William E. Demers
Please see disclaimer below*
As a business owner who has decided to incorporate it is critical to understand the nature of a corporation and its constituents (i.e. its shareholders, directors, management, employees, etc.), and its attributes as a vehicle for profit, tax planning and limitation of liability.
The corporation itself is a creature of statute, which possesses its own distinct legal personality. That is to say, (1) the corporation exists and comes into being by virtue of relevant legislation (the federal Canada Business Corporations Act or provincial Business Corporations Act in Ontario are key examples) by which it is regulated and (2) the corporation is its own legal entity which will, in its own name, generate profits, assume and meet debts, employ and contract individuals, pay taxes, hold property, and so forth.
In addition to legislative frameworks which govern corporations, such as in respect of what amounts to a corporation’s “control,” limitations on types of business activities that can be undertaken (e.g. banking, specified cooperative, insurance and trust and loan activities), where the corporation can conduct business, and the general structures of corporations, considerable flexibility exists for businesses to craft their corporate articles, by-laws and shareholder agreements to best structure its operation.
For a federal corporation, as an example, the corporation’s articles will set out its name, province where the registered office shall be situated, classes and any maximum number of shares that it is authorized to issue, restrictions (if any) on the transfer of such shares, the number of directors who will govern the corporation and any self-imposed restrictions by the corporation on its conduct of business.
The company’s by-laws will define the conduct and formalities around issues such as the meetings of shareholders, elections of board members, indemnification of directors and officers, authorities for banking transactions and the execution of legal instruments.
Unanimous shareholders’ agreements are written contracts as between the shareholders and the corporation that may qualify or supersede matters often contained in corporate articles or set forth in statute, and in particular set out the rights of shareholders where their shares are concerned, such as the nature and rights of these shares, and the abilities of shareholders to deal with said shares.
It is not uncommon for there to be restrictions imposed on such sale or transfer of shares, to protect shareholders from dilution of their holdings, to prevent unwanted third parties from taking a stake in the company and to provide options where shareholders are deadlocked and an efficient exist is required. Some examples include what are commonly known as the right of first refusal, pre-emptive rights, tag along rights, drag along rights, and shotgun clauses.
Where, as an example, a shareholder is looking to part with some or all of their shares and has received an offer to this effect, a right of first refusal will allow other existing shareholders to purchase their pro rata portions of those shares on the same terms. Where the corporation is issuing new shares from treasury, pre-emptive rights will allow existing shareholders to purchase these shares on a pro rata basis to avoid dilution.
Tag-along rights and drag-along rights are useful to ensure that where a large portion of the corporation is being acquired (perhaps with the intention of acquiring it all) the sale of a specified percentage of shares will either entitle other shareholders to sell their own shares on the same terms or will compel them to do so (hence “tag along” and “drag along”).
Shotgun clauses can be useful mechanisms where disagreement and deadlock arise between shareholders but should be treated with caution. As an example, suppose there are two shareholders who each own 50% of a company. One shareholder may offer to buy the other’s shares at price the offeror sets. If the offer is accepted, the offeree will sell their shares on those terms and the offeror will own 100% of the company. However, if the offer is not accepted, the offeree must purchase the offeror’s shares for that price. This can obviously favour or disadvantage shareholders depending on their access to cash and timing of the offer.
While shareholders of a corporation will generally enjoy liability limited to the extent of their participation in that corporation, statutory provisions impose personal liability such as where an individual has entered or purported to enter into a written contract in the name of a corporation prior to its existence. Personal liability can also result from the piercing of the corporate veil, such as in cases of fraud.
Before entering into business in a corporation’s name, business owners should ensure that the corporation has indeed come into existence by filing the necessary forms with the appropriate registering body, e.g. Corporations Canada. A certificate of incorporation will be issued by that body when the corporation is registered.
[Business Corporations (Part II) will discuss shareholder rights to profits (e.g. from dividends and share sales), tax considerations, corporate governance (i.e. the board of directors) and corporate management by the company’s officers.]
* The above article provides information of a general nature and does not constitute legal advice or the formation of a lawyer-client relationship.
For further information or advice on these topics, or for assistance buying, selling, forming, structuring or restructuring a corporation, please contact:
William E. Demers