CH-15-16 The Corporate Form: Organizational Matters – Canadian Business and the Law : Book Guide

This Document Contains Chapters 15 to 16 Chapter 15 The Corporate Form: Organizational Matters Instructor’s Manual–Answers by Dorothy DuPlessis V. CHAPTER STUDY Questions for Review, page 374 1. What does limited liability mean? Answer: The term limited liability describes shareholders’ obligations to creditors. The shareholders’ liability to creditors is limited strictly to assets owned by the corporation. Creditors may sue the corporation on a debt, but not the individual shareholders. 2. Who are the corporation’s internal stakeholders? Who are the corporation’s external stakeholders? Answer: A stakeholder in general is any person, group, or organization that can place a claim on an organization’s attention, resources, or outputs or is affected by that output. The internal stakeholders of a corporation are individuals who make decisions, formulate policy, and enter contracts on behalf of the corporation. They are those who have either a direct or an indirect role in governing the corporation and determining its mission and how it will be achieved. External stakeholders are people who have dealings with or are affected by the corporation but do not have an explicit role in governing the corporation. For example, the government, the general public, employees, customers, and creditors would all be considered external stakeholders of a corporation. 3. When should a business incorporate federally, and when should it incorporate provincially? Answer: There is no definitive answer to this question. Federally incorporated corporations have the right to carry on business anywhere in Canada, whereas provincially incorporated corporations have a right to carry on business only in the province in which they are incorporated. This difference has little practical significance because of licensing procedures through which corporations incorporated in other provinces can do business in that province. For corporations that intend to operate in more than two provinces, federal incorporation may result in lower administration costs. 4. What basic rights must attach to at least one class of shares? Answer: The basic rights that must attach to at least one class of shares are the right to vote for the election of directors, the right to receive dividends declared by directors, and the right to share in the proceeds on dissolution of the corporation, after the creditors have been paid. 5. A class of shares may include a combination of various rights and privileges. Name three examples of typical rights that may attach to a class of shares. Answer: Several answers are possible: • voting rights: the right to vote for election of directors • financial rights: the right to receive dividends when declared by directors or the right to receive fixed dividends on a regular basis • preference rights: the right to receive dividends before dividends may be paid to any other class of shareholders or the right, on dissolution, to receive investment before any payments are made to any other class of shareholder • cumulative rights: the right to have a dividend not paid in a particular year added to the amount payable the following year • redemption rights: the right to have the corporation buy back the shares at a set price. 6. What is the difference between a widely held and a closely held corporation? Answer: A widely held corporation may issue its shares to the public whereas a closely held corporation does not issue its shares to the public. 7. How can a corporation qualify as a private corporation in Ontario? What are the advantages of a corporation qualifying as a private corporation? Answer: In Ontario, a corporation qualifies as a private corporation if it has the following provisions in its incorporating document: • a restriction on the transfer of shares • a limit (with certain exceptions) of 50 shareholders • a prohibition on any invitation to the public to subscribe for the corporation’s shares The advantages of being a private corporation include the potential for lower taxes and the freedom of being exempt from the obligations of securities regulation. 8. What is a dual-class structure? Answer: It is a structure that confers different voting rights on the holder. For example, one class of shares has superior voting rights, that is, more than one vote per share. 9. Are shares freely transferable? Explain. Answer: In the absence of a restriction in the articles on the transfer of shares, shares are presumed to be freely transferable. It is commonplace, however, for corporations with few shareholders to have some kind of transfer restriction within their incorporating documents as the shareholders have a strong interest in having control over who the other shareholders are. If the corporation intends to offer its shares to the public, then restrictions on the transfer of shares are prohibited. 10. What are the basic requirements for a corporate name? Answer: A name chosen by the incorporators must not be in the use by another business. It also must not be obscene, too long, too descriptive, denote a connection to the Crown, use another family’s name without permission or be confusingly similar to another corporation’s name. The last word of the name must also identify the entity, for example as “corporation” or “limited.” 11. What is a NUANS Report, and what is its purpose? Answer: NUANS stands for “Newly Upgraded Automated Name Search.” A NUANS Report includes a list of business names, corporate names, and trademarks that are similar to the name being proposed. A NUANS report must be obtained and submitted to the government corporation registration office to support the proposed corporate name when applying for incorporation. 12. What is a shelf company, and what is its purpose? Answer: This is a corporation that has already been incorporated with temporary shareholders and directors and is available for instant transfer to its new owners. Shelf companies are often incorporated by law firms for the future use of their clients. The company does not engage in any active business. It simply sits “on the shelf” until a firm’s client needs it. 13. Describe the process for incorporating a company. Answer: • An application for incorporation must be filed. In the majority of Canada, this application is known as Articles of Incorporation. In Prince Edward Island and Quebec, the letters patent method is used. In Nova Scotia and British Columbia, a memorandum of association is used. • All jurisdictions require a company to be identified by a name or designated number. • Depending on the jurisdiction, the exact procedure varies. For example, to become federally incorporated, the articles of incorporation include the name of the corporation, the place where the registered office is to be situated, the classes of shares that the corporation is authorized to issue, the number of directors, restrictions on the business, any other provisions, and the name of the incorporators. The applicant must then send a notice of registered office, notice of directors, and a newly upgraded automated name search report, accompanied by a filing fee, to the federal corporate registry in Ottawa. 14. What is crowdfunding? Is equity crowdfunding permissible in Canada? Answer: Crowdfunding is the practice of funding a project or a business venture through soliciting small amounts of money from a large number of people, usually through the Internet. Equity funding is permissible in six provinces. 15. Compare shares with bonds. Which is the more advantageous method of raising money? Answer: Shares represent a unique ownership interest in the issuing corporation. The shareholder does not obtain any right to use the assets of the corporation or any direct right to control the corporation. Some shares give the shareholder a right to elect those who are responsible for managing the corporation. Shareholders also have rights to participate in the earnings of the corporation in the form of dividends, as well as the right to share in the proceeds on dissolution of the corporation after the creditors have been paid. A bond is a document evidencing a debt owed by the corporation. No ownership interests are inherent with bonds, and the holder has no right to participate in the management of the corporation. By issuing bonds, the corporation gives up no control. However, the interest on bonds must be paid even if no profit is made. Each method of raising money has its own benefits and negative characteristics. 16. What are the objectives of securities legislation? How are the objectives achieved? Answer: The purpose of securities legislation is to provide the mechanism for the transfer of shares, ensure that all investors have the ability to access adequate information to make informed decisions, ensure that the system is such that the public has confidence in the marketplace, regulate those engaged in the trading of securities, and remove or punish those participants not complying with established rules. These objectives are achieved through having requirements that corporations must adhere to: registration, disclosure, and insider-trading restrictions. 17. All securities acts have been amended to provide a new statutory right of action for misrepresentations contained in secondary market disclosures. What is the difference between the primary market and the secondary market for securities? What is the new statutory right of action for purchasers in the secondary market? Explain. Answer: The difference between the primary and the secondary market for securities is that in the primary market, investors purchase securities pursuant to a prospectus, offering memorandum, or securities exchange takeover bid circular. Investors in the secondary market purchase from a third party. Because of this difference, secondary market investors had to rely on a common law action for fraudulent or negligent misrepresentation and had to establish they relied on the defendant’s misrepresentation in making investment decisions. This made it next to impossible to have a class action certified because of the individual issues of reliance. The new statutory right creates the statutory cause of action without regard to whether the purchaser or seller relied on the alleged misrepresentation. This facilitates the certification of class actions by removing the issue of proof of individual class member reliance. 