enforce this contractual promise against the corporation) ii) These shares do not , however, give the shareholders a share of legal title to assets of the corporation (the corporation has legal title to the assets). iii) Liability of the equity investors (i.e. shareholders) in a corporation is typically limited to the amount of their investment by legislation (similar to limited partners in a limited partnership but without the restrictions on management involvement). iv) Shareholders share in the profits of the corporation distributed to them as a “ dividend ” h) Unlike limited partners (who have limits on extent to which they can be involved in management of limited partnership), no limit on management involvement by shareholders (since the
‘cautionary suffix’, such as Ltd. or Inc. is thought to avoid misunderstanding that actively involved investors are personally liable) i) Shareholders typically are directly involved in management when relatively few shareholders ii) If many shareholders it is more common for shareholders not to be directly involved, but rather to have a management team who may hold few or even no shares in the corporation
(1) Lots of law that attempts to ensure managers act in the interest of the shareholders
(2) Basic framework for the management of corporations is that shareholders generally elect a board of directors which appoints officers of the corporation (president (a.k.a. CEO), treasurer (a.k.a. CFO), and secretary) who either manage the day-to-day business of the corporation themselves or delegate various management responsibilities to other persons they hire.
(3) The right of shareholders to vote to elect a board of directors is one of the legal rights often provided on shares . i) Corporations are widely used. They involve not just very large corporations like Nortel and
General Motors but also banks, trust companies, insurance companies, stock exchanges, municipalities, universities, hospitals, and a host of other institutions. They are also not limited to large entities. Corporations in Canada may have as little as one shareholder and may be formed to carry on a business as small as a corner store or a shoe repair shop.
10) Business Trusts a) Sometimes a reference to a business trust is a reference to any trust that is used for commercial purposes. b) However, here we are interested in it as a reference to an express trust that is set up as a form of association for carrying on business .
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i) An express trust is one that one or more persons (known as “ settlors
”) intended to create by putting the title of property (e.g. land, money, etc) in trust in the hands of one or more persons
(known as “ trustees
”) with instructions to hold that property for the benefit of one or more other persons (known as “ beneficiaries
”)). ii) The trustees thus have title to the assets and can transact with respect to those assets on behalf of the beneficiaries. iii)
Details of operation of the trust can be set out in a document known as the “ trust instrument
”
(a.k.a. declaration of trust ) iv) The law allows for a great degree of flexibility as to what can be done in terms of how the trust will operate. v) The settlors, trustees and beneficiaries can all be different persons, or the settlors can also be either the trustees or beneficiaries or both. vi) Courts have read in numerous implied terms to trusts (e.g. trustee must perform activities themselves) unless expressly provided for in trust instrument (e.g. allow trustee to engage others). vii) The law does not recognize the trust as a separate legal entity (although the Income Tax Act effectively does for the purposes of assessing the taxable income for a trust). Thus the trust itself cannot contract with others, but trustee can. c) Flexibility of trusts allow them to be set up like a corporation : i) Equity investors (settlors) can invest by settling funds on one or more trustees who are charged with a duty to manage those funds on behalf of beneficiaries (i.e. the investors themselves) ii) Investor beneficial interests can be divided up into ‘units’ resembling shares (i.e. bundles of rights set out in declaration of trust that investors have as beneficiaries, who are therefore called ‘ unit-holders
’) iii) The trust instrument can provide for the election of the trustees by the beneficiary-investors
( replicating a board of directors of a corporation), and trustees can be given authority to delegate aspects of their management duties to others, thus allowing them to engage agents and hire managers ( similar to officers of a corporation). iv) Trustees have authority to deal with the assets and so trustees (either themselves or through agents) and not investors normally enter into contracts and conduct the business and so would normally be liable with respect to contracts or torts (either directly or vicariously) arising in the conduct of the business.
(1) Provided investor-beneficiaries are not trustees they will therefore have some protection against personal liability that may roughly approximate the limited liability of shareholders in a corporation.
(2) However, there are two main sources of liability risk for investors :
(a) May be an implied right of trustees to be indemnified for their losses by beneficiaries in some situations. The trustees can waive any right they may have to indemnification.
(b) May be possibility that the trustees will also be considered agents of the investors in some situations. Likelihood is small as long as the investors do not have significant control over the business.
(c) Thus by having the trustees waive any right they might have to indemnification from the investors and as long as the investors do not have significant control over the conduct of the business, the risk of personal liability of the investors should be quite remote. d) E.g. REIT – Real Estate Investment Trust (trustees manage real estate portfolio) e) E.g. Oil and Gas Royalty Trust (trustees manage funds for oil and gas development and pays royalties to investors) f) E.g. Mutual Funds
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g) E.g. Business Income Trusts . There are about 160 of these on the Toronto Stock Exchange (e.g.
A&W). These are set up as alternatives to the corporate form for tax advantages (see also discussion in sole proprietorship advantages/disadvantages below): i) With a sole proprietorship, business income is taxed at the sole proprietors personal tax rate
(e.g. 40%). ii) With a corporation , income is first taxed at corporate tax rate (e.g. 30%), and then when profits distributed to shareholders it is taxed again at shareholder’s personal income rate (e.g. 40%).
Although legislated mitigation of such double taxation, some double taxing remains (which can be significant as it accumulates over the years) iii) With business income trust, the trust sells units to investors and then uses those funds partly to buy shares in associated corporation but primarily to loan to that corporation, with high interest rate but agreement corporation will only pay interest if it can (and maybe also licence to corporation to use name e.g. A&W).
(1) E.g. suppose corporation has income of $1 million before taxes and interest, it pays whole million to trust as interest (so corporation has zero net income since interest is deductible as an expense and so pays zero taxes).
(2) Trust then distributes the million to beneficiaries (i.e. settlor investors) who pay taxes at their own personal rate.
(3) Thus business income trust avoids double taxation completely .
(4) As a result, unit-shares in such trusts are trading at about 40% higher than equivalent corporate shares.
11) Co-operative Associations a) E.g. to provide services at discounted rate to members b) Co-operative associations are corporate forms of organization (so see corporations above, e.g. there are directors, officers, etc) but co-operatives typically do not distribute profits as dividends to shareholders (and may have a number of other general principles that govern how the business will be carried on) c) Instead, they tend to have members and any surplus in carrying on the business tends to be returned to the members either in the form of lower prices or reduced fees for services or in benefits of some sort (so can still work for profit ) d) See Cooperative Associations Act, BC 1999 (especially s.8 for key differences to corporation, such as membership (and hence services) being open to all who are willing to take on member responsibilities)
12) Societies or non-profit corporations a) It is common to have separate Statutes for incorporation of non-profit corporations . i) Non-profit corporation is the term used in many jurisdictions in Canada (e.g. both federally and in Ontario, Alberta). ii) Non-profit corporations statutes in such jurisdictions are typically styled “ Corporations Act
”
(in contrast to the for-profit corporations statutes typically styled “Business Corporations
Act”). iii) In England and many other common law jurisdictions (including B.C.), there are Societies
Acts that allow for the incorporation of societies that will carry on their activities on a nonprofit basis (i.e. the same as non-profit corporations) b) Is a separate legal entity , so can be liable vicariously for actions of employees etc. c) Persons taking on a role somewhat similar to shareholders are typically referred to as members who usually elect a board of directors or executive committee that will manage, or supervise the management, of the non-profit corporation’s activities, which in turn may appoint offices, engage agents and hire others to carry on the activities of the corporation. d) Voting by members will also typically be required to amend the articles, by-laws or other constitutional documents of the non-profit corporation.
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e) The members may also be persons who receive the benefits of the activities performed by the nonprofit corporation. f) Societies or non-profit corporations are often used to carry on charitable activities, though charities do not necessarily have to be non-profit corporations – they could be organized as trusts or as unincorporated associations.
13) Unincorporated Associations a) Where persons act in common with a view of profit they are considered to be partners. If more than one person acts in common but not for profit they may be treated as an unincorporated association if no corporation formed : i) There are three main ways to form a new corporation:
(1) By fulfilling specific registration requirements under a statute for incorporation.
(2) By a specific statute of Parliament or a legislature forming the corporation.
(3) Granting of a charter from the Crown or letters patent issued by an agent of the Crown
(often used in the past but rarely used now). b) Not recognized as a separate legal entity and so bears some similarity to partnership : i) The unincorporated association cannot contract with other persons. Instead it is the members who enter into contracts with others, can engage other agents and employees, are responsible for torts committed in the conduct of the association’s activities (i.e. can be personally vicariously liable), and creditors will be creditors of each and every member . ii) As with partnership the members may be considered agents for each other. iii) E.g. if send your kid to baseball association, ask if incorporated (if not, may be member and so potentially liable if another kid is hurt, so also ask if has insurance)
14) Joint Ventures a)
The term “joint venture,” in a general, non-legal, sense, is used to describe a relationship among persons who agree to combine skills, property, funds, time, resources, knowledge or experience to pursue some common objective. b) Typically each member of the joint venture has some control over the management of the joint activity and agrees to share in the profits and losses of the activity. c) A joint venture is not a legally recognized concept , so is not a separate legal entity . d) Possible structures for joint ventures: i) Persons (i.e. members of the joint venture, who might be humans and/or corporations ) might carry on the joint venture through a contractual arrangement that does not amount to partnership ii) Through a partnership (perhaps with a partnership agreement ), or iii) Through creation of a joint venture corporation (with members being shareholders in that corporation, perhaps with terms of the joint venture agreement contained in a shareholders’ agreement).
15) Franchises a) A franchise is an arrangement in which a franchisor grants one or more rights to a franchisee such as: i)
The right to sell the franchisor’s products ii) Use its business name (usually associated with a particular way of carrying on business) iii) Adopt its methods, or iv) Copy its symbols, trade-marks or architecture etc over a specified period of time in a specified place. b) It is often said that the arrangement has one or more of three basic elements: i) The provision of know-how by the franchisor ii) Image recognition provided by the franchisor’s marketing support iii) Benefit of joint purchasing power allowing for quantity discounts.
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c) The right to use the business name, trade-mark, etc is the key legal element and is what is referred to as the franchise (i.e. a franchise is a licence to use ). i) The franchisor often also provides marketing support and training in the franchisor’s method of carrying on business. ii) In exchange the franchisee pays an up-front royalty or licence fee to the franchisor (e.g.
$250,000 for Tim Hortons) d) The arrangement therefore involves an exchange (i.e. it is a contract ) and thus involves contract law: i) The contract is usually written (can be very detailed), although it could be an oral contract. ii) Franchises are governed by provincial law since they deal with contracts that fall under provincial powers with respect to property and civil rights. iii) As with trusts, there is a body of law that reads in implied terms unless expressly provided for iv) Some provinces have Franchise Acts to given franchisee some protection from powerful franchisors. e) The “ franchise ” (i.e. the licence) is not a separate legal entity capable of contracting on behalf of itself. i) However, both the franchisor and franchisee could be a sole proprietor, partnership or corporation but franchisor is nearly always a corporation as too, most often, is the franchisee.
16) Multiple contracts a) Rather than one of the above associations, an alternative legal means of securing a cooperative business activity is through a series of separate contracts for each stage of production, distribution and marketing . i) E.g. to make cheap plastic pens, one might arrange for the delivery of the ink, nib and tube to a another person who would, subject to contractual terms, agree to put these items together and ship them to another person to be inserted into the housing for the pen (with arrangements that housings be delivered to the person who puts the ink-filled tube and nib into the housing).
One could make contractual arrangements with yet another person to distribute the product and contractual arrangements might also be made for another person to market the product. b) Each contract could specify how the particular stage in the production process is to be done and the consequences of a breach of the contract. Ultimately one might break everything down to the point that there are no group or joint activities , with each step undertaken by separate persons acting independently subject to the terms of separate contractual arrangements (attempting to take into account all future contingencies) i) However, this could involve high transactions costs (i.e. for negotiating, monitoring, amending and enforcing each separate contract) ii) So may be more cost-effective to have some form of business associations to organize and coordinate cooperative activity in a less costly manner. iii) However, as the organization grows in size and complexity the cost of further organization might begin to outweigh the cost of separate contracts. At that point further efforts at formal organization may not be worthwhile. Thus many possible mixes of internal work and contracting-out.
17) Focus of this course a) This course focuses on agency, sole proprietorships, the various partnerships, and corporations b) These are the most common forms of business association. c) Partnerships and corporations also have their analogues in the non-profit sector (unincorporated associations and societies or non-profit corporations) so that studying these forms of association allows one to learn a great deal about non-profit forms of association as well. In examining the non-profit forms of association one can then focus on the unique aspects of these forms of association.
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Accounting: assets, liabilties, trade credit, accnts receiv/pay, equity, balance sheet, income statmnt
1) Perhaps the most obvious need for basic understanding of accounting principles is in the requirement for financial disclose in a number of contexts.
2)
Generally speaking “ assets
” are things acquired for the business to allow for provision of services and/or production of goods, and that will have a continuing value to the business (usually beyond one year – items that are used up more quickly are considered expenses). a) E.g. cash, inventory (i.e. goods held for sale), equipment, buildings, etc. b) E.g. Can supply goods and services on credit (i.e. sell now but get paid later), known as “ trade credit
” (which becomes an accounts receivable asset). Will have a contractual right to collect the amount (i.e. the vendor has a chose in action).
3)
“
Liabilities
” (or “ debt
”) in the strict sense, represent fixed obligations (i.e. they are known in advance) a) E.g. a loan from a bank usually involves an obligation to pay back the fixed amount that was loaned with fixed periodic payments for the use of the money determined by reference to a rate of interest. b) E.g. goods or services acquired for the business on credit (i.e. buy now and pay later) known as
“ trade credit
” (which becomes an accounts payable liability i.e. an account that must be paid))
The payment will be a fixed amount or a fixed amount plus a fixed rate of interest.
4) Equity , in the strict sense, is the entitlement to residual amounts (i.e. amounts that are left over, not fixed like liabilities – roughly speaking, equity is initial investment plus profits minus losses). There is a somewhat blurry line between liabilities and equity, however. Two kinds: a)
Persons who have advanced funds as an “equity” investment will share in the profits that are the residual amount of revenues left after payment of expenses including interest expense. b) If the business is brought to an end and the assets are sold off the equity investors are also entitled to the amount left over after the liabilities have been paid.
5) Insolvency means assets are insufficient to pay all debts a) If, for example, liabilities are 10% and equity is 90%, then likely sufficient assests to cover liabilities
5) Four commonly used financial statements (these are statutorily required): a) The balance sheet shows the source of funds for the business and the uses of those funds i) Summarizes funds and uses of funds at a certain point in time (i.e. it is a snapshot ) ii) If one accounts on the asset side for what was done with every penny of the funds received then the asset side and the funds side should be equal (i.e. they should balance). iii) Usually displayed in a top-down format but it is sometimes displayed in a left-right format
(which makes the “balance” quality of it somewhat sharper). iv) In the left-right format:
(1)
One lists the “ assets
” of the business on the left -hand side (i.e. shows what was done with funds).
(2)
One lists the source of funds as “ liabilities followed by equity
” on the right -hand side (i.e. shows where funds for the business were obtained from). Liabilities are set out first followed by the equity. v) The top-down format shows the assets first followed by the liabilities and equity. b) The income statement (often called a “ statement of profit and loss ”) shows the revenues of the business less the expenses of the business. i) Thus not a snapshot like a balance sheet, but rather summarizes what has occurred over a period of time (e.g. the previous month or year). ii)
Revenues could be from “sales” of goods or services, “royalties,” “licence fees,” “rental income,” etc. These are listed first and totalled. Then expenses are listed and totalled and the total expenses are deducted from the total revenues.
(1) Various steps may be taken to separate various expenditures and to show the profits net of these expenditures.
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(2) E.g. in a retail business there is usually a section called cost of goods sold which separates out the cost of the goods acquired for retail from the other expenses of the business and often shows revenues less cost of goods sold as “ gross profit
”. Other expenses would then be deducted to arrive at net income . The other expenses would include interest expense, taxes and an expense that recognizes the depreciation of assets that deteriorate in value over time or through use. c) Statement of retained earnings shows (for a period of time like an income statement): i) The retained earnings at beginning of period ii) What happened to retained earnings during the period
(1) E.g. may have increased due to profits, and/or
(2) May have decreased due to distributions to owner (e.g. sole proprietor or as dividends to corporate shareholders) and amounts reserved (i.e. not to be distributed, such as for replacing assets) iii) Hence value of retained earnings at end of period d) Statement of changes in financial position (a.k.a. “ statement of sources and uses of funds ”).
Shows for a period of time (like an income statement): i) Where additional funds came from (e.g. profits), and ii) What was done with those additional funds (e.g. sitting in business as cash, new assets or additional inventory, or distributed to owners (e.g. as dividends for corporation form)).
Example balance sheet and income statement (for sole proprietorship)
1) Note ignoring depreciation here (assets normally depreciated, with drop in value each period accounted for in income statement as an expense)
2) Also assuming the bank loan is a ‘ term loan
’, meaning only interest payments are made each month, so the capital of the loan is not paid off till the end of the term (e.g. 2 or 5 years), unlike a mortgage.
Thus it stays as a constant liability (of $50,000).
3) Two balance sheets presented here, but may include info at two dates in one balance sheet to show how things have changed over time
Eclectic Collections
Balance Sheet as at …….. ( beginning of month )
Assets
Cash
Accounts receivable
47,500
–
Inventory
Freezers
40,000
30,000
Cash register
2,500
Light fixtures & cash counter 35,000
Shelving 10,000
Liabilities and Equity
Liabilities
Accounts payable
Bank loan
Equity
Jones’ own investment
Retained earnings
TOTALS 165,000
Eclectic Collections
Income Statement for the month ended …….. (date)
Revenues
Sales 96,500
15,000
50,000
100,000
–
165,000
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Cost of goods sold
Beginning inventory
Purchases
Cost of goods available 90,000
Less ending inventory 35,000
Cost of goods sold
40,000
50,000
Gross profit
Expenses
Interest
Rent
Heating & lighting
Total expenses
500
5,000
1,000
Net income (i.e. profit)
55,000
41,500
6,500
35,000
Eclectic Collections
Balance Sheet as at …….. ( end of month )
Assets
Cash
Accounts receivable
Inventory
Freezers
62,500
30,000
35,000
30,000
Cash register
2,500
Light fixtures & cash counter 35,000
Shelving 10,000
TOTALS 205,000
Liabilities and Equity
Liabilities
Accounts payable
Bank loan
Equity
20,000
50,000
Jones’ own investment 100,000
Retained earnings 35,000 (from net income in income statement)
205,000
Agency
Agent affects legal relations of principal (eg partner,director), v. employee/trustee (creditor access)
1)
Broad definition: An “ agent
” is a person who affects the legal relations of another person, called the
“ principal
”. a) The agent can affect the legal relations of the principal in several ways but does so primarily through entering into contractual relationships with 3 rd parties on behalf of the principal b) E.g. A (as agent) enters into a contract with X on behalf of P (the principal), A having disclosed to
X that she is acting on behalf of P, the contract will be a contract between X and P (and not a contract between X and A). c) The principal can also be vicariously liable for the torts committed by the principal’s agent .
2) Very common , and so agency law often an important part of the law of various forms of business association (will only have a summary here to provide background for rest of course ) a) E.g. when buy something from cashier (e.g. employee of university, of some food service provider, of grocery store or of clothing store) have entered into contract with university, service provider, etc since cashier not only employee but also acting as agent of university, service provider, etc in respect of some of his or her activities.
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b) E.g. Lawyers will often act as agents for their clients in various contexts. c) E.g. Bank manager acts as agent for the bank in entering into a bank loan on behalf of the bank. d) E.g. Partners in a partnership are considered agents for each other
3) Will often have a chain of agents a) E.g. The board of directors of a corporation are agents for the corporation, the officers of the corporation (appointed by the board) are sub-agents for the corporation, and they may in turn authorize sub-sub-agents, etc.
4) Agent v. employee : a) Agency may be distinguished from employment in the sense that an employee does not necessarily have the right to enter into contractual relations on behalf of the employer and may not owe the same fiduciary duties to the employer. b) However, a person who is an employee may also be an agent of the employer in some respects. c) A person can be an agent without being an employee .
5) Agent v. trustee : a) Many cases highlight both the difficulty of distinguishing between agency and trust, and the significantly different results that a finding of agency as opposed to trust can lead to. b) Agency and trust are similar in that agents and trustees both owe fiduciary duties ; the agent to the principal and the trustee to the beneficiaries. c) However, in an agency relationship the acts of agent bind principal while in a trust relationship the acts of trustee do not bind either the settlor or the beneficiaries . d) Persons who have advanced credit to a trustee in situations not involving the trustee’s activities in connection with the trust (i.e. the trustee’s personal creditors ) do not have access to the trust assets to satisfy their claims. The personal creditors of agents , on the other hand, have access to all the property (or money) held by the agent even if the agent is holding that property for transfer to the principal (or owes money to the principal). i) Thus there are often situations where C has a claim against B who is holding some property for
A. A argues that B is a trustee and holds the property in trust for A. Thus C will not have access to the property to satisfy the claim. C, on the other hand, argues that B is A’s agent thus allowing C access to the assets held by B even though A may have a claim to those assets as principal. ii) See also bankruptcy in termination of agency relationship below.
Actual authority of agnt to bind prncpl: express (writen/oral/inferred), implied (usual/customary)
1) The extent to which an agent can affect the legal relations of the principal depends on the authority (or power ) the agent has. a) See 3 rd party relationships below (e.g. ability of agent with actual authority to contract on behalf of principal to create binding contract between principal and third party)
2) There are two types of authority an agent may have (e.g. in both cases a binding contract can result between third party and principal) a) Actual authority (our focus here since it’s key to the relationship between the principal and agent) b) Ostensible (a.k.a. apparent) authority (see below)
3) Actual authority does not require consideration i.e. an agent may act gratuitously (i.e. for free) on behalf of the principal (e.g. child acting as agent for aging parents). a) Note agency law developed long before contract law (the latter requires consideration)
4) Actual authority arises where it is express or implied: a) Express actual authority –the principal stated the agent’s authority either orally or in writing (i.e. the principal intended to give the agent authority to affect his or her legal relations) i) Express authority includes the authority that can be inferred from the written or oral words expressing the scope of the agent’s authority.
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b) Implied actual authority – the authority that the principal and agent would have reasonably expected/understood the agent to have in the circumstances. To determine the implied authority of an agent, courts look to the usual or customary authority of such agents: i) The usual authority of an agent is determined by looking at what this particular agent has been allowed to do in the past by this particular principal .
(1) If the agent has done certain things in the past that are outside the given express authority
(i.e. oral or written or inferred from oral or written) but the principal has usually allowed the agent to do those things in the past, then the agent may be said to have usual authority
(and hence actual authority) to do those things
(2) Rationale: It seems unfair for the principal to allow the agent to do certain things on behalf of the principal several times and then, at some later date, when it is in the interests of the principal to do so (e.g. contract turns out to lose money), turn around and say to the agent,
“I never expressly gave you authority to do those things on my behalf. Consequently I am also not compensating you for any of your expenses or paying any remuneration we may have agreed upon for your acts on my behalf. I will also sue you for any losses you caused me while purporting to act on my behalf.”
(3) E.g. Freeman & Lockyer v. Buckhurst Park Properties (Mangal) Ltd., [1964] 2 Q.B. 480
(H.L.)
(a) Facts:
(i) Kapoor was acting as if he was the managing director (i.e. the president ) of a company.
(ii) The board of directors had never actually appointed him as managing director (i.e.
Kapoor had no written or oral grant of authority, thus no express actual authority).
However, the board of directors was aware that Kapoor was acting as managing director and allowed him to continue to do so.
(iii)Freeman & Lockyer (architect firm) sued company based on Kapoor activities.
(b)
Issue: was company bound by Kapoor’s activities?
(c) Decision:
(i) While not express (since Kapoor was never appointed as managing director), actual authority could be implied from the circumstances. The scope of that authority was based on what the directors of the board had usually allowed Kapoor to do in the past.
(4) Limitation : if the express actual authority clearly prohibits the agent from engaging in particular acts on behalf of the principal, then a few ratifications of acts of the agent contrary to that prohibition will not normally result in the agent being said to have implied actual authority. ii) The customary authority of an agent is determined by looking at the kind of authority agents of that type normally have .
(1) E.g. stockbrokers normally do certain types of things on behalf of their principals. Bank managers do certain types of things on behalf of the bank.
(2) Customary authority is different to usual authority:
(a) Usual authority looks at what this principal allowed this agent to do in the past.
(b) Customary authority looks at what agents of this type are normally allowed to do.
(3) When a principal resists a claim for compensation by an agent on the basis the agent was not within the scope of the authority expressly granted (either in writing or orally), the agent can respond by saying that agents of her or his sort customarily have the authority on which the agent acted, and there is nothing in the express (written or oral) grant of authority, or the circumstances in which the authority arose, that is inconsistent with this customary authority.
(4) E.g. Wiltshire v. Sims (1808), 1 Camp. 288
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(a) Facts: a stockbroker sold a customer’s shares on credit.
(b) Decision:
(i) There was an no express authority to sell shares on credit and an no express prohibition to sell shares on credit – thus the court looked to the kind of authority that agents of that particular type (i.e. stockbrokers ) normally have – concluded that while stockbrokers normally have authority to sell shares on behalf of their clients, they do not normally have the authority to sell shares on credit .
(5) Limitations:
(a) If there is an express grant of authority that is inconsistent with some aspect of the customary authority of agents of that type, then the express grant of authority overrides the customary authority
(i) E.g. in the stockbroker case above if there had been an express grant of authority to sell shares on credit
(b) Similarly, if there are other circumstances in the relationship between the particular agent and principal that are inconsistent with some aspect of the customary authority of such agents, then that aspect of customary authority would not apply
Duties of agent to principal: tasks, best intrst, reas care, no delegate/conflict/secret profit, account
1) The agent is said to owe certain fiduciary duties to the principal. a) It is important to note that these duties are just implied terms of the relationship between the principal and the agent. Thus the principal and agent can vary these terms by express agreement.
They may also be varied by implication from the circumstances (i.e. the circumstances make it clear that the normal implied term was not to apply). b) Under the CBCA for corporations, the duty of care of directors and officers is statutory (s.122, see
“fiduciary duties of dirs/offs” in Corporate Governance below)
2) The first duty of the agent is to perform the tasks that have been assigned to the agent according to the terms of the agreement with the principal or according to the instructions of the principal. a) Principal has a claim against the agent for any losses resulting from the agent going beyond their actual authority
3) In performing these tasks the agent has a fiduciary duty to act in the best interests of the principal a) E.g. directors or president of corporation are agents for the corporation which is the principal (not the shareholders, remember, since the corporation is a separate legal entity), and so have to act in best interests of corporation.
4) The agent must also perform his or her tasks with reasonable care a) Agency law has been around about 700 years, so duty of care here significantly predates that in tort law b) The standard of care is said to be the degree of skill and diligence which an agent in his or her position would normally possess or exercise. c) If the agent is a professional person (such as a lawyer), the agent is expected to act with the degree of skill of a reasonably competent lawyer. d) The principal would have an action for damages against an agent who failed to meet the requisite duty of care.
5) There is the duty not to delegate . a) The agent is not to delegate his or her responsibilities to anyone else, since the principal has faith in the particular agent. I.e. the principal is normally assumed to basically be saying, “Look, I trusted you to do this task, not anyone else. Don’t pass the job off to someone I don’t know or trust.” b) The remedies for an inappropriate delegation of authority are damages for any loss resulting from the delegation of authority and possibly an injunction against any further delegation of authority.
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c) Of course there are exceptions to this where this implied term of non-delegation is not considered to be a reasonable implied term . i) Thus agent can delegate where the agent has been given express authority to do so, or where the agent can be said to have implied authority to delegate in the circumstances. ii) E.g. In one case a ship was carrying perishable goods that were rotting in the hold. The captain put into shore and engaged an agent there to sell the goods. It was held that the captain had authority to delegate in the circumstances. The captain would not have known the local market at the port where he put in to respond to the emergency. It was arguably necessary in the circumstances that he engage a local agent to sell the goods. iii) E.g. In another case involving a ship, the ship was damaged and the captain, while in port in
Japan, engaged an agent in Japan to arrange for repairs . The captain was said to have authority to delegate in the circumstances. It would have been difficult for the captain to arrange for the repairs himself given the lack of knowledge of the local trades and the language barrier . Court found engaging the agent was OK, so the shipowner had to reimburse the captain for expenses.
6) Duty to avoid conflict of interest between duty to principal and personal interest a) An agent is not to put himself or herself in a position where his or her duties to the principal and his or her personal interests conflict (i.e. put yourself in shoes of agent as an individual and ask: what is my best interest, then compare this with best interest of principal). b) E.g. if the principal employs an agent to buy goods on behalf of the principal the agent cannot buy goods from themselves on behalf of the principal
. Here the agent’s personal interest is to get the highest possible price while the agent’s duty to the principal (acting in the best interests of the principal) is to get the lowest possible price. c) E.g. Similarly, if the agent is to sell goods on behalf of the principal the agent cannot be the buyer since the agent would want the lowest possible price while having a duty to the principal to get the highest possible price. d) The normal remedies for a conflict of interest transaction are that the transaction is void and the agent is required to account to the principal for any profits made in the transaction. The remedy of damages would be available to compensate for the losses caused by the conflict of interest. An injunction against further conflict of interest transactions may also be available. e) Note: CBCA allows for conflict of interest (e.g. for directors of corporation) so long as conflict is known, person is not involved in particular decision, and the deal made is fair for the corporation.
7) An agent is also not to make secret profits (raises similar concerns as with conflict of interest) a) E.g. A common example is that of a purchasing agent who gets some kickback from making the purchase from a particular supplier . A loss to the principal can occur because the agent may not have obtained the lowest possible price for the goods (i.e. a conflict). The agent has also made a profit on the side (e.g. a gift is provided by the supplier to the agent if the goods are ordered from that supplier, but really the gift should belong to the principal, and agent now in conflict since wants gift and may not get best price for principal). b) Remedies: i) The agent would have to ‘account’ for the amount of the benefit the agent received and could be required to pay any damages resulting from not getting the lowest price goods. c) E.g. A related activity of the agent that is sometimes treated as a secret profit occurs where the agent acts on behalf of a competing principal. For instance, the agent is engaged to sell certain goods on behalf of the principal which the agent does, but the agent also sells goods on behalf of a competitor of the principal without the principal’s knowledge. The agent will be required to account for any profits made by the agent from sales on behalf of the competitor (e.g. commissions on competitor sales ). d) E.g. Thompson v. Meade (1891), 7 T.L.R. 698 i) Facts: a stockbroker was asked to sell shares for a certain price (e.g. $10 per share) but sold the shares for more (e.g. $12 per share) and pocketed the difference .
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ii) Decision: The stockbroker was required to account to the principal for the extra profit made.
8) Duty to keep proper accounts a) The agent must maintain proper books of account of transactions on behalf of the principal. If the agents fails to do this there is an evidentiary presumption against agent . That is, the court will take a view of the amount of the profit to the agent or loss to the principal that is most favourable to the principal.
Duties of principal to agent: remuneration (express,implied,exclusive agent), expenses, indemnify
1) The principal also owes certain duties to the agent.
2) Requirement to pay remuneration a) The principal is often required to pay remuneration to the agent, though agent can work for free
(i.e. no contract between agent and principal, through usually there is), and default rule is no remuneration . b) Thus remuneration generally requires an express agreement . c) However, even where there is no express agreement, if circumstances are such that the agent would clearly not have been inclined to act gratuitously then the court will award remuneration to the agent i) E.g. if agent has no personal relationship to the principal, court will usually award remuneration ii) Court will award remuneration on a quantum meruit basis (i.e. what would an agent normally be expected to be paid in the circumstances). d) To get remuneration : i) The agent must be performing the obligations required of the agent under the agreement ii) The agent must , in the normal case, also be the effective cause of the sale, contract, etc .
(1) An exception to this occurs where the agent is an exclusive agent (i.e. where the agent is to be paid whether or not the agent is the effective cause of the sale or contract). This usually requires an express agreement since it must override the normal implied term.
3) The principal must also pay the expenses of the agent and indemnify the agent against losses . a) In both cases, the agent must be acting within the scope of her or his actual authority (i.e. something the agent really needed to do to carry out activities for the principal) b) Also, the expenses are not to be incurred through the fault of the agent . c) E.g. see Blair v. Consolidated Enfield
Termination: by act of parties (agremnt,unilateral), by operation of law (bankrpt,frustration,death)
1) An agency relationship is said to be terminated by the act of the parties where: a) If the agency agreement provides for the termination of the agency relationship, according to agreement provisions. b) Where the agency agreement does not provide for its termination, it is unilaterally terminable on notice. i) In contrast to an employment relationship, the assumption for an agency relationship is that there is no requirement of a reasonable notice period (idea being if either loses trust in the other want to end relationship immediately). ii) Thus, unless otherwise provided for, or unless the circumstances indicated otherwise, an agency relationship can be terminated by either party immediately on notice.
2) Agency relationships can also be terminated by so-called operation of law . a) The agency relationship is presumed to be terminated when either the agent or the principal becomes bankrupt . i) Rationale if principle bankrupt: The agent often looks to the principal for payment and thus would normally not be expected to want to continue the relationship with a bankrupt principal. ii) Rationale if agent bankrupt:
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(1) Agents often end up holding money or property for the principal. As noted above (in agent v. trustee), the agent’s creditors can normally access that money or property as long as it is in the possession of the agent (principal is just another creditor). Thus when an agent becomes bankrupt the principal normally does not want the agent to continue acting on behalf of the principal and potentially ending up with money or property due to the principal.
(2) Further, the principal may have claims against the agent for losses caused where the agent acts beyond his or her authority or in breach of his or her duty of care and claims might be worth very little against a bankrupt agent. iii) Frustration: Where the whole purpose of the agency relationship no longer exists the agency relationship is presumed to have come to an end. iv) Death of either the agent or the principal
(1) Rationale: In an agency relationship the principal trusts the particular person to whom authority is granted to act on the principal’s behalf.
3 rd party relationshps: contrct binds principl if agnt in scope of actual authorty (agent not a party)
1) The principal and agent are the first and second parties.
2)
The term “ third party
” here means persons affected by the acts of the agent on behalf of the principal . a) The purpose of the agency relationship is to allow the principal to deal with other persons through the agent. Thus an important aspect of the law of agency is the affect the activities of the agent have on the legal rights arising between the principal and third parties, and between the agent and third parties.
3) Recall from above, “ actual authority ” is the authority the principal either expressly or impliedly gave to the agent. a) Actual authority is the type of authority that is particularly relevant to the rights the principal has against the agent and to the rights the agent has against the principal. b) Also relevant re third parties. i) If the agent is acting within scope of actual authority to enter into a particular contract with another person on behalf of the principal, and if it is clear that the agent is acting as agent in its dealings with that other person, then the contract, if otherwise valid , will be a binding contract between the principal and that other person (or “ third party
”). ii) The principal will be able to enforce that contract against the other person and that other person will be able to enforce the contract against the principal. iii) The agent will not be a party to the contract ( except perhaps where the agent was clearly intended to also be a party to the contract).
Ostensible auth: if no actual auth, still K & 3 rd party claim v principal if represntatn & reas relianc
1) There is also ostensible authority (a.k.a. “ apparent authority
” or “ agency by estoppel
”) that is relevant between the principal and third parties.
2) It can arise even where the agent does not have actual authority a) I.e. even though the principal never expressly or impliedly gave the agent authority to act in the way the agent did b) Nevertheless, if ostensible authority is proved there will be a valid contract between the third party and the principal, and so either can sue for cause in action of breach of contract
3) Two elements of a claim that a person has ostensible authority to act on behalf of another are (see
Lord Diplock in Freeman & Lockyer below): a) The alleged principal must have made or permitted a representation that this alleged agent had authority to act on behalf of the alleged principal i)
Interpretation of “representation” by the alleged principal fairly broad. ii) E.g. can be express or implied from words, conduct or the circumstances of the principal (see
Freeman & Lockyer , and least cost avoidance rationale below)
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b) The third party reasonably relies on the representation to her or his detriment i) In the case of a corporation , it cannot make a representation itself – rather, a representation must be made by an agent (e.g. Board of Directors ) with actual authority to do so ii) Reliance suggests the third party would not have taken the action otherwise iii) Reasonably suggests the third party should have taken obvious and easy precautions, especially in large transactions (e.g. confirm ‘agent’ really is president by checking corporate registry, get certification from corporate secretary this agent really does have authority, etc).
See rationales below.
4) Canadian cases often refer to the English case of Freeman & Lockyer v. Buckhurst Park Properties
(Mangal) Ltd., [1964] 2 Q.B. 480 (H.L.) a) For facts and issues, see above. b) Here are some key words from Lord Diplock on which the elements noted above are based: i)
“An ‘apparent’ or ‘ostensible’ authority, …, is a legal relationship between the principal and the contractor [i.e. the ‘third party’] created by a representation, made by the principal to the contractor, intended to be and in fact acted upon by the contractor [i.e. reliance], that the agent has authority to enter on behalf of the principal into a contract of a kind within the scope of the
‘apparent’ authority, so as to render the principal liable to perform any obligations imposed upon him by such contract. … The representation, when acted upon by the contractor by entering into a contract with the agent, operates as an estoppel, preventing the principal from asserting that he is not bound by the contract . It is irrelevant whether the agent had actual authority to enter into the contract.” ii) “The representation which creates ‘apparent’ authority may take a variety of forms of which the commonest is representation by conduct, that is, by permitting the agent to act in some way in the conduct of the principal’s business
with other persons. By so doing the principal represents to anyone who becomes aware that the agent is so acting that the agent has authority to enter on behalf of the principal into contracts with other persons of the kind which an agent so acting in the conduct of his principal’s business has usually ‘actual’ authority to enter into.” c) Lord Diplock then applied these principals to the facts as follows: i)
“The judge found that the board [the board of directors of Buckhurst Park Properties (Mangal)
Ltd.] knew that Kapoor had throughout been acting as managing director in employing agents and taking other steps to find a purchaser. They permitted him to do so, and by such conduct represented that he had actual authority to enter into contracts of a kind which a managing director or an executive director responsible for finding a purchaser would in the normal course be authorised to enter into on behalf of the company. Condition (1) was thus fulfilled.
… The plaintiffs, …, were induced to believe that he was authorised by the company to enter into contracts on behalf of the company for their services in connection with the sale of the company’s property, including the obtaining of development permission with respect to its use. Condition [2] was thus fulfilled.”
5) Rationales for ostensible authority (to help understanding and predict how it will be applied) a) If a loss has resulted and the agent has disappeared or is insolvent, a choice must be made between the principal and third party as to who should bear the loss b) Protection of reliance interest of third party who are led to reasonably believe the person acting as agent has authority to act as agent (i.e. protection of individual interest) i) This interest is clearly reflected in the rule itself which calls for detrimental reliance by the third party. ii) The competing interest is sometimes referred to as “ unfair surprise
” (i.e. to the alleged principal who might be “unfairly surprised” at being bound by a contract when he or she would not have reasonably expected to be bound). However, where the alleged principal could have readily taken steps to avoid potential reliance by third parties on a reasonably perceived authority of an alleged agent then the alleged principal should not be unfairly surprised.
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c) Least cost avoidance (i.e. protection of broader societal interest) i) I.e. ostensible authority follows broad societal aim of putting the obligation to avoid the loss on the person who can avoid it at least cost (i.e. the alleged principal here), giving alleged principal an incentive to avoid the loss and reducing costs incurred in avoidance of such losses ii) Interpretation of “representation” is fairly broad and there seems to be a tendency to find that the alleged principal has made a representation. This seems reasonable where there has been some past relationship between the alleged principal and the alleged agent (i.e. there is/was some actual authority) since in such cases the alleged principal can often avoid the loss at the least cost . iii) For instance, the principal can:
(1) Check the agent’s trustworthiness before engaging the agent
(2) Monitor the agent’s behaviour
(3) Dismiss an agent who acts beyond his or her authority.
(4) Other simple ways : principal could print authority of agent on business cards, letter head, etc.
(5)
In such a case, not having the principal responsible for the agent’s authority would tend to defeat the whole purpose of agency . An agent is often engaged where the principal does not have the time to negotiate transactions with each and every third party. Otherwise , if the responsibility for the agent’s authority were left to third parties they would all have to contact the principal to confirm the agent’s authority. This would largely defeat the purpose of the agency relationship since the principal would be in contact with each third party – just what the engagement of the agent was intended to avoid. Of course in a big transaction, want some confirmation agent has authority iv) At the other extreme is the situation where the alleged agent is a complete fraud – the alleged principal has never had any contact with the person purporting to be an agent of the alleged principal. In these circumstances the person who is in the best position to avoid the loss is likely to be the third party who has at least had some contact with the person engaged in the fraud. v) Situations in between these two cases can be more difficult in terms of who is the least cost avoider of the loss.
(1)
E.g. where the third party is put on notice of the agent’s lack of authority (i.e. something about the situation should have made the third party suspicious about the agent's authority), then perhaps the third party was least cost avoider so should bear the loss. vi) Hence the second element which requires that the third party's reliance be “reasonable” allows the court to deal with such situations and put the loss on third party.
6) If claim against principal succeeds, principal might be able to claim against the agent for going outside scope of authority (see duties of agent to principal above)
7) If claim against principal fails , third party may still have claim against agent for breach of warranty of authority (see below)
Breach of warranty of authority: if no actual or ostensible auth, still claim by 3 rd party v. agent
1) A claim for breach of warranty of authority is a claim by a third party against an agent where the agent warranted that she or he had authority but in fact did not have either actual or ostensible authority (and thus 3 rd
party would not have an action against the principal).
2) Thus the third party has two claims: a) First, the third party can claim against the alleged principal on the basis that the agent had authority (either actual or ostensible). b) Second, the third party can make a claim against the agent on the basis of a breach of warranty of authority.
3) Three elements of a breach of warranty of authority are:
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a) The agent represents that she/he has authority b) The representation is false ; and c) The third party reasonably relies on the representation to her/his detriment .
4) A claim for breach of warranty of authority resembles to some extent a tort claim for negligent misrepresentation . However, it is a claim developed hundreds of years before the development of the claim for negligent misrepresentation (the latter didn’t come about till 1964). An important difference between the two claims is in the measure of damages. a) A reliance based measure of damages is used for a negligent misrepresentation claim (i.e. put in same position would have been had representation never been made) b) An expectation measure of damages is used for a claim for breach of warranty of authority . Thus damages in a breach of warranty of authority claim are intended to put the third party in the position he or she would have been in had the agent’s promise of authority had been true (see
Wickberg v. Shatsky ) c) But see also pre-incorporation contracts below (see Black v. Smallwood & Cooper , and Wickberg v. Shatsky )
Ratification by P (‘principal’) of contract even when A (‘agent’) went beyond, or had no, authority
1) Where the agent acts beyond his or her authority the principal may nonetheless choose to accept what the agent has done by “ratifying” the act of the agent. a) This can correct both the principal-agent relationship (e.g. agent can now get remuneration and no longer open to claim for going beyond authority) and principal-third party relationship (e.g. contract becomes binding)
2) A person ( P ) can ratify a contract entered into by another person (A) on their behalf if three elements are satisfied (see policy reasons below): a) The other person (A) purported to act on behalf of the person (P) who seeks to ratify (contrast with undisclosed principal below) b) The person (P) who seeks to ratify was in existence and was ascertainable at the time the other person (A) acted i) E.g. this is not satisfied in the case where person (P) who seeks to ratify is a corporation that had not been incorporated (and therefore was not in existence) at the time the other person (A) acted on its behalf – see pre-incorporation contracts below ii) The third party must also be able to ascertain P and where P is, otherwise the third party will find it very difficult to sue P if P ratifies the contract and then breaches it (e.g. P is ascertainable if business is in registry) c) The person ( P ) who seeks to ratify must have had the legal capacity to do the act both at the time the other person (A) acted and at the time of the ratification .
3)
Note words “agent” and “principal” not used here since there are cases in which a person (A) purports to act on behalf of another (P) even though that person (A) has no authority (either actual or ostensible). a) I.e. There may , in some cases, be no principal-agent relationship to begin with . b) E.g. person (A) who purports to act on behalf of another takes a deal arranged with the third party back to the person (P) on whose behalf the deal was arranged and seeks to have the person (P) on whose behalf the deal was arranged ratify the arrangement.
4) For ratification to be effective , two requirements: a) Ratification can be express, by conduct or by acquiescence (i.e. P must have done something to ratify – see policy reasons below): i) An express ratification can be oral or in writing . ii) However, conduct by the principal may also be sufficient for ratification.
(1) In general, any performance or part performance , of the terms of the contract by the principal may be sufficient to constitute ratification.
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(2) E.g.
if the contract calls for the principal to provide services and the principal begins to provide those services it may be considered sufficient to constitute ratification.
(3) Similarly, if the contract calls for the principal to deliver goods and the principal begins to deliver goods then it may be sufficient to constitute ratification. iii) A principal may also be considered to have ratified by simply waiting to see what happens over a period of time (i.e. acquiescing). b) Ratification must be based on a full knowledge (by P) of all (important) relevant facts (see policy reasons below): i) The principal is consenting to a transaction that the agent had no authority to enter into, so the principal needs to know the nature of the deal being accepted. ii) This can no doubt be a particularly slippery requirement for an effective ratification (e.g. P could almost always claim they didn’t know about some tiny detail in order to try to get out of the contract), but the principal who has ratified a contract would probably not be relieved of obligations under the contract just because the principal was not informed of a relatively minor aspect of the deal.
5) The usual consequences of ratification are that (see policy reasons below): a) Third party – principal: i) Once ratified by the principal the contract will be considered to have been formed at the date of the offer and acceptance between the agent and the third party (i.e. ratification relates back to the time of the offer and acceptance between A and the third-party. Thus an attempt by the third party to revoke her or his offer or acceptance will be ineffective, since the principal can immediately afterwards ratify which applies back in time. ii) Since now a binding contract, the principal can sue the third party and can be sued by the third party. b) Agent – principal: i) The agent is no longer liable to principal (for losses principal suffers) for exceeding her or his authority ii) The principal will be liable to the agent for reasonable remuneration and to indemnify the agent for expenses reasonably incurred by the agent in effecting the contract. c) Agent – third party: i) The agent is no longer liable to 3 rd
party for a breach of warranty of authority .
6) Policy reasons for ratification a) Mutual benefit (from liberal theory of contract law): i) At the time of the offer and acceptance between the third party and the agent the third party has presumably determined that there is some benefit from the transaction for the third party. ii) At the time of ratification by the principal, the principal has presumably determined that there is some benefit from the transaction to the principal, as long as the principal is informed of all the important aspects of the transaction (hence need for knowledge ) iii) There should therefore be a mutual benefit to the transaction and, as with other contracts, enforcement through courts may facilitate these mutually beneficial transactions. b) Unjust enrichment of principal at expense of agent i) Suppose there were no principle of ratification and suppose further that the agent acted beyond her actual authority. By acting beyond her actual authority the agent would be liable to the principal for any loss to the principal caused by the transaction. Thus the principal will benefit if the transaction goes well for the principal, but if the transaction goes badly for the principal the principal has some protection from loss by having a claim for compensation from the agent . In other words, the principal has the potential for gain with little or no downside risk.
(1) The principle of ratification protects against this by providing, as a consequence of ratification, that the agent, upon ratification, is no longer liable to the principal for acting beyond her authority.
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ii) If it were not for the principles of ratification there would be another problem for the agent. If the agent acted beyond his actual authority he would not be entitled to any remuneration or indemnification for expenses. Were it not for the notion of ratification the principal could choose to perform the contract if it were beneficial to the principal and yet not be obliged to pay or indemnify the agent .
(1) The law prevents this by providing, as a consequence of ratification , that the agent is entitled to remuneration and indemnification for expenses associated with the contract. c) Unjust enrichment of principal at expense of third party due to speculation by principal i) Ratification by acquiescence serves to avoid speculation by the principal (i.e. principal waits to see if the deal will work out well for them) that could result in an unjust enrichment of the principal at the expense of the third party.
(1) E.g. suppose that the agent acted beyond her actual and ostensible authority (so third party cannot claim against principal), and the contract may call for the principal to purchase some goods. If there was no ratification by acquiescence (rather only express or by conduct), the principal might wait a few weeks to see what happens to the price of the goods – if prices go up then the principal formally ratifies and takes advantage of the contract, but if prices go down then the principal would not ratify but might buy the goods elsewhere at the lower price without the risk of having to compensate the third party. ii) Similar reasoning applies to ratification by conduct , which avoids principal speculating by performing parts of a contract and still not being considered to be bound by the contract then the principal might perform as required until the contract turns out to no longer be to their benefit . Once again this would provide the principal with an upside benefit while having the downside risk protection of being able to back out of the deal when no longer beneficial to them, probably to detriment of the third party . iii) The requirement that the principal be in existence and ascertainable at the time the agent acts on behalf of the principal also helps avoid speculation by the principal that can enrich the principal at the expense of the third party.
(1) E.g. agent purports to act on behalf of a corporation that has yet to be incorporated (and thus is not yet in existence). If it were not for the requirement that the principal be in existence at the time the agent acted then the promoters of the corporation could wait to see if the deal was a good one then incorporate the corporation and ratify the contract. If the deal turns out to be a bad deal the promoters could simply choose not to incorporate the corporation (or could incorporate but with no assets so judgement-proof, but ratifies to get agent out of liability). If the third party did not know the corporation did not exist then the third party would be left with only an action against the agent for breach of warranty of authority ( or a possible claim that the agent was also intended to be a party to the contract ) and the agent may not be able to fully satisfy the claim. iv) Similarly, the requirement that the principal be ascertainable at the time the agent acts avoids the principal only coming forward and ratifying the contract if it were beneficial , but remaining unascertainable if the contract turned out to be unfavourable to the principal
( thereby avoiding service of documents by the third party to institute an action). d) Unjust enrichment of third party at expense of principal due to speculation by third party i) Suppose ratification did not relate back to the time of offer and acceptance between the agent and the third party, and suppose that the agent acted beyond her actual authority but with ostensible authority . The third party could speculate (i.e. wait to see if the contract were favourable and then choose to enforce it against the principal on the basis that the agent acted with ostensible authority). But if before the principal ratified the contract it turned out be unfavourable to the third party then the third party could revoke his offer (or acceptance). The third party could thus have the potential upside gain with protection against downside risk provided at the expense of the principal.
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(1) E.g. consider a sale of goods by the third party to the principal. If the price of the goods went down the third party could choose not to revoke and enforce the transaction (on the basis of ostensible authority). If the price of the goods went up the third party could revoke the contract and sell the goods elsewhere at the higher price.
(2) If part way through, third party tries to revoke because contract turning out bad for them, principal can ratify which operates back in time before their attempt to revoke e) Cures minor defects in the grant of authority i) Ratification is said to reduce litigation over the scope of actual or ostensible authority .
(1) Principal-agent litigation: If the principal claimed compensation from the agent for losses, or failed to pay or indemnify the agent, on the basis that the agent acted beyond his actual authority, then the agent would be inclined to litigate the principal’s allegation that the act was beyond the agent’s actual authority. Such litigation can be avoided where the principal has ratified the contract because of the principle that upon ratification the principal is bound to indemnify the agent, pay agreed upon remuneration and is no longer entitled to compensation for losses on the basis that the agent exceeded his authority.
(2) Principal-3 rd
party litigation: Similarly, acts by the principal that amount to ratification can avoid litigation between the principal and the third party over whether the agent acted within her actual or ostensible authority.
Undisclosed P can sue 3 rd party on contract (unless 3 rd intended agent only), & 3 rd can sue P and A
1) Sometimes agents will act on behalf of principals without disclosing to the third party that they are doing so (so agent purporting to act on their own behalf, unlike case in ratification above). In these situations the principal is referred to, sensibly, as an “undisclosed principal.” Since the agency relationship is not disclosed , the third party’s understanding is that the contract is
a contract with the person who, unbeknownst to the third party, is acting as agent .
2) The general principle is that an undisclosed principal can disclose the agency relationship and sue the third party on a contract entered into by the agent with the third party.
3) Exception : this does not apply if the third party was looking to the agent alone to perform the contract. The test for this is an objective test. The third party will be considered to be looking to the agent alone to perform if: a) The terms of the contract (written or oral) expressly require that only the agent perform the terms of the contract agreed to by the agent, or b) The circumstances indicate that the third party clearly intended to contract with the agent alone/ would not have contracted with principal . It would not be sufficient for the third party to simply say that she would not have contracted with the principal had she known of the principal’s identity. There must be some corroborating circumstances: i) E.g. where the contract is for the services of the agent (e.g. agent might be an engineer and contract is to build a bridge, but principal has no such skills/experience) ii) E.g. there is some personal aspect to the contract iii) E.g. previous relations between the principal and the third party showing third party would not have dealt with principal (see Said v. Butt where principal banned from theatre , got agent to buy them tickets, theatre refused principal entry, principal claimed breach of contract, but court held there is no contract since it was clear theatre would not have contracted with principal) iv) E.g. principal is bankrupt and third party would not have extended them trade credit v) vi) E.g. where the third party is prohibited from trading with the principal under a statute prohibiting trading with a person from an enemy country.
4) There are some reciprocal rights/protections for the third party :
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a) The third party, on learning of the agency relationship (either from principal or independently), can sue the principal b) The third party can still sue the agent as a party to the contract (even after discovering agency relationship); and c) In an action by the principal against the third party , the third party can set off (i.e. use) any rights the third party would have against the agent and can use any defence that the third party would have against the agent . i) E.g. The right of set off against the principal might arise, for example, where the principal claimed payment of $10,000 for goods delivered to the third party under the contract but the third party had already paid the agent $4,000 for the goods. The third party could set off the
$4,000 payment to the agent against the principal’s claim for $10,000 and thus just owe the principal just $6,000. ii) If the agent were to sue the third party, the third party might have a defence against the agent such as a defence of duress, mistake or misrepresentation . The third party could also use any such defence in an action by the principal.
5) Possible policy reasons for the law concerning undisclosed principals a) Mutual Benefit i) If the third party wasn’t looking particularly to the agent to perform the contract then the third party is arguably still getting the expected benefit from the contract even if the principal performs the contract. Thus there would be a mutual benefit to the contract at the time the agent enters into the contract on behalf of the undisclosed principal. Enforcement of these contracts will facilitate such mutually beneficial transactions. ii) Where the third party is looking specifically to the agent to perform, or clearly would not have entered into such a contract with the particular principal, then the third party would probably not have found the contract beneficial if the principal were to be the one performing the contract. b) Potential unjust enrichment of the third party at expense of principal i) The principal may well believe that she has a binding contract with the third party and proceed to perform the contract . If the third party could avoid performance of his part of the contract on the basis that the agency relationship was undisclosed then third party would be enriched at the expense of the principal.
(1) E.g. suppose that the contract calls for the delivery of goods to the third party in exchange for payment by the third party on terms of 30 days credit. Suppose that the principal delivers the goods and, on not receiving payment in 30 days, sues the third party on the contract. If the third party can avoid having to make the payment by saying that his contract was with the agent then the third party may be enriched at the expense of the principal (by having the goods provided by the principal without having to pay for them).
The principal might solve this problem by having the agent sue the third party . However, if the agent refuses to do so, is unavailable , or for any other reason cannot sue the third party, then the principal, were it not for the law concerning undisclosed principals, would have no recourse against the third party.
(2) One can imagine a judge’s reaction to this simple fact pattern of a purchase of goods by a third party in an undisclosed principal situation. The third party admits a contract with the undisclosed agent for the purchase of the goods at a particular price with terms of payment within 30 days of delivery. The third party also admits that the goods were delivered. The third party admits that it has now become apparent that it was the principal who delivered the goods but the third party now refuses to pay for them. It may have seemed much simpler to just order the third party to pay than to force the principal to go through the potentially expensive process of finding and joining the agent to the action to get the same result .
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c) Potential unjust enrichment of the principal at expense of third party i) The third party, on discovering the agency relationship, can also sue the principal on the contract.
(1) E.g. Consider the example above but instead have the third party delivering goods on terms that they be paid for within 30 days. The third party delivers the goods to the agent
(who did not disclose the agency relationship) and the agent then passes the goods on to the undisclosed principal . The goods are not paid for within the 30 day period and the third party discovers that there was an undisclosed principal and that the goods are in the possession of the principal. Either the agent cannot be found or the agent does not have sufficient assets to pay for the goods. The third party sues the principal . If the principal were able to say that he was not a party to the contract and thus is not liable on it, the principal would have the benefit of the goods at the expense of the third party.
(2)
One can once again imagine a judge’s reaction. The principal has the very goods he asked the agent to obtain for him on terms that the particular price for the goods be paid to the third party within 30 days of delivery but the principal is now refusing to pay for the goods. One might say this was a risk the third party took in entering into a contract with the agent unaware that there was anyone else interested in the contract. In other words, the third party took the risk that the agent would not be able to pay. However, it may have seemed quite unfair to a judge in the case that the principal should be able to keep the goods without payment. It might also open the door to fraudulent schemes by an unscrupulous undisclosed principal , working with an unscrupulous and undisclosed agent, to cause a third party to enter into a contract with an agent who was made to misleadingly to appear financially able to pay for the goods.
Principal liable for torts of agent if acting in ‘scope of authority’ (e.g. unknown fraud by partner)
1) An agent can also affect the legal relations of the principal by committing torts while acting on behalf of the principal.
2) A principal is said to be liable for a tort committed by the principal’s agent if the agent committed the tort while acting within the scope of her or his authority . a)
‘Authority’ here is a little vague – it is broader than actual authority (e.g. principals rarely give actual authority to agent to commit torts, frauds, etc), and there may have been no representation by principal that agent acting on their behalf and third party may not even have heard of principal
(so ostensible authority perhaps unhelpful) – see cases below. b) The agent simply has to be doing the kinds of things that the agent would normally do in carrying her mandate (otherwise difficulties might arise were the principal simply able to say that he did not, and would not have ever, authorized the agent to commit a tort).
3) E.g. Lloyd v. Grace, Smith & Co., [1912] A.C. 716 a) Facts: a clerk employed in the law firm of Grace, Smith & Co. defrauded a client , Emily Lloyd, of her sole remaining assets. Mrs. Lloyd owned two cottages and had loaned 450 to a Mr.
Rushworth secured by a mortgage on a house. Mrs. Lloyd was dissatisfied with the income she was receiving from these investments. She called at the law firm of Grace, Smith & Co. to consult on this. She dealt with Mr. Sandles who was the firm’s conveyancing manager and managing clerk , and who conducted the conveyancing work of the firm without supervision. Although the name of the firm was Grace, Smith & Co., Mr. Smith was the only remaining lawyer of the firm and his time was largely taken up attending to his duties as an alderman. Mr. Sandles convinced
Mrs. Lloyd to sell the cottages and call in the mortgage. Sandles left the room and returned 20 minutes later with two documents that he asked Mrs. Lloyd to sign . Mrs. Lloyd signed the documents without reading them over, believing they were something she had to sign before the sale could be proceeded with. The documents were in fact a conveyance by Mrs. Lloyd to Sandles of the cottages and a transfer of the mortgage. Sandles mortgaged the cottages to a bank for a loan
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from the bank and transferred the mortgage using the funds so raised to pay off personal debts.
Mrs. Lloyd sued Smith (the principal) b) Issue: it might be argued in these sorts of cases that principals such as Mr. Smith do not give their agents authority to commit frauds . c) Decision: i) On this point Lord Macnaghten referred to the following words of Sir Montague Smith in the
Privy Council decision in MacKay v. Commercial Bank of New Brunswick (1874), L.R. 5
P.C. 394:
(1)
“… it may generally be assumed that in mercantile transactions, principals do not authorize their agents to act wrongfully, and consequently frauds are beyond ‘the scope of the agent’s authority’ in the narrowest sense of which the expression admits. But so narrow a sense would have the effect of enabling principals largely to avail themselves of the frauds of their agents , without suffering losses or incurring liabilities on account of them, and would be opposed as much to justice as to authority. A wider construction has been put upon the words. Principals have been held liable for frauds when it has not been proved that they authorized the particular fraud complained of or gave a general authority to commit frauds: at the same time, it is not easy to define with precision the extent which this liability has been carried.” ii) Lord Macnaghten also referred to the words of Wiles J. in Barwick v. English Joint Stock
Bank (1867), L.R. 2 Ex. 259 who noted that:
(1)
“In all these cases it may be said, … , that the master has not authorized the act. It is true he has not authorized the particular act, but he has put the agent in his place to do that class of acts , and he must be answerable for the manner in which that agent has conducted himself in doing the business which it was the act of his master to place him in.” iii) Lord Loreburn noted that the clerk did have authority to “receive deeds and carry through sales and conveyances” and that the fraud occurred “in carrying through a business within his delegated power and entrusted to him in that capacity
.” iv) The decision in Lloyd v. Grace, Smith & Co.
also confirmed that the principal does not have to benefit from the agent’s fraud, nor does the agent have to intend to benefit the principal, in order for the principal to be liable for the agent’s fraud. v) See also policy reasons below
4) A more recent Canadian case, Ernst & Young v. Falconi (1994), 17 O.R. (3d) 512, has addressed the same issue in the context of a partnership: a) Facts: Falconi was a lawyer in the firm of Klien, Falconi and Associates (KFA). Falconi pleaded guilty to a charge under the Bankruptcy Act of assisting persons who were adjudged bankrupt in making fraudulent dispositions of their property. Klien had no personal involvement with the transactions. Each of the transactions involved the use of the legal services of KFA in the preparation of mortgage documents, documents transferring title to assets, corporate minutes, reporting letters and other services normally performed by a law firm in the course of a real estate or commercial practice. b) Issue: Klien argued that the acts of his/her partner Falconi (assisting clients in making fraudulent transfers) could not be considered within the ordinary scope of business of the law firm. c) Decision: On this scope of authority issue the judge hearing the motion for summary judgment in the case against Klien held as follows: i) “I agree with the submission of counsel for the plaintiff that the court need not find that it is within the ordinary course of business of a law firm for a partner of that firm to conspire with others to defeat creditors of the firm’s clients. It is sufficient if the partner used the facilities of the law firm to perform services normally performed by a law firm in carrying out the transactions as a result of which the creditors of the firm’s clients suffered loss. ... I find that the activities of Falconi were of the nature of the normal legal services provided by a lawyer
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with a real estate and/or commercial practice in that they consisted of the preparation and completion of mortgage documents, the preparation and completion of documentation for the transfer of title to assets and the preparation of corporate minutes and authorizing resolutions and that throughout these services were performed through the facilities of KFA making use of its support staff, trust account, letterhead and documents. ... I accept the submission of counsel for the plaintiff that the fact that the various actions of Falconi were for improper purposes and with intent to defraud the creditors of the bankrupts does not take the acts themselves out of the ordinary course of business of the law firm if they are in the nature of acts normally performed by the law firm in carrying on its usual business
.” d) Comment: i) Thus, although this was a partnership case, the principle is the same. Partners are agents for one another and are liable for the torts of their fellow partners committed by those partners within the scope of their authority. ii) B.C. and a number of other jurisdictions now have limited liability partnerships (LLPs)
5) Possible policy reasons for the liability of the principal for the torts committed by the agent a) Policy concerns that arise in the context of torts generally may also apply to the liability of the principal for torts committed by the principal’s agent. They may also explain why the principal cannot avoid liability simply by saying he did not, and would never have, given the agent authority to commit a tort. b) Deterrence / Least Cost Avoidance i) If a particular activity can cause harm then imposing the cost of the harm on that activity can serve to deter or discourage the particular harm-causing activity, or at least encourage the taking of steps to avoid the harm. ii) Usually torts involve more than one person engaging in activities, and perhaps both persons could have taken steps to avoid the harm. It makes sense in some situations to impose the cost of the harm on the person who could have avoided the harm at least cost (so as to consume the fewest of society’s scarce resources). The scope of authority approach can give the court some latitude for allocating a loss to a principal where the principal may have been able to take steps to avoid the loss , and so create an incentive to do so , particularly if the principal could have done so at less cost than the victim of the tort (i.e. give the principal an incentive to take steps to avoid the loss). iii) E.g. In Lloyd v. Grace, Smith & Co .:
(1) Smith have been more careful in choosing the person he engaged as a clerk (Mr. Sandles), made a more careful assessment of the person’s trustworthiness, more carefully monitored the activities of the clerk, dismissed the clerk were there earlier signs of the clerk’s propensity to commit a fraud, (as noted by Lord Macnaghten) obtained insurance against liability for frauds committed by his agents, etc.
(2) The client (Mrs. Lloyd) might also have reasonably been expected to take steps to avoid the loss. At the very least this might have involved reading the document. However, this might have seemed particularly unreasonable at a lawyer’s office where it is generally understood that the persons in the lawyer’s officer are there to look after the client’s interests. c) Allocation of the loss to the activity causing the loss (thus leading to full-cost pricing and so better allocation of resources economically) i) Closely related to the deterrence and least cost avoidance concepts is the notion that the loss should be allocated to the activity (or activities) that cause the loss. In addition to providing an incentive to avoid the loss it should also result in an increase in the price of the goods or services provided through the particular activity that covers for the added cost of harm prevention and the cost of compensation for losses that are not avoided. The price will then
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more closely reflect the full cost to society of the particular goods or services and the demand for the goods or services should adjust in response to the increased price. ii) In the Lloyd v. Grace, Smith & Co.
case the cost of law firms exercising better control over their clerks and the cost of compensating persons who suffer losses in spite of the controls should come to be reflected in the prices of legal services. d) The concern for compensation of the victim i) A judge in a case may be presented with a plaintiff who has suffered a loss that the judge may feel is deserving of compensation. A particular defendant in the case may be the only source for compensation available to the judge. This may have an affect on the judge’s view of whether the defendant should be made liable. ii) In Lloyd v. Grace, Smith & Co.
the plaintiff was a widow and the cottages and mortgage were apparently all she had. In England in 1912 there was probably little in the way of social welfare schemes. The plaintiff would have been put in very difficult circumstances if her sole source of income was not replaced. Mr. Smith, on the other hand, was in a profession that presumably paid reasonably well and he probably would not have been left destitute by having to compensate Ms. Lloyd. Perhaps even in 1910, when the fraud occurred, he may have obtained insurance that might have covered such losses (as Lord Macnaghten suggested he might have). e) Other concerns i) There may be many other concerns that influence the results of particular cases. ii) E.g. in Lloyd v. Grace, Smith & Co.
the court may have been influenced, in part, by the effect such a case might have had on the accessibility of legal services. It is generally considered important that people feel comfortable with seeking out legal advice . If compensation was not given in cases like Lloyd v. Grace, Smith & Co.
people might become reluctant to seek legal services for fear of being defrauded .
Sole Proprietorship
No separate legal entity, sole prop owns assets,controls,contracts,torts, personaly liable both ways
1)
Sole proprietorship is the simplest form of “business association” we will examine.
2) Can form a sole proprietorship simply by starting to do business (on your own – contrast with partnership)
3) The sole proprietor will be the only equity investor . a)
Thus doesn’t associate with anyone else as a co-equity investor, so it is perhaps a bit odd to describe it as a form of “association”, though there will almost invariably be “associations” that the sole proprietor will have in order to carry on the business. E.g.
‘associations’ with employees, agents, lenders (such as a bank) and trade creditors .
4) The sole proprietor is the ultimate decision-maker (see management below)
5) A sole proprietorship is not a legally recognized separate entity . Thus: a) Assets of the business are owned directly by the sole proprietor . b) When contracts are entered into in respect of a sole proprietorship business, the sole proprietor will be the contracting party and so is directly liable for the performance of the contracts. The business cannot be a party to any contract because it is not a legally recognized entity capable of entering into contracts. c) Torts committed in carrying on the business will be the torts of the sole proprietor either because of the sole proprietor’s direct involvement in the tort, or because the sole proprietor is vicariously liable for the acts of the agents and employees engaged for the purpose of carrying on the business
(i.e. when acting in scope of authority, or scope of employment) d) “ Personal liability ” of the sole proprietor (i.e.
both personal and business assets at risk for both business and personal liability & creditors i.e. goes both ways):
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i) Persons who obtain judgments against the sole proprietor based on claims arising out of the conduct of the business can satisfy those claims out of not just the assets of the business, but also out of the sole proprietor’s other assets such as personal use assets or assets used in other businesses run by the sole proprietor. ii) Persons who obtain judgments against the sole proprietor arising out the sole proprietor’s activities outside of the business can satisfy those judgments out of not only the personal use assets of the sole proprietor but also out of the assets of the business as well (i.e. creditors have access to business and personal assets) iii) Contrast with other forms of business association in which investor’s liability may be limited to the assets of the business (i.e. “limited liability”). iv) Note sole proprietor might negotiate limited liability in individual transactions (i.e. creditor can’t touch my personal assets, e.g. see ‘no-recourse’ loans below in financing, and could try same for trade credit). It was just such negotiated limited liability that was used as argument for corporations to have general limited liability.
Formation: lic reqs for biz type, register name if not own & TMM (not resemble/confuse), registry
1) Formation of sole proprietorship is very simple: a) Generally, one simply starts carrying on the business . b) Must comply with licensing requirements that may exist at federal, provincial or municipal levels for carrying on particular types of business c) Possible requirement for the registration of a business name , described below (but there is no requirement to register the sole proprietorship business itself)
2) Business name registration requirement: a) Need to register name only if using a name other than one’s own name, or using a name indicating a plurality of persons, is true not just in B.C. but in other jurisdictions as well. In several other provinces the name registration requirement is set out in a Business Name Registration Act . b) Here in B.C. it is in s. 88 of the Partnership Act the name must be filed with the registrar if : i) In the business of trading, manufacturing or mining (TMM);
(1)
Phrase “trading, manufacturing or mining” not entirely clear
(a) No definition of these terms in the Partnership Act itself
(b) Only a few business registration acts still contain this phrase
(c) Not much jurisprudence on use of these terms in the context of business registration legislation.
(2)
“Manufacturing” involves the making or producing of goods.
(3)
“Mining” is commonly defined as involving the extraction of ore from the earth.
(4) A dictionary definition of “trading” is buying and selling of goods, but defining “trading” in this way would very much narrow the application of the registration requirement and would largely serve to defeat its purpose. “
Trading
” has been interpreted in other contexts as including anything one does to earn a living (with the exception perhaps of certain professions). There is also a case in the context of business names legislation that used the
“trading, manufacturing or mining” phrase which held that a car rental business did constitute “trading” (even though not buying or selling)
(5) The cost of registering is small and a failure to register can result in a fine , so the cautious thing to do is to register . ii) Is not in partnership
(1) There is a separate section of the Act that deals with the registration of partnerships (see below, s.81).
(2) When registered, partnership business names appear on the same registry as the sole proprietorship names.
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iii) And the business name is not the sole proprietor’s own name (i.e. so not obvious who sole proprietor is, see purposes below) – or – the business name consists of a phrase indicating a plurality of persons (i.e. so might lead to misunderstanding that it is a partnership (e.g. Smith and Sons) or a corporation (e.g. Smith and Company), see purposes below). c) Partnership Act s.89
: i) The Registrar of Companies is not to register the name if it resembles the name of a corporation in B.C.
– or – if it is likely to confuse or mislead – unless :
(1) The corporation consents in writing – or – the business name was used before the corporation first used its name. ii) It is curious that the Registrar is only given authority to refuse registration where the business name conflicts with the name of a corporation registered in B.C. E.g. could be two sole proprietorships (or other non-corporations) with similar or identical business names called
High Style Footwear (with different sole proprietors), so you might be looking at the wrong entry and conclude it is different sole proprietor than the one you are dealing with. iii) The plan is apparently to rectify this soon and allow refusal of registration where any identical or confusingly similar business name has already been registered (i.e. not just limiting the
Registrar’s discretion to corporate names). d) Partnership Act s.90 requires registrar to maintain a register showing the business names on the left side with the names of the persons associated with the business on the right side. i) Thus for a sole proprietorship it would show the name of the business on the left, and the name and address of the sole proprietor on the right. e) Purposes served by the registry and requirement to register name: i) May help one track down who is behind a particular business when business name is not in name of sole proprietor (“Artie Johnston Shoes” where Artie Johnston is the sole proprietor is not problem, but “High Style Footwear” is).
(1) E.g. for person who is considering supplying goods or services on credit to identify the sole proprietor for credit check purposes
(2) E.g. for person who wants to pursue a legal claim that has arisen out of dealings with the business to determine who the real person is that can be sued.
(a) Although this may be a useful purpose served by the registry it is not technically necessary because Rule 7 of the Rules of Court allow for the sole proprietor to be sued in the name of the business and for service to be effected by leaving a true copy of the relevant document at the place of business with a person who appears to manage or control the business (this does not recognize it as a separate legal entity, rather is just for convenience) ii) Avoid deception/confusion of a name indicating a plurality of persons (i.e. suggesting a partnership business) where in fact there is only one person behind the business.
(1) E.g. the business name may have been kept from a former partnership where all the partners, except one, whose names appear in the business name have left the business.
(2) E.g. in other cases, the business name may say “and Others” or “and Company” but there is in fact just the one person as sole proprietor instead of a partnership. iii) Allow persons starting a business to avoid a passing off claim against them because they have used a business name that has been used by another person.
(1)
To avoid using someone else’s business name could check the register (as well as commercial yellow pages etc) to see if anyone has registered a name that is similar to the one you plan to use.
(2) In this way the registry may also serve as a very modest form of name protection for the person who has registered their business name.
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f) This Partnership Act registration requirement also applies to a corporation that carries on business using a name other than its own name
. A corporation is a “person” for the purposes of the legislation and thus would be required to comply with the requirement of s.88. See also below.
Funds (invest,loan,trade credit,security), mgment (sole prop,agents,lender constraints), dissolution
1) A business needs funds to acquire the assets that will be used to carry on the business.
2) Sources of funds for sole proprietorship business (recall rights side of Balance Sheet): a) Investment by the sole proprietor (single equity investor) b) Funds borrowed from one or more lenders. Most often it is one lender and that lender is usually a bank. i) To avoid personal liability on the load, sole proprietor may try to get a
‘no-recourse’ loan
, meaning liability is limited to business assets c) Trade credit . I.e. sole proprietorship buys goods (e.g. to be sold or used in the business) or services (e.g. legal services, accounting services, etc. necessary to carrying on the business) now but pays later. d) All funds (other than sole proprietor’s investment) could also be considered “securities” and thus subject to provincial securities legislation i) Securities legislation attempts to protect investors, such as by ensuring they have adequate information before investing, but producing such information (e.g. a prospectus) can be very expensive ii) If fail to follow such requirements, securities regulation has some stiff penalties and investor has statutory civil action against you
3) Management : The sole proprietor has the ultimate control over decisions concerning the business a) May delegate some of this authority to employees or agents . b) Thus a sole proprietorship management structure can, in practice, be very complex . E.g. a sole proprietorship business could, at least theoretically, grow to become very large and the sole proprietor could hire several managers to manage various aspects of the business. Each of these managers might be given authority to engage others to assist in doing the required work (with authority to engage others, etc). A quite complex hierarchy could develop. The apex of the hierarchy would, however, continue to be the sole proprietor (even though the sole proprietor’s decision-making capacity might, as we shall see, be constrained). c) There may, however, be constraints on the sole proprietor’s control. Often lenders who have advanced a significant amount of funds put restrictions on the business in an attempt to control the degree of risk to which their loans will be exposed i)
E.g. loan agreement may specify a ‘liquidity ratio’ (i.e. cash + accounts receivable + inventory
(i.e. things that can quickly be turned into cash) be at least twice account payable) ii) Lenders concerned that sole proprietor will gamble the funds they have loaned on risky business ventures, since if such ventures succeed sole proprietor will pocket any income in excess of repayment on loan (fixed amount plus fixed fee per period of time i.e. “interest”), so upside potential that increases with the degree of risk, but limited downside risk to sole proprietors investment (and liability for loan). iii) The loss of control for the sole proprietor is a trade-off that allows the sole proprietor to obtain necessary funds and keep the interest rate on those borrowed funds down. iv) Such loans will likely include provisions that say on any default of the constraints, the loan and interest is payable immediately, and will seize assets if can’t be paid (though law requires a short period of time to be given)
4) Dissolution very straight forward – sole proprietor simply stops carrying on the business . a) Since there is no requirement to register the sole proprietorship (other than possible requirement to register the business name) there is no need to register its dissolution.
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b) Since there is only the one equity investor and owner of the assets (i.e. the sole proprietor) there is no difficulty with how the assets, net of paying off the debts, gets distributed to investors. c) The sole proprietor must eventually pay off the debts (or be petitioned into bankruptcy) but once the assets are sold and the debts are paid off the sole proprietor keeps what remains.
Sole prop v corporate: easy form/dissolve & tax writeoffs now v no limitd liabilty & small biz tax
1) Advantages : a) The sole proprietorship is quite often used because it is easy to form (no formal process one must go through to form a sole proprietorship) and also very easy to dissolve (just stop carrying on the business). i) Lots of people start carrying on business in this form (often without realizing anything about the form or making a deliberate choice about it). b) Tax advantages of sole proprietorship (tax reasons are often the primary reason for choosing a particular form of business assocation): i) Losses: Profits in the sole proprietorship business are taxed directly in the hands of the sole proprietor . Since the Income Tax Act requires the taxpayer to add up their incomes from various sources and to deduct their losses from various sources, the sole proprietor taxpayer can deduct losses from the business source against income from other sources such as other businesses, property (e.g. a rental property) or employment. While one may not be planning on losses from the business, one should keep in mind that it is not uncommon for businesses to incur losses in the start up phase. ii) Tax timing: A general principle of tax saving is that it is better to pay a tax later than sooner since you can earn income on the amounts not paid (e.g., by simply putting the tax savings in an interest bearing account). If the person carries on the business as a sole proprietor the person can use the business losses immediately against other income to reduce their taxes. iii) See also tax advantages under “Why” in Corps: intro below c) In contrast , tax disadvantages for corporation : i) Losses: Corporation is treated under the Income Tax Act as separate person (i.e. a separate taxpayer), so it also must add up its income from various sources and can deduct its losses from various sources. Shareholder cannot deduct business losses from their other income because the business losses are not their losses – they are the corporation’s losses. ii) Tax timing: With the corporate form, the corporation could carry start-up-phase losses forward for a period of time and apply them against future income from the business, but business losses cannot be used against the shareholder’s other income immediately. Instead the person carrying on business through a corporation would have to wait for the business to turn a profit (which it may never do - roughly 70% of new small businesses fail within five years) iii) Other: Another potential disadvantage to the corporate form of organization is double taxation .
(1) If the business does make a profit it will be taxed in the hands of the corporation as a separate taxpayer, and when the corporation then pays that profit out to the shareholder in the form of a dividend the shareholder will also pay tax on that same profit.
(2) The Income Tax Act does contain provisions that attempt to reduce the degree of double taxation but these provisions do not always eliminate double taxation.
(3) See also discussion in Business Income Trusts in Introduction above.
2) Disadvantages : a) Sole proprietorship has no limited liability (except through negotiated transactions e.g. ‘norecourse’ loans, see above, but even with those still full liability for torts) – one reason for perhaps choosing a corporate form of organization is it provides “limited liability” as opposed to “ personal liability ” in the sole proprietorship.
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i) However, as described below, where corporation has just one or very few equity investors the
“limited liability” is often not a significant advantage practically , since:
(1) Creditors (such as for bank loans) will often insist on personal guarantees
(2) Corporation still likely needs to buy insurance to cover torts (just like sole proprietorship) b) The corporate form does have its own tax advantage if it is a small business – It may able to claim the small business deduction and thus lower its tax rate. i) This is not a complete exemption from paying tax at the higher rate since the difference between the reduced rate and the higher rate will have to be paid when the profits are distributed as dividends. ii) However, this does allow for the tax to be deferred for a period of time that will largely be in the control of the taxpayer and, as noted above, it always better to pay tax later than sooner. iii) Thus at some point after the start up sole proprietorship business begins to turn a profit it may make sense to incorporate .
Partnership
Multiple eq investors, history, eg (professionals, joint ventures, tax, & default), ad/disadvantages
1) Partnership involves more than one equity investor and is widely used (for formal definition, see existence below)
2) Origins : a) The concept of a partnership was developed primarily by the common law courts but also, to some extent, in courts of equity (due to similarities to trusts). b) It was an extension of contract law and agency law . c) In England partnership law was codified by a statute in 1890 . This English statute has been copied virtually word for word in numerous common law jurisdictions (e.g. all the common law provinces of Canada, the common law states of the United States, Australia, New Zealand, Hong
Kong, Singapore, Malaysia, etc.). d) The equivalent of the 1890 English act was first enacted in British Columbia in 1894. Parts I and
II of our current Partnership Act are essentially the same as that original 1894 Act . e) The common law and equity origins of partnership law are still relevant because the partnership acts preserve the rules of equity and common law applicable to partnership except to the extent they are inconsistent with the Act (see s. 91 of the B.C. Partnership Act ).
3) Uses of partnership : a) Professionals : i) For many years provincial legislation prohibited most licensed professionals from carrying on business through a corporation. Consequently, groups of professionals (doctors, lawyers, dentists, engineers, or accountants) would carry on business as a partnership. ii) While there has been some relaxation of restrictions on professionals carrying on business through corporations , it is still common for professionals to form partnerships (in some cases using the relatively recently created “ limited liability partnership
,” or “LLP”). b) Joint Ventures : i) Two or more corporations might engage in a joint venture. There are various ways in which the joint venture might be formally organized, but one of them is partnership. ii) Partnership involves two or more “persons”
carrying on business. Since “person” is defined in s.29 of the Interpretation Act as including a corporation, two or more corporations can be partners. iii) Partnership is not an uncommon choice for a joint venture between corporations perhaps in part because it has a flow through tax feature and thus may provide some of the same tax benefits discussed above on sole proprietorship. c) Tax Reasons :
33
i) The potential tax advantages for sole proprietorship discussed above also apply to partnerships because the Income Tax Act does not treat a partnership as a separate entity (or separate taxpayer). Instead the Income Tax Act only looks at the partnership income (or loss) for the purposes of determining each partner’s share
of the partnership income (or loss). Once that share of income or loss is determined it is then used by the individual partner in calculating her or his taxable income. Thus a partner can use her or his (or its) share of partnership losses against her or his (or its) other sources of income . This often makes partnership a sensible choice as a form of business association where there will be more than one equity investor and where there are likely to be some losses in the start up phase of the business. d) Default : persons may well be in a partnership without knowing it – there are no formalities to partnership formation (see below)
4) Advantages of partnership (similar to sole proprietorship): a) Corporate form of association has often not been available for a several professional businesses. b) Very easy to form (two or more persons simply begin carrying on business in common with a view of profit). c) Very flexible (e.g. partnership agreement), whereas corporate form requires compliance with many mandatory statutory requirements that may amount to significant constraints d) Tax advantages . Like sole proprietorship (see “Sole prop v corporate” above) – Income Tax Act only treats partnerships as an entity for property purposes, otherwise no double taxation like corporation, profits/losses ‘flow through’ to individual partners, so can deduct losses from other sources of personal income. Thus where one is going into business with one or more other persons and it is expected that there may be losses in the start up phase of the business, a partnership may make sense.
5) Disadvantages same as with sole proprietorship: a) Partners are personally liable for the contracts entered into in respect of the partnership business and for torts committed in carrying on the partnership business. b) limited liability available in a corporation or limited partnership may be a significant advantage over partnership (though where relatively few equity investors this advantage may not be that significant)
Formation: register (TMM, change of partners), exists even if fail to register, registrar keeps index
1)
The deals with both “ general partnerships
” (in Part 2 of the Act) and “ limited partnerships
” (in Part 3 of the Act).
2) There are no formal steps required to create a general partnership a) As with sole proprietorships, just start carrying on business with another person with a view to profit (see existence below) b) For reasons we will consider in more detail below, it is generally good practice to take the formal step of writing up and signing a partnership agreement c) There is a registration requirement for general partnerships but, unlike a limited partnership, a general partnership can exist without ever complying with the registration requirement. There are potential consequences of the failure to register: i) It is an offence and there may be a fine ii) S.87 even if havn’t registered, legal actions can still be brought against all or any one of the partners (though note this is less significant now due to Rule 7 of the Rules of Court , and s.53 of the Law and Equity Act )
3) Partnership Act s.81
requires persons associated in partnership for trading, manufacturing or mining
( TMM ) to file a registration statement with the Registrar a) On TMM, see discussion under sole proprietorship above b) The registration statement shows the name of the firm and the names of the persons who are in partnership in the firm.
34
c) s.82
: within three months after the formation of the firm d) Failure to file a registration statement is an offence under the Offence Act and can result in a fine of up to $2000. e) It also has the now relatively archaic consequence that it makes the partners jointly and severally liable for the debts of the firm and not just jointly liable (see s.87 and see the below on joint and several liability).
