Business Organizations Practice, Theory and Emerging Challenges [Second ed.] 9781772552171

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ROBERT YALDEN PAUL D. PATON MARY CONDON MICHAEL DETURBIDE BRADLEY BRYAN

JANIS SARRA MARK GILLEN CAROL LIAO MOHAMED F. KHIMJI GARY CAMPO

Business Organizations Practice, Theory and Emerging Challenges SECOND EDITION

Business Organizations Practice, Theory and Emerging Challenges SECOND EDITION   ROBERT YALDEN Partner Osler, Hoskin & Harcourt LLP Adjunct Professor Faculty of Law McGill University

JANIS SARRA Presidential Distinguished Professor University of British Columbia Professor of Law Peter A. Allard School of Law University of British Columbia

PAUL D. PATON, JSD  Dean of Law and Wilbur Fee Bowker Professor of Law Faculty of Law University of Alberta

MARK GILLEN Professor Faculty of Law University of Victoria

MARY CONDON Professor and Associate Dean Osgoode Hall Law School

CAROL LIAO Assistant Professor Peter A. Allard School of Law University of British Columbia

MICHAEL DETURBIDE Professor & Associate Dean Schulich School of Law Dalhousie University

MOHAMED F. KHIMJI David Allgood Professor in Business Law Faculty of Law Queen’s University

BRADLEY BRYAN Assistant Professor Faculty of Law, University of Victoria Associate Counsel Woodward & Company Lawyers LLP

GARY CAMPO Partner Woodward & Company Lawyers LLP

Toronto, Canada 2018

NOTICE & DISCLAIMER: All rights reserved. No part of this publication may be reproduced in any form by any means without the written consent of Emond Montgomery Publications. Emond Montgomery Publications and all persons involved in the creation of this publication disclaim any warranty as to the accuracy of this publication and shall not be responsible for any action taken in reliance on the publication, or for any errors or omissions contained in the publication. Nothing in this publication constitutes legal or other professional advice. If such advice is required, the services of the appropriate professional should be obtained. The acknowledgments on pages ix-x constitute an extension of the copyright notice. Emond Montgomery Publications Limited 60 Shaftesbury Avenue Toronto ON  M4T 1A3 http://www.emond.ca/lawschool Printed in Canada. We acknowledge the financial support of the Government of Canada. Emond Publishing has no responsibility for the persistence or accuracy of URLs for external or third-party Internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate. Vice president, publishing: Anthony Rezek Publisher: Danann Hawes Director, development and production: Kelly Dickson Production supervisor: Laura Bast Copy editors: Nancy Ennis, Jim Lyons, David Handelsman Permissions editor: Lisa Brant Typesetter: B.J. Weckerle Proofreaders: Norman J. MacInnes, Mikayla Castello Indexer: Paula Pike Library and Archives Canada Cataloguing in Publication Yalden, Robert, author  Business organizations : practice, theory and emerging challenges / Robert  Yalden, Partner, Osler, Hoskin & Harcourt LLP, Adjunct Professor, Faculty of  Law, McGill University [and nine others]. — Second edition.  Includes index.  Revision of: Business organizations :  principles, policies and practice / Robert Yalden … et al.  ISBN 978-1-77255-217-1 (hardcover)  1.  Business enterprises—Law and legislation—Canada—Textbooks.  2.  Corporation law— Canada—Textbooks.  I. Title.  KE1345.Y34 2018   346.71’065   C2017-903730-7 KF1355.Y34 2018

Preface Business organizations are an integral part of modern life. There is little that they do not touch in some way. Business organizations are significant employers. They consume vast quantities of resources. They produce an enormous range of goods and services. They are important vehicles in which individuals, entities focused on supplying and managing capital (including, to name but a few, pension funds, venture capital funds, private equity funds, mutual funds, and hedge funds), businesses of all kinds, and even governments invest vast amounts of money in the expectation that the funds invested will help fuel wealth creation and therefore generate a healthy return on the investment. Communities often grow up around business organizations. Many suffer when the organization in question is no longer profitable. People’s lives are directly and indirectly affected in profound ways as a result of the decisions that people leading and working within a business organization make on a daily basis about the direction in which to take the organization. Governments are regularly confronted with complex questions concerning how best to interact with and regulate business organizations—either with an eye to fostering further growth, or with an eye to controlling socially undesirable behaviour. These observations are just as true today as they were a decade ago, when we made them in the introduction to the first edition of Business Organizations. The law governing business organizations continues to raise complex policy issues, and the ways in which societies address these issues have significant implications for their economies and, more generally, for social relations. In the first edition of this book, we also noted that as business organizations evolve, the law that gives life to them and regulates their conduct also continues to evolve. This too remains true—the last decade has seen important developments reshape many parts of the law governing business organizations. One objective underlying this edition of Business Organizations is therefore to ensure that the book reflects and addresses these developments in a manner that engages the policy issues at play. Another equally important objective that shapes this edition is our desire to have the reader gain an appreciation for emerging challenges facing the law governing business organizations. Some of the challenges are ones that we broached in the previous edition and that have by no means been resolved—for example, deciding whether we should look at corporate law and securities law as distinct subjects or whether we should view them as parts of a whole that need to be considered in an integrated way.1 The issue retains its

1 With respect to this theme, see Robert Yalden, “Competing Theories of the Corporation and Their Role in Canadian Business Law” in Anita I Anand & William H Flanagan, eds, The Corporation in the 21st Century (Kingston: Queen’s Annual Business Law Symposium, 2003); “Canadian M&A at the Crossroads: The Regulations of Defense Strategies after BCE” (2014) 55 Can Bus LJ 389.

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place in this edition—corporate law and securities law are deeply intertwined because they are often concerned with the same issues. Unfortunately, being intertwined is not the same thing as being well-integrated, and corporate and securities law frequently come at problems from different perspectives. We need to confront the tensions in our business law framework that this gives rise to, just as we need to reflect on how best to ensure that corporate and securities law work together effectively. At the same time, there are emerging challenges that we did not address in the first edition of Business Organizations which now form part of this edition. The material we have included that speaks to these challenges is especially exciting because it enables one to look at the law governing business organizations from new perspectives. In a number of instances, this new material also forces one to reconsider foundational concepts that have long shaped the law governing business organizations. Some of the challenges are ones that have been with us for a long time, but have garnered insufficient attention in Canadian law schools. Chapter 4 is therefore devoted to First Nations business organizations and questions concerning how best to ensure that laws governing business organizations are both sensitive to unique issues that confront First Nation governments and properly integrated with other areas of law that affect how First Nations organize themselves when embarking on business ventures. Other challenges reflect new policy debates and new ways in which entrepreneurs are thinking about the role of business organizations. These raise fascinating questions concerning whether and how one can structure laws governing business organizations so that they also focus on goals that are distinct from (though in many cases quite compatible with) wealth creation. Chapter 8 is therefore focused on the rapidly evolving world of social enterprises and the law that has developed in conjunction with the proliferation of these forms of organization. More abstract thinking about business organizations has also continued to evolve and presents its own set of challenges. This is all for the good, since with vibrant academic debate about the nature of a firm and how best to understand a corporation comes richer tools with which to think about the challenges that flow from the way that business organizations manage their affairs. Be it legislators, regulators, courts, non-governmental organizations, investors, unions, or social activists—all are frequent participants in ongoing debate about the proper role of business organizations in our society, and all have particular ways of understanding how best to characterize the nature and structure of these organizations. The everincreasing abundance of academic literature concerning business organizations not only helps to shape these debates, but also provides tools to compare and assess the merits of disparate perspectives on the proper place of business organizations in our society. Much of the current wealth of conceptual thinking and writing about business organizations flows from the preoccupations that various academic disciplines share about how best to understand relationships between governments, private actors, citizens, and profit-making entities. For example, the discipline of economics has offered up animating principles for legal regulation of these relationships that focus on questions of efficiency and wealth maximization, with a particular focus on the role that shareholders can play in advancing these objectives. In response to this movement, there is renewed interest from decision-makers and commentators in embracing and expanding the category of so-called stakeholders concerned with or affected by the conduct of businesses. This interest is nowhere more evident than in the Supreme Court of Canada’s landmark decisions in Peoples Department Stores Inc (Trustee of) v Wise, 2004 SCC 68, [2004] 3 SCR 461 and in BCE Inc v 1976 Debentureholders, 2008 SCC 69, [2008] 3 SCR 560.

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All of us involved with this edition of Business Organizations have at one time or another struggled with how best to convey the range and depth of issues that we thought should form part of any introductory law school course on business organizations. For some of us, the source of our concern may have been our own experience as students thrown into the subject for the first time and wondering whether there was anything more to it than a maze of black letter rules. For others, experience in teaching introductory or advanced courses on business law produced the desire for materials able to do justice to riveting debates concerning the theory of the firm and policy issues to which we wanted to expose our students. For yet others, we found ourselves puzzled that so many young lawyers starting out in practice, and even many a well-seasoned lawyer, did not see the complex social implications that flow from decisions about how we construct our business law framework and regulate corporate behaviour. Regardless of the precise cause, we all felt that there was more work to be done to help those embarking on the subject for the first time appreciate that business law is a fascinating subject that is constantly confronting emerging challenges, is rich in questions of public policy, and has plenty of room for robust theoretical debates with practical consequences. This book therefore represents a collective effort to provide an approach to the subject that will expose its readers to these different aspects of a captivating and multi-dimensional subject. This edition of Business Organizations involves a new group of authors. Some of us were involved with the previous edition, while others joined to help shape this new edition. The book has benefited enormously from the perspectives that this new set of authors has brought to bear on the issues that are explored throughout the book. In putting together this edition of Business Organizations, we were focused on several objectives. We wanted to ensure that the early chapters would provide an accessible way into what can be, without question, a complex and challenging subject. We thought it desirable to provide, from the outset, a practical fact pattern that would weave its way through the book so that readers would be able to see the relevance of different aspects of the subject to a familiar set of facts. We were keen to expose readers to the links between different areas of law that affect business organizations and to provide some sense of the challenges that inevitably arise when different institutions (including legislatures, courts, and regulators) have a hand in shaping business law. But more than anything else, we were determined to ensure that the reader would get a sense for the range of issues of policy and theory that form part of the legal landscape in which business organizations must function—issues that make the subject a compelling and stimulating area of study. The book sets out to meet these objectives in a way that provides a sound grounding in the fundamentals of the law governing business organizations. Chapter 1 therefore provides an introduction to the universe of possibilities for organizing businesses that currently exist in Canada. Subsequent chapters explore issues associated with classic forms of business organization, such as partnerships (Chapter 2) and corporations (Chapters 3, 5, 6, and 10 through 15). We have included a chapter devoted to the rise of social enterprises and the intriguing policy issues that these new forms of organization raise (Chapter 8), a chapter that confirms that the laws governing business organizations evolve continuously in response to a wide range of pressures. We have also included a chapter on First Nations Business Organizations (Chapter 4), which helps one better understand some of the challenges we face as a country in adapting the laws that govern business organizations so that they are better able

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to serve First Nation governments as they pursue business ventures. We have chosen to place this chapter early in the book so that readers will not only rapidly see how concepts such as legal personhood explored in Chapter 3 raise issues for First Nations but also keep in mind issues raised in Chapter 4 when they come to subsequent chapters dealing with issues such as fiduciary duties. We also wanted to ensure that readers would gain an understanding of concepts and principles relevant to debates about the nature of a business organization. An appreciation for the literature that has arisen in this regard in recent years simply allows for a more textured and substantive discussion of issues affecting business organizations. While the law and economics movement remains a fundamental part of the landscape, it can now be seen as an important stage in a longer journey that is still unfolding in the search for a sustainable understanding of the nature of the firm. Accordingly, Chapter 9 provides an overview of different theories about how best to think of business organizations, most especially corporations. The issues of theory explored in this chapter surface regularly throughout the book and receive particular attention in the chapters that focus on capitalization of the corporation (Chapter 6), corporate governance (Chapters 10, 11, and 12), fiduciary duties (Chapter 13), the oppression remedy (Chapter 14), and mergers and acquisitions (M&A) (Chapter 15). Other aspects of this book are still relatively new components of a text devoted to the study of Canadian business organizations, or, at the very least, build on recent innovations. For example, we remain of the view that securities law is now a fundamental part of the business law landscape in Canada and students need to be exposed to basic concepts in this area to better understand how corporate law and securities law interact or conflict on matters such as corporate governance or M&A. One example of differences in philosophy between corporate law and securities law concerns remedies. Corporate law’s traditional approach has been to offer private remedies, where individuals or groups are afforded the opportunity to raise grievances as private actors and, if successful, to receive relief that is personal to their claim. Securities law has been more focused on remedies in the public interest, with broad or general applicability, and it also has, as an explicit normative goal, an overall concern with investor confidence in the capital markets. In addition to differences in remedial strategies, corporate law and securities law often seem to have different perspectives on the place and importance of shareholders in the network of legal relationships that a corporation is a party to. This is a powerful theme in Canadian business law that resurfaces regularly throughout this book. Thought needs to be given to the significance of the differences in perspective between corporate law and securities law in this regard and how best to reconcile these perspectives. Accordingly, after reviewing foundational issues relating to partnerships and the establishment and capitalization of a corporation, we turn to securities law in Chapter 7. We refer regularly to the interaction between corporate and securities law as we move on to more advanced issues relating to governance or liability strategies and M&A. In this regard, we have also carved out a distinct chapter that focuses on stakeholder remedies, including the oppression remedy (Chapter 14). The oppression remedy is a distinctive feature of Canadian business law that warrants particular attention for many reasons. It raises complex practical questions about how best to manage competing claims on the corporation. The remedial provision is more and more frequently invoked and it has blossomed into an area of study with a multitude of judicial decisions, articles, and texts devoted to better understanding this corner of Canadian business law. And last but not least, it is yet another example of fertile terrain for debate about issues relating to the best way to conceive of the nature of the firm.

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A final word is in order concerning the perspectives that are at play in this book. Canada’s business law framework has deep roots in England, but is profoundly influenced by developments in the United States. While Canada retains a distinctive body of law with its own national character, we thought it appropriate on occasion to delve into developments in other jurisdictions such as the United States, both to provide better definition to the distinctive elements of Canada’s business law framework and to enable the reader to see how legal developments in a market in which Canadian business is extremely active can influence the way our own debates about business law play out. At the same time, we thought it appropriate on occasion to remind the reader that there are countries, such as Germany and others that have embraced forms of co-determination and employee representation, that approach business law differently than the way we do in North America—differences that are rooted in distinct visions of the nature of the corporation and its role in society. The reader by now will have gathered that the book covers a lot of ground. It is therefore important to stress that there is more material in this book than most will wish to cover in an introductory course on business organizations. The book is intended to provide both teacher and student with a set of materials that can be shaped to suit the particular emphasis that different classes may wish to place on the broad range of topics that form part of business law. It is also intended to serve as a resource that students, teachers, and practitioners interested in a given subject can turn to in order to explore issues in greater depth than time may permit in an introductory business law course. The book was therefore designed with an eye not only to serving as an introductory text but also to providing a bridge to more detailed study of some of the subjects that it covers. Teachers will therefore wish to consider whether they want to use all or only portions of some of the chapters—for example, Chapters 2 (Partnership), 6 (Capitalization of the Corporation), and 15 (Mergers and Acquisitions)—when crafting an introductory course on business organizations. At the same time, it is our sincere hope that teachers will find a place in the curriculum to address issues dealt with in Chapters 4 (First Nations Business Organizations) and 8 (Social Enterprises), since both chapters cover questions that will help students get a better sense for emerging challenges in business law that are not only thought-provoking but have real consequences for how best to organize relationships between those engaged in productive activities. Another virtue of having several authors involved with this book is the appreciation that one size does not fit all—different business law programs will call for different decisions about which parts of this book to use at distinct points in the courses that form each curriculum. At the same time, it is worth stressing that the authors involved with this book share a common vision of the range of issues to which students in introductory business law courses should be exposed, with the result that a constant set of themes runs through the book’s many parts. Students and teachers interested in supplementing the material in this book with other sources may note that we have kept our eyes firmly fixed on the way in which this text fits together with two other Emond publications—extracts from both of which are included in this book. Those wishing to explore securities law issues in greater detail will want to consider using the chapter on securities law as a springboard from which to jump into Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada: Cases and Commentary (Toronto: Emond, 2017). For those who are looking for a text focused on corporate

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law, Christopher C Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) provides a valuable overview of that body of law. As a group we wish to thank the marvellous staff at Emond who have patiently worked with us as we put together this edition, one that involved quite substantial changes from the previous edition. Special thanks are due to Danann Hawes and Kelly Dickson, who worked with us while we pulled this project together and gave it definition; Nancy Ennis, Laura Bast, Jim Lyons, David Handelsman, and Norman MacInnes for their splendid editing and proofreading; and last, but certainly not least, Paul Emond for supporting the vision that underlies this book. We are grateful to the many students at a broad cross-section of Canadian law schools who have participated in our courses on the law of business organizations, thereby enabling us to refine our thinking on the subject. Each of us also has particular people that we wish to thank. Robert Yalden is grateful to his colleagues at Osler, Hoskin & Harcourt LLP for providing a stimulating and collegial environment in which to practise business law, as well as to the Faculty of Law at McGill University for providing him with the opportunity to teach courses that have allowed him to explore many of the ideas dealt with in this book. He is especially grateful to Marissa Corona (a former student and now a colleague at Osler) for her input and research and to his assistant Jacynthe Brossard for her work in revising drafts of several chapters. Paul Paton would like to acknowledge the support provided by his research assistant Ryan Bencic. Mary Condon would like to thank her research assistant Colin Lyon, as well as her assistant Nadia Azizi. Carol Liao would like to thank Kyle Fogden, and gratefully acknowledges the support of her research assistants Jordan Marks, Sergio Ortega, and Karlie Stewin. Mohamed Khimji would like to thank his research assistants Sarah Faber and Sarah Hawkins for their contribution to this edition. And last, but certainly not least, Bradley Bryan and Gary Campo would like to thank Professor John Borrows who provided helpful research advice with respect to the chapter on First Nations Business Organizations. Finally, the authors are grateful to Janis Sarra for hosting critical working sessions at the University of British Columbia during which we spent many constructive hours discussing each chapter that forms part of this book. As was the case with the first edition, one of the most enjoyable parts of putting together the second edition has been the chance for us to come together as colleagues committed to teaching business law and, in turn, to crafting a book that reflects a shared vision about a subject that we are all passionate about. The opportunity to spend time with colleagues from across Canada who are actively engaged in teaching and working with the law governing business organizations was a genuine pleasure for us all. We very much hope that you will find the outcome of this collaborative exercise as stimulating and rewarding as have those involved in putting together this edition of Business Organizations. Robert Yalden, Janis Sarra, Paul D Paton, Mark Gillen, Mary Condon, Carol Liao, Michael Deturbide, Mohamed Khimji, Bradley Bryan & Gary Campo —June 2017

Acknowledgments A book of this nature borrows heavily from other published material. We have attempted to request permission from, and to acknowledge in the text, all sources of such material. We wish to make specific references here to the authors, publishers, journals, and institutions that have generously given permission to reproduce in this text works already in print. If we have inadvertently overlooked an acknowledgment or failed to secure a permission, we offer our sincere apologies and undertake to rectify the omission in the next edition. Antonio Fici, “Introduction to Cooperative Law” in Dante Cracogna, Antonio Fici & Hagen Henrÿ, eds, International Handbook of Cooperative Law (Springer, 2013) at 16-25. Used with permission. Copyright Clearance Centre. Canadian Bar Association, Code of Professional Conduct, “Chapter V: Impartiality and Conflict of Interest Between Clients” (Ottawa: Canadian Bar Association, 2009) at 25-30. CRA Advanced Tax Ruling, “First Nation—Limited Partnership,” CRA Document 20120473041R3E. Reproduced with permission of the Minister of Public Works and Government Services Canada, 2017. CRA Document External Technical Interpretation, “Business Income of Self-Employed Indian Fishers,” CRA Document 2015-0585231E5. Reproduced with permission of the Minister of Public Works and Government Services Canada, 2017. CRA Internal Technical Interpretation 2016-0645031I7, Comments on Indian Act Bands as 149(1)(c) Entities (27 July 2016). Reproduced with permission of the Minister of Public Works and Government Services Canada, 2017. Henry B Hansmann, “Economic Theories of Nonprofit Organization” in WW Powell, ed, The Nonprofit Sector: A Research Handbook (New Haven: Yale University Press, 1987). Used with permission of Yale University Press. Robert Katz & Antony Page, “The Role of Social Enterprise” (2010) 35 Vt L Rev 59 at 85-97. Used with permission of the Vermont Law Review. Mohamed F Khimji & Christopher C Nicholls, “Corporate Veil Piercing and Allocation of Liability—Diagnosis and Prognosis” (2015) 30 BFLR 211 at 222-28. Reprinted with permission.

Pages ix-x constitute an extension of the copyright page.

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x Acknowledgments Mohamed F Khimji & Christopher C Nicholls: “Piercing the Corporate Veil In the Canadian Common Law Courts: An Empirical Study” (2015) 41 Queen’s LJ 207 at 215-24. Reprinted with permission. Dana Brakman Reiser, “Benefit Corporations—A Sustainable Form of Organization?” (2011) 46 Wake Forest L Rev 591 at 606-14. © Dana Brakman Reiser, published in the Wake Forest Law Review. Used with permission. Benjamin Richardson, Socially Responsible Investment Law (New York: Oxford University Press, 2008) 1 at 12-24. Used with the permission of Oxford University Press. Janis Sarra, “Institutional Investors Must Lead Our Transition to Long-Term Sustainability,” The Globe and Mail (2 April 2016), online: . Truth and Reconciliation Commission, We Are All Treaty People: Canadian Society and Reconciliation, Final Report of the TRC, vol 6 (Ottawa: TRC, 2015-16) at 204-8. Michael Welters, “Towards a Singular Concept of Legal Personality” (2013) 92 Canadian Bar Review 417. Used with permission.

Summary Table of Contents

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Detailed Table of Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xv Table of Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxxvii

Chapter One  An Introduction to Business Organizations . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 II. A Sample Fact Pattern with an Introduction to Some Important Terminology . . . . . . . . . . . 6 III. Forms of Business Organizations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 IV. Some Simple Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 V. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Chapter Two  Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 I. Introduction: The Nature of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 II. Origins and the Partnership Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 III. Definition and Existence of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 IV. The Legal Status of Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 V. Relationship Between Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 VI. Relationship Between Partners and Third Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 VII. Limited Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 VIII. Limited Liability Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112 IX. Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 X. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

Chapter Three  The Corporate Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

I. Introduction: The Corporate Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 II. Corporate Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 III. The Process of Incorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144 IV. Separate Legal Personality and Limited Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 V. Piercing the Corporate Veil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237

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Chapter Four  First Nation Business Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239 I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 II. History and Rationale of Use of the Corporate Form by Indigenous Peoples . . . . . . . . . . . . . 243 III. Legal Personality and the Need for Corporate Form and Identity . . . . . . . . . . . . . . . . . . . . . . . . 257 IV. Corporate Identity, Fiduciary Duty, and Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274 V. Business Structures and Economic Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292 VI. Structuring Issues: Limited Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 318 VII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 341

Chapter Five  Corporate Contractual Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343 II. Pre-Incorporation Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343 III. Post-Incorporation Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377 IV. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 389

Chapter Six  Capitalization of the Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 391

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 391 II. The Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395 III. Debt Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434 IV. Preferred Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 439 V. Convertible Securities, Rights, and Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459

Chapter Seven  Distribution of Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 461 I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 462 II. Overview of Canadian Securities Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 466 III. What Is a Security? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 473 IV. Distribution of Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 478 V. Prospectus Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482 VI. Liability for Prospectus Misrepresentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487 VII. Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 490 VIII. Continuous Disclosure Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 IX. Enforcement of Securities Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 509 X. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 514

Chapter Eight  Social Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515 II. Origins of Social Enterprise Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 524 III. International Developments in Social Enterprise Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549 IV. Social Enterprise Law in Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569 V. Introduction to Social Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 587

Chapter Nine  Theories of the Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 589

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 589 II. Economic Theories of the Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 590

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III. Socio-economic Theories of the Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 606 IV. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 618

Chapter Ten  Corporate Governance: The Stakeholder Debate . . . . . . . . . . . . . . . . . . . . . . 621 I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 621 II. Shareholder Primacy as One Approach to the Stakeholder Debate . . . . . . . . . . . . . . . . . . . . . . 622 III. Widening the Lens to Consider Broader Stakeholder Interests . . . . . . . . . . . . . . . . . . . . . . . . . . 629 IV. Shareholder Primacy Narrowly Cast . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 634 V. Stakeholder Interests Are More than Part of a Mediating Hierarchy . . . . . . . . . . . . . . . . . . . . . 636 VI. Best Interests of the Corporation Requires Considering All Stakeholder Interests . . . . . . . . 637 VII. The Stakeholder Debate and Corporations’ International Human Rights Obligations . . . . 650 VIII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 672

Chapter Eleven  Board Composition and the Role of Directors . . . . . . . . . . . . . . . . . . . . . . 673 I. The Duties of Directors and Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 674 II. Independence of Corporate Boards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 687 III. Director Appointment, Replacement, and Removal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 696 IV. Authority of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707 V. Appointment and Compensation of Officers and the Delegation of Powers . . . . . . . . . . . . . 708 VI. Directors’ Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 709 VII. The Business Judgment Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 709 VIII. Closely Held Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 711 IX. Different Treatment Under Modern Canadian Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 715 X. Shareholder Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 716 XI. Binding the Directors’ Discretion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 718 XII. Share Transfer Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 720 XIII. The Choice Between a Closely Held and a Widely Held Corporation . . . . . . . . . . . . . . . . . . . . . 723 XIV. Creating National Corporate Governance Guidelines for Publicly Traded Corporations . . 724 XV. Securities Laws Disclosure Requirements in Respect of Corporate Governance . . . . . . . . . . 730 XVI. The Role of Audit Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 742 XVII. Corporate Charity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 747 XVIII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 749

Chapter Twelve  Shareholder Participation in Corporate Governance . . . . . . . . . . . . . . . 751 I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 752 II. Shareholder Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 753 III. The Distribution of Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 760 IV. The Significance of Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 777 V. Shareholder Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 779 VI. Shareholder Voice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 785 VII. Access to Records and List of Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 796 VIII. Institutional Investor Monitoring and Activism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 799 IX. Proxy Solicitation and Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 803 X. Proposals by Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 827 XI. The Role of Regulators in Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 833 XII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 836

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Chapter Thirteen  Fiduciary Duties in Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . 839

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 839 II. Theoretical Concepts for Analyzing Corporate Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . 840 III. Fiduciary Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 846 IV. Fiduciary Duties of Corporate Directors and Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 850

Chapter Fourteen  Stakeholder Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 891

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 891 II. The Derivative Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 892 III. The Oppression Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 914 IV. Appraisal Remedy (Right to Dissent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 975 V. Other Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 990 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 991

Chapter Fifteen  Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 993

I. Introduction and Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 994 II. Formal Aspects of Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1002 III. Appraisal Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1026 IV. Buyouts and Going-Private Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1032 V. Takeover Bids . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1046 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1133

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1135

Detailed Table of Contents

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Summary Table of Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Table of Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxxvii

Chapter One  An Introduction to Business Organizations . . . . . . . . . . . . . . . . . . . . . . . . . . . 1



I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 II. A Sample Fact Pattern with an Introduction to Some Important Terminology . . . . . . . . . . . 6 A. A Fact Pattern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 B. Investment, Equity, Debt, and Trade Creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 III. Forms of Business Organizations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 A. Agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 1. Legal Concept of Agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2. Economics Concept of Agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 B. For-Profit Forms of Business Association . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 1. Sole Proprietorship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 a. Single Equity Investor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 b. “Unlimited” Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 c. Management (or Governance) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 d. No Perpetual Existence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 2. Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 3. Limited Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 4. Limited Liability Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 5. Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 a. Separate Existence (Separate Legal Entity/Personality) . . . . . . . . . . . . . . . . . . . 15 b. Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 c. Limited Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 d. Perpetual Existence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 e. Management (or Governance) Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 f. Policy Choices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 6. Limited Liability Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 7. Unlimited Liability Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 8. United States “C Corporations” and “S Corporations” . . . . . . . . . . . . . . . . . . . . . . . . . . 21

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Detailed Table of Contents 9. Business Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 a. What Is a Trust? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 b. The Business Trust Form of Association . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 i. Investors as Settlors and Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . 22 ii. Creating Equivalents to the Shares, the Board of Directors, and Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 iii. Limited Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 c. Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 d. Situations in Which Trusts Are Currently Used as a Form of Business Association . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 i. Mutual Fund Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 ii. Real Estate Investment Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 C. Not-for-Profit Forms of Association . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 1. Societies or Not-for-Profit (or Non-Profit) Corporations . . . . . . . . . . . . . . . . . . . . . . . . 25 2. Unincorporated Associations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 D. Combined for-Profit and Not-for-Profit Forms of Business Association . . . . . . . . . . . . 27 1. Co-operative Associations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 2. Mutual Organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 3. Social Enterprise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 E. Other Business Association Forms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 1. Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 2. Franchises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 3.  Multiple Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 a. Business Activity Carried on Through a Series of Separate Contractual Arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 b. Transaction Costs (Negotiating, Monitoring, and Enforcing) . . . . . . . . . . . . . . 32 c. Forms of Business Association as Means of Reducing Transaction Costs . . . 32 F. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 IV. Some Simple Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 A. The Statement of Financial Position (or “Balance Sheet”) . . . . . . . . . . . . . . . . . . . . . . . . . . 33 B. The Statement of Earnings and Statement of Comprehensive Income . . . . . . . . . . . . 34 C. Assets, Liabilities, and Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 D.  Trade Credit, Accounts Payable, and Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . 34 E. A Statement of Financial Position (Balance Sheet) for the Sample Fact Pattern Sole Proprietorship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 F. A Statement of Earnings, Revised Statement of Financial Position, Statement of Changes in Equity, and Statement of Cash Flows for the Sample Fact Pattern “Sole Proprietorship” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 1. Statement of Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 2. Revised Statement of Financial Position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 3.  Statement of Changes in Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 4. Statement of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 G. A Corresponding Statement of Financial Position and Statement of Earnings for the Business Operated Through a Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 V. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

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Chapter Two  Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45







I. Introduction: The Nature of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 II. Origins and the Partnership Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 III. Definition and Existence of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 A. The Common Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Cox & Wheatcroft v Hickman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Pooley v Driver . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 B. Statute . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 1. Section 2: Definition of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 a. Partnership Is a Relationship Between Persons . . . . . . . . . . . . . . . . . . . . . . . . . . 60 b. Carrying on Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 c. In Common . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 d. With a View to Profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 2. Rules for Determining Existence of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 C. Modern Common Law Considerations of the Definition of Partnership . . . . . . . . . . . . 62 AE LePage Ltd v Kamex Developments Ltd et al . . . . . . . . . . . . . . . . . . . . . 63 Volzke Construction Ltd v Westlock Foods Ltd . . . . . . . . . . . . . . . . . . . . . . . 65 Lansing Building Supply (Ontario) Ltd v Ierullo . . . . . . . . . . . . . . . . . . . . . . 68 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Backman v Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 McCormick v Fasken Martineau DuMoulin LLP . . . . . . . . . . . . . . . . . . . . . . 81 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 IV. The Legal Status of Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 A. The Common Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 Re Thorne and New Brunswick Workmen’s Compensation Board . . . . . 89 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 B. The Partnership as a “Firm” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 V. Relationship Between Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 A. Formation and Governance: The Partnership Act and a Partnership Agreement . . . 93 B. The Default Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 1. Partnership Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 2. Capital, Profits, Losses, Management, Admission of New Partners, and Record-Keeping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 3. Removal of Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 4. Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 5. Assignment of Partnership Interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 6. Dissolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 a. By the Partners Themselves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 b. On Death, Bankruptcy, or Dissolution of a Partner . . . . . . . . . . . . . . . . . . . . . . . 96 VI. Relationship Between Partners and Third Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 A. Liability of Partners in Contract and Tort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 1. Liability in Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 a. Apparent Authority of Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 b. Actual Authority of Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