18. What is meant by insider trading? Insider? Tippee? Answer: Insider trading refers to transactions in shares based on information that is not available to the public. These transactions are based on confidential information of a material nature. An insider is someone who is privy to information because of his or her position within a corporation. This information may not be publicly known and therefore cannot be considered by outside investors in the stock market. Insiders include directors, senior officers, and employees of the corporation issuing securities. A tippee is person who acquires material information about an issuer of securities from an insider. 19. Is all insider trading prohibited? Explain. Answer: Not all insider trading is prohibited. Certain insiders, such as directors, senior officers, certain employees, and the corporation itself, are not able to trade. Other individuals who could be classified as insiders may trade but must report any trading that they have engaged in. 20. What is a prospectus? What is its purpose? Answer: A prospectus is the document a corporation must publish when offering securities to the public. Legislation requires this and, furthermore, requires that “full, true, and plain” disclosure of material facts be included in it. The legislation assumes that prospective investors will rely on the prospectus in making investment decisions. Questions for Critical Thinking, page 374 1. Salomon v Salomon stands for the proposition that the corporation has a separate existence from its shareholders. This means that creditors of a corporation do not have recourse against the shareholders’ assets. Is this fair? Is it fair that creditors of a sole proprietorship can go after the sole proprietor’s personal assets? What is the justification for the difference in treatment? Answer: This question is an extension to the critical analysis question following the Salomon v Salomon decision. That question examined the doctrine of separate corporate personality from the perspective of the shareholder; this question asks students to consider the consequences of a corporation’s separate existence from the perspective of creditors. It can be argued that the Salomon v Salomon doctrine is fair. The corporation’s debts were created on the basis of the corporation’s credit, not that of the individual shareholders or corporate officers. Shareholders are often not involved in the day-to-day operation of a corporation and neither do they have the authority to manage the company. As such, it would not be fair if creditors could hold shareholders personally accountable for the corporation’s debts. If creditors are concerned about the creditworthiness of the corporation, they should either not deal with the corporation or insist on a personal guarantee from shareholders. Sole proprietors, conversely, have complete control over their ventures. Loans and credit that are extended to a sole proprietorship are based on the proprietor’s credit and business experience. Therefore, the different remedies available against sole proprietors and corporations are justified. 2. Nova Scotia, Alberta, and British Columbia permit a company to incorporate as an unlimited liability corporation (ULC), a vehicle whereby shareholders are, in certain circumstances, jointly and severally liable for the debts and liabilities of the corporation. The ULC is most often used by American investors in Canadian ventures because of significant advantages under U.S. tax law for U.S. residents. This is because although ULCs are generally subject to taxation in Canada on the same basis as any other Canadian corporation, under U.S. tax law they are treated for many purposes as a partnership. This treatment allows for the “flow-through” of certain income and expenses to U.S. shareholders, thus avoiding some of the double taxation that would otherwise exist. The U.S. owner of the ULC is allowed to consolidate the ULC’s foreign income and losses and to claim a U.S. foreign tax credit for any Canadian income tax paid by the ULC. The problem of exposing shareholders of ULCs to unlimited liability can be addressed by interposing an appropriate limited liability entity between the U.S. shareholders and the ULC. Why would governments amend their corporation’s legislation to allow for the incorporation of ULCs? Answer: A ULC’s partnership-like characteristics create certain advantages under U.S. tax law for U.S. residents who own investments in Canada. Therefore, this corporate form is preferred by many U.S. residents. Provincial governments amend their legislation to attract U.S.-based corporations looking to build their businesses in Canada and to remain competitive with other provinces that offer this vehicle to U.S. investors. Sources: Stephen Rukavina, “Why would anyone want an unlimited liability company?” Miller Thomson LLP (4 November 2014) online: Mondaq ; Geoff Kirbyson, “Alberta’s unlimited liability corporations will draw them in,” The Lawyers Weekly 7 April 2006 . 3. Dual-class share structures are prevalent in Canada. There are roughly 80 companies listed on the Toronto Stock Exchange that use some form of dual-class, multiple-voting share structure. Included in this group are Bombardier Inc., Canadian Tire Corp., Power Corp., Rogers Communications Inc., Shaw Communications Inc., Tech Resources Ltd., and Telus Corp. Why do you think dual-class structures have emerged in Canada? [footnote deleted] Answer: Dual-class share structures emerged in Canada for a variety of reasons. They are a means to preserve family control of a business while raising money in the capital markets. As well, past restrictions on foreign investment encouraged dual class structures as a means of avoiding the foreign-ownership restrictions while attracting foreign investment. Also, the dual-class structure provided protection in industries that are prone to takeover, such as the cable and broadcasting industries, where there a limited number of licences (i.e., the only way to get a licence is to take over an existing company that has a licence). See Tara Gry, Dual-Class Share Structures and Best Practices in Corporate Governance (Ottawa: Library of Parliament, 2005) at . 4. The Internet has had a tremendous impact on the securities industry—it has spawned online brokerages, has emerged as the primary source of information for investors, and is the means by which businesses can distribute prospectuses, financial statements, news releases, and the like. It also poses considerable challenges as its global, invisible nature increases the likelihood of fraud. Because scam artists can anonymously and cheaply communicate with a vast number of people, they can readily spread rumours that result in the manipulation of market prices, trade in securities without being registered to do so, and distribute securities in nonexistent entities. What is the rationale for regulating trade in securities? Do you think the rationale changes when the commercial activity is conducted over the Internet? Answer: The rationale for regulating trade in securities is to preserve the integrity of the securities market. Securities laws are directed at protecting investors from unfair, improper, or fraudulent practices, and fostering fair and efficient capital markets. Securities laws regulate primary and secondary market trading and the conduct of the market participants through registration, licensing, and disclosure obligations. The rationale does not change when commercial activity is conducted over the Internet. Securities regulators recognize that securities laws ought to encourage and facilitate the use of the Internet and related technologies, but they should not permit the use of these technologies to undermine investor protection or market integrity. Source: Bradley J Freedman, “Internet presents challenge to securities regulators,” The Lawyers Weekly (9 February 2001) 13. 5. The Supreme Court of Canada ruled that the federal government’s draft legislation for the creation of a single national securities regulatory body was unconstitutional. One of the strongest arguments for the establishment of a single national securities regulatory is the need for effective enforcement of securities market conduct. How does a single national body, as opposed to 13 provincial and territorial bodies, improve enforcement? [footnote deleted] Answer: A single body is likely to be more effective because it eliminates the inevitable duplication of effort that exists with 13 bodies with a corresponding multiplicity of statutes, regulations, policies, and interpretations. A single national body would “combine regulatory and criminal enforcement in the same body, provide additional tools to investigators and establish simplified national complaint handling and redress standards.” Source: Poonam Puri, “The case keeps growing for a national securities regulator,” The Lawyers Weekly (3 December 2010) 5. 6. In 2012, the United States enacted the Jumpstart Our Business Startup (JOBS) Act. The Act amends U.S. securities laws by introducing a crowdfunding exemption that allows entrepreneurs to raise funds and issue securities via an Internet portal. Once the Securities and Exchange Commission introduces rules governing the industry, equity crowdfunding will be available in the U.S. Why is Canada (see Business and Legislation: Crowdfunding, page 365) behind the U.S. in permitting equity crowdfunding? Answer: One of the answers proposed for this question is the lack of a national securities regulator. In the United States, proponents of equity crowdfunding only had to lobby one government: the federal government. In Canada, with 13 regulators the process is more cumbersome and time consuming to make equity crowdfunding legal across the country. Source: Kevin Carmichael, “Crowdfunding: Why Canada is far behind the U.S.,” The Globe and Mail (2 May 2012) online: Globe and Mail . Situations for Discussion, page 375 1. In Silver v IMAX Corp, shareholders in a class action against IMAX Corporation and certain directors and officers are seeking $500 million in damages and an additional $100 million in punitives. The shareholders allege that IMAX misrepresented its 2005 earnings revenue in press releases and other disclosures for the period 9 March 2006 to 9 August 2006. It is alleged that 2005 revenues were overstated because IMAX recognized revenues from theatres that had yet to open and that this overstatement artificially inflated the trading price of IMAX securities. On 9 March, IMAX shares traded on the Toronto Stock Exchange (TSX) at $11.94. On 9 August, IMAX issued a press release stating that the U.S. Securities and Exchange Commission had made an informal inquiry about the company’s timing of revenue recognition. On 10 August, the price of IMAX shares dropped to $6.44 on the TSX. What will the plaintiffs have to prove to be successful in the proposed class action lawsuit? How do the secondary market liability amendments in securities legislation assist the plaintiffs? If the plaintiffs are successful, how will damages be calculated? [footnotes deleted] Answer: The plaintiffs may assert a common law cause or action for negligent misrepresentation and a statutory cause of action misrepresentation. If they assert the common law action, there would have to prove that (1) the defendants owed a duty of care to the plaintiffs; (2) the defendants made an untrue, inaccurate, or misleading misrepresentation; (3) the misrepresentation was made negligently; (4) the plaintiff reasonably relied on the misrepresentation; and (5) the plaintiffs suffered damages as a result of the misrepresentation. If the plaintiffs assert the statutory cause of action, they would have to prove a misrepresentation but would not have to prove reliance on the misrepresentations. The defendants can raise statutory defences, such as due diligence and expert reliance. If the plaintiffs are successful in the statutory action, damages are calculated according to formula set out in the legislation, which provides for both proportionate liability and a cap on damages in most circumstances. If the plaintiffs are successful in the common law action, there is no such cap on the damages. 