Notes ch 11 - note PDF

Preview

Summary

note...

Description

Chapter 11 Corporations Learning Objectives

     

Analyze the separate legal entity principle Describe the advantages and disadvantages of incorporation Explain the process of incorporation Discuss the funding of a corporation Examine the roles of corporate directors, officers, and shareholders Distinguish the ways that a corporation can be terminated

Discussion ANALYZE THE SEPARATE LEGAL ENTITY PRINCIPLE

DESCRIBE THE ADVANTAGES AND DISADVANTAGES OF INCORPORATION

A corporation is a legal entity, separate and apart from the members who make it up. This is a legal fiction because the corporation does not in reality exist as a separate person, but for the convenience of the legal system, it is treated as if it does. It is to be contrasted to an individual, who is a breathing and sentient person. The separate legal entity of the corporation provides a convenient method of accumulating capital (the selling of shares) without imposing significant responsibilities on the shareholders. Those shareholders have limited liability. That is, the most they can lose if the corporation is liquidated is the amount they have invested. As a general rule there is no restriction on the free transferability of shares, although for a closely held corporation, there is usually a unanimous shareholders’ agreement which does restrict transfers of shares. For a broadly held corporation, shareholders are free to purchase and sell the shares on the open market without affecting the continuation and functioning of the independent corporation. A corporation cannot die like an individual and because it is separate from the members who make it up, the death of the shareholders will not affect the continuation of the corporation. Since management and members are separate, it is possible to have a professional management group. Limited liability, which is the main attraction of incorporation, is often countered by the requirement that the principals sign a personal guarantee of the indebtedness of the corporation to a bank when the corporation is borrowing money. However, other advantages such as free transferring of shares and succession, majority control, tax advantages and separate management remain. This makes corporations the most common method for carrying on business today.

Copyright © 2020 Pearson Canada Inc. 79

Instructor’s Manual for Business Law in Canada, 12th Edition EXPLAIN THE PROCESS OF INCORPORATION

DISCUSS THE FUNDING

OF

A CORPORATIO N

The most significant method of carrying on business in modern times has been through incorporation. The incorporation process takes place by a group of people called shareholders coming together and forming, through application to government, a corporation which then has the status of a separate legal entity. These types of bodies were originally created by royal charter or special acts of the legislature. Today the standard method by which corporations can be created is by the granting of a certificate of registration after filing articles of incorporation. Historical and limited methods for creating companies or corporations are by the grant of letters patent, or by registration, depending on the jurisdiction. Where the registration method is used, restrictions may be set out in the memorandum of association but this has no effect on those dealing with the corporation unless they have knowledge of the limitation. There is usually no similar limitation on capacity where letters patent or articles of incorporation methods are used. Note that there are other incorporated entities such as cities, universities, Crown Corporations and societies. In broad terms, corporations are funded either through borrowing or through the issuance of shares. A share does not represent ownership, but it represents the interest that each shareholder has in the corporation. When a corporation finances through the sale of shares, it is a form of equity financing rather than debt financing. When corporations borrow, they will do so either through direct loans from individuals or financial institutions, or through the sale of debentures or bonds. It should be noted that when shares are sold they can bring with them special rights and restrictions and accordingly, different classes of shareholders can be created. Typically, these classes are common and preferred shares. Common shares carry with them the right to vote in general meetings of the corporation and the right to a dividend when one is declared. With preferred shares there is a claim to a specific dividend on a regular basis, usually without the right to vote unless dividends are not paid. Even with preferred shareholders, there is no “right” to a dividend. Corporations are usually divided into broadly held and closely held corporations. As a general rule, the closely held corporation involves few shareholders and usually has some restrictions on

EXAMINE THE ROLES OF CORPORATE DIRECTORS , OFFICERS AND

Copyright © 2020 Pearson Canada Inc. 80

Chapter 11: Corporations the free transferability of the shares (such as the need to obtain the consent of the other shareholders). Broadly held corporations usually involve shares being freely traded on the stock market and are much more closely regulated. Directors of corporations are chosen by the shareholders and have responsibility for the management of the corporation. Directors owe a fiduciary duty to the corporation and not to the shareholders. They are required to act in the best interests of the corporation and usually must exhibit the degree of skill that one would normally expect from a reasonably prudent business person. Directors may also be personallyliable where insider knowledge has been misused, where the corporation has not paid wages, not remitted taxes, or has violated environmental law. They may also be charged criminally if they have directed employees to commit crimes to benefit the organization. Senior managers are responsible for the ongoing daily operation of the business and have obligations similar to the directors. Promoters are responsible for creating the corporation in the first place and their responsibility, in addition to those of the directors and managers, is to disclose all pertinent information and refrain from taking advantage of their positions at the expense of the shareholders. The shareholders have few responsibilities, but do have access to records kept by the corporation, such as the annual reports. They also have the right to vote at shareholders’ meetings and to choose the directors. In many jurisdictions shareholders have the right to bring an action against the directors on behalf of the corporation when necessary and the right to retain their percentage of the outstanding shares when new shares are issued (pre-emptive rights). Shareholders also have the right to relief from oppression when the powers of the directors are abused at their expense. In some jurisdictions shareholders can file a dissent and have their shares purchased at a fair price when they are harmed by a decision that is otherwise beneficial to the corporation. Many other rights and protections can be incorporated into a shareholder’s agreement. DISTINGUISH THE WAYS THAT A CORPORATION MAY BE TERMINATED

A corporation does not die but can be brought to an end through dissolution, or winding-up. This may be done voluntarily or involuntarily as a consequence of court order. Also if a corporation does not keep its filings up to date with the government or its agent, it can be struck from the register. There is a process for revival available for corporations that are struck.

