Clive Presents: “Corporate Law 101” for Albertans
This sets out the fundamental legal concepts relating to corporations, and their shareholders, directives, employees, creditors, and secured creditors in the jurisdiction of Alberta, Canada.
Firstly, a corporation (sometimes referred to as a “company”) is an entity created by a statute, such as the Business Corporations Act of Alberta or the Canada Business Corporations Act. The essential nature of a corporation is that it is a “created entity”, and is complete and distinct from the person or persons that created the corporation, who are generally referred to as the “Incorporators”.
The corporation is formed by completing the necessary forms under the Business Corporations Act, and forwarding the same for acceptance to the Corporate Registry. Providing the documents are in proper form, the corporation shall be accepted, and the “company” will be created and will be given a number.
That is the concept of a “numbered company”. However, instead of having a company named by number, in addition to the number, the company can request a unique name.
Choosing a Company Name:
When choosing the name of the company, keep in mind that in order to effectively maintain the corporate identity, to be separate from the incorporator or shareholder or director, the full and proper name of the company must always be used.
A company with many words in its name will tend to be shortened in practice and in usage, and that will then remove its actual corporate separate legal identity. This is a problem. We recommend a short company name, to avoid this problem.
Incorporated, the company may be labelled to be a “Limited”, “Ltd”, “Incorporated”, “Inc.”, “Corporation”, or “Corp.” or even “Co”. All of these usages reference that this is a “limited liability company”.
Liability of Shareholders:
The nature of a limited liability company is that the shareholders, who in that sense “own” the company or corporation, do not themselves have liability for any of the debts of the company. The liability of these owners (shareholders) is limited to whatever monies were put into the company, and nothing more.
The concept of limited liability, however, cannot limit a shareholder who is active in the company from being liable for his/her own acts of fraud, or his/her own acts of negligence. If any acts of fraud, or acts of negligence, may be attributed to that person, that person is liable.
Guarantee of Loan for the Company:
Further, because of the nature of the limited liability of the company, if a company is to borrow money, or if the person is to extend credit to the company such that the company owes money to the shareholder, the lender or the creditor will likely want to ensure there is someone other than this limited liability company who is responsible for payment.
The creditors or lenders often will get around this limited liability by insisting that the shareholders or directors of the company (or some other person) guarantee the repayment of the indebtedness or the performance of the obligation.
However, not all lenders or creditors have the negotiating strength to be able to insist on such a guarantee. Further, it is possible to have these guarantees themselves be “limited” in nature, and in amount.
However, the essential concept must always be kept in mind that the company is separate from the shareholders, who are not one in the same. There have been attempts at times for creditors and lenders and other persons who have “complaints” against the company to attempt to argue that the company is really the “alter ego” of the shareholders, or that they should be treated as one in the same, or, using legal jargon, the claimants seek to “pierce the corporate veil”.
The concept in that while there is a separation between the shareholders and the company, sometimes it is argued that this is only a “thin veil” that ought to be removed under certain circumstances.
Directors:
Once incorporated, the Business Corporations Act requires that there be Directors of the company. The Act governs who is permitted to be a director, and whether all or some of the directors need to be Canadian citizens. A director cannot be a bankrupt.
The Director is the active controlling mind giving directions (hence “director”) to the affairs of the company. There can be a “board of directors”.
The Board of Directors may designate some persons to be “Officers” of the company, to carry on day to day affairs of the company. Those officers are often referred to as the President, or the Treasurer, or the Secretary. These officers may also be the Directors, and may also, in another capacity, be the shareholders (and this is often the case).
Directors have obligations to act with what is known as a fiduciary duty, which can be characterized as an obligation or duty to look after the best interests of the company. Quite often at times this obligation is overlooked when the Directors are acting in their own interests and not in the interests of the company.
Director’s Liability:
In certain situations, the limited liability protection aspects of a corporation has been eroded by legislation.