4) s.90
: the Registrar keeps an index that shows the name of the partnerships registered and beside them the names of the persons who are partners in the particular firm. This provides an easy place for third parties to check to see who is a partner in the firm.
5) s.83
: when there is any change or alteration in the membership of the firm (e.g. a partner retires or a new partner is taken on), or in the name of the firm, a new registration statement must be filed. This keeps the index up-to-date with respect to who is a partner in the firm so that third parties will not be misled by the index as to who the partners in the firm are. a) Failure to file a registration statement of change is an offence under the Offence Act with a potential fine of up to $2,000. b) s.84(b): another penalty for failure to file a registration statement of change in the partnership is that the retiring partner will be deemed to continue to be a partner and therefore will be liable with respect to debts of the partnership even after his or her retirement. i) See also Retirement below.
Existence of partnership: persons carrying on business in common with view of profit (not corp)
1) Existence of partnership can be significant because (and policy considerations related to each of these three likely impact courts in deciding whether a partnership exists): a) Relation between the people: As described below, the Partnership Act sets out a default agreement between people acting as partners (unless varied by them), so need to ask: what was the nature of their agreement or understanding, and would it be appropriate that the default provisions control their agreement b) Relation to third parties: The claim that two or more persons are partners may be made by a third party who is arguing that each of those persons is liable to the third party in contract or tort because they are partners and the contract or tort arose out of the conduct of the business. See below. c) Tax issues: Whether persons are partners or not can have significant tax implications . Tax policy considerations are likely to influence the results in these cases.
2) Sections 2 to 4 of the Partnership Act deal with the existence of partnership , and apply in all three of the above cases (i.e. whether the context is the nature of the agreement between two or more persons, a claim by a third party creditor that two or more persons are partners, or a tax issue)
3) Partnership Act s.2
: “
Partnership is the relation which subsists between persons carrying on business in common with a view of profit
” a)
“
Person
” is defined in s.29 of the B.C.
Interpretation Act as including: “a corporation, partnership or party, and the personal or other legal representatives of a person to whom the context can apply according to law.” i) Thus a corporation can be a partner , two or more corporations can be partners, a corporation and an individual can be a partner, and a partnership can be a partner in another partnership. b)
“
Carrying on business
” – although there is a definition of “business” in s.6 of the Act it does not apply to Part 1 of the Act where s.2 appears. Thus the word “business” presumably takes on its ordinary meaning as (per the Oxford English Dictionary) “a trade, a profession, a person’s usual occupation; buying and selling, trade; a commercial firm; a shop.” This element of the definition is usually a relatively straight forward one to establish. See also Backman below. c)
“
In common
” is usually the most difficult part of the definition. It suggests that the persons must be carrying on the business together in some way ( so excludes employees who do not have any
35
management control). See also multiple Liability to 3 rd
parties & ‘in common’ below (provides some guidelines on what does and does not constitute partnership and is arguably an expansion upon this element of the definition). See also Backman below. d)
“
View of Profit
” means that non-profit associations are not treated as partnerships under the
Partnership Act . Profit means revenue less expenses, but the business only needs to be carried on with a view of profit i.e. profits do not actually have to be made for a partnership to exist. See also Backman below. e) Backman v. Canada (2001), 196 D.L.R. (4 th ) 193 (S.C.C.) i) Although this is a tax case it is important here because it is a recent Supreme Court of Canada case that made several observations concerning the definition of partnership contained in common law partnership acts in Canada. ii) Facts: a limited partnership was established under the laws of Texas called “The Commons at
Turtle Creek.” The limited partner investors were Americans. The limited partnership acquired land in Dallas and constructed an apartment building on it. By August of 1988 the cost of the land far exceeded its fair market value. The appellant and 38 other Canadians sought to take advantage of this loss and deduct it from their Canadian income taxes. They attempted to do this by buying out the interests of the Americans (i.e. the Americans assigned their limited partnership interests to the Canadians) then selling the apartment complex back to the Americans to realize the capital loss. iii) Issue: For tax purposes in Canada, the partnership gains or losses are attributed to the individual partners who then include the gain or loss in their individual tax returns. The
Canadians could thus deduct the loss on the Texas apartment building from their other individual sources of income as long as the relationship among them was in fact a partnership .
Thus, the Supreme Court of Canada noted that the principal issue was whether a valid partnership was created. iv) Decision:
(1)
The Court noted that “partnership” was not defined in the
Income Tax Act but in common law and provincial partnership acts. It then went on to consider some of the elements of the definition of partnership.
(2) Carrying on business :
(a)
The Court noted that the definition of “carry on business” in Black’s Law Dictionary is
“to hold one’s self out to others as engaged in the selling of goods or services .”
(b) The Court also noted the definition given by Cartwright, J. in Gordon v. The Queen
[1961] S.C.R. 592 that said that “carrying on business” involved:
(i) “the occupation of time, attention and labour ;
(ii) the incurring of liabilities to other persons; and
(iii)the purpose of a livelihood or profit
.”
(c) The Court added that it is not necessary to show that the partners carried on a business for a long period of time – a partnership may be formed for a single transaction .
(d) The court also noted that it is not necessary to show that the parties held meetings, entered into new transactions or made decisions, and that a business may be established where the sole business activity is the passive receipt of rent .
(3) In common :
(a) As to whether persons are carrying on business “in common” the court noted that the authority of any partner to bind the partnership is relevant .
(b) However, the fact that the management of a partnership rests with a single partner does not mandate the conclusion that the business was not carried on in common .
(c) The court further noted that it may be relevant to consider whether the parties held themselves out to third parties as partners .
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(d)
Other factors the court said could be considered include “the contribution of skill, knowledge or assets to a common undertaking ; a joint property interest in the subject matter of the adventure; the sharing of profits and losses ; the filing of income tax returns as a partnership ; financial statements and joint bank accounts ; as well as correspondence with third parties”
(e) See also multiple Liability to 3 rd
parties & ‘in common’ below
(4) View of Profit :
(a) On the question of “view of profit” the court noted that the tax motivation will not derogate from the validity of the partnership – it is a question of intention . It further noted that profit doesn’t have to be the overriding intention – it is sufficient that there was an ancillary profit-making purpose . It also does not require a net gain over a period of time – the business or venture could incur losses as long as there was a view of profit .
(5) The court added that whether a partnership has been established in a particular case will depend on an analysis and weighing of the relevant factors in the context of all the surrounding circumstances . It is not a question of a mechanical application of a checklist.
We will see the weighing of factors approach in the cases of Pooley v. Driver and Martin
v. Peyton considered below. v) Result:
(1) In determining whether a partnership existed on the facts the court noted that the Dallas apartment was never operated. It was just acquired and sold. Although the group of
Canadians also bought a Canadian oil and gas property and a Montana Condo complex neither of them ever produced a profit. The revenues from the oil and gas property were small ($1,000 to $1,500 per year) so an overall loss was still expected. The Canadian investors did not manage the property but had a management company manage the property. The condo was also only operated for two months and was sold 18 months later.
The court concluded the oil and gas property and the Montana condo investments were just
“ window dressing
” in an attempt to make it appear to be a partnership for tax purposes but there was no real expectation of or view of profit .
4) Partnership Act s.3
a company or association incorporated under the British Columbia Company Act
(BCCA), or under any other statute, letters patent or Royal Charter, or registered as an extraprovincial corporation under the BCCA is not a partnership a) From the definition in s.2, it might be possible to argue that shareholders in a corporation are also partners and so the Partnership Act should apply to all corporations i) (the shareholders are “persons”, through the corporation they will arguably be carrying on a business, and will be doing so in common and with a view of profit, that may be distributed to them in the form of a dividend) b) However, there is a whole separate statute dealing with the relationship between a corporation and its shareholders ( BCBCA ), so s.3 says that for a business carried on through a corporation, however formed, the Partnership Act does not apply. c)
Note it does not say that corporations cannot be partners (see ‘person’ in s.2 above)
Not separate legal entity, partner not employee/creditor, personal liability for contracts,torts,etc
1) Re Thorne v. New Brunswick (Workmen’s Compensation Board) (1962), 33 D.L.R. (2d) 167
(N.B.C.A.), leave to appeal denied, [1962] S.C.R. viii. a) Facts: Thorne and Robichaud were partners in a tree-felling and sawmilling operation.
Robichaud would fell the trees and Thorne would do the sawmilling. Thorne was injured in the sawmill and sought workers compensation. The Board refused compensation on the basis that
Thorne was not a worker. b) Issue:
37
i) The New Brunswick
Workmen’s Compensation Act
, R.S.N.B. 1952, c. 255 defined a
“workman” as an “employee.” The Board argued that Thorne could not be an employee because he was a partner with Robichaud. Partnership, the Board argued was not a legally recognized entity and that meant that an employment contract in the context of the Thorne-
Robichaud partnership business had to be a contract between the employee and Thorne and
Robichaud as co-employers. For Thorne to be an employee he would had to have made a contract with himself. This, argued the Board, was not possible – it takes two to contract. ii) Several arguments were made on behalf of Thorne that a partnership had in fact come to be regarded as a separate legal entity. c) Decision: i) A partnership is not recognized in law as a separate legal entity ii) Thus Thorne was not an employee but rather a partner , and so cannot get compensation. d) Comment: i) Note the New Brunswick
Workmen’s Compensation Act did provide for compensation for
“self-employed” persons as long as they had made the required employer contributions to the compensation fund. Thorne and Robichaud had not made any contributions to the fund.
Perhaps that affected the outcome of the case. ii) Contrast with case below where claim for worker’s compensation is made with respect to a person who carried on business through a corporation and the result was different (
Lee v. Lee’s
Air Farming Ltd.
)
2) There are several consequences of partnerships not being recognized as separate legal entities: a) Each partner is liable to the full extent of their personal assets for debts and other liabilities of the partnership business. i) Contracts entered into by partnership are contracts of each individual partner ii) All partners personally liable for torts (vicariously for employees) b) A partner may not be an employee of the partnership business (see Re Thorne above). c) A partner cannot be a creditor of the partnership ( except in very particular circumstances provided for in the Partnership Act ).
3) One should also bear in mind that a partnership is not recognized as a separate legal entity in spite of the fact that there are some instances in which it is treated as a collective entity . a) E.g. Partnership Act s.1 defines “firm”
as “the collective term for persons who have entered into partnership with one another.” b) E.g. for income tax purposes the income of the business of the partnership is calculated for the partnership firm. However, the partnership firm is not taxed. Instead the income is allocated between the partners and the partners are taxed individually on their shares of the partnership income . c) E.g. actions against a partnership may be commenced and defended in the partnership name pursuant to Rule 7 of the B.C. Rules of Court . Procedural rules of this sort are common in other jurisdictions and a similar rule was considered in Re Thorne , in which the court said that the presence of this rule did not mean that a partnership was a separate legal entity – it simply provides a convenient means of commencing an action against partners concerning claims arising out of the conduct of a partnership business.
Default ‘contract’ between partners (equality), varied by partnership agreement, can assign profits
1) Like agency law, partnership law deals with the relationship between the partners and with the relationship between partners and other persons affected by the conduct of the business (i.e. third parties).
2) The Partnership Act ( ss.21-34 , see below) sets out what is essentially a default contract that will govern the relationship between the partners to the extent they have not either explicitly or implicitly agreed otherwise (many statutory provisions in the context of business associations are default
38
provisions – the statute effectively says, “this is the way it is unless you say otherwise” – unlike more familiar statutory provisions that specify what must not be done) a)
This ‘standard contract’ facilitates the formation of partnerships by allowing persons to create a partnership without having to create their own set of rules to govern their relationship (i.e. it reduces transactions costs ). b) The default rules are based on the assumption that the partners are equal with respect to their capital contributions, rights to participate in management of the business and share in the profits of the business. c) However, these notions of equality do not reflect the way most partnerships work (e.g. they often make different contributions of capital, have different skills and different interests in the management of the partnership, and often agree on sharing profits in an unequal manner usually consistent with their contributions of capital and/or services to the firm).
3) Partnership Act s.21
: The mutual rights and duties of partners , whether ascertained by agreement or defined by this Part, may be varied by the consent of all the partners and the consent may be either express or inferred from a course of dealing. a) Some provisions also expressly provide that they are subject to any express or implied agreement between the partners (e.g. s.27) b) This ability of partners to create their own set of rules makes the partnership form of business association a very flexible form, and this is one of the key advantages of partnership. c) Since default rules based on assumption of equality, usually need express agreement that overrides default rules where they are inconsistent with what the partners want. If not overridden, risk that partners will be stuck with terms they don’t want. d) Also useful to write up a comprehensive partnership agreement (similar to shareholders agreement for corporation, though can’t attach an employment contract since partners can’t be employees) including provisions that are consistent with the default provisions in the Partnership Act , so have a document for the parties that can serve as a source for them in finding out what all their rights as partners are (so don’t have to also look at
Partnership Act , which can create unnecessary complexity and potentially add confusion)
4) Default rules : a) S.23(1): partnership property must be held and applied for the purposes of the partnership in accordance with the partnership agreement . i) S.6 provides that “ partnership property ” means property brought into the partnership, property acquired on account of the firm or property acquired for the purposes of and in the course of the partnership business. ii) S.23(2): land that belongs to partnership but held in the name of an individual (or one or more) partners (inconvenient to list out all partners if many) is held in trust for the partnership . iii) S.24 adds that property bought with money belonging to the firm is deemed to be partnership property . iv) See A.E. Lepage v. Kamex Developments below where ability to deal with individual interest in property helped the court decide co-ownership rather than partnership (although this is not impossible for partnership if agreed to). See also Martin v. Peyton b) S.27 contains the main provisions concerning the day-to-day running of the partnership business, setting out rules that govern the partnership relation “subject to any agreement express or implied between the partners”: i) s.27(a) – Partners share equally in capital, profits and losses
(1) e.g. Miles v. Clark , English
(a) Facts: photographer P and person F with funds sent into business together, under oral agreement F bought lots of equipment for P to use. A dispute arose between them after
3 weeks, P sued F for half the assets (as s.27(a) says is the default)
39
(b) Decision: The court held equivalent of s.27(a) does not apply since not consistent with their oral agreement
(c) Comment: nevertheless, this case shows the potential problems the default rules might lead to ii) s.27(b) – The firm must indemnify every partner for payments/liabilities in the ordinary and proper conduct of the business or for the preservation of the business or property of the firm.
(1) This is similar to the agency law requirement that the principal indemnify the agent. iii) s.27(c) – A partner who makes an advance of capital over and above the contribution of capital he or she agreed to make is entitled to receive a payment of interest at a fair rate. iv) s.27(d) – A partner is not entitled to interest on the capital subscribed by the partner (i.e. the return on contributed capital is in the form of profits and not payment of interest). v) s.27(e) – Every partner may take part in the management of the business.
(1) Even if not active in management (i.e. a dormant partner) can still be liable for acts of other partners (see Cox v. Hickman below) vi) s.27(f) – Partners are not entitled to remuneration for working in the partnership business. vii) s.27(g) – No new partner can be admitted to the partnership without the consent of each of the partners. viii) s.27(h) – Decisions on ordinary business matters are to be decided by a majority of the partners. However, no change in the nature of the partnership business is permitted without the consent of all existing partners. ix) s.27(i) – Partnership books are to be kept at the principal place of business of the partnership and every partner may have access to the books to inspect them or copy them. c)
S.28 provides that no majority of the partners can expel any partner “ unless a power to do so has been conferred by express agreement between the partners and the power is exercised in good faith.” Thus the default rule is that a partner cannot be removed from the partnership without that partner’s consent
, and this default rule cannot be altered by implication. If it is to be altered it must be by express agreement. d) S.29 and 35(c): any partner can dissolve partnership at any time (see dissolution below)
5) S.34: A partnership interest can be assigned , but this only means an assignee of a partner is entitled to a share of the profits and a share of partnership assets on dissolution – it does not result in the assignee becoming a partner, and so does not entitle the assignee to participate in the management or administration of the partnership business. a) Rationale: partners want to be in business with persons they know and trust, hence this default rule which means they cannot be forced to accept a new partner just because a fellow partner has sold her or his interest.
EG partnership agreement (mgmt, debt, profits, new partner, drawing, wind up, retire, records)
1) Can compare the differences between what partners want and what the default rules would produce
2) E.g. Jones (owner, currently sole proprietorship, put in $40,000) bringing in new partner (Toth) to inject new cash ($60,000) into the business
What is wanted
Jones is to manage
Default rules under Act
27(e) both manage (DIFFERENT)
Toth has veto over fundamental changes to business (should ask what kinds of changes exactly)
Toth wants control over further debt financing
(again, should clarify if this includes all trade credit e.g. buying stationary on credit)
Both are to control admittance of new partners
27(h) no change in nature of business without consent of all partners (SAME)
27(h) unclear if this would be ordinary or change in nature (UNCLEAR)
27(g) no new partners without consent of all
(SAME)
40
Jones wants management remuneration of $400 per week (not an employee though)
Share profits and losses
Jones can buy out Toth
equally
27(f) partners not entitled to remuneration
(DIFFERERNT)
27(a) equal sharing of profits and losses (SAME)
28 need consent of partner to remove them
(DIFFERENT)
Toth has to give notice period before leaving s.29,35 any partner may end partnership at any time (DIFFERENT)
3)
Should obviously put any differences or unclear’s into partnership agreement
4)
Should also put the same’s into the partnership agreement, so full set of rights are in the agreement and to provide details on each
5) Jones and Toth might also want to agree upon: a)
When they can take money out of the business (‘ drawings’
) (as opposed to retained earnings – recall Balance Sheet) b) Given their different inputs of cash (40-60), do they want equal asset split-up on winding up (as provided under 27(a)) or do they want it according to 40-60, or what c) If Jones buys out Toth, might want to require Jones to indemnify Toth on retirement so Toth no longer liable for actions taken by firm while Toth was a partner (see s.19) d) Who has signing authority at the bank e) Toth may be concerned about accuracy of records (e.g. profits depend on them yet Jones doing the management), so might want some review/audit of accounts f) Might want review/amendment provision g) Might want to provide for arbitration in case of dispute
6) Check other partnership agreements, commercially published form books, CLE and bar admission checklists, etc., to see if forgotten anything
7) Note single lawyer should be careful acting for both sides in setting up such agreements since there may be conflicts of interest (e.g. lawyer for Toth should perhaps suggest they consider a limited partnership, though for Jones this wouldn’t be so good). If single lawyer does it, should tell both partners of potential conflict and that wouldn’t be able to act for either if a dispute arises
(understandable though to want to avoid expense of each having their own lawyer)
Codified fiduciary duties between partners: fair, good faith, account & full info if compete/conflict
1) Subject to restrictions on their authority, partners are treated as agents for each other: a) The acts of a partner in carrying on the business of the partnership can therefore bind all the partners. b) See “Liability to 3 rd parties in contract” below, and Cox v. Hickman below where existence of an agency relationship was perhaps a key to determining whether a partnership existed
2) Partners therefore need to trust each other, and this is reinforced with fiduciary duties : a) The common law presumption was that partners owed fiduciary duties to one another. This is codified in B.C. Partnership Act s.22
: “a partner must act with the utmost fairness and good faith towards the other members of the firm in the business of the firm.” b) Sections 31-33 specify specific duties: i) S.31: “Partners are bound to render true accounts and full information of all things affecting the partnership to any partner or his or her legal representatives”.
(1) This is similar to the agency requirement that the agent keep proper records. ii) S.32(1): “A partner must account to the firm for any benefit derived by the partner without the consent of the other partners from any transaction concerning the partnership , or from any use by the partner of the partnership property, name or business connection
”
(1) S.32(2): This applies to transactions taken after partnership dissolved by death of partner but before affairs of partnership completely wound up
41
iii) S.33: requires that partners account for and pay over profits made from engaging in competing businesses carried out without the consent of the other partners
3) Rochwerg v. Truster (2002), 23 B.L.R. (3d) 107 (Ont. C.A.) a) Facts: Rochwerg was a chartered accountant and a partner from 1993 to 1996 in the partnership firm of Rochwerg Truster Zweig ("RTZ"). In July 1995, Rochwerg became a director of Teklogix
International Inc. (“Teklogix”) and of its wholly-owned subsidiary Teklogix Inc. both of which companies were clients of RTZ. Rochwerg disclosed his directorships to his partners in a timely fashion and remitted his first year’s directors’ fees to the firm. However, as a director of Teklogix he was also entitled to certain shares and stock options in Teklogix and he did not tell his partners about this prior to the dissolution of RTZ (on July 31, 1996 Rochwerg left the firm and the partnership RTZ was dissolved). b) Issue: i) The question after the dissolution of the partnership was whether the other partners were entitled to an accounting for Rochwerg’s shares and stock options in Teklogix. ii) Rochwerg had been a partner in several firms before the formation of RTZ. Teklogix had been his client since 1967. He was the partner of RTZ who was the primary contact between RTZ and Teklogix. In the fall of 1993 and throughout 1994 Teklogix was contemplating an initial public offering of its shares and it changed auditors to a national firm. However, RTZ remained the auditor of the subsidiary, Teklogix Inc. until June of 1995. Rochwerg continued to provide some services to Teklogix although the nature and extent of those services was not clear. c) Decision (Cronk, J.A. for the court): i) Cronk J.A. noted that no written partnership agreement existed among the partners of RTZ and accordingly the mutual rights and duties of the partners were governed by the Partnerships
Act , R.S.O. 1990, c. P.5. The court referred to the Ontario Partnership Act equivalents of sections 21, 31, 32(1), 33 and 91 of the B.C. Partnership Act and noted that the partners had not varied the terms of the equivalent of sections 31, 32(1) and 33 of the B.C. Act as they could have done pursuant to the B.C. Act equivalent of s. 21. ii)
The court also noted that “…partnership law in England has had a substantial influence on the development of partnership law in Ontario. The Act derives both from the English caselaw and the 1890 Partnership Act, 53 & 54 Vict., c. 39. Under s. 45 of Ontario’s Act, the
English jurisprudence remains relevant to Ontario's law of partnership… It follows, in my view, that the starting point for analysis of the issues in this case, is the origins of the modern partnership rules. It has long been established that partners owe a fiduciary duty to each other , and that equitable principles hold fiduciaries to a strict standard of conduct , encompassing duties of loyalty, utmost good faith and avoidance of conflict of duty and self-interest . These are well recognized, core principles of the law of partnership.” iii) The court reviewed not only the Act and the development of the common law that led up to it but also the development of fiduciary principles arising under agency law , fiduciary relations and trust law since the enactment of the Partnership Act . iv) The court then had this to say about the provisions of the Act under consideration: “Little jurisprudence regarding ss. 28, 29(1) and 30 of the Act [BCPA ss. 31, 32(1) and 33 ] has developed in Ontario. In considering the import of those provisions, and their application to this case, it is important to recognize the distinctions between ss. 29(1) and 30. First, an obligation to account arises under s. 29(1) [ s.32(1) ] without proof of a competing activity . In contrast, the obligation to account established by s. 30 of the Act requires proof of competition. Second, s. 29(1) has two branches. An obligation to account may arise wherever a benefit has been derived by a partner, without the consent of the other partners, from ‘any transaction concerning the partnership’ or from ‘any use … of the partnership property, name or business connection’.”
42
v)
The court concluded that “[a]t all times while Rochwerg was a partner of RTZ, he owed
[fiduciary] duties to his partners.” The court concluded that Rochwerg did not have a conflict of interest giving rise to an obligation to account under s.30 [ s.33
]. vi)
However, “the Teklogix shares and stock options constituted compensatory benefits in a matter ‘affecting’ and ‘concerning’ the partnership which he was obliged to disclose to his partners under s. 28 [s.
31 ] of the Act, and for which he must account under the first branch of s. 29(1) [s.
32(1) ] of the Act. vii) “Moreover, Rochwerg became a director of the Teklogix companies only because of his previous role, through RTZ and its predecessor partnerships, as their accountant and valued advisor. When Rochwerg joined the RTZ partnership and the Teklogix companies became clients of that firm, his prior connection and association with the Teklogix companies became a business connection of RTZ with two of its clients. Accordingly , I conclude that Rochwerg's benefits under the KESP were benefits derived by him from his use of a ‘partnership . . . business connection’ within the meaning of the second branch of s. 29(1) [s.
32(1) ] of the Act.
Consequently, Rochwerg is also liable to account to his former partners for the Teklogix shares and stock options on this additional ground.”
4) E.g. McKnight v. Hutchinson (2002), 28 B.L.R. (3d) 269 (B.C.S.C.) a) Facts: i) The case involved a law firm partnership that ended when Mr. McKnight learned that Mr.
Hutchinson had received earnings from part ownership in a private company. Article 2.8 of the partnership agreement provided:
“2.8 Partners may conduct business, other than the practice of law, upon notice to the other partners, and receive remuneration separately therefrom, provided that such activities shall not compromise the practice of law within the partnership by the partner or the partnership and provided further that such activities shall not prevent the full contribution of such partner to the business of the partnership. Without limiting the generality of the foregoing, such activities may include:
(a) holding of share interests in operating companies;
(b) holding of directorships of corporate bodies or other institutions;
(c) acting as an executor of an estate, except in circumstances where the appointment has occurred by reason of succeeding another partner or previous partner due to the membership in the partnership;
(d) holding and administering private investments; or
(e) providing legal or other business services to family members or to family business.” ii) Mr. Hutchinson had received honoraria from a position on a government board, fees for services as a trustee of a private trust, director’s fees from acting as a director for three companies, and earnings on shares held in connection with the companies of which he was a director. Mr. Hutchinson had become a director of each of the three companies before the formation of the partnership with McKnight. Each of the companies became clients of the law firm partnership on the formation of the partnership. b) Decision: i) Grist J. noted that the relevant provisions of the Partnership Act were ss. 22(1), 31, 32(1) and
33. He also noted that these obligations between the partners can be varied by consent of the partners, and that Article 2.8 of the partnership agreement contemplated a partner conducting business outside of the partnership so long as the business was not the practice of law. ii) He noted that Art. 2.8 reinforced the duty to disclose in s.31
of the Act. Grist J. found that there was no notice given of any of these matters. Further, Hutchinson should have given notice of the honorarium.
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iii) As to the trusts services, some them may have been law firm related services. Hutchinson’s activities on behalf of at least one of the companies involved giving legal advice to the directors of the board. iv)
Some of Mr. Hutchinson’s connections may also have put him in a conflict of interest .
Collections on bills for legal services rendered to some of these clients on behalf of the firm were left uncollected perhaps in part because Hutchinson was receiving other forms of remuneration for these clients.
Funding: trade credit, loans, partners equity investors (share profits, equally by default), security
1) The funding of the partnership is very similar to the funding of the sole proprietorship : a) The partners are the equity investors . i) They usually make cash contributions but their investments could also be in the form of property to be used in the partnership business or services, or any combination of cash, property or services. ii) Typically partners will share profits in proportion to their relative contributions , but they do not have to – they can agree on different shares. Where the partners say nothing about their contributions or their shares the presumption in s.27(a) is that they share equally in the capital, profits and losses. b) There will usually be some trade credit and typically a bank loan and perhaps others lenders (recall negotiated ‘no-recourse’
loans and credit to limit liability to business assets, but inability to limit liability for torts other than through insurance)
2) It is possible (though rare) that a partnership interest may be considered a “security” under provincial securities legislation and if so it would be subject to provincial securities legislation . a) Also be careful with loans to the partnership since they could also be considered
“securities” and thus subject to provincial securities legislation. b) If partnership interests or loans to partnerships constitute “securities” under provincial securities legislation then a prospectus would be required for the sale of these “securities” and other requirements of the securities legislation would follow unless an exemption from the prospectus requirement was available. c) If a partner is involved in management unlikely to be considered a security , but otherwise it might be. E.g. a limited partnership interest is a security
Dissolution by partners (fixed term,end of venture,notice) or by death,bankrptcy,diss of partner
1) A partnership can be dissolved by the partners themselves. a) S.35(a): one way they can do this is to set a fixed term for the partnership. At the expiry of the fixed term the partnership will be dissolved unless the partners agree otherwise b) S.35(b): it could also be agreed that the partnership be dissolved at the end of a particular venture for which the partnership was created. c) S.29,35(c): otherwise , if there is no fixed term and the partnership is not formed for a particular venture, then the partnership may be dissolved by notice of intention to dissolve and the dissolution will take effect from the date of the notice or the date specified in the notice
2) Under the Partnership Acts of most of the provinces a partnership is dissolved automatically upon the death, bankruptcy, or dissolution of a partner a) This approach is consistent with the legal nature of partnership in that a partnership is no more than the collection of the individuals in it, so that when one partner is taken out what remains is a whole new partnership because it now consists of a different group of individuals . b) Rationale: It makes sense to dissolve the partnership in these circumstances because the relationship is usually one of trust and involves the sharing of losses
. Thus you don’t want to be sharing losses with a partner that is probably no longer able to contribute to the losses since jointly liable (such as a bankrupt partner or a corporate partner that has been dissolved). You may also
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not want to be in business with the executors or administrators of the estate of a now deceased partner. c) However , if the whole partnership is dissolved then you need a whole new partnership agreement among the remaining partners to continue. This can be very frustrating , especially when some partners may use it as an opportunity to hold out for a better deal. Thus this provision is invariably altered by express agreement between the partners such that the death, bankruptcy or dissolution of a partner does not result in the dissolution of the partnership as between the remaining partners. d) The B.C. Partnership Act s.36 has dealt with this by putting in a default provision that is closer to what the partners would provide. It says that where there are more than two partners, the death, bankruptcy or dissolution of a partner only dissolves the partnership as between the deceased, bankrupt or dissolved partner and the remaining partners (i.e. the partnership agreement continues to apply with respect to the remaining partners ).
Partnership: liability
Liability to 3 rd parties in contract: partners agents each other, actual/ostensible auth, jointly liable
1) Third parties (such as creditors or contractors) will often argue that particular persons are liable on the basis that they are partners.
2) Start with the definition of partners, s.2
(see Existence of Partnership above)
3) Partnership Act s.7-11 apply to voluntary relationships between partners and third parties (i.e. contracts )
4) S.7
: apparent authority of partners a) 7(1) Every partner is an agent of the firm and other partners for the purposes of the partnership business i) See also Cox v. Hickman below where existence of an agency relationship was perhaps a key to determining whether a partnership existed b) Further, 7(2) where a partner does an act for “carrying on in the usual way business of the kind carried on by the firm” it binds the firm and her or his partners unless : i) the partner had no authority to act for the firm in the particular matter; and ii) the third party either knew the person dealt with had no authority or did not know or believe the person he dealt with to be a partner . c) Comment: this parallels ostensible authority in agency law, in particular reasonable reliance :
(1) If third party knew partner had no authority, would not be reasonable to rely on all the partners being bound by the particular partner’s unauthorized act.
(2) A third party might reasonably rely on the apparent authority of a partner to bind her or his fellow partners if that partner was carrying on business of the kind carried on by the firm and in the usual way for that business
(3) If the partner was doing some business not associated with the business of the firm, or doing it in an unusual way for that business, third party should have been suspicious and confirmed whether the partner had authority – thus reliance by the third party would not have been reasonable
5) S.8: actual authority of agent or partner a) An act or instrument , relating to the business of the firm, done or executed in the firm name (or in any manner showing an intent to bind the firm), by any person authorized to do so (whether a partner or not), is binding on the firm and all the partners . i) This does not limit the authority to actual authority, so appears to cover both actual and ostensible authority (and so appears broader than s.7 which deals with the situation where partner may reasonably appear to have authority to bind her or his co-partners).
6) S.9: if no ostensible authority, partners not bound unless particular partner had actual authority
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a) Where one partner pledges credit of the firm and does so for a purpose apparently not connected with the firm’s ordinary course of business then the firm is not bound unless the person was specially authorized by the other partners. i) Third party here has no reason to believe the partner has authority (i.e. the partner has no ostensible authority), so only way the partner’s act may still bind the firm is if the partner has actual authority to do that thing.
7) S.10: third party notice of restriction on authority of partner a) If a third party has notice of a restriction on the power of a partner then the partner’s actions in contravention of the restriction do not bind the firm. i) Degree of overlap here with s.7 (s.7 says the acts of a partner do not bind the firm where the third party “knows” the partner has no authority). However, s. 10 refers to “notice”, and it is possible to know of a partner’s lack of authority without having been given “notice” of a lack of actual authority.
8) S.11: joint liability for debts of partnership a) Every partner is jointly liable for all debts and obligations of the firm as long as one is a partner. b)
After the partner’s death his estate is also severally liable subject to the prior payment of the partner’s separate debts (this allows for an action against the estate of a deceased partner while the estate is being administered without barring actions against other partners)
Liability to 3 rd parties in tort: joint & several liability if authority or ordinary biz (partners share)
1) S.12 (similar to agency principle): the firm is liable for wrongful acts or omissions with loss or injury caused to any person where a partner : a) acted with the authority of co-partners; or b) acted in the ordinary course of business of the firm.
2) S.14: the liability under s.12 is joint and several (again, not so significant now with Rules of Court and Law and Equity Act )
3) Scope of s.12 was addressed in Ernst & Young v. Falconi (1994), 17 O.R. (3d) 512 a) Facts: Falconi was a lawyer in the firm of Klien, Falconi and Associates (KFA). Falconi pleaded guilty to a charge under the Bankruptcy Act of assisting persons who were adjudged bankrupt in making fraudulent dispositions of their property. Klien had no personal involvement with the transactions. Each of the transactions involved the use of the legal services of KFA in the preparation of mortgage documents, documents transferring title to assets, corporate minutes, reporting letters and other services normally performed by a law firm in the course of a real estate or commercial practice. b) Issue: Klien argued that the acts of Falconi in assisting clients in making fraudlent transfers could not be considered within the ordinary scope of business of the law firm. c) Decision: The judge hearing the motion for summary judgment against Klien held as follows on the issue of the ordinary scope of business of the law firm: i)
“I agree with the submission of counsel for the plaintiff that the court need not find that it is within the ordinary course of business of a law firm for a partner of that firm to conspire with others to defeat creditors of the firm’s clients. It is sufficient if the partner used the facilities of the law firm to perform services normally performed by a law firm in carrying out the transactions as a result of which the creditors of the firm’s clients suffered loss. ... I find that the activities of Falconi were of the nature of the normal legal services provided by a lawyer with a real estate and/or commercial practice in that they consisted of the preparation and completion of mortgage documents, the preparation and completion of documentation for the transfer of title to assets and the preparation of corporate minutes and authorizing resolutions and that throughout these services were performed through the facilities of KFA making use of its support staff, trust account, letterhead and documents. ... I accept the submission of counsel for the plaintiff that the fact that the various actions of Falconi were for improper purposes and
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with intent to defraud the creditors of the bankrupts does not take the acts themselves out of the ordinary course of business of the law firm if they are in the nature of acts normally performed by the law firm in carrying on its usual business
.”
4) When a partner is found liable the partner is liable for the full amount. Tort victims or persons contracting with the partnership business can claim full compensation from any one or more of the partners .
5) This liability of a partner is independent of any right of the partner to seek indemnification or contribution from the other partners. A partner who is required to satisfy such an obligation may seek contribution or indemnification from his or her fellow partners according to the terms of their partnership agreement . a) E.g. Smith has a claim against Adams and Brown of Adams & Brown Shoes for the unpaid amount due for shoes supplied on credit. Smith can proceed against either Adams or Brown or both of them. This will be the case even if it was just Adams that dealt with Smith. If Brown is made to pay the full amount of the debt Brown will, depending on the partnership agreement, normally be able to seek a contribution from Adams. However, that is a separate matter between
Adams and Brown.
Liability to 3 rd parties & ‘in common’: not partners if only co-owners or only sharing gross returns
1) Section 4 of the Partnership Act sets out a series of what are essentially presumptions that can be rebutted .
2) S.4(a): common ownership of property does not of itself make the co-owners partners . a) E.g. three persons operating separate stores – a dry cleaning shop; a convenience store; a hairdressing salon. They jointly buy a property with a building and hold it as co-owners. Each takes a space in the building but they run their businesses entirely separately. Thus none is carrying on business “in common” (even though they are tenants-in-common for the property), since there only relationship is a form of co-ownership. b) E.g. A.E. Lepage v. Kamex Developments , see below, involved distinguishing between tenancyin-common and partnership , showing distinctions can be difficult to make and how policy concerns can help predict probable outcome. c) Of course a partnership may include co-ownership, but co-ownership alone is insufficient to show a partnership exists i.e. there is a presumption here in favour of defendants, since plaintiff will be arguing they were partners (and similarly with other provisions described below) d) E.g. the three shop owners have some empty space in the building and they start renting part of that space out to other persons. They share equally in the rental profits and join in the management of the building (dealing with heating, lighting, repairs, snow removal, etc.). These additional facts might be interpreted as creating a partnership , at least with respect to the business of renting out space in the building. e) The line between the co-ownership situations and partnership can be difficult to draw, and a finding of co-ownership as opposed to partnership has significantly different implications. Under co-ownership: i) Co-owners are not agents for each other . ii) Co-owners can deal with their own interests in the property without the consent of the other co-owners. f) In contrast, under partnership: i) Partners are agents for each other ii) Unless agreed otherwise a partner cannot transfer his or her interest in the partnership without the consent of the other partners. iii) Normally no partner can deal with an interest in the property itself since the property is held by the partners jointly as an asset of the business itself.
3) S.4(b): the sharing of gross returns does not of itself create a partnership .
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a)
In interpreting “gross returns” it is useful to note that s 4(c) refers to “profits.” In the context of carrying on a business the most apt dictionary definition of “profit” is “money gained in a business transaction, the excess of returns over outlay” (see the
Oxford English Dictionary
). “Gross returns” by contrast suggests revenues before the deduction of expenses. b) E.g. a travelling play company puts on a performance in a theatre operated by the theatre owner.
The travelling play company engages its own actors, arranges for props and costumes and so on.
The theatre owner has nothing to do with this. The theatre owner maintains the theatre taking care of heating, lighting, cleaning, repair and so on. The travelling play company has nothing to do with this. However, the arrangement between the travelling play company and the theatre owner is that they will share the ticket sale proceeds between them in some proportion. The theatre owner will use her share of the ticket the proceeds to deal with her particular expenses from heating, lighting, cleaning, repair and so on, while the travelling play company will use its share of the ticket proceeds to cover its expenses for actors, props, costumes and so on. The respective businesses are being run completely separately from each other – nothing ‘in common’ here, just sharing of the “gross returns” from the performance of the play in the theatre, so no partnership.
Liability to 3 rd parties & ‘in common’: partners if sharing profits (except e.g. profit sharing loan)
1) As always, start with s.2 definition of partnership (see Existence above)
2) S.4(c) opening words: the receipt by a person of a share of the profits of the business is proof in the absence of evidence to the contrary that he or she is a partner in the business. a) In the development of partnership law before the enactment of the Partnership Act of 1890 in
England it was suggested on the basis of Grace v. Smith (1775), 2 Wm. Bl. 998 (see below) that a sharing of profits meant there was a partnership . However, in Cox v. Hickman (see below) the
House of Lords clarified this saying that the sharing of profits only created a rebuttable presumption of partnership (and the opening words of s.4(c) arguably codify this position).
3) S.4(c) goes on with some qualifications (note these qualifications do not mean it is not a partnership, only that the presumption of s.4(c) doesn’t apply – other evidence may still show partnership exists )
4) S.4(c): Receipt of a share or payment contingent on or varying with the profits does not of itself make a person a partner . a)
E.g. ad agency gets $10,000 if the client’s profits are over $1 million, $30,000 if the client’s profits are over $2 million, and $50,000 if the client’s profits are over $3 million (unlikely, more likely based on sales in practice). The client and ad agency are each doing their business on their own, thus nothing ‘in common’.
5) S.4(c)(i): payment of a debt or liquidated (i.e. predetermined) amount by instalments out of profits does not of itself make a person a partner . a) E.g. A debtor is having trouble paying a particular creditor. The creditor realizes that pressing the matter by suing and seizing assets may well result in the debtor declaring bankruptcy and, if so, that the creditor might end up with less than full payment. The debtor’s business is not doing well for the moment but things should turn around (e.g. everyone in town is sick for a while so no visitors to motel business). The creditor agrees with the debtor that he will take 10% of profits until the debt is paid off. The creditor does not, as a result of the agreement, start taking part in the debtor’s business, so nothing ‘in common’, no partnership. b) Cox v. Hickman , see below, was a somewhat more complicated version of this example, with the added difficulty of whether additional factors were sufficient to make the arrangement a partnership. c) Note s.5 subordination does not apply to this s.4(c)(i) situation since just getting paid fixed amount, not really sharing profits – see Canada Deposit Insurance Corporation v. Canadian
Commercial Bank below
6) S.4(c)(ii): a contract for the remuneration of an employee or agent by a share of the profits of the business (e.g. a bonus based on profits) does not of itself make the person a partner .
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a) E.g. articling student is told as part of the incentive for the student to take a job with a particular law firm that there will be a Christmas bonus that will vary depending on the profits of the firm during the year. A client then suffers a $100 million loss due to the negligence of the firm and claims the articling student is liable on the loss as a co-partner in the firm. Clearly unreasonable – the student has not been formally made a partner, has no say in management decisions of the firm, has no equity investment in the firm. I.e. not a partner. b) However, even though an associate not formally made a partner, if contractual right to remuneration by a share of the profits and significantly involved in management decisions of the firm, might be considered a partner. This is an example of a situation where it may make a great deal of difference as to who is making the claim that the associate is a partner. i) If the associate is making the claim that they are a partner and is seeking to obtain the benefits of the partnership agreement, it will likely be highly significant that the associate was never formally made a partner and that it was quite clear that the engagement of the associate by the firm was as an associate only and not as a partner. I.e. unlikely for court to hold the associate is a partner. ii) However, if a third party is making a claim that the associate is liable as a partner the result may be different. The more facts there are that suggest the associate was carrying on business
“in common” with the other partners, particularly from the perspective of an outside observer , the more likely it is that the associate will be considered a partner in spite of the fact that there was never a formal appointment of the associate as a partner.
7) S.4(c)(iii): a spouse or child of a deceased partner who receives an annuity out of profits is not a partner merely because of the receipt of profits. a) E.g. perhaps more in the past than now, a partnership agreement might provide a sort of life insurance in the form a right of a spouse or child of a deceased partner to receive an annuity out of the profits of the continuing partnership business. The spouse or child would not, in the normal case, have any involvement in the business at all, so would not be carrying on business ‘in common’ with the remaining partners.
8) S.4(c)(iv): (“ profit-sharing loan
”): an advance of money by way of a loan , to a person engaged in business or about to engage in a business, on a contract between that person and the lender, where the contract is in writing , the contract is signed by or on behalf of all parties to it; and under the contract the lender is to receive a rate of interest varying with the profits or a share of the profits from the business, does not of itself not make the lender a partner with the person carrying on the business a) Was not part of the common law of partnership, instead introduced in England in what was known as
Bovill’s Act
well prior to the enactment of the Partnership Act in 1890 (see Pooley v. Driver below) b) Note 4(c)(iv) does not apply if only repaying the loan principal plus interest (see Canada Deposit
Insurance Corporation v. Canadian Commercial Bank below) – see s.4(c)(i) instead. c) Somewhat controversial : i) Under the provision it is possible for a person to have an investment in a business that is almost in the purest form of “equity”
and yet the person might not be considered a partner .
Like a pure equity investor the lender could get a share of the profits. But they would presumably only get their loan principal back on windup of the firm, unlike a pure equity investor who would be entitled an unlimited share in the proceeds of a sale of the assets of a business net of the payment of debts. Since not a partner, would be entitled to share with the other creditors in the proceeds from the sale of the assets on windup, ahead of claims by the partners . Indeed, s.4(c)(iv) does not preclude the lender from even taking a security interest
(i.e. collateral that would allow the lender to rank ahead of unsecured creditors with respect to the collateral) and still claim the benefit of the provision. ii) A third party advancing credit to the business may be concerned by this. E.g. a lender making a loan for a fixed amount and at a fixed rate of interest will be concerned that these profit
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sharing lenders (that do not amount to partners) increase the incentive for the equity investors to gamble with other creditors money , since:
(1) They get a share of the profits and so can share in any upside gain from the increased risk
(2) But they have a degree of downside risk protection , since rate as creditors (and maybe even secured creditors) if business wound up.
(3) And equity investors not gambling their own money. iii) E.g. a third party considering advancing credit to the business knows that in this type of business it is rare to see more than 60% of the business’s funds coming from fixed rate loans, so they conclude there should be about 40% equity in the business (and the amount of credit being advanced doesn’t justify further investigation). When the business turns out to be insolvent the third party is surprised to find that virtually all of the funds in the business came from persons who now claim to be lenders and who either share equally with the third party in the claim on the remaining assets of the business or who have a security interest in the assets of the business and thus rank ahead of the third party to the extent of the security interest. I.e. the provision may create the risk that some persons advancing credit to the business may be deceived . See reliance in policy considerations below. iv) There may also be a concern with the potential effects of such an arrangement on tort claimants who have suffered injury as a result of the conduct of the business. These profit sharing “lenders” with limited liability (i.e. limited to their loan) can also make claims on the assets jointly with other creditors, including tort claimants , or perhaps even ahead of other creditors to the extent they have a security interest. And the person or persons running the business may have very few assets other than the assets that are held in the business, which may be financed almost exclusively by these so-called “lenders” for a share of the profits. v) E.g. Pooley v. Driver , see below, is an example of a potential abuse where profit sharing lenders had some control over a partnership (and other factors) which led the court to rule those ‘lenders’ were in fact partners .
(1) Note (in that case) that s.4(c)(iv) does not say cannot be a partnership if there is a profitsharing-loan, rather that the presumption of partnership due to profit-sharing does not apply. Thus will only be a partnership if other factors make it so.
(2) This potential abuse is addressed to some extent by s.5 (see below) and by the words in s.4(c)(iv) “ does not of itself make the lender a partner” (so additional factors can do so) vi) Such concerns in part resulted in s.5 which subordinates the claims of these “ profit-sharing lenders
” s.4(c)(iv) lenders to other creditors (see below)
(1) I.e. can share in profits without being a partner, but on winding-up the profit sharing lender will come after other creditors (although still before the partners) d) Possible justifications for s.4(c)(iv): i) Provides a mechanism for funding businesses caught in temporary difficult situation.
ii) E.g. a business (e.g. a sole proprietorship) is going through a temporary difficult time (e.g. towns people sick, so not using local businesses and outsiders are avoiding the place). The business is having trouble paying its expenses, so needs an infusion of funds, yet others don’t want to become equity investor partners in a struggling business (may lose their investment and be liable for all the debts of the business). They also don’t want to advance funds as lenders for a fixed rate of interest, since the potential for upside gain is limited (i.e. the agreed upon interest rate) but there is a substantial downside risk (i.e. if business does not recover they may lose their investment and/or get no interest, especially if business owner has already used all of the available assets of the business as collateral for other loans). Yet this business probably should not be forced into bankruptcy, and it is probably better for existing creditors that it not do so (i.e. they have more chance of being paid if business recovers ). Hence s.4(c)(iv), allowing investors to share in upside gain (through a share in the profits) while
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allowing them a degree of downside risk protection (i.e. they don’t become partners and thereby liable for all the other debts of the business). iii) E.g. see Martin v. Peyton below.
9) S.4(c)(v): a person receiving payment for goodwill out of the profits of a business is not a partner merely because of the receipt of profits. a)
The “ goodwill
” of a business is the value of the business that is not fully reflected in the market value of the individual assets used in the business. E.g. a business has assets that could each be sold separately in the market, yielding $1 million (this is sometimes referred to as the “ break-up value
” of the business). But someone may be willing to pay much more, perhaps $1.5 million, because the assets kept together in the business, together with the excellent marketing and organization set up by the persons employed in the business, will generate a stream of future revenues the present value of which is much more than $1 million. This excess over the $1 million would be the “goodwill” of the business. b) Owner may think goodwill value is high, but may be very difficult for purchaser to assess the value of the goodwill, making them reluctant to pay the amount the owner asks for. To help convince the purchaser, the current owner might propose the purchaser, for example, pay the break-up value up front and would agree to pay for goodwill out of subsequent profits of the business. In this way the current owner “signals” to the purchaser, in a credible way, that the goodwill is really there. Once the business is sold under this arrangement the purchaser will be running the business on their own (without previous owner), i.e. current owner and purchaser not carrying on the business in common. S.4(c)(v) allows for these kinds of arrangements without the risk that the vendor will be considered a partner in the business when it is being carried on by the new owner. Of course, if the vendor does retain an interest in the business and continues to be involved in it, they might well be considered a partner. c) Again, see s.5 below
10) In Pooley v. Driver and Martin v. Peyton (see below): a) Weighing the factors that are consistent with partnership and those that are not , in order to decide if a partnership should be found to exist b) The courts also stated that just because people state in an agreement they are not partners , that is not determinative (rather must use definitions and tests in Partnership Act, such as s.2: business in common with view to profit)
Liability to 3 rd parties & ‘in common’: policy considerations (reliance, unjust enrichment, LCA)
1) Direct reasonable reliance on a known participant in the business : a) E.g. See comments on A.E. Lepage v. Kamex Developments , Cox v. Hickman , Pooley v. Driver below b) Third parties may reasonably assume those involved in the management of the business as being in business together (and so not acting on their own), and so reasonably rely on them satisfying obligations in connection with the business and assume them to be jointly responsible for the liabilities undertaken. c) Hence those who act
‘in common’ or
who represent themselves (or allow themselves to be represented) as partners are generally considered partners . d) E.g. Smith (S) sells shoes to a Adams and Brown Shoe Store. S sees Adams (A) and Brown (B) around the shoe store on a regular basis, both are seen to be actively involved in managing the business, and S sometimes deals with A and sometimes with B. S may reasonably rely on both A and B as being responsible for the business and thus for paying for the shoes. What A does for the business, S reasonably assumes is binding on B as well (and similarly for B). I.e. S may reasonably assume that A has authority to act on behalf of both B and A in buying shoes (and similarly for B).
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e) This reliance rationale alone is insufficient, however, since persons are held to be partners even when they have no direct involvement in the management of the business (so-called “ dormant partners
”, see
Cox v. Hickman below) and the persons dealing with the firm had no knowledge of the person’s connection to the business.
2) Indirect reasonable reliance on a person not known to the third party : a) E.g. See comments on Cox v. Hickman , Pooley v. Driver below. b) Third parties may also rely on a person who is not involved in the business and whose connection to the business they are not aware of (i.e. a silent partner ). Recall it is highly unlikely that any business would be all, or almost all, debt financed (i.e. financed by loans with fixed rates of interest), since lenders would be letting someone else gamble with their money (and that someone else would have limited risk themselves). So if a person observes that the business has substantial assets then he or she reasonably assumes either persons other than pure lenders for fixed rates of interest have provided the capital to the business, or , there are persons who have substantial personal assets who are personably liable for the debts of the business. So third party may advance credit to the business on the reasonable assumption that there is someone who has the funds to pay the debt. c) Hence idea that if ‘in common’ or profit sharing
then generally considered partners . d) But what if this assumption is wrong (i.e. when comes to seek payment, there is no one to be held personally liable (e.g. partners are bankrupt), and all funds in the business have been provided by lenders for fixed rates of return). e) E.g. Suppose the funds that provided for the inventory and all other assets of Adams and Brown
Shoe Store came from Cory (C) who has invested not for a fixed rate of return but for a share of the profits (profit sharing loan). C does not take a direct or readily observable part in the management of the store, and C is generally unknown to persons dealing with the store. Smith
(supplier) sees the substantial investment in the store and assumes, reasonably, that this could not have come purely from lenders looking to a fixed rate of return. It seems likely that either the
Adams and Brown Shoe Store has sufficient assets to pay for the shoes or that someone with substantial assets stands behind the store (i.e. will be personally responsible for the debts of the store). For a few thousand dollars worth of supplying shoes it is not worth S checking this out in more detail. This reliance would be defeated if A and B are bankrupt, the store has no assets net of obligations to repay loans, and C is able to claim he is not liable on the basis that S had no knowledge of his involvement in the business.
3) Avoid unjust enrichment : a) E.g. See comment on A.E. Lepage v. Kamex Developments , Cox v. Hickman , Pooley v. Driver below b) A person sharing in the profits of the business is getting the benefit of the credit advanced. E.g. a supplier advances goods on credit that are then sold at a profit. The profit is shared between two individuals. When the supplier seeks payment he or she discovers that the person dealt with is now insolvent. If the other person who received a share of the profits of the sale of the items supplied can avoid having to pay for the goods by saying they are not a partner then they are getting a benefit (the profits) at the expense of the supplier (i.e. an unjust enrichment ). This was the idea of an early partnership case ( Grace v. Smith , preCox v. Hickman ) which was sometimes said to have held that a share of the profits meant the existence of partnership. In that case the court referred to a requirement that those who share in the benefits must also bear the burdens. c) Hence those sharing in profits are generally considered to be partners . d) Conversely however , suppose S sells shoes to A and B Shoe Store on credit. S knows of A and B and checks their credit worthiness. S prices the supplies (shoes) and sets the terms of credit on the basis of the assessment of the creditworthiness of A and B. A and B sell the shoes in the shoe store and share the profits between themselves and C (a profit sharing lender with no management of the business, and so S was unaware of C ). The shoes are not paid for, the shoe store assets are
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insufficient to cover the liabilities of the business, and A and B turn out to be bankrupt. S sues C.
If C is made liable, S is arguably unjustly enriched because S priced the supplies (shoes) and set the terms of credit on the basis of the creditworthiness of A and B . If S can make C liable then it is a windfall to S. e) Hence , together with policy considerations below, share in gross returns alone does not mean partner, exceptions to profit sharing always implying partner (see s.4(b) and s.4(c)(i) to (v)).
4) Least cost avoidance (LCA): a) E.g. See comment on A.E. Lepage v. Kamex Developments , Cox v. Hickman , Pooley v. Driver below b)
Ask (e.g. consider costs, ease, if large $’s involved should there have been more care): i) Who can best assess risks, and ii) Who can best control risks c) When a supplier is not paid because the business is unsuccessful and revenues of the business are not sufficient to pay the debts, there is a loss. Who should bear this loss (the supplier-creditor or some other person connected to the business)?
d) Those involved in the business with a level of management control or have a share of the profits
(in each case because they have made some investment, before which they are likely to have made an assessment of the risk of business failure) are usually in a better position to assess the risk and control for it than that of most third party creditors (who have less (or no) control over management, and (especially those who advance smaller amounts) have much less incentive than those directly involved to spend substantial sums investigating the risk of business failure). e) Putting the risk of business failure on the persons involved in the business and sharing the profits lowers the overall cost of credit , because they are in a better position to assess the risk and control for it. i) If the parties had gotten together beforehand to determine who should bear the risk of business failure, they would likely have agreed that the persons involved in the business (equity investors) and sharing the profits should bear the risk of business failure because they could control for it at lower cost than the supplier-creditor, and so they will charge less for bearing that risk than the creditor would. Thus the equity investors would likely agree to bear the risk of business failure, and so agree not to limit their liability. This approach of determining what persons probably would have agreed to ex ante is referred to as a “ hypothetical claimholders bargain ” (see also Pooley v. Driver below) ii) I.e. the persons involved in the business and sharing the profits might say we need a return of
5% per annum to bear that risk, while the supplier-creditor might say she needs a 10% return to bear that risk . Why pay a 10% return when you would only charge 5% to bear the risk yourself? I.e. business people will often assume the risk (as opposed to limited liability, such as through incorporation or a ‘no recourse’ loan) to get cheaper credit. iii) However, if this argument that equity investors would agree not to limit their liability is correct then why do we observe so much business being conducted through a limited liability form of organization? See discussion under corporations below. f) Hence general rule of making persons who are involved in the business (
‘in common’
with a view of profit, s.2) and share the profits are generally considered partners and so liable for the losses associated with business failures. i) In U.S. there is a specific control test to determine these things, and some in Canada say control is a key factor
5) Other concerns a) Some cases dealing with the existence of partnership may well be explained by distributional concerns which may be inconsistent with and override reliance, unjust enrichment or least cost avoidance.
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b) In Cox v. Hickman the court perhaps wanted to avoid discouraging useful arrangements being set up to help continue a struggling business and avoid it being broken up. c) As with agency, there can be a wide variety of unique concerns that arise in particular cases.
Some of the cases below raise additional concerns to those considered above.
Liability to 3 rd parties & ‘in common’: cases on partnrship existnce (Lepage, Cox, Pooley, Martin)
1) These cases bring out some general ideas: a) Pooley v. Driver and Martin v. Peyton examples of weighing factors that point towards partnership versus factors that are inconsistent with partnership (recall similar comment in
Backman v. Canada above) b) If it’s a dispute between two people about the terms of their agreement: if their contract says they are not partners , then the court will agree they are not c) But if it’s a dispute involving a 3 rd
party , the court will engage in the weighing , which will include consideration of the agreement between the people that says they are or are not partners
2) A.E. Lepage v. Kamex Developments
(1977) 78 D.L.R. (3d) 223, aff’d (1979) 105 D.L.R. (3d) 84n a) See discussion under s.4(a) above. b) Facts: i) A group of persons formed a syndicate to buy a property. Kamex Developments Ltd. was incorporated to hold the property in trust on their behalf. ii) The persons in the group entered into an agreement which provided that:
(1) The property was held in trust in proportion to their interests in the property and that profits from the sale of the property were to be distributed according to their interests in it.
(2) If there were deficiencies (due to expenses or the sale of the property at less than they paid for it) the parties were to share in the deficiencies in proportion to their interests.
(3) A decision to sell the property was to be made by a majority vote of the parties.
(4) No co-owner could sell his or her interest without offering it first to the other co-owners. iii) The parties met monthly to discuss the operation of the property and the sale of the property. iv) The property was listed for sale on an open listing. The parties agreed that there would be no exclusive listing . A.E. Lepage Ltd. approached March, who was a member of the syndicate, and asked for an exclusive listing. March granted the exclusive listing which meant that A.E.
Lepage Ltd. would be paid a commission on the sale of the property no matter who sold it (i.e. even if it was not A.E. Lepage Ltd. that sold the property). v) The property was sold by an agent other than A.E. Lepage Ltd. A.E. Lepage Ltd. claimed a commission and the trustee for the syndicate refused to pay the commission. c) Issue: A.E. Lepage Ltd. sued and claimed that the members of the syndicate were really partners .
The argument was that March’s acts, as one of the partners, were binding on the acts of his fellow partners so they were all bound by the exclusive listing . d) Decision: i) The arrangement among the syndicate members was ownership in common and not a partnership . ii) The court noted that the ability of the co-owners to deal with their individual property interests was inconsistent with partnership since partners normally have no such rights.
iii) The right of first refusal, common in a partnership, was not inconsistent with the basic right of the members of the syndicate to deal with their interests in the property (and so could be a reasonable provision for tenants in common).
iv) Further, the members treated their interests separately for tax purposes rather than treating it as a partnership for tax purposes. This included individual decisions on the deduction of capital cost allowance against revenues on the property. This was consistent with an intention of common ownership and not partnership.
e) Comment: policy considerations:
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i) Partnership is a flexible form of organization. Thus although partners cannot normally deal with partnership property as if it were their own , it is possible to have a partnership in which such a right is provided. ii) Persons should not be able to avoid liabilities to third parties who rely on them as partners simply by choosing to treat themselves as not being partners for tax purposes. iii) Thus the case might be said to have been fairly close to the line in terms of whether it was partnership or not. Indeed, the sharing in deficiencies and the requirement for a majority vote to sell the property might also have been said to point towards partnership , but it was held that there was no partnership. However, an examination of the case in terms of reliance, unjust enrichment and least cost risk avoidance seems to be consistent with the finding that it was not a partnership. iv) Reliance? There was no indication that March had been held out as having authority and it was not clear that A.E. Lepage relied on the other members of the syndicate as partners. Given that A.E. Lepage approached March it was perhaps incumbent on A.E. Lepage to more carefully assess the arrangement under which the property was held (a ‘reasonable reliance’ notion). Would it not have made more sense to approach the officers of Kamex Developments
Ltd. since Kamex had legal title to the property? v) Unjust Enrichment? Here one might say that it was A.E. Lepage that would be unjustly enriched in that it apparently was not responsible for the sale of the property. Thus although
A.E. Lepage may have gone to some expense in attempts to sell the property, the syndicate did not benefit from any such expense. vi) Least cost risk avoidance?
The syndicate members had very limited control over the management of the property (was held in trust). There were just monthly meetings and they could approve a sale by majority vote. Thus the ability of the members of the syndicate to control the risk was limited . A.E. Lepage might have avoided the loss at relatively low cost by simply checking with the officers of Kamex before approaching March.
3) Cox v. Hickman (1860), 8 H.L. Cas. 268 a) This was decided before the enactment of the Partnership Act in 1890, and it is sometimes said that this decision is codified in s.4(c)(i) of the Partnership Act (B.C.).
b) Facts: i) An iron foundry business, owned by Smith & Sons and operated under the name Stanton Iron
Works, developed financial problems . ii) It could not pay its creditors in a timely fashion. Rather than force a potentially successful business into bankruptcy at the risk of getting a very small portion of the amounts owed to them paid off, the creditors accepted an arrangement made with them by Smith & Sons.
Under the arrangement Smith & Sons would transfer the assets of the business to trustees . The trustees would run the business. iii) There is some dispute as to just who the beneficiaries of this trust were. One version is that
Smith and his sons were the only beneficiaries, so the trustees would run the business and pay off the creditors and then return the business assets to Smith and his sons when the creditors were paid off. The other version is that both the creditor and Smith and sons were beneficiaries, so the trustees were also to pay the creditors until they were paid off and then return the assets to Smith and sons. iv) The creditors had certain rights under the trust indenture: they had access to the books of the business, the power to elect and replace trustees, and , if they so desired, they had the power to make rules for the conduct of the business . v) Someone supplied goods to the business on credit while the business was being operated by the trustee under the arrangement. The invoice was marked accepted by agents for the trustees. This converted the invoice into a negotiable instrument. The accepted invoice was
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then endorsed in favour of Hickman who paid a sum of money for the endorsement in his favour. The invoice was not paid and Hickman sued on the accepted invoice. c)
Issue: Hickman’s problem was that the business was insolvent. He didn’t want to be just another creditor of an insolvent business. What could he do? In other words, who could he make responsible to pay the debt? Perhaps, thought his lawyer, the creditors covered under the arrangement could be made liable, but if so, on what basis? It was argued
, on Hickman’s behalf, that the creditors were partners because they were sharing profits and earlier cases (e.g. Grace v.
Smith ) had suggested that a sharing of profits meant partnership. Hickman made his claim against two of the creditors (Cox and Wheatcroft). Cox and Wheatcroft had initially been appointed as trustees although they had never acted in that capacity. d) Decision: i) The House of Lords ruled 8 to 7 that the creditors under the arrangement were not partners and were not liable to pay the debt to Hickman. Some key points in the judgments include: ii) The case is sometimes said to have overruled Grace v. Smith to the extent that Grace v. Smith could be interpreted as holding that a sharing of profits necessarily means that there is a partnership. Here the majority said that a sharing of profits is strong evidence of partnership .
However, it does not necessarily mean the relationship is one of partnership. It simply raises a rebuttable presumption of partnership. iii) Confirmed the common law position that dormant partners are liable for the acts of other partners in carrying on the partnership business. (partners not involved in the management of the business are often referred to as “dormant”, or “sleeping,” partners). iv) The judgments in Cox v. Hickman suggested that the test of whether a partnership exists is a question of whether “the trade has been carried on by persons acting on [the alleged partner’s] behalf.” In other words, were the persons carrying on the business acting as agents of the person alleged to be a partner? (see s.7 above). e) Comment: policy considerations: i) Reliance?
(1)
Direct reliance can’t be the only concern here since Hickman, as a holder in due course of the accepted invoice, probably didn’t know who Cox and Wheatcroft were since they never acted in the capacity of trustees and thus never conducted the business of the Stanton Iron
Works. Hickman does not appear to have directly relied on the creditors as partners .
(2) Hickman may have indirectly relied. If Hickman was not aware of the arrangement, and if he could not have readily become aware of the arrangement, then he would have observed substantial assets in the business and might reasonably have assumed some significant equity in the business and equity investors who would be personally liable for the debts of the business. It may have been a surprise to Hickman that the business was effectively
100% debt financed. ii) Unjust Enrichment?
Unjust enrichment could have been a factor here since the creditors benefited from the supply of goods at the expense of Hickman . However, the majority did not find in favour of Hickman and also held that a sharing of the profits does not necessarily constitute partnership. Thus while unjust enrichment might have been a factor it was not an overriding factor. iii) Least cost risk avoidance?
To the extent one can determine who the least cost risk avoider is, it appears to somewhat favour a judgment in favour of Hickman. The creditors in the arrangement probably made relatively small advances and likely did not make a careful assessment of the risk of business failure. In this they may not have been in any better a position to assess the risk of business failure than Hickman was. However , the creditors in the arrangement had some control over the business at the time Hickman became a creditor of the business, which although perhaps not much control over the risk of business failure, it is arguably a greater degree of control than Hickman had.
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iv) Other policy concerns – promoting useful arrangements :
(1) Another influence on the majority was likely that if the case had gone against the creditors
(holding them to be partners) it would have discouraged any creditors in the future to similar arrangements, resulting in businesses being broken up rather than being continued
(even though there are worth more being continued).
(2) Modern bankruptcy legislation addresses the problem in Cox v. Hickman by facilitating such arrangements while providing a means by which persons dealing with the firm can find out about, or be notified of, such an arrangement.
4) Pooley v. Driver (1876), 5 Ch. D. 458 a) Deals with provisions similar to s.4(c)(iv) of the B.C. Partnership Act.
b) Facts: i) Borrett and Hagan entered into a partnership agreement to carry on the business of manufacturing grease, pitch and manure. The partnership agreement provided for the division of capital into 60 parts and profits were to be distributed in accordance with the number of parts attributed to each person . 17 parts were attributed to Borrett, 23 to Hagan. The remaining 20 parts were attributed to persons who advanced funds by way of a loan with one part being attributed for each £500 of funds advanced. The parts allocated to Borret and
Hagen were allocated to them as a means of compensating them for their work in the partnership business. They did not provide the capital for the business. Instead, all the funds for the business were provided by the lenders . ii) The
Drivers advanced £2,500
on the terms of a separate deed setting out the terms of this loan to Borrett and Hagan. This loan agreement deed incorporated the terms of the partnership agreement between Borrett and Hagan by reference and required Borrett and Hagan to observe the terms of the partnership agreement. The loan agreement had the same term as the partnership agreement (14 years). The loan agreement also provided that the bankruptcy of the lender would result in the termination of the loan agreement (although the partnership would still be required to repay the loan). On liquidation of the partnership the loan was to be repaid out of the assets of the partnership remaining after the payment of other creditors of the partnership. c) Issue: Pooley held several bills endorsed by the partnership and sued the Drivers when the partnership went into liquidation . Pooley argued the Drivers were partners
. The Driver’s defended against this claim by relying on Bovill’s Act (which has been carried forward into our
Partnership Act in s.4(c)(iv)). d) Decision: The judgment of Jessel, MR in the English Court of Appeal included the following points: i) Compared the relationship with a typical partnership relationship: The approach of the court was to look at factors that made the arrangement appear similar to what is commonly understood as partnership versus factors that made the arrangement look like something other than partnership. For instance, among other things, Jessel MR noted the following factors as tending to indicate partnership and not just a loan:
(1) The fact that they were said to have an interest in the capital of the partnership was more consistent with partnership than a loan.
(2) The ability of the alleged lenders to enforce the terms of the partnership agreement gave them a degree of participation in and control of the business that would be unusual for a lender but not for a partner.
(3) Having the return on the lender’s investment vary
with the amount loaned was very unusual for a lender but not for a partner.
(4) Terminating a loan agreement when a lender goes bankrupt is very unusual for a loan agreement but quite common for partnership.
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(5) Having the term of the loan agreement coincide with the term of the partnership agreement was very unusual for a loan agreement but would not be unusual if the arrangement really was one of partnership. ii) The fact that the parties said in their agreement that they were not to be considered partners was not determinative of whether they were partners. iii) S.4(c)(iv):
(1) The date of the case was before the enactment of the English Partnership Act of 1890. At the time in England there was a statute known as Bovill’s Act that was roughly equivalent to s.4(c)(iv) of the B.C. Partnership Act . Jessel, MR pointed out that the saving provision in
Bovill’s Act
requires that one find that money has been “advanced by way of a loan.”
Thus the first question is whether there is a loan or not. If there is a loan then it is not partnership . If one has decided that it is a loan and not partnership, or a partnership and not a loan, then there is no need to make use of the remaining words of
Bovill’s Act
. This suggests a limited operational effect of s.4(c)(iv).
(2) However , Bovill’s Act consisted of the words of s.4(c)(iv) standing alone. In B.C.
, the opening words of s.4(c) standing alone suggests that a share of profits, even in a loan agreement, is proof of partnership in the absence of evidence to the contrary. Section
4(c)(iv) attempts to reverse this presumption by making it clear that if there is a share of profits in a loan agreement on a contract in writing signed by the parties there is no presumption of partnership. Thus there is no presumption of a partnership for such a loan , but other additional factors might indicate it is a partnership . iv) Policy considerations:
(1) Reliance? There was no direct reliance since Pooley admitted that he was not aware of the connection of the Drivers to the business. However, there might have been a sort of indirect reliance as described in the discussion of Cox v. Hickman above.
(2) Unjust Enrichment?
By sharing in the profits the Drivers would have benefited from the advance of goods or services on credit . If the amount were not paid they would have received a benefit at the expense of persons who had paid for the provision of those goods or services. Pooley was ultimately the person who paid for some of the goods or services advanced on credit.
(3) Least cost risk avoidance?
The elements in the case suggest that the Drivers were in a good position to assess and control the risk associated with carrying on the business. They could determine, and may well have determined, the potential for profits and the risk of loss for the business since they were advancing substantial sums to the business. They would have been aware of the capital structure of the business and thus would have been in a better position to assess the risk that the business would be unable to pay debts as they came due. They were in a position to control changes in the type of business engaged in through the partnership agreement because of the incorporation of the partnership agreement into the loan agreement (e.g., they could enforce the requirement of Borrett and
Hagan to engage in the business of grease, pitch and manure manufacture). Through the incorporation of the partnership agreement into the loan agreement they could control selling, lending borrowing, dissolution and the hiring and dismissal of employees. v) Jessel said that the law of England could not allow this kind of arrangement the Drivers had with Borret and Hagan without being considered partners . e) Comment: i) Jessel did not elaborate on why the law of England could not allow this. Likely because the effect of allowing the Drivers to not be partners here is that it would effectively give them limited liability (indeed, it would be even better than limited liability because they could rank with creditors ).
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ii) If limited liability could be created in this way creditors would not be aware that the main contributions of capital to the business were made by persons who effectively had limited liability . Everyone would set up in business in this way attempting to get the benefit of a lower cost of credit by having persons dealing with the firm believe that the liability of the persons sharing the profits was not limited when in fact the investors sharing the profits would have limited liability. Eventually persons advancing credit would figure this out, if not by knowing the way businesses were being organized then at least through their experience in reduced collections of accounts receivable. They would eventually charge higher amounts for credit . This would reverse the hypothetical preferred bargain the creditors and the equity investors would probably have agreed on ahead of time is one in which the equity investors would bear the risk by agreeing to personal liability since they could control the risk at lower cost (see least cost avoidance above). iii) Persons dealing with businesses would find it difficult (i.e. costly) to determine whether there was significant equity in the business and whether there was actual personal liability of equity investors or not. Third parties considering advancing credit to the firm would have to get the partnership deed and the loan deeds and verify that they were the correct and current agreements. They would then discover that the firm was essentially 100% debt financed (since the lenders for a share of the profits would share in the assets of the firm with other creditors on a dissolution). They would then have to either adjust the credit terms accordingly (e.g., charging a higher price or interest or refusing to advance credit ) or they would have had to seek personal guarantees from the lenders who advanced funds for a share of the profits. All of this would be costly and hard to justify for small advances of credit. iv) Many businesses would not want their suppliers to have to go through this or to charge prices, or have terms of credit, that reflected this added cost. The difficulty for those other businesses if the Pooley v. Driver structure became the norm would be having to signal to others that they did not have that business structure and that there was indeed substantial equity capital (i.e., investors who agreed to share in the assets of the business only after the creditors had been paid off) and that the equity investors in the business would also be personally liable for debts arising in the carrying on of the business. v) As we shall see in subsequent chapters, the way the law deals with this is by allowing a limited liability structure but only if there is a clear signal that it is a limited liability structure. E.g. a corporation must have a cautionary suffix such as “ Inc .” or “ Ltd .” The name of a limited partnership must be followed by the words “ Limited Partnership
.” Thus one cannot have an arrangement like that in Pooley v. Driver in which lenders for a share of the profits having substantial control over the business avoid being treated as partners. If you want limited liability you have to signal it. If you don’t signal limited liability you don’t have it. This gives businesses a low cost way of signally to persons dealing with the business whether the form of association has, or does not have, limited liability.
5) Martin v. Peyton 158 N.E. 77 (1927 N.Y. C.A.) a) Comment: i) As with Pooley v. Driver , this case also deals with provisions similar to s.4(c)(iv) of the B.C.
Partnership Act. Although a U.S. case it is an interesting example of the approach taken in
Pooley v. Driver of weighing factors that point towards partnership versus factors that are inconsistent with partnership in a situation where there are factors pointing both ways and the case is much closer to the line between a partnership and just a loan. ii) It is also an interesting example of a situation in which a provision such as s. 4(c)(iv) of our
Partnership Act might be justified as a means of allowing the financing of a business that is experiencing some temporary financial difficulties. iii) Partnership law in most of the United States is quite similar to that in Canada. The common law states inherited the English common law of partnership and these states also enacted
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partnership acts modelled on the English Partnership Act of 1890. The New York partnership act applied in Martin v. Peyton had a provision almost identically worded to our s.4(c), including s.4(c)(iv). b) Facts: i) The partnership of Knauth, Nachod and Kuhne ( KNK ) was in the securities business. They bought stocks and bonds. The firm was in financial difficulties . ii) Peyton was a friend of Hall who was one of the partners in KNK. Peyton loaned $500,000 in bonds to KNK which they used to secure a bank loan (i.e., KNK took the bonds loaned to them by Peyton to a bank and used them as collateral for a loan from the bank). iii) This was still not enough so Hall asked Peyton, Perkins and Freeman (PPF) to become partners in KNK. They said no. They probably said no because there was a good chance that
KNK would not recover and, as partners, PPF would have been personally liable for the debts of KNK along with the other partners of KNK. iv) However, PPF agreed to lend $2.5 million to KNK in marketable securities (probably things like stocks and bonds that were publicly traded and thus could be sold quickly and easily).
These $2.5 million in marketable securities would then be used as collateral for a bank loan of
$2 million (just as Peyton’s bonds had been used earlier). v) PPF entered into an agreement with KNK that set out the terms on which they agreed to lend the $2.5 million in marketable securities. The agreement had a number of unusual features which are discussed in more detail below. The agreement included a provision providing PPF a 40% share of the profits of KNK (but not partners) . PPF were probably unwilling to make a straight loan for a fixed rate of interest because this would have given them a limited and highly risky upside gain potential with a large downside risk in light of the difficulties the business of KNK was in (i.e., a very good chance that the whole $2.5 million loan of marketable securities would be lost). c) Issue: The business of KNK could not be returned to profitability. On the ultimate bankruptcy of
KNK the question was whether PPF were really partners instead of just lenders . d) Decision: i) A first point to note is that the court took the same position as Jessel did in Pooley v. Driver on the question of the relevance of PPF having said they would not be partners. The judgment for the court had this to say: “Assuming some written contract between the parties, the question may arise whether it creates a partnership… In passing upon it, effect is to be given to each provision. Mere words will not blind us to realities. Statements that no partnership is intended are not conclusive . If as a whole a contract contemplates an association of two or more persons to carry on as co-owners a business for profit, a partnership there is… And we are to remember that although the intention of the parties to avoid liability as partners is clear, although in language precise and definite they deny any design to then join the firm of K.N. &
K.; although they say their interests in profits should be construed merely as a measure of compensation for loans, not an interest in profits as such; although they provide that they shall not be liable for any losses or treated as partners, the question remains whether they agree to so associate themselves with the firm as to “carry on as co-owners a business for profit.” ii) The court then looked at aspects of the agreement that tended to indicate partnership and aspects of the agreement that were inconsistent with partnership . iii) Aspects inconsistent with partnership included:
(1) The securities were to be returned to PPF. Normally property contributed to a partnership becomes partnership property and is not returned to individual partners who contributed it.
(2) KNK were to turn over some of its securities as collateral for the loan by PPF of their securities. It is rare to have some partners provide other partners a security interest for their contribution.
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(3) The loaned securities were not to be mingled with other KNK securities. Normally contributions by partners are all mingled as part of partnership property.
(4) KNK could sell the securities provided by PPF but only with the consent of PPF and the proceeds were to go to Peyton and Freeman as trustees for PPF. Normally partnership assets can be sold without having to account to particular partners for the proceeds of the sale.
(5) PPF were to be paid all dividends and interest from the loaned securities. Usually all partners would share in the revenues from partnership property .
(6) If the price of the loaned securities were to increase PPF could sell securities to the amount of the excess as long as the remaining securities were sufficient for a $2 million bank loan.
Normally individual partners (or a particular group of partners) cannot deal separately with partnership property and keep the proceeds to themselves to the exclusion of other partners.
(7) PPF could substitute other securities of equal value. The normal partnership rule is that once partnership property is contributed it becomes the property of the partnership (i.e. of all the partners together) and the partner who contributed the property cannot withdraw it or substitute other property.
(8) Peyton and Freeman, as trustees, could not initiate any action or bind the firm. Normally partners are agents for all the other partners and can conduct business on behalf of the firm. iv) Before going on to note the aspects that were consistent with partnership it should be noted that any one or more of the features noted above could be put in a partnership agreement .
Partnership is a very flexible form of business association. Although there is a default set of terms discussed below, the terms can be varied to suit the circumstances. The question in
Martin v. Peyton was whether the collective effect of the unusual features noted above was enough to make the arrangement not a partnership . v) Various aspects consistent with partnership were:
(1) There was a 40% share of the profits . However, the 40% share of profits only continued until payment of a minimum of $100,000 and to a maximum of $500,000 and until the securities were returned.
(2) The managing director was to continue to be Hall with his life insured for $1 million.
(3) Peyton and Freeman, as trustees for PPF, were to be kept advised of conduct of business and were to be consulted on important matters.
(4) Peyton and Freeman could inspect the books of KNK.
(5) Peyton and Freeman could veto business they thought to be highly speculative.
(6) KNK were to assign their interests in the firm to Peyton and Freeman as trustees for PPF.
They were to put their resignations in the hands of Hall and the resignations could be accepted at the behest of Peyton and Freeman.
(7)
The partners’ right to draw funds from the firm was fixed. There was to be no distribution of profits to KNK and no loans to KNK.
(8) PPF had an option to join the firm and receive a 50% interest. vi) Overall the court concluded that the provisions taken together did not constitute a partnership . e) Comment: policy considerations: i) Reliance :
(1) The partnership business appears to have operated as it had in the past. Peyton et al. were not part of the operations of the business and so their involvement in financing the continuation of the business was probably unknown to third parties so third parties probably did not rely on them directly . ii) However, third parties may have relied indirectly in the sense that they may have expected the business to have substantial equity capital behind it. In fact the persons who advanced much of the capital, PPF, are now claiming they were just lenders.
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iii) Unjust Enrichment : Is their any unjust enrichment of PPF? There might have been if they got a share of the profits while others provided goods or services to KNK and suffered a loss . iv) Least Cost Avoidance : Here PPF had some ability to assess and control for the risk . They were putting up a substantial amount of assets which might be lost if the business were not successful. They presumably should have made a careful assessment of the risk involved.
They had a number of ways in which they could control the risk. They were to be kept advised of the conduct of the business. They had a right to inspect the books. They could veto highly speculative business. They could remove KNK partners if they felt it necessary to do so. v) Other Concerns : There is another concern that may have led to the enactment of
Bovill’s Act in England and which is reflected in s.4(c)(iv) of our Partnership Act and in partnership legislation in the U.S. (as it was in N.Y. where Martin v. Peyton was litigated). Namely, to provides a mechanism for funding businesses caught in temporary difficult situation (see discussion under s.4(c)(iv) justifications above.
New partnrs not liable for old, retired apparent partnrs continue for new, liable if repsnt as partner
1) Recall s.83
(Formation above) that when a partner retires or a new partner taken on, a new registration statement must be filed
2) Partnership Act s.19(1) liability of new partners : a person who joins an existing partnership is not liable to creditors for debts of the partnership that arose before the person joined the firm. a) This seems reasonable since partners or agents acting on behalf of the partnership before person A joined the firm would presumably not be acting on behalf of A at that time. b) Third parties would also not be relying on that person since they could easily check who was supposed to be a partner and find out that the person who was to later join the firm was not a partner at the time.
3) S.19(2) retired partners & past liabilities : on the other hand, once a person is a member of the firm and partners or agents of the firm enter into contracts that bind the firm, the person does not cease to be a party to those contracts just because he or she has left the partnership. Thus a partner who retires from a firm does not cease to be liable for partnership debts or obligations incurred before his or her retirement. a) S.19(3): Unless a creditor agrees to relieve a retiring partner from further liability (subject presumably to the normal rules of contract law governing such waivers). i) Practically speaking, reliance on this probably requires agreement at the time the contract creating the debt is entered into (since persons who have advanced credit before the partner retires may have relied on the person being a partner) ii) E.g. a large partnership seeking a loan might arrange with the lender as part of the loan agreement that retiring partners of the firm will be relieved of liability. This way the consideration for the lender’s agreement is the payment terms for the loan. The lender might be willing to grant such a right in a large partnership with a frequent turnover of partners .
New partners would replace former partners and thereby replace the lost source of payment from the retiring partner. Such an agreement with the lender might well affect the interest rate on the loan and might well be subject to constraints to protect the lender.
4) Retired partners & new liabilities : When a partner retires, third parties dealing with the firm may not be aware that the partner has retired and continue to rely on the retired partner as still being a partner.
Accordingly, under the Partnership Act a retiring partner can also be liable for debts of the partnership arising even after the partner has left the partnership, unless take certain steps: a) S.39(1): persons dealing with a firm after the retirement of a partner can treat all “apparent” members of the pre-retirement firm as partners until they have notice of the change in the partnership. i) Many things may make a person an “apparent” partner.
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(1) E.g. Dominion Sugar v. Warrell (1927), 60 O.L.R. 169 (Ont. C.A.) and Tower Cabinet v.
Ingram , [1949] 2 K.B. 397: “apparent partner” in s.39(1) has been held to mean apparent to those dealing with the firm and not what was apparent to the whole world or the community in general (since focusing on 3 rd
party’s reliance)
(2) E.g. the person may be an “apparent” partner due to the notoriety of the person as a partner
(e.g. everyone in the particular town or region knew the person was a partner)
(3) E.g. may be due to such things as the use of the person’s name
on notepaper or letterhead used by the firm or a sign outside the door.
(4) E.g. evidence under s.84(b) (see below) ii) S.39(2): for persons who have not had prior dealings with the firm the notice can be effected by way of a notice in the Gazette .
(1) This suggests that something more is required for persons who have had prior dealings with the firm. It has been held that persons who have had prior dealings with the firm must be given
“actual” notice
(see, e.g., Dominion Sugar v. Warrell and Tower Cabinet v.
Ingram ). iii) S.39(3): a retired partner will not be liable to those who can be shown not to have known that the retired partner was a partner . iv) S.39 likely applies to a change from a partnership to a corporation (see “When pierce” under
Corps: pierce below) b) S.84(b): if one fails to file a new registration statement on the retirement of a partner, this is evidence that person continues to be a partner i) Note only evidence, so likely not conclusive, but lack of new registration is evidence that could be used in s.39(1) above ii) Under older wording, Dominion Sugar held (older versions of) s.39 and 84 were separate sources of liability (e.g. even if filed a new registration statement could still be liable under s.39, or if sent 3 rd
party a letter as notice could still be liable under s.84), but wording has now changed in s.84(b) c) Policy reasons for s.39 and s.84: i) Reliance : Thus persons who had prior dealings with the firm may continue to rely on the particular retired partner as being a partner if not given notice (and hence need for retired partner to have been apparent to create such reliance). ii) The Gazette is presumably considered sufficient for persons who have had no prior dealings with the firm since they could check the Gazette before they first deal with firm to see if there had been retirements. iii) The registration provisions in Part 4 of the Act (containing s.84(b)) were added after the initial enactment of Parts 1 and 2 of the Act in 1894. The registry is no doubt a much simpler place to check in order to determine who is a partner in the partnership. That is perhaps why it was held in Dominion Sugar v. Warrell that notice in the registry is sufficient notice to persons who have not had prior dealings with the firm. iv) It is implicit in ss.39(1) and 39(2) that notice in the Gazette is not sufficient notice for persons who have had prior dealings with the firm. It was also held in Dominion Sugar v. Warrell that notice in the registry was also not sufficient for persons who have had prior dealings with the firm. If it were they would have to check the registry every time they dealt with the firm
(or through every edition of the Gazette published since they last had dealings with firm). This would be a costly burden to impose on persons who had prior dealings with the firm. It is probably much less costly for the retiring partner to notify persons who have had prior dealings with the firm. v) Of course this right to treat the retired partner as a still being a partner would not be reasonable if the person who dealt with the firm could be shown not to have known the retiring partner to have been a partner, since would be no reliance (and hence s.39(3)).
