Chapter 16 The Corporation PDF

The Corporate Form: Operational Matters Canadian Business and the Law, EIGHTH EDITION Objectives After studying this chapter, you should have an understanding of the liabilities of a corporation the duties and liabilities of corporate directors and officers the rights and liabilities of...

The Corporate Form: Operational Matters Canadian Business and the Law, EIGHTH EDITION Objectives After studying this chapter, you should have an understanding of the liabilities of a corporation the duties and liabilities of corporate directors and officers the rights and liabilities of shareholders and creditors how the corporation is terminated 2 Corporate Liability: Liability in Tort (1) A corporation is a legal person in the eyes of the law. It is responsible for its own actions, acting through human agents. A corporation may have primary or vicarious tort liability. o Primary liability arises when the corporation is regarded as the entity that committed the tort. o Vicarious liability arises when a tort has been committed by an agent or employee who is not a directing mind of the corporation. 3 Corporate Liability: Liability in Tort (2) identification theory: A theory specifying that a corporation is liable when the person committing the wrong is the corporation’s directing mind. directing mind: An individual who exercises decision making authority in matters of corporate policy. o Generally, it is the highly placed corporate officers who are classified as “directing” minds, while low-level employees are not. o A corporation may have more than one directing mind. 4 Corporate Liability: Liability in Contract Agency law largely determines when a corporation is liable on a contract and when it is not. The corporation will be bound by the contract as long as the corporate agent had actual or apparent authority. To avoid personal liability, the person signing a document on behalf of a corporation should ensure that the contract clearly indicates the person is signing on behalf of the corporation and not in their personal capacity. o It is best to avoid “pre-incorporation” contracts and use shelf corporations instead. 5 Corporate Liability: Criminal and Regulatory Liability (1) Criminal liability problem: How can a corporation be punished or jailed?—it has no body. Identification theory has been adapted to criminal law: o A corporation has committed the crime if the person who committed the crime was a directing mind of the corporation and committed it in the course of their duties to the corporation. Criminal law expands the range of individuals whose actions can trigger liability of the corporation to include senior officers. 6 Corporate Liability: Criminal and Regulatory Liability (2) For intentional criminal offences: o The corporation will be liable if a senior officer, acting in the scope of their authority and intending at least in part to benefit the corporation, engages in unsafe conduct, directs representatives to do it, or knows about the unsafe conduct but does nothing, and death or injury results. For offences based on negligence: o The corporation can be convicted if any representative causes injury or death by unsafe conduct, and the senior officer or officers in charge of the activities of the representative depart markedly from the reasonable standard of care necessary to prevent the incident. 7 Business Application of the Law 16.1 Death in the Workplace Four workers died, including the supervisor, when the scaffolding broke 13 storeys above ground. Five parties were found guilty of safety-related offences: o The supervisor had permitted the work without sufficient safety harnesses and permitted the use of marijuana. o A director was convicted of breach of the Occupational Health and Safety Act. o The project manager was sentenced to 3.5 years imprisonment for criminal negligence for allowing workers to board the scaffold when he was aware of insufficient fall protections. o Liability was also imposed on the scaffolding company and one of its 8 directors. Corporate Liability: Regulatory Offences regulatory offence: An offence contrary to the public interest. A corporation and sometimes its directors and officers face may penalties, including civil liability for damages. Corporations face liability in many areas, including the following: o taxation o human rights o pay equity o employment standards o consumer protection o unfair or anticompetitive business practices o occupational health and safety o environmental protection 9 Directors and Officers Directors are elected by shareholders, and manage or supervise the management of the business and the affairs of the corporation. o In addition to this general authority, directors have specific powers and obligations set out in legislation.  Examples: declare dividends, call shareholder meetings, adopt bylaws, and issue shares o Directors can appoint officers to carry out many of their duties and exercise most of their powers.  This does not relieve the directors of ultimate responsibility for the management of the corporation. 10 Business and Legislation 16.1 (1) Corporate Governance and Diversity Canada now requires some public corporations to disclose diversity information other than gender. The law applies to corporations incorporated under the CBCA and that have publicly traded securities. o The law requires disclosure of the number/percentage of the board of directors and senior management who are women, Aboriginal persons, members of visible minorities, and people with disabilities. 