ch2 by nuhman10

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									                                          CHAPTER 2

                     METHODS OF CARRYING ON BUSINESS

Every business must have an internal structure or organization through which the owner or owners will
operate. The types of business formats which can be adopted are numerous and range in complexity from the
sole proprietorship (one business person working for himself with or without employees) a partnership (of two
or more) to a large scale public corporation, franchised business system, joint venture or limited partnership.
The following is a discussion of the various business formats, how they operate, and how they compare with
each other in terms of utility, complexity and risk.


                                   I. BUSINESS FORMATS

A.      SOLE PROPRIETORSHIP

a.      KEY QUESTIONS

        i.       WHAT IS A SOLE PROPRIETORSHIP?

        ii.      HOW DO I START A SOLE PROPRIETORSHIP?

        iii.     WHAT IS MY LIABILITY AS A SOLE PROPRIETOR?

        iv.      WHAT IS A TRADE NAME?



        i.       WHAT IS A SOLE PROPRIETORSHIP?

        The sole proprietorship is the simplest form of business association, involving only one individual
        doing business on their own behalf and liable to the full extent of their personal assets for the debts
        and obligations incurred.

        It is an appropriate format for the new business person, as the relative lack of regulation and
        bookkeeping allows the entrepreneur to concentrate on advancing their business interests.

        The sole proprietor may have employees, but does not have partners or shareholders to participate in
        the profits or losses of the business.

        ii.      HOW DO I START A SOLE PROPRIETORSHIP?

        There is no formal structure or registration required. Thus, to start a sole proprietorship is a very
        simple matter from the perspective of paperwork. However, some type of accounting system should
        be established, and separate bank accounts for the business funds created.

        The external licensing and regulation will depend to a large extent on the type of business being
        pursued (see chapter 3 on Business Licences).
        iii.   WHAT IS MY LIABILITY AS A SOLE PROPRIETOR?

        Sole proprietors are liable to the full extent of their personal assets for debts and obligations incurred
                                                    2

     through their business.

     In addition, sole proprietors will usually have government imposed liability for such matters as
     personal income tax, source deductions of amounts due respecting employees including income tax,
     workers compensation and unemployment insurance premiums, business license fees, collection of
     sales tax levies, and Canada Pension Plan contributions.

     iv.     WHAT IS A TRADE NAME?

     A trade name is a name under which a particular business is carried on. A person who is not in a
     partnership and who is engaged in business for trading, manufacturing, contracting or mining and who
     uses as his/her business name, a name or designation other than his/her own or his own with the
     addition of and Company or some other expression indicating more than one member, must file
     this fact with the appropriate Provincial Registry, usually within six (6) months of beginning to use the
     name.

b.   WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF A SOLE PROPRIETORSHIP?

     i.      Example Problem:

     Marilyn operates a computer support and training business. This entails providing expertise in
     training new users, as well as assisting seasoned users in implementing new programs and correcting
     operational problems with existing programs. To date, Marilyns business has taken the form of
     personal contracts with each client.

     She is now becoming concerned about protecting herself against future liabilities, but would like to
     keep things as simple as possible.

     Required:

     1.      Outline for Marilyn some of the advantages and disadvantages of operating her business as
             a sole proprietorship.
     2.      How could she reduce her risk?
     3.      How is a corporation different from a sole proprietorship?

     Solution:

     1.      Advantages and Disadvantages of a Sole Proprietorship

            The sole proprietorship is the simplest form of business organization since it involves only
             one individual operating the business and owning the businesss assets.
            As the sole owner of the enterprise, the proprietor is entitled, after meeting the debts and
             other obligations, to all the profits of the enterprise. These may be reinvested or drawn out by
             way of personal renumeration as necessary.
            There are no specific statutes which regulate the operation of a sole proprietorship.
            Start-up of the business will normally only require the registration of the business name, if
             she is operating in a name other than her own and the payment of any applicable business
             license fees.
            Tax treatment of a sole proprietorship simply involves the sole proprietor including any profits
             or losses of the business in his or her personal taxable income.
     The disadvantage of a sole proprietorship is that there is no liability protection. Sole proprietors are
     personally liable to the full extent of their personal assets for all debts and obligations incurred during
     the course of operating the business. Also, if other people are employed in the business, the
     proprietor is also liable for the actions of these employees if they are acting in the course of their
     employment.
                                                      3


        2.       Reducing Risk

        Marilyn can obtain some measure of liability protection by including disclaimer or limitation clauses in
        all her business contracts.

        Disclaimer clauses simply provide that the other contracting party waives their legal right to pursue
        the personal assets of the sole proprietor in the event that a debt or obligation arising from the
        contract has not been satisfied by the sole proprietor. The extent of any liability to Marilyn might be
        the amount paid on the contract.

        The extent of liability protection afforded by these clauses depends on the clause itself.

        It should be noted that disclaimer clauses in contracts may discourage business because prospective
        clients may be skeptical of the quality of services or products offered and the reputation of the sole
        proprietor.

        3.       The Business Corporation v. The Sole Proprietorship

        Some of the principal features that distinguish the corporation from the sole proprietorship are:

                         First, the corporation has its own legal personality which is separate and distinct from
                          that of its shareholders, directors and officers.
                         Second, the corporation can therefore be sued in its own name, and equally it can
                          enter into contracts with its own shareholders.
                         Third, the shareholders are not liable for the debts or the obligations of the
                          corporation. This last advantage alone is sufficient in many instances to make the
                          corporation a preferred business vehicle.

        There are also some disadvantages to incorporating:

                         Incorporation requires the filing of documents and the adoption of a corporate
                          constitution.
                         Annual returns containing prescribed information must be filed. Legal costs are
                          involved (up to $500 for a simple incorporation) and the additional incorporation and
                          other filing fees are usually much higher than those payable by sole proprietors for
                          registration.
                         Corporations are required to hold meetings, elect directors, and provide
                          shareholders with information about corporate activities. (In the case of a one-person
                          corporation, legislation has greatly simplified these requirements).
                         Corporations are required to file separate tax returns distinct from the shareholders.

B.      PARTNERSHIPS
a.      KEY QUESTIONS

Business activities are often entered into by one or more participants. The reasons for individuals joining
forces in business are numerous and include such factors as increased borrowing power, contributions of
different business skills, and a larger initial asset base. The partnership is one common vehicle through which
individuals can pursue business opportunities together. Since partnerships are regulated by legislation in all 10
provinces it is important to understand how this legislation will impact on how partnerships are formed, and the
rights and obligations attaching to participation in a partnership.
                                                  4



    i.        WHAT IS A PARTNERSHIP?

    ii.       HOW ARE PARTNERSHIPS FORMED?

    iii.      DO YOU NEED A WRITTEN AGREEMENT?

    iv.       SHOULD YOU HAVE A WRITTEN AGREEMENT?

    v.        WHAT IS THE LIABILITY FOR A PARTNER?

    vi.       HOW ARE PARTNERSHIPS DISSOLVED?

    vii.      HOW ARE PARTNERSHIPS TAXED?

    viii.     WHAT IS A LIMITED PARTNERSHIP?



    i.        WHAT IS A PARTNERSHIP?

    The term partnership is used in everyday language to describe a variety of business, social and family
    relationships. For legal purposes the partnership is specifically defined under the various provincial
                      1
    Partnership Acts. Common to all these acts are three essential elements which must exist in order to
    establish a partnership.

              a)     a relationship between two or more persons;
              b)     in which business is carried on;
                                                                  2
              c)     with a view (or intention) to make a profit.

    Note it is not necessary that the business in fact makes a profit, only that the parties carry on the
    business with a view to making a profit.

    A legal partnership relationship often results when two or more people decide to conduct a business,
    but do not want to bother with incorporating. They would generally agree about some basic terms
    among themselves (usually divisions of profits) and then devote their attention to the business activity.

1
    Although the legislation in each province is similar, minor variations do exist. In order to follow the
    legislation, sample Acts have been used throughout the chapter as follows:

    Alberta          R.S.A. 1980 c. P-2 Partnership Act (referred to as R.S.A.)
    Ontario          1990 c. L-16 Limited Partnerships Act
                     R.S.O. 1990 c. P-5 Partnerships Act

    B.C.             R.S.B.C. c.312 Partnership Act

    Nova Scotia      R.S.N.S. c.259 Limited Partnerships Act
                     R.S.N.S. c.334 Partnership Act
                     R.S.N.S. c.335 Partnership and Business Names Registration Act
2
    R.S.A. s.1(d); B.C. s.3(c); N.S. c.334 s.4; O.N. c.P-5 s.3(3).
                                                  5

    No written partnership agreement is necessary. The relationship between these individuals is
    essentially one of contract and contract law will predominately govern dealings between them.
    However, where a term of their contract is not clear, for example with respect to admitting a new
    partner, the relevant provincial Partnership Act will impose that contract term on the parties.

    In the case of admission of a new partner, the Act would provide that no new partner can be admitted
    without the consent of all the partners. The Partnership Acts also operate to provide certainty in
    dealings with parties outside the partnership. For example, if Fred, Susan and Mabel were carrying on
    a photography business in partnership, you as a supplier of film, would expect that Susans signature
    of authorization on an invoice would be sufficient for you to collect payment. This is in fact a correct
    assumption. The law of agency is imposed under the various Partnership Acts and will bind the other
    partners if one partner makes a commitment on behalf of the firm in the ordinary course of business.
    Similarly one partner may create liability for the entire firm through fraud or negligence.

    In summary, a partnership is a relationship between persons working together to earn a profit. It is
    governed by the laws of contract and agency both of which are contained in the relevant provincial
    Partnership Act.

    ii.     HOW ARE PARTNERSHIPS FORMED?

    The provincial Acts govern the formation and operation of partnerships in each province.

    Whether or not a partnership exists is a matter determined by the facts and the courts will give
    consideration to the entire course of dealings between the parties who are alleged to have been
    operation as partners in deciding whether a partnership exists.

    The Partnership Act does, however, establish certain criteria which should be examined in order to
    best ascertain whether a partnership has been created. These include factors such as whether the
                                                                                  3
    property is owned in common and whether gross returns or profits are shared.

    Consider the following example:

    Q:      Ms. G., who runs a theater production company, decides to team up with X, manager of the
            Ritz Theater, to stage a musical. G is to receive 60% of the receipts taken at the door. Each
            party is to pay their employees separately and there is no sharing of equipment. Has a
            partnership been formed?

    A:      According to the Partnership Act, the sharing of gross receipts does not in and of itself create
            a partnership; it is only one factor (in Alberta, a strong factor) to be taken into account. Other
            factors include how employees are paid, allocation of losses and whether there is any pooling
            of the parties capital resources. As far as these other factors are concerned, the facts in this
            case would tend to indicate that a partnership has not been formed.

    iii.     DO YOU NEED A WRITTEN AGREEMENT TO HAVE A PARTNERSHIP?
    A written partnership agreement is not required for a partnership to exist. If no partnership agreement
    exists, partnerships will be governed solely by the provisions of the relevant Partnership Act which
    provides the following rules:

    a)      all the partners are entitled to share equally in the capital and profits of the business and shall
            contribute equally towards the losses, whether of capital or otherwise, sustained by the firm;

    b)      the firm shall indemnify each partner in respect of payments made and personal liabilities
            incurred by him:

3
    R.S.A. s.4(3); B.C. s.3(c); N.S. c.334 s.5(c); O.N. c.P-5 s.3(3).
                                                  6


                    in the ordinary and proper conduct of the business of the firm, or
                    in or about anything necessarily done for the preservation of the business or property
                     of the firm;

    c)      a partner who, for the purpose of the partnership, makes a payment or advance, beyond the
            amount of capital that he has agreed to subscribe, is entitled to interest on such payment or
            advance from the date of making the payment or advance;

    d)      a partner is not entitled before the ascertainment of profits to interest on the capital
            subscribed by him;

    e)      each partner may take part in the management of the partnership business;

    f)      no partner is entitled to remuneration for acting in the partnership business;

    g)      no person may be introduced into the firm as a partner without the consent of all existing
            partners;

    h)      a difference arising as to ordinary matters connected with the partnership business may be
            decided by a majority of the partners;

    i)      no change may be made in the nature of the partnership business without consent of all
            existing partners;

    j)      the partnership books are to be kept at the place of business of the partnership, or the
            principal place of business if more than one such place exists, and each partner is entitled to
            have access to and inspect and copy any of the books; and

    k)      A majority of the partners does not have the power to expel a partner unless a power to do so
            has been previously conferred by express agreement between the partners.

            In most cases it is very desirable for partners to have a written agreement which defines with
            certainty the relationship between all partners.

    iv.     SHOULD YOU HAVE A WRITTEN AGREEMENT?

    Although the Partnership Act does not require that a written partnership agreement exist, i.e., the
    partners affairs can be governed solely by the Act, the provision of the Act may not reflect the partners
    deal. The partners may wish to vary the rights and obligations which they owe to each other under the
                                                                                              4
    Act. Although these variations may be expressed or inferred from a course of dealings between the
    parties, in most cases it is desirable to have a written partnership agreement which defines with
    certainty the relationship between the partners. A sample partnership agreement is included in
    Appendix 2. When drafting a partnership agreement, consideration should be given to a number of
    key issues:

    a)      Identification of Parties

    All parties to a partnership must be identified clearly. This will include human beings as well as
    corporations, which are persons and therefore capable of entering into a partnership with
    individuals or other corporations.

    b)      Date

4
    R.S.A. s.21; B.C. s.21; N.S. c.334 s.4; O.N. c.P-5 s.20.
                                                 7


    The agreement should indicate the date on which the partnership was formed. Normally this date will
    coincide with the date of execution of the agreement, but this will not be the case where the partners
    have been in business for some time before they enter into a written agreement. Note that the start
    date of the partnership will also be the year-end date of the business for tax purposes. So it may be
    advantageous to fix the partnership start date so as to achieve a short tax year for the partners. (see
    discussion of taxation of partnerships in Tax section).

    c)      Declaration of Intention to Form Partnership

    This is a simple declaration that the parties have decided to enter a partnership for whatever purpose
    they have determined for example, to carry on the business of real estate brokers (see the preamble
    to the Sample Agreement).

    d)      Duration of the Partnership

    The Act contemplates that a partnership will continue until either:

            i)       the expiry of a fixed term, or
            ii)      the termination of the single undertaking or adventure which the partners entered the
                     agreement to pursue, or
            iii)     one partner giving notice to the other partners of his intention to dissolve the
                     partnership, or
            iv)      the death of a partner, or
            v)       the appointment of a trustee or receiver for a partner, or
            vi)      the bankruptcy of a partner, or
                                     5
            vii)     by Court order.

    Normally partners will prefer to reduce the number of events which may lead to dissolution of the
    partnership, by specifying the specific events of termination in the partnership agreement (see
    Paragraph 2 & 13, of the Sample Agreement).
                                6
    e)      Partnership Name




5
    R.S.A. s.21; B.C. s.21; N.S. c.334 s.5(c); O.N. c.P-5 s. 3(3).
6
    R.S.A. 16, ss. 39, 40; B.C. s. 39-40; N.S. C.334 ss. 39, 40; O.N. P-5 5.
                                                  8

     The various Acts require that a declaration of partnership be filed with the appropriate registry where
                                                                   7
     certain activities are to be carried out by the partnership. In Ontario and some other provinces,
     activities requiring such registration are trading, manufacturing, and mining; while in Nova Scotia, for
     example, all partnerships must be registered. Legislation in the province where the partnership is to
     be formed should be reviewed for particular registration requirements. Otherwise a declaration would
     not be required, but one may be filed at the discretion of the partners. Note that the firm name should
     be changed if a letterhead partner departs from the partnership. The Partnership Acts set out the
     rights of both third parties and former partners regarding apparent membership in a firm and notice
                                           8
     procedures for departing partners.

     f)      Appointment of Bankers

     The name of the bank and which partner(s) will have signing authority should be set out in the
     agreement. (See paragraph 4 of the Sample Agreement).

     g)      Capital Contribution of Partners

     A formula should be determined by which partners can inject capital into the partnership business. In
     paragraph 5(a) of the Sample Agreement, partners can only contribute to the partnership capital in
     equal proportion under this agreement. A partner wishing to provide additional capital can only do so:

             i)       with the consent of all the other partner(s), and
             ii)      with the understanding that the additional capital shall be regarded as a partnership
                      debt, rather than as an increase in the partnership ownership of the contributing
                      partner, and
             iii)     that the contributing partner(s) must at the request of the other partners, withdraw
                      the loaned capital from the partnership business.

     This paragraph is an example of how a written partnership agreement may be structured so as to vary
                                         9
     the provisions of a Partnership Act.

     h)      Division of Profits

     The method the partners will use to divide profits should be clear and will be a critical term of the
     agreement. (See paragraph 5(b) of the Sample Agreement).

     i)      Division of Expenses and Losses

     The Partnership Act provides that each partner must contribute equally towards the losses of the
          10
     firm. This can be varied by agreement. For example, paragraph 5(c) of the Sample Agreement
     provides that partnership losses and expenses shall be made good, firstly out the partnership
                                                               11
     earnings, and then by equal contribution of the partners.
     j)      Audited Financial Statements and Division of Profits


7
     R.S.A. s.81; B.C. s.81; N.S. c.335 s. 3(all partnerships to be registered).
8
     R.S.A. s.81; B.C. s.81; N.S. c.335 s.3(all partnerships to be registered); O.N. c.P-5 s.36.
9
     R.S.A. s.27 and 27(c) and (d); B.C. s.27 and 27(c) and s.27(d); N.S. c.334 ss.27 and 27(c) and 27(d);
     O.N. c.P-5 s.20.
10
     R.S.A. s.27(a); B.C. s.27(a); N.S. c.334 s.27(a); O.N. c.P-5 s.24(1).
11
     R.S.A. s.27(a); B.C. s.27(a); N.S. c.334 s.27(a); O.N. c.P-5 s.24(1).
                                                  9


     The partners may want to appoint chartered accountants, who will, report to the partners on the
     results of their audit of the annual partnership financial statements prepared by the partnership in
     respect to the partnership business. In paragraph 6 of the Sample Agreement a formula is provided
     where, upon the approval of the auditors report, any net profits of the partnership shall be divided
     equally among the partners. This paragraph provides a major addition to the rules provided in the
          12
     Acts.

     k)      Settlement of Firm Debts as Between Partners

     The parties will want to address the situation where if one partner pays more than his share of firm
     debts he will receive a first lien or charge against the partnership interest of another partner who is
     unable to pay his share. No such provision exists in the Partnership Acts. (see paragraph 7 of the
     Sample Agreement).

     l)      Non-Encumbrance or Assignability of Partnership Interests

     The Partnership Act does not prevent a partner from mortgaging or otherwise assigning his interest, it
                                              13
     merely limits the rights of the assignee. The parties may want their agreement to specifically prohibit
     any assignment of a partnership interest without the prior written consent of all partners (see
     paragraph 8 of the Sample Agreement).

     m)      Personal Obligations of Partners

     The Partnership Act imposes no obligations on a partner to protect his partnership interest from
     creditors. A personal obligation to pay all debts as they become due may therefore be considered in
     the agreement. (see paragraph 9 of the Sample Agreement).

     n)      Procedure Upon Dissolution of Partnership

     A mechanism for one partner to continue the partnership business upon the departure of another
     partner should be considered. For example the agreement might give the remaining partner the right
     to purchase the partnership interest of the departing partner. (see paragraph 10 of the Sample
     Agreement).

     o)      Right of Departing Partner to Purchase Partnership Assets

     Any rights to be offered to departing partners should be laid out. (see paragraph 11 of the Sample
     Agreement).

     p)      Procedure Upon Dissolution Where No Partner Purchase Partnership Assets

     The method for disposing of the partnership property should be considered if no partner wishes to buy
     the property or continue the business. For example, the parties may agree to an auction if all assets
                                                           14
     are not sold within 90 days of being offered for sale. (See paragraph 12 of the Sample Agreement).

     q)      Events Triggering Dissolution of the Partnership



12
     R.S.A. ss.27; B.C. s.27(a); N.S. c.334 ss.27(a), 27(1), 31; O.N. c.P-5 24(1).
13
     R.S.A. s.39; B.C. s.34; N.S. c.334 s.34; O.N. c.P-5 s.31.
14
     Same in A.B.; same in B.C.; same in N.S.; same in O.N.
                                                    10

     Any events that the partners would like to trigger dissolution should be clearly established. These may
     include events of particular significance to the parties for example, if the Calgary Flames win the
     Stanley Cup. (See paragraph 13 of the Sample Agreement).

     r)       Events Triggering Dissolution of the Partnership

     A duty to devote full time and energy is not imposed by the Partnership Acts. If this is important to the
     partners and their expectation such a clause should be included. (See paragraph 14 of the Sample
     Agreement).

     s)       Partnership Draws

     The Acts make no provision for periodic payments to partners against profits from the partnership
     business. Neither does the Act contemplate the payment of salaries to partners in respect of their
                                             15
     activities on behalf of the partnership. Therefore, some consensus on when the partners may take
     cash from the partnership, minimum reserves that will be maintained, and so on, should be reached.
     (See Paragraph 15 of the Sample Agreement).

     t)       Partnership Accounts

     This provision contractually provides for the maintenance of proper books of account for all
     partnership transactions. The Acts require that unless the parties agree otherwise, the books are to
     be kept at the place of business of the partnership and each partner has access to inspect and copy
                16
     the books. (See paragraph 16 of the Sample Agreement).

     u)       Arbitration

     The partners may wish to arbitrate their differences instead of litigating them in court. The same
     provision exists in the Partnership Acts, but the partners may certainly include one in their agreement.
     (See paragraph 17 of the Sample Agreement).

     v)       Notices

     The notice section specifies how notices are to be delivered to the other partners or their
     representatives. Registered mail is a common method for delivering documents which require notice
     (see paragraph 18 of the Sample Agreement).

     Obviously each partnership agreement will differ, depending on the specific needs and wants of the
     prospective partners. The use of a written agreement is desirable in almost every situation as it allows
     the partners to vary or eliminate undesirable portions of the Partnership Acts and adds greater
     certainly to the relationship between the partners.

     w)       What is the Liability of a Partner?

     It is important to distinguish between the two types of liability which may attach to a partner: first, the
     liability of a partner to third parties dealing with the partnership and second, the liability of partners to
     each other.

              a)        What is the Liability of a Partner to Third Parties?



15
     R.S.A. c.P-5 s. 27(j); B.C. s.27(9); N.S. c.334 s.27(i); O.N. c.P-5 s.24(9).
16
     R.S.A. s.27(j); B.C. s.27(i); N.S. c.334 s.27(i); O.N. c.P-5 s.24(9).
                                                  11

                      i)       The Partnership Act gives considerable guidance on the subject of third
                                               17
                               party liability. The following are some of the more common situations that
                               should be considered.

                      ii)      Every Partner Can Bind the Firm: A partner acting in the ordinary course of
                               business can commit his partners to a contract as their agent. A third party
                               dealing with such a partner is entitled to assume that all partners are
                               represented by the partner he is dealing with, unless the third party has
                               actual knowledge that the partner is acting outside the normal course of
                                         18
                               business.

                               Consider the following example: X, a partner in the firm, X Y & Z enters into
                               a valid contract with B to purchase $2,000 worth of new office furniture
                               without informing the other two partners. At a meeting the following day, Y
                               and Z vote against advancing any partnership money to pay for this
                               unnecessary expenditure. B is now demanding payment for the delivered
                               furniture. Does the partnership have to pay? The answer is yes. Under the
                               Partnership Acts, each partner is an agent of the firm, and when acting in
                               the usual course of business of the partnership he binds it to contracts
                               made with third parties.

                      iii)     Every Partner is an Agent: Each partner in a firm is the agent of every other
                               partner as regards the partnership business. This has obvious implications
                               for the potential liability of the partnership. One partner can, without the
                               knowledge of the other partners, commit the partnership to debts or
                               obligations which could not be satisfied by the business assets of the
                                            19
                               partnership.

                      iv)      Partners are Liable to the Full Extent of their Personal Assets: Because the
                               partnership is not a separate legal entity, each partner places all of his
                               personal assets at risk when he participates in the partnership business.




17
     R.S.A. ss.6-20, 40; B.C. ss.6-20, 39, 40; N.S. c.334 ss.8-21, 39, 40; O.N. c.P-5 ss.6-19, 36, 37.
18
     R.S.A. ss.78; B.C. ss. 7,8; .S. c.334 ss. 8,9; .N. c.P-5 ss.6,7.
19
     R.S.A. s.6; B.C. s.7; N.S. c.334 ss.8; O.N. c.P-5 s.6.
                                                 12

                      v)      Partners are Severally Liable: The concept of several liability may be
                              expressed as follows: when 2 or more persons are liable to a third party, that
                              party may take action against one of the liable persons alone for the entire
                              amount owing. The resolution of the action acts as a bar to further action
                                                                                            20
                              against all persons originally liable for the amount owing. For example,
                              assume the partnership of XYZ builds up a large debt load over the three
                              years of its operation. At the time of dissolution, X and Z have very minimal
                              personal assets. Y is worried that the partnerships creditors will come after
                              him for more than his one third share of the liabilities. Should he be
                              concerned? The answer is yes. Partners are both severally and jointly liable
                              for the partnerships debts. This means that Y is responsible not only for his
                              share of the debt but the entire debt of the firm as well.

                      vi)     Partners are Jointly Liable: In addition to several liability, partners may also
                              be jointly liable for debts or damages incurred by the partnership business.
                              Joint liability implies that each person responsible for debt or damage may
                              be held accountable for a portion of the liability. For example, if 4 equal
                              partners owed creditors a total of $100,000.00, the joint liability of each
                                                               21
                              partner would be $25,000.00.

             b)       What are the Liabilities of partners to Each Other?

                      The Partnership Acts set out the basic rules regarding the relationship of the
                                  22
                      partners. The key aspect of internal partnership relations however is the ability of
                      partners to create their own internal rules by way of a written partnership agreement.
                      This ability of partners to vary the internal rules which govern the relationship
                                                                    23
                      between themselves is set out in the Act. The main concept which should be
                      considered when discussing the liabilities of partners vis a vis each other is that the
                      partners will be governed by the provisions of the Act unless they choose to be
                      governed by their own agreement. The major provisions which govern the partners
                      liability to each other provide as follows:

                      i)      Partnership property shall be held and applied by the partners exclusively for
                              the purposes of the partnership and in accordance with the partnership
                              agreements;

                      ii)     Each partner is bound to render true accounts and full information of all
                              things affecting the partnership to any partner; and/or

                      iii)    If a partner without the consent of the other partners carries on a business in
                              the nature of and competing with that of the firm, he shall account for and
                              pay over to the firm the profits made by him in that business.

                      Consider the following: In order to celebrate the closing of the partnerships biggest
                      contract yet, P Partner purchases a new speedboat for his own personal use. The
                      money used to purchase the boat comes directly from the partnerships main


20
     R.S.A. ss.11(1), 14; .C. ss.11, 14; .S. c.334 ss. 12, 15; O.N. c.P-5 ss. 10,13.
21
     R.S.A. ss. 11(2), 13, 14; B.C. ss. 11, 13, 14; N.S. c. 334, ss. 22-34; O.N. c. P-5, s. 10, 12, 13.
22
     R.S.A. ss.21-34; B.C. ss. 21-34; N.S. c.334 ss. 12,14, 15; O.N. c.P-5 ss. 20-31.
23
     B.C. s.21; N.S. c.334 s.22; O.N. c.P-5 s.20.
                                                   13

                      account. Who owns the boat? Under the Partnership Act, property bought with
                      partnership money is deemed to be partnership property which is to be held and
                      applied by all partners exclusively for the use of the partnership. The partnership
                      therefore owns the boat.

     vi.     HOW ARE PARTNERSHIPS DISSOLVED?

     Questions often arise as to what events can cause a partnership to dissolve and what happens to
     partnership assets and liabilities upon dissolution. These questions are answered in the Partnership
                  24
     Legislation.

     a)      In general a partnership may be dissolved when an event such as: death, court order, or
             when it becomes unlawful for the partnership to continue. Other specific events of dissolution
             are summarized below;
                                                                                             25
             Subject to an agreement between the partners, a partnership is dissolved.

             i)       if entered into for a fixed term, by the expiration of that term,

             ii)      if entered into for a single venture or undertaking, by the termination of that venture
                      or undertaking,

             iii)     if entered into for an undefined time, by a partner giving notice to the other partner(s)
                                                                    26
                      of his intention to dissolve the partnership.

             iv)      by the death of a partner,

             v)       by the assignment of a partners property in turn for the benefit of the creditors; or

             vi)      by the bankruptcy of a partner.

             These provisions may be changed by an agreement between the parties. Consider the case
             of W & F.

             W and F enter into a partnership in order to build a golf course. Their partnership is
             evidenced by a written partnership agreement which states the term of the partnership to be
             approximately 10 months (estimated time for the construction of the course) or for so
             long as the parties desire to carry on business thereafter. The course is now finished and W
             has come to realize that his partner is not the great guy he initially thought him to be. He
             wishes to dissolve the partnership as soon as possible. Advise W.