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vi) Sections 39 and 84(b) put the onus on the retiring partner to take steps to protect against potential reliance on them still being a partner by persons dealing with the firm after the retirement. Satisfying the following shifts the onus to the persons dealing with the firm:
(1) Provide actual notice to all those with whom the firm has had prior dealings.
(a) Providing actual notice to all persons who had prior dealings with the firm may create practical difficulties. It may not be possible to identify them all. One approach would be to look through the firm’s current creditors by examining financial records for existing accounts payable and loans. However there may be several persons who have dealt with the firm previously who are no longer creditors. Thus it would be prudent to check through accounts payable in previous years and for prior lenders. Hopefully the further one goes back the less likely it is that anyone who had dealt with the firm prior to the date one checked back to can argue that the retired partner was an apparent partner. If it has been several years since the person dealt with the firm then it is arguably reasonable that they should at least check the registry again to determine who is still a partner.
(2) Put a notice of the retirement in the Gazette .
(3) File a revised registration statement removing the name of the retired partner from the list of partners in the firm.
(4) Recall s.19(3) allows for an agreement between a retiring partner, the remaining partners and creditors relieving the retiring partner from liability.
(5) Retiring partners should also consider having the partnership agreement provide a right to a retiring partner to require that specific steps , such as those required due to sections 39 and s.84(b), be taken to reduce the risk of continuing liability of the retiring partner. The partnership agreement could also provide that the remaining partners indemnify a retiring partner for post-retirement debts of the firm. This would not be of assistance if none of the remaining partners have any assets. Hopefully, however, one or more of the remaining partners will have some assets and thus the provision should provide some degree of protection.
5) S.16: a person who represents himself or herself to be a partner (whether orally, in writing or by conduct), or who knowingly allows himself or herself to be represented as a partner , will be liable to anyone who has given credit relying on the faith of the representation . a) This could apply even where there is no partnership . i) E.g.
a person with a good credit reputation might allow the use of her or his name by a sole proprietor (perhaps because the sole proprietor is a relative) to help the sole proprietor more easily obtain credit. However, if credit is advanced on the faith of such a use of the person’s name the person will be liable to the sole proprietor’s creditor. b) s.16(2): as noted in s.16(1), the representation could be made by another person as long as the first person allowed himself or herself to be so represented , and (under 16(2)) the person does not have to know of a particular representation to a particular person who advances credit. c) This is similar to ostensible authority. d) E.g. Dominion Sugar v. Warrell (1927), 60 O.L.R. 169 (Ont. C.A.) i) Facts: a grocery store business was run by Worrell in Cochrane, Ont., and was doing well.
Yates joined Worrell. Worrell left the business, but because Yates wouldn’t be able to buy anything on credit if Worrell’s name was removed from the business, so the business carried on under the name “Worrell and Yates” ii) Issue: under s.16, the business name was representing Worrell as a partner
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S.5: if not partner, subordnte profit-sharing lender & goodwill-seller on insolvency unless security
1)
Suppose a partnership owes $’s to a 3 rd
party. If that 3 rd
party cannot show a ‘person’ is a partner
(and therefore personally liable for the debt), might nevertheless be able to subordinate their claim to the
3 rd
party’s claim on insolvency of the partnership.
2) Partnership Act s.5 provides that if a) a person to whom money is advanced by way of a loan on contract as mentioned in s.4; or b) a buyer of goodwill in consideration of a share of the profits ; and either : c) becomes insolvent ; d) enters into an arrangement to pay creditors < 100 cents on the dollar; or e) dies in insolvent circumstances; then the lender, or seller of goodwill, is not entitled to recover anything in respect of the loan or share of the profits until the claims of the other creditors of the borrower or buyer for valuable consideration in money or money’s worth have been satisfied .
3) Re Fort [1897] 2 Q.B. 495 a) Facts: i) Schofield loaned £3,000 to Fort at an interest rate of 5% plus half of the profits of Fort’s business net of a management salary. The loan agreement was not in writing . Fort failed to pay on the loan and Schofield sued Fort. Fort’s defence was that he was not liable to Schofield on a loan because Schofield was in fact his partner. The court did not accept this defence, holding that Schofield was not a partner (apparently consistent with s.4(c)(iv) and no other factors suggesting partnership) ii)
Fort then became bankrupt while Schofield’s judgment debt remained unsatisfied. Schofield put in a claim with Fort’s trustee in bankruptcy. Fort’s trustee in bankruptcy refused the claim.
One basis on which the trustee refused to accept Schofield’s claim was that Schofield’s claim was subordinated under a provision equivalent to s.5 of the B.C. Partnership Act . b)
Issue: Schofield argued that he was not “a person to whom money is advanced by way of a loan on contract as mentioned in s.4” because the agreement was not in writing. Because the loan contract was not in writing the loan did not fit the particular terms of s.4(c)(iv) and thus could not be a
“contract as mentioned in s.4.” He argued that since he did not get the benefit of s.4(c)(iv) he should not have to bear the burden. c) Decision: The English Court of Appeal held that s.5 applies whether or not the contract is in writing . d) Comment: possible policy reasons for this decision is the concern that when a partnership does not do well the parties (who in fact intended to be partners) will say that the wealthier party’s investment was actually an oral loan . This would have the effect of giving the wealthier party not only limited liability but the right to share pro rata with other creditors in the remaining assets of the partnership business (and of the other less wealthy partner). It would be very hard to challenge this alleged oral contract and it could result in defeating reliance by third parties dealing with the business.
4) Canada Deposit Insurance Corp v. Canadian Commercial Bank (1992), 97 D.L.R. (4 th
) 385
(S.C.C.). a) Facts: i) The Canadian Commercial Bank was in financial difficulties. An arrangement was made between the Alberta government, the federal government and several major banks in Canada.
Loans were made to the Canadian Commercial Bank in an attempt to help it through its financial difficulties. As part of the loan agreement the lenders got a right to share in the profits of the Canadian Commercial Bank. However, the share of the profits was only to continue until the principal of the loan was paid in full together with interest at the prime rate.
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ii) Unfortunately the bank did not recover and a winding up order was issued six months later.
The loan participants sought to rank equally with the unsecured creditors of the bank. The trustee for the winding up of the Canadian Commercial Bank refused to accept this claim. b) Issues: Among the issues raised were: i) The question of whether the arrangement was of a type that fell within an equivalent provision to s.4(c)(iv) of the B.C. Partnership Act ii) If it did not fall within that subparagraph but instead fell within the equivalent of s.4(c)(i) of the B.C. Partnership Act , then did s. 5 apply? c) Deicion: Iacobucci J., writing for the court i) Cases applying s.4(c)(iv) have generally involved situations where the payment out of profits on the loan was for more than just the repayment of principal plus interest. S.4(c)(iv) does not apply where the share of the profits is limited to repayment of the principal amount of the loan plus interest . Thus the arrangement fell in s.4(c)(i) instead as the repayment of a liquidated amount out of a share of the profits. ii) S.5 does not apply to s.4(c)(i) since s.5 refers to a “contract” of a type mentioned in s.4 and s.4(c)(i) does not refer to a “contract.” The policy of s.5 is that one who shares in the profits should also share the risks. Here the participants did not get the benefit of a share of profits over and above the repayment of the principal and interest at the prime rate.
5) Sukloff v. A.H. Rushforth & Co [1964] S.C.R. 459 a) Facts: i) Although complex, briefly an initial loan was made by Sukloff for $45,000 for 10% interest plus a 50% share of the profits . Sukloff later obtained a security interest for $35,000 of this loan ii) Sukloff also later made an additional loan of $5,000 for interest at 10% with no right to share in the profits. b) Issue: how should Sukloff rank relative to other unsecured creditors on the insolvency of the borrower. c) Decision: The Supreme Court of Canada held that the subordination under s.5 does not apply to the extent there is a security interest for the debt . i) Sukloff ranked ahead of the unsecured creditors to the extent of the security interest. Thus for the $35,000 fund, Sukloff ranked ahead of the unsecured creditors. ii) Sukloff ranked with the unsecured creditors for the $5,000 advance for 10% interest with no share of the profits. S.5 did not apply to that advance of funds because it was not on a contract of a type mentioned in s.4(c)(iv) because it did not involve a right to share in the profits. iii) Sukloff was subordinated to the unsecured creditors under s.5 for the remaining $10,000 of the initial loan because it was for a share of the profits (and thus was on a contract of a type as mentioned in s. 4(c)(iv)) and there was no security interest covering that portion of the loan. d) Comment: i) Most provinces now have a common registration system for security interests under personal property security legislation (PPSA in B.C.) This allows a person considering advancing credit to check security interests granted by the potential debtor. They can also usually obtain the documents under which such security interests have been granted. Thus having s.5 not apply to the extent there is a security interest makes sense because third parties can check to see that certain assets (those over which a security interest has been taken) will probably not be available to cover advances they make to the borrower. Reliance on the availability of assets subject to registered security interests would arguably not be reasonable since the existence of these security interests can be checked in the registry at relatively low cost (in this case there was no registry, but could have checked with trustee to find out Sukloff had a security interest)
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ii) However, would the principle that s.5 does not apply to the extent of a security interest still apply if the security interest were not registered, or if it was not in some relatively easy for others to determine whether there was such a security interest?
Joint v. several liability not so important (e.g. suing one doesn’t release others, can sue firm name)
1) Joint liability versus joint and several liability comes up at a number of places in the Partnership Act a)
S.11 refers to a partner being liable “jointly” with the other partners. b)
S.14 says that a partner is “jointly and severally” liable under s. 12. c) Although s.87 no longer uses the expressions “jointly” liable or “jointly and severally” liable, it still deals with the issue of joint liability versus joint and several liability.
2) The practical effect of this distinction, as far as these provisions of the Partnership Act are concerned, is no longer as significant as it once was because of s.53
of the Law and Equity Act and Rule 7 of the
Supreme Court Rules of Court, at least as far as the particular provisions of the Partnership Act are concerned
3) Although an overly simplistic explanation (e.g. no consideration of modifications due to the
Negligence Act ), joint liability = more than one person may be liable on the same set of facts . a) E.g. suppose a debt arises out of a sale of goods on credit to a partnership business with four partners (A, B, C, and D are clearly partners). The debt is not paid and the supplier sues A. The supplier will have to prove the contract, her performance of the contract (i.e. the delivery of the goods), that the goods were advanced on credit, and that the goods have not been paid for according to the terms of the contract. b) If the supplier succeeds but A does not have enough assets to cover the damages, the supplier might sue B. The supplier appears in court again proving all the same things again. The court can’t just say all these things are res judicata because B has not yet had a chance to defend against the supplier’s allegations. So court time is consumed once again to establish the same facts with the same evidence, which is not only costly but could also lead to a different result (B being found not liable), leading to unfairness and putting the administration of justice into disrepute. c) Old rules for joint liability : i) The court therefore tried to force the plaintiff to join all the defendants who were liable on the same facts so all could be heard at the same time . It did this in two ways:
(1) First, if persons were
“jointly” liable
(i.e. liable on the same facts) then if the plaintiff chose to proceed against just one (or less than all) of them it operated as a bar to proceeding against the others .
(2) Second, if one joint debtor, or less than all of the joint debtors, were sued, that joint debtor, or those joint debtors, had a right to an order of the court staying the proceedings until the other joint debtors were joined to the action. ii) The court also put pressure on the defendants to join co-defendants . If a single joint debtor was successfully sued and the creditor satisfied 100% of the debt out of the assets of that joint debtor, that joint debtor could not obtain contribution from the other joint debtors unless they had been joined to the action. Thus even if the plaintiff did not join all the joint debtors there was a strong incentive for the joint debtors who were sued to join the other joint debtors. iii) In the supply of goods example above, if the supplier just sued A it would operate as a bar to suing B, C, or D. A might apply to court for a stay of proceedings until B, C, and D were joined to the action. If B, C, and D were not joined and the supplier was allowed to proceed and obtain judgment against A, A could end up paying the full amount of the debt without contribution from B, C, and D. A would only be entitled to contribution from B, C, and D if
B, C, and D were joined to the action.
4) In contrast, persons can be severally liable when they have all arguably caused the plaintiff’s loss but the facts on which the alleged cause is based are different for each defendant (again, simplifying by ignoring the Negligence Act here):
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a) I.e. the loss may have arisen out of a single incident but the facts that have to be established for the liability of each potential defendant are different. b) E.g. a pedestrian is crossing the street at a four-way stop and is hit by four cars, one from each direction (N,S,E,W). The pedestrian sues for their injuries, and although injuries arose out of a single incident, the facts on which the negligence claim is made against each driver are different
(driver from south had faulty brakes, driver from east was reaching for something under the dashboard, etc). So not the same concerns for added cost and conflicting results as there can be where the liability is based on the same facts. c) Having a separate action for each defendant may not be entirely unreasonable since: i) The facts that have to be established against each defendant are different. ii) Different results might make sense because the facts are different for each defendant. d) Although it may still make sense to join the parties in this case, the reasons for joining all the potential defendants are arguably not as strong as where the facts to be established against each defendant are the same. e) In these situations the defendants are said to be “severally” liable (i.e. separately liable). While the persons may be jointly liable because they have jointly caused the loss to the plaintiff (with the losses arising out of the single incident), they are also severally liable because of the separate facts pertaining to the liability of each of them. Where persons are severally liable , suing just one of them does not operate as a bar to suing the others
. If just one of several “severally” liable persons is sued that person did not have an automatic right to stay the proceeding until the other severally liable persons were joined to the action.
5) The old rules designed to force the joinder of joint debtors to actions have been modified by Law and
Equity Act s.53
: a)
S.53(1): “If a party has a demand recoverable against 2 or more persons jointly liable , it is sufficient if any of those persons is served with process , and an order may be obtained and execution issued against the person served even if others jointly liable may not have been served or sued or may not be within the jurisdiction of the court.” i) This suggests that the defendant does not have a right to a stay of proceedings until other jointly liable persons are joined to the action since it says a court order can be obtained and executed against a person sued even if other jointly liable persons have not been sued. b)
S.53(2): “The obtaining of an order against any one person jointly liable does not release any others jointly liable who have been sued in the proceeding, whether the others have been served with process or not
.” i) This modifies the rule that barred subsequent proceedings against joint debtors where the plaintiff had not joined all the joint debtors to the proceeding. As long as the others have been named in the suit, proceeding against any one person who is jointly liable does not release the other jointly liable persons. c)
S.53(3): “Every person against whom an order has been obtained who has satisfied the order is entitled to demand and recover in the court contribution from any other person jointly liable with the person.” i) This provision alters the restriction on contribution from other jointly liable persons where one of the jointly liable persons has been sued and has satisfied the judgment debt.
6) Rule 7 of the Supreme Court Rules of Court says that you can sue a partnership in the name of the firm . a) Service can also be effected by leaving a copy of the document to be served with a person who was a partner at the time the alleged liability arose or with a person who appears to manage or control the partnership business at a place of business of the partnership. b) Where an order is made against a partnership firm then execution to enforce the order can be made against the property of the firm and against any person who entered an appearance in their own name, was served with the originating process as a partner but failed to enter an appearance,
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admitted in a pleading or affidavit that she or he was a partner, or was adjudged to be a partner. If the person against whom execution is sought does not fit any of these situations then the plaintiff can still apply to the court for leave to issue execution against the person. c) The practical implication of Rule 7 is that one would normally sue in the name of the firm . One would want to effect service on the firm by leaving a copy of the document with either a person known to be a partner at the time the liability arose or with a person who appears to be in control at a place of business of the partnership firm. Service on the firm would allow execution against firm property. One would then want to consider service on individual partners to assure one’s right to execution against particular partners. d) Therefore joint liability with respect to partnership is no longer a major concern . You can sue in the name of the firm. Even if one only served process on some of the partners it would probably not operate as a bar to a subsequent proceeding against other partners either pursuant to s.53(2) of the Law and Equity Act or pursuant to a court order for leave to issue execution against a particular person under Rule 7(8) (with a possible proceeding under Rule 7(9) to determine whether that person is liable)
Limited Partnership
If benefits > costly credit, at least one gen & lim partner, only if file certificate, good for start-up
1) Investors often have a strong urge to get limited liability (e.g. recall efforts in Pooley v. Driver ), but if it became widespread (and especially if it was not obvious who had it, as in Pooley v. Driver ) creditors will either insist on personal guarantee or assume that partnerships have limited liability and so will charge higher explicit or implicit rates of interest . Yet investors, who are often willing to assume personal liability to get cheaper loans, will then find it difficult to do so because creditors will assume they have limited liability. Hence default in partnerships is personal liability .
2) But there are advantages to limited liability that can outweigh the higher cost of credit in some circumstances, especially when lots of equity investors. So how allow for limited liability in such circumstances?
3) One way to get limited liability is for creditors and investors to agree to limited liability (e.g. a “nonrecourse” loan or contract
where creditors agree they will not seek recourse to personal assets of investors). In such a case, creditors would not be deceived (they clearly know there is limited liability) and could charge higher amounts to compensate them for the greater risk of loss they face.
However , making such individual contracts with trade creditors on a daily basis would be time consuming and costly , likely outweighing potential benefits.
4) Hence the idea of limited partnership as a way to shift the default rule away from personal liability to limited liability in a way that does not generate significant costs nor deceive creditors. a) So when setting up a partnership, can decide what default rule you want in order to minimize transaction costs (and in each case can negotiate it away): i) Under general partnership, default rule = personal liability (can individually negotiate limited liability through non-recourse loan/contract, through credit will be more expensive) ii) Under limited partnership, default rule = limited liability for limited partners (can individually negotiate personal liability through personal guarantee, in order to reduce cost of credit) b) S.50: Consists of one or more general partners and one or more limited partners . c) S.57,63: Liability of limited partners is limited to the amount the limited partner contributes or agrees to contribute to the limited partnership i) E.g. if invested $1000 but agreed to put in another $4000, but firm goes bankrupt before extra amount put in, creditors can claim the full $5000 from this limited partner d) The liability of the general partners is not limited (i.e. full personal liability) e) S.51: A limited partnership is only formed by the filing of a certificate
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i) If the certificate is not filed there will be no limited partnership, no matter how clear the intention or circumstances were to create one (instead, the business will be a sole proprietorship or general partnership, each of which is formed simply by starting up business) ii) Certificate must include certain things e.g. who general partners are (see Protecting 3 rd
parties below), and rights concerning assigning a partnership interest to another or admitting new partners (see Protecting lim from gen below)
5) Advantages : a) Tax advantages of partnerships: any losses , which are more likely to accrue in the start-up phase of operation, can flow through to the partners (general and limited) and they can make use of these losses against their other sources of income. Limited partnership agreements are therefore a relatively common form of financing for start up operations . Losses can be high in early years, especially where there is some government incentive scheme of the type that allows for a very fast write-off of initial capital investments (i.e. an accelerated depreciation ). Of course investors will lose their investments if losses continue for too long. b) Flexibility – most provisions in the Partnership Act are default, meaning the partnership agreement can change them, unlike with corporations (another, but less-flexible, way to get limited liability) c) Saves costs in comparison with non-recourse loans/contracts, since don’t have to negotiate limited liability separately with every creditor
Protect 3 rd parties: suffix, no lim partner in name/mgmt/services, cert(2), no cap return if insolvent
1) Creditors often assume there is someone with personal funds behind a partnership, and so there someone to sue if they are not paid. However, in limited partnerships it may only be the limited partners who have significant personal assets. The Partnership Act , Part III (which deals with limited partnerships) includes seven provisions presumably intended to protect third parties from being deceived into believing that one or more limited partners do not have limited liability: a) S.53: cautionary suffix “Limited Partnership” must be on end of name of the limited partnership to signal third parties some of partners have limited liability (similarly for corporations with
“Ltd.”, “Inc.”, etc). This helps avoid misunderstandings, and reduces the “screening cost” (i.e. costs borne by others in trying to find out if there is limited liability). b) S.53(2): the surname of a limited partner must not appear in the name of the limited partnership
(if not, it is presumably not a limited partnership) i) This is subject to certain exceptions , such as if that surname is also the surname of one of the general partners, or business had been carried out under that name previously before admission of that partner ii) S.53(4): If a limited partner’s surname does appear in the name of the limited partnership (and it does not fall within one of the specific exceptions) then that limited partner will no longer have limited liability. c) S.64: a limited partner is not to take part in the management of the partnership. This also might deceive third parties into believing that the limited partner is a general partner. Liable as general partners if they do. i)
See also “general partner corporation with officers also limited partners” below. d) S.55: a limited partner is not to contribute services to the partnership business. This might lead a third party to believe that the limited partner is taking part in the business as one of the general partners. e) S.51: The certificate must state who the general partners are. This allows third parties to assess the credit worthiness of the partners who do not have limited liability (although the general partner is often a corporation with no assets, providing for full-fledged limited liability – see below) f) S.51: the certificate must state the contribution provided, or agreed to be provided, by the limited partners . This might assist third party creditors in determining the amount of net capital in the
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firm (i.e. how much higher the assets of business are above the liabilities), although over time knowing the contributed capital at the start of the business will likely help less and less (e.g. if business done poorly, net capital may even be negative) g) S.59: no return of capital to partners (general or limited) is permitted if after the return of capital the partnership would be insolvent i) Even if third parties have advanced credit with full knowledge there are limited partners and of who the general partners are, there is still a risk they may be taken advantage of since the partners will have better access to information about any looming insolvency of the business
(and may begin to withdraw funds from the business reducing the assets that may be the only recourse for third party creditors). ii)
This is the “ no abandoning ship
” provisions – the crew (partners), who will know of trouble sooner, must stay with the passengers (creditors) rather than taking all the life boats (assets) when they know ship (business) is sinking
64: if corp gen prtner & officer also lim prtner, will be gen unless manage ‘solely’ as officers (?)
1) It is common for a limited partnership to have a corporation as the general partner (it can be a partner since it is a ‘person’)
2) The promoters of the limited partnership business often want to be involved in the management of it and so are made officers of the corporation (so they manage the limited partnership on behalf of the general partner (i.e. the corporation)).
3) However, these promoters also often want to be investors in the business with limited liability, so they also invest as limited partners .
4) However, as noted above (s.64), limited partners can be liable as general partners where they have taken part in the management of the business (to avoid deceiving third party creditors) – does that management role make them , as officers of the corporation managing the limited partnership, general partners ?
5) Haughton Graphic Ltd. v. Zivot (1986), 33 B.L.R. 125 a) Facts: i) Printcast Publishing Network Limited Partnership (PPNLP) was involved in magazine publishing. Its general partner was a corporation by the name of Lifestyle Magazine Inc
(LMI). ii) Zivot was the president of LMI, Marshall was also an officer of LMI. iii) Both Zivot and Marshall were limited partners in PPNLP. They both took part in the running of it but did so allegedly in their capacities as officers of the general partner LMI. iv) Zivot and Marshall dealt with Haughton Graphic Ltd. (HGL) to do printing of the magazine.
They dealt with Garwood and Nash who were officers of HGL. Nash did a credit check on
PPNLP and discovered that it was organized as a limited partnership. Nash, however, was not familiar with the nature of a limited partnership. v) There was no direct evidence that either Nash or Garwood relied on either Zivot or Marshall as general partners of PPNLP. b) Issue: the Alberta Limited Partnerships Act provided that limited partners would be liable as general partners where they
“took part in the control”
of the business. Thus HGL claimed that
Zivot and Marshall were “taking part in the control” of the PPNLP and were therefore liable as general partners. The lawyer for Zivot and Marshall argued, on the basis of a line of cases in the
U.S., that there was a defence that there was no specific reliance on the limited partners as general partners. c) Decision: i) If a limited partner takes part in the control of the business he or she is liable as a general partner , hence liable here ii) This applies even though the third party did not rely on him or her as being personally liable .
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(1) It was found that there was competing authority in the U.S. on whether there was a defence of no specific reliance. The statute itself did not refer to such a defence and the court was unwilling to read such a defence into the statute. d) Criticism : i) From a policy perspective it might be more consistent with the general policy of the Act to only protect actual reliance on persons as being partners. Protection for the third party even when they clearly did not rely would seem to give the third party a windfall gain. ii) On the other hand, it might be reasonable to put a burden on the limited partners to exercise caution not only to prevent actual reliance but to prevent any possible misperception on the part of third parties. A defence of specific reliance might also encourage potentially costly litigation over the question of whether the third party actually relied.
6) Nordile Holdings Ltd. v. Breckenridge (1992), 66 B.C.L.R. (2d) 183 (B.C.C.A.) a) Facts: i) Breckenridge and Rebiffe were officers in Arbutus Management Ltd (AML). AML was the general partner of Arman Rental Properties Limited Partnership (ARPLP). ii) ARPLP bought a property from Nordile Holdings Ltd (NHL). It paid cash for part of the price and gave a mortgage for the remaining part. Amongst the documents exchanged was a disclosure statement which set out the details of the structure of ARPLP and indicated that its general partner was AML and that Breckenridge was a shareholder, director and officer of
AML. It also provided as follows:
(1)
The parties hereto acknowledge that ARP (the “Limited Partnership”) is a limited partnership formed under the laws of British Columbia. The parties hereto agree that the obligations of the Limited Partnership shall not personally be binding upon, nor shall resort hereunder be had to, the property of any of the limited partners of the Limited Partnership or assignees of their interest in the Limited Partnership as represented by Units of the
Limited Partnership but shall only be binding upon and resort may only be had to the property of the Limited Partnership or the General Partner of the Limited Partnership. iii) This clause of the disclosure statement was included as a clause of the agreement of purchase and sale. b) Trial court : i) The trial court held that “ takes part in the management of the business
” (s.64 of
BC Act) is much broader than the “takes part in control ” wording of the Alberta (and other) statutes. The court said that “management covers a broader scope of activity than control and includes any activity covered by control.” ii) The trial court also concluded that Breckenridge and Rebiffe did take part in the management of the business and would therefore be liable under s.64. The court followed the position taken in Haughton Graphic that there is no defence of no specific reliance. iii) However, the trial court found that the agreement of purchase and sale made it clear that there was to be no liability on anyone but the limited partnership and the general partner. In other words, the parties had specifically contracted out of liability of anyone other than a claim on the assets of the limited partnership itself or those of the general partner (i.e. AML) c) Decision (on appeal the B.C. Court of Appeal): i) Generally adopted Haughton Graphic :
(1) If take part in management of business, liable as a general partner
(2) Agreed that there should be no defence of no specific reliance . ii) However, the agreement of purchase and sale made it clear that Breckenridge and Rebiffe are limited partners and were not to be held personally liable , hence not liable in this case iii) The judges then went on to say some confusing stuff:
(1) Gibbs J.
held that Breckenridge and Rebiffe did take part in the management of the business in their capacities as officers and directors of AML but not in their capacities as
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limited partners. Because they did not take part in the management of the business in their capacities as limited partners so they were not liable under s.64
.
(2) McEachern J.
held it was “agreed that the limited partners acted solely in their capacity as officers of the general partnership” and thus they would not be liable under s.64. If they were made liable for acting solely in their capacities as officers of the general partner it would be an exception to the Solomon principle (i.e. that a corporation is a separate legal entity and so its officers are not liable – see below) d) Comment: i) How does one make a distinction between persons acting solely in their capacity as officers of the general partner and persons acting in their capacity as limited partners ? ii) Perhaps this (confusing) conclusion turned on the apparent admission in this case by the plaintiff creditor in the agreement that Breckenridge and Rebiffe were acting only in their capacity as officers of the general partner (so moral is don’t make such admissions)
Protecting lim “owners” from gen “managers”: gen not make biz imposs/own property, lim get out
1) Limited liability facilitates having a large number of equity investors, but can raise a number of problems: a) Small stake problem : many equity investors may have relatively small stakes in the business and so may have limited incentives to carefully monitor the management of the business b) Free-rider problem : the relatively small limited partners might rely on (or at least hope) someone else monitoring the management c) Monitoring/management is further constrained by s.64
(which makes limited partners potentially liable as general partners if they take part in the management of the business).
2) Thus limited partnership tends to create a “ separation of ownership and control
” (limited partners being the “owners”), potentially putting the limited partners at the mercy of the managers of the business a) E.g. managers waste investors money by deciding they need a huge office, a business trip to Paris, or a private golf course to entertain clients
3) Statutory provisions might therefore be expected to protect limited partners from being taken advantage of by the managers. Such provisions could be mandatory (as opposed to default) provisions, meaning they could not be altered by agreement amongst the partners. a) E.g. disclosure requirements that help limited partners assess the performance of the managers b) E.g. provisions that facilitate removal of managers where their performance is poor. c) E.g. supplement the common law with respect to conflict of interest transactions in which managers might divert business assets to themselves. d) E.g. old requirement for “directors qualifying shares” in Corporate governance below
4) However, limited partnership Acts tend to have little of these sorts of protections , the idea being they should be very flexible (relative to corporations for example)
5) The market provides some protection for limited partners, in that no new investors will invest if general partners are known to be abusing the existing limited partners (and there is now a general suspicion of limited partnerships because of bad past practices by general partners)
6) Protections for limited partners can be included in partnership agreements (and the extent to which they do so is likely to be a result of market forces)
7) There are some protections in the B.C. Partnership Act . a) S.56: i) General partners cannot do an act which makes it impossible to carry on the partnership business or consent to a judgment against the partnership . ii) General partners cannot possess partnership property or dispose of it for other than a partnership purpose . iii) These constraints are not subject to alteration in the partnership certificate.
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8) See also rights to dissolution, disclosure, account, etc in s.58(1) below.
Partner rights: disclose/account, dissolve, agreement/consent before assign/admit new, share profits
1) An important right that might assist limited partners in assessing the management of the business is a right to disclosure of information concerning the business.
2) S.58(1) rights are prefaced by the words, “a limited partner has the same right as a general partner to do any of the following”, and so are arguably just default rights and not mandatory rights a)
S.58(1)(a): right “to inspect and make copies of, or take extracts from, the limited partnership books ...” i)
The general partner’s right to inspect books is provided in s.27(i), which is prefaced by the words “ subject to any agreement express or implied between the partners …” Thus if this right were waived or modified for the general partner then it would also be waived or modified for the limited partners. The general partner may not need such a right to inspect the books if it is the general partner who keeps the books. b)
S. 58(1)(b): right “to be given, on demand, true and full information of all things affecting the limited partnership and to be given a formal account of partnership affairs whenever the circumstances render it just and reasonable.” c) S.58(1)(c): gives a limited partner the same right as a general partner to obtain dissolution and winding up of the limited partnership by court order . i) Such winding up would be a last resort to get out for an oppressed limited partner may be to seek a court order for the dissolution and winding up of the partnership. ii)
S.38: general partner’s right to obtain a court order for dissolution and winding up.
(1) “On application by a partner, the court may decree a dissolution of the partnership.”
(2) The provision sets out circumstances in which the court may make such an order.
(a) E.g. situations in which the partnership agreement would be frustrated and thus it seems unlikely that the partners could waive such a right of application in their partnership agreement. Since the general partner’s right probably cannot be waived, so too the limited partner’s right
also probably cannot be waived (i.e. this right is a mandatory and not a default right).
(b)
E.g. situations “whenever circumstances have arisen that, in the opinion of the court, render it just and equitable that the partnership be dissolved.” E.g. if the business were being conducted in a way that was oppressive to one or more limited partners.
3) S.66: “a limited partner must not assign his or her interest , in whole or in part, in the limited partnership unless : a) All the limited partners and all the general partners consent or the partnership agreement permits it , and b) The assignment is made in accordance with the terms of the consent or partnership agreement
.”
4) Contrast this with the Nunavut Act, s.72 (which is the more common default rule than the one in BC) that makes assignment of limited partner interests ‘assignable’ (meaning you continue to be a limited partner but your profits go to assignee), and allows for actual transfer of limited partnership interest
5) Where assignment is permitted in the partnership agreement, s.51(4)(b) provides that the certificate must set out provisions concerning the right to make such an assignment and the terms and conditions of the assignment. a) The need to restrict the assignment of limited partnership interests is not as important as in a general partnership (recall problem of being liable for each others management decisions, i.e. agents of one another). Thus common in limited partnerships to allow for the assignment of limited partnership interests without having to obtain the consent of all the partners (which requires express provision in partnership agreement and set out in the certificate) b) If the limited partnership interests are sold to members of the investing public then the general partner would be subject to an obligation under the Securities Act to provide certain forms of
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disclosure both on the sale of the limited partnership interests and on an ongoing basis. This would include the distribution of financial statements to the limited partners and other important information concerning the business. See below.
6) Admission of additional partners a) In larger limited partnerships, usual practice is to allow for the admission of additional limited partners to facilitate future financing needs of the business by selling additional ‘units’ (need to include this in agreement and certificate) b) S.56(d): a general partner has no authority to admit a person as a general or limited partner unless the right to do so has been given in the certificate . i) S.51(4)(c): also states a right to admit additional limited partners must be set out in the limited partnership certificate and agreement c) S.65: an additional limited partner is not to be admitted to a limited partnership except: i) In accordance with the partnership agreement and ii) By entry in the register of limited partners that must be kept pursuant to s.54(2).
7) S.61: limited partners share in the profits and in any return of capital in proportion to their contributions unless the limited partnership agreement provides otherwise.
Limited Liability Partnerships
Origins: professionals no access to lim liability, but increasing liability led to insurance crisis
1) Note: LLPs are different to limited partnerships – in LLPs, partners do not have limited liability
(rather, they just have a shield from liability created by their fellow partners)
2) Many professions (e.g. as accountants, lawyers, engineers, doctors, dentists and architects) do not have access to limited liability forms of business association. a) E.g. many professions have often been subject to either express or implied restrictions from carrying on business through corporations (e.g. had to get a licence to practice and corporations could not get one). b) Where professional corporations have been permitted they usually have not allowed the particular professional persons to have limited liability with respect to the professional services they provide.
E.g. B.C. has allowed PLC (private law corporations) for some time, but it kept personal liability for professional negligence. c) E.g. Limited partnerships not available to obtain limited liability because the professional partner needs to take part in the business.
3) Yet professions witnessed an increasing scope of professional liability and increasingly large awards, which created an insurance crisis that made it difficult to obtain adequate insurance coverage. This increased the exposure of professionals to personal liability . And imagine a huge firm of 150 partners each liable for each other, and unable to get insurance for the liabilities created by each other.
4) In the U.S. these concerns led to political pressure for some form of liability shield while still allowing professional firms to organise as partnerships. Several states adopted statutes that allowed for the creation of limited liability partnerships ( LLPs ) in which partners are given some form of partial liability protection.
5) Similar concerns and political pressure has led to the adoption of limited liability partnership statutes in Ontario and Alberta (and now in B.C.
, see Partnership Amendment Act, 2004 , S.B.C. 2004, c.38, came into force on January 17, 2005)
Partial liability shield for malpractice of other partner, name must include “LLP” or similar
1) U.S.
: limited liability partnership structures vary widely. a) Some provide that partners are not liable for the malpractice liabilities of their fellow partners.
Others provide that partners are not liable for the ordinary debts of the firm. b) Some provide for full limited liability but limit this form of association to professional partnerships. Others provide full limited liability but are not limited to professional partnerships.
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2) Ontario Limited Liability Partnership Act : a) For certain professions, partial liability shield : i) Partners are not liable for the malpractice of fellow partners or employees unless they were directly supervising the activity (so I’m not liable for their bad practices) ii) Partners not liable to indemnify their fellow partners who have been found liable for malpractice (so they can’t claim a contribution from me) b) Business name registration: i) A limited liability partnership is not allowed to carry on business unless the registered business name contains the words
“Limited Liability Partnership”
,
“LLP”
or their French equivalents. ii) No other name can be used to carry on the business.
3) The recent B.C.
amendments to the Partnership Act (see above) enable a BC partnership and a foreign partnership to register as a limited liability partnership or an extra-provincial limited liability partnership. Once the name is approved, a partnership must file a Registration Statement.
Corporations: intro, history, constitutional
Diff types of shares, share rights (voting, dividend, liquidation), mgmt (directors, officers, others)
1) Corporate forms of organization vary enormously from corner store to General Motors.
2) Equity interests in corporations (a.k.a. “companies”) are divided into shares and the holders of the shares are referred to as shareholders . a) Liability of shareholders is limited to amount of investment. b) Shareholders have a ‘bundle of rights” (misleading to call them ‘owners’)
3) Can be many different types of shares with different rights attached to them. Three basic rights must be provided somewhere in the various sets of share rights (although they do not have to all be assigned to each different type of shares): i) Voting rights : The most important voting right is the right to elect directors who will manage, or supervise, the management of the corporation. Might not attach to all shares. ii) Dividend rights : i.e. a right to receive distributions out of the profits of the corporation when the directors choose to provide such a distribution by declaring a dividend. Might not attach to all shares. iii) Liquidation rights : i.e. right to receive what remains when the assets of the corporation are sold and the liabilities of the corporation are paid off. Might not attach to all shares.
4) Management structure (see “Corporate Governance” below) includes: a) ( Shareholders ) b) Board of directors elected by shareholders i) Could consist of just one director ii) Make major decisions on corporate policy iii) Appoint officers to manage the day-to-day operations of the corporation. c) Officers may be given titles such as president (or Chief Executive Officer), vice-president, secretary, treasurer or other titles i) Officers manage the corporation d) Officers may engage others to assist in carrying out managerial tasks or in otherwise carrying on the business of the corporation. e) Can have a single person as the shareholder, director and president, though must be careful that resolutions/decisions are made by them in their appropriate role i) There is a division of powers among the roles (assigned in the corporate constitutive documents) ii) Putting shareholders at the top of the hierarchy is therefore somewhat misleading, since they may not have the power to control all the bodies below
5) Recall potential problems due to separation of ‘owners’ from ‘managers’
in limited partnerships above
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Person, perpetual, lim liab (– credit, + valuation/monitoring/risk/prices/liquidity/invest/info/scale)
1) Three key features of corporate form of association distinguish it from partnership or sole proprietorship: limited liability, separate personality, perpetual existence
2) Separate personality a) Unlike sole proprietorships and partnerships, the corporation is treated as a separate legal entity or
“person” b) Thus the corporation can own property, enter into contracts, and commit torts and crimes.
3) Perpetual existence a) Unlike a partnership where the death of a partner or the transfer of a partner’s interest to another brings (at least in principle) the partnership to an end, a corporation does not come to an end just because a shareholder has died or has sold her or his shares to another person. b) Although a corporation can be brought to end by dissolution it can potentially carry on indefinitely.
4) Limited liability a) Liability of the shareholders in a corporation is limited to the amount that they have invested in the corporation. b) Courts will sometimes disregard the corporate structure and impose personal liability on shareholders (“ piercing the corporate veil ”) i) This is especially likely in the case of a corporation with a single shareholders , and (as described below) benefits of limited liability for single shareholder are less. ii) If the single shareholder is another corporation, then even if pierce haven’t exposed anyone to personal liability, so between affiliated corporations courts tend to pierce the corporate viel iii) This is very unlikely in widely held corporations c) NOTE : the following is a very uncritical look at limited liability , and ignores a huge literature critical of it, for example: i) Limited liability can mean corporations do not fully pay for committing torts against people
(so the people hurt end up paying/suffering themselves) ii) It can increase incentives to take risks for profit, leading to all sorts of environmental and social problems iii) It can decrease prices which can lead to over-consumption of scarce resources, as current environmental problems show all too well iv) It can create an overall incentive to not take full responsibility for your actions, infusing in people and society in general a greed without conscience v) It can accumulate wealth to an incredible degree in corporations, whose marketing and political lobbying efforts can significantly impact on the effectiveness of democracy vi) Etc. d) Drawbacks of limited liability i) See also :
(1)
“Problems” under Corporations: legal personality below
(2)
“Why” under Corporations: incorporation below ii) It is common to think of the benefits of limited liability in terms of a zero sum game in which the person with limited liability benefits at the expense of creditors. Creditors , however, will often charge more for advancing credit to limited liability businesses, so creditors will have been compensated and the benefits of limited liability are coming at a cost to the persons who have limited liability
(1) Limited liability is not a zero sum game, rather it is a positive sum game (i.e. there is a gain for everyone) iii)
Even a sole proprietor might get a “non-recourse” bank loan in which the bank agrees to limit its claim on the sole proprietor to the assets of the business, effectively giving the sole
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proprietor limited liability as against the bank, for which the bank would probably charge, usually in the form of higher interest i) Recall potential problems due to separation of ‘owners’ from ‘managers’
in limited partnerships above e) Benefits of limited liability (to both investor and society as a whole) that make this higher cost of credit worthwhile:
Limited Liability (e.g. corporation) i) Reduced valuation Costs ii) & iii) Reduced monitoring costs iv) Diversification
Unlimited Liability (e.g. partnership)
Need to check:
– earning capacity (future cash flows) and risk
– wealth of fellow investors (so costs rise with more investors)
Need to control against:
– changes in wealth of fellow investors due to:
sales of their investment
changes in their personal assets
– managers putting wealth at risk
Keep number of investments to a minimum since each investment carries risk of loss of all personal wealth (and will expect compensation for added risk)
Need to check:
– earning capacity (future cash flows) and risk
– (but not wealth of fellow investors)
Not much benefit if single investor
– Don't need to monitor wealth of other investors or control their exit from the firm
– Less need to control managers since smaller potential loss (and potential for control block of investment to monitor management)
Not much benefit if single investor
Can diversify, since increased number of investments doesn't increase risk since personal wealth is not exposed with each investment v) Liquidity vi) Optimal investment decisions vii) Market price impounding information
Lack of liquidity due to:
– high costs of assessing value
– controls on transfer of shares
Managers may not make highest value investment since must take account of diversifiable risk to which investors exposed
(although they might if the highest value investment adequately compensates for costs and risk)
No single price since each investment must be valued separately (see 1 above)
Provides liquidity since:
– lowers cost of valuation
– less need for control over other investors selling their investment
Investors can diversify risk and this allows managers to ignore diversifiable risk in investment decision and make highest value investment
Single price for units of investment
– price simply reflects estimate of future cash flow and risk (see 1 above)
– thus price impounds important information on value of firm
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viii) Facilitates economies of scale
All) Reduced prices for society
Valuation and monitoring costs do not favour large partnerships, hence often insufficient accumulation of capital for economies of scale
Prices will be higher due to higher valuation and monitoring costs, etc.
Large accumulations of capital from large number of investors possible
Prices lower due to reduced costs, improved liquidity, economies of scale, etc. i) See also “Why: advantages” under Corporations: incorporation below ii) Limited liability can allow for reduced valuation costs ( of other investor’s wealth
)
(1) E.g.
to value an unlimited liability partnership business (e.g. to assess what would be willing to pay for the partnership interest), must examine :
(a) The potential future cash flows from the business and the risk associated with those cash flows (i.e. the net gains that the business can be expected to provide).
(b) The wealth of the other partners , since:
(i) Partners do not have limited liability and so risk of liabilities being greater than assets and hence personally liable for the excess liability.
(ii) Could seek indemnification from other partners but their ability to provide such indemnification depends on their individual wealth.
(c) The effort/cost to determine this rises with the number of investors (i.e. partners)
(2) In contrast, if considering purchasing shares in a corporation with limited liability, only need examine the potential future cash flows (i.e. earning capacity) and the risk associated with them. Do not need to consider the wealth of the other investors, since if liabilities are incurred that are greater than the assets, creditors claims will be limited to the assets of the business and creditors are not normally able to make the shareholders personally liable. So no need seek indemnification from other shareholders and consequently their individual wealth is irrelevant. Thus benefits of limited liability in terms of valuation costs increases with the number investors. iii) Limited liability can allow for reduced monitoring costs ( of other investor’s wealth
)
(1) As above, once you become an investor in an unlimited liability partnership may want to monitor the wealth of the other partner investors , since if their wealth goes down (or they sell their partnership interests to others who are less wealthy) then your risk of personal liability increases. While it may not be easy to monitor changes in the wealth of one’s fellow partners, it is common in partnerships to restrict the sale of partnership interests to prevent selling of partnership interests to persons with less wealth. The effort/cost to undertake such monitoring increases with the number of investors (i.e. partners)
(2) Under limited liability (e.g. corporation), will not be called upon to pay for liabilities beyond the assets of the corporation, so will not need to call upon fellow investors to contribute to paying for such liabilities or to indemnify oneself from paying for such liabilities. Consequently the monitoring costs are less. iv) Limited liability can allow for reduced monitoring costs ( of management )
(1) Management decisions more crucial in unlimited liability associations such as partnership because a bad decision could potentially result in the loss of one’s entire wealth (as opposed to just investment in limited liability situation), and so will want to monitor management more closely. v) Limited liability facilitates diversification thus reducing overall portfolio risk & prices
(1) The greater the tendency of returns on an investment to fluctuate up and down, the greater the risk.
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(a) Some sources of risk are unique to the particular investment. E.g. the risk of a fire at the firm’s main plant or the finding of a rich vane of ore or a new invention are likely to be unique to the particular investment.
(b) Other sources of risk may be the same for many or all investments. E.g. the returns on most investments will move up and down with the market as a whole.
(2) Risk that derives from sources that are unique to the particular investment can be avoided by diversification , meaning making several investments so that bad luck in one is hopefully compensated for by good luck in another, thereby reducing the overall portfolio risk .
(a) Note cannot eliminate all risk by diversification, since there is general market risk (i.e. the economy as a whole might move down)
(3) But would be reluctant to diversify through investments in unlimited liability forms of association (e.g. partnership) since each would involve the added risk that the business could become bankrupt leading to potential claims on one’s personal assets (likely outweighing benefits from diversification)
(4) By contrast, investments in limited liability forms of association do not expose personal wealth (beyond the investment) to risk.
(5) Limited liability, by facilitating diversification, also provides for societal benefits (i.e. reduced prices )
(a) With higher risk, investors generally demand compensation through greater returns from the business, which in turn means the business would have to charge more for its products or services. By facilitating diversification, limited liability reduces risk for investors thereby reducing the compensation they demand and reducing the prices the business must charge, benefiting society as a whole. vi) Limited liability improves liquidity of investments , which in turn reduces prices
(1) Liquidity in the context of investments refers to the ease with which an investment can be shifted to another investment or withdrawn from the investment for some other use.
Investors value liquidity, since if investment can be easily withdrawn the investor can have access to the funds for personal use or to shift to another investment that may be providing better returns for the given level of risk. Investors will thus pay more for more liquid investments and will demand compensation for less liquid investments.
(2) There is less liquidity in unlimited liability (e.g. partnership) than in a limited liability investment since :
(a) Cost of assessing the value of the unlimited liability investment is higher (see above), so will be more difficult to sell an unlimited liability investment because the purchaser will want compensation for the cost of valuing the investment.
(b) With respect to monitoring costs, as noted above, partners will likely have imposed some restriction on the sale of partnership interests partly in order to protect themselves against sales to less wealthy investors who may not be able to contribute to losses or indemnify the remaining partners. This will make it more difficult to sell an unlimited liability partnership interest. Such restrictions less likely on the sale of limited liability investments since the investors do not need to worry about the wealth of their fellow investors (although there may remain other reasons for restricting sales of interests even in limited liability investments).
(3) Limited liability, by improving investment liquidity, also provides societal benefits (i.e. lower prices )
(a) As noted above, a lack of liquidity is a real cost for which investors will demand compensation, and to provide this, the business will have to charge higher prices for its goods or services vii) Limited liability helps achieve optimal investment decisions
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(1) Investment opportunities that arguably should be pursued may not be with only unlimited liability enterprises (e.g. partnership ) due to their increased risk
(2) Investors demand a certain rate of return to compensate them for the use of their money and the risk involved (e.g. may want 10% returns). Managers of the business should take this into account in decision making (otherwise, if the 10% is not met, investors may withdraw their investment).
(3) Unlimited liability deters diversification and results in higher risk for which investors will demand greater returns (e.g. 14%). Thus many business activities that would have generated between 10% and 14% returns would not be undertaken. viii) Market prices from previous trades in limited liability investments impounds useful information about the value of a potential upcoming investment, and so reduces costs of assessing value when considering that investment
(1) The prices of trades in unlimited liability investments generally does not provide very useful information about the value of the investments.
(a) E.g. You are considering investing in an unlimited liability partnership. Originally 4 partners A, B, C, D, each with a 25% interest. E recently bought out D. A is wealthy but B, C, and E are not (and D was a bit less wealthy than E).
(b) If you know the price E paid for the 25% interest, since E would have had to assess the cash flows and risk on the investment just as you need to do, this may help reduce your costs of assessing the business by:
(i) Perhaps by making a preliminary investigation to see if you get a result that in the same ball park as E
(ii)
Having E’s price might provide you with an initial bargaining price that may help reduce the overall cost and time in negotiating a reasonable price with one of the other partners.
(c)
Suppose A’s interest is for sale. The price E paid for D’s may be of little help to you because E was paying a price for a partnership interest in which one of the three other partners was wealthy (based on risk E would face with A still in the partnership). You, however, will be sharing the partnership with three much less wealthy partners , and so will have greater exposure to personal liability to cover losses to creditors.
(2) In contrast, when considering an investment in a limited liability form of association, as discussed above the wealth of other investors does not matter to your risk. Rather, the relevant considerations when valuing the investment are cash flows and risk (regardless of other investor’s wealth), so the price E paid last week for the investment may yield some information about its value. Though E may have completely miscalculated the value, if there were other purchases of investments in the business then the average of the prices will give a reasonably reliable ballpark figure. This could assist in reducing your costs of assessing the value of the investment. If you are confident in recent prices at which the investment interests were trading (e.g. you have prices based on numerous trades within the past hour on a stock exchanges) you might accept the current price as an accurate assessment without making any assessment on your own. This would greatly reduce your costs of assessing the value of the investment (and hence is why stock exchange prices are published widely) ix) Limited liability may facilitate economies of scale and hence lower prices
(1) In some production processes of goods, or in some processes for the delivery of services, the per unit cost of providing the goods or services may decrease as the number of units produced increases (i.e. “economies of scale”). But increasing size of production process requires greater infusions of capital.
(2) Limited liability tends to favour greater infusions of capital than unlimited liability. The valuation and monitoring costs of partnerships may become very high with large
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partnerships, discouraging large partnerships and large accumulations of capital from large numbers of investors. With limited liability can more readily accumulate large amounts of capital from a very large number of investors , possibly with each investor contributing relatively small amounts.
(3) This can allow for reduced prices of goods and services, providing an overall benefit to society by reducing the overall consumption of society’s scarce resources
UK history: prtnershp (societas), joint stock (Crown charter, transfer prtnership, Act), Bubble Act
1) An early form of corporation in medieval times was used for public and ecclesiastical bodies , given a charter from the Crown. a) It was held early on that these entities formed by Crown charters were separate legal persons .
They could thus own property and execute deeds. b) However, they were not created to carry on business activities and thus did not really resemble the modern form of corporation.
2) Trading in medieval times was not organized through corporate forms of organization. An early form of trade organization was the “ merchant guild ”. a) Individual members of the guild traded on their own account and the guild regulated the behaviour of individual members in their trading activities, but the guild did not carry on business itself. b) It was not a separate legal entity – rather it was an arrangement among persons who carried on a particular trade for the purpose of regulating the particular trade, like a cartel.
3) Joint trading was done in some early forms of partnerships . a) One such form was the commenda in which a financier made a loan to a trader in return for, in part, a share of profits. Our modern parallel is s.4(c)(iv) of the B.C. Partnership Act . b) Another was societas , a more permanent form of association for joint trading. Members would act as agents for each other and were liable to the full extent of their private fortunes for the debts incurred by other members and by themselves in respect of the joint trading. This was the forerunner to our modern form of partnership .
4) By the 16 th
and 17 th
century companies were formed for foreign trade . The ventures were considered very risky , so few would invest their fortunes in a single voyage. Crown charters were given that typically provided a monopoly on trade in a given area. a)
E.g. Hudson’s Bay Co.
, East India Co. b) Initially these companies were organized like merchant guilds with trading on private/individual accounts . Goods from different merchants would be loaded on one or more ships for a particular voyage for trading in distant lands. Records would be keep of the goods received in return for the goods each merchant had loaded on the ship. When the ship returned the merchant would get the goods received in exchange for selling that merchant’s particular goods and that merchant could then sell the goods received. Thus the enterprise did not have the joint (or corporate) endeavour character that modern corporations have. c) Later on voyages were run on a joint stock basis . I.e. persons would make investments (i.e. pay money to the chartered company) which would then be used to buy goods for the voyage. The company would trade the goods in the distant land and bring the goods received in exchange back for sale in England, the profits from which would be distributed to the investors. d) Initially these joint trading expeditions were done for just single voyages , but later on they would run for a number of years . I.e. persons would invest funds to be used to buy goods for several trading expeditions over several years. By the end of the 17 th
century there was a permanent joint stock company in the East India Co. and individual trading was prohibited.
5) By about the 16 th
and 17 th
centuries joint stock companies were effectively being formed without reliance on a charter from the Crown. These
“joint stock companies”
were organized as large partnerships with provisions to make shares (i.e. partnership interests) transferable :
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a) Reduced transportation costs (e.g. improvement in navigation and the building of canals) by this time had increased the size of potential (distant) markets. Production could now be done on a larger scale but this required much more substantial accumulations of capital, possibly requiring a larger numbers of investors, and probably providing the impetus for very large partnerships (in spite of the costs that imposes where investor liability is not limited – see above). b) Provisions to make shares freely transferable altered the normal default rule in partnership that partnership interests are non-assignable without the consent of all the partners (and is still the default, see Partnership Act s.27(g), since partners need to monitor the wealth of their fellow investors). However, attracting investors may have required partnership interests be made freely transferable since investors may feel more comfortable investing when they know they can sell their investment interests reasonably easily. The profits to be made from larger accumulations of capital may have outweighed the costs that free transferability of unlimited liability interests may impose. c) To avoid unlimited liability, managers of these joint stock companies would often enter into norecourse (to personal assets of partners) agreements with major creditors . d) These joint stock partnerships had many characteristics similar to those of modern-day public corporations. However, being a very large partnership it was not a separate legal entity, so the
“joint stock company” could not own property – instead the partners (i.e. joint stock company stockholders) or trustees on their behalf would hold legal title to property used in the business.
The “joint stock company” could not enter into a contract as a party to the contract – instead the partners, or trustees acting on their behalf, would be the parties to the contract.
6) By the mid 16 th
century there was a decline in the importance of foreign trading companies and a growth of chartering domestic companies . However, charters were still used primarily to grant a monopoly and were not really used to govern the rights of members (or “shareholders” – i.e. company law was yet to develop).
7) By the 17 th
and 18 th
centuries companies were occasionally being formed by separate statutes passed by Parliament (in contrast to a modern general statutes of incorporation under which any number of companies can be incorporated) a)
E.g. “A Statute for the formation of the South Sea Company” b) Companies formed by these separate statutes resembled modern corporations in many respects.
However, it was not yet clear if these entities had separate legal status and the liability of investors was probably not limited to the assets of the business unless the statute expressly so provided.
8) By the early 18 th
century then, business enterprises with multiple investors could be formed as: a) Partnerships b) Joint stock companies (i.e. very large partnerships) c) Crown charter companies d) Companies formed under separate statutes.
9) The South Sea Company was formed by a separate statute in 1710 to exploit opportunities for trade with South America. a) It was hoped that the treaty being negotiated with Spain would result in British control over
Spanish interests in South America. b) It was also intended to relieve government debt by converting government annuities into stock
(i.e. investors who had purchased government annuities would sell these to the South Sea
Company in exchange for South Sea Company stock). The annuities would provide cash flow to the South Sea Company for trade and trade would provide a return on the stock. Stock was also sold by South Sea Company promoters on the basis of rumours about mountains of gold in South
America and the story of the lost city of Eldorado in which the streets were paved in gold. c) The only real trading asset the company obtained out of the treaty with Spain was a right to supply slaves from Africa to North America. In fact this business did not turn out to be particularly successful and the company soon ceased to carry on the slave trade business.
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d)
In the years just prior to 1720 the company had deteriorated into a form of “Ponzi” scheme or
“pyramid” scheme
– new issues of shares were made to pay promised dividends on previously issued shares, and to sell the new shares ever higher dividends were promised. The apparent virtually guaranteed returns on South Sea Company stock made the stock very attractive. Prices skyrocketed. However, as with all these schemes, there is ultimately an end to the number of persons willing and able to buy all the new issues of shares to keep the whole scheme going.
When this stage was reached the South Sea Company had trouble continuing its high dividends and the stock price dwindled quite quickly. e) The shares dropped in value and people who had bought the shares (including many wealthy and influential people) were losing a great deal. The solution was an Act of 6 Geo. 1, c.18 in 1720 which was nicknamed the
“
Bubble Act
”
. Its preamble railed against the dangers of joint stock companies and the need to protect unsuspecting and gullible investors against such “fraud traps”.
It made joint stock companies (i.e. the large partnerships with freely transferable shares (i.e. partnership interests)) illegal . New joint stock companies could not be formed and existing joint stock companies had to be wound up. f) This meant that there were only two remaining available ways of forming a company , and both became very difficult : i) By Crown charter (and with the Bubble Act in place administrators became very reluctant to grant Crown charters) or ii) By separate statute (which required getting onto the busy legislative agenda of Parliament). g) For the influential investors in the South Sea Company the idea (and the likely plan behind the
Bubble Act ) was simple. By making joint stock companies illegal, it limited the available avenues for investment to the remaining relatively few companies formed by Crown charter or by separate statute. The South Sea Company survived because it had been formed by a separate statute.
Investors who had investment funds returned to them on the winding up of joint stock companies would want to invest the funds somewhere and the South Sea Company would be one of the few remaining investment vehicles , so ( in theory at least) the demand for South Sea Company shares would drive the price of the shares back up . h) The Bubble Act only made matters worse, however . Joint stock companies had to be wound up and so had to realize on their assets and pay off their liabilities. One of their key assets was the right to receive payment for joint stock company shares from investors. Investors had bought their shares on credit, but now they had to pay up, so they had to get cash, and to do so they sold off their other investments, such as their South Sea Company shares. Many investors were in this predicament and the resulting pressure to sell put downward pressure on the prices of the stocks of the remaining legitimate companies, including the South Sea Company.
10) The Bubble Act may have delayed the development of corporations and corporate law in England from its enactment in 1720 until its repeal in 1825. a) After the enactment of the Bubble Act in 1720 the pressure to accumulate capital was still present and there were attempts to avoid the Act . i) Business trusts were formed in which investors settled funds on trust to be used to carry on particular businesses with the profits being distributable to the investors who were also beneficiaries of the trust. Trust instruments provisions made these trust arrangements look like modern day corporations . Trustees were elected by the investors and managed the business.
Certain decisions such as the replacement of trustees or the termination of the trust were made subject to majority vote of the beneficiary joint stock holders. ii) The general legal opinion was that the Act would not be violated if there was any kind of a restriction on the transfer of shares (i.e. partnership interests). Thus partnerships were formed which restricted partnership share transfers in relatively minor ways . b) The Bubble Act was generally not enforced through the 18 th
century, which led lawyers to create partnerships with extremely limited restrictions on the transferability of interests (i.e. the interests
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were almost, but technically not quite, freely transferable). It began to be enforced again at the beginning of the 19 th
century putting the legality of many of these business organizations in doubt.
Debates over this ultimately led to the repeal of the Bubble Act in 1825 .
11) Even after the repeal of the Bubble Act doubts remained as to the common law validity of unincorporated joint stock companies . In Duvergier v. Fellows (1828) 5 Bing. 248 Bext, c.5 it was stated that: a) The scheme in which the parties to this action were engaged was one of those bubbles by which, to the disgrace of the present age , a few projectors have obtained the money of a great number of ignorant and credulous persons, to the ruin of those dupes and their families, to commerce and to the morals of the people. ...Although the statute of 6 Geo. 1 be repealed, the common law relating to such schemes is expressly reserved by the repealing statute; and no one doubts, if it can be shewn, and it easily may, that such schemes are fraud-traps and injurious to the public welfare, that the forming of them is an indictable offence at common law.
12) Nonetheless it was held, in 1843 that unincorporated joint stock companies were legal at common law .
UK history: general Acts for incorp (1844), lim liability (1855), mem of assoc, historical rationale
1) Joint Stock Companies Act , England, 1844 a) Provided for incorporation by registration with full publicity of the particulars of the corporation’s constitution. Unlike getting a separate act passed by Parliament, made the formation of a company very easy. b) The Act, however, preserved personal liability .
2) Public opinion was in favour of limited liability . E.g. quote from The Economist in 1854: a) The question [of limited liability] has for a long time interested the public, and like many other questions much talked about but hung up for decision, its importance has been greatly diminished by the lapse of time. It has now been shown by experience that, right as the decision of the House of Commons may be in principle, in practice most of the good or evil anticipated from it has been discounted, and the alteration in the law, whenever effected, will be followed by far less beneficial or mischievous results than its advocates hope and its opponents dread. The people, by quietly adapting their practices, changes in the law, when made, are frequently more nominal than real.
At present the law, as Mr. Collier's resolution states, is that every ostensible partner who shares the profits of a trading concern renders himself liable in the whole of his property to the whole of its debts; but in practice, as is the case with mutual assurance companies, all the partners contract with each other, and the company contract with every person it deals with, that all claims shall be confined to the subscribed fund of the company . Every person with whom it deals entering voluntarily into the contract, the principle of limited liability is, by common consent , fully carried out, whatever the law may say to the contrary.
3) Limited Liability Act , England, 1855
4) Revised Joint Stock Companies Act , England, 1856 providing for limited liability was enacted.
5) During the early years of general statutes of incorporation the courts were developing what is sometimes referred to as the common law concerning companies . Where the statute of incorporation was silent on a particular matter in issue, or required interpretation, the court tended to develop a response based on partnership law but with variations that were deemed expedient.
6) Under the English Joint Stock Companies Act the company was formed as of right on the filing of the
Memorandum of Association (and the articles of association ) in the appropriate form. a) The memorandum of association was the basic document governing the corporation, regarded as a form of contract among the shareholders (referred to as “members”) b) The statute tended to leave the terms of the memorandum of association quite open with only brief requirements as to what had to be included.
7) Why did general statutes of incorporation providing for limited liability come into existence when they did?
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a) The pressure to accumulate capital probably increased dramatically in the 19 th
century. E.g. development of steam engine and railways greatly improved ability to transport goods relatively cheaply over long distances, so could now supply markets that were too costly before, thus increasing benefits of producing on a large scale. The steam engine also led the way for increased mechanization of production processes, requiring even greater accumulations of capital to acquire the expensive equipment, which would be facilitated by easy means of incorporating a company as provided by 1844 Act (recall costs of unlimited liability forms of investment increase in direct proportion to the number of investors). Thus attempts to accumulate capital from large numbers of investors probably led initially to attempts to obtain limited liability by private means, as suggested in the quote above, and ultimately to political pressure to reduce these costs by a statutory grant of limited liability. b) Alternatively, political pressure for repeal of Bubble Act and enactment of the 1844 and 1855 Acts may have been that the industrial revolution produced a new and much larger group of very wealthy persons who wanted a place to invest their wealth. Constraints on corporate forms of organization and costs imposed on investors by unlimited liability would have greatly limited their investments (recall concerns about diversification where only unlimited liability investments are available). This expanding class of wealthy individuals during the industrial revolution, it is said, would have had a strong incentive to lobby for the statutory change
Canadian History: Crown charter, special Act, letters patent, memorandum of assoc, articles, today
1) Earliest corporate forms of organization in Canada were the result of granting Crown charters . a) E.g.
Hudson’s Bay Company
, one of the English foreign trading companies that conducted much of its business in North America and still exists to this day. b) Charters were granted in the colonies to banks and for projects such as roads, canals, harbours and later, railways.
2) Some corporations were also incorporated under special acts .
3) In 1849 each of the provinces of Lower Canada and Upper Canada passed statutes allowing for the grant of letters patent to create companies for the building of roads and bridges – like Crown charters, but exercised by an administrator under a general statute of incorporation a) In 1850 the United Provinces of Canada enacted a general incorporation statute for mining, shipbuilding, manufacturing, mechanical or chemical concerns. i) Provided for limited liability (six years before they did so in England), an expeditious incorporation process with no dependence on executive discretion. ii) The corporation created under the Act was a separate entity with succession and capable of suing and being sued. iii) The statute had many of the features of modern company law. b) 1864 United Provinces Act , another general Act of incorporation provided for the grant of a letters patent on application to the Governor-in-Council. One had to give public notice of an intention to incorporate and had to satisfy the appropriate authority that the corporate name was not that of another known corporation. c) This 1864 letters patent Act was the basis of the subsequent federal Act of 1869 and of subsequent legislation in Quebec, Ontario, Manitoba, N.B. and P.E.I. d) The letters patent was granted as an exercise of the Crown prerogative , so was arguably an extension of the granting of a charter from the Crown. i) Therefore granted as a privilege and not as of right (contrast with right to incorporate upon the filing of specific documents as in the memorandum of association statutes below) ii) In contrast to a Crown charter, the letters patent was granted by an administrator appointed under the general statute of incorporation. iii) As an extension of the Crown charter concept it was short step to extend the concept of separate legal personality that had been extended to Crown charter entities centuries earlier.
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e) In contrast to memorandum of association (see below), the letters patent tended to be much more detailed with specific provisions on the conduct of the affairs of the company that could not be altered, so not flexible . i) Contrast with a memorandum of association company (below), where such matters would normally be addressed in the articles of association, which were completely flexible. f) Concept of ultra vires (see below) was not applied to letters patent companies
4) The English memorandum of association style of general statute of incorporation (in particular the
Joint Stock Companies Act of 1862 ) later became the model for statutes in British Columbia, Alberta,
Saskatechewan, Nova Scotia and Newfoundland. a) In a memorandum of association statute incorporation is a matter of right . Certain documents must be filed but once they have been filed, and are in the proper form, the administrator (usually referred to as the registrar of companies) must grant the incorporation. b) The separate legal entity concept was not clearly extended to memorandum of association companies until 1897 . c) The basic constitutional document (the memorandum of association ) is usually a fairly simple document setting out the names of initial subscribers for shares (i.e. the initial members), the name of the company, the business of the company and the amount of shares the company is authorized to issue. d) The members can then draft their own articles of association which set out rules for such things as the holding of company meetings (of both members and directors), restrictions on the transfer of shares, borrowing powers, the declaration of dividends, notices and so on. e) Concept of ultra vires (see below) was applied to memorandum of association companies f) Remains the model in Nova Scotia today –the memorandum of association is a contract , and the statute says it sets of the rights of the corporation, enforced through contract law
5) The Lawrence Committee was appoint in Ontario in 1967 to examine the state of corporate law in
Ontario, and made numerous recommendations which resulted in a new Act in Ontario in 1970. a) The new act adopted more of a U.S. approach to corporations. Under the new act the basic constitutional document of the corporation was the “ Articles of Incorporation”.
6) In the early 1970s the federal government also appointed a committee (the Dickerson Committee ) to examine corporate law. a) The Dickerson Committee adopted many of the views in the Lawrence Committee Report and made several other recommendations. The Dickerson Committee produced a draft act that was largely followed in the enactment of the Canada Business Corporations Act
(the “
CBCA
”) by
Parliament in 1975 . This new federal act was later adopted almost verbatim in Alberta,
Saskatchewan, Manitoba, Quebec, New Brunswick, and Newfoundland. In 1978 Ontario also modified its 1970 Act to bring it into line with the CBCA. b) The CBCA is an incorporation statute of the articles of incorporation type i) Can incorporate as of right once riled the necessary documents ii) Look to the statute and the filing documents to find the rights – the articles get their force from the statute
7) The federal government conducted another review of corporate legislation that extended over several years in the 1990s. On the whole it was concluded that the CBCA continued to be a fairly modern and effective corporate statute. Several amendments were made but the fundamental structure of the legislation remained the same.
8) The federal forerunner to the Canada Business Corporations Act was the Canada Corporations Act which covered both for-profit and not-for-profit corporations. a) Part IV dealt with not-for-profit corporations and is still in force . b) Thus at the federal level for-profit corporations are incorporated under the Canada Business
Corporations Act while not-for-profit corporations are incorporated under Part IV of the Canada
Corporations Act.
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c) Several provinces adopting the CBCA have also taken a similar approach by having a separate
“Business Corporations Act” for for-profit corporations and a “Corporations Act” for not-forprofit corporations. d) Some provinces, such as British Columbia, have retained the English terminology of a
“Companies Act” (or “Company Act”) for for-profit companies and a “Societies Act” for not-forprofit companies.
9) Situation across Canada today : a) It is at least theoretically still possible for a corporation to be created by grant of a Crown charter although it is unlikely to happen today. i) However, there still are some existing corporations that were formed by the grant of a Crown charter. E.g. Hudson’s Bay Company. b) It is also still possible for a corporation to be formed by special Act and this has been done, and is still often done i) E.g. for endeavours such as hospitals, municipalities, universities, stock exchanges and many other similar sorts of activities. c) Then there are the general statutes of incorporation under which incorporation can usually be relatively easily accomplished by the filing of certain documents specified in the general statute of incorporation. i) The general statutes of incorporation include not just the Canada Business Corporations Act
( CBCA ), the Canada Corporations Act ( CCA ), and their provincial equivalents (e.g. BCBCA and Society Act ) but also several other general statutes of incorporation for particular types of businesses.
(1) E.g. much of the federal Bank Act is a general statute of incorporation (adopting much of the CBCA, such as the articles of incorporation style).
(2) In addition, at the federal level there is the Insurance Companies Act and the Trust and
Loan Companies Act (and there are provincial counterparts to each of these). ii) Some general statutes are of the Articles style: CBCA, Que, Ont, Man, Alta, Sask, Nfld, NB,
PEI (letters patent) iii) Some are memorandum of association style: NS, BC d) Of course one of the first things one should do as a lawyer when dealing with a corporation (or company) is to find out how it was incorporated . This is vitally important because it determines what statute governs the internal affairs of the company.
B.C. History: English Acts 1859 & 1862, Company Act (1999 never in force), BCBCA (2003)
1) In 1859 , Sir James Douglas, by Proclamation, enacted that the then existing Statutes of England with respect to joint stock companies be extended to the Colony of British Columbia .
2) In 1866 a Companies Ordinance was passed providing that the 1862 English Act should apply.
3) Other forms of companies legislation were tried between 1878 and 1897 but in 1897 the province returned to a statute modeled on the English Joint Stock Companies Act of 1862 .
4) BC followed these UK models until it made significant amendments in 1973 . These amendments anticipated several of the more significant corporate law modifications later recommended by the
Dickerson Committee at the federal level.
5) In January of 1991 the Government of British Columbia released a discussion paper that suggested various reforms to company law in B.C.
6) Several years later, in 1999 , a new Company Act was passed but was not declared in force
7) Has since been replaced by yet another Act in 2002, the Business Corporations Act , S.B.C. 2002, c.57. a) Came into force in 2003.
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b) The new Act replaces the memorandum with an “ incorporation agreement
” and a “ notice of articles
” as the main incorporating documents (although the contents of the these documents remain similar to those that are required in a memorandum under the Company Act ). c) It retains much of the former former Act (R.S.B.C. 1996, c. 62) but with numerous modifications.
Prov incorporation of Co. with “provincial objects”, Co. can operate elsewhere but needs licence
1) Both provinces and federal government can pass valid legislation for the incorporation of companies.
2) Constitution Act , s. 92(11): province may make laws in relation to: “The Incorporation of Companies with Provincial Objects ” a) Bonanza Creek Gold Mining v. The King [1916] 1 A.C. 566 (P.C.) i) Facts:
(1) Federal government granted hydraulic mining leases to Bonanza Creek Gold Mining Ltd. in the Yukon giving Bonanza a right to obtain hydraulic mining licences on relinquished adjacent placer mining claims. Some adjacent placer mining claims were relinquished,
Bonanza sought hydraulic mining leases on these sites, but the federal government refused.
Bonanza sued the federal government to enforce its contractual right to the additional hydraulic mining licences.
(2) Bonanza Creek Gold Mining Ltd. was incorporated pursuant to an Ontario general statute of incorporation, and the Yukon government granted Bonanza a licence to carry on business in the territory.
(3) Federal government argued the contract under which the hydraulic mining licences were granted was invalid on the basis that Bonanza had no capacity to operate outside Ontario because it was incorporated under an Ontario statute and the Ontario legislature only had the power to incorporate companies with “
Provincial Objects
”. ii) Decision:
(1) The province of Ontario could confer the power to companies to carry on business within and outside the province .
(2) However, it could not confer on a company the right to operate in another jurisdiction – that is up to the other jurisdiction and subject to their legislation. Bonanza OK here since
Yukon granted it a licence to carry on business in the Yukon.
(3) As for the contract with the federal government, it was a valid contract because Bonanza had the power to carry on business in the Yukon (given by Ontario) and so it had the capacity to enter into the licensing contract with the federal government. iii) Comment:
(1) This case seem to suggest that “Provincial objects” is territorial (i.e. provincial power to incorporate for any purpose so long as it is carried on within the province – outside the province, the company is subject to restrictions of other province)
(2) Similarly, a provincially incorporated company can carry on business anywhere in the world so long as other countries permit it to do so (and they typically do).
Fed residual power to incorp, Co. power & right to operate across Canada, though doesn’t have to
1) Constitution Act , s.91
: federal government is given the power to make laws, “in relation to all Matters not coming within the Classes of Subjects by this Act assigned exclusively to the Legislatures of the
Provinces …” a) Hence, by virtue of this residual powers , feds can make laws for the incorporation of companies with objects other than “Provincial Objects”.
2) Constitution Act , s.91(15) : federal government also has power to regulate in the area of banking and has a specific power concerning the “
Incorporation of Banks
”
3) Citizens Insurance Co v. Parsons (1881), 7 App. Cas. 96 at 116-17 (P.C.) a)
Decision: In comparison to the ‘incorporation of banks” power, the federal government has a broad er power to incorporate companies under its residual power : “in relation to all Matters not
89
coming within the Classes of Subjects by this Act assigned exclusively to the Legislatures of the
Provinces”.
4)
Since provinces only given power with respect to companies having “Provincial Objects” then federal government has power with respect to incorporating companies with other than “Provincial Objects”.
However, as indicated in Bonanza Creek Gold Mining v. The King which stated provinciallyincorporated companies have the power to operate outside the province, the federal power must be something other than incorporating companies with extra-provincial powers.
5) Scope of the federal residual power: John Deere Plow Co. v. Wharton (1914) 18 D.L.R. 353 (P.C.) and John Deere Plow Co. v. Duck . The appeal in these two cases was heard together. a) Wharton facts: i) Wharton was a shareholder in a company called John Deere Plow Co. which was incorporated in British Columbia. Wharton sought to stop the John Deere Plow Company, a federally incorporated company, from carrying on business in BC. ii) B.C. legislation allowed a company incorporated outside of BC to carry on business in BC if it obtained a licence to operate in BC, but a condition of granting such a licence was that the name of the company could not be the same as or confusingly similar to the name of a company already incorporated in B.C. or registered in B.C. iii) Wharton argued that the federally incorporated John Deere Plow Company could not be granted such a licence because its name was confusingly similar to the name of the company of which he was the sole shareholder and which was incorporated in B.C. b) Duck facts: i) Duck had purchased a tractor from the federally incorporated John Deere Plow Company which alleged he had failed to pay for it and so sued him. Duck resisted the claim on the basis that BC legislation for licensing companies incorporated outside BC provided that such companies not registered in BC pursuant to the legislation could not maintain an action in BC. c) Decision: i)
Since the federal government’s residual power to incorporate companies was a power to incorporate companies with something more than just “Provincial Objects”, a federally incorporated company has the power and the right to operate throughout the country . ii) The BC legislation allowed the Registrar of Companies to refuse an extra-provincial licence on the basis that there was already a company with the same or a confusing similar name incorporated or registered in the province. If the Registrar exercised this power to prevent a federal company from registering to carry on business in BC it would be contrary to this constitutional right of federally incorporated company to carry on business throughout the country. Thus the provincial legislation could not be applied in this way since it would operate
“so as to deprive a Dominion company of its status and powers” (18 D.L.R. 360). iii) Thus a province cannot prevent a federally incorporated company from carrying on business in the province , and provincial legislation that tries to do so will be unconstitutional. iv) In the Wharton case therefore the Registrar of Companies in BC could not refuse the licence to the federally incorporated John Deere Plow Company on the basis that it had a name that was the same as, or similar to, the name of a company already incorporated or registered in BC. d) Comment: i) CBCA s.15(2) preserves federal power for CBCA corps by granting powers to carry on business throughout Canada ii) Contrast this with Canadian Indemnity Co. v. A.G. B.C. below, which stated a province can ban all companies (federal and provincial) from undertaking a certain activity (sale of insurance) in the province.
6) Great West Saddlery Co. Ltd. v. The King [1921] 2 A.C. 91, 58 D.L.R. 1 (Ont. P.C.) a) Decision:
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i) Legislation prohibiting a company from maintaining a legal action in the province unless it had obtained a licence to carry on business in the province could not be applied to a federal company ([1921] 2 A.C. 91at 121-22). ii) The ability to maintain an action was necessary to enforce contracts entered into in the course of carrying on business in the province and thus is arguably essential to the ability to carry on business in the province.
7) Colonial Building and Investment Association v. A.G. Quebec (1883), 9 App. Cas. 157 (P.C.) a) Decision: It is not necessary for the validity of a federal incorporation that the company carry on business in more than one province .
8) It has also been held that federal powers of incorporation are not limited to companies incorporated for purposes that would fall within the enumerated federal powers under s. 91 of the Constitution Act . a) Several cases have upheld various provisions of federal corporate that might be said to fall within the provincial power with respect to property and civil rights. b) E.g. federal corporate law provisions regulating takeover bids of federally incorporated companies, making directors personally liable for the improper payment of dividends, and regulating insider trading by directors and officers of federally incorporated companies have all been upheld as ancillary to federal power to legislate with respect to the incorporation of companies.
9) The feds can give federal companies the power to operate outside Canada, but not the right (will need foreign corporation registration in the other jurisdiction for that)
10) The decision in the John Deere Plow case could have potentially wide-ranging consequences , perhaps even suggesting federally incorporated companies are immune from provincial regulation (not the case – see below). An example of the broad approach is A.G. Can. v. A.G. Man.
, [1929] 1 D.L.R.
369 a) Facts: In 1912 Manitoba had enacted an early form of securities legislation concerning the sale of shares in the province. The legislation required anyone selling an issue of shares to the public to obtain a licence . An administrator would review the investment merits of the shares and would not issue a licence if they deemed the investment merits to be unsatisfactory. This discretion was challenged by the AG of Canada for federally incorporated companies. b) Issue: Could this discretion to refuse a licence be validly applied to a federally incorporated company? c) Decision: a federally incorporated company could not be refused a licence , since the sale of shares is necessary to finance a company and without that financing a company could not even begin to carry on business. d) Comment: i) A key feature of securities regulation is the regulation of an initial sale of shares by a company to the public. Securities regulation is a provincial matter since the sale of shares involves contract (thus “property and civil rights”). The federal powers have been said to be not particularly amenable to the enactment of securities regulation. ii) The position in A.G. Can. v. A.G. Man could substantially limit the effectiveness of provincial securities regulation, at least of the type enacted under the 1912 Manitoba legislation. Persons might avoid the legislation simply by incorporating a company under federal legislation.
However, modern provincial securities legislation probably does , at least for the most part, apply to federally incorporated companies even in light of A.G. Can. v. A.G. Man
Prov regs apply to federal Co. if doesn’t paralyse/discriminate, paramountcy, register name in prov
1) The John Deere Plow case above stated that provinces cannot regulate so as to prevent a federally incorporated company from operating within a province (and similarly A.G. Can. v. A.G. Man said a province cannot refuse a federal company a license to sell shares). This might suggest that provinces cannot regulate federal companies at all and that otherwise valid provincial legislation that prohibited
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the carrying on of a particular type of business in the province could be avoided by federally incorporating. A series of cases have reigned in this potential, however.
2) E.g. Lymburn v. Mayland , [1932] A.C. 318 (P.C.) a) Decision: i) An Alberta statute that prohibited the sale of securities except through a licensed broker could be applied to a federally incorporated company. ii) The reasoning was that requiring a company to sell shares through a licensed broker did not prevent the company from selling shares and thus raising the necessary funds to carry on business. Thus it would not prevent a federally incorporated company from carrying on business in the province.
3) As to the general power of provinces to regulate the activities of federally incorporated companies, it was noted in the John Deere Plow case that federal incorporation does not confer a general immunity from provincial regulatory laws (18 D.L.R. 353). The requirement that the company obtain a licence to carry on business in the province did not paralyse a federal company from carrying on its business in the province.
4) In Great West Saddlery Co. Ltd. Viscount Haldane also suggested that a federal company incorporated for the purpose of holding land would be unable to successfully attack the application of provincial legislation that prohibited all corporations , wherever incorporated, from owning land
([1921] 2 A.C. 91 at 119).
5) This approach was followed in Canadian Indemnity Co. v. A.G. B.C. [1977] 2 S.C.R. 504. a) Facts: BC had replaced private automobile insurance with a public auto insurance scheme
(ICBC). The legislation prohibited the sale of automobile insurance by anyone other than the
Insurance Corporation of BC. The Canadian Indemnity Company was one of 17 federally incorporated insurance companies that challenged the application of the legislation to federally incorporated companies. b) Decision: Legislation upheld on basis it was not restricted in its application to federally incorporated companies but applied to all companies (or legal persons) wherever they were incorporated (i.e. legislation does not discriminate ) c) Comment: It is difficult to reconcile this case with the John Deere Plow case, but it might be said that the legislation did not prevent federally incorporated companies from carrying on business in the province. Instead, it prevented all companies from carrying on a particular type of business.
6) Multiple Access v. McCutcheon (1982), 18 B.L.R. 138 (SCC) a) Decision: i) Provincial insider trading legislation that was identical to legislation in the Act under which a federal company was incorporated could still be applied to the federal company. ii) The otherwise valid federal legislation was not said to have “ occupied the field
” if it did not conflict with the otherwise valid provincial legislation.
7) Reference Re the Constitution Act (1991), 80 D.L.R. 4 th
431 (Man. C.A.) a) Decision: Provincial legislation requiring a federal company to register its corporate name , and any names under which it carries on business, has been held to be valid .
8) Re Royalite Oil Co., [1931] 1 W.W.R. 484 (Alta. App. Div.) a) Decision: Provincial legislation imposing penalties for failure to comply with the requirement to obtain an extra-provincial licence before commencing carrying on business in the province can validly be applied to a federally incorporated company b) Comment: i) A federally incorporated company has to obtain at least one extra-provincial registration in order to carry on business in Canada and will have to get an extra-provincial registration in each province in which it intends to carry on business.
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ii) A provincially incorporated company can carry on business in the province in which it is incorporated without such registration, but similarly requires an extra-provincial registration to carry on business in other provinces. iii) Thus a federally incorporated company will require one more extra-provincial registration than a provincially incorporated company. This adds somewhat to the cost of a federal incorporation.
9) For the most part, then, provincial laws apply, but still two important restrictions : a) From John Deere Plow Co.
a province cannot deny licence to federal company based on same corporate name b) From Great West Saddlery Co. Ltd. a province cannot prevent a federal company from maintaining a legal action in the province
10) Given both federal and provincial companies can operate throughout the country, there is thus a choice of 14 jurisdictions in which to incorporate (see Where below)
Corporations: incorporation/registration, legal personality
Why: adv (lim liab/immortal/transfer/bind/contract/financing) little if closely-held, dis (tax/costs)
1) The following describes seven commonly given advantages of incorporation. a) Collectively these reasons seem to suggest that one should always incorporate. b) However, a critical assessment of these advantages of incorporation suggests that in many situations they may not be particularly significant advantages and may be overridden by other considerations, particularly tax considerations .
