Module 2 - Business Organizations & Corporate Governance
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Toronto Metropolitan University *
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Course
603
Subject
Law
Date
Feb 20, 2024
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docx
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22
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Readings
McInnes, M., Kerr, I., & VanDuzer, J. A. (2022). Managing the law: The legal aspects of doing business
(6th Edition). Pearson.
o
Chapter 21: Basic Forms of Business Organizations
o
Chapter 22: Legal Rules for Corporate Governance
Introduction
In this module we will briefly review the different business organizations (i.e., sole proprietorship; general partnership; limited liability partnership; limited partnership; corporation)
that you covered in the pre-requisite course CLAW122 (Business Law). And, then we will build upon your knowledge of corporations and focus upon the internal governance of the corporation.
Corporations are creatures of statute. The
Canada Business Corporations Act
(“CBCA”) governs federal corporations. The provinces and territories have their own corporate statutes that have similarities to the CBCA. In this module we will focus upon the CBCA, since it is emphasized in the textbook.
Directors, officers and shareholders control the behaviour and performance of the corporation. They each have their own areas of responsibility. The CBCA specifies what powers must or may
be exercised by its directors, officers and shareholders. Different allocations of authority may be desirable in different circumstances, so the CBCA allows some, but not complete, flexibility as to how the control of a corporation may be divided among its directors, officers and shareholders.
The shareholders usually delegate management responsibilities of the corporation to directors, and they in turn delegate to officers. Understandably, a shareholder would be concerned about improprieties of directors and officers, and whether they are acting in the best interest of corporation. We will examine the statutory obligations (i.e., fiduciary duty, duty of care, procedural safeguards when transacting with the corporation) imposed upon directors and officers, and the statutory remedies (i.e., derivative action, oppression remedy, dissent and appraisal) available to shareholders.
The extent to which management must consider the interests of non-shareholders (e.g., employees, creditors, the public) will be looked at, and the liability of a corporation in contract, tort and criminal law will be examined.
Pause and Reflect
Please see Figure 22.1 (Relationship of Shareholders, Directors, and Officers) in your textbook. In a corporation with a small number of shareholders it is very likely that the shareholders will
also be directors and officers, and therefore will be well informed as to the effectiveness of management. However, as the number of shareholders increases, more and more shareholders will not be directors and officers, and therefore will not be intimately aware of what management
is doing. So, how do these shareholders effectively monitor the honesty and success of management? Are these rules effective? Keep this in mind as we discuss the corporate governance rules.
Topics and Learning Objectives
Topics
This module will cover the following topics:
Business Organizations
o
Sole Proprietorship
o
General Partnership
o
Limited Liability Partnership
o
Limited Partnership
o
Corporation
o
Co-operatives
Corporate Management
o
Introduction
o
How Directors and Officers Exercise Power
o
Officers
o
Management’s Duties to the Corporation
o
Fiduciary Duty
Transacting with the Corporation
Taking Corporate Opportunities
Competition by Directors and Officers with the Corporation o
Duty of Care
o
Protection for Creditors
o
Other Sources of Personal Liability for Directors and Officers
o
Managing Liability Risk for Directors and Officers
Corporate Shareholders
o
How Shareholders Exercise Power
o
Shareholder’s Access to Information
o
Shareholders’ Agreements
o
Shareholder Remedies
o
Relief from Oppression
o
Other Shareholder Remedies
Corporate Regulation and Responsibility
o
Corporate Governance in Practice
o
Corporate Social Responsibility
o
Corporate Liability for Contracts, Crimes, and Torts Learning Objectives
By the end of this module you should achieve the following objectives:
Business Organizations
o
Describe how to create different types of business organizations (i.e., sole proprietorship; general partnership; limited liability partnership; limited partnership; corporation)
Corporate Management
o
Describe the corporate structure, including the role and relationship of shareholders, directors and officers.
o
Explain the fiduciary duties of directors and officers and to whom they are owed.
o
Explain the duty of care of directors and officers.
o
Apply the applicable law where the director’s or officer’s personal interest conflict with the best interests of the corporation.
o
Apply the applicable statutory provision so as to protect a director or officer that has an interest in a material contract or material transaction with the corporation.
o
Identify the personal risks and liabilities of directors and officers.
o
Apply risk management strategies to reduce the risk and liabilities of directors and officers.
Corporate Shareholders
o
Demonstrate an understanding as to when a shareholders’ agreement should be used.
o
Demonstrate an understanding as to when a unanimous shareholders’ agreement should be used.
o
Demonstrate an understanding of the different legal remedies available to shareholders and when they would be used.
o
Apply the appropriate shareholders legal remedy in the correct circumstances.
Corporate Regulation and Responsibility
o
Demonstrate an understanding as to when a corporation will be liable for contracts, crimes, and torts.
o
Demonstrate an understanding of the different types of crimes: absolute liability, strict liability, and mens rea
.
