Evolution of Corporations Law

Evolution of Corporations Law / Corporate Personality History British Origins • Common law recognizes two principal forms of incorporation: (a) by exercise of the royal prerogative (letters patent/royal charter) and (b) by a private or general act of the legislature • Until mid 1700s, letters patent was by far the most common o Main reason for incorporation Hudson Bay or East India Company was to give them monopoly over the territory, not for limited liability • In 1720, Bubble Act was passed, restraining development of corporations law for 100 years; was devastating for business; finally repealed in 1825 • Joint Stock Companies Act was not adopted until 1844 – introducing incorporation by registration o In 1855, Limited Liability Act was past which finally allowed for limited liability, forced companies to have ‘limited’ after name to warn public about ‘dangerous’ new entity Canadian History • In 1849, acts passed in upper and lower Canada allowing for incorporation of joint stock companies for constructing roads/bridges; 1850 act then allowed for manufacturing and other purposes o 1860 and 1864 then allowed for incorporation by judicial decree and by letters patent; not abolished until 1970 when Canada Business Corporations Act occurred in 1975 (template for many provinces) • In Ontario in 1970s, passed legislation that replaced letters patent with registration o Permitted one person companies, protected third parties dealing with a corporation, codified duties of directors/officers, regulated insider trading, improved minority shareholder protection, permitted derivative action, etc. • In BC, passed Companies Act in 1973 which was very similar to federal act, but not the same (sui generis) • Business Corporations Act replaced it in 2002 o Retains ‘contract plus registration’ model of incorporation (need both – incorporation agreement and registration with registrar) • Businesses in BC can choose federal or provincial incorporation American History • In late 1800s, early 1900s, there was massive consolidation of businesses in monopolistic trusts – states were fighting this (because of potential for corruption), but there were major economic incentives to merge • The Delaware Phenomenon – to generate more tax revenue, NJ changed its legislation to allow more business freedom – other states followed – a competition to see which state govs could be the most ‘hands off’ / race to the bottom o Delaware became the dominant US corporate jurisdiction o Pressure for federal government to intervene, but some argued that directors will do what is in the best interest of shareholders (accountability) o Push persisted for a while for federal corporate law, but faded away after WWI • Canada – fairly flexible federal corporate law, so many companies incorporated federally and there was no ‘race to the bottom’ or Delaware phenomenon Differences between Canada and US 1) US has far more publicly traded companies, absolute and per capita 2) Much more liquid market; only 5.3% widely traded in Canada 3) Concentration of share ownership is higher in Canada; only 14% of companies are widely held by investors as opposed to 63% in US 4) Highly interconnected corporate relationships in Canada 5) US does not have federal corporate law as Canada does, on top of provincial legislation 6) Canada does not have have a federal securities commission - we have provincial, US has national Securities regulation • Aim is to provide an informed, transparent and honest market in the publicly issued and traded securities of corporations • Applies to all corporations regardless of where the issuer was incorporated • Slowly through 60s-70s introduced more stringent requirements for disclosure, outlawed insider trading, etc. • Sarbanes Oxley in US was echoed in Canada with even more stringent requirements Constitutional Issues • Federal corporations remain subject to provincial laws of general application; employment standards, consumer protection, and securities laws o Paramountcy can apply if there is conflict between fed and prov laws Salomon v Salomon & Co [1897] F: S incorporated his boot company by selling his personal business to the company at a price of 38,800; only shareholders were himself, wife and 5 children, each of whom had 5 shares; sale was made by issuing 20K shares to S, 1K in cash and 10K debenture • company went into bankruptcy as a result of economic depression/lost gov contracts; S lent money to company, some of which were transferred to Broderip who paid cash • Later in bankruptcy, liquidation could only pay out S’s debentures, not B and other creditors A: liquidator claims company was a mere alias of S, and that S should indemnify the company for ordinary creditors before receiving any money – says this is fraud, wants to rescind loan contract, and says 20K shares not paid up • S built up valuable business over 30 years, created a limited private company as family wanted part of the business, and to grow the business (good faith motive, no intended fraud/deceit) o Corporation was formed according/complying with legislation, no weird/abnormal internal rules (articles) for the company o Among reasons which induce people to form companies, is desire to avoid risk of bankruptcy, and increased facility afforded for borrowing