             On these facts there are three possible ways this partnership can be ended: 1) as it was
             entered into for a fixed term (i.e. 10 months) it ends upon the expiration of that term by
             operation of law; 2) a partnership for a single venture or undertaking likewise ends after the
             projects completion by operation of law; and 3) if W wants to be absolutely sure, he could
             give notice of his intent to dissolve to the partnership.

     b)      On application by a partner the court may order a dissolution of the partnership in any of the

24
     R.S.A. s.35-47; B.C. s.35-47; N.S. c.334 ss.35-47; O.N. c.P-5 ss. 32-44.
25
     R.S.A. ss.25, 36, 43, 45, 46, 47; B.C. ss. 35, 36, 43, 45, 46, 47; N.S. c.334 ss. 35, 36, 43, 45, 46, 47;
     O.N. c.P-5 ss.32-44.
26
     R.S.A. ss.39, 40; B.C. ss. 39, 40; N.S. c. 334 ss. 39, 40; O.N. c. P-5 s.37.
                                                  14

             following cases:

             i)       when a partner is shown to the satisfaction of the Court to be of permanently
                      unsound mind;

             ii)      when a partner other than the partner suing becomes in any way, other than through
                      permanent unsoundness of mind, permanently incapable of performing his part of
                      the partnership contract;

             iii)     when a partner, other than the partner suing, has been guilty of conduct that in the
                      opinion of the Court, regard being had to the nature of the business, is calculated to
                      prejudicially affect the carrying on of the partnership business;

             iv)      when a partner, other than the partner suing, wilfully or persistently commits a
                      breach of the partnership agreement or otherwise so conducts himself in matters
                      relating to the partnership business that it is not reasonably practicable for the other
                      partner(s) to carry on the business in partnership with him;

             v)       when the business of the partnership can only be carried on at a loss; or

             vi)      when circumstances have arisen that in the opinion of the court render it just and
                      equitable that the partnership be dissolved.

     c.      Finally, a partnership is dissolved by an event that makes it unlawful for the business of the
             firm to be carried on or for the members of the firm to carry on the business in partnership.

     vii.    HOW ARE PARTNERSHIPS TAXED?

     A partnership is not considered a legal entity for tax purposes, therefore, although income is
     calculated at the partnership level, it is not the partnership which pays tax on that income. Rather
     each partner must include income from the partnership into their own personal income at year end,
     according to their pro rata share in the partnership. The partners must pay tax on this income even if
     the income remains in the partnership and is not drawn upon by the partners. A running account is
     kept of amounts which have been taxed and when a partner draws upon this money in the future,
     taxation will not occur as the income has been previously taxed. In addition, deductions such as
     capital cost allowance must be made at the partnership level and therefore must be agreed upon by
     all partners.

     Individual assets held by each partner may be transferred into the partnership on a tax free rollover
     basis. Under s. 97(2) of the Canadian Income Tax Act, individual partners can defer the taxation
     which could otherwise arise on the transfer of the assets into the partnership. However, there are
     conditions attached to this rollover option. The partnership must be a Canadian Partnership
     immediately after the transfer. The Income Tax Act, s. 102, defines Canadian Partnership to mean
     a partnership where all of the members, at all relevant times, are resident in Canada. Further, the
     property which qualifies for the transfer includes all capital property, Canadian resource property,
     eligible capital property, and inventory including real property. Additionally, the partners must elect,
     pursuant to the Income Tax Act, to transfer the property into the partnership.

     viii.   WHAT IS A LIMITED PARTNERSHIP?

     The limited partnership is often described as a hybrid of the partnership and the corporation. It is a
                                                                                                  27
     form of partnership which allows a certain degree of limited liability to some participants.

27
     Limited partnerships are governed by different legislation in each province. Some provinces such as,
     British Columbia and Manitoba include limited partnerships in the Partnership Acts while some, such
     as Ontario and P.E.I. have separate Limited Partnership Acts. The Quebec provisions for limited
                                           15




partnerships are contained, along with partnership legislation in the Quebec Civil Code.
B.C. ss.48-80
N.S. c.259
                                                  16

     The key difference between a limited partnership and an ordinary partnership is that the limited
     partnership creates two types of partners, general partners and limited partners, who have different
     rights and obligations. Because of this difference and the need to differentiate between general and
     limited partners, the Act requires a greater level of documentation and registration then is required
                                                  28
     when creating an ordinary partnership including the registration of a limited partnership agreement.
     In fact, if limited liability is to be attained, complying with the registration requirements is critical.

     a)      What is a General Partner?

             All of the Acts state that a limited partnership shall consist of one or more general partners
                                                  29
             and one or more limited partners. Subject to certain provisions a general partner has the
                                                                                    30
             same rights and obligations as a partner in an ordinary partnership. The general partners
             role in the limited partnership is defined to a large extent by the restrictions imposed by the
             Act on the participation in the partnership business by limited partners. Essentially the
             general partner is responsible for conducting all of the day to day activity of the partnership
             business.

     b)      What is a Limited Partner?

             The term silent partner is often used to describe someone who contributes assets to a
             business in exchange for a share of profits but who takes no active part in the operation of
             the business. A limited partner, as defined by the Partnership Act is basically a silent partner.
             Limited partners are entitled to:

             
                                                                                       31
                      contribute cash and other property to the limited partnership

             
                                                                                                   32
                      to inspect documents and financial records of the partnership business

             
                                                                                                   33
                      to obtain a court order dissolving and winding up the limited partnership

             
                                                             34
                      to share in profits by way of income




28
     R.S.A. ss.49, 51, 61(1)(c), 64, 65(4), 65(5), 66(a), 68, 69, 70, 71, 72, 73, 77
     B.C. ss.48, 51, 62(1)(c), 65, 66(4), 67(A), 69, 70, 71, 72, 73, 74, 78
     N.S. c.259
     O.N. c.L-16
29
     R.S.A. s.50(2); B.C. s.50(2); N.S. c.259 s.4(2); O.N. c.L-16 s.2(2).
30
     R.S.A. s.55; B.C. s.56; N.S. c.259 s.9; O.N. c.L-16 s.8.
31
     R.S.A. s.54(1); B.C. s.55(1); N.S. c.259, s.9; O.N. c.L-16, s.12.
32
     R.S.A., s.57(a)(b); B.C. ,ss.58(1)(a), (b); N.S., c.259, ss.11(a), (b); O.N. c.L-16 s.10.
33
     R.S.A., s.57(c); B.C., s.58(1)(c); N.S., c.259 s.11(c); O.N., c. L-16 ss. 10(1)(c), 14(4).
34
     R.S.A., s.58(1)(a); B.C., s.59(z); N.S., c.259 s.12(2); O.N. c. L-16 ss.11(1)(a), 14(1)(b).
                                                   17

             
                                                                                      35
                      to have their limited partnership contribution returned

                     lend money to the limited partnership

             
                                            36
                      assign his interest

             Limited partners are not entitled to:

             
                                                                            37
                      have their name appear as part of the firm name

             
                                                                                                               38
                      contribute services to the partnership business, or hold land on behalf of the firm

             
                                                                                 39
                      take any partnership property as security for a loan

             
                                                                                 40
                      take part in the control of the partnership business

             The restrictions placed on the participation of limited partners in the operation of the
             partnership business make it clear that the role of the limited partner is one of providing
                                                                                                         41
             financing to the partnership in exchange for participation in profits and limited liability. This
             type of partnership is suitable when one or more partners do not wish to take part in the
             control or management of the business.

     c)      For what purposes may a limited partnership be formed?

             A limited partnership can be formed for any purposes for which an ordinary partnership could
             be formed.

     d)      What is the scope of the liability of a general partner?

             The general partner within a limited partnership incurs the same liability that he would in an
             ordinary partnership. He is bound by authorized acts of the firm. He is jointly liable with the
             other partners for the debts and obligations of the firm incurred while he is a partner, and he
             is jointly and severally liable for the liabilities of the firm resulting from the misfeasance or
             nonfeasance of a partner acting in the ordinary course of the firms business, or from the
             misapplication of money received by the firm.

     e)      What is the scope of the liability of a limited partner?

             As a general rule a limited partner is not liable for the obligations of the firm above the level of
             his capital contribution. This is analogous to shareholder liability, but limited liability may be

35
     R.S.A., s.59; B.C., ss.59(1)(b), 62; N.S., c.259 ss.12(1)(b), 15; O.N., c.L-16 ss. 11(1)(b), 14(1)(a).
36
     R.S.A., s.65; B.C., s.66; N.S., c.259 s.19; O.N., c.L-16 s.18.
37
     R.S.A., s.53; B.C., s.53; N.S., c.259 s.7; O.N., c.L-16 s.6.
38
     R.S.A., s.59; B.C., s.60; N.S., c.259 s.7; O.N., c.L-16 s.6.
39
     R.S.A., s.59(a); B.C., s.60; N.S., c.259 s.13(a); O.N., c.L-16 s.13.
40
     R.S.A., s.63; B.C., s.64; N.S., c.259 s.18; O.N., c.L-16 s.13.
41
     R.S.A., s.63; B.C., s.64; N.S., c.259 s.18; O.N., c.241 s.12 c.L-16 s.14.
                                           18

     lost (e.g. if the limited partner uses his surname in the firm name, takes part in control of the
     business, or there are false statements in the certificate of limited partnership).

f)   Who conducts the business of a limited partnership?

     The general partners conduct the business of the partnership. A limited partner becomes
     liable as a general partner if he takes part in the control of the business under the Act. There
     is also a prohibition against limited partners contributing services to the partnership. When
     considering this prohibition, keep in mind that a person may be a general partner and a
     limited partner at the same time.

g)   Can a limited partner bind the partnership?

     The answer is yes. Each partner is an agent of the firm, and the general law of agency
     applies. The act of a partner in carrying on in the usual way the business of the firm binds the
     firm unless (1) the partner acting has no authority (express, implied, actual, apparent), and
     (2) the third party knows that the partner has no authority or does not know or believe him to
     be a partner.

h)   When does a limited partnership have to file and record the certificate of limited
     partnership?

     The limited partnership is not formed until the certificate is filed and recorded.

i)   What is the consequence of a false statement in a certificate of limited partnership?

     A limited partner will lose his limited liability, if the limited partner knew of the false statements
     and did not act to amend the certificate.

j)   What restrictions are there on the withdrawal of capital by limited partners?

     A limited partner is not entitled to a return of his contribution unless there is sufficient property
     left in the firm to cover liabilities to outside creditors, all partners consent, and the certificate
     filed at corporate registry is amended to reflect the reduced capital balance.

k)   What are the statutory rights of limited partners?

     A limited partners rights include:

             the right to inspect the books
             the right to an account of the firms affairs
             the right to a judicial dissolution of the partnership
             the right to share in the profits
             the right to return of his contribution
             the right to assign his interest

l)   When is a limited partnership dissolved?

     A limited partnership is dissolved by the retirement, death or mental incompetence of a
     general partner, unless the business is continued pursuant to a right to do so stated in the
     certificate or with the consent of all the remaining partners. In addition, acts of dissolution
     applicable to ordinary partnerships apply (e.g. where notice is given, or there is a court order).

m)   What are the liabilities of general partners to account in a limited partnership?
                                                  19

                     Each partner must render true accounts and full information of all things affecting the
                      partnership to any partner
                     Each partner must also account to the firm for all benefits derived by him from any
                      transaction concerning the partnership or by use of the partnership property.

             Tax Issues

             A limited partnership can be an attractive vehicle to investors for tax purposes. For example,
             if a partnership shows a loss (which is common in the first few years of business), each
             partner is allocated their proportionate share of the loss. There are special rules in the
             Income Tax Act dealing with limited partners in this situation . The at risk rules stipulate
             that a limited partner can only write off (deduct) the amount that the partner is at risk for
             (i.e.: the amount they invested). This is to prevent the partnership from flowing through all of
             its losses to a partner who could then claim the losses and significantly reduce his/her tax
             liability.

             For example, if a limited partnership were to borrow money, the general partner(s) would be
             liable for the full amount of the loan if the bank were to call the loan. The limited partner(s)
             would only be responsible for the amount of their equity contribution. In the same way, if the
             limited partnership has a loss, the limited partner(s) would only be able to deduct from
             income the amount invested in the partnership.

             The rules do allow the excess amount that a partner is not allowed to deduct in a particular
             year to be carried forward. This is desirable, particularly when the partnership starts making
             money. The partner will still have some losses from the partnership that he/she can deduct
             from their income.

             These at risk rules only apply to limited partners. Limited Partner is defined as a partner
             whose obligations or liability is limited at law and for tax purposes, includes any partner who
             is entitled to receive a benefit, proceeds of disposition, etc. or anything that limits the loss of
             the limited partner. In effect, this broad definition can deem a general partner to be a limited
             partner for tax purposes.

b.   IDENTIFYING A PARTNERSHIP RELATIONSHIP

     Example Problem:

     Wade is currently considering starting a business that will either purchase or acquire on consignment
     Canadian art for export and sale in Japan. A business associate in Japan will be responsible for sales
     there. Wade has already determined that a substantial market exists for such art, and has
     investigated the export/import requirements of the respective countries.

     Currently, the proposed business arrangement is merely based on discussions between Wade and
     his associate. Both Wade and his associate will share costs and profits from the business equally.
     The initial overhead costs, aside from the cost of the art, will be minimal, since they are using Wades
     garage and need not rent any space for the storage and packaging of the product before export.
     However at some future time they plan to lease space in both countries.

     Both Wade and his associate will start the business with an equal amount of capital, which will be
     used either to purchase art work, or as a deposit for consignment sales. Both Wade and his associate
     will be making contracts with specific Canadian artists to purchase art for the business.

     Required:

     Advise Wade about whether the proposed business is a partnership.
                                                  20


     Solution:

     A partnership arises automatically by the operation of law whenever two or more persons engage in
     business together with a view to a profit. The Partnership Acts provides that a partnership means
     the relationship that subsists between persons (whether individuals or corporations) carrying on
     business with a view to a profit. Once this relationship exists, the persons are considered to be
     partners by law and their business relationship is subject to the Partnership Act. The relationship will
     subsist as long as the partners remain in business together and the partnership will not dissolve until
     the death, retirement insolvency or bankruptcy of any partner, unless a partnership agreement
     dictates other dissolution terms.

     If the proposed venture proceeds according to its current plan, a partnership relationship would exist
     between Wade and his associate. Clearly, they are both carrying on business with a view to a profit.

c.   HOW WILL THE PARTNERSHIP ACT IMPACT ON THE BUSINESS DEAL BETWEEN THE
     PARTNERS?

     The Partnership Acts governs the formation and operation of partnerships. The determination of
     whether there is a partnership is based on all the facts of the situation, and a partnership can exist
     without the partners ever having given any thought to whether they want to operate in that form.
     Where there is a partnership but no partnership agreement, the Act will govern the relationship
     between the partners. In most cases it is desirable to have an agreement to govern the relationship.

     Example Problem:

     Mary wishes to start a business in which she has most of the management control. In fact she has
     told her partner Pat that he would not be involved in running the business and has also told him he
     would have no responsibilities or liabilities. The purpose of the arrangement is to use Pats name for
     credit purposes only. In return Pat is to receive 10% of the profits and would be consulted about some
     of the management decisions.

     Required:

     Outline for Mary what provisions of the Partnership Act will impact on her arrangement with Pat and
     what steps she should take if any to change this. Also indicate what provisions of the Act she cannot
     alter.

     Solution:

     Mary has misled Pat and herself about the respective rights and obligations which they will assume in
     this business deal. This arrangement clearly appears to be a partnership. As such each partner is an
     agent or representative of the partnership and of the other partners for the purpose of the business.
     Any contracts, agreements or other obligations entered into by one partner in connection with the
     partnership business bind each of the other parties. Each partner is jointly and severally liable for all
     debts and obligations of the partnership while he is a partner. This means that all the partners can be
     held responsible for all debts and obligations incurred in the name of the business by one partner.
     Each partner is also jointly and severally liable for any loss or injury caused to a non-partner by the
     wrongful act or omission of any partner in the ordinary course of the partnership business.

     Subject to an agreement to the contrary, all the partners are entitled to share equally in the capital and
     profits of the business and must contribute equally to losses sustained by the firm. Each partner may
     also take part in the management of the firm subject to any contrary agreement.

     Therefore, when entering this arrangement it is advisable to enter into a partnership agreement which
                                                   21

     clearly outlines the arrangement so that future problems or disagreements can be avoided by
     reference to it. The partnership agreement should cover:

                      objectives of the partnership
                      date of business commencement
                      amount of investment to be contributed by each partner and form of investment
                      how profits and losses are shared
                      duties and participation of the partners
                      provisions in the event of death or retirement of a partner
                      duration of the agreement
                      special conditions
                      dissolution of the partnership

     Pat should also be advised that if a partnership exists, his liability to third parties will not be limited.
     The parties may want to consider a limited partnership arrangement.

d.   IS THE PARTNERSHIP AGREEMENT ADEQUATE?

              Example Problem:

     Pat and Edmond have started a Pet Care service which involves babysitting family pets while their
     owners are on vacation. They feel they are equal partners and have the following agreement to
     govern their relationship for the next six months.
                                                     22




                                                  PET CARE

                                           Partnership Agreement
Partners
                 Edmond Radu & Pat Smith

The following agreement will be upheld by the above partners in regards to the establishment and operation of
Pet Care. It will be valid for a period of six months from the date it is signed, after which it may extended or
renegotiated.

Definition of Titles and Partnership

Both partners will be senior partners, however, for public relation purposes, the following titles will appear

                 President:      Edmond Radu
                 Vice-President: Pat Smith

It is understood that these titles will have no bearing upon division of duties, decision making and operation of
Pet Care as a whole; they are figurehead titles only.

All administrative duties and decision-making in the operation of Pet Care will be divided equally among the
senior partners whenever possible.

Accounting

Monies obtained from clients or loans are to be deposited into an established bank account in the name of Pet
Care. This account is to be used strictly for business purposes. Accounting will be done at the end of each
month.

Profit Sharing

The senior partners will share an equal percentage of monthly profits. This shall constitute the senior partners
salary. Exact division of profits with respect to junior partners and investors will be agreed upon by the senior
partners at a later date. In the event of losses, the senior partners agree to assume equal responsibility.

We, the undersigned have read and agreed to abide by the terms within this partnership declaration.


        Edmond Radu                        Pat Smith
        President                          Vice-President

        Dated this      day of          , 1995
                                               23

Required:

Advise Pat and Edmond whether this agreement is adequate and how it might be improved.

Solution:

As noted earlier, a partnership agreement is not required for there to be a partnership. Therefore, this
analysis is based on the assumption that you want a partnership agreement to govern the relationship
in the event of a dispute, and to set out the roles and duties of each of the partners.

You can continue to run the business under your existing agreement if you so desire, in which case
the Partnership Act will govern the relationship only where the agreement is silent. However some of
the following changes could be made to avoid the application of the Act, giving you more control over
the relationship between yourselves and improving the agreement.

The first area of concern is the termination of the partnership. Your agreement says that the
partnership agreement will end six months after it is signed, and that at that date it may be extended
or renegotiated. Whether this agreement comes to an end or not, the partnership itself will not end on
the expiration of six months. Instead, the partnership will end only upon the happening of the events
listed in the Partnership Act. These are: the expiry of a fixed term, the termination of a single
undertaking for which the partnership was formed, one partner giving notice of his intention to dissolve
the partnership, the death of a partner, the bankruptcy of a partner, or a court order declaring the
partnership dissolved. All of these except the last can be removed as events that will terminate the
partnership, by agreement of the partners. Your agreement says nothing about when the partnership
itself is to end, therefore the Act governs, and the occurrence of any of these events will put an end to
the partnership.

One way to improve the agreement would be to put in a clause saying that a partner can give notice
of his intention to dissolve, but the notice will not be effective for a period of time, say six months. This
gives the other partner some time to assess the situation and decide what to do (i.e. whether to carry
on or not, and if so, in what manner). As noted below, however, you may want to eliminate his notice
period in certain circumstances. There is an example of a clause that provides a notice period in
paragraph 2 of the sample agreement.

You may also want to include a clause setting out what other events will result in the dissolution of the
partnership. You could include those mentioned in the Act, and others, such as the mental
incompetence of one of the partners. Or, the events mentioned in the Act can be made events which
give the other partner the option to dissolve. There is an example of this in clauses 13(c) and (d) of
the sample I have provided you with.

To provide for dispute resolution, various means can be employed. The easiest way would be by a
vote and allow the majority to rule. This is the means provided in the Act, as mentioned above. Where
there are two partners, this is usually not going to help. If your agreement is silent as to dispute
resolution, the majority vote method will be in effect, so you should consider other options. One
method is to give one partner a casting vote. The effect of this will be to allow that partner to run the
business as they choose, so this might not be a good option for you. Another option is to have a
clause providing for the dissolution of the partnership at the option of either partner. When there is a
dispute, the partners will either resolve it or dissolve the partnership. For example, if partner A wants
to expand the business into a new area, and partner B is strongly opposed to the idea, partner B can
simply give notice that the partnership is dissolved. Partner A is then free to enter the new area of
business, but without partner Bs share of the partnership assets. This way, neither partner is forced
into doing something that they do not want to do. If you want to use the dissolution clauses as a
means of dispute resolution, you may want to eliminate the notice period for dissolution that was
mentioned above.
Another way to prevent one partner from being forced into a business they do not want to enter is to
                                               24

put in a clause which restricts what the business of the partnership will be. An example of this is found
in the recitals (Whereas... and in paragraph 3 of the sample agreement). Any change in the
business will then require appropriate approval in order to change the partnership agreement recitals.
The parties may require unanimous approval in their agreement.

An alternative method of resolving disputes is to have an arbitration clause. You could put a clause in
your partnership agreement that in the event of a dispute, an independent arbitrator will be appointed
to resolve the dispute. Both partners would have to agree to be bound by the decision of the
arbitrator. I have included a sample of what an arbitration clause looks like, in paragraph 17 of the
sample agreement.

You should note that arbitration can be an expensive means of resolving disputes. You probably do
not want to use it as a means of dispute resolution for that reason alone. It may be an option for you
to consider in the future when you are less concerned with expense and more with resolution of a
dispute without dissolving the partnership. I include it simply because it is the method used in the
sample agreement.

The important thing to understand about dispute resolution in a partnership is that a partnership is a
consensual relationship between individuals and that therefore any dispute that cannot be resolved
will (and should) lead to the end of the relationship. So if you reach an impasse, you are probably best
off to end the relationship.

The next matter to address in a partnership agreement is what happens on dissolution. The
Partnership Act says that losses are to be paid first out of profits, then out of capital, and lastly by the
partners in proportions equal to the share of profits they were entitled to. In other words, when the
losses exceed the amount of assets in the partnership, the partners are personally responsible for the
difference. Assets remaining after losses are applied first to paying the debts and liabilities of the firm,
second to repaying advances to partners (as opposed to capital contributions), and third to repaying
capital to the partners. Any residue is paid to the partners in the proportions in which profits are
divisible.

All of these rules are subject to any agreement between the partners, so you could agree, for
example, that upon dissolution each partner will recover all of the assets that he or she put in (for
example, a computer). If the Act were allowed to govern the process upon dissolution, it may be that
the computer would end up being taken by a partner who did not contribute it to the partnership, or
sold to pay off liabilities of the partnership. This is because the Act requires that all assets are split
equally after liabilities are paid. If the computer is the only asset and there is a debt equal to its value,
then it must be sold to discharge the debt (unless the partners agree otherwise). Where there are
assets remaining after the liabilities are paid, one partner still might get something out that they did not
put in, as may be the case where most of the assets were contributed by one partner. An example of
how partners can agree to oust the application of these rules in the Partnership Act is in paragraph
12.

Note that paragraph 12 refers to paragraphs 10 and 11, which provide for a buy-out of the interest of
a retiring partner. You could agree to some type of arrangement like this if you choose. The effect is
that when a partner leaves (i.e. the partnership is to be dissolved), the partner who remains (the
survivor in the event of the death of a partner, etc.) can continue on in the partnership by purchasing
the interest of the retiring partner. Where there is not such arrangement, the partnership is dissolved
and a new one can be formed by the remaining partner.

Note also that there is no way to shield the partners from the ultimate responsibility for debts
outstanding after the assets of the partnership are exhausted. As noted earlier, the fundamental point
to understand about a partnership is that the partners are personally liable for its obligations.

You can also eliminate the distinction in the Act between advances and capital. A capital contribution
is a debt owed to a partner by the firm which gives the partner a larger share of the profits. For
                                                     25

     example, when you formed the partnership, you each may have contributed some equipment or cash
     to get started. It may be that the contributions were equal or roughly equal, and you may therefore
     have decided that the two of you would split profits equally. That initial contribution was therefore a
     contribution of capital. An advance, on the other hand, is a debt to a partner owed by the partnership
     for the contribution by a partner that does not give that partner a larger share of the profits. If one of
     you now decided to contribute something else to the business, it would either give you a larger share
     of the profits or it would not. In the latter case, you would still get your half share of the profits, but the
     partnership would owe you a debt. In that case it is an advance. If it gave you a larger share of the
     profits, it is a capital contribution.

     By eliminating the distinction between capital and advances, you can ensure that the division of
     partnership assets is more predictable, in particular by ensuring that certain contributions are
     recovered by the partner that put them into the partnership.

     Many of the remaining provisions of the sample agreement could be put into your agreement, if you
     so desire. You may want to read through the agreement and use it as a checklist of areas that you
     want addressed in your own agreement. For example, do you want to require that the partners devote
     their full time and energy to the partnership business (paragraph 14)? Or do you want to regulate
     draws made by the partners from the partnership accounts (paragraph 15)? These and other matters
     can be regulated by their inclusion in an agreement.

e.   CAN PARTNERS INCORPORATE?

     The partnership relationship can be entered into by individuals, by an individual(s) and a corporation
     or by two or more corporations. There are no provisions in the Partnership Act that would determine
     whether or not individuals can incorporate and carry on business through a partnership, although
     some provinces will not allow certain professionals to incorporate to carry on their profession (i.e.
     doctors and lawyers).

     Members of a partnership might also decide that instead of carrying on business through a
     partnership they would like to change to a corporate format. This transition can be expensive from a
     tax perspective unless the appropriate steps are followed.

     Example Problem:

     Miriam and Ruth have operated Summerfield Tours for four years as a partnership, and filed income
     tax returns on that basis. There is no written partnership agreement. Various assets were purchased
     by both partners on behalf of the partnership including land, a building and equipment. These assets
     were not expenses completely in the then current tax year since they remained in existence for more
     than one year. The assets qualify as capital assets for income tax purposes and have an adjusted
     cost base. These assets have also increased in value and depreciation has been claimed on the
     building and equipment. The partners are now considering carrying on their business through a
     corporation.

     Required:

     Generally outline for Miriam and Ruth what will happen to their partnership if they decide to
     incorporate now and any steps they should take.

     Solution:

     On incorporation there is a dissolution of the partnership which would result in a deemed disposition
     or sale of the partnership assets and of each partnership interest at fair market value. This will have
     serious tax consequences unless an election is made under the roll-over provisions of the Income Tax
     Act.
                                                  26

     You can dissolve the partnership and elect to rollover the capital assets into the corporation under s.
     85(2) on a tax free basis and rollover the partnership interests into the corporation by filing the form
     required by Canada Customs & Revenue Agency. Goodwill for the partnership should be rolled in at a
     nominal amount of $1. All other capital assets belonging to the partnership should be rolled in at their
     tax cost if no tax is to be paid on the dissolution.

     In order to qualify for a tax free roll-over, shares must be issued as consideration for the assets rolled
     in Under the Provincial Business Corporations Acts the shares must be fully paid for in money,
     property or services before they are issued.

f.   IDENTIFYING A GENERAL PARTNER (IN A LIMITED PARTNERSHIP)

     Example Problem:

     Wade and Cathy would like to start a new game show, called Guess the Business Format. Wade
     will be primarily responsible for the show but has collected money for an interest in the Venture. Cathy
     B. has insisted that even if she is not in direct management that she have the right to veto any
     decisions Wade makes and that the show be called the Cathy B and Wade Show. Notwithstanding
     this she hopes to avoid all liability and remain a limited partner.

     Required:

     Indicate whether Cathy would be considered a limited partner in the new business.

     Solution:

     A limited partnership, like an ordinary partnership, is governed by the provisions of the Act and the
     rules of equity and common law which are not inconsistent with the Act.

     A limited partnership consists of one or more persons who are general partners and one or more
     persons who are limited partners. The limited partnership has the same characteristics of an ordinary
     partnership except for the very significant difference that it is only the general partners who are fully
     liable for all of the obligations of the partnership. The limited partners have limited liability which is
     limited to the amount they have invested or agreed to invest in the partnership.

     There are provisions in the Act whereby a limited partner may become liable in the same respect as a
     general partner. If the surname of a limited partner appears in the firm name, a limited partner will
     become liable to any creditor unless the creditor had actual notice that he or she was not a general
     partner. B, is a short surname, but if that is Cathys surname, liability will result. A limited partner
     will become liable as a general partner where, in addition to exercising his rights and powers as a
     limited partner, he or she takes part in the control of the business. The veto power is an example of
     clear control.

     Essentially, the sole function of a limited partner is to contribute cash or other property to the
     partnership. In this regard, the limited partner is primarily an interested investor.

g.   APPENDICES

             1.       Partnership Agreement Check List
             2.       Sample Partnership Agreement
             3.       Declaration of Partnership
                                        27

                                    APPENDIX 1

                    PARTNERSHIP AGREEMENT CHECK LIST


1.    Date
2.    Description of partners
3.    Firm name
4.    Term of partnership
5.    Place of business
6.    Description of business
7.    Percentage or amount of contribution to capital
8.    Division of profits
9.    Accounting and other records
10.   Fiscal year
11.   Auditors
12.   Accounting practices
13.   Banking arrangements
14.   Restrict partners for guarantees, etc.
15.   Partners to devote full time
16.   Management
17.   Partnership contracts
18.   Drawing arrangements
19.   Retirement or death of partner
20.   Non-competition clause
21.   Sale of interest to outsider
22.   Expulsion of partner
23.   Grounds for dissolution
24.   Admission of new partner
25.   Obligation or option to purchase
26.   Valuation of partnership interest
27.   Partnership property
28.   Insurance
29.   Arbitration of disputes
30.   Registration
31.   Amendments
32.   Applicable law
33.   Inurement
34.   No assignment
35.   Notices
36.   Counterparts
37.   Signed and sealed
                                                     28

                                                 APPENDIX 2

                                       PARTNERSHIP AGREEMENT

THIS AGREEMENT made in duplicate this_________day of___________, 19______,

BETWEEN:
                  ________________, of the City of
                 Calgary in the Province of Alberta
                 (hereinafter referred to as _________ )
                                                                              OF THE FIRST PART

AND:              _________________of the City of
                 Calgary in the Province of Alberta
                 (hereinafter referred to as _________ )
                                                                              OF THE SECOND PART

WHEREAS___________________________________________________________________________ and
____________________________________have decided to enter into a partnership for the purpose of
carrying on the business of [             ] and all other businesses which can be carried on expediently or
incidentally in connection with such business.

