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                                               Business Associations
                                                    Winter 2002
                                                    Mark Gillen




Objectives:

1. Note how sole proprietorships are typically financed
     Personal savings (owner‟s investment / equity)
     Bank loan (Debt financed)
     Trade credit

2. Note who controls the business decisions of a sole proprietorship
     Sole proprietor of course! Subject to . . .
     Creditors
          o Banks
                  Require approval of further debt other than goods purchased,
                  May put in place a working capital ratio requirement (the sum of cash, any amounts due
                      on credit and the cost of inventory on hand must be twice as great as the sum of
                      amounts due on any credit received in purchasing inventory or for expenses occurred) –
                      a protection for bank to ensure that the SP‟s other creditors will not seize assets making it
                      impossible for her to make any profit
                  Security interest in the assets (collateral) – bank has a contractual right to seize assets (a
                      registered claim)

3. Note the legal consequences to the SP of relations between the business enterprise and others (e.g. tort
liability)
     Business is not recognized as a separate legal entity – both business and personal assets are attainable
          by anyone who sues or by the bank
     Owner must enter into contracts – owner and business are one and the same

4. Explain and apply the requirement to register business names
     Partnership Act
            o S.88 If,
                  1. It‟s a business of trading, manufacturing or mining;
                  2. Not in a partnership; and
                  3. The business name is not the SP‟s own name or the business name consists of a phrase
                       indicating a plurality of persons
               The name must be filed with the registrar

           o   S.89 The registrar is not to register a name if it resembles the name of a corporation in BC of if it is
               likely to confuse or mislead unless:
                    1. The corporation consents in writing, OR
                    2. The business name was used before the corporation first used the name

           o   S.90(2) The Registrar keeps an index showing:
                   1. Firm Name
                   2. Names of persons composing the firm

           o   Failure to comply: penal sanctions per Offence Act ss. 4 and 5
           o   S.88(3) – creditors can search the registry to find out who is behind a business – not necessary if
               business is named after the SP
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      Civil Procedure Rule # 7 – creditors can sue in the name of the business (this deals with problem of
       creditors not being able to find the person behind the business

Problems of SP:

      Once the business is going well, more inventory is needed which results in more accounts receivable.
       Funding must be increased to support this and sources are limited to the owner and the bank. Banks
       don‟t like to exceed 50% financing – it gets only a fixed return and that‟s a lot of capital.




I. AGENCY – RELATIONSHIPS BETWEEN PRINCIPAL AND AGENT

Definition

A situation in which a person (agent) is in a position to affect the legal relations of another person (principal)
      Distinguish from employment relationship – not all employees are in a position to affect the legal
        relations of their employer (e.g. janitor at a bank)
      Corporations are legal persons but must enter into contracts through agents
      Distinguish from trust relationship – the fiduciary duties owed are similar but a trustee need not pay
        attention to the Settlor (person from whom the trustee obtains authority) while an agent must act in
        accordance with the lawful instruction of the principal. Also, the property a trustee holds in trust is
        completely separate from his own – creditors cannot access it but if an agent goes bankrupt and is
        holding goods for the principal the creditors can sue the agent for the goods and for his personal assets

Importance of agency law – extremely common and makes up almost the whole basis for partnership and
corporate law

Objectives

I. The scope of the agent’s authority as between the principal and the agent
     1. Express authority in two ways:
           a. As per oral or written agreement (e.g. power of attorney), or
           b. As inferred from the words
     2. Implied – look to the usual or customary authority of such agents
           a. Usual - Can arise where there was no written or oral authority given (Freeman v. Lockyer)
                     i. Kapoor was allowed to carry on as if he were the managing director
                    ii. Court will look at this even when there may be oral or written authority that doesn‟t
                        include these powers or activities – Court may estop P from relying on the written
                        document (different if the powers or activities were expressly prohibited)
           b. Customary
                     i. Look to type of authority agents of this type customarily have (very general question)
                    ii. Here court is “reducing transaction costs” – instead of laying out every single term in the
                        K, you just deal with an agent and if there turns out to be a gap the court will attempt to
                        fill it. Danger: court may get it wrong. Courts may protect agent‟s reliance on what they
                        thought was their authority

II. Duties of the agent to the principal
     1. To perform obligations according to the terms of the agreement and the instructions of the principal
         (generally, must act in the best interests of the principal)
     2. Fiduciary duties:
             a. To perform with reasonable care of agents of that particular types (damages)
             b. Not to delegate (P trusts this A – not another), (damages, injunction). Corporate statutes give
                 directors this authority to delegate in order to manage the corporation.
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             c. Not to put themselves in situations where their duties and their personal interests conflict
                (accounting for profits, contract is void, damages, injunction)
             d. Not to make secret profits (accounting)
             e. Keep proper accounts (evidentiary presumption against agent)

III. Duties of Principal to Agent
     1. To pay remuneration
             a. Generally requires express agreement – gratuitous agency is rare
             b. Agent must perform obligations under the agreement
             c. Commission only if the services were the effective cause of the sale, contract, etc.
     2. To pay expenses and indemnify against loss
             a. The agent must be acting within scope of his actual authority
             b. Expenses not incurred through fault of the agent

IV. Events of Termination
    1. By act of the parties
           a. Agency agreement provides for termination
           b. Otherwise unilaterally terminable (req. reasonable notice where it is also employment
                relationship)
    2. By Operation of Law
           a. Where Principal or Agent becomes bankrupt
           b. By frustration
           c. By the death of either the Agent or Principal

II. AGENCY RELATIONSHIP WITH 3RD PARTIES

Objectives

1. Overall, in a given fact situation, be able to identify the agency law issues raised, set out the approach of
   the law on the issues, apply the law to the facts and predict a probable outcome to the litigation or give
   appropriate advice considering underlying values or policy.
2. More specifically,
       a. Be able to set out the circumstances in which an agent can be said to have ostensible authority
       b. Articulate possible reasons for the law on apparent/ostensible authority

Elements of Ostensible Authority

1. A person (alleged principal) must make a representation or permit a representation (express or implied from
   words, conduct or circumstances) that some other person (alleged agent) has authority to act on his
   behalf, and
2. The 3rd party reasonably relies on the representation to his detriment

Policy

1. 3rd Party Reliance
        a. Court will try to protect the interest involved in this reliance (in the elements of claim)
2. Least Cost Avoidance
        a. A decision on who should bear the cost of this reliance – the 3rd party or the “alleged principal”
        b. Cost is placed on the one who could have avoided the problem at least cost
        c. If there has been some relationship between the alleged principal and the alleged agent, courts
            are inclined to make the alleged principal liable
                  i. Monitor agent‟s behaviour
                 ii. Check into agent‟s background
                iii. Make 3rd parties aware of agent‟s authority
        d. Court reluctant to make 3rd party liable
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                 i. For 3rd party to verify agent‟s authority, the 3rd party must contact the principal – this defeats
                    whole purpose of agency relationship
        e. 3rd parties will be liable when:
                 i. They did not reasonably rely
                ii. There is no relationship or contact between the alleged agent and the alleged principal

III. BREACH OF WARRANTY OF AUTHORITY

Objectives

Be able to set out the circumstances in which an agent may be liable (to the 3 rd party) for a breach of
warranty of authority

Elements of a Breach of Warranty of Authority

1. Agent represents that he has authority;
2. The representation is false; and
3. 3rd party reasonably relies to his detriment

**Damages here are expectation – put the 3rd party in the position had the “agent” had the authority to make
the promise and it was fulfilled

IV. RATIFICATION

Objectives

1. Set out the circumstances in which the principal can ratify a contract, or be held to have ratified a
   contract, that the agent did not have authority to make on behalf of the principal
2. Note the consequences of the ratification
3. Note possible policy reasons for the principle of ratification

Principal can ratify if:

1. Agent purported to act on behalf of the person who seeks to ratify
2. The person seeking to ratify must be in existence and ascertainable at the time; and
3. The person who seeks to ratify must have the legal capacity to do the act both at the time the agent acts
   and at the time of the ratification

**Ratification relates back to the time of the offer and acceptance between the Agent and the 3 rd Party

The Ratification

1. Can be express or by conduct or by acquiescence;
2. The person ratifying must do so based on a knowledge of all relevant facts (i.e. ratification must be fully
   informed)

Usual Consequences of Ratification

1. Principal can sue and be sued by 3rd party
2. Agent is no longer liable for a breach of warranty of authority (3rd party can sue the P so 3rd party isn‟t
   allowed to collect twice)
3. Agent is no longer liable to P for exceeding authority (if the agent were, it would be a no down side risk for
   P)
4. Principal will be liable to Agent for reasonable remuneration or indemnity for loss (it‟s reasonable for agent
   to get this)
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Policy
1. Mutual Benefit – at the time the 3rd party deals with the agent they receive a benefit and at the time the
    principal ratifies it, he receives a benefit
2. Avoids speculation by the P against the A (or unjust enrichment of the P at the expense of the A) (that‟s
    why consequences 3 and 4 are in place)
3. Avoids speculation by the principal against the 3rd party (or unjust enrichment of the P at the expense of the
    3rd Party). See #1 under ratification – acquiescence can deem a K to be ratified. Prevents P from hanging
    back on a K to see if it‟s good or bad. Also, the agent must purport to act on behalf of a person in
    existence and ascertainable – this prevents people from not forming a corporation if the K turns out to be
    bad.
4. Avoids speculation by the 3rd party against the principal (or unjust enrichment of the 3rd party at the
    expense of the principal). Prevents a 3rd party from not accepting a K after he‟s signed it but before the P
    ratifies it – ratification relates back to the time of the offer and acceptance between the agent and 3 rd
    party.
5. Cures minor defects in the grant of authority – if you didn‟t have this, if the agent isn‟t indemnified or
    remunerated and the P claims A acted beyond his authority all this would go to litigation. But if P has gone
    ahead and performed the K, or if they‟ve acquiesced, this ends the whole question of authority. Upon
    ratification, the question of authority is wiped out.

V. UNDISCLOSED PRINCIPAL

Objectives

1. Set out the circumstances in which an undisclosed principal can disclose the agency relationship and take
   both the obligations and benefits under the contract
2. Note possible reasons for the law with respect to undisclosed principals

If the Principal is Not Disclosed

1. P can disclose agency and sue 3rd party on the contract (suddenly someone is suing the 3 rd party)
2. This does not apply if 3rd party was really looking to A which might occur if: (lots of wiggle room here)
         a. The contract terms require performance by A; or
         b. 3rd party clearly intended to K with A alone (such as where the K is for the services of A, there is some
            personal aspect to the K or 3rd party would not have K‟d with P if P‟s identity were known)
3. 3 rd Party, on learning of the agency can sue P

4. 3rd Party can still sue A (they can‟t sue both A and P – only one)
5. In an action by P, 3rd party can set off rights against A and can use any defence that would be available
   against A

Possible Reasons for This:

1. Mutual Benefit – it may not really matter who did the service. The 3rd party receives the benefit of having
   the K performed and P receives benefit of agency relationship
2. Potential unjust enrichment of the 3rd party (3rd party gets the goods but won‟t pay the principal b/c there
   was no K between them)
3. Potential unjust enrichment of the principal (P receives money in advance for the goods but won‟t deliver
   b/c there‟s no K)

VI. LIABILITY OF PRINCIPAL FOR TORTS OF AGENT

Objectives

1. Identify issues involving the liability of the P for torts of the A and set out and apply the law on the liability of
   the P for the torts of the A (test is open-ended);
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2. Note possible policy reasons for the law concerning the liability of the P for the torts of A

The Legal Rule:

It is generally said that P is liable for the torts committed by A within the scope of A’s authority

Possible Policy Reasons for This:

1. Deterrence / Least cost avoidance – if we‟re going to try and avoid this, the person who can avoid it at a
   lower cost may be the principal - they could “reign in” the agent to make sure they didn‟t commit tortious
   acts
2. Allocation of the loss to the activity causing it – one of the costs of that particular activity that the P must
   bear
3. Compensation concern – in those cases where it isn‟t explicitly stated, particularly in torts cases, but
   compensation is needed and there is no system in place to provide it




I. Introduction

    1. More than one owner (more than one equity investor). Sharing profits and liabilities, issues get more
       complicated
    2. Less common since the development of readily available techniques of incorporation
    3. Common uses of partnership:
           a. Professionals (lawyers, doctors, dentists, engineers, architects – often the regulations under which
               they operate don‟t allow them to limit their liability and form corporations)
           b. Joint ventures – companies forming partnerships
           c. Tax reasons – treats partnerships like the law does so it doesn‟t recognize a partnership as a
               separate legal entity. If you start a new business and you decide to incorporate a company
               and the 1st year you have a lot of expenses so the profits may be at a loss. You then don‟t pay
               tax b/c you have no income and you can carry this loss forward.
           d. Default
    4. The Act is a codification of earlier common law cases
    5. Format of the Act - Nature of Partnership, General Partnerships and Relationships Between Parties
       Themselves etc.
    6. As between the partners the Act is essentially a default contract – this statute gives what the general
       rule but allows for express contractual provisions to the otherwise
    7. Much of the law of partnerships is based on agency law concepts

II. Existence and Nature of Partnership

A. When Partnership is said to exist

Objectives:

1. Briefly note under what circumstances a partnership is said to exist
2. Note the likely rationale behind concluding that a partnership exists between two or more persons as far as
   the relationship between the partners is concerned
3. A partnership is said to exist where (per P.A. s.2)
       a. Persons (2 or more)
       b. Carry on business,
       c. In common; and
       d. With a view of profit
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“Person” defined in s. 29 of the Interpretation Act as including “a corporation, partnership or party, and the
personal or other legal representatives of a person to whom the context can apply according to law”

This Excludes:
      Non-profit organizations [“with a view of profit”]
      Incorporated companies or associations [s.3 – a corporation is NOT a partnership, this Act does not
        cover a corporation, corporations have their own act]

“In common”
     Used for different purposes, at least three different policy issues:
       1. Settling disputes between contracting parties,
       2. Protecting third parties;
       3. Preventing tax avoidance
     Indeterminate part that allows court to decide how they see fit (vague) – goes to 2nd objective
     Is this really the deal the partners wanted?

B. The Nature of Partnership

Objective

Be able to describe the nature of the partnership and note some of its consequences.

1. A partnership firm is not a separate legal entity (see re Thorne – T had a partner, R. R went and cut down
   trees and T was responsible for the milling operation. T injured his leg with the saw so he made a claim for
   WCB. The Board refused the claim by saying under the act you get compensation if you’re a worker
   (defined as employee) and Thorne was not an employee – he was a partner. He could not have an
   employment contract with himself b/c the partnership is not a separate legal entity).

2. Contracts entered into are contracts between each partner and the other contracting party. Therefore
   each partner is personally liable for the performance of contractual obligations (their liability is unlimited). If
   4 partners enter into a K to buy goods, each one of them is personally bound.

3. The partners jointly hold property held by the partnership for partnership business for the purposes of the
   business. In a deed for land, only one partner‟s name will appear and he holds it in trust for the others.

4. Partners are not employees of the partnership.

5. Partners cannot be creditors of the partnership.

C. Partnership Act

Objective

1. General understanding of the Partnership Act
    S.21 – Allows for a variation of rights and duties by consent
    S.22 – Partners must act in fairness and good faith
    S.27 – Rules for determining rights and duties of partners in relation to partnership
    S.28 – Majority cannot expel a partner
    S.29 – Ending the partnership

2. Compare a partnership agreement with the Act, look at what the parties have agreed to and compare
   with what the Partnership Act provides. Note conflicts.

3. Reasons for drawing up a Partnership Agreement
         a. To contract out of the Partnership Act provisions
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            b. To lay out terms for partners on paper so they are readily accessible

4. Other provisions to add into an agreement:
    Fundamental nature of the business
    Signing authority – who will have it, any restrictions upon it
    Name, place of business
    Independent accountant, bookkeeper, auditor
    Entitlement of partners to draw money out and any restrictions




Relationships With 3rd Parties

Objective

Set out the law with respect to the existence of partnership, according to ss.2 and 4 of the Partnership Act
    1. Section 2 – Definition of Partnership
                “persons”
                “carrying on business”
                “in common”
                “with a view of profit”

   2. Section 4 – Rules for Determining Partnership
         a. 4(a) – common ownership alone is not sufficient
         b. 4(b) – sharing of gross returns is not sufficient (e.g. theatre and a dance troupe)
         c. 4(c) – share of profits is prima facie evidence of partnership but a share or payment varying with
             profits is not sufficient
         d. 4(c)(i) – payment of a fixed amount of debt out of profits is not sufficient
         e. 4(c)(ii) – A contract for remuneration by a share of profits is not sufficient
         f. 4(c)(iii) – Annuity out of profits to a spouse or child is not sufficient (used to be a form of life
             insurance)
         g. 4(c)(iv) – Loan in writing for repayment by share of profits or rate of interest varying with profits is
             not sufficient (see Peyton). This allows a business to attract creditors without making them liable
             to more than the creditor has contributed.
         h. 4(c)(v) – Annuity out of profits to pay for goodwill is not sufficient. Allows for a business owner
             selling her business to signal (guarantee) to potential buyers that the business has goodwill. This
             works well for the buyer as he has to pay for the goodwill only if it is there.

Policy for finding or not finding partnership

1. Reliance
     A creditor or supplier may see two people carrying on business together so there may be a reasonable
        assumption that they‟re in business “in common”. This may lead to a reasonable assumption that
        they‟re both responsible for making payments.
     Business that are 100% debt financed (bank) are very rare – this is a limited upside gain for much
        downside risk. The bank loans on a fixed rate of interest. There is then a tendency for owners to take
        unduly high risks b/c they don‟t have much personal investment. It is reasonable for any 3 rd party to
        assume there must be an equity investor.
     There may be a background investor. It may not be financially worth it to the creditor/supplier to
        investigate who the investors are.

2. Unjust Enrichment
     Someone who is receiving a share of the profits is receiving that profit at the expense of suppliers who
       have not been paid for the supplies (if the business goes bankrupt)
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       Those who get the benefits should also bear the burden

3. Least Cost Avoidance
     Risk of business failure should be borne by the one who can avoid it at least cost
     Look to the ability of persons to assess the risk and control the risk
     For whom will it be worthwhile to assess the risk of business failure?
           o May depend on who invests the most – risk assessment is a fixed cost so it will be more
               worthwhile for the one with most invested to absorb that fixed cost
     Who is in a better position to exert some control over the risk?
           o Can the investor place restriction on how capital is to be spent?
           o Will it lower the cost of credit if an investor bears the risk of business failure thereby making more
               money for the “investor/partner”?