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c. Third-Party Notice of Restriction on Authority of Partner . . . . . . . . . . . . . . . . . 98 d. Joint Liability for Debts of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 e. Liability of New Partners and Retired Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 2. Liability in Tort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 a. Liability for Wrongful Acts or Omissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 3. Other Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 a. Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 b. “Holding Out” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 4. Retirement of Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 VII. Limited Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 A. Introduction and Overview of Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 B. Tax Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 C. Statutory Provisions and Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 1. One or More Limited Partners and One or More General Partners . . . . . . . . . . . . . 102 2. Formation by Filing Certificate or Declaration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 3. Protection of Third Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 D. Maintaining Limited Liability and Management of the Business . . . . . . . . . . . . . . . . . . 103 Haughton Graphic Ltd v Zivot . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104 Nordile Holdings Ltd v Breckenridge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 E. Relations Among the Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 1. Separation of Ownership and Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 2. Other Aspects of the Relations Among Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 a. Right to Inspect Books . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 b. Assignment of Limited Partnership Interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 c. Restriction on the Admission of Additional Partners . . . . . . . . . . . . . . . . . . . . . 111 d. Share of Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112 VIII. Limited Liability Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112 A. Introduction and Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112 Robert W Hamilton, “Registered Limited Liability Partnerships: Present at the Birth (Nearly)” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 Deborah L Rhode & Paul D Paton, “Lawyers, Ethics and Enron” . . . . . . . . 115 B. LLP Structures and Statutory Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116 1.  Full Shield Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 2.  Business Name Registration Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 IX. Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 Woronuk v Woronuk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118 X. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

Chapter Three  The Corporate Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

I. Introduction: The Corporate Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 II. Corporate Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 A. History and Development of Corporate Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 Christopher Nicholls, Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 B. Canadian Corporate Law: Three Models for Incorporation . . . . . . . . . . . . . . . . . . . . . . . . 132 1. Memorandum and Articles of Association . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133 2. Letters Patent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134

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3. Statutory Division of Powers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 C. Mandatory Versus Enabling Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135 D. The Relationship Between Federal and Provincial Corporate Legislation . . . . . . . . . . 137 1. The Constitutional Explanation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137 2. Uniformity Versus Charter Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138 Glenford Jameson, “Competing With Ourselves: Supply-Side Competition for Corporate Charters in Canada” . . . . . . . . . . . . . . . . . . . 140 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143 III. The Process of Incorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144 A. Articles of Incorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144 1. The Name of the Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145 2. Registered Office . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 3. Classes and Maximum Number of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 4. Restrictions on the Transfer of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 5. Number of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 6. Restrictions on the Business of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 IV. Separate Legal Personality and Limited Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 A. Economic Justifications and Policy Concerns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 Henry Hansmann & Reinier Kraakman, “The Essential Role of Organizational Law” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150 Frank Easterbrook & Daniel Fischel, “Limited Liability and the Corporation” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151 Mohamed F Khimji & Christopher C Nicholls, “Corporate Veil Piercing and Allocation of Liability—Diagnosis and Prognosis” . . . . . . . . . . . . . 158 B. Doctrinal Implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 Salomon v Salomon & Co, Ltd; Salomon & Co, Ltd v Salomon . . . . . . . . 162 Lee v Lee’s Air Farming Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 V. Piercing the Corporate Veil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 Mohamed F Khimji & Christopher C Nicholls: “Piercing the Corporate Veil in the Canadian Common Law Courts: An Empirical Study” . . . . 177 Walkovszky v Carlton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184 Rockwell Developments Ltd v Newtonbrook Plaza Ltd . . . . . . . . . . . . . . . 191 642947 Ont Ltd v Fleischer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193 De Salaberry Realties Ltd v Minister of National Revenue . . . . . . . . . . . . 198 BG Preeco I (Pacific Coast) Ltd v Bon Street Holdings Ltd . . . . . . . . . . . . . 204 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207 Kosmopoulos v Constitution Insurance Co . . . . . . . . . . . . . . . . . . . . . . . . . . 208 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210 Clarkson Co Ltd v Zhelka . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210 Yaiguaje v Chevron Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 220 Wildman v Wildman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221 Lynch v Segal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225 Prest v Petrodel Resources Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237

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Chapter Four  First Nation Business Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239







I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 II. History and Rationale of Use of the Corporate Form by Indigenous Peoples . . . . . . . . . . . . . 243 A. Legal Personality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244 Indian Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244 B. Restrictions on Ownership, and Protection of Rights and Title . . . . . . . . . . . . . . . . . . . . 245 C. Forms of Tax Exemption and Corporate Personhood . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245 Income Tax Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246 Indian Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246 Income Tax Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247 CRA Internal Technical Interpretation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249 Yukon First Nations Self-Government Act . . . . . . . . . . . . . . . . . . . . . . . . . . . 250 Yukon First Nation Self-Government Agreement—Standard Terms . . . 250 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251 D. Historical Reality and Future Economic Development for Indigenous Peoples . . . . . 251 Truth and Reconciliation Commission of Canada, “We Are All Treaty People: Canadian Society and Reconciliation” . . . . . . . . . . . . . . . . . . . . . 252 Royal Commission on Aboriginal Peoples (Canada), People to People, Nation to Nation: Highlights from the Report of the Royal Commission on Aboriginal Peoples . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 256 III. Legal Personality and the Need for Corporate Form and Identity . . . . . . . . . . . . . . . . . . . . . . . . 257 Michael Welters, “Towards a Singular Concept of Legal Personality” . . 258 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261 Te Urewera Act 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262 Telecom Leasing Canada (TLC) Ltd v Enoch Indian Band of Stony Plain Indian Reserves No 135 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263 Kwicksutaineuk/Ah-Kwa-Mish First Nation v Canada (Attorney General) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 266 Martin v British Columbia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267 Spookw v Gitxsan Treaty Society . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274 IV. Corporate Identity, Fiduciary Duty, and Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274 A. Separation of Ownership and Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274 Gitga’at Development Corp v Hill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282 B. Fiduciary Duties of Directors as Compared with First Nation Leaders . . . . . . . . . . . . . . 282 Blueberry Interim Trust (Re) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283 Louie v Louie . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292 V. Business Structures and Economic Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292 A. Legal Ethics and First Nation Economic Development: Representation, Conflicts, and Succession . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292 Canadian Bar Association, “Chapter V: Impartiality and Conflict of Interest Between Clients” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 296

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B. Economic and Policy Challenges for Corporate Planning . . . . . . . . . . . . . . . . . . . . . . . . . 297 1. The Challenge of Own-Source Revenue for Corporate Planning . . . . . . . . . . . . . . . 297 2. Structuring for Tax Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297 CRA External Technical Interpretation, “Business Income of Self-Employed Indian Fishers” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 298 CRA Advance Tax Ruling, “First Nation—Limited Partnership” . . . . . . . . 300 3. Economic Development and the Separation of Business and Politics . . . . . . . . . . 301 Tsilhqot’in Nation v British Columbia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302 Stephen Cornell & Joseph P Kalt, “Reloading the Dice: Improving the Chances for Economic Development on American Indian Reservations” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303 Royal Commission on Aboriginal Peoples, People to People, Nation to Nation: Highlights from the Report of the Royal Commission on Aboriginal Peoples . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 306 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309 C. Corporate Structures Used for Economic Development by First Nations . . . . . . . . . . . 309 1. Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 310 2. Partnerships/Limited Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311 3. Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311 4. Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311 5. Co-operatives and Non-Profit Societies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312 Gull Bay Development Corp v The Queen . . . . . . . . . . . . . . . . . . . . . . . . . . . 312 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 318 VI. Structuring Issues: Limited Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 318 A. Names, “Holding Out As,” and Holding Assets: General Partners and Limited Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 318 Edenvale Restoration Specialists Ltd v British Columbia (Finance) . . . . 320 R v Tron Power Inc (Tron Power Limited Partnership) . . . . . . . . . . . . . . . . . 324 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 328 B. Creditor Protection Under the Indian Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329 Indian Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329 Mitchell v Peguis Indian Band . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 330 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 340 VII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 341

Chapter Five  Corporate Contractual Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343 II. Pre-Incorporation Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343 A. The Common Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344 Kelner v Baxter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344 Newborne v Sensolid (Great Britain) Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347 Black et al v Smallwood & Cooper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 349 Wickberg v Shatsky et al . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352 Notes and Questions: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355 B. Statutory Regime . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355 Sherwood Design Services Inc v 872935 Ontario Ltd . . . . . . . . . . . . . . . . . 356 Shoppers Drug Mart Inc v 6470360 Canada Inc (Energyshop Consulting Inc/Powerhouse Energy Management Inc) . . . . . . . . . . . . 366

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Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369 Szecket v Huang . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369 1394918 Ontario Ltd v 1310210 Ontario Inc . . . . . . . . . . . . . . . . . . . . . . . . . 373 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377 III. Post-Incorporation Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377 A. Corporate Capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377 Ashbury Ry Carriage & Iron Co v Riche . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 378 B. Compliance with Internal Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 381 C. Agent Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382 1. Actual Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382 2. Apparent Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 383 Canadian Laboratory Supplies v Engelhard Industries . . . . . . . . . . . . . . . 383 IV. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 389

Chapter Six  Capitalization of the Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 391

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 391 Christopher Nicholls, Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 394 II. The Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395 A.  What Is a Share? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 396 Christopher Nicholls, Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 396 Sparling v Québec (Caisse de Dépôt et Placement du Québec) . . . . . . . 397 B. Formalities of Capitalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 402 1. Authorized and Issued Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 402 2. Common and Preferred Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403 3. Subscriptions for Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 404 C. Consideration on an Issue of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405 1. The Need for Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405 2. Discount Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405 Ooregum Gold Mining Co v Roper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405 3. Watered Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409 a. Valuation of Property or Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410 b. Modern Statutory Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410 4. Unacceptable Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411 See v Heppenheimer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 414 5. Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415 a. Who May Sue? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415 b. What Remedies Are Available? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415 D. Pre-Emptive Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 416 Stokes v Continental Trust Co . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 416 E. The Nature of a Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 422 Bowater Canadian Ltd v RL Crain Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 424 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 427 Atco v Calgary Power Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 427 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 432 Robert WV Dickerson, John L Howard & Leon Getz, Proposals for a New Business Corporations Law for Canada . . . . . . . 432 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 433

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III. Debt Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434 Christopher Nicholls, Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434 A. Priority Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 437 B. Varieties of Debt Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 437 IV. Preferred Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 439 P Hunt, C Williams & G Donaldson, Basic Business Finance . . . . . . . . . . . 439 A. Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441 1. What Is a Dividend? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441 2. Types of Dividends: Cash, Specie, and Stock Dividends . . . . . . . . . . . . . . . . . . . . . . . . 442 a. Cash Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 442 b. Dividends in Specie . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 443 c. Stock Dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 443 3. Legal Aspects of Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 444 a. Legally Permitted Types of Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 444 b. Power of Directors to Declare Unless Otherwise Provided . . . . . . . . . . . . . . . . 445 c. Directors Are Not Obligated to Declare Dividends . . . . . . . . . . . . . . . . . . . . . . . 445 i.  Fiduciary Duty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 445 ii. Oppression . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 446 d. Protection of Creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 446 B. Rights on Liquidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 449 International Power Co v McMaster University/In re Puerto Rico Power Co . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 449 1. Participation on Liquidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454 2. The Claim to Arrearages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454 V. Convertible Securities, Rights, and Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455 George S Hills, “Convertible Securities: Legal Aspects and Draftsmanship” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455 A. Rights and Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 456 B. Valuation of Conversion Privileges and Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 456 C. Anti-Dilution Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 457 Jerome S Katzin, “Financial and Legal Problems in the Use of Convertible Securities” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 457 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459

Chapter Seven  Distribution of Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 461





I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 462 Frank H Easterbrook & Daniel R Fischel, The Economic Structure of Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . 464 A. Fact Pattern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 466 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 466 II. Overview of Canadian Securities Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 466 Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 468 III. What Is a Security? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 473 Securities and Exchange Commission v WJ Howey Co et al . . . . . . . . . . . 474 Question . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 477

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IV. Distribution of Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 478 Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480 V. Prospectus Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482 A. Contemporary Developments in Prospectus Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482 National Instrument 44-101, Short Form Prospectus Distributions . . . . 483 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 484 B. Prospectus Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 484 C. Materiality and the Content of Prospectuses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485 D. Sanctions for Non-Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486 1. Failure to Deliver a Prospectus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486 2. Failure to File . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487 VI. Liability for Prospectus Misrepresentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487 A. The Statutory Civil Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487 B. The Definition of “Misrepresentation” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488 C. The Potential Defendants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488 D. The Available Defences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488 E. Limitation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 489 VII. Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 490 A. Policy Objectives of Prospectus Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 490 Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491 B. Sources of Law in the Exemptions Area . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 493 C. Significant Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 493 1. The Private Issuer Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 493 Mark R Gillen, Securities Regulation in Canada . . . . . . . . . . . . . . . . . . . . . . 495 2. The Family, Friends, and Business Associates Exemption . . . . . . . . . . . . . . . . . . . . . . 496 3. The Crowdfunding Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 496 4. The “Accredited Investor” Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 496 5. The Minimum Amount Investment Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 498 6. Offering Memorandum Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 498 D. Resale Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 499 VIII. Continuous Disclosure Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 A. “Reporting Issuers” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 B. Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 501 National Instrument 51-102, Continuous Disclosure Obligations . . . . . 501 C. Management Discussion and Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 502 D. Annual Information Forms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503 E. Timely Disclosure of Material Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503 Pezim v British Columbia (Superintendent of Brokers) . . . . . . . . . . . . . . . 504 F. Liability for Misrepresentations in Continuous Disclosure Documents . . . . . . . . . . . . . 505 Mary Condon, “Rethinking Enforcement and Litigation in Ontario Securities Regulation” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 505 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 507 G. Academic Debate About the Need for Mandatory Disclosure . . . . . . . . . . . . . . . . . . . . . 508

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IX. Enforcement of Securities Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 509 A. Criminal Code Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 509 Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 509 B. Quasi-Criminal Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 510 Mary Condon, “Rethinking Enforcement and Litigation in Ontario Securities Regulation” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 511 C. Administrative Orders Based on Public Interest Criteria . . . . . . . . . . . . . . . . . . . . . . . . . . . 512 Re Cartaway Resources Corp . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 513 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 514 X. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 514

Chapter Eight  Social Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515





I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515 JJ McMurtry & François Brouard, “Social Enterprises in Canada: An Introduction” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 518 II. Origins of Social Enterprise Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 524 Jacques Defourny & Martha Nyssens, “Social Enterprises” . . . . . . . . . . . . 524 A. Co-operative Associations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 527 Antonio Fici, “Introduction to Cooperative Law” . . . . . . . . . . . . . . . . . . . . . 528 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 533 B. Not-for-Profit Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 533 Henry B Hansmann, “Economic Theories of Nonprofit Organization” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 535 Burton Weisbrod, “The Nonprofit Mission and Its Financing: Growing Links Between Nonprofits and the Rest of the Economy” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 539 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542 C. For-Profit Social Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542 Robert Katz & Antony Page, “The Role of Social Enterprise” . . . . . . . . . . . 542 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549 III. International Developments in Social Enterprise Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549 A. United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550 1. Community Interest Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550 a. CIC Regulator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550 b. Community Interest Test and Community Interest Statement . . . . . . . . . . . . 550 c. Asset Lock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 551 d. Dividend Cap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 551 e. Interest Cap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 552 f. Annual CIC Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 552 B. United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 552 1. Low-Profit Limited Liability Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 552 a. Purpose . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 552 b. Lack of IRS Assurances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 553

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2. Benefit Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 554 a. Public Benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 556 b. Board Consideration of Stakeholder Interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . 556 c. Benefit Director . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557 d. Benefit Enforcement Proceeding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557 e. Annual Benefit Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 558 Dana Brakman Reiser, “Benefit Corporations—A Sustainable Form of Organization?” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 558 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 562 C. Other Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 562 Tineke Lambooy, Aikaterini Argyrou & Rosemarie Hordijk, “Social Entrepreneurship as a New Economic Structure That Supports Sustainable Development” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 563 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569 IV. Social Enterprise Law in Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569 A. Co-operative Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 571 1. Solidarity Co-operative (Québec) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 571 2. Renewable Energy Co-operative (Ontario) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 572 3. New Generation Co-operative (Prairies) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 572 4. Community Service Co-operative (British Columbia) . . . . . . . . . . . . . . . . . . . . . . . . . . 573 B. Community Contribution Company/Community Interest Company . . . . . . . . . . . . . . 573 1. Community Contribution Company (British Columbia) . . . . . . . . . . . . . . . . . . . . . . . . 574 a. No Regulator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 574 b. Incorporation and Community Purpose . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 574 c. Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 575 d. Asset Lock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 575 e. Dividend Cap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 576 f. Interest Cap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 576 g. Annual Community Contribution Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 576 2. Community Interest Company (Nova Scotia) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 576 a. CIC Registrar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 576 b. Incorporation and Community Purpose . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 577 c. Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 577 d. Asset Lock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 577 e. Dividend Cap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578 f. Interest Cap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578 g. Annual Community Interest Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578 V. Introduction to Social Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578 A. Responsible Investment/Socially Responsible Investment . . . . . . . . . . . . . . . . . . . . . . . . 579 United Nations Principles for Responsible Investment, “The Six Principles: Signatories’ Commitment” . . . . . . . . . . . . . . . . . . . . 581 Benjamin J Richardson, Socially Responsible Investment Law: Regulating the Unseen Polluters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 582 B. Impact Investing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 585 Karim Harji et al, “Introduction to Impact Investing in Canada” . . . . . . . 585 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 587

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Chapter Nine  Theories of the Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 589





I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 589 II. Economic Theories of the Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 590 A. Wealth Maximization and Rational Choice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 591 Richard A Posner, “Wealth Maximization Revisited” . . . . . . . . . . . . . . . . . . 591 Thomas S Ulen, “Rational Choice Theory in Law and Economics” . . . . . 593 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 594 B. Nexus of Contracts Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 594 Frank H Easterbrook & Daniel R Fischel, “The Corporate Contract” . . . . 594 Ian Ayres & Robert Gertner, “Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules” . . . . . . . . . . . . . . . . . . . . . . . . . . . . 596 C. Transaction Cost Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600 Oliver Williamson, “The Economics of Organization: The Transaction Cost Approach” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600 D. Agency Cost Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 602 Michael C Jensen & William C Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure” . . . . . 603 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 605 III. Socio-economic Theories of the Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 606 David Millon, “Communitarians, Contractarians, and the Crisis in Corporate Law” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 606 Kent Greenfield, “Corporate Law as Public Law” . . . . . . . . . . . . . . . . . . . . . . 607 Margaret M Blair & Lynn A Stout, “A Team Production Theory of Corporate Law” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 610 Spencer Thompson, “Towards a Social Theory of the Firm: Worker Cooperatives Reconsidered” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 613 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 618 IV. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 618

Chapter Ten  Corporate Governance: The Stakeholder Debate . . . . . . . . . . . . . . . . . . . . . . 621





I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 621 II. Shareholder Primacy as One Approach to the Stakeholder Debate . . . . . . . . . . . . . . . . . . . . . . 622 Fenner Stewart, “Berle’s Conception of Shareholder Primacy: A Forgotten Perspective for Reconsideration During the Rise of Finance” . . . . . . . 623 Dodge v Ford Motor Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 625 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 628 III. Widening the Lens to Consider Broader Stakeholder Interests . . . . . . . . . . . . . . . . . . . . . . . . . . 629 Kent Greenfield, The Third Way: Beyond Shareholder or Board Primacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 629 Robert Yalden, “Competing Theories of the Corporation and Their Role in Canadian Business Law” . . . . . . . . . . . . . . . . . . . . . . . . . 633 IV. Shareholder Primacy Narrowly Cast . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 634 Daniel Fischel, “The Corporate Governance Movement” . . . . . . . . . . . . . . 635 V. Stakeholder Interests Are More than Part of a Mediating Hierarchy . . . . . . . . . . . . . . . . . . . . . 636 Margaret M Blair & Lynn A Stout, “A Team Production Theory of Corporate Law” . . . . . . . . . . . . . . . . . . . . 636 Kellye Testy, “Capitalism and Freedom: For Whom? Feminist Legal Theory and Progressive Corporate Law” . . . . . . . . . . . . 636

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VI. Best Interests of the Corporation Requires Considering All Stakeholder Interests . . . . . . . . 637 Kent Greenfield, “The Third Way: Beyond Shareholder or Board Primacy” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 637 Lynne Dallas, “Two Models of Corporate Governance: Beyond Berle and Means” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 640 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 640 A. Corporate Social Responsibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 640 Cheryl Wade, “Comparisons Between Enron and Other Types of Corporate Misconduct: Compliance with Law and Ethical Decision Making as the Best Form of Public Relations” . . . . . . . . . . . . . 641 Carol M Liao, “A Canadian Model of Corporate Governance” . . . . . . . . . . 642 andré douglas pond cummings, Steven A Ramirez & Cheryl Lyn Wade, “Toward a Critical Corporate Law Pedagogy and Scholarship” . . . . . 644 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 646 B. Socially Responsible Investing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 646 Benjamin J Richardson & Maziar Peihani, “Universal Investors and Socially Responsible Finance: A Critique of a Premature Theory” . . . 647 VII. The Stakeholder Debate and Corporations’ International Human Rights Obligations . . . . 650 United Nations Principles of Responsible Investment . . . . . . . . . . . . . . . . 650 A. Corporations and Human Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 651 Norms on the Responsibilities of Transnational Corporations and Other Business Enterprises with Regard to Human Rights . . . . . . . . . . . . . . . 651 United Nations Human Rights Office of the High Commissioner, Guiding Principles on Business and Human Rights: Implementing the United Nations “Protect, Respect and Remedy” Framework . . . . 655 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 659 Araya v Nevsun Resources Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 659 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 664 B. Corporate Groups and Limits on Drawing Aside the Corporate Veil to Satisfy Stakeholder Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 664 Yaiguaje v Chevron Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 665 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 672 VIII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 672

Chapter Eleven  Board Composition and the Role of Directors . . . . . . . . . . . . . . . . . . . . . . 673



I. The Duties of Directors and Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 674 Peoples Department Stores Inc (Trustee of ) v Wise . . . . . . . . . . . . . . . . . . 675 BCE Inc v 1976 Debentureholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 683 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 685 Nielsen (Estate of ) v Epton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 686 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 687 II. Independence of Corporate Boards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 687 A. Outside Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 687 Janis Sarra & Vivian Kung, “Corporate Governance in the Canadian Resource and Energy Sectors” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 689 B. The Need for Board Diversity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 691 Janis Sarra, “Class Act: Considering Race and Gender in the Corporate Boardroom” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 691

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Aaron A Dhir, “Towards a Race and Gender-Conscious Conception of the Firm: Canadian Corporate Governance, Law and Diversity” . . 693 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 694 C. Board Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 695 III. Director Appointment, Replacement, and Removal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 696 A. Few Minimum Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 696 Janis Sarra & Vivian Kung, “Corporate Governance in the Canadian Resource and Energy Sectors” . . . . . . . . . . . . . . . . . . . . 697 B. Residency Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 698 C. Election of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 699 D. Term of Office . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700 E. Filling of Vacancies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701 F. Increasing the Size of the Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701 G. Ceasing to Hold Office . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701 H. Removal of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701 Aurum, LLC v Calais Resources Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 702 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707 IV. Authority of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707 A. Adoption, Amendment, or Repeal of the Bylaws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707 B. Borrowing Powers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707 C. Declaration of Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 708 V.  Appointment and Compensation of Officers and the Delegation of Powers . . . . . . . . . . . . . 708 VI. Directors’ Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 709 VII. The Business Judgment Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 709 Peoples Department Stores Inc (Trustee of ) v Wise . . . . . . . . . . . . . . . . . . 710 VIII. Closely Held Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 711 Re Barsh and Feldman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 713 IX. Different Treatment Under Modern Canadian Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 715 X. Shareholder Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 716 Ringuet v Bergeron . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 716 XI. Binding the Directors’ Discretion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 718 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 719 XII. Share Transfer Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 720 A. Types . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 720 B. Validity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 722 XIII. The Choice Between a Closely Held and a Widely Held Corporation . . . . . . . . . . . . . . . . . . . . . 723 Question . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 724 XIV. Creating National Corporate Governance Guidelines for Publicly Traded Corporations . . 724 National Policy 58-201, Corporate Governance Guidelines . . . . . . . . . . . 724 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 730 XV. Securities Laws Disclosure Requirements in Respect of Corporate Governance . . . . . . . . . . 730 A. Voluntary Guidelines, Mandatory Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 730 National Instrument 58-101, Disclosure of Corporate Governance Practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 730 Form 58-101F1, Corporate Governance Disclosure . . . . . . . . . . . . . . . . . . . 731 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 734 B. Financial Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 734

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C. Auditing of Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 735 Kripps v Touche Ross & Co . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 737 D. Certification of Disclosure and Fair Presentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 739 Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada: Cases and Commentary, 3rd ed . . . . . . . . . 741 E. Reporting on Internal Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 741 XVI. The Role of Audit Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 742 NI 52-110, Audit Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 743 A. Independence of Audit Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 744 B. Temporary Exceptions to Independence Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . 745 C. Financial Literacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 745 D. Non-Audit Services to Be Approved . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 746 E. Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 747 XVII. Corporate Charity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 747 Harry Arthurs, “The Hollowing Out of Corporate Canada?” . . . . . . . . . . . 748 Laureen Snider, “The Sociology of Corporate Crime: An Obituary (or: Whose Knowledge Claims Have Legs?)” . . . . . . . . . . . . . . . . . . . . . . . 748 XVIII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 749

Chapter Twelve  Shareholder Participation in Corporate Governance . . . . . . . . . . . . . . . 751





I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 752 II. Shareholder Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 753 Automatic Self-Cleansing Filter Syndicate Co v Cunninghame . . . . . . . 753 A. Election of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 755 B. Amendment of Bylaws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 755 C. Unanimous Shareholder Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 756 D. Fundamental Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 757 E. Class Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 758 III. The Distribution of Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 760 A. Development of the Use of “Restricted” (Non-Voting, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-Preferred) Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 761 B. Voting Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 762 Jacobsen v United Canso Oil & Gas Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 762 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 766 C. Equal Treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 767 McClurg v Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 767 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 776 D. Cumulative Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 776 IV. The Significance of Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 777 A. Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 778 V. Shareholder Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 779 A. Annual Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 779 B. Special Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 779 C. Ordinary and Special Resolutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 780 D. Place of Meeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 780 E. Quorum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 781 F. The Principle of Notice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 781

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G. Conduct of Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 782 Blair v Consolidated Enfield Corp . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 783 VI. Shareholder Voice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 785 A. Meetings Requisitioned by Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 785 B. Meetings by Order of the Court . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 786 C. Intervention on the Basis of Fault . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 787 D. Meetings in Widely Held Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 787 Re Canadian Javelin Ltd and Boon-Strachan Coal Co Ltd . . . . . . . . . . . . . 788 E. Constitutionality Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 791 Re British International Finance (Canada) Ltd Charlebois v Bienvenu . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 791 F. Beneficial Owners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 793 Marshall v Marshall Boston Iron Mines Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . 793 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 796 VII. Access to Records and List of Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 796 A. Access to Records . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 796 B. Mechanics of Access . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 798 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 798 VIII. Institutional Investor Monitoring and Activism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 799 Janis Sarra, “Institutional Investors Must Take a Leadership Role in Financing Climate Mitigation and Adaptation” . . . . . . . . . . . . . . . . . . 802 IX. Proxy Solicitation and Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 803 Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 804 Canada, Senate, Report of the Senate Standing Committee on Banking, Trade and Commerce on Corporate Governance . . . . . . . . . 805 A. Legal Developments in the Proxy Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 805 B. Proxy Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 806 C. Who Must Solicit Proxies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 807 D. Sample Proxy Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 808 Notice of Annual and General Meeting of Shareholders and Management Information Circular . . . . . . . . . . . . . . . . . . . . . . . . . . . 808 Genesis Land Development Corp v Smoothwater Capital Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 813 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 817 E. Compliance with More Than One Set of Proxy Solicitation Rules . . . . . . . . . . . . . . . . . . 817 F. Restrictions on Soliciting Proxies and Exceptions to Allow for Shareholder Communication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 818 Janis Sarra, “The Corporation as Symphony: Are Shareholders First Violin or Second Fiddle?” . . . . . . . . . . . . . . . . . . . 819 G. Objecting Beneficial Owners and Non-Objecting Beneficial Owners . . . . . . . . . . . . . . 819 Stuart Morrow, “Proxy Contests and Shareholder Meetings” . . . . . . . . . . 820 National Instrument 54-101, Communication with Beneficial Owners of Securities of a Reporting Issuer . . . . . . . . . . . . . . . . . . . . . . . . 821 H. The Adequacy of Disclosure and Materiality Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . 822 Harris v Universal Explorations Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 824 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 826

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I. Express Statutory Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 826 Question . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 827 X. Proposals by Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 827 A. Eligibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 827 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 830 B. Scope of Proposals Has Been Broadened . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 830 Re Varity Corp and the Jesuit Fathers of Upper Canada . . . . . . . . . . . . . . . 830 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 833 XI. The Role of Regulators in Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 833 Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 834 XII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 836

Chapter Thirteen  Fiduciary Duties in Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . 839





I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 839 II. Theoretical Concepts for Analyzing Corporate Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . 840 A. Agency Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 840 B. Team Production Theory with the Board of Directors as a Mediating Hierarchy . . . . 843 C. Broader Stakeholder Interests and Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 845 III. Fiduciary Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 846 A. The Basic Content of Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 847 B. When Does a Fiduciary Relationship Arise? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 848 C. The Default Nature of Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 849 IV. Fiduciary Duties of Corporate Directors and Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 850 A. The Duty of Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 851 1. The Standard of Care Prior to Its Codification in Canadian Corporate Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 851 2. Statutory Codification of the Duty of Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 853 a. Income Tax Act Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 853 b. Interpretation of CBCA Section 122(1)(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 855 3. Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 858 4. Damages and Causation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 859 5. Reasonable Reliance on Officials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 860 6. Due Diligence in Complying with Certain Obligations Under the Statute . . . . . . 860 7. Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 861 8. Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 862 9. Securities Regulators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 862 10. Who Pays for Breaches of the Duty of Care? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 863 B. The Duty of Loyalty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 864 1. Conflicts of Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 864 a. Strict Common Law Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 864 b. Avoiding the Common Law Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 865 i.   Conflict of Interest Provisions in Corporate Articles or Bylaws . . . 865 ii.   Ratification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 865 c. The Statutory Conflict of Interest Provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 866 i. Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 866 ii.  Abstention from Voting by Interested Directors . . . . . . . . . . . . . . . . 868

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iii.  Disinterested Director Approval and Reasonable and Fair to the Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 868 iv.  Shareholder Approval Even Where Disclosure Was Not Made as and when Required . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 868 d. Ontario and Québec Securities Regulation Requirements in the Context of Particular Conflict of Interest Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 869 2. Corporate Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 871 a. The Strict Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 873 b. Developments in Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 875 i.  Peso Silver Mines v Cropper (1965) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 875 ii.  Can Aero v O’Malley (1974) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 877 iii.  The Burg v Horn Situation Referred to in Can Aero v O’Malley . . 879 iv.  Director of Many Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 880 v.  Corporation with Many Subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . 881 vi.  Yukon Business Corporations Act Safe Harbour for Taking of Business Opportunity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 882 3. Proper Purpose and the Best Interests of the Corporation . . . . . . . . . . . . . . . . . . . . . 883 a. The Proper Purpose Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 884 b. The Best Interests of the Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888

Chapter Fourteen  Stakeholder Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 891



I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 891 II. The Derivative Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 892 A. At Common Law: The Rule in Foss v Harbottle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 892 MA Maloney, “Whither the Statutory Derivative Action?” . . . . . . . . . . . . . 892 B. Statutory Derivative Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 894 Primex Investments Ltd v Northwest Sports Enterprises Ltd . . . . . . . . . . 895 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 904 Re Northwest Forest Products Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 905 Turner v Mailhot . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 908 III. The Oppression Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 914 A. UK Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 914 B. Canadian Oppression Remedy Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 915 C. Who May Bring an Application for an Oppression Remedy? . . . . . . . . . . . . . . . . . . . . . . . 916 First Edmonton Place Ltd v 315888 Alberta Ltd . . . . . . . . . . . . . . . . . . . . . . 917 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 924 D. Closely Held Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 924 Diligenti v RWMD Operations Kelowna Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . 924 Naneff v Con-Crete Holdings Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 936 E. Widely Held Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 940 Themadel Foundation v Third Canadian General Investment Trust Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 941 Ford Motor Co of Canada v Ontario Municipal Employees Retirement Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 942 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 953 BCE Inc v 1976 Debentureholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 954

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Mohamed F Khimji & Jon Viner, “Oppression: Reducing Canadian Corporate Law to a Muddy Default” . . . . . . . . . . . . . . . . . . . . 967 F.  Relationship Between the Derivative Action and the Oppression Remedy . . . . . . . . . 970 Christopher Nicholls, Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 970 Rea v Wildeboer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 971 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 975 IV. Appraisal Remedy (Right to Dissent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 975 Christopher Nicholls, Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 975 Deer Creek Energy Limited v Paulson & Co Inc . . . . . . . . . . . . . . . . . . . . . . . 977 85956 Holdings Ltd v Fayerman Brothers Ltd . . . . . . . . . . . . . . . . . . . . . . . . 986 V. Other Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 990 A. Compliance Orders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 990 B. Winding Up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 991 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 991