NOW THEREFORE THIS AGREEMENT WITNESSES that in consideration of the mutual covenants and
agreements herein contained the parties hereto agree as follows:

1.      To enter into partnership effective as of the 1st day of________, upon and subject to the terms,
        conditions and stipulations set forth in this Agreement.

2.      Subject to the provisions herein contained, the partnership shall continue until either partner notifies
        the other partner in writing that he is terminating the partnership and the partnership shall terminate at
        the expiration of six(6) months after the giving of such notice provided that with the consent in writing
        of both the partners the partnership may be terminated without notice and on such date as may be
        specified in such consent.

3.      The name of the partnership shall be_________ and the business of the partnership shall be that of
        [_______ ] and all other businesses which can be carried on expediently or incidentally in connection
        with such business.

4.      The bankers of the partnership shall be_______________ in the City of Calgary, in the Province of
        Alberta or such other bank or banks as the partners shall from time to time agree upon. All cheques,
        drafts and other instruments and documents on behalf of the partnership shall be signed by (and only
        by) both the partners or by such persons as are from time to time designated in writing by both the
        partners. All partnership money shall as and when received be paid and deposited with the bankers of
        the partnership to the credit of the partnership account.

5.      It is agreed that:

        a)       If at any time hereafter and from time to time capital and/or further capital is required for
                 carrying on the business of the partnership such capital shall be advanced by the partners in
                 equal shares provided and it is understood that if any partner shall with the consent of the
                 other partners bring in additional capital or leave any part of his profits in the business the
                 same shall be considered a debt due to him from the partnership and shall bear interest at
                 the rate of _____% per annum but the same shall not be drawn out except upon giving sixty
                 (60) days written notice; and he shall be bound to draw out the same on a like notice given to
                 him by the other partner and at the expiration of such period interest shall cease to be
                 payable thereon. Subject to the foregoing any and all capital of the partnership from time to
                                                    29

              time belongs in equal shares to the partners;

      b)      The profits of the partnership shall be divided equally between the partners; and

      c)      The expenses and losses of the partnership in any one partnership year shall in the first
              place be paid out of the earnings of the partnership for that year and if such earnings shall be
              insufficient to pay all expenses and losses as aforesaid the deficiency shall, unless otherwise
              agree, be made up by the partners equally.

6.    It is agreed that the end of the period commencing at the date hereof and continuing up to and
      including the______ , and at the end of each partnership year thereafter terminating on the _____or
      such other chartered accountant or firm of chartered accountants as approved by the partners from
      time to time (herein referred to as the Auditor) shall forthwith make an examination of the financial
      statements of the partnership as prepared by the partners and shall make a report to the partners on
      the financial statements and shall state in the report whether in the Auditors opinion the financial
      statements referred to therein presents fairly the financial position of the partnership. For such
      purpose the Auditor shall have access to all books of account and records and all vouchers, cheques,
      papers and documents of or which may relate to the partnership business. A copy of such report shall
      be furnished forthwith upon its preparation to each partner who shall be bound thereby unless one of
      the partners objects and notice thereof is given to the Auditor who prepared the same within thirty (30)
      days after the furnishing of a copy thereof as aforesaid, in which case the Auditor shall reconsider the
      report and revise the same if the Auditor considers it necessary to do so provided that the Auditor
      shall have the sole and final decision as to whether any revision is necessary. Immediately after the
      aforesaid period of thirty (30) days or immediately after the revision of the report by the auditor or
      immediately after the Auditor has advised the objecting partner that he considers no revision is
      necessary as the case may be the net profits, if any, shown by the profit and loss account as modified
      by the Auditors report if such is the case shall, unless the partners otherwise agree, be divided
      equally between the partners.

7.    If at any time either of the partners is required to pay or become personally liable for more than his
      proportion of the partnership debts as provided for in subparagraph (c) 5, such partner shall have as
      against the other partner a right of recovery of the appropriate proportion of such payment or
      indemnification against such liability and the partner shall have on becoming liable for such debt a first
      lien or charge on the capital and all other interest or interest of the offending partner in the partnership
      business.

8.    Neither partner shall without the previous consent in writing of the other assign or encumber his share
      or interest in the partnership.

9.    Each of the partners shall at all times duly and punctually pay and discharge his separate debts,
      liabilities, obligations, duties and agreements whether present or future and keep indemnified and
      save harmless the partnership property and the other partner and his estate and effects from all
      actions, proceedings, costs, claims and demands of every nature or kind whatsoever.

10.   Unless otherwise agreed, upon the dissolution of the partnership pursuant to paragraph 13 hereof or
      upon the termination of the partnership pursuant to paragraph 2 hereof the Surviving Partner
      (Surviving Partner as used in this Agreement means the partner to whom notice of termination is
      given under paragraph 2 hereof; the partner living or of sound mind under subparagraph 2 hereof; the
      partner living or of sound mind under subparagraphs (a) and (b) of paragraph 13 hereof; or the
      partner who elects to terminate the partnership under sub-paragraphs (c) and (d) of paragraph 13
      hereof and Retiring Partner as used in this Agreement means the person who gives notice of
      termination under paragraph 2 hereof; the personal representatives or the committee of the partner
      who has died or has become a mental incompetent under sub-paragraphs (a) and (b) of paragraph 13
      hereof; or the partner who received notice of termination under subparagraphs (c) and (d) of
      paragraph 13 hereto shall have the right to purchase the share of the Retiring Partner in the capital
      assets of the business on the following terms and conditions:
                                                    30


      a)      The Auditor for the partnership shall forthwith upon such termination or dissolution make an
              examination of the financial statement of the partnership as prepared by the Surviving
              Partner made up to the date of such dissolution or termination and shall make a report on
              such financial statement of the same nature as provided for in paragraph 6 hereof and shall
              determine the value of the share of the Retiring Partner which shall be one half of the amount
              at which the net assets of the partnership shall stand in the balance sheet (excluding
              therefrom the net profits of the partnership up to and including the date of termination or
              dissolution which net profit shall be divided equally between the partners or their legal
              representatives as the case may be) of the partnership as modified by the Auditors report if
              such is the case as at the date of termination or dissolution and in preparing his report the
              Auditor shall have regard to and make all proper and necessary allowances in respect of
              depreciation, actually or reasonable estimated profits and losses on transactions which have
              been partially or entirely completed but in connection with which the profits and losses have
              not been carried into the books of the partnership and contingent or other reserves but shall
              make no allowance for goodwill. In preparing such report the value which shall be attributed
              to the fixed and other assets (excluding goodwill) of the partnership shall be as may be
              agreed upon by the partners (including the personal representatives of a deceased partner or
              the committee of a mentally incompetent partner or the retiring partner as the case may be)
              or failing such agreement shall be as determined by the Auditor, provided that the Auditor
              shall have the right to retain an appraiser at the expense of the partnership to assist him in
              making such valuation if he so desires. The valuation of the Auditor shall be final and
              conclusive. The value of the share of the Retiring Partner so determined by the Auditor shall
              be the amount of the purchase price of the share and shall be conclusive and binding upon
              the Surviving Partner and the Retiring Partner;

      b)      The amount of the purchase price of the share of the Retiring Partner as calculated shall be
              paid to the Retiring Partner as follows: twenty-five percent (25%) thereof shall be paid within
              ninety (90) days after the preparation of the Auditors report referred to in sub-paragraph (a)
              of this paragraph and the balance shall be paid in equal instalments at the expiration of one
              (1) year, two (2) years and three (3) years from the expiration of the period of ninety (90)
              days; provided however that the whole or any part of the purchase price remaining unpaid
              may be paid at any time without notice or bonus; the purchase price shall not bear interest
              upon the portion thereof remaining unpaid from time to time;

      c)      the Surviving Partner shall also enter into a covenant to indemnify the Retiring Partner
              against the debts, engagements and liabilities of the partnership both existing and future; and

      d)      upon all of the aforementioned payments being made and the covenant to indemnify having
              been given, the Retiring Partner shall execute and do all acts, matters and things necessary
              or proper for vesting the share of the Retiring Partner in the Surviving partner and enabling
              the Surviving Partner to recover and get in the outstanding assets of the partnership.

11.   In the event that the Surviving Partner elects not to purchase the share of the Retiring Partner he shall
      give notice in writing of such election to the Retiring Partner within sixty (60) days after the preparation
      of the Auditors Report referred to in sub-paragraph (a) of paragraph 10 and in that case the Retiring
      Partner shall have the right, upon electing to do so within sixty (60) days, to acquire the interest of the
      other partner in the partnership upon the same terms and conditions and for the same consideration
      as set forth in paragraph 10 hereof.

12.   a)      If the partnership is dissolved or terminated and neither the Surviving Partner nor the Retiring
              Partner elects to purchase the assets from the other partner within the periods and upon the
              terms and conditions provided for herein and if no other arrangement is made the assets of
              the partnership shall be realized and the Auditor shall forthwith prepare a report on the
              financial statements as prepared by the Surviving Partner made up to the date of the
              realization of the last of the assets of the partnership. The assets so realized shall then be
                                                   31

              applied first on the payment of the debts and liabilities of the partnership including any and all
              contributed capital which constitutes a debt pursuant to sub-paragraph (a) of paragraph 5 of
              this Agreement (second for payment to each of the partners of the amount of his capital, if
              any, in the partnership) and the surplus of the assets so realized, if any, shall be divided
              equally between the partners. The value of the share of each partner so determined by the
              aforesaid financial statements as modified by the Auditors Report if such is the case shall
              be conclusive and binding upon the parties hereto and their personal representatives.

      b)      Notwithstanding anything in this Agreement if both the Retiring Partner and the Continuing
              Partner notify the Auditor within sixty (60) days of the termination or dissolution of the
              partnership that they do not wish to exercise the respective rights given to them by
              paragraphs 10 and 11 hereof then the Auditor shall proceed forthwith after the realization of
              the assets to prepare a report as provided for in paragraph 12 hereof without proceeding to
              prepare the Auditors Report required by paragraphs 10 and 11 hereof.

13.   Subject to any and all subsequent agreements to the contrary this partnership shall dissolve on the
      date of the happening of any one of the following events:

      a)      upon the death of either of the partners;

      b)      if either of the partners become of unsound mind or be found by any court or competent
              jurisdiction to be mentally incompetent;

      c)      at the option and in the sole discretion of a partner upon the violation of paragraph 3 hereof
              by the other partner; or

      d)      at the option and in the sole discretion of a partner upon the insolvency or bankruptcy of the
              other partner.

      In the event of termination pursuant of sub-paragraphs (c) and (d) hereof the date of termination shall
      be the date upon which notice is given of the election to terminate.

14.   The partners agree to devote their full time and energy during normal working hours to the business
      of the partnership.

15.   Each partner may draw on account of his profits such amount or amounts as may be agreed upon by
      the partners from time to time but if at the periodical taking of accounts herein referred to either
      partner has drawn out during the past year a sum exceeding the profits to which he is entitled he shall
      repay the excess to the partnership.

16.   Proper accounts shall be kept in books of all partnership transactions and such books, together with
      all other documents connected with the partnership business, shall be kept at the principal place of
      business and accessible to each partner.

17.   All differences or disputes which arise between the partners or between either of them and the
      personal representatives or committees of the other of them or between the personal representatives
      and committees of the partners and whether during or after the termination of the partnership and
      whether in relation to the interpretation of this Agreement or to any act or omission of any party to the
      dispute or to any act which ought to be done by the parties in dispute or in relation to any other matter
      whatsoever touching the partnership affairs shall be referred to a single arbitrator to be agreed upon
      by the parties to the dispute and in default of agreement to a single arbitrator appointed by the court
      under the provisions of The Arbitration Act of Alberta. The award of determination which shall be
      made by such arbitrator shall be final and binding upon the partners hereto, their heirs, executors,
      administrators, assigns and committees and there shall be no appeal from such award of
      determination, provided however that in any and all cases where the Auditor exercises any discretion
      exercisable by him under this Agreement such decision shall be final and binding upon the parties and
                                                   32

       their personal representatives or committees and shall not be subject to the arbitration provisions
       provided for herein.

18.    Any notice required or permitted to be given hereunder to either partner or the personal representative
       or committees of either partner shall be in writing and shall be given by prepaid registered letter
       addressed to____________at__________, Alberta or by delivering the same to_______________,
       his personal representatives or committees, as the case may be, and to_________ at__________ ,
       Alberta or by delivering the same to____________, his personal representative or committee, as the
       case may be.


IN WITNESS WHEREOF the parties hereunto set their hands and seals this_____day of_______________,
19___.

SIGNED, SEALED AND DELIVERED
in the presence of

                                                 _______________________________

                                                 _______________________________
                                                 33

                                             APPENDIX 3

                                 DECLARATION OF PARTNERSHIP


PROVINCE OF ALBERTA                                     WE,


                                                                     (Print Partners names above)

of the City of________________ , IN the Province of Alberta, HEREBY CERTIFY:

       1.      That we are carrying on or intend to carry on trade and business as__________________ , in
               partnership under the name________________________________________________
                                                                   (Type of Business)

               of______________________________________________________________________
                                                        (Business name)

       2.     That the said partnership has subsisted since the____________day of_____________A.D.
       19____ .

       3.      And that we are and have been since the said day the only members of the said partnership.

               WITNESS OUR HANDS AT________________this _________ day of ____________ A.D.
               19_____ .


                __________________      of _________________________ , _______________________
               (Signature of Partner)               (Address)              (Occupation)


                __________________      of _________________________ , _______________________
               (Signature of Partner)               (Address)              (Occupation)



                __________________      of _________________________ , _______________________
               (Signature of Partner)               (Address)              (Occupation)
                                                 34

C.     CORPORATIONS

The private corporation is one of the most commonly asked about business formats. Although most people
have heard about corporations, and the concept of limited liability. There is a considerable amount of
additional basic information required before a reasoned decision regarding the use of a corporation in a
business venture can be made.

a.     KEY QUESTIONS

       i.       WHAT IS A CORPORATION?

       ii.      WHAT DOES LIMITED, LTD., INC., OR INCORPORATED MEAN?

       iii.     WHAT KINDS OF REGISTRATION SYSTEMS ARE THERE?

       iv.      HOW CAN I BECOME INCORPORATED?

       v.       WHAT IS A SHARE?

       vi.      WHAT ARE SHARES FOR?

       vii.     HOW DOES THE CORPORATION ISSUE SHARES?

       viii.    WHO DECIDES HOW MANY SHARES ARE ISSUED?

       ix.      WHO MAY PURCHASE SHARES IN A CORPORATION?

       x.       WHAT ARE DIVIDENDS? WHEN MUST A DIVIDEND BE PAID?

       xi.      HOW IS SHARE VALUE DETERMINED?

       xii.     WHAT ARE DIRECTORS? WHAT ARE OFFICERS?

       xiii.    HOW ARE DIRECTORS CHOSEN?

       xiv.     WHAT DO DIRECTORS DO?

       xv.      WHAT ARE THE RESPONSIBILITIES AND OBLIGATIONS OF DIRECTORS?

       xvi.     HOW DO DIRECTORS RESIGN? HOW CAN DIRECTORS BE REMOVED?

       xvii.    HOW ARE OFFICERS CHOSEN?

       xviii.   WHAT DO OFFICERS DO?

       xix.     WHAT RESPONSIBILITIES OR OBLIGATIONS DO OFFICERS HAVE?
       xx.      WHEN DO OFFICERS CEASE TO HOLD OFFICE?

       xxi.     WHAT IS A UNANIMOUS SHAREHOLDER AGREEMENT?
                                                  35


     xxii.    CAN MY CORPORATION DO BUSINESS OUTSIDE ALBERTA?

     xxiii.   WHAT IS AN EXTRA-PROVINCIAL REGISTRATION?

     xxiv.    WHEN IS AN EXTRA-PROVINCIAL REGISTRATION REQUIRED?

     xxv.     WHAT HAPPENS IF A CORPORATION DOES NOT REGISTER?

     xxvi.    WHAT IS A FEDERAL CORPORATION?

     xxvii.   WHEN SHOULD I INCORPORATE FEDERALLY?

     xxviii. WILL FEDERAL INCORPORATION GIVE NATIONAL PROTECTION TO MY BUSINESS
             NAME?

     xxix.    IS A FEDERAL CORPORATION EXEMPT FROM EXTRA PROVINCIAL REGISTRATION
              REQUIREMENTS?

     xxx.     WHAT IS A PROFESSIONAL CORPORATION?

     xxxi.    WHO CAN USE A PROFESSIONAL CORPORATION?

     xxxii.   DO PROFESSIONAL CORPORATIONS LIMIT PERSONAL LIABILITY?

     xxxiii. ARE THERE ANY SPECIAL TAX ISSUES WHICH SHOULD BE CONSIDERED?




     i.       WHAT IS A CORPORATION?

              The best short answer to the question of what is a corporation? may be to say that a
              corporation is:

              a.      a type of business organization
              b.      created by legislation
              c.      which allows one or more persons to participate in a business
              d.      without incurring full personal liability for debts and obligations created in the course
                      of doing business.

              A corporation however is usually defined by what it does, rather than by what it is. The
              following characteristics or functions can be said to define the corporation as created under
              most provincial or federal legislation.
                                                                         42
              a.      The corporation functions as a natural person           and has the rights, powers and
                      privileges of a natural person.

              b.      A corporation may be formed by one individual or a group of individuals. A

42
     C.B.C.A.: 15(1); O.B.C.A.: 14(2), 15; B.C.C.A.: 21(1); N.S.C.A. 26(8).
                                                       36
                                                                            43
                           corporation may also form other corporations.

                  c.       Shareholders doing business through a corporation incur only limited liability for loss
                                                                                      44
                           or damage resulting from their lawful business activities.
                                                                                      45
                  d.       A corporation acts through its directors, who are elected by the shareholders. The
                           directors in turn appoint officers, who act with delegated authority on behalf of the
                           corporation.

                  e.       The corporation, having the same capacity as a natural person, may buy and sell,
                           make contracts, own land, is obligated to pay tax under municipal, provincial and
                           federal schemes, and may otherwise acquire all the rights and obligations of a
                           natural person. A corporation is born by way of statutory enactment (issuance of a
                           certificate of incorporation) and dies when it is wound up or discontinued.

          ii.     WHAT DOES LIMITED, LTD., INC., OR INCORPORATED MEAN?

          Often people believe that simply by adding the words Limited or Incorporated to a business
          name you can attain corporation status and limited liability. This unfortunately is not the case.
          Incorporation is required and one of Limited, Ltd., Inc., Incorporated or the appropriate
          French language equivalent must be added to the name which the corporation carries on business
          under if full limited liability is to be achieved.

          Once appropriately registered a corporation is a legal entity distinct and separate from that of its
                          46
          shareholders. Unlike the sole proprietorship or the partnership, where the owners of the business
          bear full personal liability for the debts and obligations of the business, the owners of a corporation
          that is, the shareholders, are liable only to the extent of the value of their shares in the corporation.
          The shareholders are not required to honour the debts of the corporation. Creditors are entitled to
          realize their claims only up to the value of the assets held by the corporation. Consider the following
          examples:


       Name             Business          Personal Assets        Business Assets           Business Obligations

 Mr. A. Smith       Smiths Flowers       $100,000.00            $100,000.00               $250,000.00

 Ms. B. Smith       Smith Steel Ltd.      $100,000.00            $100,000.00               $250,000.00
                                          (100% of shares
                                          in Smith Steel
                                          Ltd.)




     Amount Which Creditors Can             Amounts Still Owing To               Amount Personally Owed by
             Realize                             Creditors                           A. Smith/B. Smith


43
          A.B.C.A.: s.5, 1(n); C.B.C.A.: 5; 5(2); O.B.C.A.: 4(1); B.C.C.A.: 5(1); N.S.C.A.: 9.
44
          C.B.C.A.: 102, pt.10; O.B.C.A.: 92(1); B.C.C.A.; 157(4); pt. 4, Div. . (2) and (3); N.S.C.A.: ---.
45
          S.97(1) pt. 9 generally A.B.C.A.; C.B.C.A.: 20(1).
46
          Salomon v. Salomon & Co: Salomon & Co. v. Salomon [1897] A.C. 22(H.L.).
                                                   37

$200,000.00                         $ 50,000.00                           $ 50,000.00

$100,000.00                         $150,000.00                           $0


      Although Ms. B. has personal assets totaling $100,000, these assets are not available to creditors of
      the business because her business is incorporated. In contrast, the personal assets of Mr. A., who is
      not incorporated, are available to creditors for debts owing by his business.

      Obviously this example does not take into account the impact of debtor protection legislation, which
      may also limit the recovery of Mr. Smiths creditors. However, this example does show how the
      concept of limited liability may be used to reduce the risk of doing business in certain situations. Note
      also that ones personal assets might be threatened in the event that the courts pierce the
      corporate veil or statutory liability.

      iii.    WHAT KINDS OF REGISTRATION SYSTEMS ARE THERE?

      Prior to the 1980's, there were 2 different systems of incorporation in Canada. In most of the Western
      provinces (except Manitoba), Newfoundland and Nova Scotia, incorporation was accomplished
      through the filing of documents entitled the Memorandum of Association and the Articles of
      Association. These provinces were considered registration jurisdictions. If the documents were in
      order, the administrator in charge of registration (often called the Registrar) was bound to register the
      documents and issue a certificate of incorporation. The company was then duly incorporated.

      In the remaining provinces, the individual(s) wanting to incorporate had to apply for a grant of Letters
      Patent of Incorporation. The granting of letters patent, being an act of the executive (cabinet) was
      not automatic. The Minister could invoke his discretion and refuse to grant the letters patent. Most
      provinces operating under letters patent systems have switched over to a registration system, with the
      exception of P.E.I. In addition, the federal government has enacted federal legislation following a
      registration system which will govern if you incorporate as a Canadian company instead of under
      provincial legislation.

      As a result, most Canadian provinces now provide for incorporation through the registration of certain
      documents. In the 1980's however, many of the registration provinces made substantial changes to
      their legislation and enacted corporations legislation, modeled to varying degrees after the Ontario
      Business Corporations Act and the federal Business Corporations Act; these included Alberta,
      Saskatchewan, Manitoba, New Brunswick, and Newfoundland. Other provinces, such as British
      Columbia, and Quebec retained their companies legislation but made substantial changes to reflect a
      system similar to corporations legislation.

      As a result, the following discussion will apply to B.C.A. (Business Corporations Act) provinces and
      generally to Quebec and British Columbia since all operate under a registration system. However, the
      systems do vary from province to province and you should check the legislation in your province to
      determine its specific requirements. There is also a registration system for not for profit or
      charitable corporations, which is beyond the scope of this work.

      Also, the discussion will not apply to P.E.I. or Nova Scotia. Though Nova Scotia has a registration
      system, it is different in some material respects from B.C.A. jurisdictions.

      iv.     HOW CAN I BECOME INCORPORATED?

      Incorporation has been achieved when a Certificate of Incorporation has been issued. However, the
      Certificate of Incorporation simply provides evidence that a corporation has been fully registered.
      Once the Certificate of Incorporation is issued, further steps must be taken in order to bring the
      corporation fully to life. Thus it is important to consider the purpose and effect of each corporate
      document in establishing the character, powers and procedures of the corporation.
                                                  38

     The basic incorporation documents usually include the Articles of Incorporation, Notice of Directors
     and Notice of Address and Registered Office. (However, if you are planning to incorporate in British
     Columbia, you should note that the Memorandum of Association is the primary document required for
     registration, and if Articles of Incorporation are not filed with the Memorandum, the corporation will be
     required to comply with those set out in the British Columbia Company Act.)

     The Articles of Incorporation generally form the backbone or skeleton of the corporation. The form,
     provided by the applicable Corporate Registry (see Appendix 1) generally contains information in 6
     separate categories though this will vary depending on which province you are concerned with:

             a.       Item 1 - Corporate Name
                                                                              47
             Generally a corporation need not be given a distinctive name ; the Corporate Registry will
             assign a registration number which can be used instead of a name. If an incorporator wishes
             to have a named corporation, a NUANS name-search report must accompany the required
             registration documents. This report, prepared for a fee by a private search house, indicates to
             the Registrar that a proposed corporate name meets all the requirements of the legislation.

             b.       Item 2 - Classes and Maximum Number of Shares
                                                                         48
             A corporation may issue more than one class of share. If a corporation issues only one
             class of share some provincial legislation provides that each share of that class must have
             the following three rights attached to it ; these are considered mandatory rights:
                                                      49



             i)       The right to vote at any meeting of shareholders of the corporation;

             ii)      The right to receive any dividend declared by the corporation; and
             iii)     The right to receive the remaining property of the corporation on dissolution.

             Other provinces require only voting and winding up rights. These provinces include Ontario
             and British Columbia.




47
     A.B.C.A.: s.10-13 reproduced in Appendix 2; C.B.C.A.: 10-13; O.B.C.A. 9-14; B.C.C.A.: 15-18; 131;
     N.S.C.A.: 15-18; 80(4); 80(5); 24(4)(a).

     C.B.C.A.: 24; O.B.C.A.: 22; B.C.C.A.: 19(allows par value shares); N.S.C.A.: 26(16) (allows par
48

     value shares).

     Some provinces, such as Alberta, have eliminated the concept of par value shares.

     A par value share is a share issued at a price lower than its face value (e.g. a share with a face
     value of $10.00 would be issued at a price of $1.00). Corporations in provinces which have eliminated
     these shares may now issue shares only at their actual value and only after they have been fully paid
     for. Other provinces, such as British Columbia, Quebec and Ontario still allow the issuance of par
     value shares, but generally require the par value price to be fully paid before the shares are issued.

49
     A.B.C.A.: 24(3); C.B.C.A.: 24(3); O.B.C.A.: 22(3); B.C.C.A.: --- (no mandatory rights); N.S.C.A.: ---(no
     mandatory rights).
                                                   39

             If a corporation has more than one class of shares, generally the articles must contain the
             rights, privileges, restrictions and conditions attaching to each class of share. Also, the three
             mandatory rights must be present among the classes of shares, but no one class need
                                          50
             represent all three rights in provinces providing for mandatory rights.

             Typically, the Articles of Incorporation will provide for one class of shares bearing all requisite
             mandatory rights (known as common shares) and one or more classes of shares with one
             or two of the mandatory rights attached (known as preferred shares). Note that the words
             common and preferred do not appear in the legislation, however they are in general
             usage in the business and legal communities. The preference given to a preferred share is
             normally a superior right over other classes of share to receive dividends and to distributions
             upon winding up. In exchange for this preferred status, the bearer of these shares
             normally gives up his voting rights, although this is not always the case.

             Pursuant to the Articles the corporation may have the power to issue an unlimited number of
             shares in any class. However, it should not be assumed that because a corporation is
             authorized to issue, for example, a million Class A shares, that it must in fact do so. This is
             not the case. The legislation generally provides that, subject to certain restrictions, the
                                                                                                     51
             directors may determine when, to whom, and for how much money shares will issue. Thus,
             providing for the issuance of an unlimited number of shares in any class may be desirable as
             it provides the directors with some flexibility in issuing shares to prospective investors or to
             the existing shareholders.

             c.       Item 3 - Restrictions if any on Share Transfers

             The company will not likely wish to be classified as a reporting company under the British
             Columbia Company Act, a distributing corporation as described in the Alberta Business
             Corporations Act or to be seen to be making a distribution of securities to the public as
             described in the Securities Act or other provincial securities legislation. Thus it is important
             that restrictions on share transfer be included in the Articles. The definition of private
             company in the applicable provincial Securities Act should be reviewed. For example the
             Ontario and Alberta Securities legislation defines a private corporation as follows:

             i)       private company means a company in whose constating document,

                      1.       the right to transfer its shares is restricted,

                      2.       the number of its shareholders, exclusive of persons who are in its
                               employment and exclusive of persons who, having been formerly in the
                               employment of the company, were, while in that employment, and have
                               continued after termination of that employment to be, shareholders of the
                               company, is limited to not more than fifty, two or more persons who are the
                               joint registered owners of one or more shares being counted as one share-
                               holder, and

                      3.       any invitation to the public to subscribe for its securities is prohibited.

             Most securities legislation exempts private companies from registering with the Securities
             Commission before trading its securities and provide an exemption from the prospectus
             requirements. Thus the Articles of Incorporation should contain restrictions on transfer and

50
     A.B.C.A.: 24(4)(b); C.B.C.A.: 24(4)(a); O.B.C.A.: 22(4); B.C.C.A.: ---; N.S.C.A.: ---.
51
     A.B.C.A.: 25(1); C.B.C.A.: 25(1); O.B.C.A.: 23(1); B.C.C.A.: 41(1); N.S.C.A.: 26(4)(m)(company to
     issue shares).
                                                  40

             total number of shareholders which bring the corporation within the definition of private
             company set out in the applicable Securities Act. Anyone considering incorporation should
             check the legislation in his province and attempt to develop share restrictions which ensure
             the corporation is exempt from securities legislation. Insofar as specific restrictions on
             transfer are concerned, these can range from merely requiring the written consent of the
             directors to complex buy-sell or option arrangements, depending on the particular needs of
             the client. Refer to Appendix 1 for sample restrictions.

             d.       Item 4 - Number of Directors

             A private or non-distributing corporation (i.e.. one which does not distribute shares to the
                                                      52
             public) must have at least one director. Most provinces require that directors meet certain
                                       53
             minimum requirements. For example in Alberta, a director cannot be less than 18, must be
             of sound mind and cannot have the status of a bankrupt. Normally, a minimum or maximum
             number of directors will be provided for, in order to give flexibility in composing a board of
             directors. If directors are to be approved by way of cumulative voting the Act also requires
                                                                 54
             that the Articles fix an exact number of directors.

             e.       Item 5 - Restrictions if any on Business the Corporation May Carry On
                              55
             Most legislation states that a corporation has the same capacity and power as a natural
             person. Thus, unlike the old Companies Act requirement, the articles or bylaws need not list
                                                                     56
             the area or areas in which the company may operate. However, a corporation may list in its
                                                                                                57
             articles any activity or activities which it is prohibited from participating in. In British
             Columbia, any restrictions on business to be carried on by the corporation are to be set out in
             the Memorandum of Association. Normally, corporations do not express any restrictions. If a
             restriction is expressed, a transaction is not generally invalidated merely because a
                                                                                                  58
             corporation inadvertently (or deliberately) infringed its self-imposed restrictions.

             f.       Item 6 - Other Provisions

             Here, reference is made to provisions which add to, or contract out of, the provisions of the
             Business Corporations Acts. If there is more than one shareholder the parties may decide to
             include a Unanimous Shareholders Agreement (U.S.A.) to restrict the normal powers given to
             directors. A U.S.A. is only available under some corporate law statutes. It is essentially a
             contract between the shareholders to manage the corporation under the terms of the
             agreement. It removes the power from the directors and transfers it to the shareholders. It
             also transfers the directors liability.