Cases

Cox v. Hickman (1860)

Facts
 Smith & Sons own a partnership business that is in financial difficulties
 Creditors see the business is failing but the cost is too high to take the business apart (physically) and sell the
   equipment
 There would be no return to the creditors and probably no buyers as the industry is dwindling
 A deal is struck between Smith and the creditors: the assets are assigned to trustees with the beneficiaries of
   the trust being the creditors. The trustees will run the business and as profits are made the creditors will be
   paid until the debts are cleared. Once the creditors are paid in full, the business will go back to Smith &
   Sons (also beneficiaries)
 Trustees run the business, suppliers supply goods with an invoice. The suppliers receive a copy of the invoice
   back marked “accepted”. This makes the invoice a negotiable instrument once the supplier endorses the
   back of it.
 Hickman buys one of these invoices and he has now effectively borne the cost of the goods supplied
 Hickman sues Cox and Wheatcroft b/c they were appointed as trustees but they were no longer trustees
 The creditors elect the trustees, can remove and replace them, the creditors can check the books they‟re
   keeping and make rules governing the conduct of the business.
 Hickman think he can go after the creditors b/c they are sharing profits

Decision
 Share of profits is a rebuttable presumption of partnership (changes the law from Grace v. Smith)
 Dormant partners can be liable even if they‟re not seen carrying on the business
 Agency test of partnership – when trade has been carried on by persons acting on behalf of someone, that
   person is liable to the trade obligations

Policy Arguments
 Indirect reliance – looking at the business with all its assets you wouldn‟t think it was 100% debt financed.
    Criticism of this – he was in the business of buying invoices, it‟s a good chance he knew exactly what was
    going on
 Unjust enrichment – if H is not paid, the creditors receive the benefit of the goods by sharing in profit but H is
    bearing the expense. The creditors are therefore enriched at H‟s expense. Criticism – the creditors are
    getting back only their original credit
 Least Cost Risk Avoidance –
    1. Creditors have lots of control – elect, replace, remove trustees, check books, make rules
    2. Both creditors and Hickman are in some position to assess the risk.
         Who is in a better position may depend on how much each has advanced.
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Broad Societal Perspective
 It makes more sense to try and keep the business going than to rip it apart so no-one gets what they‟re
   owed. If you had to make the creditors partners the whole arrangement would be defeated and would
   never happen

Martin v. Peyton (NYCA, 1927)

Facts
 KNK have a partnership in a securities firm and it is in financial difficulties. Hall asks Peyton to help out.
 Peyton loaned $500 000 but the business continued to do badly
 Hall asks Peyton, Perkins and Freeman to become partners and invest more money – they say no
 PPF instead loan $2.5 million of good securities in return for $2 million of bad securities plus 40% share of
   profits up to $500 000
 KNK then goes to bank with $2.5 million of good securities to use as collateral for a $2 million bank loan
 Provisions of the loan are laid out and it‟s stipulated 3 times that PPF are NOT partners

Decision
 The statements asserting there is no partnership do not matter – what counts is what‟s really going on
   (normally, the court upholds what is explicitly stated)
 Here there is a 3rd party claim so the court does its own investigating. Contract provisions are analyzed and
   weighs them according to whether they point to partnership or not
       o Usually, property of a partnership belongs to all parties, here PPF can get their $2.5 million of good
          securities back (inconsistent with partnership)
       o Here there is investment into a business with a security interest (inconsistent)
       o If KNK sells the good securities, the proceeds go only to PPF (inconsistent)
       o Any dividends earned by the god securities go directly to PPF (inconsistent)
       o 40% share of profits (consistent)
       o PPF had lots of control – Hall had to run the business and PPF could tell him to let any other partners
          go (consistent)
       o Right to inspect the books (consistent)
       o Veto business deals (consistent)

Policy
 Reliance – persons dealing with the firm would know it wasn‟t 100% debt financed
 Unjust enrichment – had the business been successful, PPF would have received profits over other creditors
    without risk of being liable for all the losses. They may have also lost less money than other creditors if they
    hadn‟t the benefit of the expenses from other creditors
 Least cost avoidance – PPF had some control over the business such as the ability to ensure Hall would
    manage, life insurance on Hall, ability to examine the books

Broad Societal Perspective
 Similar to Cox v. Hickman in that in this situation no-one would give KNK a loan or become partners so
   perhaps it‟s worthwhile to save this kind of business. You need to provide equity creditors potential to get
   up-side gain without the loss.
 There is now legislation in place to make sure these kinds of businesses don‟t go under

Pooley v. Driver (1876)

Facts
 B and H carried on a business of grease pitch and manure manufacturing
 To raise funds, they divided the capital into 60 parts: B got 23, H got 17 and the remaining parts were given
   to anyone who advanced $500.
 At the end of the year, any profits earned would be divided in the above way
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   B and H had a partnership agreement between themselves and each of the investors had a loan
    agreement. The loan agreement incorporated the terms of the partnership agreement.
   Part of the partnership agreement stated that the capital had to be used to carry on the business of grease
    pitch and manure manufacturing
   The term of the loan was to be the same term as the partnership agreement
   Pooley holds a negotiable instrument and is suing the Drivers. The Drives had advanced funds to the
    company and they are seeking to rely on S.4(c)(iv)

Decision
 Same approach used as in Martin v. Peyton – looked at all factors to see if they were indicative of a
   partnership or not
   Inclusion of the partnership agreement in the loan agreement – looks like partnership
   Loan agreement terminates at same time as partnership agreement – partnership
   Nothing indicates a loan agreement
 Agreeing not to be considered a partner is not determinative

Policy
 Reliance – Pooley did not rely directly on the Drivers, they were silent partners
 Unjust enrichment- to the extent that the Drivers had shared in profits of the business they would have
    benefited at the expense of the creditors
 Least cost avoidance – Drivers had many rights that allowed them to control how the business was run –
    they had more potential to control the risk and assess the risk given they had advanced a fair amount of
    funds to the business
 The law doesn‟t allow persons to advance funds purporting to be a loan and have all the rights of
    partnership and then take advantage of s.4(c)(iv). This is effectively limited liability and all partnership
    would become like this. Creditors would then start to charge more interest for the credit.
 To get limited liability you must have the label to signal to creditors that it‟s in place.

Application of S.(c)(iv) and S.5 of the Partnership Act

Objective

Determine when s.5 of the PA will apply to subordinate a loan, based on a share of profits or rate of interest
varying with profits, or an annuity out of a share of profits to pay for goodwill, to the interests of other creditors.

Review s.5

If
(i) a person to whom money is advanced by way of a loan on contract as mentioned in s.4; or
(ii) a buyer of goodwill in consideration of a share of the profits;

Either:
(i) becomes insolvent;
(ii) enters into an arrangement to pay crediors <100 cents on the dollar; or
(iii) dies in insolvent circumstances;

Then:
The lender, or seller of goodwill, is not entitled to recover anything in respect of the loan or share of the profits
until the claims of other creditors of the borrower or buyer for valuable consideration in money or money‟s
worth have been satisfied

Re Fort – The Requirement of Writing in S.4
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“In writing” does not apply although it explicitly states it. English Court of Appeal decided this because it
doesn‟t make sense that if you had a written loan agreement, the person who had it was subordinated while
the person with the same agreement, only oral, gets to rank higher.

Canadian Deposit Insurance Corporation v. Canadian Commercial Bank (SCC, 1992)

Facts
 Bank failures in general are bad news – they have a huge cascading effect and there is a substantial
   connection between money supply and the economy
 A package was put together to try and save the bank. Other banks, the Alberta and federal governments
   put in $255 million and wanted an assignment on the loans. If the bad loans don‟t pay off, they get 100%
   indemnity if the bank does well. They also got warrants on common shares and a right to a 50% share of
   the profits until the principle of the loan is paid off with interest at a prime rate.
 Bank wound up 6 months later.

Issue
Can the participants rank equally among the unsecured creditors?

Decision
 Is this a partnership? Go through 4 parts of s.2 – the CCC is carrying on the business, the participants are not
   so there is no carrying on business “in common”
 This does fall within section 4(c)(iv) – the profit payments are merely payments for monies advanced – this
   section applies only to payments of profits other than in repayment of the principle amount
 This is a s.4(c)(i) situation – does s.5 then apply to subordinate the participants‟ claims? No – s.5 refers to a
   contract of type mentioned in s.4 and s.4(c)(i) does not refer to a contract. Additionally, the policy of s.5
   refers to he who gets the benefit of profits over and above repayment of capital.

Sukloff v. Rushforth – Effect of a Security Interest

Facts
 Sukloff loaned Rushforth $45 000 for 10% interest and 50% share of the profits
 Sukloff gets a security interest for $35 000 of this loan
 Rushforth needs more money so Sukloff lends him $5000 for 10% interest only
 Rushforth becomes bankrupt and Sukloff puts in his claim

Issue
Will Sukloff‟s claim be subordinated to those of other creditors‟?

Decision
 Court broke total claim into three parts in terms of ranking
 The $5000 loan is treated equally to all other creditors – only interest charged for this one
 The $35 000 loan ranks ahead of other creditors because of the registered security interest
 The $10 000 loan without a security interest ranks below other creditors because of S.5
 Court has read into Act that Section 5 does not apply to security interests – these must be registered so
   other creditors can check the registry before advancing credit

*What about those creditors who advanced credit before Sukloff‟s $35 000 security interest was registered??


SUMMARY OF SUBORDINATION OF CREDIT ADVANCED IN RETURN FOR A SHARE OF THE PROFITS

1.      Pursuant to s. 5 a person owed money pursuant to a contract of the type mentioned in s. 4(c)(iv) or (v) is
        subordinated to other creditors [i.e. other creditors get paid-off in full before a s. 4(c)(iv) or (v) creditor
        gets paid off].
                                                                                                                          13

2.        The contract under s. 4 does not have to be in writing for the subordination in s. 5 to apply [Re Fort].

3.        In the case of a loan for a share of profits s. 4(c)(iv) does not apply where the share of profits is only
          applied to pay off the principal of the loan [Canadian Commercial Bank].

4.        Section 5 does not apply to the payment of a debt out of accruing profits under s. 4(c)(i) [Canadian
          Commercial Bank ].

5         The subordination to other creditors pursuant to s. 5 does not apply with respect to security taken for the
          debt [Sukloff v. Rushforth].

SUMMARY OF LIABILITY IN CONTRACT AND TORT

I.        LIABILITY IN CONTRACT
          s.7 partners are agents for one another
          s.7 provides that the firm is bound (to the 3rd party) by the acts of every partner who does any act "for
          carrying on business in the usual way business of the kind carried on by the firm"

          In interpreting this regard is had to:
                   (i)     The nature of the business - looking to businesses of like kind;
                   (ii)    The practice of persons engaged in it;
           S.7(2)(b) looks like ostensible authority of an agent.

          S.8 instruments signed or acts done by persons with authority bind the firm (actual authority)

          S.9 no ostensible authority then the pledging of credit of the firm by a partner does not bind the firm
          unless that partner has actual authority

          S.10 if third party has notice of a restriction on the power of a partner then the partner's actions in
          contravention of the restriction do not bind the firm

          S.11 every partner is jointly liable for all debts and obligations of the firm as long as one is a partner


II.       LIABILITY IN TORT AND FOR TRUSTS

          s.12    Firm is liable for wrongful acts or omissions where:
                            -Partner acted with the authority of co-partners
                                    -Or-
                            -Partner acted in the ordinary course of business of the firm

          s.14 The liability under s.12 or s.13 is joint and several

Ernst & Young v. Falconi

     Falconi helped clients avoid creditors through fraudulent acts contrary to provisions of the Bankruptcy Act.
     He pleaded guilty to fraud under this Act and was found personally liable to the creditors of the clients.
     The creditors of the clients also sued Falconi‟s partner – Klein.
     Klein knew nothing of what was going on. He never gave his co-partner authority to commit fraud and it‟s
      not in the ordinary business of the firm.
     Court said tough luck – Klein is still liable. It is enough to find that the activities are in the ordinary course of
      business of a lawyer.
                                                                                                                    14
III.    REGISTRATION OF PARTNERSHIPS
        s. 81  Duty to File Declaration of Partnership
               Persons associated in partnership for trading, manufacturing or mining purposes must file a
               declaration of partnership

        s. 82   Declaration must be filed within 3 months after the formation of the firm

        s. 83   Change in members of firm or firm name then must file a declaration of the change

        s. 84   Persons who sign the declaration cannot disclaim statements in the declaration

        s. 90   Registrar keeps a register showing the firm name on one side and the members of the firm on the
                other side

        s. 87   Says that one of the consequences of a failure to file a declaration is that the partners are not
                just jointly liable but are jointly and severally liable

Things that force plaintiffs to join defendants (Rule 7 changes this in Civ. Pro. Rules)
1. Only allowed to sue once (suing one is a bar to suing the others)
2. Defendant could ask court to stay proceedings join D‟s partners
3. If D had only $5 that‟s too bad – that‟s all you get

Above is why it makes sense to sue in the name of the firm and also you can serve them all by serving the place
of business. Also, it‟s wasteful and costly to sue several different times and you may get four different judgments
from four different judges. In tort, there may be 4 different sets of facts which may make sense why you have 4
different trials.

RETIREMENT OF PARTNERS

Objectives:
1.     To be able to determine when a retired partner will be liable for the debts of the firm incurred after the
       date of retirement.

2.      To be able to set out steps a retiring partner should take to avoid liability for partnership debts incurred
        after the date of retirement.

The Underlying Policy Re Retirement of Partners

Permit partners to leave the firm without being perpetually bound by continuing firm liabilities
BUT
Want to avoid losses to 3rd parties who may rely on the retired partner as continuing to be a partner

Consider the effect of s.39
1.    "Apparent" partners continue to be partners with respect to 3rd parties UNLESS notice of the change is
      given [s.39(1)]

2.      Notice can be effected by an advertisement in the Gazette for persons who had no dealings with the
        firm prior to the retirement. [s.39(2)]

3.      Something more than Gazette notice is required for persons who had dealings with the firm prior to the
        retirement [by implication from s.39(1) & (2)]. It has been held that they are entitled to "actual notice".

4.      The retired partner is not liable to those who can be shown not to have known that the retired partner
        was a partner. [s.39(3)]
                                                                                                                      15

i.e. It is similar to OSTENSIBLE AUTHORITY in Agency Law
            A retired partner is bound where she/he is apparently a partner
            UNLESS steps have been taken to avoid reliance by the third party, such as:
            1. General notice in the Gazette to those with no prior dealings
            2. Actual notice to those with prior dealings
            3. Evidence that the 3rd party had no knowledge that the person was a partner

Consider the effect of partnership registration

The general rule is that failure to file a declaration of change will cause a retired partner to be considered to still
be a partner. [s.85]

Steps that can be taken when a partner retires and governing principles:
        -Partner to be able to leave partnership without being liable for subsequent firm liabilities
        -Onus on partner to protect against 3rd party reliance
        -Act sets out scheme by which the retiring partner can satisfy the onus
        -At some point the efforts of the retiring partner will be sufficient to shift the onus to the 3rd party to take
        steps to avoid the loss created by reliance

STEPS TO BE TAKEN
1.     Provide actual notice to all those with whom the firm has had prior dealings (or, for practical purposes,
       to all the firm's current creditors). You should have a ledger with accounts payable or a database that
       will have each particular supplier and/or creditor.
2.     Put a notice of the retirement in the Gazette.
3.     File a notice of change in the firm membership (s.83)
4.     If possible, obtain agreement between the remaining partners and major creditors that the retiring
       partner be relieved of liability.
5.     Have the partnership agreement require that steps be taken to relieve retiring partner liability. If a
       declaration of change has to be filed, make sure that the steps are set out. Put in a contractual
       obligation right in the partnership agreement.
6.     Have partnership agreement provide that remaining partners indemnify retiring partners for post-
       retirement debts of the firm.

LIMITED PARTNERSHIP

1. Objectives:
   a) Be able to explain what a limited partnership is.
   b) Explain the main characteristics of a limited partnership and why limited partnership has these
   characteristics as they relate to the relationship:
              (i) Between limited partners and third parties;
              (ii) Amongst limited partners and general partners.

I.      INTRODUCTION

        UNDISCLOSED LIMITED LIABILITY -limited liability that is undisclosed may eventually lead to higher charges
        for credit (higher price for goods and services, but those in business would probably rather take the risk
        themselves as they‟re in a good position to assess and control in exchange for lower credit charges)

        BUT -some investors may accept higher credit charges in return for limited liability

        PROBLEM -how can this be effected without deception of creditors
        LIMITED PARTNERSHIPS as a solution
                                                                                                                     16
II.     WHAT IS A LIMITED PARTNERSHIP?
        1.     A limited partnership consists of [s.50]:
                       -One or more general partners, AND
                       -One or more limited partners
        2.     The liability of limited partners is limited to the amount she/he/it contributes or agrees to
               contribute [s.57].
        3.     **Formed by filing a certificate [s.51]** - crucial to defining a partnership as limited

III.    CHARACTERISTICS RE: PROTECTING THIRD PARTIES

A.      Features of the Act that are Designed to Protect 3rd Parties
        1.     Labelling Requirement - must use "Limited Partnership" [s.53] at the end of the name of the
               partnership – if you don‟t use this there is no limited liability

        2.      Equity Check – 3rd party can find out about contributions or agreed contributions by checking
                certificate [s.51] (check Minimum Capital Requirement as a cross-reference).

        3.      Anti-Deception - clear who the general partners are as distinct from the limited partners:
                (i) Must have a general partner [s.50] – people can at least check to see how credit worthy that
                person is

                (ii) Certificate states who the general partners are [s.51]

                (iii) Name of a limited partner not to appear in the name of the limited partnership - if it does
                limited partner is treated as a general partner [s.53]

                (iv) Limited partner personally liable if she/he participates in management [s.64] or limited
                partner contributes services [s.55] **This one has generated the most litigation

        4.      No Abandoning Ship - no return of capital if after payment the partnership would be insolvent
                [s.59(2); 62(1)(a); 63(2)(b)]. Without this, all the limited partners may take everything out they
                could call “income” once they realize that the business will go bankrupt.

IV.     THE RELATIONSHIPS AMONG THE PARTNERS

A.       Separation of Ownership and Control
         Less Control by Limited Partner:
              Not part of management
              Could have many investors with small investment
                    o Small Stake Problem - doesn‟t make much sense for such an investor to exercise much
                        control over the management
                    o Free Rider Problem – get someone else to control the management to ensure you get a
                        good return. Difficulty with this is that if you have a bunch of partners like this, nobody
                        ends up controlling the management of the business.
         Attempts to Protect Limited Partners:
              Can find out about rights per filed certificate
              Mandatory provisions:
              Unanimous consent for [s.56]:
                    o Act which makes it impossible to carry on the partnership business
                    o Consent to judgment
                    o General partner possessing partnership property for other than a partnership purpose
**Note that this doesn‟t amount to much.
**Also, the general partner may be a corporation without many assets or capital.

Limited Liability Partnerships
                                                                                                                        17

I. Background
     Professions often restricted to operating through partnership form with no limited liability – express or
       implied restrictions on incorporation (professional standards – e.g. writing a med exam, earning a
       license)
     Where professional corporations permitted they often did not provide for limited liability (at least with
       respect to malpractice)- the issue was primarily a tax issue (a corporation cannot carry on a medical
       practice so the doctor had to claim all the income earned)
     Increasing scope of liability particularly in large partnerships with increasing amount of liability – related
       insurance crises
     Pressure to allow for a partial liability shield while allowing firm to continue to organize as a partnership –
       partners not liable for the malpractices of their fellow partners

II. LLP Structures – Wide Variety
      Partners not liable for malpractice liabilities of their fellow partners
      Partners not liable for ordinary debts
      Full limited liability; limited to professional partnerships
      Not limited to professional partnerships

III. Structure of Limited Liability Partnerships in Ontario
       Partial Liability Shield
              o Partners not liable for the malpractice of fellow partners or employees unless they were directly
                  supervising the activity
              o Partners not liable to indemnify fellow partners for their own malpractice
              o Restricted to professionals
       Business Name Registration
              o Not allowed to carry on business as a Limited Liability Partnership unless register business name
                  containing the words “Limited Liability Partnership”, “LLP” or their French equivalents
              o Must not use any other name to carry on the business

IV. Status in Other Jurisdictions in Canada
     Other legislation in Alberta as well




                                   Chapter 2: The Corporate Form of Organization

A structure that attempts to cover everything from the corner store to Microsoft. There is a division of powers
between the shareholders and the directors – they each have their separate tasks.

