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BUSINESS ORGANIZATIONS SUMMARY - WINTER 2014 1
CHAPTER 1: WHAT IS A BUSINESS?
Effects of Business Organizations Law
! determines when individual investors and business managers are personally liable for the debts and obligations of other businesses
! affects risks incurred by other stakeholders in dealings with business
! governance structure for operation of businesses
! relationships between businesses, trade creditors, financial creditors and customers is dealt through K law, tort, property, commercial and criminal law - business law focuses on when the business is liable for the obligations created under these other areas of law
! focus on OWNERS, MANAGERS, AND BUSINESS
! business relationships affect stakeholders differently and the relationship between the owner and the investor in terms of risks/rewards Consider the primary forms of businesses: I. Corporation: statutory creation with its own existence, holding the most complex form. The corporation is a separate legal entity from its shareholders (SHs) who hold interests in the corporation. Corporations have limited liability which means that the liability is limited to the assets of the corporation and generally, not the owners of the corporation
! this may not be the case where the creditor makes an attempt to 'pierce the corporate veil'. This allows the creditor to attach to the assets of the corporation and shareholders II. Partnership: no legal division between partnership and owners of a partnership. Two or more people are required to carry on business, have mutual agency and a view to profit in common. III. Sole Proprietorship: individual carrying on business for themselves with no distinction between you and you carrying on the business. IV. Common ownerships V. Joint Ventures FIGURE 1: STAKEHOLDERS IN A BUSINESS Providers of finance (Cash) or the promotion of goods and services Shareholder Somebody with an interest in a corporation. A share is a bundle of rights including 1) the right to vote 2) the right to dividends (if declared) and 3) the right to share in the surplus of the corporation on dissolution Employee/director/community Employees can fulfill the roles of officers (ex. treasurer, president, etc.) Governments Agencies dealing with regulation of businesses Creditors
KEY STATUTES APPLICABLE: 1) Canada Business Corporations Act (CBCA) 2) Ontario Business Corporations Act (OBCA) 3) Partnership Act of Ontario (PA) a. Within which is the Limited Liability Partnership Act
TYPE 1: SOLE PROPRIETORSHIP
! TRIGGER: occurs whenever someone carries on business for their own account without taking steps to use some form of other organization Legal status/obligations
Tax advantages/disadvantages Name
*Registration with Ministry of Business and Consumer Services POLICY RATIONALE: ensure compliance, avoids market confusion and ownership of business. Creditors can access names registry. Registration
Owner and manager are the same person. Cannot employ yourself as an employee. Owner is responsible for the actions of the manager, if he is different person. Owner is sole beneficiary of profits and fully responsible for liabilities. Personal assets can be seized of if obligations not fulfilled. Can deduct losses from your income from other sources to offset losses with income through personal tax liability. Can claim insurance premiums when filing taxes. Must register name in the Ontario Business Names Act if name different than person who owns (OBNA 2(2)). Otherwise registration not required may register voluntarily (OBNA 4). If you do not comply with OBNA names requirement, you cannot bring an action in court (OBNA 7(1)) unless you seek leave (7(2)). Any one with a name deceptively similar to yours and causes injury to you is liable for statutory damages of up to 500$ (OBNA 6)
If you do not register in ON on time, you could be liable to a fine of up to 2k (OBNA 10(2))
TYPE 2: PARTNERSHIPS
! TRIGGER: when 2 + persons join together in business in common with a view to profit (OPA 2) o Case law shows that 1 transaction is sufficient o View to profit excludes charities
! Governed by Partnership Act, RSO 1990 TWO CATEGORIES OF RULES IN THE ACT ARE KEY: 1) DEFAULT: those governing dealings between partners. The act recognizes partners can have rights to determine otherwise in their partnership agreements. Only when the agreement dictates otherwise do they trump the default rules (OPA 20) a. Ex. sharing equally in losses/gains 2) MANDATORY: partnership rules set out governing partnership relations with third parties. These are more difficult to alter, if able at all (OPA 6-19) Legal status/obligations
There is no difference between the owner and the manager (they are one legal entity). Cannot employ yourself as an employee. Partners have unlimited liabilities and equally receive the awards of partnerships. Your personal liabilities can be exposed if they cannot be satisfied by partnership assets. All partners are personally liable for all torts committed by partners in connection with the business and are vicariously liable for the torts of employees committed during course of employment with partnership.
