9 Business Structures
Learning Objectives
- Differentiate between the basic forms of operating a business: sole proprietorships, partnerships, and corporations.
- Analyze how each of the various business structures impact liability on the business owner.
- Consider the differences in the types of Canadian partnerships including, general partnerships, limited partnerships, and limited liability partnerships.
- Introduce the separate legal status of the corporation and its impact on the directors and shareholders of the corporation.
- Examine the concept of piercing the corporate veil and understand when and how it may be used to hold directors and shareholders personally liable for corporate acts.
For those wishing to start their own businesses, you should never overlook the critical question of how to structure that business. There are actually a myriad of ways in which one can organize their business, and each form has significant legal and financial implications for the business owner.
The structure of a business determines its legal framework, ownership arrangements, tax obligations, liability limitations, and governance mechanisms. Understanding the different business structures that are available and such implications is essential.
In this chapter, we will explore the basic forms of structuring a business in Canada; these forms include the sole proprietorship, partnership, and corporations. As will become clear, these structures are wildly different, and each would be adopted by the business owner in specific situations. The clear goal of the chapter is to develop a comprehensive understanding of how each business structure affects the liability of the business owner or its managers.
Sole Proprietorships
The oldest and most common business structure is referred to as a “sole proprietorship”. In a sole proprietorship the individual is both the owner and operator of the business; there is no separation between the two. To put that differently, the sole proprietorship is not a separate legal entity or person.
Sole proprietorships are most common when the business is just starting out or is relatively small in scope. For example, imagine a local ice cream shop which is operated by only one individual with no other employees. It may be simplest to operate the business as a sole proprietorship where the owner makes all the decisions, generates the income, and avoids any legal complexities.
The decision to operate as a sole proprietorship should not be undertaken lightly. There are clear advantages and disadvantages to this form which are canvassed below.
Advantages and Disadvantages of the Sole Proprietorship
There can be numerous benefits from having the business and the individual owner/operator be one and the same:
- Quick Set-up – sole proprietorships are created automatically when business operations commence; they do not require any complex legal applications.
- Control – as the sole operator, the owner has complete control over the business and its decisions.
- Management Flexibility – sole proprietorships are flexible and allow changes in the business’s direction or operations quickly.
- Taxation – Sole proprietorship income/liabilities is assessed as personal income/liabilities which may be beneficial to the business owner.
- Limited Resources – sole proprietorships may have difficulty raising capital as they do not have the ability to sell ownership stakes in the business.
- Finite Business Lifespan – sole proprietorships dissolve upon the death or incapacitation of the owner. There is no indefinite lifespan of the business.
- Limited Creative Input – sole proprietorships principally rely on themselves to run operations. This can lead to situations where there is not as much creative input or business evolution.
- Unlimited Liability – as the sole owner, the individual is personally liable for all debts and obligations of the business. This means that the owners’ personal assets (i.e. home or savings) may be at risk if the business is sued or is unable to pay its debts.
Hands-down the biggest risk in operating as a sole proprietorship is the notion of unlimited liability. It is easy to foresee a situation where the business is sued, liability established, and the personal assets of the owner are then pursued.
“Though a sole proprietorship may adopt a business name and may in some instances sue and be sued in the business name it is still ultimately the individual sole proprietor who carries all legal liability. A sole proprietorship is not a separate legal entity from the owner.”
Bearss v. Scobie, 2013 ONSC 5910 at para. 20
For example, imagine our scenario of the ice cream shop operating as a sole proprietorship. If the business is sued by a customer who slipped and fell in the store, the customer may seek to collect their damages not just against the business assets, but also, against the personal assets of the owner. One would hope that the business has comprehensive insurance coverage however, the unlimited liability exposure is an ever-present concern for sole proprietorships.
Myth-Busting
Myth: “If I run a business and get sued, only the business assets are exposed.”
Incorrect. Under a sole proprietorship, there is no legal separation between the business and owner. Therefore, the owner’s personal assets are exposed along with any business assets. Individuals should be aware that they are personally liable for any debts or losses that could be pursued against the business.
Partnerships
As noted, one of the disadvantages of the sole proprietorship is that the owner may not have the benefit of creative, managerial, or financial input from others. When a business has multiple individuals sharing the risk, responsibilities and rewards from the business, it can result in more efficient operations; it can also result in the formation of a legal partnership.
Partnerships are a business structure where two or more individuals, called partners, join together to carry out the business. As partners, they are more than simply employees, rather they have a vested interest in the success of the business because they share in the profits.
Summary of the Advantages of Partnerships
- Diverse Experience – Each partner brings unique skills, knowledge, and resources to the partnership, enabling the business to benefit from a diverse range of expertise and contributions.
- Division of Labour – Partnerships allow partners to divide the workload and responsibilities so that the business does not hinge on only one owner.