SHAREHOLDERS                    Equity claimants
                                Invest for a return
                                Claims or rights in terms of voting rights, dividend rights and rights on liquidation
                                Shares are often called “bundles of rights”
                                *Liability limited to amount of investment

CORPORATION                     *Separate personality
                                *Perpetual existence – shareholders can come and go but it continues on


DIRECTORS                       Appoint officers to manage the corporation
                                Make major decisions on corporate policy
                                (Could consist of just one director)
                                                                                                                     18
                               Elected by the shareholders to either run the business or oversee it

OFFICERS                       E.g. President, Vice-President, Secretary, Treasurer
                               Manage the corporation – hire others to assist in management and carry on
                               business of the corporation


2. CORPORATE PERSONALITY AND LIMITED LIABILITY

OBJECTIVES:
You should be able to:
       1.     Note what the legal nature of the corporation is (separate entity)
       2.     Set out some of its implications
       3.     Note some of the potential problems it creates
       4.     Note how the facts of the Salomon case highlight
                      (i) The sole shareholder issue;
                      (ii) The watered stock issue; and
                      (iii) The issue of disregarding the corporate personality vis-à-vis prior creditors when the
                      form of business association is changed (there may be potential deception of creditor)

I.     THE LEGAL NATURE OF THE CORPORATION
       (OR COMPANY)

Salomon v. A. Salomon & Company Limited
     A boot manufacturing business that he ran as a sole proprietorship and then transferred it into a
      corporation. Somehow, the SP business had $31 000 and the company had $39 000 (including
      goodwill).
     $40 000 AUTH – authority of directors to issue shares (they issues 20 001 shares to Mr. Salomon and then
      one share each to 6 family members)
     $10 000 secure debentures by a floating charge – owed to Mr. Salomon
     Business went badly after the company was formed and during the year the business needed more
      cash so Mr. Salomon went to get a loan. The lender noted the business was going badly so he wanted
      collateral – but the business has a floating charge over it – so the lender took the debentures as
      collateral.
     The debentures with a face value of $10 000 were collateral for a loan of $5000 b/c the business was
      doing badly
     Mr. Salomon then put the $5000 loan into the business to try and turn it around
     Business was then put in hand of a liquidator
     Liquidator produced over $6000 from the assets and Mr. Broderick came in to get his $5000
     Mr. Salomon has equity in redemption in the debentures so now he has a secured claim
     The unsecured creditors of the business get nothing and the liquidator didn‟t accept Mr. Salomon‟s
      claim
     At trial, the judge said the company was an agent for Mr. Salomon so he was treating the company as
      a separate entity (but an agent). This means Mr. Salomon is personally liable for all the debts.
     Court of appeal called the company a trustee for Mr. Salomon as a beneficiary
     House of Lords dealt with the argument that the whole scheme was fraudulent – the company wasn‟t
      really a proper company b/c the legislation wasn‟t complied with
     The legislation doesn‟t say they have to bona fide shareholders and the House of Lords doesn‟t want to
      get into that analysis
     This case legitimates the de facto one shareholder company
     House of Lords went on to say that when the company is formed, it’s a separate person and normally it
      will not be considered the agent for the trustee
     Direct implication: Mr. Salomon can be a shareholder and a secured creditor of the business –
      shareholders can also be creditors
                                                                                                                19
       Three reasons why the court didn’t think it was a fraud on the creditors
        Business wasn‟t in trouble at the time of the transfer
        Creditors could have looked into it themselves
        He put his personal loan from the lender into the company
       Two potentials for fraud
        Watered stock issue – goodwill is added into the assets so there‟s an extra amount in the equity side also
           – may result in a balance sheet misrepresentation
        Persons Mr. Salomon dealt with while it was a sole proprietorship may think he is still personally liable
           even though the organization of the nature of the business has changed and Mr. S‟ liability is now
           limited

II.        SOME IMPLICATIONS OF THE LEGAL NATURE OF CORPORATIONS

           Salomon v. A. Salomon & Company, Limited
               o Shareholder can be a creditor of the corporation
               o Shareholder can be a secured creditor of the corporation

       Lee v. Lee’s Air Farming Ltd.
        Shareholder can be a director and officer and employee of the corporation
        Very close to Re Thorne (WCB claim refused b/c he couldn‟t be a worker)
        Here, Lee is the sole shareholder of Lee‟s Air Farming Ltd. and he‟s also the sole director, he was the
          company president and the one employee
        Mr. Lee crashed and died while working and his wife is claiming compensation under WCB but is refused
          under same basis of Re Thorne – Mr. Lee can‟t be an employee
        Court said yes he could be an employee b/c he takes instructions from the corporation which is a
          separate person

       Macaura v. Northern Assurance Co. Ltd. (don‟t worry about this one for exams)
        It is the corporation and not the shareholders that own the assets of the corporation
        Macaura transferred his interest in timberland to a company and he took back shares, he then went
         and bought insurance on the land. The insurer was himself and the problem is that he got one
         insurance and then got it again and again and then the timber burned down.
        The company owned the timber – not Mr. Macaura

Note also that the directors and officers of the corporation, as separate persons, act as agents for the
corporation

To the extent that shareholders have powers to make certain decisions with respect to the corporation, they
might also be considered agents of the corporation when acting in that capacity

Implications summary
    Company can contract with member or shareholders and those members or shareholders can be
       creditors
    Shareholders can be employees, directors and officers of the corporation
    It’s the corporation that owns the assets
    The directors and officers are separate persons and effectively the agents of the corporation

III.       POTENTIAL PROBLEMS
          Shareholders becoming creditors when the corporation is insolvent
          Payouts to shareholders when the corporation is insolvent (abandoning ship)
          Shareholder contracts with corporations that are unfavourable to other shareholders or creditors
          Deceiving third parties of who it is they are dealing with (e.g. individual or corporation)
          Incorporation to avoid personal obligations (contractual; statutory; or tortious)
                                                                                                                  20
       Thin capitalization as potentially deceptive to 3rd parties (setting up the company with lots of assets but
        in fact the equity is very small)

Advantages of Limited Liability
                     Unlimited Liability                   Limited Liability


1. Valuation           Need to Check                       Need to Check
   Costs               -Earning capacity (future cash      -Earning capacity (future cash
                       flows) and risk                     flows) and risk
                       -Wealth of fellow investors (you    (But not wealth of fellow
                       can claim indemnification from      investors)
                       them) and cost increases as
                       the # of investors increases
2. Monitoring          Need to control against             -Less need to control managers
  Costs                -Managers putting wealth at         since smaller potential loss
                       risk
                       -Changes in wealth of fellow        -Don't need to monitor wealth
                       investors due to:                   of others or control their exit
                             Investment sales             from the firm
                             Changes in personal
                               assets                      -Potential for control block of
                                                           investment to monitor
                                                           management
3. Diversification     Each investment carries risk of     Increased number of
                       loss of all personal wealth -       investments doesn't increase
                       therefore keep number of            risk since personal wealth is not
                       investments to a minimum            exposed with each investment

4. Liquidity           Lack of liquidity due to:           Provides liquidity since:
Aability to change         High costs of assessing        -Lowers cost of valuation
your investments              value                        information
relatively easily          Controls on transfer of        -Less need for control over
                              investment by fellow         other investors selling their
                              investors                    investment

5. Optimal             Managers may not make               Investors can diversify risk and
   Investment          highest value investment since      this allows managers to ignore
   Decisions           must take account of                diversifiable risk in investment
                       diversifiable risk to which         decision and make highest
                       investors exposed                   value investment

6. Market Price        No single price since each          Single price for units of
   Impounding          investment must be valued           investment - price reflects just
   Information         separately (see 1 above)            estimate of future cash flow
                                                           and risk (see 1 above)
                                                           -thus price impounds important
                                                           information on value of firm


When valuing a business, you look at its present value, its future cash flow‟s worth today and risk. There is a
compensation for risk – the discount is higher proportionally to the risk
                                                                                                                       21
B. Disregarding the Corporate Entity

1.      Introduction
        A. Separate Personality and Limited Liability
             S.45(1) – Shareholders are not liable as shareholders for any liability after default of the
                corporation
             CBCA treats corporations as a separate person (separate from shareholders, directors, officers,
                employees etc.
        B. Exceptions to Salomon Principle – cited for proposition that corporation is a separate legal entity, but
        courts have often disregarded it “when it‟s too flagrantly opposed to justice to follow the Salomon
        Principle” (Wilson J., SCC in Cosmopolis). The situations follow no consistent principle but courts will
        almost never do it.
        C. Approach
                1. Know the rhetoric – you must cite previous cases and the authority
                2. Look at typical situations in which courts have disregarded the corporate entity and draw an
                    analogy to your fact pattern
                3. Take a theoretical approach and get a feel for the court‟s willingness

        Language Used and Basis in Salomon

        Objective:
        You should be able to articulate and apply the language used by courts when they disregard the
        corporate entity.
        1. Agency (this is really a recognition –if you want to use agency then go back to agency principles), Alter Ego,
           Instrumentality, Cloak, Sham, Conduit
        2. Disregarding of Corporate Entity by Shareholders Themselves
                 Courts then look at corporate records – shareholders‟ and directors‟ meeting minutes must
                    be maintained, financial statements must be maintained
                 If there are no records, court may assume you are not treating it as a separate person and
                    then question why the court then should do so
        3. Affiliated Enterprises
                 Courts are more willing to disregard it in this context
                 Corporation A is the major shareholder of Corporation B (a subsidiary), Corporation C
                    (another subsidiary etc.)
                 Courts will then ignore separate of B to get at assets of Corporation A, or vice versa
                 Smith, Stone and Knight Ltd v. Birmingham Corporation on page 102 of text for the (really
                    dumb) tests of affiliated enterprises:
                         i. Were the profits treated as profits of the parent company?
                        ii. Were the persons conducting the business appointed by the parent company? If the
                               parent company owns more than 50% of the shares then it will elect all directors
                        iii.   Was the parent company the head and brain of the subsidiary? Did it control their
                               operations?
                      iv. Did the parent company govern the trading venture?
                       v. Did the parent company make profits by its skill and direction?
                      vi. Was the parent company in effectual and constant control?
                   Courts have stepped back a bit from these tests b/c the answers are always yes

Alberta Gas Ethylene Company v. Minister of National Revenue

    P was going to do a pipeline and needed funds to buy the assets.
    When raising funds they went to the States and offered the investment only to insurance companies.
    The insurance companies had foreign investment restrictions so they wanted a higher rate of return (12% as
     opposed to 10%).
    AGEC, to avoid this, incorporated a company in the States to issue the debentures to the insurance
     companies.
                                                                                                                   22
    When interest payments were due, the Canadian company would pay the 100% owned American
     subsidiary company that would then pay the insurance companies.
    The MNR noted the interest paid to the USA and charged withholding tax, AGEC challenged this and asked
     court to disregard the separate corporate entity between them and the American subsidiary.
    All the tests from Smith, Stone and Knight were satisfied but the court did NOT disregard the corporate entity
     – “it’s not sufficient to consider the 6 criteria, and when they are all met, to ignore the separate legal
     existence – one has to ask, for what purpose and in what context is the subsidiary being ignored?”

Gregorio v. Intrans Corp.
 G bought a truck from I.C.
 The truck came with a warranty from IC and there was a problem with the truck.
 IC was found liable on the warranty.
 He sued Pakkar Canada Ltd. in a negligence claim – the truck was built negligently.
 The difficulty with this action was Pakkar didn‟t actually build the truck – they were a Canadian subsidiary of
   an American parent company that built the truck.
 G attempted to argue that the Canadian arm of Pakkar was one and the same person as the American
   company.
 Court looked at the Smith, Stone and Knight test and stated “generally, a subsidiary will not be found to be
   the later ego of its parent, unless the subsidiary is under complete control of parent and is nothing more
   than a conduit used by the parent to avoid liability. The alter ego principle is applied to prevent conduct
   akin to fraud that would otherwise unjustly deprive claimants of their rights.”


Objective:
       Be able to assess whether a particular situation is of a type in which a court is likely to disregard the
       corporate entity noting corresponding cases as examples of such situations.

2.     Gap Filling and Implied Contractual Terms (p.95)
       1.      Introduction - Gap Filling and Transactions costs reduction
                By filling gaps, the court reduces transaction costs
                If courts apply terms all over the place, the parties may not have wanted them so they begin
                   to write around these “default rules”. As a result, transaction costs are increased
                Sometimes when courts disregard the corporate entity, all they‟re doing is implying a term
       2.      Examples
Saskatchewan Economic Development Corporation v. Patterson-Boyd Mfg. Corp.
 Shareholders in PB Mfg. incorporated another company to get a prior claim for a loan over SEDCO
 SEDCO asked court to disregard the corporate entity
 Judge said the two businesses were the same, the other company is an associated company
 The other business‟ claim is then postponed according to contractual obligations
 Court implied a term that would have added this particular scheme to the contract between SEDCO and
   PB Mfg. Corp to cover off ways that SEDCO would not get paid

Gilford Motor Company Ltd. v. Horne

    Horne had worked for Guilford as the managing director and he resigned
    When he entered his employment K, he‟d agreed that if he did resign he would not set up a competing
     business within 5 years and a radius of 3 miles of Guilford
    Horne then started a competing business within 5 years and the 3 mile radius
    Horne‟s lawyer figured out a scheme by setting up a separate company with shares divided between
     Horne‟s wife and another employee so Horne was acting as an employee
    Guilford sued Horne for carrying on the business and breaching the K
    Horne replied that it was the company that breached it – not Horn personally
    Guilford then asked the court to disregard the corporate entity
                                                                                                              23
    Court really filled a gap in the original employment contract – the two could have taken care of this when
     the K was written by including a provision covering this situation

3.      Corporations Formed to Avoid Statutory Requirements
        1.    Introduction
               Akin to gap-filling but only in a statute rather than a contract
               If the legislators had to think of every possible way in which statutory provisions could be
                  avoided then nothing would be legislated, or every act would look like the Income Tax Act
        2.    Examples

British Merchandise Transport Co. Ltd. v. British Transport Commission
 BMTC had an „A‟ trucking license and legislation said it‟s one license / person
 A subsidiary of BMTC has applied for a „C‟ license but was refused by BTC b/c the parent company already
     had one (the „A‟ license)
 The subsidiary argued it‟s a separate person so it hasn‟t got one
 Court disagreed and “filled the gap” in the legislation to include this scheme of attempting to avoid the
     legislative provision

        3.      Tax Avoidance Cases
                 Corporations are set up exclusively to avoid taxes and courts are very willing here to “avoid
                    the separate corporate entity”

4.      Affiliated Corporations (under common control)
                 1.    Introduction
                 2.    Examples
                        Smith, Stone and Knight Ltd. v. Birmingham Corp.
                        Alberta Gas Ethylene Co. v. M.N.R.
                        Gregorio v. Intrans-Corp.

Walkovsky v. Carlton
 C set up 10 corporations, each owning 2 taxis
 C was the lone shareholder of each corporations
 A taxi-driver hit a pedestrian and is sued
 The assets of the corporation aren‟t very much and the pedestrian wants to get at more
 Court did not disregard the corporate entity here b/c C would be personally liable
 You lost advantages of limited liability

Mangen v. Terminal Cabs
 Terminal Cabs is the parent company of a bunch of subsidiary companies
 Same facts as above
 Court did disregard the corporate entity here because the result was to get at assets of Terminal Cabs
  rather than making an individual shareholder personally liable

5.      Representations of Unlimited Liability

A.      Misrepresentation Theories
         Situation
         Reliance and distributional effect
               o The distributional effect of an unjust enrichment situation – when the 3rd party has relied upon
                  being able to get at an individual‟s personal assets (thinking it was unlimited liability). The
                  Misrepresenter got the lower interest rate on the basis of the expectation
         Efficiency explanation
                                                                                                                  24
               o If you‟re uncertain as to who you‟re dealing with, the best think to do is to check into it. Is this
                 actually an incorporated entity? As between the promoters and the 3rd party, the promoters
                 have easier access to the information. This will reduce the screening costs to 3 rd parties.
       Example of Common Instance of Misunderstanding
             o Sole proprietorship assets transferred to a corporation
Chiang v. Heppner
 Chiang had taken a watch in to be repaired and got a receipt for it
 The receipt gave no indication it was a corporate form of organization
 While the watch was in the shop, the shop burned down
 Chiang is suing Heppner personally for the cost of the watch b/c the corporation has no assets
 Chiang argues he was given no indication it was a corporation
 Court disregarded the corporate entity
 He probably would have left his watch there anyway

          Sections of Acts to Avoid Misconception
               CBCA s. 10(5) – you must end the name of the corporation with the cautionary suffix to signal
               limited liability and a corporation shall set out its name in legible characters on all documents it
               produces; and s. 251 – general offence provisions – presumably the consequence set out if you
               fail to comply with the CBCA
2.     Seizing Upon Misrepresentation in Tort Actions to Effect Compensation

Wolfe v. Moir
 Wolfe went roller-skating and hurt himself
 He sought compensation from the corporation but it had no assets so he sued Mr. Moir
 The roller-skating place was called Moir Sport Land and Fort Whoop Up but the company that runs it is
   called Chinook Sports Ltd.
 Nowhere was Chinook Sport Ltd. used in advertising
 Moir was found to be personally liable b/c he failed to comply with S.10(5)

6.     Non-Consensual Claimants and Incentive Costs
 Walkovshy v. Carlton – when the taxi cap hit Walkovsky he had no choice whether or not to become
   involved with Seon cabs. Courts are engaging in distributive justice and trying to find compensation for him
 You should incur costs to prevent harm up to the amount of the potential loss, it might not make sense to
   spend double them amount of a potential loss.
 If Moir can get away with having very little assets and then not be found personally liable, he won‟t take
   much care. In order to be able to compensate and take adequate levels of care, shareholders may be
   found personally liable.
 By regularly ignoring the corporate entity you totally eliminate all the benefits of limited liability
 Sanction insufficiency: a $100 000 loss and $10 000 worth of assets
 Deterrence trap: there‟s inadequate deterrence on those persons running the corporation from engaging in
   dangerous activity

7.     Other Ways of Disregarding the Corporate Entity

Objective:
       Be able to set out other approaches to making individual shareholders or directors liable for "corporate
       wrongdoing".

A.     Tort Action Against Director or Officer

Berger v. Willowdale A.M.C.
 Toronto winter, it had been raining on snow so it‟s very slushy and then it froze and snowed on top of it for
   some days
 Berger stepped out from work and slipped getting into her car. She broke her ankle.
                                                                                                                    25
      Attempted to get WCB and the amount was unsatisfactory. She can‟t sue the corporation b/c of WCB
      The president of the company is not an employee (executive officer) so she sued him
      He admitted the conditions were treacherous but did not order removal ice and snow and was then found
       personally liable
      **You‟re not actually asking the court to disregard the corporate entity – you‟re saying there‟s a separate
       tort committed by an officer of the corporation
      Inducing Breach of Contract tort – the reason the corporation broke the contract is b/c of what the
       director/officer did. What you‟re effectively doing is disregarding the corporate entity and there is some
       hesitancy in doing that.