11 Business and Legislation 16.1 (2) Corporate Governance and Diversity o The amendments do not impose quotas or any specific diversity requirements but instead introduce a “comply or explain” regime. o Corporations are required to disclose if they have a diversity and inclusion policy, and if not, to provide an explanation why. 12 Duties of Directors and Officers Directors and officers owe two types of broad duties: fiduciary duties and competence. Fiduciary duties include the following: o Directors and officers must act honestly and in good faith. o They cannot favour one group of shareholders over another, as their obligation is to the corporation as a whole. o They must not allow personal interest to conflict with their duty to the corporation. o They cannot intercept a corporate opportunity—a business opportunity in which the corporation has an interest. 13 Duties of Directors and Officers: The Fiduciary Duty Self-dealing contract: A contract in which a fiduciary has a conflict of interest. o Example: A director has materials on hand that the corporation could purchase—the director has a duty to get a good price, but personally would want to sell for a high price. o There are provisions that allow self-dealing contracts, because some might be beneficial to the company. Corporate opportunity: A business opportunity in which the corporation has an interest. o These are opportunities that, if the directors and officers were permitted to take up for themselves, would present a conflict similar to a self-dealing contract. 14 Landmark Case 16.1 Canadian Aero Service Ltd v O’Malley, 1973 CanLII 23 (SCC) Two corporate officers had been negotiating to win an aerial mapping contract. Both officers left to set up their own company, which began to pursue the very same line of work as their former employer, and successfully bid on the contract. Court: o The executives were liable to account to former employer for the profits they made under the contract. o They had breached their fiduciary duties by taking something that belonged to the corporation. 15 Ethical Considerations 16.1 (1) Corporate Social Responsibility and the Evolution of Director’s Fiduciary Duty Voluntary actions by a corporation in an economic, social, and environmentally sustainable manner are becoming more common on agendas of corporations CSR is underpinned by the notion that business is accountable to a wide range of stakeholders, including employees, suppliers, customers, government, non-governmental organizations, and the community. Example of CSR: Maple Leaf Foods launching Maple Leaf Centre for Action on Food Security, to reduce food insecurity in Canada. 16 Ethical Considerations 16.1 (2) Corporate Social Responsibility and the Evolution of Director’s Fiduciary Duty In 2019, the Canada Business Corporation Act (CBCA) was amended to codify the permissive standard for fiduciary duty: o When acting with a view to the best interests of the corporation under paragraph (1) (a) the directors and officers of the corporation may consider, but are not limited to,  the interests of shareholders, employees, retirees and pensioners, creditors, and consumers, and governments; the environment; and the long-term interest of the corporation 17 The Duty of Competence Directors and officers must exercise the care, diligence, and skill that a reasonably prudent person would exercise in comparable circumstances. 18 Case 16.1 (1) Peoples Department Stores Inc (Trustee of) v Wise, 2004 SCC 68 Wise Stores Inc was a publicly traded company and operated 50 junior department stores in Québec with annual sales of $100 million. Majority shareholders were the Wise brothers. In 1992, Wise Inc acquired all of the shares of Peoples Department Stores, and the Wise brothers became its sole directors. The companies were doing poorly. The Wise brothers implemented a joint inventory purchasing policy on the recommendation of the companies’ vice-president of administration and finance. 19 Case 16.1 (2) Peoples Department Stores Inc (Trustee of) v Wise, 2004 SCC 68 Peoples purchased and paid for most of Wise Inc’s inventory, subject to reimbursement by Wise Inc. Peoples ended up extending large amounts of trade credit to Wise. Both companies went bankrupt. Trustee in bankruptcy, representing the interests of the unpaid creditors, sued the Wise brothers, alleging that in implementing the joint inventory procurement program, they breached their duties as directors of Peoples. 20 Case 16.1 (3) Peoples Department Stores Inc (Trustee of) v Wise, 2004 SCC 68 SCC: o Wise brothers did not owe a fiduciary duty to the creditors and owed their fiduciary duty only to the corporation. o Creditors can pursue an action based on breach of the duty of care. o The court endorsed the “business judgment rule” in assessing whether directors have fulfilled the duty of care. The rule holds that the court will not second-guess business judgments that are made honestly and on the basis of reasonable information. 21 Liabilities of Directors and Officers Generally, if a director commits a tort, it will be attributed to the corporation, by virtue of identification theory. Similarly, if a director (acting as agent of the corporation) breaches a contract, the actions will be attributed to the corporation. There are times when directors and officers have personal liability for a tort or contract. 