The essential Corporate Law in Canada

These are the highlights if you want to know more about the essential Corporate Law in Canada. This entry was drafted by HazloLaw Business Lawyers. Link to E-Iure Network.

This collaboration is a brief step-by-step guidance. In no case it can be considered as legal advice. If you want -or need – legal advice, ask for a lawyer or a law firm. In that case HazloLaw Business Lawyers is an excellent option in Canada.

A variety of legal arrangements may be used to carry on commercial activities in Canada. These include sole proprietorships, partnerships, limited partnerships, corporations, franchises and joint ventures. As well, there are a number of different legal methods of carrying on non-profit activities; groups having objects of a religious, philanthropic, charitable, scientific, artistic, social, professional or sporting character may operate as unincorporated associations or non-for-profit corporations. This chapter will discuss the legal characteristics of a corporation with share capital, which is the business entity used most frequently to carry on commercial activities in Canada.

The Corporation And Shareholder Liability

A corporation is a legal entity separate in law from its owners, the shareholders of the corporation. A corporation may own property, carry on business, incur liabilities, and possess rights such as the right to sue in its own name. A corporation has perpetual existence beyond the lifetimes of its shareholders, officers and directors; it exists until it is dissolved. The shareholders own the corporation through their ownership in shares but do not own the business or the property belonging to the corporation, and the rights and liabilities of the corporation are not the rights and liabilities of the shareholders. The shareholders are said to have “limited liability” because their liability in connection with the property or business owned by the corporation is limited to the value of the assets (money, property or services) they have transferred to the corporation in exchange for shares in the corporation. It is only in exceptional circumstances that the courts will look behind the separate legal personality of a corporation and impose personal liability on a shareholder, such as where a corporation has been incorporated for an illegal, fraudulent or improper purpose. Outside of these exceptional circumstances, a shareholder’s liability to creditors of the corporation is limited to the amount of his or her investment and his or her personal assets are shielded from being used to satisfy the liabilities of the business. That said, if a corporation requires financing, lenders will often seek personal guarantees from major shareholders before making loans to a corporation, particularly if it has few assets of its own. Such guarantees can expose a shareholder’s personal assets. Normally though, not all corporate debts will be guaranteed by the shareholders as, for example, debts to trade creditors.

Statutes  That Govern Corporations

Canada has a federal system of government, and it is therefore possible to incorporate at either of two levels:

1. a) federally, under the Canada Business Corporations Act (the “CBCA”); or
2. b) provincially or territorially, under the relevant legislation in each province or territory (Canada is divided into 12 provinces and 3 territories), such as the Business Corporations Act of Ontario (the “OBCA”).

Once having chosen the corporation as the appropriate form of business entity, one must consider in which jurisdiction to incorporate. For the purpose of this chapter, it will be assumed that the choice is only between the federal and Ontario jurisdictions.

The CBCA provides for a right to incorporation through the issuance of Articles of Incorporation. A federal corporation may, subject to the licensing requirements (if any) of each province, carry on business anywhere in Canada and use its name in any province as of right. Federally incorporated corporations must have a minimum of one director in the case of privately held corporations, and three directors in the case of corporations that offer their securities to the public and whose issued securities are held by more than one person. Directors must be natural persons. For public corporations, at least two of the directors must not be officers or employees of the corporation or any of its affiliates. Directors are responsible for the management of the business and affairs of the corporation. There is also a general requirement that at least 25% of a corporation’s directors be resident Canadians, or if the corporation has fewer than 4 directors, that at least one be a resident Canadian, with the concept of “residency” being defined in the statute. This is the case even if a corporation is foreign-controlled. However, in the case of a holding company earning less than 5% of its consolidated revenue in Canada, only one-third of the directors need be resident Canadians. In certain industries that are subject to ownership restrictions (such as airlines and telecommunications) or corporations in certain cultural sectors (such as video or film distribution), corporations must have a majority of resident Canadian directors.

Ontario corporations are also incorporated by Articles of Incorporation, which the applicants are entitled to as of right. An Ontario corporation must either register or obtain an extra-provincial licence in order to carry on business in any other province and, unlike a federal corporation, this registration or licence may or may not be granted if the name of the Ontario corporation is not acceptable in the province where the application for registration or licence is being made. An Ontario corporation that is not offering its securities to the public need have only one director, who need not be a shareholder. An Ontario corporation that is offering its securities to the public must have a minimum of three directors, at least one-third of whom shall not be officers, directors or employees of the corporation or its affiliates.

