Business Organizations September 12 Introduction What is a Business? What is Business Organizations Law about?

Basic Forms of Business Organizations Stakeholders in Business Organizations - Slide diagram - Biz orgs are used to carry out commercial activities (this means we dont include not for profits) - Because they carry out commercial activities, they have relationships with many different stakeholders: - Employees: people paid a regular salary through whom the commercial activity is carried on. Dont need employees to have a business, might do it all yourself. - Customers: people buying the goods and services producing income for the comm. activity with the prospect of making money - Financial creditors: give money to the business expecting it will be paid back with some kind of return over time. Virtually all businesses have financial creditors. - Trade creditors: supply goods and services to the business but maybe not paid right away. Common for them to be supplied on credit, payment is deferred. - Public: success or failure of the biz org has an impact on the local economy. Money made gets recirculated into economy or reinvested. There may also be some impact from the orgs activities depending on their business. For example, disposing of waste in an enviro friendly way and the extent that it is not done, the public is impacted. - Government: a proxy for the public interests, ie; govt enviro regulations for what is done with waste. Engage in a variety of sector and area specific regulation as well as general economic regulation. There are also obligations of the biz org in the ITA to pay taxes on what they make. - Owners: an internal stakeholder entitled to net economic benefit of the business. Net because the biz has to pay employees, creditors, taxes, warranty commitments, and they are paid ahead of the owners. Their claim is residual, left after everything else gets paid. This is what defines an ownership interest. It is a risky interest as compared to fixed claims of creditors.

- Managers: an internal stakeholder. They run the business may be the same people as the owners, but as scale of biz increases that is less and less true. When bigger, owners are shareholders, managers are different. What is biz org law about? - All of these relationships have legal dimensions. - Contract law governs many of the relationships - Within employee relationship, employment standards, occupational health and standards, other kinds of rules employment law/labour law - With customers, there are consumer protection laws, advertising laws, etc. - With creditors, relationship based largely on contract - With public, defined in regards to regulations such as enviro regs - But biz org is about three things in this context: 1) is the org responsible? when the biz org is responsible to these various stakeholders how we know when they are liable for tort, crim, contract. Who in the biz org is responsible? Which of the internal stakeholders is responsible for tort, k, crim 2) defines to what extent the managers have to take into account the interests of the various stakeholders in deciding what it is going to do impact on enviro, public, employees, creditors, etc. The extent to which they have to consider these interests, not things theyre forced to do like follow regs, pay taxes, etc. 3) deals with the relationship between the biz org and managers on one hand, biz org and owners on the other, and the relationship between managers an downers. Provides a legal structure for internal stakeholder relations within a biz org. Stakeholders in Business Organizations - Slide diagram Sole Proprietorship - One person carrying on a business, the manager and owner of the business, but may have employees. Only one person entitled to manage and own it. Distinct feature of the SP: there are no separate stakeholders internally but all the other relationships still exist. Sole Proprietorships - Formation individual carries on business for his/her own account. Characteristics: - SP is sole owner all assets are owned by them (ex: trucks, ladders, inventory in construction business) - SP cannot employ self no person with whom they can enter k.

- All benefits accrue to SP as sole owner, all residual benefits accrue to the SP - All obligations are SPs personally, for example: Contracts SP solely responsible for all obligations. Doesnt matter if hes hired employees who may have undertook to do the work if it isnt done or not consistent with the agreement for the job, SP is responsible. Torts SP solely responsible for tortious acts of self or employees Income Tax all income from business is taxed to SP, included in income tax return subject to any expenses that might be earned in connection to earning that income. Any losses associated with the SP may also be deductible subject to limitations under the ITA. Unlimited personal liability a key feature of SP. It is not restricted in any way to the business, or the assets of the business to be more specific. If a claim is made regarding the failure to perform a k, and customer sues, liability can go to not only the assets of the business but also their personal assets like money in bank account, personal car, etc. This limits the SPs practical utility in the marketplace, they are not used in large scale businesses because they would leave themselves open for large scale liabilities. This unlimited personal liability is a disincentive to having an SP. You could manage the risk by taking out insurance but this can be costly, and there are still limitations for what you can get insurance for. Cost might not really justify the protection you get. Could also contract out of responsibility limiting liability, reducing damages to which you are liable. Bit of a cost, but it is also limited to judicial reluctance to enforce, and also only relates to those you are contracting with. If you hurt someone in the public, no contract protecting you. - Financing: another limitation of the SP only one option, you borrow money. With other forms of biz org, wider variety of raising money ie; selling shares in a corporation. - SP law is thin doesnt provide organizational structure dealing with how you would have more than one person involved. Another limitation as you have to create it entirely by yourself through contract or whatever. - For these three reasons, SP may be brought into being very simply but has these disadvantages that make it less useful in a large scale biz org, at least compared to alternatives. Stakeholders in Business Organizations - Slide diagram Partnership - the partners are the owners and managers - what defines the partnership compared to SP is that there is more than one person who is the owner and the manager. At least two people carrying on biz together. - but like SP, no distinction between biz org (the partnership) and the people who are the partners 3

Partnerships - Formation 2 or more persons carrying on business in common with a view to a profit. A legal definition coming out of the Partnerships Act (s. 2). Characteristics - Internal relationships (with other partners), that we dont have to deal with in SP: the legal characteristics of this relationship are governed by default rules (meaning they apply unless the parties agree otherwise) in Partnerships Act (ss. 20-31) - Partners are sole owners: but limits on what can do with partnership property since there is more than one person. They cant use partnership property for their own personal benefit, have to use it for partnerships benefit. - Partner cannot be an employee - All benefits of partnership accrue to partners: residual after everyone else gets paid. - All obligations of partnership are partners personally Contracts each partner responsible for all obligations in course of firms business regardless of which partner actually commits the partnership to doing it. If 10 people in partnership, one commits firm to something, others dont agree, partnership is still responsible for the performance of the obligation. Torts each partner responsible for tortious acts of self, other partners or employees in course of firms business. One partner negligent, all partners are responsible. Income Tax all income from business calculated at the partnership level and taxed in the hands of the partners. A bit different from SP context partners individually pay tax on their interests in the business. Have to pay tax even if not distributed to them in the form of cash. If they keep the money in the firm to reinvest into it, they still have to pay tax on the income. - Each partner has unlimited personal liability: same as the SP case, all personal assets and business assets may be taken for any claim made. But individual partners can be insulated from the liabilities incurred by other partners if it is a limited liability partnership (LLP). This is a huge benefit for individual partners. Partnerships - Liability of partnership (and thus partners) to third parties is governed by mandatory rules in ss. 6-19 of the Partnerships Act. This doesnt apply to SP because there is no unauthorized behaviour, only one person making the decision. - Each partner is an agent of the partnership: may bind the partnership when acting in the normal course of the partnership business. Risk of unauthorized 4

behaviour allocated to the partners. Third party entitled to hold the partnership liable when it is reasonable to think that it is a partnership obligation. Harder to argue if the behaviour is not reasonably connected to the firms business. See s.6 of Partnerships Act. How to manage risk of unauthorized obligations? Legal Protections - Partnership agreement most have a contract where they address the risk of unauthorized obligations. No impact on third parties as that is mandatory, but more about the allocation within the partnership. Ex: a rule that no single partner can sign off on an obligation without conferring with somebody else. If they didnt confer, they might have to agree that they will pay to the partners for whatever they become liable for to the third party as parts of the partnership indemnification committments. Management and control procedures in place to try and restrict liability. - Law of partnership fiduciary duty: partners obliged to always act in the best interests of the firm, not put their personal interests ahead. - Limited Liability Partnerships under Partnerships Act (ss. 10, 44.1): not everyone can take advantage of this, certain requirements of the profession Practical Protections - Relationships of trust and confidence: historically partners have been small groups of people that all knew each other. This means there would automatically be some trust/confidence built into the partnership from the beginning. An informal factor, no legal requirement but often exists. - Opportunities for informal monitoring: working together, can keep track of what other people are doing. - BUT: the effectiveness of both diminishes as size of partnership increases maybe multiple offices across prov, country. Need a set of rules where relations of trust and confidence, opportunities for informal monitoring dont exist so they turn to a LLP to do this. Stakeholders in Business Organizations - Slide diagram: Corporations - Shareholders are like owners because they have a residual claim to the assets of the corp after everyone else is paid. But this is subject to a variety of rules both in statute and in the provisions which define the characteristics of the shares. Shares represent bundle of rights and claims against the corp. Corp as separate legal entity that owns the assets, subject to liabilities, receives benefits. - Directors and officers are functionally managers. Elected by the owners. - These groups exist separately from the corp that is a key feature of a corp. A corp is a separate legal person. Corporations

- Formation filing incorporation documents with appropriate government authority. Doesnt happen automatically like SP or partnership does. Govt has to issue certificate, only at that point does it come into existence. Characteristics - Separate legal entity separate from shareholders this completely changes how we deal with the corp compared to the other biz orgs - Corporation itself -- carries on business -- owns property of business --solely responsible for obligations of business: Contracts Torts Taxes solely entitled to income from business Implications of separate legal existence - Person can be shareholder, creditor and employee - Shareholders not liable for obligations of corporation (generally). Imprecisely described, shareholders have limited liability they cant lose any more than they have invested into the corp. - Corporation has perpetual existence - Must act through human agents Separation of ownership and management - Conceptually and, sometimes, practically - Managed by board of directors (often delegated to officers) elected by shareholders - Not shareholders directly - As businesses become larger, there is a tendency for separation: - Shareholders ELECT directors who APPOINT officers this creates some issues Issue How do shareholders ensure that management (directors and officers) act in their interests? - Negligence by management: mgmt shirking responsibilities negatively impacting income of the corp, reducing the value of their shares. - Putting management interests ahead of shareholder interests: directors and senior managers paying huge salaries to themselves not justified by the business - Favouring one group of shareholders over another: directors elected by shareholders, and if there is a majority shareholder, they can control the outcome of election. Directors may be tempted to do things favoring the majority shareholder over the interest of the minority. Ex: director approving the sale of a corp asset to a majority shareholder for less than it is worth.

Corporate law responses to concerns - Controls in corporate constitution (articles aka document filed with govt to bring corp into existence, by-laws and shareholder agreement) - Duty of care, fiduciary duty and obligation not to oppress: behavioural standards - Access to information: distributed to shareholders to keep track of mgmt activity - Shareholder voting: electing directors on periodic basis - Shareholder remedies: where obligations of directors/officers not satisfied In small corporations with few shareholders separation more legal than real Readings for Next Class VanDuzer pp. 28-49 Casebook pp. 6-15 September 14 - next class read question 1 from 1997 exam online - Van Duzer 49-63 - Casebook 31-34 Sole Proprietorships and Partnerships (Part II) Sole Proprietorships - Obligations applying to all new businesses apply to SPs upon commencement of business. Eg: licences under Municipal Act; Securities Act; Registered Real Estate Brokers Act - Registration of SP name under Business Names Act required if: carrying on business AND using a name other than persons own name (s.2(2)). Need to register because it is a public record of the name being used and the person who is using it. This is important so the person with whom the business contracts can figure out who the individual is that is responsible for the obligations. - The key is that the trigger for both is carrying on business - Registration under Business Names Act: if you do not reg when you have to, you cannot sue in ON to enforce business obligation (s.7), will be liable for a fine of up to $2,000 (s.10). As a practical matter, this fine is never enforced, but there is potential, so you need to advise clients about it regardless. -- These are incentives to get you to register, so there is public record which can be relied on by those dealing with SP to identify individual who is liable for SPs obligations. You may want to register even if you do not have to, to put 7

others on notice that the name is in use. A benefit of this is that if someone registers a name misleadingly similar to yours, you have a statutory right to some damages. If you have a client starting a business as an SP or partnership, you might want to search this registry to see if such confusion may arise. - There are no legal entitlements created to the name by way of this registration. It is not like an intellectual property right. You might be able to argue that your business name is a trade-mark, but they are not affected in any direct way by this reg system. Partnerships Recap: formation 2 or more persons carrying on business in common with a view to a profit (Partnerships Act s.2) 3 Types of Partnerships: (1) General Partnership (or simply, partnership): each partner has unlimited personal liability for all obligations of the firm/partnership (Partnerships Act ss. 6, 10-13) (2) Limited Liability Partnerships: same as general partnership EXCEPT partner not personally liable for obligations of (i) another partner arising out of the negligence of another or employee or (ii) the partnership (with exceptions) ss.10, 44.1. Referred to as full shield limited liability partnership protects partners from all liabilities of the firm itself. The partnership is still responsible. This means that the assets which are partnership property, used in the partnership business, may be taken by a creditor of the partnership. The limited liability regime prevents creditors from claiming against individual partners personal assets. If there is a successful claim against the partnership, the assets of the partnership may be used to pay off the claim and this reduces the value of each partners investment in the partnership, but personal assets are still protected. (3) Limited Partnership: at least one general partner (unlimited personal liability) and one limited partner (liability limited to amount contributed to partnership). Limited Partnerships Act ss.8, 9. Example: somebody starting a business, wants to raise money for it. May use this form of partnership where they sell units to limited partners in exchange for cash. In this way, no claim against their personal assets. The general partner takes more liability, limited partners are more like passive investors. - All general and limited liability partnerships have to register under the ON Business Names Act (s.2(3)). Licensing and other requirements also apply.

- Scheme of Partnership Act: -- nature of partnership (ss.2-5) -- relationship of partners to persons dealing with them (ss.6-19) mandatory rules -- relationships of partners to each other (ss.20-31) default rules -- dissolution of partnership (ss.32-44) - The law of partnership evolved out of English common law. This means there are a lot of provisions that are hard to understand, or dont fit well into modern business activities. So what becomes more important are partnership agreements to customize the relationship, to more effectively their objectives in the contemporary marketplace. Formation of Partnership - Partnership = relation between persons carrying on business in common with a view to a profit (s.2) - These three elements are objectively determined. The court decides based on all the circumstances whether your relationship meets these requirements. A finding of partnership may be inconsistent with the parties subjective intention. They may have entered into an agreement explicitly saying they are not partners. Court is not bound by this, they look at the whole relationship and decide whether it fits within the definition. - People might not want to be partners because they dont want to protect themselves from unlimited personal liability. (1) view to a profit: need not actually make profits but not charitable, social or cultural purpose. If youre looking to just cover your costs, not a biz org (SCC decisions in Continental Bank; Spire Freezers and Backman) Spire Freezers: F: existing partnership with two businesses. One apt complex, one condo development. Condo was losing money. To deal with this, made a plan to sell interests in the partnership to businesses like Spire Freezers, and then buy the money losing condo development from the partnership triggering a loss of $10M. Goal was that profitable businesses buying interests get to deduct a share of the losses against their income. Rev Canada didnt want to allow the deduction because it was not carrying on a business just bought an interest for the sole interest of deducting the loss. R: SCC: there was a view to a profit because Spire continued as a member of the partnership while it was carrying on the second business of the partnership, the apartment complex. They continued to manage it, earned profit from it. They didnt make enough to cover the loss incurred, but it was a real business and was being carried on in a profitable manner. If the main purpose was to get access a loss to deduct, so long as there was a secondary purpose of carrying on a business toward profit, it is OK.