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Overview of Business Structures
Once an entrepreneur decides to start a business an important decision should be carefully considered and made, namely the business structure that will be used. Some business structures (i.e., sole proprietorship, general partnership) arise automatically, whereas others must be formally created (i.e., limited partnership; corporation).
Generally, there are 5 options available:
1.
Sole Proprietorship
2.
General Partnership
3.
Limited Liability Partnership
4.
Limited Partnership
5.
Corporation
This decision will, among other things, impact the personal liability that the entrepreneur will be exposed to. We will briefly discuss these options. Please see Chapter 21 for details.
Sole Proprietorship
A sole proprietorship comes into existence when a person starts to carry on business on their own, without adopting any other form of business organization (e.g., limited partnership, corporation). The main advantage of a sole proprietorship is that it is simple to set up. There is no requirement to file any documents to create the sole proprietorship. If the sole proprietorship wishes to operate the business under a name other than the sole proprietor’s name then a business
name registration (e.g.,
Sally’s Lawn Cutting Services
) must be filed. A business licence may also be required depending upon the business.
The main disadvantage is the unlimited personal liability to the sole proprietor. All the sole proprietor’s assets are at risk in the event of torts, debts or contractual obligations.
General Partnership
A general partnership is a form of business organization that comes into existence
when two or more persons carry on business in common with a view to a profit
(section 2,
Partnerships
Act
, Ontario). A partnership arises automatically when a relationship meets this definition. It is not necessary for the parties to agree, in writing or orally, that they are creating a partnership, nor
is there any requirement to file any documents with the government. So, if parties are carrying on
business in common with a view to a profit, they are in a partnership, whether they intended or not. If a partnership wishes to operate under a business name (e.g.,
Sally’s & Bob’s
Landscaping
) it will have to register that name, and for some businesses a license may be required.
The most significant disadvantage of a partnership is the unlimited personal liability that each partner is exposed to. A partner is fully liable for all partnership debts, torts and obligations. Therefore, a partner’s personal assets are at risk of being seized to satisfy such liability.
Relation of Partners to One Another
The
Partnership Act
(Ontario) creates certain default rules to govern the relationship between
partners. For example, each partner shares equally in profits and capital, each partner has the right to participate in management, the partnership will dissolve upon notice of a partner or the death or insolvency of a partner, to mention only a few. These rules are often not appropriate, so
partners can change them by unanimous agreement
(i.e., Partnership Agreement). It is recommended that partners create a partnership agreement tailored to their specific needs and circumstances, and to override some of the default rules.
Relationship of Partners to Third Parties
The
Partnerships Act
provides that each partner is an
agent
for the firm and for the other partners. The law of agency, discussed in an earlier module, becomes relevant. A partner can bind the firm and other partners to contracts and obligations with a third party, provided they are in the usual course of the business. This rule cannot be changed.
As noted earlier, partners can enter into a partnership agreement, and they can agree that one partner cannot create a contract without the agreement of all partners. However, if one partner violates this term by creating a contract with a third party, without getting the approval of the other partners, this contract will still bind the partnership and each partner. The third party is not bound by any limitation in the partnership agreement (unless the third party is actually aware of the limitation, which would not be common). But, the partner that breached the partnership agreement can be sued by the other partners for breach of contract.
Risk can be managed in a partnership but not eliminated. Firstly, partners should be vigilant and monitor each other’s conduct. Secondly, the law imposes a fiduciary duty upon each partner to act honestly and in good faith with a view to the best interests of the partnership. And thirdly, partners should enter into a partnership agreement setting out clear rules to govern their relationship.
Key Point
A general partnership
can be created without an agreement and without any government filings
. It is recommended that partners enter into a partnership agreement to tailor rules for
governing their specific relationship, and to override default rules found in the
Partnerships Act
. A third party is
not
bound by any restriction set out in a partnership agreement limiting a partner’s agency authority unless the third party is aware of the restriction.
Limited Liability Partnerships
In many provinces, certain professional partnerships, such as lawyers and accountants, may create a special form of general partnership called a limited liability partnership. In Ontario, section 44.1 of the
Partnerships Act
requires a written agreement to create the limited liability partnership
. Also, the name of the partnership must be registered and must include the words “Limited Liability Partnership” or “LLP”. In a limited liability partnership, individual partners are not personally liable for the professional negligence of their partners and some other obligations if certain requirements are met.
Key Point
To create a limited liability partnership, the partners must enter into a
written agreement to create the limited liability partnership
(unlike a general partnership that can be created without a written agreement). It is also important to remember that a
limited liability partnership
can only be used by certain professions
such as lawyers and accountants.