money o Trades can be made without exposing persons interested in it in the event of failure to the harsh provisions of bankruptcy law; can also raise money on debentures • Price was fairly extravagant, over-valued by S as owner, but that has little bearing on decision • In almost every company that is formed, subscribers are friends who sign their names without any intention to take further part or interest in the matter – there is no requirement for balance or power, different minds and wills in the business; Act just requires 7 signatories • Any member of a company acting in good faith can take debenture as outside creditor; every creditor is entitled to get and hold the best security the law allows him to take • If shares are fully paid up, does not matter whether they are in hands of one or many C: Salomon not liable R: Company is a separate legal entity, not merely an alias of the owner If a company is properly formed/incorporated, then: A shareholder is not liable to pay company debts A shareholder and the company are two distinct entities A company may exist with one shareholder (or more) A shareholder may also be a creditor, even in a one-person company Terminology • Corporation is separate legal entity from incorporator, directors/officers, shareholders, employees, etc. • Can enter into contracts, be held liable; can own, buy and sell land / lease assets, can borrow/lend money, can be liable in tort • Shareholder: provides money to corporation with hope of receiving dividends, increase in value of shares • Share is not defined in Act, but is essentially a bundle of rights depending on class – that can be used against corporation or management of corporation o Does not give you legal title to any assets of the company Limited Liability vs Creditor Protection Limited liability is principal reason to incorporate – an investor will never be liable for more than their investment • Shareholder’s assets are protected from liability (shareholder immunity) (s 87(1)) • Other reasons: o Can have separation between ownership and control o Perpetual succession – does not cease to exist when founder dies o Transferability – can sell/transfer shares to other persons o Reduces overall income tax payable Creditor protection - Limited shareholder liability is at odds with lenders who want assurances of repayment • Recommendations: o Register a security interest on the loan (mortgage on property) o Obtain a personal guarantee from the shareholder (in contract, loan agreement), increases liability § Subcontract with individual person (gets around Salomon) o Demand a higher interest rate if more risk o Advise it to refuse to lend to the corporation (if it does not make sense) • BCA has creditor protection built in o Corporate naming rules (‘cautionary suffix’ – s 23,24) – Inc. / ltd. / corp. – must use when forming contracts, invoices, orders of goods/services, etc. § Duty as lawyer to tell newly incorporated company that they must use cautionary suffix § Directors can have liability as well if not using suffix o Capital maintenance – corporation must receive cash or true equivalent when issuing shares (s 64) § corporation must not pay dividends if insolvent or making payment would cause insolvency (s 70) § Ie. not able to pay its debts – creditors must get paid before profit sharing o Publicity – must be registered, gets published in Gazette; anyone can search registry, can find headquarters and has some rights to inspect it § Corporations must keep certain records; public companies have reporting standards/rules o Officers’ and Directors’ liability – remittances not paid to appropriate entity, employees not paid, environmental issues if affected (can give rise), torts (see below) o Oppression remedy (see Chapter 10) o Duties in the vicinity of insolvency (People’s Dept Stores) – shift towards creditor protection when approaching insolvency – eg. directors should not keep making deals when they ought to realize it is unlikely they will meet obligations o Piercing the corporate veil (below) Conflict of interest – concerns/aims/goal of two or more different parties; goals are not compatible • Lawyers are bound by different rules – 3.401 lawyer must not act or continue to act for a client where there is a conflict of interest, except as permitted under this code • As a lawyer, must ask: what is the risk that my loyalty to a client would be materially/adversely affected by my own interest, duties to another client, a former client, etc. o To whom do I owe a duty of loyalty? Ie. If I receive several instructions, who do I listen to • If the company is your client, even if you take instructions from an officer, employee, etc. duty to act for the organization as a whole • Can also take on a single director/shareholder as your client, but need to be explicit about to whom your loyalty is – if you choose one person, recommend that the other people seek out independent legal advice • can have joint retainer – can represent business and employee at same time as long as no conflict in goals Torts – officers, directors are not shielded from personal liability in tort • Examples: trespass, assault, libel, some negligence • even if the person was acting in normal course of employment Said v Butt [1920] • Officer of a company could not be sued for procuring breach