Backman F: Transaction similar to Spire, but one difference no business left after property sold triggering the loss. R: Because no business being carried on with view to a profit, SCC denied the deduction of the loss. - So how do you know where to draw the line, how much business do you need to have in the partnership to fall into Spire rather than Backman? No real answer have to have some business being carried on, but how much, hard to say. (2) in common: together or jointly carrying on a business. Based on some kind of agreement. It need not be express, court will infer an agreement from the parties behaviour, but agreement must be given effect through actions directed to carrying on a business, extend to all the essential elements of a partnership. Red Burrito F: Two people entered into agreement to carry on a restaurant business. Wanted to create corp, create a bank account for the corp. But they never got around to it. One party had a lease on business premises. Agreement said the premises would be renovated, and money would come from partner corporation Red Burrito. Renovations done, restaurant opened. RB and partner disagreed locked out RB, and they didnt get benefits from the restaurant. RB sued alleging partnership. R: They did not agree to a partnership, but a corporation, although they didnt get around to making it a corp. RB argues that what they in fact did was a partnership court agreed that it was a partnership because they adequately met the three requirements. +: No express agreement to create a partnership, but it was shown in a different way. p. 39 case: F: About requirement dealing with all essential elements of a partnership. Two parties thinking they had a partnership, they referred to each other as partners, gone some way to set it up. R: But they hadnt dealt with two items: when the business was going to get started, and what each partys contribution should be without these, court found no partnership. (3) carrying on a business: business defined broadly (any trade occupation or profession s.1) and interpreted broadly (Thrush v. Read [business can mean anything, even a single transaction], Khan v. Miah [F: two parties take steps to open a restaurant, bought land, advertised, table cloth cleaning, but never opened it. So was it a partnership or not? One argued there was no business, they never sold anything. R: Everything they 10

did was directed toward carrying on a business, fact they didnt take the last step is not determinative. So it is a business.) The principal indicia of carrying on business together is sharing profits. Why sharing profits? - Sharing profits is an imperfect way of identifying when parties are carrying on business together. - Profits = revenues (sales, fees, etc.) less expenses (cost of inputs, wages, costs of manufacturing and processing, etc.) - If sharing profits, a person is concerned not just about sales, but also management. An ownership-like interest, a residual claim return depends on how successful the business is. Profit is what is left after everybody else gets paid. That is the kind of interest an owner, a SP has. - But sharing profits is not enough in itself, it depends on context (Partnerships Act s.3). There are some situations in which sharing profits does not create inference of partnership. Some examples: Eg: s.3.3 (not exhaustive) - repayment of debt out of profits - compensation to lender in the form of share of profits or interest rate varying with profits - employee profit sharing - annuity to spouse or child of deceased partner out of profits - payment of purchase price for sale of business out of profits Cox and Wheatcroft F: B.Smith and Sons have an iron works business. Have creditors including Cox and Wheatcroft. Business is struggling. Creditors concerned they wont have debts paid off. They enter into an arrangement: agree that Smith and Sons will transfer title to trustees appointed by creditors to run the business. They take direction from creditors, creditors decide if business should be wound up, etc. Smith and Sons assigns its right to profits to the creditors unless and until they are fully repaid. The amount owed to the creditors doesnt change. This is called a receivership today. While the business is being carried on by the trustees, there is a creditor who lends money to the business which is not paid lawsuit then alleges that Cox and Wheatcroft are partners in this business. R: Court is trying to address whether a partnership should be found. - Addresses the scenario whether someone is a partner or not comes up. A creditor of an existing business is unpaid. Looking for someone with money to sue. The people carrying on the business/responsible not worth suin as they have no money. Hickman, a creditor, alleging that Cox and Wheatcroft, also 11

creditors, are partners. Basis: they have appointed trustees, the business in terms of legal title has been transferred to trustees who run the biz on daily basis. They also give directions to trustees how the biz is to be carried on, can replace them, can direct them to wind up the business and sell off assets to pay down the debt. Anything left after biz of trustees carried on, B Smith and Sons get it back. - So Hickman says: theyre getting the profit, so they should be partners therefore they are personally liable for obligations of the biz, and that means their assets go to me. - Previously, the court said sharing profits = partnership. But the court here doesnt say its so simple. We looked at s.3(3) setting out five examples of relationships with sharing profits but inference of partnership should not be drawn. - H of L want a different test: for Cox and W to be partners, have to find the biz is being carried on for their benefit, the agency basis for partnership being carried on by agents on behalf of the partners. R: H of L this is not the relationship here. It is a debtor-creditor relationship. The debtor has agreed that the biz will be carried on for repaying the creditors. This doesnt transform the nature of the obligation into partnership. Simply agreement by debtor about how the debt is going to be repaid. They get the rest after creditors paid. Even though profits are shared and the creditors control a lot, still not enough to change it into partnership. +: The agency test is the test that has survived. Still the basic test we use for what a partner is. September 19 Partnerships Factors indicating partnership -- Common ownership: not of itself create partnership (s.3.1) - Mere fact that co-owners intend to acquire, hold and sell for a profit does not mean there is a partnership - Right of co-owner to deal with his/her individual interest in property separately incompatible with intention that there be a partnership. Even if right is subject to right of first refusal (AE Lepage). May be shown by how co-owners file income tax (ex does each make own decision regarding capital cost allowance deduction? AE Lepage) - It is not easy to draw bright lines when a simple co-ownership relationship turns into partnership, but two ways: (1) assets being used to carry on a business (vacant land to shopping centre) (2) engagement of alleged partner/co-owner in the management of that business AE Lepage F: Looking at the nature of the ownership interest that the partnership has. Apartment building with bunch of co-owners. A,B,M. Agreed to share any 12

profits in proportion to their interest in the apartment. Would also contribute to any losses also in proportion to interest. They were each able to sell their interest independently to a third party any time they wanted to. Only restriction in agreement: had to give a right of first refusal to other owners. Right of first refusal: before selling, have to offer to other co-owners first. Arises in a variety of contexts. In terms of selling the whole property would require majority vote of the owners. So, one of the owners, M, entered into real estate listing agreement with AE Lepage to list property for sale. M had no authority from other partners. Eventually was sold not through what Lepage did, but sue for their commission as part of their contract. Lepage sues the partnership for its commission. Co-owners: M not acting with consent, no partnership, so whatever claim they have against M isnt against them. R: Court agreed with co-owners. The right of first refusal doesnt mean this is a partnership it doesnt really limit the ability of any co-owners to sell, just have to offer it to them first. Court looked at their income tax returns. Noted that each of the co-owners made individual and different decisions about the deduction of capital cost allowance in the apartment. The value deducted from property to account for depreciation of property. So each owner made an individual decision about whether they would take it or not. They were fundamentally allowed to deal with the property however they wanted. If this was a partnership, couldnt have done that. The property would need to be used for partnership, until the partners agree to do something else with it. Agreement was just about regulating common interest in their co-owned property. Common Ownership Volzke F: Two corps in partnership B and W B owns 80% of shopping centre, W owns 20%. Decided to do renovations, got V to do construction. Never paid, V sues alleging there is a partnership carrying on the partnership business. V wants to get assets from W because it had more assets. Is there a partnership between these two? R: There is certainly co-ownership, and other indicators like engagement in management that is relevant. A list of ways that this looked like a partnership instead of co-ownership included below: involvement in mgmt may transform co-ownership into partnership so, indicators of involvement in mgmt Common bank account shared costs as well as profits spoke of each other as partners participation in financing finding in prior litigation sending tenants and prospective tenants to Bonel 13

- repairs to shopping centre premises - The court said in Volzke that the involvement in mgmt need not amount to control. So even with 20% interest still can be partners. - Participation in mgmt or other contribution is also not necessary (No. 41 called W v. MNR: partners agreed to be partners) No 41 F: Patent agents. Agreement between partners that widows of them would receive a share of the partnership profits on on-going basis. Widows didnt participate in business any way. Simply received benefits. In the agreement, widows acknowledged they were responsible for losses of the business. MNR arguing that the widows werent contributing anything so the amount should be taxed in the hands of the contributors (since they were paying tax at a higher rate) R: Responsibility for losses in the biz key factor in finding the widows partners. Specifically undertaken to be responsible for losses, carried on for their benefit, should be considered partners. Three important points: (1) involvement in mgmt for finding partnership at least where parties have agreed to be partners. Critical aspect is the agreement to be partner and to explicitly agree to share responsibility for losses. (2) the determination of the legal status of people under partnership law is determinative of the tax outcome. This is the same as corp law in general. The corp law outcome will determine the tax effect of the transaction. (3) after this case, MNR was successful in having the rules changed to specifically address this situation for tax purposes, if youre partner, youre taxed on the basis of an amount reasonable based on your contribution. So you cant do this anymore money is taxed in the hands of the people who are making the contributions to the business. Factors indicating partnership (p.48) - none of these factors are conclusive - sharing profits - sharing responsibility for losses, cinluding guaranteeing partnership debts - jointly owning property - controlling partnership business - participating in mgmt - stating intention to form partnership in k - making govt filing showing partnership (eg registration under biz names legislation, tax returns) - access to information regarding the biz - signing authority for ks, bank accounts - holding oneself out as a partner - contributing money, services or property as capital money made without fixed arrangement for repayment, not like a loan (esp if contribution is complementary to the contribution of others for the purpose of running a biz) 14

- full-time involvement in the business - the use of a firm name, perhaps in advertising - the firm has its own personnel and address - so starting point is s.2 partnership definition, then factors that are relevant for determining the definition. The key starting point is agency from Cox and Wheatcroft, then all the factors on top of it. Question 1 from 1997 Examination Existence of Partnership - Fact pattern of the question included Question 1 from 1997 Exam Bram is a successful real estate developer and was Sherrys largest client. He left his wife and is anticipating a custody battle for his two children. Sherry referred him to Amman, introducing him as her partner. Bram told Amman that he has great faith in Sherry and was confident in anyone who was her partner. Amman missed a limitation period in connection with Brams litigation and Bram is furious. QUESTION: You are a lawyer to whom Bram has come for advice. Assuming Amman is liable for negligence, is Sherry liable as well? (TWENTY (20) MARKS) - Where do you start? Think about the legal basis that her liability could arise, and that would be through a partnership (at least at this point). Also look at whether this was a joint venture (well learn about this later). So we will only focus on partnership. If S and A are partners, she would be responsible for his negligence, found in ss.10,11 of Partnership Act. - Is there a partnership? Look at s.2 two or more people, carrying on biz with view to a profit. Address those three things. Is As business being carried on for Ss benefit? This is the agency question, and probably the most important aspect of this question. - Did they enter into an arrangement? Entered agreement, run firm together - View to a profit? Not doing their work for free, substantial aspect of the business, carried out in common - One of the key things against this being a partnership: they arent really sharing profits. If A makes a ton of money in a month, arguably not much benefit to S.

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- They signed an agreement they are not partners. So if we wanted to argue in the contrary wed have to address that fact. - Other things you might like to know about this relationship not put into the facts: was B still really a client of S, their govt filings like tax returns, biz names act registration, reporting to law society re: trust accounts - Is there any argument that this is an LLP? We havent talked about this before, but you need to have a name with LLP at the end, have to separately file, have to have an agreement to be an LLP Partnership Act rules governing relations of partners to each other Why default rules, since they apply to the extent that partners dont change them? - Better to have rules in Partnerships Act than buried in Common Law - Encourage people to engage in business by reducing transactions costs. Give a kind of standard form contract to govern their relationship: extent of benefit depends upon how closely Partnerships Act standard form contract resembles what people would have agreed to if no impediments to negotiation. If the rules dont fit for them, and they dont agree to change the rules, can be a trap for the unwary they are stuck with them. - Give parties flexibility to customize partnership relationship to reflect their particular circumstances Nature of default rules? - Based on archetypal conception of partnership: Small number of persons who participate equally, financially and in management. Partnership is no more than the partners who make it up: continuation of each partner in partnership is essential to the continuation of the partnership itself - Often these big picture assumptions dont apply: in which case rules are trap for the unwary p. 50 - Each partner shares equally in capital and profits and must contribute equally to any losses (s. 24.1) but in a law firm not everybody gets the same pay. So it is almost always changed in partnerships, even small ones. The contribution to capital is also quite variable. - Each partner is entitled to be indemnified in respect of payments made or liabilities in the ordinary course of business or to preserve the business or property of the partnership (s. 24.2) - A partner is not entitled to interest on capital (s. 24.4) no immediate expectation of fixed return on the debt - A partner is entitled to interest at 5% per year on excess contributions (s. 24.3) parties need to address what the capital is, who is contributing what amount - Each partner has a right to participate in management (s. 24.5) 16

- Decisions regarding ordinary matters decided by a majority of partners in number (s. 24.8) - Each partner has equal access to the partnership books (s. 24.9) - Admission of a new partner (s. 24.7) and any change in the nature of the partnership business (s. 24.8) require unanimous consent - No majority of partners may expel a partner (s. 25) - Any person who takes an assignment of a partner's interest has no rights as a partner, except to receive the share of the partnership profits (s. 31) - Any partner may terminate the partnership by giving notice (ss. 26 and 32) - Any variation of the default rules requires unanimous consent (s. 20) Partnership Act rules governing relations of partners to each other - Fiduciary Duty Hitchcock v. Sykes: To act in the best interests of the partnership - Obligations consistent with fiduciary duty, giving effect to the basic rule: -- Render true accounts and full information (s. 28) cant keep secrets, tell them what is going on with anything related to the interest of the firm -- Account to firm for any benefit from transaction concerning partnership or use of partnership property, name or business connection without consent of partners (s. 29)(Rochwerg) -- Not to compete with partnership or must account for profits (s. 30) (Mohammadamin) -- Remedy in last two is an accounting for profit: if you obtain a benefit from either of these things, you have to account for them. Creates disincentive from engaging in that behaviour, as you wont be able to retain any benefit. Rochwerg F: Accounting firm. One asked to be a director of a client. Accountant entitled to receive directors fees and to buy shares of the client, with the option to buy more. A became director, declared the fees to the partnership, paid them over in recognition to his obligation, but the benefit he obtained through investing in the shares he felt shouldnt be associated with the firm, as he had to pay the money for them. Other partners challenged any benefit associated with the shares should go to firm because if he hadnt been working for client with firm wouldnt have had access. R: Court agreed with the other partners. Without the work being done on behalf of the firm, wouldnt have got the opportunity. +: You need to think in the context of your partnership about these possible benefits that may come up, where people get individual awards for things. Mohammadmin F: Car parts business, partner quit and set up competing business down the road. R: Inconsistent with fiduciary duty obligation extends beyond the time that the person is legally a partner.