- Increased Capital – Partnerships often have a broader financial base compared to sole proprietorships. Partners can pool their financial resources making it easier to expand business capital.
- Shared Decision-making – Partners can discuss and debate various options, leveraging different perspectives and experiences to arrive at well-informed choices.
Summary of the Disadvantages of Partnerships
- Potential Conflicts – disputes may arise regarding the direction of the business, strategic decisions, allocation of profits and losses, or other important matters. Resolving such conflicts can be time-consuming and potentially strain the partner relationship.
- Lack of Continuity – a partnership dissolves when a partner decides to leave, retire, or dies (subject to provisions in a partnership agreement). This can disrupt business operations and require the remaining partners to re-organize or even terminate the partnership altogether.
- Difficult Transfers of Ownership – transferring ownership in a partnership can be complex and may require the consent of all partners. This can make it challenging to admit new partners or allow existing partners to exit the partnership.
- Unlimited Liability – if the partnership is sued or cannot meet its financial obligations, creditors can go after the personal assets of each partner to settle the debts. This can put partners’ personal wealth and assets at risk.
Based on that review, partnerships suffer from the same fundamental disadvantage as the sole proprietorship: unlimited liability.
Up to this point, we have canvassed some of the general reasons why businesses may or may not wish to operate as a partnership. However, the conversation around partnerships is actually much more nuanced. In Canadian law, there are three types of partnerships: general partnerships, limited partnerships, and limited liability partnerships. Given that some of the risks/rewards are affected by the partnership type, each merits a further discussion.
General Partnerships
The general partnership is the classic form of partnership. It involves a scenario where two or more individuals or entities come together to carry on a business for profit and share unlimited liability. It is a relatively simple and flexible form of business ownership that does not require any formal registration to become effective.
In a general partnership, each partner contributes capital, assets, skills, or labour to the business and shares in the profits and losses (this may be an equal split or otherwise determined by a partnership agreement). The partners also can participate in the management and decision-making processes of the partnership. Given their managerial/operational involvement, each partner is personally liable for the debts and obligations of the partnership, meaning their personal assets can be used to satisfy the partnership’s liabilities.
Many provinces and territories have specifically passed legislation which codifies the rules surrounding partnerships and the legal obligations of partners. In much of this legislation, we see a specific definition of a general partnership. For example, below are the definitions of “partnership” in both the British Columbia Partnership Act and the Ontario Partnerships Act:
British Columbia – Partnership Act, R.S.B.C. 1996, c. 348 at section 2.
“Partnership is the relation which subsists between persons carrying on business in common with a view of profit.”
Ontario – Partnerships Act, R.S.O. 1990, c. P.5 at section 2.
“Partnership is the relation that subsists between persons carrying on a business in common with a view to profit…”
Interestingly, the definitions in the Ontario and BC statutes are mirror images of one another and therefore, there is quite a bit of overlap on when partnerships are legally formed.
Using the statutory definitions, it is possible to develop a clear legal test for the formation of a general partnership. Across multiple cases, the court has confirmed that a partnership is when there is a: 1) carrying on of business, 2) in common, 3) with a view to profit.
Legal Test for General Partnerships
The legal test for creating a general partnership requires the following three elements:
1. carrying on business;
This refers to engaging in commercial activities, such as selling goods or providing services with the intention of making a profit. It suggests regular and ongoing business activities rather than engaging in occasional or one-time transactions. When carrying on a business, partners actively participate in its management and operation.
2. in common;
Partners should be aligned with one another in operating the business. Here, all of the partners are acting together towards their financial success or the “view to profit”. There should be a joint and concerted effort by the partners for the business’ success.
3. with a view to profit.
The primary objective of the partnership is to generate financial profits through the partnership’s business activities. While other goals, such as providing a service to the community or promoting a cause may exist, the overarching purpose is to achieve financial gains.
It is remarkable to think how simple the general partnership legal elements are and how quickly a business relationship between two individuals could morph into a legal partnership with unlimited liability. For instance, if you and a friend or co-worker were ever acting together with a view to profit, this likely would meet the statutory definition of a partnership. For a more specific fact pattern on this evolution, see the example below.
Example – Formation of a General Partnership
Imagine a scenario. Two friends, Aisha and Carlos, decide to start a gardening business together. They meet all the requirements for a general partnership:
Carrying on business: Aisha and Carlos actively engage in the gardening business, offering services such as landscaping, lawn maintenance, and plant care. They advertise their services, purchase necessary equipment, and actively seek out clients.
In common: Aisha and Carlos contribute their skills, expertise, and resources to the partnership. They share the responsibilities and decision-making, working together to grow and manage the business. Both partners are involved in day-to-day operations, including meeting with clients, completing projects, and managing finances.