2) A corporation provides limited liability for its shareholders, in contrast to the joint and several liability of partners. a) See also “drawbacks and benefits of limited liability” in Corporations: intro above b) This may not provide much benefit in many cases. It is common for the sole proprietor or partners
(now shareholders) to have to provide a personal guarantee to: i) A bank or other lender in order to secure a loan to provide a significant portion of the capital of the business ii) A lessor if a corporation is to lease space to operate the business iii) Major suppliers who advance substantial amounts of credit c) The only remaining benefit from limited liability may be protection against personal liability for a relatively insignificant amount of trade credit and against torts committed in carrying out the business of the corporation. i) The protection against tort claimants also has to be qualified since there is a small, but not insignificant, possibility that a court may “pierce the corporate veil”
and make the shareholders personally liable, particularly in closely-held corporations (i.e. corporations with relatively few shareholders – say less than five). ii) A court might also find that one or more officers of the corporation have directly committed the tort themselves (i.e. sued personally), and in closely-held corporations the officers are usually the shareholders themselves. iii) In addition, whether one incorporates or not, it will be prudent to purchase insurance against tort claims arising out of the conduct of the business.
3) A corporation provides for perpetual succession , contrasting with indefinite tenure of partnerships. a) Perpetual existence is one of the key features of a corporation, but it does not always provide a significant advantage over sole proprietorship or partnership. b) With sole proprietorship: i) When a sole proprietor sells assets of the business , she or he may be able to assign important business related contracts to the acquirer (generally can only assign benefits of contracts but not liabilities, so usually want to get indemnified by assignee), or (if the contracts do not
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permit assignment) then the sole proprietor may have to obtain a release from those contracts and have the acquirer enter into those contracts directly (i.e. so-called
“novation” of the contracts). For many types of business this may not be a significant problem – the business may not have many contracts that require assignment or novation. ii) A similar analysis can be made for the death of the sole proprietor. For the most part the assets of the business can simply be bequeathed to a successor and the successor can continue the business. As far as major contracts are concerned, one may be able to anticipate potential future succession problems through care in the drafting of contract terms on assignment or enurement. c) With partnership: i) The problem of reconstituting partnerships after loss of a partner (through retirement, death or bankruptcy) or the addition of new partners are usually anticipated in the partnership agreement and dealt with in ways that allow for a succession of the remaining partners without having to renegotiate the entire partnership agreement. The partners usually mutually agree to continue the partnership agreement with the necessary modifications (which are usually addressed in the partnership agreement itself through a generalized drafting style). Major contracts for the partnership can also be drafted to anticipate the loss or addition of partners.
4) A corporation allows for ease of transfer of shares , in contrast to the difficulty and inconvenience of terminating partnerships to permit changes in personnel. a) With corporations: i) In terms of the corporate law position, shares are freely transferable unless there is an express restriction on the transfer of shares. ii) However, securities laws do put certain restrictions on the initial distribution and subsequent transfer of shares that are particularly likely to constrain the transfer of shares in closely-held corporations (in which the shareholders typically take part in the management of the business and want to be particularly careful about who they are in business with). In addition, they usually want to avoid the added expense of compliance with securities laws that may arise if the shares end up being publicly distributed .
(1) Consequently it is common in closely-held corporations to have a restriction on the transfer of shares that is often virtually identical to the kinds of restrictions that are often put on the transfer of partnership interests , and hence probably no significant difference in how freely one might transfer shares in a closely-held corporation and how freely one might transfer partnership interests in a partnership. b) With partnerships: i) Under Partnership Act s.27/28 default provision says need consent to transfer interest or add a new partner, but can modify this through partnership agreement (so can have freely transferable partnership interests)
5) Individual partners may bind the firm but a shareholder alone cannot bind the corporation . a) However, in a closely-held corporation the individual shareholders are usually officers of the corporation and authority is often delegated to them as agents to bind the corporation in certain capacities (and if their actual authority is constrained, still may be necessary to take care they are not cloaked with ostensible authority to bind the corporation). b) In a partnership one can constrain the authority of any individual partner to bind the firm (though will have to be carefully to ensure third parties are put on notice of such a constraint – see s.7,10 of Partnership Act ). The difference between this and the corporate context, if one remains, is a subtle one and may not, in practice, be that significant. c) As for torts , if committed by a partner (acting with authority or in ordinary course of business) then the firm will be liable. Similarly, a corporation is vicariously liable for torts committed by its officers, agents and employees. Thus in a closely-held corporation where the shareholders are also officers, agents or employees of the corporation, there will probably be very little , if any,
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difference between the vicarious liability of the corporation for torts and the liability of fellow partners for torts.
6) A shareholder can contract with or sue a corporation , whereas a partner cannot sue or contract with his/her firm. a) Because a corporation is a separate person from the shareholders of the corporation, a shareholder can enter into a contract with the corporation. This may be advantageous in some situations (but it can also cause problems). b) While it may simplify things to be able to have a shareholder enter into a contract with the corporation, there are often ways of achieving the same, or at least very similar , result in a partnership . E.g. a partner can enter into a separate contract with his or her fellow partners that is separate from, and in addition to, the partnership.
7) Corporations have facilities to secure additional capital that are not possessed by a partnership. a) To raise additional capital, corporation can use shares and debentures – but hard to see how these devices are really advantageous on their own. i) Shares: If one wants to raise additional equity capital in a partnership one can either have the existing partners invest additional sums or admit new partners . If one wanted to one could break up the investment interests into units and allocate rights such as partnership voting rights and rights to distributions on a per unit basis (i.e. making the partnership units very closely resemble shares ). ii) Debentures :
(1) These are just evidences of indebtedness . Debentures are similar to bank loan agreements, with loan amount and interest/principal repayment terms
(2) Contrary to an apparently popular belief, they are not instruments that can only be sold by corporations – anyone can produce a document called a “debenture” and sell it to another person, evidencing a debt owed by the person issuing it and with terms like debentures commonly issued by corporations. b) In addition, there remains the problem of compliance with securities legislation when a corporation sells shares and debentures to raise capital, or any other similar investments possibly including partnership interests , broadly to the public . Thus the sale of shares and debentures is likely to be constrained in a way that makes it unlikely they will be any more ready a source of finance than partnership interests or units in a limited partnership.
8) Tax advantages may accrue to the sole proprietor or small partnership which converts to the corporate form. a) See also “Sole prop v corporate” above b) Tax advantages to incorporation: i) The
“small business deduction”
can provide a significant tax advantage to incorporation .
Private corporations incorporated in Canada and carrying on “active business” in Canada (i.e. actually producing goods or services and not just holding investments) can get a reduced tax rate on the first $300,000 of income. This reduced tax is just a tax deferral, since the additional full corporate rate is charged when the income is ultimately distributed to the shareholders. However, one can control the timing of the distribution through the corporation, permitting tax planning of the timing of distributions. ii) However, this reduced rate for small business corporations will be of no advantage if the business is not making a profit in the start-up phase. c) Tax disadvantages to incorporation: i) Double-taxation aspect of incorporation – the corporation (being a separate tax payer) is taxed on its income, and that income is taxed again in the hands of shareholders when it is distributed. This problem is largely , though not completely, addressed through tax integration in the Income Tax Act . In the past, corporations were taxed at a marginal rate that roughly corresponded to the highest individual tax rate. Thus if your own marginal tax rate was
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considerably lower than the highest tax rate it might be preferable from a tax standpoint not to incorporate. However, international competitive pressures have led to a reduction in corporate tax rates in Canada so that corporate tax rates may be less than the rates for some individuals . ii) Recall the tax reasons for the use of sole proprietorships or partnerships – losses (often incurred in the start-up phase) can be passed through to the investors to be applied against other sources of income those investors have. This flow through of losses is not possible with a corporation (although is can carry losses forward for some years which helps if it one day makes a profit)
9) Added costs of incorporation a) There are costs to incorporation that do not arise with either sole proprietorship or partnership
(which are formed simply by starting to carry on business) i) The fee for the incorporation itself (though only a few hundred dollars). ii) Legal fees associated with the incorporation process (these can run to several hundred or even thousand dollars, depending on the complexity of the situation and whether a shareholders’ agreement is needed). iii) After incorporation there are requirements for the filing of annual reports with an accompanying modest fee (and in most jurisdictions incorporation and filings can now be done electronically). iv) Other added costs involve maintaining certain corporate records and the filing of an additional tax return . While these costs are usually not particularly large they should be considered.
10) Summary a) Ultimately, most of the above (for closely-held businesses) are not significant, except for tax considerations which can make incorporation advantageous.
Where: fed (CBCA) v. prov (e.g. BCBCA), choose for biz/transactions (familiar, name prot, costs)
1) As noted in constitutional (prov and fed incorporation) above, can choose to incorporate either under a federal statute (e.g. the Canada Business Corporations Act, CBCA) or under a provincial statute of incorporation (or under a company ordinance of one of the Territories) and still, practically speaking, carry on business anywhere. In short, one has a choice among 14 possible jurisdictions of incorporation in Canada. a) This choice raises the interesting possibility of a competition for incorporations , and the fees that goes with them, between the various possible jurisdictions. i) Such competition might potentially lead to a race towards the worst corporate law (e.g. allowing incumbent managers to take the utmost advantage of shareholders). ii) Alternatively it might lead to a race toward the best possible corporate law (perhaps in terms of maximizing the value of shares held by other shareholders). iii) And how might this effect any attempt to expand participation in corporate decision-making to other stakeholders, such as employees, through a statute of incorporation? b) However, are the revenues from incorporation fees enough to promote any significant degree of competition? i) E.g. in the U.S., over 50% of the corporations on NYSE are incorporated in Delaware (similar to the Liberian flag of convenience on ships) – Delaware is a small state with a limited tax base, and incorporation fees are one of its main sources of revenue, so want to be at the forefront of corporate law
2) Where to incorporate : a) Incorporate federally under the Canada Business Corporations Act ( CBCA ) i) Such a corporation will have to obtain an extra-provincial registration in every province in which it carries on business ii) It need not operate in more than one province iii) There are also a number of post-incorporation organizational steps required
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iv)
A corporation may also come to be incorporated under the CBCA by way of a “ continuance
” of an existing corporation incorporated under another statute but wishes to change its statute of incorporation to the CBCA. b) Incorporate provincially (e.g. under the British Columbia Business Corporations Act , BCBCA ) i) Such a corporation will have to obtain an extra-provincial registration for every province in which it carries on business other than the province in which it was incorporated ii) Such a corporation need not actually operate in the province in which it incorporated
3) As described above (Prov incorporation and Fed residual power), it is possible to incorporate either under federal legislation or provincial legislation and still operate throughout the country .
4) In choosing where to incorporate (i.e. forum shopping ), the statute in a particular jurisdiction may be preferable for a particular business organization or for particular kinds of transactions . a) E.g. see comment to Jacobsen v. United Canso Oil & Gas Ltd (where forum shopping arguably used to disadvantage of shareholders so one shareholder could retain control) b) E.g. Yukon legislation is (or at least was under old BCCA) seen as more favourable than BC legislation (e.g. BCCA used to require court order for amalgamations) c) E.g. Nova Scotia allows US-style flow-through of profits and losses to shareholders d) Ideally would undertake a thorough review of the available options. Short of that, there are some general comments made concerning the choice between the CBCA and a provincial statute such as, for instance, the BCCA (now the BCBCA)
5) Three reasons often given for preferring the CBCA over the BCBCA are: a) Quasi-name protection i) Federal incorporation provides some measure of protection of a corporate name in the sense that a provincial registrar would not be able to refuse the extra-provincial registration of a federally incorporated company, even if a corporation with a similar name is already registered in that province (recall John Deere Plow Co.
and Reference Re the Constitution Act above).
Thus it protects the right to have the federally incorporated company registered to carry on business in any province at a later time.
(1) However, the federally incorporated company can still be sued for passing off if it starts carrying on business in a province in which it has not carried on business before and in which there is an existing business carried on (by someone else) under the same name as the federal company. b) No restriction on maintaining an action (which can be a concern re uncertainty with respect to
“carrying on business”) – see
Great West Saddlery . Not that important since will register in the province anyway. c) Lawyers and shareholders in other provinces are familiar with it (and in Nunavut, for example, their Act is almost identical to CBCA) i) Lawyers in other provinces will tend to be familiar with the CBCA because it has been the model for statutes of incorporation in several other provinces.
6) Three reasons often given for preferring incorporation under the BCCA (now BCBCA ): a) Local lawyers here tend to be more familiar with it b) It is easier to deal with Victoria than with Ottawa i) One gets to know the Victoria people, whereas there are only a few hours in a day when you can communicate with Ottawa c) It is cheaper i) The CBCA registration charge is higher ii) The CBCA has one more extra-provincial registration than incorporation in B.C. does iii) BC has retained par value shares providing some tax advantages (to get these advantages, some Ontario corporations re-incorporate by continuance (see below) in BC just for a few days)
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How: indivs/corps right to incorp: file articles/name/office/directors, certificate, directors meet
1) Pre-incorporation steps for CBCA incorporation (note there are lots of manuals/checklists to help):
2) S.5: who can incorporate a) S.5(1) one or more individuals may incorporate a corporation – none of the individuals can be less than 18 years of age, be of unsound mind as found by a court in Canada or elsewhere, or be bankrupt b) S.5(2) one or more bodies corporate may incorporate a corporation. c) In either case, to incorporate a corporation the individuals or bodies corporate must sign articles of incorporation and comply with s.7.
3) S.7: the articles must be filed (i.e. sent to the Director) along with the documents required by s.19 &
106. a) Articles are the primary constitutional document of the corporation, and can normally only be amended by a supermajority vote of the shareholders of the corporation (so don’t put more in the articles than is necessary since changing them can be difficult/costly) b) The articles that must be signed and sent to the Director must follow Form 1 c) S.6: the articles must set out : i) The corporate name (see below for requirements on name ) ii) Any restrictions on the business of the corporation iii) Any limits on the authorized capital of the corporation iv) The classes of shares and any maximum number of shares that the corporation is authorized to issue v) If there will be two or more classes of shares, the rights , privileges, restrictions and conditions attaching to each class of shares vi) The province in Canada where the registered offices of the corporation will be situated vii) Any restrictions on the transfer of shares viii) The number of directors the corporation is to have, or the minimum and maximum number of directors the corporation is to have, and ix) Any other matters that one chooses to put in the articles of the corporation.
(1) Might want to do this if it is important to subject changes to these additional items to a broader level of approval (as required to change articles). However, putting additional items in the articles is not a common practice because it is difficult to change them. d) One must also pay a filing fee (see Reg. s.97 & Schedule 5). e)
Note the capital “D”
Director is not a director of any particular corporation, but rather is the administrator of the CBCA (see s.2(1) “Director” and s.260). When the CBCA refers to lower case “d” directors it is referring to the directors of corporations.
4) S.19(2) requires a notice of the registered office of the corporation be sent to the Director (use Form
3)
5) S.106(1) requires a notice of the directors of the corporation be sent to the Director (use Form 6)
6) S.8 & 12(1): On receipt of the required documents and assessment of whether they meet the requirements of the Act (including the acceptability of the corporate name) the Director shall issue a certificate of incorporation . a) Thus, so long as requirements are met, the incorporators have a right to the issuance of a certificate of incorporation from the Director (incorporation is a right under the CBCA and most statutes in Canada). Contrast this with earlier methods of incorporation (e.g. grant of a Crown charter or letters patent) where incorporation was an exercise of Crown prerogative (i.e. incorporation was a privilege) b) S.9: the corporation comes into existence on the date shown in the certificate of incorporation
(contrast with BCBCA, time is filing date)
7) Once incorporated, there are a number of post-incorporation steps for CBCA that need to be taken.
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8) S.104: after the issue of the certificate of incorporation, a meeting of the directors shall be held at which the directors may : a) Make by-laws i) Normally at the first meeting of directors the directors will pass a set of general by-laws
(which will form another important constitutional document of the corporation governing its internal procedures) that will deal with matters such as:
(1) Procedures at directors’ meetings
(2) Notice for and procedures with respect to shareholder meetings
(3) Procedures for the allotment and issuance of shares
(4) Procedures for the declaration and payment of dividends, and
(5) Procedures for the appointment of officers. b) Adopt forms of security certificates and corporate records i) Security certificates include certificates for shares and debentures. It is common for the directors to pass a resolution at the first meeting of directors adopting a form of share certificate. ii) The corporation must maintain certain records pursuant to s.20 and the directors at their first meeting may want to pass a resolution adopting the forms in which these records will be kept. c) Authorize the issue of shares i) Although the corporation’s articles have authorized the issue of shares, no shares will have been issued yet and the corporation will thus, as yet, have no shareholders. Thus it is common at their first meeting for the directors to pass a resolution allotting and issuing shares to persons they intend to have become the shareholders of the corporation d) Appoint officers i) The directors act as a group – they have no power to act individually until such a power is granted to them by the directors acting as a group. The normal practice is for the directors to appoint officers to carry out the specific tasks required to carry on the business of the corporation. Thus the directors at their first meeting will usually pass a resolution appointing persons as designated officers and may specifically delegate particular tasks to particular officers (i.e. granting the appointed officers authority to carry out tasks on behalf of the corporation). e) Appoint an auditor to hold office until the first meeting of shareholders i) Corporations that do not issue their shares to the public do not have to appoint an auditor and their shareholders can waive the appointment of an auditor. Corporations with shares that are distributed to the public must appoint an auditor . f) Make banking arrangements i) The corporation will probably need to be able to deposit money, withdraw money and/or draw cheques from a bank account in the carrying on of the business. It is thus common for the directors at their first meeting to pass a resolution as to the bank with which the corporation will deal and to indicate who will have signing authority for the account. g) Transact any other business. i) E.g. The directors normally have the power to borrow on behalf of the corporation, and they can also delegate this power. They may want to pass a by-law restricting either the powers of the directors to borrow or setting procedures that must be followed by the board or by the person, or group of persons, to whom the board has delegated the power to borrow. ii) E.g. It is also common for the corporation to adopt a corporate seal to be used in executing certain documents binding the corporation (although by s.23 a seal is no longer specifically required).
9) In B.C.:
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a) Under the old B.C. Companies Act (BCCA), file a memorandum stating the shareholders (who become the first directors), classes of shares, restrictions on business, etc (even simpler than the articles under the CBCA) b) Under the new B.C. Business Corporations Act (BCBCA): i) First file an Incorporation Agreement, under which incorporators agree to take the initial shares ii) Then file an Incorporation Application (similar to s.7 of CBCA) iii) With this application, file a Notice of Articles (basically the same as the old memorandum) – there are a set of articles you can choose from/amend as you wish iv) Also file an Incorporators Statement, stating who is doing the incorporation v) Fee: $350
CBCA name: important (e.g. goodwill), numbered, NUANS, prohibited/deceptive, reserve, DBA
1) Names associated with the sale of goods or services may be the names of corporations , names for particular products or names for a particular line of business .
2) Names may be important because of the value they have from recognition of the name by consumers in terms of product quality or service (often referred to as the
“goodwill” associated with the name
).
Thus, from the perspective of both the user of the name and customers, it is important that customers not be confused about whom to associate the name with.
3) There is a complex web of law dealing with commercial use of names, including: a) Federal trade name and trade mark law. b) Provincial laws with respect to the use of business names c) Federal and provincial laws concerning the registration of corporate names. d) Common law dealing with the appropriation of names (i.e. “passing off”)
4) Under the CBCA, the corporation has to have a name that is not the same as or confusingly similar to the name of another corporation or business. a) The CBCA allows for the granting of a numbered name in which the Director gives the corporation the next number in sequence together with the words “Canada Ltd” (thus ensuring the name is unique). b) If not a numbered name, the Director requires the incorporators file a NUANS (“Newly Updated
Automated Name Search”) name search report (the NUANS database contains a list of names of corporations incorporated in Canada, business names registered in Canada and registered trade names). This reports assists the Director in determining whether the proposed name is the same as or confusingly similar to other corporate names, business names or trade names.
5) S.12(1): a corporation may not be incorporated or carry on business under a name that is: a) Prohibited i) Reg. s.18 (now 23 ?): obscene names are prohibited ii) Reg. s.16 (now 21 ?): names such as “ Air Canada
,” “Parliament Hill,” Royal Canadian
Mounted Police” or “
RCMP
” are prohibited. iii) Reg. s.17 (now 22 ?): prohibits the use of a name that suggests the corporation carries on business under government approval or authority , or is sponsored or affiliated with a government unless the particular government has consented . iv) Reg. s.19 (now 24 ?): a corporate name may also be prohibited where it is too general (e.g.
Shoe Store Ltd.) or just describes a quality or other characteristic of goods or services
(Running Shoes Ltd.), is primarily or only the name of an individual (Jim Smith Ltd.), or is primarily a geographic name (e.g. Canada Ltd.).
(1) Such names would not only create potential for confusion in the market place but could severely limit the range of potential names that could be used.
(2) A corporate name usually is created with a descriptive part , a distinctive part and the suffix
(e.g. Ltd. usually used in Canada, but Inc. also acceptable – see s. 10(1) of the Act).
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(a) E.g. In Kwitfit Shoemakers Ltd. the descriptive part would be the word “Shoemakers” which suggests the corporation will be involved in the business of making shoes. The distinctive part is the coined word “Kwikfit” and the suffix is “Ltd.”
(b) The distinctive part without a descriptive part may be sufficient if sufficiently unique. v) Reg. s.20 (now 25 ?): a corporate name is also prohibited if it is confusing in the sense that it may create confusion with other corporate names, business names, or trade names .
(1) The NUANS name search helps identify corporate names, trade names and trade marks that might be confusingly similar to a proposed corporate name.
(2) Refusing such names helps to avoid confusion in which consumers might mistakenly associate a particular good or service with the wrong name thereby reducing the value of the information conveyed by the name about the quality or other attributes of goods or services. It also avoids persons looking at the wrong information in the corporate registry because they are looking at the wrong corporation’s information due to confusion with the name of the corporation they were really looking for. b) Deceptively misdescriptive i) Reg. s.23 (now 32 ?) appear to be protecting the public from a deceptive use of a corporate name : a corporate name is deceptively misdescriptive if it misdescribes:
(1) The business, goods or services to be provided in association with the name,
(2) The conditions under which the goods or services will be produced or supplied, or
(3) The place of origin of the goods or services.
6) The Director can refuse to register the name if it is prohibited or deceptively misdescriptive.
Additionally, under S.12(2): The Director may also order a corporation to change its name if it is, through inadvertence or otherwise, incorporated and carrying on business under a name that is prohibited or deceptively misdescriptive .
7) S.11(1): You can reserve a name for up to 90 days ahead. You can also use a numbered name and then later apply for a name change to a non-number name.
8) Doing business as names ( DBA ) a) Partnership Act , s.88
: Recall business name registration requirement was not restricted to the registration of the names of sole proprietorship businesses – rather, s.88 of the Partnership Act applies to any “person … who uses as his or her business name some name or designation other than his or her own name”. Under s.29 the
Interpretation Act a “person” is defined to include a
“corporation”. Thus a corporation that uses a business name other than its own corporate name must register that business name . b) E.g. Acme Shoe Ltd. might carry on business under various names including Comfy Shoes,
EnergyPlus Shoes, PlushGuppies, etc. These other names are often referred to as “doing business as” names or “DBA” names, and would have to be registered. c) Such Business name registration requirements are common in other provinces in Canada and in jurisdictions around the world.
9) CBCA requires a corporation to use the full corporate name including the cautionary suffix in all corporate documents (see Wolfe v. Moir ).
Reincorporation under new jurisdiction/statute through new corp or export/import continuance
1) A corporation incorporated in one jurisdiction may be re-incorporated (i.e. changing the statute of incorporation) under a different statute in another jurisdiction a) E.g. Ontario corporations might reincorporate in BC to get the par value shares tax advantage, then reincorporate back in Ontario (and tax advantage can outweigh the costs of these two reincorporations)
2) Note this is different to getting an extra-provincial registration (which doesn’t change the statute of incorporation.
3) Number of ways to do this, such as:
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a) Incorporate a new corporation under the statute in the destination jurisdiction , then have the new corporation issue shares to the shareholders of the original jurisdiction corporation in exchange for their shares of the original corporation. The new corporation will end up owning all the shares of the original corporation, and it can then wind up the original corporation (via a shareholder (the new corporation) resolution), transferring its assets to the new corporation. Note there are some other complexities (such as taking care of liabilities and renewing contracts with creditors and customers or original corporation) b) Several statutes of incorporation in Canada provide for a more convenient way of reincorporating, known as a “ continuance
”. Under CBCA (and similarly in many provincial statutes) need to export from current statute and then import into the new one: i) Procedure for a continuance out of the CBCA (an
“export” continuance
):
(1) Obtain a resolution from the shareholders permitting the continuance (CBCA s.188(1),(5))
(2) Obtain approval from the Director (CBCA s. 188(1))
(a) The continuance under a statute other than the CBCA may result in a significant change in the rights of shareholders under the other statute. Thus approval by the shareholders, and by the Director, may provide the shareholders with some measure of protection against adverse changes in their rights.
(3) Register in the destination jurisdiction (e.g. follow import provisions in destination province). Will usually involve:
(a) Amending the incorporation documents to conform to the requirements of that jurisdiction
(b) Satisfying the name requirements for registration ii) Procedure for a continuance into the CBCA (an
“import” continuance
):
(1) Export from the original jurisdiction: the original statute will typically require a resolution from the shareholders and approval from the registrar who administers that statute permitting the corporation to be continued under the CBCA.
(2) Then the corporation seeking to be continued under the CBCA would apply to the Director for a certificate of continuance (s.187(1)) by sending articles of continuance to the Director
(to make articles conform to CBCA) together with a notice of the registered office of the corporation and a notice of the directors of the corporation (s.187(3)).
Extra-provincial registration if “carry on business”: attorney for service, non-confusing name
1) It is common around the world to require corporations not incorporated in that jurisdiction to register before carrying on business in that jurisdiction, generally known as “ foreign corporation registration
”
(though in Canada this is commonly referred to as “ extra-provincial registration
”)
2) E.g. recall Bonanza Creek Gold Mining , where Bonanza Creek Gold Mining Ltd. was incorporated in
Ontario but was carrying on business in the Yukon under a licence from the Yukon government.
3) Common requirements of extra-provincial registration include: a) Requirement to have a registered attorney in the province who can receive service of legal documents in the province. i) Notifying someone you are suing is an essential step, and courts are reluctant to allow proceedings against a person (including a corp) who has not been notified of a suit against them and thus may not have an opportunity to be represented. Serving a person outside the jurisdiction and being able to prove that service in a manner satisfactory to the court can be difficult (and you likely don’t want to sue them in their foreign jurisdiction) ii) Thus perhaps the main reason for extra-provincial registration does is to provide a means through which a foreign corporation carrying on business in the jurisdiction can be served with legal documents within the jurisdiction (e.g. imagine you are injured by products or services they sell, or you pay for goods but they don’t deliver).
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(1) This also helps if the foreign corporation begins a suit, since the defendant or respondent will need to serve documents on the foreign corporation.
(2) Note: even if awarded damages in BC court, still need to get that award recognized and enforced in the foreign jurisdiction if that’s where all the foreign corporation’s assets are located (conflict of laws) iii) Without foreign corporation registration a foreign corporation might be able to sue persons it dealt with in the jurisdiction, while avoiding suits by persons it dealt with in the jurisdiction. b) Name approval (similar to that required for incorporation). i) The registrar can refuse registration if the foreign corporation’s name is the same as or confusingly similar to the name of a corporation (whether locally incorporated or foreign) that is already registered in the jurisdiction. In BC can use an assumed name if such problems exist. ii) This helps ensure that persons seeking information about the foreign corporation ( e.g.
to find an address for service of legal documents) don’t get confused and look at the wrong information.
4) The registration requirement is enforced through various means, including: a) Recall Great West Saddlery for federal companies b) Fines against the foreign corporation and/or its agents if it hasn’t registered (e.g. $100/day in BC) c) A prohibition against the foreign corporation maintaining a suit in the jurisdiction d) Sometimes a prohibition against the foreign corporation holding an interest in land in the jurisdiction.
5) The registration requirement typically applies when the foreign corporation is “ carrying on business ” in the jurisdiction, although the meaning of this is vague , so when interpreting it, keep in mind the main purpose of foreign (extra-provincial) corporation registration noted above (serving legal documents & suing, being able to determine their address etc)
6) Extra-provincial registration under the B.C. Business Corporations Act ( BCBCA ) (and other provinces and territories in Canada have similar extra-provincial or extra-territorial registration requirements): a)
S.375: “ foreign entities
” must register as an “extra-provincial company” within two months of beginning to “ carry on business
” in BC. b)
S.1(1) defines a “ foreign entity
” as a “ foreign corporation
” or a “ limited liability company
”. i) A “ foreign corporation ” is defined in s.1(1) as a corporation that is not a “company”. A
“company” is defined in s.1(1) as a company incorporated under the B.C.
Business
Corporations Act or a prior Companies Act
. In short, a “foreign corporation” is a corporation that was not incorporated in B.C. The definition of “foreign corporation” goes on to provide that it is a corporation that has issued shares so it is not a society or non-profit corporation. It also is not a co-operative association which is required to be registered under the Cooperative
Association Act
. A “foreign corporation” is also not a corporation incorporated under an
“Act”, meaning an Act of the legislature of the province. It is also not a corporation that has come to be incorporated under the B.C. Business Corporations Act by virtue of either a continuance under that Act or an amalgamation under that Act. ii) Limited liability companies are a relatively new type of corporate entity developed primarily in the U.S. to allow investors to carry on business through a corporate entity but still pass through any losses to the investors for tax purposes (recall this was one of the reasons for preferring to carry on business as a sole proprietorship or partnership in the start up phase of a business). There was some doubt as to whether the extra-provincial registration requirements applied to these types of entities, but the new BCBCA made it explicit, defining a “limited liability company” as a business entity that was organized in a jurisdiction other than BC and that is recognized as a legal entity in the jurisdiction in which it was organized and that is not a
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corporation, a partnership or a limited partnership. A “corporation” is defined as a “body corporate … however and wherever incorporated”. c) S.375(2): a foreign entity is deemed to “ carry on business
” in BC if : i) Its name, or any name under which it carries on business (i.e. a “doing business as” or “DBA” name), is listed in a telephone directory for any part of BC together with an address or telephone number in BC for the foreign entity, or ii) Its name, or any name under which it is carrying on business, appears or is announced in any advertisement in which an address or telephone number in BC is given for the foreign entity, or iii) It has an agent resident in BC or iv) It has a warehouse, office or place of business in BC. v) Subject to a few very narrow exceptions set out in subsections (3) and (4) of section 375, s.375(2)(d) provides that a “foreign entity” is deemed to “carry on business” in British
Columbia if “it otherwise carries on business in British Columbia”.
(1) This leaves the meaning of “carry on business” open-ended and ultimately to be determined by a court if necessary, though case law generally says it is a question of the degree of presence of the foreign entity in the province.
(2) E.g. simply shipping goods into the province (without office, warehouse, agent, etc) has been held not to be carrying on business in the province.
(a) If the registration requirement were carried this far it could greatly restrict the access persons in the jurisdiction would have to a wide range of goods produced outside the jurisdiction.
(b) Further, goods shipped into the province will usually have been acquired by a local importer/distributor (not an agent) and buyers will at least have an action against the local importer for defects in the goods or for a failure of the importer to deliver goods that have been paid for.
(c) Individual consumers who order goods directly from foreign entities outside the jurisdiction are left to take their chances, and they may not fully appreciate the difficulties they might have should the foreign entity not deliver goods paid for or deliver defective goods. However, it would be very difficult to force foreign entities to register in the jurisdiction if they only make occasional deliveries of goods in response to occasional consumer orders from the jurisdiction (since don’t have much leverage to force such registration)
(3)
As the foreign entity’s business connections to the jurisdiction increase it will become increasingly likely that they will be considered to be carrying on business in the jurisdiction. E.g. frequent visits by salespersons for the foreign entity selling substantial quantities of goods or involving substantial provisions of services not only increases the need for having the entity have a registered attorney for service, but also the leverage the jurisdiction would have over forcing the entity to register. d) If a foreign entity must register, the registration requirements include (see s.376): i) Reserving the name of the foreign entity (if name of foreign corporation already used in BC, can use an assumed name) ii) Filing a registration statement iii) Appointing one or more attorneys
(1) S.386: requires extra-provincial companies to have one or more attorneys who can be either an individual or a company.
(2) S.388: each attorney for an extra-provincial company is deemed to be authorized to accept service of process on behalf of the extra-provincial company in each legal proceeding by or against it in BC and to receive notices to the company.
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iv) S.381,382: an extra-provincial company must file notices of any changes , such as a change in the attorneys for service, a change in the corporate name, or an amalgamation. v) S.380: an extra-provincial company must also file an annual report updating its filed information.
Salomon: companies have separate legal personality & legitimized de facto one shareholder Co.
1) A. Salomon v. A. Salomon & Company, Limited a) Facts: i) Mr. Salomon had previously formed a boot manufacturing business that he ran as a sole proprietorship. Before transferring his business to a company, the balance sheet appears to have looked something like this:
Cash
Assets
Pre-sale balance sheet of sole proprietorship
£ 000
Liabilities & owner’s equity
Accounts Payable
£ 5,000
Accounts Receivable
Inventory
6,782
16,000
Leasehold Improvements 2,500
Fixtures 6,000
Owner's Equity 26,282
_____
31,282 31,282 ii) Salomon decided to expand the involvement of his family members in the business, apparently in part at the urging of two of his sons. He sold his business to a company that he had formed , with him holding most of the shares (and 6 others holding just one share each to satisfy legal requirement for seven shareholders) (and he bequeathed his shares to his children). Thus effectively Salomon turned his sole proprietorship into a corporation, though he remained in control. iii) Salomon arranged to pay off the accounts payable, because it is hard to assign obligations to another person/corporation. Under the terms of the sale agreement Mr Saloman was to be paid approximately £39,000, although the business was partly sold to the company on credit as follows. iv) Mr. Salomon was paid in part by way of
£20,001 in £1 par value shares out of 40,000 authorized shares .
(1) Recall directors of a company have the power to issue shares, although this power can be limited by a limit in the articles on the number of authorized shares (under the CBCA). To sell more, the directors have to go back to the shareholders and request the authority be extended.
(2) Here the directors (acting as agents of the company) were authorized to issue up to 40,000 shares – 20,001 shares were issued (i.e. created or given birth to) to Mr. Salomon, plus 6 to
6 other people
(3)
The shares had a £1 par value. This does not mean the shares were worth £1, but rather is simply a nominal value assigned to the shares. Originally it appears to have meant that the shareholder was liable to pay in at least the £1 par value and, if the shareholder had not paid in at least £1, the shareholder could be called upon to pay in the difference.
(4) The shares were issued as fully paid . That is, whatever the price for the shares was, it was said to have been fully paid by Mr. Salomon. If they were not fully paid, the company would have a claim against Mr. Salomon for the unpaid amount.
(5) On receiving the shares, Mr. Salomon became a shareholder of the company. Such a person is also referred to in the English style of company legislation as a “member”
(companies can be incorporated for non-profit purposes that have voting “members” rather than shareholders). v) Mr. Salomon was paid in part by debentures in the amount of £10,000
.
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(1)
A “debenture” is a document that provides evidence of a debt. Debt evidenced by a debenture usually involves payment of interest on the debt and the debt (or loan) is usually subject to specific terms set out in a document referred to as an indenture that is incorporated by reference in the debenture.
(2) In this case the debentures provided for security (some assets which could seized in the event of a default in the payment of the interest or the face value of the debenture (i.e. the amount due on the debenture)). The security for payment on the debenture was in the form of a “ floating charge ”. The floating charge doesn’t specify security in any particular assets of the company but instead represents a charge (an amount that must be paid before other debts are paid) on the assets that are present at the time of the default in payment on the debenture. Determining the appropriate time, however, is difficult, and most Canadian jurisdictions have got rid of such floating charge securities (the modern day equivalent is
“a charge on all present and after acquired property”) vi) Mr. Salomon was to be paid cash for the remaining $8,775 as it became available (so Salomon had effectively made an unsecured loan to the company) vii) Immediately after this transaction the balance sheet of the company appears to have looked something like this (there were 6 other shareholders/members with one share each):
Cash
Assets
Accounts Receivable
Post-sale balance sheet of company
£ 000
Liabilities & owner’s equity
Accounts Payable
£ 000
6,782 Debentures 10,000
Inventory
Fixtures
Goodwill
16,000
Leasehold Improvements 2,500
6,000
7,500
_____
Unsecured Loan from A.S. 8,775
Shareholder’s equity
Common shares
40,000 authorized
20,007 issued
38,782
at £1 par value 20,007
38,782 viii) Following the sale, things did not go well:
(1) There was a depression in the boot trade.
(2) There were, for the first time, strikes of workmen which led public bodies, contracts with whom were the principle source of Mr. Salomon’s business, to spread their sources of supply to reduce the risk of interrupted supply on account of strikes.
(3) Continued production, perhaps at a capacity sufficient to keep the per-unit costs down, led to an over-investment in inventory (in other words, more assets which needed to be financed). ix) Anxious to keep the business going, both Mr. Salomon and his wife lent money to the company. Additionally, the debentures were mortgaged to a Mr. Broderip who loaned all of
£5,000 on the strength of the debentures (i.e. they were collateral for the $5,000 loan from
Broderip). Unfortunately, this was not enough to stem the tide of financial difficulties for the company. Eventually there was a default on the loan from Mr. Broderip and Mr. Broderip put in a receiver . Shortly thereafter the creditors had a liquidator appointed. These unfortunate events occurred about one year after the company had been formed. x) Among the claims filed with the liquidator were the claims of Mr. Broderip on the debentures and the claim of Mr. Salomon as owner of the equitable interest in the debentures :
(1)
Mr. Broderip’s claim was for the £5,000 he had loaned to Mr. Salomon plus the accrued interest on the loan. Mr. Broderip’s security interest on the loan to Mr. Salomon was the debentures. He could claim the benefit of the debentures and thus could take advantage of
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the floating charge that secured the debentures (i.e. Broderip could step in and seize the assets of the company as necessary to cover the loan he had made to Mr. Salomon plus the accrued interest on the loan to Mr. Salomon). However, Mr. Broderip was only entitled to the £5,000 loan plus accrued interest. Once this was paid off the debentures would revert to Mr. Salomon.
(2) Mr. Salomon would then have the next claim from the assets of the company (pursuant to the floating charge security interest on the debentures) to cover the remaining £5,000 due on the debentures (and any remaining unpaid accrued interest). However, payment to satisfy Mr. Broderip's claim left only £1055 worth of assets all of which would go to Mr.
Salomon as the beneficial owner of the debentures, leaving nothing for the other creditors . xi) The liquidator challenged the claims on the basis that:
(1) The debentures were fraudulently issued. In other words, they were issued to defeat the interests of creditors.
(2) The transfer of the business should be rescinded as being fraudulent.
(3) Nothing was paid for the shares and therefore payment was due from Mr. Salomon for
£20,001 for the shares. xii) Eventually the claim of Mr. Broderip was accepted and the trial proceeded on the claim by Mr.
Salomon. b) Trial decision: i) The trial judge, in trying to find for the other creditors, decided the company could be viewed as a mere alias or agent of Mr. Salomon and thus Mr. Salomon was an undisclosed principal
(recall agency law above). Thus either Mr. Salomon could be personally liable on the debts or the company was liable as agent and was entitled to seek indemnification from Mr. Salomon.
It was on this theory that the trial judge dismissed the claim of Mr. Salomon. c) Court of Appeal decision: i) The three judges in the court of appeal did not like the transaction. They thought it was contrary to the intent of the legislature. The court of appeal preferred to compare the situation to one of trust where the company was a trustee for Mr. Salomon (the beneficiary) and the company, as trustee, was then entitled to indemnification for its expenses in carrying out the trust obligation. d) The House of Lords held in favour of Mr. Salomon : i) The Companies Act was complied with in all its particulars. Although the Act specified that seven members (persons subscribing for the shares of the company and thereby putting up initial capital) were required, it did not say that the members had to be independent or have equal shares, etc. The company did have seven members , even though six of the members were mere nominees each holding only one share . The judges were reluctant to deal with the difficulties that might be created by saying that the other six shareholders were not bona fide shareholders (e.g. just how many shares and what amount of investment would constitute a bona fide shareholder). ii) When the company was formed it was in law a different person than the subscribers to the memorandum (i.e. the shareholders) (i.e. a company is a separate legal entity ). It was not the agent or the trustee of the subscribers. If it were otherwise , the court noted, the notion of limited liability provided for in the incorporation of a company under the Act would be defeated . If the company were an agent as the trial judge had suggested then the subscribers might be directly liable for acts done in the carrying on of the company’s business or, if the company were liable because it had acted for an undisclosed principal, the shareholders (as principals) would have been required to indemnify the company for any losses it incurred. iii) Policy concerns :
(1) Potential fraud on creditors
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(a) The liquidator had raised the concern that the transaction was a fraudulent attempt to defeat the interests of the creditors. A sale of assets to a company might well be used in an attempt to avoid creditors.
(b) However, the House of Lords thought the likelihood of fraud was small in this case given the apparent value of the business at the time it was sold to the company and the fact that the Salomon’s were willing to loan money to the business in an attempt to keep the business going (not something one would do if one were attempting to defeat the interests of creditors). They accepted that the motive was to bring the other members of the family into the business.
(2) Could the creditors have been deceived
(a) The creditors might have been deceived in that they may well have dealt with the business for many years when it was a sole proprietorship and may thus not have been aware that the business was now a limited company. They might also have been deceived by the book value of the business if they ever had occasion to look at the books of the business since an excessive value may have been paid for the business.
(b) The court said that the creditors had full notice that the company was limited and that they “must be taken to have been cognizant of the memorandum and the articles of association”.
(i) The memorandum is a document setting out the name of the company, the business of the company, and the subscribed capital of the company. In other words, it allows one to find out about the powers of the company and the amount of capital that was originally available for the payment of debts.
(ii) The articles of association provide the procedural rules for such matters as meetings of the shareholders or of the directors and for the transfer of shares and payment of dividends and so on.
(c) Thus the creditors could have checked out the company’s situation. What about the persons who had dealt with Mr. Salomon before the sale of the assets to the company?
Would they have been aware of the fact that the business was now being carried on through a company and thus had a chance to check out the filed documents?
(3) Affect on existing businesses
(a) The House of Lords appears to have been concerned about the number of other businesses that might be caught by holding that this business arrangement is not valid.
They note the numerous businesses created with nominee shareholders that really had effectively only one owner.
(4) Why was there a seven shareholder rule in the statute?
(a) The House of Lords perhaps thought the rule for 7 shareholders was meaningless anyway. It perhaps had something to do with a perception that any broader societal benefits of granting limited liability would probably accrue where there was some significant number of shareholders. e) Comment: i) Discussion of the case shortly after it was decided was not so much on its confirmation that a company is a separate legal entity, but instead it was said to have legitimized the de facto oneperson company . The CBCA and most other corporate statutes in Canada have abandoned any attempt to require a specified minimum number of shareholders greater than one. ii) Note that neither the approach of the trial judge nor that of the Court of Appeal really questioned the separate legal status of a company. In the trial judge’s view
the company was
Mr. Salomon’s agent
. To be an agent for Mr. Salomon the company had to be a separate person from Mr. Salomon. The Court of Appeal’s view that the company was a trustee also appears to have presumed that the company was a legally recognized separate person in order for it to be a trustee. Keep the trial judge’s position
in mind because it is essentially the core
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concept of the rhetoric on which shareholders are, on rare occasions, made liable for acts done in the conduct of a company’s business (i.e. piercing the corporate veil).
Sharehldrs as credtrs/directrs/officrs/emplyes, corp owns assets, share contract rights, natrl person
1) There are a number of implications of separate legal personality of corporations
2) One of the implications of the Salomon case is that it is possible for a shareholder to also be a creditor of the company (e.g. can make a loan to the corporation), and a shareholder who is also a creditor can rank equally with other creditors for the amount of the debt or even ahead of other creditors to the extent of any security held for the debt. a) Contrast this with partnership – a partner cannot be a creditor of a partnership (since would be a credit of themselves), but they could theoretically have a separate contract with all the other partners
3) A shareholder can be a director, an officer, or an employee of the corporation. E.g.
Lee v. Lee’s Air
Farming Ltd. [1961] A.C. 12, [1960] 3 All E.R. 420. Here the same question arose as in Re Thorne: whether Lee could be a worker within the meaning of similar workers’ compensation legislation in
New Zealand. a) Facts i) Lee was the sole shareholder of Lee’s Air Farming Ltd. He was also the sole director , the managing director (or president ), and the company’s only employee (engaged by the company as a pilot for the purpose of spraying farm property). This is not uncommon. ii) Lee died in carrying out the aerial top-dressing. Lee’s wife made a claim for compensation under the workers’ compensation legislation. iii) The claim was resisted on the basis that Lee could not be an employee or worker within the meaning of the legislation because he was employing himself. The argument made on behalf of the board was that Lee, as an employee pilot, would be following his own orders from himself as president (managing director) of the company. One could not have the person following the orders also be the person giving the orders. b) Decision (Privy Council): i) Lee was not employing himself – rather, the company employed him. Lee and the company were not the same person – rather, the company had a separate existence from Lee. It didn’t matter that Lee would be giving orders to himself since it was the company giving Lee the orders through its agent (Lee).
c) Implications: i) Even a sole shareholder of a company can be a director, an officer, and an employee of a company. ii) The company is a separate person that acts through its shareholders to the extent they have powers to authorize certain acts by the company or through its directors to the extent that the directors have powers to authorize certain acts on behalf of the company. d) Contrast this with partnership – recall that in Re Thorne
, Thorne could not be a “worker” within the meaning of the Nova Scotia workers’ compensation legislation since he was a partner and thus could not hire himself as a worker on the principle that one cannot contract with oneself.
4) Another consequence of the separate personality of the corporation is that it is the corporation that owns the assets and not the shareholders . E.g. Macaura v. Northern Assurance a) Facts i) Macaura transferred his interest in timber to a company called Irish Canadian Sawmills Ltd. for £27,000 plus payment for the cost of felling timber already felled amounting to a total amount of £42,000. Payment was in the form of 42,000 £l par value shares of the company (so
Macaura was a shareholder of the company holding the timber interest ) ii) On Feb. 6, 1922, Macaura signed the fifth of five insurance contracts on the timber, in his own name (i.e. he is the insured party).
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iii) By some coincidence the timber was destroyed by fire on Feb 22, 1922. iv) Macaura claimed on the insurance. The arbitrator did not find any fraud, did refused the claim on the insurance contracts since Macaura, who signed the insurance contracts in his own name, did not have an insurable interest and so had nothing to lose. b) Decision: i)
On appeal, the arbitrator’s ruling was upheld (i.e. Macaura could not claim on the insurance because he did not have an insurable interest). Only the company had an insurable interest in the timber because the company owned the asset (i.e. the timber interest). ii)
Macaura’s interest as a shareholder was an interest in a distribution of profits by way of dividend and a share in the distribution of the proceeds on the winding-up of the company.
These were among the “ bundle of rights
” that the shares provided. The “bundle of rights” the shares provided did not include an interest in the property or assets of the company or in a pro rata share of the profits of the company. iii) In other words, the company had a separate existence and the assets were the company’s assets, not Macaura’s. c) Comments: i) The shareholders, as shareholders , have a contractual claim against the company with respect to the rights given in the shares they hold but they do not have an ownership interest in the assets of the company. ii) Contrast this with sole proprietorship and partnership . In a sole proprietorship the sole proprietor owns the assets. In a partnership the partners own the assets. iii) Note that Macaura v. Northern Assurance has been overruled in Canada by the S.C.C. in
Kosmopolous v. Constitution Insurance Co. of Canada , [1987] 1 S.C.R. 2. However,
Kosmopolous did not say that shareholders own the assets of a corporation – rather, it simply said that a shareholder may , at least in some situations (e.g. single shareholder) be said to have an insurable interest in the assets of a corporation. But that does not mean that shareholders own the assets of a corporation.
5) In
Sparling v. Caisse de dépôt et Placement
, [1988] 2 S.C.R. 1015 the S.C.C. affirmed the commonly accepted view, for which Macaura v. Northern Assurance is often cited, that shares are “bundles of rights”
, and that these rights do not include ownership of the assets of the corporation.
6) Corporate statutes in Canada generally also give corporations broad powers granting to them the same rights (and obligations) under Canadian law as a natural person . a) A corporation can acquire assets, go into debt, enter into contracts, sue or be sued, and even, in some situations, be found guilty of committing a crime. b) A corporation’s assets belong to the company and not to the shareholders. c) Once a corporation is incorporated, it’s separate legal status, property, rights and liabilities continue to exist until the company is dissolved, even if one or more of its shareholders or directors sell their shares, die or leave the company.
Personality problems: sharehldrs get secured/pay out insolvent, thin cap avoid liability, deception
1) See also drawbacks and benefits of “lim liab” in Corp: intro above
2) Limited liability coupled with separate personality creates a number of potential problems . Can these problems be adequately dealt with while retaining the benefits of separate corporate personality and limited liability, or are they too great to allow these concepts to continue to be acceptable?
3) The shareholders , with insider knowledge of corporation approaching insolvency , might: a) E.g. the shareholders may cause the company to become indebted to them (i.e. shareholders become creditors ) so as to defeat the interests of creditors (and any other third parties having a claim against the corporation) by sharing in the distribution of the assets of the corporation as creditors.
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i) E.g. on the eve of insolvency the corporation might issue secured debentures to the shareholders in exchange for their shares. ii) The shareholders may even be able to put themselves ahead of other creditors by taking a security interest. iii) The House of Lords in the Salomon case said there was no fraudulent intent in that particular case, but the case does suggest the possibility of making shareholders creditors and even secured creditors. How should the law address this concern? b) E.g. the company might make payouts to shareholders when it is, or is approaching, insolvency
(i.e. ‘abandoning ship’) i) Three possible ways shareholders might attempt to do this:
(1) Distribution of large dividends to the shareholders.
(2)
Repurchase (‘buy-back’) of shares by the corporation
(3) Return of the capital invested to the shareholders ii) If such things were allowed, the company as a separate person would be liable to its creditors but it might have very few assets left if it had already distributed most of its assets to its shareholders prior to an assignment in bankruptcy. iii) These are therefore largely prevented by statute (e.g. requirement for accountant to provide certification that there is no impending insolvency)
4) Since the company is a separate person from its shareholders, it can enter into contracts with its shareholders, but a company might enter into contracts with majority shareholders that are very unfavourable to others (shareholders and/or creditors). a) E.g. Mr. S has 60% of the shares, so (having more than 50% of the shares) he elects the Board.
He owns land worth $600K, and contracts with the corporation (who is under his control) to transfer the land to the corporation for $1M. Although the value of his shares has just gone down by $240K (since the corporation lost $400K on the deal), but he has personally gained $400K
($240K=160K) at the expense of the minority shareholders and/or the creditors.
5) Thin capitalization : persons might set up a company up with very little capital and thereby defeat the interests of creditors who act in reliance on the presence of some minimum adequate amount of capital, or to defeat damages resulting from tort a) This may not be a concern for creditors who choose to deal with the company, since they can check on the capitalization of the company ahead of time. b) However, it may defeat the interests of third parties such as tort claimants against the corporation.
These persons may have no opportunity to choose to deal with the company (e.g. a pedestrian hit by a company delivery truck) and may then discover that the company has very little capital to compensate them for their injuries. Thinly capitalized corporations might even be deliberately set up to allow for tortious conduct.
6) Third parties may be deceived into thinking they are dealing with an individual or partnership business when they are in fact contracting with a corporation that (so shareholders have limited liability) a) This may have occurred in the Salomon case where persons who dealt with Salomon before he transferred the assets of his business to the company may not have been aware of the transfer and thus may have believed they were still dealing with Mr. Salomon who would be personally liable for amounts owed – though probably wasn’t intentional deception in that case.
7) Persons may incorporate a company to avoid personal obligations or restrictions . a) E.g. a person may have entered into a non-competition contract, promising not to carry on a particular business in a particular area for a given period of time. To avoid the commitment the person incorporates a company and then hires themselves, saying that s/he isn’t the person carrying on the business and thus has not breached the contract. See Gilford Motors v Horne
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b) E.g. suppose licence legislation says there can only be one licence per person. A simple avoidance technique might be to incorporate a company and have it apply for another licence on the basis that it is a separate person. c) E.g. incorporate to reduce taxes
Corporations: pre-incorporation contracts
Pre-incorp Ks: At CL corp cannot ratify, promoter liable if intended party (else breach warranty)
1) Promoters of companies often try to enter into contracts on behalf of proposed corporations before the incorporation , because, for example: a) To get things ready for incorporation b) To ensure an important contract is in place before undertaking the expense of incorporation c) Delay/backlog at registry office (though with electronic filing and ability to reserve name ahead of time, this is less of an issue)
2) Recall corporation comes into existence under CBCA s.9 on date shown on certificate of incorporation (contrast with BCBCA where time is filing date, which should reduce problems of preincorporation contracts even more)
3) Normally the promoter does not have any intention of being personally liable on the contracts.
4) In some cases the promoter is aware that the corporation has not been incorporated but the person dealt with is not aware. In other cases neither the promoter nor the person the promoter deals with is aware the corporation has not been incorporated.
5) In some cases the corporation is never actually incorporated. In other cases the corporation is incorporated and purports to ratify contracts entered into on its behalf before it was incorporated. In some cases the corporation that is purporting to ratify the contract is insolvent. The third party may be left to bear a loss if the promoter is relieved of personal liability and the third party’s claim is solely against the insolvent corporation.
6) Thus two questions that typically arise are a) Whether the promoter can be personally liable on the contract b) Whether the corporation can ratify the contract.
7) Ratification ?
: a) Since a pre-incorporation contract a corporation yet to be incorporated, a person who purports to act on its behalf cannot have any authority as an agent for the corporation (the corporation would have to exist first before the steps could be taken to grant a person authority as an agent ). b) But can a corporation ratify a contract that was entered into on its behalf before it was incorporated? c) To assess this, and to understand the problems that arose with the common law (CL) position, need to review agency law on a principal ratifying a contract entered into on their behalf. A person can ratify a contract entered into by another person on his or her behalf if: i) The other person purported to act on behalf of the person who seeks to ratify ii) The person who seeks to ratify was (A) in existence and ascertainable at the time the other person purported to act on their behalf, and iii) The person who seeks to ratify must have had the legal capacity to do the act both (B) at the time the other person acted and (C) at the time of the ratification . d) Conditions (A) and (B) make it impossible (at common law under agency law) for a corporation to ratify a pre-incorporation contract (e.g. for B, it didn’t have the legal capacity to enter into a contract at a time before it was incorporated). e) These common law principles as applied to pre-incorporation contracts are confirmed in Kelner v.
Baxter (1866), L.R. 2 C.P. 174 (Common Pleas) i) Facts:
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(1) The plaintiff (Kelner) and the defendants (Baxter et al.) were promoters of the Gravesend
Royal Alexandra Hotel Company, Limited. The plaintiff was to be the manager of the hotel under the new company.
(2) Before the company was incorporated the plaintiff offered to sell a stock of wine to the proposed company for £900 which was accepted by the defendants on January 27, 1866 on behalf of the Company. On February 1, 1866 the directors of the Company ratified the agreement.
(3) However, the promoters did not receive a certificate of incorporation for the Company until February 20, 1866.
(4) The directors (to avoid personal liability to the plaintiff) then purported to ratify the agreement again on April 11, 1866 just days before the company made an assignment in bankruptcy.
(5)
The plaintiff sued the defendants (no point in suing the corporation, it’s bankrupt).
Defendants claim they are not personally liable since they were just acting as agents for the company, which ratified so it was the company that breached the contract, not them. ii) Decision:
(1) The ratification of February 1 was not a valid ratification because the company was not in existence at the time it purported to ratify (C)
(2) The ratification on April 11 was also not a valid ratification because (A) the company was not in existence at the time of the promoters purported to act on its behalf and (B) it did not have the capacity to contract at that time.
(3) The court nonetheless still felt there was clearly an intended contract and the only way in which there could be a valid contract was if the defendants were the other contracting parties. They thus held that there was a valid contract in which the plaintiffs , personally, was one party and the defendants were the other parties. f) Note CBCA s.14
(and new BCBCA ) modifies this common law position (see below)
8) Promoter bound/liable on the contract ?
: a) Note the potential following from Kelner v. Baxter for promoters to be bound/liable/a party to pre-incorporation contracts they purport to enter into on behalf of an as yet unincorporated entity b) What was not clear after Kelner v. Baxter was whether i) Promoters were automatically liable in these situations (sometimes referred to as the
“rule of law” approach ) or whether ii) Promoter only be liable if it was intended in the circumstances they were themselves to be a party to the contract (sometimes referred to as the
“rule of construction” approach
). c) The English Court of Appeal , in interpreting Kelner v. Baxter , made it clear that promoter liability was to be based on a rule of construction approach: Newborne v. Sensolid (Great Britain) Ltd.,
[1953] 1 All E.R. 708 (C.A.) i) Facts:
(1) Newborne had entered into a contract with Sensolid Ltd. to supply tinned ham to Sensolid
Ltd. The price of tinned ham fell and Sensolid Ltd. refused to take further deliveries of tinned ham from Newborne.
(2) The contract had been signed by Leopold Newborne underneath the words Leopold
Newborne (London) Ltd. It was not formally signed “on behalf of Leopold Newborne
(London) Ltd.” as had been the case in
Kelner v. Baxter .
(3) Leopold Newborne (London) Ltd. had not been incorporated. It was later incorporated and it brought an action against Sensolid Ltd, but that action was dismissed because Leopold
Newborne (London) Ltd. had not been incorporated at the time the contract was entered into.
(4) Leopold Newborne then sued Sensolid Ltd. in his own name seeking to enforce the preincorporation contract on the basis that he was a party to the contract himself. The
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argument was made on the basis of Kelner v. Baxter saying that if the contract was not with Leopold Newborne (London) Ltd. then it must have been with the person who signed on behalf of the company, namely Leopold Newborne. ii) Decision:
(1) The correct approach is a rule of construction approach , which asks whether the promoter was intended , in the circumstances, to be a party to the contract .
(2) Given the way in which the contract was signed by Leopold Newborne, the contract here was intended to be with the company and only the company. I.e. it was not intended that
Leopold Newborne be a party to the contract himself. Thus Leopold Newborne could not enforce the contract in his own name. iii) Comment:
(1) So (presumably) there was no contract at all.
(2) Potential unjust enrichment to Sensolid Ltd. here, since they perhaps speculated at the expense of Leopold Newborne (see “Pre-incorp Ks & problems of common law” below) d) This same rule of construction approach was taken by the High Court of Australia in Black v.
Smallwood & Cooper (1966), 117 C.L.R. 52 (High Court of Australia) i) Facts:
(1) Black and others had contracted to sell land to Western Suburbs Holdings Pty. Ltd. which was signed by the defendants as follows:
Western Suburbs Holdings Pty. Ltd.
Robert Smallwood
J. Cooper
}
}
}
Directors
(2) Western Suburbs was not incorporated at the time and Smallwood and Cooper signed as directors thinking the company had been incorporated and that they were directors.
(3) The plaintiffs wanted to impose liability on the basis of a rule of law reading of Kelner v.
Baxter saying that a contract was clearly intended and since it could not be with the principal (i.e. the company) which was not in existence it must have been with the purported agents Smallwood and Cooper personally. ii) Decision:
(1) The majority of the court followed Newborne v. Sensolid Ltd.
It was held that Kelner v.
Baxter was not authority for the principle that an agent signing for a non-existent principal is bound. Rather, the basis of the decision in Kelner was the inference that the defendant promoters were bound by the contract according to the nature of the contract itself.
(2) In this case it appeared to be clear that a contract with the company was intended . The company did not exist and thus it was a contract with a non-existent party and therefore no contract at all.
(3) It was nonetheless suggested that the defendants could be liable for a breach of warranty of authority (see “Agency: If no actual or ostensible” above) e) The same rule of construction approach has also been taken in BC: Wickberg v. Shatsky (1969), 4
D.L.R. (3 rd
) 540 (B.C.S.C.) i) Facts:
(1) Lawrence and Harold Shatsky became shareholders in Rapid Addressing Systems Ltd. and became directors. They decided to expand the business and to incorporate a new company,
Rapid Data (Western) Ltd., to take over Rapid Addressing Systems Ltd.
(2) Rapid Data (Western) Ltd. was never formed. It was later proposed that Celer Data Ltd. be formed to do the takeover. A certificate of incorporation for Celer Data Ltd. was issued on
May 11, 1966.
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(3) On May 9, 1966, two days before the certificate of incorporation was issued, the plaintiff
(Wickberg) was hired as a manager. The terms of employment were written in a letter dated May 9 and was on letterhead with the name of Rapid Data (Western) Ltd. on top.
The letter was signed by Lawrence Shatsky. The letter noted that Wickberg was to get a salary of $15,000 per annum (about $250,000 in today’s money). A few days later
Lawrence Shatsty told Wickberg that the company was to be referred to as Rapid Data
(Western) without the “Ltd.”
(4) The business did not go as well as anticipated, and Lawrence and Harold Shatsky could not keep up with paying Wickberg’s salary. They asked him to work on straight commission.
With the company’s business not doing particularly well, Wickberg refused to work on straight commission. On Aug. 26, 1966 Wickberg was dismissed for his failure to work on straight commission.
(5) Wickberg sued for wrongful dismissal. His difficulty though was that he had to prove he had an employment contract. The contract named Rapid Data (Western) Ltd. which was never created. And it couldn’t be a contract with Celer Data Ltd. because the purported contract was concluded on May 9 th
, two days before a certificate of incorporation was issued for Celer Data Ltd.
(6) Wickberg therefore made the following arguments (among others):
(a) Lawrence Shatsky was liable as a party to the contract on the basis that the contract was on behalf of a non-existent principal and so, applying the rule of law approach in
Kelner v. Baxter , Lawrence Shatsky was a party to the contract.
(b) Lawrence and Harold Shatsky were liable for a breach of warranty of authority in warranting that the company was in existence and that they had authority to act on behalf of the company ii) Decision:
(1) A person signing on behalf of a non-existent company is not automatically personally liable . The distinction between Kelner v. Baxter and Black v. Smallwood is that in Kelner v. Baxter it could reasonably be implied from the circumstances that there was a contract between the plaintiff and the persons who signed on behalf of the non-existent corporation.
In Black v. Smallwood the circumstances suggested that it was not intended that the contract bind Smallwood or Cooper. In other words, the court took the rule of construction approach to Kelner v. Baxter .
(2) In this case, it was not the intention that either Lawrence Shatsky or Harold Shatsky would be personally liable on the employment contract (rather, it was intended that it be a contract with a company – Rapid Data (Western) Ltd.).
(3) However, there was a breach of warranty of authority in that Lawrence Shatsky and Harold
Shatsky represented the existence of Rapid Data (Western) Ltd. and that they could sign on behalf of Rapid Data (Western) Ltd. while they knew the company did not exist (see
“Agency: If no actual or ostensible” above)
(a) Damages awarded in this case were only nominal however since there was no connection between the damage suffered by the plaintiff and the breach of warranty of authority
(i) To determine damages, the test is: what position would Wickberg have been in has the misrepresentation not been made?
(ii) All Wickberg would have had (if the representations had been correct) would be an action against Rapid Data (Western) Ltd. on a claim of wrongful dismissal.
(iii)However, this would have yielded nothing because the company through which the business was operated was now bankrupt (and so too would have been the business as originally planned)
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(iv) Thus Wickbery effectively lost nothing as a result of the breach of warranty of authority iii) Comment: thus the promoter can be liable for a breach of warranty of authority, but the damages may be nominal where the corporation, or the business which it was intended would be carried on by the corporation, is now insolvent
Pre-incorp Ks: problems of CL=loss of reliance/unjust enrich/costs/unreasonable, but opportunistic
1) The common law position created a risk for both the promoter and the third party that there would be no enforceable contract, creating a risk that reliance on the purported contract will be defeated : a) Black v. Smallwood and Wickberg v. Shatsky involved cases in which the third party could not enforce the contract against the company. b) Newborne v. Sendolid Ltd.
involved a situation in which the neither the promoter nor the company could enforce the purported contract.
2) It also create the potential for an unjust enrichment of promoters at the expense of third parties or third parties at the expense of promoters, if one performs but then cannot enforce it on the other: a) E.g. Newborne v. Sensolid (Great Britain) Ltd above b) E.g. had the court not found the promoters liable in Kelner v. Baxter , Kelner would have borne the entire loss on the wines that he supplied for the hotel company rather than having that loss shared amongst all the promoters (including Kelner as a co-promoter).
3) The common law position also creates unnecessary precautionary costs . a) To deal with the risk of a potentially unenforceable contract, both parties will have to take precautions to ensure that the corporation has in fact been incorporated. b) It would make more sense to have just one party (the one who can do it at least cost ) incur the cost of confirming that the corporation has in fact been incorporated. This will usually be the promoters – in most cases they will know whether the corporation has been incorporated, or if not they could simply check with their lawyer. c) Of course, in closing a major contract should ask to see certificate of incorporation (and get exact name of corporation (e.g. is it “Ltd.” or “Limited”) early on to do necessary searches)
4) The third party would have expected to have a contract with the corporation itself so, in most cases, it would be reasonable to allow the corporation to adopt the contract as its own and relieve the promoter of liability unless it was genuinely intended that the promoter be a party to the contract.
5) However , one needs to address the opportunistic use of an adoption of a contract by a corporation. a) E.g. where the contract is no longer beneficial to the promoters, the promoters might then incorporate the corporation, fail to put any assets in it, have it adopt the contract relieving them of liability, and leaving the third party with an action only against an insolvent corporation. This would give the promoters the opportunity to gain on a contract if it continued to be beneficial to them but avoid liability on the contract if it was not beneficial to them – i.e. they would be speculating at the expense of the third party . b) E.g. Kelner v. Baxter , Newborne v. Sensolid (Great Britain) Ltd
Pre-incorp Ks: CBCA modifies CL, person bound unless express & corp can adopt, const/juris Q’s
1) CBCA s.14 modifies the common law position . a) S.14(1) provides that, unless the contract expressly provides otherwise (see s. 14(4)), a promoter who enters into, “or purports to enter into”, a “written” contract in the name of or on behalf of a corporation before the corporation comes into existence, is personally bound by the contract and is entitled to benefits of the contract. i) I.e. this codifies the automatic ‘rule of law’ interpretation of Kelner v. Baxter ii)
Originally s.14(1) did not have the words “or purports to enter into
”. The original wording was perhaps a codification of the rule of construction approach to Kelner v. Baxter , since if a promoter purported to enter into a contract on behalf of a pre-incorporated corp and it was not intended for promoter to be a party to the contract, then there was no contract, so (without the
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words “or purports to enter into”) the section would not apply and the promoter would not be personally bound (this interpretation was taken Westcom Radio Group Ltd. v. McIssac (1989)
45 B.L.R. 273 (Ont. Div. Crt.) for an equivalent Ontario provision). iii)
The section was subsequently amended to add the words “or purports to enter into”. It thus now appears to codify the rule of law approach to Kelner v. Baxter . iv)
Note “ written contract
” – so if the contract is not in writing the section does not apply. This appears to leave the common law for oral contracts. v) Cannot adopt if contract has been repudiated – Landmark Inns v. Horeak (see below) b) S.14(2) then provides that a corporation can “adopt”
a contract within “a reasonable time”
after it comes into existence (thus overriding Kelner v. Baxter ). If the corporation adopts the contract then the corporation is bound by and is entitled to the benefits of the contract, and the person who purported to act on behalf of the corporation is no longer liable on the contract or entitled to the benefits of the contract. The corporation can adopt the contract by any action or conduct signifying its intention to be bound by the contract. c) S.14(3) allows the court to apportion liability between the corporation and a person purporting to act on behalf of the corporation. i) The Dickerson Report (the drafters of the CBCA) noted that one of the instances it had in mind for the apportioning of liability would arise where the promoters had corporation adopt a contract on the eve of bankruptcy ( Kelner v. Baxter arguably involved such a situation).
Promoters might incorporate a new no-asset corporation (a
‘shell’
) and have it adopt so as to get the promoter out of liability. Such mechanisms allow promoters to speculate , only creating liability for themselves when contract appears to be working out well. ii) E.g. see situation in Landmark Inns v. Horeak (see below) iii) S.14(3) not applied in Bank of Nova Scotia v. Williams since third party aware dealing with company so takes risk of its insolvency d) S.14(4) provides that the parties can “expressly” agree
in the written contract that the person who enters into the contract on behalf of the corporation before it came into existence is not bound by the contract or entitled to the benefits of the contract. i) Simply having corporate name on contract insufficient – Landmark Inns v. Horeak (see below) e) S.14 may also affect pre-incorporation subscription ( offer) to buy shares (see “Issuing shares” under Corps: financing below)
2) Cases applying provisions equivalent to CBCA s.14
: a) Landmark Inns v. Horeak , [1982] 2 W.W.R. 377 i) Facts:
(1) Horeak and three other persons were planning to enter into an optical business.
(2) On October 25, 1979 Horeak signed a lease for space in the plaintiff’s shopping mall (the
Gordon Place Shopping Centre). He signed the lease as chairman of “South Albert Optical and Contact Lenses Ltd.” The company was not incorporated until February 25, 1980. In the interim Horeak and his three partners decided to lease other premises in another mall
(the Southland Mall).
(3) The plaintiff had incurred costs of modifying the premises according to the defendant’s plans, and didn’t rent it out to anyone else (thinking Horeak et al. were moving in). The defendant (Horeak) then notified the plaintiff of its intention not to proceed with the lease.
The plaintiff claimed for the cost of renovations ($4,150) and six months of lost rent
($1,792.99 per month = $10,758).
(4) Thinking he was about to be sued, Horeak incorporated South Albert Optical and Contact
Lenses Ltd., and on March 19, 1980 had it adopt the Gordon Place Shopping Centre lease contract. Horeak then claimed that since the corporation adopted the contract he was relieved of any liability on the contract by s.14(2) of the Saskatchewan Business
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Corporations Act (the same provision as CBCA s.14(2)) and that since he signed in the name of the corporation it was an express provision in the terms of s.14(4) that he was not to be bound. ii) Decision:
(1) The court held for the plaintiff awarding damages of $12,419.61.
(2) S.14(1) codifies Kelner v. Baxter (although it did not indicate which interpretation of
Kelner v. Baxter it thought was codified by s.14(1)). A corporation cannot adopt a contract which has been repudiated since the contract is at an end and thus there is nothing to adopt.
Horeak had repudiated the contract when he notified the plaintiff of the intention not to proceed with the lease. Therefore s.14(2) would not operate to relieve Horeak from liability.
(3) Simply having the name of the company on a contract is not sufficient for the purposes of s.14(4) to alter the liability of the promoter under s. 14(1) – altering s. 14(1) requires an express written provision stating that promoters assume liability iii) Comment: The circumstances of the case are consistent with the kinds of circumstances in which the Dickerson Committee (the drafters of the CBCA) felt s.14(3) was necessary.
However , instead of invoking s.14(3) to allocate the liability back to Horeak, the court seized upon a different notion (i.e. that a corporation cannot adopt a contract that has already been repudiated) b) Bank of Nova Scotia v. Williams (1976), 12 O.R. (2d) 709 i) Facts:
(1) Mrs. Aikins put a second mortgage on her house with the Bank of Nova Scotia. The proceeds were then loaned to H. Williams Mechanical Contractors Ltd. on July 5, 1973. A cheque for the amount of the loan was deposited in the account set up for the company. A certificate of incorporation for the company was issued on July 20, 1973.
(2) Mr. Williams and Mrs. Aikins were the promoters of the company. They became the directors of the company and ran the business of the company. On July 26, 1973 the company delivered a promissory note to Mrs. Aikins for the amount of the loan (as allowed under equivalent of CBCA s.14(2)). There was no directors resolution with respect to this promissory note but it was signed by the only two directors of the company.
(3) By July of 1974 the company became insolvent and ceased active business by September of 1974. Mrs. Aikens made a claim on the loan against Mr. Williams asking that the court exercise its discretion under the Ontario Business Corporations Act , 1970 to apportion liability between the promoters and the corporation under equivalent of CBCA s.14(3)
(Mrs. Aikins was thinking here it would be fair for her and the other promoter, Mr.
Williams, to share the loss equally). ii) Decision:
(1) The court refused to exercise its discretion to apportion liability . It said that,
(a)
“there may be times when the company and the one who contracted on its behalf should not be able to agree as to the assumption of liability to the detriment of the person with whom the contract was made. However, in the situation before me, Mrs.
Aikins was not misled as to which party she was advancing moneys to [i.e. the company], nor did any action of Mr. Williams or the company mislead her as to who would be assuming responsibility for repayment
.” iii) Comment: Unlike the case where promoters have an insolvent corporation adopt a contract on the eve of bankruptcy (one of the instances the Dickerson Report had in mind for apportioning liability), here the third party was aware of who he or she was dealing with (i.e. the corporation), and implicitly accepted the risk that the corporation would not be able to pay.
3) Constitutional question re: CBCA s.14
:
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a) Pre-incorporation contracts deal with the enforceability of contracts, but laws relating to contracts fall within the provincial power over property and civil rights. The federal government has a residual power to incorporate companies and presumably has ancillary powers associated with the power to incorporate companies. b) But does this ancillary power include a power to regulate contracts (and hence alter provincial contract law) that were entered into before a CBCA corporation came into existence ? (seems an odd extension of ancillary powers). This question has not been addressed by the courts. c) So if you don’t want the CBCA to apply, might argue it is unconstitutional.
4)
Jurisdictional (or “conflicts of law”) problems
: a) Suppose CBCA s.14 is constitutionally valid. b) What happens if the pre-incorporation contract is in a province where the common law on preincorporation contracts would normally apply ? Presumably the CBCA provision would be paramount . c) What if the contract was completed in BC (say) and was to be performed in BC but the company was incorporated in Ontario or Saskatchewan where the business corporations statute there has an equivalent provision to CBCA s.14? d) What if the original intention was to incorporate under the CBCA but the incorporation took place under the BCCA or vice versa (i.e. original intention was to have the company incorporated under the BCCA but the incorporation was done under the CBCA)? In such a case, might argue the law of the intended jurisdiction should apply (but of course alternative argument is that the law where the corporation was actually incorporated should apply)
Pre-incorp Ks: BCBCA modifies CL, promoter deemed warranted corp will exist & adopt
1) The old B.C. Company Act (BCCA) had no provision on pre-incorporation contracts (so law in BC on pre-incorporated contracts continued to be the common law).
2) However, the British Columbia Business Corporations Act (S.B.C. 2002, C.57) (“ BCBCA ”) contains s.20 on pre-incorporation contracts:
3)
S.20(1) & s.20(2) deal with the problem with the word “contract” that plagued the original version of the CBCA – both refer to a person who “purports to enter into a contract”. Also note no mention of need for contract in writing (so can be oral)
4) S.20(2) deems the promoter
(“facilitator”) to have warranted that the company will come into existence and will adopt the purported contract, all within a reasonable time a) This is a sort of statutory misrepresentation provision – the promoter is liable for any breach of this deemed warranty b) S.20(8) if expressly agreed in writing, 20(2) does not apply c) Note s.20(2) does not make the promoter liable on the contract itself (as does the CBCA). d) Also note s.20(2) seems to leave open the possibility that the promoter could be liable/bound on the contract but only if the promoter was in fact intended to be a party to that contract (i.e. according to the common law ‘rule of construction’, as in Kelner v. Baxter (this part of the common law does not appear to be affected by the BCBCA)) e) S.20(2)(c) sets the measure of damages as if the company existed when the purported contract was entered into, the person who entered into the purported contract in the name of or on behalf of the company had no authority to do so, and the company refused to ratify the purported contract. This would appear to produce the same result as in Wickberg v. Shatsky . i) If the third party is dealing with a corporation then it is incumbent on the third party to check into the credit worthiness of that corporation. If the warranty had been true and the third party ended up with a contract with the corporation but the corporation would have been bankrupt then the third party will get only nominal damages .
5) S.20(3) company may , within a reasonable time, adopt the pre-incorporation contract (overriding
Kelner v. Baxter on this point)
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6) S.20(4) on adoption, promoter ceases to be liable under 20(2) for the deemed warranty (but note still leaves open possibility of promoter being a party under the common law)
7) S.20(5) if doesn’t adopt
within reasonable time, the promoter or third party may apply to court for order making new company restoring benefits it received under the pre-incorporation contract
( addresses the potential for an unjust enrichment of the company at the expense of either the third party or the promoter)
8) S.20(6) similar to CBCA allowing for apportioning liability
Pre-incorp Ks: creative ways of enforcing, practical advice (e.g. incorp quick with number name)
1) A creative use of the common law (in the broader sense of law and equity) provides a number of ways of avoiding the common law pre-incorporation contract problem discussed above. a) Promoter as trustee of a chose in action : The promoter could be treated as a trustee of a chose in action for the corporation. This would put the promoter under a fiduciary obligation to enforce the contract and would allow an order permitting the company to sue in the name of the promoter as trustee. b) Company as assignee : The circumstances may allow the court to treat the contract as having been assigned to the company (as opposed to ratification by the company). c) Restitutionary principles : The court might accept that although there was no valid contract with the corporation there was a “quasi contract” allowing for a restitutionary based remedy. This could allow a court to redress an enrichment of one party by the performance of another in the believe that there was a valid contract. d) Infer a second contract from a course of dealings : The court might look at part performance of the terms of the original attempted contract and infer another contract between the third party and the corporation. e) Promoter as agent for the third party to make an offer to the company : The promoter might be viewed as an agent of the third party with authority to make an offer to the corporation on the same terms as those involved in the dealing between the promoter and the third party. A purported ratification or adoption by the company could then be considered an acceptance of an offer conveyed by the promoter as agent for the third party. f) Provisional contract to become binding on a future event (the incorporation of the company ) : Yet another alternative is to consider the contract as a provisional (or conditional) contract that would take effect on the incorporation of the company and its adoption of the contract.
2) Even with the statutory provisions there are risks associated with pre-incorporation contracts for both the promoters and third parties. These risks suggest some practical solicitor’s advice
: a) First, promoters who have approached a solicitor to incorporate a corporation should be warned of the problem and instructed that they should not enter into contracts on behalf of the corporation, or at least, that if they do so in a jurisdiction with a provision such as CBCA s.14 there is a risk of personal liability . b) Second, for those promoters who are intent on proceeding quickly one can often have a corporation incorporated fairly quickly . However, there can be problems with the corporate name.
This can be addressed by incorporating under a numbered name and then changing the name later .
If this is done the promoters will have to understand that contracts entered into on behalf of the corporation will have to be entered into under the numbered name and not the proposed, but yet unaccepted, corporate name. c) Third, for any significant transaction , unless one is intimately familiar with the client’s corporate status, it would be a good practice to check the corporate registry to confirm the corporate status checking for the certificate of incorporation and that the corporation remains in good standing. i) To do this you first have to make sure you know where the corporation has been incorporated.
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ii) Then you need to be very careful that you have the correct corporate name in every detail noting every character in the name and details such as whether it is “Ltd.” or “Inc.” abbreviated or “Limited” or “Incorporated” spelled out in full. iii) It is also common in major transactions to require a certified copy of the certificate of incorporation from the secretary of the corporation as a closing document for the transaction.
Corporations: piercing the corporate veil
Piercing the veil: ignoring separate legal entity, holding shareholder/director/officer personly liable
1) The Salomon case is often cited for proposition that a corporation is a separate legal entity . However, as a judge in India once said “a great deal of water has flown down the Ganges since
Salomon v.
Salomon ” (quote from Bhopal case, on whether could pierce the corporate veil of Indian subsidiary to get at US Union Carbide)
2) While it is rare (and hence an uphill battle to argue it before a court), the courts have sometimes disregarded the concept of the corporation as a separate person or separate legal entity to assign liability to individual shareholders, directors or officers (referred to as “ piercing the corporate veil
”)
3) Kosmopolous v. Constitution Insurance Co. of Canada, [1987] 1 S.C.R. 2 a) According to Madam Justice Wilson, courts will pierce the corporate veil where it would be “ too flagrantly opposed to justice ” to apply the principle of the Salomon case (i.e. separate legal personality) b) While an arguably accurate summary, this is vague so not particularly helpful c) As Madam Justice Wilson also noted, the situations in which courts will disregard separate corporate personality follow no consistent principle .
4) To understand when courts will pierce the corporate veil, the following looks at: a) The reasons/rhetoric courts have given for disregarding the corporate entity. b) The various types of cases showing situations where courts have disregarded the corporate entity
(see various “When pierce” below) c) Possible broader policy reasons for disregarding the corporate entity in those types of cases (see various “When pierce” and “Theory of when to pierce” below)
5) Remember though that courts will only rarely disregard corporate personality
Reasons/rhetoric for piercing: agency/alter ego, disregard by sharehlders, akin to fraud, subsidiary
1) When piercing the corporate veil courts have referred to a number of reasons for doing so, as follows:
2) Agency, alter ego, puppet, instrumentality, sham or cloak a) The trial judge in the Salomon case said that Salomon could not claim on the debentures and would be personally liable to the creditors on the basis that the corporation was just an agent of his
(so it’s still a separate entity i) I.e. not really piercing the veil here), but its actions bind the shareholders as principals , so the debts incurred by the corporation are really the debts of the shareholders, and the shareholders are also liable for the tortious acts of the corporation when acting within the scope of its authority b)
In other cases they more loosely refer to the corporation as the “ alter ego
”, “ puppet
” or
“ instrumentality ” of the shareholder, as a “conduit” for the shareholder, or as a mere “ sham ” or
“ cloak
” for the shareholder i) Unclear in such cases if corporation viewed as agent of shareholders, or whether court has really pierced the corporate veil and is treating the corporation and the shareholder as the same person c) While somewhat unclear, use this rhetoric if trying to convince judge to disregard the separate legal entity of a corporation
3) Disregard of corporate entity by the shareholders or directors themselves
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a) Courts have referred to the failure of the shareholder(s) to maintain the separate identity of the corporation (e.g. Tato Enterprises , Roydent Dental ), such as: i) Failure of shareholder to keep separate accounting records for the corporation ii) Failure to maintain corporate records that the corporation is required to maintain iii) Failure to hold corporate meetings iv) Failure to make regular corporate filings v) Failure to use full corporate name with cautionary suffix (e.g. Chiang v. Heppner , Wolfe v.
Moir ) vi) Etc. b) Thus important for lawyer for corporation to make sure all these things are done each year
4) Conduct akin to fraud a) Courts occasionally say they are disregarding the corporate entity on the basis that the promoters of the corporation used the corporation to engage in “conduct akin to fraud”, as in English case of
Gilford Motor Company Ltd. v. Horne, [1933] Ch. 935 (C.A.) (see below)
5) Affiliated enterprises a) E.g. parent company has over 50% voting rights of subsidiaries (in which case accountants consolidate financial statements for the entire collection of corporations) b) The courts appear to be more willing to disregard the corporate entity where the effect of doing so is to link a parent company with its subsidiary or to link a subsidiary with one or more other subsidiaries through a parent corporation. In other words, the court will look at the whole group of related corporations or at what is sometimes referred to as the whole “corporate enterprise.” c) See also “When pierce: affiliated” below d) Smith, Stone and Knight Ltd. v. Birmingham Corporation , [1939] 4 All E.R. 116 is often cited for the tests in making such a linkage & for piercing (which were set out as a basis for determining whether a subsidiary was really just an agent of the parent corporation): i) Facts:
(1) Smith, Stone and Knight Ltd. (SSKLtd) owned all the shares of a subsidiary company that carried on business in Birmingham.
(2) The City of Birmingham expropriated the premises on which the subsidiary carried on business and compensated subsidiary for its business loss. SSKLtd sought compensation for additional losses to it due to the expropriation, and asked the court to pierce the corporate veil so it could see SSKLtd’s losses and not just the subsidiary’s (the law with respect to expropriation was such that a considerably lesser amount would be paid if it was only the subsidiary’s claim).
(3) The City challenged the right of SSKLtd to seek compensation since it was a separate legal entity – the subsidiary company – that carried on business on the premises. ii) Decision:
(1) The court said that an exception to the Salomon principle arises where the corporation is simply an agent of the shareholder. The 6 tests suggested were:
(a) Were the profits treated as profits of the parent company?
(b) Were the persons conducting the business appointed by the parent company?
(c) Was the parent company the head and brain of the trading venture?
(d) Did the parent company govern the trading venture, decide what should be done and what capital should be embarked on the venture?
(e) Did the parent company make profits by its skill and direction ?
(f) Was the parent company in effectual and constant control ?
(2) Applying these tests the court found SSKLtd to be a proper claimant (i.e. the separate corporate entity of the subsidiary was disregarded ).
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iii) Comment : the problem with these tests is that the answers are virtually always yes in virtually every parent-subsidiary relationship (e.g. consider consolidate accounting, and parent has management control over subsidiary) e) But the corporate entity of subsidiaries is not disregarded in every affiliated company case . Thus affiliated alone not enough , there must be something more going on in these cases, such as one of the above rhetoric’s
(e.g. agency/alter ego/failure to comply with corporate formalities/akin to fraud) as demonstrated in the following cases f) Gregorio v. Intrans-Corp. (1984), 18 O.R. (3d) 527 (C.A.) i) Facts:
(1) Gregorio bought a truck from Intrans-Corp. that was defective (improperly aligned frame).