of contract between the company and other party • Officers/directors could not be sued for committing economic torts if they are acting in normal scope of office • This was modified by SCC in ADGA ADGA Systems Int’l Ltd v Valcom [1999] F: ADGA claimed that competitor Valcom raided its employees and caused economic damage – claiming against director and 2 employees who led the recruitment program I: whether directors can be sued for actions as individuals when the actions were genuinely directed to the best interests of the company A: “The consistent line of authority in Canada holds simply that, in all events, officers, directors and employees of corporations are responsible for their tortious conduct even though that conduct was directed in a bona fide manner to the best interests of the company, always subject to the Said v Butt exception (procuring breach of contract between your company and the other contracting party) – Valcom liable as they are not privy to contract • Lewis v Boutilier – does not matter if the corporation might also be liable • Berger v Willowdale – action against officer allowed despite action against company being barred by Workmen’s Compensation Act Baron Summary: there will be situations where there will be cause of action against company and senior management, but never against a shareholder who is just a shareholder • There is independent cause of action against an officer/director for breach of fiduciary duty, as well as a cause of action against the company Piercing the corporate veil • There are situations where we look through the company into the particular shareholders (‘disregarding the separate legal personality of the corporation’) • Categories: o If a company is created for fraudulent purposes (Lynch), courts will pierce through company and extend liability to shareholders o If there is conflict with other legislation, like Income Tax Act, courts can look in favour of CRA and extend liability • Holding company – a company that buys shares of subsidiary companies – can own lots (wholly owned subsidiary, or not) o Does not have any operations, just set up for liability / income tax reasons o Parent company is similar but usually has its own operations De Salaberry Realties v MNR [1974] F: two wealthy families incorporated a variety of companies, and had a ‘grandparent’ company that owned shares of subsidiary (‘parent’) company, that owned shares of sub-subsidiary (‘sister’) • Incorporated a new sister company for the purpose of buying land, to develop and purportedly build shopping malls; what they were actually doing was buying and selling land to make a profit o All policy/decision-making done at grandparent company level • CRA did not agree with how they were filing their taxes, wanted to collect Court considerations: at sister level, businesses were buying land for as much as $2M, but the share structure was valued at tiny amounts like $1000 – companies were just borrowing from the other companies (thin capitalization) o Thought it was a half-hearted attempt to look like they were actually doing business o They were careless about zoning bylaws so intention was clearly just to sell it at a profit o Minister was curious why they needed so many sister companies, why not just one? I: Should the corporate veil be lifted and the collection of companies analyzed as one? (increases tax liability here) A: The appellant company is a shield – its conduct must be ascertained by the course of conduct of the whole group of companies – the parent companies are in an intimate and immediate domination of the appellant company which has no independent functioning on its own R: 6 considerations for determining whether a subsidiary was carrying on the business of a parent company 1) Were the profits treated as profits of the parent company? 2) Were the persons conducting the business appointed by the parent company? 3) Was the parent company the head and brain of the trading venture? 4) Did the parent company govern the adventure, decide what should be done and what capital should be embarked on the adventure? 5) Did the parent company make the profits by its skill and direction? 6) Was the parent company in effectual and constant control? Need these considerations + some policy concern (eg tax avoidance) Clarkson v Zhelka [1967] F: Selkirk incorporated several companies, was controlling shareholder; one of those many companies (Industrial) bought land 1959 – money came from other companies in loan • In 1960, Selkirk, for Industrial, transfers land to sister Zhelka for promissory note worth $120,000 • In 1961, Zhelka mortgages the land to G; Z doesn’t pay, so G commences foreclosure action; part of the land was sold, and the cash was used to pay off mortgage and a province of ON tax lien • Z receives interest adjustment and it ends up in another of S’s companies (Fidelity) • • S went personally bankrupt in 1960, Clarkson was appointed as trustee, trying to figure out who owns what Claims that the transfer to Z not real, should be able to pierce corporate veil and go after that land o They think he transferred it to escape his creditors A: The companies in S’s corporate structure were interrelated in that there were transfers of assets from one to another, or advances of money between them, although none were