With a view to profit: Aisha and Carlos enter into the partnership with the intention of making a profit. They expect to generate revenue by providing gardening services. Their primary goal is to grow the business and earn income from their joint efforts.
Foundational Law — Blue Line Hockey Acquisition Co., Inc. v. Orca Bay Hockey Limited Partnership, 2009 BCCA 34
In November 2003, three titans of Vancouver business, Francesco Aquilini, Tom Gaglardi, and Ryan Beedie, formed a group and began negotiating with John McCaw Jr. to purchase a 50% ownership stake in the Vancouver Canucks hockey team. By March 2004, Aquilini had decided to withdraw from the group, leaving Gaglardi and Beedie to continue negotiations with McCaw Jr. However, unknown to Gaglardi and Beedie, Aquilini also began negotiating separately with McCaw and quickly reached an agreement to purchase a 50% stake in the team and the hockey arena (then known as GM Place).
Aquilini also obtained an option to buy the remaining 50% at a later date. Gaglardi and Beedie sued Aquilini alleging that he breached his duty to them as partners by taking advantage of a business opportunity that belonged to the partnership.
The trial judge determined that there was no formal partnership between Aquilini, Gaglardi, and Beedie; this was because the three parties had only informally agreed to “work toward [a] formal arrangement.” As a result, there were no obligations of good faith or loyalty owed among them. Further, the trial judge found that the three businessmen had no authority to make binding agreements on behalf of the others — a sign of a partnership. All the proposals given to McCaw Jr. were considered expressions of interest, and a consensus among the three was still required for any proposal to become a binding agreement. They did not discuss the maximum price they were willing to pay or the specific terms they would accept. Any member could leave the group at any time. All of these factors, indicated there was no partnership.
Gaglardi and Beedie appealed the trial ruling. In its decision, the BC Court of Appeal found that there was no intention, either through written evidence or the conduct of the parties, to conduct business together with the goal of making a profit. Their understanding of each other’s wishes was vague, and they had only committed to paying their lawyer’s fees. Additionally, there was no actual offer to purchase the hockey team; only expressions of interest were made. Aquilini was not bound to remain a member after leaving the group, and each individual was free to pursue their own interests. Once again, the court found no partnership had ever been formed.
A point that demands emphasis is that, under a general partnership, partners can be held personally liable for the partnership’s debts and obligations. This means that the partners’ personal assets can be sought to satisfy any creditors of the partnership. There are a few specific situations where this type of personal liability may arise.
Firstly, if the partnership is sued for any reason, each partner can be held personally liable for the damages arising from the lawsuit. Imagine if a construction business operated as a general partnership and a client sued for faulty workmanship. If the client’s case for damages was successful, all partners would be personally liable for the damages awarded to the client.
Secondly, if the partnership becomes insolvent and is unable to pay its debts, the partners can be held personally liable for the partnership’s obligations. For example, if a general partnership is in the real estate sector and faces significant financial losses and is unable to repay loans, the partners may be required to use their personal assets to satisfy those debts.
Lastly, partners in a general partnership have the authority to bind the partnership to contracts. If a partner enters into a contract that is disadvantageous or results in a liability, all partners can be held personally responsible. For example, suppose a partner in a general partnership signs a lease agreement for a commercial property at an exorbitant rent without the consent or knowledge of other partners. In such a scenario, all partners would be liable for the excessive rent and any associated penalties or damages.
To address the liability concerns that are present in general partnerships, there are two other forms of partnerships which may be considered; these are known as the limited partnership and the limited liability partnership.
Limited Partnerships
A limited partnership (“LP”) is a business partnership that consists of at least one general partner and one or more limited partners. This structure provides a way for partners to pool their resources and conduct business while expressly limiting some of the liability concerns experienced by general partners.
Under a limited partnership, there will always be two types of partners: the general partner(s) and the limited partner(s):
General Partner(s)
A limited partnership must have at least one general partner who assumes full liability for the partnership’s debts and obligations. General partners have management authority and decision-making power, and they are responsible for the day-to-day operations of the business. They also have personal liability for the partnership’s debts and can be held personally liable for any legal actions taken against the partnership.
Limited Partner(s)
Limited partners are investors in the partnership and typically contribute capital or assets to the business. They have limited liability, which means their personal liability is restricted to the amount they have invested in the partnership. For example, if an individual invested $50,000 into a new restaurant as a limited partner, they would have the right to share in partnership profits however, their liability would be capped at the $50,000 investment.
Limited partners do not participate in the management or day-to-day operations of the business and usually have a more passive role. This is why limited partners are sometimes referred to as “silent” partners; they are silent on any managerial or operational aspects of the business. If limited partners become actively involved in management decisions, they may lose their limited liability status and become personally liable for the partnership’s debts.