             Notice of Directors (see Appendix 3)


52
     A.B.C.A.: 97(2); C.B.C.A.: 102(2); O.B.C.A.: 132; N.S.C.A.: 93.
53
     A.B.C.A.: 100(1); C.B.C.A.: 105(1); to (4); O.B.C.A.: 118; B.C.C.A.: 138(1); 139; 133; N.S.C.A.:
     96,95(1).
54
     A.B.C.A.: 102; C.B.C.A.: 107; O.B.C.A.: 120; N.S.C.A.: 125.
55
     A.B.C.A.: 15(1); See note 42.
56
     A.B.C.A.: s.16(1)
57
     A.B.C.A.: s.16(2)
58
     A.B.C.A.: 16(3), 17; C.B.C.A.: 16(1), (2), (3), 17; B.C.C.A.: 22(1) - (3), 26; N.S.C.A.: 31.
                                                  41

             This form or its equivalent is generally used in two situations:

             1.       When incorporating, to indicate who the original directors are. Most provinces have
                                                                                            59          60
                      residency requirements for directors and requirements for directors generally,
                      though these vary from province to province. British Columbia, for example, has both
                      a Canadian residency requirement and a British Columbia residency requirement.

             2.       When a corporation replaces directors for whatever reason, a notice of that change
                      must also be filed with the Registrar.

             Notice of Address (see Appendix 4)
                                                                                61
             A corporation must have a registered office within the province.        A notice of

             i)       the registered office
             ii)      a separate records office (if any)
                                                                   62
             iii)     post office box for service by mail (if any)

             must be sent to the Registrar at the time of incorporation. As with the Notice of Directors
             form, any change in registered office, records office or P.O. box location must be
             accompanied by a notice filed with the Registrar.

             Bylaws

             It is possible for a corporation to do business without adopting a form of bylaw. Such a
             corporation would rely on the provisions of the applicable Act for direction in carrying on its
             day to day affairs. Normally however, the corporation will adopt a form of bylaw, in order to
             take advantage of those sections of the Act which may be changed, expanded or deleted by
             the use of a bylaw.

             Unanimous Shareholders Agreement




59
     A.B.C.A.: s.100(3).
60
     See note 52; A.B.C.A.: s.100.
61
     A.B.C.A.: s.19(1).
62
     A.B.C.A.: s.19(2); C.B.C.A.: 19(1); O.B.C.A.: 14; B.C.C.A.: 39(1); N.S.C.A.: 79(1).
                                                  42

             The Unanimous Shareholders Agreement (U.S.A.) is typically used in situations where there
             is a small group of shareholders who are active in the day to day management of the
                                             63
             corporation. Some provinces give the authority to enact a U.S.A. However, not all provinces
             have such a provision. The U.S.A. has the general effect of removing authority from the
             board of directors and placing it directly in the hands of the shareholders. This means that the
             shareholders directly control the actions of the corporation, rather than using their authority to
             vote in directors, who then act on behalf of the corporation. It should also be pointed out that
             the shareholders also assume all the potential liabilities of a director when they enter into a
             U.S.A. The U.S.A. may also change the level of shareholder consent required to make a
             decision for the corporation. As the name implies, the unanimous consent of all shareholders
             is required in order to enter a U.S.A. or to amend it. The shareholders can determine what %
             of votes is required to pass a resolution, including requiring that consent in all cases be
             unanimous. This requirement of unanimity is perhaps the key feature of the U.S.A.: on the
             one hand this feature protects the rights of minority shareholders by assuming that their
             consent is required before any corporate decision is made; on the other hand, the provision
             has the potential to create a corporate stalemate or inertia in which the corporation is unable
             to make even the most trivial decisions because of the intransigence of one shareholder. In
             order to avoid this situation, most U.S.A.s include some type of mandatory buy-sell or
             corporate repurchase plan, which has the effect of allowing a dissenting shareholder to
             depart from the corporation with a fair price for his shares, while permitting the remaining
             shareholders to get on with the business of running the company.

             The mandatory buy-sell (or shotgun) is a popular type of escape mechanism often
             found in a U.S.A. The basic operation of the shotgun is as follows:

             Step 1: Shareholder A offers to buy all Shareholder Bs shares at a given price.

             Step 2: Shareholder B receives As offer and has 15 days to accept or reject it.

             Step 3: If B does not accept As offer to buy within 15 days, then B is deemed to have
                             agreed to buy all of As shares at the given price.

             On the surface at least the shotgun method would seem to guarantee the departing
             shareholder a fair price for his share. However, there are limitations on the effectiveness of
             the shotgun. Consider the situation where Shareholder A knew that Shareholder B was in
             a cash-poor situation, and offered his shares to B at an unreasonably low price, knowing that
             B could not raise the money to accept the offer? Also, how would you structure a shotgun
             buy-sell for a corporation that had more than 2 shareholders? In the first circumstance, the
             shotgun fails to protect the weaker shareholder. It is effective in protecting both parties
             only where the two parties are in an equal bargaining position. The second situation is also
             problematic. In most circumstances involving more than 2 shareholders the shotgun would
             not achieve the desired result. It almost certainly would result in a shift in the balance of
             power or control in the corporation which would be unsatisfactory to any remaining
             shareholders.

             A mandatory corporate repurchase (or put) gives the dissenting shareholder the right to
             resell his shares directly to the corporation. The tax consequences of such a sale are that the
             earnings are deemed a dividend. Normally the price to be paid for the shares is determined
             on the basis of an audit of the corporations books which determines the value of the
             corporation on a per share basis. Once the value is determined, the shares are delivered to
             the corporation (normally with conditions attaching to prevent the corporation or the
             remaining shareholders from repudiating the repurchase agreement or altering the agreed
             price to be paid) and the departing shareholder is paid out. Often times the payment is
             scheduled over a period of months or years, in order to allow the corporation to pay the

63
     A.B.C.A.: s.140; C.B.C.A.: 146(1); B.C.C.A.: ---; N.S.C.A.: ---.
                                                   43

             departing shareholder without being forced to gut the corporation of assets to do so.

             Other Documents - The Minute Book

             In addition to the articles, bylaws, notice of address and directors, and the U.S.A. (where
             applicable), a number of other documents must be assembled and retained with the
             corporate records. This collection of documents is referred to as the minute book, a
             reference to minutes of directors and shareholder meetings which are kept as a record of
             business transacted at those meetings. The specific documents vary depending on the
                                                            64
             jurisdiction, but the requirements are similar. A non-comprehensive list of suggestions as to
             the various documents which should be included in the minute book is provided below:

             1.        Minutes of Directors Meetings - Most legislation requires the directors of the
                                                                                             65
                       corporation to hold an organizational meeting following incorporation. The directors
                                                                                    66
                       will normally make bylaws, adopt a form of share certificate authorize the issue of
                       securities, appoint officers, appoint auditors or accountants, make banking
                       arrangements including the adoption of banking bylaws, and transact any other
                       business. After the organizational meeting, minutes should be created for each
                       subsequent directors meeting, and these minutes recorded in the minute book. The
                       minutes will reflect the major decisions made by the Board of Directors, and are
                       often required as evidence that the corporation has complied with the provisions of
                       the Act, or Income Tax Act or other statutes which govern the operation of the
                       corporation. It is important that the directors, or the corporate secretary, if one is
                       appointed, be diligent in keeping the minutes up to date.
                                                                                              67
             2.        Minutes of Shareholders Meetings - All provincial legislation requires the
                       directors to call an annual shareholders meeting following the date of incorporation,
                       and regularly thereafter. Each province has its own specific time lines. In Alberta for
                       example, the annual shareholders meeting must be called within 18 months of the
                       date of incorporation and not later than every 15 months thereafter. In British
                       Columbia, it must be held less than 15 months from the date of Incorporation and not
                       later than every 13 months thereafter. And in Quebec, the annual meeting is a set
                       out in the by-laws. Normally in a small corporation setting, the first annual meeting of
                       shareholders will be held immediately after the organizational meeting of the
                       directors. The minutes of the shareholders meeting will detail the resolutions which
                       were placed before the shareholders and the results of the votes taken to confirm or
                       reject those resolutions. Normally at the first meeting of shareholders, the acts of the
                       Board of Directors at the organizational meeting will be confirmed. As with the
                       directors minutes, it is important that the minutes of each shareholders meeting be
                       included in the minute book.




64
     A.B.C.A., 20(1), 99(1); C.B.C.A.: 20(1); 104(1) B.C.C.A., 187(1), 184(1); N.S.C.A., 89(1).
65
     A.B.C.A.: s.99.
66
     A.B.C.A.: s.45; C.B.C.A.: 49; B.C.C.A.: 48, 49; N.S.C.A.: ---.
67
     A.B.C.A.: 127(1); C.B.C.A.: 133(a).
                                                    44
                                                                              68
                       Special attention should be paid to the provisions which deal with shareholders
                       meetings, voting, and U.S.A.s. A sample shareholders minute has not been
                       provided. Instead, a shareholders resolution is provided in Appendix 8. This type of
                                                                                 69
                       document is allowed in some provinces, such as Alberta, and is convenient to use
                       with a small corporation as long as all shareholders are in agreement. However, it
                       should be noted that not all provinces have similar provisions. Ontario and British
                       Columbia, for example, do not provide for this type of document.

              3.       Certificate of Incorporation - The Registrars office will issue a certificate upon
                       receipt of the required incorporation documents and fees. The certificate is normally
                                                             70
                       kept at the front of the minute book.

              4.       Registers - Registers or lists of current directors, officers and shareholders are
                       required by the Act to be maintained in the minute book. In addition, registers of
                                                                                                  71
                       securities, mortgages and debentures may also be maintained as required.
                                                                                                                72
              5.       Annual Returns - Each corporation must file an annual return with the Registrar.
                       Failure to file this form (which is mailed to the corporations registered office by the
                                                                                                73
                       Registrar) can result in the corporation being struck from the rolls. Copies of all
                       annual returns should be retained in the minute book. It should be noted that the
                       provisions for each province may vary. Under the Quebec Companies Act, failure to
                       file the return for 2 consecutive years can result in dissolution. British Columbia has
                       a similar provision. However in Alberta failure to file in one year can result in being
                       struck from the rolls. Therefore, it is important to check the legislation in the
                       appropriate province.

     v.       WHAT IS A SHARE?

     A share represents ownership of a percentage of a corporation. Typically shares carry one or more of
     the following rights: the right to vote, to receive dividends or to share in the assets if the corporation is
     wound up. Blacks Law Dictionary (5th ed.) defines share of corporate stock as follows:

     Share of corporate stock. A proportional part of certain rights in a corporation during its existence, and
     in the assets upon dissolution, and evidence of the stockholders ratable share in the distribution of
     the assets on the winding up of the corporations business.
                                                                                                                74
     The Business Corporations Act in each applicable province authorizes corporations to issue shares
     as does the British Columbia Company Act and the Quebec Companies Act.

     vi.      WHAT ARE SHARES FOR?



68
     A.B.C.A.: s.126-140; C.B.C.A.: 132-154; O.B.C.A.: 92-114; B.C.C.A.: 163-186; N.S.C.A.: 163-186.
69
     A.B.C.A.: s.136; C.B.C.A.: 142; B.C.C.A.: ---; N.S.C.A.: ---.
70
     A.B.C.A.: s.8, 9; C.B.C.A.: s.8, 9; O.B.C.A.: s.6, 7; B.C.C.A.: 9(1), 11; N.S.C.A.: 26(1), 28(1).
71
     A.B.C.A.: s.20(1); see note 59 above.
72
     C.B.C.A.: 263; B.C.C.A.: 356; N.S.C.A.: 10(1).
73
     A.B.C.A.: s.205; C.B.C.A.: 212; B.C.C.A.: 281(1)(a); N.S.C.R.A.: 7(1).
74
     A.B.C.A.: part V; C.B.C.A.: part V; O.B.C.A.: ss. 22-44; B.C.C.A.: part 3; N.S.C.A.: part III.
                                                   45

     One of the most important perceived advantages of incorporation is the ability to raise money by
     issuing shares or stock in the corporation to family, friends, or other investors. One must
     remember however that shares carry the right to vote, to dividends and to profit on winding up.
     Therefore share distributions may involve a dilution of ownership of the corporation and may in fact
     result in a loss of control of the corporation. Normally, the entrepreneur will want his or her investors
     to share the risk of the venture and participate in profits (if any) but will not want them to have any say
     in management. Thus it is important to fully understand what shares represent, how they are issued,
     what rights and obligations attach to shares, and how share sales or purchases for small corporations
     are regulated by the applicable Business Corporations Act or Company legislation and the Securities
     Act in each province.

     vii.    HOW DOES THE CORPORATION ISSUE SHARES?

     (See the previous discussion under Articles of Incorporation; Item 2 - Classes and Maximum Number
     of Shares)

     The incorporator of the corporation sets the initial share structure of the corporation, which is normally
     approved as part of the Articles of Incorporation or Memorandum of Association by the directors at
     the organizational meeting. The directors or officers then receive subscriptions, (offers to purchase
     shares) from prospective shareholders. The directors accept the subscriptions from those persons
     who are eligible to purchase shares, and issue share certificates in exchange for the appropriate
                   75
     consideration (usually cash or property). Stated capital accounts are then established and
                                            76
     maintained for each class of shares. In addition, a corporation which has more than a specified
                                                                                       77                78
     number of voting shareholders must prepare and maintain a shareholders list. The legislation sets
     out the requirements for producing share certificates (as well as certificates representing other
     securities issued by the corporation), the requirements for securities registers, and the various
     procedures for transmitting securities, dealing with defects in security documents, and rules governing
     transfers and possession of securities.

     viii.   WHO DECIDES HOW MANY SHARES ARE ISSUED?

     The Act gives the directors the right, subject to the provisions of the articles, bylaws, unanimous
                                                                                   79                 80
     shareholders agreement (if any), and any pre-emptive shareholders right , to issue shares. The
     number of shares issued will normally be determined by the total number of shares available and the
     total number of shares subscribed for by potential shareholders. In a private or non-distributing
     corporation, limits on the total number of shareholders will also have an impact on the total number of
     shares issued. Clients will commonly assume that if the corporation is authorized in the Articles to
     issue a certain number of shares then the entire authorized amount must be issued. This is incorrect;
     the fact that a corporation is able to issue one million Class A shares, for example, does not mean
     that it is required to do so.

     ix.     WHO MAY PURCHASE SHARES IN A CORPORATION?

     This question relates to the distinction between distributing (public) and non-distributing (private)

75
     A.B.C.A.: 25; C.B.C.A.: 25; O.B.C.A.: 23(3); B.C.C.A.: 42; N.S.C.A.: 109.
76
     A.B.C.A.: s.26; C.B.C.A.: 26; B.C.C.A.: ---; N.S.C.A.: 20(3).
77
     A.B.C.A.: s.132; C.B.C.A.: 138; B.C.C.A.: 191; N.S.C.A.: 42.
78
     A.B.C.A.: part VI; C.B.C.A.: part VII; O.B.C.A.: ss. 22-44; B.C.C.A.: part 3 Div. 2; N.S.C.A.: part 3.
79
     A.B.C.A.: s.28; C.B.C.A.: 28; B.C.C.A.: 41; N.S.C.A.: ---.
80
     A.B.C.A.: s.25.
                                                  46

     corporations. Theoretically, there are no limits on the number of persons who may purchase shares in
     a distributing corporation, while non-distributing corporations are restricted as to their total number of
     shareholders (see the previous discussion under Articles of Incorporation: Item 3 - Restrictions If Any
     on Share Transfers). Otherwise the applicable Acts give no qualifications or restrictions as to who
     may be a shareholder, leaving the responsibility for deciding who may purchase shares with the
     directors of the corporation.

     x.      WHAT ARE DIVIDENDS? WHEN MUST A DIVIDEND BE PAID?

     A dividend is simply a distribution to the shareholders which is based on their share ownership.

     Blacks Law Dictionary (5th ed.) defines dividend as follows:

     Dividend. The payment designated by the board of directors of a corporation to be distributed pro rata
     among the shares outstanding. On preferred shares, it is generally a fixed amount. On common
     shares, the dividend varies with the fortunes of the company and the amount of cash on hand, and
     may be omitted if business is poor or the directors determine to withhold earnings to invest in plant
     and equipment. Sometimes a company will pay a dividend out of past earnings even if it is not
     currently operating at a profit.

     Depending on its particular share structure, a corporation may never be obligated to pay a dividend,
     particularly if it does not issue preferred shares. As the above definition indicates, it is normally the
     directors who determine when a dividend may be paid, and that determination is normally based on
     the performance of the corporation in a given year or quarter. Note however that a corporation which
     would otherwise wish to pay a dividend may be prevented from doing so by provincial legislation. In
     Alberta, for example, s.40 provides that:

     A corporation shall not declare or pay a dividend 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 thereby be less than the aggregate of
                                                                 81
             its liabilities and stated capital of all classes.

     In other words, if a corporation is not proposing to pay dividends out of profits or retained earnings, it
     may have difficulty satisfying the financial tests set out in s.40 and would thus be prohibited from
     declaring or paying a dividend despite the wish of the directors to do so. Other provinces have
     identical or similar requirements.

     Dividends need not always be paid in money, although this is the most common method. Alberta and
     Ontario legislation for example provide that dividends may be paid in the form of money or property,
                                                                                82
     or by issuing fully paid shares in the company to the existing shareholder. However, some provinces
     such as British Columbia have no similar provisions. If the dividend is paid by way of new shares, then
     the amount of the dividend must be paid into the stated capital account of the class or series of
     shares to which the dividend applies.

     xi.     HOW IS SHARE VALUE DETERMINED?




81
     C.B.C.A.: 43; O.B.C.A.: 38(3); B.C.C.A.: ---; N.S.C.A.: ---.
82
     A.B.C.A.: s.41; C.B.C.A.: 43; O.B.C.A.: 38(2); B.C.C.A.: ---; N.S.C.A.: ---.
                                                   47

     Subject to certain restrictions, it is the directors who determine what the amount consideration or
                                                   83
     value of a share will be at the time of issue. The consideration paid for a share need not be money,
     but any non-monetary consideration, whether it is property or past service, must be equal in value to
                                                                                                        84
     the amount of money which the corporation would otherwise have realized on the sale of the share.

     When setting share value, the directors should consider both the capitalization needs of the
     corporation and the investment capacity of the shareholders. The law requires that a share may not
                                                                                                85
     be issued until the full consideration required for that share is paid to the corporation. Since each
     share represents a fraction of the total value of the corporation, every effort should be made to assign
     a value which relates to the value of the corporation. Even a new corporation with very little in the way
     of assets has a determinable value which should be reflected in the issue price of its shares.

     When cash or assets are given to a corporation in exchange for shares, it is important that the share
     value fairly reflects the value of those assets not only in order to satisfy the legislation requirements,
     but also in order to avoid undesirable tax exposure on the transfer of the assets.

     xii.    WHAT ARE DIRECTORS? WHAT ARE OFFICERS? - INTRODUCTION

     It may be difficult to distinguish the duties of officers, directors and shareholders in the context of the
     small corporation. Most entrepreneurs see themselves as the owners of their corporation,
     responsible for all aspects of management and control and the recipients of any profit or loss realized
     in the business. Because the corporate format is often imposed over a pre-existing sole proprietorship
     or partnership, there is often confusion as to how directors and officers are created and what their role
     is in the corporation. It is important to clarify this aspect of the incorporation process, as the rights,
     powers and obligations of the directors and officers are central to the overall operation of any
     corporation.

     xiii.   HOW ARE DIRECTORS CHOSEN?

     The incorporator inserts the names of the first directors of the corporation on the Notice of Directors
                                                                                                        86
     form or its equivalent which is submitted to the Corporate Registry at the time of incorporation. At
     the first annual meeting of the shareholders following incorporation, and at each succeeding annual
     meeting, the shareholders elect the members of the board of directors. Note that the directors named
     in the Notice of Directors or equivalent document hold office until the first annual meeting of
     shareholders is held which may not take place for more than a year following the date of
                    87
     incorporation. Note also that the legislation gives considerable latitude to a corporation to include
     provisions in its articles or Unanimous Shareholders Agreement (if applicable) dealing with
     appointment of directors other than by election, extension of terms for directors, and appointment of
                                          88
     directors by creditors or employees.

     Normally the directors of a private corporation will also be the principal shareholders of the
     corporation, or individuals selected by the principal shareholders. Most provinces set out the minimum
     requirements of a director: In Alberta for example, s.100 provides:

83
     A.B.C.A.: s.25.
84
     A.B.C.A.: S. 25, 25(4); C.B.C.A.: 25(3), 25(4); O.B.C.C.A.: 23(4); B.C.C.A.: 43(1), 43(2), 43(3);
     N.S.C.A.: ---.
85
     A.B.C.A.: s.25(31).
86
     A.B.C.A.: s.101(1).
87
     C.B.C.A.: 106(1), 106(2), 106(3), 127(1); O.B.C.A.: 119(1); B.C.C.A.: 137, 134(2); N.S.C.A.: ---.
88
     A.B.C.A.: s.101.
                                                   48


     Qualifications of directors. - (1) the following persons are disqualified from being a director of a
     corporation:

             a)       anyone who is less than 18 years of age;
             b)       anyone who

     1.      is a dependent adult as defined in The Dependent Adults Act or is the subject of a certificate
             of incapacity under that Act,

     2.      is a formal patient as defined in The Mental Health Act 1972,
     3.      is the subject of an order under The Mentally Incapacitated Persons Act appointing a
             committee of his person or estate or both, or
                                                                                                 89
     4.      has been found to be a person of unsound mind by a court elsewhere than in Alberta.

     Other provinces have analogous legislative requirements. Also, directors must consent to their
                                                                                                              90
     appointment or election, either in writing or by conduct, or else their election or appointment is void.
                                                                         91
     A non-distributing corporation may have as few as one director. This will be the case in the typical
     owner-manager business. Note also that there may be residency requirements for directors under the
     incorporating legislation. In Alberta, a minimum of one third of the directors must be resident
     Canadians, and in the case of most corporation statutes, the minimum number is 50%. British
     Columbia also requires at least one director to be ordinarily a resident in British Columbia. Since the
     requirements may vary slightly you should check the legislation in the appropriate province to
     determine exact requirements. You should also note that directors do not have to be shareholders.

     xiv.    WHAT DO DIRECTORS DO?

     In the absence of a unanimous shareholders agreement, the directors of a corporation are
                                                                                  92
     responsible for managing the business and affairs of the corporation. The directors make the
                                                                              93
     bylaws, or rules which govern the internal regulation of the corporation. Their power to make bylaws
     unless restricted in the Articles or by a unanimous shareholders agreement gives the directors
     considerable latitude in how they manage the corporation, since bylaws come into effect when passed
     by the board of directors, and need only be presented to the shareholders for confirmation,
                                                                               94
     amendment or rejection at the next annual meeting of the shareholders. The Directors also have the
                                                               95
     authority to borrow money on behalf of the corporation.
     xv.      WHAT ARE THE RESPONSIBILITIES AND OBLIGATIONS OF DIRECTORS?




89
     See note 52 above.
90
     A.B.C.A.: s.100(5), 100(6); C.B.C.A.: ---; B.C.C.A.: 136(1); N.S.C.A.: 94(1).
91
     A.B.C.A.: 97(2); see note 51 above.
92
     A.B.C.A.: 97(1); C.B.C.A.: 102; O.B.C.A.: 115(1); B.C.C.A.: 141(1); N.S.C.A.: ---.
93
     A.B.C.A.: 98; C.B.C.A.: 103; O.B.C.A.: 116; B.C.C.A.: 6 (filed with articles); N.S.C.A.: 21(schedule 1
     table A).
94
     A.B.C.A.: 98(2) - 98(5); C.B.C.A.: 103(2) - (5); O.B.C.A.: 116(2); B.C.C.A.: ---; N.S.C.A.: ---.
95
     A.B.C.A.: 98(1); C.B.C.A.: ---; B.C.C.A.: 124; 125; N.S.C.A.: 102 (company).
                                                  49

     Corporate legislation confers great power on the directors. With this power comes responsibility and
     liability. The corporation, as an inanimate legal personality, must rely on the skill and good judgment
     of its directors in the everyday course of business. Each province therefore imposes some level of
                                      96
     personal liability on directors.

     A director is personally liable to the corporation for any resolutions approved by him which result in a
     loss of money to the corporation arising out of the issue, purchase or redemption of the corporations
     shares. In most provinces these losses include:

            any difference in value between the price of shares issued and the non-monetary
             consideration received for those shares;

            any amount paid for the purchase, redemption or acquisition of its own shares, where there
             are reasonable grounds for believing that the corporation would then be unable to pay its
             liabilities as they come due;

            any amount paid as commission on a sale of shares where the commission paid is
             unreasonable;

            any amount paid as dividends where the aggregate of realizable corporation assets would
             then be insufficient to pay the corporation liabilities as they come due;

            any amount paid under a contract of indemnity in favour of a director or former director,
             where losses to the corporation resulted and the director did not act honestly and in good
             faith with a view to the best interests of the corporation;

            any amount paid to a dissenting shareholder, where there is a proposal to change the rights
             attached to his shares, if the amount paid is not the fair market value of the shares.

     In some provinces directors also have personal liability in respect of wages owed to employees of the
     corporation. Each Provincial Act details the situation in which the directors will find themselves jointly
     and severally liable for employee wages. Generally, that they will be responsible for up to 6 months of
                                                             97
     wages owed to each employee of the corporation. Not all provinces impose such liability on
     directors; British Columbia for example, has no such provision.

     In addition to their obligations regarding financial transactions and in some cases employee wages,
     the directors also have a fiduciary or trust obligation to the corporation in respect of contracts entered
     into with the corporation. As a result, most legislation sets out the requirements for disclosure by
     directors of any personal involvement in a material contract or proposed material contract offered to
                      98
     the corporation.




96
     A.B.C.A.: s.113-115; C.B.C.A.: 118, 114,120; O.B.C.A.: 130-132; B.C.C.A.: 48, 144, 145; N.S.C.A.:
     99.
97
     A.B.C.A.: s.114.
98
     A.B.C.A.: s.115.
                                                   50

      It is important to note that the duties of a director to the corporation extend beyond those expressed in
      the Business Corporations Act or companies legislation. Other legislation may impose specific duties
      on a director, including the Income Tax Act, applicable provincial corporate Income Tax Acts,
      Securities Acts, Labour Acts, etc. Directors generally also have a duty imposed by the legislation to
      act honestly and in good faith with a view to the best interest of the corporation and to exercise the
                                                                                                             99
      care, diligence and skill that a reasonable, prudent person would exercise in similar circumstances.
      This reflects the codification of a pre-existing common law doctrine regarding the conduct of directors.
      Recent cases on the duty of care of directors show that courts are increasingly willing to find directors
      negligent and liable for damages where they fail to exercise reasonable care and skill in the
      performance of their duties.

      Directors may be able to avoid liability under these provisions if they dissent or abstain from voting on
      a resolution or action of the board of directors. Note that a positive action is required. A director is
      deemed to consent to a resolution or action passed at a meeting at which he was present. Only by
                                                                     100
      taking some positive action as set out in the applicable Act can he be seen to have dissented. A
      director may also be shielded from liability where he relies in good faith on financial statements
      provided to him by an officer or auditor of the corporation, or where he relies on opinions or reports of
      recognized professionals made to the corporation.

      A corporation may, in certain circumstances, indemnify or reimburse a director for damages which
                                            101
      would otherwise be payable by him. A corporation may also be able to maintain liability insurance
      on behalf of directors. Note the two tests which must be satisfied before a director may be indemnified
      by the corporation or receive payments from a policy of insurance:

      1.      The director must have acted honestly and in good faith with a view to the best interests of
              the corporation.

      2.      In the case of a criminal or administrative action or proceeding that is enforced by a monetary
              penalty, the director must also prove that he had reasonable grounds for believing that his
              conduct was lawful.

      Obviously, director indemnification must not be regarded as a given considering the restrictions
      imposed and recent developments in case law. Thus it is important that the business person be fully
      aware of the serious nature and responsibilities attaching to the position of director to make an
      informed decision about accepting or rejecting a position on the board of directors.

      xvi.    HOW DO DIRECTORS RESIGN? HOW CAN DIRECTORS BE REMOVED?
                                                                           102
      The legislation governs the resignation and removal of directors. In most provinces a directors
      letter of resignation becomes effective when the letter is received by the corporation, or upon the date
      specified in the letter, whichever is later, however not all provinces specify this in their statute.

      Subject to provisions governing cumulative voting or a unanimous shareholders agreement, the
      shareholders may decide, by majority vote or special resolution, to remove a director.

      xvii.   HOW ARE OFFICERS CHOSEN?



99
      A.B.C.A.: s.117; .B.C.A.: 122; O.B.C.A.: 132(8); .C.C.A.: 142; N.S.C.A.: ---.
100
      C.B.C.A.: 123, 123(4); O.B.C.A.: 135; B.C.C.A.: 151(4); N.S.C.A.: ---.
101
      A.B.C.A.: s.119; see note 85 above.
102
      A.B.C.A.: s.103, 104; C.B.C.A.: 103(2),104(2) - (4); O.B.C.A.: 122; B.C.C.A.: 154(3); N.S.C.A.: ---.
                                                   51

      The directors have the general power to appoint officers, specify their duties and delegate to them
      powers to manage the business and affairs of the corporation, except where that delegation is
      prohibited by the legislation. Note that this general power may be restricted by the articles, bylaws or a
                                             103
      unanimous shareholder agreement.

      xviii.   WHAT DO OFFICERS DO?