As under the CBCA, at least 25 percent of the directors of an Ontario corporation must be resident Canadians, or if the corporation has fewer than four directors, at least one must be a resident Canadian. Furthermore, in the context of an Ontario corporation, unless the Articles of Incorporation otherwise provide, a majority of directors’ meetings in each fiscal year must be held in Canada. Quorum for a meeting of directors is often set out in a corporation’s by-laws, and if it is not, quorum will by default be a majority of the directors (or the minimum number of directors) of the corporation, and in no case may quorum be less than two-fifths of the total (or minimum) number of directors. A resident Canadian is defined in the legislation as an individual who is resident in Canada and is either a Canadian citizen or, in certain circumstances, a permanent resident.

Branch Operation

It is possible to do business in Canada without incorporating by carrying on business through a “branch operation”. In order to do so a company must register as an “extra‑provincial corporation” in Ontario and any other province in which it carries on business. The provincial naming rules apply to branch operations, meaning that the corporation’s corporate name may not be registered in a province if it is the same as or similar to one that is already in use in that province, and in Quebec, a foreign corporation must register a French language name. Depending on the nature of the activities undertaken, provincial registration may be required even if the corporation does not have a “permanent establishment” in the province for income tax purposes. While there is provision for penalties for failure to register, we know of no instance where such provision has been invoked and a penalty levied. If unregistered, however, an extra‑provincial corporation is not capable of registering an interest in land or maintaining a proceeding in a court in Ontario in respect of any contract made in whole or in part in Ontario in connection with business carried on in Ontario. It should be noted that if a company carries on business in Canada through a branch, it is required to keep books and accounting records at the Canadian place of business and to open such records upon request for audit by Canadian taxation authorities.

Process Of Incorpotarion

Incorporation under both the CBCA and OBCA is accomplished by delivering Articles of Incorporation in the form prescribed in the regulations to the appropriate government department, together with the required supporting material and fees. The Articles must contain the following information about the corporation: name, registered office address; number of directors and the name(s) of the first director(s); restrictions on the nature of the business that can be carried on by the corporation (if any); the corporation’s capital structure; and restrictions on the transfer of shares (if any). On receipt of the Articles conforming to the applicable regulations, the applicable government authority issues a Certificate of Incorporation to the corporation and the corporation comes into existence on the date shown on the Certificate. Once the Articles have been processed, both the CBCA and OBCA require that certain corporate records must be kept by the corporation, including a copy of the Articles and by-laws and all amendments thereto, registers indicating the owners of shares and recording all share transfers, a copy of any unanimous shareholder agreement known to the directors, minutes of meetings and resolutions of shareholders, copies of certain notices required by the statute, adequate accounting records and records containing the minutes of meetings and resolutions of the directors and any committee thereof. The Ontario statute also requires the corporation to maintain a director’s register, although it is commonplace for corporations in any Canadian jurisdiction to do so. Except for the Articles, the corporate records listed above are not public documents. Recent amendments to the OCBA also require Ontario corporations to maintain records of all real property held by those corporation. Unlike other records of the corporation, this real estate register must be kept at the registered office of the corporation and must include information about the acquisition of the real property by the corporation, and certain information about the real property itself such as the municipal address, property identification number, legal description and tax roll number.

It is typical to prepare a general by-law to fix the general rules governing the operation of the corporation, for example, meetings, notice, quorum for meetings, officers, proxies, execution of documents and other matters of a continuing nature.

The corporation may change the corporate characteristics set out in its Articles such as the corporation’s capital structure. The general rule is that the Articles can be amended only by means of a special resolution passed by the shareholders. A special resolution is defined as a resolution passed by two-thirds of shareholders who voted in respect thereof at a meeting of shareholders, or a resolution that is signed by all the shareholders who are entitled to vote on that resolution. After a special resolution amending the articles of a corporation has been passed, Articles of Amendment that contain the amendment must be sent to the appropriate government department, which will then issue a Certificate of Amendment to the corporation. There are a few exceptions to the general rule that a corporation’s articles must be amended by a special resolution. For example, a change in the directors or in the address of the registered office usually do not require an amendment to the Articles. Instead, only a notice of such changes is sent to the appropriate government department.