(2) Intrans-Corp. ordered the truck through Paccar Canada Ltd. (a.k.a. Peterbuilt of Canada) the Canadian subsidiary of the U.S. manufacturer, Paccar Inc. Paccar Canada Ltd. ordered the truck from Paccar Inc.
(3) A breach of warranty claim by Gregorio was successful against Intrans-Corp (under sale of goods contract law which has an implied warranty of fitness for purpose)
(4) Gregorio also made a claim against Paccar Canada Ltd. in tort for negligent manufacture of the truck (and there was an indemnification claim by Intrans-Corp. against Paccar Canada
Ltd.). However, Paccar Canada Ltd. did not manufacture the truck – its parent company
Paccar Inc. manufactured the truck. But jurisdictional/conflict of laws problems to sue the
US manufacturer, so wanted to go after the Canadian subsidiary. ii) Issue: Gregorio argued Paccar Canada Ltd. was responsible for the negligent manufacture of the truck because it was one and the same person as the parent company Paccar Inc. (i.e. asked court to ignore the separate legal identity to the Canadian subsidiary) iii) Court of Appeal decision (Laskin, J.A. for the court):
(1) The trial judge erred in disregarding the corporate entity of the subsidiary Paccar Canada
Ltd.
(2)
“Generally, a subsidiary, even a wholly owned subsidiary , will not be found to be the alter ego of its parent unless the subsidiary is under the complete control of the parent and is nothing more than a conduit used by the parent to avoid liability . The alter ego principle is applied to prevent conduct akin to fraud that would otherwise unjustly deprive claimants of their rights.” g) Alberta Gas Ethylene Co. v. M.N.R., [1989] 41 B.L.R. 117 (FTD) Affd [1990] 2 C.T.C. 171
(FCA) i) Facts:
(1) Alberta Gas Ethylene Co. (“AGEC”), a Canadian corporation, sought financing for a pipeline, to come from various insurance companies in the U.S. (in exchange for a debenture)
(2) The insurance companies faced US restrictions on the non-domestic proportion of their investment portfolios, because of which they charged a higher rate of interest for nondomestic loans. To get the lower rate, AGEC incorporated a 100% owned US subsidiary in Delaware under the name Alberta Gas Ethylene Company Security Corporation
(“ASCO”).
(3) The loan from the insurance companies was made to ASCO, which then made a loan in a corresponding amount to AGEC. AGEC paid interest to ASCO in the same amount that
ASCO was required to pay on the loan to the U.S. insurance company lenders.
(4)
The Minister of National Revenue assessed AGEC for ‘withholding taxes’ on interest payments made to ASCO as a non-resident. AGEC argued:
(a)
ASCO had no existence. It was just “a straw man”, “a shell company” and no more than a borrowing arm of the plaintiff (i.e. AGEC is not really paying a non-resident, since ASCO is really the same as AGEC). Thus the court should “lift the corporate
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veil” and ignore the separate identity of ASCO. It would then become obvious that
ASCO was doing nothing more than carrying on the business of the plaintiff.
(b) ASCO was just its agent. In support of this it was argued that the six tests in Smith,
Stone & Knight were satisfied. ii) Trial decision:
(1) It is not “sufficient to consider
the six criteria and when they are all met (as they are in the present case) to ignore the separate legal existence of the subsidiary company. One has to ask for what purpose and in what context is the subsidiary being ignored.”
(2)
“What is more, I do not interpret the jurisprudence as ignoring the existence of subsidiary corporations per se . Rather, it seems to me that the jurisprudence proceeds on the basis that in certain circumstances, consequences will be drawn despite the legal existence of separate subsidiary corporations
.”
When pierce: stop creation of new corp to avoid contract/legislation/tax (gap fill to reduce costs)
1) The following lists situations in which courts appear to be more inclined to pierce the corporate veil together with the possible policy reasons for doing so (on policy, recall pros and cons of limited liability in Corps: intro above)
2) Creation of corporation to avoid contractual obligation – court will disregard corporate entity to gap fill (reducing transactions costs) a) There are numerous ways in which a creative use of a corporation might allow a person to avoid the basic obligation entered into in a contract b) Although the parties did not put in a provision restricting the use of a corporation to avoid obligations under the agreement, the courts may read in such a provision as it would have been put in had the parties directed their minds to it (the court fills in this gap by disregarding the separate corporate entity of the corporation) c) Policy reason – to reduce transaction costs : i) Could simply let the loss lie where it falls and thus give the parties an incentive to be more careful in setting out the terms of their agreement and contemplating potential pitfalls. But given the many creative ways to use a corporation to avoid the basic obligation entered into in a contract, trying to anticipate all of them and then drafting provisions that protect against them could be very costly . ii) The cost may be sufficient to make the contract no longer worthwhile, or it may affect the consideration offered under the contract since one, or possibly both, of the parties must be compensated for the cost of negotiating and drafting provisions that deal with various uses of corporations to avoid contractual obligations. iii) Thus, if the court did not fill in the gaps the cost of transactions may well be substantially increased. iv) Courts do have to be careful, however , that they fill in the gaps in the way the parties likely would have filled in the gaps. If they impose obligations on parties that they would not have anticipated then persons entering into similar future transactions will have to put in detailed provisions to avoid the problems courts create by mistaken gap filling . This can lead to higher transactions costs if the court does not follow an approach of being reasonably certain about how the parties would have filled in the apparent gap if they had turned their minds to it. d) Gilford Motor Company Ltd. v. Horne, [1933] Ch. 935 (C.A.) i) Facts:
(1) Horne had been the managing director of Gilford Motors Company Ltd. (GMCLtd) until he resigned in 1931.
(2) His employment contract had a non-competition clause that said he was not to engage in a competing business with a radius of three miles of GMCLtd for a period of five years after leaving his employment.
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(3) Horne tried to avoid the clause by setting up a company (J.M. Horne Co.) with the shares divided equally with his wife, and with Horne as an employee. J.M. Horne Co. carried on the same business as GMCLtd within the three mile radius and within the five year period.
(4) Horne argued he was not breaching the contract, rather it was J.M. Horne Co. that was doing so ii) English Court of Appeal decision:
(1) The company was a sham designed to avoid Horne’s obligations under the noncompetition contract .
(2) The court treated Horne and the J.M. Horne Co. as one and the same person . Thus the competing business of J.M. Horne Co. was treated as Mr. Horne’s own competing business and he had thus violated the non-competition clause in his employment contract.
(3) The court said that the reason for disregarding the corporate entity of J.M. Horne Co. was that it was being used to engage in “ conduct akin to fraud
.” iii) Comment:
(1) The problem of the incorporation of a company to engage in a competing business might easily have been avoided by a more carefully drafted non-competition clause that made it clear that if Mr. Horne was a major shareholder or significant employee of a competing company that would also be a violation of the clause.
(2) However, this would require that the parties turn their minds to a range of ways in which the non-competition clause could be avoided and negotiate their way to a satisfactory resolution of the clause. Even then the clause might not catch all the possibilities for avoiding the application of the clause.
(3) Thus by treating the J.M. Horne Co. and Mr. Horne as one and the same person the court was essentially filling a gap in the contract in a way that the parties presumably would have had they turned their minds to it. The willingness of courts to do this helps contracting parties avoid the costs of fully specifying every means by which a corporation could be used to avoid a contract .
(4)
The difficulty with the test given though (conduct “ akin to fraud
”) is that it can be very hard to assess what is “akin to fraud.” It apparently doesn’t have to amount
to common law fraud . What Mr. Horne was doing was breaching a contract. The general rule in contract is “perform or pay”, and a breach of contract is not fraud (it is simply a choice of the party to the contract). Nor is an ordinary breach of contract it really akin to fraud . e) Saskatchewan Economic Development Corp v. Patterson-Boyd Mfg. Corp. [1981] 2 W.W.R. 40 i) Facts:
(1) Paterson-Boyd Mfg. Corp. (PBMfg) received a loan from Saskatchewan Economic
Development Corporation (“SEDCO”) pursuant to a contract to which the PBMfg shareholders (Patterson, Boyd and Hoffman) were parties (and giving security on PBMfg assets, and agreement not to give anyone else a higher priority charge on those assets)
(2) The contract bound PBMfg to not pay principal or interest on any loan from a shareholder or an “associated company” until SEDCO paid in full
for its loan. The contract also prohibited sales to any company in which any PBMfg director or major shareholder was directly interested unless the sale was made at prevailing market prices and credit terms.
The shareholders (Patterson, Boyd and Hoffman) also each executed an “Assignment and
Postponement of Claim” document under which they postponed all present and future claims by them against PBMfg to SEDCO .
(3) PBMfg got into financial difficulty. A bank from which the company had a loan on a revolving line of credit reduced its line of credit from $200,000 to $100,000, resulting in
PBMfg not having sufficient funds to carry on its manufacturing business.
(4) Patterson and Boyd (shareholders of PBMfg) incorporated a new corporation by the name of PB Fabricators Ltd. and deposited funds in it . PB Fabricators made a loan to PBMfg ,
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and PBMfg issued a debenture (evidence of the loan) to PB Fabricators that gave PB
Fabricators a first charge on inventory of PBMfg’s custom manufacturing business (but not on the inventory in its pump manufacturing business).
(5) Paterson and Boyd argued that the custom manufacturing business was a new business of
PBMfg that had not been carried on by PBMfg when SEDCO had advanced funds to
PBMfg.
(6) PBMfg continued to do poorly. SEDCO sued arguing the loan repayments to PB
Fabricators (and hence on to Paterson and Boyd) beached their contract (as also did giving
PB Fabricators a first charge on assets) ii) Trial judge upheld the validity of the debenture issued to PB Fabricators. iii) Court of Appeal decision:
(1) The court first decided the case purely based on interpreting the contract:
(a) Rejected the finding that custom manufacturing business was not carried on at time of
SEDCO loan and thus the postponement of claims by shareholders and associated companies in the SEDCO loan agreement applied to the custom manufacturing business.
(b)
Interpreted the term “associated company” in the SEDCO loan agreement to include a company with which the shareholders were associated so that the clause about the postponement of payments of principal and interest precluded payments to PB
Fabricators before SEDCO was paid.
(2)
That was sufficient to dispose of the case, but because the term “associated company” was not clearly defined (and so created some uncertainty), the Court went on to hold that even if PB Fabricators was not an “associated company” the court should lift the corporate veil.
(3) The shareholders of PBMfg were using PB Fabricators to do things which they had contracted not to do under the terms of their agreement . The loan by PB Fabricators was really a loan by the shareholders of PBMfg (i.e. by Patterson and Boyd).
(4) The court cited Gilford Motor Company Ltd. v. Horne as authority for piercing the corporate veil in this situation – thus
PB Fabricators’ separate legal entity ignored
so that it is one and the same with Patterson and Boyd
(5) The Court thus concluded that the debenture to PB Fabricators should be subordinated to the debenture of SEDCO since the debenture issued to PB Fabricators was really in favour of Patterson and Boyd who had promised to postpone their claims in favour of SEDCO. iv) Comment:
(1) The first approach (based purely on contractual interpretation, particularly the expression
“associated company”) would have amounted to saying that PBMfg had breached its contract with SEDCO by making payments to PB Fabricators. The remedy would have been damages against PBMfg, but since it was now bankrupt that wouldn’t be much use for SEDCO.
(2) Thus, while the piercing of the corporate veil was arguably obiter dictum given the court’s interpretation of the contract, piercing made PB Fabricators and Patterson and Boyd parties to the breach since they were one and the same with PBMfg. This allowed SEDCO to obtain damages for breach of contract from PB Fabricators and Patterson and Boyd.
(3) Here it seems clear that what was done by Patterson and Boyd was what was intended would not be done (i.e. payments effectively to PBMfg shareholders (via PB Fabricators) on a loan from the shareholders). By piercing the corporate veil the court is getting the result the parties would presumably have agreed to had they turned their minds to it (thus gap filling by the court saves the SEDCO lawyers time and expense trying to account for every eventuality in the contract)
3) Creation of corporations to avoid statutory requirements – court will disregard corporate entity to gap fill (avoids costly drafting)
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a) In some cases a corporation may be used as a means of avoiding a statutory requirement or restriction. If the court disregards the separate corporate personality in these cases it is arguably engaged in a form of gap filling just as it is in the case of filling gaps in contractual terms (i.e. court is effectively saying: if the legislature had turned its mind to the situation now before the court, it would surely have dealt with the matter by putting in a provision that prevented the use of a corporation to avoid the statutory obligation or restriction). b) As with contractual gap filling, there may be many ways in which a corporation can be used to avoid statutory requirements or restrictions. If the legislature were required to anticipate all of these situations it could make the legislative drafting process very costly and dilatory. c) E.g. British Merchandise Transport Co. Ltd. v. British Transport Commission , [1961] 3 All
E.R. 495 i) Facts:
(1) Legislation permitted only one licence per person . In particular, it did not permit a holder of a C licence to also hold an A licence.
(2) The petitioner was a corporation that held a C licence , and it formed a subsidiary corporation which applied for an A licence . The licence was refused on the basis that the petitioner already held a C licence.
(3) The petitioner responded that:
(a) The person applying for the licence, the subsidiary corporation, did not hold a C licence (indeed, it did not hold any licence)
(b) The subsidiary was a separate company from the parent company so the fact that a separate person (the parent company) held a C licence was irrelevant. Thus the legislation did not permit the refusal of a licence to the subsidiary, and the petitioner sought an order of mandamus requiring the registrar to issue a licence to the subsidiary. ii) Decision:
(1) The licence was legitimately refused .
(2) The subsidiary corporation was used as a mere device to do precisely what the legislation said one could not do.
(3) The court thus disregarded the separate personality of the subsidiary, hence concluding the petitioner already had a licence so it couldn’t get another iii) Comment:
(1) The court was thus arguably filling in a gap. The drafters of the legislation might have dealt with ways in which a corporation could be used to avoid the one licence per person provision in the legislation. But there might be many permutations of the use of a corporation to avoid the legislative restriction and addressing all the possibilities in the legislation might have been costly and might have significantly delayed the legislation.
Piercing the corporate veil in these situations may help avoid some of these costs. d) Perhaps the most frequent cases that arguably fit in the statutory gap filling category are tax avoidance cases . The courts have shown a willingness to disregard the corporate entity in many of these cases, especially when the only purpose for the corporation is to avoid taxes . i) The Income Tax Act is a good example of the degree of detail that may be required to close off gaps if the court does not close them off. For many years the principle of interpretation of taxing statutes was that that a tax would not be imposed unless the legislation very clearly laid out the obligation to pay tax (i.e. taxing statutes were interpreted quite strictly). This may explain in part the length and detail of the Income Tax Act much of which is directed at warding off attempts to avoid tax. Trying to anticipate every way in which a corporation might be used to avoid all the taxing provisions of the Act may be near to impossible and attempting to do so would probably make the Act even more complex. ii) See Dunford, The Corporate Veil in Tax Law (1979), 27 C.T.J. 282.
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iii) E.g. a real estate company bought land for $100,000 and sold for $150,000. This will usually be treated as a $50,000 capital gain, 50% of which will be taxed. However, if the business is engaged in the business of buying, selling and speculating on land, then the $50,000 will be treated as income, 100% of which will be taxed. Real estate companies have tried to avoid this by setting up a new corporation for each and every real estate deal, claiming that each such subsidiary is not in the business of land speculation since it only did one deal. Courts have disregarded the separate legal personality of subsidiaries in such cases.
When pierce: more willing to pierce affiliated/subsidiary to parent Co. than to indiv shareholders
1) See also in
“Reasons/rhetoric” above
the legal rhetoric invoked by courts when they pierce the corporate veil between affiliated corporations. Generally courts appear much more willing to pierce the corporate veil between affiliated corporations . Why ?
2) One reason can be highlighted by contrasting two U.S. cases, which both involve essentially the same fact pattern with one key difference a) Mangen v. Terminal Cabs Ltd.
, 272 N.Y. 676 (1936 N.Y.A.D.) i) Facts:
(1) Terminal Cabs Ltd. was the parent company of four subsidiary taxicab companies , owning
60% of the shares of each of the subsidiary companies (the other 40% of the shares of each being held by two individual shareholders).
(2) The plaintiffs were injured when their car hit a pillar after swerving to avoid a cab owned by one of the subsidiary companies (each with little assets and only statutorily required minimum insurance). The plaintiffs sought to pierce the corporate veil of the subsidiary to get to the parent company Terminal Cabs Ltd. ii) Trial court decision:
(1) The accident was the result of the negligence of the taxicab driver and there was no contributory negligence by the plaintiffs.
(2) The court did pierce the corporate veil to make all subsidiaries and the parent company
(Terminal Cabs Ltd) one and the same legal person, and hence give the plaintiff access to the parent company’s assets b) Walkovsky v. Carlton, 223 N.E. 2d 6 (1966). i) Facts:
(1) Carlton carried on a taxicab business. He set up ten separate cab companies , with him as individual shareholder of all , with each cab company’s assets consisting of just two taxicabs. Taxicab companies tend to use old cars and they get a lot of mileage and a lot of abuse, so the cabs in each of these companies were probably not worth very much (i.e. each cab company was thinly capitalized ). Each company carried the statutory minimum required third party liability insurance of $10,000.
(2) Walkovsky was a pedestrian who was struck by a taxicab owned by one of these ten taxicab companies. His injuries were significant and the assets of the cab company (Seon
Cabs Inc.), together with the insurance of $10,000, were not sufficient to compensate
Walkovsky for his injuries. He sought to have the court disregard the corporate entity and make Carlton personally liable. ii) Decision: A majority of the court refused to pierce the corporate veil to make Carlton (the single shareholder of all the cab companies) personally liable for Walkovsky’s injuries. c) Comment : i) One essential difference in the cases:
(1) In Mangen v. Terminal Cabs the shares of the subsidiary cab companies were owned by another corporation (Terminal Cabs Ltd.) (which of course had its own shareholders) – court did pierce in this case
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(a) I.e. there was an intermediary (Terminal Cabs Ltd.) between the individual shareholders and the separate cab companies
(2) In Walkovsky v. Carlton the shares of the separate cab companies were each owned by an individual , namely, Carlton. – court did not pierce in this case ii) Why the difference between the court decisions?
(1) In Mangen v. Terminal Cabs did pierce, but this did not get to the assets of an individual shareholder ( rather, only got to parent company , Terminal Cabs Ltd). Thus the shareholders of Terminal Cabs Ltd were made worse off because their shares would now be worth less since the assets of Terminal Cabs Ltd. would be reduced, but they would not be personally liable .
(a) Thus a shareholder in Terminal Cabs Ltd. would not have to worry about the ability of other shareholders to contribute to any losses, or to seek indemnity from other shareholders, etc.
(b) In short, the benefits of limited liability discussed above would not be lost (e.g. shareholders in Terminal Cabs Ltd. would not have to be checking the wealth of their fellow shareholders or monitoring their wealth, etc). Courts may not articulate the benefits of limited liability when they make decisions on piercing the corporate veil, but they do seem to have a sense of the potentially significant implications of piercing the corporate veil (as demonstrated by their general reluctance to pierce the corporate veil, and their apparent greater willingness to pierce the corporate veil between affiliated corporations where benefits of limited liability are not lost).
(2) In Walkovsky v. Carlton the majority refused to pierce, and noted, “it is one thing to assert that a corporation is a fragment of a larger corporate combine which actually conducts the business… It is quite another to claim that the corporation is a “dummy” for its individual stockholders who are in reality carrying on the business in their personal capacities for purely personal rather than corporate ends… Either circumstance would justify treating the corporation as an agent and piercing the corporate veil to reach the principal but a different result would follow in each case. In the first, only a larger corporate entity would be held financial responsible … while in the other, the stockholder would be personally liable.”
(a) It might be noted there was only a single shareholder here, so there are very little benefits from limited liability to be lost (and, as demonstrated by other cases, courts do appear more willing to pierce in cases of sole shareholders – see “Theory of when to pierce” below)
3) See also “Theory of when to pierce” below (e.g. maintains benefits of diversification )
When pierce: misreps – sole prop/partner to corp, non-comply (e.g. register, suffix, use name), torts
1) Misrepresentations mislead others into thinking no limited liability – pierce to hold shareholders personally liable
2) Misrepresentation theory: a) If voluntary claimants (i.e. those who chose to deal with the firm, as opposed to an involuntary claimant such as someone hit by a company truck) are aware the business enterprise provides limited liability for equity investors (e.g. they can check this ahead of time though it will involve some “ screening cost
”, which is reduced by legal requirements for a signal of limited liability, such as a suffix e.g. “Ltd.” or “Limited Partnership”), they can either refuse to deal with the business enterprise, or charge a premium (reflecting any added risk that they will not be paid or that other terms of the contract will not be performed), or get personal guarantees , etc b) To avoid having voluntary claimants charge such a premium, etc , the persons operating the business enterprise might be inclined to misrepresent the situation so as to mislead persons dealing with the business into believing that its equity investors will not have limited liability. Might also
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mislead others inadvertently (e.g. when incorporate a partnership). If this were allowed , it would make it more difficult to determine whether any particular business enterprise provided limited liability to its equity investors, and persons dealing with a business enterprise would seem to be left with three options: i) Incur additional screening costs to determine whether the equity investors did indeed have limited liability; ii) Incur the cost of obtaining personal guarantees from the investors; or iii) Just charge a premium without bothering to do either of the first two c) Whichever approach is taken it increases the costs of business transactions across the board . d) Making equity investors personally liable where they have misrepresented the extent of their liability avoids the incurrence of these added costs. Equity investors should be made liable even where the misrepresentation is inadvertent since it is presumably cheaper for the equity investors to be aware of the legal status of the business enterprise and notify persons who deal with the business enterprise of that status than it is for each and every person dealing with the business enterprise to independently determine the legal status of the business enterprise. e) The concept of misrepresentation in piercing the corporate veil is that persons dealing with the corporation are somehow deceived into thinking their contract was with some person other than the corporation .
3) This is most likely to occur when a business carried on by a sole proprietor or partners is transferred to a corporation , in which case persons previously dealing with the business (and still dealing with same people who are now agents of the corporation) may not realize it is now a corporation with limited liability for those persons (recall Saloman ). a) The shareholders may be unjustly enriched at the expense of such misled persons who may, for example, advance credit on terms they might not otherwise have had. b) By piercing the corporate veil in these situations the court compensates the persons who are misled and creates an incentive for those transferring business assets to corporate entities to inform persons who previously dealt with them and who might otherwise be unaware of the limited liability created by the transfer ( otherwise those dealing with partnership will have to check its status every time they deal with it to make sure it’s still a partnership) c) Recall statutory requirement in Partnership Act s.39
for notice when “change in its constitution”, which likely includes a shift from a partnership to a corporation (see “Retired partners and new liabilities” in “New partners not liable for old” in Partnership above) d) Gelhorn Motors Ltd. v. Yee (1969), 71 W.W.R. 526 (Man. C.A.) i) Facts:
(1) The defendants, Yee and Wilcox, carried on a car exchange business. They began dealing with Gelhorn Motors Ltd. (GML) in October of 1961, before application for incorporation sometime in November of 1961 (eventually a corporation under the name Empire Car
Exchange Ltd. (ECEL) was incorporated)
(2) Orders for cars continued to be made after the incorporation. GML sued Yee and Wilcox for unpaid amounts on cars sold and delivered to the car exchange business. Yee and
Wilcox did not dispute the contract for the cars or the delivery of the cars, but argued that the suit should be against ECEL since the business was carried on by ECEL and the contract was thus with ECEL. ii) The Manitoba Court of Appeal decision:
(1) The evidence indicated that GML had not been made aware of the incorporation .
(2) The court therefore disregarded the corporate entity, so treated ECEL and its shareholders as one and the same, so Yee and Wilcox were personally liable .
4) There have been several other cases which involve more questionable applications of a misrepresentation theory . a) Corkum v. Lohnes (1981), 81 A.P.R. 477 (N.S. App. Div.)
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i) Facts:
(1) Corkum sued Lohnes for blockage of his right of way and for damages arising from the pollution of his well
(2)
Lohnes had entered into a contract to fell lumber on a property near Corkum’s property.
The contract was signed in Lohnes’ own name, and he agreed to indemnify the owner of the property (Mr. Fancy) “for any and all claims made by anyone against the [owner] in respect to damages or trespasses or any other claim in respect to the said lands.”
(3) One of the defences raised by Lohnes was that the action should have been brought against
Elmer Lohnes Lumbering Ltd. (ELLL) and not against him personally because it was
ELLL that carried on the business, so if any damage was done to Corkum it was done not by him personally but by ELLL. ii) Decision:
(1) Lohnes was estopped from denying responsibility for the blockage of the right of way or damages to the well since he had signed the contract with the third party (indemnifying the nearby property owner Mr. Fancy) in his own name . iii) Comment:
(1) The contract in question here was not a contract between Corkum and Lohnes – it was a contract between Lohnes and Mr. Fancy. Lohnes’ failure to sign the contract with Fancy in the name of the company was nonetheless treated as preventing Lohnes from denying personal liability.
(2) Corkum was thus not misled here by entering into a contract – rather, this was tort claim.
The theory for piercing the corporate veil in this case probably fits better into the nonconsensual claimants considerations discussed below. b) As an example of an even less plausible case of misrepresentation: Chiang v. Heppner (1978), 85
D.L.R. (3d) 487 (B.C.) i) Facts:
(1) Chiang left her $2,500 watch with Mr. Heppner for repair. Although the business was carried on under the name Heppner Jewellers Ltd. (HJL), Chiang received a receipt ticket in the name of “Heppner Credit Jewellers”.
(2) Chiang returned to the store approximately ten times in the next several months but the watch was never ready because certain parts had been lost by the defendant. Mr. Heppner had kept the watch in the safe but when the parts arrived it was left on the work bench while it was being repaired. The store was destroyed by a fire (that destroyed several shops in the Abottsford Shopping Mall) and the watch was badly damaged. ii) Decision:
(1) The judge first dealt with the responsibility of a bailee for value
(2)
The judge then considered the question of Mr. Heppner’s personal responsibility: “A further question of the defendant Heppner’s personal responsibility arises. It is clear that
Mr. Heppner held himself out to be a sole proprietor and his claim ticket , Ex. 2, showing the name ‘Heppner Credit Jewellers’, gives no indication of the limited company . There is no evidence that the plaintiff could in any way have been aware of the organization,
Heppner Jewellers Ltd. All the plaintiff's dealings were with Heppner on a personal basis.
Accordingly, I hold that Heppner has personal responsibility to the plaintiff.” iii) Comment :
(1) It is unlikely that Chiang’s decision to leave her watch with Heppner was in any way influenced by whether Heppner’s jewellery business was carried on by Heppner as a sole proprietorship or through a corporation .
(2) There was some indication that although there was insurance for HJL, the insurance company was denying liability. That may explain, in part, the reason the suit was brought against Heppner personally. The plaintiff might have a reasonable expectation that a watch
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repair shop would have insurance that would cover losses due to fire and that any damage to the watch while in the repair shop would be covered under that insurance. Making
Heppner liable here might have simplified matters . Heppner could then proceed against the insurance company (perhaps through HJL).
(3) Rhetoric wise, Heppner didn’t follow corporate formality of using full corporate name with cautionary suffix (Ltd), thus wasn’t properly treating it as a separate legal entity himself
5) Generally the failure to comply with corporate formalities , particularly in a sole shareholder corporation, increases the risk that the corporate entity will be disregarded . a) E.g. Chiang v. Heppner above b) Tato Enterprises Ltd. v. Rode (1979), 17 A.R. 432 (Alta. Dist. Ct.) is a perhaps more difficult case of misrepresentation. i) Facts:
(1) Tato Enterprises Ltd. (TEL) was owed money on a written contract entered into with Scott
Bradley Ltd. (SBL). The contract was signed on behalf of SBL by Edward Rusnak as secretary and by Glen Rode as president.
(2) In fact there was no such company as SBL . There was a Scott Bradley Marketing Ltd.
(SBML) but no business had been done through it, it did not have a bank account and had no assets. Amounts that were paid were paid by Glen Rode personally, and SBML did not purport to ratify anything done by Rode. ii) Decision:
(1)
The court held Rode personally liable stating that, “In this case, …, the corporate formalities have clearly been offended and, in fact, there has been a wide and broad failure of compliance with corporate formalities. The failure of the defendant Rode to take the time and trouble to determine the correct name of the corporation and to conduct his business in that name is simply a further evidence of his failure to comply with those requirements of The Companies Act which are necessary if a person purporting to be an agent of a corporation is to avoid personal liability . Accordingly, the limited liability otherwise available to a director or officer of a body corporate as the agent of that corporation, is not available to the defendant Rode and it is my view that the contracting parties in the matters before me are the plaintiff and the defendant Rode personally
.” iii) Comment:
(1) Here TEL must have assumed that it was dealing with a corporation but the court still made Rode personally liable . Arguably TEL should have made sure just who it was dealing with. On the other hand, there was clearly an intended contract but a mistake was made as to who the parties to the contract were. As between TEL and Glen Rode, Glen
Rode was arguably the one who could have avoided mistake at least cost . c) Roydent Dental Products Inc. v. Inter-dent Int'l Dental Supply Co. of Canada [1993] O.J. 708 i) Facts:
(1) The plaintiff, Roydent Dental Products Inc. (RDPI) had sold goods to Inter-dent
International Dental Supply Co. (IIDSC) on credit and was not paid.
(2) RDPI had made no inquiry into whether IIDSC was a corporation or not. It was in fact just an unincorporated division of another company. ii) Decision:
(1) Nonetheless, the shareholder of the company was found personally liable on the basis that the shareholder had failed to register the business name of the division and therefore had failed to comply with requisite legislative formalities. iii) Comment:
(1) In this case the plaintiff appears not to have relied on personal liability , in that the plaintiff did not make any inquiries as to whether the entity dealt with was an incorporated entity or not. However, it would have been difficult for the plaintiff to make inquiries since the
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business name was not registered. The business name also gave a misleading impression that the entity was a corporate entity.
(2) Recall that just because the word “company” (or its abbreviation) appears it does not necessarily mean it is an incorporated entity. It is common for partnerships to add the words “ and Co.
” and it is also possible that partners have retired leaving just a sole proprietor continuing to carry on the business under the “and Co.” name. d) Failure to use the cautionary suffix i) Section 10(5) of the CBCA (and similar sections in other corporate statutes in Canada) require the corporation to put the corporate name, together with the cautionary suffix (e.g. “Ltd.”) on every order form, contract, invoice, etc. of the corporation. The consequence of not doing so under the CBCA is that it is an offence under CBCA s. 251 of the Act not to do so. ii) However, courts have frequently seized upon this failure to comply with the corporate statute as a basis for making a shareholder personally liable . iii) E.g. Chiang v. Heppner above, Wolfe v. Moir below e) Seizing upon misrepresentation in tort actions to effect compensation (see next section)
When pierce: compensate non-consensual tort victims, use misreps (bizarre), distrib justce/deternce
1) The primary example of an involuntary (i.e. non-consensual) claimant would be the victim of a tort committed in the conduct of the business enterprise. a) E.g. a pedestrian hit by a van used by a courier business would not be a voluntary claimant.
Unlike someone choosing to contract with a business, the pedestrian could not choose the business whose van would hit them, nor would they be able to charge the business a premium for limited liability.
2) Seizing upon misrepresentation in tort actions to effect compensation a) In some cases courts seize upon a failure of the promoters of a company to treat the company as a separate entity in order to effect compensation in tort actions. Tort claimants , however, are not normally persons who deal with the company in advance and thus are not mislead as to the nature of the entity they are dealing with. i) E.g. in Walkovsky v. Carlton , Mr. Walkovsky did not have much choice about whether he was about to be hit by a taxi owned by the thinly capitalized Seon Cabs Inc. b) Generally cases involving tort claimants involve concerns other than misrepresentation but the court may use rhetoric suggesting that some kind of misrepresentation may have occurred. E.g.
Wolfe v. Moir (1969), 69 W.W.R. 70 i) Facts:
(1) Barry Wolfe went roller skating at Fort Whoop Up operated under the business name
“Moir’s Sport Land”, and the words “Fort Whoop Up” were worked into the tiles of the building (i.e. these were two DBA (doing business as) names )
(2) In fact the business was carried on through a corporation, Chinook Sports Ltd. The ticket
Barry purchased only referred to Fort Woop-Up and advertising about Moir’s Sport Land, and Fort Whoop Up did not mention Chinook Sports Ltd.
Other formalities regarding the corporation were apparently also not followed .
(3) Barry Wolfe was injured and sued Moir in his personal capacity. Moir argued that it was the corporation that carried on the business and that it was thus the corporation that should be sued for the tort. ii) Decision:
(1) The court held that Moir had failed to follow statutory requirements and that he therefore took the risk of being held personally liable . iii) Comment:
(1) CBCA requires one to use the full corporate name including the cautionary suffix in all corporate documents . Failure to do so results in a penal sanction for breach of the statute.
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Nothing in statute says that the consequence is the disregarding of the corporate entity .
This is a consequence the court has imposed in the circumstances.
(2) Generally the failure to comply with corporate formalities, particularly in a sole shareholder corporation, increases the risk that the corporate entity will be disregarded.
(3) But must ask:
(a) Was there a misrepresentation in Wolfe v. Moir as a result of the failure to use the corporate name? If the corporate name had appeared on the ticket, in the advertising and, perhaps also in the roof tiles, would Barry Wolfe have made a different decision as to whether he would go roller skating?
(b) If the corporate name had appeared on the ticket and advertising should it have made any difference as to whether compensation would be provided to Barry Wolfe? Why should the observation of the corporate formalities be relevant? In some cases the concern for compensation may be equally as strong, but if the corporate formalities are observed then the tort victim may not be compensated. This seems a bizarre way of deciding who should be compensated.
(c) Is the effect of penalizing those who do not follow the corporate formalities a way of encouraging those who incorporate companies to engage lawyers to assure that the corporate formalities are observed? Is there any other real benefit to ensuring that corporate formalities are observed?
3) A better way to consider tort cases is to think of underlying policy reasons: a) Distributive justice : i) The concern for compensating tort victims may explain a somewhat greater willingness of courts to pierce the corporate veil in tort cases . E.g. Wolfe v. Moir ii) E.g. if corporate assets insufficient to fully compensate the tort victim, make shareholders, directors, officers and/or employees personally liable to make up the shortfall in compensation.
Here the benefits of preserving limited liability may be surrendered to address the distributive consequences of not fully compensating a tort victim. b) Deterrence: incentive costs and efficiency i) The concern to create sufficient deterrence may also explain a somewhat greater willingness of courts to pierce the corporate veil in tort cases . ii) The injury caused by the van might have been in part the result of something in control of the managers of the courier business. E.g. they might have set up an incentive for drivers to make speedy deliveries by paying the drivers on a per delivery basis. This could give the drivers an incentive to drive too fast and recklessly thereby increasing the risk of injury causing accidents. iii) Imposing liability on the business enterprise, making the investors pay the damages, could create an incentive on the managers to devise a compensation method that takes this risk into account. iv) However, if investor liability is limited to the amount of their investment, there is a potential for a so-called “ sanction insufficiency
” or “ deterrence trap
”. If investors have invested only
$1M but the potential damages are $10M, they will not have to cover the full damages so do not have an incentive to cause managers to take the full cost into account in devising the driver compensation mechanism. v) One way of restoring the full incentive effect is to override the limited liability of investors in tort claims, but this could result in the loss of the benefits of limited liability to society, and other problems . E.g. who should be liable, shareholders at the time of the accident, at the time of the action was brought, or at the time judgment is rendered, etc.? vi) Perhaps there are other ways to deal with these concerns that do not result in the loss of efficiency benefits (e.g. more insurance or a broader accident compensation scheme )
4) However , courts do not automatically pierce the corporate veil in tort cases .
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a) E.g. court did not pierce in Walkovsky v. Carlton (although it was a 5-2 split decision). Making
Carlton personally liable would presumably have provided greater compensation for Walkovsky, perhaps encouraging others in his position to carry better insurance. However, there might be little incentive for a relatively judgment proof person who owned two beat up old cabs to carry better insurance. Perhaps what was required was a requirement for persons operating cab companies (or driving cars) to carry much higher levels of insurance that the statute required.
Agent (dir/off/emp) liable tort v involuntry claimnts (safety/competitors) (if personal interst/fraud?)
1) There are a number of other ways to hold agents of a corporation (i.e. directors/officers/employees, who may also be shareholders) personally liable without disregarding the separate legal personality of corporations. a) Since a corporation can only act through human beings, a tort committed by a corporation must be committed by the act of one or more individuals. b) The corporation is vicariously liable for the tort if the individuals, acting as agents for the corporation, committed the tort in the scope of their authority as agents. However, agents themselves can be liable for their tortious acts. c) Thus instead of (or in addition to) suing the corporation for the tort one might also consider suing the individuals. d) Concern, however, that making an officer of the corporation liable (especially when the officer is also a shareholder of the corporation) amounts to making “an end run around the corporate veil
” e) This is most common in closely-held corporations .
2) Berger v. Willowdale A.M.C. (1983), 145 D.L.R. (3d) 247 a) Facts: i) Ms. Berger worked for Falken Automobiles Inc. (FAI) which had a car display area and a repair shop in Toronto. Weather was changeable (snowed, freezing rain, slush, slush froze). ii) Mr. Falkenberg, the president of FAI had instructed certain employees to clear the ice from the steps and the area in front of the establishment. The employees failed to do this and Mr.
Falkenberg did not follow up to ensure that the job had been done. It snowed again so the ice was concealed by snow. Ms. Berger slipped getting into her car at the street in front of the business establishment. iii)
As an employee the remedy for Ms. Berger was to make a worker’s compensation claim under worker’s compensation legislation. Ms. Berger was not happy with the compensation she received through worker’s compensation. She could not seek additional compensation from the company because a tort action against the employer (the company) was precluded by the legislation. Instead she sued Mr. Falkenberg. iv) The first defence was that the Worker’s Compensation Act precluded an action against either the employer or a fellow employee. b) Decision: i) The
Workers’ Compensation Act provision precluding an action against a fellow employee did not apply to an executive officer of a corporation since an executive officer was not an
“employee” under the Act. ii) It was held that the president (Falkenberg) had a duty to make sure the walkway was safe for the employees and was negligent in failing to see to it that the ice was removed.
3) Said v. Butt [1920] 3 K.B. 497 a) Facts: i) There was a dispute between Mr. Said and Mr. Butt. Mr. Butt was the managing director of the Palace Theatre Ltd. Mr. Said had made certain allegations against Mr. Butt and other officials of the theatre concerning a light opera produced at the theatre. These allegations were deeply resented by Mr. Butt and the theatre officials, and refused to sell Mr. Said tickets to a new play.
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ii) He sent Mr. Pollock to buy a ticket on his behalf , who never disclosed that he was buying a ticket for Said. On the evening of the performance, Butt saw Said in the vestibule of the theatre and gave instructions to the attendants that Said was not to be allowed admission even if he had a ticket. They offered Said the money for his ticket but he refused to take the money. iii) Mr. Said brought an action against Mr. Butt for the tort of inducing breach of contract. b) Decision McCardie J: i) Issue of undisclosed principal
(1) Before a breach of contract could be induced there had to be a contract. But was there a contract here? Mr. Pollock did not disclose that he was acting for Mr. Said. Mr. Said was thus an undisclosed principal.
(2) Normally an undisclosed principal can disclose the agency relationship and sue the third party directly, but not if it is clear that the third party would not have contracted with the principal had they known the identity of the principal (as is clearly the case here – the
Palace Theatre Ltd. would not have contracted with Mr. Said had they known that Mr. Said was the person on who’s behalf the ticket was being purchased).
(3) Thus there was no contract with Mr. Said and Mr. Butt could not be liable for inducing a breach of a contract that did not exist. ii) The following on potential liability of officers of companies for inducing breach of contract is therefore obiter .
(1)
“if a servant acting bona fide within the scope of his authority procures or causes the breach of a contract between his employer and a third person, he does not thereby become liable to an action of tort at the suit of the person whose contract has thereby been broken…
(2) Judge went on to say this exception is specific to the tort of inducing breach of contract :
“Nothing that I have said to-day is, I hope, inconsistent with the rule that a director or a servant who actually takes part in or actually authorizes such torts as assault, trespass to property, nuisance , or the like may be liable in damages as a joint participant in one of such recognized heads of tortious wrong.” c) Comment: i)
In spite McCardie’s additional remarks,
Said v. Butt was occasionally subsequently cited for the broader proposition that directors or officers of corporations could not be liable for torts committed when they were acting bona fide within the scope of their authority as agents for a corporation.
(1) E.g. McFadden (below), itself a case of inducing breach of contract but one in which the officers of the corporation were found personally liable, discussed the Said v. Butt exception as an exception based on directors, officers or employees acting bona fide within the scope of their duty. ii) This broader interpretation was questioned more recently by the Ontario Court of Appeal in
ADGA Systems International Ltd. v. Valcom (below)
4) McFadden v. 481782 Ont. Ltd. (1984), 47 O.R. (2d) 134 a) Facts: i) The plaintiff, McFadden was employed by Practical Management Associates Inc. (“PMAI”), a
U.S. corporation. The employment contract was for a fixed term until July 1, 1982, and thereafter was terminable on 60 days notice . ii) On June 1, 1981, Norman and Mary Taylor (husband/wife) incorporated Practical
Management Associates (Canada) Inc. (“PMAC”) under the Ontario
Business Corporations
Act , which later changed its name to 481782 Ontario Limited. PMAC bought the Canadian business of PMAI and continued to employ McFadden under the terms of his contract with
PMAC. The business assets were later sold back to PMAI except for accounts receivable from upcoming services to be provided by PMAC. After the accounts receivable were taken in, the
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remaining funds in PMAC were withdrawn as salary or dividends in favour of Norman and
Mary Taylor. iii) McFadden was dismissed April 5, 1982. iv) Further funds were withdrawn from PMAC over the course of the next three days rendering
PMAC insolvent . b) Decision Callon J: i) Norman and Mary Taylor were held personally liable for the tort of inducing breach of contract . ii)
“I have some difficulty with the rationale offered for the decision in Said v. Butt
… in
Winfield’s Law of Torts … The fact that the agent is an alter ego of the corporation may afford a defence to the corporation (since it makes no sense to sue it for both breaching and inducing itself to breach a contract), but it is not clear why that should relieve the agent. For as a general rule , an agent is always liable personally for his tortious acts , notwithstanding that his acts (and hence his liability) may in law also be those of the corporation … And it is also accepted that a principal may be relieved of liability for the tortious act of his agent, where the act is outside the agent’s scope of authority
, real or implied – though the agent himself remains liable ... iii) “It appears to me that the real reason for relieving the agent of liability lies instead in the realm of justification, inasmuch as an act of inducement may be excused if there is “ sufficient justification
”… And it is clear that under both statute and common law a director or officer of a company is under a duty to act with a view to the best interests of the company . Acts of inducement are justified where they are “taken as a duty”. iv)
“In short, if an officer or director of a corporation is to be relieved, as an agent, of the consequences of his otherwise tortious act of inducement, it is not because he is the company’s alter ego. Rather, it is because in so acting he acts under the compulsion of a duty to the corporation. His act is thus justified. But where he does not act under such a duty, as, for example, where he fails to act bona fide within the scope of his authority, his act is no longer justified, and he becomes liable . The corporation remains insulated from the legal consequences of such an act, inasmuch as the director or officer has acted outside the scope of his authority . v)
“Thus if it could be said that in acting as they did Norman and Mary Taylor were acting in furtherance of their duties and obligations as directors and officers of PMAC, then they would have available to them the defence of justification for any breach of contract they induced.
But in procuring and inducing the breach of the plaintiff’s contract with PMAC, they were not acting in furtherance of any such duties and obligations.”
5) The Ontario Court of Appeal recently reviewed the so-called Said v. Butt exception to the liability of officers in: ADGA Systems International Ltd. v. Valcom Ltd.
(1999), 43 O.R. (3d) 101 a) Facts: i) ADGA brought an action against its competitor Valcom Ltd. ii) ADGA had a contract with Correctional Services Canada for technical support and maintenance of security systems in federal prisons. The contract was up for renewal in 1991.
The tender required the tendering party to provide the names of 25 senior technicians. iii) ADGA had 45 such employees while Valcom had none.
Valcom’s
sole director and two of its senior employees convinced senior employees of ADGA to allow their names to be used on
Valcom’s tendering document, to come to work for Valcom if their tender were successful and to convince other ADGA employees to do the same. All but one of the 45 ADGA employees signed on with Valcom. iv) ADGA sought damages against Valcom and its director and senior employees on the basis of, among other things, the tort of inducing breach of contract . b) Decision (Carthy J.A. for the court):
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i) Quoted McCardie J. in Said v. Butt noted above, and then commented as follows: ii)
“For present purposes, I extract the following from McCardie J.’s reasons. iii)
“First, this is not an application of
Salomon . That case is not mentioned anywhere in the reasons. iv) “Second it provides an exception to the general rule that persons are responsible for their own conduct . That exception has since gained acceptance because it assures that persons who deal with a limited company and accept the imposition of limited liability will not have available to them both a claim for breach of contract against a company and a claim for tortious conduct against the director with damages assessed on a different basis. The exception also assures that officers and directors, in the process of carrying on business, are capable of directing that a contract of employment be terminated or that a business contract not be performed on the assumed basis that the company’s best interest
is to pay damages for failure to perform . By carving out the exception for these policy reasons, the court has emphasized and left intact the general liability of any individual for personal conduct.”
(1) I.e. exception for tort of induced breach of contract is to avoid double compensation and to allow for breaches when economically rational to do so – but exception is limited to this one tort v) Carthy, J.A. then cited cases, including Berger v. Willowdale A.M.C. (1983), 145 D.L.R. (3d)
247, in which an officer or employee was held liable for tortious conduct in carrying out duties on behalf of the company . vi) Carthy, J.A. then explained the development of the cases in the following way, “Although the jurisprudence on this subject has followed a very straight path since the decisions in Salomon v. Salomon and Said v. Butt , in recent years in this jurisdiction judges hearing motions to dismiss claims have tended to smudge these principles, inspired, in my view, and as expressed by them, by the legitimate concern as to the number of cases in which employees, officers and directors are joined for questionable purposes. The assumption has filtered into reasons for judgment that the employee is absolved if acting in the interests of the corporation , the employer, even in cases that do not raise the Said v. Butt defence.” vii) Carthy, J.A. also noted the distinction drawn by LaForest, J. in the Supreme Court of Canada case of London Drugs v. Kuehne & Nagel (S.C.C.) between voluntary claimants (i.e. those that had dealt with the company so should understand it is limited liability), who have in some manner accepted that their recourse would be to the company only , and involuntary claimants who have not implicitly accepted that their recourse would be limited to the company and who
“ naturally look for liability to the persons who have caused the harm
”. viii) Carthy, J.A. concluded that, “… there is no principled basis for protecting the director and employees of Valcom from liability for their alleged conduct on the basis that such conduct was in pursuance of the interests of the corporation. It may be that for policy reasons the law as to the allocation of responsibility for tortious conduct should be adjusted to provide some protection to employees where, for instance, they are acting in the best interests of the corporation with parties who have voluntarily chosen to accept the ambit of risk of a limited liability company. However , the creation of such a policy should not evolve from the facts of this case where the alleged conduct was intentional and the only relationship between the corporate parties was as competitors
.” c) Comment: i) ADGA Systems thus appears to limit the Said v. Butt exception to cases involving the tort of inducing breach of contract . ii) The reason for this is that in the tort of inducing breach of contract the plaintiff would have a claim for damages against the corporation for breach of contract and a claim for damages again against the directors, officers or employees responsible for inducing the breach of contract. This problem would arise in every case of a breach of contract by a corporation since
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the decision to breach would have to have been made by one or more individuals on behalf of the corporation. While the court may be able to deal with the potential for double compensation in some way it would still be left with the problem that the damages for each claim are calculated on a different basis. iii) The plaintiff in these cases would also have dealt with the corporation in entering into the contract and thus, subject to potential misrepresentation problems discussed above, should have appreciated that it was dealing with a corporation and that its claim would be limited to the assets of the corporation . iv) There may be other situations in which voluntary tort claimants tort claims against directors, officers or employees should be constrained , but Carthy J.A. was unwilling to expand on these until a specific fact situation arose in which to assess whether such protection should be extended.
6) The ADGA Systems case prompted a lot of comment. It raised the spectre of potential substantial tort liability for directors, officers and employees . Two recent B.C. cases , while citing ADGA , follow a much narrower principle. a) Rafiki Properties Ltd. v. Integrated Housing Development Ltd. (1999), 45 B.C.L.R. (2d) 316 i) Facts:
(1) Rafiki Properties Ltd. had contracted with Integrated for development management services in the development and construction of a hotel. Rafiki alleged that it relied to its detriment on false representations of Integrated and its two principles (who were the only shareholders, directors and officers of Integrated). ii) Decision Clancy J:
(1) Adopted the principle set out in an earlier B.C. case that a director “can only attract personal liability if he is acting outside the scope of his authority in being motivated by advancing a personal interest contrary to the interests of the company, or by fraud , or with malice
.” b) Better Off Dead Productions Ltd. v. Pendulum Pictures (2002), 22 B.L.R. (3d) 122 (B.C.S.C.) i) Facts:
(1) Better Off Dead claimed they relied on misrepresentations in advancing funds to Pendulum
Pictures and extended the claim to the president of Pendulum. The president sought to have the claim against him personally dismissed. ii) Decision Holmes J:
(1)
Dismissed Better Off Dead’s claim against the president of Pendulum saying, “I find nothing to distinguish the situation here from that addressed by Clancy J. in Rafiki
Properties Ltd … Clancy J. reviewed the authorities, including the Ontario Court of
Appeal’s decision in
ADGA Systems … which recognized some scope for the individual liability of directors and officers for tortious conduct even when committed in the course of their duty .
(2)
“[Clancy J.] concluded … that an individual defendant will bear personal liability for acts committed on behalf of a company only where the torts are those of the individual and the allegations show an identity or interest separate from that of the company
.” [i.e. not good faith and within scope]
7) Some policy considerations in making directors, officers or employees personally liable for torts committed in carrying on the business of the corporation a) Could overcome the “ deterrence trap ” or “ sanction insufficiency ” problem (discussed above) and restore the incentive to take sufficient care . b) However , this could lead to excessive deterrence with managers emptying the coffers of the business enterprise at the expense of investors to protect themselves from liability (e.g. imagine tort loss would be $200K, but if take protections to avoid it the loss to the company might be
$10M)
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c) This potential for excessive deterrence could be controlled by indemnifying the directors and officers for liability they incur and through the purchase of insurance . The costs of the indemnification and insurance would be born by the business entity without extending the liability of investors beyond the amount of their investment, and could be reflected in the prices for the goods or services provided by the business enterprise so that consumers bear the full cost of harm prevention or compensation that production of those goods or services entails. d) Difficulties with an insurance solution to the problem of compensation have arisen in the past.
Burgeoning tort liability in the 1980s led to uncertainty about the potential scope of liability, making it harder for insurers to predict claims and to price insurance coverage. This, coupled with regulatory difficulties in setting adequate premiums for insurance associated with these uncertain levels of loss, led to the absence of insurance for various types of losses (e.g. it was difficult to obtain insurance for environmental losses). An insurance crisis could limit the effectiveness of insurance at balancing deterrence and excessive deterrence. However, the solution to this problem probably rests in insurance regulation to reduce the likelihood of an insurance crisis rather than in refusing to make directors and officers (the so called “gatekeepers”) personally liable for their tortious acts.
Oppression remedy: dir/off liable for unfair prejudicial acts to creditor/dir/off (eg. dismissal)
1) It may also be possible in some cases to make director or officers liable on the basis of a corporate oppression remedy a) E.g. in a closely-held corporation, shareholders often also act as directors – those directors might effectively lock another shareholder’s investment into the company but fail to ever pay out any dividends (channelling profits out of the company through directors salaries instead). The lockedin shareholder might try using the oppression action against the directors.
2) CBCA s.241 allows the court to make an order for relief on the basis that the conduct of the affairs of the corporation has been oppressive or unfairly prejudicial to , or that unfairly disregarded the interests of, a “complainant” in the “complainant’s” capacity as a “ security holder, creditor, director or officer
”. a) S.241(3): the court is given wide powers for providing relief including the power to make “an order compensating an aggrieved person
” (s.241(3)(j)). The court might then make an order for compensation against a particular director or officer of the corporation. b) This was done, for example, in PCM Construction Control Consultants Ltd. v. Heeger , [1989] 5
W.W.R. 598. i) Facts: The plaintiff (a shareholder and director of the corporation) was held to have been wrongfully dismissed . The corporation , however, had been reduced to a mere shell corporation (not unlike the McFadden case above). ii) Decision: In addition to the wrongful dismissal, the court held that there were various oppressive acts and applied the ABCA equivalent of CBCA s.241(3)(j) (an order compensating an aggrieved person) ordering the other directors of the corporation to compensate the plaintiff.
3) See also Fergusson v. Imax below (influence to ensure dividends not paid out so ex-wife didn’t get anything)
4)
See also “ derivative action
” by shareholders in Corporate Governance below ((s.238,239))
Dir liable for shares not paid for, actions if insolvent (shareholders also), unpaid wages, enviro
1) Although a corporation is a separate person from its directors and shareholders, there are some CBCA provisions which allow for disregarding this separate personality
2) CBCA s.118
sets out a number of circumstances in which directors (and shareholders ) may be found personally liable . a) S.118(1) directors can be liable for issuing shares without receiving full payment for the shares. b) S.118(2) directors can be liable for purchasing, redeeming or otherwise acquiring shares , paying commissions for the sale of shares, paying dividends , providing financial assistance to
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shareholders, directors, officers or employees, or for paying an indemnity to a director or officer if certain tests of insolvency are not satisfied . c) Even though shareholders are separate persons from the corporation they can be held liable under s.118(4) to indemnify a director who has been held liable under s.118(2) where they have been recipients of any of the funds paid out pursuant to a resolution of the directors contrary to the provisions listed in s.118(2).
3) Unpaid wages: a) When a corporation is in financial difficulties it may be unable to pay all of its liabilities as they come due. In an effort to keep the business going management may decide not to pay certain liabilities, such as payroll. Employees may capitulate in this for fear of losing their jobs if the business goes under. b) If a claim were made by employees against directors or officers for the unpaid wages, the directors or officers might well defend by relying on the separate personality of the corporation saying that the employees’ contracts are with the corporation and their claim is solely a claim against the corporation. This vulnerability of employees has been addressed in employment standards legislation and in corporate legislation. c) CBCA s.119 overrides any argument that the directors are not liable on the basis that the employee contracts are with the separate corporate legal entity. It provides that directors are jointly and severally liable to employees for up to six months of unpaid wages . d) Section 96 of the B.C. Employment Standards Act provides similar protection for up to 2 months of unpaid employee wages. e) This way of addressing unpaid employee wages when corporations are in insolvent circumstances has led to problems . When the corporation is experiencing financial difficulties directors , fearing the risk of personal liability, have resigned en masse at a time when it can ill afford to be without a board of directors (resolutions of a board of directors may be required for decisions that might be made in the context of attempting to restore the company to financial viability), thus almost guaranteeing insolvency . i) This is therefore an area of law that perhaps requires amendment , and other mechanisms of protecting employees against unpaid wages should be considered. E.g. it has been suggested to put employees in a higher position on an insolvency, perhaps even ahead of secured creditors.
4) There are also provisions under environmental legislation that hold directors personally liable
Theory of when pierce/for who: voluntary (gap fill reduce costs), involuntry (when costs > benefits)
1) Other stakeholders may be affected by the limited liability of the corporation. They may end up with unsatisfied claims and may not have appreciated the significance of the limited liability status of the corporation when they dealt with it. a) E.g. customers may have warranty claims which will not have matured into full claims at the date of bankruptcy. If the corporation becomes insolvent the benefit of the warranty will be lost (i.e. its value drops to zero). b) E.g. Employees may also have built up their skills or abilities (human capital) in the business and can not achieve nearly as high a wage in other businesses. If the corporation becomes insolvent they suffer a loss, yet there is no recognition of this loss in bankruptcy proceedings. c) Should such losses be compensated ? Should they be compensated by disregarding the corporate entity and making shareholders personally liable?
2) The arguments concerning the benefits of limited liability (discussed above) were made in articles that were directed at developing a theory of corporate veil piercing . The theory is briefly summarized here
(and for this distinction between voluntary/involuntary, see also London Drugs v. Kuehne & Nagel above)
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a) For voluntary relationships (i.e. consensual claimants), as described in the various types of cases for piercing above (see “When pierce”), associated policy reasons include: i) Piercing the corporate veil to gap fill in contracts – avoid transaction costs of trying to anticipate (and draft provisions for) every means of using a corporation to avoid contractual requirements ii) Piercing the corporate veil to gap fill in statutory requirements (e.g. tax) – similarly, avoid costs of anticipating (and drafting legislation to prevent) every means of using a corporation to avoid statutory requirements. iii) Avoid costs of gathering information – the misrepresentation cases may involve situations in which promoters of the company could have avoided confusion or misconceptions at lower cost than the persons dealing with the company.
(1) If the promoters were not made liable in these situations then the outsiders dealing with the company would have to be much more careful to make sure they knew exactly who they were dealing with.
(2) In the case of a sole proprietorship or partnership business (which might transfer to corporate form), outsiders would have to check every time they dealt with the business to make sure that it was still being run as a sole proprietorship or partnership. Such assessments are presumably much more expensive for outsiders than they are for promoters who should know or have ready access to information concerning the exact nature of form of organization under which the business is being carried on. b) For involuntary relationships (i.e. non-consensual claimants) i) In the case of tort claims , a claim against a corporation may lead to insufficient compensation where the appropriate compensation is greater than the assets of the corporation. The unsatisfied compensation is arguably a cost of allowing limited liability. Where this cost is likely to be greater than the benefits of limited liability , then it would seem to make sense from the standpoint of overall social welfare to make an exception to limited liability . ii) More likely to pierce in one-person or few shareholder companies
(1) For such companies, the costs imposed by limited liability are likely to outweigh any benefits of limited
(2) Recall the benefits of limited liability, particularly the valuations costs and monitoring costs, increase with the number of shareholders . Where there is just one shareholder, limited liability does not reduce monitoring costs or valuation costs at all relative to unlimited liability. Where there are very few shareholders the savings of limited liability in terms of monitoring costs and valuations costs are likely to be small. Thus courts may be more willing to pierce the corporate veil in such cases. iii) More likely to pierce where it leads to claim against limited liability parent Co.
rather than individual shareholders
(1) Piercing the corporate veil between affiliated corporations does not make any individual shareholders liable. Thus no individual shareholder loses the benefits of diversification .
(2) With the benefits of diversification still intact there should be no impact from piercing the corporate veil between affiliated corporations on optimal management decision making
(i.e. they should still make decisions without taking into account diverisifiable risk).
(3) Since individual investors will not be made personally liable there will be no need for any individual investor to seek indemnification from fellow investors or make sure that fellow investors can bear their share of any losses imposed on individual shareholders. Thus there will be no need to incur costs to check on the wealth of fellow investors before purchasing a share or monitoring or controlling the wealth of one’s fellow shareholders after the purchase of shares.
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(4) Since an investor would not have to check the wealth of fellow shareholders before making an investment the price paid by the investor would still impound information about the value of the investment.
(5) In short, the benefits of limited liability would not be lost as a result of piercing the corporate veil between affiliated corporations .
Corporate financing: shares (3 rights), debentures, securities regulation
Shares: bundle rts not own, three rts (vote/div/proceeds) somewhere, classes (discretionry divs OK)
1) Like sole proprietorships and partnerships, corporations have debt and equity finance : a) Equity investors in a corporation hold shares. b) Debt finance for the corporation can come in the form of trade credit or bank loans. Some corporations also borrow funds through a distribution of debentures to a broader group of lenders. c) Distributions of shares and debentures (and other investment interests) sometimes require compliance with provincial (and territorial) securities laws .
2)
Shares are typically described as being “bundles of rights”. E.g. Sparling v. Caisse de dépôt et
Placement , [1988] 2 S.C.R. 1015 a)
Decision: shares were described in the following way: “A share is not an isolated piece of property. It is rather, in the well known phrase, a ‘bundle’ of interrelated rights and liabilities . A share is not an entity independent of the statutory provisions that govern its possession and exchange. Those provisions make up its constituent elements. They define the very rights and liabilities that constitute the share’s existence. The CBCA defines and governs the rights to vote at shareholders’ meetings, to receive dividends, to inspect the books and records of the company, and to receive a portion of the corporation’s capital upon a winding up of the company, among many others. A ‘share’ and thus a ‘shareholder’ are concepts inseparable from the comprehensive bundle of rights and liabilities created by the Act.” b) Comment: i) Shares are similarly defined in CBCA ii) The rights, and consequent bundles of rights, that can be created are subject to few restrictions and thus the potential bundles of rights are virtually infinite (though other statutes have spelled out more the types of shares that are allowed) iii) A share is not a property right in the assets of the corporation, nor does not represent a proportionate ownership interest in the corporation itself. It is a bundle of rights (and to some degree may also involve obligations).
3) There are three basic rights that individual shares may or may not carry: a) Voting right : The right to vote on company matters requiring shareholder voting (especially voting for the directors of the company) b) Dividend right : The right to receive dividends when declared by the board of directors c) Right to proceeds on dissolution : On dissolution of the corporation the right to receive the property of the corporation remaining after creditors and any other persons with claims against the corporation are paid off.
4) Shares are presumed to be equal in all respects unless otherwise indicated. a) This presumption was made by courts prior to it being specifically addressed in corporate statutes. b) S.24(3): Where there is just one class of shares , the rights of holders are equal in all respects and that class of shares will have each of the three rights referred to in s.24(3) – thus the company’s incorporating documents do not need to set out the rights attaching to the shares
5) But differences between classes (or series) of shares are allowed a) The primary means of making distinctions between shares is by creating different classes of shares, each with a different bundle of rights
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b) The CBCA allows for different classes of shares with different rights and restrictions (s.6(1)(c)(i);
24(4)). c) Where there is more than one class of shares the rights , privileges, restrictions and conditions attached to each class must be set out in the articles (s.6(1)(c)(i), s.24(4)). d) S.24(4): The three rights must appear somewhere in the corporation’s share structure (but need not all appear in any one class of shares), since someone must elect directors, someone must be entitled to receive a distribution of the profits, and someone must be entitled to the proceeds on a dissolution net of the company’s liabilities. e) Shares within a class are presumed to have equal rights (e.g. see Bowater below), subject to
“series rights”
(see below). f) To create a validly separate class of shares there must be a distinction in some right between that class and other classes, although it appears that it may not take much of a distinction for a validly created separate class to exist. McClurg, R. v., [1990] 3 S.C.R. 1020 i) Facts:
(1) Jim McClurg and Verlye Ellis formed Northland Trucks (1978) Ltd. under the
Saskatchewan Business Corporations Act
(“SBCA”). The husbands took class A common shares which were the voting shares. Their wives took class B non-voting common shares.
The articles provided that each class carried , “the distinction and right to receive dividends exclusive of other classes in the said corporation”
(2) In 1978, 1979, and 1980 dividends of $100 per share were declared on the class B shares giving $10,000 income to each of the wives. The Minister of National Revenue reassessed the McClurg’s and Ellis’s for taxes for those years.
(3) The Minister of National Revenue argued that s.24(3) of the SBCA (same as CBCA s.24(3)) requires specific rights to be set out in the articles. I.e. the provision here was not sufficiently distinct with respect to dividends to distinguish the separate rights of the classes and override the presumption of equality.
(4) The Tax Court of Canada found for the Minister but was overruled by the Federal Court
Trial Division and the Federal Court of Appeal. ii) Majority SCC judgment of Dickson C.J.
(1) Although shares are presumed to be equal the discretionary dividend clause gave sufficiently differentiated rights between the classes to displace the presumption of equality .
(2) Rights do not need to be specific to the class (i.e. two classes can share the same right).
There simply has to be some right over which there is a distinction while other rights can be the same. It is also possible to allocate a discretion to the board of directors .
(3) There was no problem with such a scheme under the common law and there was no statutory provision in the SBCA preventing such a discretionary dividend clause. It would have thus, in Dickson’s view, been paternalistic to invalidate the clause where there was no complaining shareholder. Overall it was a valid exercise of contractual rights between the corporation and its shareholders.
(4) Dickson C.J. noted that corporate law should generally facilitate allowing parties to structure corporations as they wish . iii) Minority SCC judgment of LaForest J.
(1) The presumption with respect to shares is that all shares have equal rights and all shareholders should be treated equally. The provision was thus improper because it was not sufficient to displace the presumption of equality between shares, because the discretionary dividend clause applied to all classes and therefore all should have received equal dividends.
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(2) The discretionary dividend was also invalid, LaForest argued, because it allows an allocation based on the personal characteristics of shareholders rather than on the share structure of the corporation.
(3) The SBCA does not give a right to use discretionary dividends, and discretionary dividend clauses expose minority interests to self-serving behaviour that is not properly protected by minority rights like the oppression remedy or litigation under the derivative action provision (i.e. there would be a risk that controlling/majority shareholders would put in a discretionary dividend clause with a share structure that gives them a different class of shares than the minority interests and then would only allocate dividends on their own class of shares).
(4) LaForest further argued that an allocation of dividends under a discretionary dividend clause would encourage a breach of duty by directors since it would not be in the best interests of the company. LaForest also expressed concern that if a discretionary dividend clause were held to be valid then presumably a discretionary voting clause would also be valid (see below for more on the presumption of equality in the context of voting rights)
Sharehldr register, share certifs in registerd form, transfer (agent/broker/depository), invalid/fraud
1) Shareholder register : a) The corporation is required to maintain a register in which it records (CBCA s. 50): i) The names and addresses of shareholders ii) The number of shares held be each shareholder iii) The date and particulars of the issue and transfer of each share. b) The register must be kept at the registered office of the corporation or at a separate records office of the corporation (s.20).
2) CBCA s.49(1): Each shareholder is entitled to a share certificate if they request one a) Share certificates are pieces of paper evidencing rights to shares (they are securities certificates) b) CBCA s.49(13): The certificate must either show on its face the rights, restrictions and conditions on the share, or a statement of the right of the shareholder to have a copy of the rights, privileges, restrictions and conditions of the share provided to them on request c) CBCA s.49(7),(8) other provisions with respect to what must be put on share certificates. In particular, if there is any restriction on the transfer of shares then this must appear on the certificate or the provision will be invalid against any third party (s.49(8)).
3) Under the CBCA s.49(7) shares must be issued in registered form a) This is in contrast to bearer form certificates in which the person who owns the shares is the person who is the bearer of the certificate i) It was common in the early days of companies to have share certificates in bearer form ii) It made the transfer of shares very easy, but the certificates had to be carefully kept – if they were lost or stolen the finder or thief could easily claim to be the owner). iii) Also created problems in terms of communicating with shareholders (since the company may not know who the actual bearers of the certificates were) b) To protect the certificates against theft, there was a move towards registered security certificates. c) Registered form is now the most common form of security certificate i) This means that the name of the person who is the registered owner of the shares must appear on the face of the share certificate, and they own the share no matter who the bearer of the certificate is
4) Transferring shares : a) When a shareholder sells shares in registered form , the legal title to the shares can be changed by: i) The seller endorses the share certificate (or a separate document) assigning or transferring the security or giving a power to transfer the security (CBCA s.65(3)).
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ii) The purchaser submits the share certificate can then be submitted to the issuer (the secretary of the corporation), along with any documentation required to verify the transfer (e.g. form of transfer), and the issuer is required to register the transfer (CBCA s.76). iii) The issuer then records the transfer showing the purchaser as the registered shareholder and destroys the existing share certificate . iv) The new shareholder is entitled to a share certificate (i.e. with name of purchaser on its face) or a written acknowledgment of the right to receive a share certificate (CBCA s.49(1)). b) This tends to be the process in closely-held corporations (i.e. corporations with relatively few shareholders) that have not sold shares broadly to the public, with the secretary of the company recording transfers, destroying old certifications, and issuing new ones. c) However, this process of canceling and issuing new certificates every time there is a trade in the shares can be an extremely expensive process where the shares trade frequently . Institutional developments have greatly simplified this process for the transfer of shares in corporations with publicly traded shares. i) The transfers of shares are usually conducted for the company by an agent who specializes in handling the transfer of shares (and is referred to as a “ transfer agent
”, typically a trust company for publicly held companies). ii) Thus the change in registered ownership to shares is effected by delivering the properly endorsed certificate to the transfer agent along with other required supporting documentation.
The transfer agent then registers the transfer, cancels the certificate in the name of the transferor and issues a new certificate in the name of the transferee.
(1) E.g. A has a certificate showing A to be the registered owner of 5,000 shares. A sells
1,000 shares to B. B could be made the registered owner in respect of 1,000 shares by having A endorse the share certificate indicating the transfer of 1,000 shares to B. A would deliver the endorsed certificate to B who would then submit it to the transfer agent.
The transfer agent would register the ownership of 1,000 shares in the name of B and reduce A’s registered ownership by 1,000 shares. The transfer agent would then cancel the certificate for 5,000 shares in A’s name and issue two new certificates, one in A’s name for
4,000 shares and one in B’s name for 1,000 shares. iii) The great deal of paper work involved with increasing volumes of transfers of securities was reduced substantially by brokers who keep inventories of securities of many different companies. When a client ordered securities, they would purchase the securities for the client, but instead of obtaining a certificate from the vendor’s broker and sending it to the transfer agent for cancellation and issuance of a new certificate, the broker simply made a bookkeeping entry showing that the client was the beneficial owner of securities that were held in the broker’s inventory and were registered in the broker’s name . iv) A net payment and delivery obligation system further reduced paper work. In the trading in securities Broker A might engage in a number of transactions on behalf of its clients with
Broker B involving XYZ company shares. Each broker might sometimes be acting for the purchaser of XYZ shares, and sometimes for the vendor of XYZ shares. At the end of a day of trading , the transactions between broker A and broker B involving shares of company XYZ could be netted out .
(1) E.g. if A ended up purchasing more XYZ shares for its clients from B than B did from A,
A would pay B for the difference and B would deliver an appropriate number of XYZ company share certificates (currently in B’s name for the benefit of B’s clients) to A. A would deliver these certificates to the XYZ Co. transfer agent to be cancelled and reissued in the name of A v) This approach of broker inventories of securities, coupled with meeting only the net payment and share certificate delivery obligations, substantially reduced the amount of paper work involved in the transfer of securities in registered form. It was facilitated by the development
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of clearing agencies . Brokers set up these clearing agencies and then reported transactions they engaged in to the clearing agency. The clearing agency would then perform the task of netting out the various payment and delivery obligations between brokers. vi) Even these net transfers between brokers could be reduced by having the issuer appoint a nominee holder of the securities . Banks often served in this capacity. The company issuing the securities could contract with the nominee to be the registered holder of the securities and to make bookkeeping entries of the names of persons on who’s behalf the bank was holding the security. Quite often the names of securities brokers would appear in the nominee’s records and the brokers would also have an entry showing they held the beneficial interest in the securities on behalf of their client. The use of nominee registered holders of securities reduced the amount of cancellations and reissuances of security certificates. The difficulty with the nominee system was that there would be different nominees for different securities and thus notifying the nominee of a transfer would first require identifying who the nominee was for that particular security. vii) A further simplification in the 1980s was the creation of security depository institutions . In
Canada the key depository institution is the Canadian Depository for Securities (a subsidiary of the Toronto Stock Exchange). Instead of having multiple nominees the depository institution serves as a single nominee owner . The depository institution keeps an inventory of certificates for securities of frequently traded shares and usually also performs the clearing function for netting out transactions between brokers. When a broker has a net obligation to deliver shares it is no longer necessary for it to deliver certificates representing those shares to other brokers. Instead, the depository institution simply makes a bookkeeping entry indicating, in terms of the example given above, that broker A is now the beneficial owner of the shares which broker B is obligated to deliver. Thus there is no delivery of certificates to broker A and no need on the part of broker A to have a certificate in the name of broker B cancelled and reissued in the name of broker A. viii) The effect of this is that the registered owner of the majority of securities of publicly held corporations is often a depository institution . While the development of depository institutions has greatly simplified security transfers by avoiding the physical transfer of certificates it has complicated the task of communicating with security holders . The securities register does not show the names of the beneficial owners of the securities. Instead it will often just show the depository institution as the registered holder of the securities. Tracing the beneficial ownership of the securities thus often requires tracing through the depository institution to find the broker on whose behalf the securities are held and then tracing it through the broker to the person on whose behalf the broker holds the securities.
5) Problems with defects in the validity of share issuances or transfer . a) Many of the statutory provisions on the transfer of shares and in articles or bylaws can be understood in terms of the need to assure that the transfer is a bona fide transfer and the extent to which the issuer is obliged to inquire into the bona fides of the transfer (e.g. CBCA ss.51(7),
(8),65,76-80). b) The statutory provisions on securities transfer deal with a variety of issues. They deal with such matters as i) An over-issue of securities (i.e. an issuance by the directors of more securities than they were authorized to issue) ii) The effect of a defect in validity of security (e.g. certain corporate requirements for signatures on certificate not met or for steps concerning the issuance of securities) iii) Fraudulently created share certificates , warranties of agents dealing with securities, and the title of the purchaser and effect of adverse claims against vendor. c) Recall one of the key benefits of limited liability is that it makes shares more readily transferable thus allowing investors to liquidate or alter their investments more quickly .
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d) However , the approach of the courts with respect to the transfer of securities was that they were assignments of legal rights . Purchasers of shares thus got an assignment of the vendors legal rights and as such they took the legal rights “ subject to the equities
”. In other words, any defence that might have been raised with respect to the vendor’s legal title could also be raised with respect to the purchasers legal title. Thus if there was one fraudulent transfer followed by a whole chain of transfers in which purchasers paid for the securities the whole chain of transfers would be invalid . The owner who had been subject to the fraud could claim a good title against all the subsequent purchasers. This approach had a tendency to make the purchaser somewhat circumspect in making a purchase. e) These potential problems for purchasers were exacerbated by the decision in Ruben v. Great
Consolidated Fingold, [1906] A.C. 439, 75 L.J.K.B. 843 i) Facts: the company secretary forged the signatures of the directors on a share certificate registered in the name of bankers who provided a loan to the company secretary on the security of the share certificates. Upon the default on the loan, the guarantor of the loan, who was obliged to pay on the guarantee, sought to have the shares registered in its name. The company refused to register the transfer. ii) Decision: It was held that the secretary did not have, nor was held out to have, authority to forge the signatures. iii) Comment: As a consequence of the case the purchaser of securities also took them subject to the risk that they may have been fraudulently issued by an employee of the issuer. f) To some extent these problems were dealt with by companies putting in stricter systems to control access to blank certificates and systems of safeguards to avoid the issuance of fraudulent certificates. Purchasers and transfer agents also required guarantees from transferors as to the authenticity of the signatures which at least gave some other person who could be sued in the event the signature was a forgery. g) Under the CBCA : i) These problems with the transfer of shares are dealt with by making securities negotiable instruments (see s.48(3); and s.55,57,60,etc). ii) S.18(e),57 also overrule the decision in Ruben v. Great Consolidated Fingold.
iii) S.59 specifies the extent of the warranty of authority of a transfer agent or registrar entrusted with the signing of security certificates, namely, that the security is genuine, their acts with respect to the issue of the security are within their authority, and that they have reasonable grounds for believing the security is in the form and within the amount the corporation is authorized to issue. iv) Note that the provisions of the CBCA apply to “ securities ” which is defined in s.48. The term applies to debentures as well as shares since the term includes “an instrument issued by a corporation that is ... of a type commonly dealt in on securities exchanges or markets or commonly recognized in any area in which it is issued or dealt in as a medium for investment”
Common v prefered: pref divs only unless participation, cumulative, on liquidate share beyond pref
1) The
CBCA just refers to “shares.”
It does not designate different types of shares in the way that many other corporate statutes around the world do. However, CBCA corporations usually do have a class of shares referred to as the “common shares.” They also often have one or more classes of “preferred shares.”
2) Common shares have three main rights attached to them. These are: a) The right to vote on company matters requiring shareholder voting, especially voting for the directors of the company; b) The right to receive dividends when declared on a pro rata basis ( subject to any preferred dividend rights); and
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c) The right to a pro rata share of the proceeds on a dissolution of the corporation, net of payments to creditors or other claims against the corporation, and net of claims of classes of shares with preferred claims to the proceeds on dissolution.
3) Preferred shares are “preferred” because they typically have a preference with respect to some right, usually a preference with respect to receiving dividends and/or receiving a share of the proceeds on liquidation. a) A preference with respect to dividends means that when the directors of the company declare a dividend the preferred shares get paid a specified amount on each share before any dividends can be paid on the common shares (or, more generally, on any shares with a subordinate right to dividends). i) E.g. you have 1,000 common shares, and 1,000 preferred shares carrying a right to $5 per share before any dividends can be paid on the common shares (i.e. a ‘ preferred dividend’
of
$5000). If a dividend of $4,000 is declared then each preferred share will get $4 per share and the common shares will get nothing (and the missing $1 per share would be carried over to the next year if they are cumulative preferred shares (see typical features below)). If a dividend of
$6,000 is declared, the preferred shares will get $5 per share and the common shares will get
$1 per share. ii) The normal rule with shares is that they are presumed to have equal rights unless the incorporating documents clearly specify otherwise. However, in International Power Co. v.
McMaster University (sub nom Re Porto Rico Power Co.) [1946] S.C.R. 178 the Supreme
Court of Canada held that as a matter of construction, a priority claim to dividends implicitly precludes a right to share in any dividends beyond the fixed preferred amount of the preferred dividend unless it is expressly provided for .
(1) E.g. if you simply say that the shares have a right to receive a dividend of $5 per share before any dividend is paid on the common shares, then the preferred shares will be limited to the $5 per share dividend and won’t be entitled to share in any further dividend amounts declared. If you want the preferred shares to share in additional amounts beyond a fixed dividend amount, then the share specifications for the class will have to make this quite clear.
(2) This presumption is overridden by a participation right (see typical features below) iii)
See “Dividends” below b) A preference with respect to proceeds on liquidation means that the preferred share gets a specified amount on liquidation before any of the proceeds can be distributed to the common shareholders (or, more generally, on shares having a subordinate right to proceeds on liquidation). i) E.g. there are 1,000 common shares and 1,000 preferred shares, and the preferred shares have a right to $100 per share from the proceeds on liquidation. If the company realized $80,000 on liquidation, each of the preferred shareholders would receive $80 per share and the common shareholders would receive nothing. ii) In contrast to the presumption of no further share in dividends beyond a preferred amount, the
Supreme Court of Canada in International Power Co. v. McMaster University (sub nom Re
Porto Rico Power Co.) held that there is a presumption of equality with respect to preference shares when it comes to a share in the proceeds on dissolution . iii) E.g. if the preferred shares have a preferred right to receive $100 on dissolution before the common shares get anything, they will get the $100 and then share in anything left over with the common shares on a pro rata basis unless the incorporating documents specify otherwise.
If you don’t want to give the right to preferred shareholders to share beyond the fixed amount on a liquidation then this must be set out. iv)
If “ priority as to dividends and capital
” then arrearages of dividends will be paid out of liquidation proceeds (see typical features below) c) Typical preferred share features
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i) A preferred share is said to be a cumulative preferred share if any dividend that is unpaid in any given year accumulates and is to be paid in a subsequent year .
(1)
E.g. a company has Class A “common shares” and Class B “preference shares”. Suppose the preferred shares have a right to a $5 dividend before any dividends can be paid on the common shares and suppose this right is cumulative. If in year 1 the company does not declare a dividend, then the unpaid $5 per share on the preferred shares accumulates to the next year. In year 2 the preferred shares would each be entitled to a payment of $10 per share before anything could be paid on the common shares. If no dividends were declared then the unpaid $10 would accumulate to the following year and $15 would be due on the preferred shares before anything could be paid on the common shares in year 3.
(2) If the shares were non-cumulative then the $5 unpaid in year 1 would not accumulate to the following year. In year 2 the preferred shares would only be paid $5 before any dividends could be paid on the common shares.
(3) Non-cumulative preferred shares are not very common . When they do occur it is usually in a situation where the preferred shareholder in some way has significant voting rights that can allow the shareholder to put in directors who are more likely to declare a dividend .
This is more likely to be the case in a closely-held company.
(4) If there is a preferred right to a dividend with no indication of whether or not it is cumulative, then the presumption is that the preferred dividend right is cumulative ( Webb
v. Earle (1875), L.R. 20 Eq. 556).
(5) Further, where the shares are entitled on dissolution to a “ priority as to dividends and capital ” then the presumption is that the shares are entitled to arrearages of dividends on a dissolution.
(a)
If the entitlement on liquidation is “ priority as to capital
” only then the presumption is that there is no entitlement to arrearages . ii) A participation right allows the preferred shareholder to participate in the distribution of dividends beyond the preferred dividend right .
(1) E.g. preferred A shares have a right to a $5 dividend before any dividends can be paid on the common B shares. If given a participation right, would be able to get the $5 dividend per share on a declaration of dividends and, if the amount of the dividend declared were sufficient that additional amounts remained after paying off the $5 preferred dividend then it would be shared between the Class A common shareholders and the Class B preferred shareholders according to the nature of the participation rights provided .
(2) E.g. suppose there were 1,000 common shares and 1,000 preferred shares. Suppose the preferred shares had a preferred dividend of $5 per share per annum and a right to then share pro rata with the common shares on any additional dividends. Suppose the directors declared a dividend of $15,000. In this case the preferred shareholders would get their $5 per share preferred dividend leaving $10,000 of declared dividend remaining. The 1,000 common shares and 1,000 preferred shares would then share pro rata in the remaining
$10,000 with each share entitled to a dividend of $5 per share. Thus the preferred shareholders would get a total dividend of $10 per share while the common shareholders would get $5 per share.
(3) E.g. Compare this to preferred shares having no participation right – the preferred shares would have ended up with a dividend of $5 per share while the common shares would have gotten $10 per share.
(4) International Power Co. v. McMaster University (above) held that if it is not specified that the preferred shares are participating then they are presumed to be non-participating .
See also Will v. United Lankat Plantations Co. [1914] A.C. 11 (H.L.) and Re Canadian
Pacific Ltd. (1990), 68 D.L.R. (4 th
) 48 (Alta. C.A.).
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iii) Sometime preferred shares have a conversion right (so shares are ‘convertible’) that allows the preferred shares to be converted into common shares at a predetermined conversion ratio . I.e. the preferred shareholder can surrender a predetermined number of preferred shares for a predetermined number of common shares. iv) Sometimes the preferred shares are given a retraction right (i.e. they are retractable). This allows the shareholder to sell the shares back to the company at a predetermined price (this is not normally provided for) v) Redeemable : sometimes the company reserves the right to buy back the preferred shares at a predetermined price . This allows the company to do some refinancing at a future time at a predetermined price for the repurchase of the preferred shares. This is also sometimes referred to as a
“call” provision
. The predetermined price is usually set at a premium to the price for which the shares were issued (a “ call premium
”).
(1) These latter two can be used to avoid capital gain taxes . E.g. suppose mom and dad have been carrying on a business for awhile, making lots of money. If they simply sold their shares, there’d be a significant capital gain. There may be an advantage to putting the capital gain in the hands of the children, by restructuring the corporation through an estate freeze (i.e. parents, who have had common shares, exchange them for a retraction right and an redemption right (set at a rate of $100 to lock in the value of $100), so never make a capital gain on the shares), but the kids do not have redemption/ retraction rights
Other share types: non-voting (thro’ recapitalization or dual issuance), special/subordinate voting
1)
See also “Shareholder voting” below.
2) Many corporations have only one class of shares. Others have a class of common shares and one or more classes of preferred shares. Some corporations have other special classes of shares, which can be of a wide variety but the more common ones are nonvoting common shares (or “uncommon common shares”) and special voting shares.