In Alberta Canada, the Directors are directly liable for unpaid GST, for unpaid Employee Income Tax withholdings, unpaid WCB payments, and Directors will be liable for 6 months wages for employees who are not paid.
Sometimes a Director may avoid the foregoing statutory liabilities providing the Director can demonstrate the Director was duly diligent, such that Director should not be responsible for the non-payment.
However, simply put, if the company has not made these payments, it will be difficult for a Director to avoid personal liability in that regard. It is for this reason that Directors must be confident of the financial status of the company, and directors must ensure that these statutory obligations are paid in advance of other liabilities.
In these circumstances, often directors insist that there be Director’s “Errors and Omission” insurance to cover any liability in that regard.
Shareholders:
The Shareholders are, in a simple sense, the “owners” of the company and give directions to the company by appointing directors. The appointment of directors occurs at an Annual General Meeting (AGM) that must be held each year, as required by the Act.
At an AGM, the Shareholders review the “audited” (unless the Shareholders waive the requirement for an audit) financial statements of the company, and review the affairs of the company, and can pass resolutions regarding the business of the company and the direction the company may take those directions, to be implemented by the Directors.
A Shareholder can request a Special Meeting of the Shareholders, and may in that regard change the manner in respect of how the company shall carry on its affairs.
The shareholders may remove directors from Office.
Unanimous Shareholders Agreement:
At times, the Shareholders will decide that they need to place restrictions on the affairs of the company and upon the directors, and in other business matters, and will enter into what is known as a Unanimous Shareholder’s Agreement (or referred to as an USA).
The USA will often make changes to what would otherwise be the voting powers of Shareholders, or may fix management fees may be paid, or, may set out how monies will be contributed into the company by way of Shareholder loan or otherwise, or may direct how dividends and other payments will be made from the company and, equally important, may set out how one Shareholder may buy the other Shareholder’s shares in the company (often referred to as a buy-sell clause, or sometimes referred to as “shotgun” clause).
It is prudent for Shareholders to have a USA if there are any Shareholders who hold less than 50% of the company.
Windup of Company:
On the windup of the company, all assets are sold, all debts paid and any surplus shall be distributed to the Shareholders. Usually in payment of their Shareholder’s Loans.
Profits:
Shareholders are entitled to dividends from profits from the company at year end, providing that the Shareholders vote in favor of such a dividend.
The Directors normally make recommendations in that regard.
Not all profits of the company each year need to be paid out to Shareholders, and it is usual for a significant amount of the profits to be retained in the company, and these are referred to in the financial statements of the company as “Retained Earnings”.
How to become a Shareholder:
A Shareholder may become a Shareholder in a number of ways, such as:
The incorporator may become the initial Shareholder. Typically, when this occurs, the price paid for the shares issued by the company and the price paid to the company, will be nominal. Usually this is $1 a share, and usually 100 shares are issued (this will be discussed below).
After a company has commenced, new shareholders may become Shareholders by either:
a) Purchasing shares from an existing Shareholder at a price that they negotiate between them; or
b) the company can issue more shares from the “treasury” of the company.
Those shares must reflect a fair amount of value of the company. Accordingly, if there were initially 100 shares issued to the initial, only one, incorporator, this incorporator could add a 50% shareholder by either:
a) having the corporation issue another 100 shares. Those then now 200 issued and outstanding shares would then have a value reflective of the value of the company (after the shares have been paid for); or
b) the initial incorporator may sell ½ of his 100 shares, at whatever price he negotiates, such as there are now 2 Shareholders each holding 50% of the 100 issued outstanding shares.
Shareholders Directors:
These Shareholders give direction by what is known as a “Shareholder Resolution” arising from a Shareholder meeting to this affect.
A Shareholder meeting may be held in person with everyone in attendance or, depending on the bylaws of the company may be done by proxy, or by telephone meeting or otherwise.