2. Steering Clear Ltd. is a manufacturer of an expensive automatic helmsman, which is used to navigate ocean cruisers. Perry Jones ordered such a helmsman on behalf of a company called Cruisin’ Ltd. The helmsman was supplied, but Cruisin’ Ltd. did not pay its account. Because of this delinquency, Steering Clear Ltd. decided to investigate the background of Cruisin’ Ltd. and discovered that it has a grand total of two issued shares—one held by Perry and the other by his wife. Perry has advised Steering Clear Ltd. that the debtor company has only $5 in the bank and may have to go out of business soon. Steering Clear wants to sue Perry personally for the debt. Will Steering Clear be successful? On what basis? What is the largest obstacle facing Steering Clear’s potential action against Perry? What should Steering Clear have done differently from a business perspective? [footnotes deleted] Answer: This situation is based on the following case: Henry Browne & Sons Ltd v Smith, [1964] 2 Lloyd’s Rep 477 (QB). Henry Browne & Sons Ltd. claimed money for goods and services supplied to repair a yacht. The order for the repairs was made by Mr. Robin Smith on behalf of Ocean Charter Ltd., a corporation of which Smith is the sole director and incorporator. Browne claims payment from Smith personally on that basis that Smith was acting on his own behalf when he placed the order, as the company was a mere sham or merely a name under which Smith traded. Alternatively, Browne claims that the order was placed by Ocean Charter, as agent for Smith. Smith refuses to pay because he claims that the goods and services ordered by him were not for him personally but were for another “person,” Ocean Charters. The court was not convinced that the order was placed by Smith on his own behalf. Even though Smith is the sole director and incorporator of Ocean Charter, a limited company, its incorporators are distinct legal entities, and it is only in special circumstances that this difference can be ignored. Further, there was no evidence that Ocean Charter was acting on behalf of Smith. Therefore, Smith is not personally liable for Ocean Charter’s debt. (end of case summary) This situation is a straightforward application of the principle in Salomon. Jones ordered the equipment on behalf of Cruisin’, therefore Cruisin’ is liable on the contract, not Jones. Only in exceptional circumstances would Jones be liable. These situations are explored in Chapter 16. It may be useful to again review this problem after discussing the doctrine of “lifting or piercing the corporate veil.” To be successful Steering would need to convince the court that Jones was acting in his personal capacity, the company was acting for Jones, or that the corporation was a mere sham. The fact that there are only two shareholders is not evidence of a sham. This problem also allows for an examination of how Steering could have done things differently. Strategies include • checking into the background and creditworthiness of a the corporation before entering the contract • insisting on cash transactions • refusing to do business with companies that are undercapitalized or are not creditworthy • requiring personal guarantees from shareholders, directors, or third parties 3. Sophie Smith has an opportunity to open a designer shoe store in a new mall. She believes that the shoe store will be quite lucrative because of the mall’s location adjacent to a condominium development catering to young professionals. To take advantage of favourable tax laws, Sophie has decided to incorporate a company, and to save money she is going to do it herself. She knows that she will need a name for her corporation. Some of names that she is considering are Shoe Store Inc., Princess Sophie’s Shoes Ltd., DownTown Shoes Inc, Sophie Smith Ltd., Nu Shuz Inc., Sophie Smith Clothing and Apparel Inc., and simply, Sophie’s Shoes. Are there any problems with the names that Sophie is considering for her corporation? Explain. Assume that Sophie has XZONIC Shoes Inc. approved as the corporation’s name. What rights does registration of a corporate name give Sophie? Answer: Sophie needs to conduct a name search before choosing a name for her corporation. She needs to search the corporate registries to ensure that the name she chooses is not already being used by another business. In addition, she needs to search the federal trademark database to ensure that no one has registered the name as a trademark. Possible problems with the name being considered by Sophie are the following: • Shoe Store Inc. is not distinctive enough. • Princess Sophie’s Shoes Ltd. suggests an association with the royal family but because the royal family is not involved in selling shoes and there is no Princess Sophie, it may be okay. • DownTown Shoes Inc. may be too close to well-known Canadian shoe retailer Towne Shoes. • Sophie Smith Ltd. would not be acceptable because it lacks a descriptor. • Nu Shuz Inc. may not be distinctive enough because it sounds like “New Shoes,” which is not distinctive. • Sophie Smith Clothing and Apparel Inc. may be okay, provided no other business has this name. • Sophie’s Shoes is not acceptable because it lacks a legal element. The registration of a name does not give any inherent protection because, as noted in Paws Pet Food v Paws & Shop, a judge may overrule the registrar if another name is similar. But generally, registration will give the person the right to use a name and the right to prevent others from using the same or a similar name in the same line of business. 4. Paws Pet Food & Accessories Ltd. (Paws Pet Food) was incorporated under the Alberta Business Corporations Act. Three years later, Paws & Shop Inc. (Paws & Shop) was created under the same piece of legislation. Both corporations operated in Calgary, and both were in the business of retailing pet food and accessories. Paws Pet Food was successful in getting a court order directing Paws & Shop to change its name even though the registrar had approved and registered its name. Why do you think Paws Pet Food was successful in getting the court order? What are the costs to Paws & Shop of a name change? The registrar made a mistake in registering Paws & Shop’s name. Who should bear the cost of the mistake—the business itself or the taxpayers? Answer: This case illustrates that there is no inherent protection in the fact that the registrar has approved a corporate name for use. A judge can overrule the registrar and, furthermore since the tort of passing off can be committed unintentionally, a company with a name that is confusingly similar to another company can end up paying damages even though the registrar had approved the name to begin with. The costs to Paws & Shop’s, in addition to the legal costs of the action, include the cost of new signage, brochures, business cards, listings etc., and the cost of obtaining a new name. Who should bear the risk of a mistake being made—the business itself or the taxpayers? It is important to understand the process of acquiring a corporate name. “Approval” of a name by the registrar is somewhat misleading: the registrar does not actually approve the name but merely proceeds to record the name of the corporation. The “approval” is for all practical purposes a rubber stamp that follows upon the submission of a name search (NUANS report) prepared by a recognized search company. It is therefore not surprising or unfair that the registrar does not bear the risk of a mistake being made. A business acquiring a name could attempt to transfer the risk of a mistake occurring to the search company through contractual provisions. 5. Globex Foreign Exchange Corporation (Globex) is an Edmonton-based currency trader. It entered into a contract with 3077860 Nova Scotia Limited (Numberco) for the purchase by Numberco of nearly 1.2 million British pounds. Carl Launt is the sole director and shareholder of Numberco. He funded Numberco with a deposit of $124 676. Canadian dollars to effect the trade with Globex. Numberco failed to pay for the rest of the funds purchased and Globex incurred a loss of nearly $90 000 when it resold the currency. Globex commenced an action for breach of contract against Globex and discovered that it was a defunct company with no assets. Is there any legal basis for holding Launt responsible for the unpaid debt of Numberco owed to Globex? Could Globex successfully argue that Numberco was Launt’s agent? How could Globex have better protected itself in this situation? [footnote deleted] Answer: This situation is based on Globex Foreign Exchange Corp v Launt, 2010 NSSC 229 and the facts set out above are a serviceable summary. On motion for summary judgment, the case was dismissed on the basis that there was no evidence of an agency relationship. On appeal, the court held that the existence of an agency is a matter best for trial. See agency Globex Foreign Exchange Corp v Launt, 2011 NSCA 67. As a corporation is an entity separate from its shareholders, it is liable for its own debts, and the shareholders are not responsible for the corporation’s debts. However, in some circumstances the court will pierce the corporate veil and impose personal liability on the shareholders (piercing the corporate veil is discussed in Chapter 16). As there does not appear to be any evidence of a fraud or sham, the court is unlikely to pierce the corporate veil and hold Launt responsible for Numberco’s debts. That said, it is possible that Launt could be liable on the basis of agency, if it can be established that Numberco was acting on behalf of Launt in the purchase of the currency. A finding of agency does not require a piercing of the corporate veil but a finding that the corporation is acting on behalf of the shareholder. Evidence of an agency relationship would have to be presented. Globex could have better protected itself in this situation by insisting on a personal guarantee from Launt, the sole shareholder and director of Numberco. 