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Partnership Property (ss. 21, 22) - Once property -- contributed to partnership, -- acquired on its behalf or for the purposes and in the course of the partnership business or -- bought with partnership money it becomes partnership property - Important legal consequence: Must be held and used exclusively for partnership purposes and in accordance with the partnership agreement. The person is not allowed to change their mind, the other partners can be within their rights to deny them the ability to withdraw the property. What would you do about this? Need an agreement up front about what is partnership property and what is not need to think about these things before the problem arises. Once a problem has arisen it is difficult to get an agreement because everyone will behave differently based on the situation. So we advise people up front, create structures for their relationship up front to avoid problems like this. - Applies even if individual partner continues to hold property i.e. partner cannot sell property that he/she owns if has become partnership property Partnerships Act rules governing relations of partners to third parties (ss. 6-19) - Govern when partnership liable to third parties - Mandatory -- But can address consequences in partnership agreement -- Reduce likelihood of unwanted liability -- Management and control arrangements -- Provide for indemnification BUT agreement has no impact on liability of partnership or partners to 3P Basic Rules - Partner is agent of partnership: partner has some authority to bind the partnership and the scope of that authority is defined in the Partnership Act. The partner has the ability to create liabilities/obligations on behalf of the firm. The firm incurs obligations based on what the partners do. - Partnership liable for -- Obligations incurred by partner carrying on, in the usual way, business of the kind carried on by the partnership UNLESS Partner had no authority in fact AND Third party dealing with partner knows of lack of authority or does not know or believe him to be a partner (subjective knowledge)(s. 6). Ex: law firm aims to give legal advice but many do other things like estate trustees, investment advice, etc. That is not law, but things like that define the scope of the partnership business, liabilities and obligations that it creates. If you give investment advice, that is part of the firm business. If it is negligent, the partnership is likely to be found liable because giving it was part of the ordinary scope of the business even though they only really set out to practice 18

law. It is about the practical operation, what actually goes on, rather than what is generally the scope. -- Wrongs in ordinary course of business of the partnership or with authority of all partners (s. 11) applies to torts including fraud (e.g. Falconi). How is fraud part of the ordinary course of business? Falconi F: lawyer advising a client about how to fraudulently dispose of their property in anticipation of their bankruptcy by transferring it to friends and relatives, which would defeat the claims of creditors. This is prohibited under the BIA. Partner found liable for the fraud is the firm liable as well? R: Was the fraud in the ordinary course of partnership, or with the authority of the partners? The court said the test is whether the unlawful acts are of the sort that it woud be within the scope of the partnership if it were done for legitimate purposes. The lawyer was doing something that is the kind of thing lawyers do, drafting agreements for the transfer of property. That was enough to say the fraud is covered, and the other partners were found to be responsible. Basic Rules person liable as partner where held out as a partner and - This is for liability of a person who is not a partner. Previously was for people who are partners. - Person held out (any representation that you are a partner) self or knowingly permitted self to be held out (knowledge of a general holding out sufficient). Can be a general holding out to the public at large, doesnt need to be to the specific person AND - Holding out is to person who advances credit to the firm on the faith of the holding out (reliance dont have to actually advance credit, but that you have relied on the person being a partner, recall question from 1997 exam) (s. 15) (Tower, National Building Society) - May be liable under s. 15 even if never were or no longer are a partner. An independent basis for liability may be something seen on exam recall 1997 question. One of the bases for the claim was not only that they were in partnership, but alternatively that there was a holding out within the meaning of s.15. Tower F: Partnership with two people. One partner leaves, said to the other person carrying on business, they are not a partner, take them off the letterhead, disassociate from firm. Person left had old letterhead paper with old partner on it, used it in connection to enter into k with third party. Default on commitment. Third party sues and alleges person left still a partner because of letterhead. R: Applying s.15. Person is not a partner, but have they been held out, permitted themselves to be held out? No, didnt allow themselves, gave express directions to not be held out. Not a sufficient basis to apply s.15. 19

National Building Society F: law firm giving opinion that turned out to be wrong, negligent. On letterhead of firm, list of lawyers including Lewis. L was not a partner, associate. Client sued Lewis alleging he had been held out as a partner on the letterhead. R: Court willing to accept that L was being held out and he was consenting to it, but claim was unsuccessful. Client had not relied on L being a partner relied on the opinion to their detriment but L was not part of the file, didnt figure in what gave rise to the negligence. Indicates the importance of the reliance component for establishing liability.

- Say there is a partnership with $90,000 assets. There is a claim against the firm for $50,000. D enters into the partnership with $10,000 in assets, making partnership assets $100,000 for a 10% interest. The litigation claim is commenced and is successful so the assets of the firm are reduced down to $50,000. If youre D, you bought a 10% interest for $10,000 but it is now only worth $5,000 or 5% in comparison to the original interest. What should you do to avoid this if you were D? Should see whether there are claims against the firm might not be easy to find. Need existing partners to say there are no claims, or agree and tell you what the claims may be. On top of this, youd want an indemnity agreement for situations like this prior to joining them. Maybe increase interest to 20% or cash payment, or some other solution. - What happens when you leave? With reference to diagram above the starting assumption is the person not liable for new obligations arising after they leave. Unless creditor dealt with firm before their retirement entitled to assume the partner who left is still a partner. They will continue to be liable for new obligations to that existing creditor client. But there are exceptions: either creditor didnt know D was a partner prior to their retirement, so no 20

expectation of his responsibility, or they were given actual notice of the retirement. Practically speaking, would want most clients to be given notice either through e-mail, newspaper, etc. of your retirement. - Creditors dealing with the firm for the first time after retirement: only circumstance D could be responsible is where there has been a holding out within the meaning of s.15. s.36(2) filing a notice in the Ontario Gazette, but business people dont regularly read this. - D is never responsible if they die or become insolvent - Protecting yourself as a partner leaving: get the notice in the Ontario Gazette. Ensure that you are not held out as a partner tell the remaining partners to not hold you out as a partner. One of the key ways is if their name is used in the firm name you may want your name taken out although this is a problem because the name likely has goodwill attached to it. The ways to address this: insist your name is taken out, or seek indemnification commitment on behalf of the partners. This assumes that they would be able to pay you back so you need to consider the legal consequences and the risks, and the client doesnt have to allow their name to be used. - Maybe you also put it in the newspaper, trade publication, blog to give notice. September 21 Limited Liability Partnerships (ss. 10, 44.1- 44.4) A general partnership except - An individual partner not liable for debts or obligations of partnership or another partner arising out of negligence, or wrongful acts or omissions of -- Other partners or -- Employees, etc. Or other debts or obligations of partnership UNLESS -- Act or omission of other partner or employee constitutes a crime or fraud (criminal or civil) OR -- Partner knew or ought to have known of act or omission and did not take actions to prevent it that a reasonable person would have taken (ss. 10, 13, 24 and 44.1) - This is why we call it a full shield LLP this is not the same in AB and BC Partner remains liable for own negligence and wrongful act or omission and that of person directly supervised or controlled by the partner - The firm remains liable. To the extent that there is a negligence claim against a lawyer in the firm, the firm is still responsible such that all firm assets are available to a person making a claim. But this shield prevents the claimant from eventually seeking the personal assets of the individual partners except those that were professionally negligent.

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French text - Subsection 10(3) Le paragraphe (2) ne dgage pas lassoci dune socit responsabilit limite de sa responsabilit au titre de ce qui suit : a) b) c) les actes ou omissions ngligents ou illgitimes que commet un coassoci ou un employ qui nest pas plac sous sa surveillance directe si les conditions suivantes sont runies : (i) les actes ou omissions taient de nature criminelle ou frauduleuse mme sil ny a pas eu dacte criminel ou domission criminelle proprement dits, [or missing] so under French version it would seem that if you were making a claim against a partnership, the shield of liability does not ioperate if it was fraudulent and they were aware of such thing. (ii) lassoci avait connaissance ou aurait d avoir connaissance de lacte ou de lomission et na pas pris les mesures quauraient prises une personne raisonnable pour empcher quil ne soit commis. +: Limited Liability Partnerships Formed by - Satisfying requirements set out in ss. 44.1 to 44.4 - Sign agreement designating as Limited Liability Partnership must be written agreement (s. 44.1) For a general partnership, you dont need to have an agreement, but for an LLP, need it in writing. - Registering under the Business Names Act (s. 44.3), which all partnerships are required to do. Note: Extra-provincial limited liability partnerships governed by liability rules of home jurisdiction despite carrying on business in other jurisdiction, but must register under the Business Names Act (s. 44.4) Other Requirements: - Partnership carries on the business of a profession governed by a statute and the statute permits limited liability partnerships. Permitted for lawyers by Law Society Act s. 61.1 - The governing body of the profession requires mandatory minimum insurance for all members of partnership. The LLP says to consumers that the only person you can hold responsible is the person you are dealing with directly. So in order to support this everybody needs to have insurance to cover possible claims. - Partnership name includes words or abbreviation indicating limited liability partnership (e.g. LLP or SRL). Show that there is a different allocation of risk compared to if you were just dealing with a regular partnership. Dissolution of Partnership

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Partnerships are fragile in the absence of agreement to the contrary can be dissolved easily and in multiple ways: -- Expiry of fixed term (s. 32(a))(e.g. Pooley: parties agreed pship last 14 years) -- Termination of single adventure or undertaking (s. 32(b)) normally associated with joint ventures. People coming together, combining their resources for a limited purpose. If you have that kind of situation, and it is a partnership when the common purpose is formed, then it is terminated when that is done. Furthermore, it has to meet the level of being a business. -- Partner giving notice of intention to dissolve (ss. 32(c), 26): in absence of agreement to contrary, can end whenever they want, unilaterally. Typically dealt with in a partnership agreement: cannot be dissolved on notice of one person, person looking to leave has to give proper notice. Matthews case: pship agreement said partner cant leave without 6 months notice. But pship agreement didnt say that the partner was prohibited from dissolving the firm. Guy wants to leave, restricted by 6 months, so wanted to dissolve the firm. Court said that the parties must have meant that an individual could not terminate the firm either, gave a generous reading to the pship agreement. -- Death or insolvency of any partner (s. 33(1)): this is also not practical for large firms. Typically changed in partnership agreements as well. -- Partner permits share of partnership property to be charged for his or her separate debt at option of partnership (s. 33(2)): contemplates scenario where partner goes to bank, says they have interest in partnership and wants to borrow money. Bank asks for security on the loan, bank takes interest in partnership. But partner doesnt have separate property interest in the firm. This should never happen. Anamolous provision that should never come up for us. -- Business of partnership becomes unlawful (s. 34): ex - all lawyers in firm become disbarred -- By court order (s. 35): if partnership agreement changed the circumstances for dissolution, may need to go to court. Different grounds for court to rely on in making an order to dissolve the firm. Last one is catch-all, where it is just and equitable to dissolve the firm. s.44 of Partenrships Act: when pship is dissolved creditors get paid off first. Anything left goes to advances made by partners, then capital paid back. Anything left after that distributed to partners according to their profit entitlements. If the partnership is insolvent, may have to go under the BIA. Partnership Agreements Purposes - Reproduce Partnership Act provisions for partners' information: can be useful since this is where people would naturally first look. But some want to minimize the size of the agreement. - Modify standard form provisions of Partnership Act (ss. 20-31, 32) to replace; or 23

supplement - extend and tailor to the particular needs of the partners: defining to what each thing the default rules apply - Respond to mandatory provisions of the Partnership Act especially ss. 6-19 risk of unauthorized liability to third party Issues in Partnership Agreements - A non-exhaustive list of issues. Instead designed to focus on the default rules. Name - Ownership issues: typically a concern when somebody leaves. - Liability issues: still liable to people thinking you are a partner when you leave the firm but they still use your name - Registration issues Description of business - Recall s.6 that every partner is an agent of the firm. Also recall that the scope of a business is what it actually does so why both describing the business? You want to inform all the partners expectations about what the business is supposed to be. Most will respect this. So there is a value for the parties to actually do this, in three specific examples: - Clarifies parties intentions regarding activities (s. 29) - Helps define scope of non-compete obligations (s. 30) - Establishes basis for contribution and indemnity - Generally useful for informing parties the expectations and defining the scope of obligations Membership Default Rules -- All must consent to admission (s. 24.7) and expulsion (s. 25) -- Retirement of partner dissolves partnership (ss. 26, 32) -- Entitlement of departing partner to payout of capital and share of profits on retirement or expulsion (s. 42(1)): Share of profits or 5% based on share of capital at option of departing partner if not paid. Ex: partner leaves, normally they get their capital investment back. They get a portion of the profits. But if theyre not paid, they can choose to get their share of profits until paid back, or 5% of capital over time. Issues -- Lesser degree of consent: hard to get people leaving to agree sometimes -- Criteria for admission: how to become a partner, articulated in some way -- Expulsion or retirement should not dissolve -- Process for expulsion including payout: typically, may be some kind of deferral of payment obligations. In small firms, with one person leaving, it may be quite onerous for them to pay that person in full at the time of their departure. 24

Capitalization Default rules -- All share equally (s. 24.1): generally all partners dont contribute the same amount of money. -- No interest (s. 24.4) -- Return on excess contributions = 5% (s. 24.3) -- Almost all of these rules are typically changed Issues -- Change entitlement -- Initial and subsequent contributions: might want rules for the requirement of the partners to contribute for things like expansion, renovation, etc. Ex: may have to contribute a proportion equal to the proportion of capital they own. -- Process for return on various events: retirement, expulsion -- Returns on excess contributions -- so you may need to define capital, contributions etc. Profits Default rule -- All share equally (s. 24.1) Issues -- Change entitlement: Criteria to determine entitlement ex: hours billable, non-billed work, etc. Firms often annually review for allocation of profits, decide on what should be the allocation based on this for each partner. Partnership draw: draw against your partnership entitlement, and then when there is a determination of profits, there is an adjustment that you would hope is larger than the money you have drawn. -- Process for reviewing application of criteria periodically -- Process for paying draws to partners Management Default rules - All may participate (s. 24.5) and have access to partnership books (s. 24.9) - Decisions on ordinary matters by majority of partners in number (s. 24.8) - Changes to nature of business require unanimous consent (s. 24.8) Issues - Delegation and allocation of power - Arrangements for collective action no rules in the Partnership Act for this. Might want to set out when you meet, how many times, what a meeting consists of, voting at the meetings, etc. The larger the partnership the more rules you need in this regard. - Risk management: authorization and control procedures dealing with things like negligence. None of the rules impact the third partys ability to make a 25

claim against the firm, but they are intended to prevent those claims from being made in the first place. Ex: have internal review process before partners give some legal opinion. Benefit of having it in partnership agreement is that it makes it legally binding downside is that it makes it rigid, hard to change, maybe more formal than you want in your partnership. - As the firm gets bigger, not everyone is going to be able to manage to the same extent Joint Ventures - Not a distinct form of business organization or relationship with precise legal meaning. It is used to describe a functional relationship where two or more people combine their resources for some purpose - Key feature limited in time and purpose - In a joint venture, the relationship is governed by some kind of contractual obligation between the parties. The issue that arises for us in this scenario is that we know what contract law says, but we want to know whether there are any legal implications of this kind of arrangement beyond what is actually expressed in the contract. - Contractual Joint Ventures do they have any legal consequences outside those provided for in contract? CMHC v. Graham - Partnership-like liability attributed to joint venturer where -- Contribution of both parties of money, property, skill or knowledge to common undertaking -- Joint interest in subject matter -- Mutual control and management -- Arrangement limited to one project -- Expectation of profit -- Mutual sharing of profit CMHC v. Graham F: CMHC entered contract with Bras dOr to build a bunch of houses. Gave them specifications and other measurements for these houses, also consulted with B when the houses were being built. Also provided financing for this to be done. B builds the houses and undertakes to pay back the amount of financing that CMHC has provided. As security for this, B gives CMHC a mortgage giving them the right to seize the house in the even that B defaults. G buys a house from B, and as part of the arrangement, pays some to B and the balance of the purchase price by assuming a portion of the mortgage $200k. Defects in the house, so G stops paying the mortgage. C sues G for default under the mortgage. G argues that he doesnt have to pya because he argues C and B are in joint venture they are both responsible to him for his damages in the house. He can offset his mortgage payment with the damage claim. The consequence, assuming that they are in a joint venture is that B AND C are both responsible for the defects. Diagram is in the slides. 26