Chapter Fifteen  Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 993





I. Introduction and Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 994 A. Fact Pattern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 994 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 995 B. Social and Economic Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 995 1. Value Creation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 997 2. Consequences of Mergers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 998 3. Stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1000 a. The State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1000 b. Consumers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1000 c. Creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1001 d. Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1001 II. Formal Aspects of Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1002 A. Sale of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1004 B. Sale of Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1004 Cogeco Cable Inc v CFCF Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1006 1. The Quantitative Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1019 2. The Qualitative Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1019 Mark Gannage, “Sale of Substantially All the Assets of a Corporation” . 1020 C. Amalgamation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1021 R v Black and Decker Manufacturing Co . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1022 D. Other Merger Techniques . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1024 1. Plan of Arrangement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1024 Christopher Nicholls, Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1025 2.  Reverse Acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1025 3.  Triangular Merger . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1025 III. The Appraisal Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1026 A. The Market Exception . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1028 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1028 Report on Mergers, Amalgamations and Certain Related Matters . . . . 1028 B. Valuation of Dissenters’ Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1029

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xxxv

IV. Buyouts and Going-Private Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1032 Neonex International Ltd v Kolasa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1034 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1040 A. Class Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1042 B. Buyout Requirements in Ontario and Québec: MI 61-101 . . . . . . . . . . . . . . . . . . . . . . . . . 1043 C. Benefits and Costs of Buyouts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1045 V. Takeover Bids . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1046 A. Control Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1046 1. Selecting the Target Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1046 2. Techniques for Acquiring Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1047 B. Takeover Bid Regulation and Auction Theories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1049 1. Takeover Bid Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1049 2. Auction Theories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1051 C. Defensive Tactics: An Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1052 1. Making the Target Seem Attractive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1053 2. Making the Target Seem Unattractive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1053 3. Offensive Tactics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1053 4. Share Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1054 5. Takeovers and Stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1054 Teck Corporation Ltd v Millar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1056 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1063 6. Managerial Passivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1063 D. Defensive Tactics: The US Landscape . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1066 Peter Dey & Robert Yalden, “Keeping the Playing Field Level: Poison Pills and Directors’ Fiduciary Duties in Canadian Take-Over Law” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1066 Jody W Forsyth, “Poison Pills: Developing a Canadian Regulatory and Judicial Response” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1070 Jack B Jacobs, “Fifty Years of Corporate Law Evolution: A Delaware Judge’s Retrospective” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1073 Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1080 E. Defensive Tactics: The Canadian Landscape . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1082 1. Poison Pills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1082 2. Staggered Boards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1084 3. Shark Repellents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1084 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1085 Maple Leaf Foods Inc v Schneider Corp . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1085 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1102 F. Which Institutions Should Supervise Defensive Tactics in Canada? . . . . . . . . . . . . . . . . 1103 Robert Yalden, “Canadian Mergers and Acquisitions at the Crossroads: The Regulation of Defence Strategies after BCE” . . . . . . . . . . . . . . . . . . 1103 347883 Alberta Ltd v Producers Pipelines Inc . . . . . . . . . . . . . . . . . . . . . . . . 1108 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1122 Hecla Mining Company (Re) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1127 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1133

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1135

Table of Cases A page number in boldface type indicates that the text of the case or a portion thereof is reproduced. A page number in lightface type indicates that the case is quoted briefly or discussed. Cases mentioned within excerpts are not listed. 1184760 Alberta Ltd v Falconbridge Ltd (2006), 20 BLR (4th) 6 (Ont Sup Ct J) . . . . . . . . . . . . . . . . 1021n 1394918 Ontario Ltd v 1310210 Ontario Inc (2002), 57 OR (3d) 607 (CA) . . . . . . . . . . . . . . . . . . . . . . . . 373 347883 Alberta Ltd v Producers Pipelines Inc (1991), 80 DLR (4th) 359, [1991] 4 WWR 577 (Sask CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888n, 1083n, 1108 642947 Ont Ltd v Fleischer (2001), 56 OR (3d) 417 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193 85956 Holdings Ltd v Fayerman Brothers Ltd (1986), 46 Sask R 75 (CA) . . . . . . . . . . . . . . . . . . . 986, 1005 Abbey Glen Property Corporation v Stumborg (1978), 85 DLR (3d) 35 (Alta SC (AD)) . . . . . . . . . . . 879n Aberdeen Railway Co v Blaikie Brothers, [1843-60] All ER Rep 249 (HL) . . . . . . . . . . . . . . . . . . . . . . . . . 864 AC Acquisitions Corp v Anderson, Clayton & Co, 519 A2d 103 (Del Ch 1986) . . . . . . . . . . . . . . . . . . . 1080 AE LePage Ltd v Kamex Developments Ltd et al (1977), 16 OR (2d) 193, 78 DLR (3d)  223 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61, 63 Ahpin v Ahpin, 2004 ABQB 492 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177n Aleyn v Belchier (1758), 1 Eden 132 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 884n AP Mfg Co v Barlow, 98 A.2d 581 (NJ 1953) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 747 Araya v Nevsun Resources Ltd, 2016 BCSC 1856 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 659 Armitage v Nurse, [1997] 2 All ER 705 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 849n Armstrong v Northern Eyes Inc (2000), 48 OR (3d) 442 (Sup Ct J), aff’d [2001] OJ No 1085 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 940 Ashbury Ry Carriage & Iron Co v Riche (1875), LR 7 HL 653 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 378 Atco v Calgary Power Ltd, [1982] 2 SCR 557 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 427 Athabasca Holdings Ltd v ENA Datasystems Inc (1980), 30 OR (2d) 527 (H Ct J) . . . . . . . . . . . . . . . . . 787 Atlantic Waste Systems Ltd v Canada (Attorney General), 2014 BCSC 490 . . . . . . . . . . . . . . . . . . . . . . . 109 Auerbach v Bennett (1979), 393 NE 2d 994 (NYCA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 913 Aurum, LLC v Calais Resources Inc, 2016 BCSC 1173 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 702, 786 Automatic Self-Cleansing Filter Syndicate Co v Cunninghame, [1906] 2 Ch 34 (CA) . . . . . . . . 753, 755 B Love Ltd v Bulk Steel & Salvage Ltd (1982), 141 DLR (3d) 621 (Ont H Ct J) . . . . . . . . . . . . . . . . . . . . . 787 Babic v Milinkovic (1971), 22 DLR (3d) 732 (BCSC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 808n Babic et al v Milinkovic et al (1972), 25 DLR (3d) 752 (BCCA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 808n Backman v Canada, 2001 SCC 10, [2001] 1 SCR 367 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47, 62, 73 Baffinland Iron Mines Corp, Re (2010) 33 OSCB 11385 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1126 Balls v Strutt (1841), 1 Hare 146, 66 ER 984 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 884n Bamford v Bamford, [1970] 1 Ch 212 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1066n

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Banks, Re (2003), 26 OSCB 3377 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 863n Bannon v Pervais (1989), 68 OR (2d) 276 (Dist Ct) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 266n Barnes v Andrews, 298 F 614 (SDNY 1924) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 859 Barsh and Feldman, Re (1986), 54 OR (2d) 340 (H Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 713 Basic v Levinson, 108 S Ct 978, 99 L Ed 2d 194 (US Ohio 1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 508n Bastien Estate v Canada, 2011 SCC 38, [2011] 2 SCR 710 . . . . . . . . . . . . . . . . . . . . . . . . . . . 246n, 247, 340 BCE Inc v 1976 Debentureholders, 2008 SCC 69, [2008] 3 SCR 560 . . . . . . . . . . . . . . . . . . . 257n, 629, 675, 683, 858, 888-89, 954, 1024, 1080, 1085, 1122-23 Bell Houses Ltd v City Wall Properties Ltd, [1966] 2 QB 656 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 380 Bernard et al v Valentini et al (1978), 18 OR (2d) 656 (H Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1065 BG Preeco I (Pacific Coast) Ltd v Bon Street Holdings Ltd (1989), 60 DLR (4th) 30, 37 BCLR (2d) 258 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204, 210 Biovail Corporation, Re (2010), 33 OSCB 8914 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 863n Birch v Cropper, [1889] 14 AC 525 (HL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 423n Black and Decker Manufacturing Co, R v, [1975] 1 SCR 411 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1022 Black et al v Smallwood & Cooper (1966), 117 CLR 52 (HCA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 349, 355 Blaikie v Barrack, 524 F2d 891 (9th Cir 1975) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 508n Blair v Consolidated Enfield Corp (1993), 15 OR (3d) 783 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 783 Blueberry Interim Trust (Re), 2011 BCSC 769 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283, 292 Bonanza Creek Gold Mining Co v The King, [1916] 1 AC 566 (PC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 378n Bond v Barrow Haematite Steel Co, [1902] 1 Ch 353 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 447n Bonisteel v Collis Leather Co (1919), 45 OLR 195 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 887n, 1065 Bowater Canadian Ltd v RL Crain Inc (Ont CA) (1987), 62 OR (2d) 752 (CA) . . . . . . 423n, 424, 432, 767 Brazilian Rubber Plantations and Estates Ltd, Re, [1911] 1 Ch 425 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 851 British International Finance (Canada) Ltd Charlebois v Bienvenu, Re, [1968] 2 OR 217, 68 DLR (2d) 578 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 791 Brown v Duby (1980), 28 OR 745, 111 DLR (3d) 418, 11 BLR 129 (H Ct J) . . . . . . . . . . . . . . . . . . . . . 818n Budd v Gentra Inc (1998), 43 BLR (2d) 27 (Ont CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 939 Buff Pressed Brick Co v Ford (1915), 33 OLR 264, 23 DLR 718 (App Div) . . . . . . . . . . . . . . . . . . . . . . . 404n Burg v Horn, 380 F (2d) 897 (2d Cir 1967) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 879 Caleron Properties Ltd v 510207 Alberta Ltd, 2000 ABQB 720 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 991 Can Aero v O’Malley, [1974] SCR 592 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 877, 879 Canada v Buckingham, 2011 FCA 142 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 855n Canada Tea Co Ltd, Re (1959), 21 DLR (2d) 90 (Ont H Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455n Canada Trust Company and The Guelph Trust Company, Re The, [1950] OR 245 (SC) . . . . . . . . . . . 423n Canadian Gas & Energy Fund Ltd v Sceptre Resources Ltd, [1985] 5 WWR 43 at 57 (Alta QB) . . . 1030n Canadian Javelin Ltd and Boon-Strachan Coal Co Ltd, Re (1976), 69 DLR (3d) 439 (Que Sup Ct) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 788 Canadian Jorex Limited and Mannville Oil & Gas Ltd, In the Matter of (1992), 15 OSCB 257 . . . . . . 1123 Canadian Laboratory Supplies v Engelhard Industries, [1979] 2 SCR 787 . . . . . . . . . . . . . . . . . . . . . . . . 383 Canadian National Railway Co v McKercher LLP, 2013 SCC 39 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294 Canadian Tractor Co (Clarke’s case), Re (1914), 7 WWR 562 (Sask SC) . . . . . . . . . . . . . . . . . . . . . . . . . 404n Cardiff Savings Bank, Re, [1892] 2 Ch 100 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 851, 858 Carson, Re, [1963] 1 OR 373, 37 DLR (2d) 292 (H Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441 Cartaway Resources Corp, Re, 2004 SCC 26, [2004] 1 SCR 672 . . . . . . . . . . . . . . . . . . . . . . . . . . . 512n, 513 Casurina Limited Partnership v Rio Algom Ltd (2002), 28 BLR (3d) 44 (Ont Sup Ct J) . . . . . . . . . . 1044n Chapman v Treakle, 2014 BCSC 2127 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243n Chapters Inc, Re (2001), 24 OSCB 1657 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1124 Cheff v Mathes, 199 A2d 548 (Del 1964) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1063, 1066, 1080

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Chevron Corp v Yaiguaje 2015 SCC 42, [2015] 3 SCR 69 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177n Churchill Pulpmill Ltd v Manitoba, [1977] 6 WWR 109 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 904 City Equitable Fire Insurance Co Ltd, Re, [1925] Ch 407 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 852n, 854 Clarkson Co Ltd v Zhelka (1967), [1967] 2 OR 565, 64 DLR (2d) 457 (H Ct J) . . . . . . . . . . . . . . . . . . . . 210 Clow Darling Ltd v Big Trout Lake Band (1989), 70 OR (2d) 56 (Dist Ct) . . . . . . . . . . . . . . . . . . . . . . . . 266n Cogeco Cable Inc v CFCF Inc (1996), 136 DLR (4th) 243 (Que CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1006 Commandant v Wahta Mohawks, [2006] OJ No 22 (Sup Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 266n Commissioners for Special Purposes of the Income Tax v Pemsel, [1891] AC 531 (HL) . . . . . . . . . . . 534n Committee for the Equal Treatment of Asbestos Minority Shareholders v Ontario (Securities Commission), 2001 SCC 37, [2001] 2 SCR 132 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 512 Communities Economic Development Fund v Canadian Pickles Corp, [1991] 3 SCR 388 . . . . . . . . 380n Continental Bank Leasing Corp v Canada, [1998] 2 SCR 298 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 380n Cotnam v Brougham, [1918] AC 514 (HL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 380n Cox & Wheatcroft v Hickman (1860), 8 HL Cas 268 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49, 51, 61-62 Custodian v Blucher, The, [1927] SCR 420 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 448n CW Shareholding Inc v WIC Western International Communications Ltd (1998), 39 OR (3d) 755, 160 DLR (4th) 131 (Gen Div) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 856n, 1103, 1126 Cyprus Anvil Mining Corporation v Dickson (1982), 40 BCLR 180, 20 BLR 21 (BSC) . . . . . . . . . . . . 1040n Dairy Corporation of Canada Limited, Re, [1934] OR 436, [1934] 3 DLR 347 . . . . . . . . . . . . . . . . . . . 805n Deer Horn Mines Ltd, In the Matter of, [1968] OSCB 12 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 479 De Salaberry Realties Ltd v Minister of National Revenue (1974 Trial Division) (1974), 46 DLR (3d) 100 (FCTD) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198 De Salaberry Realties Ltd v The Queen (1976 Court of Appeal) (1976), 70 DLR (3d) 706 (FCA) . . . . 198 Deer Creek Energy Limited v Paulson & Co Inc (QB), 2008 ABQB 326 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 977 Deer Creek Energy Limited v Paulson & Co Inc (CA), 2009 ABCA 280 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 977 Denham & Co, Re (1883), 25 Ch D 752 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 851n-52n Diligenti v RWMD Operations Kelowna Ltd (1976) 1 BCLR. 36 (SC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 924 Diligenti v RWMD Operations Kelowna Ltd (1977) 4 BCLR 134 (SC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 935 Dimo Holdings Ltd v H Jager Developments Inc (1998), 43 BLR 123 (Alta QB) . . . . . . . . . . . . . . . . . 867n Dodge v Ford Motor Company, 204 Mich 459, 170 NW 668 (1919) . . . . . . . . . . . . . . . . . . . . . 445-46, 625 Domglas Inc v Jarislowsky Fraser & Co Ltd (1982) 138 DLR (3d) 521 (Que CA) . . . . . . . . . . . . . . . . . . 1031 Domglas Inc. Re (1980), 13 BLR 135 at 157-58 (Que SC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1027n, 1031 Dovey v Corey, [1901] AC 477 (HL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 852n Dubé v Canada, 2011 SCC 39, [2011] 2 SCR 764 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246n-47 Duke of Portland v Topham (1864), 11 HLC 32, 11 ER 1242 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 884n Eclairs Group Ltd and Glengary Overseas Ltd v JKX Oil & Gas plc, [2015] UKSC 71 . . . . . . . . . . . . . . . . 885 Edenvale Restoration Specialists Ltd v British Columbia (Finance), 2013 BCCA 85 . . . . . . . . . . 320, 328 Edmonton Country Club v Case, [1975] 1 SCR 534 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 722 Ernst & Young Inc v Falconi (1994), 17 OR (3d) 512 (Gen Div) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 Escott v BarChris Construction Corp, 283 F Supp. 643 (1968) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 489 Esso Standard (Inter-America) v JW Enterprises et al and MA Morrisroe, [1963] SCR 144 . . . . . . . 1040n Ex Parte James (1803), 8 Ves Jun 337, 32 ER 385 (Ch D) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 864n, 874-75 F de Jong & Co, Re, [1946] Ch 211 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454n Falconbridge (2006), 29 OSCB 6783 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1124 Farnham et al v Fingold et al, [1973] 2 OR 132, 135 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 905 Ferguson and Imax Systems Corp, Re (1983), 43 OR (2d) 128 (CA) . . . . . . . . . . . . . . . . . . . . . . . 446, 1042n Ferguson v Imax Systems Corp (1980), 12 BLR 209 (Ont H Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1042n

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First City Financial Corp v Genstar Corp (1981), 33 OR (2d) 631 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1065 First Edmonton Place Ltd v 315888 Alberta Ltd (1988), 40 BLR 28 (Alta QB) . . . . . . . . . . . . . . . . . . . . . . 917 Flatley v Algy Corp (2000), 9 BLR (3d) 255 (Ont SC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 940 Flitcroft’s Case (1882), 21 Ch D 519 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 447 Ford Motor Co of Canada v Ontario Municipal Employees Retirement Board (2006) 263 DLR (4th) 450, 79 OR (3d) 81 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 942 Ford Motor Co of Canada v Ontario Municipal Employees Retirement Board (1998), 36 OR (3d) 384 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1031 Foss v Harbottle (1843), 2 Hare 460, 67 ER 189 (HL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 894, 905 Frame v Smith, [1987] 2 SCR 99 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 848 Fraser v MNR, [1987] 1 CTC 2311, 87 DTC 250 (TCC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 853 Freeman & Lockyer (A Firm) v Buckhurst Park Properties (Mangal) Ltd and Another, [1964] 2 QB 480 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382n Genesis Land Development Corp v Smoothwater Capital Corporation, 2013 ABQB 509 . . . . . . . . . 813 George Albino, Re, [1991] 14 OSCB 365 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 474n Gitga’at Development Corp v Hill, 2007 BCCA 158, [2007] BCJ No 536, 238 BCAC 205, 66 BCLR (4th) 349, 30 ETR (3d) 37, 156 ACWS (3d) 267 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275 Glen Harvey Harper, In the Matter of (2004), 27 OSCB 3937 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 513n Global Securities Corp v British Columbia (Securities Commission), 2000 SCC 21, [2000] 1 SCR 494 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 467n Goldex Mines Ltd v Revill (1974), 7 OR (2d) 216 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 848n Goldhar and Quebec Manitou Mines Ltd et al, Re (1975), 61 DLR (3d) 612, 9 OR (2d) 740  (H Ct J (Div Ct) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 990 Goldhar et al and D’Aragon Mines Ltd, Re (1977), 15 OR (2d) 80 (H Ct J) . . . . . . . . . . . . . . . . . . . . . . . . 806 Grace v Smith, 2 Sir W Bl 998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Gray v New Augarita Porcupine Mines Ltd, [1952] 3 DLR 1 (UK JCPC) . . . . . . . . . . . . . . . . . . 865-66n, 868 Greenhalgh v Mallard, [1943] 2 All ER 234 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 718 Groupe d’action d’investisseurs dans Biosyntech c Tsang, 2016 QCCA 1923 . . . . . . . . . . . . . . . . . . . 894n Guerin v The Queen, [1984] 2 SCR 335 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 848n Gull Bay Development Corp v R, [1983] FCJ No 1133, [1984] 1 CNLR 74, [1984] 2 FC 3 . . . . . . . . . . . 312 H & H Logging Co v Random Services Corp (1967), 63 DLR (2d) 6 (BCCA) . . . . . . . . . . . . . . . . . . . . . . 380n Handley v Stutz, 139 US 417 (1891) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 408 Harris v Universal Explorations Ltd, 1982 ABCA 87, 17 BLR 135 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 824 Haughton Graphic Ltd v Zivot, [1986] OJ No 288, 33 BLR 125 (H Ct J) . . . . . . . . . . . . . . . . 104, 319, 328 Hecla Mining Company (Re), 2016 BCSECCOM 250, 39 OSCB 8927 . . . . . . . . . . . . . . . . . . . . . . . . . . 1127 Hedley Byrne & Co v Heller & Partners Ltd, [1964] AC 465 (HL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488 Hellenic & General Trust Ltd, Re, [1976] 1 WLR 123 (Ch) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1042-43 Hely-Hutchison v Brayhead Ltd, [1968] 1 QB 549 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382 Hess Manufacturing Company, In re (1894), 23 SCR 644 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410 Highfields Capital I LP v Telesystem International Wireless Inc (2002), 29 BLR (3d) 249 (Ont Sup Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1044n Hodgkinson v Simms, [1994] 3 SCR 377 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 848 Hogarth v Rocky Mountain Slate Inc, 2013 ABCA 57, 542 AR 289 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177n Hogg v Cramphorn, [1967] Ch 254, [1966] 3 All ER 420 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 887, 1064-65 Hovsepian v Westfair Foods Ltd, 2003 ABQB 641, [2004] 5 WWR 519 . . . . . . . . . . . . . . . . . . . . . . . . 1019n Howard Smith Ltd v Ampol Petroleum Ltd, [1974] 1 All ER 1126, [1974] AC 821 (PC) . . . . . . 884, 1065 HR Harmer Ltd, Re, [1958] 3 All ER 689 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 915

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Icahn Partners LP v Lions Gate Entertainment Corp, 2011 BCCA 228 . . . . . . . . . . . . . . . . . . . . . . . . . . 888n International Power Co v McMaster University/In re Puerto Rico Power Co, [1946] SCR 178 . . . . . . . 449 Jacobsen v United Canso Oil & Gas Ltd (1980), 113 DLR (3d) 427, [1980] 6 WWR 38, 11 BLR 313 (Alta QB) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 427, 762 Jacobsen v United Canso Oil & Gas Ltd (1980), 12 BLR 113 (NS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 766 Jarvis, R v, 2002 SCC 73, [2002] 3 SCR 757 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 511n Jay v North 692 F 2d 880 (2d Cir 1982) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 913 Johnston v Greene, 121 A (2d) 919 (Del SC 1956) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 880 Jones v FH Deacon Hodgson Inc (1986), 56 OR (2d) 540, 31 DLR (4th) 455 (H Ct J) . . . . . . . . . . . . 487n Katz v Bregman, 431 A2d 1274 (Del Ch 1981) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1020 Keech v Sandford (1726), Sel Cas T King 61, 25 ER 223 (Ch D) . . . . . . . . . . . . . . . . . . . . . . . . . 864n, 874-76 Kelly v Canada (Attorney General), 2013 ONSC 1220 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 266n Kelly v Electrical Construction Co (1907), 16 OLR 232 (H Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 754n Kelner v Baxter (1866), LR 2 CP 174 (Common Pleas) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .344, 355, 404 Kerr v Danier Leather, (2004) 46 BLR (3d) 167 (Ont Sup Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 489-90 Kerr v Danier Leather (2006), 20 BLR (4th) 1, 77 OR (3d) 321 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . 489-90 Kerr v Danier Leather Inc, 2007 SCC 44, [2007] 2 SCR 331 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486, 488-90 King v Gull Bay Indian Band, [1983] OJ No 2152, 38 CPC 1 (Co Ct) . . . . . . . . . . . . . . . . . . . . . . . . . . . 266n Kosmopoulos v Constitution Insurance Co, [1987] 1 SCR 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208 Kripps v Touche Ross & Co, [1997] 6 WWR 421, 33 BCLR (3d) 254 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . 737 Kucor Construction & Developments & Associates v Canada Life Assurance Co (1997), 32 OR (3d) 548 (Gen Div) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Kwicksutaineuk/Ah-Kwa-Mish First Nation v Canada (Attorney General), 2012 BCCA 193 . . . . . . . 266 Lac Minerals Ltd and Royal Oak Mines Inc, (1994), 17 OSCB 4963 . . . . . . . . . . . . . . . . . . . . . 1083n, 1123 Lac Minerals Ltd v International Corona Resources Ltd, [1989] 2 SCR 574 . . . . . . . . . . . . . . . . . . . . . . . 848 Lane v Page (1754), Amb 233 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 884n Langley’s Ltd, Re, [1938] OR 123, [1938] 3 DLR 230 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 805n Lansing Building Supply (Ontario) Ltd v Ierullo (1989), 71 OR (2d) 173 (Dist Ct) . . . . . . . . . . . . . . . 68, 73 Laskin v Bache & Co Inc (1971), 23 DLR (3d) 385 (Ont CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 848n Lee v Lee’s Air Farming Ltd, [1961] AC 12 (PC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173 Leggat et al v Jennings et al, 2013 ONSC 903 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 798 LePage Ltd v March et al, [1979] 2 SCR 155, 105 DLR (3d) 84n . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61, 63 Li v Global Chinese Press Inc, 2014 BCCA 53 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 798 Limelight Entertainment Inc (2008) 31 OSCB 1727 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 478 Loeb, Ltd, In the Matter of, [1978] OSCB 333 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1045 Louie v Louie, 2015 BCCA 247 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287 Lynch v Segal (2006), 82 OR (3d) 641 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225 MacMillan Bloedel Ltd v Binstead (1983), 22 BLR 255 (BCSC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 878n Maple Leaf Foods Inc v Schneider Corp (1998), 42 OR (3d) 177, 44 BLR (2d) 115 (CA) . . . . 888n, 1085 Marshall v Marshall Boston Iron Mines Ltd (1981), 129 DLR (3d) 378 (Ont H Ct J) . . . . . . . . . . . . . . . . 793 Martin v British Columbia, [1986] 3 CNLR 84, 3 BCLR (2d) 60 (SC) . . . . . . . . . . . . . . . 266, 267, 275, 292 Martin v Gibson, [1907] 15 OLR 623 (H Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888n Matic v Waldner, 2016 MBCA 60 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 877n Mayland and Mercury Oils Limited v Lymburn and Frawley, [1932] 2 DLR 6, [1932] 1 WWR 578 (Alta JCPC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 467n

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McAteer v Devoncroft Developments Ltd, 2001 ABQB 917 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 867n McClurg v Canada, [1990] 3 SCR 1020, 76 DLR (4th) 217 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 427, 767 McCormick v Fasken Martineau DuMoulin LLP, 2014 SCC 39, [2014] 2 SCR 108 . . . . . . . . . . . . . . . 81, 88 McKenzie Securities Limited, R v W (1966), 56 DLR (2d) 56, 55 WWR 157 (Man CA)(1 . . . . . . . . . . 467n McKnight v Hutchison (2002 BC Supreme Court), 2002 BCSC 1373, 28 BLR (3d) 269 . . . . . . . . . . . 95-96 McKnight v Hutchison (2013 BC Court of Appeal), 2013 BCCA 340 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 McKnight v Hutchison (2014 BC Court of Appeal) 2014 BCCA 472 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 McKnight v Hutchison (2015 BC Supreme Court), 2015 BCSC 1886 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 MDC Corporation and Royal Greetings & Gifts (1994), 17 OSCB 4971 . . . . . . . . . . . . . . . . . . 1083n, 1124 Mennillo v Intramodal Inc, 2016 SCC 51, [2016] 2 SCR 438 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 940 Metcalfe and Sons Ltd, [1933] Ch 142 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454 Mitchell v Peguis Indian Band, [1990] 2 SCR 85, 71 DLR (4th) 193, [1990] 5 WWR 97, 110 NR 241, [1990] 3 CNLR 46, [1990] ACS no 63, 67 Man R (2d) 81 . . . . . . . . . . . . . . . . . . 245, 330 MM Companies v Liquid Audio, Inc, 813 A2d 1118 (Del 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1084n Montgomery and Montgomery v Shell Canada Ltd (1980), 111 DLR (3d) 116 (Sask QB) . . . . . . . . 1029 Moran v Household Int’l, Inc, 500 A.2d 1346 (Del 1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1070 Morris Funeral Service Ltd, Re (1957), 7 DLR (2d) 642 (Ont CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 786 Mosely v Koffyfontein Mines Ltd, [1904] 2 Ch 108 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 408-9 Multiple Access Ltd v McCutcheon, [1982] 2 SCR 161 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 467n Naneff v Con-Crete Holdings Ltd (1995), 23 OR (3d) 481 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 936 Nedco Ltd v Clark and Communications Workers of Canada, Local Number 4 (1973), 43 DLR (3d) 714 (Sask CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177n Neil, R v, 2002 SCC 70, [2002] 2 SCR 631 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293-94 Neo Material Technologies Inc, Re (2009) 32 OSCB 6941 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1125 Neonex International Ltd v Kolasa (1978), 84 DLR (3d) 446 at 452 (BCSC) . . . . . . . . . . . . . 1030n, 1034 Newborne v Sensolid (Great Britain) Ltd, [1953] 1 All ER 708 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . 347, 355 Nielsen (Estate of) v Epton (QB), 2006 ABQB 21 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 685 Nielsen (Estate of) v Epton (CA), 2006 ABCA 382 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 686 Nordile Holdings Ltd v Breckenridge (1992), 66 BCLR (2d) 183 (CA) . . . . . . . . . . . . . . . . . . . 107, 319, 328 North-West Electric Co v Walsh, The (1898 SCC) (1898), 29 SCR 33 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 408 North-West Electric Co v Walsh, The (Man QB) (1897), 11 Man LR 629 (QB) . . . . . . . . . . . . . . . . . . . . . 408 North-West Transportation Co Ltd v Beatty (1887), 12 App Cas 589 (JCPC) . . . . . . . . . . . . . . . . 866, 870 Northern & Central Gas Corporation Limited v Hillcrest Colliers Limited (1976), 59 DLR (3d) 533 (Alta SC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1065 Northwest Forest Products Ltd, Re, [1975] 4 WWR 724 (BC SC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 905 Nowegijick v The Queen, [1983] 1 SCR 29 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246n Oakbank Oil Company v Crum, [1883] 8 AC 65 (HL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 423n Olson v Phoenix Industrial Supply Ltd (1984), 9 DLR (4th) 451 (Man CA) . . . . . . . . . . . . . . . . . . . . . . . 1065 Olympia & York Enterprises Ltd and Hiram Walker Resources Ltd et al; Re Interprovincial Pipe Line Ltd and Hiram Walker Resources Ltd et al, Re (1986), 37 DLR (4th) 193, 59 OR (2d) 254 (H Ct J (Div Ct)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 678, 888n, 1020, 1065n, 1081 Omnicare, Inc v NCS Healthcare Inc, 818 A.2d 914 (Del 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1082 Ooregum Gold Mining Co v Roper, [1892] AC 125 (HL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405 Otineka Development Corp v Canada, [1994] 1 CTC 2424, [1994] 2 CNLR 83 (TCC) . . . . . . . . . . . . . . 248 Pacific Coast Coal Mines Ltd v Arbuthnot, [1917] AC 607 (PC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 823 Pacific Coast Coin Exchange v Ontario Securities Commission, [1978] 2 SCR 112, 80 DLR (3d) 529, 2 BLR 212 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 474