In broad strokes, the LP allows individuals to invest in a business while limiting their liability to the extent of their investment. However, limited partners are legally more complex then general partnerships and can have specific filing requirements in order to permit them. For example, in British Columbia, to create a limited partnership, a certificate of limited partnership must be filed with the appropriate British Columbia registrar.
Assuming the certificate of limited partnership is filed, limited partnership’s name will then be noted by the words “Limited Partnership” or the abbreviation “LP” to clearly indicate its limited liability status.
Limited Liability Partnerships
A limited liability partnership (“LLP”) is a partnership structure that combines elements of a partnership and a corporation. It is designed to offer the partners limited liability protection while maintaining the profit-sharing benefits of the partnership.
In an LLP, the partners have limited personal liability for the debts and obligations of the partnership. This means that their personal assets are generally protected in event the LLP faces lawsuits or other liabilities. Despite this limited liability benefit, partners can still be held personally liable for their own professional negligence or misconduct.
Another benefit to LLPs (as opposed to LPs) is that, under an LLP, the limited partners are permitted to manage the partnership. We previously noted that an LP required that limited partners avoid any managerial or operational input; if the limited partner drifted in management, they lose the limited liability protection. However, the LLP address this concern — the partners can manage the partnership while also maintaining their limited protection.
LLPs are commonly used (and sometimes only allowed to be used) by professionals such as lawyers, accountants, architects, and consultants. Whether a business is permitted to register as an LLP is determined by the applicable provincial or territorial statute where the partnership operates.
As with LPs, if the specific provincial/territorial filing requirements are met, the limited liability partnership’s name will be noted by the words “Limited Liability Partnership” or the abbreviation “LLP”. The following are a few examples of partnerships which have successfully registered as an LLP:
Corporations
In terms of legal implications, the corporation stands as completely unique from the sole proprietorship and the partnership. A corporation is a separate legal entity distinct from its owners (the shareholders) or managers (the directors or officers); the corporation is a “person”. As a “person”, corporations have legal rights similar to those of individuals, including the ability to enter into contracts, sue or be sued, and own property.
One of the primary advantages of incorporating a business is that the shareholders’ liability is generally limited to their investment in the corporation. In most cases, shareholders are not personally responsible for the debts or obligations of the corporation beyond their initial investment unless they have provided personal guarantees for the corporation’s business. Accordingly, there is a clear incentive to utilize the corporate form as it offers significant protection from liability.
While we will come back to the notion of the corporation’s separate legal existence, the following is a summary of the many reasons why business owners should contemplate incorporation:
- Ongoing Existence – a corporation has a potentially infinite lifespan. It continues to exist even if its shareholders or directors change due to death, retirement, or transfer of shares.
- Raising Capital – corporations have various avenues to raise capital to finance their operations and expansion. They can issue different classes of shares, such as common shares and preferred shares that can be sold to investors. Corporations can also access debt financing by issuing bonds or obtaining loans from financial institutions.
- Ownership Transfers – owning shares in a corporation offers a high level of flexibility and transferability. Shareholders can buy or sell their shares freely, allowing for easy entry or exit of investors.
- Tax Benefits – corporations often enjoy certain tax advantages. They may be eligible for deductions and tax credits not available to other business entities or individuals. Additionally, corporations can often benefit from favourable tax rates on capital gains, dividends, and corporate income.
- Person-hood – unlike the sole proprietorship and partnership, the corporation is a distinct legal person. This person-hood allows the company to act on its own behalf and provides a shield of protection to its shareholders and directors.
- Limited Liability – building off of the person-hood, shareholders and directors enjoy limited liability. Neither can be held liable for the debts or liabilities of the corporation. Shareholders’ liability is specifically limited to the amount of their investment in the company.
Based on the chart above, there are clear and compelling reasons for why a business would want to incorporate rather than operate under another business structure.
One of the reasons why there may be hesitation on the part of businesses to incorporate is a perceived sense of complexity or expense that goes along with incorporation. Interestingly though, incorporating a business is not as complex as it may appear. It is possible that an individual could navigate the incorporation process on their own by submitting the required documentation and paying the federal or provincial filing fees. However, in most cases, it is advisable to hire a lawyer to incorporate, as doing so, will (hopefully) ensure that all legal aspects are properly handled.
The cost of hiring a lawyer for a simple incorporation is often in the range of $1,500 to $2,500, but this can vary depending on the complexity of the business and the location. This fee typically covers the lawyer’s time and expertise in drafting documents, providing legal advice, and ensuring statutory compliance. While this cost may seem significant for an upstart business with tight capital, it is a worthwhile investment to ensure limited liability for the shareholders/directors in the event something goes wrong with the business.
Federal or Provincial Companies
In Canada, incorporations can occur either at the provincial or federal level. This option exists because the Constitution Act permitted incorporation rights to both the Federal and Provincial levels of governments.