R: They are not in a partnership, but they were in a joint venture. The legal consequences for this are the same as if they were in a partnership. - Contractual Joint Ventures do they have any legal consequences outside those provided for in contract? - Partnership-like liability attributed to joint venturer where -- Contribution of both parties of money, property, skill or knowledge to common undertaking: B contributing skill, labour, property and C is contributing financing, specifications for the house, consultation during building, also approved purchasers -- Joint interest in subject matter: initial arrangement for financing is the mortgage, where transfer of legal title to ppty dev to C, B retains equitable interest. So shared interest in the real estate. -- Mutual control and management: same as the first factors C provided specs, consulted, purchasers approval, B involvedi n building and sale -- Arrangement limited to one project: C has lots of activities, this is only one of the things it does, B involved in lots of other projects -- Expectation of profit: C seemed to not be actually profiting, at least not in conventional sense. They were getting repayment of the debt, a fixed amount. Didnt matter how B managed the cost, price sold, mortgage debt was fixed. B was in a position where they could increase their profits based on good job, higher sale price etc. Court satisfied that C had financial interest through the mortgage debt. -- Mutual sharing of profit -- This case is rarely followed why? If you have all these things, might meet the definition of partnership in s.2. But this might be something important to argue in an exam! Maybe a scenario where it doesnt look like a partnership, but maybe you can argue a joint venture. Sounded a bit like hed want to put this on the exam recall 1997 exam question in addition to talking about partnership liability, might consider liability for joint venture. Fiduciary Duty? - Do people who are in this kind of relationship owe each other a fiduciary duty? A duty to act in the best interests of the best interest, to not put a joint venturers interest ahead of the total joint venture activity. - Yes - on facts in Wonsch v. National Bank F: W construction enters into K joint venture with D, to build Waterpark Place. Ws main job was to build, D was going to manage it as a business sell units, find tenants, etc. While building, W runs up debt of about $1M from NB. W has trouble paying the debt. NB concerned they wont get paid back. D, because they are in joint venture, is aware of the difficulties and the debt. D goes to NB: says they will buy the debt for $750K. W might not give them anything, going to become bankrupt, etc. NB takes the deal, assigns claim for $1M to D. D then sues W for the whole $1M. W argues that D isnt allowed to

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enforce this debt because D as a joint venturer owes fiduciary duty to other joint venturer, cant profit from their debt. R: Court finds fiduciary duty, says D cant enforce the $1M debt. The have a claim for the $750K, but cant actually try to profit from taking advantage of the difficulty of your joint venture partner. +: Subsequent cases havent followed this approach in applying general principles of duty and law, when you have commercial parties not operating under disadvantage they should be able to look after themselves. Court shouldnt be creating fid duties, except where one party is vulnerable to another. This will be very rare in arms length commercial relationships. So this argument has generally not been successful due to absence of vulnerability. - But not in all joint ventures finding that one party vulnerable to the other must be made (Visagie v. TVX Gold Inc.) - Duty not to disclose confidential information International Corona v. Lac Minerals F: Parties negotiating that fell apart, IC smaller, Lac bigger, IC gave info to Lac that was eventually exploited for profit by Lac. IC argued that they communicated the info in confidence. R: This expectation should be protected by law, requirement to compensate IC for profits made by exploiting the information. Extra legal consequences that may arise outside contract in joint venture relationship 1) use CMHC 2) establish a fiduciary duty 3) confidential info between, recipient of info is expected to maintain confiden Limited Partnerships General Description (s. 2(2)) Limited Partnership Act: At least one general partner and one limited partner. A general partner is what we have been talking about all along, limited partner has liability that is limited to the extent of their contribution. This is different from the limited liability sometimes talked about in association with shareholders. Limited partners only liable up to the ceiling that they have agreed to contribute. This might be called true limited liability, as opposed to the looser limited liability of shareholders in a corporation. How Formed file declaration in accordance with Limited Partnerships Act (s. 3): in a general partnership, just need relationship under s.2 meaning. Sets out name of partnership and the identity of the partners. You have to renew it every 5 years.

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Why have a limited partnership? Business proposed, general partner willing to take on the risk but they need to raise money. This is just one form of business they could use. Go to a bunch of people, get them to make contributions as limited partners. Why do this instead of a corporation? The main reason is that usually for tax reasons, people will be interested in investing in this business as limited partners. The tax motivation: business is likely at least early on to have losses and limited partners will be able to deduct those losses against their income. It is generally a vehicle for someone who wants partnership treatment from the profits/losses of the business, and generally the limited partners are passive investors that arent really involved in the business. Liability General Partner - unlimited (s. 8) Limited Partners - limited to extent of contribution (s. 9) Limit is lost if (a) "takes part in the control of the business" (s. 13(1)); or (b) allows name to be used in firm name (s. 6(2)) kind of like holding out in Partnerships Act BUT can "advise as to [firm's] management" (s. 12(2)(a)) How do you distinguish between advising and controlling? Hard to distinguish Houghton Graphics and Nordile Holdings. Made more complicated by typical business structures in limited partnership context. Houghton Graphics F: Diagram on slides. Setting up limited partnership, need limited and general partner. General partner is going to be a corporation. The corporation is a separate legal entity. Conceptually, in many ways it is just like a separate legal person. As a general partner, it has unlimited liability for any obligations in the limited partnership. So you can only go after the assets of the general partner and corps generally have few assets. Dont need houses, cars, etc. Practically speaking, this is a device to protect a business against the claims of creditors people commonly insert a corp as a general partner for this reason. Z set the corp up in this situation, has control over the corp as a major shareholder. So he is not responsible for obligations of the limited partnership. The corp can only act through natural people acts through Z as a shareholder he elects himself as director and officer of the corp. Through that capacity, conducts limited partnership business, including entering into obligations with H. Finally, Z is a limited partner personally, and has agreed to invest the amount for that role as well. Why would he want to do this? Z might want to be one so he participates in the distribution of profits, or gets losses, from the business. The amazing three headed limited partner. Z enters into k with H using the limited partnership, and there is a default. H sues the limited partnership doesnt have many assets looks to corp, not many assets, looks to Z. So wants to argue that Z has taken part in the

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control (s.13(1)) of the business and loses his limited liability. Z argues that he is only acting on behalf of corp general partner, not personally. R: Z is the person who is doing this, asking the court to adopt an abstract look at the way he has set things up to let him off the hook. A regular person would say Z is doing all these things, not simply a case of someone giving advice. But the corp has to act through somebody why should it trigger personal liability through that person, Z? Court not satisfied that Z should be able to claim hes only a limited partner, he is in control of the business. +: Nordial Holdings is a similar case essentially facts were same except the person like Z was not a substantial shareholder. The court adopted a more formalistic approach, said the person should not have liability beyond their liability as a limited partner. Rights of Limited Partners - share in profits and have their investment returned (ss. 11, 15) - inspect books and make copies (s. 12(2)); - get full and true information regarding the limited partnership (s. 10); and - to obtain dissolution by court order (s. 10): rules of Partnerships Act apply to general partnerships except to the extent that they conflict with the rules set out in Limited Partnership Act -- Transfer of Limited Partnership Interest (s. 18): the transferee is not a substituted limited partner ie; doesnt have all the rights of a limited partner unless it is approved by all the partners or is done in accordance with the partnership agreement. Recall partnerships: cant replace yourself with someone unless everyone agrees, or there is a provision in partnership agreement allowing for that. Generally there is one, agreements have this ability, people want to be able to sell their investment easily, dont want to have to find all the partners to get their agreement instead agreement provides consent to a process for the transfer of limited partnership interest. Dissolution (ss.15(4), 21, 23) of Limited Partnership - Death, retirement, mental incompetence or dissolution of general partner UNLESS there are other general partners, right to continue in partnership agreement and all partners agree that continues: defining characteristic ceases to exist - All limited partners cease to be limited partners: another defining characteristic ceases to exist. But they might continue as a regular partnership. - Limited partners contribution is not returned when required to be under LP Act or limited partnership insolvent - Dissolution under Partnership Act (PA. ss. 35, s. 46): can apply to court for dissolution. S.46 sets out hierarchy of the way the legislation will apply. Other Points for Limited Partnerships - Person can be both a general and limited partner (s. 5(1)): might do this if they want to participate in the profits/losses as a limited partner. But they still 30

have the same liability. It can only be the financial interest as a limited partner that can be of interest. - Limited partner can lend money to general partnership, create a debtor/creditor relationship (section?) - General partner can be and typically is a corporation - Often attractive so limited partner can deduct tax losses against other income (p.65-66) - No class on Monday, October 17 - Make-up: Friday, October 28, 4:30 Read - VanDuzer pages 90-98 September 28 Constitutional Issues - Corporations Jurisdiction to Incorporate Provinces -- Power to incorporate corporations with provincial objects (Constitution Act s. 92(11)). What are provincial objects? -- Can create corporations with capacity but not the right to carry on business in other provinces (Bonanza Creek). The right has to be accorded by the legislature that has authority in that jurisdiction. The capacity is subject only to the recognition of those jurisdictions of that right. In ON: Extraprovincial Licensing Act aids in this recognition also says ON will grant the automatic right of any corp in another Canadian juris to carry on business in ON. -- Right given by other provinces in provincial licensing statutes Canada -- Power to incorporate found in POGG (Parsons) -- Federal corporations have the power and the right to carry on business in each province. They are not subject to provincial licensing requirements. But they dont need to actually carry on business in more than one province. -- If you have a client who wants to carry on business across the country, might think fed is better because it would give them the right to do so, and they also wont be required to license under provincial statutes. BUT licenses are virtually never declined so its not really a barrier to carrying on business in another Canadian juris, although if the name you want to use is already in use in the prov, or confusingly similar, that can be a problem. You can avoid this problem if you incorporate federally but there may be trademarks, domain name issues. So the corporate law problem goes away but it doesnt necessarily get rid of legal problem. -- The key difference between federal and provincial incorporation -- Limited practical effect - But when you start carrying on business in a province, you still have to file an information filing

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Jurisdiction to Regulate Provinces - Cannot directly legislate solely in relation to status or powers of federal corporations. Cant control their shareholding scheme, say they cant have a particular name, etc. No requirement of ON to recognize limited liability of corps from other provs, but they would due to their desire to have reciprocity when their corps go to that prov. - Can legislate in relation to the way federal corporations exercise their powers if -- Legislation primarily in relation to a head of jurisdiction in section 92 (like, for example, property and civil rights which is most common), AND -- Not inconsistent with federal legislation: otherwise paramountcy applies (e.g. A.G. Man v. A.G. Can. F: prov legislation required fed corps carrying on biz in the province to have certain kinds of provisions in their constitutional documents. The idea was to protect investors in Manitoba. Justified it with s.92, property and civil rights of the people of Manitoba. R: Inconsistent with fed legislation says you dont have to have these characteristics in your articles. The prov legislation is not effective. Lymburn v. Mayland F: ON govt, to protect investors, said you cant issue securities shares to ON investors unless you give a certain amount of disclosure. S.92 property and civil rights. Imposed a procedural requirement on fed corps to provide disclosure had to follow the process when issuing shares, to ensure informed decision making. R: This was acceptable, not found to be against fed legislation. - Can legislate solely in relation to head of jurisdiction in section 92 - even if effect is to sterilize federal corporation Canadian Indemnity v. AGBC F: BC wanted to set up prov auto insurer. To create prov corp, and all auto insurance required to be obtained from this insurer, excluding insurance companies from the market. Done solely from s.92, property and civil rights to protect people who insure their cars in BC. Not related to federal corps per se, but had effect of excluding the insurance companies. R: Doing this within their jurisdiction under s.92 irrelevant that they are unable to do business. Canada -- Cannot legislate directly in relation to status or powers of provincial corporations

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-- Can directly affect how exercise if legislation primarily in relation to area of jurisdiction under section 91 -- Has not arisen much most regulation of business is provincial: things like telecommunications, banking, federally incorporated insurance companies are exclusions though. Dual incorporation - need to know that people can incorporate in either the provs or feds, and will be impacted by both juris in different ways depending on how incorporated - once you incorporate under a particular juris and have an issue, you have to look to that legislation. Any other corporate law is completely irrelevant. If there is something helpful under the fed statute, that doesnt matter now. Same with things in statutes in other provs when you incorp federally. - so you need to be aware of the two corporate statutes, what their differences are, the costs and benefits of incorporating under one or the other Incorporation and Organization of Corporations To Incorporate OBCA Rules - File the Articles of Incorporation Form 1: define the characteristics of the corp, the shares and the characteristics of them, the directors, board etc. - Name Search Report: in assignment: needs to go in with the articles. The idea is that by requiring one, they are requiring people to have a look to make sure the name they have chosen in available and not used by somebody else, not confusingly similar to a name used by somebody else. - Fee $360 - $300 if done on-line: plus service provider fee, in ON -- Under CBCA is $250 - $200 if done on-line - Must also have consent of directors not signing articles though need not be filed. You need to maintain a record of it at least to ensure you dont name people who dont actually want to be directors. To Organize - Directors Meeting: preferably done right away to do a couple things: -- Issue shares: secured the governance of the corp into perpetuity. If no shareholders, no one who can do anything on behalf of the corp is something happens to the directors. Even one share to one person means there is somebody who can elect new directors. If shareholder(s) dies, it passes to someone else depending on their will/intestacy. So issuing shares creates personal property that continues to exist indefinitely at least until the corp itself dissolves. -- General By-law: procedural rules about things like shareholders meetings, how the voting works, whats the quorum, what the roles of the officers are, etc. An important complement to the default rules in the corp statute dealing with these organizational issues. Like partnership agreements, might change default rules to meet needs of people in the corp. -- Appoint Officers: CEO, President, Secretary etc. and make delegate to them some powers to do things in the corp. s.102 CBCA: directors have the power 33

to manage, supervise the management of the business and affairs of corp. They have plenary power to do everything. But practically speaking, not the directors that want to make all the decisions about hiring/firing, leasing, buying supplies etc. So the board of directors delegate these roles through a meeting, pass to other people. -- Banking Arrangements: every corp/business needs a bank account. But for a corp, the bank si going to look for documentation that the corp has properly authorized the account, and who the people are that are going to use the account. - Shareholders Meeting -- Approve By-law: nature of by-law is that it has to be presented to shareholders for approval. -- Elect new directors: only where directors listed in articles are not permanent directors you want. - Shareholders Agreement -- With small numbers of shareholders, they often want to tailor the governance relations between them. -- Might want to have votes correspond to shares owned but maybe they want to have agreement that unanimous consent is required for shareholder approval. Can put this in the shareholders agreement. -- Might also have limits on how shareholders can transfer shares; ie: right of first refusal. As a lawyer, you need to look at the following things in advising a corporate client: - governing statute - articles - by laws - resolutions passed by shareholders - shareholders agreement Function of Corporate Law - Why do we have corporate law? - The main goal: Encourages people to invest money in businesses. People primarily tend to invest based on what the return on the investment is expected to be people more likely to invest if they expect a lower return. The return may be dividends, or that you expect the share to go up and sell it later. The things that the law can do to increase returns is going to have a positive impact. - As a rational investor, youd be unlikely to want to invest in something risky. But might be willing to take a risk if the potential returns are larger. -- Increase Returns for Shareholders