Copyright © 2020 Pearson Canada Inc. 81

Instructor’s Manual for Business Law in Canada, 12th Edition Answers to Questions 1. What is meant by a corporation’s having a separate legal identity? The separate legal identity means that, in law at least, the corporation is a separate legal person from its shareholders and also separate from the management. Principles such as limited liability and the longevity of corporations are based on this concept. 2. Explain how the liability of a shareholder is limited. In corporations where a shareholder invests a certain sum, the most that the shareholder can lose is the amount of the investment. Creditors cannot go beyond the assets of the corporation and sue the shareholders to seek a return on the debt. The shareholder therefore has limited liability. 3. Explain under what circumstances a court will “lift the corporate veil.” It is appropriate to “lift the corporate veil” if principals participate in fraudulent or criminal conduct or the avoidance of obligations that ought to be honoured. 4. Why are the principles of agency law relevant to corporations? Since the corporate entity is a legal fiction, all of its activities must be carried out through the services of real people acting as agents. The principles of agency law set out in Chapter 10 are, therefore, extremely important when dealing with corporations. Directors and employees, from officers right down to clerks, may have actual or apparent authority to bind the corporation, depending on the nature of their jobs. 5. Explain how a personal guarantee reduces the limited liability of the principals of a closely held corporation. A personal guarantee, if granted to a creditor of the corporation by one of the principals of the corporation, makes the principal directly liable for the debts of the corporation. This protects the creditors of the corporation but overrides the limited liability the principals might otherwise enjoy. 6. Explain the advantages of free transferability of shares and how and why this right is often modified by shareholder agreement. The main purpose for the creation of a corporate identity in the first place is to facilitate capital investment from as large a pool of investors as possible. Through a share purchase, investors are able to invest significant funds and are also free to withdraw from the operation by selling those shares without disrupting the operation of the corporation. In smaller corporations, however, such free transferability of shares can be a disadvantage. When there are few shareholders the personality of the shareholders becomes important since they are often involved in the running of the corporation and so restrictions are commonly placed on the transferability of shares in closely held corporations.

Copyright © 2020 Pearson Canada Inc. 82

Chapter 11: Corporations 7. Set out and explain some of the disadvantages associated with the corporate method of carrying on business. Unlike partnership it is difficult to make major changes in the corporation since incorporating documents have to be altered. The position of a minority shareholder is one of relative weakness in a corporation, whereas a single partner has considerable amount of power and can often veto decisions if the Partnership Act applies. The running of the corporation is usually more expensive. 8. Distinguish among companies and corporations that have been created by special acts of parliament, by royal charter, by registration, by letters patent and by filing articles of incorporation. Historically, one of a kind businesses were created by royal charter (e.g. The Hudson Bay Company). Now this is done by special act of parliament (CBC, CNR, etc.). For general purposes several different methods of incorporation have been developed. Some provinces use the registration system that requires the registration of certain documents with the appropriate government agency. Letters patent jurisdictions, developing their systems from the royal charter power, create corporations by the governing authority granting letters patent. In more recent times jurisdictions such as the federal government and most provinces have turned to a method which involves the filing of articles of incorporation to obtain a certificate. 9. Explain the significance of the memorandum of association in a registration jurisdiction. Contrast it with the role of articles of incorporation and articles of association. The memorandum of association in a registration jurisdiction is the document that accomplishes the creation of the corporate body. It is analogous to a constitution in that it sets out important matters such as the name of the company, the authorized share capital and the objects of incorporated entity. The articles of association are more like the bylaws of the incorporated entity used in other jurisdictions. These bylaws deal with the day-to-day operation of the incorporated entity including how the shares are issued and cancelled, requirements for meetings of the board of directors and shareholders, voting procedures, etc. The articles of incorporation used in such jurisdictions as Ontario and the federal government are quite different from the articles of association in that they are analogous to the memoranda of association in a registration jurisdiction and comparable to a constitution. In those jurisdictions there are separate bylaws dealing with the day-to-day operation of the corporation. 10. What is a “society” and how does it compare to a corporation. A society is also a body corporate, but its objects specifically are not to make a profit. 11. What is the capacity of most corporations? What is the exception to this rule? Modern corporations have all the powers and capacity of a natural person unless the articles of association or memorandum place restrictions on those powers.