Sometimes a Shareholders meeting can be done in effect by all Shareholders simply signing a resolution to that effect.
Providing Monies to the Company:
A company may obtain monies to operate through a number of sources.
Firstly, a Shareholder/ incorporator may decide to capitalize the company by issuing shares and having the Shareholder pay to the company monies for the purchase of those shares. When the company is created, it has zero “book” value.
The incorporators may cause the company to issue 100 shares to the incorporator at a price. For example, typically it is 100 shares at $1, and the company received a total of $100. At that point the company is worth $100 and therefore the shares of the incorporator reflecting the value of the company would be worth $100. ($1.00 each Share). The company could then use the $100 to carry on business.
Secondly, instead of issuing the corporate shares from treasury for $100, the company could simply issue the shares the total of $1, and obtain $99 loan from the Shareholder (this is often referred to as a Shareholder Loan). At that stage, the company will have $100 in the company but it will have indebtedness due to the Shareholder for $99, and as such the company’s net value in effect would be affectively $1. However, the company will have $100 to utilize in its business and to earn a profit.
Thirdly, the company could obtain a loan from a bank. The bank could lend $100 to the company. The company would then have an indebtedness due to the bank of $100 and the net value in the company, therefore, is $0. In order for the bank to lend the money to the company, however, the bank will take security over the assets of the company (the $100 placed in the company) but will generally require a guarantee of the shareholders of the company or its Directors. That guarantee may or may not be secured on other assets of the guarantor (such as a mortgage on the guarantor’s home).
Keep in mind that a Shareholder who makes a loan to the company is not legally different from a bank or other lender that lends money to the company. The Shareholder is also permitted to take security over the assets of the company, similar to a bank lender. The Shareholder may also require other Shareholders to guarantee the indebtedness. These are all negotiated situations.
Fourthly, the company can earn income. Once the company earns income by its operations, then and after payment of the expenses incurred in those operation (including the wages to be paid to the employees of the company), the net profits remain in the company.
After taxes are paid on those net profits at the corporate tax rate, the company has a choice of paying dividends on those net profits to the Shareholders, or retaining the profits in the company to grow an even bigger business. The decision making in this regard is generally done at the Shareholders AGM, and/or through other Special Meetings of the Shareholders. In between meetings with Shareholders, the Directors of the company make the decisions in this regard (reflective of the best interest of the company and sometimes reflective of the best interests of the Shareholders).
Shareholders as Employees:
Being an employee of the company is a different capacity than Shareholder of the company. It is different than being a Director of the company. However, being an employee of the company may also be a Shareholder, and may also be a Director, depending on the circumstances.
For this reason, the company must be careful in deciding whether or not it is going to permit an employee of the company to become a Shareholder.
If, at a later date, there is reason for the employee to be terminated from the company, unless there are specific agreements in place to this effect, the employee will also remain a Shareholder, which may be problematic within the company.
Employment Contract:
If this is an important employee of the company, it is appropriate for there to be an employment agreement with the employee. This contract will generally set out the terms of the employment and the remuneration, but should also set out the terms of what occurs upon termination the employee, would the employee be restricted from carrying on business similar to that of the company (this is referred to as a non-competition clause).
The Agreement should specify that upon termination, the employee must return all company property and information to the company, and shall specify that the employee must agree not to use any confidential information of the company for his own use at a later date. Further, the employee must agree not to disclose confidential information regarding the affairs of the company to third parties, not in the best interest of the company.
Overall:
Overall, in all of these circumstances, it can be seen that one person, in many capacities, might be the Incorporator, the Shareholder, the Director, the Officer, the Employee, and the Secured Creditor or the Unsecured Creditor of the Company.
All of these different “hats” or capacities are important to understand, and must be kept separate in one’s thinking, in respect of and regarding the affairs of the company, and such particular person’s relationships to the company.
So — that is “Corporate Law 101” distilled.
Clive Llewellyn — Llewellyn Law