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Lowers transactions costs with default rules: corp law provides framework for governance in the corporation. To the extent these rules are a good fit, dont need to make new ones, saves some costs. Low cost limited liability: shareholders protected from claims of creditors of the corp business. Shareholders not responsible. Corp law does this, otherwise individuals would be liable. Dont need to take small amounts of assets, purchase lots of insurance, contract out of every risk you face. Also cant contract all the time, sometimes you impact people with whom you dont have a contractual relationship. -- Decrease Shareholder Risk - Limited Liability: any creditors of business being carried on only have access to assets that the business has. Creditor is basically limited to pool of assets that the corporation has. - Mandatory rules protecting all shareholders: SH concerned about what management is doing. This only arises when corps reach certain scale where everyone has different roles, SH not the managers as well. When separation between SH and management, practical issue is how the SH are protected against things mgmt might do. Ex: mgmt wants to pay excessive salaries, shirk duties, negligent. These rules protect the SH including fiduciary duty, s.134 OBCA: officers have to act with the best view of corp also standard of care in s.134. Behavioural standards applying for the benefit of SH. - Mandatory rules protecting minority shareholders: often person with most shares has most votes. So the directors are kind of at the mercy of the majority SH. How do minority SH ensure their interests are protected against majority SH and directors making deals? Oppression remedy: minority SH can apply for relief, quickly, if mgmt operates in a manner that is oppressive of minority SH. This encourages investment of minority SH, in some ways a corresponding detriment to be a majority SH this is a balance struck in the corp statute. -- Also imposes balancing mandatory rules protecting non-shareholder stakeholders: ways that other people not directly dealing with the corp are protected. Limited liability can have a negative effect on creditors, since they can only claim against the corp. So corp law is a sort of intervention in the marketplace, to favour SH. Balancing Rules Protecting Non-Shareholder Stakeholders - Limits on Limited Liability -- Judicial Disregard of Separate Legal Personality -- Personal Liability of Directors and Officers if also shareholders - For Torts: when acting on behalf of the corp - Unpaid Wages (s. 131-s.119 CBCA) - Income Tax Withholdings (s.227.1 ITA): directors have to take adequate care that this does not happen, otherwise liable - Liability for Breach of Duty to the Corporation (s. 134-s.122 CBCA): basic standards of behaviour primarily designed for the protection of the corp. 35

Because they protect the corp, have incidental benefit for anybody with an interest in the corp. - Regulatory Offences: if they had a hand in dumping toxic material into a stream, for example - Oppression (s. 248): non-shareholder stakeholders have been successful arguing this, such as creditors. Say that the conduct of the corp has been oppressive to them, deprived creditor of their ability to recover. + Once again, note that all of these reduce the practical benefit of limited liability. This is not to say that these are not good reasons for doing this, though. - This does not disregard the corporation for the benefit or any other creditor or anybody else it is only a decision by a judge in a single particular case to allow a creditor to pursue directly against the shareholder. Disregard of Separate Corporate Legal Personality - diagram on slides. Corporation owes money to all of the other parties. The financial creditors, trade creditors, employees can go directly after shareholders. This is normally something creditor asks for in specific litigation because it is not going to get obtain sufficient compensation from the corporation. - When will the courts do this? No good set of rules or answer for this. It is generally rare. Partly because there is no legislative authority for them to do it, they have made it up entirely on their own. Statute clearly says liability for corp cannot be pursued against shareholders. - But courts will generally use it in circumstances where the corp form is being abused. Most common: fraud. Other Rules Protecting Non-Shareholder Stakeholders - Corporate Name - Inc., Ltd. etc. (s. 10 in both Accts): you have to indicate that you are a corp, a separate legal person. Need a legal suffix to indicate your are a corp entity. Which one you choose is entirely up to you. You also have to use this on legally significant documents, like contracts. This can be a signal to a bank, for example, to want to look at the assets of the corp, wonder how they are going to get paid, etc. because they know that the only entity they will have access to if there is a default is the corp itself. - Restrictions on Share Issuance (s. 23): shares cant be issued on credit. - Restrictions on Use of Corporate Funds (s. 130): there used to be rules that required a minimum amount of investment by shareholders so thered be at least some money to cover claims that may come up. Canada doesnt do this why? Once the money goes into the corp, no guarantee that its going to stay there, likely will be put toward a business purpose. No real protection therefore in requiring a certain amount of money go into the corp at the beginning. Instead, we have provisions that say once money does go in, there are restrictions about what you can do with it ex: you cant redistribute to shareholders and in the process prejudice against creditors who have claims against the corp. 36

Restrictions on Use of Corporate Funds (s.130) - dividends (s. 38): typically money, paid to the shareholders. A discretionary decision of the BOD to distribute corporate assets to shareholders. - redemption and repurchase of shares (ss. 30, 31, 32): net effect of this is to take corporate assets and distribute to the shareholders. - payments on the granting of certain shareholder remedies (ss. 185 & 248): a court may order, or statute may require that payments be made to shareholders because of certain things that may have happened. Ex: if you disagree with fundamental changes of the corp, can be paid for this. - Director liability if they make these kinds of payments unless 2 TESTS met ->Must have reasonable grounds to believe that: (1) Corporation is not and would not be made insolvent: the Solvency Test. Looks at the reasonable obligations of the corporation as they become due. (2) Realizable value of the corporations assets would be less than its liabilities (and, in some cases, stated capital for all classes of shares): the Capital Impairment Test. Realizable value looks at the pile of assets the corp has and asks if I sold all those assets, what would I get/realize from it? Compare to all the amounts owed to creditors in total. The stated capital is money or things that have been contributed to the corp in exchange for shares. The stated capital is sort of an accounting for the cumulative contributions of shareholders reflects total amount contributed. So realizable value of assets must be = liabilities (creditors)[+stated capital (shareholders)]before you make any payment, and in some cases you must have enough to pay off your shareholders, hence why it is added in brackets. - Restrictions on Use of Corporate Funds (s. 130) including (continued) -- indemnities to directors and officers where not permitted (s. 136): if payment is made where conditions are not satisfied under the statute, directors bear personal responsibility if they have authorized that payment. -- unreasonable commissions on share purchase (s. 37) - Public Filings: information for non-shareholders stakeholders respecting what is going on in the corp and this can be helpful for evaluating the risk that people dealing with the corp will be subject to October 5 Corporate Law and Securities Law Securities Law - Overview -- Basic purpose: regulation of securities markets in the public interest. - What are securities? Stock, interest in mutual funds, commodity futures (where you buy a right to purchase a commodity at a later date), bonds, options. An umbrella term covering any kind of interest in a business. - What is a securities market? Where theyre bought and sold the TSX. The point about securities markets is that they are places where people who have 37

money to invest exchange it for securities. The businesses want to use that money for some business purpose. Two goals of regulation: -- Investor protection against fraud and unfair practices (like insider trading where parties have relevant information from inside the corp that will impact the price of the stock). To encourage confidence of the public in the market. -- Efficient functioning of securities markets: want to get the money from the savers to the businesses. The market is the exchange point, and we want to make sure it is not costly for businesses to issue securities to people, can be done quickly, with minimum administrative problems. - Tension between the two: efficiency of the market may be impaired if there are lots of provisions against fraud. Four main aspects of Securities Law (1) Disclosure by issuers regarding securities and business. issuers are any kind of thing issuing securities could be limited partnership, corporation, trust, or other kind of business organization. Issuer must disclose on initial issue and on timely and regular basis thereafter, ie; when new things develop in the business. (2) Regulation of securities market participants: professional participants in the marketplace, like stockbrokers ie; BMO (3) Insider trading (wont talk about) (4) Takeover bids: take it or leave it offer to the shareholders (wont talk about) Nature of Securities Regulation - Securities regulators in each province and territory, each province and territory has their own securities act. The Canadian govt would like to take over the securities regime. But QC and AB have made constitutional challenges to this. Issue: does fed govt have constitutional authority to legislate in the area of securities regulation? Business community in favour of one single regulator, dont like having to deal with all the different ones, it is seen as an inefficiency. Prov govts argue: distinctive differences between their markets, want to ensure they are reflected in securities regulations. - Regulatory instruments -- Statutes in each province/territory -- Regulations -- Rules: less common. Rules can be made in provs by security regulators themselves. In ON, ON Sec Commission can make binding legal rules with same effect as regulations. So admin agency making legally binding rules = very unusual. Why? Sec markets are very complex, change very fast. ON Sec Commission, with its expertise, in touch with how those rules should be created. Not all provs have this though. -- Policies: may also be recommendations to business to behave a certain way. Canadian Securities Administrators 38

- effort to create a degree of harmony between the various prov bodies. Commissions that come together and try to agree on common rules. When they do, issue either: -- National (everyone agrees to same rules) and Multilateral (many provinces have agreed) Instruments: once in place, understanding that respective securities commissions will make sure it is implemented either through rulemaking or regulations, as law. -- National Policies Relationship Between Corporate and Securities Law Differences in -- Purpose - Securities law regulate markets for publicly traded securities - Corporate law isnt really about markets, determines nature of corporation, governs relationships of corporate stakeholders for the purpose of encouraging people to carry on business through the corporation. This is essentially about entrepreneurship. -- Scope of Application - Securities law - All business organizations offering in jurisdiction subject to the sec laws of that jurisdiction. - Corporate law corporations incorporated under particular jurisdiction subject to the corp law of that jurisdiction. - Diagram on slide: Say a corporation is incorporated in ON governed by ON corp law. This has implications for the relationship between shareholders and directors. But say there are some shareholders in BC, Ireland, and ON. Head office and BOD in Ireland. Operations in the Congo. All of these things are still governed by ON corporate law rules. Securities law is concerned with anywhere that the corp is offering shares. So those in BC, Ireland, ON, regulated by their own securities law. About where the investors are, doesnt matter where the business is being carried on either. -- Enforcement - Securities law: Active enforcement by public authority, the securities commissions. Frequently intervene when they dont like takeover bids, prosecute insider trading, other unfair practices in the market. - Corporate law: Mainly private enforcement (Self-enforcing). Weak public enforcement. Participants/stakeholders given remedies in the statute and it is up to them to pursue those remedies. -- Substantive Law - Securities law Mandatory disclosure of information to market (public) Procedures for certain transactions e.g. takeover bids Including disclosure to shareholders, approval requirements Corporate governance practices requirements 39

- Corporate law Nature of corporation Rights of outsiders dealing with the corporation Allocation of powers between shareholders, directors and officers including disclosure of information, approval requirements Decision making process Regulation of Securities Distribution Prospectus requirements Apply if trade is a distribution e.g. first sale Process Preliminary prospectus filed Issuer can solicit expressions of interest Comment letters from securities regulators Final prospectus Securities can be sold Civil liability for misrepresentation Exemptions securities involve little risk or purchaser does not need protection Continuous and timely disclosure and corporate governance obligations apply once distribute p.125-139, CB 68-73 October 12 Readings for Next Class VanDuzer pages 146-161 Separate Legal Personality - Salomon - s.15 of both Acts - The basic conceptual model of the corp is that we should think about it as a separate legal person. It has the same basic set of characteristics as a natural person. Obviously this can only be taken so far, but in terms of its basic legal characteristics, it has a separate legal existence. Salomon F: Always referred to as standing for a strong endorsement of the separate legal existence of corp. AS operates business as sole proprietorship. Incorporates based on new English Act. One of the requirements is that you needed 6 shareholders. Gave a single share to his wife and each of his kids. They contribute a nominal amount in return for them. He then transfers the business to the new corp, and in return the corp issues him 20,000 shares and $10,000 debentures and $1,000 cash. This added up to $31,000. So he became the majority shareholder and also has a claim under the debentures. Debentures: debt obligation carrying with it a security interest in the assets of 40

the business. This means that if there is a default on repaying the debt, then AS the individual can seize assets up to $10,000 to satisfy debt obligation. After transfer, business starts to fail. The business ran up debts to unsecured creditors of $7,773. Corp becomes insolvent, liquidator appointed by corp to gather assets and pay out claims and if anything left pay it to shareholders. Liquidator realizes that if the $10,000 debenture is paid to AS, wont be anything left for unsecured creditors. Liquidator disagrees with this, because AS is really continuing to carry on the business despite corporation. So wants us to disregard separate legal existence of the corp, or should say that it is really AS carrying on the business and using the corp as an agent on his behalf. R: No what AS has done here is exactly what the English Parl anticipated when they passed the legislation transferring a business to a corp. We should not disregard the separate legal existence of the corp. Give full effect to what the legislature clearly intended. AS can take all of the assets under his claim to the debentures. McNaghten: on the argument that the shareholders are really just a sham, clearly just there to meet the requirements of needing shareholders. McN didnt care, they could be dummies for all he cared. Dont have to do anything. Nature of Shareholders Interest in the Corporation Kosmopoulos F: Small business carried on by K. Incorporates the business based on advice from insurance agent. But K continued to be the tenant under the lease where his business was located, took out the insurance in his own name with respect to the business and the businesss bank account was in his name. Damage done to the business, K wants compensation from insurance company. Insurance company refused because the assets damaged were owned by the corp, not him and so even though he has an insurance policy, he does not have an insurable interest in those assets. Argued that K does not have a direct ownership interest in the assets. R: SCC: the nature of the insurable interest is not limited to a direct legal interest, but it is any interest which will be negatively affected if the assets which are insured would be damaged or lost. Looking at the situation: true K doesnt have an ownership interest, but he is affected if the assets are destroyed because he is a sole shareholder. His shares suffer because of the damage. The destruction of the assets would have reduced the value of his shares and so on this basis the court found he had an insurable interest. - A decline in the value of the corporate assets has to come out of the value of the shares, because your corporate liabilities will not change because you have suffered damage. If you owe $50K to the bank, shares valued at $50K, and lose $25K in damages to assets, it has to come out the value of the shares, and nowhere else. Disregard of the Separate Personality of the Corporation

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- Court rigidly adhere to separate personality (Salomon): this is what the legislature has intended, dont want to get involved in changing the law - But will disregard in limited circumstances for limited purpose Stakeholders in Business Organizations - diagram recall allowing financial creditors to make a claim directly against shareholders despite a major purpose of incorporation to protect the shareholders from being held personally liable. It is not easy to predict when a court will be motivated to do this. It doesnt happen often, but does happen sometimes. Grounds for Disregarding Separate Personality of the Corporation Its just not fair: the use of the corp in a particular case may be flagrantly opposed to justice. But this has an uncertain scope - often associated with other grounds. Not very helpful, doesnt help for predictability. More likely to be exercised: - if claim by creditor rather than shareholder (Kosmopoulos): normally when creditor is making the claim, theyre not getting paid. Theyd ask for this when the corp doesnt have enough assets. K wanted to disregard his interests in the corp and just say that he was being insured. But the court denied this, couldnt allow him to just disregard because it was more convenient for him. - if result is simply to impose liability on another corporation rather than an individual (DeSalaberry) More Grounds Objectionable purpose - Most common ground. Doesnt have to necessarily be illegal, but has to be wrong, offensive to the court in some way that it would be inappropriate for the person to use the corporation in such a way: -- Fraud (Big Bend Hotel: K operated hotel that burnt down, made a claim on his insurance. Got another hotel, didnt disclose his previous fire loss history for insurance and instead created a corporation where he didnt disclose the info that its only shareholder had these problems. Hotel burnt down, K wanted to get payment from insurance. They refused. R: The only reason K made this corp was to disguise his prior fire loss history, done fraudulently, therefore disregarded the separate existence of the corp and treat the insurance policy as if K applied for it personally. Since he did not disclose, insurance does not have to pay.) -- Misrepresentation as to identity of corporation Bon Street: two people, K and M negotiating purchase of real estate. All negotiations done on behalf of Bon Street Developments which to sellers knowledge has certain assets. At the last minute, K and M changed the name of their numbered corp, with no money, to Bon Street Developments. They 42