Limited Partnerships
In Ontario, the
Limited Partnership Act
allows for the creation of a special partnership called a “
limited partnership
” that can only be
created by filing a limited partnership declaration
with the provincial government. In a limited partnership there is at least one
general
partner
and at least one
limited partner
. The general partner has unlimited liability. The limited
partner has limited liability that is limited to the amount of their investment. A limited partner can lose their limited liability if they participate in controlling the business or if they allow their names to be used in the firm name (but not if they merely provide management advice).
Key Point
A limited partnership is
created
when a
limited partnership declaration is filed
with the government. There are 2 types of partners,
general partners
having unlimited liability, and
limited partners
that have liability limited to their investment.
Please see
Concept Summary 21.3 (Liability Rules in 3 Types of Partnerships)
in the textbook.
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Corporation
The corporation is the most common business structure used by entrepreneurs. The corporation is
a separate legal entity that carries on the business. The owners of the business are the shareholders, but they are separate and apart from the corporation; therefore, the shareholders do not have liability for the business. The shareholders only risk what they have paid for the shares in the corporation.
A corporation is only created when certain documents are filed with the government. A corporation can be created as a federal corporation or a provincial or territorial corporation. To create a corporation,
articles of incorporation
must be filed together with a name search (if applicable) and the fee. The articles set out the name of the corporation, the class and number of shares that may be issued, the number of directors, restrictions on transferring shares, and any restriction on the business of the corporation. Once incorporated, the corporation now exists and can carry on business. The directors named in the articles will be the first directors and will have a director’s meeting to issue shares to shareholders and to pass a general bylaw (e.g., list of officers the corporation will have; notice provisions for meetings; quorum requirements; signing authority; etc.). The shareholders will have a meeting to elect directors and to pass the general by-law. If there are a few shareholders, they may agree to enter into a
shareholders’ agreement
to alter the governance structure of the corporation.
The corporation must maintain a
minute book
containing, among other things, the articles of incorporation, by-laws, minutes of shareholders’ meetings and resolutions, annual filings, and shareholders’ agreement, if any.
As noted earlier, shareholders have
limited liability.
They can lose what they invested in the corporation in return for their shares. Creditors can only recover what is owed to them from the assets of the corporation. In rare cases, a court may
pierce the corporate veil
by disregarding the separate legal existence of the corporation to impose personal liability on a shareholder for a corporation’s obligation. The court will usually only do this in cases of serious wrongdoing or unfairness or both. For example, when a business has been incorporated to do something that would be illegal or improper for the individual shareholder to do personally, the courts have disregarded the separate existence of the corporation.
See textbook for a discussion of cooperatives.
Useful Information
Please see the federal government website for useful information about federal corporations:
Create your Articles of Incorporation
.
Co-operatives
Co-operatives are a special type of corporation. They can be incorporated federally or provincially. The textbook describes three key differences (compared to business
corporations) that relate to (a) mission, (b) share issuance and (c) members benefiting from the co-operative’s activities. Please review the textbook’s discussion
carefully and then proceed to the activity below.
Activity
Samantha is a producer of textile goods and would like to create an organization to benefit other textile producers like herself. The co-operative would then sell the goods of the members. She has heard from a friend that a co-operative might suit her needs. Samantha would like for the organization to require that all members be
textile producers. Samantha knows of only one co-operative and that co-operative does not issue shares. Since Samantha thinks the new organization would need to issue shares, she feels that a co-operative would not suit her needs.
Discuss whether a co-operative has the potential to fulfill Samantha’s needs.
A co-operative might possibly be suitable for Samantha. It is true that some co-
operatives do not issue shares. However, that is not a requirement. A co-operative may choose to issue shares or refrain from issuing shares. Moreover, it is common for a co-operative like the one Samantha contemplates to require that all members be producers of the goods that are sold by the co-operative.
Directors’ Powers
Shareholders elect directors by a simple majority of votes. The directors manage or supervise the management of the corporation. The directors exercise their power collectively at meetings or by way of written resolutions.
The directors’ powers to manage or supervise can only be restricted, in whole or in part, by a unanimous shareholders agreement (“USA”), in which case the shareholders then assume those duties which have been removed from the directors. We will discuss USA in a later section.
In the absence of a USA, the directors are obligated to manage the corporation, not the shareholders. The shareholders are the owners, but not the managers.
However, in a smaller corporation a person may be a shareholder, a director and an officer.
The CBCA imposes upon directors a
duty to disclose interests in material contracts or transactions
(s.120),
fiduciary duty
and
duty of care
(s.122).
Officers’ Powers
The CBCA authorizes the directors, subject to the articles, by-laws or any USA, to designate and
appoint officers. The directors can specify the officers’ duties and delegate to them the power to manage the corporation, save and except certain decisions which only directors can exercise (i.e.,
issuing shares, declaring dividends, repurchasing shares).