6. In 2010, Frank Stronach relinquished control of auto parts giant Magna International. Since 1978 Magna has had a dual-class, multiple-vote share structure. Through this structure, Stronach was able to control the company despite owning just 0.6 percent of its 113 million shares because his 720 000 Class B share each carried 300 votes, while the remaining 112 million Class A shares had one vote each. In return for cancelling the Class B shares, the Stronach family trust received US$300 million in cash and 9 million new Class A shares. In addition, Stronach received a four-year consulting contract and a 27 percent stake in Magna’s electric car business. It is estimated that the deal was worth $1 billion—an 1800 percent premium on the value of Stronach’s shares. Seventy-five percent of the Class A shareholders voted for the deal, and, subsequently, the Ontario Superior Court approved the deal. Market reaction to the deal was also favourable—on the day following the announcement of the deal, Magna shares closed up 14 percent on the Toronto Stock Exchange. What are the problems with dual-class share structures? What are the advantages? Do you think the deal to eliminate the dual-class structure at Magna was fair? [footnote deleted] Answer: There are two views on dual-class share structures. Detractors believe a dual-class share structure is unfair. First, it confers economic power on a few, while the majority bears the financial risk. Second, the superior-class shareholders are in a position to get benefits for themselves, such as extravagant pay, generous bonuses, and the like, at the expense of the majority. Third, a dual-class structure can entrench poor management and insulate managers from accountability for their actions. Fourth, some studies indicate that companies with a dual-class share structure underperform those with a single-class structure in the long run. Supporters of dual-class shares, usually the owners, argue that these structures protect the company from the need to meet short-term profitability goals at the expense of the long-term success of the company. They also argue that the structure protects a company from any unwanted takeover bids because voting control resides with the founders. This, they say, ensures the stability of the board and ensures that shareholders continue to benefit from the founders’ skills and expertise. Finally, they note that some of the best-performing companies in their sectors in Canada are companies with a dual-share structure. See Tara Gry, Dual-Class Share Structures and Best Practices in Corporate Governance (Ottawa: Library of Parliament, 2005) at . It is difficult to conceive of the deal being fair, as Mr. Stronach had all of the cards in negotiating the deal. The shareholders had the choice of having the Class B shares cancelled at the price specified or continuing to allow Stronach the benefits of control. That said, both the Ontario Superior and Divisional Courts approved the agreement as “fair and reasonable.” See Michael McKiernan, “$1-billion Magna deal’s fairness scrutinized,” Canadian Lawyer Magazine (21 March 2011) at . 7. Former RBC Dominion Securities investment banker Andrew Rankin was found guilty in Ontario provincial court of 10 counts of tipping a friend, Daniel Duic, about pending corporate deals. Duic used the tips to make a net profit of over $4.5 million in stock trades in a 12-month period. Insider-trading charges against Duic were dropped in return for his testimony against Rankin and the payment of a $1.9 million fine. Rankin was acquitted of 10 counts of the more serious offence of insider trading because he was apparently not aware of his friend’s deals and he did not directly profit from them. Rankin was sentenced to six months in jail. Rankin’s conviction, however, was overturned because of contradictory evidence (inconsistencies in Duic’s evidence) and errors by the trial judge. Before a new criminal trial was to begin, the Ontario Securities Commission (OSC) agreed to withdraw criminal charges in return for an admission by Rankin that he engaged in illegal tipping. Rankin also agreed to a payment of $250 000 towards OSC’s investigation costs, a lifetime ban from working in the securities industry or serving as a director or officer of a public company, and a 10-year ban on trading on securities in Ontario. What are the problems with insider trading? Why is it difficult to secure a conviction for improper insider trading? Do Rankin’s penalties fit the “crime”? Why or why not? Answer: An insider is defined as a person whose relationship with the issuer of the securities is such that he or she is likely to have access to relevant material information concerning the issuer that is not known to the public. Therein lies the problem with insider trader—access to information not available to the public. Prosecution is difficult because of a lack of evidence particularly non-circumstantial evidence. There are often no witnesses, no written documents, and events may have occurred in another country (such as in the Bre-X case discussed in Ethical Considerations: Bre-X Minerals: The Final Chapter text page 371). In addition, the burden of proof is beyond a reasonable doubt when securities commissions elect to deal with insider trading in a court as opposed to in front of a panel of commissioners. (Courts are often preferred because of the seriousness of the charges and the potential for a prison sentence as punishment). Some factors to consider in determining whether the penalties fit the crime: Rankin did not appear to directly profit from passing on the information. His friend, Daniel Duic, the person who did profit handsomely received a lighter penalty in return for his testimony against Rankin. Duic did not have to surrender returns from all of his trades—he paid back $1.9 million which stemmed from the profit from illegal trades that was discovered by the OSC at the time the deal was negotiated. Apparently he made about $7 million in trades from 1997 to 2001 so he ended up with a handsome profit from the illegal trades. Rankin clearly tipped Duic and although he may not have directly benefitted, he did benefit through gifts and trips from Duic. Rankin was in a position of trust with a very good income so there was not a “good” reason for him to provide information to Duic. He did not receive a jail sentence. Penalties are needed to send a strong deterrence message. Source: Shirley Won, “The wealthy valet,” The Globe and Mail (17 March 2009) online: The Globe and Mail . 8. Alimentation Couche-Tard Inc. is the Canadian leader in the convenience store industry. At 8:30 a.m. on 6 October 2003, Couche-Tard publicly announced a deal to purchase the 2013-store Circle K chain. Completion of the deal would make Couche-Tard the fourth-largest convenience store operators in North America. When trading opened on the Toronto Stock Exchange at 9:30 a.m., the company’s class B stock was up 40 cents at $17.50. The price steadily gained all day to close at $21, for a gain of $3.90. Within five minutes of the opening, Roger Longré, a Couche-Tard director bought 1500 shares and by 10:30 he bought a further 2500. At the end of the day, he had a one-day gain, on paper, of $11 372. Did Longré breach any legal requirements? Did he breach any ethical requirements? Should insiders be prohibited from trading before earning announcements and after major announcements? Should insiders be required to clear all proposed trades in the company’s securities with a designated in-house trading monitor? [footnote deleted] Answer: Longré traded after the deal was announced to the public. If he properly reported his trading as per the requirements of the securities legislation, he has not done anything illegal. Some may argue what he did was unethical because he “rushed” the market. However, the markets move fast on information, and it is the job of those who are in the industry to move quickly on behalf of their clients when news breaks. In this sense, Longré had no advantage over anyone else. Many companies have policies that provide for a senior officer to approve and monitor the trading activity of all insiders. Other companies adopt trading blackout periods, when insiders are prohibited from trading in securities. In some instances, the blackout period is before earnings reports; in other instances, it is from the end of each bookkeeping period until two days after the earnings report is published. Companies adopt these policies to give insiders fewer opportunities to get into trouble and outsiders less cause for suspicion. Source: “Insider trading: A special report,” The Globe and Mail (18 December 2003) B6-7. Chapter 16 The Corporate Form: Operational Matters Instructor’s Manual–Answers by Dorothy DuPlessis V. Chapter Study Questions for Review, page 409 1. How can a corporation be liable in tort law? Explain. Answer: A corporation can be liable under primary and vicarious liability in tort law. It is primarily liable when it is the entity that directly committed the tort. It is vicariously liable when an agent or employee who is not a directing mind of the corporation commits the tort. 2. How does a corporation enter a contract? Explain. Answer: A corporation enters into a contract through the actions of the corporation’s agents, employees, or directors who have actual or apparent authority. 3. How is the criminal liability of a corporation determined? Answer: A corporation has committed a crime if the person who committed the crime was a directing mind or a senior officer of the corporation, if the crime was committed in the course of the duties, and if the actions were done for the benefit of the corporation. 4. When is a director personally liable for committing a tort? Answer: Some courts have ruled that directors are not personally liable provided that they were acting in furtherance of their duties to the corporation and their conduct was justifiable. In Ontario, however, recent case law suggests that directors will almost always be responsible for their own tortious conduct, even if they were acting in the best interests of the corporation. Where the director’s conduct is extreme, she will be found liable for committing a tort regardless of the approach taken by the courts. 