then changed the name of Bon Street Developments to Bon Street Holdings. Vendor entered into contract with the Bon Street with no money. K and M then refused to close. Vendor wanted the sale then because no chance would get the price on the market now. Sues them for fraud, but really wants breach of contract damages. Argues that K and M perpetrated a fraud regarding the identity of the corp they were contracting with. Because of the fraud respecting the identity, should be able to claim damages against the original Bon Street. R: Not fraud going to identity. Found that vendor intended to enter into contract with the corporation that signed at the closing. Should have investigated further. Not going to substitute the corp with assets into the contract which has been negotiated. Found this was only a fraud with respect to the assets, not the identity, so not enough to disregard the separate legal existence of the corp. Phillips (p.133 in footnotes): Clear misrepresentation with respect to eh identity of a person entering into a k. P had a negotiation, came to agreement in writing. Just as they were signing the agreement, he put in the name of a corp instead of his own name. R: Misrepresentation of who was going to be signing to the contract, so they ruled that he was just signing as himself, disregarded the separate existence of the corp.) -- Breach of contract Gilford F: Person stops working for corp, had non-compete obligation with them, and set up a corp and provided services that competed. Original employer enforced the non-compete, individual argued doing through the corp not them personally. R: Just using the corp to avoid your personal obligation. Not allowing him to avoid. Rogers Cantel F: Corp subject to non-compete with Rogers. This corp they are connected starts to compete, Rogers wants to enforce the agreement. Corp argued that it is not them, another corp. R: Not allowed to use another corp to get around your obligations as a corp to not compete. +: You need to think about the extent to which a person can use a corporation to compete rather than in their personal capacity. -- Reduce taxes (Desalaberry): if you structure your affairs to minimize tax liability, that has been a situation where court sometimes thinks corp separate legal existence should be disregarded. Effect of GAAR? In SCC Stubart case: court has said that no reason corps cannot structure their affairs to avoid tax. GAAR then introduced to create a statutory basis for disregarding the separate 43

legal existence of the corp to deal with certain kinds of tax planning structures. Tension between freedom to structure to lower tax liability and GAAR. DeSalaberry F: Parent corp had lots of money. Interested in real estate development. Every time they bought a piece of property, create new corp to buy the property. Many subsidiaries holding only a single piece of property. One was DeSalaberry. The property that D held was determined that it should be sold got the proceeds from the sale. D filed income tax return and characterizes the income as a capital gain rather than income from a business. This was a significant difference (cap gains not taxed at all at that time). Argued not a business, was a one-off transaction. CRA said you cant look at D on its own, have to look at it on context of larger corp group. Looking this way, there is a business run by parent, to buy and sell real estate through all these smaller subsidiaries. This group is really a business. Effectively CRA wanted to disregard the separate legal identity of D, and merge them together. R: Disregard the separate legal identity, required D to pay tax based on it being from a business. Agency - Conceptually distinct from disregarding separate existence of corporation BUT effect is the same. Characterizing the corporation as the business carrying out the wishes of the principal, being the shareholder. Normally for this to occur, the agent has to be given authority by the principal to negotiate the contract and commit the principal to a binding obligation. But in this context, it has nothing to do with the issue of authority so kind of a misrepresentation to call it agency it at all. More focused on control, not authority. Why should control be the deciding factor? Nothing in the legislation that says this. But the court said that if you have a scenario where the shareholder is exercising so much control that its not like the corp has any real separate existence, we should come to a conclusion that the corp is not acting independently and therefore hold the shareholder responsible. But now we need high amount of control PLUS additional factors. Factors: - extensive control over corporation (Smith, Stone & Knight) - no legitimate business purpose - conduct akin to fraud that would otherwise unjustly deprive claimants of their rights (Gregorio) - so not just high degree of control, have to link it to some other objectionable purpose Other factors - Lack of respect for corporate form (Walkovsky (YES); Newtonbrook Plaza (NO): corp enters transaction on behalf of K, sole shareholder, and corp fails to 44

close. NP sues K alleging he was responsible for breach of contract. Argued that there was a failure by K to respect the corporate form no directors resolution authorizing trans, deposit paid by K personally, legal fees paid by K. So NP argued K was personally responsible. R: This was enough in these circumstances.): where individuals are kind of careless about whether they have acted on behalf of corp or personally. - Thin capitalization (Desalaberry (YES): court was encouraged here by D having no money, given to it by parent corporation. Walkovsky (NO)): not having enough invested money from shareholders to cover your reasonably anticipated liabilities. W case: cab had minimum insurance required by law, hit someone, victim sues. Tries to claim against shareholder as corp has no money. R: Doesnt matter corp has no money, not enough to disregard separate legal existence of the corp. + Bottom line on all of this: when you are arguing about this, need to consider all of the factors discussed here. Special Corporations Without Full Limited Liability Nova Scotia unlimited liability companies under Companies Act Shareholders liable to contribute to debts on bankruptcy or wind-up Professional Corporations in every province (e.g., OBCA ss. 3.1-3.4) Shareholders liable for professional negligence Requirements All shares owned by members of profession All officers and directors are shareholders Name includes professional corporation Articles restrict business to practice of profession Governing legislation permits incorporation Or listed in s. 3.1(2) October 19 - MacGregor guest lecture The Corporation In Action Liability in: (1) Torts (2) Crim (3) Contract Tort Liability - Vicarious liability: liability for one in respect of the acts of another - When we look at agents carrying out duties for another, two ways we can conceptuality vicarious liability: (1) principal agency: principal is responsible for the actions of the agent (2) employment context: not so much vicarious 45

liability but where the master is primarily for the liability of the employee both end up at the same place though, where one is vicariously liable for the actions of another in the discharge of their duties. - The proposition is identical when you introduce a corporation you still have vicarious liability applying. The general proposition is that corps can be vicariously liable for tortuous acts of its agents and servants. - Why impose this liability on the corporation? (1) The corporation has the ability to introduce policies, directions, guidelines to prevent these sorts of tortuous acts from occurring. (2) Corps are far more able to pay than the employee/agent in most cases. (3) the corp reaps the rewards of the activity, therefore it should bear the risks/costs this makes sense based on the idea that tort law is compensatory, not penal. - What would a defence of a corp be in respect of a tort carried out by an employee/agent? That the act was not within their duties as employee/agent a frolic of their own taking them outside of the scope of his or her duties. What might a frolic of their own be? Ex: truck driver takes their truck for a joyride far out of their work area. Criminal Liability - Do we tend to hold natural persons liable for the crim acts of their agents and servants? No. So vicarious liability does not play a role in crim liability. But there are certain exceptions: if a statute imposes vicarious liability for example in parent/child. As a general rule, vicarious liability not in the crim context. Three Distinct Types of Offences (1) Absolute Liability (2) Strict Liability (3) Mens rea offences Absolute Liability - is there any possibility of the accused being able to exculpate themselves once the actus reus is shown to have happened? No. Crown just has to show act took place. - What is required to convict a corp for this: liability flows from the commission of the actus reus such that the corp is liable for the acts carried out by its employees. The corp is deemed to assume automatic primary liability for the acts of the employee. - Primary liability comes from Estey in Canadian Dredge & Dock Co. referred to in text. Strict Liability 46

- the Crown still needs to show actus reus, but then the accused can show they did due diligence. Demonstrate that you at the very least took reasonable care to attempt to prevent the act from taking place. - primary liability, again according to Estey, in terms of the actus reus, falls on the corp. But the defence for the corp can then be demonstrated by certain persons carrying out corporation responsibilities. - Who are these people? Due diligence must be demonstrated by someone who could be called a directing mind of the corporation. Mens rea offences - Crown must prove actus reus but mens rea as well. - A problem here because a corp doesnt really have a mind of its own. As a consequence, one extreme would be to say the corp cannot be convicted for these offences because it cant have the requisite mental element. But this is not what our law maintains. Canadian Dredge & Dock: Estey views a number of possibilities in terms of establishing mens rea when it comes to the corp. - One possibility: vicarious liability but not possible for mens rea offences - Another possibility: no liability unless it is the ultimate mind of the corp that possesses the guilt required. So no liability unless there was some form of direction or approval from the board. The difficulty with this principle is that it is highly unlikely that the board will actually be involved in advocating an illegal activity. - Third possibility: identification theory - midway between the two. This theory says that if we can identify the wrongdoer with part of the mind of the corp, then that is sufficient. You can say the employee was part of the directing mind of the corp, then that is sufficient to establish the mens rea necessary to uphold the offence by the corp. This attributes the guilty mind of the person who may be said to be part of the guilty mind of the corp to the corp itself. - Who is the directing mind? The difficulty is in figuring out how broad we should construe this. The Board, directors and officers at least in most circumstances. Waterloo Mercury Sales F: Used car manager of dealership. He instructed certain mechanics to turn back the odometer readings. This of course made the cars more valuable, and the corp and employees benefit. Was the used car manager a directing mind of the corp? - If the higher directing minds ie; the board specifically ordered to not do things like turning back odometers, that may be a defence. - If the manager did something that only benefitted him and not the corp, then that would be a fraud on the coporation and an adequate defence. - In applying the identification theory, there are some questions and considerations that make the exercise easier. 47

(1) Who is the actor identify who actually committed the offence. (2) Was that person a directing mind of the corporation? (3) Was that person carrying out his/her assigned functions. Not that the used car manager had the assigned function of turning back odometers but was carrying out his duties in the operation of the car dealership. If that was the case, then (4) Directing mind becomes attributed to the corporation - Going back to Mercury Auto Sales: if there was a direction from the board to not turn back odometers, would that make a difference? Depends in the normal course you will expect the board to issue the sort of directors that require its agents and employees to act in accordance with the law. This is not going to be a foreign act of the board. This direction of the board would likely not allow for the corp to allow liability for a mens rea offence. But this depends because if this was a significant issue and the board took specific steps to address this, followed up with monitoring, then arguably you would have a situation where the corp in fact have done enough to not allow the sales managers mental state to be identified with the corp. There would certainly be the employee going against their employer orders if no benefit to corp accruing to this act, then that would be a defence for the corp. - What if it was the chief mechanic who did this all by herself? She is likely making a decision outside of her duties she is supposed to fix cars not making a decision about sales. - What if the sales manager turned a blind eye to this, or took no steps to stop what was going on? This is a sort of implicit approval. Something to consider. - Bill C-45 amended the Crim Code: a more vigourous set of rules implemented which broadened the liability of corps beyond that would arise through identification theory. Slides to come based on this bill. - Highlights: the liability of a corp is now triggered by specific actions taken by a senior officer. They are defined as a person who does one of two things (1) plays an important role in the establishment of the corps policies. This picks up the notion that courts have used when applying the identification theory you have a person carrying out a function of the corp, who can be identified with the corp because they have some aspect of a policy-creating role. This is now in the CC: a senior officer is one who plays an important role in the establishment of a corps policies (2) plays an important role in the managing aspect of the corps activities a supervisory role instead of a policy-making role. - The legislation automatically includes a director, CEO and a chief financial officer of the corp. all of these people are deemed to be senior officers. If this is the case, what defence is precluded? You might want to argue that in a 48

particular case that this senior officer was not a directing mind in that situation. But the legislation deems these people to be a senior officer and therefore connected. - This applies not just to corps, but broadly defined as associations including partnerships. Negligence Based Offences - s.22.1 of the Crim Code also has a separate section dealing with negligence based offences. They do not require mens rea. The conditions are different for the imposition of corp liability. - Requirements: organization is a part to a negligence-based offence if: (1) one of its representatives is party to the offence representatives is defined very broadly agents, contractors AND (2) senior officer responsible for the part of the organization in which the offence occurred departs markedly from the standard of care expected that if exercised would likely have prevented the offence from occurring - Quick summary: corp crim liability and liability in tort - tort: frolic on his own, vicarious liability used in these circumstances for policy reasons. Crim: absolute liability is an auto primary responsibility imposed on the corp. actus reus all you need. Strict liability is similar to absolute with auto primary liability, but there is a due diligence defence. Have to show that someone in the directing mind/will of the corp did the due diligence, not just anybody. Mens rea: identification theory requires a directing mind to have the mens rea cant be anyone working for the corp, because you would essentially be adopting vicarious liability, and therefore doesnt give the proper state of mind for a true crime. - Closely read the slides on the crim code provision, which broadens criminal liability in respect of mens rea offences beyond the ID theory. Also, where it sets out conditions for who is responsible for a negligence based offence. - ID theory is important because it informed this new crim code provision, and also important for strict liability offences. Liability for a Corporation in Contract - generally based on the doctrine of agency, where the corporation is the principal and that corporation acts through a number of agents. Corporation delegates by statute to directors, directors to officers and officers to employees. - the issue often arises in terms of a corp not wanting to be bound by a contract. A third party will want them to be bound by it. The difficulty is that often the corp itself may not have given authority to the person to enter into 49

the contract but where the third party has relied on what it thinks the authority is that the person actually has. In law, we always try to strive for an appropriate balance. Here the balance that the law is trying to achieve: the corp shouldnt be bound by contracts where it in fact gave no authority to enter into that contract, but the third party entering a contract on a belief that they had the authority, we shouldnt prejudice that third party. The third party simply does not have access to all the underlying private records of the corp to determine whether or not it has the authority to enter into the contract. - Big transactions are really not the issue likely do a lot of checking, lawyers, board involved, etc. But there are still many transactions that can be problematic. - Actual authority: where the person who the third party is dealing with has actual authority to enter into the contract. The basis for this authority can be found in articles, statute, USA, or any delegation based on that. It can stem from a number of sources, these being the most frequent. Employment contracts are also included. - Apparent authority: often referred to as ostensible authority, a subset of which could be usual authority. With actual authority, the person entering into the k on behalf of the corp has actual authority. With apparent authority, person entering into k may or may not have actual authority but appears to have the authority to enter into the k. The authority is apparent. One classic example of this: sales clerk in a store. Assume that by virtue of their position has authority to enter into contracts they may not, but has apparent authority. As a result, this apparent authority protects the third party and the corp will not be able to respond by saying they didnt actually have authority to enter the k. Important point: a person with apparent authority must be given by someone with actual authority in respect of that given area of activity. This is a very significant point you cant take upon yourself apparent authority. You must be given it by someone with the authority in that actual area. - The principle behind a corp being bound by someone exercising apparent authority: the corp is holding out, or making a representation that is relied upon by the third party. Therefore, estoppel applies, it is essentially what is behind it. The corp is estopped from saying that person had insufficient authority to enter into the contract. So why is it essential that the apparent authority be given by someone who has the actual authority to give it? Need someone with the power to make that kind of representation to tie it back to the corporation in a more meaningful way. - The corp used to be able to say, in response to and as a defence to apparent authority that the third party should have known that they couldnt enter into those kinds of ks because of their publicly filed documents that limited their 50

ability. Even if you had no actual notice, you had constructive notice of the publicly filed documents (by-laws). - Constructive notice was then somewhat modified by the indoor management rule which said that where you have a publicly filed document, and where it requires some internal step to have been taken before you could enter into a specific k, you are entitled to assume that internal step has been taken. The bylaw might say that directors can enter into $200K loan with the agreement of the directors this can be seen publicly, but we cant see the resolution allowing it. So the indoor management rule can assume that this step has been taken. The thinking is that the third party would have no way of knowing where a directors resolution had been passed or not. - Constructive notice rule, qualified by indoor management is in the CBCA and OBCA look closely at ss.17,18,19 of OBCA. Constructive notice has been essentially abolished. Having said that, you still need actual or apparent authority for a third party to be able to rely on a contract being entered into. The other important point to note is that the OBCA prohibits the corp from relying on a considerable number of defects in authority such as the corp not complying the articles/bylaws. This is all contained in 17,18,19 of OBCA. - Think about the balancing that the court is doing to protect the interests of the corp and the third party. Appreciate that the authority comes in two ways. Apparent authority, we need to understand, is that there is no actual authority. The key ist hat it must be given by someone with actual authority over that area. October 24 Incorporation and Organization of Corporations -- To Incorporate in Ontario > Articles of Incorporation (Form 1) > Name Search Report > Fee $360 - $300 if done on-line but must pay service provider fee >> Under CBCA is $260 - $200 if done on-line -- Must also have consent of directors not signing articles though need not be filed. Lawyers should make sure they have documentation evidencing the consent of these directors. Articles of Incorporation (continued) -- Class and Number of Shares >> Name (e.g. common shares): can call them whatever you want. But practical advice: if use an expression like common shares, that will suggest a particular bundle of characteristics the right to vote, to receive dividends, and to get part of the corp property on dissolution. The best approach seems to be to call them something people know, and then further set out, so it is 51