3) Non-voting common shares have the same rights as voting shares except that they do not carry the voting right. a) Became very popular in Canada in the late 1970s and early 80s. They allow controlling groups to obtain further financing by selling non-voting shares without losing much in the way of control over the corporation. b) They were also very popular with investors . The voting shares typically sold at a premium to the cheaper non-voting shares because the voting right was valued by those persons interested in asserting some control over the corporation. Investors who intended to own only a small percentage of the outstanding shares derived little or no benefit from keeping the voting right because, with a small percentage of the voting right, they had little hope of influencing shareholder voting outcomes. Thus they tended to sell their voting shares, buy non-voting shares and pocket the difference in the price between the two. c) Two ways in which a corporation may create a class of non-voting common shares: i) In a recapitalization , new voting shares would be issued to certain preferred persons (insiders) and existing common share rights would be altered (by amending the articles) to remove their voting right. The change in the common share rights would require a special resolution of the shareholders but often there were sufficiently significant blocks of shares to secure such special resolutions. ii) In a dual class share issuance . a new class of shares without voting rights is created and sold to the public. Thus the existing common shareholders retain their common shares with the voting right. If they want to hold non-voting common shares instead they can individually choose to do so by selling their common shares and buying non-voting common shares. d) The issuance of non-voting common shares has raised investor protection concerns and there was considerable debate about whether such non-voting common shares should be allowed (for many
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years the New York Stock Exchange prohibited corporations listed on the New York Stock
Exchange from issuing non-voting common shares). i) Arguments against :
(1) The creation of non-voting common shares was inefficient since it often left those in control of the management of the corporation without the corresponding residual claims
(or rights to the full share of the dividends since dividends would be paid on the nonvoting shares). They thus would not have a sufficient incentive to act in the interests of shareholders .
(2) There might be distributional effects , in that pre-existing investors might have paid for their shares in the expectation that management was subject to the threat of a loss of control (e.g. takeover bid), only to later have the threat of a loss of control removed through a dual class recapitalization. It is this type of concern that led to a Securities
Exchange Commission rule in the US prohibiting dual class recapitalizations . However, dual class share issuances were permitted since these did not pose the same potential for distributional consequences (since investors could individually choose to sell their voting shares). ii) Arguments for :
(1) On the other hand, it might be the case that such share issuances were efficient in that they gave managers an incentive to develop firm-specific human capital (i.e. skills specific to the firm that can not be used in other firms, and thus skills for which managers would not be compensated if they had to find work in other firms), since such share issuances could provide them with control over the voting rights thus allowing them to prevent a takeover bid , giving them a measure of protection against being removed from office before they could capitalize on their investments in firm-specific human capital.
(2) Some managers may also value control more highly than others such as family held corporations .
4) Control may also be maintained within a given group of shareholders by issuing special voting shares and subordinate voting shares . a) E.g. special voting shares may carry 10 votes per share , while subordinate voting shares might carry one vote per share.
Dividends: cash/specie/stock, dir may declare (best intrsts/oppress), debt from profits, not if insolve
1) Three kinds of dividends (and CBCA s.43 expressly allows for all three forms): a) Dividends are usually paid in cash . b) However, they can be paid in other forms of property in which case they are referred to as dividends in specie . i) E.g. ABC Shoe Store Ltd. might pay a dividend in the form of one pair of running shoes for every 100 shares owned by a shareholder. ii) The use of physical inventory for dividends would be extremely rare . However a more common type of in specie dividend might involve XYZ Investments Ltd. distributing shares it owns in another company (MegaVideo Ltd) to its shareholders as a dividend. c)
Sometimes a corporation pays what is known as a “ stock dividend
”. i) A stock dividend is in the form of more (fully paid shares) shares in the same company . ii) E.g. MNO Ltd. might give its shareholders one additional share for every 20 shares they currently own. iii) Note the assets of the company will not change as a result of a stock dividend, and presumably the value of the assets will not change either. What the shareholder now has is just more shares carrying residual rights to the proceeds from the same assets having the same value as before. Thus the usual effect of a stock dividend is that the value of the stock goes down to the point that for the holder of 100 shares who received 5 additional shares, the 105 shares held is
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worth the same amount as the 100 shares were worth before (i.e. if the shares were worth $10 before the price would fall to about $9.42).
2) A preferred class of shares may have a limited return or participation rights (see “Common v.
Preferred shares” above)
3) The directors have the power to declare a dividend . a) This is subject to a unanimous shareholder agreement to the contrary (see “Closely held corps” below) b) It is part of the directors’ power to manage the corporation under s.102 because it is not specifically allocated to the shareholders (or the directors) and thus falls under the residual management power of the directors in s.102
. See “Powers of dirs” in Corporate Governance below. c) That this is a power of the directors is reinforced by s.115(3)(d) which provides that the directors cannot delegate the power to declare dividends.
4) The directors are not obligated to declare dividends, however . a) The declaration of dividends is a management decision. The directors declare dividends if they think it is appropriate to do so. However, in exercising this power they must do so (as with all their powers) in the best interests of the corporation and not in a way that is oppressive to one or more shareholders . b) There may be rare situations where the directors are under an obligation to pay dividends . i) E.g. Dodge v. Ford Motor Co., 170 N.W. 668 (1919 Michigan Supreme Court)
(1) Facts: The Ford Motor Co. had amassed substantial retained earnings. Henry Ford (a director) had refused to declare a dividend so that the company could use funds for plant expansion. However, when questioned as to the purpose of the plant expansion, Henry
Ford said that the purpose was to expand his production system for the greater benefit of society and not for the purpose of earning profits for the company.
(2) Decision: Providing for what Ford saw as a charitable benefit for society was not a basis for not paying a dividend, but rather was a breach of the duty on directors to act in the best interests of the corporation , and it was assumed that the best interests of the company involved making profits for the company
(3) Comment: If the retention of the earnings and plant expansion had been expressed as being for the purpose of making greater profit for the company than the failure to pay dividends would have been alright. ii) E.g. Fergusson v. Imax (1983), 43 O.R. (2d) 128 (C.A.)
(1) Facts:
(a) There was a falling out between a husband and wife (the Fergusson’s) who were both shareholders in the corporation along with two other couples.
(b) The wives held preferred shares and the husbands held common shares. Mr. Fergusson used his position of influence to see to it that there were no dividends paid . Mr.
Fergusson and the other couples got returns from the company in the form of salaries for work in the company. Mrs. Fergusson no longer worked for the company, so without dividends she got no return on her investment.
(2) Decision: this refusal to pay dividends was oppressive to Mrs. Fergusson and granted a remedy under the oppression remedy provision in the Ontario Business Corporations Act .
(3)
See also “Corporate oppression actions” under piercing the veil above
5) Once the directors have declared a dividend it becomes a debt of the corporation . a) I.e. the shareholders can sue to be paid the amount of the dividend.
6) Dividends can only be paid out of the profits of the corporation. This includes any accumulated but undistributed profits from previous years (i.e. the retained earnings of the corporation). a) Payments in excess of profits are considered returns of capital and there are quite different requirements with respect to returns of capital (see “stated capital account” below).
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7) Dividends cannot be declared or paid if the corporation is insolvent at the time, or if payment would make the corporation insolvent (CBCA s.42). a) S.42 provides that a dividend can not be paid if: i) The corporation is, or would be after the payment of the dividend, unable to pay its liabilities as they come due; or ii)
The realizable value of the corporation’s assets would, after the payment, be less than the aggregate value of its liabilities and stated capital of all classes. b) The directors can be personally liable if they consent to a resolution that a dividend be declared where there are reasonable grounds for believing that the corporation is insolvent or would become insolvent on the payment of a dividend (CBCA s.118(2)(c)). Thus before declaring a dividend directors should get an opinion from accountants as to the solvency of the corporation and the effect of the proposed dividend on the solvency of the corporation. c) A shareholder who has received dividends in such circumstances can also be ordered to pay to directors any money the shareholder received as a result of a distribution of dividends contrary to s.42 (see s.118(5)).
8) Shareholders are the ones entitled to receive the dividend, but shares can be bought and sold, so have to determine who is entitled to receive the dividend (i.e. who the shareholders are as of some fixed point in time). Thus the directors will normally set a “ record date ” (see CBCA s.134(1) which allows for the setting of a record date for the payment of dividends). a) If no record date is set then the record date is the close of business on the day on which the directors pass the resolution declaring the dividend (s.134(3)). b) The company will prepare a list of shareholders of record on that date and the dividend will be paid to “shareholders of record” on that date
. c) Shares that are publicly traded are said to go “ex dividend”
on a date a few days ahead of the record date . I.e. shares traded after the ex dividend date will not receive the dividend. The ex dividend date is a few days before the record date because it takes a few days to settle trade transactions by way of delivery of share certificates, which will allow the purchaser of the shares to become registered as a shareholder. i) As discussed above, however, the transfer of shares in public corporations generally no longer involves the registration of trades in shares on the corporation’s shareholder register
. Instead the transfers are transfers of equitable interests in the shares and are recorded on the books of the trustee (or nominee) holder of the shares.
Shareholder voting (eg. of directors): equal in class unless articles/closely-held (e.g no step-down)
1) See also “Shareholder powers”, “Shareholder voting”, “Shareholder meetings” in Corporate
Governance below
2) Voting is probably the most important of the shareholder rights (see “Other share types” above)
3) In particular, shareholders with a voting right can vote to elect the directors of the corporation, influencing how the corporation will be managed. a) Directors are elected by “ordinary resolution” which is defined in s.2(1) of the CBCA as a resolution passed by a majority of the votes cast by the shareholders who voted in respect of the resolution.
4) The holders of voting shares also have to approve changes to the articles of incorporation or certain major corporate transactions (such as an amalgamation, continuance or dissolution). a) Voting in these situations requires a
“special resolution”
which is defined in CBCA s.2(1) as a resolution passed by two-thirds of the votes cast by shareholders who voted in respect of the resolution.
5) Even non-voting shares may get voting rights in some circumstances . a) Corporations often have classes of shares that do not have a voting right (e.g. a class of non-voting common shares , and preferred shares typically do not carry a voting right). Such classes of shares
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that do not generally carry a voting may be given a voting right in particular circumstances . E.g. preferred shares may be given a right to vote where dividends have not been declared for a significant period of time. b) In addition, the CBCA (and other corporate statutes in Canada) give shareholders rights to vote in particular circumstances even where the class of shares they hold do not otherwise carry voting rights. These voting rights are referred to as class voting rights and generally involve situations where a change in the articles of incorporation or some other major corporate decisions (such as an amalgamation ) that will have a prejudicial impact on the rights or interests associated with a particular class of shares.
6) As noted above, there is a general presumption that all shares are equal in all respects unless otherwise indicated. a) CBCA s.140(1) unless the articles otherwise provide, each share entitles the holder to one vote at a meeting of shareholders. b) CBCA s.24(3) if only one class of shares, rights are equal in all respects c) The articles of a CBCA corporation can require a greater majority than that called for in the Act for everything except voting to remove a director (see “Term of Office” in “Role/qualifications/etc of Directors” under Corporate Governance below) d) There are a number of cases interpreting these equal treatment provisions in situations involving voting restrictions e) Bushel v. Faith, [1970] A.C. 1099 (H.L.) (also discussed below) i) Facts:
(1) The Articles of Association of Bush Court (Southgate) Ltd. allowed a shareholder who was also a director to have 3 votes per share on any shareholder resolution to remove them as director
(2) There were three shareholders – sisters Bushel and Bayne, and their brother Faith. Each held 100 shares (there was only one class of shares ). Bushel and Bayne sought to remove
Faith at a shareholders’ meeting. There was a vote by show of hands (which is the normal practice – see CBCA s.141(1)). The vote was 2 to 1 in favour of removal.
(3) Faith then demanded a poll which he was entitled to do (see CBCA s.141(2)). This allowed Faith to express in a paper ballot that he was voting his 3 votes per share on all of his 100 shares against the resolution (i.e. 300 votes against). Bushell and Bayne were not being removed so they each had just one vote per share. The result was thus that the resolution was defeated on the pole by 300 votes to 200 votes.
(4) Bushel and Bayne then sought an order that Faith was validly removed as a director. Their claim was based on s.184 of the English statute (same as CBCA s.109
) that a director can be removed by ordinary resolution of the shareholders (the idea being a simple majority of shares can vote-out a director) ii) Lower courts:
(1) At trial, an injunction was granted restraining Faith from acting as a director on the basis that “it would make a mockery” of s.184 if it were held otherwise.
(2) This was reversed in the Court of Appeal. iii) House of Lords:
(1) Agreed the Court of Appeal. I.e. the voting provisions upheld .
(2) Lord Donevan noted that the Act did not preclude granting of different amounts of votes
( i.e. special voting rights ). He concluded that therefore the resolution was a validly defeated resolution – there was no ordinary majority to pass the resolution. S.184 (CBCA s.109
) did not say that the resolution must be based on one vote per share and it easily could have.
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(3) Lord UpJohn said the legislature must have known of special voting rights and if the legislature had wanted to restrict special voting rights in these circumstances it would have said so.
(4) Lord Morris dissented arguing that this was an unconcealed attempt to prevent removal of a director contrary to s.184. iv) Comment:
(1) An
‘ordinary resolution’ includes special voting rights
(2) This decision is perhaps reasonable. The company had only the three shareholders who likely consented to the provision in the articles with the very purpose of keeping each of them involved in the management through a directorship position. The resolution to remove Faith probably arose out of a dispute between him and his sisters. If Faith was removed as a director it was likely that, given the animosity, the earnings of the company would henceforth be removed in the form of directors’ fees
by the remaining directors (the sisters). Faith would have seen no return on his investment . His investment would probably have been effectively frozen in and worth nothing to him henceforth. Concern over this very possibility was probably the reason for the inclusion of the article in the first place. All three shareholders may have needed, and probably wanted, that kind of protection.
(3) Note, however: you should not use the type of article used in this case to protect against removal of a director or officer in a closely held corporation. Given the decision in the
Canadian case of Jacobsen v. United Canso Oil & Gas Ltd. (below) there is considerable doubt as to whether such a provision would be valid in Canada . There are much better ways of providing this protection (see shareholder agreements in Corporate Governance below)
(4) Further, this approach of giving more votes to a shareholder/director to try to safeguard their directors position does not guard against the other shareholders simply waiting till the term is up and then electing in a different director
(5) Contrast also with Re El Sombrero and Re Opera Photographic Ltd (shareholders seeking court ordered shareholder meetings) f) Jacobsen v. United Canso Oil & Gas Ltd. (1980) 11 B.L.R. 313 (Alta. Q.B.) i) Facts: United Canso Oil & Gas Ltd. was incorporated in 1954 under the federal Companies
Act by letters patent. In 1964 the company created a by-law which provided that a shareholder could only vote a maximum of 1000 shares . The company was continued under the Canada
Corporations Act and later was continued under the CBCA . ii) Issue: was the by-law valid? iii) Decision:
(1) The by-law was not valid . The court referred to English company law texts by Palmer and by Gower for the proposition that the presumption of law is that shares confer equal rights and liabilities .
(2) If voting rights are to vary then this must be done through separate classes of shares.
(a) The court noted that sections 102 and 103 of the Companies Act had said that there was one vote per share and s.12 provided that each share without nominal or par value was to be equal to each other share subject to special rights to separate classes. The court said that s.102 and 103 contemplated the issuance of separate classes of shares to get differing voting rights. The court thus concluded that the by-law was not valid under the Companies Act at the time the by-law passed.
(b) It was further held that s.104 and 105 of the Canada Corporations Act were similar to s.102 and 103 of the Companies Act and therefore the supplementary letters patent with the by-law was also invalid under the Canada Corporations Act .
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(c) Then the court carried the analysis through the CBCA noting that CBCA s.140
is similar to the old ss.102 and 103 of the Companies Act . Thus there was one vote per share unless the articles otherwise provided .
(d) The court further noted that CBCA s.24(3) says that where there is only one class of shares (as there was in United Canso Oil & Gas Ltd.) then all shares are equal in all respects and the shares have equal voting rights , dividend rights and rights to share in the proceeds on dissolution. Therefore the by-law was also invalid per s.24
of the
CBCA. Thus cannot make a distinction in the number of votes per share on the basis of characteristics of the particular shareholder who held the shares (i.e. in this case a shareholder who happened to hold more than 1,000 shares).
(3) Comment:
(a) Shortly before the judgment was rendered the company was reincorporated in Nova
Scotia. In a similar petition to the court in Nova Scotia the court declined to rule on the validity of the clause but the tenor of the judgment nonetheless suggested that the clause might be valid under the Nova Scotia Companies Act . What the Buckley family had done was to shop for a new set of laws under which the by-law might be upheld.
This is an interesting feature of corporate law in that it allows one to choose the forum for incorporation and thus choose the set of corporate laws that one wishes to be governed by. In this case the choice of forum was arguably used to the disadvantage of shareholders .
(b) Is Bushel v. Faith consistent with Jacobsen v. United Canso ? In both cases there was only one class of shares , so the shares are, as the English texts by Palmer and by Gower both note, presumed to be equal in all respects. Yet in Bushel v. Faith the court upheld the provision in the Articles which effectively allowed Faith to have three votes per share while the sisters only got one vote per share, while in Jacobsen v. United Canso the court did not allow votes to be limited by by-law to 1,000. As noted above, there is some doubt whether a provision of the type in Bushel v. Faith would be upheld in
Canada.
(c) The cases can perhaps be reconciled on a policy basis . As noted above, in Bushel v.
Faith the company was closely-held and the shareholders all likely consented to the provision. In contrast, in Jacobsen v. United Canso it is less likely that the shareholders consented to the bylaw . The company (United Canso) was widely-held with over 12 million shareholders and was controlled by the Buckley family which held approximately 0.33% of the shares. The provision was clearly designed to prevent a transfer of control by way of a takeover bid (leaving only the proxy mechanism as a means of effecting a change in control). Thus one good reason for not allowing such a provision is that it would effectively prevent a takeover bid and thus could allow a relatively small controlling interest to remain in control even though it was doing a very poor job managing the corporation (and possibly looting shareholders through excessive executive compensation and consumption by executives on the company account). g) Bowater Canadian Ltd. v. R.L. Crain Inc. & Craisec Ltd. (1987), 62 O.R. (2d) 752 i) Facts:
(1) Craisec Ltd. held common shares of R.L. Crain Inc. carrying one vote per share.
(2) Craisec Ltd. also held all of the shares of another class of shares called the “special common shares”. The articles of R.L. Crain Inc. gave the holders of the special common shares 10 votes per share as long as the shares were held by Craisec . However, the articles further provided that the shares had only one vote per share if they were held by someone else (i.e. in the hands of a transferee ).
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(3) Craisec had gotten the special common shares about 30 years earlier in the context of the purchase of Business Systems Ltd (BSL). Craisec Ltd. had agreed to deliver 41,750 common shares of R.L. Crain to BSL shareholders who in exchange gave their BSL shares to R.L. Crain Ltd. In consideration of Craisec Ltd. providing 41,750 common shares of
R.L. Crain Ltd. to Business Systems Ltd. shareholders Craisec Ltd. received 167,000 special voting shares of R.L. Crain.
(4) Bowater Canadian Ltd. had acquired several common shares of R.L. Crain Inc. and challenged the right of Craisec to 10 votes per share on the special common shares.
(a) Comment:
(i) It appears that Bowater Canadian Ltd. was attempting to acquire control of R.L.
Crain Ltd. But it couldn’t because no matter how many common shares it got,
Craisec would have more votes on account of its 10 votes per share on the special voting shares it held. If Bowater could get Craisec’s 10 votes per share on the special voting shares reduced to one vote per share, it might then be able to exercise control over R.L. Crain Ltd.
(ii) Craisec wanted to retain the so-called
“step down” provision on transfer
. This would allow it to sell some of the special common shares without losing control of
R.L. Crain Inc. ii) Trial:
(1) The trial judge held that it was not acceptable for the transferee to get just one vote per share due to a change in the voting rights on the transfer of the shares. However, the shares could retain their 10 votes per share as a special right of the class (i.e. any transferee would also get 10 votes per share).
(2) Bowater appealed the decision (it wanted the 10 votes per share removed) and Craisec cross-appealed (to retain the “step down” provision of the shares). iii) Appeal decision:
(1)
The “step down” provision was invalid . The transferee would have to have the same rights as Craisec (i.e. 10 votes per share).
(2) The court interpreted s.24
as requiring that rights in a class apply equally to all shares of the class (agreeing with the trial judge). Were it otherwise there would be a potential for fraud .
(a) Comment:
(i) Bowater Canadian Ltd. may thus stand for the narrow proposition that within a given class the shares must have equal rights (subject to separate series rights).
(ii) The court did not indicate the nature of the potential for fraud but presumably it would involve a transferee perhaps being duped into believing that he or she would get 10 votes per share when, if the step down provision were upheld, he or she would only get one vote per share.
(3) Having only one vote per share on transfer was not valid since one can’t treat different holders of the same share differently .
(a) Comment:
(i) Bowater Canadian Ltd. may thus stand for the broader proposition that all shareholders of a class must be treated equally. This could have significant ramifications .
1.
E.g. in an amalgamation one might give certain shareholders voting shares in the amalgamated company while other shareholders would get cash for their shares. If the principle is the broader principle that shareholders must be treated equally, then this would not be permitted.
(ii) Many companies also have so-called “poison pill” provisions that allow them to control takeover bids . These poison pill provisions have a trigger provision that
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says: when one shareholder acquires 20% or more of the shares, certain poison pill rights come into effect, such as allowing all other shareholders the rights to buy more shares of the corporation at a very low price. If the principle is the broader equal treatment principle then this kind of poison pill provision would not be valid .
(4) The 10 votes per share was found to valid . The court noted that this right had been present for 30 years and no complaint had been brought (i.e. shareholders purchased common shares on understanding that there was a class of shares with special voting rights).
Proceeds on dissolution: presume pro rata unless articles preference/arrearages for cumulative divs
1) S.24(4): At least one class of shares must have a right to receive proceeds on a dissolution of the corporation. a) Because of the presumption of equality of shares all shares are entitled to share pro rata in the net proceeds on dissolution unless any special entitlements to share in the net proceeds are spelled out in the articles . b) Preferred shares often have a preference with respect to receiving the net proceeds on dissolution, usually a right to be paid a specified amount per share. It may also include arrearages of cumulative dividends and, unless it is specifically indicated otherwise, preferred shares participate ratably with the common shares in any amount remaining after the payment of their preferred amount on dissolution (see “Common v preferred” above).
Pre-emptive rights for buying shares in class to maintain proportionate interest (optional, pro-rata)
1) A pre-emptive right gives existing shareholders of a class of shares the right to purchase any newly issued shares of that class . a) E.g. suppose a corporation had 100,000 common shares issued and outstanding. Suppose further there were pre-emptive rights attached to those shares that gave the holders of common shares the right to purchase newly issued common shares on a pro rata basis (i.e. according to the number of shares owned by the shareholder) and suppose the corporation were to issue an additional 20,000 shares. A shareholder who held 5,000 of those common shares would be entitled to purchase
1,000 of those shares before they were offered to someone else (5,000/100,000 or 1/20 of the newly issued shares). If that shareholder chose not to purchase those 1,000 shares then they could be offered to other persons. b) Pre-emptive rights allow shareholders to maintain their proportionate interest in shares of a given class . c) CBCA s.28
: there is a pre-emptive right if the articles so provide (so a pre-emptive right is optional under the CBCA), and if it is given for a given class of shares , the shareholders of that class can buy a pro rata portion of the newly issued shares (i.e. in proportion to the number of shares they already own).
Directors issue shares: allocation limit, subscription/allotment, fully paid for (no watering stock)
1) Power of directors to issue shares a) CBCA s.25(1): subject to the articles , the by-laws or any unanimous shareholder agreement , it is the directors who decide on when to issue shares, who to issue them to and for what consideration . i) S.115(3) this is a power that the directors cannot delegate . ii) In France, Germany and Japan the power to issue shares was originally a power of the shareholders, but company law was amended to put this power into the hands of the directors, likely because it makes it easier to finance a project when needed, rather than waiting for the required period to hold a shareholders’ meeting to get approval of the sale of shares. b) Authorized limit and no authorized limit i) The approach that was common in the past was to put a limit on the power of directors to issue shares, known as the
“authorized” amount
of shares the directors can issue.
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(1) E.g. if the authorized limit was 100,000 shares, then once the directors had issued 100,000 shares they would have exhausted their authority to issue shares. They could not issue any more shares without getting an extension of the authorized limit, by an amendment to the articles , which required approval from the shareholders at a shareholders’ meeting.
Organizing a shareholders’ meeting could take some time and can be costly , so could become difficult to obtain additional equity financing when it was needed. This problem was avoided by lawyers putting in extremely high authorized limits in the original articles of the corporation (e.g. an authorized limit of 100,000,000,000 shares), effectively converting the authorized limit into an authorization for the directors to issue as many shares whenever they wanted. ii) CBCA s.6(1)(c): can set out an authorized limit in the articles (forcing directors to go back to the shareholders if they want to issue more), but the articles need not do so (so possible under the CBCA to have no authorized limit on number of shares directors are allowed to issue.
2) When the corporation proposes to issue shares, persons can apply to purchase them. An application to purchase shares is referred to as a subscription a) The subscription is normally treated as an offer to buy shares which the corporation can accept . b) There have problems from time to time with subscriptions to purchase shares made before the corporation was incorporated . i) The corporation could not validly accept the offer until it became incorporated, so the
(potential) shareholder can withdraw her or his offer before acceptance by the corporation and, since it is merely an offer, the corporation , once incorporated, is not bound to accept the offer
(see Re Canadian Tractor Co. (1914), 7 W.W.R. 562 (Sask S.C.)). ii) This was held not to be the case if the subscription was in the memorandum (of a memorandum of association corporation) or the letters patent (of a letters patent corporation)
(see Buff Pressed Brick Co. v. Ford (1915), 33 O.L.R. 264, 23 D.L.R. 718 (App. Div.)). iii) The pre-incorporation subscription issue has also been dealt with in some cases by:
(1) Treating the subscription as a continuing offer ; or
(2)
Regarding a shareholder’s conduct after incorporation as constituting a new offer .
(3) CBCA s.14 (pre-incorporation contracts) might now also address these pre-incorporation subscriptions in some cases (see “Pre-incorp Ks: CBCA” under Corps: pre-incorp Ks above) c) The directors will decide which subscriptions to accept and thus to whom the shares will be issued. When directors make this decision they are said to “ allot
” the shares. d) An underwriter will often be used for public issue of shares (who put their reputation on the line)
3) CBCA s.25 allows the directors to issue shares for whatever consideration the directors determine
(can be money, property or past services )
4) The
“Watered Stock” problem
arose with respect to the consideration on shares because of the tendency to issue shares in return for assets that were significantly overvalued . a) The argument in these situations is that the creditors are deceived by the inflated figures for assets and capital on the balance sheet (or “watered” figures and thus the term “watered” stock). b) The creditors in these cases could be successful in a claim that the shareholders should contribute the difference between the actual value of the assets conveyed to the corporation in return for the shares and the amount at which the shares were allegedly sold for (the latter being recorded on the balance sheet). c) E.g. in the U.S. case ( See v. Heppenheimer , 61 A. 843 (1905 N.J. Court of Chancery) i) The promoters of the company had bought assets for which they had paid $2.25 million. They conveyed these assets to the company in return for bonds with a face value of $1 million and shares which were recorded in the books of the company as having been issued for a value of
$4 million. Thus the company allegedly had $5 million worth of financing, so recorded a corresponding amount on the asset side of the balance sheet (i.e. the books showed assets of $5
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million). The difference between the $5 million figure that appeared on the balance for the assets and the $2.25 million that was actually paid for the assets was said to be “goodwill”. ii) The company was unsuccessful and the creditors ultimately sought to recover from the shareholders. iii) In this case (netting out the amount for the bonds) the shareholders would have to pay $2.75 million (i.e. $4 million (the recorded value of the shares) less the actual value of the equity
(assets of $2.25 million – $1 million for the bonds)). d) CBCA s.25(3) prohibits watered stock : “a share shall not be issued until the consideration for the share is fully paid in money or property or past services that are not less in value than the fair equivalent of the money that the corporation would have received if the shares had been issued for money.” e) Remedies for watered stock i) CBCA s.118(1): directors of a corporation who vote for or consent to a resolution authorizing the issue of a share under s.25 for a consideration other than money are jointly and severally liable to the corporation to make good any amount by which the consideration received is less than the fair equivalent of the money that the corporation would have received if the share had been issued for money on the date of the resolution.
(1) S.118(6) allows for the defence if they did not know and could not reasonably have known that the share was issued for a consideration less than the fair equivalent of the money that the corporation would have received if the share had been issued for money.
(2) CBCA s. 251: directors may also be subject to penal sanction for having breached a provision of the Act
(3) Thus if a share is to be issued in exchange for property other than money the directors should get a professional opinion regarding the value of the property . ii) Actions may still be available against shareholders who contributed money, property or services for an amount less than the recorded price of the shares. iii) It may also be possible for creditors to make such a claim in an oppression application (see
“Corporate oppression actions” under Corps: piercing above) iv) There may be a non-reliance defence – a question from U.S.
jurisprudence on such actions is whether the creditor making a claim has actually relied on the misrepresentation on the balance sheet caused by the watered stock.
(1) If the creditor became a creditor before the alleged watering of stock then the creditor could not have relied , so allowing the creditor to succeed in an action against the directors or shareholders would effectively give the creditor a windfall gain.
(2) A creditor who became a creditor after the alleged watering of the stock may also not have relied on the misrepresented balance sheet figures.
(3) The question in the Canadian context is whether the courts would entertain such a nonreliance claim in an action by creditors against directors or shareholders.
(a) As far as the statutory action against directors is concerned the CBCA does not seem to expressly provide for such a defence .
(b) However, such a defence may be available under the B.C.
Company Act provision since it requires the director to compensate for a loss sustained and it might be argued that no loss is sustained by a third party where the third party did not rely on the misrepresentation.
5) CBCA s.25(3) requires that shares be fully paid for (in money or property or past services), and a promissory note or promise to pay is not considered property for which shares may be issued (s.25(5)) a) In the past , companies would issue shares for a particular price and then simply take a downpayment on the shares.
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i) E.g. you could have a $1 par value share which you sell for $10 and simply receive $2. The remaining $8 would be an account receivable of the company (typically referred to as subscriptions receivable ). b) To the extent that amounts were unpaid on the shares it could be deceiving to creditors if shares were sold to impecunious persons on credit with the recording of an asset of subscriptions receivable. In fact the asset might well not be worth anything close to what it was recorded at on the books of the company (since the amounts might be largely uncollectable).
6) CBCA s.25(2): Shares must be non-assessible a) Companies would sometimes subject shares to additional assessments (i.e. further contributions that the shareholders would have to make to the company). The early notion of par value worked like this where shareholders paid in less than the par value b) Subjecting shares to subsequent assessments might be deceiving to investors who thought their liability was limited to the amount paid for the shares. c)
See “Par value” below
Co. can buy back (but not hold) its shares: redeemable, retraction, solvency (dir/sharehldr liability)
1) S.34(1): a corporation can repurchase its own shares a) S.34(2): this is subject to financial solvency tests that provide that the corporation can not purchase or otherwise acquire its own shares if: i) The corporation is, or would after the payment be, unable to pay its liabilities as they come due; or ii)
The realizable value of the corporation’s assets would, after the payment, be less than the aggregate value of its liabilities and stated capital of all classes.
2) S.30(1): a CBCA corporation is not permitted to hold shares in itself . a) Thus if it does repurchase its own shares it must cancel them or , where it has a limit on the number of authorized shares, it can restore the shares to the status of authorized but unissued shares . b) Some corporate statutes in other jurisdictions do allow the corporation to hold its own shares.
When a corporation holds its own shares the shares are referred to as “ treasury stock
”.
3) S.36(1): a corporation may also purchase its own shares as a result of an express term for the repurchase of shares in its articles (e.g. as part of a redemption right on a particular class of shares). a) This is again subject to financial solvency tests (s.36(2)) – the corporation may not redeem the shares if: i) The corporation is, or would after the payment, be unable to pay its liabilities as they come due; or ii)
The realizable value of the corporation’s assets would, after the payment, be less than its liabilities plus the amount required to pay prior claims of other classes of shares on dissolution. b) Sometimes the company reserves the right to buy back preferred shares
(called “ redeemable
” or a
“call” provision) at a predetermined price (usually set at a premium to the price for which the shares were issued, called a “call premium”), allowing the company to do some refinancing at a future time at a predetermined price for the repurchase of the preferred shares. See typical preferred share features above (in “Common v. preferred”).
4) Sometimes preferred shares are given a retraction right (i.e. they are retractable), allowing the shareholder to sell the shares back to the company at a predetermined price . See typical preferred share features above (in “Common v. preferred”).
5) S.118(2): the directors can be personally liable to restore to the corporation any amounts paid contrary to the financial solvency tests in s.34(2) or s. 36(2). a) Shareholders who receive amounts paid contrary to these provisions may be required to return the amounts to the directors (s.118(5).
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Series within class of shares (with diff rights but not priority over that class) if authorized in articles
1) When funding is needed it is typically needed relatively quickly . a) If an existing class of shares (with rights set out in the articles) are suitable to raise funds, the directors can normally issue more shares (subject to any authorized limit) without delay (except for securities regulation requirements). See “Directors issue shares” above. b) However, if it is decided that some different share rights should be offered to finance the particular venture, then the directors will have to go to the shareholders to approve the creation of the new class of shares, which requires an amendment to the articles (which in turn requires shareholder approval which can be too slow ).
2) CBCA s.27: to allow the directors to provide shares that are more marketable at the particular time, the directors can be authorized in articles to issue the shares of a class of shares in “series” a) Such authorization would have to appear in the articles filed on incorporation, or the articles would have to be subsequently amended to create the new class of shares and provide in the articles that the directors could issue shares of that class in series b) Each series of a given class of shares can be given separate rights and restrictions that may be more appropriate for marketing the shares at the time the directors choose to issue them. i) E.g. you might have a $5 per share preferred dividend right on series 1 Class B preferred shares which are non-cumulative and non-participating. You could then create series 2 Class
B preferred shares having a preferred dividend of $8 per share and which are cumulative and participating preferred shares if such features are necessary to sell a subsequent issue of the preferred shares. c) There is a risk with this that subsequent shareholders of a class will be better treated than the holders of earlier series of shares of the class. i) The CBCA tries to protect against this by providing that no series in a class can be given any priority over any other series in the class with respect to dividends or proceeds on liquidation. ii) See also class and series voting rights in Corporate Governance below
No par value shares (meaningless/deceive), ‘stated capital accnt’ (funds from shares, distrib capital)
1) The par value of a share was originally conceived to be the amount the shareholder was required to contribute to the company. It was a “par” or “equal” value of contribution that would be attributed to all the shares of a given class of shares. a) Originally the par value was the minimum required contribution on the shares. If the shares were sold at a price less than the par value, the shareholder’s liability was not limited to the amount paid in . The shareholder could be required to contribute the difference between the par value and the price paid. Thus if the company were to become bankrupt , the creditors could force shareholders who paid a price less than the par value to pay the difference between the par value and the price they paid. b) Benefits i) The par value concept could provide a further ready source of finance in that the company could call upon those who had paid less than the par value for their shares to pay up the difference. E.g. if the par value on the shares was $1 and if the shares were sold for $0.50 per share, then the company could get additional finance by calling upon the shareholders to pay in the additional $0.50 per share. ii) The par value might also be said to provide creditors with a basis for assessing the amount of capital they could access to cover the credit they extended, simply by multiplying the number of shares by the par value. c) Problems i) It was not long after the first general statute of incorporation that it was held that issuing shares for a price less than their par value was an ultra vires act of the company (see Ooregum Gold
Mining Co. Ltd. v. Roper [1892] A.C. 125 (H.L.)).
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ii) The result was that in order to be able to readily sell a given class of shares, even if the price went down, the tendency was to set the par value at a very low figure – usually well below the price at which one expected to sell the shares. iii) As a result, the par value became meaningless .
(1) Because set so low, the par value figure bore no relation to the amount of capital .
Additionally, since could not issue shares at a price of less than the par value, there was no excess of par value over the price paid which the company could call upon the shareholders to pay in as a ready source of finance.
(2) In fact, the par value would never have really served as a satisfactory means of assessing the value of the equity in the company. Once the business started operating, the value of the equity could go up or down depending on the value of the assets relative to the value of the liabilities . Multiplying the par value of the shares times the number of shares would yield a positive value but if the business was doing poorly the value of the assets might well be less than the value of the liabilities. iv) This also resulted in a “ contributed surplus ” which was deceiving
(1) Since the shares were always sold at a price greater than the par value of the shares, the equity of the company was recorded as the number of shares times the par value, plus a separate account called “contributed surplus” (the number of shares times the difference between the price and the par value). Various commentators suggested that this
“contributed surplus” was deceiving to creditors, since some creditors viewed this as an extra cushion against the event of bankruptcy. However, once the business was in operation and accumulating debts with depreciating assets, it was very possible that the company would be in insolvent circumstances in spite of the presence of an account called
“contributed surplus” on the balance sheet. v) Par value was also deceiving to investors as representing the worth of a share
(1) It was also felt that the par value concept was deceiving to investors since many investors tended to assume that the par value represented the worth of the share. However, the par value was simply a nominal value assigned to the share and had no relation to the worth of the share. The shares could be worth more or less than the par value of the share. d) CBCA s.24(1) prohibits par value shares i) The above concerns led the Dickerson Committee to recommend doing away with the par value concept, and the CBCA did so. ii) Instead, the directors assign a stated value for the shares for the purposes of the capital accounts. iii) See also “ Shares must be non-assessible ” in “Directors issue shares” above
2) CBCA s. 26(1): a stated capital account is maintained for each class or series of shares that has been issued. a) The stated capital account consists of the total amount for which shares of the class or series have been issued . b) E.g. if 1,000 class A shares are issued on day 1 for a stated value of $10 per share, and then 2,000 more class A shares are issued on day 30 for a stated value of $13 per share, then the stated capital account for class A will appear as follows: i) Class A shares $36,000 (1,000 x $10 per share and 2,000 x $13 per share) ii) 3,000 shares issued and outstanding iii) The stated capital per share would be $36,000/3,000 shares = $12 per share. c) Stated capital is not cash. It is simply a bookkeeping entry showing a historical record of the amount of funds raised by the sale of shares of each class or series. The funds received will appear as an asset on the balance sheet . i) Note this cash will likely be spent on other assets used in running the business. If the business does well the assets may be worth a great deal more than the amount that was raised through
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the sale of shares. If the business does poorly the assets may be worth considerably less than the amount raised through the sale of shares. ii) Thus the amount recorded is not affected by increases or decreases in the value of the assets. d) The stated capital account must be kept up to date : i) If more shares of a class or series are issued , the applicable stated capital account must be adjusted to reflect the increase in the total amount of funds raised by the sale of shares of that class or series. ii) Also, if shares of a class or series are repurchased or redeemed (or otherwise acquired), then the applicable stated capital account must be adjusted to reflect the reduction in the total amount of funds raised by the issue of shares of that class or series.
(1) S.39 provides, for instance, that on a redemption or repurchase of shares, the reduction in the stated capital account must be equal to the stated capital per share (for that class/series account) times the number of shares repurchased/redeemed/etc e) CBCA s.38(1): shareholders may also approve by special resolution a reduction in a stated capital account i) E.g. to distribute capital to shareholders .
(1) Such return of capital has an affect on the success of the business and can have tax consequences for individual shareholders. It is a significant change , and so must be approved by the shareholders by special resolution.
(2) A payment to shareholders as a result of a distribution of capital to shareholders also reduces funds available in the corporation to pay amounts due to creditors , so is potentially harmful to creditors. Thus under s.38(3), a return of capital subject to financial solvency tests :
(a) The corporation is, or after the reduction would be, unable to pay its liabilities as they become due; or
(b) the realizable value of the corporation’s assets would thereby be less than the aggregate of its liabilities.
Debt finance: bank line of credit/term loans (security/accl), sell notes/comm paper/bond/debenture
1) As with the sole proprietorship and partnership, corporate debt financing may take the form of trade credit or loans. Loans are usually obtained from a bank , although loans might also come from other persons including shareholders . It is more common in the corporate context to also find corporate borrowing through the sale of commercial paper and/or the sale of debentures.
2) Bank loans a) Loans are contractual arrangements. A loan from a bank obtained by a corporation will be based on a contract between the corporation and the bank (the written document evidencing the loan might, for instance, be entitled “Loan Agreement”). The terms of these agreements could vary widely but there are two common types of loan agreement: i)
Banks will often provide a “ line of credit
” or “ revolving line of credit
” to finance short term fluctuations in a firm’s cash requirements. A revolving line of credit allows the borrower to borrow up to a specified limit. The borrower takes up the loan as necessary and then pays down the loan when cash becomes available. This form of bank loan is usually used to finance the day-to-day cash inflows and outflows of the business. This can be especially useful for seasonal businesses which can draw on the bank loan to cover expenses during the busy season and pay it down when accounts receivable in the busy season are paid or to cover up front expenditures early in the season which are paid down as the busy season progresses. ii) Bank term loans are provided for longer periods of time and normally involve a fixed sum to be paid at a later time with interest payments to be made on a regular basis. They may instead require that the loan be retired through a series of installments. The terms can vary from relatively short terms to longer terms .
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(1) A common practice is to match the terms of loans to the lifespan of particular assets or groups of assets. This matching may reduce potential risks. For instance, suppose the corporation is buying an asset with an estimated 10 year life span but gets a term loan for just two years. At the time the corporation gets the loan on the acquisition of the asset the managers are reasonably confident that the asset will help generate sufficient before interest profits to pay the interest on the loan, accumulate amounts to pay off the principle and still leave a satisfactory profit. However, after two years the loan will have to be replaced with a new loan. If interest rates have gone up at that time the pre-interest profits on the asset may not be sufficient to pay the interest. iii) Bank loans usually have terms that are intended to provide some protection to the bank . The bank’s concern is that the borrower has enough money to cover both the interest and the principle on the loan.
(1) The bank may be concerned that the borrower not engage in businesses that are very risky .
If a very risky business does well the bank’s interest and principle will get paid, but if it does not do well the bank will probably not be paid back. The borrower, especially a corporate borrower with limited liability, might be willing to take the risk since the borrower will get the upside gain if the business does well (paying off the fixed rate of interest and the principle while pocketing the rest) but will have limited downside risk if the business doesn’t do well (especially if the investors have limited liability). One thing the bank may do to address this risk is restrict the kinds of businesses the borrower can engage in. The risk of the borrower gambling with the bank’s money increases as the amount borrowed increases, so the bank may also require that the ratio of liability to total assets be limited to some percentage (e.g. 60%).
(2) The bank might also restrict the way the borrower manages the business. For instance, the bank may require the borrower to maintain a minimum “working capital ratio.”
Essentially this is a requirement that the things the borrower can turn into cash quickly
(e.g. usually cash in a bank account, accounts receivable, and inventory) be at least some number (e.g. 2) times the sum of liabilities that will have to be paid in the near term (e.g. accounts payable). In other words the bank is trying to make sure the borrower will have enough funds to pay expenses as they come due and have funds left over to pay interest on the loan.
(3) The bank may also require the borrower to grant the bank a security interest (i.e. collateral ) over certain assets of the borrower. If the borrower doesn’t pay, the bank can seize the assets to which the security interest applies. iv) A common clause is an “ acceleration clause ” which provides that if the borrower defaults on any of its obligations the bank can require that all amounts become due immediately. The main thing this will apply to is the principle amount of the loan.
(1) E.g. if the bank loaned $1,000,000 and the agreement was that the $1,000,000 principle amount was to be paid back in 10 years time, a default by the borrower two years into the loan agreement would result in the $1,000,000 principle being due immediately instead of in 10 years time.
(2) It would also normally be provided that if there was a security interest, the right to seize the asset would arise if there were an event of default. The events of default that would trigger the acceleration clause (or the right to seize) would typically include the failure to pay interest or principle as they became due, the failure to comply with any of the ratio requirements, or failure to comply with restrictions under the loan agreement on the conduct of businesses.
3) Corporations also often obtain debt finance through the sale of notes (or commercial paper) and through the sale of bonds or debentures.
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4) The corporation may sell notes (or commercial paper) which are promissory notes that constitute promises to pay a specified amount of money at specified time in the future. Usually the time is relatively short term (usually for 30, 60 or 90 days). The promise may be just a promise to pay the fixed amount or may include a promise to pay the fixed amount plus interest. Investors pay money to the corporation in return for the promise to receive the fixed amount at the future date. a) E.g. a $100,000 note maturing in 90 days might sell for $98,000 but the corporation would be obliged to pay $100,000 in 90 days. The note thus carries an implicit rate of interest in that the buyer invests $98,000 but at the end of 90 days gets back $98,000 plus $2,000 as a fee for the use of the buyer’s/investor’s money. b) The sale of commercial paper by a corporation is like getting a short term bank loan but instead of getting a loan from the bank the loan comes from potentially numerous investors who buy the commercial paper. The notes are usually in reasonably large denominations of perhaps $50,000 or
$100,000. The buyers usually include institutions such as banks, insurance companies, and pension funds. They often include other commercial corporations that use commercial paper as a place to store funds that may be needed in the reasonably near future. Storing the funds in cash or in a bank account often will not generate the same returns in interest as commercial paper does.
Commercial paper can be a convenient place to store the needed funds because it can usually be sold fairly quickly. The lender (buyer of the commercial paper) does not have to wait until the maturity date to get the money back – the lender can simply sell the commercial paper to another person (in legal terms, by “negotiating” the note).
5) A large amount of debt finance , say for example, $50 million, may be divided into 50,000 bonds or debentures having a face value of $1,000. These would be sold to the public and could be owned by as many as 50,000 individuals (although some individuals might buy more than one debenture). The bond or debenture (which is simply an evidence of indebtedness ) would require the payment of
$1,000 to the investor at some time in the future (called the “principal amount” or “face value” of the bond), perhaps in ten years time, and require the payment of interest at a specified rate at regular intervals. a) E.g. a bond or debenture might express on its face an obligation to pay the holder $1,000 (the
“face value”) at the end of ten years. It would provide the holder with a right to receive interest at say 5% semiannually, or in other words, a right to receive $50 every six months until maturity. At maturity the holder would have the right to receive $1,000. b) Bonds or debentures do not generally carry the right to vote at company meetings (although they may be given voting rights at company meetings in specific instances of default ). The bond or debenture would be subject to numerous contractual terms which are typically set out in an agreement (i.e. a contract) referred to as the indenture. Bonds or debentures usually carry longer periods of time to maturity of perhaps 5, 10, 15 or 20 years. The sale of bonds or debentures is like getting a long term bank loan but instead of getting the loan from a bank the loan comes from the potentially numerous persons who buy the bonds. Often bonds are sold to primarily institutional investors such as banks, insurance companies, mutual funds, pension funds, etc. c) There is no real legal distinction between a “ bond
” and a “ debenture
”. A “debenture” is a document that provides evidence of indebtedness. However, in business “street lingo” a reference to a “ bond ” is usually understood to mean that the payment obligations are secured by some assets of the borrower. The word “ debenture
” in business “street lingo” is usually understood to mean that the payment obligations are not secured by assets of the borrower. Sometimes a “bond” is thus referred to as a “secured debenture.” As usual, the approach of the courts would be to look at the substance of the contract regardless of what name has been used to describe the obligation. d) Bonds or debentures are subject to contractual terms that can include a virtually infinite variety of terms. Since they are essentially like bank loans except that they involve borrowing from potentially numerous investors, many of the terms are quite similar to those that would be found in a bank loan.
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i) The terms of the agreement may provide for a security interest in assets of the corporation (in which case the instrument will typically be referred to as a bond). ii) They usually include terms such as controls on further debt finance , a series of events of default such as non-payment of interest or principal or the failure to meet certain specified accounting ratios , and rights of the bond or debenture holders upon an event of default such as an acceleration clause , a right to appoint a receiver or receiver manager , or to appoint one or more directors to the board of directors, to seize assets of the corporation, and so on. iii) Bonds or debentures may also include special features such as a right to convert the bond into other securities of the corporation (such as common shares of the corporation). They may contain a participation right allowing the bond to share in the profits of the corporation beyond the payment of interest on the bonds (these are called “ income bonds
”). They may be sold with warrants which allow the bondholder to buy shares of the corporation at a specified price within a specified period of time. e) There can be problems with the enforcement of the terms of the indenture where there are a large number of bondholders. The bondholders will face the small stake and free-rider problem . It will not be worthwhile for any one of them to enforce the terms of the indenture and each bondholder would prefer to have another bondholder incur the costs of enforcement while still receiving the benefit of enforcement at no cost to themselves. i) Consequently it was, and still is, common practice for issuers of bonds or debentures to appoint a trustee to enforce the terms of the indenture on behalf of the bondholders or debenture holders . Issuers would have such trustees appointed because it would be hard sell an issue of debentures without the appointment of a trustee – investors would know that it was unlikely that the terms of the indenture would be enforced. ii) Problems can arise with the appointment of these trustees for the debenture holders. Trustees chosen by the issuer might be inclined to act in the issuer’s interests, particularly where the trustee had some close connection to the issuer. Issuer’s might want to give the appearance of likely enforcement by appointing a trustee while at the same time limiting the likelihood of enforcement by appointing persons who would not really be competent at the enforcement of the terms of the indenture or the issuer might constrain the steps that the trustee could take in seeking to enforce the indenture. Consequently, both the CBCA , and most other corporate statutes in Canada, have rules governing trustees . These rules are based on the U.S. Trust
Indenture Act of 1934 . The CBCA has the following rules:
(1) Qualification
– trustees must be incorporated under and subject to controls under statutes governing the incorporation of trust companies [CBCA s.84];
(2) Conflict of Interest – trustees can not have a conflict of interest with the issuer [CBCA s.83];
(3) Access to List of Debenture Holders
– trustees must be permitted access to the list of debenture holders for the purpose of communicating with them for the purpose of voting or other matters relating to enforcement [CBCA s.85];
(4) Power to Demand Evidence of Compliance
– trustees have the power to demand evidence of compliance with the terms of the indenture [CBCA s.86-88];
(5) Must Give Notice of Default – trustees must give the debenture holders notice of a default by the corporation [CBCA s.90];
(6) Duty of Loyalty and Duty of Care – trustees must act honestly and in good faith for the interests of debt holders and with the care skill and diligence of a reasonably prudent trustee [CBCA s.91].
Securities (shares/bonds/debentures/etc): prospectus, disclosure, insider trading, takeover bid
1) Securities include shares, bonds or debentures and other investment schemes .
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a) Securities laws are not limited to shares, bonds, debentures. Can also relate to private loans (e.g. from me and you) if there is an investment element to it
2) In very general terms, securities regulation deals with the sale and trading of securities . a) I.e. the distribution of securities (i.e. sale by a securities issuer such as a corporation), the postdistribution trading of those securities amongst investors, insider trading, market manipulation, takeover bid regulation, the regulation of persons providing services in the securities industry (e.g. brokers, underwriters, investment advisors), and the sale of mutual funds. b) E.g. if someone comes in to incorporate, always ask where they are getting their funds – if they are not coming out of their own pockets, check securities laws c) Securities regulations are also increasingly imposing requirements on corporate governance (e.g. corporations selling shares in the US and/or list on an exchange in the US, a whole other set of regulations (e.g. statute in response to Enron) impose restrictions on corporate governance)
3) Sources of securities law in many of the jurisdictions that follow the English model of corporate statute, the general statute of incorporation will contain provisions concerning the requirement to provide a prospectus for a public offering of securities . The general statute of incorporation will also typically contain provisions on continuous disclosure such as financial disclosure and proxy circulars
(documents providing information to shareholders for shareholder meetings). These statutes, such as those in the Malaysian and Singaporean companies Acts, often contain codes for takeover bid regulation as a schedule to the Act. Securities Acts in these jurisdictions tend to focus on regulation of the securities industry and securities trading including provisions on the registration of persons engaging in securities business, market manipulation and insider trading.
4) In Canada , as in the United States, these matters are primarily dealt with in separate securities statutes
(although the CBCA does have provisions on financial disclosure and proxy solicitation ). Until recently the CBCA had provisions on takeover bid regulation , but these were repealed leaving the regulation of takeovers to provincial securities regulation. a) Securities regulation is a matter of provincial jurisdiction in Canada. Each of the ten provinces, and the territories, have statutes dealing with securities regulation. British Columbia, Alberta,
Saskatchewan, Ontario, Nova Scotia and Newfoundland have very similar securities acts. The
Quebec Securities Act , while differently worded, in practice works in much the same way as the statutes in the provinces noted above. b) The securities acts, like most other statutes, grant a power to the Lieutenant Governor in council to create subordinate legislation known as regulations. Developments in the late 1980s raised concerns over the slowness of the regulatory process in responding to the rapid rate of change in securities markets. By the mid-1990s several provinces had responded by granting provincial securities regulators powers to create a form of subordinate legislation similar to regulations but known as “rules”. This rule-making power is similar to the rule-making power that the Securities
Exchange Commission in the United States has. c) Securities legislation, and rules and regulations created pursuant to securities legislation, give provincial securities administrators wide discretionary powers . The provincial securities administrators will often indicate the principles on which they intend to exercise those powers by issuing policy statements. Thus provincial securities law is found in provincial securities acts, securities regulations, securities rules and provincial securities administrative policies.
5) National co-operation : the securities administrators in each of the provinces have long recognized the difficulties issuers of securities face in complying with inconsistent regulations from the various provinces when they attempt to distribute securities in more than one province. By the early 1950s they began to meet as a group to address the problems created by inconsistent regulatory schemes.
Together the group was known as the “
Canadian Securities Administrators
”. i) Initially they met annually and later semi-annually. Now they have a permanent staff with offices in Toronto. They have generally sought consistency in securities acts although not with complete success since the legislation is passed in provincial legislatures so the provincial
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statutes are, in the final analysis, not within their control. While the statutes may vary somewhat from province to province, the Canadian Securities Administrators try to harmonize the operation of the statutes in practice through consistent provincial securities regulator rulemaking and administrative policy. ii) The Canadian Securities Administrators attempt to achieve consistent rule-making by having the Canadian Securities Administrators’ staff draft rules that can be adopted by provincial securities administrators across the country. Where these rules are agreed to for adoption across the country they are referred to as “ National Instruments ”. The Canadian Securities
Administrators try to achieve consistency in administrative policy as well by having provincial securities administrators agree to “
National Policy Statements
”. National Instruments often leave some discretion to provincial securities administrators and are thus often accompanied by policy statements known as “
Companion Policies
”. Occasionally only some of the provincial or territorial administrators agree to the adoption of instruments proposed by the
Canadian Securities Administrators. These are often brought into effect by the regulators of the agreeing jurisdictions and are referred to as “ Multilateral Instruments ”.
6) Stock exchange regulation a) As noted further below, an issuer of securities may choose to issue its securities on a stock exchange . If it does so it will have to enter into a listing agreement with the stock exchange .
Under the agreement the issuer agrees to comply with the rules and policies of the exchange.
These rules and policies include corporate governance requirements, disclosure requirements and rules governing various specific transactions. b) Although Canada had several stock exchanges not too many years ago, these have now been consolidated into the Toronto Stock Exchange . Toronto Stock Exchange has a main exchange and a venture capital exchange referred to as the Toronto Venture Exchange.
7) Distribution of securities to the public a) Most of the provincial securities acts provide that a prospectus is required when there is a
“distribution” of a “security”
(see, e.g., British Columbia Securities Act , s.61). To determine when a prospectus is required one thus has to look at the definitions of “security” and “distribution”.
Before doing that we should first note that the prospectus requirement is not limited to distributions of securities by corporations. It applies to distributions by “persons” including not just corporations but also individuals and trustees. i) The term “ security ” is very broadly defined to include not just shares and debentures but also warrants, options, rights and other instruments or transactions that have a similar investment character
. The definition of “security” in provincial securities acts is quite similar to the definition in the U.S. Securities Act of 1933 . Canadian courts (including the Supreme Court of
Canada) have also explicitly followed U.S. court decisions on the meaning of the term. Thus this quote from an American securities regulation text (Thomas Lee Hazen, Treatise on the
Law of Securities Regulation , 3d ed. (St. Paul: West Publishing, 1995, note 19 at pp.28-9) is indicative of the potential breadth of the term “security”:
(1)
“What do the following have in common: scotch whisky, self improvement courses, cosmetics, earthworms, beavers, muskrats, rabbits, chinchillas, fishing boats, vacuum cleaners, cemetery lots, cattle embryos, master recording contracts, animal feeding programs, pooled litigation funds and fruit trees? The answer is they have all been held to be securities within the meaning of federal or state securities statutes.”
(2) For instance, in SEC v. W.J. Howey Co., the court held that the sale of one acre lots that consisted of rows of fruit trees were securities. The lots were sold to persons who did not manage them themselves but who left the management of the lots to a common management service company. The share of profits the individual purchasers of the lots got from orange grove operation was based on the number of lots an individual owner had relative to the total number of lots under the common orange grove management. In other
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words, while the transaction was made to look like just a sale of interests in land, it had qualities very similar to the sale of shares. ii) In the past provincial securities acts required a prospectus when there was a “distribution to the public”. The meaning of the “the public” was fraught with difficulties. Most provincial securities acts now require a prospectus simply when there is a “ distribution ” of a security.
The term is very broadly defined . It includes, among other things, “a trade in a security of an issuer that has not been previously issued.”
(1) The expressions used to define a “distribution”, like the one referred to above, refer to a
“trade” in a security. The term “trade” is broadly defined and includes, for instance, “any sale or disposition of a security for valuable consideration.” b)
Thus any offering of “securities”
that have not been previously issued will require a prospectus even if the securities are not being offered to the “public”.
This prospectus requirement is obviously overly broad . It would make financing for small businesses almost impossible given the cost of preparing a prospectus. It would also make offerings for large businesses unnecessarily expensive when they issue securities to sophisticated investors who arguably don’t need the protection of securities regulation (e.g. banks, insurance companies and other institutional investors that specialize in the acquisition of securities and buy securities in relatively large quantities). Thus the approach in most Canadian securities acts is to begin with this very broad and inclusive definition of “distribution” and then provide specific exemptions from the requirement to provide a prospectus. i) An extensive analysis of exemptions is beyond the scope of these notes. However, a brief examination of Multi-lateral instrument MI 45-501, adopted in Ontario, Saskatchewan, Alberta and British Columbia will give an idea of how these exemptions work while reviewing what are probably the most important exemptions for entities seeking public financing in those major securities markets in Canada. ii) Small Business Exemptions : Small businesses can avoid the prospectus requirement by taking advantage firstly of an exemption for up to the first $3,000,000 raised from no more than 35 investors. The investors must be given a one page information sheet that explains how risky investments in small businesses can be, gives some basic points on investment strategy (e.g. the importance of diversification), and notes some key questions they should have answered by the promoters of the business. In addition to this $3,000,000 exemption, small businesses can access investment from certain accredited investors without having to file a prospectus.
The accredited investors that small businesses can access include persons who alone or together with their spouse have assets with a realizable value of more than $1,000,000 or have income before taxes of more than $200,000 (or $300,000 in combination with their spouse).
Accredited investors small businesses can access without filing a prospectus also include the promoters and the spouse, parents, grandparents or children of the promoters or of officers or directors of the issuer. Another accredited investor the small business can seek funds from without a prospectus is a corporation, limited partnership or trust that has $5,000,000 or more in assets on its most recently completed financial statement. iii) Exemptions for issuers that have publicly traded securities : Issuers that already have distributed securities pursuant to a prospectus may want to raise further funds through a
“ private placement
”. A private placement involves distributing shares without filing a prospectus by distributing the shares to persons who do not need the protection that a prospectus is intended to provide. These persons are assumed not to need the protection of a prospectus because they are either sophisticated investors or would have access to advice from investment advisers. These investors include institutional investors such as banks, trust companies, insurance companies, pension funds, credit unions, mutual funds, municipalities and governments. Corporations, trusts or limited partnerships that have $5,000,000 or more in
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assets on the basis of their most recent financial statements would also be among the persons to whom an issuer of publicly traded securities might make a private placement. c) The prospectus distribution process i) If it is intended that an offering be made to the public rather than a private placement or some other prospectus exempt distribution then a prospectus will be required. Forms of prospectuses under provincial securities regulation set out specific required items of disclosure such as arrangements with underwriters, the expected proceeds of the issue, the intended use of the proceeds of the issue, a description of the rights on the securities, the nature of the issuer’s business, the backgrounds of the directors, and so on. The disclosure is not limited to the specific items but includes disclosure of all material information (i.e. information that would likely affect an investor’s decision on whether or not to acquire the securities). ii) The process for issuing securities involves filing a preliminary prospectus with each of the securities administrators in the jurisdictions where one proposes to distribute the securities.
The securities administrators then vet the prospectus to see if it complies with the requirements of the Act and Rules or Regulations, and look for gaps in disclosure. The administrators then issue a comment letter indicating problems or concerns they have with the prospectus. When the issuer has responded to these concerns to the satisfaction of the securities administrators the issuer can file a final prospectus . The administrators briefly examine the final prospectus and issue a receipt for it if all is in order. With the receipt for the final prospectus in hand the sale of the securities can begin. The period between the filing of the preliminary prospectus and receiving the receipt for the final prospectus is known as the “ waiting period
”. Selling activities are constrained during this waiting period. The issuer, or the underwriters, may only solicit expressions of interest in the securities disclosing only the nature of the issuer’s business, the price of the security and where the security can be acquired. They may also give out the preliminary prospectus. iii) The Canadian Securities Administrators have created a National Instrument dealing with distributions in multiple jurisdictions in Canada . Very briefly stated, the process is one in which the comments on the prospectus are coordinated through a “principle jurisdiction” selected by the issuer. iv) There are also alternative prospectus procedures . One alternative procedure allows for the pricing of the security after receipt for the final prospectus. Another alternative procedure allows for a short-form prospectus designed to expedite the securities commission vetting process by relying on continuous disclosure documents (see below) to provide information on the business of the issuer. This is normally only open to issuers with a significant size with a significant market following. There is also a shelf offering procedure allowing the issuer to qualify offerings of particular types of securities for up to two years in advance. d) Stock exchange listing i) An issuer of securities can make a public offering of securities without listing securities on an exchange. This has not been common in Canada in recent years. In addition to its main board, the Toronto Stock Exchange operates a Venture Exchange the listing requirements for which are much easier to meet than those of the Toronto Stock Exchange.
8) Continuous disclosure a) The CBCA has provisions on financial disclosure and information circulars required when proxies are solicited . This is discussed in a subsequent chapter on corporate governance. b) Provincial securities acts also have continuous disclosure requirements for issuers of securities that have made a distribution of securities pursuant to a prospectus. These issuers are referred to in most provincial securities acts as “ reporting issuers
”. CBCA corporations, subject to a possible constitutional argument to the contrary, have to comply with these provincial (and territorial) securities act disclosure requirements. A provincially incorporated corporation would have to
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comply with the disclosure requirements of securities acts in any province or territory in which it has distributed securities pursuant to a prospectus. c) Provincial securities act disclosure requirements include financial disclosure, proxy circular disclosure, insider trading reports and timely disclosure. Insider trading reports require disclosure of trades made by directors and senior officers of the issuer, and entities affiliated with the issuer, within 10 days of the trade. Timely disclosure involves disclosure of material information concerning an issuer by press release as soon as possible. d) Disclosure under provincial securities acts is generally required to be done electronically. The documents filed are kept on a database called “SEDAR” for “System for Electronic Disclosure and
Retrieval”. This system is very similar to the U.S. EDGAR (“Electronic Data Gathering And
Retrieval”) system.
9) Regulation of insider trading a) A detailed discussion of insider trading is beyond the scope of these notes. However, these brief remarks will hopefully provide a basic picture of how it is regulated. First, it is a matter that is primarily regulated under provincial securities acts. Unlike the U.S. which has developed insider trading regulation largely on the basis of court decisions interpreting SEC Rule 10b-5, the approach in Canada has been to enact a detailed statutory regime. Under this approach insiders include a wide group of persons specified in the legislation. Instead of using the term “insider”
(which is typically used for insider reporting requirements) the persons subject to insider trading prohibitions are described as persons in a “special relationship” with the issuer . i)
Persons who are in “special relationship” include not just directors, officers and employees of an issuer but also the directors, officers and employees of affiliated corporations, persons (and employees of persons) providing professional or business services to an issuer of securities
(e.g. a law firm, accounting firm, underwriting firm), persons (and employees of persons) proposing to do a takeover, merger or other business combination with the issuer, persons formerly in any of the relationships described above, and persons who, directly or indirectly, have received a tip from any of the persons described above. b)
Persons in a “special relationship” with the issuer are prohibited from trading with knowledge of material information concerning an issuer where that information has not been generally disclosed .
Persons in a special relationship with the issuer are also prohibited from informing others of material information that has not been generally disclosed unless that information must be disclosed in the necessary course of the issuer’s business or in the necessary course of the person in the special relationship. These insider trading prohibitions are supported by a wide range of potential sanctions. i) First there is a criminal sanction. In addition to potential imprisonment, a fine of up to three times the profit made or the loss avoided can be imposed. ii) Second, there is a potential action by persons who traded with the person in the special relationship for any loss incurred by the person as a result of the trade. iii) Third, there is a potential action by the issuer for an accounting to the issuer by a director or office of the issuer who has benefited from insider trading or informing. This action can be brought by a security holder of the issuer or by the relevant securities commission on behalf of the issuer. iv) Fourth, the securities commissions have the power to impose a variety of administrative sanctions including a cease trade order, a denial of exemptions, or a prohibition against the person acting as a director or officer of a reporting issuer. c) This current form of insider trading regulation under most provincial securities acts began with the enactment of the Ontario Securities Act in 1978. It is very similar to the approach taken by Japan in 1988, by a European Union directive in 1989 and by Singapore and Malaysia.
10) Takeover bid regulation
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a) A takeover bid is a bid to acquire sufficient shares of a corporation in order to control the management of the corporation. Acquisition of more than 50% of the voting shares would allow the bidder to control the appointment of directors and thereby control the management of the corporation. In publicly traded corporations with widely-held shares, it is also often possible to control the appointment of directors with considerably less than 50% of the shares. b) Takeover bid regulation of the sort that has become common in many jurisdictions around the world was enacted in the province of Ontario in 1967, a year before similar legislation was enacted in the U.S. pursuant to the Williams Act in 1968. It is dealt with in Canada in provincial securities acts. c) The provincial securities acts define a “takeover bid” as an offer for securities
that would result in the offeror owning , directly or indirectly, 20% or more of the equity securities of any class of securities of the issuer. Where an offeror makes a takeover bid, the bid must comply with certain rules. i) The bid must be made to all holders of the target issuer’s shares
(of the class of shares sought) and the bid must be kept open for a minimum of 35 days. Shares tendered by offerees can be withdrawn anytime within the bid period. ii) If the offeror makes a bid for less than all the shares of an issuer then the shares must be taken up on a pro rata basis not on a “first-come first-served” basis. iii) The bidder must provide a takeover bid circular that complies with a required form and sets out information that would assist offerees in assessing whether to tender their shares under the bid. iv) The directors of the target issuer must also, within fifteen days of the bid, send to the offeree shareholders a circular setting out information concerning the bid that would be relevant to the offeree shareholders in assessing whether to tender their shares under the bid. Required items included in the circular are set out in a form for the directors’ circular. The directors must also recommend either the acceptance or rejection of the bid giving their reasons for the recommendation. v) Consideration paid under the bid must be the same for all offerees tendering under the bid.
Thus if the consideration offered during the bid period is increased, the increased consideration must be paid to all offerees who tender even if they tendered their shares before the consideration was increased. Collateral consideration cannot be paid to a holder of a significant block of shares (e.g. a new car or house or some other shares on the side). d) Early warning requirements : The takeover bid provisions usually also contain a provision requiring the issuance of a press release by a person who acquires 10% or more of the voting shares of a reporting issuer. A further press release is required whenever the person acquires an additional 2% or more of the voting shares of the issuer. These provisions are intended to deter so called “ creeping acquisitions
” and to provide an “early warning” of potential changes in control of reporting issuers. e) Poison pill plans : It has become common for issuers to adopt poison pill plans. These plans usually involve the issuance of rights to buy further shares of the issuer to existing shareholders.
These rights allow existing shareholders to acquire shares of the issuer at a price that is significantly below the market price of the shares. These rights, however, only come into effect when a person acquires more than a specified percentage of the voting securities of the issuer. The person who acquires 20% of the voting securities does not get to exercise the rights (does this fit with the requirement of equal treatment of shareholders of a class or series?). There is also usually a provision allowing the board of directors to waive the effectiveness of the rights. The rights will also normally be waived if the person who acquires the specified percentage of shares makes a bid for the shares that complies with rules set out in the rights plan. These rules often follow the takeover bid legislation rules but usually require a much longer minimum bid period. This gives directors of the target issuer more time to respond to the bid by searching out potential competing
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bids. It also puts the directors of the target in a good bargaining position to negotiate with the bidder. Securities administrators can control the use of poison pill plans and other target issuer defensive tactics through their administrative powers, especially their power to issue a cease trade order. i) The Canadian Securities Administrators have issued a National Instrument indicating their position on the use of target issuer defensive tactics. In general terms, their policy is to encourage auctions for takeovers that should lead to higher prices for target issuer shares.
They are opposed to defensive tactics by target management that would block takeovers ii) completely but accept defensive tactics that would serve to increase the price per share for target shareholders.
In the context of poison pills, securities administrators can stop the continued operation of a poison rights plan by issuing a cease trade order on the rights. This would prevent target shareholders from being able to exercise the rights. Securities administrators have indicated that they will not cease trade poison pill rights as long as the rights plan is serving the function of encouraging competing bids or extracting a higher price from the bidder.
Corporate governance: dirs/offs
Objects/powers, agent (dir/off) actual/ostnsble authority, old CL of ultra vires (not in corp capacity)
1) A common approach around the world, in both common law and civil law jurisdictions, has been for general statutes of incorporation to require that constating documents of the corporation (e.g. the memorandum of association or articles) set out the objects and powers of the corporation: a)
The “ objects
” of the corporation would be the purposes for which the corporation was created (i.e. the kinds of businesses that the corporation would engage in), allowing investors to assess the risk of making an investment in the corporation. i) E.g. the corporation may have been incorporated for the purpose of manufacturing widgets, which would be stated in the objects clause in the memorandum of association. b)
The “ powers
” would identify the kinds of things the corporation could do in carrying on the business/objects of the corporation, again helping investors assess the risk i) E.g. In order to raise funds to acquire assets to be used in the manufacture of widgets, the corporation has the power to borrow money and grant a security interest in assets of the corporation to the lender. Knowledge of this would let investor’s know that there was a potential for borrowing by the corporation that might expose it to a higher risk of bankruptcy, and that there might be secured creditors who could claim a significant portion of the assets of the corporation to satisfy the debts owed to them.
2) Authority of agents (e.g. directors/officers) of the corporation a) The directors and officers of the corporation are agents of the corporation (recall Agency above). b) They act with actual authority which can be found in : i) Express : the constating documents of the corporation (such as the articles and by-laws of a
CBCA corporation, or the memorandum and articles of a memorandum of association corporate statute), resolutions of shareholders, resolutions of directors, or terms of employment or agency contracts, and: ii) Implied : in the usual authority (what this particular person has been allowed to do in the past) or the customary authority (what persons occupying similar positions are usually allowed to do) (see “Actual authority” in Agency above) c) They also have ostensible authority (the authority which third parties reasonably rely on in the circumstances in which they encounter the agent) (with representation made by an agent with actual authority to do so, such as Board of Directors – see in Agency above) d) Recall also claim by 3 rd party v. agent for breach of warranty of authority
3) Scope of authority limited to the capacity of the corporation .
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a) The authority of an agent cannot extend to doing things on behalf of the principal that the principal could not do themselves. b) E.g. an agent for a minor (or other legally incompetent person) could not enter into a contract on behalf of a minor that the minor could not enter into. c) Similarly, a director or officer of a corporation cannot enter into a contract on behalf of the corporation that the corporation itself could not enter into because it has no capacity to so so.
Such contracts are said to be ultra vires (i.e. beyond the power of) the corporation (see case law below)
4) Old common law (CL): a) Suppose the objects and powers of the corporation are interpreted as reflecting the capacity of the corporation. Acts of the corporation that were contrary to these objects or powers would then not be legally valid acts. Thus a contract entered into by an agent of the corporation on behalf of a corporation that was contrary to the objects or powers of the corporation would be void (i.e. the contract never existed). It is not a question of the agent’s authority
, whether actual or ostensible – rather the corporation (as principal) simply could not enter into such a contract. b) As described below, this was the interpretation that courts in common law jurisdictions gave to acts contrary to the objects or powers of the corporation. c) Leading case was Asbury Railway Carriage & Iron Co. v. Riche (1875), L.R. 7 H.L. 653 i) Facts:
(1) The memorandum of association for the Asbury Railway Carriage & Iron Co. (ARCIC) set out the following objects for the company: “to make, sell or lend or hire, railway plant, fittings, machinery and rolling stock ...” and the memorandum of association stated that a special resolution was necessary to alter this.
(2)
ARCIC entered into a contract with Riché under which Riché would construct a railway in
Belgium. Two years later, after construction had started, ARCIC repudiated the contract.
Riché sued.
(3) ARCIC claimed the contract was ultra vires the company. I.e. that ARCIC had no capacity to enter into the contract and so the contract was void, and thus there was no contract on which Riché could sue. ii) House of Lords:
(1) The contract was ultra vires the ARCIC.
(2) Although the memorandum of association could be altered by a special resolution of the shareholders, the contract was contrary to the objects of the memorandum of association at the time it was entered into.
(3) The contract could not be ratified even by a unanimous shareholder ratification. This was because there was no contract to ratify . The principal (i.e. the company , ARCIC) could not ratify the contract because the principal itself had no power (or capacity) to enter into the contract.
(4) Lord Cairns:
(a)
“Objects” are put in the memorandum of association pursuant to s.8 of the Companies
Act of 1862
(b) S.11 of the Act says this is a covenant binding on the company and each member
(c)
S.12 of the Act says that the objects can’t be changed (unless the memorandum of association says they can and then only according to the terms of the memorandum)
(d) Therefore the company cannot deviate from the objects set out in the memorandum – it is a violation of the statute to do so.
(5) Lord Chelmsford provided a similar analysis:
(a) A contract that is beyond the objects is a violation of the Companies Act and therefore the contract is not just voidable but void . Since the contract was void (i.e. in the eyes
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of the law it never existed ), it could not be ratified by the shareholders since there is no contract to ratify. iii) Comment:
(1) Thus any attempt by corporate agents to commit corporate funds to a business other than those listed in the objects of the corporation, or to enter into contracts outside of those objects, would be invalid and the corporation would not be bound (even if the agents had acted in a way that appeared to third parties to be within their authority as agents of the corporation). The corporation itself simply could not engage in business that were not within the objects (or powers, or capacity) of the corporation. d) Going along with the ultra vires doctrine was the common law doctrine of constructive notice
(regarding limited powers when corporation acting within its objects but going outside its powers to achieve those objects) and the limited application of that doctrine according to the indoor management rule (see “CL 3 rd
prty constrctve notice” below) e) The ultra vires doctrine and these associated doctrines have all been modified by legislation – see next few sections
CL ultra vires: pros/cons, mostly gone (CBCA ntrl prsn pwrs, limt auth not capacty, shrhldr remdy)
1) Justifications for the ultra vires doctrine a) The ultra vires doctrine was said to be justified as a method of protecting creditors and investors from increases in the risk associated with their investment in a company. Investors may have invested, and creditors may have advanced credit, based on the risk associated with the particular types of businesses that the company might carry on under its objects. If the company could start carrying on businesses other than those listed in its objects, then the investors and creditors might be exposed to much riskier types of businesses than they had anticipated. b) As noted in the history section above, early uses of the corporate form of organization included corporations formed for quasi-public projects such as roads, canals, harbours and railways. The corporate form may have facilitated the raising of capital for the particular projects. There may have been a concern to ensure the money raised would be used for the quasi-public purpose for which the corporation was formed, and not diverted to other activities. c) Objects clauses were also said to be necessary to control for the risk of bankruptcy in some types of corporations, particularly banks and insurance companies . Besides the loss to depositors and insured parties, bankruptcies of banks or insurance companies can have significant impacts on the economy as a whole. One potential source of such bankruptcies could arise where persons running the bank or insurance company used corporate funds for other risky commercial enterprises, outside of the banking or insurance objects of the corporation
2) Problems with the ultra vires doctrine a) The risk of non-enforcement worked against both third parties and the corporation . b) The ultra vires could create a hardship on third parties who had to bear the risk that contracts they had entered into with the corporation could not be enforced. This could lead to an unjust enrichment of the corporation where the third party had performed or had begun to perform. i) Third parties would either have to charge a premium to cover for the risk or they would have to check the objects to see that the corporation could carry on the proposed activity. c) The problem cut the other way as well. Corporations might find that contracts it had entered into were not enforceable and third parties might be unjustly enriched by the performance, or partperformance, of the contract by the corporation. i) The corporation itself would have to either charge a premium for the risk or would have to check that its objects covered the proposed activity. d) Where the contract involved a significant amount of money both third parties and the corporation tended to take steps to reduce the risk . They both engaged lawyers to read through the objects clauses and render opinions as to whether the corporation could engage in the activity called for in
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proposed contracts. These steps involved costs which had to be paid for thus increasing the costs of goods and services .
3) Corporate responses to the ultra vires doctrine a) Corporations responded so as to reduce the risk associated with the ultra vires doctrine. They had lawyers draft very broad objects clauses often running to several pages. The clauses would also include broad incidental powers allowing the corporation to do anything incidental to all of the specific listed objects (and providing a way for a court to find an action valid, even if it did not appear to fit within any of the many listed objects). Thus the practical response was to try to give the corporation the capacity to do virtually anything. b) E.g. a corporation might be incorporated for the purpose of manufacturing widgets. However, to avoid the risks associated with the ultra vires doctrine, the objects clause would set out that the corporation could engage in the manufacture, or wholesale or retail distribution of widgets, wompoms, thingamobobs, doodads, whatchamacallits, and on, and on, for pages and pages. It would allow the corporation to extract ores used in any of the manufacturing processes or to acquire and manufacture anything that would be used in the manufacture or distribution of widgets, wompoms, etc. It would provide wide ranging powers to borrow, to buy, to sell, to hire, to lease, to build, etc., etc. for the purpose of manufacturing or distributing, or extracting ores related to the manufacture of, widgets, wompoms, etc., and would conclude with a catchall power to do anything that was incidental to any of the listed objects.
4) Courts also responded to the problems created by the ultra vires doctrine. a) They tended to read objects clauses very broadly and gave wide scope to incidental powers .
5) Nevertheless, the ultra vires doctrine continued to cause problems a) While the practical and judicial responses helped keep the ultra vires doctrine problems at bay, there were still residual costs and risks . b) Where significant contracts were entered into, it still made sense for both third parties and the corporation to get a legal opinion that the particular contract was within the objects of the corporation. Thus there was still the cost of obtaining a legal opinion (and now it involved having the lawyer examine many pages of objects clauses which may have had a tendency to increase the cost). c) While objects clauses were expansive for many corporations, there was still the risk that contracts entered into might be beyond the objects of a particular corporation either because that corporation did not have extensive objects clauses, or because, even with extensive objects clauses, the particular contract might be still held by a court not to fit within the objects of the corporation or within its incidental powers to achieve those objects. d) Either a person contracting with the corporation or the corporation itself might, for instance, later regret a contract it had entered into and seek to avoid obligations under the contract by arguing that the contract was ultra vires the corporation. This could lead to costs of litigation and the potential for unjust enrichment of the sort described above. e) In spite of the practical responses to the ultra vires doctrine and the usually broad approach of the courts, there were still occasions when courts would find obligations entered into on behalf of a corporation were ultra vires the corporation. E.g. Re Introductions Ltd. [1970] Ch. 199: i) Facts:
(1) The objects clause stated that the company was to provide services to visitors to the
Festival of Britain. When the Festival of Britain was on, the company dealt in deck chairs.
Later, after a period of inactivity of the company, and with new shareholders and directors, the company entered into the business of breeding pigs (presumably a business of relatively little appeal to persons visiting Britain for a festival).
(2) The memorandum of association included a power to borrow funds to pursue the objects of the company and a clause that said that the objects clauses were to be construed independently. The company secured a loan through a bank for the purpose of the pig
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breeding business. The bank knew that this was the purpose of the loan and that the memorandum of association did not provide for pig breeding as an object of the company.
(3) The argument in favour of upholding the borrowing was that the borrowing power should be read independently of the object of catering to visitors to the Festival of Britain and thus the borrowing power gave the company a capacity to borrow for any purpose. ii) Decision:
(1) The court did not accept the argument that the borrowing power was to be read independently to give the company a capacity to borrow for any purpose. According to the court, one could not raise a mere power to an object of the company simply by having a clause that said that all the clauses should be read independently .
(2) The borrowing power had to be for some purpose and the only purposes allowed were those set out in the objects of the company (i.e. catering to visitors to the Festival of
Britain). iii) For a case with a similar result see Reid Murray Holdings Ltd. v. David Murray Holdings
Proprietary Ltd. (1972), 5 S.A.S.R. 386. f) Thus in spite of attempts by courts to read objects clauses broadly, there were still risks that corporate actions would be found to be ultra vires the company and it was still necessary for both the company and third parties to check the objects clauses or take the risk that the contract with the company would be unenforceable.
6) Legislative response a) The legislative response in most general statutes of incorporation in Canada was to begin by giving a corporation incorporated under the statute the powers of a natural person . i)
CBCA s.15(1): the corporation “has the capacity, and subject to this Act, the rights, powers and privileges of a natural person.” b) Then the statute would allow the business or powers of the corporation to be restricted in the memorandum or articles i)
S.16(2) provides that “a corporation shall not carry on any business or exercise any power that it is restricted by its articles from carrying on or exercising, nor shall the corporation exercise any of its powers in a manner contrary to its articles.” c) However , statutes go on to provide that while an act of the corporation might be invalid for other reasons (such as illegality or duress), they would not be invalid merely by reason that the particular act was contrary to a restriction on the business or powers of the corporation. i) I.e. overrides the ultra vires doctrine (though still might be able to show a contract etc. is invalid due to other reasons, such as misrepresentation, duress, etc) ii) S.16(3): “no act of a corporation, including any transfer of property to or by a corporation, is invalid by reason only that the act or transfer is contrary to its articles or this Act.” d) If the directors or officers of a CBCA corporation cause the corporation to engage in a business or exercise a power that it is restricted from engaging in/exercising, then the shareholders of the corporation can take remedial action : i) Shareholders , exercising their voting rights, might be able to remove the directors and elect new directors who might then subsequently replace officers who had acted beyond the restrictions. ii) The shareholders might, for instance, seek a restraining order against the directors or offices under s.247 restraining the directors or officers from further transgressions. This would make any further transgressions subject to a contempt of court proceeding. iii) In acting contrary to the articles, the directors and officers would have acted beyond their authority and would be subject to an action by their principal (i.e. the corporation) under agency law.
(1) Normally the person who would decide that the corporation should bring a action are the directors. The directors might be unwilling to bring an action against themselves, and
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where many of the directors are also officers of the corporation (which is often the case) the directors may also be unwilling to cause the corporation to bring an action against the officers.
(2) Recognizing this the CBCA provides a mechanism that facilitates an action by the corporation that is initiated by the shareholders . This is called a derivative action
(s.238,239), discussed below.
(3) May also be possible for aggrieved shareholders to bring an oppression action to address acts of directors or officers that are contrary to the restriction contained in the articles. e) What the CBCA and other general statutes of incorporation have done is give the corporation a broad capacity like that of other natural persons, but allow restrictions that are not constraints on capacity but , rather, are simply constraints on the powers (or authority ) of persons acting on behalf of the corporation. Where persons acting on behalf of the corporation act contrary to the restrictions expressed in the articles, they have not acted in a way that is beyond the capacity of the corporation but simply beyond their powers (or authority). f) Investors and creditors can still have protection from changes in the business risk in this scheme in legal and market ways: i) The shareholders can control deviations from proposed businesses by putting restrictions on the business the corporation can carry on and then taking action against directors and officers who cause the corporation to deviate from this (see above) ii) With relatively liquid markets (i.e. markets in which shares or debt obligations of the corporation can be traded relatively easily), one can control the increased risk as a result of the corporation engaging in new and more risky business risk by making a portfolio adjustment
(i.e. selling the shares or debt obligations of the corporation that has increased its risk and substitute with other less risky investments). The cost to the investor of the change in risk of the corporation’s business is just the cost of making a change in one’s portfolio of investments. iii) Creditors with bonds or debentures from the corporation can either sell them (if liquid market in them), or include in them a provision that a change in the business of the corporation is an event of default (so breach of contract action) iv) The statutory provisions that get rid of the ultra vires doctrine put control over making sure the company confines its businesses to those the investors relied on in the hands of the investors who are probably in a better position to control for it by carefully selecting the managers of the business and by monitoring their activities. g) In England , where the ultra vires doctrine originated, the law has been changed pursuant to a
European Union directive on company law that required member states to do away with the doctrine of ultra vires .
