Problems in Canadian Business Law

1. Problems in Canadian Business Law Pol/Soc Sci 3165 6.0A Tuesdays, 2:30-5:30 pm Simon Archer sarcher@torys.com

2. Movie Review • “The Corporation”, Achbar, M. based on book by Balkan, J. • Anyone seen it? Thoughts? Populism? • What role does corporation play... • in the movie? • in the capitalist system? • How are corporations similar to “natural persons”? • How are corporations dissimilar to people? • What is the primary “engine” or “driving force” or reason behind “corporate behaviour”? • What was the primary remedy identified? • Question: is a corporation a “democratic” form of association, or a “totalitarian” form of association (or neither)?

3. Last class • Partnerships

4. Mini problems • Simon and Tina purchase a sail boat in crap condition with the aim of fixing it up and selling again. Are we partners? Why? • Simon and Tina decide to make a partnership. They call their partnership Tina LLP and register their partnership, and hire Grajame to clean up the boat. Grajame carelessly injures Annie, who wants to sue him. Annie wants to know who she can sue.

5. Answers • Simon and Tina are probably partners. We have collaborated on the project for the purposes of profiting. We do not have enough information about the rest of the relationship. • Annie can sue Grajame, and Grajame’s employers are vicariously liable *if* he injures Annie in the course of his duties. Annie can sue the partnership, and usually, all partners are liable for the torts of other partners or employees of the firm. This is a firm liability, not a personal liability, so Simon is liable for the negligence as well. Alternately, we say that if Annie sues Tina, Tina can claim against Simon for his portion of the liability.

6. Missed class • Financial Statements, valuation, stuff. • Slides on web. • Not testable because we had no class. • If you’re interested, take a peek. • If you’re going to be a business wonk, read closely and learn everything you can about valuation of a business.

7. This class • Just who are they? • Historical development of the corporation • Nature of a corporation • Methods of incorporation • The incorporation process • A “typical case”: Salomon v. Salomon

8. History • Royal Prerogative (e.g. Hudson’s Bay Co.) • Limited liability arose in late 1800’s • cf. rise of massive train accidents, rich passengers able to sue • Created by legislation in USA after War of Independence (no monarch to exercise prerogative) • Canada followed suit in 1849-1867 period • Q1: The Charter applies to all government actors. It applies to those who regulate corporations. It does not apply to corporations per se. Why?

9. Nature of a corporation • Separate legal entity • Powers of a natural person • Shareholders have limited liability • Agents bind it in contract • Must operate within Articles of Incorporation or Charter (e.g., scope of business)

10. Nature... • Principal distinguishing features • Aspects of Control – Board of Directors • Limited Liability – no general partners • Transfer of Ownership – easy • Term of Operation – unlimited • Governed by statute • Separate existence from shareholders • Name style identifier – Ltd, Corp, Inc

11. Methods of incorporation • Royal Charter • Not used anymore • Letters Patent • Version of royal charter • Special Act • Banks, etc. • General Act • Doctrine of constructive notice • Indoor management rule

12. CORPORATION LAW INDOOR MANAGEMENT RULE No Need for Contracting Party to Inquire Behind Authority Provided by Officer of Corporation if It Appears to Be in Order Written Authority or Approval of Contract Provided CONTRACTING PARTY AUTHORIZED OFFICER OF CORPORATION SHAREHOLDERS OR DIRECTORS Contract Authority to Bind Corporation in Contract (as Required)

13. Making a person: procedure • Proposed name search • Application for Articles of Incorporation • Government filing • Get certificate of incorporation • Initial By-laws and Resolutions

14. Salomon v. Salomon • Leading case on basic corporate theory and “one-man” companies, UK, 1896 • NB: UK behind others because need for some development was slower • Aron Salomon had carried on business successfully as a leather merchant for many years • In 1892 Aron agreed to sell all the assets of his leather business to a newly incorporated entity named “Aron Salomon and Company Limited”

15. Salomon • Aron and six other family members formed a company and contributed £1 each for seven shares • The Company then bought the assets of the leather business and paid Aron by giving him 20,000 shares valued at £1 each and £10,000 face value of secured debt.

16. Salomon Balance Sheet at Inception Short Term AssetsLiabilities Cash £ 7Secured Debt to Aron £10,000 Long Term AssetsShares Leather Business £30,000 Outstanding 20,007 £20,007 Total £30,007 £30,007

17. Salomon The Incorporation - “Aron Salomon and Company, Limited” • There was a general incorporation statute that granted shareholders “limited liability” - major concept. • Statute required 7 individuals to sign the incorporation document and to become shareholders in the corporation.