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Page v Austin (1884) 10 SCR 132 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410n Paul Donald, In the Matter of, [2012] 35 OSCB 7383, 4 BLR (5th) 252 . . . . . . . . . . . . . . . . . . . . . . . . . 512n Peit v Speiser, 806 F2d 1154 (1986) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 508n Peoples Department Stores Inc (Trustee of) v Wise, 2004 SCC 68, [2004] 3 SCR 461 . . . . . . . . 629, 675, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 710, 856-60, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888-89, 914n, 916n Perez v Galambos, 2008 BCCA 91 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 849 Peso Silver Mines Ltd v Cropper (1965), 56 DLR (2d) 117 (BCCA), aff’d [1966] SCR 673 . . . . . . . 875-78 Pezim v British Columbia (Superintendent of Brokers) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 504 Poche v Pihera (1983), 50 AR 264, 6 DLR (4th) 40 (Alta QB) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 849n Pooley v Driver (1876), 5 Ch D 458 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51, 81 Prest v Petrodel Resources Ltd, [2013] UKSC 34 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230 Primewest Energy Trust v Orion Energy Trust, (1999) 1 BLR (3d) 294 (Alta QB) . . . . . . . . . . . . . . . . . 427n Primex Investments Ltd v Northwest Sports Enterprises Ltd, [1995] BCJ No 2262 (SC) . . . . . . . . . . . . 895 Psychological Association (Ontario) v Mardonet, 2016 ONSC 4528 . . . . . . . . . . . . . . . . . . . . . . . . . . . 889n Rea v Wildeboer, 2015 ONCA 373 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 971 Regal (Hastings) Ltd v Gulliver, [1942] 1 All ER 378 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 864n, 873, 875-78 Revlon, Inc v MacAndrews & Forbes Holding, Inc, 506 A (2d) 173 (Del SC 1986) . . . . . . . . . . . 557, 1070, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1085, 1102 Ringuet v Bergeron, [1960] SCR 672, 24 DLR (2d) 449 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 716 Riviera Farms Ltd v Paegus Financial, [1988] 29 CPC (2d) 217 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177n Rochwerg v Truster (2002), 58 OR (3d) 687, 23 BLR (3d) 107 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Rockwell Developments Ltd v Newtonbrook Plaza Ltd, [1972] 3 OR 199 (CA) . . . . . . . . . . . . . . . . . . . . 191 Rooney v Cree Lake Resources Corp (1998), 40 CCEL (2d) 96 (Ont Ct Gen Div) . . . . . . . . . . . . . . . . . . . 868 Routley’s Holdings Ltd, Re (1960) 22 DLR (2d) 410, [1960] OWN 160 . . . . . . . . . . . . . . . . . . . . . . . . . . . 787 Royal British Bank v Turquand (1856), 6 E & B 327, 119 ER 886 (Excheq Ct) . . . . . . . . . . . . . . . . . . . . . 381 Royal Host Real Estate Investment Trust and Canadian Income Properties Real Estate Investment Trust (1999), 22 OSCB 7819 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1124 Salomon v Salomon & Co, Ltd; Salomon & Co, Ltd v Salomon, [1895-1899] All ER Rep 33 (HL) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162, 176, 210, 282 Sanford v The Queen, [1996] 1 CTC 2016 (TCC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 854 Scott v Scott, [1943] 1 All ER 582 (Ch) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 754n Scottish Insurance Corp v Wilsons & Clyde Coal Co, [1949] AC 462 (HL (Scot)) . . . . . . . . . . . . 423n, 454 SEC v WJ Howey Co, 328 US 293 (1946) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 474 See v Heppenheimer, 61 A 843 (NJ Ch 1905) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411 Seldon v Clarkson Wright and Jakes, 2012 UKSC 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87-88 Severn & Wye v Severn Bridge Railway Co, [1896] 1 Ch 559 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 448n Sharbern Holding Inc v Vancouver Airport Centre Ltd, 2011 SCC 23, [2011] 2 SCR 175 . . . . . . . . . . . 684 Shelter Corporation of Canada Ltd, Re, [1977] OSCB 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 474n Sheppard v. Bonanza Nickel Mining Co of Sudbury (1894), 25 OR 305 . . . . . . . . . . . . . . . . . . . . . . . . 381n Sherwood Design Services Inc v 872935 Ontario Ltd (1998), 3 OR (3d) 576 (CA) . . . . . . . . . . . 356, 369 Shield Development Co v Snider, [1976] 3 WWR 44 (BCSC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1065 Shoppers City Ltd and M Loeb, Ltd, Re, [1969] 1 OR 449, 3 DLR (3d) 35 (H Ct J) . . . . . . . . . . . . . . . 1040n Shoppers Drug Mart Inc v 6470360 Canada Inc (Energyshop Consulting Inc/Powerhouse Energy Management Inc), 2014 ONCA 85 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 366 Silber v BGR Precious Metals Inc (1998), 41 OR (3d) 147 (Gen Div) . . . . . . . . . . . . . . . . . . . . . . . . . 1029-30 Sinclair Oil Corporation v Levien, 280 A (2d) 717 (Del SC 1971) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 881 Slightham, Re, [1996] 30 BCSC Weekly Summary 38 (BCSEC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 863n

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Smith & Fawcett Ltd, Re, [1942] Ch 304 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888n Smith v The Queen, [1960] SCR 776 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 467n Smoothwater Capital Partners LP I v Equity Financial Holdings Inc, 2014 ONSC 324 . . . . . . . . . . . . . 807 Soper v The Queen, [1997] 3 CTC 242, 97 DTC 5407 (FCA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 854 Sparling v Québec (Caisse de dépôt et placement du Québec), [1988] 2 SCR 1015 . . . . . . 397, 421, 423 Specialized Surgical Services Inc, Re, 2002 BCSECCOM 675 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 863n Speight v Gaunt (1883), 9 AC 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 849n Spookw v Gitxsan Treaty Society, 2017 BCCA 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 266, 269 Standard Trustco Ltd, Re (1992), 15 OSCB 4322 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 862 State of Hawaii v Hawaii Market Center Inc, 485 P 2d 105 (Hawaii 1971) . . . . . . . . . . . . . . . . . . . . . . . . 474 Steven Thompson Family Trust v Thompson et al, 2012 ONSC 7138 . . . . . . . . . . . . . . . . . . . . . . . . . . 849n Stevens v Home Oil Co (1980), 123 DLR (3d) 297 (Alta QB) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1043 Stokes v Continental Trust Co, 78 NE 1090 (NY Ct App 1906) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 416, 421-22 Szecket v Huang (1998), 42 OR (3d) 400 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369, 377 Tawich Development Corp v Québec (Deputy Minister of Revenue), [2000] 3 CNLR 383, 55 DTP 5144 (Que CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 248 Taylor v London Guarantee Insurance Co (2000), 11 BLR (3d) 295 (Ont SC) . . . . . . . . . . . . . . . . . . . . . . 940 Teck Corporation Ltd v Millar (1972), 33 DLR (3d) 288, [1973] 2 WWR 385 (BCSC) . . . . . . . . . . 629, 685, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 887-88, 1056, 1080 Telecom Leasing Canada (TLC) Ltd v Enoch Indian Band of Stony Plain Indian Reserves No 135, [1992] AJ no 845, [1994] 1 CNLR 206 (Alta QB) . . . . . . . . . . . . . . . . . . . . . . . . . . 263, 266, 292 Themadel Foundation v Third Canadian General Investment Trust Ltd (1998) 38 OR (3d) 749 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 941 Theratechnologies Inc v 121851 Canada Inc, 2015 SCC 18, [2015] 2 SCR 106 . . . . . . . . . . . . . . . . . . . . 507 Thorne and New Brunswick Workmen’s Compensation Board, Re (1962 Court of Appeal) (1962), 33 DLR (2d) 167 (NBCA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88, 89, 93 Thorne and New Brunswick Workmen’s Compensation Board. Re (1962 SCC) [1962] SCR viii . . . . . . 89 Tron Power Inc (Tron Power Limited Partnership), R v, 2013 SKQB 179 . . . . . . . . . . . . . . . . . . . . . . . . . . . 324 Tsilhqot’in Nation v British Columbia, 2007 BCSC 1700 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240n, 302 Turner v Mailhot (1985), 50 OR (2d) 561 (H Ct J) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 908 United Canso Oil & Gas Ltd, Re (1980), 41 NSR (2d) 282 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 795 Unitrin, Inc v Am Gen Corp, 651 A.2d 1361 (Del S Ct. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1082 Universal Explorations Ltd (Re) [1983] 1 WWR 542, 23 Alta LR (2d) 57 (CA) . . . . . . . . . . . . . . . . . . . 826n Unocal Corp v Mesa Petroleum Co, 493 A.2d 946 (Del 1985) . . . . . . . . . . . . . . . . . . . . . . 1070, 1080, 1085 UPM-Kymmene Corp v UPM-Kymmene Miramichi Inc (2002), 214 DLR (4th) 496 (Ont Sup Ct J), aff’d (2004), 250 DLR (4th) 526 (Ont CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 855 UPM-Kymmene Corp v UPM-Kymmene Miramichi Inc (CA) (2004), 250 DLR (4th) 526, 32 CCEL (3d) 68 (Ont CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 711, 855n Varity Corp and the Jesuit Fathers of Upper Canada, Re (1987), 59 OR (2d) 459 (H Ct J) . . . . . . . . . 830 Varity Corp and the Jesuit Fathers of Upper Canada, Re (CA) (1987), 60 OR (2d) 640 (CA) . . . . . . . . 830 Volzke Construction Ltd v Westlock Foods Ltd, 1986 ABCA 136, 45 Alta LR (2d) 97 . . . . . . . . 61, 65, 73 Walkovszky v Carlton, 26 NYS 2d 585, 223 NE 2d 6 (NY Ct App 1966) . . . . . . . . . . . . . . . . . . . . . . . . . . 184 Wall v London and Northern Assets Corporation, [1898] 2 Ch 469 (CA) . . . . . . . . . . . . . . . . . . . . . . . 785n Weinberger v UOP, Inc, 457 A(2d) 701 (Del 1983) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1031 Whitehorse Copper Mines Ltd, Re (1980), 10 BLR 113 (BCSC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1040n Wickberg v Shatsky et al (1969), 4 DLR (3rd) 540 (BC SC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352

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Wildman v Wildman (2006), 82 OR (3d) 401 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221 Will v United Lankat Plantations Company, Limited, [1914] AC 11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454 Williams v Canada, [1992] 1 SCR 877 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247, 340 Willson v British Columbia (Attorney General) (sub nom West Moberley First Nations v British Columbia), 2007 BCSC 1324, [2007] BCJ No 1929 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 266n Woronuk v Woronuk, 2015 ABQB 116 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118 Wotherspoon v Canadian Pacific Ltd (CA) (1982), 35 OR (2d) 449, 483-91 (CA) . . . . . . . . . . . . . . . . . . 824 Wotherspoon v Canadian Pacific Ltd (SCC), [1987] 1 SCR 952, 39 DLR (4th) 169 . . . . . . . . . . . . . . . . 824 Wragg Ltd, Re, [1897] 1 Ch 796 (CA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410n Yaiguaje v Chevron Corporation, 2017 ONSC 135 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215, 664, 694 YBM Magnex International Inc, Re (2003), 26 OSCB 5285 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 862 Zapata Corporation v Maldonado (1981), 430 A 2d 779. (Del SC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 913 Zysko v Thorarinson, 2003 ABQB 911 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 867n

CHAPTER ONE

An Introduction to Business Organizations





I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 II.  A Sample Fact Pattern with an Introduction to Some Important Terminology . . . . . . . 6 A.  A Fact Pattern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 B.  Investment, Equity, Debt, and Trade Creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 III.  Forms of Business Organizations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 A. Agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 1.  Legal Concept of Agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.  Economics Concept of Agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 B.  For-Profit Forms of Business Association . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 1.  Sole Proprietorship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2. Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 3.  Limited Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 4.  Limited Liability Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 5. Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 6.  Limited Liability Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 7.  Unlimited Liability Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 8.  United States “C Corporations” and “S Corporations” . . . . . . . . . . . . . . . . . . . . . . 21 9.  Business Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 C.  Not-for-Profit Forms of Association . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 1.  Societies or Not-for-Profit (or Non-Profit) Corporations . . . . . . . . . . . . . . . . . . . 25 2.  Unincorporated Associations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 D.  Combined for-Profit and Not-for-Profit Forms of Business Association . . . . . . . 27 1.  Co-operative Associations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 2.  Mutual Organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 3.  Social Enterprise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 E.  Other Business Association Forms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 1.  Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 2. Franchises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 3.  Multiple Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 F. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 IV.  Some Simple Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 A.  The Statement of Financial Position (or “Balance Sheet”) . . . . . . . . . . . . . . . . . . . . . 33 B.  The Statement of Earnings and Statement of Comprehensive Income . . . . . . . . 34 C.  Assets, Liabilities, and Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 D.  Trade Credit, Accounts Payable, and Accounts Receivable . . . . . . . . . . . . . . . . . . . 34

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Chapter 1  An Introduction to Business Organizations E.  A Statement of Financial Position (Balance Sheet) for the Sample Fact Pattern Sole Proprietorship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 F.  A Statement of Earnings, Revised Statement of Financial Position, Statement of Changes in Equity, and Statement of Cash Flows for the Sample Fact Pattern Sole Proprietorship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 1.  Statement of Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 2.  Revised Statement of Financial Position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 3.  Statement of Changes in Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 4.  Statement of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 G.  A Corresponding Statement of Financial Position and Statement of Earnings for the Business Operated Through a Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 V. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

I. INTRODUCTION The study of business organizations is the study of the ways that people organize to carry on productive activities. It is an important subject because so many of the goods and services produced in our society are produced through the forms of organization examined in this book. The forms of organization studied in this book are used for businesses as small as a single boutique retail store to as large as General Motors Corporation. The corporate form, in particular, is also used by banks, universities, hospitals, municipalities, and many nonprofit organizations and charities. The forms of organization studied in this book are everywhere in our society. This is an especially exciting time to be studying business organizations. While concerns about business organizations not behaving in socially responsible ways have been around for a long time,1 recent years have seen a renewed focus on such concerns, as well as the development of forms of business organization that seek to achieve social, cultural, or environmental aims in addition to traditional for-profit objectives. Questions about taking into account the interests of a wider range of stakeholders are raised throughout this book and Chapter 8 examines the growing popularity of, and forms for, what has been called “social enterprise.” Greater attention is also now being paid to business organizations issues for Canada’s Indigenous peoples. There are issues such as requirements for legal personality and the need for a corporate form and identity by First Nations and Indian Bands; the relationship between fiduciary duties of Indigenous leaders and directors of corporations; and concerns for liability protection, tax exemption, and economic development. Chapter 4 examines First Nations business organizations. Corporate governance has also seen significant change in recent years, much of which has been in the securities regulatory context. Chapter 7 provides an introduction to the securities regulatory context; corporate governance developments in the securities regulatory context are taken into account in many chapters, particularly Chapters 11 and 12, dealing with the role of directors and shareholder participation in corporate governance.

1 See e.g. the debate between Adolf Berle and E Merrick Dodd in the 1930s, discussed in Chapter 10, Section II.

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This chapter provides an introduction to the study of the law of business organizations. Many law students enter the study of business organizations with little or no background knowledge of business or the different ways in which persons may associate to carry on business. The purpose of this chapter is to provide a brief overview of many different forms of business organization. The text and materials in this book are intended for use in courses that usually go by the name “business organizations” or “business associations.”2 A course in business organizations or business associations is about the way in which persons associate or organize to carry on a business. “Business,” broadly defined, is that which keeps a person occupied. 3 In a business organizations course, the term “business” is used in a somewhat narrower sense that relates to the production or provision of, or trade in, goods or services, or, somewhat more narrowly still, as relating to the carrying on of those activities for profit. Although much of this book focuses on the organization of for-profit activities, a broader notion of business as including for-profit, not-for-profit, or a combination of for-profit and not-for-profit activities is useful because it brings together a wide range of organizational forms, discussed in this chapter and elsewhere in this book, that share the characteristics of being organizational forms for the governance of the production of, or trade in, goods or services. The book, therefore, discusses not only for-profit forms of business organization but also not-forprofit forms, forms that can combine for-profit and not-for-profit objectives, and forms of organization for Indigenous businesses that may involve a for-profit objective as well as broader Indigenous community objectives. Most of us engage in some form of productive activity every day. This activity may involve working at home by preparing meals, washing clothes, or cleaning. Many people will also go out to work each day and participate, in some way, in a collective process that provides goods or services for people other than themselves or those they live with at home or are related to. It may be at a hair salon, a video shop, an automobile factory, a shipyard, a construction site, a non-governmental organization office, a law office, the offices of a firm of accountants, and so on. The factory, shipyard, or construction site might be said to ultimately produce products— for example, cars, ships, or houses. The other activities listed above might be said to provide services of various types. While some products or services might be produced by a single individual acting entirely on their own, most will involve joint activity.

2 The course is called “Business Associations” at University of Victoria, University of Calgary, Osgoode Hall Law School (York University), University of Windsor, Queen’s University, McGill University, Thompson Rivers University Faculty of Law, and Schulich School of Law (Dalhousie University). It is called “Business Organizations” at University of British Columbia, University of Saskatchewan, University of Toronto, University of Ottawa, and University of New Brunswick. The corresponding courses go by the name “Corporations Law” at University of Alberta and “Corporate Law” at Western University. 3 The Oxford English Dictionary, 2nd ed (Oxford: Oxford University Press, 1989), vol II gives many meanings for the word “business.” One of them (definition 13 a) says, “In a general sense: action which occupies time, demands attention and labour.” This definition is consistent with the definition of the phrase “carrying on business” that the Supreme Court of Canada in Backman v Canada, 2001 SCC 10, [2001] 1 SCR 367 noted was defined in Black’s Law Dictionary as “to hold one’s self out to others as engaged in the selling of goods and services.” The Supreme Court in Backman also noted the definition of “carrying on business” given by Cartwright J in Gordon v R, [1961] SCR 592 (citing Smith v Anderson (1880), 15 Ch D 247 (CA)) who said that it involved, “(i) the occupation of time, attention and labour; (ii) the incurring of liabilities to other persons; and (iii) the purpose of a livelihood or profit.”

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Each of these activities, or businesses, typically requires some form of facility in which the work can be done, equipment for doing the work, and supplies of various sorts. For instance, the hair salon will normally require space in a building, and may require equipment such as chairs, sinks, cabinets, and hair dryers. It will need an inventory of the goods used to provide its services to customers. The space in the building may be leased and paid for out of the revenues of the business. It may even be possible to lease the equipment. But some of the things used in the business may require that some funds be invested in the acquisition of those things. Although it is possible that a single individual provides all the funds needed to carry on the activity, the funds usually come from more than one source. The various business activities referred to above, which most persons participate in each day, thus involve relationships with other persons. In these activities, persons work together to provide the goods or services. These activities normally require funds that come from more than one source, which means that there are relationships with, and between, the fund providers. The various business activities referred to above also create relationships with the persons who supply goods or services used in carrying on the activity. There are also relationships with the persons who consume the goods or services produced. Business activities usually have an impact on other persons, either in the local community or beyond, even where those other persons are not involved directly in the activities, in consuming the goods or services produced by the business, or in supplying goods or services used in the business. The persons directly involved in providing the goods or services as investors, managers, or employees; those involved as suppliers or consumers; or others affected by the activities of a business are often referred to as “stakeholders.”4 The law of business organizations might, at a broad level, be said to be about relationships between persons involved in activities to provide goods or services for persons other than themselves or the persons they live with at home or are related to. It is about law relating to the ways in which persons associate with each other or organize themselves to carry on the activities that produce, provide, or trade in goods or services. The associations or organizations used by persons to produce, provide, or trade in goods or services can, as noted above, involve everything from a local diner to a multinational enterprise with hundreds of billions of dollars in assets. They can be used in the services provided by a bank, hospital, university, or municipality. A course in business associations, therefore, involves the study of law that relates to activities and relationships that are an important part of the lives of virtually everyone. While a course in business organizations is about the law relating to the relationships noted above, it is not about all of the law implicated in such relationships. The wide range of laws implicated in those relationships include, for example, employment law, competition law, environmental law, tort law, and contract law. A course in business organizations usually focuses on for-profit productive activities and primarily on the relationships among the equity investors, creditors, and the persons who manage the business. It may also consider not-for-profit forms of organization or forms of organization that combine both for-profit and not-for-profit objectives. Courses in business organizations typically focus primarily on 4 The term “stakeholder” has come to be used in the corporate law, or business associations, context to refer to persons who are affected by the carrying on of a business activity and therefore may have an interest in—that is, a concern about—how that business is conducted.

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partnership law, corporate law, and securities law. One should bear in mind that although a course in business organizations focuses on partnership law, corporate law, and securities law, it inevitably has links to many other areas of law including, to name a few, agency law, contract law, insolvency law, and civil procedure. In Canada and the United States, and in many other jurisdictions around the world, stakeholders other than investors and managers, such as the employees and the local and broader communities, do not typically have a direct say in how the business will be run or managed. The interests of these other stakeholders are addressed in other areas of law. Employee interests are addressed in, for example, contract law relating to employment, employment standards legislation, labour relations legislation, and health and safety regulations. Relationships with consumers are addressed in laws such as competition laws, consumer protection laws, tort law, and product safety regulations. Relationships with suppliers are addressed by laws such as contract law and competition law. Relationships with creditors are partly addressed by laws relating to business associations, but are also addressed more generally by bankruptcy laws, personal property securities legislation, banking law, fraudulent conveyance laws, and fraudulent preference laws. The local and broader community interests may, in part, be addressed through laws such as environmental protection laws, tort laws, and tax laws. The approach to protecting the interests of other stakeholders in business activities (other than investors, creditors, and managers) described in the last paragraph is not the only approach that can be taken. The approach noted in the previous paragraph has been criticized and it has been suggested, for instance, that the interests of these other stakeholders might be more effectively addressed if they were given a more direct say in how a business is run. Some jurisdictions, such as Germany and Sweden, do, indeed, require direct employee representation on the board that oversees the management of a business organization.5 The approach in North America tends to reflect the approach to protection of the various stakeholders described in the above paragraph. One may wish to keep this North American tendency in mind while reading the materials, as well as competing approaches such as requiring direct employee representation on the board and other approaches mentioned in these materials or those that you may think should be adopted. Is the approach to protecting the interests of other stakeholders referred to in the previous paragraph an appropriate approach? Are there other approaches that would better protect the interests of other stakeholders? One should bear in mind that the features of the various forms of business organization discussed in this book involve policy choices. When reading about the various features of 5 Laws requiring employee representation on the board that oversees the management of a business organization are referred to as employee co-determination laws. On the history of employee co-determination laws in Germany, see Ewan McGaughey, “The Codetermination Bargains: The History of German Corporate and Labour Law” (LSE Law, Society and Economy Working Papers 10/2015). There are also employee co-determination laws in Sweden, France, and the Netherlands. For Sweden, see The Employment (Co-Determination in the Workplace) Act (1976:580) and the Board Representation (Private Sector Empoyees) Act (1987:1245), both online: ; see also the discussion in e.g. Jenny Julén Votinius, “Employee Representation at the Enterprise­—Sweden,” online: . For a discussion of employee co-determination in France and the Netherlands (as well as other countries in Europe) see .

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different forms of business organization in this chapter and throughout the rest of this book, ask why different forms of business organization have adopted the features they have and whether the policy choices made about such features are the right ones. Section II, immediately below, sets out a sample fact pattern to give context to some of the forms of organization discussed in this chapter. Section III briefly describes various ways in which persons associate with each other for the purpose of carrying on for-profit business activities. Section IV provides a brief introduction to some accounting concepts that can be useful in the study of business associations.

II.  A SAMPLE FACT PATTERN WITH AN INTRODUCTION TO SOME IMPORTANT TERMINOLOGY The purpose of this section is to provide a relatively simple set of facts for a simple business. The fact pattern also provides an opportunity to introduce some important terminology that can be understood in the context of the fact pattern and which will be encountered later in the book. Other terms will also be introduced later on in the book.

A.  A Fact Pattern Aya Nang had put aside $75,000 to invest in her own business and managed to convince a bank to give her a $50,000 loan. With these funds, she set up a convenience store that she called “Quick Buys” in the town where she had grown up. She had in mind not only that persons could come and shop at the store, but also that persons could order goods from her store that she would deliver. She leased 1,200 square feet of space in a small mall located on the busiest road in the town. She used the funds she had saved and the funds loaned by the bank to install lighting, a cash counter, shelving, freezers, and storage cabinets. She also bought a cash register and an inventory of goods to sell in the store. She was able to buy some of the goods she bought to stock her inventory on credit—that is, the suppliers of the goods delivered them not for cash on delivery but simply on Aya’s promise to pay for the goods at a later date. When the store is in operation there will be various expenses. These will include the cost of goods sold in the store, the monthly rental fee, the monthly interest payments on the bank loan, and the cost of electricity for lighting, heating, and air conditioning. The bank loan carried a set rate of interest to be paid in equal monthly installments. The $50,000 advanced (the “principal amount” of the loan) was to be repaid to the bank at the end of five years. The bank, however, was concerned that the business might do poorly before the end of the five years. If that caused Aya to not have sufficient assets to pay off all her debts other than the bank loan, then Aya’s assets could be long gone before the principal amount on the loan came due at the end of five years. The bank wanted to be able to take action to get the principal and any unpaid interest on the loan back if there were signs that the cash being earned in carrying on the business might not be enough to pay off the debts incurred in carrying on the business as they came due for payment. To address this concern, the bank put various provisions in the loan agreement. For instance, the loan agreement specified that the ratio of the sum of cash, any amounts due on credit advanced by Aya (that is, where she delivered goods to customers in return for their promise to pay at a later

II.  A Sample Fact Pattern with an Introduction to Some Important Terminology

7

date), and the cost of inventory on hand be twice as great as the sum of amounts due on any credit received in purchasing inventory or for expenses incurred. This was intended to assure that the cash obtained in carrying on the business or that would be obtained in the near future (that is, from sale of inventory in the store or collections from customers who had purchased on credit) would be more than ample to pay amounts owed to suppliers for goods Aya had purchased on credit. The loan agreement also provided the bank with a “security interest”—what is sometimes referred to as “collateral.” This would permit the bank to seize and sell specified assets belonging to Aya in the event that she breached specified provisions of the loan agreement, such as the requirement to pay interest or principal and the requirement, referred to above, to have cash and near-term sources of cash that are twice as great as amounts due on credit. The proceeds from the sale of the assets could then be used to pay amounts owing to the bank. The bank’s security interest under the loan agreement extended to all of Aya’s assets, including those used in the business and those she owned for her personal use. The loan agreement also provided that Aya obtain approval from the bank before she received any other loans—that is, from persons other than the bank—except for credit she received on goods or services she acquired.

B.  Investment, Equity, Debt, and Trade Creditors Investors in a business are persons who provide funds that are used to acquire assets or employ workers that will be used in the business. They provide the funds in exchange for some future payment that will return the funds to them plus an amount that compensates them for not having the use of the funds themselves while they are invested. In the fact pattern, Aya is an equity investor. The term “equity” in this context refers to a right to receive a “residual” (left over) amount. In Aya’s business she will have revenues from the sale of goods in the store. Out of these revenues Aya will have to cover expenses such as the cost of the goods she sells in the store, the rent, the interest, electricity, and so on. But if the revenues generated by the business are sufficient to cover these expenses, she will be entitled to the residual, or left over, amount. This residual of revenues less expenses incurred in generating those revenues is the “profit” (sometimes also called the “net income”) of the business. If the business is brought to a close and all the assets used in the business are sold off, the proceeds will first need to be used to pay all the outstanding creditors such as the bank and persons who supplied goods on credit. Once those obligations are met, Aya can retain the remaining, or residual, proceeds (subject, though, to claims that her personal (that is, non-business) creditors may have against her). While Aya is the equity investor, the bank and the persons who supplied goods to Aya on credit are also investors. They are collectively referred to as the “creditors.” The persons who supplied goods or services on credit are generally referred to as “trade creditors.” The bank and the trade creditors have provided some of the funds used to acquire the assets that are used by Aya in carrying on the convenience store business. Instead of being entitled to a “residual” amount as Aya is, they are entitled to receive fixed payments. The trade creditors normally receive the amount they charged for goods or services supplied. The bank is entitled to receive fixed payments of interest and, at the end of the term of the loan (five years in the case of the loan to Aya), the principal amount of the loan. Such future fixed payment

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obligations are referred to as “debt” and the funds provided in return for fixed future payment obligations are referred to as “debt finance.” Not all investments break down into equity investors who invest in exchange for residual claims and debt investors who invest in exchange for fixed payments. Investments can be made in exchange for a virtually infinite variety of possible benefits. Later in the text you will encounter forms of investment that are made partly in exchange for fixed future payments and partly in exchange for residual claims—that is, investments that consist of an overlap of debt and equity. With this starter set of facts and terminology in mind, Section III provides a brief look at several forms of business association.

III.  FORMS OF BUSINESS ORGANIZATIONS A. Agency Agency is not normally treated as a form of business organization in the sense that the other forms of business organization discussed below are. It is, however, noted here to begin with since a great deal of business activity is conducted through agents and agency is essential to the way many forms of organization, such as a partnership or a corporation, carry on business. You will encounter two different agency concepts in this book: (1) the legal concept of agency, and (2) an economics concept of agency. Each is briefly described below.

1.  Legal Concept of Agency In the legal conception of agency, an “agent,” broadly defined, is a person who affects the legal relations of another person, called the “principal.”6 The agent can affect the legal relations of the principal in several ways, but does so primarily through entering into contractual relationships on behalf of the principal. If, for example, A (as agent) enters into a contract with X on behalf of P (the principal), A having disclosed to X that she is acting on behalf of P, the contract will be a contract between X and P (and not a contract between X and A). The principal can also be vicariously liable for the torts committed by the principal’s agent. Agency, as noted above, is not normally considered a form of business association. Agents do not need to be (although they may be) investors in a business either as creditors or equity investors. Agency relationships are mentioned here, however, because of their importance in various forms of business association. Aya, operating as a sole proprietor, may find, perhaps as the business expands, that she cannot deal with all her customers and suppliers all the time. From time to time, she may need to have someone else deal with some of her customers or suppliers on her behalf. In the partnership and corporate forms of business association that are the primary focus of this book, agency is essential. Partners, for instance, are agents for each other. Corporations must almost invariably also engage agents to carry on the day-to-day business activities of the corporation. 6 In GHL Fridman, The Law of Agency, 7th ed (London: Butterworths, 1996) at 11, “agency” is defined as “the relationship that exists between two persons when one, called the agent, is considered in law to represent the other, called the principal, in such a way as to be able to affect the principal’s legal position in respect of strangers to the relationship by the making of contracts or the disposition of property.”

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2.  Economics Concept of Agency In the economics concept of agency, an agency relationship is said to arise where “one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent.”7 The focus in the economics concept of agency is on the costs that can arise in such a relationship. Suppose that in the fact pattern, set out above in Section II, Aya Nang had provided all the funds for the business—that is, without borrowing any funds from the bank. Suppose also that Aya Nang did not engage any employees, but did all the work herself. Aya would then be carrying on the business entirely on her own behalf (ignoring, for the moment, other possible stakeholders in her business). If Aya chose to slack off on a particular day and thereby lost $1,000 of profits she would otherwise have made in her business, then she would bear the entire $1,000 loss herself. Suppose instead that Aya got another person to invest in the business and agreed to share half the profits with that other person. Suppose also that the other investor is not taking part in running the business, leaving Aya to run the business herself. Now if Aya slacks off on a particular day and thereby loses $1,000 of profits that would otherwise have been made in the business, Aya bears only one half of that loss (that is, $500)—the other investor bears the other half of the loss ($500). Aya is, in part, acting on behalf of that other investor. She may, or may not, be an agent in the legal sense, but she is an agent in the economics sense in that her work in carrying on the business is, in part, being done on behalf of the other investor. The risk that Aya may slack off and cause a loss to the other investor is a cost of this “agency relationship.” It is this kind of cost that in the economics concept of agency is referred to as an “agency cost.” This economics concept of agency is explored in more detail in Chapter 9.

B.  For-Profit Forms of Business Association 1.  Sole Proprietorship a.  Single Equity Investor In a sole proprietorship there is just a single “equity” investor, referred to as the sole proprietor. In the fact pattern set out above in Section II.A, Aya is a sole proprietor. She is the person (the only person) entitled to receive the residual amounts—that is, the profits of the business and the proceeds of a sale of the assets of the business net of amounts owing to creditors.

7 See Michael C Jensen & William C Meckling, “Theory of the Firm, Managerial Behaviour, Agency Costs and Ownership Structure” (1976) 3:4 J Financial Economics 305 at 308; see also, Clifford W Smith Jr, “Agency Costs” in John Eatwell, Murray Milgate & Peter Newman, eds, The New Palgrave: A Dictionary of Economics, 1st ed (London: Palgrave Macmillan, 1987), where it is said that “[a]n agency relationship is defined through an explicit or implicit contract in which one or more persons (the principal(s)) engage another person (the agent) to take actions on behalf of the principals. The contract involves the delegation of some decision-making authority to the agent.” The implicit contract referred to here would not necessarily be a legally binding contract, but would involve one person acting on behalf of another.

