Corporation Law

Corporation Law

A corporation is an artificial entity created by or under the laws of a state. Corporation law (also referred to as company law) is the body of law that governs the formation, governance and dissolution of corporations. The corporation is the dominant form of business organization in Canada. Sole proprietorships and partnerships are other widely used noncorporate forms of business organizations. Although there are more partnerships and sole proprietorships than there are business corporations in Canada, the corporate form of organization is most often chosen for larger business operations, and the bulk of total business revenue is earned by incorporated businesses. Cities, universities, charitable organizations and other entities are often incorporated as well; however, corporation law is predominantly concerned with corporations that carry on business for profit.

The Nature of a Corporation

A corporation has 5 distinctive attributes: 1) a separate legal personality; 2) perpetual existence; 3) limited liability; 4) free transferability of an investor's interest; and 5) centralized management. The pre-eminence of the business corporation is in large measure due to the presence of these desirable characteristics.

A corporation has separate legal personality in the sense that it is a legal person separate and distinct from its shareholders, directors and officers. A corporation may enter into contracts and own property in the same manner as a natural person. The corporation may also sue and be sued in its own name. Because a corporation is considered to be a separate legal entity, it may enter into contracts with its own shareholders. A corporation may also be convicted of a criminal offence provided that the criminal provision provides for a fine in lieu of imprisonment.

A corporation has perpetual existence in that it continues to exist until it is liquidated or dissolved. The death of a shareholder, even if he or she is the only shareholder, does not affect the existence of the corporation. Corporations therefore are a relatively stable form of business organization.

Shareholders who invest in a corporation enjoy limited liability in that they are not liable for the debts or other obligations incurred by the corporation. When a corporation goes insolvent, the shareholders will lose their investment (ie, their shares in the corporation), but they will not be responsible for the debts of the corporation.

The corporate form of organization provides an ideal vehicle for investment by virtue of the free transferability of its shares. Unless a restriction is included in the corporate constitution, a shareholder may sell the shares without the consent of the directors, officers or other shareholders. The free transferability of shares in combination with the limited liability afforded to shareholders led to the creation of stock markets, where large volumes of shares are bought and sold. The existence of organized stock markets greatly enhances the liquidity of the shareholder's investment. The business corporation therefore provides a mechanism for the accumulation of blocks of capital with which large projects can be financed, and a means through which the public can invest and participate in these projects.

Structure of Corporations

The structure of a corporation consists of shareholders, directors and officers. Corporations are subject to a centralized management structure in that the authority to manage the business is allocated to the directors. Directors are responsible for supervision of the business activities, the appointment of the officers and for broad policy decisions. Corporate officers are delegated responsibility for the day-to-day operations of the business.

Shareholders play a passive role in the management of a corporation. They are given no direct control over business decisions. They are, however, given the right to vote for directors at the annual general meeting of shareholders and have the right to vote on a limited number of extraordinary corporate transactions. Although the directors, officers and shareholders occupy distinct roles, an individual may act in more than one capacity. In the one-person corporation, all of these functions may be carried on by a single shareholder and director who is also the president of the organization.

Centralized management creates a separation between ownership and control. Some commentators are concerned that the top managers of widely held corporations (ie, corporations with a large number of shareholders, none of whom has a controlling block of shares) may not be properly accountable to the shareholders who are the residual owners of the firm. Others argue that although the potential for abuse of managerial power exists, it is best controlled through the discipline of market forces.

A distinction is often drawn between a distributing corporation (also referred to as a public corporation) on the one hand and a nondistributing corporation (also referred to as a closely held corporation or private corporation) on the other. Distributing corporations actively solicit the public to buy their shares, which are usually traded on a stock exchange. This activity is subject to regulation by the securities legislation of each province in which the securities are traded, and by the regulations of each stock exchange upon which the shares are traded.

A nondistributing corporation has a limited number of shareholders. Often there is a limitation on the transferability of the shares, and the corporation is prohibited from soliciting public purchase of its securities. In some cases, the participants seek to ameliorate the distinction between ownership and control that is inherent in a centralized managerial structure in order to allow greater participation by the shareholders in the management of the corporation. Many of the distinctive features of the corporation may be lacking in such corporations, and for this reason they are sometimes referred to as incorporated partnerships. The primary reasons that these incorporators choose the corporate form of organization is to obtain the benefits of limited liability or to take advantage of the different tax regime pertaining to corporations.

Legal Creation of Corporations

Before 1970, there were 2 basic forms used by the various jurisdictions in Canada for the creation of companies. Both derived from English law. The first was by grant of letters patent from the Crown. This form was the direct descendent of the great monopolistic Crown companies of the 16th and 17th centuries in England such as the HUDSON'S BAY CO. The second type of companies statute involved incorporation by registration of memorandum and articles of association. This form derives from the English Companies Act of 1862.

The 1970s saw a wave of law reform in corporation law in Canada. In 1970 Ontario enacted the Business Corporations Act modelled primarily upon the corporate law of New York State. In 1975 the federal government enacted the Canada Business Corporations Act. A modified form of this legislation has since been adopted in Alberta, Saskatchewan, Manitoba, New Brunswick and Newfoundland. This form of legislation has therefore become the dominant form of incorporation statute in Canada. British Columbia and Nova Scotia continue to use a memorandum of association model of incorporation statute, while Prince Edward Island continues to use a letters patent statute.