22 Liabilities of Directors and Officers: Liability in Tort Courts do not agree on when the actions of a director, when carrying out their duties, can result in personal liability. But courts do agree that there can be personal liability. Directors and officers should take care not to commit torts. 23 Liabilities of Directors and Officers: Liability in Contract A director faces personal liability on a contract if the actions show that the director intended to assume personal liability: o The director contracts on their own behalf and on behalf of the company. o The director guarantees the contractual performance of the company. 24 Liabilities of Directors and Officers: Liability by Statute Statutes place obligations on directors, which, if not adhered to, can result in being personally liable. o Example: The Canadian Environmental Protection Act states that directors who participate in an offence may also be guilty of the offence. Other statutory breaches include the following: o failure to pay employee wages o failure to remit required taxes o insider trading o improperly transporting dangerous goods 25 Case 16.2 (1) Midwest Properties Ltd v Thordarson, 2015 ONCA 819, leave to appeal dismissed 2016 CanLII 30455 (SCC) Midwest purchased an industrially zoned property and building. Midwest became interested in acquiring the adjoining property owned by Thorco Contracting Limited, which was controlled by John Thordarson. Midwest’s environmental studies found PHC contamination on both properties caused by Thorco activities. 26 Case 16.2 (2) Midwest Properties Ltd v Thordarson, 2015 ONCA 819, leave to appeal dismissed 2016 CanLII 30455 (SCC) Thorco had breached orders related to the storage of the PHCs. Thorco and Thordarson had been convicted of environmental offences and had not complied with orders to clean up the property purchased by Midwest. Midwest was successful in suing Thordarson for damages, in his personal capacity, pursuant to the EPA, as the individual who controlled the pollutants. o Midwest sued for nuisance and negligence, pursuant to s 99 of the EPA (Ontario). 27 Business Application of the Law 16.2 (1) Avoiding the Risk of Personal Liability Directors can reduce their exposure to personal liability by exercising care, diligence, and skill in their duties. Directors can meet the statutory standard of care by being attentive, active, and informed. In this regard, directors should o regularly attend directors’ meetings o read all relevant materials o ask questions and speak up at meetings o keep personal notes of meetings and review minutes of meetings 28 Business Application of the Law 16.2 (2) Avoiding the Risk of Personal Liability Directors should (cont’d) o make all their decisions informed decisions o do what is necessary to learn about matters affecting the company o identify possible problems within the company o stay apprised of and alert to the corporation’s financial and other affairs o ensure that they receive reliable professional advice Directors should ensure an indemnification agreement with their company is in place. Directors should have D& O insurance. 29 Shareholder Liability (1) Shareholders have few responsibilities with respect to the corporation. Unlike directors and officers, the shareholder has no duty to act in the best interests of the corporation. A shareholder o can freely compete with the corporation o is not obligated to attend shareholder meetings, cast their vote, read the corporation’s financial reports, or take any interest whatsoever in the progress of the corporation o is not generally liable for the debts and obligations of the corporation because of the principle in Salomon 30 Shareholder Liability (2) lifting the corporate veil: Determining that the corporation is not a separate legal entity from its shareholders. This is rarely done by the courts, except when they are satisfied that a company is a “mere facade” concealing the true facts. It must be shown that there is complete domination and control by the shareholder, and that the corporate form must have been used as a shield for conduct akin to fraud. 31 Business Application of the Law 16.3 (1) Yaiguaje v Chevron and Piercing the Corporate Veil From 1964 to 1992 in Ecuador, Texaco dumped billions of litres of toxic oil- drilling waters into open-air pits. The contamination had devastating effects on the rain forest and rivers and caused long-term adverse health effects on residents. Chevron had acquired Texaco and was ordered by the Ecuadorian Court to pay US$9.5 billion in damages. Chevron refused to pay the award and as it no longer had assets in Ecuador. 32 Business Application of the Law 16.3 (2) Yaiguaje v Chevron and Piercing the Corporate Veil US courts refused to enforce the judgment in the United States. A claim against Chevron Canada (CC) was rejected on the basis that it was a different entity from Chevron. The Canadian court also refused to lift the corporate veil, holding there was insufficient evidence to suggest the CC was a mere puppet of Chevron. 33 Shareholder Rights There are three categories of shareholder rights: o right to vote o right to information o financial rights Different classes of shares allow for different rights associated with them, and different levels of shareholder participation in the corporation. 