Business Forms and Arrangements PDF

Business Forms and Arrangements Canadian Business and the Law, EIGHTH EDITION Objectives After studying this chapter, you should have an understanding of the characteristics of the major forms of business organization the advantages and disadvantages of the major forms of business or...

Business Forms and Arrangements Canadian Business and the Law, EIGHTH EDITION Objectives After studying this chapter, you should have an understanding of the characteristics of the major forms of business organization the advantages and disadvantages of the major forms of business organization the legal consequences of a partnership the methods of arranging business activity 2 The Sole Proprietorship (1) This is the oldest, simplest form of business organization. It is the most often used form of business organization. There is no legislation pertaining to the sole proprietorship as such, but you may need to obtain a business licence and register a trade name. It is easy to set up. 3 The Sole Proprietorship (2) Sole proprietorship: An unincorporated business organization that has only one owner. The owner has unrestricted legal responsibility for obligations. There is no legal distinction between the business and its owner. 4 Financial Liability in a Sole Proprietorship Sole proprietors have significant financial liability because any obligation of the business is the owner’s personal liability. Borrowing o As it is not a legal entity, it must borrow in the name of the owner, who is personally liable for the debt. Contract liability o Contracts must be entered into by the owner, who is personally liable for breach of any contract. Tort liability o The owner is personally liable for torts committed by employees. 5 Profit Sharing and Decision Making in a Sole Proprietorship The owner bears all of the risk of failure and reaps all of the profits. The owner has all decision making authority and can made decisions quickly and independently. 6 Sources of Capital, Taxation, and Transferability in a Sole Proprietorship Sole proprietorships have limited access to capital because of sole ownership. Access to capital is limited to owner’s own assets and any credit available to the owner. A sole proprietorship is not a legal entity, and all profits and losses are reported on the owner’s personal income tax return and taxed at the owner’s tax rate. A sole proprietorship cannot be transferred or sold because it is not a legal entity, but its assets may be sold. 7 Regulation of Sole Proprietorships There are no formal requirements to form a sole proprietorship; one simply begins business activity. They are subject to the same regulation as any other form of business, such as zoning laws and consumer protection legislation. Some specialists may require a licence to practice their specialty—for example, lawyers, doctors, electricians. Some industries and forms of business are subject to regulation—for example, door-to-door selling and interprovincial trucking. Municipalities may impose registration or licensing requirements. The name must be registered if the business uses a name other than the owner’s name. 8 Pros and Cons of a Sole Proprietorship Pros Cons simplicity unlimited personal liability speed and independence working alone (but can have profit motive employees) lower costs limited access to capital (can tax benefits—can claim only borrow) business expenses limited lifespan (dies with control over decision making owner) tax disadvantages (must claim all business income with personal taxes) 9 The Partnership partnership: A business carried on by two or more persons with the intention of making a profit. It is similar to a sole proprietorship, in that neither has a legal personality— or legal existence—separate from the people who comprise them. There are no special steps to create a partnership—it arises automatically when two or more people do business together with an objective of making a profit. 10 Financial Liability in a Partnership Each owner has unlimited personal liability for the entire debt of the partnership, not just a proportion of the debt, but they are entitled to be reimbursed from the other partners for their share of the debt. joint liability: Liability shared by two or more parties where each is personally liable for the full amount of the obligation. As it is not a legal entity, its debts are personal debts of the partners. Each partner is liable for any breach of contract by the business. The personal assets of the partners are available to satisfy any debts of the business. 11 Profit Sharing and Decision Making in a Partnership The partners decide how profits and firm assets are to be divided. o For example, ownership may be 50%–50%, 70%–30% ,and so forth. o Legislation presumes equal ownership if the partners cannot agree on how to divide the partnership. Decision making is by majority, and disagreement can impede business decision making. 12 Sources of Capital, Taxation, and Transferability of Partnerships More owners give the partnership access to more capital availability. The partnership is not a separate legal entity, and therefore any income from the partnership business is allocated to the partners on the basis of their interest in the partnership, and they must, in turn, include it on their individual tax returns. Partners do not individually own or have a share in specific partnership property. Each partner has an interest in all partnership property. 