Copyright © 2020 Pearson Canada Inc. 83

Instructor’s Manual for Business Law in Canada, 12th Edition 12. Explain why the concept of a par-value share is misleading and why the use of such shares has declined. With a par-value share a specific value is attached to the share certificate at the point of issue. Such a value has no significance except at the point of issue. A par value share may be issued at $1.00, but once on the market the value of that share is determined by the marketplace and may vary from $.50 to $5.00. It may also be discounted at the point of issue and the par value price may bear no relationship to its trading price. 13. What is meant by a “preferred” share? Contrast this with the “common” share. Explain why the term “preferred shares’’ is misleading. It is possible to create different classes of shares and while many different characteristics can be given to these shares, usually they are divided into common and preferred shares. Preferred shares give the shareholder preference in relation to dividends. That is, a set amount of dividend is payable to the shareholder. That dividend must be paid before any dividends are paid to common shareholders. Preferred shares do not usually carry with them a right to vote unless the dividend payments are in default. Common shares carry a right to vote and a right to dividends if they are declared. In other words the majority common shareholder controls the corporation. 14. Does a shareholder, whether preferred or common, have a right to a dividend? Explain. No shareholder has a right to demand a dividend. Whether a dividend is paid or not is determined by the board of directors. Even when a preferred share is involved, which sets out that the preferred shareholder is entitled to a yearly dividend, that is not a debt and the corporation is not obligated to pay it. Shareholders cannot sue to force payment of a dividend unless the dividend has been declared and has not been passed on to the shareholders. 15. What is the significant difference between a bondholder and a preferred shareholder, both of whom are entitled to a specified payment each year? The preferred shareholder is an investor in the corporation and has no right to demand a dividend and cannot sue upon failure to receive one. A bondholder is a creditor of the corporation who can sue or enforce payment through realizing any related security involved if the corporation fails to pay. 16. Distinguish between a closely held and a broadly held corporation and explain the differences in terms of the provisions in place in your jurisdiction. The answer to this question will vary with the circumstances and the jurisdiction, but essentially the shares of a broadly held corporation are either traded on the stock exchange or the corporation is so large that it has been designated as such by the appropriate government agency. A closely held corporation is usually smaller, often a family organization, with just a few shareholders and some restrictions on the free selling of those shares. A broadly held corporation is subject to more control than a closely held corporation. In some jurisdictions closely held corporations are referred to as private corporations and in others as non-reporting corporations. Copyright © 2020 Pearson Canada Inc. 84

Chapter 11: Corporations 17. Set out the nature of the duties owed by a director of a corporation. To whom are these duties owed? Who else in the corporate organization owes similar duties? The director has an obligation to be careful in dealings on behalf of the corporation and can be sued for negligence if that duty is violated. The director also has the duty of a fiduciary which is to act in the best interests of the corporation, be loyal, avoid conflicts and otherwise to act in the utmost good faith towards the corporation. The director cannot take advantage of opportunities that come because of the position as director, must disclose any situations of conflict of interest and cannot start any business in competition with the corporation. The duty is owed to the corporation and not the shareholders. A similar duty is owed by the officers. 18. Explain why it is becoming increasingly difficult to get prominent individuals to serve as directors of Canadian corporations. Not only has the standard of care required of a director increased (now to the level of a reasonably prudent business person) but directors also face a number of situations where they can be held personally liable for the corporations actions. In addition to unpaid taxes and wages, the directors can be personally liable for violations of environmental legislation and even in some jurisdictions, violations of consumer protection legislation. This risk can be managed through an appropriate indemnity of the director from the corporation, backed up by directors’ and officers’ liability insurance. 19. Who is usually responsible for running the affairs of the corporation? Although directors are legally responsible for management, in a large corporation they usually appoint a managing director or chief executive officer (CEO), who is given overall responsibility, along with a managing committee of the directors, to run the affairs of the corporation. The day-to-day operation of the corporation is assigned to others who report to the CEO. These officers may include an executive vice- president, treasurer, secretary, and other senior executives, such as vice presidents and managers, as deemed appropriate for the organization. 20. How can a promoter avoid personal liability for pre-incorporation contracts? Some jurisdictions allow corporations, once they or formed, to ratify a preincorporation contract. If such is possible it will reduce the risk to the promoters. Where ratification is not possible, promoters should include a provision in the contract exempting themselves from any resulting liability. 21. Explain any duties shareholders assume. Summarize the rights of the shareholders in relationship to other shareholders, the management and directors of the corporation. The shareholder has no duty to the corporation unless he or she qualifies as an insider or has some position within the corporation. The shareholder has significant rights to certain information and can have access to records. The shareholder has a right to receive a copy of the annual report and financial statements. The shareholder has a right to vote on shareholder resolutions (where such power has been given) and to vote for the board of directors. The shareholder has the right to have that vote made by proxy. In Copyright © 2020 Pearson Canada Inc. 85

Instructor’s Manual for Business Law...