7) Ultra vires doctrine may continue for some corporations : a) It is tempting, but wrong, to conclude that legislative modifications have completed done away with the doctrine of ultra vires . b) The statutes that do away with the ultra vires (and constructive notice doctrines, see below) do so only for corporations incorporated under those particular statutes. Even these statutes may not completely eliminate these doctrines. i) E.g. CBCA s.3(4): “no corporation shall carry on the business of (a) a bank ; (b) a company to which the Insurance Companies Act applies; or (c) a company to which the Trust and Loan
Companies Act applies.”
(1) This might mean it is beyond the capacity of a CBCA corporation to carry on such businesses? Alternatively, s.15 and 16(3) might be interpreted in a way that would avoid the application of the ultra vires doctrine if CBCA corporation carried on such businesses. c) While the general statutes of incorporations such as the CBCA and its provincial (and territorial) counterparts cover most corporations incorporated in Canada, there are many other statutes under which corporations may be formed .
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i) E.g. corporations are sometimes formed under special acts (i.e. a statute enacted specifically to incorporate a particular corporate entity). These statutes often do set out the objects and powers the corporate entity they create. If these statutes do not contain provisions altering the ultra vires and constructive notice doctrines then those doctrines may still apply. ii) Further, in the commercial today one often deals with corporations incorporated in other jurisdictions. The doctrines of ultra vires and constructive notice may still apply to these corporations, particularly if they were incorporated in common law jurisdictions that have either followed or received the Asbury Railway Carriage & Iron Co. v. Riche case and its progeny.
(1) While corporations incorporated in civil law jurisdictions often have objects clauses , they have not generally interpreted these as restricting the capacity of the corporation or making acts contrary to the objects void.
8) It is perhaps noting that the ultra vires doctrine probably does not apply to Crown Charter or letters patent companies . a) This is why the discussion above refers to objects and powers clauses in memoranda of association. b) There was authority early in context of Crown Charter companies to the effect that they were separate legal entities with the powers of natural persons . Since letters patent companies involved an extension of the concept of granting Charter they were arguably separate legal entities with the powers of natural persons. Indeed there was authority to this effect. c) While objects and powers might be set out in Crown Charters or letters patent, they probably operated in the same way restrictions on the businesses and powers of corporations under the
CBCA. That is, they probably operated as restrictions on the authority of corporate agents such as the directors of the board or persons appointed as officers of the corporation.
CL 3 rd party constructive notice of restrictd powers unless indoor mgmt rule, limited by BC/CBCA
1) As noted above, prior to the legislative modifications that gave corporations natural person powers, a corporation’s memorandum of association
would typically set out the powers of the corporation to give effect to its objects . a) Normally these powers would be exercised on behalf of the corporation by the board of directors of the corporation or by officers with delegated authority by the board of directors. The memorandum of association might, however, set out constraints on the exercise of corporate powers . b) E.g.
the corporation might be able to borrow funds and might be able to grant a security interest over accounts receivable or inventory but not over land , fixtures or equipment owned by the corporation. c) E.g. it might be able to exercise a power but only if certain steps were followed – certain actions by the company may require approval of the shareholders of the company, such as requiring a specified percentage of shareholders vote in favour, or it may require approval from the holders a specific class of shares. Other steps may require a resolution of the board of directors or approval from certain officers of the company.
2) Here we are not talking about the company lacking the capacity to carry out the act (that is where the ultra vires doctrine might apply). We are talking about limits on power (or authority) of the directors and officers to carry out acts that are within the capacity of the company. a) A word of caution here in reading cases on ultra vires and constructive notice. The expression
“ ultra vires ” means “beyond the power of”, but has been used for two different meanings by courts, so need to carefully distinguish between them: i) It has been used where the particular act undertaken on behalf of the corporation was beyond the capacity of the corporation.
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ii) It has also been used where the particular act was within the capacity of the corporation but was beyond the powers of (or outside the scope of the authority of) the board of directors , or an officer , or agent of the corporation.
3) CL doctrine of constructive notice a) Because the memorandum and articles of the company were publicly filed they were available to third parties. It was held that third parties were deemed to have knowledge of the contents of the memorandum and articles . Thus if the articles provided for a constraint on the exercise of a power the third party was deemed to have knowledge of this constraint. i) E.g.
if the articles provided that the corporation could borrow to satisfy the objects of the corporation but provided that there was no power to grant a security interest in any assets of the corporation with respect to such borrowing, then the third party was deemed to have knowledge of that restriction. When the third party loaned funds on the security of assets of the corporation and then sought to enforce the contract by seizing the secured assets on an event of default, the third party would have trouble succeeding. b) The third party might argue that the officer who entered into the loan agreement on behalf of the corporation had ostensible/apparent authority to grant a security interest in the assets of the corporation perhaps because the directors had, in some way, represented that the officer had such an authority and the third party had relied on that representation. However, the response of the corporation could be that the third party could not have reasonably relied on such a representation by the directors because the third party is deemed to know of the restriction in the articles , and so it would be unlikely the third party would succeed in establishing the reliance element of an apparent (or ostensible) authority c)
This “doctrine of constructive notice” created an additional risk for the third party , since they had to check the filed documents relating to the company to make sure that there were no restrictions on the powers of the directors and officers of the company.
4) The
CL “indoor management rule” limited
the application of this constructive notice doctrine a) The third party was not deemed to know of any indoor/in-house (i.e. not publicly available) restrictions on the authority of directors or officers . i) E.g. suppose that the articles had said that the directors or officers could not grant a security interest in the assets of the company in borrowing funds unless the granting of the security interest was approved by a majority of the shareholders of the company. If the third party could not get access to the minutes of shareholder meetings to check whether the shareholders had approved the granting of the security interest, then the third party was not deemed to have any knowledge of whether the necessary shareholder approval had been granted, and so was entitled to assume that it had been ( subject , of course, to direct knowledge to the contrary). b) Thus if the documents by which one might confirm whether the agent had authority or not were not publicly available then the constructive notice doctrine did not apply. The third party might then more readily establish the reliance element of an apparent authority claim unless the third party, in some way, knew the agent did not have authority . c) This was a particularly effective limitation on the risks created by the constructive notice doctrine in the context of letters patent companies because the letters patent was the only publicly filed document, and the likely place for restrictions on management powers was in the by-laws which were not typically filed.
5) Legislative modifications a) General statutes of incorporation in Canada typically do away with the constructive notice doctrine . b) E.g. CBCA s.17
: “
No person is affected by or is deemed to have notice or knowledge of the contents of a document concerning a corporation by reason only that the document has been filed by the Director or is available for inspection at an office of the corporation.” There are a couple of cautionary notes here.
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i)
First, “corporation” is defined in the CBCA s.2(1) to mean “a body corporate incorporated or continued under this Act and not discontinued under this Act”. Thus s.17 should not interpreted as an attempt by Parliament to say that the constructive notice doctrine is eliminated for every corporation wherever incorporated. Parliament does not have the constitutional power to do that. Rather, it only says there is no constructive notice with respect to a corporation that is incorporated under the CBCA . ii)
Second, the “Director” is not a reference to a director of the corporation or to the board of directors of the corporation. CBCA s.2(1) defines the capital “D” “Director” as “the Director appointed under section 260” and the Director appointed under s.260 is the person appointed by the Minister to administer the CBCA. c) As for the indoor management rule (no deemed knowledge under the constructive notice doctrine if the documents that contained a constraint on the exercise of corporate powers were not publicly available), once the constructive notice doctrine is removed there appears no need for such an exception. i) E.g. the Company Act in BC simply did away with the constructive notice doctrine and said nothing about the indoor management rule . ii) The CBCA , and statutes modeled on it, however, includes a codified version of the indoor management rule .
(1) E.g. s.18
: the corporation cannot assert against a person dealing with the corporation (and who is claiming, for example, that the persons acting on behalf of the corporation had authority to so act) that:
(a) The articles, by-laws or any unanimous shareholder agreement have not been complied with (so the corporation can not answer the third party’s claim merely by asserting that the acts of the purported agent were contrary to the articles, by-laws or a unanimous shareholder agreement)
(b) The place identified as the registered office of the corporation in the most recent notice of the registered office sent to the Director is not the registered office of the corporation.
(c) However , the corporation can make such an assertion where the person has, or ought to have, knowledge of the constraint by virtue of the person’s relationship
with the corporation
(i) E.g. you were the lawyer who drafted the provision, so you knew about it (see below)
(2) Is there a constitutional division of powers issue here? The constructive notice doctrine was a concept developed by courts in the context of actions, usually to enforce a purported contract , in which an apparent authority argument was made. This would be part of property and civil rights and thus a provincial area of jurisdiction under section 92(13) of the Constitution Act . But might Parliament have an ancillary power to enact such a provision in legislation which in pith and substance is about the incorporation of companies with objects other than provincial objects ? d) Caution: as with ultra vires above, it is tempting, but incorrect, to say that statutes have completely done away with the the constructive notice doctrine with its related indoor management rule : i) Does the codified version of the indoor management rule in CBCA s.18 preserve some room for the constructive notice doctrine? E.g. suppose the person dealing with the corporation is a director or officer of the corporation or the corporation’s legal counsel
. Should such a person be deemed to know of the contents of the corporate documents (such as the articles) because they ought to know of the contents by virtue of the person’s relationship
with the corporation
(see s.18 above)?
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ii) The general cautionary point is that when one is dealing with a corporation, should always find out how it came to be incorporated . If it was incorporated under a statute of some sort, which is normally the case, then in which jurisdiction was that statute enacted? Does that jurisdiction have a ultra vires or constructive notice doctrine? If so, does the particular statute under which the corporation was incorporated alter those doctrines?
Directors: role/qualifications/residents/min #, first dirs then elected, term/removal/vacancies
1)
Recall “management structure” in “Diff types of shares” in Corporations: intro above
2) Under the CBCA (and other corporations statutes in Canada) it is the directors who manage, or at least supervise the management of, the corporation, not the shareholders, although day-to-day management is usually delegated to officers. a)
CBCA s.102: “the directors shall manage, or supervise the management of, the business and affairs of the corporation”. i) This section declares what was the practice for many years before the enactment of s.102 or the forerunners of s.102. ii) See “Powers of dirs” below , and note more specific powers are often subject to articles/bylaws/unanimous shareholder agreements (USAs) iii) S.102(1),146: unanimous shareholder agreements ( USAs ) can reallocated management control from directors to shareholders (see “Closely held corps” below, but see note of misuse under
Canadian residency requirements below) b) The directors also normally have the power to appoint the officers of the corporation (CBCA s.121) who normally conduct the day-to-day management of the corporation (see “powers” below)
3) Qualification requirements for directors : a) CBCA s.105 provides that directors be: i) Natural persons (i.e. individuals not corporations) ii) Over 18 years of age; and iii) Not adjudicated mental incompetents or bankrupts (the latter requirements re: financial status is because the CBCA imposes liabilities on directors in various circumstances (mostly in s.118 and 119)) b) For many years a person had to own shares of the corporation in order to be a director (
“director’s qualifying share”
). Presumably the idea was to align the interests of the directors with the interests of the shareholders so that the directors would act in the interests of the shareholders
(recall “Protecting lim ‘owners’ from gen ‘managers’” in Limited Partnership above). Usually the qualifying share requirement was nominal and probably did not serve its intended purpose.
Consequently most Canadian statutes no longer impose a share qualification requirement. i) CBCA s.105(2) specifically provides that a director need not have a qualifying share , but it does allow for the articles to provide for a share qualification for directors (i.e. a director’s share qualification is optional).
4) CBCA s.102(2): the minimum number of directors for corporations that have not publicly distributed their shares is one , and for a corporation that has made a public distribution of its shares (a
“distributing corporation”) the minimum number of directors is three . a) There is no maximum number of directors. b) The articles for any given corporation can provide for a fixed number of directors or can set out a minimum and maximum number of directors.
5) CBCA s.105(3): at least 25% of the directors must be “ resident Canadians
” and where the corporation has less than four directors at least one of the directors must be a “resident Canadian”. a)
“Resident Canadian” is defined in CBCA s 2(1), and includes citizens of Canada ordinarily resident in Canada, landed immigrants (except those eligible for Canadian citizenship who have chosen not to apply for it), and certain citizens of Canada ordinarily resident abroad (see CBCA
Regs. s.13).
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b)
See also s.114(3) in “Directors’ meetings” below for similar requirement on directors present to form a quorum c) When the CBCA was first enacted there was a requirement that a majority of the directors be resident Canadians . This was not a recommendation of the Dickerson Committee but was a requirement added at the committee stage before the Act was passed in 1975. There were many complaints about the requirement for a majority of resident Canadian directors so the provision was amended in 2001 to reduce the majority requirement. i) Before the amendment a common, but dubious practice, used particularly with wholly owned
Canadian subsidiaries, was to appoint a majority of resident Canadians (or even all resident
Canadians) to the board of directors and then strip the board of any real power using a unanimous shareholder agreement under s.146(2) allocating the powers of the directors to other non-resident persons. ii) In addition to the ethical question of deliberately attempting to avoid a requirement of the legislation there was the question of whether it in fact complied with the residency requirement. A “director” is defined under s.2(1) of the Act as a “person occupying the position of a director by whatever name called.” If the responsibilities of the director have been transferred to another person (a non-resident) under a unanimous shareholder agreement, then the person to whom those powers have been transferred is arguably a “director” though not so called. d) The underlying reason behind the Canadian residency requirement appears to be that Canadian residents will be more responsive to Canadian national interests in the operation of a corporation’s affairs than non-citizens would be. However, the CBCA does not make the promotion of
Canadian national interests a statutory duty of directors . Directors, whether Canadian residents or not, are presumably free to manage the corporation for the purpose of maximizing shareholder wealth within the confines of the law. Thus a non-Canadian parent corporation might well appoint
Canadian resident directors who do not have the nationalistic perspective that those who argued for the residency requirement may have expected them to have. e) Although it is now somewhat dated, it is perhaps interesting to note that a 1984 Conference Board of Canada report indicated that the proportion of resident Canadian directors on the boards of
Canadian companies was on average considerably higher than a bare majority. It increased from
84% in 1977 to 87% in 1982.
6) First and subsequent election of directors by shareholders : a) Since it is the directors who manage or supervise the management of the corporation the election of directors is one of the most important matters on which the shareholders vote , and is the primary method by which shareholders can exercise some control over the way in which the corporation is managed. i) This is significant even for shareholders whose shareholding is too small to individually influence the outcome of an election of directors (e.g. only holds 100 shares out of 4M issued), since others can acquire their shares and others’ and potentially acquire sufficient voting rights to influence the outcome of an election or removal of directors. This potential for the replacement of directors , and thus also of the officers (i.e. managers), gives existing directors and officers/managers an incentive to effectively manage and act in the interests of shareholders . b) As noted in Corps: incorporation above, one of documents that must be sent to the Director to form the corporation is a notice of the first directors of the corporation (CBCA s.106(1)). They hold office until the first annual meeting of the corporation (s.106(2)) which must be held within
18 months of the incorporation of the corporation and every 15 months thereafter (s.133(1)). c) Subsequent election : at the first annual meeting of the corporation and at every annual meeting thereafter the directors are elected by an “ ordinary resolution ” of the shareholders (s.106(3)).
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i)
An “ordinary resolution” is defined in s.2(1) as a resolution passed by a simple majority of the votes cast by shareholders who voted on the resolution. ii)
Many provisions of the CBCA are default provisions, often worded as “subject to the articles, the by-laws or a unanimous shareholder agreement”. These provisions can be altered by setting out different provisions in the articles, the by-laws or a unanimous shareholder agreement. There are no such initial words in CBCA s.106. This suggests that the requirement that shareholders elect the directors cannot be altered or waived (i.e. it is a mandatory requirement that shareholders elect the directors of the corporation) iii) See “Shareholder powers”, Shareholder voting: does it matter?”, and “Shareholder meetings: usual steps at AGM” below
7) Term of office a) Normally the term of a director begins from the time of the annual meeting at which the director is elected and ends at the ensuing annual meeting of shareholders (s.106(5)). The articles may , however, provide for a term of up to three years (s.106(3)). b) There is no limit on the number of times a director can be re-elected . c) S.106(6) provides that if shareholders fail to elect directors at a meeting where directors should be elected, the incumbent directors remain in office until their successors are chosen. d) Staggered boards : s.106(4) allows for the articles of the corporation to provide that not all the directors be elected at the same meeting of shareholders. Since the directors can have terms of up to three years if the articles so provide, one can have one-third of the directors elected in each year. i) E.g. if the board had nine directors, then three could be elected in each year if they were given three year terms. e) A corporation, a shareholder or a director may apply to court under s.145 to resolve any controversy concerning the election or appointment of a director. The the court may make “any order it thinks fit” including an order restraining the person whose election or appointment is disputed from serving and ordering a new election subject to judicial supervision. f) S.108 provides that a director ceases to hold office during her or his term of office when she or he dies, resigns, becomes disqualified, or is removed from office by a resolution of the shareholders.
8) S.109(1) allows for the removal of a director by an ordinary resolution of shareholders (i.e. simple majority), and s.6(4) provides that the articles may not require a majority higher . This is the only matter for which the articles of a CBCA corporation cannot provide a greater majority than that called for in the Act. a) Bushel v. Faith , [1970] A.C. 1099 (H.L.) (see also above) suggests that in some circumstances the requirement for a majority might be avoided . i) Facts:
(1) There were three shareholders – the brother Faith and his sisters Bushel and Bayne.
Bushel and Bayne sought to remove their brother as a director.
(2) However, the articles of the company provided that on a resolution to remove a director, that director would get three votes per share while other shares continued to have their normal one vote per share. Faith managed to defeat the resolution by voting three votes for his shares pursuant to the articles. ii) Decision:
(1) The sisters applied for but were not granted an order restraining Faith from acting as a director. The court held that the article was not invalid (i.e. OK ) noting that there were such things as special voting shares that carried more than one vote per share and
Parliament must be taken to have known of this (i.e. Parliament did not intend to prevent the assignment of more than one vote per share in special situations). iii) Comment:
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(1) As noted above, the decision in Bushel v. Faith is questionable on the basis that allowing
Faith to have three votes while his sisters got only one vote per share on the same class of shares violated the principle of equality of shares within a class .
(2) On the other hand, the decision helped avoid Faith being ‘frozen-out’
(i.e. if the sisters could have removed him, they could direct profits to themselves through salaries and never declare a dividend, so Faith’s investment might become worthless)
(a) Do not use this multiple-votes-per-share approach to avoid being frozen-out however – better approaches discussed below
(3) However, even if the principle of equality of shares within a class were to be honoured it would not prevent setting out a special class of shares in the articles that would have multiple votes per share on a resolution to remove a director . E.g. in Bushel v. Faith the directors could each have been given their own special class of shares, in addition to common shares, that would have voting rights only on a resolution to remove that director and would carry sufficient special voting rights to allow them to defeat a resolution to remove them.
9) CBCA s.111(1) gives the directors the power to fill vacancies on the board (e.g. resulting from death or resignation or bankruptcy – while a shareholder meeting could be set up to fill such vacancies, they can be very costly). However, the directors may not fill a vacancy that results from an increase in the number, or minimum number of directors. Nor can they fill a vacancy that results from the failure by the shareholders to elect the number, or minimum number, of directors required by the articles. a) S.109: the shareholders can remove a director by ordinary resolution, and under s.109(3) a vacancy that results from the removal of a director may be filled at the same shareholders’ meeting that approved the removal. The directors may fill the vacancy caused by the removal only if the shareholders do not do so.
10) S.122: duty of care of directors and officers
Pwrs of dirs: mgmt(115(3)) bylaws, borow, isue shares, call sharehldr meet, fill dirs/auditor, apt offs
1) The CBCA specifically allocates several powers to the directors (as do other corporate statutes in
Canada). a) Note which powers directors have and when those powers can be reallocated to the shareholders
(e.g. by articles/bylaws/unanimous shareholder agreement) which is key for setting up closelyheld corporations b) See also “fiduciary duties of dirs/offs” below
2) Management (or supervision of management) power (residual), with restrictions on delegation a) CBCA s.102
: as noted above, subject to unanimous shareholder agreements (USAs), directors have the authority to manage the corporation, or at least supervise its management. i)
Since subject to USA, this power can be reallocated to shareholders (see “shareholders powers” below) ii) This is a broad power of the directors and likely operates as a sort of residual power . Only if the power is not allocated elsewhere , it is probably a part of the general management powers. iii) Other powers allocated in the statute to the directors or to the shareholders are more specific
(and also often subject to articles/bylaws/USAs ). If a matter falls under one of these more specific powers, then it will be subject to those restrictions and will not fall under s.102. iv) S.115(3) restricts the authority of directors to delegate their powers (see below), and in so doing it implicitly suggests that these powers are in fact powers of the directors under s.102.
These powers include:
(1) Issuing securities (e.g. shares/debentures/bonds) or a new series of shares
(2) Purchase, redemption or other acquisition of shares issued by the corporation;
(3) Declaration of dividends ;
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(4) Submission to the shareholders of any question or matter requiring the approval of the shareholders;
(5) Approval of any financial statement put before the shareholders.
(6) Approval of a takeover bid by the corporation or a directors’ circular
(prepared in connection with a bid to takeover the corporation);
(7) Approval of a management proxy circular ;
(8) Filling a vacancy among the directors or in the office of auditor
(9) Adopting, amending or repealing by-laws of the corporation v) See also “Dirs power to delegate” below, and requirement to provide notice if a directors meeting is to deal with any s.115(3) matters (see “Directors’ meetings” below)
3) Adoption, amendment or repeal of by-laws (subject to articles/bylaws/USAs) a) CBCA s.103(1) gives the directors the power to adopt, amend or repeal bylaws (and recall s.104 general bylaws at first meeting). However, this is only a default allocation in favour of the directors since the power of the directors to adopt, amend or repeal by-laws is subject to : i) The articles ii) The bylaws iii) A unanimous shareholder agreement . b) Thus power can be reallocated to shareholders (see “shareholders powers” below) c) S.103(2): bylaws by directors effective until next annual shareholder meeting, when any change the directors make in the by-laws must be put before the shareholders at the next annual meeting of shareholders (so effective thereafter only if approved by the shareholders or approved as amended).
4) The power to borrow (subject to articles/bylaws/USAs) a) It was difficult to raise funds if had to wait till next shareholder meeting. b) CBCA s.189(1): the directors have the power to borrow subject to the articles , the by-laws or a unanimous shareholder agreement . i)
Since subject to …, this power can be reallocated to shareholders (see “shareholders powers” below) c) The directors may delegate the power to borrow to a director, a committee of directors or an officer subject to any restriction on this in the articles, by-laws or a unanimous shareholder agreement (s.189(2)).
5) Power to issue shares (and series if articles allow) a) CBCA s.25: as noted above, the directors have the power to issue shares. b) S.27: the directors may also have the power to issue shares in series if that power has been given to them in the articles.
6) Calling of meetings of shareholders a) S.133: the directors of the corporation are to call annual or special meetings of the shareholders .
Although the shareholders may requisition a meeting in certain circumstances (see below), the calling of shareholder meetings is primarily a power of the directors. The directors send out the notice of the meeting and thus determine the agenda for shareholder meetings. b) This is a significant power for the directors allowing them to exert considerable control over the governance of the corporation. c) Proxy solicitation is the means of communication with shareholders for the purposes of shareholder meetings. d) Other ways to have a shareholder meeting include requisition by the shareholders themselves, or by court order
7) Appointment of additional directors (if articles allow) a) S.106(8): if the articles so provide the directors may appoint one or more additional directors but limits the appointment of additional directors to one-third of the directors elected at the previous annual meeting of shareholders.
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8) Filling a vacancy on the board of directors a) CBCA s.111: the directors have the power to fill a vacancy on the board of directors that arises due to the death or resignation of a director (see limits in “Role/qualifications/etc” above) b) S.109(3): they also have the power to fill a vacancy created by the removal of a director at a shareholders’ meeting if the shareholders’ meeting does not replace the director.
9) Filling a vacancy in the position of auditor a) Where an auditor is appointed it is normally by the shareholders at the annual meeting of shareholders. However, if the auditor were to resign/die/etc during the year the directors are given the power in s.166(1) to replace the auditor unless the articles of the corporation require that a vacancy in the position of the auditor can only be filled by a vote of the shareholders (166(3)).
10) Appointment and compensation of officers and the delegation of powers (subject to articles etc) a) CBCA S.121: subject to the articles, by-laws or a unanimous shareholder agreement, the directors designate the offices of the corporation, appoint officers and delegate powers (and determine the compensation of officers) i) Thus power can be reallocated to shareholders (see “shareholders powers” below) b) S.125: directors set compensation c) This is one of the most significant powers of the directors since otherwise the directors might be subject to the principle that they could not delegate their authority as agents of the corporation.
There might be an implied power of delegation but s.121 makes the right to delegate clear. d) As discussed further below, widely-held corporations are typically managed by officers appointed by the directors leaving the directors in a largely supervisory role. However, the power of directors to appoint officers who manage the corporation remains a significant device since shareholders can exercise their voting powers to replace the directors who can then replace the officers of the corporation.
Dirs can delegate (cmte,offs,mgmt K): 115(3) limits & maybe CL limits on time/extent of delegation
1) S.115(1): directors can appoint a managing director (resident Canadian) or a committee of directors , and delegate to them any powers of the board a) Other relevant committees include: i) Mandatory audit committee for public corps (see below) ii) TSX recommended nominating committee for nominating new Board members (see below) iii) Some (e.g. TSX) have also recommended compensation committee for setting directors remuneration (under s.125 directors currently set their own pay) iv) Some (e.g. TSX) have also recommended a litigation committee (to decide when to sue) which, to appear legitimate, should be composed of independent directors (e.g. suppose there’s to be litigation over a conflict of interest allegation against a director, would require independent people to decide whether to proceed with it)
2) The effectiveness of replacing the directors of a corporation as a shareholder control device would be seriously hampered if the directors had delegated all, or virtually all , of their powers. Consequently the directors may not delegate all, or virtually all, of their powers. See also “dirs remove offs” below.
3) CBCA s.
115(3) : the directors cannot delegate certain powers (see “Management” in “Powers of dirs” above)
4) Even prior to the enactment of CBCA s.115(3) the courts would restrict certain delegations of power by the directors a) Courts did this on the theory that: i) There was an implicit limit on their power to delegate or ii) Excessive delegation was contrary to public policy . iii) For current situation, see trade-off below b) E.g. Hayes v. Canada-Atlantic & Plant S.S. Co. 181 F. 289 (1st Cir. 1910) i) Facts:
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(1) Although decided in a U.S. first circuit court, the company involved was incorporated under a Canadian federal companies act (the Dominion Companies Act ).
(2) The letters patent permitted the directors to annually appoint an executive committee with powers and duties as the by-laws determined. The by-laws required the directors to appoint two directors who, with the president, would form the executive committee which would have the “full powers” of the board of directors (i.e. “full powers” of Board of directors purportedly delegated to a committee consisting of two directors plus president )
(3) Hayes (president) and Gale acting as the committee:
(a) Removed Perry from the office of treasurer and put Hayes in his place;
(b) Directed payment to Hayes (as salary) and directed payments of other amounts in dispute between Hayes and the company in Hayes favour;
(c) Fixed a salary for Hayes as president at $1,854.20
(d) Amended the by-laws such that special meetings of shareholders could only be called by the president (Hayes);
(e) Amended the by-law to one director and one president for the committee ;
(f) Amended the by-law for meetings of directors so they could only be called by the president
(4) Perry actually had the majority shareholding interest . However, Perry had been effectively frozen out of any control over the company through the decisions of the committee. ii) Decision:
(1) The applicable law was the Canadian company law since the applicable conflict of laws rule was a “statutory domicile” rule – i.e. the applicable law governing the relationship between the shareholders and the directors and officers was the law of the jurisdiction in which the company was incorporated.
(2) This was an attempt to capture all the powers of the company and close out the shareholders . The directors could not delegate all their powers and put up a new management in lieu of that formally established by the shareholders (and thereby freezing out the shareholders).
(3) The court said that it could only give force to the words “full powers”
in the by-law by limiting them to the ordinary business transactions of the corporation. Thus such matters as the removal of Perry from office, determining compensation of officers and calling of shareholders meetings could not be removed from the powers of the directors. c) Another way in which the powers of the directors might be delegated is through management contracts . Two U.S. cases highlight this problem: i) Sherman & Ellis v. Indiana Mutual Casualty 41 F. 2d. 588 (7th Cir. 1930)
(1) Facts:
(a) The Indiana Mutual Casualty Inc. had contracted for the underwriting and executive management of Indiana Mutual to be provided by F. Ellis though the firm of Sherman
& Ellis, Inc. for a period of twenty years with compensation at 10% of the net earned premium. Indiana Mutual Inc. terminated its contract after an unsuccessful attempt by the state to have a receiver appointed. Sherman & Ellis sought specific performance and subsequently money damages for a breach of the contract (after a receiver was successfully appointed).
(b) The validity of the contract was challenged as being void as against public policy.
(2) Decision:
(a) The court held that it was clear that a corporation can delegate certain managerial duties to strangers for a limited period but such duties cannot be indefinitely delegated to outsiders.
(b) The contract in this case was not valid . It was contrary to public policy because:
(i) The time frame (20 years) was too long , and
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(ii) It delegated all the powers of management .
(c) The court noted the policy concern that there was an expectation that the corporation be managed (or the management supervised) by the persons elected by the shareholders .
The court stated that, “The grant of corporate power by a state is upon the hypothesis that these powers shall be exercised by the corporation’s officers, annually elected, by the stockholders and not by the officers of another corporation.” ii) Kennerson v. Burbank Amusement Co. 260 P. 2d. 823 (Calif. C.A. 1953)
(1) Facts:
(a) A contract between Kennerson and the Burbank Amusement Co. called for Kennerson to manage all matters including bookings, personnel, admission prices, salaries, contracts, expenses and “the exclusive right to fix and establish all policies to be followed in the operation of the Manor Theatre” for a period of five years .
(b) A new board of directors of Burbank Amusement Co. was elected and they resolved to cancel the contract with Kennerson
(c) Kennerson sued for breach of an employment contract.
(2) Decision:
(a)
The court said that “by this contract ... the board has attempted to confer upon
[Kennerson] the practical control and management of substantially all corporate powers.”
(b) The court noted that as long as the corporation exists its affairs must be managed by the duly elected board. It said that the board can delegate its authority to act but cannot delegate its function to govern .
(c)
As the court noted, “
The problem is one of degree . If the contract, as in the instant case, attempts to delegate substantially all corporate powers to an agent, then it has gone too far .”
5) Fortunately s.115(3) sheds some light on the limits of the directors’ power of delegation . a) Without it we would be left with the rather vague notions in Hayes , Sherman & Ellis, and
Kennerson . These cases do suggest , however, that the directors cannot delegate all of their powers . How far they can go in delegating their powers is a matter of degree. The longer the period of time they delegate their powers for, and the greater the extent of the delegation of powers, the greater the likelihood that the delegation is improper. b) These cases and principles are still relevant in jurisdictions where the corporate statute does not address the scope of delegation. They may also still be relevant for a CBCA company: i) E.g. consider a delegation of management powers in a management contract with an outside manager that respected all the restrictions in s.115(3) but delegated all other management powers for a period of 50 years . This might still be considered an improper delegation of management powers. ii) The issue of the delegation of management powers has been a topical issue of late. Some of the now popular income trusts have been set up with management contracts, often set up in favour of the existing management prior to the reorganization of the business as an income trust. In some cases these contracts have made extensive delegations of management powers for long periods of time. One might argue that these management contracts are not a problem
– that they do not constrain shareholders control over management.
Shareholders could appoint new directors who could then cancel the management contracts . But if the contracts are held to be valid then changing the management would involve a potentially very large compensation in damages that could significantly deter a change in management. c) The legal position appears to attempt to strike a trade-off between the need for directors to delegate powers to get the work of the company done (and this might include contracts with outside managers who specialize in a particular aspect of management) and the countervailing need to retain some scope for shareholder control over the management of the corporation.
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Directors meets: articls/bylaws, CBCA quorum/res Canadins/115(3) notice/in lieu, dirs duty of care
1) The boards of corporations incorporated under the CBCA can vary from having as little as one director (for a closely-held corporation) to many directors. Thus the suitable process for a meeting of the directors may vary considerably from one corporation to another. This may explain why the
CBCA does not provide much in the way of detail concerning meetings of directors of the board. The details of directors meetings are left to the by-laws of the corporation.
2)
What little the CBCA does say about directors’ meetings is set out in s.114
(note “subject to” where it appears): a) S.114(1): subject to the articles or the by-laws (i.e. it is a default term) the directors may meet at any place and on such notice as the by-laws require (but see 114(5) below on notice) b) S.114(2) provides that subject to the articles or by-laws (i.e. a default provision) the quorum is a majority of the board or a majority of the minimum number of directors in the articles. i) S.114(3) (and this is mandatory – i.e. not subject to articles/by-laws): at least one quarter of the directors present be resident Canadians , and if there are less than four directors then at least one of the directors must be a resident Canadian (see also s.105(3) in “Qualifications” above) c) S.114(5): if the directors’ meeting will deal with any
of the matters set out in s.115(3) (see
“Powers of dirs” above) then the notice of the meeting must specifically indicate that such a matter will be dealt with at the meeting. Otherwise there is no requirement to specify the purpose of the business of the meeting (subject to bylaws) i) S.114(6): a director may waive notice of a meeting of directors in any manner. Further, the attendance of a director at a meeting of directors is a waiver of notice of the meeting except where the director attends the meeting for the express purpose of objecting to the transaction of any business at the meeting on the grounds that the meeting was not lawfully called (e.g. perhaps because the meeting proposes to transact business on one of the matters for which notice must be provided under s.114(5) and such notice has not been given). d) Amendments in recent years have expanded on the ability to hold meetings without having to have all the directors physically present in the same place. S.114(9) permits meetings by conference call or electronic or other communications facilities that permit all participants to communicate adequately with each other during the meeting. It goes on to provide that a director participating in the meeting by such means is deemed to be present at the meeting. e) A meeting in the normal sense of the word might be said to require more than one person and indeed it has been so held in at least one court case. The CBCA permits a corporation to have one director and accordingly it makes it clear in s.114(8) that where a corporation has just one director , that “director may constitute a meeting
.”
3) S.117: it is not necessary to hold a meeting of directors if all of the directors sign a written resolution in lieu of the meeting . This is common in closely-held corporations where the persons serving as directors all agree on the matter to be dealt with. A resolution can be written up and circulated amongst the directors.
4) According to a 1984 Conference Board report, widely held corporations have an average of eight board meetings a year, and the average for all corporations is six meetings a year ( Canadian
Directorship Practices: A Profile 1984 14 (1984)). While the CBCA does not prescribe how frequent directors’ meetings should be, but at some point the failure to hold meetings might give rise to liability for breach of the duty of care under s.122(1)(b) a)
Recall directors can also be liable for shares not paid for (see above), and see also “Agent (dir/off) liable tort” in Piercing above, and “fiduciary duties of dirs/offs” below
Boards public corps: often weak, CBCA 2 ‘outside’ (non-mgmt) dirs & audit cmte, TSX, reforms
1) Although legislation puts directors at the apex of the management structure (i.e. they can do the planning, strategy decisions, hire, fire, supervise and monitor managers, etc), what role do directors really play in reality?
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2) In Myles Mace, Directors: Myth and Reality ( 1971 ) found that in the US boards of directors of publicly held corporations did not manage the corporation , and usually did not have much of a role in either setting corporate strategy or in monitoring the performance of the management. a) Although they had to pass a resolution appointing the president of the corporation they tended to simply appoint the person recommended by the outgoing president . b) Mace did however conclude that directors had some useful function . He argued that the fact that the president had to appear before the board was a discipline upon the president. Further, directors either individually or occasionally in groups gave useful advice to the president. There were also rare cases in which a president was removed from office and replaced when the president’s performance had been insupportably bad. c) Mace redid his study of the practices of boards of directors in the United States roughly ten years later and found similar results (see Directors: Myth and Reality—Ten Years Later , 32 Rudgers L.
Rev. 293 ( 1979 )) d) Note that directors are often managers as well
3) In the 1970s the Conference Board of Canada did a series of lengthy interviews with 50 persons who held between them 265 directorships in over 130 Canadian public corporations (see Conference
Board of Canada , Canadian Directorship Practices: A Critical Self-Examination (1977). In summarizing the interviews, the Conference Board of Canada noted the following: a) Management often controls the board rather than the other way around, and the board’s effectiveness is often a function of the president’s desire for or tolerance of its informed input b) Boards are excessively hesitant to fire top management c) A person with a full-time job cannot adequately attend to directorship duties if he holds more than two to six outside directorships.
4) Another study by the Conference Board of Canada in 1984 found that the majority of board members were “outside” directors not affiliated with management . However, it found that for 93% of firms reporting, including small to large corporations, the nomination of new directors was considered a board prerogative. See Conference Board of Canada, Canadian Directorship Practices: A Profile
1984 .
5) Professor Melvin Eisenberg , The Structure of the Corporation (1976) found that instead of trying to make sure boards of directors were in a position to actually “manage” or even “supervise the management” of the corporation, it would be better to focus on what boards might reasonably be expected to do and then adjust the law and the structure of boards to meet such expectations. a) The role that Eisenberg thought the board was best suited to perform was the selection, monitoring and, if needed, removal of the president . b) To do this Eisenberg felt the board needed to be controlled by non-management outsiders and the board’s audit committee (the committee of the board that reviews financial disclosure) needed to be made up exclusively of outside directors. Eisenberg also felt that the outsider directors on the board should have sole control over proxy solicitation (i.e. the means of communication with shareholders for the purposes of shareholder meetings).
6) American Law Institute (ALI), Principles of Corporate Governance and Structure; Restatement and
Recommendations (Tentative Draft No. 1, 1982): a report on principles of corporate governance
(strongly influenced by Professor Eisenberg’s views) which recommended that a majority of the directors of public corporations be independent of the management of the corporation. The recommendations (reflected in changes to the Model Business Corp Act that is used by many states) on board structure were controversial and in a subsequent draft many of the recommended mandatory provisions on board structure were changed to voluntary recommendations (American Law Institute,
Principles of Corporate Governance: Analysis and Recommendations (Tentative Draft No. 2, 1984)).
7) The Saucier Report prepared in 2001 for the Toronto Stock Exchange suggested that there are six core functions of the board : a) Choosing the CEO (Chief Executive Officer) (i.e. the president);
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b) Setting the broad parameters within which the management team operates (e.g. strategic planning; a framework for monitoring management opportunities and risks; approving major corporate transactions); c) Coaching the CEO and the management team; d) Monitoring and assessing the performance of the CEO; e) Setting the CEO’s compensation and approving the compensation of senior management; f) Providing assurance to shareholders and stakeholders about the integrity of the corporation’s reported financial performance . g) This report also found that many corporations are not satisfying the TSX guidelines below
8) CBCA Board structure requirements a) S.102(2) (and similar provisions in other corporate statutes in Canada): public corps under CBCA must have at least 3 directors requires that at least two directors of a public corporation not be employees or officers of the corporation or any of its affiliates . The requirement is mandatory. i) However, it does not require that a majority of the directors be “outside” directors since the number of directors in the majority of Canadian public corporations is more than eight . ii) It also leaves open the possibility of having on the board several persons that meet the CBCA requirement (i.e. not employees/officers …) that may have had some business relationship with the corporation prior to their appointment.
(1) E.g. could appoint retired officers of the corporation, lawyers from the law firm that acts for the corporation , officers of advisor firms such as the corporation’s investment banker firm or accounting firm. Directors of this sort are not likely to be entirely independent of the incumbent management since their continued engagement by the firm may depend on their cooperation with incumbent management. b) The 1984 Conference Board of Canada report indicated that the most common types of “outside” directors were: i) Independent businessmen, financiers, and consultants (21%); ii) Business executives (19%) iii) Executives of banks or service industries (14%); iv) Practicing lawyers (12%) v) Executives of non-bank financial institutions (11%); and vi) Educators, union officials, lobbyists and government officials (6%). c) Should CBCA outside director requirements be strengthened?
i) If having a majority of outside directors resulted in better quality management then why don’t corporations adopt such a strategy ? ii) Appointing outside directors and disclosing to investors the independence of the directors could operate as a signal to investors that there would be independent monitoring of management , which should increase the value of the shares (since the board might more reasonably be expected to replace weak managers). This would be in the interests of the promoters of the corporation (the management included) since it would facilitate the raising of capital . In other words, market forces might result in corporation’s adopting an optimal board structure. iii) The Conference Board of Canada Report in 1984 suggests that this has happened since it found that boards in Canada already have a majority of “independent” outside directors
. Even on a narrower definition of outside director, excluding non-employee directors with a business or family relationship to the firm, the outside directors still comprised 55% of board memberships (yet see poor compliance with TSX guidelines below) iv) One difficulty with expanding the scope of the definition of an outside director is that often the most useful kind of outside director is one with some relation to the firm. Directors who are chosen from the staffs of the corporation’s bankers, underwriters and lawyers can facilitate the flow of information between the corporation and these important service providers.
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v) Also difficult to strengthen the CBCA since the CBCA applies to many different types of corporations yet the best board composition varies from one corporation to another (e.g. requiring too large a board can make decision making difficult) d) CBCA s.171: public corps must have an audit committee , made up of three or more directors, a majority of whom are not officers or employees
9) When a corporation goes public in Canada it is common for it to list on the Toronto Stock Exchange or the Toronto Venture Exchange . a) To list on the Exchange the issuer of the securities must enter into a listing agreement under which the issuer agrees to comply with the rules , by-laws and policies of the Exchange . b) In 1994 the Dey Report , done for the Toronto Stock Exchange, recommended that a majority of directors of corporations listed on the Exchange be “independent”
directors. The Report suggested a much more restrictive approach to what would be considered “independent”. After consultation the Dey Committee recommended that its corporate governance recommendations not be mandatory but that listed corporations that did not follow the “guidelines”
would have to report in their annual reports to shareholders that they did not follow the guidelines and that they would have to explain in their annual why the guidelines were not followed. The Toronto Stock
Exchange adopted the recommendations of the Dey Report: c) The guidelines (not mandatory) are set out in the TSX Rules s.474(1) , and recommend that the board of directors should assume responsibility for : i) The adoption of a strategic planning process; ii) The identification of the principal risks of the corporation’s business and ensuring the implementation of appropriate systems to manage these risks; iii) Succession planning, including appointing, training and monitoring senior management ; iv) A communications policy for the corporation; v) The integrity of the corporation’s internal control and management information systems. d) TSX Rules s.474(2) recommends that a majority of the board consist of individuals who “qualify as unrelated directors
.” i)
It provides that an “unrelated director” is: “… a director who is independent of management and is free from any interest and any business or other relationship which could, or could reasonably be perceived to, materially interfere with the director’s ability to act with a view to the best interests of the corporation , other than interests and relationships arising from shareholding.” ii) Where the corporation has a significant shareholder (defined as a shareholder who has the ability to exercise a majority of the votes for the election of the board of directors), the guidelines provide (s.474(2)) that the board should include a number of directors who do not have interests in or relationships with either the corporation or the significant shareholder . iii) Management directors are presumed to be related directors . iv) Independence is a difficult concept, however, and there is some doubt whether all directors reported as independent really are e) TSX Rules s.474(4) of the guidelines recommends that a committee of exclusively “outside, i.e. non-management, directors” and a majority of whom are unrelated directors should be appointed with responsibility for nominating new board members . f) TSX Rules s.473 requires listed companies to provide a complete description of the company’s system of corporate governance in its annual report with specific reference to each of the guidelines . i) Where the company’s system is inconsistent with the TSX guidelines or the guidelines were not applicable, an explanation of the differences or their inapplicability is required. g) A survey of compliance with the TSX guidelines done by the Saucier Committee found that 51% of corporations did not fully comply with the requirement to disclose their corporate governance practices against each of the TSX guidelines.
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h) But the TSX has very limited enforcement mechanisms (e.g. if it delisted the corporation, this only really punishes the shareholders, employees, etc)
10) Outside directors are not necessarily a cure-all , however: a)
Literature suggests people in groups get caught up in ‘ group-think
’ b) Studies suggest outside directors often just rubber stamp recommendations from management c) Outside directors may not be totally independent (and hence don’t act differently from insiders) d) Even if truly independent, may have limited time due to full time jobs, etc e) Hence suggestions for reform include: i) Maximum number of directorships that one person can have ii) Minimum number of director meetings iii) Minimum length of meetings iv) Creation of separate groups of advisors for independent directors who can collect information on the company without approval from management
Dirs remve offs: sharehldr control/takeover v long-term/ low pay/human cap/parachute, cts uphold
1) Recall s.121: directors designate and appoint officers (e.g. president/CEO/management director (the latter being a chief office held by a director), treasurer/CFO, etc), and officers manage day-to-day affairs of the corporation a) S.122: duty of care of directors and officers
2) There is a trade-off between preserving the easy removal of managers (i.e. officers), versus providing managers with long-term contracts and compensation if the contract is terminated (see also “Directors powers to delegate” above): a) Long-term contracts can have negative effects by reducing the control of shareholders to ensure efficient management, which in turn can make raising capital more difficult i) Directors may remove officers , and the power to do so is key to the effectiveness of the election and removal of directors as a shareholder control device . If the shareholders are going to have control over the management of the corporation then they must be able not only to replace the directors of the corporation by appointing new directors, but those directors must have the power to change the management of the corporation by replacing the officers of the corporation. ii) However , where officers have long-term contracts , removing them may result in actions for wrongful dismissal with potentially high damage awards . For example, if management is doing a poor job there may be an incentive for someone to acquire enough shares to elect a new board of directors who could then replace the managers. However, if replacing the managers requires that huge damages awards must be paid out by the corporation, it could significantly deter the takeover of the corporation and subsequent replacement of the management. If the damages awards are greater then the perceived gains from the takeover, then there would be no incentive to do the takeover.
(1)
A corporation’s promoters might have an incentive to retain the potential for takeovers , since it can make raising capital required to carry on the business easier .
(2) If the market is aware that there is little or no potential for a takeover then it may not be willing to pay as much for the shares, since it raises the risk that management could become inefficient and without a potential for their removal the shares would be of little value.
(3) If this problem is anticipated ahead of time the market price for the shares will be quite low, and the corporation will have difficulty raising the required capital. This of course depends on the market anticipating this. If the market is good at anticipating this sort of problem (i.e. if it is efficient) then there will be an incentive for the corporation’s promoters to get the right trade-off between long-term contracts and retaining the potential for replacement of management.
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(4) By upholding long-term contracts (see cases below), courts have effectively left it to the corporation to set compensation that makes this trade-off.
(5) See also golden/tin parachutes below b) On the other hand, long-term contracts may be mutually beneficial to the corporation and its officers, and there are considerations of reliance and fairness. i) The tendency of courts to uphold long-term employment contracts (as the cases below will demonstrate) may be motivated in part by the reliance of the employee
(1) People employed as officers may have reasonably expected to be either employed for the term of the contract or adequately compensated for an early dismissal.
(2) The officer may accept lower pay in return for the security of a long-term contract and the company might be unjustly enriched by allowing it to get away with removing them before the end of the agreed upon term (i.e. “shareholder opportunism”).
(3) Such an expectation may give officers an incentive to build firm specific human capital
(a) With the hope of a long-term reward managers may be more willing to invest their
“human capital” in the corporation (engaging in management activities for a corporation normally requires developing a knowledge of the corporation’s business, its customers, its staff, internal procedures and firm culture – it can take considerable time and effort to develop this knowledge). Much of this knowledge will not be transferable to other corporations (referred to as “firm specific human capital”).
(b) This deserves compensation if prematurely terminated – firing a manager who has spent considerable time and effort building up firm specific human capital without compensating the manager for these efforts might also be seen as shareholder opportunism .
(c) If the manager is aware of the risk that her or his job could be terminated within a relatively short period of time with little or no compensation, then the manager may not have much incentive to develop this firm specific human capital. ii) From the perspective of the corporation :
(1) The officer will probably value the security of a long-term contract and the corporation will benefit if the officer is willing to accept less pay as a result.
(2) The corporation will benefit from a more effective manager who has developed their human capital, including firm specific human capital. iii) The long run effect of allowing dismissal without consequence would be that companies would not be able to enter into these kinds of contracts and might well end up having to pay higher pay to compensate for the lack of security in the job (i.e. a mutually beneficial contract for both parties would be defeated).
3) The general approach of the courts has thus been to uphold long-term contracts – the manager can be dismissed, but the damages must be paid. a) Re Paramount Publix Corp.
, 90 F. 2d 441 (1937, U.S. Court of Appeal, 2d Circ.) i) Facts:
(1) Sam Katz was employed by Paramount Publix Corp. as an executive for a 3 year period at a salary of $2,500 per week (huge in the 1930s) plus options on stock every six months beginning on January 1, 1932.
(2) After just 10 months, in October of 1932, he was dismissed. He filed an action for
$265,498.
(3) The company was later in receivership. Section 60 of the Act under which the company was incorporated provided that officers could be removed by the directors and it was argued that Katz could be removed regardless of the 3 year term of the contract. ii) Decision:
(1) The court expressed the concern that such an interpretation of s.60 would mean that an employee could be dismissed without cause and without consequence to the company.
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The result would be that companies would not be able to enter into binding employment contracts with persons appointed as officers.
(2) Thus the provision, according to the court, should be interpreted to mean that directors can remove person from a particular office or agency but if they dismissed them from their employ entirely there would be the usual consequences of breach of an employment contract . b) The court in Re Paramount Publix Corp suggested that a person could be removed from a particular office or agency without consequence – it would only be if the person was dismissed entirely from their employment that the usual consequences of breach of an employment contract would arise. There is, however, a concept of constructive dismissal . A Canadian example of this in the context of a senior management contract arose as early 1916 in Montreal Public Service
Co. v. Champagne (1916), 33 D.L.R. 49 (P.C.) (although they did not use the term “constructive dismissal” at that time). i) Facts:
(1) Champagne was employed as a general manager of Montreal Public Service Co. Under the contract he was give control over “all the administration of the business of the company ... subject only to such direction and control as it is the duty of the directors to exercise.”
(2) Some time after Champagne had been working under the terms of the employment contract the Montreal Public Service Co. appointed a president. Champagne was placed under the direct supervision of the newly hired president . ii) Decision:
(1) The court held that Champagne was entitled to damages for breach of contract . c) Shindler v. Northern Raincoat Co. Ltd. [1960] 2 All E.R. 239 i) Facts:
(1) Shindler had been the managing director and controlling shareholder of the Northern
Raincoat Co. Ltd (NRCL). He sold his shares to Lloyds Retailers Ltd. (LRL), a public corporation, and LRL agreed to retain the plaintiff as managing director (i.e. chief officer) of the subsidiary (i.e. NRCL) for a period of ten years .
(2)
NRCL’s articles included art. 68 of Table A of the U.K. Companies Act , 1929, to the following effect: “The directors may from time to time appoint one or more of their body to the office of managing director or manager for such term and at such remuneration ... as they may think fit ...; but his appointment shall be subject to determination ipso facto if he ceases from any cause to be a director , or if the company in general meeting resolve that his tenure of office of managing director or manager be determined.”
(3)
During the term of Shindler’s employment, LRL decided they wanted to sell NRCL to another public company, which did not wish to retain the plaintiff as managing director.
After protracted negotiations between Shindler and LRL concerning comparable alternative employment proved unsuccessful, Shindler was removed as a director , of
NRCL by an extraordinary resolution approved by the NRCL’s shareholders (i.e. by LRL), and therefore (according to the articles) also as managing director. ii) Decision:
(1) Shindler was entitled to damages for wrongful dismissal .
(2)
The court rejected the company’s claim that the contract of employment would be ultra vires if interpreted to exclude a power in the company’s general meeting to terminate it for whatever reasons seemed sufficient to the shareholders.
(3) The principle to be applied was that where a party enters into an arrangement whose effectiveness requires continuance of an existing state of circumstances, there is an implied engagement on his part that he shall do nothing of his own motion to put an end to that
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state of circumstances (i.e. they removed him as director, which in turn meant, under
NRCL’s articles, his officer position (managing director) came to an end) iii) See also Read v. Astoria Garage (Streatham) Ltd., [1952] 1 Ch. 637; and Southern
Foundries (1926) Ltd. v. Shirlaw , [1940] A.C. 701 (H.L.).
4) A related issue is the use of so-called “ golden parachutes ”, which is basically a liquidated damages term in an employment contract for corporate executives that gives them very lucrative compensation if they are dismissed from their job. a) Some of these have been so highly lucrative (e.g. $800M) that they have raised eyebrows in the media, with the public and with courts in the U.S. and, more recently, with courts in Canada. The more extravagant parachutes (i.e. the “golden” ones) have been struck down in several cases in the
U.S.
b) They have been replaced by somewhat less lucrative (but still highly lucrative) contracts that have been upheld. These have gotten the nickname “ tin parachutes.
” c) These parachute contracts have been said to perform an important function. When someone is trying to takeover a company (i.e. acquire sufficient shares to replace the directors and then subsequently replace the officers) the existing management tends to resist the takeover so they can keep their jobs. Parachute provisions in their employment contracts can reduce their incentive to resist takeovers . This allows managements to be replaced where they performing poorly. d) They also allow existing management to send a signal to the market that they will perform in the interests of the shareholders . It is a credible signal because it effectively says that if they do poorly they can be replaced. e) Of course, if the contracts are excessive they could also significantly deter takeovers . Does the court need to step in and declare void parachute provisions that are excessive? If information on these contracts is available to the market and if investors can properly assess the effect of these contracts then they would presumably reduce the price of the shares where the parachute provisions were so generous that they served to discourage takeovers. This could make it difficult for the corporation to raise capital required to carry on the business. If the market cannot properly anticipate or assess when parachute provisions are excessive then perhaps the court should step in .
But how would a court determine when a parachute provision was excessive? It would presumably vary from one corporation to another. What might be excessive in one corporation would not necessarily be excessive for another. Would a court be any better than the market in assessing whether a parachute provision was more detrimental then beneficial?
Dirs/offs fid duty: honest, good faith (conflct of intrst, corp opportnty, authorty), best intrsts of corp
1) Directors and officers of corporations are fiduciaries and have fiduciary duties (similar to those agents are typically said to owe to their principal).
2) CBCA s.122(1)(a) provides a very general codified enunciation of the fiduciary duties of directors and officers: “
Every director and officer of a corporation in exercising their powers and discharging their duties shall act honestly and in good faith with a view to the best interests of the corporation
”
3) This duty is to the corporation, not to the shareholders or creditors (see Peoples Department Store v.
Wise below)
4) These duties are similar to duties of agent to principal.
5) The duty of good faith includes: a) The duty of a director or officer not to engage in transactions in which the director or officer has a conflict of interest (i.e. a conflict between the personal interest of a director and the interest of the corporation). See s.120 disclose of interest. b) The duty not to take corporate opportunities (roughly corresponding to the duty of agents not to make secret profits) c) The duty to act for a proper purpose (i.e. within the scope of their authority)
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6) Excessive executive salaries might be contrary to the best interests of the corporation (see UPM-
Kymmene Inc.
below)
Dirs/offs fid duty: care (causation/biz jdgmnt rule), dilignce (deem consent), skill
1) CBCA s.122(1)(b) also provides a very general codified enunciation of the fiduciary duties of directors and officers: “ Every director and officer of a corporation in exercising their powers and discharging their duties shall exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.”
2) Pre-statutory : a) The common law standard of care standard was a very lenient standard under which it was virtually impossible to find a party liable for a breach of their duty of care. b) No duty to be diligent (i.e. to attend meetings on a regular basis) – Re Cardiff Savings Bank ,
[1892] 2 Ch. 100 i) Facts:
(1)
The Marquis de Bute became a director at the age of 6. He attended his first directors’ meeting at the age of 27.
(2) When financial difficulties occurred at the Cardiff Savings Bank the liquidator sought compensation from the Marquis for imprudent decisions that led to the downfall of the bank. ii) Decision:
(1) The Marquis de Bute was not held liable for his failure to attend company meetings.
(2) The court held that a director need only exercise reasonable care at those meetings which the director attends . c) Duty depends on the personal circumstances of the particular director – Re Brazilian Rubber
Plantations and Estates Ltd.
, [1911] Ch. 425 i) Facts:
(1) An enterprising promoter of a rubber business with a plantation in South America, and who was acting on behalf of a syndicate of investors, managed to convince four interesting characters to become directors of a newly formed company that would acquire the plantation from the syndicate.
(2) First there was Aylmer who professed to be ignorant of business. Then there was Tugwell who was 75 years old and deaf. Barber, who was in the rubber business, was told that his sole responsibility was to value the rubber arriving in London. Hancock joined because
Barber and Tugwell joined, and they were, after all, reputable business persons.
(3) The company issued a prospectus (approved by the directors) that was provided by a syndicate of investors that was selling the rubber plantation to the company. The prospectus said that the plantation had 12,500 acres when in fact there were only 2,000 acres. The prospectus alleged that there were 400,000 trees when in fact there were only
50,000. The prospectus was used to sell shares in the company to the public and the proceeds from the sale of the shares would then be used to buy the South American rubber plantation from the syndicate.
(4)
The syndicate had bought the rubber plantation for £15,000 and sold it to the company for
£30,000 cash plus 120,000 £1 par value shares (i.e. they sold it for £150,000 which was to be paid for by the company with £30,000 cash plus 120,000 £1 par value shares of the company).
(5) The liquidator of the company sued the four directors for damages claiming they were negligent in approving the prospectus . ii) Decision:
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(1) It was held that the standard of care is the reasonable care expected to be taken in the circumstances by a person on his own behalf. The circumstances to be taken into account included regard to the defendant’s own knowledge and experience
.
(2) Thus one had to take into account the fact that Aylmer was ignorant of business, that
Tugwell was 75 years old and deaf , and that Barber was only engaged to price the rubber.
In the case of Tugwell the standard was thus what one would expect not of a “reasonable person” but of someone who is 75 years old and deaf.
(3) The court further held that as far as syndicate member representations about the rubber plantation in the prospectus were concerned, it was alright for the directors to rely on the reports of syndicate members even though the members of the syndicate had a personal interest in the transaction. iii) Comment:
(1) The weakness of the standard in Re Brazilian Rubber Plantations is highlighted by the argument of the liquidator that the mere difference in price between what the syndicate paid for the plantation and what the price for the sale to the company was should have tipped the directors off that something was amiss. The directors were nonetheless not found liable .
d) Summary of the common law duty of care for directors and officers – Re City Equitable Fire
Insurance Co. Ltd.
, [1925] Ch. 427 (C.A.) i) Facts:
(1) There was an order for the winding-up of a once profitable insurance company which showed a large deficit of £1.2 million when there were large trading profits. The managing director had fraudulently diverted funds from the company and was convicted and sent to prison.
(2) The liquidator sought to make the directors and the auditors of the company liable for negligence in not identifying the fraud . ii) Decision:
(1) Romer, J. summarized the law on the duty of care of directors and officers noting:
(a) Reasonable Care : The degree of care to be taken is to be measured by the care an ordinary person might be expected to take in the circumstances on their own behalf (i.e. the Re Brazilian Rubber Plantations standard).
(b) Degree of Skill : The degree of skill to be taken is that which can be expected of a person of his/her knowledge and experience (i.e. the Re Brazilian Rubber Plantations standard).
(c) Degree of Attention : A director is not bound to give continuous attention to the affairs of the company (i.e. the Re Cardiff Savings Bank position on the diligence of directors).
(d) Trust of Officials : Directors can trust officers to perform duties honestly in the absence of grounds for suspicion. iii) Comment: see reference to this case in Soper v. The Queen below e) Proof of causation required i) Another difficulty with the duty of care is that one must show that the damages suffered were caused by the director’s or officer’s breach
of the duty of care. ii) This can be difficult in the context of a corporation where there may be any of numerous other factors that may be alleged as the true cause of the loss to the corporation. iii) E.g. Barnes v. Andrews 298 F. 614 (1924 S.D.N.Y.)
(1) Facts:
(a) Andrews became a director of Liberty Starters Inc. (which made starters for Ford cars and for aeroplanes) on October 19, 1919 and served until he resigned on June 21, 1920.
He was a friend of the president of the company.
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(b)
During Andrews’ time as a director there were two meetings of the board. Andrews missed one of the meetings due to death in the family.
(c) During time Andrews was a director 500,000 shares were sold, officers and employees were hired and a plant (already built when Andrews took office) was equipped.
(d) The business failed. The plaintiff receiver attempted to claim against Andrews for the loss on the basis of Andrews’ negligence.
(2) Decision:
(a) The court held that a director has a duty to keep informed in some degree of detail.
Although Andrews’ was not liable for the failure to attend meetings, he had failed to keep himself adequately informed (he had only spoken to the president during commutes to work).
(b) However, the court noted that the plaintiff must also show that:
(i) The performance of the director’s duties would have avoided the loss ; and
(ii) The amount of the loss that would have been avoided.
(c) The court noted that it was hard to tell just what the reason for the company's failure was. The court also pondered just what action Andrews’ could have taken to avoid
the loss, and said that Andrews’ couldn’t be
held liable simply on the basis that he was not well suited to the job.
(d) The court also noted the concern that no one would be a director if they were subjected to liability for any loss (i.e. if they were made guarantors against loss). iv) This requirement of causation has recently been noted in the Supreme Court of Canada decision in People’s Department Stores Inc. v. Wise (2002), 244 D.L.R. (4 th
) 564 (S.C.C.) where the judgment of the court stated that,
(1)
“In order for a plaintiff to succeed in challenging a business decision he or she has to establish that the directors acted :
(a) In breach of the duty of care, and
(b) In a way that caused injury to the plaintiff.” f)
The “ business judgment rule
” is the flip side of the duty of care. i) Under the business judgment rule the directors’ judgment
with respect to managing the corporation will not be second guessed by the court . ii) The presumption is that the directors have acted in good faith and in the honest belief that the action taken was in the best interests of the corporation. iii) The reason for this approach is that the courts do not want to become adjudicators of the correctness of business decisions. It would require gathering of large volumes of information about the corporation and the business. The court , not being experts in business , would then presumably have to rely on expert testimony to assess whether business decisions were properly and carefully made. There is a concern that with the benefit of hindsight and more time than the directors may have had to consider the issues, they will not fairly reflect the circumstances under which management made the decisions. iv) Too exacting a duty of care with the benefit of hindsight might cause directors and officers to become overly cautious . They are, after all, managing a business and managing a business involves taking some risks. They often need to respond quickly to take advantage of business opportunities and thus may make some decisions in a relatively short space of time and with only the information obtainable in that short space of time. v) Consequently courts do not engage in second-guessing management decisions. They accept that directors will make errors in judgment. vi)
The expression “business judgment rule” comes from U.S. cases. However, the principle has long been recognized in Anglo-Canadian jurisprudence.
(1) In Re Smith and Fawcett , Lord Greene said that directors must exercise their discretion in
“what they consider, not what a court considers, to be the interests of the company.”
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(2) In Howard Smith v. Ampol Petroleum
, Lord Wilberforce said: “There is no appeal on the merits from management decisions to courts of law; nor will courts of law assume to act as a kind of supervisory board over decisions within the power of management honestly arrived at”
(3) The expression “business judgment rule” has more recently appeared in Canada . In particular, in the Supreme Court of Canada decision in
People’s Department Stores Inc. v.
Wise (2002), 244 D.L.R. (4 th
) 564 (S.C.C.) the judgment of the court noted (at 589) that,
(a) “Canadian courts, like their counterparts in the United States, the United Kingdom,
Australia and New Zealand, have tended to take an approach with respect to the enforcement of the duty of care that respects the fact that directors and officers often have business expertise that courts do not.
(b)
“Many decisions made in the course of business, although ultimately unsuccessful, are reasonable and defensible at the time they are made. Business decisions must sometimes be made, with high stakes and under considerable time pressure , in circumstances in which detailed information is not available .
(c)
“It might be tempting for some to see unsuccessful business decisions as unreasonable or imprudent in light of information that becomes available ex post facto. Because of this risk of hindsight bias , Canadian courts have developed a rule of deference to business decisions called the ‘business judgment rule’, adopting the American name for the rule.”
(d)
Later (at 590) the court added that, “In determining whether directors have acted in a manner that breached the duty of care, it is worth repeating that perfection is not demanded. Courts are ill-suited and should be reluctant to second-guess the application of business expertise to the considerations that are involved in corporate decision making, but they are capable , on the facts of any case, of determining whether an appropriate degree of prudence and diligence was brought to bear in reaching what is claimed to be a reasonable business decision at the time it was made.” vii) As noted above, the business judgment rule is the flip side of the duty of care. The greater the scope given to the business judgment rule, the less the scope given to the duty of care. The problem is where to draw the line between errors of judgment and lack of due diligence . The common law approach to the duty of care of directors and officers suggests an extensive scope to the business judgment rule giving directors a great deal of latitude to make errors in judgment. viii) More cases below on business judgment rule
3) Statutory duty of care a) Modern corporate statutes often have provisions codifying the standard of care. CBCA s.122(1)(b) provides that in exercising their powers and discharging their duties directors and officers must “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.” b) The statutory position can be compared to the common law position as follows: i) Reasonable Care :
(1) The care of directors and officers is to be measured against the care of a “ reasonably prudent person
” but taking into account how such a person would act “in comparable circumstances.”
(2) The Dickerson Committee that recommended the enactment of s. 122(1)(b) said that the difference between common law standard and the statutory standard was that the common law standard was a subjective standard taking into account the degree of care, skill and diligence that could reasonably be expected of the particular director, having regard to the particular director’s knowledge and experience, while the statutory standard was an objective standard of the “reasonably prudent person”.
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(3) This suggests a difference to the common law in Re Brazilian Rubber Plantations and
Estates Ltd , but see Soper v. The Queen below ii) Degree of Skill :
(1) The degree of skill to be exercised is to be that of a reasonably prudent person “in comparable circumstances .”
(2)
While the “reasonably prudent person” element here suggests an objective test, the additional words of “in comparable circumstances” may introduce a subjective element taking into account the particular person’s knowledge and abilities. iii) Degree of Attention :
(1)
Section 122(1)(b) does require the level of diligence of a “ reasonably prudent person
.”
(2) The level of required diligence is reinforced by a requirement in CBCA s.122(3) that a director who was not present at a meeting of the directors is deemed to have consented to resolutions passed at the meeting unless , within seven days after becoming aware of the resolution, the director causes her/his consent to be placed in the minutes of the meeting or sent by registered mail to the registered office of the corporation. iv) Trust of Officials :
(1) S.123(4): a director is not liable for good faith reliance on financial statements , or a report of a lawyer, accountant, engineer or other professional person.
(2) After the enactment of the statutory duty of care in the CBCA, the question was whether the statutory standard was a higher standard than the common law standard. There were very few Canadian decisions and the tendency was to look to developments in the U.S.
(where several jurisdictions had also codified the duty of care) to get a sense of what the modern standard of care was.
4) Developments in the business judgment rule and the duty of care in the U.S.
a) In Kamin v. American Express Co., 383 N.Y.S. 2d 807 (Sup. Ct., N.Y. County) affd, 54 A.D. ed
654, 387 N.Y.S. 2d 993 the scope of the business judgment rule was held to be limited to fraud or bad faith . b) In other cases, the scope was said to be involve a concept of gross negligence . Even where gross negligence was applied it was often suggested by commentators that the basis of such cases was a sense of fraud or bad faith but that the evidence wasn’t strong enough for such an accusation so the court latched onto the concept of gross negligence. c) An interesting example of the scope of the business judgment rule (especially for baseball fanatics and historians!) is Shlensky v. Wrigley 237 N.E. 2d 776 (1968 Ill. C.A., 1st Cir.) i) Facts:
(1) The case involved the company that owned Wrigley field where the Chicago Cubs played baseball. Other baseball stadiums throughout the league had added lighting to allow for night games . This was said to greatly increase profits since many more persons could get to night games than could get to day games.
(2) The principle shareholder and president of the company refused to put lights in at Wrigley field. He was well-known to be a baseball purest who was adamant that baseball was a daytime game.
(3) A shareholder brought a derivative action against directors for breach of their duty of care .
He claimed that lights should be installed in Wrigley Field. Wrigley Field was the only field out of the fields for 20 teams that did not have lights and night games and he complained that there was a loss of operating revenues from the lack of night games.
Indeed the Chicago Cubs had operating losses from their baseball operations. There was also evidence of much higher attendance for the Chicago White Sox (the other Chicago team) weekday games played at night.
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(4) Wrigley argued, however, the lights would have a deteriorating effect on the surrounding neighborhood . If the neighbourhood deteriorated , Wrigley argued, the market value of
Wrigley field would go down to the detriment of the corporation. ii) Decision:
(1) The court noted that that courts will generally respect the business decisions of directors unless they have acted fraudulently , in breach of good faith or have a conflict of interest .
(2) In this case, the court was not satisfied that there was a breach of good faith. The effect on the surrounding neighbourhood might be something a director would consider in relation to the corporation’s profits or value. There was no requirement, the court noted, that the directors follow the lead of other corporations involved in baseball. d) The scope of the business judgment rule was arguably significantly reduced (thus expanding the scope of the duty of care) in 1985 in the case of Smith v. Van Gorkom , 488 A.2d 858 (1985) i) Facts:
(1) TransUnion was a corporation that had substantial income tax credits which could be applied against other income to reduce taxes. However, it lacked sufficient income to take advantage of the tax credits.
(2) In August of 1980 the board considered the possibility of a merger with a corporation that could take advantage of the tax credits . The CEO said the proper price range would be $50 to $60 per share.
(3) Van Gorkum was the chair of the board of directors of TransUnion. In September he approached a man by the name of Pritzker with respect to the purchase of TransUnion shares for $55 per share . Van Gorkum then met with TransUnion management on
September 20th. Only two members of the management supported the deal.
(4) On the same day Van Gorkum took the proposal to the board of directors. The proposal was approved by the board on the basis of a twenty minute presentation, without copies of the merger agreement, without a formal evaluation of the value of the shares of the corporation other than the representation by the CEO that $55 would be at the bottom end of the fair price range .
(5) The board was advised by an attorney that they could face litigation if the offer were turned down and that there was no requirement that they obtain a separate evaluation from an investment banker.
(6) The offer was considered again on October 8 and then again on January 26. There were five inside directors and five outside directors. Of the five outside directors four of them were CEOs in other corporations and one of them was the former Dean of the University of Chicago Business School.
(7) A class action was taken by a group of shareholders who asked for rescission of the transaction or damages against the members of the directors of the board on the basis that they had breached their fiduciary duty of care . ii) Majority decision:
(1) The majority of the court found the directors liable for over $10 million in damages.
(2) The majority decision noted the fiduciary duty of directors to act with care but with the protection of the business judgment rule to promote the full and free exercise of managerial powers. The majority noted that the business judgment rule is a presumption that the directors acted :
(a) In good faith ;
(b) In an honest belief that they were acting in the best interests of the company; and
(c) That they were doing so on an informed basis .
(3) The party attacking this presumption must show sufficient evidence to rebut the presumption to cause the directors to have to answer an apparent lack of good faith, honest belief or lack of an informed decision.
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(4) The majority adopted the gross negligence standard of the duty of care (i.e. directors have breached the duty of care, and are not entitled to the protection of the business judgment rule, if they have been grossly negligent).
(5) The majority found the directors grossly negligent in that they did not adequately inform themselves of Van Gorkum’s role in the sale, that they were uniformed as to the intrinsic value of the company and that they were grossly negligent in approving the sale on only two hours’ consideration
with no documents and no inquiry as to the basis of the CEO’s
$55 estimate of the price.
(6) The magnitude of the premium and the collective experience of the directors was no excuse for not checking into the price. Legal advice that an independent assessment of the price was not absolutely necessary was also no excuse for not getting an assessment where it made sense to do so. iii) Dissent:
(1) The dissent in the case basically asked how the majority could second-guess the business acumen of directors with as many years of business experience as these directors had. The dissent noted the backgrounds and experience of the directors and the fact that they had recently considered a five year plan and a Boston Consulting Group report that gave them a detailed awareness of the company’s current situation. In other words, they did not need to take time to inform themselves of the company’s situation – they were already well aware of it having just spent a considerable amount of time becoming informed in the context of developing the five year plan. iv) Comment:
(1) The case raised concerns . The actions of the board would not be at all uncommon and indeed were said to be much better than what frequently occurs (especially in organizations where the directors have far less expertise). If experienced CEO’s, CPA’s, lawyers and
Dean’s of Business schools could be found liable in a not uncommon type of board meeting then it suggested a potentially very high exposure to liability for the many directors who had far less experience and far less information on which to assess decisions.
(2) Concerns were expressed that such an exposure to liability would have an impact on the willingness of people to become directors , on the compensation they would have to be given to convince persons to become directors, or the cost of insurance required to protect them from liability.
(3) The case in fact caused such a stir that the Delaware legislature passed a modification to the Delaware corporate law that allowed corporations to limit the liability of directors.
This was followed in several other U.S. states.
(4) Although it was a U.S. case it caused concern in Canada as well prompting, indeed, an
Alberta Law Reform Commission report on the “TransUnion” case.
5) Developments in Canada a) Cases on the scope of the statutory duty of care under s.122(1)(b) of the CBCA and of similar provisions in other Canadian corporate statutes have been slow to come. However, there are now several decisions that are have addressed the scope of the statutory duty of care of directors and officers. b) One interesting signpost along the way was the decision in Dixon v. Deacon, Morgan, McEwen,
Easson (1989) 41 B.C.L.R. (2d) 180 (B.C. S.C.) which suggested that the statutory standard was probably a stricter than the common law standard i) Facts:
(1) The plaintiff lost a substantial sum of money shortly after purchasing 80,000 shares in a company by the name of National Business Systems Inc. The plaintiff took action against the brokers, officers and directors of the company and the company auditors.
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(2) One of the defendant directors sought to have the action dismissed on an application for a summary dismissal on the basis that there was no cause of action). The particular defendant director had not attended any meetings of the company. He was a member of the statutory audit committee but never took part in the work of the audit committee. He did not know the name of the CFO. He had signed between 30 and 40 blank sheets of paper which he gave to the company solicitor to use for whatever purpose the company saw fit. ii) Decision:
(1) After a review of the common law position and the statutory codification, Bouck J. felt it would be not be appropriate to grant the application (for summary dismissal of the case) because, among other reasons, the law with respect to directors’ liability for breach of their duty of care “is complex and unsettled, requiring much fuller attention ...”
(2) He suggested that the statutory standard may have modified the common law standard and would not make a decision on the scope of the standard in an application for summary dismissal. c) Fraser v. MNR , [1987] 1 C.T.C. 2311, (1987) 87 D.T.C. 250 i) Facts:
(1) There are many cases on the duty of care the directors are to take in withholding employee taxes from employee paycheques and remitting those amounts to the federal government.
The provision in the Income Tax Act imposing this duty of care is identical , word for word, to the duty of care of directors under the CBCA.
(2) In Fraser v. MNR , Fraser was one of three directors. He was appointed VP of manufacturing and was responsible for securing raw materials.
(3) The other directors were Foster and Bolton. Bolton was a Chartered Accountant and took care of financial matters.
(4) The company had a Post Office contract. The post office was delinquent in payment. This led to financial cash flow problems for the company. Needed funds were found by failing to remit employee income taxes that had been withheld. A tax official showed up inquiring into the matter.
(5) Fraser thus became aware of the problem. He checked with Bolton who was in charge of such matters. Bolton said everything was OK, and that it was going to be paid with an incoming $30,000. Ultimately the amounts were left unpaid and an action was taken against Fraser alleging that he breached his duty of care in seeing to it that the amounts were paid. ii) Decision:
(1) The court held that Fraser had done nothing to prevent the failure to remit the tax. The court looked to Fraser’s relative skill
(i.e. as one of the “circumstances”) and concluded
Fraser was intelligent and could have done something. He had a duty to be vigilant and to take all reasonable steps to see that the Income Tax Act was being complied with .
(2) The court also held that Bolton did not have exclusive control over the accounting/financial end of the business and it was something that Fraser, as a director, also had responsibility over. iii) Comment:
(1) The case, curiously, seems to suggest a subjective standard . The court arguably did not apply just a “reasonably prudent person” test but took a specific circumstance of Fraser, namely his intelligence, and used it to hold him liable for a breach of the duty of care.
(2) This case suggests a fairly high standard of care , especially when compared to the standard in the older common law cases. However, caution should be applied in extending this apparent high a standard of care into other cases that do not involve the withholding of income tax .
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(3) A failure of the directors to exercise an appropriate standard of care in most companies can lead to a market response such as a takeover bid or a proxy battle . Even without a takeover bid or proxy battle, shareholders in publicly-held corporations have a market response that is a simpler response than litigation – they can sell their shares . Decreasing share prices will make it more difficult for the management to raise funds from the public in the future.
Thus the market works as a sort of back-up mechanism for the enforcement of the duty of care .
(4) The collection of withholding taxes will not have a market back-up mechanism . The market would not perceive a firm as doing a bad job if it managed not to pay taxes (as long as this did not attract substantial liability in terms of penalties). The court may need to intervene and enforce a higher standard for the collection of withholding taxes. This does not mean that the court applies a different technical legal standard for words in the Income
Tax Act that are also in the CBCA. Presumably, given the identical wording, the court has to apply the same standard. However, one might wonder:
(a) First, whether courts might be influenced by an appreciation of the difference in effectiveness of non-legal mechanisms for ensuring directors take care in the tax remission situation as opposed to the business management situation.
(b) Second, whether, from a policy perspective, the standard should be the same in the two situations given the difference in the effectiveness of non-legal incentive mechanisms in the two situations. d) Soper v. The Queen , 97 D.T.C. 5407, (1997) 149 D.L.R. (4 th
) 297 (F.C.A.) i) Facts:
(1) Soper was a tax case like the Fraser case involving a director’s liability for a failure by a corporation to remit taxes withheld from payments to employees .
(2) Mr. Soper was an experienced businessman who became a director of Ramona Beauchamp
Inc. He became a director to lend his reputation to and to promote the corporation’s business.
(3) Not long after he became a director he was given a copy of the corporation’s balance sheet.
It indicated that the company was in serious financial difficulties . Mr. Soper did not make any inquiries concerning tax remittances and he did not take any action concerning tax remittances. ii) Majority FCA decision:
(1) The standard of care to be exercised with respect to withholding tax remittances under the
Income Tax Act is identical to that under the CBCA .
(2) The majority noted that the codified standard in the CBCA largely reflected the common law position as set out in Re City Equitable Fire Insurance Co. Ltd.
, [1925] Ch. 427
(C.A.) .
(3) The competence expected of a director under CBCA s. 122(1)(b) is that of a reasonably prudent person with the knowledge and experience of the particular director (i.e. taking account of the “comparable circumstances”). The court suggested the standard had increased to the extent that it was not sufficient for a director to simply say that she or he had done their best – they have to have done what a reasonably prudent person with the knowledge and experience of the director would have done. The majority indicated that the test is both a subjective and objective test :
(a) It is subjective to the extent that the words “in comparable circumstances” suggest one take into account the particular director’s knowledge and experience
.
(b) It is objective to the extent that the director must exercise the care that a reasonably prudent person of similar knowledge and experience would exercise.
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(4) Mr. Soper, an experienced businessman, was held liable . He knew or ought to have known from the exercise of reasonable prudence, that there might be a problem with the remittances.
(5) The majority contrasted the case with Sanford v. The Queen, [1996] 1 C.T.C. 2016
(T.C.C.) in which another director in Ramona Beauchamp Inc. had been found not liable taking into account the fact that she had little involvement in the administrative or financial matters in the corporation and had no training or experience in these areas. She had authority to co-sign cheques for the corporation and when she became aware of the failure to make remittances she arranged for the issuance of a cheque to pay the outstanding remittances but was not aware that their were insufficient funds for the payment in the corporation’s bank account. e) UPM-Kymmene Inc. v. UPM-Kymmene Miramichi Corp.
, (2002), 214 D.L.R. (4 th
) 496
(1) Facts:
(a)
Involved a CBCA corporation by the name of Repap Enterprises Inc. (“Repap”). The corporation, which was in the pulp and paper industry, was in financial difficulties.
(b) In January of 1999 Mr. Berg was appointed as a director and as chair of the board of directors. He had been nominated by the largest shareholder of Repap, Third Avenue
Funds.
(c) Mr. Berg retained new legal counsel on behalf of Repap. He instructed the law firm to prepare a draft agreement between himself and Repap under which he was employed as an executive with salary and benefits .
(d) The draft agreement was considered by the board on February 22, 1999. The board consisted of six members, two of whom were long-serving directors and the other four of whom were new directors attending their first meeting of directors for Repap. The board resolved to seek guidance from a compensation consultant before approving the agreement.
(e) Subsequent to the meeting one of the two long-serving directors resigned. Several directors (including the remaining long-serving director) indicated their objections to the agreement to the chair of the compensation committee. The chair of the compensation committee wrote to the president of Third Avenue Funds indicating the problems with the draft agreement and then he also resigned as a director of Repap.
(f) Mr. Berg then recruited two new directors to replace the two that had resigned. One of these new directors became the chair of the compensation committee. The compensation committee met only once, on March 23 rd just before a full board meeting, to consider the agreement. They discussed the agreement for seven minutes .
The compensation consultant’s report was not available to the committee. The chair of the compensation committee indicated his support for the agreement.
(g) The meeting of the full board then followed and the report of the compensation consultant was introduced. The chair of the compensation committee served as the chair of the meeting (Mr. Berg having left the room for the discussion of the agreement). After about one-half hour of discussion the board approved the agreement.
(h) There was considerable shareholder opposition to the agreement when it was disclosed.
It resulted in a proxy battle to replace the board that was actually led by Third Avenue
Funds.
(i) The new board was elected in August and Mr. Berg responded by terminating his employment under the terms of the agreement and sued for breach of the agreement in a New York court.
(j) The shareholder then sued to have the agreement set aside on the basis that it was oppressive and that it constituted a breach of fiduciary duty by Mr. Berg. The two
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directors that had been recruited by Mr. Berg were sued for breaching their duty of care.
(2) Decision:
(a) The salary and many of the benefits were said by the court to be inappropriate, excessive and contrary to the best interests of Repap.
(b) The court held that all of the directors present at the March 23 rd meeting had breached their duty of care under CBCA s. 122(1)(b).
(c) The court also held that the directors have a duty to proceed cautiously ( particularly on a non-urgent matter such as an employment contract for an executive) and to educate themselves thoroughly . They should obtain the views of management and of experts on executive compensation.
(d) The court noted that the business judgment rule only protects directors who “are scrupulous in their deliberations and demonstrate diligence in arriving at decisions.” f)
People’s Department Stores Inc. v. Wise
(2002), 244 D.L.R. (4 th
) 564 (S.C.C.) i) Facts:
(1)
The shares of Peoples Department Stores Inc. (“Peoples”) were acquired by Wise Stores
Inc. To facilitate the formal amalgamation a change was made in the accounting system for domestic and imported inventory between the two corporations. While the change in the accounting system addressed an administrative problem in the amalgamation it led to a large and increasing unsecured debt owed by Wise Stores Inc. to Peoples. This had apparently not been foreseen when the accounting change was made.
(2) Ralph, Lionel and Harold Wise (the Wise brothers) held the majority of the shares, and were senior officers and directors, of Wise Stores Inc. They had approved the accounting change on the advice of the senior officer (Mr. Clément) responsible for finance and administration. There were informal discussions and a full board meeting at which the accounting change was discussed.
(3) Both corporations were later declared bankrupt. The assets of Wise Stores were insufficient to pay the debt owed by Wise Stores Inc. to Peoples. The trustee in bankruptcy for Wise Stores Inc. sued the Wise brothers for a breach of the duty of care under CBCA s.122(1)(b) for approving a change in the accounting system that resulted in such a large debt owing to Peoples. ii) Trial decision:
(1) The Quebec Superior Court found the Wise brothers liable for a breach of the duty of care.
The court held that a duty of care was owed to creditors when the corporation was approaching insolvency. The breach of the duty involved not only the adoption of the accounting system but the failure to monitor the debt afterwards. iii) C.A. decision:
(1)
The Quebec Court of Appeal reversed the trial court’s decision. It said that the duty of care does not shift from the shareholders to the creditors when the corporation is approaching insolvency.
(2) It held that the Wise brothers had met the duty of care in the circumstances. The Court of
Appeal was critical of the approach of the trial court which had used the oppression remedy standard of “unfair prejudice” or “unfair disregard” in assessing whether the directors had breach their duty of care under CBCA s. 122(1)(b).
(3) The Court of Appeal noted that Mr. Clément (the senior officer who gave the advice) had a
Bachelor of Commerce degree and had worked for Wise Stores for 15 years. The Court of
Appeal considered the accounting change to have been a reasonable change in the circumstances and that the Wise brothers had acted reasonably in following the advice.
(4) The Court of Appeal also noted that the new accounting system had been presented to the audit committee three months after it was instituted and that the audit committee had raised
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no objection to the new accounting system. Although suppliers had been critical of the system they continued to supply Wise Stores on credit. The Court of Appeal noted the effect that the entrance in the market of Wal-Mart had on retail prices at department stores.
