"5'O<C'_U' "U" "AQlllP";, j , ou ut u LUllIll reglMer as Apple zngmeenng or J::i Engineering or any other name,

34 I CHAPTER 5

provided, however, that a business name does not violate trademarks and will not be confused with other corporate or business names in the province of registration. As well, statutes may place ' restrictions on use of profession-related words, such as "engineering" or "architecture."

Sole proprietors must also follow all other legislative requirements for a business, including obtaining a business license. If sole proprietors hire people, they are bound by mandatory labour legislation.

The principal disadvantage of operating as a sole proprietor is liability. The individual is com- • pletely and fully liable for all debts and obligations of the business. A second potentially serious disadvantage is that at certain income levels, individuals are taxed at a rate higher than corporations. The advantages of operating as a sole proprietor are that the set-up costs are lower than those of a corporation, there are no corporate reporting and filing requirements, and, at low income levels, there may be tax advantages. Compared with partnerships, sole proprietorships have the advantage of not exposing an individual to liability for mistakes made by partners.

5.2 Partnerships

Partnerships are governed by the Partnership Act in each province. It is a good business practice for partners to enter into a partnership agreement that governs the way the partnership conducts business. The partnership agreement generally sets rules including authority to sign contracts, the division of profits, procedures for business decisions, and procedures for dissolving the partnership.

Subject to the terms of the partnership agreement, each partner has authority to enter into contracts and carryon business in the name of the partnership. Even where the partnership agreement limits the authority of the partners, parties doing business with the partnership are unaware of the terms of the partnership agreement and therefore assume that every partner has unlimited authority and liability. This joint authority is very important, because each partner is jointly liable for all of the debts and obligations of the partnership, and such liability is not limited to that partner's proportionate share. For example, if Smith of Smith & Jones buys a new computer system for the business, the computer store can sue both Smith and Jones for the unpaid amounts for the computer system. However, if the computer system was purchased for Smith's personal use and not as part of the business, the computer store can only pursue Smith.

(a) Forming a Partnership

The circumstances of a partnership determine whether it is a legal partnership. If two or more parties sign a partnership agreement, they are partners, although other indicators of partnership still have to be present.' However, even without a partnership agreement, they may still be considered partners under the terms of a Partnership Act. If two or more parties jointly participate on a continuing basis in the management of a business, declare themselves to be partners, and/or make a joint monetary contribution to start a business, many Partnership Acts consider them legal partners. For example, if three musicians put on a concert, they are unlikely to be considered a partnership; but if they put on a series of concerts, the law may consider them partners.

Most provinces require partnerships to register. Like sole proprietors, partnerships must follow all other legal requirements, including obtaining a business license. Partnerships that hire people are also bound by mandatory labour legislation.

'Backman v. Canada, [2001]1 S.C.R. 367.

"~""y,,,,,-,,

• For example, see in Ontario the Limited Partnership Act, R.S.O. 1990, c. L.16, s. 9.

(a) Separate Legal Entity

A corporation is considered a separate legal person. For example, Bill Smith may own all of the shares of Smith's Painting Ltd., but that does not mean that Bill is Smith's Painting Ltd. For this reason, Bill and Smith's Painting Ltd. must keep separate records and separate bank accounts and must act as separate persons. If Bill treats his corporation as himself, then Smith's Painting Ltd. risks losing its limited liability status, and Bill could become personally liable for the company's debts and obligations.

However, even though legally Bill and Smith's Painting Ltd. are separate legal persons, some liabilities are shared, even if Bill maintains appropriate separation. For example, if Smith's Painting Ltd. is a small company, its bank and many of its larger suppliers will probably require Bill to sign a personal guarantee for the debts owed by Smith's Painting Ltd. before they advance funds or supplies because they suspect that Bill's Painting Ltd. does not have significant assets.

In addition, some statutes ignore the limited liability status of a corporation and place personal financial responsibility on the directors and officers. These exclusions to what is known as the corporate veil (the limited liability shield of the corporation) are discussed below.

36 I CHAPTER 5

5.3 Corporations

A corporation is a legal entity that permits large numbers of individuals to invest in a common business venture, while limiting the liability of the business to the new legal person, the corporation. A corporation must use one of the words Corporation, Corp., Incorporated, Inc., Limited, or Ltd. as part of its name in order to provide notice to parties doing business with it that liability for corporate debts and obligations is limited to corporate assets and does not extend to the shareholders, officers, directors, or employees.

Corporations can be created pursuant to the federal Canada Business Corporations ActS or provincial statutes. In either case, a corporation must be registered in every province in which it does business.

(b) Corporate Organization and Control

Corporations are owned by shareholders in proportion to their shareholdings. Individuals, partnerships, and corporations can be shareholders. Shareholders vote to elect directors and authorize fundamental changes to the corporation.

Directors are individuals who direct the business of the corporation. The directors elect officers, often from amongst themselves, such as the president, vice-president, and corporate secretary, who provide a closer operational direction for the business. Officers and directors must be individuals and cannot be corporations.

Legal documents create the corporation and define the types and number of shares to be issued and the name of the corporation. These documents are called articles of incorporation, memoranda of association, or letters patent, depending on the jurisdiction where the corporation is first registered. Bylaws and articles of association created when the corporation is formed list more detailed rules relating to the authority of officers and directors and the holding of meetings.

S R.S.C. 1985, c. C-44.