BUSINESS ORGANIZATIONS SUMMARY - WINTER 2014 3
All partners share equally in capital and profits, contribute equally to losses; changes to ordinary matters require majority; nature of partnership requires all partners to agree; introducing partners requires consent of all (OPA 24) Each partner is an agent of the partnership which means they can bind the partnership when acting in the usual course of business (OPA 6). This does not happen if the third party is aware of the limit on someone's authority and the limit does not grant the person authority to bind partnership. Relationship dissolves when a partner leaves unless a partnership agreement stipulates otherwise. Partnership is a 'firm' that can be sued in the partnership name (OPA 5). Judgment in a partnership cam be enforced against the property of a partnership. Even if a partner joins at the time of an outstanding liability, he is liable (Save misrepresentation). In order to protect yourself from decreased partnership interest, you should include an indemnification clause in your agreement.
If a new partner enters the corporation WITH a liability, other partners are liable even if they didn't know about it (given mutual agency). Treated as a collective entity for taxes. Income for partnership = adding up all partnership revenues and deducting expenses. The flow of income depends on capital contributions. Partner's share in the partnership is disclosed for personal income tax calculation OBNA 2(3): cannot identify the name to the public unless firm name has been identified by the registry (mandatory) You do not have an interest in property, but rather an interest in the property of the partnership at large. The partnership interest is there by virtue of your partnership and you cannot sell property. Upon dissolution, property is often sold and profits are divided up. All property belongs to all partners collectively.
TYPE 3: CORPORATIONS Legal status/obligations
These are creatures of statute. They are separate from the owner/investor of the business. Corporation can employ the investor/shareholder or creditor (could even have 1 shareholder). There is an exclusive responsibility for liabilities. The corporation is the sole beneficiary. If the corporation is co-signed, or borrows, the bank requires a guarantee/indemnification that strips the owner of limited liability. Limited liability transfers the risk from the owners to the creditors. The idea is that you're only responsible for what you invest in the company. This incentivizes investment because the most that you can lose is your investment.
Problems with the legal separation between the owner and the manager can be COMPENSATION and TAKEOVER BIDS. The latter is where the SHs are bought out and the management may be changed because they can elect a new Board of directors. If another corp is buying SHs, they will have to pay premiums which will excite SHs. SHs elect the board of directors who delegate to the directors. SHs do not participate in management of corporation. Corporation acts through agents including directors and officers of the corporation. Can be liable in tort or crime. Tensions with the law and corporations
1) introduces corporate democracy because SHs can vote directors in or out 2) statutory duty on directors to act in the best interests of the corporation 3) SHs have a substantial right to information 4) SHs have a host of remedies
OTHER TYPES OF BUSINESSES Special Corporations: there are some 'special forms' of corporations that are created under certain acts of parliament or the provincial legislature o ex. Bank Act require that banks exclusively incorporate under this Act Joint Venture: wide variety of legal arrangements in which 2+ parties combine resources for limited purpose for a limited time or both. Can be established by contract. Single project or undertaking. B
CMHC v Graham F: CMHC develops plans for housing and pays B to build the, as a security. G buys house from B and takes over mortgage. B received X amount of $ for each house constructed. G sues CMHC and B due to defective house, arguing that both are liable. H: CMHC participated in joint venture which was founded in a K with B. JV is one where persons agree by K to engage in common, ad hoc pooling of resources without forming partnerships in the legal sense. There is a community of relationships and mutual interests with a JV.