18. Salomon • Aron, his wife, a daughter and four sons signed as incorporators • Name “Aron Salomon and Company, Limited” • Capital - authorized number of shares 40,000 - each share nominal value of £1 • Aron, his wife and five of his children each subscribed for 1 share at £1 per share • The company was duly registered under the statute

19. Salomon • Each incorporator had previously transferred 1£ for 1 share each. • Aron transferred all the assets of his leather business to the corporation, which assets he said were worth £30,000 • The corporation therefore had a liability of £30,000 which it satisfied by • issuing 20,000 shares to Aron (nominal value £1 each)

20. Salomon • issuing a debenture, which recorded the £10,000 debt owing to Aron, and was secured by a charge on all the assets of the new company • Such a secured debt must be properly registered, which was done

21. Salomon • Aron borrowed personally £5,000 from Broderip • Aron gave Broderip as security, a pledge of his £10,000 debenture • Pledge is the delivery of goods by a debtor to his creditor to be kept by the creditor until the debt is satisfied - legal title remains in pledgor - possession must pass to pledgee - pawn is same concept

22. Salomon • Debenture required company to pay interest (normally quarterly or half-yearly) • Company defaulted on interest payment in 1893 • Broderip sued the company to collect money owing on the debenture • Company went into liquidation (bankruptcy)

23. Salomon • Distress sale of assets • Pay liquidator etc. first • Pay Broderip £5,000 plus interest • Balance £1,500 • Claims against balance: - Aron Salomon on his debentures £5,000 + int. - Unsecured creditors £7,733 8s.3d. - Shareholders £20,007

24. Salomon • If Aron had not transferred his business to the company he would: • get nothing on the liquidation; • be responsible personally to pay all the unsecured creditors.

25. Salomon • Corporations are created by statute and one looks to the statute for basic guidance; • Corporations are entities completely separate from their “owners”; • Corporations own their assets and can deal with them freely;

26. Aside • Corporations are “persons” under federal (s.35) and Ontario (s.29) Interpretation Acts • Transfer at inflated value carried by acceptance of all shareholders • Creditors only have rights they bargain for • There is nothing wrong with a one person company?

27. Aside • CBCA s.5(1) says: - One or more individuals not one of whom a) is less than 18 years of age b) is of unsound mind and has been so found by a court in Canada or elsewhere, or c) has the status of bankrupt, may incorporate a corporation by signing articles of incorporation and complying with section 7 (which section requires sending the articles and two other forms to the Director)

28. Aside • There can be several layers of investment in a corporation with different levels of priority or subordination • Equity (shares) are subordinate to debts, whether secured or unsecured. • All debts are equal unless secured

29. Aside • Various security statutes and concepts - PPSA - Mortgage - Floating Charge • Subordinate by contract

30. Salomon • The Court made several clear statements… • Incorporators need not all invest significant amounts - so long as incorporation requirements are met. • Once you have a corporation, the motives of the persons forming it are irrelevant (with obvious extreme exceptions). • Once incorporated there was a legal entity and the business belonged to it and not to Mr. Salomon. • Artificial creation of the law. Legal existence. Legal entity.

31. Lord MacNaughten • “The company is at law a different person altogether from the subscribers… and though after incorporation the business is precisely the same as it was before… the company is not in law the agent of the subscribers or trustee of them. Nor are the subscribers as members liable… except as provided.”

32. Aside • A corporation is a creature of its own statute - s. 45(1) of CBCA says shareholders are not liable for acts or defaults of the corporation (except for very limited situations specified in the statute) • Basic concept is no shareholder liability beyond the money the shareholder contributed - the shareholder owns shares but does not own the corporation or its assets.

33. Theory • Limited liability means you decrease the need to monitor the liability. • Reduces the need to monitor other shareholders as their liability is also set. • Free transfer gives shareholder a way to exit • Can establish a fair price. • Allows for diversification.

34. Questions • Some say there is higher cost of borrowing if shareholders have limited liability as creditors cannot go after the shareholders. • Others say that if unlimited liability, equity investors will expect higher rates of return to compensate risk while lenders will charge less. • Equity investors are more likely to monitor management b/c they stand to lose their investment before the debt holders are impacted.

35. More questions • Was Salomon and Company, Limited really just a legal fiction that realigned responsibilities - i.e. nothing new in productivity? • Are corporations separate people? • What kind of people are they? • Next week... • piercing the corporate veil

36. Essay Topics • Should corporations have the same right to free speech as natural persons, as guaranteed by s. 2(b) of the Charter? Why, or why not? • Should there be a single national securities regulator in Canada? Why, or why not? • Should business methods be patentable? Why, why not? • I will add one more topic on the subjects we cover, post-reading week.