13 Agency and the Partnership Act Partnership law is based on contract law, agency law, and provincial partnership legislation. Provincial partnership legislation defines when a partnership exists and what the relationship of partners is to the outside world. Provincial partnership legislation has optional rules (subject to an agreement to the contrary) for the relationship of the partners to one another and how the partnership ends. 14 When a Partnership Exists A partnership exists when two or more people carry on business in common with a view toward profit. The court will look to the essence of the relationship rather than the labels used by the parties. o A person who conducts themself as if they were a partner—by sharing in profits, managing the business, or contributing capital to establish a business—is a partner in the eyes of the law. Partnership legislation also sets out circumstances that do not by themselves create a partnership, such as joint ownership of of property. 15 The Relationship of Partners to One Another Partnership legislation provides that partners are agents of one another and of the firm. As agents, partners are fiduciaries: o Partners must put interests of one’s partners ahead of one’s own interests. o Partners cannot compete with the partnership. o Partners cannot use partnership property for personal profit. o Partners cannot use a partnership opportunity for personal gain. 16 Partnership Agreements Partnership agreements are recommended but not mandatory. A partnership agreement should address the following: o creation of the partnership (names, addresses, description of business) o capital contribution of each partner, and how it is managed o decision making duties, limits, and dispute resolution mechanisms o profit distribution o rules for changing the partnership, adding new partners, retirements o dissolution of partnership, valuation of assets 17 The Relationship of Partners to Outsiders Partners are agents of the firm, and the firm and other partners are responsible for the contract entered into by a partner. Partners may enter into an agreement to restrict their authority, but outsiders will not be bound by this unless they are aware of the agreement. Partners are jointly and severally liable for torts committed by a partner. joint and several liability: Individual and collective liability for a debt. Each liable party is individually responsible for the entire debt as well as being collectively responsible for the entire debt. 18 Case 14.1 (1) Blue Line Hockey Acquisition Co, Inc v Orca Bay Hockey Limited Partnership, 2008 BCSC 27, aff’d 2009 BCCA 34, leave to appeal denied 2009 CanLII 38635 (SCC) Three businessmen, A, G, and B, agreed to work together to potentially purchase 50 percent of the Vancouver Canucks. They discussed generally the terms of an offer but did not discuss the specific terms other than each would own one-third of the interest acquired in the Canucks. All three understood that no member of the group could bind the others. Several proposals were made that were rejected by the owners. A left the group but indicated he was still interested in acquiring a share. G and B developed a proposal to purchase 100 percent of the team and arena and told A he could not participate. 19 Case 14.1 (2) Blue Line Hockey Acquisition Co, Inc v Orca Bay Hockey Limited Partnership, 2008 BCSC 27, aff’d 2009 BCCA 34, leave to appeal denied 2009 CanLII 38635 (SCC) A, without informing G and B, entered negotiations with the team owners and reached agreement to purchase 50 percent of the team and the arena with an option to purchase the remaining 50 per cent. G and B sued A for breach of fiduciary duty. Court: o They agreed one would be a spokesperson but would not have authority to bind the others. o There was no valid contract between A, G and B to form a partnership, merely an agreement to work together to purchase property. 20 Pros and Cons of Partnerships Pros Cons ▪ simplicity ▪ unlimited personal liability ▪ lower costs ▪ loss of speed and ▪ greater access to capital independence ▪ profit motive ▪ limitations on transferability ▪ tax benefits ▪ profit sharing ▪ tax disadvantages 21 Business and Legislation 14.1 (1) The Partnership Act: The Relations Between Partners All common law provinces have an Partnership Act modelled on the British Partnership Act. Mandatory provisions relate to the relationship between partners and outsiders. The relationship between partners is captured in optional rules: o All partners share equally, in profits and losses. o Property acquired is used for the partnership. o Partners are indemnified by others for liability incurred for the partnership. o Excess payments from a partner earn interest. 22 Business and Legislation 14.1 (2) Optional rules, continued o Each partner takes part in business management. o No partner will receive payment for acting in the business. o No new member will be admitted without consent from all. o Disputes may be decided by a majority. o Partnership books will be kept at the place of business. o No simple majority can expel a partner. 23 Business Application of the Law 14.1 Responsibility for Partner’s Debts Conduit, a partner in a Toronto bar, learned her partner had not paid HST, and then learned a bank had obtained a $62 000 judgment against him for another debt from another business venture. The bank ended up getting a court order against the bar for his debts and sought to make Conduit personally liable for his debt. Conduit and the bank settled out of court in a confidential settlement. 