(5) Taking these factors into account in light of the subjective-objective standard adopted in
Soper , which the Quebec Court of Appeal approved of, the appeal court held that the trial decision had failed to take account of the problems facing Peoples and Wise Stores, that it was a logical change, that it proposed by a person of demonstrated competence, and that the suppliers who were affected by it had accepted it. iv) S.C.C. decision:
(1) On appeal, the SCC addressed the question of whether a duty was owed to creditors when the corporation is approaching insolvency. The court noted that the duty of loyalty in s.122(1)(a) required directors and officers to “act honestly and in good faith with a view to the best interests of the corporation
”. Thus the duty of loyalty is not owed to any particular stakeholder such as the shareholders or the creditors , but rather to the corporation and that this duty does not change when the corporation “is in the nebulous
‘vicinity of insolvency’”.
(2) The court then noted, however, that the duty of care in s.122(1)(b) is different in that it provides that “every director and officer of a corporation in exercising their powers and discharging their duties shall … exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.” It thus does not provide that the directors owe this duty specifically to the corporation. “Thus,” the court noted, “the identity of the beneficiary of the duty of care is much more open-ended, and it appears obvious that it must include creditors
.” Thus if there is a breach of the standard of care creditors can succeed in an action against the directors where they also show damages and causation.
(a)
The court also discussed the scope of the statutory standard. It noted the words “in comparable circumstances” which, according to the court, “modifies the statutory standard by requiring the context in which a given decision was made to be taken into account.” The court rejected the
Federal Court of Appeal’s
characterization of the standard in Soper as an “ objective subjective” standard
.
(b) The Supreme Court of Canada preferred to describe the standard as an objective standard saying (at 588-89) that, “To say that the standard is objective makes it clear that the factual aspects of the circumstances surrounding the actions of the director or officer are important in the case of the s.122(1)(b) duty of care, as opposed to the subjective motivation of the director or officer, which is the central focus of the statutory fiduciary duty of s. 122(1)(a) of the CBCA.”
(c)
The court noted that, “Directors and officers will not be held in breach of the duty of care under s.122(1)(b) of the CBCA if they act prudently and on a reasonably informed basis. The decisions they make must be reasonable business decisions in light of all the circumstances about which the directors of officers knew or ought to have known.”
(d) On the facts the Supreme Court of Canada agreed with the Quebec Court of Appeal that “the implementation of the new policy was a reasonable business decision that was made with a view to rectifying a serious and urgent business problem in circumstances in which no solution may have been possible.”
6) Summary : a) The common law standard for the duty of care (measured by the care an ordinary person might be expected to take in the circumstances on their own behalf) is quite similar to the statutory standard in CBCA s.122(1)(b). However, the common law standard in light of cases such as Re Cardiff
Savings Bank , Re Brazilian Rubber Plantations , and Re City Fire and Equitable Insurance appears to have been quite a low standard (to the point that the defendant’s in the Dixon v. Dixon, Morgan,
211
McEwen case had the temerity to argue there was no duty at all). When the duty of care was codified in statutes such as the CBCA the question raised was whether the standard had been raised either in light of the codification or in light of changing times and circumstances.
b) Cases such as Smith v. Van Gorkum in the U.S. and tax cases in Canada such as Fraser , and, more recently, Soper , applying the identically worded standard of care in the Income Tax Act , suggested that the standard had increased. Although the trial decision in Wise was reversed on appeal it indicated, perhaps, a greater willingness of a judge to find a breach of the duty then might have been the case at the time of Re City Fire and Equitable . UPM-Kymmene also suggests an increase in the standard of care over the common law standard. c) However, the Fraser , Soper , Van Gorkom and UPM-Kymmene cases are exceptional. i) Fraser is exceptional in terms of an extension to the corporate law (as opposed to tax law) context because the collection of tax may impose substantially greater needs for judicial intervention where the market mechanism would not otherwise provide a backup. ii) Van Gorkom appears exceptional because it is generally regarded to have overstepped the bounds in requiring too much of directors, so much so that it led to legislation in the U.S. allowing corporations to put limits on director liability for a breach of the duty of care. iii) The UPM-Kymmene case, when contrasted with Re Brazilian Rubber Plantations does suggest a higher standard of care. Both cases involved contracts that were arguably highly unfavourable to the corporation and its shareholders. In UPMKymmene the court found the directors had breached their duty of care while in Re Brazilian Rubber Plantations the court did not find the directors had breached their duty of care. The UPM-Kymmene case still appears to have involved a fairly egregious case of self-dealing supported largely by directors who were recruited by the person who would benefit from the contract with the corporation. It might be said to fit into with the suggestion made by Professor Clark that U.S. cases in which directors have been found liable for a breach of duty of care come very close to fraud.
7) Indemnification and Insurance : a) CBCA s.124 permits the indemnification of directors and officers and permits insurance to be taken out for the protection of directors and officers. Generally indemnification and insurance are not allowed where the director did not act in good faith or where the director did not have reasonable grounds for believing that her/his conduct was lawful. Thus, subject to these qualifications, there is some means for controlling a director’s exposure to liability. b) If the scope of the duty of care is increased the result will probably not be a significant increase in damages paid by directors and officers. In order to attract persons to such positions corporations will probably have to provide insurance to protect directors and officers and an increase in the scope of the duty of care will probably thus just lead to increased directors’ and officers’ insurance costs for corporations. This may serve to provide a degree of protection to shareholders and creditors. c) While perhaps a laudable outcome, it will come at the cost of increased prices for the goods and services of corporations and thus the cost will at least in part be borne by consumers and in part by the very shareholders it is intended to protect. To the extent that increased prices reduce demand for goods and services it may also lead to reduce outputs and thus possibly reduced employment .
In other words, it is possible that the incidence of the cost of an increased scope of the duty of care will be borne partly by employees, partly by consumers and partly by shareholders. d) Perhaps market responses to a lack of care by directors and officers are simpler and cheaper than litigation, consequent indemnification and increased insurance in many situations. Successful actions for a breach of the duty of care should perhaps be left to the more egregious cases bordering on self-dealing or involving a failure to withhold and remit employee income taxes.
8) Steps in advising directors and officers on their duty of care:
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a) At a practical level what does one advise a client who is a director of a corporation in terms of their duty of care. An American text by Robert Clark entitled Corporate Law made the following recommendations (based on Francis v. United Jersey Bank ): i) Get a rudimentary understanding of the business ii) Keep informed about the corporation’s activities iii) Engage in a general monitoring of corporate affairs and activities iv) Attend board meetings regularly v) Review financial statements regularly, and vi) Make inquiries into doubtful matters, raise objections to apparently illegal actions, consult counsel and/or resign if corrections are not made. b)
These suggestions seem consistent with the Supreme Court or Canada’s pronouncement on the statutory standard of care in People’s Department Stores Inc. v. Wise (2002), 244 D.L.R. (4 th
) 564
(S.C.C.) that, “Directors and officers will not be held in breach of the duty of care under s.122(1)(b) of the CBCA if they act prudently and on a reasonably informed basis. The decisions they make must be reasonable business decisions in light of all the circumstances about which the directors of officers knew or ought to have known.”
Corporate governance: shareholders
Sharehldr pwrs: elect dirs/chnge bylaws,art/amalg/sell assets/continuance/disolve/dedlck, not mgmt
1) The CBCA creates a division of powers in which the shareholders are given a series of specific powers , the directors are given a series of specific powers (e.g. powers to appoint officers, borrowing powers, the power to initiate by-law changes), and the directors are also given what is, in effect, a residual power, namely, the power to manage or supervise the management of the corporation. a) Some aspects of this division of powers are mandatory (i.e. it cannot be changed): i) E.g. the power of shareholders to elect directors , approve changes in the articles , and to approve the fundamental changes referred to above cannot be taken away from the shareholders (see below) ii) The class voting rights of shareholders are also mandatory (see below) b) Some aspects are default : i) Firstly, specific powers allocated to directors can often be reallocated to shareholders by either the articles , the by-laws or a unanimous shareholder agreement (e.g. the by-law powers
(s.103), the power to appoint officers (s.121), and the borrowing power (s.189(1)). ii) The management of directors can also be reallocated but only by a USA (unanimous shareholder agreement) (see s.103).
2) Shareholder powers are specifically set out in the CBCA: a) Note only get to vote on these rights if have general voting rights , and all those with such rights
(even if split amongst several classes) vote as one collective (but see “class voting rights”
below – might have right to vote as a class even if don’t have general voting rights) b) As mentioned in division of powers above, management and certain specific powers of directors if reallocated to shareholders by articles, bylaws, or USA c) The power to elect directors i) See “First and subsequent election of directors by shareholders” in “Role/qualifications/etc of directors” above ii) The shareholders have the power to elect directors at annual shareholder meetings (and this is one of the most important rights of shareholders allowing them a means to exert some control over who manages the corporation or at least can allow for management to be changed through a takeover bid) ( see “Removing offs” above) d) The power to approve the amendment of by-laws
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i)
As noted in “Powers of dirs” above, the default rule is that directors have the right to initiate by-law changes in CBCA corporations, and that these changes must be ratified by the shareholders at the next annual meeting of shareholders. Since this is a default arrangement, it can be altered in the articles, by-laws or an unanimous shareholder agreement (s.103). ii) Even where the power to initiate changes in the by-laws is left in the hands of the directors, the shareholders can make proposals for changes in the by-laws (s.103(5)). e) The power to approve fundamental changes : i) The CBCA (and other corporate statutes in Canada) provide shareholders with some control over significant changes to the business of the corporation or the capital structure of the corporation. While this kind of control could be provided through the share rights given to shareholders by the promoters of the corporation, our statutes make these rights mandatory
(i.e. shareholders have these rights regardless of what the articles or memorandum of articles say ) ii) The control is provided by way of a voting right. Some protection is given to minority interests with respect to major changes by requiring supermajority voting – that is, something more than a mere 50% of the votes cast.
(1) In the CBCA the supermajority voting requirement is two-thirds of the votes cast (see
CBCA s.2(1) definition of “special resolution”). iii) Under the CBCA, a special resolution ( of those shareholders holding shares that carry the right to vote generally on matters that come before the shareholders’ meeting) are required for various significant (or “fundamental”) changes:
(1) CBCA s.173: to make changes in the articles of incorporation, such as
(a) S.173(1)(a): Change the corporate name
(b) S.173(1)(b): Change the registered office
(c) S.173(1)(c): Change in a restriction on the business of the corporation
(d) S.173(1)(d): Change maximum number of shares that can be allocated
(e) S.173(1)(e): Create a new class of shares
(f) S.173(1)(g): Change the rights and restrictions of any issued or unissued shares
(g) S.173(1)(m): Increase or decrease the number , or the minimum or maximum number, of directors
(h) S.173(n): Change restrictions on share transfer
(2) In many of these cases, will also need each affected class to pass a special resolution according to their “ class voting rights
” (see below)
(3) S.183: approve an amalgamation of the corporation with another corporation
(a) E.g. company A and company B merge to form a new company C, shareholders of A and B get shares in C in exchange for their shares in A and B, A and B then wind up
(b) Need shareholder approval since shareholders with C shares not in same position as they were before with A or B shares
(4) S.189(3): the sale or lease of all or substantially all of the corporation’s assets
(5) S.188: a continuance of the corporation under the laws of another jurisdiction (i.e. a different corporate statute)
(6) S.211: a liquidation and dissolution of the corporation f) See distinction of ordinary v special business and need for ordinary v special resolutions below
3) Directors have the power to manage the corporation (CBCA s.102) and normally do so by delegating the day-to-day management to officers whom they appoint (s.121) (see “Powers of dirs” above). Thus the shareholders do not manage the company. Shareholders do not have a power to dictate to the directors how to manage the company or what to do in particular situations. Thus it is wrong to think of shareholders as in effect principals and directors agents, allowing shareholders to tell directors what to do. a) E.g. Automatic Self-Cleansing Filter Syndicate Co. Ltd. v. Cunninghame [1906] 2 Ch. 34 (C.A.)
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i) Facts:
(1) The company had been incorporated in 1896 with objects in its memorandum that included sale of the undertaking of the company.
(2) The articles had a standard clause for memorandum of association companies that the directors had the power to manage including the power to do all such things the company could do that were not by the statute or the articles required to be done by the shareholders’ meeting (subject to “such regulations, not being inconsistent with these presents, as may from time to time be made by extraordinary resolution ...”).
(a) The articles/memorandum of association could have been amended by a three-quarters vote of the shareholders to shift management power away from directors, but this was not done
(3) The directors were also expressly given the power to “sell
, lease, abandon, or otherwise deal with, any property , rights, or privileges to which the company may be entitled, on such terms and conditions as they may think fit” and to “enter into all such negotiations and contracts and rescind and vary all such contracts, and execute and do all such acts, deeds, and things in the name or on behalf of the company as they might consider expedient for or in relation to any of the matters aforesaid.”
(4) One of the shareholders , McDiarmid, wanted the assets of the company to be sold . He arranged a contract for the sale of the assets of the company. He then requisitioned a meeting of the shareholders to approve the sale and the shareholders so resolved by a vote of 1502 to 1198 (approx. 55%).
(5) The directors did not think the contract was in the best interests of the company and did not execute the contract. McDiarmid applied to the court for an order compelling the directors to carry out the contract. ii) Decision:
(1) The directors were not obliged to sell assets, since sale of assets of the company was the prerogative of the directors subject , in the case of the articles of this particular company, only to an extraordinary resolution of the shareholders (effectively to amend the articles to allow the shareholders make the decision).
(2) The court noted that the directors are not agents of the shareholders – they are agents of the company
. According to the court, “It is not fair to say that a majority at a meeting is for the purposes of this case the principal so as to alter the mandate of the agent.” b) The directors are thus agents of the company (the principal), and a change in the grant of authority by the company must be done according to the incorporating statute and the articles . c) Shareholders do not have an overriding or residual power over the directors. – shareholders do not generally have the power to dictate management to the directors d) Policy for limit on shareholder management power : i) Efficiency : having control for day-today decisions in the hands of shareholders would make day-to-day management decisions quite cumbersome and expensive (e.g. may be many shareholders) ii) Still, could allow shareholders to override specific director management decisions. But this would make it difficult for the board and management to maintain a cohesive plan for the company if it were constantly subject to being overridden by decisions of the shareholders. iii) This allocation of powers may also provide a degree of minority shareholder protection by preventing groups of shareholders from pursuing private interests.
(1) E.g. in Cunninghame it might have been the case that McDiarmid may have derived some private gain from the transaction. Perhaps that was why the directors opposed the transaction. iv) Not giving shareholders residual control may also avoid side payments from management to shareholders to discourage shareholders from pursuing a particular action.
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4) There may be cases where the shareholders have the power to act in case of a deadlock on the board of directors such that nothing can be done by the board. In these cases the continued viability of the company may require action by the shareholders. a) E.g. Barron v. Potter [1914] 1 Ch. 895 i) Facts:
(1)
There were only two directors, Barron and Potter (also the company’s managing director).
Two directors were required for a quorum. At a validly called directors’ meeting the chair of the meeting, Potter, had two votes in case of a tie.
(2) There was a standstill because of falling out between Barron and Potter. Barron sought an extraordinary meeting of shareholders to appoint new directors, while Potter sought to have directors exercise their power to appoint directors in interim period. ii) Decision:
(1)
Attempts that had been made to call a directors’ meeting held to be invalid (for lack of a quorum) and it was held that shareholders could appoint new directors at extraordinary meeting since “for practical purposes there was no board at all” and thus a shareholder election of directors was required to avoid the ongoing deadlock . iii) Comment:
(1) This was, however, a case involving the appointment of directors which is a power shareholders normally have . It is not clear whether a residual power would exist to allow shareholders to exercise a management power .
Shrhldr voting: generl right to vote, class voting rights for prejudicial changes, does voting matter?
1) See also “Shareholder voting” in Corporate financing above
2) Shareholders exercise their powers through voting at meetings of shareholders. Shareholders who have the general right to vote can vote collectively in such meetings. a) See “Shareholder powers” above for what kinds of things can vote on b) See ordinary v special business below for what needs ordinary v special resolution
3) Class voting rights : a) Whether or not shares have general voting rights (s.176(5)), they may have a right to vote as a class in certain special situations, generally when the rights of that class would be prejudicially affected by a change in their rights, or creation of rights for other classes that negatively affects them. b) In such cases, the class must approve the change that alters or prejudices their rights, and so the proposed resolution must be approved by a separate resolution of that class alone (i.e. not counting the votes of other classes). c) Although promoters might give shareholders a class voting right voluntarily, the CBCA (and other corporate statutes in Canada) make the class voting right mandatory in most cases (so, in those cases, the right cannot be overridden by any document such as the articles, bylaws or even a unanimous shareholder agreement) d) Note this is in addition to any resolutions that must be passed under general shareholder powers above for shareholders with general voting rights. i) E.g. if about to add a new class of shares, will need all shareholders with general voting rights to collectively pass a special resolution under s.173(1)(e), and then each class with rights under s.176(1)(e) below will need to pass a special resolution individually e) S.176(1): a class vote is required (and note a special resolution might also be required by all shareholders under s.173(1) above): i) S.176(1)(a): To increase or decrease any authorized limit on a class of shares ii) S.176(1)(b): Where there is an exchange, reclassification or cancellation of shares iii) S.176(1)(c): To add, change or remove rights, privileges or restrictions on a class of shares
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iv) S.176(1)(d): To increase rights or privileges of any class of shares having rights equal or superior to the shares of such class v) S.176(1)(e): To create a new class of shares equal or superior to a particular class vi) S.176(1)(f): To make an inferior class of shares equal or superior to a particular class f) S.176(5): the shares of a class having a right to vote as a class carry the right to vote whether or not the class otherwise has voting rights g) S.176(6): provides that a separate resolution of the class is required, and the resolution must be a
“ special resolution ” of the class (by s.2(1) this means two-thirds of the votes cast by shareholders who voted in respect of the resolution, providing some protection to minority interests of the class). h) S.176(4) series vote : if a series of shares is affected by a resolution in some manner different from other series of the class then the series of the class will also have the right to vote separately as a series. i) Class voting rights often arise in other fundamental changes as well, such as: i) On an amalgamation (s.183(4)) ii) A sale, lease or exchange of all or substantially all of the assets of the corporation(s.189(7)) iii) A liquidation and dissolution (s.211(3)) iv) A class vote might also arise on a continuance to the extent any change were to occur in the relative rights of the classes of shares on the continuance.
4) Does shareholder voting matter ? a) Some theories/observations suggest shareholder voting does not matter very much (at least in widely-held corporations – see “Closely held corps” below): i) In widely-held corporations voting can be nearly meaningless due to the problem of so called
“ rational shareholder apathy
”, which has two causes (recall “Protecting lim “owners” from gen
“managers”” in Limited Partnership above):
(1) Since such shareholders have small stakes which makes it not worthwhile to monitor management.
(2) Shareholders may also be tempted to free-ride on the monitoring efforts of other shareholders. ii) These two problems can lead to almost no monitoring and no informed and carefully considered exercise of voting rights. The effect is that management can often manage with little or no constraint from shareholders. iii) This has led to calls for increased “ shareholder democracy
” to make it easier for shareholders to become informed and to exercise their voting rights. However, others have said that shareholders who do not like what management does have a much easier way to deal with the problem than exercising their voting rights – they can simply sell their shares . b) On the other hand, other theories/observations suggest shareholder voting does matter : i) Many corporations have substantial control blocks where the control block holder will have a greater stake and thus a greater interest in monitoring management . There is evidence that these control blocks do monitor management.
(1) The blocks sell at a premium to other shares, and where large block trades occur they are often followed by changes in senior management of the corporation. This may be especially important in Canada where by far the majority of corporations (80%) have a control block shareholder (usually families). ii) The market can also promote more meaningful shareholder voting
(1) If shares are in the hands of the public, they can be taken up in a takeover bid allowing the bidder to acquire sufficient shares to take over control of the corporation.
(2) But why would a promoter of a corporation allow shares get into the hands of the public with risk of losing control (e.g. could have sold non-voting shares and retained the voting shares in their own hands)?
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(3) A general distribution of voting shares is quite common , however, perhaps because it is a form of management bonding (i.e. of promising to act in the interests of shareholders) – by distributing voting shares to the public they expose themselves to the risk of a takeover , giving them an incentive to manage effectively and thus raising the value of shares (since investors will be willing to pay more for shares in well managed corporations) and thus facilitating raising of the required capital to carry on the business (making it attractive to the promoters) iii) The value of shareholder voting is also supported by ‘ transactions cost theories ’:
(1) For the most part one cannot benefit from such expenditures for other transactions such as investing in some different corporation’s securities. When transactions costs arise that can’t be redeemed from other transactions, one of the parties to the transaction may have an upper hand. That party can threaten to quit the transaction , which would expose the other party to the waste of the initial transaction costs , and such a threat can be used to gouge out any gains the other party might make.
(2) E.g. In the purchase of shares the investor may incur costs assessing the value of the shares. The investor may spend $1000 determining shares are worth $20 per share when the shares are being sold at $18 per share. Provided the investor buys more than 500 shares, the $2 difference will be more than enough to compensate for the initial transaction costs. However, management may subsequently take this gain away through a lack of diligence , shirking, or consumption of corporate resources . A voting right is a mechanism, albeit a weak one, for protecting against such post-transaction opportunism . For the shareholder, whose contract with the corporation does not regularly come up for renewal, this may the best means available.
Sharehldr meets: annual/special, ord/spcl biz, quorm, notce, steps, chair (good faith/impartial)
1) In order for shareholders to properly exercise their general and class voting rights, they must be given the opportunity to gather in person (or through their representatives) in one place at one time to discuss issues and to exercise their voting rights (as an aspect of ‘shareholder democracy’). Corporate statutes in Canada typically set out a mixture of mandatory and enabling provisions concerning the calling of shareholder meetings .
2) Annual meetings : CBCA s.133(1) requires shareholder meetings to be held within 18 months of incorporation and annually thereafter (which, under s.133(1) means within 15 months from last annual meeting and not more than six months after the end of the corporation’s preceding financial year). a) These are referred to as ordinary meetings in the UK b) S.142: shareholders can unanimously consent to resolutions in lieu of shareholder meeting
(especially useful in “Closely held corps” where AGM done by circulating a resolution which all shareholders sign – see below)
3) Meetings called at any other time are referred to as special meetings (s.133(b)). a) In memorandum of association jurisdictions (e.g. UK) these other meetings are referred to as extraordinary meetings.
4) The election of directors (s.106(3)), the consideration of the financial statements , and the appointment of auditors (s.162(1)) are called ordinary business which requires an ordinary resolution (defined in s.2(1) as majority of votes cast)
5) All other business dealt with at meetings of shareholders is called special business (s.135(5)) which requires special resolution (defined in s.2(1) as two-thirds majority of votes cast)
6) Meetings for a CBCA corporation are to be held in Canada (s.132) at the place designated by the directors unless a place is designated in the by-laws (s.132). a) Meetings can be held at a place outside of Canada if the articles so specify or if all the shareholders agree (s.132(2)).
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7) S.139(1) provides that unless the by-laws provide otherwise, a quorum for a shareholders’ meeting is a majority of the shares entitled to vote at the meeting either present or represented by proxy. a) Closely-held corporations might have strict quorum requirements to ensure all shareholders should be involved. However, this can result in shareholders being able to stop meetings by not showing up. See “Court Ordered” meetings below. b) A quorum need not continue to be present throughout the meeting (s.139(2)). c) If there is no quorum at beginning of the meeting then the shareholders can adjourn the meeting but cannot transact other business (s.139(3)). d) Bylaws may provide for smaller quorums, especially in publicly held companies due to rational apathy (see “Does voting matter” above)
8) S.135(1): a notice period of at least 21 days but not more than 60 days in advance of the meeting is required. a) A record date may also be set not more than 60 days ahead of the meeting (s.134). b) Notice of special business must state the nature of the business in sufficient detail to allow a shareholder to make a reasoned judgment on whether to vote for or against the resolution
(s.135(6)). c) Shareholder can waive notice and attendance generally considered waiver unless there to object to validity of meeting (s.136, especially useful for “Closely held corps” – see below) d) With depository institutions and other nominee ownership of securities (i.e. only one shareholder on company’s record that holds shares for numerous beneficial owners – see agent/broker/depository in “share transfers” in Corporate Financing above) the notice requirements in our statutes have become inadequate for the meeting materials to be distributed to the beneficial owners, and for instructions to be received from those owners in time for shareholder meetings. i) Consequently the Canadian Securities Administrators have passed National Policy 41 which requires a record date to be set 35 to 60 days ahead of the meeting (a record date is important since shares change hands so need to specify the time at which to determine and lock in who are the shareholders with rights to a particular notice, vote, dividends, etc) ii) 25 days ahead of this the corporation is to request the names of the beneficial owners of shares which will normally be other nominee owners who can then give their list of beneficial owners. iii) 33 days before the meeting the corporation must send to the nominee owners the number of sets of materials necessary for distribution. iv) The nominee owners must send the meeting materials to shareholders at least 25 days before the meeting.
9) Conduct of meetings a) There are books setting out sample agendas, and see also Roberts Rules or other procedure books b) Annual meetings of even publicly-held companies are often a rather drab affair. The following steps are the usual steps at an annual shareholders’ meeting
: i) The designated person takes the chair. ii) The chair receives the report of the scrutineers on proof of notice of the meeting and on the presence of a quorum . iii) A motion is typically requested to dispense with the reading of the minutes of the last annual meeting . A motion for approval of the minutes of the last annual meeting is then requested. iv) The annual report is then typically presented with the president’s remarks and the auditor’s report is read out. There is then typically a shareholder vote on a motion for the approval of the financial statements . v) The next step is typically the election of directors .
(1) Usually a slate is proposed by management ahead of time and there are usually no additional nominations (in which case a motion for approval of the slate is then voted on).
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(2) Where there are additional nominations (which can be made ahead of time) the usual procedure is to distribute ballots where the shareholders or proxyholders can mark in the nominees in favour of whom they wish to vote their shares and noting the number of shares they are voting in favour of the listed directors. vi) There is typically next a motion for the appointment of auditors (who are normally the previous year’s auditors) and the meeting may then approve a motion concerning the remuneration of the auditors. c) S.141(1) provides for voting done by a show of hands (which just counts number of people voting each way, regardless of how many shares each holds) unless a poll is demanded (which counts by shares). A poll can be demanded before or after a vote by a show of hands (s.141(2)). d) S.20(1)(b) requires that minutes of shareholder meetings re to be kept (signed by the chair of the meeting). e) Chair of the meeting : i) The by-laws of CBCA corporations usually provide that the chair of the board of directors or the president of the corporation is to act as the chair of the shareholders’ meeting. ii) Case law has considered the duties of the chair : iii) Wall v. London and Northern Assets Corporation , [1898] 2 Ch. 469 (C.A.)
(1) Facts:
(a) There was resolution before the meeting to sell the assets of the company.
(b) Dissenting views were expressed which were eventually brought to an end by a favourable vote on a motion to close debate. At a subsequent meeting to confirm the resolution, a resolution to adjourn was proposed which could have stopped the matter, but discussion on it was terminated by a resolution to close debate . Resolution to sell assets was eventually approved.
(c) The vote on the resolution was challenged by a dissenting shareholder on the basis that the chair had not allowed adequate time for debate on the motion.
(2) Decision:
(a) The court held that the chair of the meeting must act in good faith and in an impartial manner and must allow shareholders to speak to matters before the meeting.
(b) However, meetings are costly and the business of the meeting needs to be completed without undue delay and expense such as might occur where discussion leads to adjournments to subsequent meetings. Thus the chair need only allow a reasonable time for reasonable arguments and can put down a minority bent on obstructing the business of the meeting.
(c) In this case, the Chair had allowed reasonable debate iv) Re Marshall (1981) 129 D.L.R. (3d) 378
(1) Facts:
(a) William C. Marshall was a director and shareholder in Marshall Boston Iron Mines
Ltd.
(b) Royal Trust held 405,001 shares in escrow, registered as follows:
(i) 202,501 to Raymond J. Marshall
(ii) 202,500 to Charles C. Marshall, Jr.
(c) Raymond and Charles were the legal owners of some of these shares, holding them for beneficial owners . The beneficial ownership of the shares was divided among six directors of the company and five other persons.
(d) At an annual meeting held on Oct. 8, 1981, William Marshall and two other beneficial owners instructed Raymond, Charles and Royal Trust to vote the shares they had a beneficial interest in in favour of the William Marshall nominated slate of directors
(and not in favour of the existing board of directors). Charles voted his shares he held for the beneficial owners as instructed, but Raymond voted his shares in favour of
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existing board, contrary to the voting instructions he was given (he failed to execute a proxy for 36,750 shares registered in his name but owned beneficially by William and the two other shareholders who had given the instructions)
(e) The Chair of the meeting was the president of the company and a member of the existing board of directors. He was in favour of the existing board and was aware of instructions of the beneficial owners of the shares.
(f) William requested an order for a direction to the Chair to tabulate votes according to instructions of beneficial owners. If the shares were so tabulated the William Marshall nominated slate would have been elected instead of the existing board.
(2) Issue: was the chair required to go behind the legal title per the shareholder register and assess the dispute between the beneficial and legal owner ?
(3) Decision:
(a) The person who is the legal owner votes .
(b) The court noted that that the chair would not have either the legal training or the time to consider such disputes . The time to settle disputes would disrupt the meeting. There would be uncertainty at the outset as to who could vote at the meeting – chaos would result otherwise. v) Re United Canso Oil and Gas Ltd. (1980), 41 N.S.R. (2d) 282
(1) Facts:
(a) A maximum 1,000 votes per shareholder by-law was struck down, but the company had already reincorporated in Nova Scotia where the court there declined to decide on the validity of the 1,000 votes per shareholder restriction.
(b) However, a dissident group of shareholders got together enough of the shareholders to oust the Buckley management even with the 1,000 share voting restriction. At the meeting the election of directors resulted in the ousting of the Buckley team on the votes, but John Buckley (the president and the chair ):
(i) Refused proxies of corporate shareholders that had been executed with facsimile signatures
(ii) Refused to accept proxies of corporate shareholders without proof the boards had approved of the proxies
(iii)Refused to accept proxies executed by stockbrokers without evidence of client’s authorizations
(iv) Refused to accept the tabulation of votes of professional tabulators
(v) Ruled that a quorum was not present and adjourned the meeting.
(2) Decision:
(a) The court held that the facsimile signatures were alright , and that client and board authorizations were not necessary unless there was some evidence that brought their validity into question.
(b) The chair could not just adjourn the meeting on his own.
(c) The chair had not acted in an impartial manner.
(3) Comment:
(a) This is an example of an egregious case of the Chair not exercising their fiduciary duties to the company . vi) Blair v. Consolidated Enfield Corp. (1993), 15 O.R. (3d) 783
(1) Facts:
(a) Blair was the president and chair of Consolidated Enfield Corp.
(b)
At the shareholders’ meeting there was a question as to whether proxies should be voted for or against the management slate of directors. Blair questioned whether he could make the ruling since his election was at stake (i.e. conflict). The company’s
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solicitors said he could and should rule that proxies should be voted in favour of the management slate.
(c) Canadian Express brought an action against both the company and Blair for a declaration that its ballot was properly cast for the replacement board.
(d) The court held in favour of Canadian Express and awarded costs of $165,000 against
Consolidated Enfield and Blair. However, since Canadian Express now controlled
Consolidated Enfield it only sought costs against Blair . Blair then sought indemnification from Consolidated Enfield.
(2) Issue: the question was whether Blair had acted honestly and in good faith as is required for an order of indemnification for the Chair
(3) Decision:
(a) It was held that legal advice does not automatically sanctify the director . Nonetheless it is to be considered .
(b)
As to the question of the chair’s interest in the result, the court noted that the chair in a corporate meeting often has an interest as a director or shareholder and therefore that interest does not automatically make the decision not bona fide . The court noted that some decision had to be made – there was no obvious error. There was no suggestion that Osler’s advice was other than professional (although they too had an interest in the matter). vii) Policy questions:
(1) Should corporate meetings have independent chairs?
(courts have ordered them in other contexts – see Re Canadian Javelin Ltd below ). Should corporations be required to hire professional chairs for meetings, perhaps with legal knowledge to address disputes such as arose in Marshall ?
(2) If this were required would the additional cost be prohibitive for smaller corporations? Is the cost justified in most annual corporate meetings where there are often no contentious issues? Perhaps the court could order an independent chair in specific circumstances.
(3) What happens in Blair if Blair reasonably relied on the legal advice but it was other than strictly professional?
Shrhldr requisition meets (5%), court ordered (impractical/deadlock/illegal acts/widely held battle)
1) Shareholder requisitioned meetings : a) Normally it is the Board of directors who call shareholder meetings . However, corporate statutes commonly provide for shareholder requisitioned meetings. b) CBCA s.
143 : i) The holders of not less than 5% of the shares carrying a right to vote at the meeting sought to be held may requisition the directors to call a meeting of shareholders for the purposes stated in the requisition. ii) The shareholders must:
(1) Prepare a document setting out the purpose of the meeting
(2) Sign the document; and
(3) Send the document (or documents) to each director and to the registered office of the corporation. iii) The directors must then call the meeting unless :
(1) They have already set a record date for notice of a meeting
(2) They have given notice for a meeting or
(3) The purpose of the meeting is one for which the directors could refuse a shareholder proposal under s.137(5)(b) to (e). iv) If the directors do not call the meeting within 21 days of receiving the requisition then any shareholder who signed the requisition may call the meeting. The cost to the shareholders of
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requisitioning the meeting (e.g. they send out notice themselves) are to be incurred by the corporation unless the shareholder meeting resolves otherwise.
2) Shareholder meetings by court order : a) CBCA s.144: the court can order a meeting of shareholders of the corporation “ if for any reason it is impracticable to call a meeting of shareholders ...: i) In the manner in which meetings of those shareholders may be called, or ii) To conduct a meeting in the manner prescribed by the by-laws and the Act, or iii) For any other reason the court thinks fit ”. b) Under the CBCA the application may be made by a director, shareholder or the Director under the
Act. c) The court may order a meeting to be called and to be held and conducted in such manner as the court directs, including varying the quorum for the meeting. d) As the following cases show, court ordered meetings are not entirely consistent. e) In the UK , courts have been more willing to intervene in cases of deadlock : i) Re El Sombrero [1958] Ch. 900 (Eng. Ch. Div.)
(1) Facts:
(a) Two shareholders, who were also directors, held 50 shares each. A third person held
900 shares of the total of 1,000 shares outstanding.
(b) A quorum for a shareholders’ meeting was two shareholders . No shareholder meeting was called for one and a half years because the two incumbent directors (the holders of
50 shares each) refused to go to the meeting (since they didn’t want to be removed as directors). The third shareholder applied for a court ordered meeting and asked for a change of the quorum requirement.
(2) Decision:
(a) The court noted that impracticable is not the same thing as impossible – what one needs to ask is whether in all the circumstances it is practical to hold the meeting .
(b) The directors were preventing the holder of 900 shares from exercising his statutory right to remove the directors. The directors were also in breach of their statutory duty to call a meeting.
(c) The court thus ordered the meeting, varying the quorum requirement for the meeting.
(3) Comment:
(a) In this case the court resolved the deadlock in favour of the person who had the substantial majority of the shares.
(b) A probable result of this in a closely-held corporation such as this (just three shareholders) would be the lock-in of the investment of the two director/shareholders with no say in the management . Funds could well be removed from the company in the form of directors’ fees and management salaries with the two 50 share shareholders receiving nothing once they have been removed from the board of directors. The quorum requirement may well have been intended to prevent the two directors and holders of just 50 shares from being removed from involvement in the management.
(c) Contrast with Bushel v. Faith ii) Re Opera Photographic Ltd. [1989] 1 W.L.R. 634 (Ch.D.)
(1) Facts:
(a) There were two shareholders. One held 49% of the shares and the other held 51%.
There was a falling out between the shareholders.
(b) The shareholder holding 51% requisitioned a meeting of shareholders but the quorum requirement for the meeting was two shareholders (a protection device for the minority shareholder) so the meeting could not be held because the 49% shareholder refused to attend.
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(c) The 51% shareholder thus sought a court ordered meeting asking the court to vary the quorum requirement for the purposes of the meeting. The 49% shareholder argued on the basis of the English case of Westbourne Galleries that the corporation here was a form of quasi-partnership under which equitable principles would require that the 51% shareholder should not be in a position to oust the other shareholder from management and so defeat the expectations of the minority shareholders. He argued that the
Westbourne Galleries case overrode the Re El Sombrero case.
(2) Decision:
(a) The court held that one can’t prevent
the 51% shareholder from exercising his right to remove a person as a director .
(b) The remedy for the 49% shareholder , the court held, is to use the right to sell out
(provided for in the articles) or to bring an action for oppression or winding-up .
(3) Comment:
(a) Are the sell out, oppression remedy and winding-up remedies adequate remedies?
Except for the sell out they happen after the fact and can involve substantial legal fees .
(b) How do these cases fit with Bushel v. Faith where the special voting right on removal of a director was upheld and that provision was probably designed to do much the same thing as the quorum requirements in Re El Sombrero and Re Opera Photographic . f) Canadian courts have tended to avoid intervening in battles for control in closely-held corps : i) Re Morris Funeral Service Ltd. (1957) 7 D.L.R. (2d) 642 (Ont. C.A.)
(1) Facts:
(a) The company shareholding (total 278 shares) was as follows:
(i) Morris Estate 147 shares (over half)
(ii) Widow Morris 98
(iii)Donald (the son) 30
(iv) Arthur 1
(v) Kelly 1
(vi) McPhee 1
(b) The executors of the estate were Morris (the mother and widow), Kelly and McPhee.
(c) The individual shareholders were the directors (Widow, Don, Arthur, Kelly and
McPhee). Kelly was the managing director.
(d) Don and his mother wished to remove Kelly as managing director and substitute Don.
The other three (Arthur, Kelly and McPhee) were opposed .
(e)
Because of the deadlock the estate could not be represented at the shareholders’ meeting. Consequently no shareholders’ meeting could be held because the quorum requirement for the meeting was 60% of the shares and so could not be met . Don and
Ma applied for a court ordered meeting asking for the quorum requirement to be reduced to two shareholders with 120 shares.
(2) Lower court ordered the meeting on the terms requested but this was reversed on appeal.
(3) Appeal court:
(a) Would not order a court ordered meeting that would favour one faction over another.
According to the Court of Appeal, “the section may not be invoked successfully for the express and sole purpose of placing in control of the company’s directorate and affairs one of two or more contending factions among the shareholders.” ii) Re Barsh and Feldman (1986), 54 O.R. (2d) 340 (Ont. H.C.)
(1) Facts:
(a) The shareholders of Feldbar Construction Co. Ltd. were as follows:
(i) Feldman – one share
(ii) Ben (Papa) Barsh – one share
(iii)Harvey (Junior) Barsh – one share
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(b) Each share carried one vote per share.
(c) The company had been incorporated to develop and build on certain property. The last meeting had been held in April 1966 when the company was last active. The company had been set up with a quorum of 3 for meetings of directors and shareholders, and
Feldman as a signing party on company cheques.
(d)
Ben died and Junior ended up holding Ben’s share as trustee, with the beneficiaries being S&E Consultants (owned by Junior and his wife) to the extent of 50%, and 25% for his brother Joseph and 25% for his sister Stella. Junior wanted to develop two vacant tracts of land owned by the company. Feldman was not interested and was not consenting to corporate resolutions for the transfer of the share to the estate or the election of a corporate solicitor as a director to replace Ben Barsh.
(e) Junior requisitions a meeting of shareholders but there was the problem with the quorum requirement. Junior then sought a court ordered meeting asking for the quorum requirement to be reduced from 3 shareholders to 2 shareholders holding 51%.
At this point Feldman was consenting to resolutions to approve financial statements, electing officers and appointing the solicitor as a director to replace Papa and approving the share transfer. However, Feldman was not consenting to a shareholders’ meeting.
(2) Decision:
(a) The court noted that varying the quorum as requested would effectively eliminate the requirement of consent from Feldman which was the basis of the original agreement.
The quorum requirement of 3, the court noted, was intended to protect Feldman from the controlling interest of Papa and Junior – he was protected by attending a meeting for which there was an agreed agenda.
(b) It was said that the court will not exercise its discretion to change a quorum where it would have the effect of locking one party into the company . The court noted the Re
Morris Funeral Service Ltd. case for the proposition that the court will not normally favour one group of shareholders against another .
(c) The answer to the disagreement, according to the court, was either negotiation to an agreement, or , if there was no agreement, a winding-up of the company.
(3) Comment:
(a) This was a small company. The investments were made under certain terms with certain expectations. The court here was unwilling to lock Feldman into a company in which he may not get any return thereafter . Feldman would have been left in a very poor bargaining position if the quorum had been varied as Junior wanted it.
(b) Can Re Morris Funeral Service Ltd. and Re Barsh and Feldman be reconciled with
Re El Sombrero and Re Opera Photographic Ltd.
?
(i) E.g. in Re Opera Photographic the court ordered a meeting for the majority shareholder leaving only remedies such as the oppression remedy for the minority shareholder, whereas in Re Barsh the court refused to order a meeting since it would have eliminated the protection for the minority shareholder.
(c) Also note Re Canadian Javelin Ltd.
below which effectively settled a battle for control in the case of a widely-held corporation g) Courts have intervened on the basis of fault : i) Re Routley's Holdings Ltd. [1960] O.W.N. 160
(1) Facts:
(a) There were 158 shares held as follows:
(i)
Routley’s Ltd. 130
(ii) J.F. Boland 26
(iii)Bertha Boland 1
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(iv) Clara May Routley 1
(b) The individuals (J.F., Bertha and Clara) were the directors and J.F. Boland was the president. No annual meeting had been held for many years. Clara and Routley’s Ltd. threatened litigation if no meeting were called. A meeting couldn’t be called because the quorum requirement was 3 shareholders holding 50% of the shares.
(c) Boland (the president ) called a meeting at his law office. He then rejected the proxies of Clara and Routley’s even though they were valid proxies . Boland continued the meeting even though there was no longer a quorum for the meeting.
(2) Decision:
(a) The court ordered a meeting of the shareholders at which the quorum would be 50% of the shares represented and two shareholders represented. The meeting was to be held at a neutral locale.
(b) In giving reasons for the court ordered meeting the court noted the clear breaches of law by Boland and the need for a court ordered meeting to prevent further breaches. h) Courts have intervened to protect shareholders in a battle for control in widely-held corporations
(note Re Morris and Re Barsh above were both closely-held corporations): i) Re Canadian Javelin Ltd. (1977) 69 D.L.R. (3d) 439 (Que. Sup. Crt.)
(1) Facts:
(a) Canadian Javelin Ltd. was a Canada Corporations Act Company.
(b) Mr. Doyle owned Boon-Strachen and Javelin Foundaries Ltd.
(c) Doyle, Boon-Strachan and Javelin Foundaries collectively owned 18% of the shares of
Canadian Javelin.
(d) The board of Canadian Javelin Ltd. consisted of Doyle and several of his nominees.
Doyle was being sought on several indictments with respect to securities law violations in the US. He left Canada to avoid extradition.
(e) On March 6, 1976 a directors’ meeting was held where 6 directors purported to remove
Balestreri as the president (Doyle’s pick for president) and accept an alleged resignation of Doyle. Doyle and his co-horts claimed that the directors’ meeting was not validly called. They held a separate directors’ meeting on March 15th, 1976 in St.
Kitts and purported to rescind the resolutions of the March 6th meeting. There were thus two groups each claiming to be the valid board of directors (as in Charlebois below)
(f) No annual shareholders’ meeting was held and no notice for an annual shareholders’ meeting had been given. If the issue of which board could validly call a meeting was not resolved the annual shareholders’ meeting would not be held in time to satisfy the
Securities Exchange Commission (SEC) filing requirements in the U.S. and this could result in serious difficulties with continued financing .
(g) A court action with respect to the validity of the directors’ meetings had been taken and had held that the meeting of March 15th was of no effect. However, the decision was being appealed and the resolution would not occur until at least early 1977 ( too late for calling an annual meeting of shareholders ).
(h) Doyle et al. applied for a court ordered meeting.
(2) Decision:
(a) The court ordered the shareholder meeting .
(b) The court noted that the court can order a meeting where “ for any reason it is impracticable to call a meeting of shareholders.”
(i)
“Impracticable,” according to the court does not mean impossible . One needs to look to the circumstances and ask if it is practical that the desired meeting can be conducted without an order of the court.
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(ii) Here the court ordered the meeting because the situation (having two parallel boards) was detrimental to the best interests of the company (particularly in terms of future financing).
(iii)The court said it should do as little violence as possible to the articles and bylaws in calling a meeting. Here, however, the court made several orders with respect to the meeting to attempt to ensure that it would be conducted in a fair manner (including appointing an independent chair of the meeting and giving the chair broad powers).
(c) Comment:
(i) The court ordered meeting in this case had the effect of resolving a battle for control in favour of Doyle (the person indicted on several counts of securities fraud). The Court’s concern here was the effect that not having a meeting would have on the company and all the shareholders if it could not proceed with financings in the U.S. Here it was not just a question of the bargaining position of two sides in a closely-held corporation. Other persons were affected here, namely, the large number of shareholders who may suffer a loss while the two competing factions battle for control of the board. There were no consequences of the sort that can happen in a closely-held company (such as a person’s investment being locked in ). i) Powers of shareholders at court ordered meetings : i) Charlebois v. Bienvenue [1968] 2 O.R. 217 (Ont. C.A.)
(1) Facts:
(a) A shareholders’ meeting of British International Finance (Canada) Ltd. was purportedly held at which new directors were elected and the appellants (the existing directors) were not elected. The appellants started an action challenging the validity of the shareholders meeting .
(b) An interim injunction was granted but the case was yet to be heard on the merits. The court ordered a shareholder meeting on the basis that until the resolution of the case no one would know which of the two alleged boards could act on behalf of the company and consequently it was impracticable for the company to call a meeting (as in Re
Canadian Jevelin above)
(2) Issue: in ordering the meeting the key questions for the court were:
(a) Whether the court ordered meeting could give shareholders powers beyond the powers of shareholders at any other meeting (and the question of whether they could elect directors at a meeting other than an annual meeting);
(b) Whether the proposed election of directors at a meeting other than an annual meeting was beyond the powers of the shareholders.
(3) Decision:
(a) The court held that the power for the court to order a meeting did not give the court the power to give the shareholders powers beyond what they would have had in any other meeting (would be equivalent to amending the statute)
(b) In this case the shareholders did not have the power to elect directors at any meeting other than an annual meeting, so the court could not give the shareholders the power to elect directors at other meetings of the company.
(4) Comment:
(a) Under CBCA s.109 can have a special meeting. But general point from this case is that the Court cannot include in its order the granting of shareholder powers they would not ordinarily have under the statute (e.g. Court cannot give shareholders management powers they don’t otherwise have)
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Mgmt must solicit proxies (shrhlder democrcy), any solicitatn form & proxy circular (narrowed)
1) A number of issues have historically limited shareholder democracy in widely-held corps: a) As mentioned above, limited liability facilitates the development of widely-held corporations, but this carries the so-called problems of “ separation of ownership and control
” or “ rational shareholder apathy ” (due to small stake and free rider problems) Consequently shareholders often don’t go to shareholder meetings and so may not effectively exercise their voting rights. b) When shareholders wanted to exercise their right to vote but could not be personally present, could try to do so by proxy. Corporations often voluntarily solicited proxies in order to get a quorum, pass resolutions and get on with company business. However, there was a common law rule that there was no right to be represented by proxy at shareholder meetings unless the articles or bylaws so provided. c) Other common law rules with respect to proxies : i) Notice for shareholders’ meetings required that shareholders had a right of notice to the meeting with information sufficient to allow the shareholders to form a reasoned judgment on whether to vote for or against a resolution. ii) Courts might also not approve of management’s form of proxy if it did not enable the shareholders to exercise a real choice as to whether to vote for or against a resolution or to withhold a vote in favour of a proposed slate of directors or the appointment of an auditor. d) Additionally, some practices limited the usefulness of proxy solicitation for shareholders. i) E.g. it was a common to provide no choice with respect to who the proxyholder would be (i.e. if you wanted someone different you would have to prepare your own form of proxy, which, due to shareholder apathy, many wouldn’t). e) Proxy solicitation by a dissident group could also come with very little information on who the dissidents were or what their real interest was in soliciting proxies. f) See also management control over shareholder meeting agenda (in “Shareholder proposals” below), financial disclosure and access to list of shareholders
2) The response in the US in the 1930s (hot on the heals of the Berle & Means book on the separation of ownership and control in corporate America) was the introduction of mandatory solicitation of proxies by management and proxy circular disclosure requirements for both management and anyone else who solicited proxies. In this way shareholders were arguably provided with a greater scope for the exercise of shareholder democracy in that they were given a better opportunity to be represented at the shareholders’ meeting and had information to make a more informed use of their voting rights.
3) Proxies allowed under the CBCA : a) s.147: A proxy is a form (i.e. a piece of paper) signed by a shareholder that appoints a proxyholder (in common language, ‘proxy’ refers to the proxyholder) b) S.147: A proxyholder is a person appointed to act on behalf of a shareholder c) S.148: A shareholder entitled to vote (either with general voting right or class voting right) at a meeting of shareholders is entitled to appoint a proxyholder d) S.148: The rights of the proxyholder are the same as the shareholder subject to the authority granted by the shareholder (proxyholder is an agent of the shareholder, so see Agency law above) e) S.152(2): A proxyholder may be constrained on a vote by a show of hands but can demand a poll i) I.e. one person may be a proxyholder for many shareholders, but those shareholders might want to vote in different ways, and the proxyholder on a show of hands cannot put their hand up both for and against a resolution (in such a case they would have to demand a poll)
4) S.149(1): Management must solicit proxies from each shareholder entitled to vote: a) S.149(2): Unless : i)
It is not a “distributing corporation” and ii) It has fifty or fewer shareholders entitled to vote at the meeting (). b) A “ distributing corporation ” is a corporation that has made a distribution by way of a prospectus under provincial securities laws (see s.2(1) and Reg. s.2). See “closely held corps” below.
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c) A failure to solicit proxies is an offence (s.149(3) & (4)). d) Solicitation of proxies could be enforced through the compliance order provision in s.247.
5) S.150(1), Reg.54: Anyone soliciting proxies must follow certain rules on proxy forms : a) Requires a clear indication that someone other than a designated person can be appointed (Reg. s.54(3) & (4)). i) E.g. in a management proxy solicitation for electing directors, management can type in a proposed director but must leave a space for shareholders to put in someone else’s name b) Allowing voting for or against resolutions or a bold-face indication of how the proxyholder will vote the shares (Reg. 54(5) & (6)). c) Requiring that the person soliciting proxies state who is soliciting (Reg. s.54(1)). d) These provisions codify and expand on some of the common law
6) S.150:
Anyone who “solicits” proxies must provide a proxy (a.k.a. information) circular a) Since management must solicit proxies, management must also provide an information circular.
Similarly, anyone else soliciting proxies must include a circular. b) Under the CBCA the disclosure document is referred to as a “proxy circular” while under provincial securities acts it is generally referred to as an “information circular.” c) A proxy circular is a document that contains sufficient information to allow a shareholder to make a decision on each matter of business for which the proxy is solicited (contents are detailed in
Regs.57,61). i) Statutory forms set out certain required information and require disclosure of any other information necessary to allow the shareholder to make a reasoned decision on matters before the shareholders’ meeting (s.150 and Regs. 35 and 38). ii) S.154: where there is an untrue statement of a material fact or an omission of a material fact required to be included or necessary to make a statement contained in the circular not misleading in light of the circumstances in which it was made, then the court may , on application of an interested person, make any order it thinks fit including:
(1) Pre-meeting: restraining the solicitation , adjourning the meeting, or ordering a correction to the circular
(2) Post meeting remedies might include declaring resolutions passed at the meeting void d) When securities have been distributed subject to a prospectus under provincial securities laws, then those securities laws normally also require proxy solicitation along with an information circular. i) Thus one has to comply with both the corporate statute requirements and the securities law requirements. This can result in conflicting requirements (although these might be dealt with through exemption provisions in securities acts). e) CBCA s.147 provides a broad definition of “solicitation”
, which includes: i)
“A request to execute or not to execute a form of proxy or to revoke a proxy” (s.147(b)) and ii)
“The sending of a form of proxy or
other communication to a shareholder under circumstances calculated to result in the procurement, withholding or revocation of a proxy
” (s.147(c)). iii) There are a number of exceptions – see s.147(b) iv) Brown v. Duby (1980), 111 D.L.R. (3d) 418 involved a battle for control of United Canso.
(1) Facts:
(a) Buckley, with just 0.33% of the shares, controlled a widely held corporation (i.e.
0.33% was sufficient to control election of directors, since, for example, Buckley in close cooperation with current directors would know when directors were about to call a meeting of the shareholders so could get their proxy solicitation out first – if other shareholders wanted to challenge the current board, their proxy solicitation would arrive later, and if shareholders had already completed the first one, shareholder apathy makes it unlikely they would cancel the first and then execute the second)
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(b) The defendants opposed the Buckley control and wanted to warn shareholders that the
Buckley family would be sending out their proxy solicitation out first. The defendants were members of a shareholders’ committee that had engaged DF King & Co. (a U.S.
Co. providing proxy solicitation services). DF King & Co., in conjunction with the defendants, sent letters.
(c) The letter, dated March 7, 1980, noted, among other things, that:
(i)
“Management may also attempt to point with pride to the recent rise in the price of
United Canso stock – even though the stock has only recently sold at the levels it reached in 1974.
(ii)
“
Do not be misled by these tactics. We ask you not to sign any proxy for the
Buckley slate of directors, but to consider, in your own best interests, the information we will be reporting to you.
”
(d) The letter was sent only to residents of the United States and it was argued that it would not have constituted a “solicitation” under U.S. laws (even thought the CBCA definition was copied word-for-word from U.S. federal securities law rules).
(e)
The Buckley family sued, claiming the letter constituted a “solicitation” of proxies within the meaning of the CBCA s.147 and that it was not in the prescribed form and didn’t include a proxy circular
(2) Decision:
(a) The court held that the letter of March 30 was a solicitation of proxies within the meaning of s.147 and that it did not comply with the requirements in terms of the form of proxy or circular requirements.
(b) It also held that the sending of the letter in the United States only does not excuse noncompliance with the CBCA since the CBCA applies with respect to all shareholders no matter where they are situated since it is effectively the corporate contract amongst the shareholders (in other words, the court applied the statutory domicile rule with respect to the applicable corporate law).
(c) However, the court refused to grant an injunction on a balance of convenience test.
(i) An injunction, the court noted, would have made it very difficult for defendants to solicit proxies because management would get to the shareholders first and thus shareholders would have to revoke the management proxies to provide proxies to the dissident group. This would put the dissidents at a substantial disadvantage .
(ii) The court also suggested that there would also be a deleterious reputational effect on the dissidents from having a court order against them and this would also weaken their position. v) In the U.S. institutional investors brought pressure for changes to proxy solicitation rules .
(1) Institutional investors (e.g. banks, mutual funds, insurance firms, pension funds, etc) have become increasingly significant investors in markets of widely-held corps in North
America in recent years. They often hold very substantial investments in corporations that can not be liquidated easily (e.g. in some cases they can only invest in Canadian corps), and so are stuck with existing management. They wanted a greater say in how corporations were being managed (which some say is good since it overcomes shareholder apathy, but others question since the institutional investors themselves are widely-held, so who monitors the so-called monitors), but the definition of “solicitation”
made it difficult for them to attempt to influence shareholder voting (e.g. even a phone call by one shareholder to another to talk about voting might satisfy s.147).
(2) This led to changes in the U.S. in 1992. Under the revised SEC rules, shareholders can announce publicly how they will vote and give intended reasons for their vote without triggering the proxy solicitation requirements .
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(3) A shareholder can also communicate with other shareholders without triggering the proxy solicitation requirements if the communication is not made “under circumstances reasonably calculated to result in the procurement of a proxy.”
(4) These revisions to the U.S. rules were adopted in the CBCA in 2001 with the addition of subparagraphs (v), (vi) and (vii) of the definition of “solicitation” in CBCA s. 147.
(a) E.g. (v) public announcement of how will vote and reasons
Shrhldr proposals (shrhldr democracy), in proxy circular plus supporting stmt, can be social causes
1) Corporate statutes provide for shareholder voting on matters such as electing directors and fundamental changes such as amendments to articles or by-laws. However, if management continues to control the agenda for the meeting it can still retain considerable control over the meeting process and thereby limit the influence of shareholders .
2) CBCA s.
137 (copying U.S. federal securities law rules) allows shareholders to put their own proposals /resolutions before shareholder meetings in a relatively low cost fashion, since it allows them to put the proposal and their supporting statement for it on the management proxy circular
(rather than having to do their own separate proxy solicitation and circular) a) CBCA s.137(1)(a): a registered or beneficial shareholder is entitled to submit a proposal . i) A shareholder, or group of shareholders, is entitled to submit a proposal if the shareholder, or group of shareholders, has at least 1% of the voting shares or the value of the shares held has a market value of at least $2,000 and the shares have been held for at least six months
(s.137(1.1) and Reg.46).
(1) These requirements were legislated in response to cases such as Greenpeace below ii) The words “or beneficial ” were added to s.137(1) in 2001 to deal with cases that held that the reference to a “shareholder” could only mean a “registered shareholder” (see
Greenpeace
Foundation of Canada v. Inco. Ltd. (Feb. 23, 1984, Ont. High Court) and Verdun v. Toronto
Dominion Bank , [1996] 3 S.C.R. 550). b) S.137(2): The proposal is to be set out in the management proxy circular . i) The shareholder can include a supporting statement of up to 500 words (s.137(3) and Reg.48). c) Shareholders with more than 5% of the shares of the class entitled to vote can nominate directors
(s.137(4)). d) S.137(5): requirement and limits on proposals : i) The proposal must be submitted 90 days (Reg. 49) ahead, must not be for the primary purpose of redressing a personal grievance , and must not be a proposal that does not relate in a significant way to the affairs of the corporation . ii) There must not have been a similar proposal in the past two years that did not get a specified minimum support (s.137(5)(d) and Regs.50 & 51). iii) The proposal must also not be for the purpose of securing publicity (s.137(5)(e)). e) If the corporation refuses the proposal it must give notice of its refusal (s.137(7)). i) If the corporation refuses the proposal then the shareholders can apply to court for a consideration of whether the proposal was properly refused (s.137(8)).
(1) E.g. see cases below on proposals for social causes ii) The corporation can also choose to apply to court to determine whether the proposal can be properly refused (s.137(9)).
3) There have been some problems with shareholder proposals. a) First, should shareholder proposals be used as a way of reallocating day-to-day management decisions to the shareholders’ meeting ? i)
A shareholders’ meeting may be a cumbersome procedure for day-to-day management decisions. ii) The shareholders in a widely-held corporation may lack the expertise and support staff that would help in making a rational decision.
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b) Second, there is the concern that the proposal mechanism might be used simply as a device for harassing the corporation (e.g. by a competitor who gets some small amount of shares or by some person who has a personal grievance against the corporation or one or more of its directors or officers). c) Third, to what extent should one allow the meeting process to be encumbered by proposals about which the corporation has little or no power to do anything or that don’t relate to its business? (e.g. calls for amendment of anti-trust laws). Here one should bear in mind that the meeting process is costly and there is company business to be done. Thus there may be trade-offs to be made in the context of shareholder proposals.
4) In addressing these trade-offs the rules in the U.S. that were copied in CBCA s.137 said that a shareholder proposal could be refused by the corporation if personal (see s.137(5) above) or if was
“ primarily for the purpose of promoting general economic, political, religious, social or similar causes
.” a) E.g. the U.S. case of Medical Committee for Human Rights v. SEC , 432 F.2d 659 (1970) i) Facts:
(1) The Medical Committee for Human Rights held shares in Dow Chemical and sought to have it include a shareholder proposal calling for the corporation to no longer produce napalm .
(2) The corporation’s refusal of
the proposal was challenged. ii) Decision:
(1) The court held that the corporation could not refuse the proposal since even though it might have been motivated by a social cause it was something that was within the powers of the shareholders . The shareholders were entitled to amend the articles to add a restriction to the businesses that the corporation could engage in. Thus the shareholders could vote to amend the articles to restrict the corporation from producing napalm.
(2) The resolution was put before the shareholders and garnered about 3% vote in favour of the resolution. b) There were a few Canadian cases that took a much more restrictive approach to shareholder proposals, even though corps could amend their articles to implement the proposal: i) E.g. Re Varity Corp. and Jesuit Fathers of Upper Canada (1987), 59 O.R. (2d) 459, affd
(1987), 60 O.R. 640 (C.A.)
(1) Facts:
(a)
Jesuit Fathers of Upper Canada sought to put before the shareholders’ meeting a resolution to terminate Varity’s investments in South Africa .
(b) It would have arguably been within the power of the shareholders to amend the articles to restrict the corporation’s business by providing that the corporation could not engage in a business in South Africa. The proposal began with a preamble about concerns over apartheid in South Africa (might have been better to leave this out to make it sound more directly related to the corporation)
(2) Decision:
(a) The court held the proposal could be properly refused on the basis that it was for a political cause . ii) Similarly, in Greenpeace Foundation of Canada v. Inco. Ltd. (Feb. 23, 1984, Ont. High
Court)
(1) Facts: Greenpeace sought to include a proposal that would reduce sulpher dioxide emissions to 247 tonnes per day.
(2) Decision: The court held, among other things, that the proposal was properly refused on the basis that it was primarily for a social cause .
(3) Comment: the court also refused the proposal since Greenpeace wasn’t a registered shareholder but rather was a beneficial shareholder (see s.137(1)(a) above which allows
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beneficial shareholders to put forward proposals, but requires them to have a non-trivial holding of shares for at least 6 months, to avoid a holder of a single share causing trouble at shareholder meetings)
5) CBCA s.137 was amended in 2001 to remove the restriction on shareholder proposals that are
“primarily for the purpose of promoting general economic, political, religious, social or similar causes
.”
Financial disclosure to shrhldrs, auditor & cmte, access to records, disclosure under securities law
1) In addition to the proxy circular, shareholders are provided with financial disclosure in order to assess the performance of corporate management. a) CBCA s.155 requires the directors of the corporation to put before the shareholders comparative annual financial statements . b) The financial statements must be formally approved by the directors (s.158). c) The financial statements must include a balance sheet, income statement, statement of retained earnings (showing increases to and decreases in retained earnings) and a statement of changes in financial position (showing sources and uses of funds over the year) (Reg.72). d) The statements are to be prepared according to “Generally Accepted Accounting Principles” following the guidelines set out in the CICA (Canadian Institute of Chartered Accountants)
Handbook. This effectively delegates the standards of financial disclosure to the CICA.
2) A distributing corporation must appoint an auditor (s.162,163). a) A non-distributing corporation (see “ Closely held corps” below) can dispense with the appointment of an auditor (s.162,163). b) S.169: an auditor of the corporation must make an examination as necessary to report on the annual financial statements in accordance with the guidelines in the CICA Handbook. c) The report of the auditors is to be put before the shareholders (s.155). Thus the annual financial statements of a distributing corporation must be audited . d) S.171: requires a distributing corporation to have an audit committee consisting of not less than three directors a majority of whom are not officers or employees of the corporation. i) S.171(3) requires the audit committee to review the financial statements before the financial statements are approved by the directors. ii) The auditor of the corporation is entitled to notice of and to be present at every meeting of the audit committee (s.171(4)). iii) Note no requirement for a non-distributing corporation (i.e. closely held corp) to have an audit committee (see “Closely held corps” below) e) S.161 provides that the auditor must not have a conflict of interest with the corporation. It provides that a conflict of interest is a question of fact and goes on to deem a person not to be independent if the person is, or if any of the person’s partners, are: i) A business partner, director, officer or employee of the corporation or any of its affiliates ii) Beneficially owns or controls (directly or indirectly) a material interest in the securities of the corporation or any of its affiliates, or iii) Has been a receiver , receiver manager, liquidator or trustee in bankruptcy of the corporation or any of its affiliates within two years of the appointment of the person as auditor. f) The conflict of interest concern has been raised in recent years in the U.S. in widely publicized problems involving Enron and Worldcom. The result in the U.S. was the enactment of legislation that, among other things, set up a statutory body to monitor auditors and put restrictions on persons acting as auditors where they provided other services to the corporation. g) Accounting firms often provide services other than auditing , including tax and management consulting services. The risk of loss of these other servicing contracts, in addition to the loss of the audit assignment, may cloud the independence of the auditors.
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3) The shareholders and in some cases the public are also given access to certain records of the corporation. a) CBCA s.20(1): the corporation is required to prepare and maintain , at its registered office or at a records office designated by the directors, the articles and by-laws and all amendments to them, a copy of any USA (unanimous shareholder agreement), the minutes of shareholder and director meetings, resolutions of shareholders, copies of the notice of directors and changes in the directors and their addresses, and a securities register . b) S.20(2): requires that the corporation prepare and maintain accounting records and minutes of directors’ meetings. c) S.21(1): for non-distributing corporations the shareholders and creditors and the Director can have access to the corporation’s records
( other than the records of the directors’ meetings and the accounting records). d) S.21(1): where the corporation is a distributing corporation , any person can have access to the records of the corporation ( other than the records of the directors’ meetings and the accounting records).
4) Where a corporation has distributed securities under a prospectus , the corporation becomes a
“ reporting issuer
” and is subject to securities regulation continuous disclosure requirements that include (and this disclosure must be in electronic form and is publicly available on the SEDAR database (System for Electronic Data Analysis and Retrieval, www.SEDAR.com
)): a) Financial disclosure (which provides for unaudited quarterly financial statements in addition to annual audited financial statements) b) Information circulars for security holder meetings c) Annual information forms d) Insider trading reports and e) Timely disclosure of material changes
Access to list of shrhldrs: anyone for distribtng Co., sh/creds for non-dist, but only for Co. purposes
1) Purpose : access to the list of shareholders is important for such matters as: a) Engaging in proxy solicitation b) Requisitioning a meeting (since need 5% to requisition) c) Making a takeover bid (need to offer to purchase all shareholder’s shares)
2) There are 2 ways to get the list: request it or inspect the register:
3) CBCA s.21(3): any person with respect to a “ distributing corporation ” (as defined in s.126) can request a list of the shareholders of the corporation. a) For a non-distributing corporation the shareholders and creditors can have a list provided. b) S.21(3): the list can be requested by paying a reasonable fee (set by the corporation) and sending an affidavit with name and address (s.21(7)) and (per s.21(9)) indicating that the list will not be used for a purpose other than : i) An effort to influence the voting of shares of the corporation ii) An offer to acquire shares of the corporation, or iii) Any other matter relating to the affairs of the corporation
(1)
E.g. can’t use list to try and sell stuff to all the shareholders.
(2) Company might refuse to give a list if it thinks it is not for a corporate purpose. E.g. State
Ex. Rel. Pillsbury v. Honeywell Inc.
, 191 N.W. 2d 406 (1971 Minnesota Supreme Crt)
(a) Facts:
(i) A person bought one share and became a registered shareholder to be able to get a list of shareholders. The acknowledged purpose of seeking a list of shareholders was to communicate with other Honeywell shareholders to convince them to stop
Honeywell from manufacturing anti-personnel fragmentation bombs .
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(ii) This attempt to stop the production of fragmentation bombs was not done out of a concern for the economic well-being of Honeywell, but because the petitioner was politically opposed to the production of anti-personnel fragmentation bombs no matter how profitable they may have been to the corporation.
(iii)The corporation refused to provide the list.
(b) Issue: could the list be refused on the basis that the purely political motive for access to the list did not constitute a “corporate purpose.” Is a “corporate purpose” limited to the economic interests of the corporation?
(c) Decision:
(i) The court said that a mere statement that one has a proper purpose not sufficient.
The court refused to follow cases that held that a desire to communicate with shareholders is a per se proper purpose.
(ii) The court held that access to the list to impose political views on the corporation is not a proper purpose for access to the shareholder list – a proper purpose is one connected with a genuine economic interest of the company . c) S.21(3): the corporation must provide the list within ten days and it must be made up to within 10 days prior to the receipt of the affidavit.
4) The problem with a request for the list of shareholders is that it can be a little out of date (e.g. the corporation has time to respond since it has 10 days to provide the list, such as if it suspects a takeover bid is about to occur). The alternative is to inspect the shareholder register although this may be impractical where there is a very large number of shareholders. a) S.20(1)(d): the corporation is required to keep a shareholder register with the names and addresses of the shareholders. b) S.21(1): provides a right to inspect the list of shareholders at the records office of the corporation during usual business hours. c) S.21(1.1): requires that the person seeking access to the list provide an affidavit that is the same affidavit required for a request to have the corporation prepare a list of shareholders (see s.21(3) above). d) S.21(1): allows shareholders or creditors of a non-distributing corporation , and any person in case of distributing corporation , to inspect the shareholder register during usual business hours. e) When someone is seeking the list of shareholders the corporation knows something is up. There is good chance that the person interested in the shareholder list is interested in some form of control battle such as a proxy contest or takeover bid. Not surprisingly the corporation often tries to resist attempts to gain access to the shareholder list . It appears that courts will stop attempts to interfere with access to the list of shareholders. i) E.g. Cooper v. Premier Trust Co. [1945] O.R. 35, [1945] 1 D.L.R. 376
(1) Facts:
(a) The company secretary made it difficult for applicant to inspect the shareholder list :
(i)
First, the company secretary was reluctant to accept the applicant’s I.D. on the
Tuesday (the share certificate said “Janet Cooper” and the I.D. card said “Janet
Deborah Cooper”).
(ii) On the Wednesday the applicant brought I.D. satisfactory to the company secretary but the company secretary suggested she come back near the end of the day on the
Thursday at 3 p.m.
(iii)On Thursday she got to see the shareholder list for one hour before being interrupted by the company secretary. The company secretary asked how much longer she would be and she said she only got as far as the letter B or C. The company secretary then said that he needed to enter transfers (which in fact were from (i) the company general manager to company general manager in trust; and
(ii) from the company general manager to the company secretary).
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5)
(iv) A further inspection was arranged between the applicant and the company secretary for the following Monday. The applicant’s employer (solicitors) informed the company secretary by telephone on the Thursday that an inspection delayed to
Monday would not be satisfactory and that the employee (applicant) would be back on the Friday morning at 10:00 a.m. to inspect and that if inspection was not permitted a writ would be forthcoming.
(v) The inspection on the Friday was not allowed on the basis that they had agreed on the Monday.
(b) An application was brought to the court for an order that the respondent keep open the shareholder register for inspection during reasonable business hours.
(2) Decision:
(a) The court intervened here saying that one hour of inspection in five days was not good enough .
(b) The court held that the Friday refusal unwarranted – there was no agreement since no consideration (so not a contract) and since she had a statutory right of inspection .
Comment: Thus it appears that a court will intervene where the right to inspection is (3) unreasonably refused .
Note registered shareholder often just a depository institution (which holds shares for beneficial owners), so the list of registered shareholders alone isn’t much good. There is a Canadian securities instrument designed to help find out who the beneficial owners are.
Closely-held (non-distrb): fewer reqs (no notice/auditor/procy solicit) since less shrhldr apathy
1) Widely-held corporations have many shareholders, and hence significant potential for the separation of ownership and control and shareholder apathy (due to having a small stake in the corporation and being inclined to free-ride on the monitoring efforts of others) a) Our legislation addresses this potential separation of ownership and control through mechanisms such as the mandatory solicitation of proxies, proxy circulars, financial disclosure, audit committees, shareholder proposals, etc. b) Many of these mechanisms designed to deal with widely-held corporations may not make sense in the context of a closely-held corporation . Some jurisdictions have 2 statutes, one for public corps and one for private corps. c) Our statutes attempt to deal with this by being modeled on widely-held corps, them making a number of exceptions/modifications for closely-held corps.
2) Reasons for different treatment : a) There are relatively few shareholders in the closely-held corporation, each having substantial investments in the corporation. b) Thus each shareholder has a relatively large stake and so has a much greater incentive to be involved in monitoring the management of the corporation, usually through being actively involved in the management themselves. i) With relatively fewer shareholders wanting to be more involved in the management of the corporation it may make sense to have more of the day-to-day decisions in the closely-held corporation put in the hands of the shareholders . ii) With fewer shareholders having a more substantial stake in the corporation, the separation of ownership and control problem and of shareholder rational apathy are thus not nearly as significant a problem in the context of a closely-held corporation. iii) Thus there is less of a need for mandatory proxy solicitation and proxy circulars since shareholders will be inclined to take steps to inform themselves and to exercise their voting rights at shareholder meetings
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iv) There may also be less of a need for mandatory financial disclosure and the appointment of an auditor (with associated costs) since shareholders will more readily be willing and able to inform themselves with respect to the condition of the company. c) With no established market for the shares the shareholder’s investment will be difficult to liquidate. They will not want to be stuck in business with others whom they do not trust or whom they believe are not capable of doing a good job. d) Thus they tend to want some control over who they are in business with and thus tend to want to put in share transfer restrictions .
3) There is no precise definition of the closely-held corporation. a) However, the above 4 attributes (few shareholders, active in management, no market, transfer restriction) are common for closely-held corps b) Statutory definitions i) The initial drafters of the CBCA took a “functional” approach to closely-held corporations – the overall question apparently being one of when the costs of the particular mandatory provisions outweigh the benefits. This led to different test for which kinds of corps need financial statement disclosure, which audit committees, which mandatory proxy solicitation, and so on. ii) Recent amendments to the CBCA have moved away from the functional approach to a global definition applying to the various requirements of the Act. The global definition is whether the corporation is a “distributing corporation”
(1)
A “distributing corporation” is a corporation that has made a distribution of its shares under a prospectus or similar disclosure document pursuant to provincial securities laws
(see CBCA s.2(1) “distributing corporation” and Reg.2).
4) Statutory exceptions/modifications for closely-held corps: a) Waiver of notice to shareholder meetings : i) S.136: The corporation will not have to provide notice to a shareholder for a shareholder meeting if the shareholder has waived her or his right to notice of shareholder meetings ii) Although this is not limited to closely-held corporations, such a waiver of notice to shareholder meetings is a useful feature for closely-held corporations to allow for the calling of shareholder meetings without the usual notice requirement (e.g. to have a meeting sooner than the usual 21 day notice period) b) One shareholder meetings : i) Since one or more persons can incorporate a company, it is possible to have a company with only one shareholder. Such a corporation is clearly a closely-held corporation. ii) S.139(4): allows for shareholder meetings in such corporations by expressly recognizing one shareholder meetings. c) Unanimous consent in writing to resolutions in lieu of shareholder meeting : i) S.142: allows for shareholder resolutions in writing in lieu of holding a meeting. ii) The resolution in writing must be unanimous, so it is most likely to be feasible in corporations with relatively few shareholders. iii) It is quite a common practice to have the usual annual meeting business of the closely-held corporation done by circulating a resolution which all the shareholders sign. d) Dispensing with an auditor : i) S.163: allows the corporation (by shareholder resolution at each AGM) to dispense with the requirement of appointing an auditor where the corporation is not a distributing corporation. e) No requirement for an audit committee : i) S.171: There is also no requirement for an audit committee where the corporation is not a distributing corporation f) Avoidance of management proxy solicitation requirement :
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i) S.149(2): Mandatory solicitation of proxies by management is not required where the corporation is not a distributing corporation and has fifty of fewer shareholders entitled to vote
Closely-held: shareholdr agreement on how to vote, dirs can’t but can realloc mgmt to sh thro USA
1) Shareholders can enter into shareholder agreements as to how they will vote their shares. a) This can allow shareholders to increase their collective voting power and potentially exercise control over the corporation, whether closely-held or widely-held. b) These agreements were challenged on the basis that such agreements fettered the discretion of shareholders and were thus contrary to public policy. Courts, however, rejected these arguments with respect to shareholder agreements that constrained voting and such agreements were held to be valid (e.g. Ringuet v. Bergeron , [1960] S.C.R. 672). Shareholders agreements are simply contracts between the shareholders that sign on. c) Such agreements are also expressly allowed under CBCA s.145.1. d) In the closely-held corporation, the voting agreement can be used to ensure certain persons continue to be elected director in the corporation (e.g. shareholders could agree to vote each other in as directors) or otherwise have involvement in the management of the corporation. e) Note these shareholder agreements need not be unanimous (e.g. a group of minority shareholders might try to pool their votes to get control away from a majority shareholder). There are thus quite different to USAs (see below)
2) Alternatively , another way in which shareholders can ensure that they vote their shares in agreed upon ways is to assign the voting rights to a trustee under a trust indenture that sets out the way in which the trustee is to vote the shares. a) This method has not been used very much in Canada due to tax law consequences
3) Directors agreements on voting not allowed, but can reallocate by USA to shareholders (who can then use one or more shareholder agreements to vote as a block(s)) a) While it was held that shareholders can constrain how they will vote their shares as shareholders, it was held in Ringuet v. Bergeron , [1960] S.C.R. 672 that it was contrary to public policy for directors to constrain how they would vote as directors. i) Directors have a duty to act in the best interests of the corporation. ii) Each time they vote on a matter they must do so in a way that is in the best interests of the corporation (see fiduciary duties of dirs/offs above). Thus they cannot bind their discretion in advance by agreeing to vote in a way they may later turn out to be not in the best interests of the corporation. iii) The effect of this was that shareholders in a closely-held corporation could agree to vote their shares to make each other directors of the corporation, but they could not agree on how they would vote as directors when it came to appointments of corporate officers or other major management decisions. iv) In Ringuet v. Bergeron this would have allowed the directors to remove Bergeron as the president of the company even though four shareholders had agreed not to remove him as president. v) These powers could also not be put in the hands of the shareholders where statutes, such as the statute in Ringuet v. Bergeron , provided that the directors are to manage the corporation. b) The CBCA sought to rectify this by allowing the management powers of directors to be reallocated to shareholders under a USA (unanimous shareholder agreement) (s.146, and s.102 which says that the directors shall manage the corporation “subject to any unanimous shareholder agreement”). i) The USA must be unanimous. Thus such an agreement is only likely to be practical in the context of a closely-held corporation. ii) The USA can thus provide that certain management decisions normally made by the directors can be allocated to the shareholders. The USA can then go on to provide for how the shares are
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to be voted on the particular management issue (or separate, non-unanimous shareholder agreements can be used to form voting block(s))
(1) E.g. A common provision to put in a unanimous shareholder agreement is a provision to the effect that the shareholders , and not the directors, will decide who the officers of the corporation are to be, and will then go on to say that the shares will be voted so that X will be president, Y will be vice-president, etc. c) Other powers can also be reallocated from the directors to the shareholders . i) Specific management powers such as the declaration of dividends or issuance of shares could be allocated to the shareholders d) To see if it is possible to transfer a power, follow these steps : i) Examine the provision under which a directors power is provided in the Act (e.g. the borrowing power is under s.189(1) and (2), the power to appoint officers is under s.121, and so on – if it is not a specific power of directors, then it likely falls under the directors general management power in s.102). ii) Then see what methods the statute allows to reallocate the power (e.g. s.121 says that the power can be reallocated in the articles, by-laws or a unanimous shareholder agreement). iii) Then assess which of these documents would be the most appropriate document for reallocating the power (in a closely-held corporation this will normally be a unanimous shareholder agreement). iv) Once a power has been reallocated to the shareholders in the document considered most appropriate, there may the question of determining how shareholders agree to vote on the matter and put the terms of that agreement in the shareholders’ agreement.
4) See also oppression remedies for shareholders (in piercing above)
Closely held: share trnsfr provs (avoid bad associates, handle death/bkrptcy, fair price for shares)
1) There are various reasons for share transfer provisions : a) Often imposed to control transfer of shares in order to avoid undesirable business associates and preserve relative interests . b) Might also want to allow transfers so that shareholders have some kind of a market for their shares, so when they want to get out of the business and do something else with their money there is a way that they can do this without having to dissolve the business ( and establish a fair price for their shares so they are not forced to sell at a very low price when they want out) c) May be a desire to have a mechanism that allows a shareholder to be forced out to resolve a deadlock or to get rid of a person who others in the company can no longer deal with . Such a forced buyout provision can allow this to happen without forcing the dissolution of the company. d) Can allow for a forced buyout /transfer of shares to deal with the occurrence of a particular event or at least an option for shareholders to buy out the shareholder to whom the particular event has occurred. Such provisions are not uncommon to deal with the following events: i) If one of the shareholders dies and her or his shares are then controlled by the administrators of that shareholder’s estate, the other shareholders will have inherited a new business associate who they not have chosen as an associate. ii) A similar result might occur where one of the shareholders has a spousal separation in which, by agreement or court order, that shareholder’s shares are part of a division of property. The remaining shareholders can then effectively end up with a new business associate who they would not have chosen as an associate. iii) Often a small business will require additional finance which needs to come in part from the existing shareholders. In addition, the shareholders may have signed personal guarantees for a bank loan. In either of these situations they will not be happy to find that one of their coshareholders is bankrupt and cannot contribute to further financing or cannot contribute to paying back the bank loan on her or his personal guarantee
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(1) Compare with automatic dissolution of partnership on bankruptcy
2) In Edmonton Country Club v. Case [1975] 1 S.C.R. 534 it was held that although there is a presumption that shares are freely transferable the transfer of shares can be restricted . a) Thus it appears that share transfer restrictions are generally valid with the possible exception of an absolute restriction on transfer .
3) There are a number of types of share transfer provisions , such as: a) Absolute restriction on share transfers (but see Edmonton Country Club above) i) Does not allow any kind of share transfer. ii) Advantages:
(1) Avoids undesirable business associates
(2) Preserves the relative interests of the various shareholders in the business.
(3)
Prevents one or more shareholders from “squeezing out” another shareholder (i.e. forcing that other shareholder to accept a very low price for her or his shares). iii) Disadvantages:
(1) Cannot use share transfers to deal with deadlocks when they arise.
(2) Does not allow shareholders to get their money out of the business when they want to do something else with their money.
(3) The only solution to deal with these problems would be to force a dissolution of the corporation. b) Consent restriction on share transfers i) Allows shares to be transferred on the consent of certain persons. The consent is usually a consent of the board of directors which often consists of the shareholders in the corporation. ii) Advantages:
(1) Allows shareholders to sell their shares and get out of the business.
(2) Can also help avoid the introduction of undesirable business associates since shares will only be transferred to outsiders upon consent.
(3) Can help to preserve relative interests of shareholders especially if the consent required is unanimous. Shareholders who are concerned about preserving relative interests could then refuse to consent to a transfer unless it in some way preserved the relative interests of shareholders in the corporation.
(4) Because a consent transfer provision does at least allow for the transfer of shares it could help to resolve a deadlock as long as one or another of the shareholders is willing to sell her or his shares and the others are willing to consent to the sale. iii) Disadvantages:
(1) While these provisions can go some way to resolving deadlock, they are not very effective unless the deadlocked shareholders are willing to at least co-operate on the transfer of shares.
(2) Consent restrictions are also weak in providing shareholders with a market for their shares.
Not only is consent required but the consent can be used to effectively force a departing shareholder to accept a very low price for her or his shares (though might be able to use oppression remedy in such cases) c) Shot Gun restriction on share transfers i)
The shot gun (or “
Russian roulette
”) provision gives a person who receives an offer the right to either accept the offer or impose the same offer on the initial offeror . These provisions can be structured so that the first offer is an offer to buy or an offer to sell. ii) In the offer to buy format, one person makes an offer to buy the shares of the other – the other person can then either accept that offer and sell his or her shares, or buy the shares of the initial offeror at the same price as set by the initial offeror. iii) Advantages:
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(1) Provides for a cheap means of setting a fair price for the shares. The initial offeror will presumably set a fair price knowing that her or his own shares could be purchased by the offeree at this same price. iv) Disadvantages:
(1) Where the offeree is financially unable to acquire the initial offeror’s shares, it can put the initial offeror at a significant advantage, possibly allowing the initial offeror to acquire the offeree’s shares at a price that is less then the value of the shares (i.e. A has lots of money,
B has little, A offers B low price for B’s shares knowing B couldn’t buy A’s shares even at that low price) d) First option i) The shareholder who wants to sell their shares arranges for an offer from a third party . The offer must then be put before the other shareholders who have a right to buy a proportionate amount of the selling shareholder’s shares on the same terms as were arranged with the third party. ii) This allows the non-selling shareholders to keep out a third party who they do not approve of and to retain their relative shareholding position. e) Forced Buyout and event options – see various reasons above i) The shareholder agreement will normally provide for a means of determining a value for the shares for forced buyouts or event options. The valuation techniques can involve arbitration or agreed upon valuators and can describe various methods of valuation.
4) Shareholders agreement might also agree on insurance so corporation can buy shares of a shareholder that dies
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