An officer, like a director, has a
fiduciary duty
,
duty of care
and
duty to disclose interests in material contracts or transactions
. However, the officer does not have the benefit of the statutory provision that permits reliance on financial statements and reports of independent experts, as do directors (s. 123(5) CBCA).
Fiduciary Duty
A fiduciary duty is often imposed by the law upon a person (i.e., the fiduciary) that has the power to expose another to risk of loss. This principle prohibits a fiduciary from putting their personal interests ahead of the best interests of the other party.
In an earlier module we discussed the fiduciary duty of an agent to their principal, and a partner to their partners. Directors and officers of a corporation are also in positions where they can expose the corporation to risk of loss. So, at common law a fiduciary duty was imposed upon them. However, this fiduciary duty has been codified in section 122(1) of the CBCA which states
“
a director and officer of a corporation in exercising their powers and discharging their duties shall (a) act honestly and in good faith with a view to the best interests of the corporation…
”
This statutory duty is broad and may apply in many different circumstances. Let’s break down section 122(1) (a).
Duty Owed to the Corporation
Section 122(1)(a) expressly states that the duty is to the corporation. This begs the question “what is in the best interest of the corporation?” Historically, the courts interpreted this to mean maximizing shareholders’ share value. However, the Supreme Court of Canada expanded and refined the answer to this question.
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Pause and Reflect
Please see Case Brief 22.1 (
BCE Inc. v. 1976 Debentureholders
[2008] 3 SCR 560) in your textbook. After reading this, look at section 122(1.1) CBCA below, that the federal government added in 2019.
What was the federal government doing?
Why did they do this? Do a little research and see
if the Ontario government made a similar amendment to the
Ontario Business Corporation Act
.
122
(1)
Every director and officer of a corporation in exercising their powers and discharging their duties shall
o
(a)
act honestly and in good faith with a view to the best interests of the corporation; and…
(1.1)
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 following factors:
o
(a)
the interests of
(i)
shareholders,
(ii)
employees,
(iii)
retirees and pensioners,
(iv)
creditors,
(v)
consumers, and
(vi)
governments;
o
(b)
the environment; and
o
(c)
the long-term interests of the corporation.
The purpose of section 122(1)(a) is to prohibit directors and officers from placing their personal interests in conflict with their duties to act in the best interests of the corporation.
As section 122(1)(a) sets out, directors and officers must act honestly. So, they cannot act dishonestly in exercising their powers and discharging their duties. This would prohibit a director
or officer from charging personal expenses to the corporation or stealing from the corporation.
Conflicts may arise in a variety of ways, we will look at a few of them. A director or officer would have a conflict of interest if they are, directly or indirectly:
1.
transacting with the corporation; or
2.
taking a corporate opportunity.
Transacting with the Corporation
An officer or director may have interests separate and apart from the corporation that might come into conflict with the corporation’s interests. For example, a director may own a business that provides services that the corporation requires. If the director’s business sells those services to the corporation the director would have a serious conflict of interest. The director wants the corporation to buy his business’ services; however, is the transaction in the best interest of the corporation? Is the transaction in the director’s personal best interest or the corporation’s? Are those services available from other businesses on better terms? At one time, the law prohibited a director or officer from such a transaction. But it is now statutorily recognized that such a transaction may be appropriate in certain cases, provided that certain procedures are followed. Section 120 of the CBCA creates procedural safeguards that must be followed to permit such a transaction.
Section 120 CBCA requires:
1.
directors and officers to give adequate notice
of their interest, in writing and to be recorded in the minutes, to the board of directors;
2.
directors must not vote
on the approval of the contract by the Board of Directors; and
3.
the Contract must be fair and reasonable to the corporation.
Importantly, if the procedural safeguards are not followed, then a court may, upon application of the corporation or a shareholder, set aside the contract on such terms as it thinks fit. Further, the court may require the director or officer to account to the corporation for any profit or gain realized on it.
Taking Corporate Opportunities
A director or officer who takes advantage of a business opportunity which the corporation either had or was seeking would be breaching their fiduciary duty. If breached, any personal profit or gain from the opportunity would have to be paid over to the corporation.
The leading case in this area is the Supreme Court of Canada decision in
Canadian Air Service Ltd. v. O’Malley
.
Pause and Reflect
Please see Case Brief 22.2 (
Canadian Air Services Ltd. v. O’Malley
(1974) SCC) in your
textbook. What factors persuaded the court that the opportunity belonged to the corporation?
Despite O’Malley’s resignation, what factors persuaded the court to prohibit O’Malley from appropriating the opportunity?
When does an opportunity become a corporate opportunity? The court in
Canadian Air Service Ltd.
and in subsequent cases have identified a number of factors that suggest an opportunity has become a corporate opportunity:
1.
actively pursuing opportunity;
2.
maturity of opportunity;
3.
significance of opportunity;
4.
private opportunity; and
5.
no rejection.