Unless the Articles, by-laws or a unanimous shareholder agreement provide otherwise, the directors of a corporation may make, amend or repeal any by-laws that regulate the business or affairs of a corporation. A by-law or an amendment or repeal of a by-law is effective as soon as a directors’ resolution is passed at a meeting or signed by all the directors. Once the directors make, amend or repeal a by-law, they must submit the by-law to the shareholders of the corporation at the next meeting of shareholders. The shareholders will then confirm, reject or amend the by-law. If a by-law, or an amendment or repeal of a by-law is rejected by the shareholders, or if the directors do not submit the by-law, amendment or repeal to the shareholders, it ceases to be effective on the date of rejection or on the date of the meeting of shareholders at which it should have been submitted. A by-law or an amendment to or repeal of a by-law may also be proposed by any shareholder entitled to vote at a meeting of shareholders. If the by-law, amendment or repeal is passed at a meeting of shareholders, it is effective from the date of such adoption, and no action by the directors is required. An ordinary resolution of shareholders is required to approve or confirm a by-law or an amendment or repeal of a by-law. If it is desirable to create rules which cannot be altered except by a greater majority of the shareholders, those provisions can be included in the Articles by way of an amendment, and any future change would then require a special resolution of shareholders.

Both CBCA and OBCA corporations must file annual information returns with the appropriate government department.

Share Capital

A corporation can be incorporated with only one class of shares, which may be designated “by any name that the incorporator wishes. Typically where there is one class of shares, these will be denominated as “common” shares. However, in Canada, the name given to a class of shares does not affect the rights of those shares, although there are certain informal naming conventions that are often followed. Where a corporation has only one class of shares, the rights of the holders of that class of shares must be equal in all respects and must include a specific set of rights which are: (1) the right to vote at any meeting of shareholders of the corporation; (2) the right to receive the remaining property of the corporation on dissolution; and (3) the right to receive dividends if and when declared by the directors of the corporation. Where the Articles provide for more than one class of shares, each of the three (3) rights set out above must be attached to at least one class of the authorized shares, but all of the rights are not required to be attached to any one class. Furthermore, not all classes of shares must have the right to vote at shareholders’ meeting. However, the OBCA and CBCA grant voting rights even to non-voting shares in certain circumstances. These circumstances generally refer to situations in which the rights of one class of shares would be prejudiced by the change to the Articles, such as when a new class of shares is declared that has dividend right superior to those of an existing class. In that case, the existing class would have to approve the proposed amendment by two-thirds majority (or unanimously in writing), whether or not that class otherwise has voting rights. If an amendment is approved by special resolution in circumstances where a class was entitled to vote separately, the shareholders of that class who voted against the amendment are entitled to have the corporation purchase their shares for “fair value”. Other fundamental changes to the corporation also require the approval from each class of shares. These include amalgamations, arrangements, the sale of all or substantially all of the corporation’s assets and the dissolution of the corporation. These changes must be approved by a special resolution of each class of shareholders, whether or not such class of shares otherwise has voting rights.

Most corporations (other than publicly traded corporations) have tight restrictions on the transfer of shares. Such restrictions are usually found in the Articles as well as in shareholder agreements. Typically, the consent of at least the majority of shareholders or directors is required before a share transfer in a private corporation is permissible. Subject to the Articles, by-laws, any unanimous shareholder agreement, and applicable securities laws, the directors may issue shares at any time and to such persons and for such consideration as they determine and may declare dividends at any time.

Meetings Of Directors And Shareholders

Once the corporation is organized it is customary for the directors to meet at least once per year prior to the annual shareholders’ meeting to approve the corporation’s financial statements so that they can be presented to the shareholders (shareholders do not technically approve the financial statements, but have a right to receive them at each annual meeting).

Except where the articles or the by-laws of the corporation provide otherwise, the majority of the meetings of the directors of an Ontario corporation in any year must be held in Canada. There is no similar CBCA requirement. This requirement is not applicable where a written resolution is passed and signed by all of the directors or shareholders entitled to vote on that resolution, as applicable.

Under both the OBCA and CBCA the shareholders of a corporation are required to hold annual meetings, which must occur within 15 months of the previous meeting. In the case of a CBCA corporation such meeting must also occur within 6 months of the end of the previous fiscal year. Meetings of shareholders of CBCA corporations must be held in Canada unless all shareholders agree to a meeting outside of Canada. For an OBCA corporation, the directors, subject to the Articles and any unanimous shareholder agreement, may determine the place of the shareholders meeting, failing which it will be held at the corporation’s registered office in Ontario. At an annual meeting, the shareholders will carry out certain prescribed business such as receiving and considering the financial statements for the previous financial year, electing directors for the subsequent financial year, appointing auditors for the next year (or, in the case of private corporations, dispensing with the need to do so), and passing resolutions dealing with any other matters referred to in the notice of the meeting of shareholders. Shareholders may elect directors for a term not exceeding three years. A director not elected for an expressly stated term ceases to hold office at the close of the first annual meeting of shareholders following his or her election. However, if no directors are elected at a meeting of shareholders, the incumbent directors continue in office until their successors are elected. After the shareholders’ annual meeting, the newly-elected directors would meet to elect the president and other officers of the corporation. Directors are authorized to fix the remuneration of the directors, officers and employees of the corporation. The directors’ discretion in this regard may be limited by provisions in the Articles, the by-laws or a unanimous shareholder agreement.