5. To whom do directors owe duties? Answer: Directors owe a duty of competence and a fiduciary duty to the corporation. They do not have any social responsibilities. They have no obligation to pursue policies that are desirable in terms of objectives and values of society, nor do they have an obligation to consider interests other than those of the shareholders. Corporate legislation reflects this approach. 6. What is a self-dealing contract? Answer: A self-dealing contract occurs when someone is dealing on both sides of the contract in different capacities, such as when someone is selling something in the capacity of an individual and buying it in the capacity of a director. Many jurisdictions have passed laws to allow this as long as the contract is fair, the person discloses the contract to the corporation in writing, the person does not participate in the vote concerning the purchase, and the contract is fair and reasonable to the corporation. 7. What are the duties of directors and officers? Answer: The duties of directors fall into two broad categories: a duty of competence and a fiduciary duty. The duty of competence requires directors to exercise the care, diligence, and skill that a reasonably prudent person would exercise in comparable standards. The fiduciary duty requires directors to act honestly and in good faith with a view to the best interests of the corporation. 8. Do directors owe duties to the corporation’s creditors? Explain. Answer: Corporations do not owe a fiduciary duty to their creditors. They do, however, owe a duty of care to their creditors. 9. Is a director liable for a corporation’s contracts? Explain. Answer: A director does not generally attract liability for the corporation’s contracts. However, a director faces personal liability on a contract if the facts indicate that the director intended to assume personal liability. 10. How may a director avoid personal liability when carrying out her corporate duties? Answer: Directors can avoid personal liability by exercising care, diligence, and skill in the performance of their duties. Directors can meet the statutory standard of care by being attentive, active, and informed. In this regard, directors should make all their decisions informed decision,; do what is necessary to learn about matters affecting the company, identify possible problems within the company, stay apprised of and alert to the corporation’s financial and other affairs, regularly attend directors’ meetings, and ensure they receive reliable professional advice. Directors may also protect themselves by ensuring that an indemnification agreement is in place and by ensuring that the corporation carries adequate insurance. 11. What is meant by the term “lifting the corporate veil”? When will courts “lift the corporate veil”? Answer: Lifting the corporate veil means holding the shareholders of a corporation personally liable for the corporation’s acts. Courts are generally reluctant to lift the corporate veil, except when they are satisfied that a company is a mere facade concealing the true facts. 12. What three main rights do shareholders have? Answer: The three main rights that shareholders have are the right to vote, right to information, and financial rights. 13. What rights to dividends do shareholders have? Answer: Preferred shares with cumulative dividend rights entitle their holders to accrue undeclared or unpaid dividends due from previous years. All other shareholders have a right to dividends only if the dividends are declared. Shareholders’ rights to declared dividends depend on the order of preference. All shareholders belonging to the same class have a right to an equal dividend. 14. When is the dissent and appraisal remedy appropriate? Answer: The dissent and appraisal remedy is appropriate when a dissenting shareholder disapproves of fundamental changes being made to the corporation. In certain circumstances, the dissenting shareholder may elect for the corporation to buy his shares at a fair market price. It is limited to specific actions, such as changes to the restrictions on share transfers or restrictions on the business a corporation may carry on; the amalgamation or merger with another corporation; or the sale, lease, or exchange of substantially all of the corporations’ assets. 15. What is the difference between a derivative action and an oppression action? Answer: A derivative action is brought by a shareholder on behalf of the corporation to enforce a corporate cause of action. An oppression action is a personal action brought by a shareholder (or other stakeholder) to address unfair corporate conduct and treatment. 16. When is a shareholders’ agreement appropriate? What issues should a shareholders’ agreement address? Answer: A shareholders’ agreement is appropriate in a small, closely held corporation. It is appropriate for shareholders who want to define their relationship to each other in a manner that is different from that provided by the governing statute. The agreement should address management of the company, protection for the minority shareholder, control over who the shareholders will be, provision of a market for shares, capital contribution, buy–sell arrangements in the event of a dispute, and a mechanism for terminating the agreement. 17. What protection do creditors have from shareholders stripping the corporation of its assets? Answer: Creditors have protection through various legislative provisions, including a provision that forbids a corporation from paying a dividend to shareholders if doing so would jeopardize its ability to pay its own debts as they fell due. 18. How is a corporation terminated? Answer: A corporation may be terminated following the legislated procedures applicable in its jurisdiction. In most jurisdictions, these procedures will be found in the Companies Act or a separate Winding-up Act. Another method is to simply let the company lapse. A court may also order a company to be terminated when a shareholder has been wrongfully treated and no other remedy would do justice between the parties. Finally, a corporation may go bankrupt. Questions for Critical Thinking, page 409 1. What are the arguments for prosecuting, convicting, and punishing corporations? Does holding corporations criminally responsible serve any social purpose? What are the arguments against prosecuting, convicting, and punishing corporations? Answer: Canada, as well as most common law jurisdictions, has taken the position that a corporation is capable of committing a crime. The arguments for prosecuting, convicting, and punishing corporations relate to the separate legal personality of the corporation. As the corporation is capable of enjoying rights, it is equally capable of assuming responsibility for criminal acts. Another justification offered is that prosecuting the corporation provides an opportunity to consider the impact of corporate pressure and the system in use in the corporation on commission of the offence rather than focusing on an isolated act by an employee. A further justification often put forward for criminal prosecution of the corporation is to prevent the corporation from reaping a profit derived from the commission of a criminal offence. Whether holding corporations criminally responsible serves a social purpose is debatable. A corporation is criminally liable when a directing mind or senior officer commits an offence. If it is that individual who is responsible for the crime, then why prosecute the corporation? Attributing conduct back to the corporation makes sense if the object is to compensate the victim. That, however, is not the purpose of criminal law. It is also unclear how prosecuting the corporation increases the deterrent effect of prosecution. The arguments against prosecuting, convicting, and punishing corporations relate to the fictional nature of a corporation. A corporation is not a separate decision-making entity. To fix the corporation with criminal liability, it is necessary to relate the crime back to someone who stands behind the corporation—someone who causes the corporation to commit the crime. There are numerous problems with the “identification” theory.” First, it has a narrow application because only a person who qualifies as a “directing mind” or is a senior officer can trigger a corporation’s criminal liability. In reality, however, corporations are becoming more and more decentralized, and important decisions are often made at a much lower level. Second, by focusing on the acts of one or a few persons, there is a tendency to overlook the content of corporate policies and values that may encourage the commission of crimes but that do not necessarily emanate explicitly from one or a few persons. For example, there could be “institutionalized sloppiness” in the implementation of a corporation’s maintenance or security policies. Finally, this approach tends to punish corporations for the acts of one or a few individuals instead of punishing a corporation for acts that emanate from its deficient corporate culture. Also of concern in prosecuting corporations is the issue of punishment. A corporation cannot be jailed and fines may not be a deterrent. To address some of this concern, the amendments (see the textbook, pages 381–382) have increased the maximum fines that can be imposed on corporations and set out the factors that a court should consider when fining an organization: • moral blameworthiness: the economic advantage gained and degree of planning involved in committing the crime • public interest: the need to keep the corporation running and preserve employment, the cost of investigation and prosecution, and any regulatory penalty that is distinct from those under the Criminal Code • prospects of rehabilitation: penalties imposed on managers and employees by the organization, previous convictions for regulatory offences, whether the victim was compensated, attempts to hide assets to avoid paying the fine, and measures taken to reduce the likelihood of further criminal activity See: A Plain Language Guide: Bill C-45—Amendments to the Criminal Code Affecting the Criminal Liability of Organizations at . 