      Officers of a corporation use the authority given to them by the board of directors to manage the
      business affairs of the corporation. Officers are not elected by the shareholders, they are hired by the
      directors to perform various functions within the corporation. The legislation requires, in the absence
      of a unanimous shareholder agreement, that a corporation have at least one director, but most
      legislation, with the exception of British Columbia, does not require the appointment of any officers.
      Entrepreneurs will often wish to appoint a president, vice-presidents, corporate secretaries, etc. as
      they are familiar with these titles. Corporate bylaws will normally provide for the appointment of senior
      executive officers, and often lower-level managers as well. Officers will typically be hired because they
      have specific job skills which are required to run the corporation on a day to day basis, including
      accountancy, engineering, law, etc. as well as previous management experience. Directors, by
      contrast, may or may not have specific expertise which is valuable to the corporation, but are normally
      selected on the basis of overall business experience and shareholder preference.

      xix.     WHAT RESPONSIBILITIES OR OBLIGATIONS DO OFFICERS HAVE?

      Officers of a corporation are subject to the same basic duties and responsibilities as directors, which
      is reflective of the fact that officers operate with power that is delegated from the directors. (See the
      discussion regarding the responsibilities and duties of directors.) Obviously officers do not have
                                                                        104
      responsibility in areas where there is no delegation of power , but the principles of disclosure and
      duty of care do extend to both directors and officers.

      xx.      WHEN DO OFFICERS CEASE TO HOLD OFFICE?

      The applicable Acts give no direction in respect of either the resignation or removal of officers. The
      articles and bylaws or unanimous shareholders agreement may deal with procedures for resignation
      or dismissal, depending on the specific needs and requirements of a particular corporation.

      xxi.     WHAT IS A UNANIMOUS SHAREHOLDERS AGREEMENT?

      (Please refer to discussion under Unanimous Shareholders Agreements)

      xxii.    CAN MY CORPORATION DO BUSINESS OUTSIDE ALBERTA? - INTRODUCTION

      Entrepreneurs often have business aspirations beyond provincial boundaries. The capacity of a
      corporation incorporated in a particular province to do business in another province is therefore often
      a major concern. By registering a corporation in other provinces, the corporate identity can be
      extended into other jurisdictions.

      xxiii.   WHAT IS AN EXTRA-PROVINCIAL REGISTRATION?




103
      A.B.C.A.: s.116; C.B.C.A.: 121; O.B.C.A.: 133; B.C.C.A.: ---; N.S.C.A.: ---.
104
      A.B.C.A.: s.113, 114; see note 85 above.
                                                     52

      Extra-provincial registration allows a corporation incorporated under the laws of one province to do
      business in one or more different provinces. If a corporation from Ontario wants to carry on business
      in Alberta, for example, registration involves filing certain statements and corporate documents with
      the Registrar. This is followed by the issuance of a certificate by the Registrar proving that the
                                                    105
      corporation is validly registered in Alberta.

      xxiv.   WHEN IS AN EXTRA-PROVINCIAL REGISTRATION REQUIRED?

      Most legislation requires that every extra-provincial corporation which carries on business in the
      province must register within 30 days after commencing to carry on business. For example, in Alberta
      s. 264 of the A.B.C.A. gives the definition of carrying on business in Alberta:
                                                                                        106



      Carrying on business in Alberta:

      1)      For the purposes of this Part, an extra-provincial corporation carries on business in Alberta if:

              a)       its name, or any name under which it carries on business, is listed in a telephone
                       directory for any part of Alberta,

              b)       its name, or any name under which it carries on business, appears or is announced
                       in any advertisement in which an address in Alberta is given for the extra-provincial
                       corporation,

              c)       it has a resident agent or representative or a warehouse, office or place of business
                       in Alberta,

              d)       it solicits business in Alberta,

              e)       it is the owner of any estate or interest in land in Alberta,

              f)       it is licensed or registered or required to be licensed or registered under any Act of
                       Alberta entitling it to do business,

              g)       it is, in respect of a public vehicle as defined in the Motor Transport Act, the holder of
                       a certificate of registration under the Motor Vehicle Administration Act, unless it
                       neither picks up nor delivers goods or passengers in Alberta,

              h)       it is the holder of a certificate issued by the Alberta Motor Transport Board, unless it
                       neither picks up nor delivers goods or passengers in Alberta, or

              i)       it otherwise carries on business in Alberta.

      2)      The Registrar may exempt an extra-provincial corporation from the payment of fees under
              this Part if he is satisfied that it does not carry on business for the purpose of gain.

              Other B.C.A. provinces and British Columbia have similar provisions but the specific
              requirements should be checked.

      xxv.    WHAT HAPPENS IF A CORPORATION DOES NOT REGISTER?




105
      A.B.C.A.: s.266-271; C.B.C.A.: ---; N.S.C.A.: ---; B.C.C.A.: 321.
106
      C.B.C.A.: ---; B.C.C.A.: ---; N.S.C.A.: ---.
                                                   53
                      107
      Most legislation creates a general penalty in the nature of a fine which may be up to $5,000.00 for
      any person who contravenes the provisions of the Act dealing with extra-provincial registrations. Note
      also that an unregistered corporation lacks the capacity to commence or maintain an action in the
      province in question.

      xxvi.    WHAT IS A FEDERAL CORPORATION?

      In addition to the various provincial systems for incorporation, the Canada Business Corporations Act
      provides federal legislation for the incorporation of companies to do business on a national scale. The
      federal corporation may be advantageous for some businesses but it is important that the role and
      function of the federal corporation be clearly understood prior to selecting it as a business format,
      since the costs of establishing and maintaining the federal corporation are significantly higher than
      those for a provincial corporation.

      A federal corporation is one incorporated under the terms of the Canada Business Corporations Act;
      the federal legislation governing corporations created under federal authority. The federal power to
      create corporations is generally drawn from s.91 of the British North America Act, while the provincial
      power is specifically allowed in s.92(1) of the same act. The legislative scheme of the Canada
      Business Corporations Act is similar in many respects to that of the Alberta Business Corporations
      Act, however, there are some key differences. Thus it is important to carefully review the federal act
      when answering specific questions on the Act.

      xxvii.   WHEN SHOULD I INCORPORATE FEDERALLY?

      Generally, federal incorporation is used when a company intends to operate in a business which is the
      subject of federal, rather than provincial, regulation. Examples of federally regulated businesses
      would include broadcasting, telecommunications, railroads, shipping and air travel. There is, however,
      no legislative restriction preventing one from incorporating federally to pursue any business purpose,
      whether of a local, regional, national, or international scope. Financial considerations will normally
      lead to the selection of the less expensive provincial format in cases where the business does not
      intend to operate outside the sphere of provincial regulation.

      xxxviii. WILL FEDERAL INCORPORATION GIVE NATIONAL PROTECTION TO MY BUSINESS
                     NAME?

      People often assume that, because federal corporations are intended to operate on a national basis,
      that a corporate name duly searched and approved by the federal Registrar will give them a monopoly
      on the use of that name. Their hope is that by registering the federal corporation under the chosen
      name, any other business, whether incorporated or not will be precluded from using that particular
      name. Unfortunately this is not the effect of registering a corporate name. The Canada Business
      Corporations Act states only that a corporation shall not use a name that is prohibited or
      deceptively misdescriptive or that is reserved for another corporation or intended corporation. Thus
      while reserving a federal corporate name would prohibit another federal corporation from using the
      same name, the reservation would have no effect on the right of an unincorporated business to use
      the same, or similar name.

      xxix.    IS A FEDERAL CORPORATION EXEMPT FROM EXTRA-PROVINCIAL REGISTRATION
               REQUIREMENTS?

      As discussed previously, provincial and federal corporations must go through a registration process in
      order to carry on business in provinces outside the one in which they were created. In theory, a
      federal corporation would not have to register extra-provincially, as the legislation under which it is
      created is federal, rather than provincial, and thus extends to all jurisdictions within Canada.


107
      C.B.C.A.: ---; B.C.C.A.: 337(2); N.S.C.A.: ---.
                                                   54

      xxx.    WHAT IS A PROFESSIONAL CORPORATION?

      In Canada, certain professional groups are prohibited from conducting their business through a
      corporation. For example, doctors, lawyers, dentists and certain other professions whose clients rely
      on the personal skill and expertise of the practitioner cannot use the corporate veil to absolve
      themselves of personal liability in respect of their professional activities.

      In some provinces however, such as Alberta, an exception is made provided certain requirements are
      met. For example, in Alberta the following provisions must be included:

      Corporate Name: The name of a professional corporation must include the words Professional
                                        108
      Corporation (s.10(2) A.B.C.A.). In addition, the governing legislation of the profession may impose
      other restrictions on the allowable names for a professional corporation (e.g., see s.147 of the Rules
      of the Law Society of Alberta).

      Liability: The articles of a professional corporation must include a provision which allows for unlimited
      liability on the part of the shareholder of the corporation in respect of his professional activities
      performed on behalf of the corporation. (It is assumed that most professional corporations will be
      one-man corporations.)

      Ownership of Shares: The shareholders in a professional corporation must be members of the
      governing professional body under which the professional corporation is formed. For example, the
      shareholders in a professional corporation formed under the Legal Profession Act would have to be
      members in good standing of the Law Society of Alberta.

      Approval of Governing Body: Before the corporate documents are submitted to the Registrar the
      incorporator must obtain the written approval of the governing body of which he is a member (e.g. a
      medical doctor seeking to incorporate would need the approval of the Alberta College of Physicians
      and Surgeons). The governing body examines the incorporating documents to make sure they
      conform to the particular requirements imposed by the governing rules. Once this approval is given,
      the incorporating documents may then be submitted to the Registrar.

      Permit: Once the Certificate of Incorporation is received from the Registrar, a certified copy of same
      as well as a certified copy of the Certificate of Status must be submitted to the governing body (along
      with an application form and fees) in order to receive a permit. The permit, which is authorized under
      the rules of the governing body, is renewable annually and requires that the owners of shares and
      members of the board of directors of the professional corporation also be members of the governing
      body under which the professional corporation is formed.

      xxxi.   WHO CAN USE A PROFESSIONAL CORPORATION?

      The use of professional corporations is restricted to those professional groups who:

              a)       are prohibited by law from doing business through a normal corporation, and
              b)       are governed by legislation or rules which permit the use of a professional
                       corporation.

      Professional groups which can use the professional corporation include:

              a)       Medical doctors - The Medical Profession Act

              b)       Lawyers - The Legal Profession Act

              c)       Dentists - The Dental Profession Act

108
      C.B.C.A.: ---; O.B.C.A.: 3(1); B.C.C.A.: ---; N.S.C.A.: ---.
                                            55


         d)      Accountants - The Chartered Accountants Act


xxxii.   DO PROFESSIONAL CORPORATIONS LIMIT PERSONAL LIABILITY?

Note with respect to the professional practice of the individual (see discussion of liability above).
                                                                56

Special Tax Issues Which Should be Considered

a)      Theres a good chance that the venture will lose money for a few years; should I incorporate?
        Because the corporation is a separate tax entity, the losses belong to it, not you. If the venture fails, the losses disappear with
        the corporation. On the other hand, losses in sole proprietorship or partnership may be used immediately by you against income
        from other sources and are not lost if the business goes under. For tax purposes you are probably better off to operate as a sole
        proprietorship or partnership until you can see a profit on the horizon.

b)      The venture is starting to make a great deal of profit now, which I intend to reinvest in the business; should I
        incorporate?
        You probably should if the corporation will qualify for any of the reduced corporate rates such as those resulting from the small
        business deduction or the manufacturing and processing credit.
        If the profit is earned through a sole proprietorship or partnership, the profit will be deemed to be fully distributed and will be
        taxed at your personal rate.

        If the profit is significant, the tax rate may be extremely high, leaving you with less to reinvest. By incorporating, you can
        effectively defer the difference in tax liability arising between the low corporate rate and the high personal rate.

        Assume that your business earns $100,000 before tax and you would like to reinvest one-half of the net earnings. As a sole
        proprietor you will pay approximately $40,000 in tax, leaving $30,000 for you and $30,000 for reinvestment.

        If you incorporate and pay yourself a salary of $50,000, you will pay approximately $15,000 in tax on this amount, leaving
        35,000 for you. If the small business rate of 20% applies, the remaining $50,000 will be subject to $10,000 tax, leaving $40,000
        for reinvestment.

        You end up with more money for yourself and more to reinvest.

c)      I own several rental properties. Should I incorporate and run the rental income through the corporation? Everyone
        knows how low corporate tax rates are!
        Sorry, only certain corporations qualify for the mystical small business deduction that reduces the tax rate to 20%. The rental
        business would be a specified investment business; unless you have more than five full-time employees, you would be
        subject to tax at approximately 45%, the highest corporate rate.

        You would have to earn about $300,000 before the average personal rate reached this level.

d)      Should I pay myself out of my corporation only by way of salary?
        Definitely not. By mixing your renumeration by way of salary and dividend, you can minimize your tax liability. You can receive
        about $20,000 in dividend income (assuming that you have no other income) without paying tax. Before doing this you should
        remember that dividends are paid from after tax corporate dollars. If the corporation is eligible for the small business deduction,
        a 20% tax rate will already have been paid.

        You must balance this against your personal tax rate if you took the same amount in salary.

        As a general rule, at levels of income tax below $40,000 you should take salary in order to utilize your personal tax credits and
        therefore minimize the overall tax liability on your personal and corporate income. At higher levels of income, dividend income
        will be more beneficial and dividend income is treated specially in the hands of the shareholder due to the dividend tax credit.
        This gives a credit against federal tax otherwise payable equal to about 1/4 of the dividend in recognition of the fact that the
        dividends are paid from after tax dollars. You should consult a lawyer or tax accountant to determine the optimal salary/dividend
        mix for your business.

e)      Will I get a better tax break when I sell my business if I incorporate?
        There is a special increased capital gains exemption of $500,000 for individuals who dispose of qualified small business
        corporation shares.

        To qualify as a qualified small business corporation share of an individual, the share must be a share of a corporation which
        is a small business corporation. For this purpose, a small business corporation is defined as a Canadian-controlled private
        corporation all or substantially all of the fair market value of the assets of which is attributable to assets used in an active
        business carried on primarily in Canada by the corporation (or a related corporation or are shares or debt of connected
        corporations that are small business corporations).
                                                    57


                                COMPARISON OF BUSINESS FORMATS


                        SOLE PROPRIETORSHIP              PARTNERSHIP                CORPORATION

 1. Organizational      - lowest                                  -          - highest
    Complexity                                    middle

 2. Tax Unit            - individual                                         - corporation

 3. Basic Tax           - personal rates                                     - corporate rates
                        - progressive marginal rates (0-47%)                 - flat rates, but may be
                                                                               stepped
                        - income, losses and expenses from                   - additional liability at all
                          shareholder level                                      sources combined

 4. Accumulation of     - all income is fully distributed for tax purposes   - deferral if the shareholders
    Profit                    in the year                                       marginal rate exceeds the
                                                                                 corporation rate

 5. Allocation of       -attributed to the        -pro rata attri-           - flow through of gains as
     Gains and           proprietor               bution to partners             salary or dividends
       Losses

 6. Application of      - current and carryover losses may be applied        - corporation gets carryover
     Losses                 against income no any source; carryover             losses
                             losses erred personal deductions

 7. Formation,          - no tax consequences if applicable tax              - no tax consequences if
    Modification        provisions are complied with.                        applicable tax provisions are
 and                                                                           complied with (*paperwork
 Termination                                                                    required to meet tax rules).

b.      TAX ISSUES FOR THE NEW BUSINESS

        Example Problem:

        Peter B. is an expert at floral arrangements. He is currently employed at Gorgeous Flowers 3 days
        a week and at the Holly Point Florists for two, doing flower arrangements. He has decided to strike
        out on his own. He has heard there are tax advantages to incorporating. He expects to earn about
        $251,000 this year but it may be more and wants to avoid having taxes etc. deducted from his
        paycheck. He plans to operate his business in Alberta.

        Required: Outline for Peter the potential advantages of incorporation Indicate any traps he should
        be aware of.

        Solution: There are two significant tax issues that require some discussion with respect to the setting
        up of a small business in these circumstances. First, whether there are any tax advantages to
        incorporating a company versus operating the business as a sole proprietor. The second issue relates
        to your expressed desire to be paid as an independent contractor without employer s deducting
        taxes, etc. from your paychecks.

        i.      Tax Advantages/Disadvantages for Incorporation

        There are many tax motivated reasons for incorporating a company. From the circumstances you
        have identified, I believe that taking advantage of the Small Business Deduction (SBD) is the only one
                                             58

relevant to yourself. The effective rate of taxation with the deduction is approximately 20% on the first
$200,000.00 of income. If your only income for a tax year was dividend income paid out from your
company, then due to the gross-up and credit provisions of the Income Tax Act, you would pay
no personal income tax on dividend income up to approximately $27,000.00/year. Thus, if your
company made $27,000 profit a year, and you declared a dividend from the company amounting to
the full after tax retained earnings, the effective combined rate of taxation of both you and your
company is 20.00%. If you had earned that $27,000 in your personal capacity as an employee, or
sole proprietor you would, depending on the province in which you live, probably have paid more.

Note, this assumes no R.R.S.P. contributions, which would make the effective personal tax rate even
lower. At this income rate, the SBD provides no great tax savings.

But, if business income significantly exceeds these amounts, incorporation does provide some tax
advantages. If the company was to earn $50,000.00 profit in a year, under the Small Business Rate
you would pay $9420.00. That would leave $40,580.00 remaining in retained earnings for you to
either leave in the company, deferring the payment of personal income tax on such amounts until
some later date, or to distribute through dividends. If you required $23,000 to live on, then once again
you would be able to declare a dividend and get that money out of the company tax free. The left over
earnings would remain in the company. In contrast, if you were to earn that $50,000 profit as a sole
proprietor you would have had to pay tax on the entire amount in the year you earned it. This would
amount to approximately $14,098 in taxes, significantly hirer than the $9,420 discussed above. (Note,
this assumes no R.R.S.P. contributions to defer taxes.) But in the first example, we assumed you only
needed after tax income of $23,000/year to meet your personal expenses. Things drastically change if
you require the dividend payout of the full retained earnings. Your personal tax liability on the payout
of $40,580 dividend would be $5,515. Thus, combining both the tax paid by the company and your
personal tax on the profits amounts to $14,935. There are many different permutations that would
create different tax savings and issues, but either way, it is apparent that any tax savings derived
through incorporation are insignificant compared to incorporation costs if annual income is below a
certain amount or if you intend to merely pay all retained earnings out of the company in the year they
are earned.

In any event, if you intend to take advantage of the SBD and incorporate there is an obstacle to
overcome. The SBD is available only against active business income that is not from a Personal
Services Business. Such a business is defined in s.125(7)(d) of the Income Tax Act and, as I
understand your future business operations, your business would probably fall within the definition,
especially if you provide your services regularly to one or two florist shops. If you work regularly for
one establishment you appear to be an incorporated employee who would be reasonably
regarded as an officer or employee of the person...to whom or to which the services were provided.
Thus, since you would fall within the definition, the Small Business Rate (18.84%) would be
unavailable and you would have to pay tax at the full corporate rate.

ii.     Independent Service Contractor

One of the reasons that you identified for contracting your services was the fact that when the florist
shops paid you, they would not have to make any deductions for tax, etc. This is not necessarily so.
Case law has shown that you cannot merely structure the arrangement between employee and
employer on paper so that it appears that the employee is an independent contractor. You must
look to the whole scheme of operations to determine the relationship between the parties. It is
unnecessary to get into the many requirements courts have identified. It is enough to say that you
should ensure that your business does not appear to be, in fact, employment by one or two flower
shops. The distinction between mere employment and independent service contracts is really a
matter of control. Who decides how to reach the final results? How much control does the employer
retain in how the service or good is produced? Who owns the tools that are required? Does the
contractor bare the risk of loss or chance of profit. Is the contract for a specific event or good? How is
the employee or individual paid? To pay by the hour or a monthly salary?
                                                      59

        Note if you are found to be an employee, this would not only the require employer to make certain
        deductions from your pay, but it also severely restricts the deductions from income that you are able
        to make. The number of allowable business deductions far exceed deductions for employees.

        iii.     Goods and Service Tax Implications

        I also think it is important to note a few things in this regard. If your gross income from sales or
        services exceed $30,000 a year, you will be required to charge an extra 7% for those services and
        required to remit those monies quarterly to the government. This doesnt really have an adverse
        effect on you, since it is the flower shops that are paying the extra amount, but it may appear to those
        shops that it costs them more to hire you as a contractor rather than as a employee. But it must be
        noted that the G.S.T. is only intended to ultimately tax the consumer. As long as they have enough
        sales, they can offset the 7% they pay you through an input credit against the 7% they collect and
        remit to the government.

c.      INCORPORATION DOCUMENTS

Corporations may only be formed by registration . Each province has its own laws governing the creation of
corporations within the province. In addition the Canadian government has also enacted federal legislation that
will govern if you wish to incorporate as a Canadian Company. The following documents are for corporations
incorporated in the province of Alberta.

Mr. Acme is in the process of expanding his widget making business. He currently operates as a sole
proprietor. He wishes to continue as the sole owner of the business, but would like to have some capacity to
attract outside investment at a future date, or provide for the inclusion of his children as shareholders (but with
no management power) as they grow older, as well as limiting his personal liability in respect of the business.

The following documents are samples of the documents which Mr. Acme could use in order to incorporate.

        i.       Articles of Incorporation
        ii.      Notice of Directors
        iii.     Notice of Address

In addition, in order to run the corporation a number of additional documents must be prepared and kept in the
corporate minute book.

        i.       Minutes of Directors Meeting
        ii.      Minutes of Shareholders Meeting
        iii.     Certificate of Incorporation
        iv.      Registers
        v.       Annual Returns
        vi.      Subscription form

Some corporations may also prepare additional documents to tailer the operation of the corporation to meet
their specific needs. Such documents might include

        i.       Corporate by-laws
        ii.      Employment Contracts
        iii.     Other Contractual arrangements

The shareholders may also decide to enter an agreement amongst themselves or with the corporation on
matters of importance to them such as the sale of shares to outsiders. As a result the following documents
might also be prepared.

        i.       Shareholder Agreement
        ii.      Unanimous Shareholder Agreement
        iii.     Voting Trust Agreement
                                               60


Samples of these documents are on the enclosed disk.
                                                  61

                                      ARTICLES OF INCORPORATION


1. NAME OF CORPORATION:

                ACME INDUSTRIES LTD.



2. THE CLASSES, AND ANY MAXIMUM NUMBER OF SHARES THAT THE CORPORATION IS AUTHORIZED TO ISSUE.

                Yes, See Schedule A attached




3. RESTRICTIONS ON SHARE TRANSFERS (IF ANY):

                Yes, See Schedule A attached


4. NUMBER, OR MINIMUM AND MAXIMUM NUMBER, OF DIRECTORS THAT THE CORPORATION MAY HAVE.

                Minimum of I, Maximum of II

5. IF THE CORPORATION IS RESTRICTED FROM CARRYING ON A CERTAIN BUSINESS, OR RESTRICTED TO CARRYING ON A
CERTAIN BUSINESS. SPECIFY THE RESTRICTION(S);

                None
6. OTHER RULES OR PROVISIONS (IF ANY):

                See Schedule A attached


7. DATE

                       00/00/00
                year    month   day



            A.B. Acme                 123 Anywhere Street Calgary,
                                      Alberta A1B 2C3
                                                     62

                                        SCHEDULE A
                           TO THE ARTICLES OF INCORPORATION OF LTD.

The corporation is authorized to issue an unlimited number of Class A and Class B shares without
nominal or par value.

The holders of the Class A shares shall have the rights, privileges and conditions of the holder of common
shares; without restricting the generality of the foregoing the holders of Class A shares are entitled:

        (a)     to vote at any meeting of shareholders of the Corporation except meetings of holders of
                another class of shares;

        (b)     To receive any dividend declared by the Corporation on the Class A shares;

        (c)     to receive subject to the rights of holders of shares of a class other than Class A shares,
                the remaining property of the Corporation on dissolution.

The Class B shares shall have the following rights, privileges, restrictions and conditions:

        (a)     Issuable in Series:

        The Class B shares may at any time and from time to time be issued in one or more series, each
        series to consist of such number of shares as may, before the issue thereof, be determined by
        resolution of the Directors of the Corporation.

        (b)     Designation, Rights, Privileges, Restrictions and Conditions of Series:

        Subject to the provisions of the Business Corporations Act, the provisions herein contained and to any
        provisions in that regard attaching to any outstanding series of Class B shares, the Directors of the
        Corporation may by resolution fix from time to time before the issue thereof the designation, rights,
        privileges, restrictions and conditions attaching to each series of Class B shares including, without
        limitation, the rate or amount of dividends or the method of calculating dividends (which may be
        cumulative or non-cumulative), the dates of payment thereof, the redemption and/or purchase prices,
        and terms and conditions of any redemption and/or purchase rights, any voting rights, any conversion
        rights and any sinking fund or such other provisions.

        (c)     Distributions:

        The Class B shares of each series shall, with respect to the payment of dividends and the
        distributions of assets in the event of any liquidation, dissolution or winding-up of the Corporation,
        whether voluntary or involuntary, or any other distribution of the assets of the Corporation among its
        shareholders for the purpose of winding-up of its affairs, rank on a parity with the Class B shares of
        every other series and be entitled to a preference over the Class A shares of the Corporation
        ranking junior to the Class B shares. The Class B shares of any series may also be given such
        other preferences, not inconsistent with the provisions hereof over the Class A shares of the
        Corporation and over any other shares of the Corporation ranking junior to the Class B shares as
        may be fixed in accordance with the provisions hereof.

        (d)     Dividends:

        No dividends shall at any time be declared or paid on or set apart for payment on any shares of the
        Corporation ranking junior to the Class B shares unless all dividends up to and including the
        dividend payable for the completed period for which such dividends shall be payable on each series of
                                                       63

        Class B shares then issued and outstanding shall have been declared and either paid or set apart
        for payment at the date of such declaration of payment or setting apart for payment on such shares of
        the Corporation ranking junior to the Class B shares; nor shall the Corporation call for redemption
        or redeem or purchase for cancellation or reduce or otherwise pay off any of the Class B shares
        (less than the total amount then outstanding) or any shares of the Corporation ranking junior to the
        Class B shares unless all dividends up to and including the dividend payable for the last completed
        period for which such dividends shall be payable on each series of the Class B shares then issued
        and outstanding shall have been declared and either paid or set apart for payment at the date of such
        call for redemption, purchase, reduction or other payment of.

        (e)      Voting:

        Except as otherwise specifically provided in the Business Corporations Act and except as may be
        otherwise specifically provided in the provisions attaching to any series of the Class B shares, the
        holders of the Class B shares shall not be entitled to receive any notice of or attend any meeting of
        shareholders of the Corporation and shall not be entitled to vote at any such meeting.

        (f)      Amendment of share Provisions

        The provisions hereof may be repealed, altered, modified, amended, or amplified with the approval of
        the holders of the Class B shares given as follows:

                 (i)       any approval given by the holders of the Class B shares shall be deemed to have
                           been sufficiently given if it shall have been given in writing by the holders of all the
                           outstanding Class B shares or by a resolution passed at a meeting of holders of
                           Class B shares duly called and held upon no less than 21 days notice at which the
                           holders of at least 25% of the outstanding class B shares are present or are
                           represented by proxy and carried by the affirmative vote of not less than two-thirds of
                           the votes cast at such a meeting, in addition to any vote or other consent or approval
                           that may be required by the Business Corporations Act of Alberta. If at any such
                           meeting the holders of at least 25% of the outstanding Class B shares are not
                           present or represented by proxy within one-half hour after the time appointed for
                           such meeting then the meeting shall be adjourned to such date not less than 15 days
                           thereafter and to such time and place as may be designated by the Chairman, and
                           not less than 10 days written notice shall be given of such adjourned meeting. At
                           such adjourned meeting the holders of Class B shares present or represented by
                           proxy may transact the business for which the meeting was originally called and a
                           resolution passed thereat by the affirmative vote of not less than two-thirds of the
                           votes cast at such meeting shall constitute the approval of the holders of the Class
                           B shares;

                 (ii)      on every poll taken at any meeting of holders of Class B shares, every holder of
                           Class B shares shall be entitled to one vote in respect of each Class B share
                           held. Subject to the foregoing, the formalities to be observed in respect of the giving
                           or waiving of notice of any meeting and the conduct thereof shall be those from time
                           to time prescribed in the articles or by-laws of the Corporation with respect to
                           meetings of shareholders.

Restrictions of Share Transfers
(a)     No shareholder shall be entitled to sell, transfer or otherwise dispose of any interest in the share or
        shares of the capital of the Corporation without the prior approval of the directors of the Corporation
        expressed either by resolution passed by the votes of a majority of the directors present at a meeting
        of the directors or by a written instrument signed by a majority of the directors.
                                                     64


(b)    The Corporation shall not make a distribution to the public of any of its securities.

(c)    The number of the Corporations shareholders, exclusive of:

       (i)     persons who are in its employment and are shareholders of the Corporation; and

       (ii)    persons who, having been formerly in the employment of the Corporation and have continued
               to be shareholders of the Corporation after termination of the employment,

       is limited to not more than fifty persons, two or more persons who are joint registered holders of one
       or more shares being counted as one shareholder.

Right of First Refusal

(a)    In the event that any holder of Class A shares of the Corporation (the Offeror) desires to sell,
       transfer, assign or otherwise dispose of any Class A shares in the Corporation (the proposed
       sale), the Offeror shall first make an offer in writing to all other Class A shareholders of the
       Offeror. Such offer shall specify and incorporate the exact terms and conditions of the proposed sale.