Specifically, section 92(11) assigned the provinces the authority over “incorporation of companies with provincial objects” meaning that provinces would regulate the creation and administration of provincially-focused companies.
However, the Federal level of government also has the power to incorporate federally-regulated companies. These federally-regulated companies can operate anywhere in Canada while provincially-regulated companies will be limited to the province they are incorporated in (unless the company seeks extra-provincial authority to operate in another province).
The decision to choose between federal and provincial incorporation is in the hands of the business owner and depends on several factors, including the nature of the business, its scope, and where it expects to be doing business. For example, incorporating provincially is suitable for businesses that primarily operate within a specific province or territory and have no intention of expanding nationally.
The statutes regulating companies is also different depending on if the company will be registered federally or provincially. Federal companies are incorporated under the Canada Business Corporations Act, R.S.C., 1985, c. C-44 (“CBCA”).
Once registered under the CBCA, the company can operate across Canada and conduct business in multiple provinces and territories.
- Alberta – Business Corporations Act, R.S.A. 2000, c. B-9
- British Columbia – Business Corporations Act, S.B.C. 2002, CHAPTER 57
- Manitoba – The Corporations Act, C.C.S.M. c. C225
- New Brunswick – Business Corporations Act, S.N.B. 1981, c. B-9.1
- Newfoundland and Labrador – Corporations Act, R.S.N.L. 1990, c. C-36
- Nova Scotia – Companies Act, R.S.N.S 1989, c. 81
- Ontario – Business Corporations Act, R.S.O. 1990, c. B.16
- Prince Edward Island – Business Corporations Act, R.S.P.E.I. 1988, c B-6.01
- Quebec – Companies Act, C.Q.L.R. c. C-38
- Saskatchewan – The Business Corporations Act, R.S.S. 1978, c. B-10
- Northwest Territories – Business Corporations Act, S.N.W.T. 1996, c. 19
- Nunavut – Business Corporations Act, S.N.W.T. (Nu) 1996, c. 19
- Yukon – Business Corporations Act, R.S.Y. 2002, c. 20
Brief Overview of the Incorporation Steps
in seeking to incorporate a company, one can expect to encounter a few keys steps. Ultimately, it begins with a name search and the completion of an incorporation application.
Reserve a Name
The first step in incorporating a federal or provincial business is naming the corporation and ensuring that the name is available to be registered. Businesses must request their name and have its reservation approved by the relevant Registrar of Companies.
The naming process typically starts with a search of existing company names to determine whether the name is available or if there could be conflict with an existing registered business. Certain provinces like British Columbia have actually established simple search engines to conduct corporate name searches:
The British Columbia Corporate Name Search Area:
https://www.names.bcregistry.gov.bc.ca/
Importantly, only names following a certain format will be accepted by the applicable Registrar of Companies.
Registerability of a Corporate Name
Corporate names require the following three elements to be registrable:
1. Distinctive Element
Business names require a unique and memorable component that set it apart from other businesses operating in the same industry. This element can be a word, phrase, or combination of letters that captures the essence of the company’s brand identity. The distinctive element can also be a “numbered” company which is a business identified solely by a number, typically assigned by the corporate registrar.
2. Descriptive Element
The descriptive element provides information about the type of business or industry the company operates in. This element communicates the company’s core activities, specialization, or field of expertise. It helps potential customers understand what the company does and what they can expect from its products or services. For example, if a company is involved in technology consulting, its descriptive element could be “Technology Solutions,” “Consulting Services,” or “IT Advisors”. Each operates as a shortcut to what the business does.
3. Corporate Designation
The corporate designation is a suffix added to the end of the corporate name to denote the type of business entity. Common corporate designations include “Limited,” “Ltd.,” “Corporation,” “Corp.,” “Incorporated,” or “Inc.”.
Think back to our example of the ice cream shop which operates as a sole proprietorship; let’s imagine it now wishes to incorporate. We will have to select a name that contains the distinctive element, descriptive element, and corporate designation. A few examples could be “Chilly Bliss Frozen Treats Inc.”, “Creamy Swirls Ice Cream Corp.”, or “Frosty Delights Ice Cream Ltd.”.
The Articles
As part of the incorporation process in British Columbia, the incorporators (those incorporating the company) must provide “articles of incorporation”. The articles of incorporation are the primary document that outlines the internal rules and regulations of the company.
Section 12 of the British Columbia Business Corporations Act refers to the necessity of the articles:
More fully, the articles will typically contain a number of provisions, including:
- rights and duties of the shareholders and directors;
- procedures to be followed in electing directors or holding meetings;
- special rights or restrictions attached to the shares;
- restrictions, if any, on the business that may be carried on by the corporation; and
- powers that may be exercised by the corporation.