2. The Canadian Democracy and Corporate Accountability Commission, an independent body designed to investigate corporate influence has recommended that corporation laws should be amended to allow directors, at their discretion, to take into consideration the effect of their actions on the corporation’s employees, customers, suppliers, and creditors, as well as the effects of their actions on the community in which the corporation resides. How does the Supreme Court of Canada’s decision in BCE account for stakeholders’ interests? What is the problem with directors owing duties to all stakeholders? [footnote deleted] Answer: The Supreme Court of Canada in both Peoples v Wise and BCE state that directors may consider the interests of stakeholders, and in BCE, the court states that directors owe a duty of care to creditors. This is some recognition of stakeholders’ interests. The idea of accounting for all stakeholder interests can be problematic in its scope—how far is the corporation obligated to go? How many interests does it need to take into consideration? Does requiring managers to respond to a set of ill-defined social imperatives that go beyond profit maximization amount to expropriation of the property invested by the shareholders? What happens if various interests collide? The notion that managers of a corporation are accountable only to shareholders has the virtue of being verifiable, codified, and easily understood. 3. There are literally dozens of statutes that impose personal liability on directors and, in many cases, officers. Directors and officers face liability, for example, under securities, environmental, employment, tax and bankruptcy, and insolvency legislation. Why do you think this has occurred? What are the problems associated with holding directors to higher standards? How can directors protect themselves in an increasingly litigious environment? Answer: Directors have been subject to more liabilities (see, for example, BCF, Provincial and Federal Laws Applicable to Directors’ Liability Guide (2010) at , which highlights the vast array of legislative provisions imposing personal liability on directors). The increased liability is due to several factors, including the following: • In an effort to influence corporate conduct, legislatures have passed a large number of statutes that impose personal liability on directors and officers for their own acts and omission and for those of the corporation. • The standard of care, skill, and diligence imposed on directors by legislation is higher than that previously required by the common law. • Shareholders have become increasingly active in scrutinizing the role and performance of the directors and officers. The problems associated with increased liabilities for directors include reluctance on the part of people to sit on the board of directors, increased cost of directors and officers (D&O) liability insurance, and increased incidence of litigation involving directors. Directors can adopt the following strategies to help manage their risk: • Reduce: directors can reduce their risk of liability by acting with “due diligence”; • Transfer: directors can transfer all or part of their risk through indemnification and insurance. The Business Application of the Law: Avoiding the Risk of Personal Liability (page 382) sets out some information on general conduct for directors. Following these guidelines helps the director to rely on the defence of due diligence. Directors may also be indemnified against losses by the corporation or the shareholders; similarly, a corporation can purchase insurance against liability incurred by the directors and officers. It should be noted, however, that there are business and legal limitations on the scope of available indemnification and insurance. For example, D&O insurance normally contains exclusions such that claims relating to the dishonesty of the officer or director are excluded. 4. In Canadian Aero Service Ltd. v O’Malley (page 388) the court set out factors in determining whether the appropriation of an opportunity is a breach of a fiduciary duty. Do you see any problems with applying these factors? How can directors ensure that they have not breached a fiduciary duty if they take a corporate opportunity for themselves? Answer: Lisa Peters points out that there are some problems with the test for determining whether an appropriation of an opportunity is a breach of a fiduciary duty. The problems with this fact driven test is that there is no guidance given as to the weight to be given to each factor and there is no guidance on how many of these factors, taken together, results in a breach of a fiduciary duty. Because the test is difficult to apply, directors may ensure that they have not breached the fiduciary duty by getting corporate approval. The approval would necessitate full disclosure of the facts surrounding the opportunity, abstention from voting on the issue, and approval from the board of directors for the appropriation of the opportunity. Some authors have also suggested that approval of the shareholders is preferable. Source: Lisa Peters, “Corporate opportunity: A primer—part 1,” Lawson Lundell (5 May 2001) online: Lawson Lundell . 5. Several countries including the United States and the United Kingdom require public companies to hold annual shareholder votes on executive compensation (so called “say on pay” votes). In Canada, although such votes are proliferating, they are not mandatory. What is the purpose of such votes and should they be mandatory? Why or why not? Answer: Say on pay votes give shareholders an opportunity to express their opinion on executive compensation packages. The purpose is to increase accountability, transparency, and improve linkage between performance and pay. The Canadian Coalition for Good Governance is in favour of say on pay arguing that it is important in helping to ensure that a corporation’s approach to compensation reflects the link between the corporation’s strategic plan and compensation. In other words, the votes are an important part of the engagement process between the shareholders and the directors. Other proponents argue that it helps curb excessive compensation packages and improves communication between shareholders and the board of directors (because a negative outcome is embarrassing, there is an incentive to seek out shareholder approval). Those not in favour have raised the following, among other, issues: • the complexity of executive compensation does not lend itself to shareholder review; • the vote distracts from directors’ responsibility for compensation; • the difficulty in interpreting the results (is the vote on the entire compensation package, parts of the package, or is it a vote on the overall performance of the company?) Sources: See: Darren Henderson & David Fraser, “Why Canada should adopt mandatory say-on-pay,” Ivey Business Journal (January/February 2014) online: Ivey ; David Lefebre, “Updating shareholder democracy,” The Lawyers Weekly (18 February 2011) 15; and John Tuzyk & Julia Tomson, “Say-on-pay—What’s next?” Blakes (14 September 2011) online: Blakes . 6. In 2010, Syncrude Canada Ltd. received the largest fine in Alberta history for the violation of environmental legislation that resulted in the death of 1606 birds (see page 384). Prosecutors hailed the $3-million fine as precedent-setting and sending a clear message that the province will react to protect the environment. Critics of the fine, however, complained that the fine was a mere “drop in the barrel” for Syncrude and would not solve the problem of toxic tailings ponds and dead birds. They pointed out that the fine represents about a half a day’s profit for the oil sands company. Do you agree with the position of the prosecutors or the critics? Is fining corporations the best way to deal with environmental transgressions? Why or why not? [footnote deleted] Answer: Agreement with the prosecutors or critics is a matter of opinion. On the one hand, the fines are the largest environmental penalty in Alberta history and set an industry-wide precedent, the company indicated its regret and indicated that it would improve its environmental performance, the company suffered a public relations nightmare, and the $3 million goes to fund worthwhile environmental projects—a diploma program in Wildlife management at Keyano College in Fort McMurray, a study on bird migration patterns and the effectiveness of bird deterrent at the University of Alberta, and the purchase of land for a nature conservancy east of Edmonton. On the other hand, the fine is very small figure compared with Syncrude’s oil revenues of $7 billion in 2009, represents only about a half-day of profits, and does not eliminate toxic tailings ponds or ensure that more ducks will not die in the future. See: See Darcy Henton, “Syncrude found guilty,” The Edmonton Journal (26 June 2010) 1; Josh Wingrove, “$3-million fine a drop in the barrel for Syncrude,” The Globe and Mail (23 October 2010) A20. Fining is one way of dealing with a corporation’s environmental transgressions, but it is debatable whether it is the best way. As noted above, a fine is often only a “slap on the wrist” to a large corporation and may not act as a deterrent. Other possibilities are imposing alternative types of penalties, such as suspension of operations, revocation of licences, or cleanup orders, or fining the directors and officers, who are responsible for the corporation’s actions. The latter may only be meaningful if the corporation cannot indemnify the directors and officers and insurance does not cover the fine. Situations for Discussion, page 410 1. Jerome Neeson is a shareholder in Gourmet Chefs Inc., a company that owns and operates a test kitchen in a large metropolitan area. The company is involved in a number of businesses, including catering at high-end business functions, giving cooking lessons, and developing new recipes. Gourmet Chefs recently added to its staff a top chef who was trained at Le Cordon Bleu cooking school in France. Jerome anticipated that the company’s profits would increase in the future, and he was very happy with the direction that the company was moving. He was therefore very surprised to receive notice of a shareholders’ meeting, where the directors proposed to sell the company’s test kitchen. Jerome is opposed to the sale and does not want to be involved with Gourmet Chefs if the sale is completed. Advise Jerome. Answer: If Jerome is adamant about not wanting to be involved with Gourmet Chefs if the company’s test kitchen is sold, he should attend the shareholders’ meeting and vote against the proposal. If the shareholders approve the sale by a two-thirds majority vote, he is entitled to exercise the dissent and appraisal right. By voting against the proposal, he may elect to have his shares bought by the corporation. This right applies only when there is a fundamental change to the corporation. The sale of the test kitchen is a fundamental change as it involves the sale of substantially all of the corporation’s assets. 