34 Classes of Shares common share: A share that generally has a right to vote, share in dividends, and share in proceeds on dissolution. preferred share: A share or stock that has a preference in the distribution of dividends and the proceeds on dissolution. 35 Shareholder Right to Vote The shareholder’s right to vote includes the following rights: o one shareholder general meeting each year o be given notice of the meeting o attend the meeting o ask questions o introduce motions o have a proxy  proxy: A person who is authorized to exercise a shareholder’s voting rights. 36 Shareholder Right to Information The right to information includes the following rights: o inspect the annual financial statements o apply to the court to have an inspector appointed if it can be shown there is serious concern about mismanagement o inspect certain records, including minute books o know whether directors have been purchasing shares of the corporation 37 Shareholder Financial Rights Financial rights include the following rights: o the right to receive any dividend declared by the corporation o share in the assets of a corporation on dissolution may include pre-emptive rights pre-emptive rights: A shareholder’s right to maintain a proportionate share of ownership by purchasing a proportionate share of any new stock issue. 38 Shareholder Remedies Shareholders have remedies available to them if they are dissatisfied with the corporation: o sell shares (easy in public corporations; may come with restrictions in private ones) o dissent and appraisal right: The right of shareholders who dissent from certain fundamental changes to the corporation to have their shares purchased at a fair price. o derivative action: A suit by a shareholder on behalf of the corporation to enforce a corporate cause of action. o oppression remedy: A statutory remedy available to shareholders and other stakeholders to protect their corporate interests.  It is used when the actions of the corporation have oppressed or prejudiced interests of shareholders. 39 Other Shareholder Remedies (Optional) Shareholders’ agreement: An agreement that defines the relationship among people who have an ownership interest in a corporation. Unanimous shareholders’ agreement (USA): An agreement among all shareholders that restricts the powers of the directors to manage the corporation. o This ensures control remains with the shareholders. 40 Case 16.3 (1) Mennillo v Intramodal Inc, 2016 SCC 51 Intramodal was owned by Menillo and Rosati. They conducted their affairs informally and did not often comply with the formal requirements of the CBCA. For example, when shares were issued, neither party paid for them and Mennillo’s share certificate was not signed. They rarely put anything in writing, among other things. As court noted, “this was a two-person, private company in which the dealings between the parties were marked by extreme informality.” Menillo wished to resign from the corporation as director and officer. 41 Case 16.3 (2) Mennillo v Intramodal Inc, 2016 SCC 51 Mennillo commenced an oppression action against Intramodal and Rosati, alleging that he had been wrongfully removed as a shareholder as proper CBCA procedures were not followed. Court: o Although Intramodal failed to comply with corporate law formalities in registering the transfer of shares, the SCC affirmed that oppression is judged by “business realities,” not “narrow legalities.” o The courts will consider the oppression remedy in context, assessing the parties’ reasonable expectations based on the nature of their relationship and how they conducted business. 42 Business Application of the Law 16.4 (1) Managing Risk Through Shareholders’ Agreements Agreements allow the shareholders to do the following: o define their relationship o provide mechanisms if the relationship encounters problems o provide means for undoing the relationship 43 Business Application of the Law 16.4 (2) Managing Risk Through Shareholders’ Agreements Agreements should address the following: o management of the company o protection for the minority shareholders o control over who the other shareholders are o provision of a market for shares o capital contribution o buy–sell arrangements in case of dispute 44 Creditor Protection (1) A corporation is responsible for its own liabilities, including debts. o But shareholders cannot strip a corporation of its assets in order to avoid paying creditors.  This is illegal, and creditors have a priority claim over shareholders to the assets on insolvency. 45 Creditor Protection (2) The Canada Business Corporation Act includes provisions that prevent abuses by shareholders, such as the following: o a corporation paying dividends to shareholders if doing so would jeopardize its ability to pay its own debts as they fall due o paying dividends if that would make the company insolvent Supreme Court has stated directors also owe duty of care to creditors. o Creditors can use the oppression remedy to protect from prejudicial conduct by directors. 46 Termination of the Corporation Corporations can be terminated in different ways: o winding up: The process of dissolving a corporation.  This is a complex process. o lapse: The corporation neglects to file an annual report or to follow other reporting requirements.  This is simple and results in company being struck from corporate register. o Courts can order a company terminated if it is the only way to do justice between the corporation and its shareholder(s). o Corporations can go bankrupt, resulting in termination. 47