Competition by Directors and Officers with the Corporation
Generally, a director or officer can terminate their relationship with the corporation and go into competition with it. However, while having a fiduciary duty one cannot compete with the corporation. The
Canadian Air Service Ltd.
case showed us that a fiduciary that terminates their relationship with the corporation cannot take a corporate opportunity that they helped develop.
A fiduciary that uses a corporation’s confidential information for personal gain would also breach their fiduciary duty.
The remedy for a breach of fiduciary duty would include having to disgorge any profit or gain.
Key Point
So, a few takeaways regarding the fiduciary duty of directors and officers:
1.
Section 122 codifies the fiduciary duty;
2.
fiduciary duty is owed to the corporation;
3.
act honestly (e.g., do not steal from corporation);
4.
act in the best interests of the corporation (e.g., cannot put their own interests ahead of the corporation’s interests); and
5.
do not take corporate opportunities.
Duty of Care
Section 122
(1)
CBCA states:
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Every director and officer of a corporation in exercising their powers and discharging their duties
shall
(a) …
(b)
exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
What must be done to meet this standard will depend upon the facts and circumstances of each case. At a minimum, officers and directors must have a basic understanding of the business and monitor the business. They must act as a “
reasonably prudent person
”. However, the reference to “
in comparable circumstances
” adds a subjective element to the duty. In other words, the greater your knowledge or experience the higher the standard. A lawyer who is a director would be held to a higher standard with respect to the legal affairs of the corporation. An environmental expert who is a director would be held to a higher standard with respect to environmental issues. The standard of care will also be influenced by the position the person holds. For example, a director who sits on the audit committee would be expected to be more informed of financial matters than a director who does not.
Importantly, a director or officer who is not involved in some aspect of the corporation’s business is not relieved from their duty of care. For instance, if a particular matter has been delegated outside the sphere of a director, the standard the director must meet will be based on a person in comparable circumstances. If the director has little or no information about the matter, the standard may be low. However, if the director becomes aware of, for instance, a statutory violation, they could not ignore it; they would be expected to act upon it.
Failure to meet the standard of care exposes directors and officers to liability to the corporation for damages.
The
business judgement rule
is a common law rule that recognizes that directors and officers must make decisions and sometimes those decisions do not work out; in other words, the standard for directors and officers is not perfection. If a decision falls
within the range of reasonable alternatives that were available in the circumstances and the process for making the decision was also reasonable
it would generally be seen to have met the standard. Directors and officers must ensure that decisions are based upon adequate information and advice.
Protection for Creditors
As discussed, directors and officers have a duty to the corporation. They do not have a duty to creditors of the corporation. Therefore, creditors must protect themselves. As we will see in later modules, creditors should try to reduce their risk by obtaining collateral, guarantees and indemnities.
There are statutory provisions that indirectly benefit creditors, and as noted above, section 122(1.1) CBCA expressly states that directors and officers
may
consider the interests of creditors.
There are statutory provisions that prohibit a corporation from distributing money or assets to shareholders, directors, officers or employees if that would threaten the corporation’s ability to pay its creditors. Under the
solvency test
, a corporation cannot authorize dividends (section 42 CBCA) or repurchase or redeem shares (section 34-36 CBCA) unless there are reasonable grounds for believing that the corporation could pay its liabilities to its creditors as they become due. Section 118 CBCA makes directors personally liable if they approve dividends or share repurchase or redemption contrary to these statutory provisions. If the provisions are breached by
the directors the compensation is payable to the corporation, not the creditors.
Other Sources of Personal Liability for Directors and Officers
In addition to the personal liability for breach of duties to the corporation, directors and officers also face other statutory and tortious risks. For example, the CBCA makes directors personally liable for up to 6 months of unpaid employee wages when a corporation is bankrupt (subject to a due diligence defence). The
Income Tax Act
, environmental protection statutes and other regulatory statutes have made directors and officers liable for corporate violations. This is found to be a more effective way of encouraging corporations to comply.
Managing Liability Risk for Directors and Officers
Some statutes give directors and officers a “due diligence defence”. For instance, section123(5) of the CBCA states that directors are not liable for breach of their section 122(1) fiduciary duty and duty of care if they in good faith relied on financial statements or reports of professionals (e.g., lawyers, accountants). This section does not apply to officers.
Some other risk management tools are:
Corporation’s Mandatory Indemnity (s. 124(5) CBCA)
: In the event the director or officer was not at fault, complied with their fiduciary duty, and had reasonable grounds for believing their conduct was lawful they are entitled to indemnification from the corporation.
Corporation’s Optional Indemnity (s.124(1) CBCA)
: In the event the director or officer was at fault
but had complied with their fiduciary duty and had reasonable grounds for believing their conduct was lawful, a corporation may
indemnify them.