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b.  “Unlimited” Liability You will notice in the fact pattern that the bank made the loan to Aya. Aya is the person who will be legally obligated to pay the interest and principal to the bank. It was also Aya who bought the light fixtures, cash counter, shelving, freezers, storage cabinets, cash register, and an inventory of goods. Aya will have the legal title to these assets. Aya will have to pay the creditors. Aya will be the person who is legally obligated to pay the rent. Where a person operates a business as a sole proprietor there is no legally recognized entity separate from the sole proprietor that enters into arrangements with banks, lessors, suppliers, or customers. There are numerous implications of the fact that where a person carries on a business as a sole proprietor there is no separate legally recognized business entity. As indicated in the last paragraph with reference to the fact pattern, it is the sole proprietor who owns the assets of the business and who contracts personally with the bank, suppliers, employees, and customers of the business. If torts occur in carrying on the business (perhaps a customer is injured by slipping on an unmarked wet floor), then the sole proprietor will be personally liable for the damages. Where the sole proprietor obtains a loan to provide funds used in acquiring assets for the business under a loan agreement, such as the one between Aya and the bank, the sole proprietor will be personally obliged to comply with the terms of the loan agreement. If there is a default on the loan (for example, non-payment of interest or principal or some other breach of the loan agreement), then the bank can normally enforce its claim against the sole proprietor’s assets used in the business and the sole proprietor’s personal assets. This is the normal result because sole proprietors are obliged to meet their obligations to the bank. Where those obligations are not met, the bank can claim damages from the sole proprietor. If those damages are not paid by the sole proprietor, the bank can seek execution against the sole proprietor’s assets. The sole proprietor’s assets are all the assets the sole proprietor owns, and these include both the assets held for carrying on the business and those held for personal use. The law makes no distinction between these assets—they are all assets owned by the sole proprietor. There are other forms of business association in which the liability of equity investors is limited to the amount they have invested in the business. However, as can be seen from the discussion above, the sole proprietor does not normally have limited liability, or, as it is sometimes loosely expressed, the sole proprietor has “unlimited liability.” The sole proprietor is personally liable, and execution against all of the sole proprietor’s assets may be obtained to satisfy claims against the sole proprietor. Carry this lack of a legally recognized entity separate from the sole proprietor one step further. If the sole proprietor takes out a personal loan, perhaps for a vacation or to buy a car for personal use, and then defaults on that loan, the unpaid lender can seek compensation from either the business or personal assets of the sole proprietor, or both. There are two further qualifying notes. First, the sentence concerning the bank loan noted that “the bank can normally enforce its claim against the sole proprietor’s assets used in the business or the sole proprietor’s personal assets.” However, the sole proprietor may be able to obtain a so-called non-recourse loan in which the lender (such as a bank) agrees to have recourse only to the assets of the business and no recourse to the borrower’s personal assets. Indeed, the sole proprietor might, at least theoretically, obtain non-recourse arrangements with any persons who advance credit to the sole proprietor or who enter into contractual relations with the sole proprietor in relation to the business. For instance, such an

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arrangement might be made with a lessor. Such an arrangement might also be made with all the suppliers who advance goods on credit, although the cost of making such arrangements may be prohibitively high where the number of creditors is large and the amounts of credit involved are small. It is important to bear this possibility in mind, since it is possible for a sole proprietor to obtain a degree, perhaps even a substantial degree, of limited liability by making a series of such arrangements. Of course it will not be possible to make such an arrangement with potential future tort creditors, and for these potential liabilities it may behoove the sole proprietor to obtain insurance. Banks are also unlikely to agree to such a limitation. The second qualifying note is that one often hears reference to an “incorporated sole proprietorship.” Usually it is intended to mean that there is a person who is the single equity investor by virtue of being a sole shareholder in a corporation through which the business is carried on. The combining of the word “incorporated” with the words “sole proprietorship” can cause confusion. The corporate form, as discussed further below, is a recognized separate legal entity. It can also, subject to qualifications we will note later, provide limited liability for the equity investors (the shareholders). As noted above, with a sole proprietorship there is no legally recognized entity that is separate from the sole proprietor through which the business is run, and it does not provide limited liability for the sole proprietor—the sole proprietor would have to contract separately for limited liability with all the persons with whom the sole proprietor deals.

c.  Management (or Governance) Aya will manage the convenience store business, making decisions on a day-to-day basis. For the most part, she can make these decisions on her own and will not have to consult with other persons. However, she does not have complete control over the management of the business. The bank has put constraints on her management decisions. She must, for instance, make sure that the sum of cash, any amounts due on credit advanced by her, and the cost of inventory on hand is twice as great as the sum of amounts due on any credit received in purchasing inventory or for expenses incurred. If she does not do this, she faces the risk that the bank might choose to exercise rights under the loan agreement that arise in the event she does not maintain this ratio. Sole proprietors may face constraints such as these in arrangements with major creditors who seek to protect their investments in the business.

d.  No Perpetual Existence The existence of the sole proprietorship comes to an end on the death of the sole proprietor. It may be continued for a time in the administration of the estate after the sole proprietor’s death, but once the assets of the estate have been distributed, neither that sole proprietor nor his or her estate will be carrying on the business—there will be a new sole proprietor and thus a new sole proprietorship.

2. Partnership Aya has been operating the business for some time now. Many people come to the store and it is a success. Aya wants to expand by leasing more space in the building where the store is located. This will involve an increase in the total rental payments, require the installation of

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more shelving and cabinets, and, if increased business materializes, likely lead to increased accounts receivable. It will mean that there will be a larger stock of goods—that is, inventory—in the store at any given time. All this is going to require funds. All of Aya’s funds are tied up in the store already. The success of the store has already led to the need to fund larger amounts of inventory and accounts receivable, as well as the need to keep greater amounts of cash on hand to pay for goods acquired, so the bank loan has increased to nearly 60 percent of the total assets used in the business. Consequently, the bank is reluctant to extend further financing. Aya seeks funds from her close friend Tomi. After some discussion, Tomi agrees to advance $100,000 in exchange for a share of the profits from the business, thereby making Tomi an equity investor. To entice Tomi to join her in the store business, Aya has agreed to having Tomi make important business decisions jointly with her. The arrangement between Aya and Tomi is known as partnership. Partnership involves more than one equity investor, each equity investor being referred to as a partner. Typically, each of the partners has some say in how the business is managed. Partnerships are discussed in further detail in Chapter 2. The partners may conduct business through agents and they may hire employees. The partners may manage the business directly themselves or they may hire a manager or management team and limit their role to overseeing the management of the partnership business. Agency relationships are an important element of partnership law because, unless otherwise provided, the partners themselves are considered to be agents for each other. The partnership will typically also borrow funds, so there will usually be one or more creditors. As with sole proprietorship, these creditors have a stake in the business and may impose constraints on the way the partners manage the business. In most jurisdictions, partnerships are not recognized as separate legal entities. Thus a “partnership” cannot enter into contracts with other persons.8 Instead it is the partners who enter into contracts with others. Where a tort arises in the conduct of the business, the partners themselves will be responsible either directly or vicariously for their part in the commission of the tort. In other words, the partners are personally liable. Further, since the partnership is not recognized as a separate legal entity, assets of the business are not owned by the “partnership,” but instead are owned by the partners. Under the common law, and under several partnership statutes, the relationship between the partners comes to an end on the death or bankruptcy of any one of the partners. A partnership may be reconstituted thereafter, and there may be statutory or agreed-on provisions for its reconstitution, but the partnership that existed before the death or bankruptcy of a partner no longer exists. The concept of partnership was developed under the common law. The common law developed rules governing the relationship between the partners themselves and between partners and third parties. These rules have been codified in statutes in common law jurisdictions across Canada. The rules governing the relationships between the partners are default rules. Default rules are rules that apply where the parties have not made their own 8 One of the consequences of this is that a partner cannot be “an employee of the partnership” since the partnership, not being recognized as a separate legal entity, cannot enter into a contract of employment with a partner. An arrangement could, however, be made in which the partners agree as part of their overall partnership agreement to pay a wage or salary to a particular partner for particular services provided by that partner.

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rules by express or implied agreement. In the partnership context they are rules that apply where the partners have not expressly or by implication specified their own rules to govern their relationship. For instance, if Aya and Tomi did not discuss the proportion in which they would share in the profits of the business, then partnership laws would normally have a default rule that would indicate what their shares would be. If Aya and Tomi did set out their own terms on the sharing of profits, then the partnership law default rule would not apply.

3.  Limited Partnership Tomi, who joined Aya in the partnership above, might instead be willing to advance funds, but might not be interested in participating in the control or management of the business (perhaps due to time constraints and other commitments). If Tomi is not going to take part in the management or control of the business, then Tomi might want to consider becoming a limited partner. A “limited partnership” is a type of partnership (that is, more than one equity investor) that has one or more partners whose liability is limited to the amount of their investment and one or more “general partners” whose liability is not so limited. In the example, Tomi could be a limited partner and Aya could be the general partner. Tomi’s liability would then be limited to the investment Tomi made (or agreed to make) in the business, while Aya would continue to be personally liable for debts incurred in carrying on the business. This ability to limit the liability of investors may be crucial in attracting investors. Many investors may be unwilling to invest without this sort of limit on their potential liability. Limited partnerships are discussed in further detail in Chapter 2. The right to form a limited partnership was not a creation of the common law. The right to form a limited partnership has instead been provided for by statute. A limited partnership can only be created by registration pursuant to the statute of the jurisdiction in which one wishes to register. Statutes in common law jurisdictions that provide for limited partnership often restrict the involvement of the limited partners in the running of the partnership business.9 The statutes may provide, for instance, that limited partners may not take part in the “control” of the business, or, as in some statutes, that limited partners may not take part in the “management” of the business. That is why, in the example given in the paragraph above, Tomi’s lack of interest in taking part in the control or management of the business suggests that in negotiations with Aya, Tomi might want to raise the possibility of being a limited partner. Limited partnership is also similar to partnership in that the limited partnership is not a legally recognized separate entity. Thus, the partners (both general and limited) collectively own the assets of the partnership business. Further, as noted with non-limited partnerships discussed above, contracts between the limited partnership and others are, unless otherwise provided, contracts between those others and all the partners, both general and 9 This continues to be the case in Canadian limited partnership legislation: see e.g. Alberta Partnership Act, RSA 2000, c P-3, as amended, s 64; British Columbia Partnership Act, RSBC 1996, as amended, s 65; Ontario Limited Partnerships Act, RSO 1990, c L.6, as amended, s 13(1). Limited partnership legislation in the various states of the United States also restricted the involvement of limited partners in the running of the partnership business until 2001. Since then many states have amended their limited partnership legislation by adopting s 303 of the Revised Uniform Limited Partnership Act, which eliminates this restriction.

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limited. While, given their restricted involvement in the running of the business, the limited partners may not be directly liable for torts committed in carrying on the business, they may be vicariously liable for the acts of agents and employees engaged in the carrying on of the business. However, as noted, the liability of the limited partners is limited to the amount of their investment.

4.  Limited Liability Partnership Another type of partnership that has recently been provided for in several jurisdictions in Canada is a “limited liability partnership.” Be careful here. Although the name for this type of partnership is similar to “limited partnership,” it is a different concept. Legislation allowing for limited liability partnerships responded to concerns about an increasing scope of liability in large partnerships, particularly professional partnerships. The problem in large professional partnerships was that where one partner had engaged in acts that led to liability in tort (for example, for negligence) all the other partners were vicariously liable even though they may have had nothing to do with the particular tortious behaviour. Several provinces have legislation permitting limited liability partnerships.10 The model for limited liability partnership adopted in most provinces allows professionals (for example, doctors, lawyers, accountants, and engineers) to form a limited liability partnership in which partners are not liable for the acts of their fellow partners or employees unless they were directly supervising the activity that caused the loss.11 This model is known as “partial shield” limited liability. Some jurisdictions, such as British Columbia, Ontario, Saskatchewan, and New Brunswick, allow for “full shield” limited liability partnerships in which the liability of partners is limited not just with respect to liability arising from the acts of fellow partners or employees but also from debts owing to creditors of the firm generally.12 Law firms, for example, often operate as limited liability partnerships, signalled by the use of the letters “LLP” as a suffix to the partnership name. Otherwise, the limited liability partnership functions like an ordinary partnership. As with an ordinary partnership, the limited liability partnership would not be recognized as a separate legal entity. Limited liability partnerships are discussed in further detail in Chapter 2.

10 See e.g. Alberta Partnership Act, RSA 2000, c P-3, as amended, Part 3; British Columbia Partnership Act, RSBC 1996, as amended, Part 6; Manitoba, Partnership Act, CCSM c P30, Part III; New Brunswick Partnership Act, RSNB 1973, as amended, c P-4, Part III; Nova Scotia Partnership Act, RSNS 1989, s 334, Part II; Ontario Partnerships Act, RSO 1990, c P.5, as amended, ss 44.1 to 44.4; Saskatchewan, Partnership Act, RSS 1978, c P-3, as amended, Part IV. 11 See e.g. Manitoba, Partnership Act, supra note 10, s 69; New Brunswick, Partnerships and Business Names Registration Act, RSNB 1973, c P-5 (as amended by SNB 2003, c 14, s 7), s 8.1; Nova Scotia Partnership Act, supra note 10, s 51; Ontario Partnerships Act, supra note 10, s 44.2; Alberta Partnership Act, supra note 10, ss 81 and 82; Saskatchewan, Partnership Act, supra note 10, s 86. The British Columbia limited liability partnership is not restricted to professional partnerships: see the British Columbia Partnership Act, supra note 10, ss 96 and 97. 12 British Columbia Partnership Act, RSBC 1996, as amended, s 104; New Brunswick Partnership Act, RSNB 1973, as amended, c P-4, s 48; Ontario Partnerships Act, RSO 1990, c P.5, as amended, s 10(2); Saskatchewan, Partnership Act, RSS 1978, c P-3, as amended, s 80.

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5. Corporations If a business is likely to incur losses in the early stages, it may make sense for tax reasons to operate the business as a sole proprietorship or partnership (or limited partnership). This would allow losses incurred in the business to be applied against other sources of income that Aya, or Aya and Tomi, might have.13 However, when Aya sought further financing from Tomi, her business had been a success for some time. The business had been doing well enough to expect reasonable profits in the future and Aya’s accountant suggested that instead of continuing as a sole proprietor, or entering into a partnership or limited partnership with Tomi, she consider carrying on the business through a corporation. This, the accountant noted, would allow Aya and Tomi to take advantage of a small business deduction for tax purposes.14 The corporate form of organization is the main topic of discussion in this book, occupying some or all of the discussion in Chapters 3 through 15. Corporations are often said to have three key features: separate existence (or separate legal entity/personality), limited liability, and perpetual existence. Each of these key features is briefly noted below. Three other features of a corporation are sometimes also noted: free transferability of shares, centralized management, and a measure of shareholder control over management. As discussed further in Section III.B.5.f below, these various features of the corporate form are not imperative but involve policy choices. The equity investors in for-profit corporations are referred to as shareholders and the business is managed or supervised through a board of directors. The nature of shares and the management structure of for-profit corporations are also briefly noted below.

a.  Separate Existence (Separate Legal Entity/Personality) Unlike sole proprietorships and partnerships, a corporation is recognized as a separate legal entity. Consequently, the corporation can enter into contracts with other persons and is liable in the event that it breaches those contracts. Since the corporation can contract with other persons, it can borrow from other persons and it can buy goods on credit. Thus, a

13 Under the Income Tax Act, RSC 1985, c 1 (5th Supp), as amended, a taxpayer includes in his or her income income from various sources such as employment, business, or property and deducts losses from sources such as employment, business, or property. Deducting losses from sources of income reduces overall taxable income and thereby reduces the amount of tax payable. The Income Tax Act treats corporations as separate taxpayers. A shareholder in a corporation cannot deduct losses that a corporation has incurred since the corporation is a separate taxpayer. The Income Tax Act does not treat partnerships as separate taxpayers. Instead the profit or loss of a partnership is calculated and then allocated to partners in accordance with the allocation of profits and losses under the partnership agreement. If the partnership suffers a loss, it is allocated to the partners (such as Aya and Tomi) and a partner can deduct that loss from other sources of income the partner may have. A sole proprietor’s business is also not treated as a separate taxpayer under the Income Tax Act. Consequently, a loss incurred in a sole proprietorship business can be deducted from other sources of income the sole proprietor may have. While losses incurred by a corporation can be carried forward to be deducted from income in future years, the benefit of the deduction is deferred to those future years and may never arise if the corporation does not make a profit in future years. 14 See the Income Tax Act, ibid, s 125.

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corporation, as a separate legal entity, can have creditors. Because of its separate legal existence, the corporation can also be liable for torts arising from carrying on the business conducted through the corporation. The corporation, since it is a separate legal entity, can own assets. Thus, the corporation normally owns the assets used in the business.

b. Shareholders Normally, a corporation will have several equity investors. It was common in the past to require a minimum number of equity investors in a corporation (for example, five or seven).15 In Canada, however, corporate statutes generally allow for corporations with only one equity investor. The interests of equity investors in for-profit corporations are divided into shares, and the equity investors are typically referred to as shareholders. These shares consist of bundles of legal rights that investors can assert primarily against the corporation. These shares do not, however, give the shareholders legal title to the assets of the corporation. It is the corporation, as a separate legal entity, that has legal title to the assets. Shares are presumed to be freely transferable; however, as will be seen in Chapter 7, the trading of shares in privately held companies can be subject to significant securities regulatory constraints. It is also common in privately held companies to impose significant restrictions on the transfer of shares. In the example above, Aya, instead of operating as a sole proprietor, could carry on the business through a corporation. She could be the sole shareholder in the corporation. If Tomi joined Aya as an equity investor in the business, Tomi would also be a shareholder in the corporation. The assets used in the business—for example, the light fixtures, cash counter, shelving, freezers, storage cabinets, inventory of goods for sale and accounts receivable—would be owned by the corporation. Aya as shareholder, or Aya and Tomi as shareholders, would have rights associated with the shares they owned. These rights might include, for example, the right to share in a distribution of profits of the corporation (as a “dividend”); the right to share in a distribution of the net proceeds of liquidation on the dissolution of the corporation; and the right to vote on important matters concerning the corporation (such as the election of the directors for the corporation, which is discussed further in Section III.B.5.e below).

c.  Limited Liability The liability of the shareholders in a corporation is typically limited to the amount of their investment. In that respect their position is similar to that of limited partners in a limited partnership. However, unlike a limited partnership, there is no constraint on the extent to which shareholders can become involved in the management of the business. Thus, if Aya were the sole shareholder, she could take part in the management of the business and still have her liability limited to the amount she had invested in the business. If Aya and Tomi 15 See e.g. The Companies Act, 1862 (UK), 25 & 26 Vict, c 89, s 6, which required seven or more persons for the formation of an incorporated company without limited liability. In Canada, see e.g. the Canada Corporations Act, RSC 1970, c C-32, s 5, which required not less than three persons to form a company under the Act; and see e.g. the Nova Scotia Companies Act, RSNS 1900, c 128, s 6, which required three persons for the incorporation of a company under that Act.

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were shareholders, either or both of them could take part in the management of the business and still have their liability limited to the amount they had invested in the business. When Aya approaches Tomi to ask him to invest in the business, Tomi might be willing to invest under two key conditions. First, he might want to take part in the management of the business along with Aya. Second, he might also indicate that he is not willing to invest unless his potential liability is limited to the amount of his investment. As noted above, a limited partnership would not work to limit Tomi’s liability to the amount he has invested if Tomi takes part in the “control” or “management” of the business. A corporation would, however, allow Tomi to invest as a shareholder in the corporation and would allow him to take part in the management of the business without incurring the same risk of losing his limited liability as a shareholder. As noted above in the discussion of limited partnerships, the ability to offer investors limited liability may be crucial to attracting investors. While corporate statutes typically do limit the liability of the shareholders to the amount of their investment (or the amount they have agreed to contribute), it is possible to have a corporate statute that does not provide such a limited liability protection. The earliest corporate statute in England did not provide limited liability.16 Unlimited liability companies are provided for in corporate legislation in Alberta, British Columbia, and Nova Scotia.17 Thus it is still possible for a corporation to have a separate legal personality, but have equity investors whose liability is not limited to the amount they have invested.

d.  Perpetual Existence While a corporate statute could theoretically require a limit on the length of time for which a corporation could exist, corporate statutes typically do not impose such requirements. Thus a corporation, recognized as a separate legal entity, could exist indefinitely. Its existence can be, as it is sometimes said, “perpetual.” Shareholders can become bankrupt or die, and it will not affect the continued existence of the corporation. Thus, for example, if Aya was the sole shareholder and she died, her shares would pass to her executor or administrator and then perhaps be passed on to her heirs. The corporation would not come to an end. It would continue to exist in the same way it had before Aya’s death, even though there was a change in the persons who were the shareholders in the corporation. If Aya and Tomi were partners and sold their partnership interests to Smith and Jones, the Aya and Tomi partnership in the business would come to an end. Even though the business itself might be carried on by Smith and Jones in exactly the same way it had been carried on by Aya and Tomi, it would still be a new partnership. The partners would be Smith and Jones and, subject to meeting certain requirements on the 16 The first general statute of incorporation in England was enacted in 1844: see the Joint Stock Companies Act, 7 & 8 Vict, c 110. That Act did not provide for limited liability: see e.g. sections XIII, XXV, and LXVI. Limited liability was made available for joint stock companies by the Limited Liability Act, 18 & 19 Vict, c 133. A revised act for the incorporation of joint stock companies was enacted in the following year and it provided for limited liability for shareholders: see the Joint Stock Companies Act, 1856, 19 & 20 Vict, c 47, s LXI; see also the discussion of limited liability in Christopher Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) at 77-82. 17 See Part 2.1 (ss 15.1 to 15.9) of the Business Corporations Act, RSA 2000, c B-9; Part 2.1 (ss 51.1 to 51.9) of the Business Corporations Act, SBC 2002, c. 57; and the Companies Act, RSNS 1989, c 81, ss 9(c), 12, and 68; see also the discussion of Nova Scotia unlimited liability companies in Nicholls, supra note 16 at 83-84.

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retirement of Aya and Tomi as partners, Smith and Jones would be the persons liable for the subsequent debts incurred in the business, not Aya and Tomi. If, instead, Aya and Tomi had become shareholders in a corporation through which the business was carried on, they could sell their shares to Smith and Jones and the corporation would continue on as it had before. With Aya and Tomi as shareholders, the debts or other obligations incurred in carrying on the business would have been the debts or other obligations of the corporation. After the sale of the shares to Smith and Jones, subsequent debts or obligations incurred in the carrying on of the business through the corporation would be the debts or obligations of the corporation just as they had been before the transfer of the shares. The assets acquired by the corporation for the purpose of carrying on the business while Aya and Tomi were shareholders, along with any additional assets acquired by the corporation, would continue to be the assets of the corporation after Smith and Jones replaced Aya and Tomi as the shareholders of the corporation.

e.  Management (or Governance) Structure In corporations with many shareholders, the shareholders generally do not control the dayto-day management of the corporation’s business. Instead, it is common to have a management team that may hold very few, or possibly even no, shares in the corporation. The basic framework for the management of corporations is that shareholders elect a board of directors. That board of directors then appoints officers of the corporation who either manage the day-to-day business of the corporation themselves or delegate various management responsibilities to other persons they hire on behalf of the corporation. A corporation has no physical existence, so it cannot negotiate contracts or conduct business without the assistance of human beings. Thus, a corporation must act through its board of directors18 or through agents appointed by the board of directors on behalf of the corporation. As a separate legal entity, the corporation can also hire employees (although it would do so through the board of directors or its agents appointed by the board of directors). While this basic structure for a corporation can involve a high degree of centralization of management in a hierarchical structure, the corporate form is actually quite flexible. Even a corporation with a large number of shareholders can be structured to allow for decentralized management. Shareholder control over the management of the corporation is effected primarily through a right to elect the directors of the corporation.19 If the directors are replaced, the newly elected directors can then appoint new persons as corporate officers to carry on the day-to-day management of the business. This basic structure for a corporation that has many shareholders can be, and usually will be, varied where the corporation has only a few shareholders. Where the corporation has only a few shareholders, the shareholders often become directly involved in management. In the example above, Aya, as a sole shareholder in a corporation incorporated to carry on the business, could elect herself as the sole director of the corporation. She could then 18 The board of directors acts collectively, usually through majority vote. The board of directors acting in this way is treated as the “directing mind” of the corporation. 19 Shareholders also typically have the right to approve a limited range of particular corporate transactions such as amalgamation, a sale of all or substantially all the assets of the corporation, or a dissolution of the corporation.

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appoint herself as an officer of the corporation. She might, in her capacity as the sole director of the corporation, or in her capacity as an officer of the corporation with authority delegated to her by herself as sole director, engage one or more employees or agents to assist her in carrying on the business of the corporation. Aya could also, if she wished, elect other persons as directors of the corporation who might then appoint Aya or other persons as officers of the corporation. If Tomi joined Aya as a shareholder in the corporation, then Aya and Tomi could elect one or both of themselves as directors and appoint one or both of themselves as officers. They could also elect persons other than themselves as directors of the corporation and those directors could appoint Aya or Tomi as an officer of the corporation, appoint both of them as officers of the corporation, or appoint other persons as officers of the corporation. Aya and Tomi can be employees of the corporation. In entering into such an employment contract, they would not be contracting with themselves because the employer would be the corporation as a separate legal entity. If the business grows and seeks additional funds, it may need to raise a portion of those funds through equity investments. In the context of a for-profit corporation, this is done by issuing more shares. The shares might be sold to many shareholders, perhaps thousands of shareholders, or even millions of shareholders. The usual legal model for the management of a corporation involves shareholders voting to elect directors who then manage the corporation or supervise the management of the corporation. The directors of the board appoint officers who manage the day-to-day affairs of the corporation. These officers would normally also be given authority to hire employees on behalf of the corporation and perhaps also to delegate some aspects of their authority to these employees. The legal model thus allows for the creation of a hierarchical management structure that can be a simple structure or a large and complex structure. It allows a considerable degree of flexibility in the corporate management structure, thus allowing the corporate structure to respond to a wide range of circumstances varying from a corner store to a multinational, multi-billion-dollar enterprise.

f.  Policy Choices While reading this book, bear in mind that the features of a corporation described above, or indeed of other forms of business organization, do not arise because of the operation of some physical laws of nature—they arise because of policy choices. One might create a form of organization, perhaps referred to as a “corporation,” that has a separate existence, but does not have limited liability or perpetual existence. One might, indeed, create a form of organization with any combination of the features of separate personality, limited liability, and perpetual existence (or the features of free transferability of shares, centralized management, or shareholder control over management). Each is possible, and the creation of an organization with all of these features is a policy choice. Similarly, the management structure of a corporation is also a policy choice. The law might instead call for the election of a board of directors by some corporate stakeholder other than shareholders, some combination of corporate stakeholders, or some completely different approach. As suggested earlier in this chapter, one might approach the protection of the interests of stakeholders other than shareholders by allowing those other stakeholders to have a more direct say in the management of businesses rather than protecting them indirectly through various other laws such as consumer protection laws, employment laws, and so on.

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Discussion of the corporate form of organization occupies a large part of this book. It is a form of organization, with modest variations, that has endured for a very long time. One might want to ask why this form continues to be widely used and perhaps also whether it should continue to be widely used.

6.  Limited Liability Companies In Section III.B.5.c above, concerning corporations, it was noted that one of the characteristics that corporations normally have is limited liability for their equity investors (although this is not necessarily so). It thus seems a bit odd that in the United States there would be an additional type of corporate entity referred to as a “limited liability company.” The US limited liability company combines features of partnerships and corporations. The members of a limited liability company can elect to treat it as a partnership for federal tax purposes. This allows the income of the limited liability company to be treated as income of the members and taxed in their hands. This so-called flow-through taxation can be beneficial for the members of the limited liability company.20 Although a partnership or limited partnership would provide this sort of flow-through tax treatment, the limited liability company provides the additional benefits of separate corporate personality and limited liability.

7.  Unlimited Liability Companies The Nova Scotia Companies Act 21 has long allowed for “unlimited companies” based on similar provisions in earlier United Kingdom companies acts.22 With the unlimited liability company, shareholders are jointly and severally liable for the debts of the company. Although the Nova Scotia unlimited company was seldom used, it became popular when tax advisers in the United States became aware of it and realized it had tax advantages under US tax laws for investment in Canada by US investors. In particular, it allowed US investors to avoid a degree of double taxation of corporate income by allowing the income not to be taxed in the corporation, but to flow through to investors so that it was taxed only once in their hands as shareholders. Many Canadian subsidiaries of US corporations were being

20 There are two potential advantages of flow-through taxation. One is that, as discussed in the context of the Canadian Income Tax Act, supra note 13, losses that flow through to individual investors can be deducted against other sources of income, thereby reducing taxable income, which reduces the amount of tax payable. The other potential advantage to investors in the United States is that there is a degree of double taxation of corporate income—that is, the income is taxed once in the hands of the corporation and then again in the hands of shareholders when dividends are paid. There is a degree of double-taxation of corporate income in the United States: see the discussion in e.g. Kyle Pomerleau, “Eliminating Double Taxation through Corporate Integration,” Fiscal Fact No  453 (Tax Foundation, February 2015), online: . Flowthrough tax treatment means the income will be taxed only in the hands of the investors—the shareholders in a limited liability company. 21 RSNS 1989, c 81. 22 See e.g. The Companies Act, 1862 (UK), 28 & 29 Vict, c 89, s 6, which provided that persons could form “an incorporated Company, with or without limited liability” (emphasis added). The Nova Scotia Companies Act, RSNS 1900, c 128, s 6 also referred to the incorporation of a company “with or without limited liability” (emphasis added).

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incorporated using the Nova Scotia unlimited liability form. These incorporations in Nova Scotia brought revenues to the province by way of incorporation fees. In 2005 Alberta sought to obtain similar incorporation fee revenues by also allowing for the incorporation of unlimited liability companies, and British Columbia did the same in 2007.23

8.  United States “C Corporations” and “S Corporations” One may from time to time hear of a “C corporation.” That expression arises under federal income tax law and describes a corporation that is taxed separately from its shareholders. In the United States, a C Corporation must file an income tax return and pay tax on the income it earns from carrying on the business of the corporation. The expression “S corporation” also arises under federal income tax law and describes a corporation that is not taxed separately from its shareholders—it does not have to file a federal income tax return or pay tax on the income it earns from carrying on the business of the corporation. Instead, like the tax treatment of partnership income, the income flows through to the shareholders and is taxed in their hands only and not in the hands of the corporation. The shareholders are taxed on their pro rata share of the income of the corporation based on their relative rights as shareholders to receive income of the corporation. To qualify as an S corporation, the corporation must have just one class of shares and no more than 75 shareholders who, subject to limited exceptions, have to be individuals who are citizens or residents of the United States.24 For S Corporation treatment, the qualifying corporation must file an election with the Internal Revenue Service to be treated as an S corporation.25

9.  Business Trusts It is also possible to use a trust to set out a management structure for a business. A trust used for this purpose is usually referred to as a “business trust.”26

a.  What Is a Trust? The type of trust that is used in a business trust is an express trust. An express trust is one that one or more persons intended to create. It involves one or more persons referred to as “settlors,” who put the title to property in trust in the hands of one or more persons who are referred to as “trustees,” with instructions that the trustees hold that property for the bene– fit of other persons who are referred to as “beneficiaries.” The settlors, trustees, and

23 See SA 2005, c 8, s 9, adding Part 2.1, ss 15.1 to 15.9 to the Business Corporations Act, RSA 2000, c B-9; and see the Financial Statutes Amendment Act, 2007, SBC 2007, c  7, adding Part 2.1 on unlimited liability companies to the Business Corporations Act, SBC 2002, c 57. 24 See 26 US Code § 1361—S Corporation defined, art A. 25 Ibid; see also § 1362(a). 26 Sometimes the term “business trust” is used to describe any trust that is used for commercial purposes. Others use the term “commercial trust” to refer to trusts created for commercial purposes, generally leaving the expression “business trust” to refer to a trust that is set up as a form of association for carrying on business.