clear and easy to follow what kind of shares they are. If you say preferred shares it means something in the market it isnt legally specific but it creates an idea of legal entitlements. >> Rights, privileges, restrictions and conditions (e.g. vote, dividends and entitlement to property of corporation on dissolution three rights must be present in all shares, not necessarily in same class, but have to be there). In general, try to keep these as simple as possible. Stay precise, consistent with statute. >> Number - unlimited or maximum amount: most commonly have an unlimited number, but can fix it. Reason unlimited is most common is that it is most flexible. Any time directors want to issue shares they can, no constraint. SH might want to constrain the power of directors to issue shares, and do this by setting a max amount in the articles. Changing your articles to allow for max shares will cost money, too. So basic approach is to say it is unlimited and find another way in the agreement to constrain director ability to issue shares. -- In general, what youre trying to do is create a bundle of rights which are going to be attractive to people who might prospectively buy the shares. In a small business, you might have all those people in the room talking to you and what their interests are, what rights they want. You might also want to think about attracting unknown, potential shareholders. -- The bundle of rights has two characteristics: (1) governance the shares give entitlements to be able to help govern, ie; the right to vote, how they want to participate in the governance. The right to vote is important because it is the way that directors get put in place (they have the right to do everything in the corp), and there are some things that SH need to approve, by a shareholder vote. But the effect of the voting right depends not just on it being attached to the shares, but also how many votes/shares each person gets. If you have 51% of shares/votes you can influence every vote, unless higher necessary vote proportions are necessary. (2) economic interests: what type of these interests do the shares create? Usually dividends, the property on dissolution. -- Some practical constraints on creating highly customized share rules. The outcome of these constraints is that a small corp with small amount of shareholders we dont tend to see highly customized share provisions. Why? It requires a lot of time, ie from lawyers to draft them. They create the risk that they will no longer be appropriate when circumstances change. Creating highly customized share provisions may make it difficult to sell those shares. Drafting customized share provisions is difficult. When drafting share provisions you have to remember youre creating legal entitlements just like statutes or contracts create them. You need to show similar care when drafting share provisions because however you describe them is the way the shares are going to be represented. Its important to be precise and detailed 52

about the way you describe the shares so use precedents! This is useful for assignment. You should also look to the default rules in the statute if what you want is already set out there, you dont need to say it in the articles but maybe still want to set that out so it is clear. Bottom line: keep it simple. If you dont, run the risk circumstances change, people wont want to buy them, glitch in the drafting, too complicated, etc. Restrictions on issuing, transferring or owning shares Transfer - subject to securities rules - if no restrictions - are freely transferable: personally property I own that I can pass whenever I want, when I die, etc. - each shareholder wants to control who becomes shareholder: often in small businesses, therefore working closely together. There is an incentive to maximize as they have an asset that will increase in value when they work harder. Also might not want the other SH to leave. Dont want someone we dont know to own a share, having to work with them. BUT - each shareholder also wants to be as free as possible to sell own shares: an economic matter, want to receive as much money I can when I sell them. - How to accommodate these conflicting interests? usually require approval of directors or shareholders. Another way: the right of first refusal is common. Transfer used to need restrictions to be exempt as private company under Ontario Securities Act from requirements to file prospectus. - three limitations included in articles: 1. restriction on transfer in articles 2. limit on number of shareholders 3. prohibition on invitation to public to subscribe for shares - Securities Act amended in 2001 - 2001-2005 exemption for Closely-held issuer got rid of private company exemption. Could issue shares to people with close relationship to corp, but only up to $3M - Since 2005 - under National Instrument 45-106 - Private Issuer may issue securities without filing prospectus (s. 2.4) - National Instrument 45-106 Private Issuer exemption (VanDuzer pp. 484-5) - Requirements >> Not a reporting issuer corp not filed prospectus >> Transfer of shares requires approval of directors or shareholders in articles or shareholder agreement. >> Outstanding securities held by not more than 50 people: not including current and former employees >> Has distributed securities only to: -- Accredited investors: high net worth individual. Presumed to be sufficiently sophisticated to make the inquiries to know whether this is a proper thing to 53

put their money into. $1M in financial assets, or income exceeding $200K for a number of years. -- Current and former directors, officers, employees and consultants: theyre all involved in the business itself in some way -- Others who are not the public: connected to people in the business presumed to not need the protection >>and some other requirements (e.g. information statement given to investors) -- Generally too complicated to include all these things in the articles, and may be too detailed to stand up over time. The securities commission can make a change of rules on their own to respond to things they perceive to be happening in the market. -- s.17 OBCA: if you have restrictions in your articles, corp has to comply with it but an individual may seek remedies under the corp statute as well. This creates a risk for the corp. -- At incorporation, need to think that when the shares aer issued, prospectus requirements wont apply. Want to fit yourself under the exemptions use the private issuer exemption byt including the provision that transfer of shares requires approval or directors or SH Issuance - pre-emptive rights (OBCA s. 26): right included in articles that says directors cant issue new shares to anyone else unless they offer them to other SH, based on the proportion that SH currently owns. Ie; owns 10%, entitled to buy 10% of new shares. Protects them from their interest being diluted. - define class of acceptable shareholders: Why? Generally probably shouldnt because its very hard to know who all the potential SH might be in the future. Reason you see limits on this: where the corp is going to operate in a regulated industry where the part of its scheme is to impose restrictions on who the SH are e.g. Canadian residents (ss. 42, 45) Number of Directors -- Fixed or a range?: generally put in a range for flexibility. Range of ex: 1-10 makes it easy to expand the number. If you fix the number, you have to go and amend the articles which creates an administrative hurdle and brings with it certain costs. -- Minimum one (1) -- How many do you want? Depends on factors such as: 1 what do the SH want, and are there SH who, as part of their governance expectations want to be directors? In a small biz, maybe everybody is a director. Another scenario: venture capital investments put up a lot of money, want a seat on the board. 2 Size: board of 3 can make decisions easily. As you get bigger, becomes harder to have meetings with them. > Registered Office (ss. 5(1) and 14(3)): not necessarily the same as the head office where the senior management is. It is an office with certain legal

54

characteristics. This is where the corp can be reached by the bureaucratic body dealing with the particular statute. > Restrictions on business (ss. 17, 248 (oppression), 253 (compliance)): in their articles, corps used to have to state what kind of business they were going to do. Problem it created: businesses would often engage in things outside the scope of what they were allowed in their articles. This could void contracts. Now, you dont have to say what youre going to do. The starting point is s.15 all the rights of a natural person. But maybe there are reasons to impose restrictions on what the corp can do ie; corp shall not engage in lending of money. If they go against this restriction, s.17 says it doesnt necessarily void what you did as a corp. But doesnt tell legal consequences instead may trigger s.248 and s.253. Generally lawyers dont recommend restrictions in their articles. > Other: generally dont put anything in here to keep things simple. Incorporation Process Corporate Names Why Protect? Protection of goodwill Avoid confusion in the marketplace Corporate Law Rules Cannot have name prohibited by or does not meet requirements of Regulations (s. 9(a), (c)) same as or similar to existing entity if use likely to deceive (s. 9(b)) If have name contrary to s. 9 Director may, after hearing, issue articles of amendment changing name (s. 12) Corporate Names Corporate Law Rules - Corporate Names - Regulations under the OBCA Prohibited or do not meet requirements (OBCA ss. 9(a) and (c)) Prohibited Scandalous, obscene or immoral (Reg. s. 13) Prohibited by law (Reg. ss. 14, 15) Mis-describes business, goods, services, conditions of sale or origin (Reg. s. 17) Corporate Names Corporate Law Rules - Corporate Names - Regulations under the OBCA Requirements Cannot be used unless condition (e.g. consent) satisfied (Reg. ss. 15, 16) Cannot use if not distinctive (Reg. s. 11) Too general - Corporation Corporation Only descriptive Manufacturing Inc. Primarily or only a name of an individual - VanDuzer Inc. Primarily or only geographic name used alone 55

Japan Inc. Unless 20 years use or secondary meaning General Motors Corporate Names Corporate Law Rules - Corporate Names - Regulations under the OBCA Same or similar names likely to deceive OBCA s. 9(b) Criteria for comparison (Reg. s. 3) Distinctiveness Length of use Nature of use Nature of trade Degree of similarity Geographic area of use Exceptions (Reg. ss. 4, 5, 6, 8, 9, 10) Corporate Names Provincial Regulation - Provinces have the following powers CBCA corporations - entitled to carry on business in any province including use of corporate name - BUT province May refuse to allow to use non-corporate name if carrying on business exclusively within province by refusing name registration (e.g. Ontario Business Names Act s. 4(2)) May not refuse to allow to use non-corporate name if engaged in interprovincial business (Manitoba Names Reference) May require registration of business name Corporate Names Provincial Regulation - Provinces have the following powers (continued) Other corporations (i.e. incorporated outside the province and not CBCA corporations) May refuse to allow use of corporate or non-corporate name in province by refusing name registration re: non-corporate name (e.g. Ontario Business Names Act ss. 2(1), 4(2)) or refusing provincial licence or require name change re: corporate name (e.g. Ontario Extra-provincial Corporations Act ss. 10 and 11) Corporate Names and Trade Marks Relief for infringement of trade-mark caused by use of confusing trade-mark or trade name (Trade-marks Act - s. 6 (definition of confusion) and s. 20 (infringement)) Comparison with corporate law Trade name includes corporate names and any other name Trade-mark and trade name not necessarily the same Confusion about confusion Damages or injunction vs. articles of amendment Seek relief in different fora Corporate Names 56

Provincial Regulation Provincial Passing Off Law Basis of Relief representing products in a manner likely to deceive must show actual damage to business or goodwill or likelihood of damage Legally distinct from claims regarding trade-mark infringement, confusion under corporate statutes, liability under business names legislation, and domain name rules The Brick Case Bricks Fine Furniture Ltd. - a Winnipeg furniture business - challenged Brick Warehouse Corps right to use its corporate name before CBCA Director Brick Warehouse sued Bricks Fine Furniture for trade mark infringement in the Federal Court Federal Court refused to stay proceedings before Director Bricks Fine Furniture counterclaimed for passing off in Federal Court and sued Brick Warehouse for passing off in Manitoba Manitoba court stayed the passing off action Corporate Names Names and the Incorporation Process Name search of NUANS database Not required for number names (OBCA s. 8(2)) Pre-clearance under CBCA s. 11 - no OBCA equivalent Corporate Names Incorporation Process Why Protect? (1) Protection of goodwill: reputation for doing good work that attracts people to the business. We protect this because we want businesses to invest in doing the things that develop good will. (2) Avoid confusion in the marketplace: identical and deceptively similar names can confuse consumers, particularly depending on the use of both Corporate Law Rules Cannot have name: prohibited by or does not meet requirements of Regulations (s. 9(a), or (c)) same as or similar to existing entity if use likely to deceive (s. 9(b)), meaning creating confusion in the marketplace. -- If have name contrary to s. 9, Director may, after hearing, issue articles of amendment changing name (s. 12), giving effect to the name change - In ON, the regulator doesnt review the name search, compare the name you want to the ones out there. There is a federal regulator that does this under the CBCA, however. So the degree of scrutiny when incorporating in ON is much less. Doesnt mean the rules are less important, but more about assessing the risk. Regulations under the OBCA 57

Prohibited or do not meet requirements (OBCA ss. 9(a) and (c)) Prohibited -- If scandalous, obscene or immoral (Reg. s. 13) -- Prohibited by law (Reg. ss. 14, 15): university, co-op, condominium -- Mis-describes business, goods, services, conditions of sale or origin (Reg. s. 17) Requirements -- Cannot be used unless condition (e.g. consent) satisfied (Reg. ss. 15, 16): ie; cant use architect unless the profession gives you consent -- Cannot use if not distinctive (Reg. s. 11): this means inherently distinctive, in isolation, not compared to other names. Does it create a distinct identity for the corp? > Too general - Corporation Corporation > Only descriptive Manufacturing Inc. > Primarily or only a name of an individual - VanDuzer Inc. > Primarily or only geographic name used alone: ex: Japan Inc. > But can have one not completely distinctive if 20 years use or secondary meaning General Motors > Typically, In order to comply you need some kind of distinctive element, a descriptive element, and in accordance with s.10, a legal element. This is practically speaking for the name to be sufficient. The more distinctive the distinctive part is, less important the descriptive part is. Same or similar names likely to deceive: OBCA s. 9(b) -- Note the standard is likely to deceive, dont have to prove deception just the likelihood. An issue could come up before the new business even starts using the name in the market. We have seen this in the problems with Target coming to Canada, as a Canadian business has already been operating with that name. -- Criteria for comparison (Reg. s. 3) - Distinctiveness - Length of use: whose was used first, generally they prevail. But also how long have the names been used in the marketplace if both have existed in the marketplace without any problem arising, may be that the market is capable of making a distinction between the two names. - Nature of use: what kind of business being carried on under these names are they in competition, what do they make? - Nature of trade: are you selling to same customers, using same suppliers, etc. - Degree of similarity: not just the words, but ideas, sounds created by the names - Geographic area of use: likelihood dramatically reduced if carrying on business in places across the country from each other, unless they carrying on business across the country. 58