Insurance (s. 124(6) CBCA)
: Since indemnities only have value if the corporation is financially able to pay, an insurance policy would be more comforting. Also, insurance policies can be broader in scope and cover matters that an indemnity does not. A corporation may
purchase such insurance.
Key Point
Indemnities and insurance will
not
cover a director for a breach of their fiduciary duty.
Activity
Being asked to become a director for a corporation is often an honour and is prestigious; however, as you’ve learned, there are risks associated with being a director. Please read
Business
Decision 22.1
in your textbook and answer the questions below.
Question: What concerns would you have about accepting the offer to be a director and a member of the environmental compliance committee?
Answer:
If you become a director you would have a fiduciary duty and a duty of care to the corporation.
There are potential conflicts that may arise between your duties to the corporation and what Jamal may ask you to do. Jamal is a majority shareholder and therefore controls who gets elected as a director, including you. Jamal is also the person that asked you to become a director,
so you feel obligated to him. And, Medex Inc. is a major client of your environmental consulting business, and future contracts can be influenced by Jamal. These different factors can put pressure, direct or indirect, upon you to approve matters that favour Jamal over the corporation or minority shareholders or both.
With respect to any proposed contract between Medex Inc. and your environmental consulting business you must comply with the statutory procedural safeguards:
o
You must give adequate notice of your interest to the board of directors;
o
You must not vote on whether the board approves it or not; and
o
Contract must be fair and reasonable to the corporation.
If you become a director and accept a position on the environmental compliance committee your duty of care in the area od environmental compliance will be higher. You must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances
. Since you have more environmental experience and knowledge and sit on the environmental compliance committee you will be held to a higher standard.
Question: What strategies could you adopt to minimize these risks?
Answer:
You must diligently fulfil your fiduciary duty and duty of care to the corporation.
Require the corporation to provide mandatory and optional indemnities as permitted under the corporate statute.
Require the corporation to purchase insurance in your favour.
PLEASE NOTE
: Indemnities and insurance will
not
cover a director for a breach of their fiduciary duty.
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Please see
Concept Summary 22.1 (Director and Officer Liability and Risk Management)
in
the textbook.
How Shareholders Exercise Power
Before we discuss how shareholders exercise power, let’s consider the overlapping roles they sometimes play.
Private corporations
usually have few shareholders and the same people are often the shareholders, directors and officers. On the other hand,
public corporations
have distributed their shares to the public and will therefore have many shareholders, but only a very few shareholders will be directors and officers.
In that context, shareholders must make decisions by voting on matters, and how they vote depends upon whether it is a private or public corporation. With a private corporation the shareholders are usually the directors, so the shareholders meeting is a formality. Shareholders may vote in person at a meeting or by way of a written resolution. On the other hand, with a public corporation most shareholders are not directors and therefore the shareholders meeting is an important opportunity to question management and vote on proposals.
Directors are responsible for calling shareholder meetings, and annual meetings must be held at least every 15 months. At the annual shareholders meeting directors are elected, the auditor is appointed and financial statements are discussed. Additional shareholders meetings can be called
if necessary.
Shareholders Access to Information
In order to monitor management, shareholders will need access to information. Corporations must store the articles of incorporation, by-laws, shareholders minutes and resolutions and share register. The shareholders and creditors are entitled to see these documents. The corporation must also store directors’ minutes and resolutions, but shareholders and creditors are not entitled to see them.
Shareholders are also entitled to view the audited financial statements, unless all shareholders have waived the auditing requirement.
Shareholders’ Agreement
Shareholders have the right to agree as to how they will vote their shares. A shareholder may wish to enhance or protect their interest by entering into a shareholders’ agreement. A shareholders’ agreement may be between any number of shareholders. They are common in corporations with a small number of shareholders.
Imagine a corporation with 3 equal shareholders (10 common shares each). A simple majority of shares would be able to elect all the directors. So, any 2 of the shareholders would have enough votes to elect the directors. You may not be one of the 2, and therefore are not elected as a director. A shareholders’ agreement could be used to require that each shareholder (or their appointee) be elected on the board of directors and that all shareholders’ decisions must be approved by all shareholders.
Unanimous Shareholder Agreements
The CBCA and other similar corporate statutes permit the creation of a unanimous shareholder agreement (“USA”). A USA is an agreement that restricts, in whole or in part, the powers of the directors to manage the business and affairs of the corporation. A USA must have all shareholders as parties. A USA permits shareholders to assume the rights, powers, duties and legal obligations which they have removed from the directors. A regular shareholders’ agreement
(i.e., not a USA) is not capable of doing this.