B.        Use of Corporate Oppression Action
                   S.241 – a complainant (defined in s.238 – very broad) may apply to court for an order under
                     this section if the court finds that in respect of the corporation, any act that is oppressive or
                     unfairly prejudicial or unfairly disregards the interest of . . .
                   S.241(3) – powers of the court: damages, specific performance, accounting, anything the
                     court thinks fit

8.        Statutory Provisions Under Which Separate Corporate Personality Disregarded
           B.C. Employment Standards Act s. 96; CBCA s. 119 – directors are liable for unpaid wages of
              employees, employees also have a preference under Bankruptcy and Insolvency legislation, as a
              result of this however, the entire Board of Directors will resign
           CBCA s. 118 – authorizing issue of a share for consideration, abandoning ship,

VI.       Other Stakeholders Affected by Limited Liability and Disregarding the Corporate Entity
           Potential unrecognized claims of customers for warranties that aren‟t covered
           Perhaps there should be some kind of scheme to compensate
           Firm-specific human capital – skills that are not transferable to another corporation

VII.      General Theory for the Disregarding of the Corporate Entity

A.   Voluntary Relationships - Consensual Claimants (persons who deal with corporation)
 They compensate themselves – they can build in an extra interest charge or something more b/c they are
   aware of the limited liability
              1.      Avoid Costs of Transacting Around Avoidance of Liability (Guildford Motors; British
                      Merchandise Transport)
              2.      Avoid costs of Gathering Information (misrepresentation theory

B.        Involuntary or Non-Consensual Claimants
                 1.      More Likely to Disregard in One-Person or Few Shareholder Companies b/c there are no
                         benefits to limited liability with single shareholder companies (see Easterbrook & Fischel
                         chart above)
                 2.      More Likely to Disregard Where it Leads to Claim Against Limited Liability Parent Co.
                         Rather than Shareholders – with this you don‟t lose the advantages of limited liability

C. PREINCORPORATION CONTRACTS

Objectives:
       1.         Be able to set out and apply the common law with respect to pre-incorporation contracts and
                  the modifications in the CBCA. (BC has no provisions right now to deal with pre-incorporation
                  contracts)
          2.      Be able to assess whether the CBCA provision will apply (conflict of laws problem – s.119 -
                  directors are liable for unpaid wages but employment contracts are provincial)
                                                                                                                26
I.         Review of Ratification
     Often people aren‟t aware that the corporation hasn‟t been formed yet, sometimes it turns out the
      corporation is never formed
     Is this promoter going to be personally liable on the contract?
     Sometimes the company eventually gets formed and seeks to ratify the contract
     Corporation may get formed but then goes insolvent so the promoters seek to ratify the contract to ensure
      they aren‟t personally liable
     Two requirements necessary:
           o Agent has to purport to act on behalf of a principal that is in existence and ascertainable at the
                time
           o Principal must have the capacity to do the act that the agent is conducting on their behalf, both at
                the time the agent acts and at the time of the ratification

II.      The Common Law Position

Kelner v. Baxter (1866)
 K was the manager of an Assembly Room, he had a deal with the defendant that they were going to carry
    on a hotel under the name of Royal Alexander Ltd.
 P made an arrangement to sell a stock of wines, D accepted the proposed K on behalf of the company.
 The K was accepted on January 27, on Feb. 1 the directors of the company met and ratified the contract.
 On February 20 a certificate of incorporation for the company was issued
 April 11 – the directors met again to attempt to ratify the K, shortly after the company went bankrupt.
 Principal was not in existence at the time, on April 11the principal did not have the capacity at the time the
    agents acted.
 Even though it couldn‟t be ratified, the court held Baxter personally liable – it was clear a contract was
    intended, it couldn‟t be a K with the company b/c of the principles of ratification so it must be a K with the
    defendant.
 If a company is not in existence at the time a K was made on behalf of the company, the K cannot be
    ratified
 A person signing on behalf of the company may be personally liable.
 Rule of law – if promoters sign on behalf of a company not in existence, the rule is they‟re personally liable.
 Rule of construction – it‟s not an automatic rule of law – it depends on the particular contract and
    circumstances and asks if it was intended the promoters be parties to the contract. If they were then the
    promoters are liable on the K.

Newborne v. Sensolid Ltd.
 Promoter wants the contract to be enforced (contrast with Kelner)
 Newborne had a K with Sensolid where Sensolid was going to buy tinned ham
 The price of tinned ham went down and Sensolid refused delivery b/c they wanted to buy it cheaper
   elsewhere
 The written contract was signed by Newborne under “Newborne London Ltd.”
 The difficulty was the company hadn‟t been incorporated yet and was incorporated after Newborne tries
   to enter into the K with Sensolid
 The company sued Sensolid on the contract
 On Kelner v. Baxter, the company didn‟t exist at the time the K was entered into so it can‟t ratify
 Newborne then sued in his own name, as the promoter, b/c it was an attempted contract that turned out it
   couldn‟t be with the company so it must be with the promoter
 Court said no – it was clear that what was intended was two parties to the contract: Sensolid and
   Newborne London Ltd. Newborne himself is not a party to the contract therefore he can‟t sue on it.
 Rule of Construction approach – look at the situation to see what was intended

Black v. Smallwood & Cooper
 Black was selling land to Western Suburbs Holding Ltd.
                                                                                                               27
      On the left side it said Western Suburbs and under that Smallwood and Cooper signed with “directors” in
       parentheses
      Western Suburbs Holdings Ltd. was not incorporated at the time
      Smallwood and Cooper don‟t want the K enforced
      Black relies on Kelner and says the company didn‟t exist so it must be with Smallwood and Cooper
      Court took the Rule of Construction approach – they were clearly signing on behalf of the company and it
       was a K only with the company. Black could not enforce the contract

Wickberg v. Shatsky
 Lawrence and Harold Shatsky had taken a controlling interest in a company called Rapid Addressing
   Systems Ltd.
 They were going to incorporate a new company to take over Rapid Addressing. The new company would
   be called Rapid Data Western Ltd.
 Rapid Data was never formed, instead Seller Data Ltd. was formed and incorporated on May 11
 On May 9 the Shatsky brothers hired a manager – Wickberg – on a salary of $15 000 per annum
 They set out the terms of employment on letterhead that said Rapid Data Western Ltd.
 A few months later, the brothers went to Wickberg and asked him to work on straight commission (the
   company wasn‟t doing too well). Wickberg didn‟t want to.
 The brothers fired Wickberg and Wickberg brought a wrongful dismissal suit
 It turns out his K didn‟t exist b/c it was with Rapid Data
 He looks to an intent to contract and b/c the company didn‟t exist it must be with Lawrence and Harold
   Shatsky (rule of law)
 Court ruled that you have to look for an intention to include promoters in the K and here there was no
   intent. **It‟s not automatic that promoters be liable
 Wickberg‟s lawyer brought a breach of warranty of authority argument (agency). There is a representation
   that is false and the 3rd party relied upon it. Court accepted this.
 Breach of warranty of authority looks a lot like negligent misrepresentation claim and the remedy in tort is
   you put the person in the position they would have been in had the promise been not made at all.
 Remedy for Breach of warranty of authority is the expectation measure of damages – put W in the position
   he would have been in had the K been fulfilled

Short version
 A company cannot ratify a contract if it made before its existence
 Promoters may be liable on the contract if through interpretation it is found they were intended to be parties
 May also be a claim of breach of warranty of authority but the remedy may not be satisfactory

Problems with common law
 Risk for promoters and the 3rd party that there may be no contract to enforce
 If you have one party performing and the other party refuses, you have a reliance element plus potential
   for unjust enrichment
 Because both parties face this risk, they would have to take steps to make sure that the company‟s in
   existence (to avoid this problem)
 Lawyers will want to see the certificate of incorporation and also do a corporate search to ensure the
   company‟s not dissolved
 The promoter is in the best position to determine if the company is incorporated or not, perhaps this is why
   the rule of law is good  see CBCA s.14

III.      CBCA S. 14
A.        How s. 14 Modifies the Common Law
           S.14(1) now clearly codifies the rule of law approach from Kelner v. Baxter
           The person who signs on behalf of the corporation is personally bound unless you provide otherwise
             (s.14(4)). If there is an express provision of the contract you can alter the default in s.14(1).
           S.14(2) gets around the problem of the corporation not able to ratify – “a corporation can adopt a
             K after it comes into existence by any action or conduct signifying intention to be bound thereby.”
                                                                                                               28
            When it does that, the promoter who signed on behalf of the corporation is no longer liable or
            entitled to the benefits.
           S.14 (3) – the court, on application of a person, can apportion liability between the corporation and
            the promoter. This may be used when the promoter passes liability to a corporation with no assets

B.        Landmark Inns v. Horeak
    Horeak and some partners were going to enter into an optical business
    Oct 25 they go to P‟s shopping mall and signed a lease for space
    Horeak signed the lease as Chair of South Albert optical company
    They then see a better price for space in another mall and rent space there
    Meanwhile, P was modifying a place in their mall for use by Horeak and partners
    P is now losing rent and lost money in the modifications
    Feb.25 following, the companies incorporated and they informed Landmark Inns that they‟re taking the
     space in the mall
    On March 19, South Albert then adopts the contract and Landmark Inns goes to take action
    South Albert turns out to have no assets so they go after Horeak
    He says he entered into the K on behalf of the company, that company has now ratified it so he is no
     longer bound S. (14(2)) of Saskatchewan Business Corporations Act
    Court did not go to 14(3) but instead they pointed out you can‟t adopt a K when there isn‟t one. There isn‟t
     one b/c Horeak and others had repudiated the contract by telling Landmark they weren‟t coming.
    The repudiation brings you back to 14(1) and the promoters are still liable.
    Signing in the name of the company is not considered an express provision altering the default of 14(1)

C.       Bank of Nova Scotia v. Williams
    Uses 14(3) specifically
    Mrs. Aikens put a 2nd mortgage on her house with the Bank of Nova Scotia
    She loaned the proceeds of the mortgage to H.C. Williams Contracting Ltd. on July 5 th
    A cheque for the amount was deposited in the account for the company on the same day
    The company received a certificate of incorporation on July 20
    Mr. Williams and Mrs. Aikens were the promoters of the company and became directors and ran the
     business of the company
    On July 26 they issued a promissory note to Mrs. Aikens
    The company becomes insolvent in 1974 and Mrs. Aikens makes a claim on the loan against the company
     but it has no assets
    He‟s the promoter who acts on behalf of the company before it came into existence so supposedly under
     14(1) he may have been personally liable but for the promissory.
    Under 14(2) it suggests the company adopted the contract so the promoter is no longer liable
    Aikens now wants court to apportion liability between company and promoter
    Court refuses b/c “there may be times when the company and the one who K’d on its behalf should not be
     able to agree on liability to the detriment of the person with whom the K was made, however, here Mrs.
     Aikens was not misled as to which party she was advancing money to, nor did Williams mislead her as to
     who she was dealing with”

D.      When Will the CBCA Provisions Apply?
1.      Constitutional Problem – this deals with K law and that‟s a provincial power. This may be an ancillary
        power under federal corporate law making power.
2.       "Purports to enter into” – deals with original problem of 14(1)
3.      "Written Contract" – if it‟s an oral contract presumable you‟re back to the common law
4.      Jurisdictional Problems – 1st you have to figure out which law applies, you need to be creative! If the
        company can‟t ratify the K but the promoter‟s a party to it, the promoter could assign his rights to the
        company. You could also enter into a new contract if it turns out the old one won‟t work. A contractual
        right could also be seen as a chose in action (piece of property), if the promoter is holding this for the
        company it may be seen as a trust.
                                                                                                                  29
               Chapter 3: Historical and Constitutional Aspects and the Process of Incorporation

A. Historical Development of Corporations

Objectives
   1. Be able to describe the historical development of corporations in the UK, Canada and BC
   2. Be able to articulate a historical explanation for why the statute of incorporation providing for limited
       liability came into existence when it did
           a. South Sea Bubble puts a hold on limited liability evolution for many years
           b. Building canals and roads adds pressure
           c. Middle of industrial revolution – steam engine with railways adds more pressure and ability to
                 manufacture on a large scale takes an enormous amount of funds

I. History of UK Corporate Law Developments

   1. Public and Ecclesiastical Bodies – given Charters from the Crown and it allowed them to operate as a
      separate legal entity. Exercise of the prerogative of the Crown.
   2. Merchant Guilds – self-regulatory organization operating like a cartel. Carried on own separate
      businesses.
   3. Early Forms of Partnership – borrowed from Roman concepts – persons carrying on business together
   4. Crown Charters for Foreign Trade Ventures – e.g. East India Company, granted a Crown Charter (like a
      monopoly). Several persons traded together and funded a series of voyages and shared profits on a
      regular basis.
   5. Joint Stock Companies – very large partnerships and shares were freely transferable to raise capital
   6. Domestic Chartering – rights to carry on a particular type of trade and gave them a separate legal
      entity
   7. The South Sea Bubble
   8. Joint Stock Companies Act 1844 - people can register the company but its basically a large partnership
   9. Limited Liability Act 1855 and Joint Stock Companies Act 1856

II. Canadian Corporate Law History

   1. Early Crown Charters – Hudson‟s Bay Company, used to finance companies to build public roads and
      canals
   2. 1849 Letters Patent Act and 1850 United Provinces Act – grant of letters patent to create companies to
      build public roads and bridges; provided for corporations that would carry on business of mining, ship
      building etc. by filing certain documents – no dependence on executive permission
   3. 1864 United Provinces Act – replaced 1850 Act with a Letters Patent style of executive discretion to
      grant corporation
   4. Memorandum of Association Statute – adopted by western states and was a corporation as of right,
      Letters Patent used by eastern states (+ Manitoba)
   5. Modern developments – concern that statutes were outdated and Dickerson reported in 1975 and
      created CBCA. Picked up a lot of changes previously recommended in Ontario (Lawrence
      Committee). Alberta, Sask., Man., Quebec, NB and Nfld. all adopt the statute. Ontario models its
      statute on CBCA.

III. BC Corporate Law History
     1. 1866 – an ordinance adopted the English statute of 1862 and in 1870s they experiment with lots of styles
     2. Around 1897 they returned to English style Memorandum of Association statute
     3. 1973 – went back and adopted many things Lawrence committee suggested and adopted a number
        of things from Dickerson committee and grafted it on to BC Act

IV. Summary Re Different Types of Legislation In Canada
                                                                                                           30
Articles of Incorporation       Memo of Association        Letters Patent
CBCA                            Nova Scotia                PEI
New Brunswick                   British Columbia
Quebec
Ontario
Manitoba
Alberta
Saskatchewan
Newfoundland

B. Constitutional Position

Objectives
   1. Note the basis for federal and provincial powers to incorporate companies
   2. Describe the scope of this power to incorporate companies in each jurisdiction

I. Basis of Provincial and Federal Powers

Both provinces and feds have power
   1. Provincial power – s.92(11) – incorporation of companies with Provincial Objects
   2. Federal Power – s.91 general words – matters not specifically assigned to the provinces (Citizens
       Insurance v. Parsons)

II. Scope of Provincial Power

Bonanza Creek Gold Mining v. The King

Facts
 Licensed to operate in the Yukon and got assignment of mining leases from adjacent properties
 Arrangement: they would have a right to mining claims if the other persons who had claims had
   relinquished them
 Federal government refused to grant Bonanza those claims once the others had relinquished
 Federal government said that Bonanza Creek Gold Mining is incorporated in Ontario and Ontario has
   power to incorporate companies with provincial objects so Bonanza cannot operate in the Yukon

Decision
 Bonanza has power to operate anywhere in the world they want
 “Provincial Object” is not a territorial restriction
 Ontario couldn‟t give Bonanza Creek Gold Mining the right to operate in the Yukon – it can give it the
   power but not the right
 Presumably the Federal Government could stop Bonanza from operating in the Yukon but they didn‟t

III. The Scope of the Federal Power

   1. Meaning of Federal Power
         a. Federal power must mean objects other than “provincial objects”
         b. “Provincial objects” means power to operate within the Province and outside subject to other
            jurisdiction laws, then
         c. Federal objects must mean power and right to operate in other Canadian jurisdictions without
            being prevented from doing so by those other Canadian jurisdictions
   2. Scope of Federal Power

a. John Deere Plow Co. v. Wharton and Duck
                                                                                                              31
Facts
 JD Plow incorporated under federal statute
 Wharton carried on business under John Deer Plow Co. incorporated in BC
 JD sued Wharton and Duck – Duck bought equipment from federal JD Plow company and refused to pay
 In Wharton‟s case, the registrars refused to grant a license to fed. JD to operate in BC – there is already a
   John Deere Plow Company Ltd.
 In Duck‟s case, legislation said that if you‟re not registered in BC you can‟t maintain an action in BC so Duck
   thinks JD Plow can‟t enforce the contract

Decision
 Federally incorporated companies have power and right to operate in BC (anywhere in Canada)
 Duck had to pay
 Registrar cannot stop a federal company from operating in a provincial jurisdiction

Reference re Constitution Act
 Challenge to extra-provincial registration
 If a federal company wanted to carry on business in Manitoba under its company name or some other
   name, this legislation required that those names be registered in Manitoba
 Court said you can force a federal company to register their business names

**S.88 PA – companies must register a name if they are doing business under that name that isn‟t their own

ICBC
 BC said nobody can sell insurance except ICBC
 Provinces can restrict companies from carrying on business – that‟s legal
 Provinces cannot specifically discriminate against federal companies from doing business

Provinces can now pose all kinds of restrictions on federal companies you just can‟t go over the line by doing so
in a way that discriminates against federal companies

Federal company benefits
    You can‟t be refused to register or maintain an action

C. The Incorporation Process

Objectives

Be able to:
   1. Set out the documents that must be filed and steps that must be taken to incorporate a company
       under the CBCA
   2. Note the steps in the process of continuance and the reasons for them
   3. Note when an extra-provincial registration is required and the reasons for it

I. Incorporation

A. Steps in the Incorporation Process, CBCA ss.5-7

One or more individuals or corporations may form a corporation by:
   1. Filing articles of incorporation (s.6, form 1on p.293 in CBCA book)
   2. Filing a notice of the registered office (ss.7,19, form 3)
   3. Filing a notice of directors (ss.7, 106, form 6)
   4. Paying the prescribed fee
   5. Filing a NUANS (Newly Upgraded Automated Name Search) Name Status Report (Regs. S.15)
                                                                                                                                  32
B. The Issuance of a Certificate of Incorporation (CBCA s.9)

C. CBCA Incorporating Documents

The CBCA Articles and By-Laws
    1. Articles – deal with matters such as:
           a. The corporate name; any restrictions on the business of the corporation;
           b. Any limits on the authorized capital of the corporation; the classes of shares and share rights and
               privileges;
           c. The location of the registered offices of the corporation;
           d. Any restrictions on the transfer of shares;
           e. And any other matters that one chooses to put in the articles of the corporation (but you usually
               don‟t – it‟s very difficult to amend; requires 2/3 majority of shareholders)
    2. By-Laws deal with matters such as:
           a. Procedure at directors‟ meetings (how, quorum, where etc.);
           b. Notice for and procedures with respect to shareholder meetings (how, when);
           c. The allotment and issuance of shares (if you don‟t want directors giving shares to their best friends);
           d. The declaration and payment of dividends (any restrictions, procedure);
           e. The appointment of officers