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beneficiaries can all be different persons, or settlors can also be either trustees or beneficiaries or both. The details of the operation of the trust can be set out in a document (the “trust instrument,” which is often given the title “declaration of trust”), and the law allows for a great degree of flexibility as to what can be done in terms of how the trust will operate. The law does not recognize the trust as a separate person (although the Income Tax Act effectively does so, but only for the purpose of determining the taxable income for a trust). Since a trust is not a separate legal entity, it is the trustees who have title to the assets and who can transact with respect to those assets on behalf of the beneficiaries.

b.  The Business Trust Form of Association i.  Investors as Settlors and Beneficiaries With this short note on the express trust one can quickly see how a trust can be set up to look quite similar to a corporation. Equity investors can invest by settling funds on one or more trustees who are charged with a duty to manage those funds on behalf of beneficiaries. The beneficiaries are the investors themselves.

ii.  Creating Equivalents to the Shares, the Board of Directors, and Officers Investor beneficial interests can be divided up into units resembling shares. The trust instrument can provide for the election of the trustees by the investor-beneficiaries, thus replicating the board of directors of the corporation. The trustees can be given authority to delegate aspects of their management duties to others, thus allowing them to engage agents and hire persons who can be given management duties similar to those given to officers of corporations.

iii.  Limited Liability Since it is the trustees that have the authority to deal with the assets, it is the trustees who would normally be liable with respect to contracts or torts arising in the conduct of the business. Thus, as long as the investor-beneficiaries are not trustees they will have some protection against personal liability that may roughly approximate the limited liability of shareholders in a corporation. Since the trustees are carrying on the business, it will be the trustees who enter into contracts (either themselves or through agents) and who will be liable for torts committed in the conduct of the business (either directly or vicariously). Since the investors do not normally themselves enter into contracts concerning the conduct of the business, they will not be liable as parties to such contracts. The investors will not normally be directly or vicariously liable for torts committed in the conduct of the business, since the investors do not normally conduct the business activities of the business trust, either themselves or through agents or employees. There are, however, two main potential sources of liability risk for investors. One is based on an implied right of trustees to be indemnified for their losses by beneficiaries in some situations. The other is based on the possibility that the trustees will also be considered agents of the investors in some situations. The trustees can waive any right they may

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have to indemnification, thus avoiding the otherwise implied right of trustees to have the beneficiaries (who are the investors in a business trust) indemnify them for their losses. With respect to the potential agency argument, the likelihood of the trustees being considered agents for the investors is small as long as the investors do not have significant control over the business. Thus, by having the trustees waive any right they might have to indemnification from the investors, and as long as the investors do not have significant control over the conduct of the business, the risk of personal liability of the investors should be remote. 27

c. Example Although it would be unusual to use a business trust as a structure for a business such as the Quick Buys convenience store business (for reasons noted in Section III.B.9.d below), one can consider how this might be done. Aya and Tomi could settle funds on persons they selected as trustees for the purpose of running the store business. The trustees could acquire the assets needed to carry on the business and then carry on the business. Profits from the business could be distributed to Aya and Tomi as beneficiaries of the trust. A trust instrument (often entitled “declaration of trust”) could set out the terms of the trust. This might, for instance, allow Aya and Tomi as beneficiaries to elect trustees on a regular basis. It could set out the rights of beneficiaries to share in the distribution of the profits of the business and to share in the net proceeds if the business were brought to an end, the assets were sold, and the debts incurred by the trustees were paid off. The trustees could be given authority to delegate certain of their duties to other persons who might thereby have a similar function to officers of a corporation. Since it would be the trustees who carry on the business, the trustees would be liable for the debts incurred in carrying on the business. If, therefore, Aya and Tomi were trustees, they would be liable for the debts of the business. Consequently, if Aya and Tomi wanted to recreate the limited liability they might have in a corporation, they could not be trustees themselves. They would also have to make sure that the declaration of trust included a clause in which the trustees waived their right to indemnification. In addition, they would have to be careful that the degree of control they were able to exert over the trustees did not have the effect of making the trustees their agents. If the trustees could be construed as being agents for Aya and Tomi, then Aya and Tomi would be liable as principals for debts incurred or vicariously liable for torts committed in the carrying on of the business.

d.  Situations in Which Trusts Are Currently Used as a Form of Business Association The trust is not normally used as a form of business association in the way described in the example above. The main problem with using a trust in the way described in the example is that the Income Tax Act deems a trust to dispose of its assets every 21 years. This deemed disposition of assets triggers capital gains tax. The Income Tax Act deems a disposition 27 See the discussion in e.g. R Flannigan, “Beneficiary Liability in Business Trusts” (1982-84) 6 E & TQ 278; and Mark R Gillen, “Income Trust Unitholder Liability: Risk and Legislative Response” (2005) 42 Can Bus LJ 325 at 332-43.

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because tax on capital gains arises only on a disposition of a capital asset and one could use a trust, even under the common law remoteness of vesting perpetuity rule, that would last for quite a long time (potentially many years more than just 21 years) without a disposition of the assets of the trust. Assets held by a sole proprietor, a partnership, or a corporation are not subject to this 21-year deemed disposition rule. Exceptions are, however, made for certain types of trusts. Mutual fund trusts and real estate investment trusts (REITs) are not subject to the 21-year deemed disposition rule.28 Trusts are, therefore, often used for mutual funds and real estate instatement funds.29

i.  Mutual Fund Trusts A mutual fund collects funds from many investors and invests them in a diversified portfolio of investments in securities such as shares in corporations, debentures, government bonds, and commercial paper. This allows investors to get a diversified portfolio much more cheaply than they would be able to obtain on their own. It can also provide investors with the benefit of investment expertise of mutual fund managers, which the investors may lack themselves. Organization of a mutual fund as a trust allows for the income on the mutual fund investments to flow through to mutual fund investors (the beneficiaries of the trust) without a tax first being imposed on the mutual fund trust as long as the income of the mutual fund is distributed to investors. The use of a trust for a mutual fund with the benefit of this tax flowthrough treatment would be strongly discouraged if the mutual fund trust was required to pay capital gains tax on all its assets every 21 years because of the 21-year deemed disposition rule for trusts. An exception to the 21-year deemed disposition rule is therefore made for mutual fund trusts. 30

28 The 21-year deemed disposition rule is in s 104(4) of the Income Tax Act, supra note 13. It applies to “every trust,” but in defining “trust” s 108(1) states that in applying s 104(4) “trust” does not include “a trust that, at that time, is a unit trust.” The definition of “mutual fund trust” in s 132(6) requires that a “mutual fund trust” be a “unit trust resident in Canada.” A trust that qualifies as a “mutual fund trust” will therefore not be a “trust” for the purposes of s 104(4) and will therefore not be subject to the 21-year deemed disposition rule in s 104(4). A “unit trust” is defined in s 108(2). A real estate investment trust will also be exempt from the 21-year deemed disposition rule if it qualifies under the Income Tax Act as a “mutual fund trust.” 29 In the 1990s, creative tax practitioners came up with a way of reorganizing a business to use a trust to get the benefit of flowthrough taxation, which could avoid a degree of double taxation of corporate income. It also took advantage of low rates of taxation for certain types of investors, such as those saving for retirement and investors who were not residents of Canada. The basic idea was to create a trust for investment in a particular business that met the requirements for a “mutual fund trust” under the Income Tax Act. That way, the trust could rely on the mutual fund trust exemption from the 21-year deemed disposition rule for trusts. The Income Tax Act was amended to cut off this particular use of the trust for a particular business or for a small number of businesses. The amendment was done in such a way as to preserve the exemption from the 21-year deemed disposition rule for mutual fund trusts and real estate investment trusts that maintained a portfolio with many investments. For further details on this “business income trust” phenomenon and the changes that brought it to an end, see Robert Yalden, Janis Sarra, Paul Paton, Mark R Gillen, Ronald Davis & Mary Condon, Business Organizations: Principles, Policies and Practice (Toronto: Emond Montgomery, 2008) ch 12 at 1111-73. 30 See supra note 28.

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ii.  Real Estate Investment Trusts A real estate investment trust is similar to a mutual fund. Funds are collected from numerous investors and are invested in various real estate investments. Like the mutual fund trust, the use of a trust for such a pooling of real estate investments allows the income on the real estate investments to be taxed only in the hands of the investors, and not first taxed in the hands of the trust, as long as the income on the real estate investment portfolio is distributed to the investors. The use of a trust for such a real estate investment fund would be strongly discouraged if the trust was required to pay capital gains tax on all its assets every 21 years due to a 21-year deemed disposition rule for trusts. The 21-year deemed disposition rule does not apply where the real estate investment trusts qualifies under the Income Tax Act as a mutual fund trust.31

C.  Not-for-Profit Forms of Association Although the primary focus of this book is on for-profit forms of association, it is worth noting that the common for-profit forms of business association have their analogues in the not-for-profit sector. For example, there are not-for-profit corporations and not-for-profit unincorporated associations, which share some similarities with partnerships.

1.  Societies or Not-for-Profit (or Non-Profit) Corporations It is common to have separate statutes for the incorporation of not-for-profit (or non-profit) corporations that will carry on their activities on a not-for-profit basis. Persons taking on a role somewhat similar to shareholders in for-profit corporations are typically referred to as members. The members usually elect a board of directors or an executive committee that will manage or supervise the management of the not-for-profit corporation’s activities. The board of directors or executive committee may then engage agents and hire others to carry on the activities of the corporation. In addition to voting to elect a board of directors or an executive committee, voting by members will also typically be required to amend the articles, bylaws, or other constitutional documents of the not-for-profit corporation. The members may also be persons who receive the benefits from the activities performed by the not-for-profit corporation. The expression “not-for-profit” or “non-profit” corporation is used to describe such corporations in many jurisdictions in Canada.32 In some Canadian jurisdictions there is a separate not-for-profit corporation statute styled “Corporations Act” in contrast to the for-profit corporation statute, typically styled “Business Corporations Act.”33 In other Canadian jurisdictions, both for-profit and not-for-profit companies or corporations can be formed under

31 See supra note 28. 32 See e.g. the Canada Not-for-profit Corporations Act, SC 2009, c 23; in Saskatchewan, see The Non-profit Corporations Act, SS 1995, c N-4.2. 33 See e.g. the Ontario Corporations Act, RSO 1900, c C.38 and the Ontario Business Corporations Act, RSO 1990, c B.16; in Alberta, see the Companies Act, RSA 2000, c C-21, part 9, and the Alberta Business Corporations Act, RSA 2000, c B-9; and in New Brunswick, see ss 16 and 18 of the Companies Act, RSNB 1973, c C-13 and the New Brunswick Business Corporations Act, SNB 1981, c B-9.1.

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a single general statute of incorporation styled a “Corporations Act” or a “Companies Act.”34 However, both British Columbia and Nova Scotia have a “Societies Act” that allows for the incorporation of societies that will carry on their activities on a not-for-profit basis.35 Societies, or not-for-profit corporations, are often used to carry on charitable activities. However, charities do not have to be set up as not-for-profit corporations. They could be organized as trusts or as unincorporated associations. Not-for-profit corporations get special tax treatment under the Income Tax Act.36 The Income Tax Act taxes income and capital gains. A not-for-profit corporation, as the name suggests, is not intended to earn a profit. Although it may earn a surplus in a given year, as long as that surplus does not accumulate for a prolonged period, the not-for-profit corporation will not be subject to tax under the Income Tax Act.37 If the not-for-profit corporation carries on charitable activities and becomes registered as a “registered charity,” receipts can be given to persons who make donations to the corporation so that they can claim tax credits for their charitable donations.38 What constitutes a “charitable activity” is, for the most part, determined according to the trust law definition of “charitable purposes.” It is important for a charitable not-for-profit corporation (or other charitable organization) to maintain its status as a registered charity if it wants to continue to allow its donors to get tax credits for their charitable donations.

2.  Unincorporated Associations Although persons who carry on business in common with a view to profit are considered to be partners, if they act in common but not for profit and have not formed a corporation, they are described as members of an “unincorporated association.” An unincorporated association is not recognized as a separate legal entity and therefore cannot enter into contracts with other persons—it is the members of the unincorporated association who are parties to contracts entered into in carrying on the activities of an unincorporated association. An unincorporated association cannot be responsible for a tort committed in carrying on the activities of the unincorporated association because it is not recognized as a separate legal entity. It is, instead, the members who will be responsible for torts committed in carrying on the activities of the unincorporated association. The members may be considered agents for each other in the carrying on of the activities of the unincorporated association, and the members can engage other agents and employees. Amounts owed to creditors with respect to debts incurred in carrying on the activities of an unincorporated association will be owed by the members of the unincorporated association, not the unincorporated association because it is not a recognized legal entity capable of incurring debts either by way of contract or tort. 34 See e.g. part II of the Prince Edward Island Companies Act, RSPEI 1974, c C-14 (ss 89 to 91); for Manitoba, see part XXII of the The Corporations Act, CCSM c C225; and for Newfoundland and Labrador, see part XXI of the Corporations Act, RSNL 1990, c C-36. 35 See e.g. the BC Societies Act, SBC 2015, c 18; and the Nova Scotia Societies Act, RSNS 1989, c 435. 36 RSC 1985, c 1 (5th Supp.), as amended, ss 149(1)(l). 37 See paras 8 and 9 of the income tax Interpretation Bulletin, IT-496R on non-profit organizations, online: . 38 See the Income Tax Act, supra note 13, ss 118.1 and 149.1.

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D.  Combined for-Profit and Not-for-Profit Forms of Business Association The primary objective of the partnership and corporate forms of association described above is normally profit. Profit is, in fact, part of the definition of partnership in partnership legislation. The discussion under this heading is about forms of business association that may pursue profits but may also pursue other objectives. An important part of the objectives of co-operative associations and mutual organizations discussed below is to serve their members. Some more recent forms of association, discussed below under the heading “social enterprise,” may also combine a profit objective with one or more not-for-profit objectives.

1.  Co-operative Associations Much of what was said earlier about corporations applies to co-operative associations since co-operative associations are corporate forms of organization.39 For instance, as a corporation, a co-operative association is treated as a separate legal entity with potential perpetual existence. It has shareholders (referred to as members),40 and it has directors and officers. A key distinguishing feature of a co-operative form of organization is that it is subject to cooperative principles.41 A common principle for co-operative corporations is that there is one vote per member 42 instead of the normal one or more votes per share approach in for-profit corporations. Another common co-operative principle is that the co-operative corporation is organized to serve the common needs of the members of the co-operative.43 This principle 39 See e.g. the Ontario Co-operative Corporations Act, RSO 1990, c 35, s 1(1), which defines “co-operative” to mean “a corporation carrying on an enterprise on a co-operative basis” (emphasis added); see also the BC Co-operative Association Act, SBC 1999, c 28, s 1(1), which defines “association” to mean “an association incorporated … under this Act” (emphasis added). 40 “Member” was a term used in English companies acts to refer to the shareholders of a company: see e.g. The Companies Act, 1862 (UK), 25 & 26 Vict, c 89. It was also the term used in e.g. An Act for the Incorporation and Regulation of Joint Stock Companies and Trading Corporations, RSBC 1897, c 44, and the Nova Scotia Companies Act, RSNS 1989, c 81. The members of a co-operative corporation typically hold shares: see e.g. the Ontario Co-operative Corporations Act, supra note 39, s 25, which states that “the authorized capital of a co-operative shall be divided into shares.” Section 26(2) states that “where a co-operative has only one class of shares, that class shall be membership shares,” and s  26(3) states that “where a cooperative has more than one class of shares, one class shall be membership shares … , and the other shares shall consist of one or more classes of preference shares.” On classes of shares and the meaning of preference shares, see Chapter 6. 41 See e.g. the Ontario Co-operative Corporations Act, supra note 39, s 1(1), which defines “co-operative basis” to mean that the corporation is “organized, operated and administered upon the following principles and methods.” See also the BC Co-operative Association Act, supra note 39, s  8(1), which states that a cooperative association incorporated under the Act “must carry on business on a co-operative basis,” and s 8(2), which sets out co-operative principles. See also the Cooperatives Act, SA 2001, c C-28.1, s 2; The Co-operatives Act, CCSM c C223, s 4(1); Co-operative Associations Act, RSNS 1989, c 98, s 2(d); and The Cooperatives Act, 1996, SS 1996, c C-37.3, s 3. 42 See e.g. the Ontario Co-operative Corporations Act, supra note 39, s 1(1), which in its definition of “cooperative basis” includes among the co-operative principles the principle that “each member or delegate has only one vote” and see the BC Co-operative Association Act, supra note 39, s 40(1), which states that “a member has one vote on all matters to be decided by the members,” and s 40(2) adds that “a member’s right to vote derives from membership and not membership shares.” 43 See e.g. the BC Co-operative Association Act, supra note 39, s 8(2)(a), which states that “membership in the association is open in a non-discriminatory manner to persons who can use the services of the association.”

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of serving the common needs of members is reflected in a further common co-operative principle that profits of the co-operative corporation are shared among the members on the basis of how much they use the services of the organization, not on how many shares they own.44 For example, co-operative corporations often distribute profits to their members in the form of lower prices or reduced fees for services.

2.  Mutual Organization A mutual organization is very similar to the co-operative association described above. Like the co-operative association, it is formed for the benefit of the members of the organization and usually operates on a non-profit basis with the members benefiting from the services of the mutual organization. Unlike co-operative associations formed under co-operative association legislation, a mutual organization is not set up through a specific statute for the formation of mutual organizations, but can be set up as a corporation (such as a society or not-for-profit corporation),45 or it may operate as an unincorporated association.46 The members of the mutual organization typically provide capital through payment of fees instead of contributing capital in exchange for shares. Fees paid by members may be for services such as banking, mortgages, property or crop damage protection for farmers, fire insurance, retirement benefits, disability or sickness insurance, or assistance to needy members. The mutual form of organization has a long history. It has been used in England for “building societies” that provided mortgages to its members and for “friendly societies” that provided pensions, co-operative banking, or insurance services. It has been used for farmers to protect against property damage (such as a barn fire) or crop damage due to bad weather. In the past, stock exchanges, including the Toronto Stock Exchange, were often organized as mutual organizations for member brokers. Many well-known insurance companies, such as Mutual of Omaha and Lloyds of London, have operated as mutual organizations. A “mutual organization” should not be confused with a “mutual fund.” A mutual fund is typically organized as a corporation or trust that pools funds from investors to invest in a diversified portfolio of securities such as shares, corporate debentures, and government bonds or treasury bills.47

3.  Social Enterprise Chapter 8 of the book focuses on social enterprise. “Social enterprise” has been defined by the Canadian federal government’s Ministry of Innovation, Science, and Economic Development in the following way: 44 See e.g. the Ontario Co-operative Corporations Act, supra note 39, s 1(1), which in its definition of “cooperative basis” includes among the co-operative principles the principle that “any surplus funds arising from the business of the organization, after providing for such reasonable reserves and interest or dividends, unless used to maintain or improve services of the organization for its members or donated for community welfare or the propagation of co-operative principles, are distributed in whole or in part among the members, … (ii) in proportion to the volume of business the members have done with or through the organization.” 45 See above Section III.C.1. 46 See above Section III.C.2. 47 See above Section III.B.9.d.i.

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A social enterprise seeks to achieve social, cultural or environmental aims through the sale of goods and services. The social enterprise can be for-profit or not-for-profit but the majority of net profits must be directed to a social objective with limited distribution to shareholders and owners.48

Under this definition social enterprise may include charitable organizations since they sometimes carry on profit-making activities to a limited degree—for example, running a cafeteria or a gift shop—and directing the profit to the organization’s charitable activities. Not-forprofit corporations can also earn profits, or surpluses, as long as these are ultimately directed to the corporation’s not-for-profit objectives. Co-operative and mutual forms of organization may also pursue social, cultural, or environmental objectives. In addition, for-profit corporations may, at least to some degree, also seek to achieve social, cultural, or environmental objectives. Even where a for-profit corporation’s objective is a pure profit objective, it has long been recognized that it can follow socially responsible activities that can reasonably be said to promote its profit-making objectives. The modern Canadian approach to the fiduciary duties of directors and officers recognizes that the directors and officers may take into account the interests of stakeholders other than just the shareholders. Further, while it has been held in the past that the presumed objective of a for-profit corporation is the pursuit of profit, corporate statutes, even for-profit corporate statutes, do not provide that the sole object of the corporation is profit and do not preclude the inclusion of other corporate objectives. There have, however, been a number of recent attempts to provide for forms of organization, usually corporate forms, that either make it clear that not-for-profit objectives will be pursued in addition to for-profit objectives or that attempt to provide a clearer legal basis for pursuing not-for-profit objectives in addition to for-profit objectives. Recently, several new forms of organization have been developed that attempt to facilitate the pursuit of social, cultural, or environmental aims through the sale of goods and services. These include benefit corporation statutes in the United States49 and legislation

48 Government of Canada, Directory of Canadian Social Enterprises, online: . 49 For example, since August of 2013, a “Public Benefit Corporation” can be formed under Delaware Corporation Law that is “a for-profit corporation … that is intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner” and that must, in its certificate of incorporation, identify one or more specific public benefits that it will pursue. See Title 8 (Corporations), Chapter 1 (General Corporation Law), Subchapter XV (Public Benefit Corporations) (79 Del Laws, c 122, § 8) s 362(a). For a general discussion of this legislation, see Felicia R Resor, “Benefit Corporation Legislation” (2012) 12 Wyo L Rev 91 at 101-2 and 106-13. A historical precursor to benefit corporation statutes was the “B Corp” designation provided by an organization known as “B Lab,” which would certify a corporation as a “B  Corporation” based on an impact assessment of the corporation’s governance, labour, community, and environmental practices: see “Performance Requirements,” online: B Corporation website (visited 4 April 2017). Another development in the United States was the low-profit limited liability company, which used the limited liability company form (see Section III.B.6 above) with branding as low-profit relating to its social goals: see e.g. Robert M Lang Jr, “The New Way to Organize Socially Responsible and Mission Driven Organizations” (2007) 5 ALI-ABA 203 at 205-6; Cody Vitello, “Introducing the Low-Profit Limited Liability Company (L3C): The New Kid on the Block” (2011) 23 Loy Con L Rev 565; and Thomas Kelly, “Law and Choice of Entity on the Social Enterprise Frontier” (2009) 84 Tulane L Rev 337.

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allowing for the formation of Community Interest Corporations in the United Kingdom50 and Nova Scotia51 with similar legislation in British Columbia allowing for the formation of Community Contribution Corporations.52

E.  Other Business Association Forms 1.  Joint Ventures53 A business may also be carried on as a “joint venture.” The term “joint venture,” in a general, non-legal, sense, is used to describe a relationship among persons who agree to combine skills, property, funds, time, resources, knowledge, and/or experience to pursue some common objective. Typically, each member of the joint venture has some control over the management of the joint activity and agrees to share in the profits and losses of the activity. There is, however, no precise legal meaning of the term “joint venture.” A “joint venture” is not recognized as a separate legal entity. The agreement to set up the joint venture could be a partnership agreement. The members of the joint venture might, for instance, be two separate corporations carrying on the joint venture through a partnership. The terms of the joint venture agreement would then appear in the partnership agreement. A joint venture might also be carried on through a corporation. Two corporations, for instance, each with their own separate business activities, might set up a separate corporation through which they carry on a joint venture. Each of the joint venture corporations could be shareholders in the joint venture corporation. Key terms of their joint venture

50 In the United Kingdom, part 2 of the Companies (Audit, Investigations and Community Enterprise) Act 2004, UK 2004, c 27 provided for the formation of (or conversion of an existing company into) a “community interest company”(or CIC, usually pronounced “kick”). A community interest company is one that satisfies a community interest test (see s 36(5)(b) for new companies and s 38(4) for existing companies), and the community interest test is met if a reasonable person might consider that its activities are being carried on for the benefit of the community (s 35). On the formation of a community interest company, see also the website of the Office of the Regulator of Community Interest Companies, . 51 See An Act Respecting Community Interest Companies, SNS 2012, c 38 (which came into force on 15 June 2016); see also the Community Interest Companies Regulations, NS Reg 121/2016. For a discussion of the Nova Scotia community interest company, see Pauline O’Connor, “The New Regulatory Regime for Social Enterprises in Canada: Potential Impacts on Nonprofit Growth and Sustainability,” Centre for Voluntary Sector Studies, Ryerson University, Working Paper Series vol 2014(1), online: Centre for Voluntary Sector Studies (visited 4 April 2017) at 31-32. 52 This was provided for in amendments to the BC Business Corporations Act that came into effect in July 2013: see the Finance Statutes Amendment Act, SBC 2012, c 12, s 8, which amended the BC Business Corporations Act, SBC 2002, c 57 by adding part 2.2, ss 51.91 to 51.99 (brought into force on 29 July 2013—BC 63/2013). See the discussion of the BC community contribution company in O’Connor, supra note 51 at 28-31; and Michael Blatchford & Margaret Mason, “Introducing the Community Contribution Company: A New Structure for Social Enterprise” (presented for the Legal Education Society of Alberta, November 2013), online: Bull Houser (visited 4 April 2017). 53 For a brief but more extended discussion, see e.g. J Anthony van Duzer, The Law of Partnerships and Corporations, 3rd ed (Toronto: Irwin Law, 2009) at 76-79.

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agreement might be contained in a “shareholders’ agreement” entered into by each of them as shareholders in the joint venture corporation. The terms under which the joint venture is to be operated may simply be set out in a contract with no partnership being created and no corporation being formed for carrying on the joint venture business.

2. Franchises54 Franchises are also often used in the business context. A franchise is an arrangement in which a franchisor grants a franchisee one or more rights, such as the right to sell the franchisor’s products, use its business name, adopt its methods, or copy its symbols, trademarks, or architecture over a specified period of time in a specified place. The right to use the business name, or other licensed rights, is what is referred to as the franchise. That business name is usually associated with a particular way of carrying on business. The franchisor often also provides marketing support and training in the franchisor’s method of carrying on business. In exchange, the franchisee pays a royalty or licence fee to the franchisor. A franchise arrangement has one or more of three basic elements: the provision of knowhow by the franchisor, image recognition provided by the franchisor’s marketing support, and the benefit of joint purchasing power allowing for quantity discounts. The key legal element of a franchise is the licence to use the name, trademark, etc., provided by the franchisor to the franchisee. The arrangement involves an exchange, and thus involves a contract. The contract is usually written, although it could be an oral contract. Franchises are governed by provincial law because they deal with contracts that fall under provincial powers with respect to property and civil rights. The “franchise”—that is, the licence—is not a separate legal entity capable of contracting on behalf of itself. However, the franchisor could be a sole proprietor, partnership, or corporation, but it is nearly always a corporation. The franchisee could likewise be a sole proprietor, partnership, or corporation, but is most often a corporation.

3.  Multiple Contracts a.  Business Activity Carried On Through a Series of Separate Contractual Arrangements The various ways of associating to carry on business described above involve arrangements among persons as to how they will carry on a particular business activity. An alternative legal means of securing a co-operative business activity is through a series of separate contracts. Consider a simple item like a cheap plastic pen. One might arrange for the delivery of the ink, nib, and tube to another person who, subject to contractual terms, agrees to put these items together and ship them to another person to be inserted into the housing for the pen (with arrangements that housings be delivered to the person who puts the ink-filled tube and nib into the housing). One could make contractual arrangements with yet another person to distribute the product, and contractual arrangements might also be made for another person to market the product.

54 See van Duzer, ibid at 21-22, and see generally Frank Zaid, Franchise Law (Toronto: Irwin Law, 2005).

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Each of these contracts could have terms dealing with how the particular stage in the production process is to be carried out, with further terms as to the consequences of a breach of the contract. Ultimately, one might break everything down to the point that there are no group or joint activities. Instead, every step could be done by separate persons acting independently subject to the terms of separate contractual arrangements. The whole production and distribution process could thus be coordinated through a series of explicit contracts.

b.  Transaction Costs (Negotiating, Monitoring, and Enforcing) In many business activities the multiple contract approach could involve very high costs in terms of negotiating each separate contract and in terms of monitoring and enforcing the performance of each contract. Consequently, it may be more cost-effective to have some form of organization or association to coordinate activities in a way that would be less costly than negotiating, monitoring, and enforcing numerous separate contractual arrangements.

c.  Forms of Business Association as Means of Reducing Transaction Costs Business associations of various forms might thus be seen as methods of organizing cooperative activity to reduce these negotiating, monitoring, and enforcement costs. As the organization grows in size and complexity, the cost of further organization might begin to outweigh the cost of separate contracts. At that point, further efforts at formal organization may not be worthwhile.

F. Summary This section has examined a wide range of forms of business organization. Both legal and economic concepts of agency were noted because of the importance of agency in business relationships generally and its central importance in most forms of business organization. Various for-profit forms of business organization were then considered, including sole proprietorship, partnership, limited partnership, limited liability partnership, corporations (including a note on unlimited liability companies, C corporations, and S corporations), and business trusts (including mutual funds and real estate investment trusts). Not-for-profit corporations or societies were then briefly noted, along with unincorporated associations. Forms of business organization that can combine for-profit and not-forprofit activities were then noted, including co-operative associations and the mutual form of organization. Mention was also made of the concept of social enterprise. Last, mention was made of other ways of organizing to carry on business, such as joint ventures and franchises. The possibility of carrying on a business activity through a series of contracts was noted as a contrast to forms of organization that internalize transactions, and also with a view to introduce the notion that one way to understand the use of certain forms of business organization is as a means of reducing transactions costs that would likely be associated with organizing a business activity through a series of separate contractual arrangements.

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IV.  SOME SIMPLE ACCOUNTING Some simple principles of accounting can be useful in the commercial law context generally. There are aspects of the study of business associations where some simple accounting concepts can also be useful. Perhaps the most obvious use of accounting principles is in the requirement for financial disclosure in a number of contexts. This section is intended to provide a simple introduction to some basic financial statements and a few important terms. Four commonly used financial statements under international financial reporting standards (IFRS) are:



1. the “statement of financial position” (in the past also referred to as a balance sheet); 2. the “statement of comprehensive income” (which includes a “statement of earnings” arising from the business [sometimes also called a “statement of profit/loss”] and a statement of other sources of income or loss); 3. the “statement of changes in equity”; and 4. the “statement of cash flows.”

The notes below focus on what, for our purposes, are the more important of these statements—the statement of financial position and the statement of earnings. A simple statement of changes in equity and a simple statement of cash flows are also provided below so one can get a very general sense of what these statements are about. The objective here is not to learn the complexities of financial accounting in a few pages, but merely to see, in very simple and general terms, the kind of information that these common financial statements seek to convey. Later in the book reference will be made to the requirement since the beginning of 2011 that public corporations follow IFRS in presenting their financial statements. The IFRS are the culmination of years of effort to address countryto-country variation in financial reporting standards that made it difficult to compare financial statements prepared according to the financial reporting standards of one country with financial statements prepared according to different financial standards in another country. Private corporations can use IFRS in preparing their financial statements, but they can also use what are referred to as accounting standards for private entities (ASPE) based on Canadian accounting standards that differ in some respects from the IFRS. Examples of financial statements are provided below on the basis of a simple fact pattern. These statements don’t strictly follow proper accounting standards because the purpose is to provide simple examples without delving into the potential complexities of accounting.

A.  The Statement of Financial Position (or “Balance Sheet”) The statement of financial position is usually displayed in a top-down format, but it is sometimes displayed in a left-right format. The left-right format makes its “balance” quality somewhat sharper. In the left-right format one lists the “assets” of the business on the lefthand side. One lists the “liabilities and equity” on the right-hand side. The right-hand side shows where funds for the business were obtained. The assets side (the left-hand side) shows what was done with those funds. If one accounts on the asset side for what was done with every cent of the funds received, then the asset side and the funds side should be equal—that is, they should balance.

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The top-down format shows the assets first, followed by the liabilities and equity. Either way, the statement of financial position, or balance sheet, briefly put, shows the source of funds for the business and the uses of those funds.

B.  The Statement of Earnings and Statement of Comprehensive Income The statement of earnings part of the statement of comprehensive income shows the revenues of the business less the expenses of the business. The revenues could be from, for example, “sales” of goods or services, “royalties,” “licence fees,” or “rental income.” These are listed first and totalled. Then expenses are listed and totalled and the total expenses are deducted from the total revenues. That is the essential nature of the statement of earnings, although various steps may be taken to separate various expenditures and to show the profits net of these expenditures. For instance, in a retail business there is usually a section called “cost of goods sold” that separates the cost of the goods acquired for retail from the other expenses of the business, and often shows revenues less cost of goods sold as “gross profit.” Other expenses would then be deducted to arrive at net income. The other expenses would include interest expense, taxes, and an expense that recognizes the depreciation of assets that deteriorate in value over time or through use. The statement is referred to as a statement of comprehensive income because, in addition to showing the profit or loss from carrying on the business (or businesses), it also separately shows other sources of increases or decreases to assets or increases or decreases in liabilities (other than those due to contributions by investors or distributions to investors).

C.  Assets, Liabilities, and Equity Generally speaking, “assets” are things acquired for the business that will have a continuing value to the business (usually beyond one year). As noted above, the sources of funds are styled “liabilities and equity.” The liabilities are set out first, followed by the equity. “Liabilities,” or “debt,” in the strictest sense, represent fixed obligations. For instance, a loan from a bank usually involves an obligation to pay back the fixed amount that was loaned with fixed periodic payments for the use of the money determined by reference to a rate of interest. Sometimes goods or services may be acquired for the business on credit—that is, buy now and pay later. The payment will be a fixed amount or a fixed amount plus a fixed rate of interest. “Equity,” in the strict sense, is the entitlement to residual amounts—that is, amounts that are left over. Persons who have advanced funds as an “equity” investment share in the profits that are the residual amount of revenues left after payment of expenses, including interest expense. If the business is brought to an end and the assets are sold off, the equity investors are also entitled to the amount left over after the liabilities have been paid.

D.  Trade Credit, Accounts Payable, and Accounts Receivable As noted above, sometimes goods or services will be acquired for a business on credit. This credit is typically referred to as “trade credit.” Trade credit extended to the business by suppliers of goods or services will appear on the liabilities section of the statement of financial position as “accounts payable”—that is, an account that must be paid. Sometimes the

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IV.  Some Simple Accounting

business itself will extend trade credit to others. For instance, it may sell goods or provide services and allow the buyer of the goods or services to pay for them later. The vendor will have a contractual right to collect the amount. In other words, the vendor has a “chose in action.” This will be reflected on the vendor’s statement of financial position as an asset, typically in an account referred to as “accounts receivable”—that is, an amount the vendor is entitled to receive, or collect, at some point.