Share Transfer
In a corporation with a small number of shareholders it is often very difficult to sell and value shares. Shareholders’ Agreements can be utilized to assist with creating a procedure to sell and value such shares. The type of provisions to address this vary tremendously; however, two commonly used clauses are:
“right of first refusal” – a shareholder that wants to sell their shares must offer them to other shareholders first, and if they refuse to buy, then they can be offered to third parties.
“shotgun buy-sell” – a share transfer mechanism that forces one shareholder to buy out the other.
Shareholder Remedies
Shareholders that have had their interests injured by directors or the corporation have a number of possible remedies available, such as:
Derivative action;
Relief from oppression;
Liquidation and dissolution, or winding up;
Dissent and appraisal right.
Derivative Action
If a corporation has been harmed by a party causing a loss this will have a negative impact on shareholder value. Shareholders would expect directors to take legal action against the
wrongdoer to seek a remedy. However, if directors do not authorize such legal action, sometimes
because the directors are involved in the wrongdoing or they have breached their fiduciary duties, what can a shareholder do? Corporate statutes permit a shareholder to seek a
derivative action
(s.239 CBCA). A shareholder can apply to court to seek permission to bring a legal action, on behalf of the corporation, against the wrongdoers. Any damages or other remedy would be awarded to the corporation.
Relief from Oppression
Another statutorily authorized remedy available to a shareholder is the
oppression remedy
(s. 241 CBCA). This remedy is available to the shareholder directly (unlike the derivative action). A
shareholder can claim relief from an
act or omission by the corporation or its directors that oppresses
or unfairly disregards or prejudices the interests of the shareholder
. The courts have interpreted this to mean that the remedy is available when the
reasonable expectations of shareholders about management
behaviour
have not been met
. The court can order whatever
it deems necessary to remedy the problem, including granting the remedy in favour of the shareholder, as opposed to the corporation. Some of examples of behaviour that the courts have found oppressive are:
Planning to eliminate minority shareholders;
Approval of a transaction lacking a valid corporate purpose that is prejudicial to a particular shareholder;
Actions that benefit the majority shareholder to the exclusion or the detriment of minority shareholders.
Did You Know?
The Supreme Court of Canada in
Wilson v. Alharayeri
(2017) held that a corporation’s directors and officers, as opposed to the corporation, may be personally liable in an oppressive action.
Liquidation and Dissolution
This remedy involves the corporation’s assets being sold, its creditors paid off, any remaining money distributed to the shareholders, and the corporation terminated. This is an extreme remedy
and usually a remedy of last resort. The court must conclude that it is “
just and
equitable
” to end the corporation. For example, this may be appropriate when two equal shareholders cannot agree on how to run the business.
Dissent and Appraisal Right
A shareholder who dissents in connection with certain fundamental changes can require the corporation to purchase their shares at “fair value”. A fundamental change, such as major
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amendments to the articles of incorporation, sale of all or substantially all the assets of the corporation outside the ordinary course of business, require at least 2/3 of the shareholder votes to approve it. If the fundamental change is approved by at least 2/3 of the votes, those shareholders who voted against it are entitled to have their shares purchased by the corporation at
“fair value”.
Activity
Please read
You be the Judge 22.1
(
Rea v. Wildeboer
2015 ONCA) in your textbook and answer the questions posed.
Then compare your answers with the ones suggested below.
Answer:
1.
The directors and officers breached their fiduciary duty to the corporation. Not surprisingly the directors were not pursuing remedies for breach of fiduciary duty because they were involved in the wrongdoing. With a derivative action a shareholder can ask a court to give permission to bring an action against the directors and officers on behalf of the corporation. If the derivative action is successful the damages would be paid
to the corporation.
It is arguable that the oppression remedy may also be available. The misappropriation of the corporation’s funds ($50–$100M) by the directors and officers reduced the value of the shares. The reasonable expectation of management behaviour by a shareholder, such as Mr. Rea, was not met. Therefore, Mr. Rea was oppressed by the corporation and directors and therefore should be able to apply directly to the court under the oppression remedy. If successful, any monetary remedy would be paid directly to Mr. Rea. The court
can also order any other remedy it deems appropriate in the circumstances.
2.
In
Rea v. Wildeboer
the court acknowledged there was a potential overlap between a derivative action and the oppression remedy. The court ultimately held that only a derivative action could be pursued in this case.
Securities Laws
Securities laws are complex. They supplement corporate statutes. They address corporate governance, but also many other matters. Please see the textbook for examples of matters they may govern.
Corporate Governance in Practice
Some corporations have few shareholders, and others have many. Corporations with one shareholder or a few are often involved in management by virtue of being appointed a director or
officer, or through the effects of a shareholder’s agreement or a USA. However, as the number of
shareholders increases, many more shareholders are not involved in management and become largely, if not entirely, reliant upon directors and officers fulfilling their duties and acting in the best interest of the corporation. This imposes 2 types of “agency costs” on shareholders: costs of management misbehaviour and costs associated with monitoring management and seeking remedies.