Wonsch Construction v Danzig and National Bank ONCA F: W and D enter JV. W would build and D would do fitting. W contributes 3 million via line of credit, D at 1.6 million - both agree liability was 50/50. Endeavour flops and debt is 2.65 million. W pays it down to 1.065 million and bank willing to see receivable for 800 K. D buys it and then demands 1.065 from W. H: There was a JV between W and D. There was a fiduciary duty between W and D and D breached it.
BUSINESS ORGANIZATIONS SUMMARY - WINTER 2014 5
NOTE: courts are not wiling to impose on JV. If there is a K, there may be fiduciary duties. Parties have the right to K how they see fit with JV. CL imposes a FD in a JV. But note that this depends on the facts in terms of how complex the JV is.
Strategic Alliances: involves more or less legal formality and greater or less degrees of cooperation among an alliance of participants. Terms may be used to describe less involved relationships (Ex. agreement to do research and development together, market products jointly, share information) License: purely contractual relationship where licensor agrees to permit another to use something in the form of intellectual property or otherwise. Licensor owns rights of that item (trademark, copyright, royalties, etc.) Franchises: purely contractual relationship under which franchisor gives franchisee right to operate business system in return for a set of fees. Relationship doesn't create a partnership or joint venture (usually in the agreement). The right to use trademark is given in exchange for running the business and training personnel. This may be risky because a lot of franchisees have no idea what their rights are. Key elements in ON include: 1) duty of fair dealing 2) disclosure 3) withdrawal right (60 days of the date received disclosure) 4) damages for misrepresentation 5) right to organize and deal collectively with franchiser Distributorship: one business agrees to sell another's product (like a supplier or manufacturer with another entity selling products) Business trusts: mutual funds, real estate investment funds, etc. Someone (Settlor) gives title to property to someone else (trustee) to be held for the benefit of a third person (beneficiary). Investors are settlers and beneficiaries. No statute governing trusts. Everything created in a declaration of trust. Legal tax advice may be required. Rules re: beneficiary are complicated. Liabilities incurred are not enforceable against beneficiary. These are not separate entities, even though they are taxed as if they were. Prospective trust beneficiaries transfer money to a trustee which lens it to a corporation that agrees to pay it back plus substantial interests. Corporation pays trust all of its available cash from operations as interest which it can deduct for tax purposes.
CHAPTER 2: DISTINGUISHING FEATURES OF A PARTNERSHIP
! 3 ELEMENTS: CARRYING ON BUSINESS, IN COMMON, WITH VIEW TO PROFIT
! a view to profit need not be primary; it can be ancillary [Backman v The Queen 2001 SCC; Spire Freezers v The Queen 2001 SCC]; need not actually profit
! "carrying on a business" can refer to every trade, occupation or profession.
! commercial activity satisfies the notion of a view or expectation of profit [Stewart SCC]
! agreement in common can be verbal or written - court looks to the intention of the parties when looking at the interpretation of the agreement
! In determining whether a partnership exists or not we look to: o Joint tenancy or common property does not in itself create a partnership as to anything held or owned [3(1) OPA]
Sharing of gross returns doesn't create a partnership whether persons sharing such returns don't have a joint or common right or interest in any property from which return derived o A receipt indicating share of profits is proof, but receipt of share or payment contingent on profits of business doesn't make someone a partner in the business.
! CAPITAL: usually refers to total amount contributed to a business by owners and lenders. With partnerships, it refers to the amounts contributed by the partners
! Partners cannot transfer their interests - she can transfer her right to receive profits from the partnership business
! S. 6 OPA: every partners is an agent of the firm whose actions with third parties bind on the firm unless the third party knows that an individual does not have the authority to act and that person does not have authority to act. o
CASE LAW ON PARTNERSHIPS Cases: Cox, Spire, Backman, Pooley, Continental Bank KEY QUESTIONS: o 1) ON WHOSE BEHALF IS THE BUSINESS CARRIED ON? [COX]
o 2) IS THERE AN INTENTION TO PROFIT? (CAN BE ANCILLARY) [SPIRE]
o 3) WHAT DOES THE PARTNERSHIP AGREEMENT SAY? [CB]
o 4) TO WHAT EXTENT IS CONTROL EXERCISED OVER PARTNERSHIP? [POOLEY]
Cox & Wheatcroft v Hickman 1860 HL F: partnership with the smith brothers ran into financial difficulty. Creditors wanted protection. Trustees (Creditors - Cox) were appointed to run the business until the profits could revert to the Smiths. Hickman was a creditor - he advanced $ to the partnership and took a promissory note. H goes after creditors because he claims they were partners. D: Creditors are not partners. They were carrying out business; profits were always that of the Smiths. Smiths mortgaged their debts to them until they were paid. The creditors just had their capital returned.