D. Post-Registration Steps (Under CBCA) – at 1st Directors’ meeting (1st directors picked by those deciding to
incorporate the company, after this the directors will be elected)
    1. Pass the general by-laws;
    2. Approve share certificates;
    3. Allot and issue shares (the persons signing the memorandum are subscribing for shares so they get some, this allotment is for
         those who aren‟t subscribers to the memorandum);
    4.   Appoint officers;
    5.   Appoint auditors (or have a resolution waiving the appointment of an auditor);
    6.   Resolution on what will be the fiscal year end;
    7.   Banking resolution (company bank and signing authority)

E. Name Approval Process

S.11 – you can reserve a name for up to 90 days ahead of time
It needs to be fairly specific
Three parts
      Descriptive – describes the business (____ Chemical Ltd.)
      Suffix (ltd., inc.)
      Distinctive – something unique

F. The Choice Between the CBCA and the BCCA

Why choose the CBCA
    Name protection – not an IP right and not a defence to tort of passing off – but rather you cannot be
      refused registration in a province b/c someone else is operating under that name (very qualified): John
      Deere Plow
    No restriction on maintaining an action (John Deere Plow)
    Most lawyers and business people are familiar with it
    Prestige associated with it

Why not choose CBCA
    Provincial one is cheaper
    You must still pay the registration fee in each province
    Lawyers in BC are more familiar with BCCA
    Easier to deal with people in Victoria than people in Ottawa (better hours, nicer)
                                                                                                                 33

II. Reincorporation / Continuance

A. Reincorporation – a corporation incorporating under another jurisdiction
    We‟ve got a BCCA company and we want to incorporate under CBCA
    One or more individuals will incorporate a federal company
    Allocate and issue virtually all shares to BC company in exchange for all of the assets of the BC
       Company
    Wind up the BC Company and take the assets (shares) and distribute them to the shareholders of the
       BC Company so they have CBCA shares
    Assets of the BC Company are now the assets of the CBCA company

B. Continuance – will continue to operate in a new jurisdiction (allows Reincorporation in a much simpler
mechanism)
     Obtain a resolution for the company shareholders permitting the continuance (BCCA s.37(a)(b); CBCA
       s.188(1),(5);
     Obtain approval from the Registrar/Director (BCCA s.37(1)(b); CBCA s.188(1)
     Register in the other jurisdiction making amendments to the incorporation documents to make them
       conform to the requirements of the jurisdiction in which the company is being incorporated (BCCA
       s.36(3); CBCA s.187(2) – one still has to satisfy the name requirements for registration

D. Extra-Provincial Registration

1. The Registration Requirement
     Corporations incorporated outside of BC must be registered to “carry on business” in BC – must obtain
       extra-provincial registration with 30 days of commencing to “carry on business” in BC (BCCA s.297)
     Must file Form 13 (BCCA s.299) which requires an office in BC and an attorney to provide a place and
       person for the receipt of the service of documents (see BCCA s.304)
     Failure to register is an offence which can result in a fine of up to $50 per day (BCCA s.312(2))
     An agent or personal representative of an extra-provincial company that fails to register can also be
       liable to a fine of $50 per day (BCCA s.313)
     An extra-provincial company can not maintain an action BC and can not hold an interest in land in BC
       (BCCA s.312(1) – this does not apply to federal companies (BCCA s.312(4))

2. The Meaning of “Carry on Business”
     Generally this is a question of degree of presence of the extra-provincial company in the province
     Deemed to be carrying on business in the province if:
          o Name is listed in a telephone directory for any part of BC;
          o Name in an advertisement in which a BC address is given;
          o Have a resident agent or representative in the province; or
          o Have a warehouse, office of place of business in the province
          o BCCA s.1(8) - otherwise it is a general question of whether it is carrying on business in the
             province (just selling goods to a resident of BC and delivering those goods to that person is not
             carrying on business in BC)

3. Purpose
 Allows a person who deals with a company carrying on business in BC to have a place in the province
    where that company can be served with process for the purpose of commencing an action in BC and, a
    place where certain documents concerning the company are available for inspection

E. Restrictions on Management Authority

I. Agency Relationship
     Directors and officers have actual authority to act as agents for the corporation
                                                                                                                 34
      Look to CBCA, company by-laws, articles of incorporation, resolutions for shareholders, resolutions for
       directors, written employment contracts, usual and customary authority or acting within ostensible
       authority for restrictions

II. Ultra Vires
      Presumably, the agent can‟t do something that even the principal can‟t do
      “Beyond the power of the corporation”

Objectives:
   1. Be aware of the doctrine of ultra vires and be able to apply it in instances where it has not been
       overridden
   2. Be able to articulate the problems with the ultra vires doctrine, the practical response to it and the
       subsequent legislative response to it in the CBCA

A. The Ultra Vires Doctrine
     Companies can incorporate under their very own act and there may be nothing in there overruling the
       ultra vires doctrine (unlike the CBCA and BCCA overruling provisions)

Ashbury Railway Carriage & Iron Co. v. Riche

Facts
 Company had all sorts of objects in its articles
 Contract with Riche to construct a railway in Belgium
 Riche began building the railway
 2 years later, the railway company breached the contract
 Riche sued

Decision
 S.12 of the company said you can‟t change the objects of the company
 The company cannot deviate from the objects set out in the memorandum b/c if it did it would breach the
   statute
 The Act prohibits the company from engaging in activities outside of its objects
 Company could not build a railway according to its articles so the K was beyond the powers of the
   company
 The K was between Riche and someone with no capacity to do what the K said so it‟s void

B. Justifications
     Method for protecting creditors and investors from the company doing something unduly dangerous
     Concern with respect to early companies, particularly Crown Charters that were set up to do something
        quasi-public. Want to make sure that the person uses the funds to build what the funds were given for.
     These kinds of objects clauses protected against risk of bankruptcy those types of companies we really
        don‟t like going bankrupt (e.g. banks and insurance companies)

C. Problems with the Ultra Vires Doctrine
    Party they contract with must bear the risk that the K may not be enforced
    The corporation may think they have the power to enter into it so they can‟t sue on it either
    Leads to potential unjust enrichment – Riche spent 2 years working on the railway – one side may get
       benefits but then repudiate the contract
    Persons would either have to charge an extra premium to cover the risk, or make sure that what the
       company is doing is within its object (both 3rd parties and the company itself)
    Both sides get lawyer‟s opinions on whether its between object of the company and it created a great
       deal of expense
                                                                                                                35
D. Response to the Ultra Vires Doctrine
     Drafted very broad objects clauses (listed everything they could possible think of + any other powers
       incidental to this kind of thing)
     Now the lawyer must read his/her way through these pages of objects clauses
     There would still be cases you would find ultra vires despite all these attempts to get around it

E. Ultra Vires Doctrine Continued to Cause Problems
     Contracts would be void, creates reliance by both parties, with unjust enrichment on one side and both
        sides ended up spending money to cover lawyer‟s opinions

F. Legislative Response
     CBCA s.15(1) – gave companies power of natural persons
     CBCA s.16(2) – shall not carry on any business that it is restricted by its articles from carrying on
     CBCA s.6(1)(f) – you can put any restrictions on
     CBCA s.16(3) – no act of a corporation is invalid by reason only that the act is contrary to its articles or
        this act
     Wanted protection for shareholders (ultra vires did this by saying if it does anything contrary to what it‟s
        supposed to do, the act is invalid), now we‟re saying the act is valid but the directors caused it to do
        something so the shareholders can sue
             o CBCA s.247 – shareholders can get an order saying the directors must comply with the articles
             o CBCA s.239 – bring a derivative action (causes corporation to sue the directors)
             o CBCA s.241 – Application to court re oppression (open ended provision allowing you to bring an
                 action against directors)
             o Procedurally, it‟s a lot easier to bring an action under oppression remedy rather than derivative
                 action

III. Constructive Notice and the Indoor Management Rule

Objectives:
   1. Be able to describe the constructive notice doctrine, the indoor management rule and the legislative
       modifications these doctrines in the CBCA
   2. Be able to apply the constructive notice doctrine and the indoor management rule both in their original
       form and as modified by the CBCA (CBCA gets rid of them and goes back to basic, ordinary principles
       of agency law)

A. Powers / Authority
   1. Powers Generally – look under statute, main documents that set up the corporation and look to internal
      documents like by-laws, shareholders resolutions, employments contracts
   2. Constraints on Powers – some actions of directors may require approval of the shareholders, sometimes
      you need a certain level of shareholder approval (more than 50%), approval from a particular class of
      shares, directors may need a resolution of the board, certain officers may have to approve it,
          a. Not a question of being beyond power of company but rather beyond power of directors and
              officers of the company
          b. Judgment may use “ultra vires” but it means beyond the powers of that particular officer etc.

B. Constructive Notice Doctrine
       Documents are publicly filed – may be available to 3rd parties
       3rd parties dealing with that corporation are deemed to know the contents of publicly filed
          documents

C. Indoor Management Rule
     If those documents are not publicly available, the 3rd party is not deemed to know what‟s in them
     Same sort of problem as above where the directors could borrow funds and it said they could grant a
       security interest as long as the shareholders approved it, (private company so shareholders‟ resolutions
                                                                                                                     36
       and meeting minutes are private). Bank has no way to confirm that the shareholders‟ resolution has
       been made so they would not be deemed to know.

D. Legislative Modifications
     CBCA s.17 – no constructive notice – no person is deemed to have notice or knowledge of a document
       by reason only that the document is publicly filed or available for public inspection
     CBCA s.18 – you can‟t assert that the articles haven‟t been complied with

IV. To what extent do the Ultra Vires Doctrine and the Constructive Notice Doctrine still apply?
     Nowhere a province has adopted the CBCA (or BCCA)
     If a company is incorporated under another statute you still check to see if the corporation has powers
        of a natural person and then if any restrictions on power are enough to invalidate a contract
     Generally civil law countries did not adopt ultra vires doctrines, the ones to worry about are former
        British commonwealth companies

                                    Chapter 4: Capitalization of the Corporation

A. Equity Securities

I. Types, Allotment, Issuance and Consideration

Objectives:
   1. Be able to describe the nature of a share
   2. Be able to describe:
           a. The main types of equity securities; and
           b. The rights attached, or that can be attached, to those securities

A. The Nature of a Share
     Capital of a corporation is a share
     Shareholders are referred to as “owners” of a corporation – it‟s more common to refer to them as one of
       a group of stakeholders
     Shareholders have a set of rights – this doesn‟t mean they “own” the corporation
     Shares are a bundle of rights
     Macaura v. Northern Insurance states that shares are a bundle of right

Sparling v. Caisse de depot et placement
 Arguing it didn‟t have to comply with insider trading provisions in a statute
 Court said Caisse doesn‟t have crown immunity in this case – if you get benefits in the statue then you also
   bear the burden
 Shares are bundles of rights
 P.188 – “a share is not an isolated piece of property, it is rather a bundle of interrelated rights and liabilities,
   a share is not an entity independent of the statutory provisions that govern its possession and exchange.
   They define the very rights and liabilities that constitute the shares‟ existence. CBCA defines the rights. A
   share is inseparable from the comprehensible bundle of rights and liabilities made by the Act”

B. Classes of Shares [CBCA s.6(1), s.24(4)
     Very open-ended – you can have any bundle of rights you want (types of shares are infinite) [see series]
     CBCA s.6(1)(c)(i) and s.24(4)

C. Frequently Used Types of Shares
       1. Common Shares have three main rights (look at 24(3) – if you have only one class of shares, these
          three rights must be included)
                   Voting rights to vote on those company matters that require shareholder approval (e.g.
                      election of directors)
                                                                                                                 37
                   Right to receive dividends on a pro rata basis (based on # shares you own)
                   Right to receive proceeds on liquidation of company
       2. Preferred Shares
               Preference
                      If the directors declare a dividend, or when distributing proceeds on dissolution, these
                         preferred shares get paid first
                      Presumption with respect to Dividends Beyond the Preferred Amount (Intl. Power
                         Company v. McMaster) – the dividends are limited to the preferred amount. IF you
                         want the preferred shareholders to share in the extra amount (after they‟re paid off
                         with the preferred dividend) you have to state that
                      Presumption with Respect to Proceeds on Liquidation Beyond the Preferred Amount –
                         the preferred shareholders share in proceeds after the preferred amount is paid out
                         (Intl. Power Company v. McMaster). If you want to cap it, you must state that
               Typical Preferred Share Features
                      Cumulative v. Non-Cumulative – if the preferred share doesn‟t get paid in full the first
                         year, it carries forward to the next year (cumulative). N-C preferred shares are quite
                         rare
                      Participating v. Non-Participating – preferred shares are non-participating as a
                         presumption but you can change this any way you like (e.g. 5 preferred shares = one
                         common share)
                      Convertible / Non-Convertible – a conversion feature says that at some point the
                         preferred share can be surrendered to the company and you‟ll get some other share
                         from the company (to a common share, to several common shares etc.)
                      Retractable / Non-Retractable – the shareholder can tender their shares to the
                         company and have the company buy them back from them a pre-set price
                      Redeemable / Non-Redeemable – the company can buy the share back from you
                         at a pre-set price (company may want to be able to re-finance)

D. Power to Issue Shares

Objectives
Be able to:
   1. Note who has the power to issue shares and the scope of the power
   2. Describe the issuance of shares in series and note the purposes of it
   3. Describe the terms “subscription” and “allotment”

1. The Power of the Directors s.25(1)
        S.25(1) – subject to the articles, by-laws or shareholder agreements (makes this a default provision)

2. Authorized Limit and No Authorized Limit
        Directors would be given an authorized limit of selling shares
        Would have to get approval from the shareholders, this created an impediment so the lawyers
           drafting would set a really big limit (effectively there was no authorized limit)
        S.6(1)(c) – you don‟t have to have an authorized limit

3. Shares in Series [CBCA s.27]
     You can take a bundle of shares and divide them into classes
     You then divide the classes into series, each series has its own bundle of rights
     If you want to create a new class of shares, it‟s the shareholders (directors have power to issue, but
       shareholders only have power to create by amending the articles – these set out rights, restrictions, etc.
       on the shares)
     Reason for series is if the directors have one class of shares but want to raise capital and need
       something a little different than the present class of shares (they may not sell well in the current market,
       for example). There must be a shareholder meeting to create the shares.
                                                                                                                   38
      Shares in series allow the shareholders to create the new class and then give the directors rights to issue
       shares in different series and allow the directors to set the rights on the particular series. Provides
       flexibility for director to create shares that hit the market at the right time.
      Check 27(3) – you can‟t give one series a preference over another series

4. Subscriptions and Allotment
       (a)     Subscriptions – application to the company to get shares (like a newspaper subscription). Public
               offering for the 1st time results in over-subscription so you must decide who will get what shares
       (b)     Allotment – deciding who gets how many shares

E. Consideration on an Issue of Shares

Objectives

Be able to:
   1. Describe the par value concept, the problems with the concept and the CBCA response to it;
   2. Describe the CBCA position on the assessibility of shares;
   3. Describe the watered stock problem and the available remedies under the CBCA

1. Par Value vs. No Par Value Shares
     Par value is the amount the shareholder agrees to contribute – it is part of the shareholder‟s liability
     If you had a par value on a share of $1 and the shareholder paid 50 cents, the shareholder can be
        called upon by the corporation to pay the additional 50 cents. The creditors can also go after the
        shareholder for the other 50 cents
     It provided a further, ready source of finance when the corporation needed more money to expand.
     Basis for determining the capital available for creditors, in determining what capital will be available,
        you take the number of shares issues and multiply that by the par value
     Problems [CBCA s.24(1)]
            o The figure was meaningless to begin with and became more so afterward. About 50 years after
               the original statute of incorporation in England, the issue came up whether a company was
               allowed to issue share for less than its par value. The case says that it is an ultra vires act of the
               corporation.
            o Contributed Surplus Deceiving
            o CBCA said it‟s meaningless and deceptive so they got rid of it. “Shares shall be in registered
               form and shall not be in nominal or par value”

2. Fully Paid [CBCA s.25(3)]
     Was potentially deceptive in terms of having that asset on the balance sheet b/c you still had to find
        the shareholders and do the collections process.
     S. 25(3) “A share shall not be issued until the consideration for the share is fully paid”. And directors can
        be liable for the difference (s.118). Directors want a paper trial showing they received full payment for
        the shares

3. Assessable vs. Non-Assessable [CBCA s.25(2)]
     Edmonton Golf and Country Club case
     You buy the share initially (like an initiation fee) and then next year an assessment on you shares would
       happen and you would have to pay a further amount
     This would really mess up stock market trading – you‟d have to make sure it wasn‟t assessment or then
       take the assessment potential into account
     “Shares issued by a corporation are not assessable” s.25(2)

4. Watered Stock
    The “watered stock” problem – think of fattening up a watermelon to make it seem heavier than it is
    CN Hepenheimer – example of this problem. This company had the idea that there was a straw mill
       business and if they bought up all the mills, they‟d have a monopoly. With the monopoly they could
                                                                                                                 39
       increase the price. They paid 2.25 million for the mills they bought. They set up the company and
       transferred the assets of mills into the company. Assets should show 2.25 million but they put it down as 5
       million. The extra was the increased value due to the monopoly (goodwill). On the other side, they took
       back bonds of one million and shares at 4 million. Problem: in fact they found it difficult in buying more
       mills so they couldn‟t monopolize the industry. The assets were really worth 2.25 million so the shares
       were really worth 1.25 million. But the balance has assets overstated by 2.75 million and equity
       overstated as 2.75 million. The balance sheet is then watered, or puffed up. Supposedly creditors get
       deceived and future shareholders also get deceived.
      Prohibition Against Watered Stock in the CBCA s.25 (3) – shares must be fully paid in money, or payment
       in property or you can pay in past services that are not less in value than the fair equivalent for money.
      Remedies for watered stock –
            o Directors Jointly and severally Liable (s.118) to the corporation for the difference, sub 4 – director
                can apply to court compelling shareholders paying money back to corporation,
            o Directors subject to penal sanction s.251
            o Actions Against Shareholders – creditors or liquidators can get shareholders to pay in the
                difference

II. Pre-Emptive Rights

Objective
Be able to describe the pre-emptive rights, the purpose of such rights and the CBCA position on pre-emptive
rights

1. If more shares are issued of the class of shares that you own, then they have to offer the newly issued shares
to you first. The usual approach is to offer in proportion to the number of shares that you already own

2. Purpose – that shareholder retains their proportion of shares (percentage)

3. CBCA s.28 – pre-emptive right doesn‟t have to be on a pro rata basis, or there may be a different formula to
figure out how many of the shares the shareholder can buy. It‟s an optional provision. It looks like this applies
when you‟re issuing a new series you must offer it to owners of previous series.

III. Dividends

Objective: Be able to describe different types of dividends, the scope of the power to distribute dividends and
the dividend distribution process.

1. Cash, Specie and Stock Dividend [CBCA s.43]
     Cash dividend – issue the money out of the bank account
     Specie – a company makes widgets, and they decide that for every share owned shareholders will
       receive one widget. Most common type is one in which the particular company owns shares of some
       other company and decides to distribute these shares to it shareholders. Spinoff – parent company has
       a number of subsidiaries and decides that one subsidiary needs to be sold off. The parent company
       has shares of this subsidiary so it declares it a dividend and pays it in subsidiary company shares.
     Stock dividends – you get more stock of the same company – see example in book. The value of each
       individual share goes down (you‟re issuing more shares for the same value of assets) so the value of
       what a shareholder has stays the same.