- Exceptions (Reg. ss. 4, 5, 6, 8, 9, 10): similar names may be permitted. S.5: affiliated corps, those that are under common control one controls other or entity controlling both. Another is successor corps: a transfer of the business from one entity to another, same business but carried on by someone else. They are entitled to use that name in some circumstances. - Ex: ABC Manufacturing Inc and DEF Manufacturing Inc. ABC carries on a business with certain assets. They then sell to DEF. DEF now gets ABCs assets. They may want to take advantage of ABCs reputation that they have developed. If ABC agrees to change its name as part of the deal, say to XYZ, then DEF would be permitted to change its name to ABC Manufacturing Inc. This is permitted under s.4 in the regulations. Browns Bottle (p.151) F: Irwin Browns carried on business, Browns Bottle Canada Ltd. Sold business to somebody else, set up I. Browns Packaging Ltd. BBC Ltd. not happy with him using this name Browns a distinctive part of their name. Businesses operating in similar markets. Wanted him to change the name of his business. R: Was there a likelihood of confusion? Using the criteria for comparison from regs, s.3. What is the nature of the businesses? BBC produces packaging material. IB does not produce, more a consulting business. Arent exactly the same. They used some of the same suppliers and sold to some of the same customers, in same geographic area. But this wasnt a problem relatively small, sophisticated customers therefore likelihood for confusion going to be small. Also notes that the name is not the same one refers to bottle, one to packaging. Also distinctive using of the letter I.. In addition stated we also need to consider that Irwin Brown should be able to carry on business using his own name shouldnt apply the rules in a way that could possibly deprive him from carrying on business using his name. Provincial Regulation - Provinces have the following powers -- CBCA corporations - entitled to carry on business in any province including use of corporate name - BUT province - May refuse to allow to use non-corporate name if CBCA corp is carrying on business exclusively within province by refusing name registration (e.g. Ontario Business Names Act s. 4(2)): under the Business Names Act, if a corp is using a name other than its corp name, it has to register it. Ex: ABC Manufacturing Inc. carrying on business as Toys for Kids in the marketplace their non-corporate name. Any time you use another name, you have to register. Manitoba Names confirms that provs can require this even from fed corps. - May not refuse to allow to use non-corporate name if engaged in interprovincial business (Manitoba Names Reference): if fed corp carrying on business outside of borders of one prov, prov cant refuse the use of that non-corporate name. Doesnt mean it cant require the registration of the non-corp name, but cant refuse. With respect to trademarks: it is exclusively in fed juris, so provs cant 59

directly regulate TMs. But if TM is in non-corp name, can require register but cant refuse. - May require registration of business name -- Other corporations (i.e. incorporated outside the province and not CBCA corporations) - Two statutes in ON: Business Names Act require everyone operating in the prov using a name other than corp name to register. Extra-provincial Corps Act: must obtain a licence, if incorped outside of ON, to operate in ON. - So ON may refuse to allow use of corporate or non-corporate name in province by > refusing name registration re: non-corporate name (e.g. Ontario Business Names Act ss. 2(1), 4(2)) or > refusing provincial licence or require name change re: corporate name (e.g. Ontario Extra-provincial Corporations Act ss. 10 and 11) - to assess this, use basically the same criteria as the things in the federal statute - in ON, we dont require other Canadian corps incorped outside of ON to obtain licences, but they still need to meet the requirements of the name rules. Coming in from the US, you need a licence, so that is the difference. Corporate Names and Trade Marks - What is a trade-mark? Words or symbols that are used in connection with the sale of goods or services in the market. TM Act tries to offer relief for infringement of trade-mark caused by use of confusing trade-mark or trade name (includes both corporate names and non-corporate names) (Trademarks Act - s. 6 (definition of confusion very similar to s.2 of regs) and s. 20 (infringement)) -- Comparison with corporate law - Trade name includes corporate names and any other name - Trade-mark and trade name not necessarily the same - Confusion about confusion: no cases telling us about the test for confusion about TMs being the same as the confusion between corp names. The context is slightly different anyway. There might not be a problem with the TM being confused with a business name, but two business names could be seen as more confusing. See the Apple example in the book two retail stores one in womens clothing, one in sports equipment. - Damages or injunction vs. articles of amendment: TM infringement can give you damages, injunctive relief, stop the infringing party from continuing to use the mark, destroy the goods with the mark. If complaining about corp name, can only get the other party to change their name no damages or other kinds of relief. Also have seek relief in different for a TMs are in fed court, corp names go before a director. Provincial Regulation: Provincial Passing Off Law 60

--Basis of Relief - representing products in a manner likely to deceive (intention) doesnt have to be done through the name, could be through advertising, way stores set up, similar images, etc. - must show actual damage to business or goodwill or likelihood of damage --Legally distinct from claims regarding trade-mark infringement, confusion under corporate statutes, liability under business names legislation, and domain name rules The Brick Case F: Bricks Fine Furniture Ltd. - a Winnipeg furniture business - challenged Brick Warehouse Corps right to use its corporate name before CBCA Director. Brick Warehouse sued Bricks Fine Furniture for trade mark infringement in the Federal Court. Federal Court refused to stay proceedings before Director because the issues were not the same, the decisions would not necessarily be connected. Bricks Fine Furniture counterclaimed for passing off in Federal Court, sued Brick Warehouse for passing off in Manitoba. MB court stayed passing off action. R: The case ultimately settled. The example is just to show the complexity of the system in practice. October 26 Names and the Incorporation Process -- Name search of NUANS database: includes all names incorporated in Canada, except Quebec which has its own database. You may want to take other steps to ensure that the name chosen by the client is available check business directories, etc to make sure its not out there. - NUANS search not required for number names (OBCA s. 8(2)) -- Pre-clearance under CBCA s. 11 - no OBCA equivalent: essentially preclearing the name 90 days beforehand -- Must use full corporate name on all invoices, contracts, orders for goods and services and negotiable instruments (s. 10): ABC Manufacturing has to use that name, not Toys for Kids on these particular documents, as they create legal obligations. Post-Incorporation Organization - After getting your certificate of incorporation. In order to organize you need to do certain things - Directors Meeting: key thing is to issue shares, as this guarantees effective operation of the corp into perpetuity as there is always someone there owning parts of the corp. If the directors die, without issuing shares, things get messy. In general, you want to get the shares out to protect from this. Also

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want to issue a general by-law for when, how meetings are called. Appointing officers, opening bank accounts, etc. - Shareholders Meeting: approve the by-law when the directors present it to them. - Shareholders Agreement: typically these are all drafted in advance of incorporation. Deals with share transfers, governance structure and voting allocation to meet the needs/interests of the shareholders. Also may deal with share transfer, things like right of first refusal. - Records in Minute Book: Accessible at registered office available to shareholders and creditors (ss. 140, 145 CBCA 20 and 21) Scale of the Corporation - We have corps that need different rules sometimes, depending on how big they are. Smaller corps: - Private corporation - Closely held corporation - Close corporation -- In this situation dont need an elaborate governance scheme as the parties can work it all out between themselves Larger corps: - Public corporation - Widely held corporation -- Many shareholders, most remote from the management. There has to be a set of accountability mechanisms built in to ensure the management work in the SH best interests. These governance rules are not going to be the same as those for smaller corps. - There is, of course, all kinds of variations in between the sizes. So this means that we have the challenge of trying to figure out the best way to meet the needs. -- So we have created a distinction between non-offering corporations (OBCA) and offering corporations (OBCA) one does not allow shares to be purchased by the public, the other does not. We also has to remember that securities law then comes in when dealing with shares, which sets out many different rules applying to the situations. -- The basic proposition: different categories of corp in different scale have to have different rules to deal with their unique situations. OCT 26 Scale of the Corporation - We have corps that need different rules sometimes, depending on how big they are.

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Smaller corps: - Private corporation - Closely held corporation - Close corporation -- In this situation dont need an elaborate governance scheme as the parties can work it all out between themselves Larger corps: - Public corporation - Widely held corporation -- Many shareholders, most remote from the management. There has to be a set of accountability mechanisms built in to ensure the management work in the SHs best interests. These governance rules are not going to be the same as those for smaller corps. - It is a continuum as corps are not just large or small, they are anywhere in between as well. Need different compositions depending on the scale of the corp. With one person, they will run the corp however they want. Small number of SH who are also management, likely easy for them to all reach an agreement. Once there are lots of SH and remote management, you need formal accountability mechanisms in terms of legal obligations that will apply in the governance scheme. Requirements for information about the corps progress, how meetings are held, how they can get involved, etc. - There is, of course, all kinds of variations in between the sizes. So this means that we have the challenge of trying to figure out the best way to meet the needs. -- So we have created a distinction between non-offering corporations (OBCA) and offering corporations (OBCA) one does not allow shares to be purchased by the public, the other does not. We also has to remember that securities law then comes in when dealing with shares, which sets out many different rules applying to the situations. -- The basic proposition: different categories of corp in different scale have to have different rules to deal with their unique situations. OBCA Offering Corporation - Certain additional obligations - Four main differences/additional obligations: (1) Mandatory Proxy Solicitation information to SH, disclosure about what is going to be decided at meetings and info on the activities of the corp, including -- Financial Statements (ss. 111, 154, 160). The proxy part allows for participation by checking off a box, and sending it in, so they dont have to attend the meeting in person.

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(2) File Financial Statements publicly so not only SH but anybody has access to those FS this is because if youre a public corp, likely that your shares are being bought and sold by the public on the stock market (s. 156) (3) Minimum of 3 Directors (s. 115(3)) -- 1/3 not officers a degree of independence from management, so that they can exercise unbiased oversight. But 2/3 can be officers, so still significant management control possible. (4) Audited Financial Statements and Audit Committee (ss. 148, 158): management produces FS, and accountants reviews those statements to determine that theyre prepared in accordance to generally accepted accounting principles (GAAP). Fairly presenting the financial position of the corp. The audit committee has to be a majority of non-officers, and review the auditors process. Designed to provide independent oversight of the presentation of the financial position of the corp. If SH agree, can dispense with auditing requirement often done in small corps because it is expensive. If everyone is actively involved in the business, might not need to incur the expense for an external audit if you are an offering corp though, you cant do that. CBCA additional obligations for special types of corporations Distributing Corporation - Effectively the same as the offering corporation -- Audited Financial Statements and Audit Committee (ss. 162-3, 171) -- File Financial Statements (ss. 155, 160) -- Minimum of 3 Directors > At least two of whom are not officers or employees (s. 102(2)) -- Prohibition on short-selling (ss. 126, 130): you borrow shares at one moment, and when the price goes do you buy the shares that are cheaper and replace them. So youre betting that the price of the share will go down. CBCA doesnt want directors and officers betting like this against the company an incentive to have the companys shares go down. - Corporations with more than 50 shareholders and distributing corporations -- Mandatory Proxy Solicitation (s. 149(2)). Ex: high tech corp compensates employees to give them shares. Havent sold the shares to the public, but you have grown such that your SH exceed 50. Then you need to engage in proxy solicitation. This is something a bit different from OBCA kicks in at 50 rather than at offering. - In most of the situations that these rules regarding the scale of corp apply, securities rules are also likely to apply. - Usually when you create a corp, it is going to be a relatively small one, small amount of people, not an offering corp. But you may create a new corp just for the issuance of securities, although this is rare.

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Ontario Securities Act - If you want to make sure the onerous rules apply to you, you have to put in place in the articles exemptions such as: - Private issuer (OSC Rule 45-501) > Add restriction on transfer and (possibly) limit on number of shareholders in articles: remember you have to have 50 SH or less to qualify > To ensure availability of exemptions from prospectus and registration requirements Choice of Jurisdiction of Incorporation -- The bottom line is that there really arent that many significant differences, not a lot to choose between, but still some differences. -- Disclosure Obligations > Imposed by jurisdiction of incorporation and jurisdiction where carrying on business. If federally incorporated, have to file annual return (s.63 CBCA). If carrying on business in ON in addition to that, you also have to file an initial notice under Corporations Information Act. Also have to file annually an annual return, and notice of change. > Initial Notice > Annual Return: dont have to file this if youre ON corporated > Notice of Change: change your directors, for example, need to file new notice -- Practically speaking, the filing information is very minimal and doesnt have a big impact, just have to remember to file in both places if fed incorped. If youre carrying on business in multiple provs, regardless whether fed or prov incorped you have to do this for each of them. -- Where Corporation Will Carry on Business > Foreign extra-provincial corporations need licence in Ontario: Agents for Service (Ontario Extra-Provincial Corporations Act s. 19). Carrying on business in any prov needs to be licensed usually pretty easy, unless your name is objectionable. If fed incorped, dont need to do this. > Licensing and disclosure obligations triggered by carrying on business in province. Defined in OEPCA s. 1(2) and (3). Presence through website alone seems to not be covered. -- Liability for Provincial Tax > Based on income earned in the Province, not generally based on incorporation, so not something that is a significant determinant -- Provisions of Corporate Law - For example, is there anything about the OBCA systematically better than the CBCA? It is hard to make reliable generalizations like this they are pretty similar. The differences are not such that one always represents a better set 65

of rules for every client. CBCA originally was enacted with the intention to promote the uniformity of corporate law in Canada, so a lot of provs enacted very similar statutes to the CBCA. > Dominance of the CBCA model. Distinctive features based on 2001 amendments (p. 183) this introduced significant differences from provs that were enacted based on it so many adopted new amendments to follow the CBCA. > Use of private arrangements to overcome differences: Many of the rules are like Partnerships Act in that they are default rules unless the SH agree to change them. You can exclude an ON rule if youre incorped provincially, and follow a fed rule, just set out that you have agreed for example in shareholders agreement. -- Prestige Recognition - idea is that if you do business internationally, might look better to them that youre incorped federally rather than provincially. -- Fees - fed fees are less than provincial fees this might make a difference for some small businesses but not an enormous one -- Possibility of continuance under the laws of another jurisdiction - if business is likely to be carried on in another prov, might want to incorporate federally. Remember that most corp statutes allow for continuation meaning you can migrate from one juris to another if incorp in ON, you can continue federally. Through a process the corp can cease to be governed by prov law and become governed by fed law, as well as by one prov law to another. Pre-incorporation Contracts - Say you have someone agent/promoter who enters into agreement with third party on behalf of a corp that is not yet in existence. - Why might this happen? Often in real estate industry where there are trans, set up corp after deal is made to be the buyer of the property. - The agents plan is that when the corp comes into existence is that the k will be binding on the corp and the third party Issues -- Is the agent liable personally? What if the corp never comes into existence? This would be very important for the parties involved. -- Can the corporation adopt the contract after it comes into existence, to achieve what was originally intended? -- If so, is the agent still liable? Common Law Position -- Liability of agent depends on intention of parties 66

> Often not clear: Signed by corporation = agent not liable. Signed for corporation = agent liable. -- Corporation not liable unless fresh consideration: corp cant simply adopt the k, needs to be a new k, even though manifestly inconsistent with parties intention Statutory Reform to provide more certainty (s. 21 OBCA, s.14 CBCA) -- Agent is liable under contract unless parties specifically agree to the contrary -- Corporation can adopt contract and, if does so, agent is relieved of liability. Agent bears risk until adoption. -- Third party to contract may apply to court for apportionment of liability between agent and corporation. Why? To avoid abuse of adoption to avoid personal liability (e.g., Landmark Inns: landlord entered into agreement to lease with corp not yet incorped although landlord didnt know this. The person acting on behalf of corp purported to sign as the chairman of the corp. Lease supposed to happen Jan. 1, tenant decided they didnt want to enter into the lease. Incorped corp, adopted the lease, but corp had no assets. Landlord applied to court for apportionment of liability and got it.) Outstanding Issues -- CBCA (s. 14) only applies to written contracts. OBCA applies to both oral and written. This means that an oral k, then incorp federally, only get the common law rules. -- If corporation never incorporated what rules apply? There is no answer to this. Some say the rules where parties intended to incorp. Others say should look at conflict of laws rules. Some say you cant apply these rules at all, statute only applies to a corp that actually exists. -- Requirement for a contract > Does this mean that must find contract between agent and third party for statute to apply? If you have to establish that there is a k, then the statute hasnt fixed anything, takes us back to the common law rules > 2001 Amendments to CBCA eliminate problem includes purporting to enter contract > Re OBCA has not fixed it in that legislative regard but court has held contract not requirement, just need to attempt: Szecket v. Huang (VanDuzer p. 190) > So both juris have fixed it, one with legislation, and one with judicial interpretation > When does adoption occur? Sherwood Design Services (on course web site) - a cautionary tale about adoption

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F: Two people K and S. K offered to buy property from S on behalf of corp to be incorped. S accepted so they formed a k. So K is the agent/promoter, king with third party S on behalf of corp yet to be incorped. K goes to his lawyer and asks them to set up a corp to complete the trans. Firm has one set up already, will use this Shelf Corporation to complete it. Lawyer drafts up a bunch of documents transfer the share from the partner in the firm to K, electing K as the sole director, etc. including a draft legal opinion saying that once the trans is closed, the k between S and Shelf Corp will be binding. But K then doesnt want to close. S has claim for breach of k. In meantime, Ks lawyers have the corp, transfer the Shelf Corp to another client in the same way as that to K. S sues this version of the Shelf Corporation. R: ONCA agrees with S. Sending draft closing documents to S constitutes an adoption by the corporation of the agreement. So even though transferred to the other client, therefore the corp is now responsible. Lawyers likely had to settle with their client to deal with the mess. Abella: we should view this as an adoption because it is essential in commerce to rely on communications from other lawyers with respect to what is going to happen. Even though the consequences are entirely unfair to the new client, that is the legal requirement. DISSENT: shouldnt think of this as an adoption. The only communication here was draft documents, and at the most this should be seen as an intention to adopt. There was never an effective adoption. 225-251

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