38 I CHAPTER 5

6 See Chapter 12, p. 139. 7 p,,s,fh,, l!)lI!'> • c. /1-7.,

8 R.S.C. 1985, c. D-1.

• R.S.C. 1985, c. E-19. IOS.C.1991 c.46.

II R.S.C. 1985, c. B-3. 12 R.S.S. 1978, c. C-30. 13 R.S.C. 1985, c. E-15. 14 R.S.C. 1985, c. I.

0) FIDUCIARY DUTY Officers and directors owe a fiduciary dutys to the corporation. For example, officers and directors cannot operate separate competing businesses or take profits of the business solely for themselves. In addition, they must always act in the best interest of the corporation, be loyal to the corporation, act honestly and in good faith, and declare all conflicts of interest. These obligations are absolute; but they are only owed to the corporation, not to its shareholders. As a result, only the corporation can sue officers and directors for breaches of these duties. However, forcing a corporation, which is controlled by the officers and directors, to sue those same officers and directors can be difficult. Thus, in order to provide a remedy for oppressed minority shareholders in a corporation reluctant to sue its officers and directors, some provinces now permit derivative actions, which are court actions by the oppressed minority shareholders against a corporation's officers and directors.

(ii) CONFLICTS OF INTEREST Conflicts of interest are discussed in detail in Chapter 3. In general, for corporations, a conflict of interest occurs when the interests of the corporation conflict or could conflict with the interests of the officer or director. For example, if a person with a business selling office supplies is also director of a corporation about to enter into a long-term contract for the purchase of office supplies, then that person has a conflict of interest. He or she must declare the conflict of interest in the purchase discussions and avoid participating in any way in the discussion or decision about the contract.

Conflicts of interest can also occur when the personal interest of the officer or director is in conflict with his or her duty to the corporation. For example, a director should avoid accepting personal gifts from parties doing business with the corporation. Officers and directors must ensure that they do not accept gifts from parties that are capable of influencing their decisions.

(iii) GOVERNMENTAL LIABILITIES Several statutes and regulations place specific obligations and liabilities on officers and directors. For example, labour standards legislation generally places an obligation for unpaid employees' wages on officers and directors if the corporation goes bankrupt and fails to pay such wages. Other legislation, such as the environmental legislation discussed in Chapter 23, places due diligence obligations on officers and directors.

Under professional and other statutes, such as the Aeronautics Act,7 the Defence Production Act,8 and the Export and Import Permits Act,· directors and officers of a corporation that has committed an offence can be found individually guilty of the same offence as the corporation, Directors and officers also have specific duties under the Bank Act, 10 the Bankruptcy Act,ll and the Consumer Products Warranties Act. 12 In addition, officers and directors can also be held liable for unpaid wages under provincial labour standards acts; unpaid GST under the Excise Tax Act;13 failure to remit Canada Pension Plan deductions; failure to maintain and remit income tax under the Income Tax Act;14 breaches of occupational health and safety legislation; and breaches of trust under construction lien statutes.

40 I CHAPTER 5

TABLE 5-1 Advantages and Disadvantages of Organizational Structures

Disadvantages

SOLE PROPRIETORSHIP

PARTNERSHIP

CORPORATION

_ Unlimited liability

_ Lack of continuity in business organization in absence of owner _ Difficulty raising capital

Disadvantages _ Unlimited liability _ Lack of continuity _ Divided authority

_ Difficulty raising additional capital _ Difficulty finding suitable partners

_ Possible development of conflict between partners

Disadvantages _ Closely regulated

_ Most expensive form to organize _ Charter restrictions

_ Extensive record keeping necessary

_ Possible development of conflict between shareholders and executives

Advantages

_ Relatively low start-up costs

_ Greatest freedom from regulation

_ Owner in direct control of decision making

_ Minimal working capital required

_ Tax advantages to owner

_ All profits to owner

Advantages

_ Ease of formation

_ Relatively low start-up costs

_ Additional sources of investment capital _ Possible tax advantages

_ limited regulation

_ Broader management base

Advantages _ limited liability

_ Specialized management _ Ownership is transferable _ Continuous existence

_ Separate legal entity

_ Possible tax advantage _ Easier to raise capital

Source: Modified from "Advantages and Disadvantages of Each Form of Business Organization." Reprinted with permission from the Government of Saskatchewan, Saskatchewan Industry and Resources, Business and Co-operative Services. http://www.cbsc.orgiservlet/ContentServer?cid= 1 081945275353&pagename=CBSC_ ON%2Fdisplay&lang=en&c=Guide FactSheet.

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e) All of the above

ANSWERS

42 I CHAPTER 5

10. D

1. D

2. Due diligence means that all reasonable steps have been taken to satisfy statutory obligations. An example of due diligence is the creation of policies and procedures relating to protection of the environment. By creating these policies in response to environmental legislation, an officer or director is acting with due diligence. If an employee breaks these policies, or physical circumstances suddenly change to render the policies ineffective, the officer will not be held individually responsible because he or she had developed policies in due diligence.

3. Directors are individuals who direct the business of the corporation. Officers, such as the president, vice-president, and corporate secretary, provide a closer operational direction for the business. Shareholders own the business and do not necessarily have a role in the business.

4. They can obtain an indemnity from the company they will be working for, and they can purchase directors' and officers' liability insurance.

5. Not guilty. The information was made public prior to the shares being sold.

6. D

7. B

8. If the negligence relates to the business of the partnership, the answer is yes.

9. F