2. Power of Directors to Declare Unless Otherwise Provided [CBCA s.115(3)]
     Directors declare dividends unless provided otherwise
     In other countries it may be a power of the shareholders

3. Directors Not Obliged To Declare Dividends
     Sometimes the court will force the dividend in the context of an oppression action
     They have a fiduciary duty to act in the best interests of the corporation
                                                                                                               40

4. Dividends Become Debt of Company When Declared
     When things are getting bad, shareholders may decide to abandon ship (siphon everything out of the
        corporation to them before it goes to a liquidator)
     Directors can declare them, and they have a wide scope

5. Dividends Can Only Be Paid Out Of Profits
     Verner v. General and Commercial Investment Trust – you can pay dividends as long as you do not pay
        it out of the contributed capital of the company (that should be saved for the creditors)
     You can also pay dividends out of retained earnings – earning you‟ve made in previous years that you
        haven‟t distributed
     If you suffer a loss one year, you can still pay a dividend out of the earning from previous years

6. Can’t Be Paid if Payment Would Leave Company in Insolvent Circumstances [CBCA s.42]
     The realizable value of the assets would be less than the aggregate of stated value of all shares
     To make sure the realizable value of the assets is positive then you can pay a dividend
     If this happens, you‟re back to s.118 – directors voting for a resolution authorizing a payment of a
       dividend contrary to s.42, they are jointly and severally liable to restore to the corporation any amount
       so distributed

7. Record Date and Ex Dividend Date
     The company must keep a register of who the shareholders are
     If you‟re going to pay a dividend, the company must know who to pay it to – the ones on the
       shareholder registry
     The company will normally will set a record date for payment of dividends, on that date, at the ends of
       the day, they‟ll look to the registry
     Ex dividend date – you negotiate the price on the stock market and then you have three days to
       execute the contract. If you buy the share today, you will not get the dividend.

IV. Share Repurchases – Two Main Concerns

1. Creditor Protection
    1. Abandoning ship problem
    2. Stock price manipulation (concern for creditors and shareholders)




Trevor v. Whitworth
Facts
       Concern by a former shareholder about repurchases of shares by company

Held
 Ultra vires for company to repurchase its own shares
 Memorandum didn‟t say it was set up for the purpose of repurchasing its own shares
 There are provisions in the Company Act for returning capital – not by repurchasing shares
 Protects creditors by making sure the stock of capital stayed in the company – creditors can look at
   contributed capital to make sure the company can cover its debts (no redemption right on this)

A lot of statutes in Canada have gotten around this and specifically allowed companies to repurchase their
shares.

S. 36 – a corporation may purchase or redeem any redeemable shares at prices not exceeding redemption
prices set in the articles
                                                                                                            41
S.36(2) – a corporation shall not make any payment to purchase or redeem any redeemable shares issued by it
If there are reasonable grounds for believing that
         (a)    The corporation is, or would after the payment be, unable to pay its liabilities as they become
                due; or
         (b)    The realizable value of the corporation‟s assets would after the payment be less that the
                aggregate of
                (i)     its liabilities, and
                (ii)    the amount that would be required to pay the holders of shares that have a right to be
                        paid . . .

S.118 – directors liable . . .

S.34 (1) Acquisition of corporation‟s own shares
     (2) Limitation (to protect creditors)

S.38 (1) Other reduction of stated capital
     (3) Limitation

S.39 – when repurchasing shares you have to cancel those shares

1. Shareholder Protection

a. Rationale
     If a corporation buys back its own shares, it will buy from some but not all the shareholders
     The directors may have a good idea how the corporation is doing
     They‟ll repurchase when the shares are unusually low and it may signal the market
     Those people who sold their shares sold them for less than they‟re worth. There could be advantage
        taken of the selling shareholder.
     Although CBCA doesn‟t specifically deal with that, securities laws deal with it in a number of ways and
        stock exchanges also address this.

b. Protective Provisions
     Issuer Bid Regulation – if a large amount is repurchased in a short period of time a disclosure document
       must be given to all shareholder
     Public Announcement - for relatively small amounts (e.g. 5% over 12 months) – corporation must make a
       public announcement that it is purchasing its own shares. Empirical evidence shows the price goes up
       making the shares no longer undervalued
     Insider trading laws regulate situation where directors and officers know information the public doesn‟t
     Going Private Transaction – when a corporation buys back all outstanding shares, it must disclose
       information to sellers including a formal evaluation / assessment of the firm value
     Stock Exchange Rules – when a corporation lists on a SE, it enters contract called “listing agreement”
       where it agrees to abide by rules of stock exchange, punishment for breach may be de-listing. Also, if
       brokers are involved in market manipulation schemes they may be barred from the SE

If a company is purchasing its own shares others may be observing this buying frenzy. The price gets raised,
everyone else starts buying too so the company sells. Company has access to information that the rest of the
market doesn‟t.

Davis v. Pennzoil

Facts
 Concern abut Pennzoil‟s prices
 Pennzoil hired someone who suggested they clear off a large outstanding block of shares and buy it up
 Purchase shares on the market and at the same time announce they were engaged in an expansion or
   acquisition program
                                                                                                              42
   Purchase a Target Company, exchange Pennzoil shares for Target shares
   Pennzoil controls Target and then incorporates Target assets into its own

Decision
 A violation of certain provisions of Securities Exchange Act of 1934
 Rule 10(b)(5) – market manipulation
 In Canada we don‟t have a lot of similar provisions – s.380 – 400 of Criminal Code deal with fraud, stock
   market transactions and market manipulation

c. Repurchases may provide useful mechanisms
 Effective way of returning investment funds / some contributed capital to shareholders
 Effective way for management to signal that shares are undervalued – it‟s important to have the prices be
    reasonably accurate (means more that they‟re using corporation funds than if they‟re telling everything‟s
    going great). Not likely to use corporation funds to buy shares if they‟re overvalued or perfectly valued.

B. Debt Securities

Objectives:

1. Describe typical types of debt finance used by corporations;

2. Note the reasons for the appointment of a trustee for the enforcement of bond or debenture terms and
CBCA requirements with respect to such trustees

1. Typical Types of Debt Finance

A. Bank Loans

i. Line of Credit – to finance some short-term expenses, business may use lots of it at one time of the year and
then pay off lots of it at another time of year. Bank lets it go up to a certain amount. E.g. Tour Operators –
book large quantities well in advance and pay for most of it in advance. Money goes out with nothing coming
back in until the tours get booked in a few months.

ii. Term Loan – something that would finance something you‟d have for a longer term. Interest is paid on a
regular basis and at the end of the period, the principal must be all paid off.

B. Commercial Paper, Bonds and Debentures

i. Notes / Commercial Paper – getting a very short term loan from a bunch of other people (not from a bank).
Those other people tend to be other corporations. It is an IOU for x amount. E.g. This Corporation owes the
bearer of the note $100 000 due three months from now. The borrower buys these commercial papers for a
little bit less (say, $98 000). They have built in $2000 as interest. These papers trade just like shares.

ii. Bonds or Debentures
        a. Described – legally, there is no different between the two but on the street, bond means secured
        and debenture means unsecured. They are basically documents providing evidence of indebtedness.
        They‟re kind of like commercial papers, on the face it says X will pay Y Z amount in 10 years. In the
        interim, X will pay Y interest. Holder of the bond is a creditor.

       b. Terms – infinite array of things you can do.
                   Conversion right – bond will say that the person who holds it can surrender to the
                       company and get a right to convert it into another instrument of security from the
                       company (e.g. shares).
                                                                                                                  43
                         Or, you can attach warrants to the bond or debenture - $10 000 10 years from now at
                          interest plus you can purchase shares from the company over a certain period of time at
                          a particular price.
                         Participation Right (like preferred shares) – often referred to as income bonds: if company
                          makes a profit you get to share in it.
                         A security interest may also be stipulated
                         Negative pledge – you gave us a right to these assets and you won‟t give anybody a
                          higher right
                         Ratio tests – set up to say that you‟re worried you‟re not going to get paid,
                              1. Ratio of Assets to Liabilities - lower the ratio, the closer the company is to
                                  insolvency so the bond holder is worried he won‟t get paid;
                              2. Working Capital Ratio - take things (cash, accounts receivable and assets) that
                                  can be converted into cash fairly quickly, divide into liabilities that have to be
                                  paid fairly soon;
                              3. Times Interest Earned - look at profits on income statement before any interest
                                  that gets paid and then divide that by the interest.
                         Indenture will say if you don‟t meet the ratio requirements etc., there will be called an
                          Event of Default and any of the following things will happen: lender will get rights for
                          example, to seize assets, or right to put in a Receiver Manager
                         Acceleration Clause – when an even of default occurs, this clause says “you missed the
                          interest last week so not only is the interest due but also any other payment including the
                          principal normally due at the end of the period of the loan”

2. Trustees

A. Rationale

i. Small Stakeholder Problem
 None of the debentures may not be worth enough to spend money monitoring or enforcing
 Management then has free rein to do whatever they want

ii. Freerider Problem
 Debenture holders all rely on the other debenture holders to spend the money monitoring and enforcing
     the company activities and payments
 Result: debentures become worthless because the terms are never enforced and companies continually
     default on them
 Companies then needs a way to raise capital

iii.   Solution – Independent Trustee
      The corporation appoints a trustee who holds the right on debenture holders‟ behalf to enforce the terms.
      It makes sense for the trustee to spend money to enforce the terms.
      Trustee enforces for all the debenture holders. We get over the Small Stake Problem b/c the trustee is
       enforcing many debentures so it‟s a large stake.
      You have to watch out for what kind of trustee is appointed – one may be friends with the directors, one
       may is totally incompetent (sends a false signal).

B. Trustee Requirements
        1.    Qualifications [s.84] – must be a licensed trust company
        2.    Conflict of Interest [s.83]
        3.    Access to List of Debenture Holders [s.85]
        4.    Power to Demand Evidence Of Compliance [s.86-88]
        5.    (Must) Give Notice of Default [s.90]
        6.    Duty of Care [s.91]
                                                                                                                       44
                                      Chapter 5: The Distribution of Securities

Objective – be aware that a prospectus may be required when shares, bonds, debentures or other securities
are distributed

I. Prospectus Requirement
    1. Prospectus is a disclosure document (very long) and provides two types of information:
           a. Information about particular security being sold (whether shares, bonds, debentures etc.)
           b. Information about the business of the person selling the securities (what is the business, who is
               managing, types of risks involved)
    2. When is it required (for everyone, for everything)
           a. Given to an investor when an investor buys a security – they have two days to examine it
               (consumer protection provision) and back out if they want to
           b. When a sale of a security is made, by an issuer of the security, when it‟s directly or indirectly to
               investors and there is no exemption from this requirement
    3. What is a security?
           a. Include shares, bonds, debentures but, more generally, it is basically any other form of
               investment is which the investor is led to expect profits primarily from the efforts of others

II. Continuous Disclosure – once you‟ve distributed securities and you‟ve had to use a prospectus, you‟re
subject to a whole range of Continuous disclosure obligations and these are things like:
        1.             Periodic financial reports (every three months);
        2.             Annual proxy circulars;
        3.             Insider trading reports filed on a monthly basis; and
        4.             Material change reports (whenever anything really significant or important happened
            that would likely have an affect on the share price you must issue a press release).

Reporting Issuers / Distributing corporations must make all of these continuous disclosures.

                                        CHAPTER 6 Governance Structures

I. Agency costs – economy concept, anytime anyone does something on behalf of somebody else it raises an
agency costs problem. The agent may not act in the best interests of the principal so the principal must
engage in
       1. Monitoring costs – costs of making sure person acting on one‟s behalf is doing so with their best
       efforts on one‟s behalf

       2. Bonding costs – costs of agent signalling to principle that she or he will give her or his best efforts on
       behalf of the principal (simplest thing to do is buy insurance)

Agency Costs =         Monitoring Costs     +         Bonding Costs           +       Residual
                              |                                |
                       Governance Structure           Liability Strategies
                              |                                |
                                                      Signal to market

As soon as the benefit of monitoring exceeds what it‟s worth, the monitoring will stop. This residual leaves a little
room for the agent to get lazy

II. Directors and Officers

A. The Role of Directors

s.102 – the directors manage or supervise the management of the corporation
                                                                                                                       45
       subject only to a unanimous shareholder agreement (*single, most important provisions in the CBCA)
       the only way you can take away the director‟s power to manage or supervise is by a unanimous
        shareholder agreement

B. Qualification Requirements

s.105(1) individual, 18 or over, not bankrupt; not of unsound mind
s.105(2) no share qualification requirement unless the articles so provide
s.105(3) 25% of directors must be Canadian residents (critics would like to get rid of this altogether)

C. Number of Directors

s.102(2) one or more for a corporation
     Minimum of three directors for a distributing corporation with more than one shareholder (two of whom
        can‟t be officers or employees of the corporation)
     Distributing Corp = corporation distributing corporation under a prospectus
     When you sell securities generally to the public, they want you to disclose information in the prospectus
        – everything requires a prospectus unless you are given a very specific exemption (public interpreted
        very broadly)
     You can have any number of outside directors – subject to minimum of two
     If you‟re listed on a SE, they have a quasi-requirement that you have more that 50% independent
        directors (not officers, shareholders with more than 10%, part of the bank you deal with)

D. Election

First Directors – notice of first directors sent to the director when the corporation is formed (s.106(1)) – usually
promoter of the corporation

Subsequent election – first directors hold office until the first meeting of shareholders when directors are elected
at that meeting and each subsequent annual meeting of shareholders (s.106(2), (3)). You don‟t have to have
the 1st meeting for 18 months.

E. Term of Office

Term of not more than 3 years [s.106(3)]

No stated term then director ceases to hold office at the close of the first annual meeting of shareholders
following the director‟s election [s.106(5)]

Staggered terms – not all directors have to be elected at the same meeting (e.g. could have 9 directors each
with terms of 3 years and having only 3 directors elected in each year) [s.106(4)]

F. Filling of Vacancies

If a vacancy occurs between annual shareholder meetings (due e.g. to the death or retirement of a director)
then the remaining directors can fill the vacancy (subject to certain exceptions) [s.111]

G. Ceasing to Hold Office

Directors cease to hold office when the directors dies, resigns, becomes disqualified or is removed from office
by a resolution of the shareholders [s.108]

H. Removal of Directors
                                                                                                                46
s.109 – shareholders have the right to remove a director from office by ordinary resolution and the vacancy
created can be filled by the shareholders at the meeting called for the purpose of removing the director

s.2(1) – “ordinary resolution” - a vote of 50% of shareholders entitled to vote on the matter

Buschel v. Faith – it‟s very easy to set it up at the beginning so you can‟t remove a director – you could give a
director a special class with a voting right that if the person owning that share may be removed from a director,
that person gets a billion votes

Easy to subvert s.109 but it isn‟t ever done – this may be a liability strategy on the part of directors

I. Authority and Powers of Directors

Directors have the power (subject to the articles, by-laws or a unanimous shareholder agreement) to:
     Issue shares (s.25)
     Adopt, amend or repeal by-laws – must be approved by shareholders at next annual meeting (s.103) 
       if it‟s not approved then it ceases to be valid
     Borrow (s.189(1)) (changed from the common law)
     Grant a security interest in the property of the corporation s.189(1)
     Designate the offices of the corporation s.121
     Appoint officers s.121
     Specify the duties of officers and delegate powers to manage to them (subject to s.115(3)) s.121
     Fix the remuneration of directors, officers, and employees of the corporation

Directors may appoint a managing director or committee of directors from among their number and delegate
powers to the managing director or committee subject to the restriction in s.115(3), but see s.115(1)

Restriction on delegation – while directors may delegate their duties there are limits on the degree of
delegation, s.115(3) (you would be taking away the one main control device)

J. Removal of Officers

Directors have authority to appoint and remove officers. But what if the contract under which the officer
agreed to serve has a specified term or a minimum period of notice to remove officer? Generally it has been
held that the directors cannot summarily remove such an officer. While the officer can be dismissed
immediately the corporation must still pay damages for the early dismissal.

Takeover Bid – buy enough of the shares to get control, requisition a special meeting where you remove the
existing director and they go to remove the officers. Problem: those officers have a contract for a minimum
period of notice for removal, if the corporation fires him, it‟s a breach of contract. Directors argued they have
to be able to remove the persons or else they won‟t have effective control of the corporation. Court still held
they must pay damages for early dismissal.

Arguments for fixed term – pay them less for the security, gives officer greater incentive to learn about the
corporation if they have job security

K. Directors’ Meeting

Mechanics of calling directors‟ meetings is usually specified in the by-laws of the corporation.

Quorum is a majority of the directors unless the articles or buy-laws specify otherwise s.114(2)

Meetings by conference call are permitted s.114(9)
                                                                                                               47
Written resolutions signed by all the directors will suffice in lieu of a meeting s.117

One director present can constitute a meeting where there is only one director s.114(8)

No specified number of meetings per year – at some point failure to hold meetings could be considered a
breach of the duty of care under s.122 – average number of meetings per survey is about six / year

L. How Boards of Public Corporations Operate

When you read the statute, you get the impression that directors supervise the management of the corporation
so they‟re at the apex and controlling everything. It‟s the directors who would decide who the president is,
and who the other senior officers of the corporation are, decide corporate policy and strategy, ask key,
discerning questions of management to make sure they‟re doing a good job.

Some surveys of how boards really operate show that directors basically “rubber stamp” whatever the officers
suggest. Boards of directors don‟t usually decide policy and strategy – the officers do, when it comes to
replacing the existing president, formally the board appoints the new one but practically the outgoing
president does it. It looked like boards didn‟t do anything really.

Questions raised about these boards – who is running the corporation? Argued that there are some benefits to
the board: management must make some efforts to justify their actions to the directors, this is a useful thing to
make management do. In some extreme cases, boards of directors will dismiss the president (when he is doing
a bad job).

When you look down the list of members of the board, you see the names of management. In a distributing
corporation, only two directors must be non-management and non-employees. You could have a board of 20
and have 18 as officers of the corporation. It was suggested we should require corporations to have more
outside directors and the CBCA only requires the 2. Stock exchanges have “corporate governance guidelines”
which state they want a minimum of 50% of independent directors. If the corporation doesn‟t, it must justify this
to the SE and to its shareholders (very uncomfortable thing to do).

Outside directors may not be very effective. Corporations can be very complicated, outside directors do not
make directing their full-time job so they‟re busy elsewhere. They don‟t get to know the corporation very well –
how can they be fully informed about what‟s going on? Outside directors normally acquiesce and rubber
stamp anything the management recommends.

                                              Shareholder Voting Rights

I. Shareholder Control Over Directors (?)

s.102 – the directors manage or supervise the management of the corporation (they do not have to do what
the shareholders tell them). Subject ONLY to a unanimous shareholder agreement.

Otherwise the directors have the powers reviewed earlier subject to contrary provisions in the documents the
Act says can be used to alter the default arrangements under the Act.

There is thus a division of powers. The directors have certain powers and the shareholders cannot override
these powers by decisions made at shareholder meetings. In other words, if the shareholders tell the directors
to manage the corporation in a certain way or dismiss a particular officer the directors do no need to do what
the shareholders have requested. The directors are responsible for the management of the corporation and
they must do so according to the best interests of the corporation s.122.

Minority protection of shareholders from exploitation by a majority of shareholders.