2. Roland Roy, an employee of Goodnuff Used Cars Ltd., turned back the odometers on several cars that were sold to unsuspecting customers. Goodnuff Used Cars Ltd. was charged under the following provision of the Criminal Code: s 380. (1) Every one who, by deceit, falsehood or other fraudulent means, whether or not it is a false pretence within the meaning of this Act, defrauds the public or any person, whether ascertained or not, of any property, money or valuable security or any service, (a) is guilty of an indictable offence and liable to a term of imprisonment not exceeding fourteen years, where the subject-matter of the offence is a testamentary instrument or the value of the subject-matter of the offence exceeds five thousand dollars… Is Goodnuff Used Cars Ltd. guilty of the crime of fraud? If Goodnuff Used Cars Ltd. is convicted of the crime, what factors will the court consider in imposing punishment? Answer: A corporation can be convicted of fraud—a crime requiring a guilty mind—if it can be shown that the corporation possessed the required mens rea. The existence of mens rea is determined by application of the identification theory discussed in the textbook (page 380). The corporation is criminally liable when the employee, who actually committed the offense, while carrying out her assigned function, is the directing mind or senior employee of the corporation. Although Roland is an employee, it is not known whether he is a directing mind or senior officer of the corporation, therefore, it cannot be determined on the facts presented whether Goodnuff is liable for the criminal offence. If it is determined, that Roland is a directing mind or a senior officer, Goodnuff may argue in defence that the crime was committed exclusively for the benefit of the individual not the corporation. In Canadian Dredge & Dock Company Ltd v The Queen, [1985] 1 SCR 662, Justice Estey stated: Where the criminal act is totally in fraud of the corporate employer and where the act is intended to and does result in a benefit exclusively to the employee-manager, the employee-directing mind, from the outset of the design and execution of the criminal plan, ceases to be a directing mind of the corporation and consequently his acts could not be attributed to the corporation under the identification doctrine...in my view the identification doctrine only operates where the Crown demonstrates that the action taken by the directing mind: a) was within the field of operation assigned to him; b) was not totally in fraud of the corporation; and c) was by design or result partly for the benefit of the company. If Goodnuff is convicted of the crime of fraud, the court will consider the following factors in sentencing: • moral blameworthiness—the economic advantage gained; degree of planning involved in committing the crime; • public interest—need to keep the corporation running and preserve employment; the cost of investigation and prosecution, any regulatory penalty, which is distinct from those under the Criminal Code; • prospects of rehabilitation—penalties imposed on managers and employees by the organization, previous convictions for regulatory offences, whether the victim was compensated, attempts to hide assets to avoid paying the fine, measures taken to reduce the likelihood of further criminal activity. 3. Lennie purchased a quantity of pressure-treated lumber from GoodWood Building Ltd. (GoodWood) last April. Lennie used the wood to build a deck around the front of his house. By the fall, however, he found that the wood was starting to rot, and it appeared that the stain used to treat the wood was peeling away. When Lennie tried to contact GoodWood, he discovered that their store had closed and the company was insolvent. Lennie managed to locate the salesman who sold him the wood, and he agreed that the wood appeared to be defective. He also told Lennie that the wood had been imported from Thailand so a lawsuit against the manufacturer would probably be long and expensive. He suggested that Lennie bring an action against the directors and shareholders of GoodWood. The shareholders and directors are Jim, Tim, and Tom. What are Lennie’s chances of success against the shareholders and directors? Does your answer change if GoodWood is an unincorporated business in which Tim, Jim, and Tom are the owners and managers? What are Lennie’s chances of success against them in this circumstance? Answer: Lennie’s chances of success against the shareholders are slim because of the independent legal persona of the corporation. Courts are usually reluctant to lift the “corporate veil” to find the shareholders liable for the actions of the corporation. Similarly, the chances of success against the directors are also slim. Directors do not generally attract liability for the corporation’s contracts. The principles of agency operate such that the corporation is liable for its own contracts and the directors, who have acted as agents for the corporation, are not liable. If GoodWood were an unincorporated business, the answer would change because then Tim, Jim, and Tom would not be able to hide behind the independent personality of the corporation and could be held personally liable. Lennie’s chance of success against them in this circumstance is much better. However, if the company has become insolvent, it is possible that Tim, Jim, and Tom have also become insolvent and, therefore, the claim is not worth pursuing. 4. The board of directors of Gismos & Widgets Inc., a manufacturer of computer components, has embraced the “green shift.” It takes great pride in its decisions that have benefited both the corporation and the environment. Examples of their environmentally friendly decisions include replacing all light bulbs with lower wattage bulbs, replacing old delivery vehicles with low-emission vehicles, installing solar panels on the rooftop, and instituting a recycling program for obsolete computers. Recently, a member of the board suggested that Gismos & Widgets purchase a large tract of land and have it preserved as a sanctuary for migrating birds. Other members of the board are in agreement, but a group of shareholder activists have gotten wind of the idea and have threatened to sue the directors. If the board approves the purchase, on what potential basis could the shareholders sue? Are they likely to be successful? Explain. Answer: The directors of a corporation have a fiduciary duty to the corporation to act honestly, in good faith, and with a view to the best interests of the corporation. When the “green shift” involves decisions that are financially profitable, it is easy for the directors to argue that they are acting in the best interests of the corporation. When directors make decisions that benefit the environment, with little or no tangible benefit to the corporation, it is more difficult for the directors to argue that they are acting in the best interests of the corporation. Traditionally, the best interest of the corporation has been taken to mean the maximization of profits. However, in Peoples v Wise, the Supreme Court of Canada stated that other factors besides economic ones may be relevant in determining what directors should consider when managing with a view to the best interests of the corporation. The court stated that the board of directors may consider the interests of shareholders, employees, suppliers, creditors, consumers, governments, and the environment. Based on these comments by the court, it might be difficult to challenge the directors’ decision to purchase a tract of land for a bird sanctuary. Conversely, the shareholders could possibly pursue an oppression claim. In BCE, the Supreme Court of Canada stated that reasonable expectations were the cornerstone of an oppression claim. A shareholder could argue that his reasonable expectation is the maximization of profits and that decisions that favour the environment over profitability defeat this expectation. Therefore, such decisions are harsh or oppressive. However, as the directors have embraced the “green shift,” it is difficult for shareholders to argue that it was their reasonable expectation that the directors would focus on profit only. See Maurizio Romano and Jatinder Chera, “Duties of directors in light of ‘going green’ initiatives,” Blakes (2 February 2009) at . 5. Ryan and Sean are shareholders and directors of Springfield Meadows Ltd. (Springfield), a company that has developed land for a large trailer park. Springfield has 20 other shareholders. Ryan and Sean are approached by Louise, who wants to create a company whose business it will be to lease trailers. Ryan and Sean are interested in participating as directors and shareholders in this new company, since this would be a good way to fill up some of the vacant sites at Springfield’s trailer park. The new company is a big success, and Sean and Ryan receive impressively high dividends on a regular basis. Eventually, the other shareholders in Springfield learn about Sean and Ryan’s new company and sue them for breach of their fiduciary duty. The shareholders contend that Sean and Ryan should have developed the opportunity to get into the trailer-leasing business for the benefit of Springfield and should not have taken that opportunity for themselves. Are Sean and Ryan in breach of their duty to act in the best interest of Springfield? Answer: This situation involves an application of the corporate opportunity doctrine. The fiduciary duties owed by directors limit their ability to take advantage of business opportunities for personal benefit. The existence of a corporate opportunity depends on the unique facts of each case—see Canadian Aero Service Ltd v O’Malley on page 388 of the textbook for a discussion of the factors. Although the courts have not established precise tests, it is clear that if a corporate opportunity or knowledge of an opportunity is obtained in the course of carrying out the director’s duties, the director cannot take it for himself. It is irrelevant in the determination of whether a director has breached his duty that the corporation could not avail itself of the opportunity. However, a director may be permitted to take an opportunity if the corporation consents to the director’s involvement after full and complete disclosure. In applying these general principles to Ryan and Sean, it would have to be determined whether they obtained the opportunity by reason of their position as directors. That being the case, the opportunity would belong to Springfield, and they would have to account for the profit made on the opportunity. It is also worth noting that Ryan and Sean owe their fiduciary obligation to Springfield, the corporation, not the shareholders. It is assumed that the shareholders are bringing a derivative action on behalf of the corporation to enforce the corporation’s rights. Assuming that it would apply, section 120 of the Canada Business Corporations Act would place the following obligations on Sean and Ryan in dealings between the trailer park company and the leasing company: 120. A director or officer of a corporation who (a) is a party to a material contract or proposed material contract with the corporation, or, (b) is a director or officer of or has a material interest in any person who is a party to a material contract or proposed material contract to with the corporation, shall disclose in writing to the corporation or request to have entered in the minutes of meetings of directors the nature and extent of his interest.... In addition to following a set of statutory rules described in s. 120, the director or officer must be prepared to demonstrate that the contract was “reasonable and fair to the corporation at the time it was approved. 