Directors’ And Officers’ Duties And Liabilities

The following is not meant to be an exhaustive review of possible sources of liability for directors and officers, but is merely indicative of the scope of such liability.

A director’s duty is owed first and foremost to the corporation. Both legislative statutes and the common law establish the parameters of a director’s duties. Some of these duties and obligations, specifically, the fiduciary duty, the standard of care and some of the statutory liabilities, apply with equal force to officers. It is the duty of the directors to manage or supervise the management of the business and affairs of a corporation. Unless provided for in a unanimous shareholder agreement, the shareholders of a corporation cannot usurp the directors’ power to manage the corporation. Of course, shareholders can also be directors of a corporation, in which case, they will take on the duties and liabilities of directors. Shareholders can exercise indirect control over the business and affairs of the corporation since they elect the directors.

The CBCA and OBCA impose a fiduciary duty on directors and officers of a corporation with respect to the management and operation of that corporation. The fiduciary duty states that every director and officer must act honestly and in good faith with a view to the best interests of the corporation. This duty recognizes that directors and officers are in a position of trust over the actions of a corporation. In this regard, directors and officers cannot engage in certain activities such as, putting their personal interests in conflict with the best interests of the corporation, competing with the corporation, or taking a corporate opportunity for personal profit that a corporation either could have obtained for itself or was actively seeking. Directors and officers also have a duty to disclose their interest in a material contract or transaction of the corporation.

In addition to the fiduciary duty, directors and officers of a corporation must also meet a minimum standard of care with respect to the exercise of their duties, that is, every director and officer, in exercising his or her powers and discharging his or her duties, must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. The courts have tempered the effect of the duty of care in some respect by developing the business judgment rule. This rule provides that business decisions are presumed not to be a breach of duty in the absence of fraud, illegality, bad faith or conflict of interest on the part of the decision maker, as long as there is a rational connection to a business purpose. The intent of this rule is to prevent courts from second-guessing the business decisions of management with the benefit of hindsight, or from setting a standard of conduct that is so high that it would hinder directors from doing what they think is best for the corporation.

Both the fiduciary duty and the duty of care are absolute, meaning directors and officers cannot contract out of, or otherwise excuse themselves from these obligations.

In addition to directors’ and officers’ fiduciary duties and the standard of care which they must observe, there are other specific statutory liabilities imposed upon directors personally. Many of these specific liabilities are imposed upon directors for making errors which could have an adverse effect on the financial position of the corporation. For example, under both the CBCA and OBCA, directors may not declare a dividend if there are reasonable grounds for believing that after the payment of the dividend, the corporation would become insolvent. If directors pay dividends in these circumstances, they will normally be jointly and severally liable for the amount of dividends paid and not recovered by the corporation. Other errors that expose directors to liability include liability for authorizing the issue of shares for inadequate consideration, an improper loan, payment or an improper indemnity, an improper payment to a shareholder, an improper commission, and an improper redemption, purchase or other acquisition of shares.

A director is not liable for breach of fiduciary duty or standard of care or for any specific liability discussed above if the director acted in good faith in reliance upon financial statements of the corporation which an officer of the corporation or the auditor represents to reflect fairly the financial condition of the corporation, or upon a report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made by such a person.

Another important statutory liability imposed on directors is personal liability for as much as six months’ wages of employees together with as much as 12 months’ vacation pay. As a result, if a corporation becomes insolvent, this obligation can result in a significant financial obligation for the corporation’s directors.

There are many other statutes which impose civil and criminal liability on directors and officers of a corporation for outstanding liabilities and obligations of a corporation. Most of these are related to matters such as taxation, the environment, employees and reporting requirements.