II. Shareholder Powers
                                                                                                                    48

1. Election of Directors (S.106)

2. Amendment of By-Laws s.103
     Shareholders approve changes initiated by directors (subject to the articles, by-laws or a unanimous
      shareholder agreement)
     Shareholders can make proposals for by-law changes

3.      Fundamental Changes
        • Certain changes are considered of such significance that shareholders are entitled to vote on the
           changes
        • To help protect minority interests these changes must be effected by a “special resolution” [s. 2(1)]
           requiring 2/3rds of the votes cast on the particular resolution at the shareholders‟ meeting

        Fundamental Changes:
           • Amendment of articles [see s. 173]
           • Amalgamation (two corporations combining to form one corporation – when they combine a
              new set of articles will be made, and the different classes of shares may get treated in different
              ways) [s. 183]
           • Continuance in another (non-CBCA) jurisdiction
           • Sale, lease or exchange of all or substantially all of the assets of the corporation [s. 189(3),(6),(8)]
           • Voluntary liquidation and dissolution [s. 211(3)]

        Class (and possibly also series) Voting Rights
                In some cases fundamental changes also require that separate classes of shares must approve
                of the change by a special resolution of the just the shareholders of the class.

        These rights arise where:
           • Amendments of the articles in which one class of shares may be disadvantaged relative to one
                or more other classes of shares [see generally s. 176(1)]
           • Amalgamation [s. 183(3), (4), (5)]
           • Sale, lease or exchange of all or substantially all of the assets of the corporation [s. 189(6), (7),
                (8)]
           • Liquidation and dissolution [s. 211(3)]

        Where class-voting rights arise, shares of a class have a right to vote whether or not they otherwise carry
        a right to vote. [s. 176(5)]. These shares have a separate right to vote.

        Separate resolutions of each class having a class voting right are required. [s. 176(6)]

                                              SHAREHOLDER MEETINGS

I. BASICS OF SHAREHOLDER MEETINGS

    Annual Meetings
    First annual meeting [CBCA s. 133(a) – within 18 months]
    Subsequent annual meetings [CBCA s. 133(a) – within 15 months of last annual meeting]

    Special Meetings / Extraordinary Meetings
     Meetings at other times called “special meetings” [CBCA s. 133(b)] (or “extraordinary meetings”)

    Ordinary Business
     Election of directors, receiving of financial statements, and appointment of auditors is “ordinary business”
     [CBCA s. 135(5)]
                                                                                                                       49
      Ordinary business requires an “ordinary resolution” (majority of votes cast) [CBCA s. 2(1)]

     Special Business
      All other business is called “special business” [CBCA s. 135]
      “Special business” requires a “special resolution” [2/3 per CBCA s. 2(1)]
            Place
              In Canada per CBCA s. 132

            Quorum
             CBCA s. 139(1) majority of s/hs entitled to vote represented in person or by proxy (unless the by-laws
             specify otherwise)

            Notice
             CBCA s. 135 >21days, <50 days
             Notice of special business must state the nature of the business in sufficient detail to allow a s/h to
             make a reasoned judgment on it [CBCA s. 135(6)]

II. CONDUCT OF MEETINGS

A.       Normal Meeting Process
         Steps in the Meeting
          Voting
             Voting is usually done by a show of hands unless a poll is demanded [s. 141(1)] -a poll can be
             demanded before or after a vote by a show of hands [s. 141(2)]
          Minutes
             Minutes are to be kept (signed by the chair of the meeting) [s. 20(1)(b)]
          Chair
             Unless the articles provide otherwise the chair can be any member elected by members present at
             a meeting
             Standard by-laws of CBCA co. usually provide for chair of board or President

B.       DUTIES OF THE CHAIR
          Act in good faith in an impartial manner
          Allow shareholders to speak to matters before the meeting but need only allow a reasonable time
          No duty to go behind legal title of share ownership to identify voting preference of beneficial
            shareholders (where a person who had the legal title to the shares voted the shares in one way and
            the beneficial owner wanted it voted the other way, the court said the chair must recognize only
            the person who has the legal title). If you got a whole bunch of these challenge, it might be very
            complicated and the Chair would need to assess all the evidence and it would take too long.
          Chair does not have to be independent - chair having an interest in the result does not
            automatically make the chair‟s decision invalid

IV.      SHAREHOLDER REQUISITION OF MEETING

         Under the CBCA s. 143
             Holders of not less than 5% of the shares carrying a right to vote at the meeting sought to be held
                may requisition the directors to call a meeting of shareholders for the purposes stated in the
                requisition
             The shareholders must:
                (i)      Prepare a document setting out the purpose of the meeting;
                (ii)     Sign the document; and
                (iii)    Send the document (or documents) to each director and to the registered office of the
                         corporation.
                                                                                                                      50
                The directors must then call the meeting unless they have already set a record date for notice of
                 a meeting, have given notice for a meeting or the purpose of the meeting is one for which the
                 directors could refuse a shareholder proposal under s. 137(5)(b) to (e)
                If the directors do not call the meeting within 21 days of receiving the requisition then any
                 shareholder who signed the requisition may call the meeting
                The cost to the shareholders of requisitioning the meeting are to be incurred by the corporation
                 unless the meeting resolves otherwise

V.        MEETINGS BY ORDER OF COURT

     The court can order a meeting of shareholders of the corporation "if for any reason it is impracticable to call
      a meeting of shareholders ... [(1)] in the manner in which meetings of those shareholders may be called, or
      [(2)] to conduct a meeting in the manner prescribed by the by-laws and the Act, or [(3)] for any other
      reason the court thinks fit". [CBCA s. 144] E.g. all the directors die in a crash
     Under the CBCA the application may be made by a director, shareholder or the Director (guy who
      administers the Act) under the Act

VI.       ACCESS TO THE LIST OF SHAREHOLDERS

A.        Purpose – if you‟re going to make a takeover bid, you need to know how to get a hold of all the
          shareholders. You may also want to influence the votes.
B.        Ways of Obtaining Access
          1.     Require Corporation to Produce List
                  Who Can Request?
                  CBCA s. 21(3) - any person with respect to a "distributing corporation" - otherwise s/hs and
                      creditors can have a list provided
                           How is List Requested?
                           Send an affidavit (plus a reasonable fee) with name and address and [per CBCA s.
                              21(9)] that the list will not be used for a purpose other than:

                             1. An effort to influence the voting of shareholders of the corporation
                             2. An offer to acquire shares of the corp.; or
                             3. Any other matter relating to the affairs of the corporation.

E.g. Pillsbury v. Honeywell – someone thought Honeywell should stop producing personal fragmentation bombs
so they tried to get a list of the shareholders. Honeywell refused and this refusal was held up by the court.

                            Obligation on Corporation?
                             CBCA s. 21(3) - provide within ten days made up to within 10 days of the receipt of
                             the affidavit

                            Use of Request that Company Provide List?
                             Company required to keep list of s/hs [CBCA s. 20(1)(d)]
                             There is a right to inspect the list at the company office during usual business hours
                             [CBCA s. 21(1)]
                             -CBCA s. 21(1) - s/hs or creditors of non-distributing corp. and any person in case of
                             distributing corp. can inspect list

                                     Proxy Solicitation in the Public Corporation

1.        Reasons for Proxy Solicitation Provisions
         Common law rule that a shareholder had no right to be represented by proxy unless the constating
          documents of the corporation so provided
         Corporations typically did provide for shareholder representation by proxy because otherwise it was
          diffictul to get a quorum at shareholder meetings
                                                                                                                    51
        Common law rule that shareholders by given sufficient information to allow them to make a reasoned
         judgment as to whether to vote for or against a particular matter to be dealt with at a shareholders‟
         meeting
        Some solicitation practices still considered inappropriate – e.g. giving the shareholders a form of proxy
         without an opportunity to suggest an alternate proxyholder than the one set out on the form and not
         giving the shareholder a choice as to how to vote the shares
        There were also concerns about the information provided by dissident proxy solicitations – e.g. making it
         clear who the dissidents were and what their interest were

II. Proxies and Who Must Solicit Them

a.       Proxy Basics
1.       What is a proxy? It is a form signed by a shareholder which appoints a proxyholder (s.147)
2.       Proxyholder? A person appointed to act on behalf of a shareholder (s.147)
3.       Who can appoint a proxyholder? A shareholder entitled to vote at a meeting of shareholders (s.148)
4.       Rights of a proxyholder? The same as shareholder subject to the authority granted by the shareholder
         (s.148;152(2)). Proxyholder may be constrained on a vote by a show of hands - s.152(2) but can
         demand a poll
5        Who Must Solicit Proxies? Management must solicit proxies from each shareholder entitled to vote,
         s.149(1)

UNLESS

         CBCA s.149(s) and 151 – not a distributing corporation and no more than 50 shareholders or exemption
         granted by the Director (on “distributing corporation” see CBCA s.2(1) and regs. S.2(1))

C.      Form of Proxy
Provisions to avoid problems of earlier forms by:
   1. Requiring a clear indication that someone other than a designated person can be appointed Reg.
        48(3) and (4)
   2. Allowing voting for or against resolutions Res.
   3. Requiring

III. Who Must Send an Information Circular

A.       Who?
        Anyone who “solicits” proxies (s.150)
        Except that if dissidents need not send dissidents‟ proxy circular if solicitation is to no more than 15
         shareholders s.150(1.1)
        Prescribed solicitations conveyed by public broadcast, speech or publications ss.147 (b)(v), 150(1.2),
         Reg ss. 61(b), 63

                                 ACCESS TO RECORDS AND FINANCIAL DISCLOSURE

RECORDS
   Corporation must prepare and maintain at its registered office (or other place in Canada designated by
   the directors) records containing [s. 20(1)]:
        The articles and by-laws and all amendments to them
        A copy of any unanimous shareholder agreement
        Minutes of meetings and resolutions of shareholders
        Copies of notices of directors and change of directors
        A securities register
                                                                                                             52
   These documents can be examined by shareholders, creditors and the Director during the usual business
   hours of the corporation and, where the corporation is a distributing corporation, any other person may also
   examine these records. [s. 21(1)]

   The corporation must also prepare and maintain [s. 20(2), (2.1)]:
       Minutes of meetings and resolutions of directors
       Accounting records

FINANCIAL DISCLOSURE
    Annual financial statements (comparative and including a balance sheet, income statement,
      statement of retained earnings and statement of changes financial position) [s. 155]
    Distributing corporation then the financial statements must be audited [s. 155, 163]
    Non-distributing corporation can resolve not to appoint an auditor [s. 163]
    Can apply for an exemption from the Director [s. 156]
    To be sent to shareholders before the annual meeting [s. 159]
    Distributing corporations must send the financial statements to the Director [s. 160]

IV. Shareholder Proposals

A. Shareholder Proposals and Shareholder Democracy
    Concern with a small stake problem  widely held corporations
    Shareholders don‟t have much interest to monitor (reduced monitoring costs but here it‟s a problem)
    Separation of ownership and control  owners are the shareholders and the directors are in control –
       management is in actual control of the corporation
    Reacted with legislation
    Another example – voting by proxy and all those rules, now you can put in the proxy circular paper
       about what you want to propose
    Initially, the legislation had problems b/c management would get proposals for all kinds of weird things
       (e.g. repeal tax laws) and it wasn‟t something the corporation could do. Should you be using corporate
       meetings for this kind of thing?

B. The Statutory Provisions

CBCA. S.137
    A shareholder (registered or beneficial – usually there is now only one registered shareholder –
      Canadian Depository) is entitled to submit a proposal s.137 (1)
    But the shareholder must have been a shareholder for at least six months and hold the lesser of 1% of
      the outstanding voting shares or voting shares with a market value of $2000 s.137(1.1) and Reg s.40
    Proposal to be set out in the information circular [s.137(2)]
    The shareholder can include a supporting statement [s.137(3) and Reg. S.42]
    Shareholders with more than 5% of the shares of the class entitled to vote can nominate directors
      [s.137(4)]
    Corporation can refuse to put proposal on management proxy solicitation if [s.137(5)]:
          o Not submitted 90 days ahead
          o Submitted for the purpose of redressing a personal grievance
          o It clearly appears that the proposal does not relate in a significant way to the business or affairs
              of the corporation
          o A proposal was submitted by same person in the last two years and the person did not appear in
              person or by proxy to present the proposal
          o Substantially the same proposal was submitted in the past five years and the proposal received
              less than 3% support if submitted once, 6% if submitted twice and 10% if submitted 3 or more
              times
          o The proposal is being used to secure publicity
    Corporation to give notice of refusal within 21 days s.137(7)
    Shareholder can apply to courts (to force corporation to put it on) s.137(8)
                                                                                                                 53
      Corporation can apply to courts (to get a declaration to see if they have to put it on or not) s.137(9)

                               ACCESS TO RECORDS AND FINANCIAL DISCLOSURE

RECORDS
   Corporation must prepare and maintain at its registered office (or other place in Canada designated by
   the directors) records containing [s. 20(1)]:
        The articles and by-laws and all amendments to them
        A copy of any unanimous shareholder agreement
        Minutes of meetings and resolutions of shareholders
        Copies of notices of directors and change of directors (also available at public registry)
        A securities register (a list of all shareholders and debenture-holders)

   Shareholders, creditors and the Director can examine these documents during the usual business hours of
   the corporation and, where the corporation is a distributing corporation, any other person may also
   examine these records. [s. 21(1)]

   The corporation must also prepare and maintain [s. 20(2), (2.1)]:
       Minutes of meetings and resolutions of directors  not generally accessible – only by directors
       Accounting records – then used to provide financial disclosure which must be provided to
          shareholders

FINANCIAL DISCLOSURE
    Annual financial statements (comparative and including a balance sheet, income statement,
      statement of retained earnings and statement of changes financial position [s. 155]
    Distributing corporation then the financial statements must be audited [s. 155, 163]
    Non-distributing corporation can resolve not to appoint an auditor [s. 163]
    Can apply for an exemption from the Director [s. 156]
    To be sent to shareholders before the annual meeting [s. 159]
    Distributing corporations must send the financial statements to the Director so they are publicly
      available [s. 160]

Corporate Governance
Should corporate law be mandatory or enabling? Mandatory  this is what you MUST do e.g. proxy solicitation,
prepare financial statement and sent to shareholders, keep corporate records. Enabling  s.189(1) Borrowing
powers, default provisions.

Corporate Charter Competition –USA has 50 corporate statutes but 70% of companies on NY Stock Exchange
are listed under Delaware. Most are in Delaware b/c it has the most lax corporate statute – the one that allows
management the greatest degree of flexibility to take advantage of shareholders. Others say it has the very
best statute. Once corporation reincorporate to Delaware, share prices consistently go up.

Shareholder Passivity – relates back to shareholder democracy.
    Each has a small stake, rationally it doesn‟t make sense in monitoring the management of the
      corporation. Not much control on management.
    Over the last 30 years, the major shareholders of the market are 90% institutions (banks, trust companies,
      insurance companies, securities firms, mutual funds, pension funds). They have the major control and
      hold 10 to 20% of the shares of the corporation. They have a large stake and an incentive to monitor
      control of the corporation.
    Large incentive is due to large stake and knowledge that no-one else will monitor (no free rider
      problem) and they have difficulty liquidating shares. Trying to unload that much will drive the price way
      down. They‟re stuck with the shares and the management. Very strong incentive to monitor.
      Separation of ownership and control isn‟t a big problem anymore.
    There are now laws in place deterring investors from holding such large stakes – some see this as a
      problem.
                                                                                                            54
   Directors of the major institutional investor are then monitoring the directors of the other company.
                                                                                                                55
                                     Chapter 6 – Closely Held Corporations

I. Introduction
      Most corporation have relatively few shareholders and the same concerns don‟t arise

II. Nature of the Closely-Held Corporation and Why it is Treated Differently

Objective – note the typical characteristics of closely held corporations and the reasons for treating them
differently than widely-held corporations

A. Nature of the Closely Held Corporation
    Relatively few shareholders
    Active in the management of the business - often they‟re really partnerships but they‟ve chosen to carry
       on business in corporate form
    Tends to be no established market for the corporation‟s shares – when you go to sell your shares, you
       can‟t go through a broker. You have to find your own purchaser.
    Usually a restriction on the transfer of shares – all shareholders are closely involved and they don‟t want
       to deal with just anybody, even though you technically have limited liability, each shareholder will
       probably have given the bank a personal guarantee. This leads to worry about wealth of fellow
       shareholders

B. Reasons for Different Treatment
       1. Large Stake – no problems in not monitoring as they have a strong interest in what‟s going on
       2. Separation of Ownership and Control Problem not as severe b/c there is no small stake problem and
          no free rider problem either. It‟s up to each individual shareholder to monitor. Less of a need for
          mandatory proxy solicitation – that person is going to show up to the shareholder meeting. May not
          even need a proxy circular b/c everyone is pretty involved in the business on a day to day basis.
          Mandatory financial disclosure – each shareholder probably knows the accuracy, looks at
          accounting records themselves
       3. Desire to Control Who They‟re in Business With – strong concern about transfer of shares and place
          large restrictions on this.

Other countries often have a separate statute for closely held corporations.

III. Statutory Definition of Closely-Held Corporations and Statutory Modifications for Closely-Held Corporations

Objective:
(i)    Note the approach of the CBCA with respect to defining closely-held corporations
(ii)   Note at least three modifications to the corporate statutes with respect to closely-held corporations

A. Statutory Definitions
    CBCA s.2(1) “distributing corporation”
    Regs. S.2 and Schedule 2 to the Regs – page 204 and 241
           o If you‟re listed on a SE or you‟ve filed a prospectus, you‟re a distributing corporation (your shares
               are available for trading)
    Public/private definition

B. Statutory Modifications
    1. Waiver of notice to meetings s.136
    2. One shareholder meetings s.139(4)
    3. Unanimous consent in writing to resolutions in lieu of meeting s.142
    4. No requirement for an audit committee s.171 (at least 2 directors who aren‟t officers and they have to
        review financial statements with auditor)
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   5. Dispensing with an auditor s.163 (having an audit can be proportionally more expensive than in a large
      corporation)
   6. Reduced financial disclosure s.160(1)
   7. Avoidance of management proxy solicitation requirement s.149(2)
   8. Number of directors s.102(2) – distributing corporations have minimum of 3, with Closely Held
      Corporations, you need only


IV. Shareholder Agreements

Objective:
Note the reasons for the use of shareholder agreements under the CBCA + Deal with a problem like #22

A. Voting Agreements Generally
    “I promise to vote my shares a certain way” and “I too promise to vote my shares a certain way”
    A contract – consideration is the promise
    Perfectly legal (Ringuel v. Bergeron)
    S.145.1 – a written agreement between 2 or more shareholders regarding how they‟re going to vote is
       okay
    This is how shareholders with small holdings that aren‟t particularly influential could amass a greater
       voting power
    Or, each of the persons agreeing to the voting agreement will settle their shares on a trustee and then
       the trust instrument (written document) will require the trustee to exercise the voting rights in a certain
       way. Also, the trustee would disburse the dividends accordingly.