subsidiaries • Only person to benefit financially from their operation was S himself • S was not called as a witness, and there are many gaps in evidence – too much has been left to unsafe conjecture • His companies are all under his power – his nominees are all family members that he likely dominates in decisionmaking (all one-man companies) • Money that ended up in Fidelity was really the property of Industrial, and was relatively minor • Industrial was not created for any fraudulent purpose, when it was created in 1958 there is no evidence that S was insolvent – cannot trace any of S’s personal assets into the hands of industrial o this is not a case where a debtor has transferred his own assets to a corporation of his making for the purpose of avoiding existing personal liabilities or obligations, nor has he made secret profit o general rule is Salomon, and only exception is where it would be flagrantly opposed to justice to not pierce the veil o “if a company is formed for the express purpose of doing a wrongful act, or if when formed, those in control expressly direct a wrongful thing to be done, the individuals as well as the company are responsible to those to whom liability is legally owed” • Therefore, not going to pierce the corporate veil here – they are two distinct entities, no fraudulent purpose Lee v Lee’s Air Farming [1961] F: Lee operated a business flying an airplane over farming land spraying fertilizer (was essentially a one-man company); was appointed governing director of the company for life, and was appointed chief pilot at a salary arranged by him; • one article held that master servant relationship will exist between him and company in course of employment • Lee died flying his plane – wife is claiming compensation from workers compensation board • Board claims that because he was governing director who had all control of the company, he cannot be a servant of the company A: Lee died carrying out his duties as an employee, not as a director • He was paid a salary which was recorded – work that was being done was at request of customers whose contractual rights were only against the company o Cannot be said that when he died he was discharging duties as a governing director • Just as the company and deceased were separate legal entities so as to permit of contractual relations being established between them, so also were they separate legal entities so as to enable the company to give an order to the deceased (contract was made between him and the company) R: a person who is president/director of corporation can also be an employee of the corporation Lynch v Segal [2006] F: Marital breakdown, wife L applies for spousal/child support, husband S flees the jurisdiction • L then seeks a court order against his corporations because S has no assets in his name • When S set up companies, he set it up to distance himself from his wife and his creditors in every possible way - He was an expert at setting up these corporate screens, using aliases, etc.; incorporated by an Ontario solicitor D • there were lots of blank spots in filings – incorporated on behalf of an unnamed beneficial owner, no recording letter (notes/summary), transfer forms/share forms were blank o D instructed to appoint himself as sole shareholder/director of company, to prepare and execute the blank forms providing that the land be held in trust for the beneficial owner o He was told to resign as director and send blank forms to S’s solicitor on obscure island country • This was done allegedly because there was ‘mysterious high-end foreign investor’ operating through the trusts • S had already done similar things to his mansion and other assets where money was transferred to untouchable foreign bank accounts after selling off assets A: Mr. Siegel and his corporations can be treated as law as the same thing – he is beneficial owner of shares/land • General rule is Salomon – that a corporation is unique legal personality o But, in Wildman, court addressed that it is not an absolute principle – courts will not enforce ‘separate entities’ notion where ‘it would yield a result too flagrantly opposed to justice, convenience or the interests of the Revenue’ • A more flexible approach is appropriate in the family law context, particularly where – as here – the corporations in question are completely controlled by one spouse, for that spouse’s benefit, and no third parties are involved o In Wildman, in similar circumstances, court ordered to put a charge on companies as well as him personally, to pay the spousal support payments o “The law must be vigilant to ensure that permissible corporate arrangements do not work an injustice in the realm of family law” – Wildman • S was using the corporate structure for one sole purpose, to disguise his property so that his spouse and children would have no claim against him should he ever defend against a claim • Piercing the corporate veil is an essential mechanism for ensuring that a spouse and children of the marriage receive the financial support to which, by law, they are entitled • Would put vesting order on the lands R: Salomon does not apply when separate personality is used for the purpose of avoiding financial obligations (fraudulent purpose), especially in the family law context (‘flagrantly opposed to justice’)