Public Companies

All Canadian provinces have some form of legislation (such as the Securities Act and the regulations made thereunder in Ontario) restricting sales of securities to the public. The term “securities” is broadly defined and includes the shares of a corporation as well as many debt instruments such as bonds, options to acquire shares, etc. In order to trade in a security, a corporation must qualify the securities that will be issued to, and traded by, the public with the appropriate regulatory body (in most Canadian jurisdictions, this body is the Securities Commission) and comply with all the statutory rules and conditions imposed by the regulatory body. Issuers of securities who offer securities to the public (for example, a corporation whose shares are listed for trade on a Canadian stock exchange) as well as certain persons having close connections to the issuer (“insiders”) must comply with all statutory laws and conditions imposed by the regulatory bodies that have jurisdiction over it. Failure to comply can lead to high monetary penalties and criminal conviction.

The process for becoming a publicly traded corporation (technically known as a “reporting issuer”) is somewhat complex. In addition to retaining a registered dealer to underwrite the offering, the distribution of securities requires the preparation and filing of a “prospectus” with the applicable regulatory bodies. A prospectus is a comprehensive disclosure document which is intended to provide full, true, and plain disclosure of all material facts in respect of the securities offered by the corporation. It includes information about the corporation, a description of the share capital and the class of shares or other securities to be sold including their offering price. The prospectus must also contain historical audited financial statements of the issuer.

Canada currently does not have a single central securities regulator. Therefore, an issuer seeking to qualify its securities for sale to the public must file a prospectus with the thirteen provincial and territorial regulators. That said, there exist reciprocal accommodations between the various regulators such that the process is not as onerous as it might sound.  Only once the prospectus has been filed and receipts have been issued for it by the regulatory body may the securities be sold to the public. The information contained in a prospectus must also be continually updated to remain accurate. Thus, “publicly offered” corporations or “public companies” are required to comply with the requirements for continuous disclosure. The continuous disclosure regime primarily deals with the publication and distribution of financial information on an ongoing basis and the preparation of informational documents in conjunction with meetings of shareholders. In addition, public companies are required, where a “material change” occurs in the affairs of a reporting issuer, to forthwith issue and file a news release authorized by a senior officer, disclosing the nature and substance of the change, and thereafter file a “material change report” within 10 days of the date on which the change occurred. A “material change” is a change in the business, operations or capital of a company that would reasonably be expected to have a significant effect on the market price or value of its securities or, a decision to implement such a change by the board of directors (or other persons acting in a similar capacity) who believe that confirmation of the decision by the board of directors (or other persons acting in a similar capacity) is probable.

Securities laws provide for exemptions whereby an issuer is not required to meet all the requirements demanded of a public corporation, and particularly the requirement that securities be qualified by prospectus. In particular, most securities laws have an exemption for private corporations. This is known as the “private issuer” exemption in Ontario. In order to qualify for this exemption, a corporation must have the following characteristics:

1. The constitutive documents of the corporation restrict the rights of shareholders to transfer their shares;
2. the total number of shareholders of the corporation does not exceed 50, excluding current and employees of the company; and
3. the securities of the corporation have only been issued to certain prescribed classes of persons, including:

• directors, officers, employees, founders or control persons of the issuer;
• certain immediate family members of a director, executive officer, founder or control person (or of a spouse of these persons);
• close personal friends or close business associates of a director, executive officer, founder or control person;
• current securityholders of the issuer; and
• accredited investors (described in more detail below).

If a corporation meets these qualifications it may issue shares to the prescribed groups of individuals mentioned above. Thus, most small to mid-size corporations are able to allow sales and transfers of shares by meeting the above requirements (and not filing a prospectus).

There are a number of other exemptions available under Canadian securities laws, the most common of which is the “accredited investor” exemption. This exemption permits companies to raise any amount of investment at any time from any number of accredited investors who purchase securities for their own account. While there are many classes of accredited investors, the most commonly used are: (1) the class based on the net worth of the investor, under which the investor, either alone or with his or her spouse, has net financial assets (generally cash or securities but not real estate or non-financial personal property) with a value of over $1 million (Cdn.); and (2) individuals with net income (before tax) in each of the last two calendar years of over $200,000 (individually) or over $300,000 (with a spouse) and who in either case has a reasonable expectation of the same level in the current year; and (3) corporations, partnerships, limited partnerships or other entities with net assets of at least $5 million (Cdn.) as indicated on its most recently prepared financial statements.

Other commonly used exemptions are the “Family, Friends and Business Associates” exemption which is available to close relatives, personal friends and business associates of the issuer’s directors and officers, where the investor can demonstrate that they have a sufficiently close relationship to fall under the exemption; and the “Minimum Amount Exemption”, which allows for the issuance of shares to investors who invest at least $150,000 in securities of the issuer.