**Court answered this case by looking to see on whose behalf the partnership is being carried on. The partnership was being run on behalf of the Smiths. After this case, the Bolvills Act 1865 was enacted which indicated in s 3(d) that if you loan money to a business where you get a return, that doesn't make you a partner.
***Spire Freezers v The Queen 2001 SCC F: CDN company, Spire, acquired a 75% interest in Peninsula Cove Corp (US partner). The US company bought the losses of the partnership and an apartment building. Spire's interest in the partnership was to deduct its share of that loss against its income to reduce the income tax it had to pay given losses. Spire continued to manage apt complex which earned profit, but not enough to offset a 10 million dollar loss. Once Spire left, CDNs sold interest and incurred loss which they claimed on income tax act. CRA disallowed losses claimed. I: Did the CDN company exist as a partnership?
BUSINESS ORGANIZATIONS SUMMARY - WINTER 2014 7
Ratio: Where there is an ancillary profit-making motive, that will satisfy a partnership. The view to profit is not a strictly quantitative analysis - quantum of losses doesn't negate the holding of a partnership Reasons: Just because the CDN company entered into the transaction mainly to reduce their income tax liability by gaining access to the losses, that doesn't not prevent the finding of a partnership. Three ingredients of partnership met: 1) carrying on business - interest in apt building 2) it was carried on in common 3) there was a view to profit (original partnership was valid with a view to profit when CDNs added). Backman v The Queen 2001 SCC F: US company bought land and apt building complex. Became partners with another CDN entity that wanted to partner up for income tax purposes. Complex was sold to US partners and the CDN company acquired 1% of CDN gas and oil property at $5000. CDNs disposed of complex to US partners and accounted for losses in taxes. CRA disallowed claim for losses arguing there was no partnership I: Is Backman a valid member of a partnership to be able to deduct losses on income tax statements?
D: not a partnership (no view to profit) Ratio: Where there is a motive to deduct losses for tax purposes, that is not indicative of a partnership. There is a distinction between an intention with a view to profit and a motive. Reasons: holding a 1% interest is insufficient to make it a partnership. There is no evidence that Backman intended to make a profit - the purchase of the oil and gas property didn't establish an ancillary intention to form a partnership in that property - no continuity. Backman didn't spend much time in management. Although the selling of the company was not indicative of the partnership, the absence of a view to profit is what brings the court to a position to say that there is no partnership. Pooley v Driver 1876 HL F: unpaid creditor looking at partner's pockets in a manufacturing partnership for fish, grease and manouevre. Total capital contribution was 30 K - Borrett and Hagan (Lenders) were partners and contributed 20 K (other 10 came from creditors). Lenders received share of profits as return. After 14 years (Advance of loan required this time commitment), profits were part of capital contribution and distributed. Lenders had to pay back losses. Lenders tried to fit themselves into Bolvills Act to avoid paying losses. Driver sues Pooley (both partners) when business flops. H: Lenders were found to be partners Ratio: The wording of a partnership agreement and the degree of control persons exercise is key with respect to whether or not there is a partnership. Reasons: partners had interest in capital, which is indicative of ownership interest in business. Lender's ability to enforce covenants of partnership agreement gives them degree of participation and control for business that's unusual for lenders and makes them sound like partners. It's unusual for a lender to be required to pay back profits received on an original investment (sounds more like a partnership liability).
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