(b)    The Offeree(s) may accept the offer to purchase any or all of the Class A shares within a ten (10)
       day period, the offer shall be deemed to have been refused.

(c)    If any offered shares still remain unaccepted after the ten (10) day period the Offeror may, subject to
       the Articles and By-laws, sell, transfer, assign or otherwise dispose of all (but not less than all) of the
       unaccepted shares to any person, firm or corporation at a price not less than the price and on terms
       not more favourable than terms at which such shares were offered to the Offeree(s).
                                                              65

                      NOTICE OF DIRECTORS OR NOTICE OF CHANGE OF DIRECTORS



 1. NAME OF CORPORATION:                                           2. CORPORATE ACCESS NUMBER:

            ACME INDUSTRIES LTD.




3. ON THE 00 DAY OF OO , 19 00 , THE FOLLOWING PERSON(S) WHERE APPOINTED DIRECTOR(S):




             NAME                      MAILING ADDRESS (INCLUDING POSTAL CODE)            RESIDENT ALBERTAN

 A.B. Acme                         123 Anywhere Street Calgary, Alberta, A1B 2C3                         Yes [ ]
                                                                                                         No [ ]

 I.M. An investor                  456 Venture Capital Drive Calgary, Alberta B4E 5F6                    Yes [ ]
                                                                                                         No [ ]

4. ON THE     DAY OF        19     THE FOLLOWING PERSON(S) CEASED TO HOLD OFFICE AS DIRECTOR(S):




                    NAME                                      MAILING ADDRESS (INCLUDING POSTAL CODE)

                      N/A




5. AS OF THIS DATE THE DIRECTOR(S) OF THE CORPORATION ARE:


            NAME                    MAILING ADDRESS (INCLUDING POSTAL CODE)               RESIDENT ALBERTAN

                                                                                                         Yes [ ]
                                                                                                         No [ ]

           As Above                                                                                      Yes [ ]
                                                                                                         No [ ]

                                                                                                         Yes [ ]
                                                                                                         No [ ]

                                                                                                         Yes [ ]
                                                                                                         No [ ]

6. TO BE COMPLETED ONLY BY ALBERTA CORPORATIONS:
  ARE AT LEAST HALF OF THE MEMBERS OF THE BOARD OF DIRECTORS RESIDENT ALBERTANS?

         YES [ ]              NO [ ]

 7. DATE                                                   SIGNATURE                             TITLE
                        00/00/00                       A. B. Acme                         Incorporator
                       YEAR MONTH DAY
66
                                           67

                  NOTICE OF ADDRESS OF NOTICE OF CHANGE OF ADDRESS



 1. NAME OF CORPORATION                       2. CORPORATE ACCESS NUMBER


       ACME INDUSTRIES LTD.




3.    ADDRESS OF REGISTERED OFFICE (STREET ADDRESS, INCLUDING POSTAL CODE OR
      LEGAL LAND DESCRIPTION).

      123 Anywhere Street
      Calgary, Alberta
      A1B 2C3




4.    RECORDS ADDRESS (STREET ADDRESS, INCLUDING POSTAL CODE OR LEGAL LAND
      DESCRIPTION).


      As Above




5.    ADDRESS FOR SERVICE BY MAIL IF DIFFERENT FORM ITEM 3 (POST OFFICE BOX
      INCLUDING POSTAL CODE).


      As Above




 6. DATE                              SIGNATURE                          TITLE

       00/00/00               A. B. Acme                  Incorporator
                                                  68

D.   JOINT VENTURES, SYNDICATES, BUSINESS COOPERATIVES
a.   KEY QUESTIONS



     i.      a)       WHAT IS A JOINT VENTURE?

             b)       SHOULD THE AGREEMENT BE WRITTEN?

             c)       HOW CAN CO-VENTURERS PROTECT THEIR INTERESTS?

             d)       HOW CAN CO-VENTURERS PLAN FOR THE TERMINATION OF THEIR
                      VENTURE?

     ii.     WHAT IS A SYNDICATE?

     iii.    WHAT IS CO-OWNERSHIP?

     iv)     WHAT IS A BUSINESS TRUST?

     v)      COOPERATIVE ASSOCIATIONS

             a)       WHAT IS A CO-OPERATIVE?

             b)       HOW DO CO-OPERATIVES OPERATE?

             c)       HOW ARE CO-OPERATIVES ESTABLISHED?

     vi)     SOCIETIES

             a)       WHAT IS A SOCIETY?

             b)       IS IT A SOCIETY?

             c)       ARE SOCIETIES CHARITIES FOR TAX PURPOSES?



     i.      a)       WHAT IS A JOINT VENTURE?

     The phrase joint venture has had various meanings attributed to it. Sometimes it is equated with a
     partnership. On some occasions, it is used to refer to an association of two or more persons for a
     limited purpose without the participants becoming partners. At other times it is used in the generic
     sense to refer to any combination of resources by two or more persons in order to conduct a
     commercial venture jointly under agreed rules. Defined as such, it is sufficiently broad to cover a wide
     variety of commercial arrangements carried on jointly by and for the benefit of the participants,
     including a partnership, a limited partnership or a corporation.
     For legal purposes, the distinction between a joint venture and a partnership, in particular, is very
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important as the rules with respect to both liability and taxation will vary depending on how the venture
is categorized. For example, joint venturers are not subject to the provisions of the Partnership Act
nor are they considered agents of each other in the same way that partners are. Joint venturers are
also not required to comply with tax rules that would otherwise, for example, obligate all partners to
claim their tax write offs for capital cost allowance (depreciation) in the same year.

Unfortunately, the law is not clear about exactly what is required to distinguish a partnership from a
joint venture, nor is it clear about the liability that joint venturers may assume on behalf of each other.
Notwithstanding these limitations, many legal arrangements are entered into and described as joint
ventures by the parties. The most common example includes a land developer and a building
contractor who enter a joint venture to build a housing development. Individuals, corporations,
partnerships or any combination can all enter joint venture arrangements. Whether or not the terms of
their agreement or partnership law will be imposed in actions against the venture by third parties will
be determined by the courts on a case-by-case basis.

b.      SHOULD THE AGREEMENT BE WRITTEN?

In most cases, there should be written agreements between the members of the joint venture both to
set the rules, at least on the major points, by which the venture will be governed and to establish that
a joint venture and not a partnership exists between the parties. Some of the matters to be included in
the agreement might include: the nature of the commercial activity in which the joint venture will
engage, the contribution of each co-venturer, their share in any profits and losses, the duration of the
joint venture, the management arrangements for the venture, how and when a co-venturer may obtain
his share of the profits or the return of its contribution to the venture and the provisions for a
dissolution of the joint venture.

The agreement might also include a statement that, in the event a court of law or other competent
tribunal determines the joint venture to be a partnership, the agreement be construed as a partnership
agreement for the purposes of providing alternatives to the statutory rules governing the partnership
relationship.

The written documentation should contain as few of the positive indicia of partnership and as many of
the negative indicia of partnership to enable the parties to establish that their relationship is not a
partnership.

The following aspects of the formal documentation may be relevant when considering whether an
arrangement is considered a joint venture:


        1.       A clear statement that the parties intend to operate as co-tenants or co-venture with
                 respect to the joint venture and not as a partnership;

        2.       A statement that the parties do not share fiduciary obligations and are not agents for
                 each other;

        3.       A provision that each party;

                 i)       Will be free to compete with the joint venture and will not be liable to
                          account to his co-venturers for profits from competing activity;

                 ii)      Will be free to enter separate dealings with the joint venture and will not be
                          required to disclose such dealings to his co-venturers;

                 iii)     Will be free to use any knowledge or information gained through his
                                               70

                           participation in the joint venture for his or her personal benefit;

                  iv)      Will be free to capitalize on any business opportunity that arises solely out of
                           his participation in the joint venture.

         4.       A provision that each co-venturer may:

                  i)       assign his or her interest without the consent of his co-venturers;

                  ii)      provide for the disposition of his or her interest in the joint venture on death,
                           allowing for a deceased partys successors to take the deceaseds place in
                           the venture.

         5.       A statement that each party is free to contract with others for the performance of the
                  partys obligations under the agreement.

c.       HOW CAN CO-VENTURERS PROTECT THEIR INTERESTS?

A major concern of any participant in a joint venture is that he be able to protect his interest in the joint
venture. This is often accomplished by requiring that all co-venturers agree before any action is taken
by the joint venture or that any co-venturer can veto any action with which he disagrees. Some of the
other common techniques used to protect co-venturers are:

         1.       Ensuring equality as to votes cast by all of the co-venturers;

         2.       The creation of a deadlocked board of directors, management committee or other
                  body managing the business of the joint venture by permitting each co-venturer to
                  appoint an equal number of members;

         3.       A requirement that a representative of each co-venturer sign cheques, contracts and
                  other documents;

         4.       A requirement that the consent of each co-venturer be obtained prior to committing
                  the joint venture to various fundamental acts, such as signing certain types of
                  contracts, making or committing certain expenditures or other obligations;

         5.       Imposing restrictions on the transfer of each co-venturers interest in the joint
                  venture or on any change in the equity interests of the co-venturers without notice to
                  the other co-venturers.

                  Such provisions, if accepted by the co-venturers, are implemented by including them
                  in the joint venture agreement.

d.       HOW CAN CO-VENTURERS PLAN FOR THE TERMINATION OF THE VENTURE?

         One of the most important matters to consider in connection with a joint venture is the
         method for terminating it. Often the parties will want a mechanism which permits some co-
         venturers to be able to continue to carry on the joint venture, rather than having it dissolved
         and the assets sold when one co-venturer wishes to terminate his involvement in the joint
         venture. Different mechanisms can be used depending upon the nature of the activities of the
         joint venture, the relationship between the co-venturers, their contributions to the joint venture
         and their relative commercial strengths and weaknesses. No method will be suitable in all
         instances. One should choose the type of arrangement that is foreseen to be the most
         realistic method in each case. It should be a method which the co-venturer will be able to
                                              71

        exercise as the need arises. For example, he must have the financial resources. It should
        also be a method, if possible, which does not put the co-venturer at a disadvantage in relation
        to the other co-venturers.

        Some of the commonly used arrangements include:

        1.       Right of first refusal: a co-venturer, prior to selling his interest to a bona fide third
                 party, is obliged to offer his interest to the other co-venturer(s) on the same terms as
                 the bona fide third party offeror was prepared to accept, but if the right of first refusal
                 is not exercised, the co-venturer is free to sell to the third party offeror. A practical
                 problem facing the co-venturer who receives the offer is that he may be obliged to
                 exercise the right of first refusal if he does not wish to become associated with the
                 third party offeror.

        2.       Shotgun buy-sell: In its simplest form, one co-venturer names a price, and the other
                 co-venturer(s) decides whether to buy or sell at that price. Except for the matter of
                 price, a buy-sell clause may, and perhaps should, settle other important terms
                 relating to the buy-sell (such as terms of payment, security, non-competition
                 covenants etc.). If the buy-sell clause does not provide for such terms, the clause
                 may not be useful. For example, if the clause does not contain a non-competition
                 covenant, no co-venturer may be willing to invoke the clause because he would not
                 want to be a purchaser without obtaining such a covenant.

        3.       Puts or Calls - A call is an option which enables one co-venturer to call upon
                 another to sell its interest in the venture on terms which are usually settled when the
                 call option is granted. A put is an option which enables one co-venturer to put its
                 interest in the venture to another co-venturer and require the latter to buy the interest
                 on terms which are settled when the put option is granted. The put or call
                 may be absolute in its terms or may be contingent upon compliance with various
                 covenants, such as performance criteria or other arrangements such as employment
                 arrangements.

                 If it is not possible to terminate a joint venture in any other way, an application may
                 be made to the courts.

ii.     WHAT IS A SYNDICATE?

The word syndicate is used as a business term to describe a group of persons who have pooled
their resources for some common purpose. Notwithstanding the widespread use of the term, in law
there is no such entity as a syndicate. The group of persons pursuing the common interest may
constitute a partnership.

For example, if three hotel companies put up $5,000 each to buy and operate a successful Vancouver
hotel, the syndicate would likely be considered to be a partnership, particularly if the companies
were all in the hotel business. It is clear that they are carrying on business in common with a view to
profit regardless of what they call their arrangement.

iii.    WHAT IS CO-OWNERSHIP AND HOW DOES IT DIFFER FROM A PARTNERSHIP?

Co-ownership simply means that more than one person owns the property. It differs from a
partnership relationship which results in both agency between the partners and unlimited liability of the
partners (as a result of the agency relationship) to creditors. Co-ownership of property results in
neither. Some of the other main differences between co-ownership and partnership include:
                                                72

         a)       Co-ownership does not necessarily require the showing of profit or loss. Partnership
                  does.

         b)       A co-owner can, without the consent of his co-owners, transfer his interest or, in the
                  case of land, his equitable interest to a stranger. A partner is in a much more
                  restricted position.

         c)       One co-owner is not the agent, real or implied, of the other co-owners. A partner is,
                  so far as concerns activities falling within the scope of the partnership.

         d)       A co-owner has no lien on the property owned in common for outlays and expenses,
                  or for what may be due from the co-owners as their share of a common debt. A
                  partner does.

iv.      WHAT ARE BUSINESS TRUSTS?

A business trust is an alternative to co-ownership of property. Typically, the trustee of a business trust
holds the legal title to its property, but the title is held for the benefit of the beneficiaries of the trust.

The advantage of business trusts is that they are easy to administer. Since legal title to all of the
trusts property is in the trustee, it is much easier to transact with the property. In contrast, joint
ventures may require the signatures of all of the participants to the business arrangement. This can
become quite cumbersome when there are numerous transactions.

Business trusts are not used extensively in Canada any more due to the high rate of tax on inter vivos
trusts. They were sometimes used in cases where tax write offs were expected, since some of these
write offs could be flowed-through to the investors. More recently, however, business trusts have
become even more unattractive due to changes to the Income Tax Act. For example, when the assets
of a business trust are distributed to the beneficiaries, any increase in value is now taxable to the trust
at top marginal rates. Business trusts are more common in the United States.

v.       CO-OPERATIVE ASSOCIATIONS

a)       WHAT IS A CO-OPERATIVE?

Some businesses are operated through co-operative associations. These may be loosely defined as a
democratically-controlled association of persons that operate for the purpose of either supplying
themselves with goods or services, or in some cases to market goods and services. Food co-
operatives or, in Alberta, rural gas co-operatives, are examples of supply co-ops. Agricultural
products provide classic examples of goods that reach the public through agency marketing co-
operative associations, particularly dairy and wheat products.
Whether the co-operative is an association established to supply goods or services or an association
established to market goods, all co-operatives share one thing in common, they are all regulated by
provincial legislation, specifically governing co-operative associations.

b)       HOW DO CO-OPERATIVES OPERATE?

Co-operatives are similar to corporations in that they are a distinct entity at law and are thus capable
of forming contracts and being sued. Further, they have perpetual existence and their members
(shareholders) have limited liability.

However, it is important to note that a co-operative unlike most corporations, does not have the
capacity of a natural person when entering business arrangements. Therefore, when dealing with a
co-operative one must look to the Memorandum of Association, the Bylaws and any legislation that
                                             73

dictates the co-operatives capacity. The association is required to file basic forms setting out its
name, its object or objects and the location of its registered office. Each co-operative association
must also have bylaws under which the affairs of the association are to be regulated, governed and
managed. Therefore, in considering the issue of whether a co-operative has the capacity or power to
enter into a certain transaction or perform a certain act, look first to the Memorandum of Association
to determine whether the association has the power to carry out the transaction.

Under the various provincial statutes, cooperatives also have several other characteristics which are
unique:

        1.       each member has only one vote,
        2.       voting can not be delegated or done by proxy,
        3.       interest and dividends on capital are limited by law,
        4.       a co-operatives business is carried on primarily for the benefit of its members,
        5.       the business of the corporate body is carried on as nearly as possible at cost after
                 providing for reasonable reserves and the payment or crediting of interest or
                 dividends on capital, and
        6.       any surplus arising from the business, after providing for reasonable reserves or the
                 maintenance and improvement of services, is distributed in whole or in part among
                 the co-operatives members.

c)      HOW ARE CO-OPERATIVES ESTABLISHED?

The legislation of each province (Co-operative Associations Act) regulates how co-operatives are
established. Typically, applications are made to a Minister or director specifying the co-operatives
name, business objective or purpose, place of association and selected financial information. Some
provinces also require that co-operatives have a minimum number of members (e.g., Alberta requires
10 or more members while British Columbia requires a membership of 5 or more persons); other
provinces have no such restriction. Once the association has complied with the required formalities
the director or Minister will grant a certificate or designate the association a co-operative. The use of
the term co-operative in the business name is also dictated by provincial legislation.

vi.     SOCIETIES

a)      WHAT IS A SOCIETY?

A society is a form of incorporation, created for a purpose other than carrying on a trade or business.
Individuals wishing to pursue any benevolent, philanthropic, charitable or other useful purpose may
choose to incorporate under the provincial Society Acts or under federal legislation. The advantages
of incorporating a society are similar to the advantages of incorporating for a business purpose.
Significantly, incorporation under the Society Act allows individuals to pursue benevolent or charitable
activities without exposure to unlimited liability relating to those activities.

b)      IS IT A SOCIETY?

Some business ventures are formatted as clubs or information-based organizations. The organizers
will incur costs and may hope for some profit. For example, assume someone named Mr. Buston
would like to incorporate The Innovators Information and Aid Society under the Society Act. Among
other assistance to be provided by this society, Mr. Buston plans to advertise that it will pay patent
and prototype cost for twenty five percent interest of each designs value after cost. Would this
proposed organization be viewed as a Society under the Society Act? The answer is no.

The Society Act sets out the steps by which a group of people can have a society incorporated. Under
                                                  74

     all societies, legislation a basic requirement is that a society must not participate in a trade or
     business. If the society will pay patent and prototype cost for twenty-five percent interest of each
     designs value after cost, the receipt of this royalty by the society suggests that the society is
     pursuing a trade or business (financing inventors in exchange for a future share of profits) contrary to
     these requirements. This feature of the societys objectives would have to be revised in order to
     comply with the Societys Act.

     c)      ARE SOCIETIES CHARITABLE ORGANIZATIONS FOR TAX PURPOSES?

     The process of incorporation as a society does not entitle the society to claim charitable status for
     income tax purposes. Canada Customs & Revenue Agency has established its own criteria for
     determining when an organization can claim charitable status in respect of any income generated in
     the course of pursuing a charitable activity. Status in respect of any income generated in the course of
     pursuing a charitable activity.

b.   CHOOSING A JOINT VENTURE

     Example Problem

     The following three groups have come to you with their proposed venture.

     1.      The board of directors of the Fourth Street Church, an old and venerable institution which has
             occupied land owned by it for some seventy-five years has become aware that the church is
             sadly in need of substantial renovations. The parish is wealthy and sophisticated but wants to
             consider means by which it can build the new church without substantial immediate cost to
             themselves. They are willing to enter into an arrangement with other parties provided that
             they retain ownership of the land (which they feel compelled to do because of its earlier
             contribution by one of their original parishioners). The church is not taxable under the Income
             Tax Act. They will consider striking a deal to have the church occupy part of a larger building
             provided that there is no possibility of eviction or losing its interest in that larger building.

     2.      Bigco is a substantial lessee of property in Calgary for its various offices. The offices are all
             administrative in nature and it would benefit the company to consolidate its operations in one
             building. Bigco is taxable at the maximum rate. In order to minimize its occupancy cost and to
             benefit from potential appreciation and higher immediate write-offs Bigco is willing to enter
             into an arrangement where they become an owner or co-owner with respect to a building they
             will occupy. However, if a co-ownership arrangement is entered into Bigco insists on a right of
             first refusal with respect to any interest sold in the building.

     3.      Architectco is a partnership engaged in architectural and engineering design work. Over the
             years it has built a substantial portfolio of real estate investments, many of which it has
             designed itself. It is now ready to design a flagship building in which it would occupy premium
             space. It is willing to consider an arrangement whereby it would forego fees for its
             engineering and design services in order to acquire an interest in a project. However, a
             greater concern is protection of its substantial investments and its professional members; as
             a result Architectco is fully taxable and thus would appreciate any opportunities that might
             arise for shelter of that income.

     Required: Review the fact situation and determine the most appropriate form of business association
     to accommodate everyones objectives.

     Solution: Everyones objectives and requirements can substantially be met through the organization
     of a joint venture.
                                              75


Bigco would be the owner of the building and therefore would arrange the additional financing
required to complete the project. Bigco, as owner, would then be entitled to claim tax write-offs in the
form of capital cost allowance and would also be entitled to deduct the cost of borrowing for the
venture. This meets Bigcos goal of benefitting from higher write-offs. Bigco made an investment in
anticipation of an appreciation in the value of the building.

The Church will retain ownership of the land but lease the portion required for the building to Bigco for
the maximum period that such a leasehold interest can be granted with renewal options. Bigco will in
turn lease back the portion of the building that the Church requires for its purposes for the same
length of time. The lease agreements between the Church and Bigco would include covenants to the
effect that the existence of the one lease is dependant upon the existence of the other. This gives the
Church security from eviction.

In meeting Architectcos objectives, it will be necessary to put a value on their contribution to the
venture. Their most important concern is limited liability. The safest vehicle for achieving this goal is a
limited partnership. However, it seems likely that providing design and engineering services would be
sufficient involvement in the business to convert Architectcos limited partnership interest to a general
partnership interest, and expose the firm to liability as a partner.

A joint venture is more consistent with everyones needs. The difficult problem is determining what
Architectco should be getting in exchange for its contribution. They want to occupy premium space in
the building, to have some sort of an interest in the project. These objectives could be met by
notionally selling the required space to them in exchange for their services. Architectco can then
dispose of their interest at will, subject only to a right of first refusal held by Bigco.

This arrangement is also consistent with the concept of a joint venture in that the relationship between
Architectco and its co-venturers is of limited duration and for a limited purpose. Architectco
contributes its services to the project and takes away its interest on completion. The ongoing
relationship is limited to the right of first refusal held by Bigco. [It is clear from A.E. LePage v. Kamex
(1977), 16 O.R. 92d) 193; Affd [1979] 2 S.C.R. that such a right is consistent with the existence of a
Joint Venture relationship].

As noted above, there may be an advantage to a limited partnership arrangement here in that limited
liability is more certain, that is, if the project is deemed not to be a joint venture it will likely be
considered a partnership, however, there are also several disadvantages. Most notably, income will
be calculated at the partnership stage for tax purposes requiring agreement on the method of
calculating income and the partnership At Risk rules will apply to limit the deduction of losses to the
amount of any contribution of actual capital (this would exclude the contribution of services by
Architectco).

It should also be noted that registration requirements must be met to ensure the limited liability of the
limited partners and at least one of the parities would have to take on the role of general partner and
the risk of liability for the entire project.

It is clear that the agreement will have to be carefully drafted to ensure the arrangement is not
construed as a partnership.

The agreement should contain as many of the elements of a joint venture as possible. The intention of
the co-ventures should be clear throughout the agreement. For example, the agreement should be
called a Joint Venture Agreement and contain statements to the effect that a fiduciary relationship is
not being created [that the parties are not agents of one another], disclaimers of responsibility for
debts and obligations of co-venturers, and a clause stating that the co-venturers are not prohibited
                                           76

from participating in similar competitive businesses.
                                                  77

                  II. OTHER BUSINESS ARRANGEMENTS
     Franchising in Canada has developed into an enormous and dynamic business activity. For many
     years, it has been a dominant factor in such fields as automobile sales, gasoline retailing and soft
     drink bottling. These traditional forms of franchising still account for 80% by dollar value of all
     franchise sales in Canada. However, in the past twenty years, franchising has become a marketing
     technique for an extensive range of products and services, predominantly in the fast food, automobile
     repair and personal service businesses.

a.   KEY QUESTIONS


     i.      WHAT IS A FRANCHISE?

     ii.     WHAT IS THE PURPOSE OF FRANCHISE LEGISLATION, AND TO WHOM DOES IT
             APPLY?

     iii.    WHAT SHOULD A PROSPECTIVE FRANCHISEE KNOW ABOUT HIS RIGHTS UNDER
             THE LEGISLATION?

             a)       FEDERAL
             b)       PROVINCIAL

     iv.     WHAT IS THE DIFFERENCE BETWEEN A FRANCHISE AND A PYRAMID OR MULTI-
             LEVEL MARKETING SCHEME?

     v.      WHAT IS A DISTRIBUTION AGREEMENT?



     i.      WHAT IS A FRANCHISE?

     Most people associate the word franchise with the popular food and clothing chains in existence
     today, for example: McDonalds, Boston Pizza, or The Gap. The advantage of entering into a
     franchised business is that the product or service has been tested in the marketplace, thus reducing
     the risks associated with starting a wholly independent business.

     In most cases, it is a package deal where the franchisor allows the franchisee to use its trademark,
     tells the franchisee how to set up and run the business, and gives the franchisee certain prescribed
     assistance such as site selection and a model bookkeeping procedure to follow. The franchisor
     sometimes also undertakes certain continuing obligations such as advertising, training, quality control,
     and business advice. Normally, the price for all this is a fixed fee plus a certain percentage of sales.

     The franchisor usually retains some rights as to quality control and advertising (e.g., McDonalds food
     has to meet certain standards, and the Golden Arches trademark must be used at the location).
     However, the franchisee runs the business with the franchisor acting as the helper and counselor.
     The franchisor helps to reduce the risk of starting out in business by providing a tested and proven
     package.

     The franchise fee generally entitles the franchisee to the following help, services, and support:
                                             78

a)      Site selection assistance that includes feasibility studies, demographic analysis, and location
        selection;

b)      Lease negotiation assistance where the franchiser provides help and advice on negotiating a
        lease;

c)      Financial assistance in financing the start-up and initial operating costs (Note: some
        franchisors provide financial assistance, the others should at least provide detailed guidance
        in obtaining financing);

        d)       Training;
        e)       Continuing support;
        f)       Advertising and marketing;
        g)       Discounts on products and equipment;
        h)       Research and development;
        i)       On-call assistance

In Alberta, a franchise has a state legal definition. According to the Franchises Act (Alberta) you are a
franchise if you have been granted the right to engage in a business that satisfied three criteria (s.
1(d)):

1.      It is a business in which goods or services are being sold, offered for sale, or distributed,
        under a marketing or business plan that is prescribed in substantial part by the franchisor or
        its associate;

2.      It is a business that is substantially associated with a trademark, service mark, trade name,
        logotype or advertising of the franchisor or its associate, or designating the franchisor or its
        associate, AND;

3.      It is a business that involves either:

        (i)      a continuing financial obligation to the franchisor or its associate by the franchisee,
                 and also, significant continuing operational controls by the franchisor or its associate
                 on the operations of the franchised business, OR;

        (iii)    a payment of a franchise fee (defined as a direct or indirect payment to purchase or
                 operate a franchised business).

The Act also defines the terms master franchise, subfranchise, subfranchisor, and
subfranchisee. These terms are not essential to developing an understanding of the Franchises
Act, though in the event that you further contemplate becoming involved in a franchised business, you
are urged to consult the definitions in the Act.

ii.     WHAT IS THE PURPOSE OF THE FRANCHISES ACT (ALBERTA)?

The Franchises Act has three primary functions:

       It requires franchisors (sellers) to disclose necessary information about the franchise to the
        prospective franchisee (buyer). The information that is required to be disclosed is intended to
        assist the prospective franchisee to make an informed decision before entering into any
        franchise agreements (s. 2(a));

       It provides for legal remedies in the event that the Franchises Act is breached (s. 2(b));
                                           79

       It governs the relationship between franchisors and franchisees, and is intended to promote
        fair dealing between the parties (s. 2(c)).

To whom does the Franchises Act apply?

If:

       the proposed business venture meets the definition of franchise provided above;

       the franchised business is to be operated either partly or wholly in Alberta, AND;

       the purchaser of the franchise is an Alberta resident OR has a permanent establishment in
        Alberta for the purposes of the Alberta Corporate Tax Act;

then the Franchises Act applies to the business venture, so long as the sale was made on or after
November 1, 1995 (s. 3(1)).

iii.    WHAT SHOULD A PROSPECTIVE FRANCHISEE KNOW ABOUT HIS RIGHTS UNDER
        THE LEGISLATION?

Anyone considering the possibility of buying a franchised business has certain rights, and the
franchisor (seller) has certain obligations.

(a)     What are the obligations of a franchisor?

A franchisor must give every prospective buyer of a franchise a copy of a disclosure document.
The disclosure document must meet certain formalities which are prescribed in the Act, and
regulations. These formalities relate mainly to:

       when the disclosure document must be released (timing);
       what information must be contained n the disclosure document (contents).

        (i)     Timing

        The disclosure document must be received by the franchisee;

               at least 14 days before the franchisee signs any agreement relating to the franchise,
                OR;

               at least 14 days before the franchisee makes any payment relating to the franchise,

        whichever occurs first (s. 4(2).

        A franchisee may be asked to make a payment of a fully refundable deposit, prior tot he
        release of a disclosure document. The payment of a fully refundable deposit IS NOT a
        payment relating to the franchise (s. 4(6)), so long as the deposit meets certain criteria
        (s. 4(8)):

               the deposit must be refundable without any deductions;
               the deposit cannot exceed the amount that is prescribed by the regulations;
               the deposit agreement can in no way bind the prospective franchisee into entering a
                franchise agreement.
                                            80

        As well, there are three types of agreements which are NOT considered to be agreements
        relating to the franchise (s. 4(7)):

               an agreement concerning payment of a fully refundable deposit;
               a confidentiality agreement, which concerns the keeping confidential of any
                information and material that is provided to a prospect franchisee;
               an agreement designating the location or territory of a prospective franchised
                business.

        Thus, any one or all of these agreements may be entered into, and payment of a fully
        refundable deposit, may be required, without the franchisor being required to issue a
        disclosure document.

(b)     Contents

The franchisor must ensure that the disclosure document provided to the prospective franchisee
contains the following information:

       anything that is required by the regulations to be included in the disclosure document (s.
        4(3)(a);

       copies of all proposed franchise agreements (s. 4(3)(b));

       financial statements, reports, and other documents which the regulations require (s. 4(3)(c)).