Incorporation Application/Notice of Articles
Once the Incorporation Application has been approved and the corporation is officially incorporated, the Certificate of Incorporation is issued by the BC Corporate Registry. The Certificate of Incorporation is also commonly referred to as the “Notice of Articles” which serves, among other things, as proof of the corporation’s legal existence.
The Notice of Articles is a publicly accessible document and can be requested by anyone interested in obtaining information about the corporation. It also contains information about the registered and records office, directors, and share capital of the corporation which is discussed below.
I. Registered and Records Office
A corporation must establish a registered and records (“R and R Office”) office to ensure proper management of its essential documents. One of the primary responsibilities of the R and R Office is to carefully preserve and organize various documents, including:
- the Certificate of Incorporation which serves as legal proof of the corporation’s formation and existence;
- the Central Securities Register which contains details about the company’s shares and their ownership;
- the Register of Directors which provides an updated list of individuals serving as directors within the corporation;
- copies of shareholder resolutions which are decisions passed by the shareholders; and
- the minutes of every shareholder and directors’ meeting, capturing the decisions, discussions, and resolutions made during these gatherings.
II. Register of Directors
The Notice of Articles will list the full names of the directors of the corporation as well as indicate their consent to serve as a director. While most people can serve as corporate directors, the BC Business Corporations Act does identify a few individuals who are not qualified to act as a director such as: anyone under the age of 18 years, found by a court to be incapable of managing their own affairs, is a person who is undischarged from bankruptcy, or has been convicted in or out of BC of an offence involving fraud.
III. Share Capital
The Notice of Articles will also outline the share capital of the corporation. This includes details such as the number and classes of shares authorized by the corporation, any restrictions on share transfers, and any other relevant provisions related to share capital.
Unless explicitly restricted, shares generally have three fundamental rights that shareholders can exercise:
- Voting Rights – shareholders have the right to vote in corporate elections. Each share typically carries one vote, and shareholders can participate in important decisions that require shareholder approval, such as the appointment of directors, mergers, or major changes in the company’s bylaws.
- Dividend Rights – shareholders are entitled to receive dividends, which are a portion of the company’s profits distributed to shareholders. Common shareholders receive dividends after any obligations to preferred shareholders have been fulfilled.
- Liquidation Rights – Shareholders may have the right to receive a portion of the remaining assets after dissolution. After all debts and obligations have been settled, common shareholders are entitled to the residual value or proceeds from the liquidation in proportion to their ownership.
That being said, the rights of shareholders can be limited by the corporation’s ability to create share classes.
As part of its bundle of rights, a corporation can create different types of shares with distinct characteristics. These share classes can have different rights, privileges, or restrictions associated with them. For example, a corporation may issue common shares, which typically carry voting rights and entitle the shareholder to a proportional share of dividends and assets upon liquidation. However, a corporation might also issue preferred shares that may have priority in dividend payments or liquidation proceeds but do not carry voting rights.
There is tremendous flexibility in crafting different share classes. Ultimately, corporations can use the varying share classes to financially benefit some investors, offer others the ability to vote on corporate decisions, or both.
The information about the share classes will be listed in the corporation’s Central Securities Register.
Summary
Assuming compliance with the many requirements we saw throughout, the corporation will be registered. At this point, the corporation would be considered a separate legal entity.
External Resource
The British Columbia government has a series of primers on the incorporation of provincial companies. You can review the following site to get further information on the steps to incorporate:
The Corporate Veil
It has been made clear that one of the stark benefits of incorporation is the limited liability for the shareholders and directors. The law actually refers to this limited liability using multiple different forms of terminology: corporate personality, corporate shield, and also as, the corporate veil.
The corporate veil is a fascinating concept. It refers to the legal separation between a company or corporation and its shareholders, directors, and officers. In effect, the owners and managers of a company are behind a veil which shields them from personal liability for the debts, obligations, and liabilities of the corporation. In other words, the directors’ and shareholders’ personal assets are generally protected from being used to satisfy the company’s liabilities.
The concept of the corporate veil is fundamental to corporate law. It’s designed to ensure that corporations have access to investors and qualified individuals to serve as directors. The idea is that, if the owners and managers, are immune from the corporation’s liabilities then there is greater willingness to participate in a company.
“It is a fundamental principle of corporate law that shareholders are not, as a general rule, responsible for the actions of the corporation.”
Chisum Log Homes & Lumber Ltd. v. Investment Saskatchewan Inc.,
2007 SKQB 368 at para. 46
The principle of the corporate veil was first established by the English courts in the seminal case of Salomon v. Salomon & Co. Ltd., [1987] A.C. 22 (H.L.) referred to below.
Foundational Law – Salomon v. Salomon & Co. Ltd., [1897] A.C. 22 (H.L.)
The case involved a dispute between Mr. Salomon, a shoe manufacturer, and his company, Salomon & Co. Ltd.