24 How and Why a Partnership Ends The Partnership Act provides for termination under certain circumstances. o If entered into for a fixed term, by the expiration of the term. o If entered into for a single venture or undertaking, by the termination of that venture or undertaking. o By any partner giving notice to the others of their intention to dissolve the partnership. o Following the death, insanity, or bankruptcy of a partner. This can be changed by the agreement and needs to be in cases such as large firms, who have partners entering and leaving. Legislation provides process for property—proceeds from sales go to debts and liabilities, then to loans, then capital contributed by partners, and then divided to partners. 25 Business Application of the Law 14.2 Managing Partnership Risks Choose partners with care. Educate partners on their authority and limits, and the consequences of exceeding them. Monitor the activities of partners. Notify clients and customers of the departure of partners to prevent being held liable for debts contracted by departed partners. Insure against liabilities for wrongdoing. 26 Limited Partnership limited partnership: A partnership in which the liability of some of the partners is limited to their capital contribution. A limited partnership requires a written agreement that must be registered with the appropriate provincial body. At least one partner has unlimited liability (the general partner(s)), while others have limited liability. Limited partners have a liability limited to the amount that they have contributed to the partnership capital. Limited partners have the right to share in profits and the right to have their contribution returned on dissolution, but they cannot take part in the management of the partnership or they lose their limited liability. 27 Limited Liability Partnership limited liability partnership (LLP): A partnership in which the partners have unlimited liability for their own malpractice but limited liability for other partners’ malpractice. An LLP has the characteristics of a general partnership, but with specific limitations on the liability of partners. It is designed to address the concerns of professionals who are not permitted to use incorporation as a means of achieving limited liability. The limited liability varies between jurisdictions. 28 The Corporation A corporation is a distinct legal entity in law and capable of assuming its own obligations. It is usually the safest vehicle for conducting business because the owners have limited liability. limited liability: Responsibility for obligations restricted to the amount of the investment. It is the most important form of business organization today. It is managed by a board of directors elected by the shareholders. Shareholder: A person who has an ownership interest in a corporation. Director: A person elected by the shareholders to manage a corporation. 29 Profit Sharing, Decision Making, and Sources of Capital in a Corporation Profits are distributed to shareholders through dividends. dividend: A division of profits payable to shareholders. The corporation is managed by a board of directors who may hire officers to assist in running the corporation. A corporation obtains capital by borrowing or selling shares. A share represents a unit of ownership in the corporation and provides an opportunity to earn dividends and an increase in share value. In the event of business failure, creditors are paid ahead of shareholders. 30 Taxation and Transferability of Ownership in a Corporation Corporations are legal entities that pay their own taxes apart from the shareholders, who pay tax on capital gains, dividends, and salaries received from the corporation. Reduced or deferred taxes may sometimes be gained through the appropriate splitting of distributions to shareholders between dividend and salary payments. A shareholder can sell or bequeath their shares with no interference from corporate creditors because the shareholder has no liability for corporate debts. Transferability may be restricted by the corporation’s incorporating documents or a shareholders’ agreement. 31 Perpetual Existence and Regulations Because the corporation exists independently of its shareholders, the death or bankruptcy of one or more shareholders does not affect the existence of the corporation. Like sole proprietorships and partnerships, a corporation must comply with laws of general application. 