Because regulations are frequently amended, both the franchisor and franchisee should inform
themselves of the most recent regulatory requirements concerning the contents of the disclosure
document.

(c)     Are there any exempt ions to the requirement that a disclosure document must be
        provided to a franchisee?

The Franchises Act lists several specific circumstances where a prospective franchise sale will be
exempt from disclosure requirements of the Act (s. 5(1)). The Minister may also, by way of regulation,
create additional exemptions.

According to the Act, a sale of a franchise will be exempt from the disclosure requirements under any
one or more of the following circumstances:

        (i)     Where a franchisee sells a franchise, if the following four conditions are met:

                        if the franchisee is not the franchisor, an associate of the franchisor, or a
                         director, officer or employee of the franchisor or its associate;

                        if the sale is for the franchisees own account;

                        if it is a case where the master franchise sells the entire franchise; and

                        if the sale is not effected by or through the franchisor. However, a franchisor
                         may maintain a reasonable right to approve or disapprove of a sale
                         (s. 5(2)(a)). A franchisor also maintains the right to require a payment of a
                         transfer fee, so long as the amount of the transfer fee has been previously
                         specified in the franchise agreement. If there is no transfer fee specified in
                                     81

                 the franchise agreement, the franchisor still maintains the right to charge a
                 transfer fee, so long as the fee does not exceed the reasonable actual costs
                 incurred by the franchisor to process the transfer (s. 5(2)(b).

Generally speaking, sales that meet the criteria outlined above are sales that are NOT made
for the purposes of expanding the franchise and creating additional outlets. Rather, the sale
is made for the purpose of selling a franchise outlet already in existence.

(ii)     Where the franchise is sold to a person who has been either:

                an officer or director of the franchisor, or
                the franchisors associate

for at least six months and it is sold for that own persons account (s. 5(1)(b)). As a general
proposition, and individual meeting, these characteristics would already possess or have
access to the type of information that is required to be included in a disclosure document.

(iii)    Where the sale of an additional franchise is made to a person already owning
         an existing franchise

So long as the additional franchise is substantially the same as the franchise that is currently
owned and operated, a disclosure document will not be required (s. 5(1)(c)). Again, such an
individual would already possess or have access to the type of information that is required to
be included in a disclosure document.

(iv)     A renewal or extension of an existing franchise agreement (s. 5(1)(d))

(v)      If the franchisee is required, by the terms of the sale of the franchise, to make
         a total annual investment to acquire and operate the franchise (s. 5(1)(e)): so
         long as the amount of the investment does not exceed the amount prescribed by the
         regulations (currently $5,000.00).

(vi)     Where the sale of the franchise is made by any of the following classes of
         persons: an executor, administrator, sheriff, receiver, trustee in bankruptcy, or
         guardian on behalf of a person other than the franchisor or the estate of the
         franchisor (s. 5(1)(f)).

(vii)    Where the sale concerns the right of a person to sell goods or services within
         or adjacent to a retain establishment as a department or division of the
         establishment, if the person is not required to purchase goods or services from the
         operator of the retail establishment (s. 5(1)(g)).

(viii)   Where the sale is a sale of a fractional franchise (s. 5(1)(h)). A fractional
         franchise is defined as a franchise which has been granted to a person to sell goods
         or services within a business which that person has an interest. The sales from such
         a franchise must be anticipated by the parties at the time the franchise is entered
         into, not exceed, in relation to the total sales of the business, the percentage that is
         prescribed by the regulations. The current regulations (July, 1996) state that the
         permitted maximum percentage of fractional franchise sales to total sales is 20%.

         If your proposed business venture does not fall under one of the above categories,
         you may still qualify for an exemption that has been made pursuant to the regulation
         (s. 6(1)). It is also possible to apply for an exemption. The Minister has the authority
         to exempt the following:
                                              82


                          any person or class of persons;
                          any sale of a franchise, or any class of sale of a franchise;
                          any franchise or class of franchise.

(d)      Does the franchisor have any other special rights as a franchisee, and are there any
         special obligations of a franchisor?

Yes

Fair Dealing

Every franchise agreement imposes on each party a duty of fair dealing in the franchise
agreements performance and enforcement (s. 7).

Association

A franchisor (or its associate) must not in any way prohibit or restrict any franchisee from:

        forming an organization of franchisees;
        associating with other franchisees in any organization of franchisees (s. 8(1)).

A franchisor (or its associate) must not directly or indirectly penalize a franchisee for engaging in any
of these association activities (s. 8(2)). If a franchisor contravenes the rights of a franchisee to
associate, a franchisee has a right of action in damages against the franchisor or its associate, as the
case may be (s. 11).

Jurisdictional Control

The law of Alberta applies to franchise agreements (s. 16). This is an important restriction on the
relationship between franchisors and franchisees in Alberta. Normally, parties to a business
agreement are free to chose which laws they wish to govern their agreement.

If a franchise agreement restricts the application of Alberta law, or restricts the jurisdiction or venue to
hear a dispute to any place outside Alberta, that provision will be void if the claim is otherwise
enforceable under the Alberta Franchise Act (s. 17).

(e)      What are your legal rights if a franchisor has breached the provisions of the
         Franchises Act?
         (i)    What if the franchisor fails to provide the disclosure document to the
                prospective franchisee within the time period stated in the Act?

         The franchisor must strictly comply with the timing requirement set out in the Act. A failure to
         do so gives the franchisee an automatic right to rescind all franchise agreements, and to be
         fully compensated by the franchisor for any losses.

         The franchisee must meet certain deadlines prescribed by the Act for the rescission to be
         enforceable:

                 the franchisee must give notice of the cancellation to the appropriate person (the
                  franchisor or its associate) no later than sixty (60) days after receiving the disclosure
                  document, OR;
                                             83

                no later than two (2) years after the franchisee has been granted the franchise,

        whichever occurs first (s. 13).

        If the franchisee exercises his or her right to rescind all franchise agreements, it has the
        effect of canceling all franchise agreements (s. 14(1)(a)). If the only agreement in existence
        at the time is an offer to purchase, the rescission will function to withdraw the offer to
        purchase (s. 14(1)(b)).

        Upon receiving notice of a cancellation brought about by these circumstances, the person
        receiving the notice must then fully compensate the franchisee for any net losses that the
        franchisee incurred in acquiring, setting up and operating the franchised business (s. 14(2)).

(ii)    What if the information provided in the disclosure document was misrepresented by
        the franchisor, and the franchisee suffers loss because of relying on the
        misrepresentation?

        The franchisee will have a right of action for damages against both the franchisor, and
        anyone who signed the disclosure document which contained the misrepresentation (s. 9(1)).

        A misrepresentation is defined as an untrue statement of material fact, an omission to state a
        material fact that is required to be stated, or an omission to state a material fact that needs to
        be stated in order for a statement not to be misleading.

        The franchisee only needs to establish that there is a misrepresentation in the disclosure
        document. Once that is established, it is deemed that the franchisee relied on it (s. 9(2)).

(f)     Can franchisees waive any of the rights they have been given under either the
        Franchises Act, or the regulations?

No. The Act is intended to protect the franchisee. Any waiver or release of any requirement of the Act
or any regulation that has been signed by a franchisee will be void and unenforceable (s. 18).

(g)     Does the new Franchises Act apply to franchises which were bought or sold prior to
        this Act being created?

Some parts of the Franchises Act will apply to franchise businesses bought or sold prior to the coming
into force of the Act.

For the Act to apply to already existing franchises, the following two criteria must first be met:

       the franchised business must be operating, or will be operating partly or wholly in Alberta,
        AND
       on November 1, 1995, the franchisee must have been an Alberta resident or had a
        permanent establishment in Alberta for the purposes of the Alberta Corporate Tax Act.

If these two criteria are met, the parts of the Act that will apply to the these franchises are:

        s. 5(1)(d) & (f): existing franchises will be exempt from the disclosure requirements only if
        the agreement being made is for the renewal or extension of an existing franchise
        agreement, or if the sale of the franchise was a sale by an executor, administrator, sheriff,
        receiver, trustee, trustee in bankruptcy or guardian on behalf of a person other than the
        franchisor or the estate of the franchisor. All other exemptions to the disclosure requirements
        (which exemptions are listed in s. (5) will not apply.
                                                   84


             The Minister has authority to exempt these franchises from complying with any part of the Act
              (s. 6).

             Such franchise agreements will still impose on each party a duty of fair dealing (s. 7).

             The provisions in the Act concerning the rights of franchisees to associate with other
              franchisees (s. 8) will apply to these franchises, and the remedies will be the same (s. 11).

      Disclosure requirements will not apply to the sale of a franchise if, before the coming into force of the
      Act (prior to November 1, 1995) a franchise agreement was entered into, but one or more of the
      agreements required to be entered into to complete the sale occurred after the coming into force of
      the new Act, AND a prospectus or statement of material facts was given to the franchisee in
      compliance with the old Act (s. 22(1)). This transitional provision allows sales which were commenced
      under the old regulatory framework, but not yet completed at the time the current Act came into force,
      to be completed.

      Conclusion:

      A prospective franchisee is entitled to be fully informed by the franchisor about the material aspects of
      franchise operation. This is the function of the disclosure document. The information that is to be
      included in the disclosure document may be found in the Act and in the regulations, and the
      requirements must be strictly complied with.

      IV.     WHAT OTHER LEGISLATION GOVERNS FRANCHISES?

              a)       Federal

      Attention should be paid to the provisions of the Competition Act particularly the sections dealing with
      exclusive dealing, and pyramids schemes.(See Chapter 5, consumer protection legislation)

              b)       Provincial

      There are a number of provincial statutes affecting franchisees and franchisors. These include
                            109
      securities legislation , provincial unfair business practices legislation, pyramid operations
                 110
      legislation , and consumer protection legislation relating to product warranties, disclosure of cost of
      borrowing, (see chapter 5) and registration and licensing of certain types of selling operations. (see
      chapter 3).

      If the purchase or sale of the franchise involves the transfer of shares, the franchisee/franchisor will
      want to be sure the filing and reporting provisions of the provincial Securities Act(s) of the
      jurisdiction(s) in which the transfer will occur, have been met. Whether a trade in franchise securities
      will be caught by the Securities Act will depend on whether or not the company holding the shares can
      be classified as a private company, (i.e. one whose articles of incorporation include a share
      transfer restriction, any public offering to purchase shares is prohibited, and the number of
      shareholders is limited).


109
      Securities Act, R.S.A. 1980 c.s-6, R.S.B.C. 1979 c. 380; R.S.M. 1970 c. 5-50; R.S.NFLD. 1970 c.349;
      R.S.N.S. 1989 c.418; R.S.O. 1980 c.466; R.S.P.E.I. 1988 c.s-3; R.S.Q. 1977 c.v-1.1; R.S.S. 1978
      s.42;Security Frauds Preventor Act, R.S.N.B. 1973 c.s-6;
110
      Pyramid Franchises Act, R.S.S. 1978 c.P-50; Pyramid Distribution Act, R.S.B.C. 1979 c. 351.
                                                     85


      If the trade does not involve a private company and the transaction does not fit within the
      exemption, one or more of the parties involved may be required to file an initial and final prospectus
      (document of financial disclosure) as well as making continuous disclosure of any material
      changes. Strict insider trading rules enforced by both criminal and civil liability, will also be applicable.

      v.       WHAT IS THE DIFFERENCE BETWEEN A FRANCHISE AND A PYRAMID OR MULTI-
               LEVEL MARKETING SCHEME?

      Multi-level marketing involves a scheme in which goods or services are provided by the person
      promoting the scheme to other persons who participate in the scheme. Those participants transact
      with the ultimate consumer elsewhere than at the premises in which the promoter carries on his
      business. The prospect is held out to participants of receiving payments or other benefits if more
      participants are recruited. In short, the business takes on a pyramidal form.

      Franchises are typical examples of multi-level marketing. Franchisors engaged in multi-level
      marketing schemes should be particularly aware of the pyramid sales prohibitions contained in the
      Federal Competition Act. The definition of scheme of pyramid selling appears in section 55(1) of
      the Act.

      The Act was designed for the protection of members of the public who have invested effort and
      money in the recruitment of participants into pyramidal schemes in the hope and expectation of future
      financial benefit. Based on case law, it would appear that an essential element of the evil which
      Parliament envisaged is that some participants in such a scheme might find themselves having paid
      for a product without a reasonable opportunity of disposing of it. This element is contemplated by
      subparagraph 55(1)(b)(iii) of the Act.

      Pyramid sales schemes are inherently deceptive practices because the sales made operate on the
      basis of a geometric progression, resulting in early-market saturation; each distributor is soon in
      competition with the distributors whom he sponsors not only for the business of the ultimate
      consumer, but for recruitment of potential new distributors. The result is that the chance to receive
      bonuses from sales made within the scheme to or by recruits of recruits will only exist, generally
      speaking, for the earliest participants in the scheme in any given market. The investment of time,
      effort and money by later participants in the scheme is made at a time when the opportunity to earn
      the bonuses promised does not realistically exist.

      Subsection 55(2) prohibits anyone from inducing or inviting another person to participate in a scheme
      of pyramid selling. However, subsection 55(4) provides that the prohibition contained in subsection
      55(2) does not apply in respect of any scheme of pyramid selling that is licensed or otherwise
      permitted by or pursuant to an Act of the legislature of a province. The exemption is considered to
      apply only in the province in which the scheme is licensed to operate and would not apply to another
      province unless the scheme was also licensed as a pyramid scheme by that other province.

      Presently, the only provinces which permit pyramid sales schemes are British Columbia, Alberta and
      Saskatchewan. Section 1(1)(m) of the Alberta Franchises Act defines a pyramid sales franchise
                      111

      as a scheme, arrangement, device or other means whereby a participant pays a franchise fee and

               i)       is required or receives the right to recruit one or more other persons as participants
                        who are subject to a similar requirement or who obtain a similar right, and


111
      Franchises Act, R.S.A. 1980 c. F-17; Pyramid Franchises Act, R.S.A. 1978 c. P-50; Pyramid
      Distribution Act, R.S.B.C. 1979 c.351.
                                             86

        ii)      has the right to receive money, credits, discounts, goods or any other right or thing of
                 value the amount of which is dependent on the number of participants.

The legislation requires anyone trading in a pyramid sales franchise to apply for and receive a license.
The application procedure involves full disclosure of the operation. The registrar (or in the case of
Alberta, the chief of securities) has wide discretionary powers to refuse or revoke a license. For
example, in Alberta, the Chief of Securities Administration must be satisfied:

        a)       that the majority of the income of the persons involved will derive from the sale of
                 goods or services to the public;

        b)       that franchisees who obtain goods pursuant to the pyramid franchise arrangement
                 may receive a refund of the cost price of unsold inventory on termination of the
                 franchise; and

        c)       that there is a suitable limitation on the number of franchisees to be located in any
                 area in relation to the population within the area; and

Thus while pyramid sales are acceptable in some provinces, one should be careful to ensure
compliance with all statutory requirements. In this regard, anyone interested in participating in a
multi-level or pyramid scheme should be cognizant of section 206(e) of the Criminal Code which
prohibits schemes by which person(s) on payment of sums are entitled to larger sums. Section
206(1)(e) in its entirety reads as follows:

s.206(1)         Every one is guilty of an indictable offence and liable to imprisonment for a term not
                 exceeding two years who

        d)       conducts, manages or is a party to any scheme, contrivance or operation of any kind
                 by which any person, on payment of any sum of money, or the giving of any valuable
                 security, or by obligating himself to pay any sum of money or give any valuable
                 security, shall become entitled under the scheme, contrivance or operation to receive
                 from the person conducting or managing the scheme, contrivance or operation, or
                 any other person, a larger sum of money or amount of valuable security than the
                 sum or amount paid or given, or to be paid or given, by reason of the fact that other
                 persons have paid or given, or obligated themselves to pay or give any sum of
                 money or valuable security under the scheme, contrivance or operation.

The scope of this section was explored by the Alberta Supreme Court which held the following:

1.      The key to the offence is that a participant shall become entitled to receive from others under
        the scheme an amount larger than his investment. It is the space of time occupied by the
        completed scheme that must be considered. Accordingly, it is irrelevant whether the money
        to be received by the participant is paid before or after he has joined the scheme as long as
        the scheme envisages its eventual payment. The dominant words in the sub-section are
        shall become entitled under the scheme.

2.      A legitimate business may contravene the sub-section to the extent that a part, even a small
        part of the business, consists of a scheme prohibited by this sub-section. Thus the legitimacy
        of a business is not a factor to be considered once any part of its operations are construed as
        a lottery scheme.

VI.     WHAT IS A DISTRIBUTION ARRANGEMENT?

Distributorship arrangements are simply contracts by another name. Therefore it is clear that a
                                              87

distributorship arrangement will carry terms and conditions as generally found in contracts, and will be
governed by the general principles of contract law if there is a dispute. Some of the terms found in
distributorship arrangements can include:

         a)       Distributor

(obligations of the Retailer). These can include the obligation to use the best efforts possible to sell
and promote the manufacturers product within a given territory, and the obligation to refrain from
selling a similar or directly competitive product of another brand.

         b)       Manufacturers Obligations

For example, obligations on the manufacturer to produce and deliver the product to the retailer on a
timely basis and to refrain from selling the product to another similar supplier within a given territory.
There may also be obligations to make replacement parts available to the retailer or to provide
support services for the retailer in the event of faulty products.

         c)       Minimum Initial Purchase

A distributor arrangement can be used by the producer to ensure that all of the producers first series
of products has a market. For example, the agreement can provide that the distributor will make a
minimum initial purchase of 25 units, thus allowing time to obtain materials in bulk to produce 25 units
and have guaranteed market for the finished product. The agreement can also provide that further
purchases of the product be made within a certain time period and above a certain amount. It should
be noted, however, that a manufacture is unlikely to get a retailer to agree to purchase a continuous
number of products unless there is a clause allowing the manufacturer to be relieved of this obligation
in the event of a decline in demand.

         d)       Trade Name Protection

If a company desires to protect its product by way of a trade name, the distributorship agreement can
allow a distributor to utilize this name in an advertising or promotional capacity to increase sales. The
agreement however can also place restrictions on the use of the name by the distributor to ensure
that the good name of the product or company is not damaged.

         e)       Indemnity

The distributorship agreement may also include provisions protecting the manufacturers from any
harm or damage caused to any person as a result of the operations or practices of the retailer. This is
usually reciprocated however by a clause providing that the retailer will also be indemnified (held
harmless), from any damage occurring as a result of defects in the product or its manufacturing. This
is a standard clause and is usually for the benefit of both parties since it basically provides that neither
party will be liable for the others practices.

         f)       Assignment

Finally, the distributorship agreement can contain a provision requiring the retailer to notify the
manufacture of the assignment of its interest to sell the product or it may in fact prohibit assignment
altogether. By such a clause, the manufacturer can ensure that only reputable retailers are allowed to
promote the product thus further protecting the products good name.

To summarize, distributorship arrangements are an effective method of marketing a product. They
can provide for a certain amount of stability, predictability and protection for the manufacturers
                                                   88
              112
      product.

b.    SHOULD YOU FRANCHISE?

      Example Problem

      The Franchisee

      George Smola has an opportunity to start a pizza business. He is undecided about whether he should
      start as a franchisee or whether he should be an independent businessman.

      Required:        Generally outline for George the pros and cons of a franchise operation.

      Solution: I understand you are undecided as to whether to start your own business or get involved as
      a franchisee with an established franchise. A franchise arrangement can be beneficial to the first- time
      businessman because instead of being out there on your own, you have the support of an established
      parent company, called the franchisor, who has learned how a particular industry operates. This
      means that with the assistance of the franchisor you may be able to obtain their guidance with respect
      to business decisions and avoid costly mistakes. In addition to the franchisors knowledge of the
      industry, franchisors often provide franchisees with assistance in areas such as: financing, site
      selection, building construction, employee training, and support in the initial start-up period. All this
      support generally means that the risk of failure is reduced.
      I understand that one of your main concerns is financing your new business. Lenders are usually
      more willing to lend money to an entrepreneur who has the backing of a successful franchisor than
      they are to an independent entrepreneur who has no experience.

      There are a number of disadvantages to the franchise system also. The most important is that the
      franchisor charges you a fee for his services. This fee is normally taken directly off of your sales
      revenue and is not taken out of your profits. The significance of this is that theoretically you could be
      losing money on your franchise and the franchisor still receives his fee. Of course, the franchisor has
      a stake in your business, but you must understand that he has transferred as much risk as possible to
      the franchisee. Another important disadvantage is that there is very limited freedom in operating a
      franchise. The cornerstone of the franchisors success is that the product or service that his
      franchisees sell to the public must be consistent so that the public can identify with the franchise
      name. The franchisor will enforce very specific standards which generally allow for very little
      deviation. It must also be remembered that you are very dependent on the franchisor. Usually
      franchise agreements are tailored to the needs of the franchisor and not the franchisee and provide
      the franchisee with few rights.

      Despite the disadvantages outlined above, franchising is a popular business alternative because of its
      reduced risk level. The key to success in franchising is selecting the right franchise. This means that
      before diving into a franchise, the potential franchisor must read and understand all the terms of the
      franchise agreement, investigate the track record of the franchisor, and learn about how the franchise
      system works.

      The Franchisor

      From the franchisors perspective the issues are somewhat different.

112
      Canadian Franchise Guide. White & Zeid, 1990 Richard de Boo Publishers. An Introduction to
      Franchising in Alberta for Franchisors. Alberta Securities Commission, December 1986. Minding Your
      Own Business - Volume 3. Federal Business Development Bank, January 1982.
                                          89


1.   Initial Considerations - Setting up a Franchise

     In determining how to begin and follow up any franchising program, a franchisor must initially
     be willing to commit himself to a heavy time and financial investment in setting up such a
     program.

     He must determine how feasible it is to franchise his product - considering any registered
     trademarks and the business/sales system - keeping in mind primarily the following: whether
     he has the ability, both financial and otherwise, to franchise, the reason behind why he
     wishes to franchise and the likelihood of growth and financial success.

     Having made the decision to proceed, a franchisor must then determine: a) the type of
     franchising program he wishes to operate, b) who will administer the program, c) what type of
     program controls will be required, and d) how the franchisor will receive income from the
     franchise.

     a)      Here, he needs to consider whether he wishes to have single unit, multiple unit
             franchising or area franchising, keeping in mind that the latter two require
             considerably more financial and management ability than the former.

     b)      As to who will administer the program, he must determine whether as a proprietor he
             will take on this responsibility, or whether he will hire and train someone to act in
             such a capacity; balancing the considerations that hiring someone will involve
             another financial commitment, as opposed to the time commitment involved if he
             personally assumes the responsibility.

     c)      Controls on the program involve such considerations as the location of the
             franchisee, development of an operations manual which is an integral part of what he
             is selling, the required conformity to the manual, and ongoing administration of the
             program controls.

     d)      Finally, he will need to consider how the income from the franchises is to be divided
             between initial franchise fees and continuing royalties for use of your trademark.

2.   Registration Under the Franchises Act of Alberta

     An application for registration of a franchise includes a multitude of information, such as
     whether or not the applicant has ever been convicted of any offence anywhere in the world,
     other than minor traffic violations; has ever been held liable in a civil action involving fraud,
     embezzlement, fraudulent conversion, or misappropriation of property; has ever been
     declared bankrupt or made a voluntary assignment in bankruptcy; or has ever been refused a
     fidelity bond. All the preceding information and answers to other information requested bear
     upon the decision as to whether permission will be granted to trade in a franchise, and a
     prospective franchisor should be aware of this.

     Also required to be filed are audited financial statements of the franchisor as of a date not
     more than 120 days prior to the date of application. Unaudited financial statements as of a
     date not more than 90 days prior to the date of application, and a comfort letter from the
     auditors, may be filed instead.

     In addition, the franchisor must file a prospectus. While there is no format specified in the Act
     or Regulations, Section 8 of the Act indicates that a prospectus shall provide full, plain and
     true disclosure of all material facts relating to the franchise proposed to be offered.
                                                    90


              A copy of the franchise agreement must be appended to the prospectus/application
              materials.

              Preparing a prospectus is very time consuming and will require a minimum of one month. The
              cost to have a reputable legal firm prepare and administer prospectus filing and draw up a
              franchise agreement is probably in the order of $10,000 if you do not prepare drafts of the
              documents yourself.

              The applicant must also include an affidavit signed by him, certifying that he has made full,
              plain and true disclosure of all material facts. All of the preceding documents are to be mailed
              to the Registrar, along with a fee of $250.

              Only when a receipt for the prospectus has been issued by the Registrar may trading in a
              franchise take place. Such a receipt may be withheld under Section 12 of the Act where, for
              example, the prospectus or other documents fail to comply with any requirement, or where it
              is not in the public interest to issue the receipt if the applicant has a criminal record, lack of
              business experience or finances. In these cases, the applicant will be so notified within 30
              days of receipt of the application for registration.

              If such a receipt is issued, but it is thought that the franchisors finances are not adequate to
              fulfil his obligations, then the Director of the Alberta Securities Commission may order that the
              franchise fees be escrowed until the franchisee opens business, or at the option of the
              franchisor, the latter may furnish a surety bond as required by the Director, often in the
              amount of $50,000 - $100,000.

c.   FACTORS TO CONSIDER IN IDENTIFYING A FRANCHISE

     One of the most commonly asked questions by people starting businesses is whether their proposed
     venture will be considered a franchise.

     Example Problem

     Angel Skin Care would like to begin operations in Canada through a home marketing plan.
     According to the marketing plan the company will be providing both goods and services. The goods
     will be the Angel Skin and Health Care Products which are currently manufactured and sold in
     Norway. The services include training and sales manuals; hair and skin care courses complete with
     diplomas for passing; product descriptions and prices; and binders to put these materials in. The
     services also include the right to use the companys trade name and possibly logo or trade mark;
     product advertising; sales training; seminar assistance; and your overall simple, easy-to-manage
     system. If a seminar is conducted in a home other than a distributors, you will provide the hostess
     with a $30 gift certificate.

     In return, the distributors must buy Angel products from the Company at the companys wholesale
     prices and sell them in their designated districts at the companys retail prices, pocketing the
     difference. They must also pay their district manager an initial $50 fee for training plus a 5% fee on all
     retail sales made whenever their district manager assists them with their selling seminars (home
     parties). Twice a year, the top three distributors in each district will receive a bonus. The bonuses will
     amount to 10% of all sales revenues (presumably wholesale).

     The district managers will recruit, train and motivate the distributors in their district. For this they will
     receive a commission of 25% on all wholesale purchases made by the distributors in their districts.
     However, the distributors will buy directly from your company without going through the district
                                              91

managers.

Required:

Considering all the factors outlined in the Franchise Act, determine whether or not Angel Skin Care
would be operating a franchise in Alberta. In addition consider any other legislation that might be of
concern in particular the Competition Act of Canada and the Trademark Act.

Solution:

The plan as outlined appears to offer rights which fit all 5 definitions of a franchise as defined in the
Franchise Act (the Act) of Alberta. To be a franchise however, there must also be a franchise fee paid
directly or indirectly for one or more of the franchise rights. Should you charge any fees to the
distributors to allow them into the program or to use the system, these would appear to be
franchise fees. Furthermore, the amounts you plan to charge your distributors both for goods and
services, including training, appear to fit all 4 definitions of a franchise fee, unless these amounts can
fit within the 3 exceptions listed in the Act. Two of the exceptions are as follows:

1.      The purchase of or agreement to purchase goods in a reasonable amount at the current
        wholesale market rate;

2.      The purchase of or agreement to purchase services in a reasonable amount at the current
        market rate;

and the third excepts reasonable credit card charges.

The policy statement for the Act appears to state that an indirect franchise fee exists where goods or
services are purchase above the current wholesale market rate or the current market rate,
respectively. This appears to include royalties or percentages on sales.

What the current wholesale market rates for goods or what the current market rates for services are,
may not be easy to determine. In addition, it may be difficult to determine just what amount would
be considered by the administrators of the Act or by the courts, to be a reasonable amount. The
more bells and whistles provided, the more likely it is that the operation will be considered a
franchise.

In your case there appear to be plenty of bells and whistles. The particular marketing plan which
you are proposing is therefore difficult to characterize, especially without further information on how a
distributor or district manager would be admitted to the scheme.

If it is considered a franchise, the Act states that

        No person shall trade in a franchise in Alberta either on his own account or on
        behalf of any other person until there have been filed with the Chief of Securities
        Administration both an application for registration in the prescribed form and a
        prospectus in respect to the offer of that franchise and until a receipt for the
        prospectus has been obtained from the Registrar.

A trade includes a purchase, sale, disposition or other dealing in a franchise for valuable
consideration, or any attempt to do so. It also includes any act, advertisement, conduct or negotiation
in furtherance of such activities.

A trade is deemed to have occurred in Alberta if
                                              92


a)      an offer to sell or a sale is made in Alberta,
b)      an offer to buy is accepted in Alberta,
c)      the franchisee is domiciled or ordinarily resident in Alberta,
d)      the franchise will be operated in Alberta,
e)      an offer to sell is made from Alberta, or
f)      an offer to sell or an offer to buy is accepted by communicating the acceptance to a person in
        Alberta either directly or through an agent in Alberta.

The penalties for contravening the Act or the regulations made under the Act appear to be as follows:

a)      in the case of a person, a maximum fine of $2,000 or a maximum jail sentence of one year, or
        both,
b)      in the case of a company, a maximum fine of $25,000 and
c)      if a company is found guilty, every director or officer who authorized, permitted or acquiesced
        in the offense is also guilty of an offense and liable to a maximum fine of $2,000 or a
        maximum jail sentence of one year, or both.

The Act applies whether or not a person is aware of it or of its application to his operations. It also
applies to contracts, agreements or arrangements, either express or implied, and whether oral or
written. Thus if your operation is considered to be a franchise, it appears that it will not matter whether
your arrangement is oral or written, express or implied, or even if all you think you have is a purchase
and sale agreement with your distributors; you will still fall within the application of the Act.