Mr. Salomon had been operating as a sole proprietor and decided to incorporate his business (after incorporation, the business became known as Salomon & Co. Ltd.). He transferred his business assets and liabilities to the newly formed company in exchange for shares. Mr. Salomon owned 20,001 out of the 20,007 shares issued by the company, while his wife and five children each held one share.
Unfortunately, the company encountered financial difficulties and it went into liquidation. The company had many creditors who were owed money but there was very few assets remaining in the company to satisfy all the debts. The liquidator argued that the company was a mere façade or agent of Mr. Salomon and that he should be personally liable for the company’s debts. The case eventually reached the House of Lords, which had to determine the legal status of the company and the liability of its shareholders namely, Mr. Salomon and his family.
The House of Lords unanimously ruled in favour of Mr. Salomon and upheld the separate legal personality of the company. The court held that once a company is duly incorporated, it becomes a distinct legal entity separate from its shareholders. The directors and shareholders are afforded protection by the corporate veil.
The court explained that Salomon & Co. Ltd. was not a mere alias or agent for Mr. Salomon but was rather a separate legal person with its own rights and liabilities. Therefore, the debts and obligations of the company were its own, and the shareholders were not personally liable for them beyond their unpaid share capital.
The case firmly established the principle of corporate personality and limited liability, which has been a cornerstone of modern company law in common law jurisdictions around the world.
“The company is at law a different person altogether from the subscribers to the memorandum and, though it may be that after incorporation the business is precisely the same as it was before and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or a trustee for them. Nor are the subscribers as members liable in any shape or form, except to the extent and in the manner provided in the Act.”
Salomon v. A. Salomon & Co., [1897] A.C. 22 (H.L.), at para. 50
Continuing our ice cream parlour example, suppose the company “Frosty Treats Ice Cream Inc.” is incorporated. Frosty Treats then borrows a significant sum of money from a financial institution to expand its operations, purchase new equipment, and develop new flavours of ice cream. However, due to unforeseen circumstances such as increased competition, the company experiences financial difficulties and is unable to repay the loan.
The lender’s recourse, in this instance, would typically be limited to the assets of the company itself. The lender can seek repayment through various means, such as liquidating the company’s assets or negotiating a repayment plan, but the personal assets of the shareholders and directors are shielded. The limited liability feature of the corporate veil ensures that the shareholders’ personal assets, such as their homes or bank accounts, cannot be seized to satisfy the loan given to Frosty Treats.
There is still some liability on the part of the shareholders though it is limited to the amount they have invested in Frosty Treats Inc. For example, if a shareholder invested $10,000 in the company, their liability is generally restricted to that amount. They are not personally responsible for repaying the loan or any other debts beyond their initial investment.
Piercing the Corporate Veil
As noted, under normal circumstances, the shareholders and directors are not personally responsible for the corporation’s obligations. However, the protection afforded by the corporate veil is not absolute.
Piercing the corporate veil allows a court to disregard the separate legal identity of a corporation and hold its shareholders or directors personally liable for the corporation’s debts or liabilities. It is typically used, when a court determines that the corporation has been involved in some form of fraud, injustice, or unfair activity. The court can then disregard the corporate person-hood and hold the individuals behind the company personally responsible.
Myth-Busting
Myth: “If I’m incorporated, they can never go after my personal assets.”
The myth that incorporating a business provides absolute protection for personal assets is not entirely true. While incorporating a business does create a legal separation between personal and business assets, it does not provide complete immunity from personal liability. For example, personal liability is possible where there is a personal guarantee of the debt, the wrongful act was personally committed by the business owner individual, or if there is a compelling reason to disregard the separate legal status of the business — what is called piercing the corporate veil.
It’s easy to see how, any time a corporation is involved, the plaintiff will want to pierce the corporate veil. However, the concept is used sparingly by courts and seen to be an exceptional remedy. Courts want to respect the corporate form and therefore, disregarding its existence is a rare circumstance.
“It is trite law that an incorporated entity is a legal person distinct from its directors and shareholders … The presumption is a robust one … However, the protection from company liabilities that is afforded by the corporate veil to directors and shareholders is not absolute.”
SPC Holdings v. Gabriel, 2013 BCPC 31 at para. 12
That said, there are instances where justice demands looking beyond the corporation and finding liability on the shareholders or directors. There are a number of instances where the veil can be pierced and, many of these scenarios, rely on some form of fraud on the part of the shareholders or directors.
Legal Test for Piercing the Corporate Veil
Generally, for the corporate veil to be pierced, the court must be satisfied that one of the following applies:
- the company was formed for the express purpose of committing a wrongful act;
- once the company was formed, those in control of it expressly directed a wrongful act;
- the company is a sham – that is, a mere agent, or façade or alter ego, of a controlling corporator; or
- clear and express statutory provisions permit the lifting of the corporate veil.