E.  A Statement of Financial Position (Balance Sheet) for the Sample Fact Pattern Sole Proprietorship Recall from the fact pattern set out in Section II that Aya Nang had put aside $75,000 to invest in her own business and that she borrowed $50,000 from a bank. Suppose Aya bought lighting for $15,000, shelving for $10,000, a cash counter for $8,000, freezers for $30,000, a cash register for $3,000, and had storage cabinets installed at a cost of $12,000. Suppose also that she started her business with $40,000 of inventory, of which $15,000 had been acquired on credit. Because she acquired $15,000 worth of her inventory on credit, she will have to pay this amount at some point in the future. It appears on the statement of financial position set out below as “Accounts Payable.” Suppose the rate of interest on the loan from the bank requires her to make interest payments of $500 every month. A statement of financial position reflecting this information is set out below. QUICK BUYS STATEMENT OF FINANCIAL POSITION As at the beginning of the business Assets Cash $ 22,000 Inventory 40,000 Shelving 10,000 Freezers 30,000 Cash Register 3,000 Light Fixtures 15,000 Cash Counter 8,000 Storage Cabinets 12,000 Total Assets $140,000 Liabilities and Owner’s Equity Liabilities: Accounts Payable Bank Loan Owner’s Equity: Total Liabilities and Owner’s Equity

$ 15,000 50,000 75,000 $140,000

The statement of financial position above is intended to give a simple picture of this key financial statement. Under “Liabilities and Owner’s Equity” it shows Aya’s source of funds for her business. Her funds came from her own investment of $75,000, the bank loan of $50,000, and the accounts payable of $15,000 (because those who provided goods on credit are partly financing Aya’s inventory of goods for sale). Under “Assets,” it shows how the funds

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were used with the amounts spent on inventory, shelving, freezers, the cash register, lighting, the cash counter, and storage cabinets, together with the amount of cash remaining after those purchases. If the uses of every dollar of every source of funds in the “Liabilities and Owner’s Equity” are accounted for in the assets of the business, then the dollar value of the sources of funds should equal the dollar value of the uses of funds. The statement of financial position above shows the total sources of funds (the “Liabilities and Owner’s Equity”) to be $140,000. The “Assets” (or uses of funds) shows the total uses of funds to be $140,000. Thus, the statement of financial position balances: the total sources of funds balances with (or equals) the total uses of funds. It is a picture of the assets, liabilities, and equity in the business at a particular point in time. In the example above, it is a picture of the assets, liabilities, and equity in the business at the point in time that the business is about to start operating. This simple presentation of a statement of financial position hides many potentially more difficult accounting questions. For instance, should Aya’s right to the use of the leased property be treated as an asset? Accountants have considered this and do indeed recognize a lease as an asset in certain circumstances. That then requires a method for assessing the value of the lease. If the lease is recognized as an asset, then what is the corresponding source of funds for that asset? The lighting, shelving, freezers, and the cash register may well be “fixtures.” If so, then they might not belong to Aya and she might simply have the right to use those fixtures for the life of the lease. This would depend on the lease agreement. If Aya does not own those “fixtures,” then it might not be appropriate to list them as assets. They would, however, be improvements to the property that might make the lease that much more valuable to Aya. Should this be recognized in some way? These are questions that we will leave to the accountants. For now, the point is to be aware of a statement of financial position as an important financial statement and to have a basic understanding of what a statement of financial position shows. A perusal of the statement of financial position highlights some of the stakeholders in a business. These include the equity investors and the creditors. It also highlights some of the decisions that will have to be made in the management of the business—for example, what long-term assets should be acquired (such as the equipment Quick Buys purchased); how much cash or inventory should be kept on hand; what kind of credit terms should be offered to customers, since this will affect the level of accounts receivable and how much will actually be collected on sales made; what proportion of the business should be financed with debt relative to equity; and what proportion of the debt should be long-term debt and what proportion should be short-term debt.

F.  A Statement of Earnings, Revised Statement of Financial Position, Statement of Changes in Equity, and Statement of Cash Flows for the Sample Fact Pattern Sole Proprietorship Suppose that over the course of one month of operations Aya has sales at her store that have a total value of $96,500 and that $66,500 of these sales were made for cash. The other $30,000 of sales were made on credit—that is, the customers promised to pay for the goods at a later date. Aya also made purchases of goods for sale amounting to $50,000. At the end of the month she had a remaining inventory of goods for sale of $35,000. She still owed $20,000 for goods she purchased on credit. Her interest expenses

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IV.  Some Simple Accounting

on the loan came to $500, she paid rent of $10,000, and she incurred a cost of $1,000 for heating and lighting. Aya made cash payments for the interest expense, the rent expense, and the heating and lighting expense. She had cash on hand at the end of the month of $32,000.

1.  Statement of Earnings The statement of earnings set out below is based on this information. QUICK BUYS STATEMENT OF EARNINGS For the month ended [Date] Revenues (Sales) $96,500 Less: Cost of Goods Sold Beginning Inventory $40,000 Add: Purchases 50,000 Total Goods Available for Sale 90,000 Less: Ending Inventory (35,000) Cost of Goods Sold 55,000 Gross Profit

41,500

Less: Expenses Rent 10,000 Heating and Lighting 1,000 Interest 500 Total Expenses 11,500 Net Earnings $30,000

A statement of earnings shows the net earnings (or net income or profit) or loss of the business for a given period of time. The profit is the revenues less the expenses incurred in generating those revenues. The revenues in Aya’s business come in the form of “sales.” In other businesses they might be lease or rental fees, franchise fees, or royalties. The particular statement of earnings above is set out for a retail business to reflect the profits from sales less the cost of the goods sold (often referred to as the “gross profit”). Don’t get caught up in trying to figure out how the “cost of goods sold” is calculated. The purpose here is to get a sense of what these kinds of statements look like and of the kind of information they generally provide, rather than being able to create them. Other expenses are then deducted from the gross profit. Statements of earnings from different types of businesses—for example, manufacturing or rental—may be constructed in somewhat different ways; however, the common feature of statements of earnings is that they show net earnings or loss determined by showing revenues less expenses.

2.  Revised Statement of Financial Position We can also have a look at how the statement of financial position changes as a result of one month of operations. Recall that the statement of financial position shows the assets, liabilities, and equity at a particular point in time. The statement of financial position below shows the situation at the end of the first month of operations.

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Chapter 1  An Introduction to Business Organizations QUICK BUYS STATEMENT OF FINANCIAL POSITION As at the end of the first month Assets Cash Accounts Receivable Inventory Shelving Freezers Cash Register Light Fixtures Cash Counter Storage Cabinets Total Assets

$ 32,000 30,000 35,000 10,000 30,000 3,000 15,000 8,000 12,000 $175,000

Liabilities and Owner’s Equity Liabilities: Accounts Payable Bank Loan

$ 20,000 50,000

Owner’s Equity: At Beginning of Month $75,000 Increase in Owner’s Equity 30,000 At End of Month Total Liabilities and Owner’s Equity

105,000 $175,000

There are some important differences to note between the statement of financial position at the beginning of the month and the statement of financial position at the end of the month. First, the “Accounts Receivable” figure of $30,000 reflects the fact that $30,000 of Aya’s sales were made on credit. The other important difference is that the statement of financial position at the end of the month shows that Aya’s equity has increased by $30,000, the amount of the profits for the month. One should note that this profit of $30,000 is not some special pot of cash that is sitting somewhere. It is part of the sources of funds that have been used in acquiring the assets that the business has at the end of the month. If Aya wants to withdraw some of the profits, she will have to either reduce the cash on hand (which may not be advisable since the cash may be needed to meet short-term payment obligations), borrow more funds, or sell off some of the assets of the business. When, and how, one makes a distribution of profits is another important decision in the management of the business. Notice that the assets have increased by $35,000 since the beginning of the month (from $140,000 at the beginning of the month to $175,000 at the end of the month). This includes $30,000 of accounts receivable that were not there before and $10,000 more of cash (cash of $22,000 at the beginning of the month and cash of $32,000 at the end of the month), less a decrease in inventory of $5,000 (from $40,000 at the beginning of the month to $35,000 at the end of the month). There has also been a $35,000 increase in liabilities and owner’s equity over the course of the month consisting of the $30,000 profit mentioned above and an additional $5,000 in accounts payable. The statement of earnings for the month and the end-of-the-month statement of financial position set out above have avoided (no doubt improperly) some other important accounting

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IV.  Some Simple Accounting

issues. For instance, some of the assets—for example, the shelving, freezers, cash register, light fixtures, cash counter, and storage cabinets—have been used for a month and may have deteriorated. Should this reduction in value be reflected on the statement of financial position? Should the statement of earnings reflect the cost of any such deterioration as an expense—usually called “depreciation”? If one does attempt to reflect changes in the value of assets on the statement of financial position, how should it be done? Does one attempt to assess the current market value of the assets, or should another technique be used? These again are questions we will leave to the accountants. However, some reflection on these questions should reveal that choices have to be made in determining how accounting statements are prepared. These choices can involve difficult trade-offs. For financial statements to be useful to investors it helps to have a degree of consistency not only for a given business enterprise from year to year, but between business enterprises so that reasonable comparisons can be made between financial statements. As we will see, financial disclosure is an important part of the disclosures made to persons investing, or considering investing, in business enterprises. Although we will not be examining the particular details of financial accounting, it is an important part of the overall regulatory scheme for business enterprises.

3.  Statement of Changes in Equity A statement of changes in equity shows the changes in the equity accounts in the statement of financial position. Fortunately for Quick Buys this statement is a simple one. QUICK BUYS STATEMENT OF CHANGES IN EQUITY For the Month of [Date] Owner’s equity at the beginning of the month Add: Retained earnings Owner’s equity at the end of the month

$ 75,000 30,000 $105,000

A statement of changes in equity for a corporation will often show a number of items. Like this simple statement of changes in equity for Aya’s Quick Buys sole proprietorship business, it will show the equity investments of shareholders showing the amount received from prior sales of shares. It will show increases in share capital from additional sales of shares during the period under consideration and reductions in share capital from repurchases of shares during the period under consideration. It will show gains in retained earnings from net earnings during the period under consideration or it will show a reduction in retained earnings due to a net loss in the period under consideration. It will also show reductions in retained earnings from payments of dividends during the period under consideration.

4.  Statement of Cash Flows A key starting point for understanding the idea behind a statement of cash flows is that the statement of earnings set out above is done on an “accrual basis.” That is, it records sales as revenues even when no cash is collected at the time of sale—that is, when a legal right to be paid arose—and it records expenses even if no cash went out at the time the expense was incurred—that is, when the legal obligation to make the payment arose. For instance, the

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Chapter 1  An Introduction to Business Organizations

statement of earnings shows revenues from sales of $96,500, since sales in the amount of $96,500 were made even though only $66,500 was received in cash from those sales. The short facts also indicate that while Aya made purchases of goods for sale of $50,000, there was also an increase in accounts payable from $15,000 at the beginning of the month to $20,000 at the end of the month, and since the other expenses for interest, rent, and heating and lighting were paid in cash, this $5,000 increase in accounts payable came from purchases made on credit that were still unpaid at the end of the month—that is, only $45,000 in cash was actually paid out for the $50,000 worth of purchases. A statement that shows cash flows can provide an additional source of important financial information concerning a business. Indeed, creating projected cash flow statements for future periods can be helpful in planning to deal with potential cash shortfalls or even excess accumulations of cash. Cash is needed to pay liabilities as they come due for payment, and failure to pay liabilities as they come due can have significant consequences for the business (including potentially causing the business to be brought to an end). Cash shortfalls will require some form of further financing in the form of, perhaps, further investments from equity investors or, more likely, additional borrowing (usually from a bank). It is helpful to be able to plan for that. Excess accumulations of cash are not good either because cash, even if in a bank account, will earn little or no return. It is better to invest those excess amounts of cash in investments that pay a return (such as government treasury bills or other forms of investment that can be sold and converted back into cash when needed for the business), make further purchases of assets to run the business (for example, expand Aya’s store), or pay amounts out to investors (such as to the bank to reduce the bank loan, if possible, or to equity investors). There are two methods of creating and presenting a cash flow statement. One is the direct method and the other is the indirect method. The indirect method is the form the cash flow statement usually takes. Unfortunately it is a method that is, at least initially, more difficult to understand. The basic idea behind the direct method is to identify sources of, or inflows of, cash, and to also show uses of, or outflows of, cash leaving a net gain or reduction in cash. A statement of cash flows for Aya’s Quick Buys business after one month of operation using the direct method is shown below. QUICK BUYS STATEMENT OF CASH FLOWS For the Month Ended [Date] (Direct Method) Sources of Cash Cash sales Uses of Cash Cash paid for purchases of supplies Purchases Less: Increase in Accounts Payable Net Cash paid for expenses Interest Rent Heating and Lighting Total uses of cash Net Gain in Cash

$66,500

$50,000 5,000 $45,000 500 10,000 1,000 56,500 $10,000

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IV.  Some Simple Accounting

The indirect method begins with net income (or net earnings) and makes adjustments for items in the statement of earnings and the statement of financial position that did not involve cash inflows or outflows. It would not, for example, show the cash outflows for interest, rent, or heating and lighting that in the simple fact pattern were said to have been paid in cash. These cash items are already reflected in the statement of earnings as deductions in determining net income. A statement of cash flows for Aya’s Quick Buys business after one month of operation using the indirect method is shown below. QUICK BUYS STATEMENT OF CASH FLOWS For the Month Ended [Date] (Indirect Method) Net Earnings: Adjustments to convert net earnings to cash flows: Add: Decrease in inventory $ 5,000 Increase in accounts payable 5,000 $10,000 Deduct: Increase in accounts receivable ($30,000) Net Increase in Cash

$30,000

($20,000) $10,000

This indirect method begins with net earnings from the statement of earnings. That net earnings figure came, in part, from the top line of the statement of earnings, which shows $96,500 of revenues from sales. As the facts indicate, only $66,500 of those sales were for cash, with the remaining sales of $30,000 being on credit. This $30,000 of sales on credit is, on the facts given, reflected in the accounts receivable at the end of the month. That is $30,000 that was not received in cash, so it has to be deducted from the net earnings to adjust for that noncash item. The increase in accounts payable is added, since that increase in accounts payable, on the facts given, came from purchases of goods on credit—that is, for which cash was not paid out. The decrease in inventory also represents a non-cash item. Part of the sales for the month came from inventory that was on hand at the beginning of the month, and that decrease in inventory became part of the expense of cost of goods sold on the statement of earnings. However, no cash went out during the month for that inventory because it was already on hand in inventory at the beginning of the month. The point here is not to understand how to produce a statement of cash flows but rather to see what, in general terms, such a financial statement would look like (usually using the indirect method) and what the statement is intended to show. Statements of cash flows usually provide much more information than is shown in either of the versions of the statement of cash flows for one month of operations of the Quick Buys business. What is shown here is cash flows from operation of the business, which was all that was relevant on the facts given. One would normally see a breakdown for “investing activities” that, in the context of Quick Buys, might include cash outflows for cash paid to buy new equipment or cash inflows for cash received on the sale of old equipment. One often also sees a breakdown for “financing activities” that might, in the context of Quick Buys, include cash inflows from additional investments of cash by equity investors, or cash outflows from

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cash payments to reduce the principal amount on the bank loan or cash payments out to equity investors reducing their investment.

G.  A Corresponding Statement of Financial Position and Statement of Earnings for the Business Operated Through a Corporation The statement of financial position and statement of earnings for a corporation will look quite similar to those for Aya’s sole proprietorship above. However, the equity portion of the statement of financial position is usually labelled “Shareholders’ Equity,” with the investments made by shareholders set out under “Capital Stock” or “Shares,” and the increases in equity from the profits of running the business enterprise set out as “Retained Earnings.” Where the corporation has issued more than one type of share, the capital stock or shares account will be broken down into separate accounts for different types of shares. Suppose Aya ran her business through a corporation called “Quick Buys Ltd.” Suppose also that when the corporation was formed, 750 shares were issued to Aya at a price of $100 per share in exchange for Aya’s investment of $75,000. The statement of financial position at the end of one month of operations might then look like the one set out below. QUICK BUYS LTD. STATEMENT OF FINANCIAL POSITION As at the end of the first month Assets Cash Accounts Receivable Inventory Shelving Freezers Cash Register Light Fixtures Cash Counter Storage Cabinets Total Assets Liabilities and Equity Liabilities: Accounts Payable Bank Loan Shareholders’ Equity: Capital Stock (750 shares issued at $100 per share) $75,000 Retained Earnings 30,000 Total Shareholders’ Equity Total Liabilities and Owner’s Equity

$ 32,000 30,000 35,000 10,000 30,000 3,000 15,000 8,000 12,000 $175,000

$ 20,000 50,000

105,000 $175,000

As with the “Increase in Owner’s Equity” above in the case of a sole proprietorship, the “Retained Earnings” do not represent a pot of cash that can be accessed. The “Retained Earnings” are just part of the source of funds that allowed for the acquisition of the various assets set out on the assets part of the statement of financial position. Here the cash on hand happens to be more than the retained earnings. However, where the business has made profits

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V. Conclusion

for a longer period of time and new assets have been acquired or old assets replaced, it is not uncommon for the retained earnings to be much greater than the amount of cash on hand. If it is decided that some portion of the prior profits are to be distributed to the shareholders (in what is referred to as a “dividend”), then it will be necessary to come up with the cash to pay the dividend. This may require holding off on acquisitions to allow sufficient cash to accumulate, liquidating some of the assets of the business, borrowing funds, or issuing more shares in exchange for cash contributions. A statement of changes in equity for a corporation would include, in addition to changes in retained earnings, changes in share capital from the sale of shares or from the repurchase of shares. A statement of cash flows for a corporation would, in showing cash flows from “financial activities,” include cash inflows from sales of shares to investors and cash outflows from cash payments of dividends to shareholders or for the repurchase of shares.

V. CONCLUSION This chapter has sought to highlight the importance of business organizations as a subject and its particularly topical character in light of the recent development of forms of organization that seek to achieve social, cultural, or environmental aims in addition to traditional for-profit objectives and in light of the current attention now being given to forms of business organization for Canada’s Indigenous peoples. It also sought to provide an understanding of the study of business organizations as a study of the way people associate to carry on activities that will produce, provide, or trade in goods or services, doing so in forms of organization that range from very small to very large and that can involve either for-profit objectives, not-for-profit objectives, or both for-profit and not-for-profit objectives. It provided a sample fact pattern to provide context and then examined a wide range of forms of organization, including the main forms of organization that are examined in this book. The chapter also looked at some simple accounting and simple financial statements because financial statement disclosure will be referred to later in the book and it is useful to have a sense of the nature of that disclosure. Some simple accounting concepts can also be useful in understanding legal concepts in business associations. With this “birds-eye” view in place, the remainder of the book examines in more detail many of the topics highlighted in this chapter.

CHAPTER T WO

Partnership









I.  Introduction: The Nature of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 II.  Origins and the Partnership Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 III.  Definition and Existence of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 A.  The Common Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 B. Statute . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 1.  Section 2: Definition of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 2.  Rules for Determining Existence of Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . 62 C.  Modern Common Law Considerations of the Definition of Partnership . . . . . . . 62 IV.  The Legal Status of Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 A.  The Common Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 B.  The Partnership as a “Firm” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 V.  Relationship Between Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 A.  Formation and Governance: The Partnership Act and a Partnership Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 B.  The Default Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 1.  Partnership Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 2.  Capital, Profits, Losses, Management, Admission of New Partners, and Record-Keeping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 3.  Removal of Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 4.  Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 5.  Assignment of Partnership Interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 6. Dissolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 VI.  Relationship Between Partners and Third Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 A.  Liability of Partners in Contract and Tort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 1.  Liability in Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 2.  Liability in Tort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 3.  Other Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 4.  Retirement of Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 VII.  Limited Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 A.  Introduction and Overview of Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 B.  Tax Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 C.  Statutory Provisions and Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 1.  One or More Limited Partners and One or More General Partners . . . . . . . . . 102 2.  Formation by Filing Certificate or Declaration . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 3.  Protection of Third Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102

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D.  Maintaining Limited Liability and Management of the Business . . . . . . . . . . . . . 103 E.  Relations Among the Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 1.  Separation of Ownership and Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 2.  Other Aspects of the Relations Among Partners . . . . . . . . . . . . . . . . . . . . . . . . . . 110 VIII.  Limited Liability Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112 A.  Introduction and Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112 B.  LLP Structures and Statutory Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116 1.  Full Shield Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 2.  Business Name Registration Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 IX.  Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 X. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

I.  INTRODUCTION: THE NATURE OF PARTNERSHIP Partnership is one of the basic and essential forms of business organization both historically and at present. It is founded on a relationship of trust. Although the majority of this book focuses on corporations, partnerships remain a critically important way for people to undertake business together. The simplicity, tax treatment, and relative lack of formality of most partnerships are often attractive to individuals and small businesses wanting to share responsibility for business investment and operation without the ordinary complications and expense of the corporate form. Chapter 1 provided an introduction and overview of partnership, and noted that while the concept of partnership was developed under the common law, rules governing the relationships between partners were codified in statutes in common law jurisdictions across Canada. This chapter explores these rules and the common law at greater length, considering not only the way they govern the relationship between parties but also the relationships between partners and third parties with whom they might deal. The statutory definition of partnership in s 1 of the Alberta Partnership Act, RSA 2000, c P-3 (APA) is representative of the partnership statutes of common law provinces in Canada: “[T]he relationship that subsists between persons carrying on a business in common with a view to a profit.”1 By definition, a partnership thus has more than one member and is thereby distinguished from a sole proprietorship. It is, however, like a sole proprietorship in that the partners carry on the business themselves directly. Unlike a corporation, which has separate legal personality (discussed further in Chapter 3), the partnership is not a legal entity separate from its partners. This has a number of significant consequences, including unlimited liability of each of the partners for the debts and obligations of the partnership. The essence

1 See also e.g. the Partnership Act, RSBC 1996, c 348 [BCPA], s 2: “Partnership is the relation which subsists between persons carrying on business in common with a view of profit”; Partnership Act, RSNS 1989, c 334 [NSPA], s 4: “Partnership is the relation which subsists between persons carrying on a business in common, with view of profit, but the relationship between members of any incorporated company or association is not a partnership within the meaning of this Act”; and Partnership Act, RSA 2000, c P-3 [APA], s 1(g): “’partnership’ means the relationship that subsists between persons carrying on a business in common with a view to profit.”

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of partnership is multilateral agency—each partner is the agent of all the other partners in matters relating to the business of the partnership. As a result, a partnership requires a great deal of trust between its members. Further, the ease of formation and dissolution of partnerships means that parties need to exercise care to ensure that they create the partnership they want, or act to ensure they do not create a partnership when they would prefer another set of rules to govern themselves. As the materials below explore, statutes and the common law create a series of default rules that may apply even where, in the circumstances, the parties intend something other than the existence of a partnership. Can a partnership be formed for a single transaction? What is the difference between partnership and co-ownership? When does a partnership end? When does it begin? While a province’s partnership statute provides a default template, the common law and the acts of the parties are key elements in determining the parties’ rights, duties, and entitlements. The balance of the chapter engages these issues. In addition to the basic partnership form, this chapter also considers limited partnerships and limited liability partnerships.

II.  ORIGINS AND THE PARTNERSHIP ACT The modern concept of a partnership was developed primarily in the common law courts, but also, to some extent, in courts of equity. Roman law had a partnership concept known as societas; similar concepts were also recognized in other ancient legal systems. 2 In England, partnership law was consolidated and codified in a bill that later became the Partnership Act, 1890 (UK), 53 & 54 Vict, c 39. Each of the common law provinces has enacted its own partnership legislation based on this English statute: see the 2001 Supreme Court of Canada discussion in Backman, 2001 SCC 10, [2001] 1 SCR 367, excerpted below. The English statute was copied virtually word for word elsewhere, including in common law states of the United States, Australia, New Zealand, Hong Kong, Singapore, and Malaysia. The equivalent of the 1890 Partnership Act was first enacted in British Columbia in 1894. Parts 1 and 2 of the current BC Partnership Act, RSBC 1996, c 348 (BCPA) are essentially the same as that original 1894 Act. Although the codification of the law concerning partnerships is useful and reviewing the specific provisions in the relevant provincial partnership statute is necessary when dealing with the formation and operation of a partnership in a province, the statute itself does not provide a complete understanding of the law. Common law and the rules of equity also remain important. Section 45 of the Ontario Partnerships Act, for example, provides that the “rules of equity and of common law applicable to partnership continue in force except so far as they are inconsistent with the express provisions of this Act.” Comparable provisions are contained in the partnership statutes of all other common law provinces. As discussed further below, the structure, management, rights, and obligations of the partners and the partnership are all a matter for agreement between the partners. In the

2 See the discussion in Alison R Manzer, A Practical Guide to Canadian Partnership Law (Aurora, Ont: Canada Law Book, 2009) at 1.250.

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absence of any agreement, however, the terms of the provincial partnership statute will govern—for example, s  24 of the Ontario Partnerships Act provides that the “interests of partners in the partnership property and their rights and duties in relation to the partnership shall be determined” by the rules set out in the statute “subject to any agreement express or implied between the partners.” The statute is thus often said to provide a “template” partnership agreement for the parties, one which may or may not fit their particular circumstances. Parties will therefore often draft their own partnership agreement, thereby “contracting out” of the statutory provisions. One of the matters that may not be contracted out, however, is the existence of the partnership itself. That issue is discussed in the next section.

III.  DEFINITION AND EXISTENCE OF PARTNERSHIP The relationship between persons engaged in a business enterprise together is not always immediately clear. One of the most basic and sometimes most difficult questions from a legal perspective is whether a partnership has in fact been formed. The existence of a partnership is subject to application of both the common law and the applicable partnership statute. This apparently simple question can become quite complex—for example, is coownership the same as partnership; is a joint venture a partnership, or something else; does an agreement by the parties that an arrangement does not constitute a partnership determine the matter, or is it simply strong evidence? Why does it matter? Because a partner faces unlimited liability for all partnership debts, contracts, and obligations, the question about whether a partnership exists (and by extension whether an individual is a partner and therefore bears unlimited liability) has significant consequences and, accordingly, has attracted both statutory and common law attention. Persons may be in a partnership without knowing that the law is treating their business relationship as a partnership. Third parties dealing with these persons may claim that these persons are partners in order to ascribe joint and several liability to them in contract or tort for all of the debts and obligations arising out of the conduct of the business. Another contrasting consideration is the tax benefits associated with partnerships. The Income Tax Act, RSC 1985, c 1 does not treat a partnership as a separate entity (or separate taxpayer). Instead, the Income Tax Act looks only at the partnership income (or loss) for the purposes of determining each partner’s share of the partnership income (or loss). Once that share of income or loss is determined, it is then used by the individual partner in calculating his or her (or its) taxable income. Accordingly, a partner can use his, her, or its share of partnership losses against other sources of income. This often makes partnership a sensible choice as a form of business association where there will be more than one equity investor and where there are likely to be some losses in the start-up phase of the business. In this case, the parties may want to ensure that the business is characterized as a partnership and not some other form of business organization. Section III.A sets out two of the leading English cases addressing the question of the formation of a partnership, both decided prior to the introduction of the 1890 Partnership Act. Following that, section III.B introduces the statutory definition of partnership adopted first in that Act and subsequently in virtually identical form by the common law jurisdictions in Canada.

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A.  The Common Law

Cox & Wheatcroft v Hickman (1860), 8 HL Cas 268 [An iron foundry business owned by Smith & Sons and operated under the name “Stanton Iron Works” developed financial problems. It could not pay its creditors in a timely fashion. Rather than force a potentially successful business into bankruptcy at the risk of realizing a small portion of the amounts owed to them, the creditors accepted an arrangement made with them by Smith & Sons. Under the arrangement, Smith & Sons would transfer the assets of the business to trustees. The trustees would run the business. There was some dispute as to just who the beneficiaries of this trust were. One version was that Smith and his sons were the only beneficiaries. Under this version, the trustees would run the business and pay off the creditors and then return the business assets to Smith and his sons when the creditors were paid off. The other version was that both the creditors and Smith and his sons were beneficiaries. Under this version the trustees were also to pay the creditors until they were paid off and then return the assets to Smith and his sons. The creditors had certain rights under the trust indenture. They had access to the books of the business. They had the power to elect and replace trustees and, if they so desired, to make rules for the conduct of the business. Someone supplied goods to the business on credit while the business was being operated by the trustees under the arrangement. The invoice was marked “accepted” by agents for the trustees. This converted the invoice into a negotiable instrument. The accepted invoice was then endorsed in favour of Hickman, who paid a sum of money for the endorsement. The invoice was not paid, and Hickman sued on the accepted invoice. However, because the business was insolvent, Hickman sought alternative recourse to collect on the invoice rather than simply becoming another creditor of the insolvent business. Hickman claimed against two of the creditors (Cox and Wheatcroft), arguing that they were partners because they were sharing profits; if found to be partners, they would therefore be liable on the invoice. Earlier cases—for example, Grace v Smith, 2 Sir W Bl 998—suggested that a sharing of profits meant partnership. The majority of the House of Lords held that under the arrangement the creditors were not partners and were not liable to pay the debt to Hickman.] LORD CRANWORTH:  The liability of one partner for the acts of his co-partner is in truth the liability of a principal for the acts of his agent. Where two or more persons are engaged as partners in an ordinary trade, each of them has an implied authority from the others to bind all by contracts entered into according to the usual course of business in that trade. Every partner in trade is, for the ordinary purposes of the trade, the agent of his copartners, and all are therefore liable for the ordinary trade contracts of the others. Partners may stipulate among themselves that some one of them only shall enter into particular contracts, or into any contracts, or that as to certain of their contracts none shall be liable except those by whom they are actually made, but with such private arrangements third

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persons dealing with the firm without notice have no concern. The public have a right to assume that every partner has authority from his co-partner to bind the whole firm in contracts made according to the ordinary usages of trade. This principle applies not only to persons acting openly and avowedly as partners, but to others who, though not so acting are, by secret or private agreement, partners with those who appear ostensibly to the world as the persons carrying on the business. •  •  •

It is often said that the test, or one of the tests, whether a person not ostensibly a partner, is nevertheless, in contemplation of law, a partner, is whether he is entitled to participate in the profits. This, no doubt, is, in general, a sufficiently accurate test; for a right to participate in profits affords cogent, often conclusive evidence, that the trade in which the profits have been made, was carried on in part for or on behalf of the person setting up such a claim. But the real ground of the liability is that the trade has been carried on by persons acting on his behalf. When that is the case, he is liable to the trade obligations, and entitled to its profits, or to a share of them. It is not strictly correct to say that his right to share in the profits makes him liable to the debts of the trade. The correct mode of stating the proposition is to say that the same thing which entitles him to the one makes him liable to the other, namely, the fact that the trade has been carried on on his behalf, i.e. that he stood in the relation of principal towards the persons acting ostensibly as the traders, by whom the liabilities have been incurred, and under whose management the profits have been made. Taking this to be the ground of liability as a partner, it seems to me to follow that the mere occurrence of creditors in an arrangement under which they permit their debtor, or trustees for their debtor, to continue his trade, applying the profits in discharge of their demands, does not make them partners with their debtor, or the trustees. The debtor is still the person solely interested in the profits, save only that he has mortgaged them to his creditors. He receives the benefit of the profits as they accrue, though he has precluded himself from applying them to any other purpose than the discharge of his debts. The trade is not carried on by or on account of the creditors; though their consent is necessary in such a case, for without it all the property may be seized by them in execution. But the trade still remains the trade of the debtor or his trustees; the debtor or the trustees are the persons by or on behalf of whom it is carried on. •  •  •

I have, on these grounds, come to the conclusion that the creditors did not, by executing this deed, make themselves partners in the Stanton Iron Company and I must add that a contrary decision would be much to be deprecated. Deeds of arrangement, like that now before us, are, I believe, of frequent occurrence; and it is impossible to imagine that creditors who execute them, have any notion that by so doing they are making themselves liable as partners. This would be no reason for holding them not to be liable, if, on strict principles of mercantile law, they are so; but the very fact that such deeds are so common, and that no such liability is supposed to attach to them, affords some argument in favour of the Appellant. The deed now before us was executed by above a hundred joint creditors; and a mere glance at their names is sufficient to show that there was no intention on their part of doing anything which should involve them in the obligations of a partnership. I do not rely on this; but, at least, it

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shows the general opinion of the mercantile world on the subject. I may remark that one of the creditors I see is the Midland Railway Company, which is a creditor for a sum of only £39, and to suppose that the directors could imagine they were making themselves partners is absurd. … Judgment reversed.—Lords’ Journals 3 August 1860 NOTES AND QUESTIONS

1.  Cox & Wheatcroft v Hickman was decided before the enactment of the Partnership Act in 1890. In 1865, the British Parliament sought to clarify the common law position discussed in the case by providing, in Bovill’s Act, 28 & 29 Vict C 86, that receipt by a creditor of a share of profits of a business in particular circumstances was not sufficient to make that creditor a partner in the business. Bovill’s Act is discussed in Pooley v Driver, excerpted next. 2.  The majority in Cox & Wheatcroft is sometimes said to have overruled a prior decision in Grace v Smith to the extent that Grace v Smith could be interpreted as holding that sharing profits necessarily means that there is a partnership. Although the majority said that a sharing of profits is strong evidence of partnership, that alone does not necessarily mean the relationship is one of partnership. It simply raises a rebuttable presumption of partnership. Should sharing of profits be sufficient to indicate partnership? What is the policy reason for the approach adopted in the case? 3.  Cox & Wheatcroft v Hickman also confirmed the common law position that “dormant” partners (or partners not involved in the management of the business) are nevertheless liable for the acts of other partners in carrying on the partnership business. The question of “limited partners” is addressed later in this chapter. What is the rationale for holding “dormant” partners equally liable? 4.  The remark in the final paragraph of the excerpt from the decision notes that it would be “absurd” for a creditor to have intended to become a partner in a business for a comparatively insignificant amount. Should the amount of the debt owed to a creditor matter in considering whether that creditor is participating as a partner? 5.  The next case, Pooley v Driver, considered Cox & Wheatcroft, the provisions of Bovill’s Act, and the dividing line between status as merely a lender to a partnership and status as a partner. Consider the manner in which the provisions in question are similar to current provincial statutes—for example, BCPA s 4(c)(iv); Ontario Partnerships Act, RSO 1990, c P.5 (OPA), s 3(3)(d); APA s 4(c)(iv); and the Nova Scotia Partnership Act, RSNS 1989, c 334 (NSPA), s 5(c)(iv).