Furthermore, if the marketing plan you are currently operating in Norway is the same, and if the offer
to sell the plan or system in Norway is or was made from Alberta, you could be deemed under e)
above to be or to have been trading in a franchise in Alberta. You would then be subject to the Act,
even though your marketing plan was sold to parties in Norway.

If you are intent on avoiding a franchise operation, you may be able to do so by executing selling
agency agreements with the district managers and distributors.

If you hire the district managers and distributors as employees, it appears that there will be no
franchise.

Competition Act

You should also be aware that the Franchise Act is not the only Act which you need to be concerned
about. Whether or not your marketing plan is considered to be a franchise, the Competition Act of
Canada will apply to your business practices. It deals with two types of practices:

a)      reviewable practices: reviewable but not punishable by the Competition Tribunal, and
b)      practices which constitute criminal offenses: punishable under the Criminal Code of Canada.

Reviewable practices include: refusal to supply; exclusive dealing; market restriction; tied selling; and
certain matters concerning foreign activities. They also include mergers, abuse of dominant position,
and delivered pricing.

Criminal offenses include: conspiracy; price discrimination; promotional allowances; price
maintenance; pyramid selling; referral selling; and misleading advertising. Some of these are
described below.

Criminal Offenses
                                             93

Price discrimination apparently occurs by the granting of any discount, rebate, allowance, price
concession or other advantage to one or more competing purchasers (distributors) and not to others.
It is apparently permissible to differentiate between purchasers in different geographic locations
provided they will not be seen to be in competition with each other. It is also apparently permissible to
grant temporary concessions to purchasers for the purposes of opening specials, sales to meet spot
competition, or inventory clearances. Apparently, volume discounts can also be given on a limited
basis provided these discounts are made available to all competing purchasers who buy the same
quantity or volume. Cost differences in selling to different purchasers are apparently not justification
for price discrimination. However, any difference in transportation costs can apparently be charged
separately.

Promotional allowances for advertising or display purposes are apparently criminal offenses if they
are granted to one competing purchaser and not to others on proportionate terms. If they are granted
on proportionate terms, usually on a fixed percentage of gross sales to all purchasers, they are
apparently okay.

Retail price maintenance apparently occurs by an attempt, directly or indirectly, to influence upwards
or to discourage the reduction of, the price of a product in the marketplace. It apparently includes any
attempts by agents or salesmen to influence the retail price of products sold by purchasers. A
suggestion by a producer or supplier as to a resale or minimum resale price is apparently a criminal
offense if it does not include a disclaimer. The disclaimer must make it clear that the person to whom
the suggestion is made is under no obligation to accept the suggestion, and will in no way suffer in his
business relations with the producer or supplier if he fails to accept the suggestion. Such a disclaimer
is apparently required on any suggested retail price list. In addition, whenever a supplier or producer
advertises a resale price, he must apparently make it clear that the product may be sold at a lower
price, or the ad will constitute a criminal offence. However, it is apparently not an offense to suggest a
maximum price. Therefore, it appears that it will be important for you to watch how you word your
price lists and ads, and what your district managers (agents) say to your distributors.

Pyramid selling appears to be one or both of the following two selling schemes:

a)      One person pays a fee to participate and receives a right to earn a benefit for recruiting
        others into the scheme, or for sales made to others recruited into the scheme (it appears that
        this one could apply if your district manager pays a fee to participate, since he will be
        recruiting distributors into your plan and receiving bonuses on their sales); or

b)      One person sells to a second person who receives the right to earn a benefit for sales not
        made to or by him (the second person) and not made to ultimate consumers with no right of
        further participation in the scheme attached. This one apparently applies to a scheme which
        has been described as inventory or front end loading. New participants, usually as an
        entrance requirement, purchase large stocks of inventory which they cannot sell, on the hope
        of receiving percentages on purchases made by their recruits. Schemes of this kind pay
        bonuses to an individual for sales not made to him or by him or the final consumer. It appears
        that to avoid application of this definition, no bonuses can be paid on sales not made to
        ultimate consumers.

The pyramid-selling provisions are complicated and not particularly easy to understand. If they are
contravened, a criminal record will result and the fines can be quite high. Advice from a lawyer should
therefore be sought to ensure pyramid selling does not occur.

Reviewable Practices

Reviewable practices, on the other hand, are not criminal offenses. The Competition Tribunal may
issue an order (such as prohibition) regarding them, and only if a person fails to comply with the order
                                             94

does a criminal offense occur. Some of the reviewable practices which may apply in your situation are
discussed below.

Exclusive dealing apparently occurs where a supplier requires his customers (distributors) to deal only
or primarily in products supplied or designated by him, or to refrain from dealing in a specified class of
product except as supplied by the supplier. Apparently, exclusive dealing also occurs where a
supplier induces a customer to so deal or to refrain from so dealing by offering to supply product to
the customer on more favourable terms.

Market restriction apparently occurs where a supplier, as a condition of supply, requires a customer to
supply any product only in a defined market (geographic area) like Calgary. It also apparently occurs
where a supplier penalizes a customer if he supplies any product outside the defined market.

Tied selling apparently occurs where a supplier of a product requires a customer to also acquire some
other product from the supplier, or to refrain from using or distributing a competitors product. It also
apparently occurs where a supplier induces a customer to do these things by offering to supply the
product to him on more favourable terms.

However, the Competition Tribunal apparently will not issue a prohibitory order:

a)      Where exclusive dealing or market restriction will only be engaged in for a reasonable period
        of time to help a new supplier or a new product to enter the market. The courts have held that
        5 or 6 years is a reasonable period of time.

b)      Where tied selling is engaged in on a reasonable basis having regard to the technological
        relationship between or among the products, or where it is engaged in by a person who lends
        money in order to better secure loans made by that person.

c)      Where these three practices are engaged in between affiliated entities. This includes an
        agreement whereby one party grants to another the right to use a trademark or trade name to
        identify the others business, or where a business franchise system is conducted under the
        franchisors trademark. This is provided, however, that a multiplicity of products are obtained
        from competitive sources of supply and from a multiplicity of suppliers, and that no one
        product dominates the business. Or,

d)      Where, in food or drink franchises, a franchisor supplies a franchisee with ingredients that the
        franchisee processes into articles of food or drink which are sold in association with a
        trademark of the franchisor.

Any contracts or agreements which you sign with district managers or distributors, or franchisees if
you decide to go the route of a franchise, should properly address the matters dealt with by the
Competition Act of Canada.

Trade Mark Act

You should be aware that the Trade Mark Act (Canada) requires that all licensed users of a trademark
be registered under this Act in order to maintain the registered owners exclusive right of use of the
trademark throughout Canada. Therefore, it is necessary that the franchisor require the franchisee
execute the appropriate Registered User Agreement under the Act, as a condition of granting under
the franchise agreement a license to use the trademark.

Also of critical importance here is that the distinctiveness of a trademark can be destroyed if a
licensed user provides services different from those for which it was licensed to use the trademark.
                                                  95

     The franchisor must therefore require by agreement that the franchisee maintain quality control
     standards and permits the franchisor to so determine by periodic inspection. The onus is then on the
     franchisor to make sure quality control is maintained through supervision.

     Because of the possibility that the franchise agreement may be terminated, the franchisor should
     ensure he is constituted as attorney-in-fact of the franchisee in order to be able to cancel the
     registration of the franchisee as registered user of the trademark in such an instance, rather than
     relying on the franchisee to do this.

     The franchisor should also require that in spite of the franchisees use of the trademark, the
     franchisee should be identified as a separate legal entity from the franchisor for the purpose of limiting
     third party liability.

     In addition, if the franchisee is a corporation or becomes one, the franchisor should prohibit the use of
     the trademark in the corporate name, also for purposes of third party liability, but also to maintain the
     distinctiveness of the franchisors trademark.

d.   FACTORS TO CONSIDER IN A FRANCHISE AGREEMENT

     A franchise agreement, which should usually be drafted by a lawyer, sets out all the terms and
     conditions which govern the relationship between the franchisor, and each franchisee. It is important
     therefore, that the agreement be comprehensive and carefully prepared. It is recommended that a
     standard agreement be drafted with suitable provision for future changes in the operation.
     Consistency and standardization are also key words that should characterize the relationship with
     each franchisee as it will avoid problems that might result from treating them differently.

     The basic goal of a franchise agreement from the franchisors viewpoint is to protect the proprietary
     interest, when granting a franchise to the franchisee for the use of the trademark and operations
     system. It is important that the franchisor maintain control over the franchisees operations, however,
     the control exercised should not limit the franchisee to the extent that the relationship becomes one of
     master/servant or of agency. The control referred to is embodied in the franchise agreement and
     the actual course of excessive control would mean the franchisor would be exposed to greater third
     party liability.

     Example Problem

     Richard and John are considering franchising their exclusive rickshaw business throughout Canada
     and the United States, together with their registered trademark Rambling Rickshaws. They are
     very concerned about the basic issues which should be addressed in their franchise agreement in
     order to ensure the success of their venture.

     Required:

     Consider what basic matters should be included in Richard and Johns agreement to protect their
     interests.

     Solution:

     The agreement should set out the obligations of the franchisor and the franchisee. The following list of
     obligations of you, the franchisor, should be considered in conjunction with your goals, and you should
     include only those obligations you intend to provide on a continuing basis:

             a)       franchisee and managerial staff training;
                                             96

        b)       franchisee seminars and retraining courses;
        c)       site selection and layout assistance or leasing assistance;
        d)       building plans and specifications;
        e)       provision of an operations manual;
        f)       assistance in the opening period including a standard bookkeeping and reporting
                 system;
        g)       specifications of required machinery and equipment purchases;
        h)       continuing consultation;
        i)       periodic inspections for quality control;
        j)       national, regional or local advertising;
        k)       continued protection and renewal of trademark;

The cost of providing some of the above services may be shared or carried totally by the franchisee.
These fees should be set out clearly in the agreement.

The value of your franchise is affected positively by the fact that you are the sole and exclusive owner
in Canada of all proprietary and other property rights in your registered trademark once obtained. This
fact should be noted in your agreement. Further, you should consider under what terms the territory
will be granted to the franchisee. Each franchisee will desire an exclusive territory in order to protect
his long-term investment. This may not be in your best interest. It is conceivable that more than one
franchise could operate successfully in certain cities. You might consider including a clause stating
the exclusive territory to be a certain limited number of square miles so long as the franchisee
faithfully performs all his obligations.

The franchisees obligations will be concerned with maintaining the success of the operation and
prohibiting any deviation from the operations system you have devised. The following obligations are
those commonly imposed on franchisees:

        a)       financial reporting and timely payments
        b)       attendance at various training and retraining programs
        c)       insurance requirements and indemnification provisions
        d)       provision of adequate working capital
        e)       full-time commitment to the business
        f)       use of products or equipment specified by the franchisor and purchased from the
                 franchisor or other approved suppliers
        g)       strict compliance with the franchisors operations manual
        h)       a covenant to repair and maintain the franchised premises
        i)       restriction of other goods and services the franchisee may provide on the franchised
                 premises
        j)       a covenant as to proper trademark usage
        k)       partaking in advertising and promotional campaigns as required
        l)       must enter a registered agreement in respect of the franchisors trademark
        m)       compliance with all federal, provincial and municipal laws and bylaws
        n)       carrying on operations in defined business hours

You should consider any further restrictions on what the franchisee may and may not do on the
business premises and further obligations as to what he must do.

There are three main types of franchising fees: a lump sum initial fee; a monthly royalty fee based on
gross sales of the franchise; and an advertising fee usually based on a percentage of growth.

In setting the fee structure, you should consider those fees which will reflect the value of the operation
and maintain the marketability of the franchise units. The agreement should clearly set out the fee
                                             97

structure. The initial fee should be payable on signing the agreement and it should be fully
earned at that point. It should also be non-refundable on termination of the agreement for any
reason. Recall that you are prohibited under the Franchises Act from accepting any payments until
after your agreement has been registered and the potential franchisee has received a Statement of
Material Facts or Prospectus.

In setting the term of the Franchise Agreement, you should consider the amount of the initial
investment required by the franchisee so that the term allows amortization of certain capital payments.
You may consider granting a right of renewal upon expiration of the term, if the franchisee is not in
default of any obligations outlined in the Franchise Agreement. You may charge a renewal fee to
cover administrative costs and you may charge a further initial franchise fee. These elements should
be set out concisely in the Agreement.

The Franchise Agreement should provide for default and termination. In the event the franchisee fails
to pay any sums due or fails to meet the material obligation, the franchisor may terminate the
Agreement after notice of default has been given. In addition, termination of the Agreement may occur
immediately in the event of material breaches of the Agreement such as closure or abandonment of
the franchise business premises, bankruptcy, insolvency or liquidation of the franchisee; seizure of
the premises or goods by creditors; attempted assignment of the Franchise Agreement by the
franchisee without consent; disclosure of confidential information; assignment or improper usage of
the franchisors trademark or improper calculation of the franchise fee payable. You should consider
providing means for a franchisee to have a right to terminate the Agreement.

If there are other ancillary Agreements such as a lease or sublease, a debenture or a mortgage back
to the franchisor, you should consider cross-default provisions, with the result that a default under one
Agreement is a default under all related Agreements between you and the franchisee. Additional
consideration should be given to the rights and obligations to the parties following termination. A term
in the Agreement should require the franchisee to cease representing himself as a representative of
the franchisor and must immediately cease to display the franchisor s trademark for any purpose
whatsoever. In addition, all operation manuals and other inventory or assets forming part of your
business system should be returned immediately. The Agreement should provide that you own the
manual at all times or that it will be returned for nominal considerations.

The Agreement should grant the franchisor an irrevocable appointment of attorney for the franchisee
upon termination, so enforcement of the preceding obligations is possible. As well, the franchisor
should be able to enforce such obligations as the immediate transfer of the right to all telephone
listings, transfer of a lease Agreement and cancellation of the registered user s Agreement. If you
wish to have the right to repurchase the franchisees equipment, fixtures and building upon
termination, the cost should be defined in the Agreement. One method of determining the repurchase
price is the original cost less depreciation. It should be pointed out to the franchisee that after a
number of years such price will be low or nil. In the alternative, the repurchase price may be fair
market value, with a method set out by which the value may be determined.

It is suggested that a restrictive covenant be added to prevent the franchisee from entering into a
competing business during the term of the Agreement. You should also consider restricting the
franchisees right to enter a competing business upon termination of the Agreement, for a reasonable
time period. In order for the non-competition clause to be valid, it must extend only to those types of
business that the parties were carrying on, for a reasonable period of time and area, in order that your
interests are protected. This clause should be severable so that if it is found to be invalid, the whole
Agreement will not also fail. The franchisee should be precluded from representing himself as a
current or past franchisee of the franchisor. These controls are very important for the continued
success of your operations.
                                            98

The Agreement should provide that it constitutes the entire Agreement between the parties and no
other oral representations form part of this Agreement.

If you do make statements or representations upon which the franchisee relies, you must ensure that
they are true and complete as there are strict disclosure standards you must meet under the
Franchises Act. For example, if an earnings clause sets out a schedule of projected earnings, the
data base must be disclosed. You should stipulate that the figures given are estimates only and no
assurance is given that the franchisee will ever achieve those earnings.

You should consider what terms will operate if you choose to allow the franchisee to sell or assign his
interest. The terms should extend to any sale or assignment including a deemed assignment on the
transfer of shares of a corporate franchisee or the transfer from an individual to a personally-
controlled corporation. The terms may include requiring the franchisee to give written notice of his
intentions and the terms of the sale or assignments; further dealings should be contingent upon the
franchisors consent to those terms and conditions; the Assignee or Purchaser must execute a new
Franchise Agreement and all ancillary Agreements affecting the Franchise Agreement; the Assignor
must terminate the Franchise Agreement and all ancillary agreements; and there should be payment
of a transfer fee from the Assignor to the franchisor for administrative costs.

Finally, you should consider a mechanism for settling disputes between the parties.
                                                  99

            III. CHOOSING THE RIGHT BUSINESS FORMAT
     The type of format chosen to operate a business is most often dependent on the individual needs of
     the entrepreneur. However, broad-based needs can be better accommodated under certain business
     styles than others. For example, where liability limitation is of much concern the separate legal entity
     created by incorporation may be the best route. In contrast, if administrative ease and informality of
     operation are important, a sole proprietorship may be the answer.

a.   KEY QUESTIONS


     i.      WHAT ARE THE MAIN ADVANTAGES AND DISADVANTAGES OF EACH BUSINESS
             FORMAT?

     ii.     WHAT OTHER FACTORS SHOULD BE CONSIDERED?



     i.      ADVANTAGES & DISADVANTAGES

     As discussed, the three main business formats are: sole proprietor; partnership; and incorporation.
     Some advantages and disadvantages of each are set out below:

     Sole Proprietor:

             a)       simplest form of business association;

             b)       involves one individual doing business on his/her own behalf and being liable to the
                      full extent of their personal assets for the debts and obligations incurred as a result
                      of the business;

             c)       relative ease with which bookkeeping is carried on, very informal;

             d)       allows proprietor to concentrate on developing his business interest;

     Advantages

             1.       informality of administration;
             2.       negligible start up fees;
             3.       no profit sharing, partners, or shareholders to deal with;

     Disadvantages

             1.       full personal liability;
             2.       government imposed liability for income tax, workers compensation and
                      unemployment insurance premiums, (if have employees), potential business license
                      fees, collection of sales tax levies (for goods and services) and Canada Pension plan
                      contributions.

     Partnership:
            a)        engaging in business with one or more participants;
            b)        statutory regulation - The relation that subsists between persons carrying on
                                              100

                  business in common with a view to profit.;
         c)       can either be by written agreement or by the Act for deemed partnerships;
         d)       profits generally shared;
         e)       decision making generally shared.

Advantages

         1.       increased borrowing power with more than 1 person;
         2.       different contributions of business skills;
         3.       a larger initial asset base.

Disadvantages

         1.       income tax is determined at the partnership level and not at the level of the individual
                  partners;
         2.       two types of liability - liability to third parties and liability to the other partners;
         3.       every partner is an agent of the others (one partner could commit to debts and
                  obligations on behalf of the others without their knowledge);
         4.       partners are liable to the full extent of their personal assets (because a partnership is
                  not a separate legal entity).
         5.       partners are both jointly and severally liable

Incorporation

         a)       a separate legal entity, distinct from those who formed it;
         b)       company may enter into contracts, own property, sue and be sued in its own right;
         c)       limited liability.

Advantages

         1.       limited liability; shareholders are not personally liable for debts, obligations or acts of
                  the corporation except to the extent of any personal guarantees;
         2.       corporate existence does not end with the death of a shareholder;
         3.       ownership can be transferred through the sale of shares;
         4.       corporation may be eligible for the small business deduction and other tax
                  advantages.

Disadvantages

         1.       the principal disadvantages of incorporation are the costs ($250 - just for filing) and
                  the additional documentation required (i.e. annual returns, more advanced
                  accounting, separate tax returns for the corporation).

ii.      OTHER FACTORS

Some of the other factors that are considered in choosing a business format are outlined below:

         a)       Limited Liability

In a partnership, each partner is a co-owner of the partnership assets and jointly liable to the full
extent of the assets for the liabilities of the business. In a limited partnership, only the general partner
has unlimited liability. In a sole proprietorship, the sole proprietor has unlimited liability. In a
corporation, the shareholders liability is limited to his investment in the business.
                                             101

        b)       Desirability of Perpetual Existence

A corporation continues notwithstanding the death or withdrawal of a shareholder or director. The sole
proprietorship dissolves upon the death of the sole proprietor. Subject to a partnership agreement, the
partnership may dissolve upon the happening of one of a number events.

        c)       Number of Persons Involved

Generally, where a large number of investors are involved, a corporation is preferred. Corporate rules
respecting control, procedure, shareholder rights and limited liability prove attractive to most investors.
Procedures of reorganization in a corporation are less onerous than drafting new partnership
agreements or amending existing agreements on the admission of new partners.

        d)       Relationship of Proposed Proprietors

In a partnership, one partner can bind the partnership through the rules of agency. A shareholder can
not bind the corporation because of their independent legal existence. However, officers of the
corporation also act as agents to the corporation. Under agency principles, officers acting under
authorization have the ability to bind other officers and the corporation itself. Shareholders are able
to contract with or sue the corporation. However, a partner cannot contract with or sue the
partnership.

        e)       Borrowing Requirements

Lenders look first to the ability of the borrower to repay any loans. New corporations are often unable
to borrow significant amounts because they usually have few assets. Lenders find partnership
attractive since individual partners are fully responsible for partnership obligations. Often, lenders will
require small corporations to provide personal guarantees by the principal shareholders. Therefore,
the principal of limited liability is displaced by a shareholder personal guarantee.

        f)       Availability of Government Grants

Some grants and loans are available only to corporations while others are available to all types of
business. Assistance in this matter may be obtained at the New Venture Business Clinic.

        g)       Costs

Generally, incorporation of a business is expensive not only in legal fees but also with registration and
filing fees. However there are associated costs with a partnership which could increase depending
upon the complexity of the partnership agreement.

        h)       Income Tax

The basic corporate tax rate is about 45% (depending on the province you live in). There are however
a number of special rate reductions available under the Income Tax Act. The most common is the
small business deduction (SBD), which results in an effective corporate tax rate of 16-25% (again
depending on the province). The SBD is generally available to small, private Canadian corporations
on the first $200,000 of business income earned each year. This favourable tax rate is not available to
partnerships or sole proprietors.

Shares of a small business corporation may also qualify for the $500,000 capital gains exemption.
This will result in a substantial tax savings if the business is ever disposed of.
                                                    102

                                          BUSINESS FORMATS:

                 A Comparison of Sole Proprietorship, Partnership and Corporation


                      SOLE PROPRIETORSHIP                   PARTNERSHIP               CORPORATION

 Definition           An individual doing business         Two or more              A legal person,
                      with a view towards making a          persons doing             created by statute, for
                      profit.                              business with a view      the purpose of doing
                                                            towards making a          business.
                                                            profit.

 Governing            no regulatory scheme governs          The Partnership Act       The Business
 Legislation          formation                             governs. There is         Corporations Act, the
                                                            some internal             Securities Act, etc...
                                                            regulation.

 Liability of         The owner is solely liable to the     The partners are          The corporation is
 Owners               full extent of all assets for any     jointly and severally     solely liable...(with
                      debt or obligation arising out of     liable...                 certain exceptions)
                      the business.

 Taxation             The owner is taxed as an              The partners are          Separate corporate
                      individual - has wider range of       taxed as individuals      tax rates - different
                      potential deductions than             - income flows            rates depending on
                      employees                             through the               nationality of
                                                            partnership to the        corporation
                                                            partners each year        shareholders taxed
                                                                                      when dividends are
                                                                                      paid

 Other Factors                                              - ordinary              - Private vs
                                                            partnerships              public
                                                            - limited               corporations
                                                            partnerships              - federal corporations
                                                                                      - directors liability
                                                                                      - shareholders rights



b.      FACTORS TO CONSIDER IN CHOOSING THE RIGHT BUSINESS FORMAT FOR EXPANSION

        Example Problem

        Skyhawk currently carries on an insurance brokerage business as well as providing financial planning
        services under the business name of Skyhawk Insurance & Investments. The business has been
        carried on for approximately one year.

        Part of the financial planning services is advice as to the investments which a client should consider.

        Skyhawk wishes to establish an additional 20 offices throughout Canada in the next 3 years (referred
        to herein as the Other Offices). The Other Offices would be independent of the existing operation
        (the Home Office) in that they will be owned by a third party.
                                            103

In establishing these Other Offices Skyhawk will:

a)      provide a policy and procedure manual;
b)      train the Owner and the manager of the Other Office;
c)      allow the Other Office to use the name Skyhawk Insurance & Investments;
d)      provide sponsors to the Other Offices (i.e., ensure that the Other Offices have contracts
        with insurance companies so that insurance policies may be sold;
e)      open the Other Offices
f)      supervise the Other Office for a period of time; and
g)      provide an advertising system.

The consideration to be received by Skyhawk for these services will be $25,000 (the Initial Fee)
plus a percentage of gross or net income (the Percentage).

Required: Outline for Skyhawk the various ways it could carry out its expansion plans and the factors
it should consider.

Solution: There are several means by which Skyhawk could carry out its expansion plan. These
include:

a)      franchising;
b)      partnership;
c)      joint venture; and
d)      separate jointly owned corporation.

There are two criteria which we have identified in suggesting the various business formats. Firstly,
you do not want to be liable for the operation of the Other Offices. Secondly, you want to ensure that
the Skyhawk name is only used by worthy operations. In other words, you want to protect the
reputation of Skyhawk.

a)      Franchising

The definition of a franchise in the Franchises Act is a very broad definition and would certainly apply
to the structure set out above. The obvious disadvantage in franchising is the cost of complying with
the Franchises Act, including the preparation and filing of a franchise prospectus.

However, there are certain advantages. The prospectus would be a persuasive selling document to
encourage franchisees to enter into the Franchise Agreement. The prospectus would provide
additional credibility. The franchise business format would also provide a relatively risk-free return to
you. The Percentage could be based on gross sales. Therefore, it would be receivable whether or not
the franchisee is making a profit. A franchise arrangement would also allow control over the Other
Offices operations without exposure to the liabilities of that Other Office.

To ensure the relationship is not a franchise, the business format must be structured so there is no
franchise fee involved. This will generally mean that you will have to make an investment in the Other
Offices.

b)      Partnership

You could expand your existing operation by entering into a partnership with the Owner. Your initial
time and energy (i.e. reflective of the $25,000 Initial Fee) could be your contribution of capital to the
partnership in return for an interest in the partnership.
                                                   104

     For example, your time and energy (valued at $25,000) would be contributed to the partnership. The
     Owner would contribute $25,000 cash. These contributions wold entitle you and the Owner to equal
     50% interests in the partnership. You could subsequently withdraw the $25,000 cash. Depending on
     the Partnership Agreement, this draw could be treated as a reduction in your partnership interest (i.e..
     to 5%).

     Profits and losses will be shared by the partners in the appropriate ratio (depending on the partnership
     agreement). Therefore, there is some risk whether you will receive any future cash allocations. Only is
     the partnership is profitable will you receive a share. This is contrasted to the franchise arrangement
     where you could receive the Percentage based on gross income.

     An additional downside to the partnership arrangement is control and liability. If the partnership were
     registered as a limited partnership pursuant to the Partnership Act of Alberta, you could become a
     limited partner thereby limiting your liability to the capital contribution (including a promise to
     contribute additional or future amounts) to the partnership. However, the Partnership Act provides that
     if the surname of a limited partner appears in the firm name of the limited partnership (unless it is also
     the surname of one of the general partners), that limited partner is liable as a general partner to all
     persons who have extended credit without actual knowledge that the limited partner is not a general
     partner.

     In addition, if a limited partner takes part in the control of the partnership, that limited partner becomes
     liable as a general partner. Therefore, if you become a limited partner of a limited partnership and you
     take control of the business you will become a general partner and liable for all partnership liabilities.
     Given that you intend to supervise the Other Offices, at least at the commencement of its operations,
     it appears that you will be considered to be a general partner.

c.   JOINT VENTURE

     It is very difficult to distinguish between a joint venture and a partnership, however, it is crucial to
     make the distinction because of the consequences if the business arrangement is found to be a
     partnership. Joint ventures are generally only liable for their respective shares of the joint ventures
     liabilities, whereas partners (excepting limited partners) are jointly and severally liable for all of the
     liabilities of the partnership.

     Some of the distinguishing factors which may indicate that the business arrangement is a joint venture
     rather than a partnership are:

              i)       An intention to form a joint venture. This may be indicated by a statement in the joint
                       venture agreement and calling the parties joint venturers, however, merely calling
                       the arrangement a joint venture will not preclude a finding of a partnership.

              ii)      All persons with the joint venture should be advised that they are in fact dealing with
                       a joint venture and not some other business arrangement.

              iii)     A joint property interest in the subject matter of the joint venture.

              iv)      A right of mutual control or management.

              v)       Sharing of gross revenues and expenses (rather than simply sharing profit and loss).

              vi)      Normally, the limitation of the arrangement to a single business undertaking.

     The joint venture arrangement results in the same risk of return on investment as the partnership did.
     The income and expenses must by shared, therefore, if the Other Office is not profitable you will not
                                                          105

            realize a return. In addition, if the Other Office incurs losses, you will be liable for at least a portion of
            those losses.

d.          SEPARATE CORPORATION

            In order to avoid the liability that arises from entering into business with another party by way of
            partnership or other means, Skyhawk can set up subsidiary corporations to act as branch offices.

            You stated your goals were to extract a fee of approximately $25,000 from each branch office as start
            up costs and then to take annual amounts from these branch offices in return for using the name
            Skyhawk Investments & Insurance. If you register Skyhawk Investments & Insurance as a trade
            name of your corporation, you can sell the registered trade name as part of the package of materials
            you sell to each branch office prior to start-up. You can then enter into an Agreement with the c.
            subsidiary corporation for the payment of ongoing fees for the use of the trade name. However, the
            payment of a fee for the use of a trade name makes the system that you have set up look like a
            franchise. If the Franchises Department of the Alberta Securities Commission finds this to be a
            franchise, then a large number of problems are created as stated in the discussion of franchises in
            this letter.

            If you can set up subsidiary corporations that do not look like franchises, one method of obtaining
            annual payments from the subsidiaries is to set up corporations with at least 2 classes of voting
            shares, in which Skyhawk (the parent corporation) owns all or a percentage of a class of preferred
            shares with a guaranteed and fixed dividend of a certain percentage of the subsidiarys profits or a
            fixed dividend of a percentage of the value of the shares. For example, if the paid up capital of each
            preferred share is set at $100 and you own 1000 of these shares then a dividend fixed at 15% of the
            paid up capital of the share will result in a dividend of $15,000. Certain conditions can be placed on
            the class of shares so that you are guaranteed an annual dividend in any amount that the parent
            corporation and the subsidiary can agree on.
A:\685 - Chapter 2.WPD

								
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