In practice, shareholders’ legal rights are not always very effective to ensure management fulfills their duties to shareholders.
Pause and Reflect
Please read Ethical Perspective 22.2 (“Board Management and Diversity”) in the textbook. As a self-reflection exercise, answer questions #1 and #2. While reflecting upon those questions, consider the following:
Aside from the evidence that board diversity leads to better performance, are there any other reasons besides that which would justify pursuing board diversity?
What if the policy provided by the corporation is vague, ambiguous or so lacking in detail that it provides little comfort to those who believe in board diversity?
Even if there is a satisfactory policy, what if the corporation doesn’t seem to be interested in actually following it? Corporate Social Responsibility
Corporate social responsibility refers to a corporation’s commitment to environmental protection
and sustainability as well as going beyond what the law requires to ensure that a corporation takes responsibility for the impact of its actions on the environment, consumers, employees, the local community, and other affected stakeholders.
C
ontracts
As discussed in the Module on Agency, a corporation is liable for contracts created by its agents that have
actual authority
or
apparent authority
.
Many corporate statutes have an
indoor management rule
. This rule states that a corporation cannot rely on any provision in its articles, by-laws, or any USA, that creates a defect in the agent’s authority to defeat a contractual claim. Also, a corporation cannot claim that a person held out as an officer, director, or agent has not been duly appointed or does not have the usual authority of that position. However, a third party cannot rely upon the indoor management rule if
they knew or should have known of the agent’s defect.
Pause and Reflect
Please read section 18 of the CBCA, known as the indoor management rule.
Notice the broad nature of section 18(1) and the
exception in section 18(2).
Authority of directors, officers and agents
18
(1)
No corporation and no guarantor of an obligation of a corporation may assert against a person dealing with the corporation or against a person who acquired rights from the corporation that
o
(a)
the articles, by-laws and any unanimous shareholder agreement have not been complied with;
o
(b)
the persons named in the most recent notice sent to the Director under section 106 or 113 are not the directors of the corporation;
o
(c)
the place named in the most recent notice sent to the Director under section 19 is not the registered office of the corporation;
o
(d)
a person held out by a corporation as a director, officer, agent or mandatary of the corporation has not been duly appointed or has no authority to exercise the powers and perform the duties that are customary in the business of the corporation or usual for a director, officer, agent or mandatary;
o
(e)
a document issued by any director, officer, agent or mandatary of a corporation with actual or usual authority to issue the document is not valid or genuine; or
o
(f)
a sale, lease or exchange of property referred to in subsection 189(3) was not authorized.
Exception
(2)
Subsection (1) does not apply in respect of a person who has, or ought to have, knowledge of a situation described in that subsection by virtue of their relationship to the corporation.
Crimes
A corporation can be criminally liable. There are 3 types of offences: absolute liability offence, strict liability offence and
mens
rea
offence.
Absolute Liability Offence (ALO)
A corporation commits an ALO when a person acting on its behalf (e.g., employee in course of employment) commits an act prohibited by law. There is no defence available for an ALO.
Strict Liability Offence (SLO)
A corporation commits an SLO when a person acting on its behalf (e.g., employee in course of employment) commits an act prohibited by law. However, for an SLO the corporation has a “
due
diligence defence
” available. This defence requires the corporation to show that a person who is a “
directing mind
” of the corporation acted reasonably in the circumstances to prevent the offence. A “directing mind” refers to a person who has responsibility to establish corporate policy in the are in which the offence occurred.
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Mens
Rea
Offence (MRO)
A corporation commits an MRO when a person acting on its behalf (e.g., employee in course of employment) commits an act prohibited by law and a “senior officer” had the required intention or knowledge to commit offence or knew an employee would commit the offence and failed to take all reasonable steps to prevent the offence. A senior officer refers to any person who either plays an important role in setting the corporation’s policies or is responsible for managing an important aspect of the corporation’s activities.
Torts
A corporation may be liable in tort because:
1.
the directing mind of the corporation committed the tort; or
2.
it is vicariously liable for a tort committed by an employee in the course of employment.
Please see Concept Summary 22.2 (Corporate Criminal Liability) in the textbook.
S
ummary
We reviewed the different business organizations (i.e., sole proprietorship; general partnership; limited liability partnership; limited partnership; corporation) that you covered in Chapter 21 and
then we delved deeper into corporations and their internal governance. We discussed the role of directors, officers and shareholders, and how shareholders agreements can be used to alter the duties and responsibilities of the parties. And we examined the statutory obligations (i.e., fiduciary duty; duty of care; procedural safeguards when transacting with the corporation) imposed upon directors and officers, and the statutory remedies (i.e., derivative action; oppression remedy; dissent and appraisal) available to shareholders.
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