Process of Incorporation

Under the Business Corporations Act model of incorporation statute, the incorporators must file with the registrar of corporations a statutory form called "articles of incorporation" together with a notice of registered office and a notice of directors. The articles of incorporation contain the corporate constitution. It must set out the name of the corporation, the classes of shares and the rights and restrictions pertaining to each class of shares, if there is more than one class, any restrictions on the transfer of shares and any restrictions on the business that the corporation may carry on.

Following the issuance of a certificate of incorporation by the registrar, the corporation comes into existence. The directors named in the notice of directors then hold an organizational meeting, issue the shares of the corporation and adopt by-laws to govern procedural matters and internal management.

Often the most difficult part of the incorporation process is obtaining clearance for the name of the proposed corporation. A corporate name must be unique and distinct from the name of all other existing corporations in the province of incorporation and may not conflict with the name of a federally incorporated corporation. The delay can be avoided if the incorporators choose to use a numbered corporation designation. The corporate name must include a suffix such as "Inc" or "Ltd" to alert third parties that the entity is subject to limited liability.

Shares in a corporation confer 3 basic rights on the shareholder; namely, 1) a right to vote at a meeting of shareholders; 2) a right to share in the profits of the corporation by the receipt of dividends; and 3) the right to receive a share of capital of the corporation upon its liquidation or dissolution. A corporation may have more than one class of shares. If there are more than one class of shares, the 3 rights may be distributed amongst the classes as stipulated in the articles of incorporation. If there is only one class of shares, each share will carry an equal right.

The incorporations statute does not limit the manner in which the rights may be distributed amongst the various classes of shares, except to provide that each of the 3 rights must attach to at least one class of shares. However, certain patterns and terminology have become widespread. Preferred shares confer a preference usually in the form of a preferred right to dividends or to the repayment of capital on the dissolution of the corporation. Common shares carry a right to vote at meetings of shareholders, a right to share in the capital of the corporation after satisfying all liabilities and any preference rights to the return of capital, and the right to dividends after the payment of any preferred dividends. Nonvoting and multiple voting shares may also be created.

Corporate Conflicts

Corporations law attempts to address 3 types of conflicts; namely, 1) conflicts between shareholders and outside creditors of the corporation; 2) conflicts between corporate managers and shareholders; and 3) conflicts between majority shareholders and minority shareholders.

Conflicts between outside creditors and shareholders often arise in relation to corporations that are financially distressed. Creditors rank above shareholders on a distribution of assets in a corporate insolvency. Shareholders may attempt to circumvent their lower ranking by orchestrating a distribution of corporate assets to the shareholders prior to BANKRUPTCY or other insolvency proceedings. Corporation statutes create limitations on such distributions. For example, the directors of a corporation are personally liable if they declare a dividend if it would result in the corporation being unable to pay liabilities as they become due or if certain balance sheet tests cannot be met.

Modern corporation law adopts 3 strategies for controlling conflicts between managers and shareholders. First, it imposes a duty of care, diligence and skill and a fiduciary duty of loyalty on directors and officers who exercise managerial power. Second, it gives shareholders an enhanced ability to obtain a remedy from the courts where there has been an abuse of managerial power. Third, it requires disclosure of important corporate information to the shareholders.

The fiduciary duty requires that corporate directors and officers devote their undivided loyalty to the corporation. They are not permitted to appropriate for themselves corporate opportunities that properly belong to the corporation or to otherwise place themselves in a situation where their own personal interests conflict with the interests of the corporation. Much of corporate law concerns the regulation and resolution of such conflicts of interest in a myriad of different business contexts. Directors and officers are also liable if they use information not generally known to the public to profit from the sale or purchase of their shares in the corporation, an activity known as "inside trading."

Perhaps the most important change brought about by the corporate law reform movement in Canada has been the reshaping of the legal remedies available to shareholders. In the past, a complaining shareholder had only a limited ability to seek redress from the courts. Courts were loath to interfere and to substitute their judgement for that of the corporation's management unless it were shown that the conduct amounted to fraud. Shareholders now enjoy an expansive right to apply to court for leave to commence a derivative action in the name of the corporation where the directors or officers have failed to do so because of a personal interest in the matter.

Corporate Information

The primary source of information about the financial affairs of a corporation is the annual report containing the audited financial statements, which must be presented to the shareholders at each annual general meeting of shareholders. An auditor, who is an independent party who reviews and comments upon the financial information provided by the corporation, must also be appointed. To supervise the auditor's work, to act as a channel of communication between the auditor and directors and to ensure the independence of the auditor, distributing corporations are required to have an audit committee of the directors, the majority of whom cannot be full-time employees of the corporation.

Notice of the annual meeting of shareholders of any distributing corporation must include an annual report and a proxy circular containing information about the corporation and the proposed slate of directors. The circular must contain sufficient information on any transaction which requires shareholder approval so as to enable a reasonably intelligent shareholder to assess the proposed changes. The provincial securities commissions must be notified of any sale or purchase of shares transacted by the directors and officers of a distributing corporation.

Minority shareholders who feel that their interests have been unfairly sacrificed for the benefit of the majority shareholders are given a number of legal remedies. The courts are given an extremely wide latitude to grant relief where actions of the corporation or its directors or officers has been oppressive or unfairly prejudicial to the interests of the minority shareholder. In addition, minority shareholders are given a dissent and appraisal right under which they may dissent from certain fundamental changes to the nature of the corporation, such as amalgamations with other corporations or the alteration of the share structure, and are given the right to compel the corporation to buy back their shares at fair value.