SPC Holdings v. Gabriel, 2013 BCPC 31 at paras. 13.
Each of the exceptions to the piercing the corporate veil are unified by the notion that it would be fundamentally unfair for the directors of shareholders to escape liability simply because the corporation is a distinct entity. While they share the same goal of fairness, each of the exceptions are slightly different in their context.
I. Company Formed for the Express Purpose of Committing a Wrongful Act
If it can be proven that a company was established with the specific intention of carrying out illegal, fraudulent, or wrongful activities, a court may disregard the corporate structure and hold the individuals behind the company personally liable. In this case, the court views the company as a mere instrument created to facilitate a wrongdoing — therefore, the veil can be pierced.
II. Company Formed and those in Control Expressly Direct a Wrongful Act
Even if a company was not initially formed with wrongful intentions, if the individuals in control of the company deliberately direct or instruct it to engage in illegal or wrongful activities, the court may disregard the corporate veil. This ensures that those in control of company cannot shield themselves from personal liability by acting wrongfully through the corporate form.
III. Company is a Sham, Mere Agent, or Alter Ego
In some instances, a company may be considered a mere sham or alter ego of a controlling shareholder or owner. This occurs when the company is not used as a separate entity, but rather as a facade or extension of the controlling individual. If the court determines that the corporate structure is being abused or disregarded to service the needs of the personal individuals behind the company, it may pierce the corporate veil and hold the individual liable for the company’s actions.
Again, in all these scenarios, piercing the corporate veil would be seen as justified given the attempt to misuse the corporate person-hood.
Example – Piercing Frosty Treats Ice Cream Inc.’s Corporate Veil
Let’s circle back to the example of the incorporated company, Frosty Treats Ice Cream Inc. What are some hypothetical scenarios in which the corporate veil could be pierced and liability attach to the directors or shareholders of the company:
Express purpose of committing a wrongful act: Imagine if the shareholders of Frosty Treats Ice Cream Inc. establish the company with the explicit intention of defrauding customers. They plan to sell substandard, unsafe ice cream products while misrepresenting their quality and ingredients so that they can make quick profits. The corporate veil could be pierced because of the wrongful purpose in setting up the company.
Those in control expressly directed a wrongful act: Imagine the company is four years old, and the directors of the company instruct their accountants to engage in tax fraud resulting in substantial losses to investors when the scam is uncovered. The shareholders could be held personally responsible for the damages caused even though it was through the form of the corporation.
Sham or Alter Ego: Here, the shareholders commingle their personal assets with those of the company, use company funds for personal expenses, or fail to observe basic corporate formalities like maintaining separate accounting records. The court may determine that the company is merely a façade or alter ego of the controlling shareholders and not a legitimate separate entity. In such a case, the shareholders could be held personally liable for the company’s obligations, debts, or damages, thereby piercing the corporate veil.
Foundational Law – SPC Holdings v. Gabriel, 2013 BCPC 31
This case involved a homeowner named Rob Gabriel who hired SPC Holdings and Construction Ltd. (“SPC”) to perform roofing work on his property. However, the work done by SPC was found to be deficient, and Mr. Gabriel refused to pay the invoices. As a result, SPC sued him for payment, and in response, Mr. Gabriel counterclaimed against the company. He was successful in his counterclaim and was awarded $25,000 (the statutory maximum at the time) by the court, along with expenses. However, SPC was unable to pay the judgment as it was no longer in operation and was effectively “judgment proof” because of its lack of assets.
Subsequently, Mr. Gabriel sought to sue the directors of SPC Holdings in their personal capacity to enforce the judgment. The case centered on the issue of whether Mr. Gabriel could pierce the corporate veil to hold the directors personally liable for the judgment.
The court uncovered several manipulations by the directors of SPC Holdings that took place shortly after Mr. Gabriel counterclaimed for the deficient roofing work. The directors purportedly brought SPC Holdings’ operations to an end and formed a new company called “SPC Roofing and Waterproofing”. This new company essentially succeeded SPC Holdings and continued its roofing business under the same trade name, logo, and address. Assets of SPC Holdings were transferred to the new company, including vehicles and equipment. The end result was a hollowing out of SPF Holdings while transferring the assets to SPC Roofing.
The directors’ actions were found to be wrongful, illegitimate, and carried out in bad faith. The new company benefited from the goodwill and reputation of SPC Holdings while leaving the old company incapable of meeting its obligations to Mr. Gabriel. The court concluded that the directors of SPC Holdings had disregarded the corporate form of SPC Holdings when faced with a potential liability. Consequently, the directors had disqualified themselves from the protection typically provided by the corporate veil.
The court found it appropriate to pierce SPC Holdings’ corporate veil and Gabriel was permitted to seek his damages against the directors personally.