6. Peter sold his barbershop business to Andy for $25 000. As part of the agreement of purchase and sale, Peter agreed to a restrictive covenant that prohibited him from providing barbering services in an area within a 10-mile radius of his former shop for a period of one year. Within a month of the sale, Peter had incorporated a company and commenced cutting hair in violation of the restrictive covenant. Is there anything that Andy can do about this situation? Should he do anything? [footnote deleted] Answer: This situation is based on the following case: Gilford Motors Co v Horne, [1933] Ch 935 (CA). Gilford Motor Co. Ltd. was a manufacturing company that purchased car parts from other manufacturers and assembled vehicles with them. Edward Horne was hired as managing director of Gilford Motors when the company was incorporated. During his employment at Gilford Motors, Horne signed an agreement in which he guaranteed that he would not “solicit, interfere with or endeavour to entice away from the company any person, firm or company who at any time during or at the date of the determination of the employment of the managing director were customers of or in the habit of dealing with the company.” Shortly after his employment with Gilford Motors came to an end, Horne opened a business for the sale of spare parts of Gilford vehicles and began selling to Gilford Motor’s customers. Gilford Motors sought an injunction against Horne and his company, J.M. Horne & Co., Ltd., to restrain him from soliciting or otherwise interfering with any of Gilford Motor’s customers and to enforce the covenant. The wording of the covenant was at issue in the case. The court had to determine if the covenant was wider than reasonably necessary for the protection of Gilford Motor’s trade. While the trial judge found that the covenant was too wide, the Court of Appeal held that it was not. It was, therefore, enforceable by injunction. The court began by reiterating the general proposition that a covenant in restraint of trade is prime facie unenforceable at law but also noted that there have been many exceptions to this broad proposition. The only test of the validity of an agreement in restraint of trade is whether or not such an agreement is reasonably necessary for the protection of the employer’s trade. In this case, the court found that the purpose of the covenant, protection of the company business, was reasonable. The court also held that the separate personality of a corporation would not be respected where the corporation is being used to commit a deliberate wrong. An injunction was issued against both Horne and his company. (end of case summary) This situation presents an opportunity to review the enforceability of restraint of trade covenants, which are discussed in Chapter 8 and touched on again in Chapter 20. From the perspective of corporation law, the question is whether a restrictive covenant that binds an individual (Peter) is enforceable against a corporation that the individual incorporates. In other words, is this a situation in which the separate personality of the corporation is ignored? In this case, the answer is yes, as the corporation is being used to deliberately commit a wrong. Andy would be able to get damages and an injunction to prevent Peter and his corporation from operating a barbershop. Whether Andy should take any legal action depends on the cost, time, and uncertainty involved in proceeding. These factors are discussed in Chapter 4 of the textbook. 7. In Allen v Aspen Group Resources Corporation, a class action lawsuit was certified against a Yukon oil-and-gas firm for alleged misrepresentations and omissions in a takeover circular. Included among the defendants are WeirFoulds LLP, a prominent Toronto-based law firm that acted on behalf of Aspen and advised it in connection with the takeover bid, and one of the firm’s partners, Wayne Egan. Egan acted as legal counsel for Aspen and had been a member of its board of directors. The plaintiffs argue that Egan’s liability for both for his work as a lawyer and in his capacity as a director extends to WeirFoulds. What are the problems with professionals, such as lawyers and accountants, serving as directors for corporate clients? What are the advantages for the professional? What are the advantages for the corporation? Answer: Problems may arise when the professional’s role overlaps; that is, she continues to provide accounting or legal advice while acting as a director. As a director, the professional must serve the best interests of the corporation; as an advisor, the professional must give the soundest advice possible in a timely fashion. These roles may at times conflict. For example, a professional may be inclined to vote in favour of a proposed transaction if it means work for the professional’s firm. Also, a professional may lose a degree of objectivity when she becomes a director. The professional may avoid expressing her real opinion for fear of losing a valued client. Further, what if the corporation chooses not to follow the professional’s advice? Should the professional cease giving advice? Should the professional resign from the board of directors? A professional, particularly a lawyer serving on a board, may also be held to a higher duty as the courts may assume the director is very knowledgeable about directors’ duties. For these reasons a growing number of law firms have discouraged their members from becoming directors. The advantages for the professional are financial rewards and increased experience, which can assist in performing professional duties. It also demonstrates that the client has a considerable confidence in the professional’s abilities, and it may generate additional business for the professional and her firm. The advantages for the corporation are the experience and expertise of the professional. Also, broader exposure to the activities of the corporation will give the professional a greater appreciation for business operations, resulting in higher quality advice. Sources: Elaine Wiltshire, “The perils of being a board member and a lawyer,” The Lawyers Weekly (26 March 2010) 23; Michael Rappaport, “Danger: Lawyer on board,” Canadian Corporate Counsel Association (Summer 2010) 26; and Luis Millan, “Directorships expose lawyers to liability risks,” The Lawyers Weekly (29 January 2010) 9. 8. Basil Dobbin was a director of Sports Villas Inc., a company that was incorporated to acquire a lodge and golf course about 220 kilometres west of St. John’s, Newfoundland, at Port Blandford. The golf course catered primarily to golf vacationers and delegates to conferences. A large percentage of the clientele of the golf course came from the Avalon Peninsula (a large peninsula that makes up the southeast portion of Newfoundland; both St. John’s and Port Blandford are on the peninsula) and a large majority of them from St. John’s. Approximately three years after the incorporation of Sports Villa, Dobbin incorporated a company, Clovelly Golf Course Inc., for the purpose of the development of a golf course in St. John’s. This golf course did not have a hotel and it catered to clientele interested in several hours of golf after work. The golf course at Clovelly was intent on fostering the new and beginner golfer as opposed to the more expert and experienced golfer. Is Dobbin’s position as director of both Sports Villas and Clovelly a breach of his fiduciary duty? Explain. There is a public or societal interest in ensuring that directors adhere to a strict code of conduct. What is the problem with holding directors to a strict code of conduct? [footnote deleted] Answer: The fiduciary corporate duty does not preclude multiple memberships on the boards of different companies. Thus the fact that Dobbin is on both boards is not a breach of the fiduciary duty. The question is whether the golf courses were in competition, therefore putting Dobbin in a conflict of interest. The golf courses were 220 kilometres apart, which in and of itself made it difficult for them to compete. In addition, the two courses had different facilities catering to different markets. The Sports Villas golf course catered to vacationers and delegates to conventions whereas the Clovelly golf course catered to the casual afternoon or evening recreational golfer. The court held there was no conflict. The court also held that Dobbin had not appropriated to his own benefit a corporate opportunity and information in which Sports Villas had a proprietary interest. There was no agreement between the parties that all future golf developments would be pursued through Sports Villas and Dobbin did not use confidential information gained as a director of Sports Villas. Any programs, procedures, systems, and plans used by Dobbin were general knowledge that any prudent business person bent on establishing a golf course would gather. Holding directors to a too strict code of conduct may result in insufficient latitude to those who have the aptitudes and inclinations to involve themselves in a wide variety of business activities. It is in the overall interests of society that these individuals are able to pursue their interests so as to improve the economy. There is a societal interest in not applying the standard beyond what is necessary to preclude directors from placing themselves in positions of potential conflict between their corporate fiduciary duties and their own personal interests. Solution Manual for Canadian Business and the Law Philip King, Dorothy Duplessis, Shannon O'byrne 9780176570323, 9780176509651, 9780176501624, 9780176795085