B. Using Voting Agreements to Constrain Directors’ Power
     “We not only want to determine who the directors are” but we also want this particular person be a
       president of the corporation, this one to be the secretary etc.
     Directors decide this
     Ringeur v. Bergeron – remaining 4 parties in a voting agreement, a group voted to get rid of the
       president and the president sought a remedy. Here, if you violate the agreement you lose your shares.
       The agreement was valid b/c “voting agreements are valid” but also, in those voting agreements, it is
       contrary to public policy to constrain the votes of the directors. You can‟t make an agreement as to
       how the directors will exercise their discretion.
     When directors act, they must act in best interests of the principal (corporation). Shareholders vote and
       act in their own interests. Directors though are agents so they cannot constrain how they‟re going to
       vote. If you enter an agreement that says “directors shall vote in the following way”, it‟s considered not
       valid.
     For Closely-held corporations, it‟s not easy to sell shares if things aren‟t going your way. Directors can
       become completely frozen out. Ahead of time, you want everyone to agree on ground rules – e.g. this
       person gets to say as the manager. To make sure someone becomes a director, you can enter into a
       voting agreement.
     To make sure they become managers, you cannot use a voting agreement (constrains directors‟
       powers)

C. Constraining Directors Powers under the CBCA
    If we don‟t do anything, who has the power? Is it okay to leave it there?
    You can put a provision in either the Articles or the by-laws and put a director‟s power back in the
      hands of the shareholders and the shareholders can agree to who will be the directors (here you‟re
      constraining the shareholders‟ power and not the directors‟)
    Directors have the power to manage generally (s.102)
    Can we take this power away? Yes – but only in a unanimous shareholder agreement
    Power to borrow is in s.189 is the directors‟. Therefore, you can‟t constrain borrowing powers in a voting
      agreement. You can take the power away in the Articles (difficult to amend though and you must also
      file the amendment and this costs money), in the by-laws, or by unanimous shareholder agreement.
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                                             Chapter 7 – Liability Strategies

Fiduciary Duties of Directors and Officers

I. Introduction
      Fiduciary duties as a bonding device
      Fiduciary duties under the common law were default rules. The articles or by-laws could waive these
         duties for directors and officers.
      To the extent these duties were not waived they could be viewed as promises by the promoters /
         management to act in the interests of shareholders back up by the threat of legal action.

S.122(1) – the duty of loyalty, act honestly in good faith, duty of care of a reasonably prudent person
S.122(3) – these duties cannot be waived except for 146(5)

II. The Duty of Care

Objectives:
1. Identify situations in which an argument for a breach of the duty of care may arise.
2. Discuss the scope of the duty of care noting the business judgment rule and the effect of the statutory
codification of the duty of care.
3. Make the argument that a breach of the duty of care has occurred applying the law to the facts.

A. The Pre-Statutory Standard (Very Low)

Re Cardiff Savings Bank
 The Marquis de Butte was a director since the age of 6
 Creditors were suing the bank but it had no assets
 They went after the Marquis b/c they thought he had breached the duty of care b/c he hadn‟t been to a
   meeting ever
 Court held he did NOT breach the duty of care

Re Brazilian Rubber Plantations and Estates Ltd.
 A bunch characters formed an investment syndicate and got money to buy a rubber plantation in South
    America
 They paid $15 000 pounds for the plantation
 They formed a company in England and the investors syndicate would sell the plantation to the company
 They then found some other people to be directors for the company
 Aylmer was a director and was completely ignorant of business, Tugwell was another director and he was
    75 and very deaf, Barber was involved in the rubber business so his job as a director was to price the rubber.
    Hancock was also a director b/c the others were his friends
 The bad characters sold the rubber plantations to the company for $30 000 pounds plus they took back
    $120 000 pounds worth of shares
 They produced a prospectus to raise the money for the company, in it, it said the plantation had 12 500
    acres when it had only 2000 acres.
 Shareholders were ripped off so the directors were all sued
 Court said the standard of care the directors ha to exercise is the reasonable care expected to be taken in
    the circumstances by a person acting on their own behalf. In this case, they looked at it and said, for
    Aylmer because he knew nothing about business, for Tugwell b/c he was old and deaf and for Barber b/c
    he only had to price, they all got let off

Re City Fire Insurance
 Here, the judge set out the details of the standard of care
 The directors here also got off the hook
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   An insurance company had been very profitable and had continued to show on its income statement
    substantial income and yet it turned out it had a serious deficit. There was really no value to the equity at
    all. Net of liabilities was less than 0.
   Turned out the president had been stealing from the company for the last several years.
   Liquidator for creditors sued the directors for letting it happen
   Judge said you must take the degree of care to be measured by the care an ordinary person might be
    expected to take in the circumstances on their own behalf
   With a degree of skill expected of a person of his or her knowledge and experience.
   If you don‟t know anything, the standard is low
   A director is not bound to give continuous attention to the affairs of the company, directors can trust
    officers to perform their duties honestly in the absence of grounds for suspicion

B. The Business Judgment Rule

Smith v. Van Gorkum (High standard? Limited BJR?)
 Trans Union had some losses and could take advantage of them for tax purposes if they could merge with
   another company who had profits
 VG arranged a deal with someone to purchase shares of company for $55 per share
 Management of TU was opposed to it, on the same day VG took it to board of directors.
 Board met a couple more times to discuss this transaction, overall they met for 2 hours and ultimately
   approved the transaction
 Board of directors had 10 directors, 5 were outside, 4 of those were CEOs of other corporation with many
   years of experience in that capacity and the other was Dean of U of Chicago business school. Presumably
   this board is very knowledgeable
 Shareholders took an action to have the merger rescinded and sought damages against directors
 Court speaks of the BJR (flip side of duty of care) – courts will not second guess management decisions,
   court will presume that decision by management will be made in good faith, in an honest belief they acting
   in best interests of company and they were doing so on an informed basis.
 Cost of second guessing management decisions can be very expensive – judge must weigh expert opinions
 The only way the court will override the BJR is that directors must be grossly negligent
 Majority of the courts said the directors were grossly negligent on the basis the directors didn‟t inform
   themselves enough
 Much higher standard

C. Statutory Standard
 S.122(1)(b) – exercise the care, skill that a reasonably prudent person in the circumstances (exactly the
   standard they set out in Re City Fire Insurance Co.)

Fraser v Minister of National Revenue – suggests a very high standard of care, directors have withheld part of
an employees‟ wage for the tax requirement. Under the Income Tax Act, the directors must exercise the same
duty of care as under the CBCA in making sure that withheld money gets to the government. Here, Canada
Post wasn‟t paying their bills on time to this company so the company used the money withheld from the
employees. Fraser, a director, was found liable by looking at circumstances – Fraser was knowledgeable about
business so he didn‟t exercise adequate care given that.

   When it comes to directors and officers mismanaging, there are market mechanisms to give them a strong
    incentive to manage well. The law is another mechanism but it‟s not as important. Tax cases, on the other
    hand, need the strong law to enforce directors and management to comply with taxes.
   S.123(3)(4) – if you‟re not at a directors‟ meeting and a resolution is passed, you‟re deemed to have
    approved it. You have 7 days to correct that through certain mechanisms.

III. Conflicts of Interest
Objectives:
        Identify transactions where a conflict of interest can be sid to exist and advise as to:
                                                                                                                  59
       (i)     the potential consequences of the conflict of interest
       (ii)    how the consequences can be avoided

A. Pervasiveness of Conflicts of Interest
Four Common Situations:
    Transaction between corporation and a director or officer
    Transaction between a corporation and another corporation in which a director/officer has an interest
    Transactions between partially-owned subsidiary and the parent company (subsidiary has a minority
        interest of some sort). In a parent-subsidiary transaction, when the subsidiary loses the parent loses but
        b/c the parent has only a partial interest it doesn‟t lose as much as the subsidiary
    General transactions between one corporation and another where there are common directors. A sells
        land to B, each has 5 directors but three of the 5 are the same. Those directors for A wants the highest
        possible price but their duty to B is to get the land at the lowest prices
Closely-Held Corporation‟s Situation
    They have difficulty getting financing – they‟re not public and don‟t want to issue a prospectus b/c it‟s
        so expensive
    One place they raise $ from is from the shareholders themselves – the shareholder loans $ to the
        corporation  that‟s a conflict
    Directors decide remuneration for officers and in CHC, the directors and officers are the same
Expert Directors
    E.g. you want your lawyer to be on the board of directors, or a major client will have a representative
        on the board for the information connection
    Parent-subsidiary situation – parent wants to put directors on the board to determine who the officers of
        the subsidiary are,

B. The Common Law Rule
     Strict rule (Aberdeen Rlwy Co. v. Blaikie Brothers – Aberdeen K‟s to buy something from Blaikie Bros.
       Blaikie was a director on Aberdeen. K involved 4100 tonnes of railway stuff to be supplied and about
       2700 tonnes had been supplied. The price had then fallen so Aberdeen didn‟t want the stuff anymore.
       Blaikie Bros. sued for specific performance – Aberdeen said it was a voidable contract b/c there was a
       conflict of interest. Court held this was the case. It didn‟t matter the K had gone on for some time, or
       that Blaikie was only one of 16 directors. Court doesn‟t look at whether the K was done in good faith or
       anything like that. There‟s a conflict so the transaction is automatically voidable
     Consequence is that the transaction is voidable so the company can get out of it with no harm
     Common thing was to have provisions in the Articles that said there would be no conflict of interest as
       long as directors disclose it and don‟t vote on the issue they‟re conflicted on

Potential consequences – K could be voidable, director or officer is required to account for any benefit they
received

C. Statutory Test
    S.122(1)(a) – act honestly and in good faith
    S.120
       If:
               1) disclosure asap [s.120(1)-(4), (6)];
               2) Approval by directors shareholders (interested directors not voting unless the transaction
               relates to director‟s remuneration or indemnity or insurance, is a transaction an affiliate
               [s.120(5),(7),(7.1)], and
               3) reasonable and fair [s.120(7), (7.1)]
       The contract not void or voidable and director or officer not required to account [s.120(7), (7.1)]

       Application for remedy s.120(8) – court may set aside contract transaction on any terms it thinks fit or
       require the director or officer to account to the corporation
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IV. Corporate Opportunities
Objective:
       Be able to identify situations where an argument can be made that a director of officer has improperly
       taken a corporate opportunity

A. The Strict Rule
     Whose opportunity is it (does it belong to the corporation or not)?
     If it‟s the corporation‟s, is it fair the director can take if for himself?
     Strictly – it‟s never fair under any circumstances

Regal (Hastings) v. Gulliver
 Says in some cases we will look at it, gives an idea as to what corporate opportunities are.
 Regal owned a cinema and the company to own more than one cinema
 Directors set up subsidiary company for buying more cinemas
 Opportunity to obtain leases on two other cinemas but landlord insisted the subsidiary has over $5000 of
   take-up capital. $2000 was the most it could come up with for the subsidiary.
 All 6 directors had arranged to come up with $500 each to come up with remaining $3000
 Person who took over Regal (Hastings) caused it to sue the directors b/c the directors came up with $3000
   themselves instead of letting Regal Hastings buy the whole $5000 worth of shares.
 **This was a corporate opportunity b/c they acquired shares in subsidiary by reason, and only by reason, of
   the fact that they were directors of Regal and in the course of their execution of office.
 It didn’t matter that the directors acted in good faith – how is the court going to determine that after the
   fact? Very hard to second-guess directors so court isn‟t even going to look into it.

B. Relaxation of the Strict Rule

Peso Silver Mines v. Cropper - can consider whether opportunity bona fide rejected by the corporation.
 Three of 6 directors of Peso were also officers and they were offered some mining claims.
 Directors looked at situation and said Peso is financially strapped and had to pass on the opportunity.
 Peso got probably 200-300 similar offers / year.
 6 weeks after the board meeting at which Peso decided not to take the claims
 the geologist approached C, V and W so the three of them formed a company and took the claims.
 Peso was sold, new directors caused Peso to sue C, V and W. V and W accounted but C said he wouldn‟t
   pay the company for the claims.
 In Court of Appeal, judges concluded that it wasn’t a corporate opportunity b/c he did not get opportunity
   by reason and only by reason that he was a director/officer of Peso – it came to him 6 weeks later.
 Court also looked at the hypothetical raised in Regal (hastings) case – what if the directors took the
   opportunity later instead of at the meeting? In those circumstances they would not be liable for taking an
   opportunity.
 They looked at good faith of the directors

Canadian Aero v. O’Malley – a broad fairness test applied.
 CanAero was looking to make a bid on mapping.
 They sent O‟Malley to do a prelim fly-over to prepare a bid.
 CanAero put conditions on the bid, O‟Malley had been investigating situation and knew if he prepared a
   bid with conditions it would lose.
 CanAero had also told them if they couldn‟t get the bid they‟d be fired.
 O‟Malley resigned, formed a separate company, prepared a bid and it won.
 CanAero then sued him for taking a corporate opportunity and it succeeded.
 Laskin, looking at it, refused Regal and Peso, applied a broad fairness test with nine factors.

Burg v. Horn – A need for flexibility
 Horns asked Burgs to form a corporation in which to do real estate investment with them
 Burgs actually owned several corporations to do real estate transactions through.
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   Horns then complained that a number of opportunities had come along but only some of them were
    brought to the Burg‟s corporation with the Horns.
   Court said that was okay – Horns couldn‟t expect that Burgs would bring all transaction to this one
    corporation. Example of situation where flexibility may be needed

V. Proper Purpose / Best Interests
Objectives:
       Be able to identify situations where an argument can be made that the directors have acted either for
       an improper purpose of contrary to the best interests of the corporation and set out the argument on
       the basis of the facts given (usually takes place in take-over situation)

A. Proper Purpose
   1. Identify the power
   2. Identify the intended purpose of the power
   3. What was the primary or substantial purpose for which the power was used
   4. Did the primary or substantial purpose fit with the intended purpose of the power

If yes, then power exercised for a proper purpose
If no then power not exercised for a proper purpose and was therefore an invalid exercise of the power

B. Best Interests
If the power was exercised for a proper purpose then one must assess whether the power was exercised in the
best interests of the corporation. I.e. did the directors of officers exercising the power have the authority to do
what they did? If they did there is still the question whether exercise of the power complied with their fiduciary
duties (duty of loyalty and duty of care.)

But the purpose of the power is rarely set out. There may be a range of reasonable purposes for the exercise of
a power and one should perhaps avoid making an overly hasty and constraining assumption about the
purposes of a power. Instead one should perhaps proceed directly to the question of whether the power was
exercised in the best interests of the corporation.

VI. Personal and Derivative Actions
Objectives:
Be able to:
    1. Note distinctions that have been made between personal and derivative actions.
    2. Note the historical
    3. Identify situation
    4. Note the steps

A. Historical Development and Nature of Personal and Derviative Actions

1. Derivative Actions and Constraints on Derivative Actions

Foss v. Harbottle
 Directors sold land at less than it was worth for their own benefit.
 Shareholders complained. Directors are agents, they breached a fiduciary duty they owed to the
    corporation.
 Directors decide if corporation will sue. Here, the directors breached the duty.
 Complainant wanted to cause corporation to sue the directors.
 Court said that‟s okay – if directors won‟t do it then someone else can. Shareholders had to have a
    majority vote to bring the derivative action.
 But, here the directors held a majority. This doesn‟t do minority shareholders any good.

2. Personal Actions
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      Initial concept of a personal action – shareholders holds contractual rights in shares, where there has
       been a breach the claim will be against a corporation. You may also be able to make a claim against
       the persons who caused the corporation to breach the contract.
      Constraints on personal actions – shareholders would go to a meeting, a director would serve as the
       chair of the meeting, a proxyholder would give his proxy to the chair and the chair would refuse it.
       Shareholder was then denied the right to vote b/c the chair knew the proxy would vote shares in a
       contrary way. Chair has a fiduciary duty so the court said this was a derivative action – the duty was
       owed to the corporation. This would need a majority of shareholders to vote in favour of suing the
       Chair. This takes us back to Foss v. Harbottle
      Personal or derivative on the basis of the source of the injury - more scope for minority shareholders to
       bring actions. It‟s personal if there‟s an injury done to you that‟s somehow different from injuries to other
       shareholders (the loss didn‟t derive from the loss of the corporation and other shareholders)

B. Statutory Derivative Action

S.239 – subject to subsection 2, a complainant may apply to a court for leave to bring an action in the name
and on behalf of a corporation or any of its subsidiaries, or intervene in an action to which any such body
corporate is a party, for the purpose of prosecuting, defending or discontinuing the action on behalf of the
body corporate

(2) No action may be brought and no intervention in an action may be made under subsection 1 unless the
court is satisfied that
     Complainant has given reasonable notice to directors
     The complainant is acting in good faith
     It appears to be in the interests of the corporation or its subsidiary that the action be brought,
         prosecuted, defended or discontinued

The Oppression Remedy

Objectives – be aware of the availability of the remedy and note why the oppression remedy is the preferred
way of proceeding

I. Need for an Oppression Remedy

Diligenti v. RWMO Operations
 Some disputes arose about P, what he was doing and what his remuneration would be.
 The other three people involved had a meeting and voted to remove P as a director.
 After doing that, they then met as directors of the board and removed him from his opposition as a
     manager, they then voted for a substantial increase in director fees and management salaries,
     consideration in interest being paid for those who provided personal guarantees, different place for
     shareholder meetings.
 Normally, you can prevent all this from happening in a shareholders‟ agreement but it didn‟t happen here.
 Now he would have to show the directors acted in bad faith in order to get leave to bring a derivative
     action. Everything they did was perfectly legitimate. His investment is now 0 – there will never be a
     dividend payment b/c it will all be sucked out in management fees etc.

II. The Statutory Oppression Remedy
A. Who can Apply?
      S.241 – a “complainant” as defined in s.238

B. Grounds on Which Remedy Can be Given? S.241(2)
    Act or omission of corporation or affiliate effects a result
    Business or affairs of corporation or affiliates conducted in a manner; or
    Powers of directors of corporation or affiliates exercised in a manner
                                                                                                             63
      OPPRESSIVE TO, UNFAIRLY PREJUDICIAL TO, OR THAT UNFAIRLY DISREGARDS THE INTERESTS OF
      ANY SECURITY HOLDER, CREDITOR, DIRECTOR OF OFFICER

C. Remedies s.241(3)
    Broad array of possible remedies set out
    Court is not limited to the remedies set out – court may do anything it thinks fit

Ebrahimi v. Westbourne
 E and N both owned 500 shares.
 N‟s son wanted to join in, each decided to give the son 100 shares each.
 There is then a falling out, the two Ns then vote new directors etc to oust E.
 Court looked at expectations of parties when corporation was entered into.
 Was it an expectation E would continue as a director etc.?

Expectation principle is the basis on which courts decide the remedy. Where parties don’t have an
arrangement written down, the court is “filling the gaps”.

Opression Remedy is Preferred Way of Proceeding b/c:
 In some cases, the persons would apply under O.R. and defendant would say the P is complaining that D
   took a corporate opportunity, had a conflict of interest or breached a duty of care. D would say it‟s a
   derivative action. Sometimes court agreed, but the majority of courts think even derivative claims can be
   brought under an oppression action
 Most oppression applications are breaches of fiduciary duties. Court has gone ahead and dealt with it as
   an oppression
 With an oppression remedy, it‟s an application and procedurally it‟s different than suing. In an application,
   evidence is dealt with in affidavits – much faster and easier and cheaper. A derivative action requires an
   application to get leave, then start an action – witness, examining, discoveries, writs, fees. Remedies are
   also limited in derivative actions– accounting, voidable transaction, maybe damages
 A complainant can bring an application under Oppression – wider scope than derivative action (includes
   employees bringing wrongful dismissal-like claims, creditors etc.)

				
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