32 Pros and Cons of Corporations Pros Cons limited liability higher costs flexibility public disclosure greater access to capital greater regulation continuous existence dissolution tax benefits tax disadvantages transferability possible loss of control potentially broad management potential bureaucracy base 33 Comparison of Major Forms of Business Organization Characteristic Sole Proprietorship Partnership Corporation Creation At will of owner By agreement or conduct of By incorporation documents the parties Duration Limited by life of owner Terminated by agreement, Perpetual unless dissolved death Liability of owners Unlimited Unlimited Limited Taxation Net income taxed at Net income taxed at Income taxed to the corporation; personal rate personal rate dividends and salary taxed to shareholders Transferability Only assets may be Transferable by agreement Transferable unless incorporating transferred documents restricts transferability Management Ownder manages All partners manage equally Shareholders elect a board to manage unless otherwise specified in the affairs of the corporation; officers agreement can also be hired 34 Business Arrangements: The Franchise It is a contractual agreement between a manufacturer/wholesaler/service organization (franchisor) and an independent business (franchisee) who buys the right to own and operate unit(s) of the franchise. The franchisor owns the trademark or trade name and permits another to sell under that trade name. Franchise agreements cover how the business is run, where supplies can be purchased, royalties paid, charges for advertising, etc. The relationship between franchisor and franchisee does not normally create fiduciary obligations. 35 Business and Legislation 14.2 Ontario’s Franchise Legislation: Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000, C 3 The regulation of franchising is within provincial jurisdiction and six provinces have enacted franchise statutes. The act does the following: o defines franchise and elements need to establish a franchise o sets out disclosure requirements o imposes a duty of fair dealing o establishes a right of association 36 Case 14.2 Fairview Donut Inc v TDL Group Corp, 2012 ONSC 1252, aff’d 2012 ONCA 867, leave to appeal refused 2013 CanLII 26760 (SCC) Tim ­Hortons franchisees complained that changes introduced by the franchisor negatively affected their profitability, including a requirement that franchisees to purchase par-baked goods from a central bakery rather than baking the products in-store from scratch and that the franchisor charged unreasonably high prices for the ingredients. Court: There was no requirement that a new product or model had to be profitable in its own right and no implied term requiring Tim Hortons to supply ingredients to franchisees at lower prices than they could obtain on the open market. The good faith and fair dealing duty does not require the franchisor to consider the franchisees’ interests at the expense of its own. 37 Business Arrangements: Joint Venture A joint venture is an association of business entities that unite to carry on a business venture. Normally, the entities will share profits and losses from the venture, which is usually but not always limited to a specific project or a period of time. Joint ventures can take a variety of forms, such as a partnership or an equity joint venture, or may simply be a contractual arrangement between parties. 38 Case 14.3 Blue Line Hockey Acquisition Co, Inc v Orca Bay Hockey Limited Partnership, 2008 BCSC 27, aff’d 2009 BCCA 34, leave to appeal denied 2009 CanLII 38635 (SCC) Refer to Case 14.1 discussion for facts. Was there a joint venture between Gaglardi, Beedie, and Aquilini? Did Aquilini owe any duties to Gaglardi and Beedie? Court: Like partnerships, joint ventures must be founded on contract. The parties must intend to enter a joint venture and must have agreed on all essential terms. In this case, there was no agreement as to the identity of the parties, there was no certainty of subject matter, and there was no agreement on the price. 39 Business Arrangements: Strategic Alliance A strategic alliance is a co-operative arrangement among businesses that may involve joint research, technology sharing, or joint use of productions. The relationship is usually contractual in nature. For example, KPMG in Canada has a host of alliances with leading technology, data, and services companies such as IBM and Microsoft to assist clients with a range of issues including cybersecurity, blockchain technology, digital labour, and regulatory change. 40 Business Arrangements: Distributorship or Dealership These are similar to a franchise and usually arise when one party agrees to sell products or provide services prescribed by a manufacturer. It is often seen in the automotive and computer industries. The relationship is governed by a contract. Normally there is no agency or fiduciary relationship. 41 International Perspective 14.1 Going Global Strategic alliances are one of the leading business strategies of the 21st century. Strategic alliances can help firms lower costs, exploit each other’s specialized skills, fund costly research and development efforts, and expand into foreign markets. Using a strategic alliance to access a foreign market usually involves “partnering” with a “local” to take advantage of their familiarity with the social, cultural, legal, and other conditions in the market. 42 Business Arrangements: Sales Agency sales agency: An agreement in which a manufacturer or distributor allows another to sell goods or services on its behalf. The agent is not the vendor but acts on behalf of the owner (the principal) of the goods or services. Fiduciary obligations are owed. This arrangement is often seen in the travel, real estate, and insurance industries. 43 Business Arrangements: Product Licensing product licensing: An arrangement whereby the owner of a trademark or other proprietary right grants to another the right to manufacture or distribute products associated with the trademark or other proprietary right. The relationship is contractual. It is common in clothing, sporting goods, and merchandise connected to the entertainment industry. 44