Pooley v Driver (1876), 5 Ch D 458 [Borrett and Hagen entered into a partnership agreement to carry on a business of manufacturing grease, pitch, and manure. The partnership agreement provided for the division of capital into 60 parts. Profits were to be distributed in accordance with the number of parts attributed to each person. Seventeen parts were attributed to Borrett and 23 parts

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were attributed to Hagan. The remaining 20 parts were attributed to persons who advanced funds by way of a loan, with one part being attributed for each £500 advanced. The parts allocated to Borrett and Hagan were allocated to them as a means of compensating them for their work in the partnership business. They did not provide capital for the business; all funds for the business were provided by the lenders. The Drivers advanced £2,500 on the terms of a separate deed that detailed the arrangements under which the loan was advanced to Borrett and Hagan. The loan agreement deed incorporated the terms of the partnership agreement between Borrett and Hagan by reference and required Borrett and Hagan to observe the terms of the partnership agreement. The loan agreement also provided that the bankruptcy of the lender would result in the termination of the loan agreement (although the partnership would still be required to repay the loan). On liquidation of the partnership the loan was to be repaid out of the assets of the partnership remaining after the payment of the other creditors of the partnership.] As the report of the case details: The Plaintiff Rodney Pooley was the holder of several bills of exchange drawn, accepted, or indorsed by the said firm of Charles Borrett & Co., between the years 1868 and 1873, and amounting in the aggregate to about £5000, which bills had been put into circulation for the purpose of raising money for carrying on the business of the firm. In October, 1873, the firm of Charles Borrett & Co. went into liquidation by arrangement, and the Plaintiff then applied to the Defendants for payment of the money due on the bills, on the ground that the above-mentioned deeds constituted them partners in the firm. The Defendants, however, repudiated any liability on their part as partners, alleging that they were mere lenders of money upon a “contract in writing” under the Partnership (Bovill’s) Act, 1865 (28 & 29 Vict. c. 86). The Plaintiff then brought this action, claiming a declaration that the Defendants were partners in the firm of Charles Borrett & Co. from the time of its formation until the date of its going into liquidation, and that the Defendants were liable for all the debts of the firm, and for all bills drawn by or in the name of the firm: also the usual accounts. The action now came on for trial. JESSEL MR:  The real question I have to decide in this case is, whether certain contracts, which are admitted to have been entered into, made the Defendants partners in the firm of Charles Borrett & Co. If they did, then the Plaintiff, the holder of certain bills of exchange drawn or indorsed by that firm—whether he gave value for them or not is admittedly immaterial—is entitled to the relief which he asks: if not, the action must be dismissed. Now, first of all, I must decide the question as to what sort of evidence I must rely upon to prove the partnership. I am not going to define a partnership. The attempt has been made by very many people, and some of the attempts are collected together in the wellknown book by Mr. Lindley, now Mr. Justice Lindley. At pages 2 and 3 of the 3rd Edition he gives fifteen definitions of partnership by different learned lawyers: I think no two of them exactly agree, but there is considerable agreement amongst them; and I suppose anybody reading the fifteen may get a general notion of what partnership means. But I

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am not left to decide this case on any notions of my own of what is a partnership. Whatever may amount to a partnership is a subject which has been settled by decision according to English law, and the incidents of the partnership simply follow from the establishment of the fact of the partnership. If the partnership is established as a fact, then the liability to creditors is a mere incident flowing from the establishment of the fact. But it is a contract of some kind undoubtedly—a contract, like all contracts, involving the mutual consent of the parties: and it is undoubtedly a contract for the purpose of carrying on a commercial business—that is, a business bringing profit, and dividing the profit in some shape or other between the partners. That certainly partnership is. Whether it is anything more or not has been a question between various authorities, but it is that certainly. The Civil Code of New York, which contains the first definition quoted, gives this as a definition: “Partnership is the association of two or more persons for the purpose of carrying on business together and dividing its profits between them.” It undoubtedly is that. Whether it is that and something more is a question of consideration, some writers adding qualifications which are not to be found in that definition, and others excepting out of it even the community of profit; but it is at least that. There could not be a partnership without there was a commercial business to be carried on with a view to profit and for division of profits; and as a general rule, I take it, if it fulfils that definition, it is a partnership. I say, as a general rule, that simple definition appears, so far as it goes, to be an accurate definition. Then whether or not the association requires that one or more of the partners shall contribute labour or skill, or what they shall contribute, is a question which may be considered as subsidiary; but I take it that the ordinary meaning of the word “partnership” is that, no doubt as a rule, each partner does contribute something, either in the shape of property or skill. … You can have, undoubtedly, according to English law, a dormant partner who puts nothing in—neither capital, nor skill, nor anything else. In fact, those who are familiar with partnerships know it is by no means uncommon to give a share to the widow or relative of some former partner who contributes nothing at all, neither name, nor skill, nor anything else. •  •  •

This association which I have to consider certainly comes within about twelve out of the fifteen definitions, therefore primâ facie this is a partnership according to those definitions. But that is not alone enough: there is authority which tells me how to find out whether a certain contract is a partnership or not. If we find an association of two or more persons formed for the purpose of carrying on in the first instance, or of continuing to carry on business, and we find that those persons share between them generally the profits of that business, as I understand the law of the case as laid down by the highest authority, those persons are to be treated as partners in that business unless there are surrounding circumstances to shew that they are not really partners. That, of course, brings me again to another question, which must always be considered, and that is, whether, looking at the contract as a whole, it is intended to secure the benefit of a partnership with or without its liabilities; or whether it is not intended that the benefits of a partnership shall be secured.

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I do not know that I can put it better than it is put in the case of Mollwo, March, & Co. v. Court of Wards, “If cases should occur where any persons, under the guise of such an arrangement,” that is, the guise of an arrangement as creditor and debtor, “are really trading as principals, and putting forward, as ostensible traders, others who are really their agents, they must not hope by such devices to escape liability; for the law, in cases of this kind, will look at the body and substance of the arrangements and fasten responsibility on the parties according to their true and real character.” It is a question of substance and not of mere form. The leading case on the subject, and the one which, being of the highest authority, is of course binding upon me, is the case of Cox v. Hickman, before the House of Lords. … The next Lord who made a speech, Lord Cranworth, put it in this way: “It is often said that the test, or one of the tests, whether a person, not ostensibly a partner, is nevertheless, in contemplation of law, a partner, is, whether he is entitled to participate in the profits. This, no doubt, is in general a sufficiently accurate test; for a right to participate in profits affords cogent, often conclusive evidence, that the trade in which the profits have been made, was carried on in part for or on behalf of the person setting up such a claim. But the real ground of the liability is, that the trade has been carried on by persons acting on his behalf. When that is the case, he is liable to the trade obligations, and entitled to its profits, or to a share of them. It is not strictly correct to say that his right to share in the profits makes him liable to the debts of the trade. The correct mode of stating the proposition is to say that the same thing which entitles him to the one makes him liable to the other, namely, the fact that tile trade has been carried on on his behalf, i.e., that he stood in the relation of principal towards the persons acting ostensibly as the traders, by whom the liabilities have been incurred, and under whose management the profits have been made.” Now what Lord Cranworth means there is quite plain. He says in fact that the participating in the profits is sufficient proof of partnership if there is nothing to get rid of it. If you find an association, and a contract made by the members of the association that the trade is to be curried on, and that they are to share the profits in certain proportions, then that makes a partnership, unless you can shew from the surrounding circumstances some other relation. It is not impossible to shew some other relation, but, as he says, it is very difficult to do so. •  •  •

The question of course is whether a man is liable as a dormant partner. Now a dormant partner means a person who does not take an active part in the conduct of the business, and who may be, and often is, prohibited from taking such active part. Therefore, when the inquiry is whether a man is a dormant partner, it does not appear to me to aid that inquiry by saying that there are provisions preventing his taking an active part in the conduct of the business, or that there are provisions which make it optional for him to take an active part in the business or not. It only shews he is not an active partner. … The only other speech to which I think it necessary to refer is the speech of Lord Wensleydale. He says: “The law as to partnership is undoubtedly a branch of the law of principal and agent; and it would tend to simplify and make more easy of solution, the questions which arise on this subject, if this principle were more constantly kept in view. Mr. Justice Story lays it down in the first section of his work on Partnership. He says, ‘Every partner is an agent of the partnership’”—now there it is laid down in so many

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words, in the House of Lords, that that is what he is agent for—”’and his rights, powers, duties, and obligations, are in many respects governed by the same rules and principles as those of an agent; a partner virtually embraces the character of both a principal and agent’ … A man who allows another to carry on trade, whether in his own name or not, to buy and sell, and to pay over all the profits to him, is undoubtedly the principal, and the person so employed is the agent, and the principal is liable for the agent’s contracts in the course of his employment. So, if two or more agree that they should carry on a trade, and share the profits of it, each is a principal, and each is an agent for the other, and each is bound by the other’s contract in carrying on the trade, as much as a single principal would be by the act of an agent who was to give the whole of the profits to his employer. Hence it becomes a test of the liability of one for the contract of another, that he is to receive the whole or a part of the profits arising from that contract by virtue of the agreement made at the time of the employment. I believe this is the true principle of partnership liability.” That is the test. Of course Lord Wensleydale does not mean that it is a test which cannot be rebutted; it was rebutted in the case before him. His Lordship then continues: “Perhaps the maxim that he who partakes the advantage ought to bear the loss, often stated in the earlier cases on this subject, is only the consequence, not the cause, why a man is made liable as a partner.” Then he goes on to state the reasons why he thinks in the case before him there was no contract of partnership. •  •  •

[T]he judgment in Cox v. Hickman had certainly the effect of dissolving the rule of law which had been supposed to exist, and laid down principles of decision by which the determination of cases of this kind is made to depend, not on arbitrary presumptions of law, but on the real contracts and relations of the parties. It appears to be now established that, although a right to participate in the profits of trade is a strong test of partnership, and that there may be cases where, from such perception alone, it may, as a presumption, not of law but of fact, be inferred; yet that whether that relation does or does not exist must depend on the real intention and contract of the parties.” Then the same learned Judge says: “It may well be, that where there is an agreement to share the profits of a trade, and no more, a contract of partnership may be inferred, because there is nothing to shew that any other was contemplated; but that is not the present case, where another and different contract is shewn to have been intended, viz., one of loan and security.” •  •  •

In October, 1868, Borrett and Hagen agree to become partners in carrying on the business together of grease, pitch, and manure manufacturers. Borrett had carried it on before alone, but he and Hagen now made an arrangement of partnership. The arrangement in substance was this: that they should contribute certain shares of the capital, and should give their services in order to carry on the business; that the rest of the capital should be contributed by other persons who were disposed to come forward under the provisions of the Act to which I shall call attention presently—the Act which is commonly called Lord Chief Justice Bovill’s Act—and then that the capital should be divided in certain proportions, giving everybody who put in £500, amongst those other contributors, a share in the capital in proportion, and a share in the profits indefinitely. When the partnership is wound up this capital is to be paid back preferentially. The contributors

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were to take their share of the profits, but if it turned out that, on taking a final account, the profits of any years which had been paid, being added together, exceeded the total profits made from the business, the contributors were to pay back the excess, not exceeding in any event the amount they had contributed, and of course not exceeding in any event the amount they had received in profits. That is the substance of the deeds; but besides that, there were a great many of the provisions usually inserted in partnership deeds, and every one of those provisions was extended to the contributors; that is to say, if they had been ordinary dormant partners, those provisions would have been inserted in their favour, and would have given them every right which, as far as I can understand, an ordinary dormant partner would have. I put it to the learned counsel, in the course of the argument, whether they could suggest any right which would be given to an ordinary dormant partner, not possessed by these contributors, and after consideration and discussion they were unable to do so. That is the general effect of the deeds. That, then, is the position of the parties. The partnership was for the term of fourteen years; the loan also was for the same term. If the partnership comes to an end sooner, the loan must come to an end sooner; so that, in fact, if you were to describe the contributors as dormant partners in the concern, liable to a limited extent to loss, and with a guarantee of their capital from the active partners, you would exactly describe their position; and I do not know of any other shorter mode of describing the position of these contributors. Well, if that is so, is not that exactly the thing which it was intended should not take place—that a man should not put forward another to carry on the business ostensibly and himself take the profits? It is the very object and meaning of the transaction, as I understand it, to give these contributors that very position which dormant partners usually occupy, with certain collateral advantages—exceptional, perhaps, but not altogether unusual; unusual, no doubt, in the sense that I have seldom seen—I was going to say so barefaced, but, when you come to see the reason of it, I will say so palpable—an intention exhibited on the face of the documents to give the contributors all the benefits of the partnership, and if possible to secure them from suffering from the liabilities. •  •  •

It was said, and said with considerable force, … that they never intended to be partners. What they did not intend to do was to incur the liabilities of partners. If intending to be a partner is intending to take the profits, they did intend to be partners. If intending to take the profits and have the business carried on for their benefit was intending to be partners, they did intend to be partners. If intending to see that the money was applied for that purpose, and for no other, and to exercise an efficient control over it, so that they might have brought an action to restrain it from being otherwise applied, and so forth, was intending to be partners, then they did intend to be partners. But if it is tried by the other test, whether they intended to be protected under Bovill’s Act from liability to third persons, then I think they did intend to be protected from liability. But it comes back again to the same point, namely, what is the true construction of the Act? Is what they did within the provisions of the Act, or without? •  •  •

The first section of the Act is this: “The advance of money by way of loan to a person engaged, or about to engage, in any trade or undertaking upon a contract in writing with

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such person, that the lender shall receive a rate of interest varying with the profits, or shall receive a share of the profits arising from carrying on such trade or undertaking, shall not, of itself, constitute the lender a partner with the person or the persons carrying on such trade or undertaking, or render him responsible as such.” •  •  •

The Act is this, that the advance of money must be “by way of loan.” Now what does that mean? It is not the “advance of money,” but “the advance of money by way of loan.” I take it to mean this, that the person advancing must be a real lender; that the advance must not only profess to be by way of loan, but must be a real loan; and consequently you come back to the question whether the persons who enter into the contract of association are really in the position of creditor and debtor, or in the position of partners, or in the only third position which I think could be suggested, that of master and servant. But the Act does not decide that for you. You must decide that without the Act; and when you have decided that the relation is that of creditor and debtor, then all the Act does is this: it says that the creditor may take a share of the profits, but, as I understand the law as laid down by the higher authorities to which I have referred, if you have once decided that the parties are in the position of creditor and debtor you do not want the Act at all, because the inference of partnership derived from the mere taking a share of profits, not being irrebuttable, is rebutted by your having come to the conclusion that they are in the position of debtor and creditor. … I must decide for myself whether the parties are really in the position of creditor and debtor before I can apply the Act at all. [Discussion of the deeds of partnership omitted—see note 1 below.] These are the documents on which I am called upon to decide, and I must say that I have come to a clear conclusion that this is not a transaction of loan within the meaning of the Act of Parliament; that the true relation of the parties towards one another was that of dormant and active partners, and not of mere creditors and debtors; that in this case I need not rely on one provision or on two provisions, but on the whole character of the transaction from beginning to end. It is an elaborate device, an ingenious contrivance, for giving these contributors the whole of the advantages of the partnership, without subjecting them, as they thought, to any of the liabilities. I think the device fails; and that, looking at the law as it stands, I must hold that they are partners, and liable to the consequences of being partners, and to the whole of the engagements of the partnership, and consequently liable for the whole of its debts. The Plaintiff is, therefore, entitled to a judgment on these bills. NOTES AND QUESTIONS

1.  The approach of the court was to look at factors that made the arrangement appear similar to what was commonly understood to be a partnership as opposed to factors that made the arrangement look like something other than a partnership. In the section omitted from the excerpt discussing the particular deeds of partnership, Jessel MR notes the following factors as tending to indicate partnership and not simply a loan:

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Chapter 2  Partnership a. the fact that the alleged lenders were said to have an interest in the capital of the partnership; b. the ability of the alleged lenders to enforce the terms of the partnership agreement, which gave them a degree of participation in and control of the business that would be unusual for a lender, but not for a partner; c. having the return on the lender’s investment vary with the amount loaned, which was unusual for a lender, but not for a partner; d. terminating a loan agreement when a lender goes bankrupt, as the arrangement here provided, which is unusual for a loan agreement, but common for a partnership; and e. having the term of the loan agreement coincide with the term of the partnership agreement, which is unusual for a loan agreement, but not unusual for a partnership arrangement.

What other factors might differentiate between a loan and a partnership arrangement? Why does the different status matter? 2.  How does Jessel MR respond to the argument that the parties’ agreement stated they were not to be considered partners? 3.  The case was decided before the enactment of the 1890 Partnership Act. The statute known as Bovill’s Act referred to in the judgment is roughly equivalent to s 4(c)(iv) of the BC Partnership Act and other comparable provincial partnership statutes. Jessel MR pointed out that the saving provision in Bovill’s Act requires a finding that money has been “advanced by way of a loan.” The first question is thus whether there is a loan. If there is a loan, then it is not a partnership. If the decision is that it is a loan and not a partnership, there is no need to make use of the remaining words of Bovill’s Act. This suggests a limited operational effect of s 4(c)(iv). However, the relevant section of the BC Act provides: 4. … (c)  [T]he receipt by a person of a share of the profits of a business is proof in the absence of evidence to the contrary that he or she is a partner in the business, but the receipt of a share, or of a payment contingent on or varying with the profits of a business, does not of itself make him or her a partner in the business, and in particular (i)  the receipt by a person of a debt or other liquidated amount by instalments or otherwise out of the accruing profits of a business does not of itself make him or her a partner in the business or liable as a partner, (ii)  a contract for the remuneration of an employee or agent of a person engaged in a business by a share of the profits of the business does not of itself make the employee or agent a partner in the business or liable as a partner, (iii)  the spouse or child of a deceased partner who receives by way of annuity a portion of the profits made in the business in which the deceased person was a partner is not merely because of the receipt a partner in the business or liable as a partner, [and] (iv)  the advance of money by way of loan to a person engaged or about to engage in a business, on a contract between that person and the lender under which the lender is to receive a rate of interest varying with the profits or is to receive a share of the profits arising from carrying on the business, does not of itself make the lender a partner with the person carrying on the business or liable as a partner, as long as the contract is in writing and signed by or on behalf of all the parties to it, and …

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The opening words of s 4(c) start with the proposition that a share of the profits is proof of a partnership in the absence of evidence to the contrary. Section 4(c)(iv) attempts to reverse this presumption. In effect, s 4(c) standing alone suggests that a share of the profits, even in a loan agreement, is proof of partnership in the absence of evidence to the contrary. Section 4(c)(iv) attempts to make it clear that if there is a share of profits in a loan agreement on a contract in writing signed by the parties, there is no presumption of partnership. Something else must be shown to establish that a partnership exists. 4.  The effect of permitting the Drivers not to be partners in this situation would be in essence to grant them limited liability, permitting them the full benefits of partnership participation while shielding them from creditors of the firm. If limited liability could be created in this way, creditors would not be aware that the main contributions of capital to the business had been made by persons who were shielded. Creditors would bear the additional costs of attempting to figure out who had limited liability in this fashion, or would increase lending costs accordingly to address the uncertainty. Section VIII on limited liability notes that the way in which the law deals with this is by allowing a limited liability structure only if there is a clear signal to the market that such a structure is being employed—for example, by having the partnership name followed by the suffix “Limited Partnership.”

B. Statute The language of the 1890 English Partnership Act is in essence adopted in each common law province. Although there are differences in certain provisions from province to province, the basic template and legal entitlements and responsibilities set out within all of the Partnership Acts are similar. Reference is made here to the BC Partnership Act and the Ontario Partnerships Act as representative, but it is of course important to consider the specific statute within the relevant jurisdiction under scrutiny. Note that while the BC Act deals with both “general partnerships” and “limited partnerships,” Ontario addresses limited partnerships in a separate act (the Limited Partnerships Act, RSO 1990, c L.16). Limited partnerships are dealt with in detail, below, in Section VII. There are no formal steps required to create a general partnership. In British Columbia there is a registration requirement for general partnerships (Part 4 of the Act), but, unlike a limited partnership, a general partnership can exist without ever complying with the registration requirement. Failure to register a partnership does not mean that the partnership does not exist; the parties, however, may be subject to the potential consequences of a failure to register (including a fine: see s 90.5). The Ontario Partnerships Act contains no such registration provision; the provincial Business Names Act, RSO 1990, c B-17 (BNA), however, sets out requirements for partnerships to register the firm name of the partnership (see ss 3 and 4). The most significant consequence of a failure to register in accordance with the requirements of the Business Names Act is that a person carrying on business in contravention of the relevant provisions will not be able to maintain a proceeding in an Ontario court in connection with that business except with leave of the court: BNA s 7. The Ontario Partnerships Act has six principal sections:

1. nature of partnership (ss 2-5), 2. relation of partners to persons dealing with them (ss 6-19),

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relation of partners to one another (ss 20-31), dissolution of partnership (ss 32-44), limited liability partnerships (ss 44.1-44.4), and general (ss 45-46).

As noted above, while the 1890 Partnership Act codified the common law, the provincial acts are not a complete “code”: s 45 of the Ontario Act provides that the rules of equity and common law applicable to partnerships continue in force except insofar as they are inconsistent with the express provisions of the Act. Further, s 20 of the Ontario Act provides: The mutual rights and duties of partners, whether ascertained by agreement or defined by this Act, may be varied by the consent of all the partners, and such consent may be either expressed or inferred from a course of dealing.

Sections 2 and 3 of the Ontario Act provide important definitional guidance with respect to whether a partnership may be said to exist in a particular situation. Section 2 defines partnership as the relation that subsists between persons carrying on a business in common with a view to profit, but the relation between the members of a company or association that is incorporated by or under the authority of any special or general Act in force in Ontario or elsewhere, or registered as a corporation under any such Act, is not a partnership within the meaning of this Act.

Section  3 then sets out a series of rules to which “regard shall be had” in determining whether a partnership does or does not exist. In British Columbia, ss 2 to 4 deal with the existence of partnership: s 2 provides the definition of partnership; s 3 details “persons who are not a partnership”; and s 4 sets out rules for determining whether a partnership does or does not exist in particular circumstances.

1.  Section 2: Definition of Partnership Section 2 in both the BC and Ontario acts (and comparable provisions in other provincial statutes) sets out four essential elements of a partnership as defined by the statute:

1. 2. 3. 4.

a relationship between persons, carrying on business, in common, and with a view to profit.

These are considered briefly, in turn.

a.  Partnership Is a Relationship Between Persons In British Columbia, “person” is defined in s 29 of the Interpretation Act, RSBC 1996, c 238 as including “a corporation, partnership or party, and the personal or other legal representatives of a person to whom the context can apply according to law.” Thus, a corporation can be a partner. Two or more corporations can be partners. A corporation and an individual can be partners. A partnership can also be a partner in another partnership. Note that the Partnership Acts also contain provisions regarding the entry and exit of partners from a partnership. Section 18 of the Ontario Act, for example, speaks of whether

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liability attaches to a “person who is admitted into an existing firm,” and of agreements discharging liabilities from a “retiring partner.” Section 25 contemplates the expulsion of partners; s  32(c) contains provisions regarding termination of the partnership by notice; s 33(1) declares the dissolution of the partnership upon the death or insolvency of any partner. Section 5 speaks of the “firm” that exists, for purposes of the Act, when persons have entered into partnership with one another. Because matters like the admission and exit of partners are such a critical component of the partnership contract, most partnerships will ensure that these issues are dealt with in detail in a personalized partnership agreement.

b.  Carrying on Business Section 1(1) of the Ontario Act provides that the term “business” in the Act “includes every trade, occupation or profession.” For many years provincial legislation prevented most licensed professionals from carrying on business through a corporation. Consequently, groups of doctors, lawyers, dentists, engineers, and accountants would carry on business as a partnership. Although there has been some relaxation of restrictions on professionals carrying on business through corporations, it is still common for professionals to form partnerships, and then for that partnership to seek to become a “limited liability partnership” or “LLP.” Limited liability partnerships are addressed below in Section VIII.A. The question of whether holding land together constitutes “carrying on business” is a matter considered but not resolved by s 3.1 of the Ontario Act, which provides: Joint tenancy, tenancy in common, joint property, common property, or part ownership does not of itself create a partnership as to anything so held or owned, whether the tenants or owners do or do not share any profits made by the use thereof. [Emphasis added.]

Co-ownership of land is therefore not automatically a partnership, though it may be. The decision in AE LePage Ltd v Kamex Developments Ltd et al (1977), 16 OR (2d) 193, 78 DLR (3d) 223 (CA), excerpted below, addresses this particular issue in greater detail.

c.  In Common This part of the definition presents difficulties, because it suggests that persons must be carrying on business together in some way. Section 3 of the Ontario Act sets out a nonexhaustive set of rules for determining whether a partnership exists; s 4 of the BC Act contains a similar set of rules providing some guidance on what does and does not constitute partnership. The idea of carrying on a business “in common” may suggest that all partners need to be commonly or collectively involved in the management of the business. However, as the court holds in Volzke Construction Ltd v Westlock Foods Ltd, 1986 ABCA 136, 45 Alta LR (2d) 97, extracted below, one can be a partner without active participation or without having control over the business; there can be silent partners, and managing partners, provided that they are carrying on a business in common. This imposes an obligation on all partners to take responsibility for the authorized actions of their partners. In this regard it is sometimes necessary to distinguish between a passive investor and a creditor, as in Cox & Wheatcroft and Pooley—a creditor may have a definite interest in the

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success of the business, but not be a partner (because the creditor is not carrying on business in common with a view to profit). Even after codification, a key element remains whether the creditor has an interest in the profit and management of the firm.

d.  With a View to Profit This part of the definition means that non-profit associations are not treated as partnerships under the Partnership Act. If the object of the association is social or cultural, it will generally not be a partnership. Note that the statutory requirement is a “view to profit” (or a “view of profit”); profits do not have to actually be made in order for a partnership to exist. This is considered further in Backman, 2001 SCC 10, [2001] 1 SCR 367, excerpted below.

2.  Rules for Determining Existence of Partnership The definition of partnership in s 2 is not the end of the discussion in the statute about when and where partnership might be found to exist. Section 3 of the Ontario Partnerships Act (and s 4 of the BC Partnership Act) sets out a series of rules for determining whether, in particular circumstances, a partnership does or does not exist. Some of these provisions are designed to clarify issues considered in the cases set out below. It is a non-exhaustive list, and provides illustrations of situations where partnership will not necessarily be presumed to exist. Sections 3(2) and 3(3) of the Ontario statute, for example, might be seen as an attempt to mitigate the harshness of the common law regime that usually held a creditor liable as a partner in a way that paralleled the judicial effort in Cox & Wheatcroft, extracted above, to do the same. Section 3(2) thus provides that a “sharing of gross returns does not of itself create a partnership.” Section 3(3) notes that the receipt of a share of the profits of a business is prima facie evidence of partnership, but that such receipt of a share or payment contingent on or varying with the profits of a business does not of itself make the recipient a partner. It then sets out further particular instances or situations where, absent other factors, partnership is claimed not to exist, including where a creditor receives payment of debt by installments out of profits: s 3(3)(a); an employee receives remuneration by sharing in profits: s 3(3)(b); an heir of a deceased partner receives an annuity payment related to profits from the business: s 3(3)(c); lenders have an agreement to receive a rate of interest that varies with the profits, or a share of profits, providing that the agreement is in writing: s  3(3)(d); and a person receives an annuity or payment relating to the sale of goodwill of the business, which of itself is not presumed to create a partnership: s 3(3)(e). This statutory guidance must be considered in the context of all of the circumstances of the case, something discussed further by the Supreme Court of Canada in Backman, below.

C.  Modern Common Law Considerations of the Definition of Partnership It should be clear from a review of the Partnership Act that while the statutory codification of the common law provides guidance and additional insight into when a business association is a partnership, the legal definition of partnership is still not always clear. The cases in this section address some of the key questions arising in respect of the existence of partnership—when does joint ownership of property constitute a partnership; what does it mean

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to “carry on business in common”; what is the difference between a “joint venture” and a partnership; and is “profit” necessary in order to have a partnership?

AE LePage Ltd v Kamex Developments Ltd et al (1977), 16 OR (2d) 193, 78 DLR (3d) 223 (CA), aff ’d [1979] 2 SCR 155, 105 DLR (3d) 84n BLAIR JA (for the court) (orally):  This is an appeal from a judgment of Van Camp J in which she allowed the claim of the respondent, a real estate agent, for commission under an exclusive listing agreement. During the term of the exclusive listing agreement the property, a large apartment building, was sold through another agent and the amount of the commission claimed was $45,000. Judgment was given against the appellants but not against the corporate defendant, Kamex Developments Limited. The question in this case is whether the appellants constituted a partnership and, if so, whether the defendant March signed the listing agreement as a partner binding the partnership. The appellants purchased the property in question in 1970 under the name of one of them, “M. Kalmykow in trust.” The defendant corporation was then incorporated to hold the property in trust for the appellants. It executed a declaration of trust and concurrently entered into a written agreement with them. The agreement specified that the property was to be held by the defendant corporation in trust for the appellants in proportion to their interests as set forth therein. It provided that revenues and profits from the property should be paid to them in proportion to their interests and that they should be liable to pay any deficiency to the corporation in the same proportions. It provided for the sale or transfer of the interest of the appellants in the property to third parties after the other appellants named in the agreement had been given a first opportunity of refusal. The agreement also provided that any decision “regarding the sale or other dealings with the said apartment building” was to be made by a majority vote defined as the majority of the interests in the property of the appellants. The evidence disclosed that the appellants met monthly in order to discuss the operation of the property and also the possibility of its sale. At some stage the property was listed for sale by what is called an open listing. A decision was taken by the appellants as a group that there should be no exclusive listing. Employees of the respondent approached March, one of the appellants and as a result he executed the exclusive listing agreement. The learned trial Judge found that he signed this agreement on behalf of all the other appellants, and that he was understood to have done so by the employees of the respondent. She also found that he was not authorized by the appellants to sign the exclusive listing agreement and his act had not been approved by them. The respondent’s statement of claim alleged: On October 6, 1972, the Plaintiff entered into a written agreement (hereinafter referred to as “The Listing Agreement”) with the Defendant, March. At the time of execution of the Listing Agreement, the Plaintiff was advised by March that he was a member of the partnership and had authority to enter into the Listing Agreement on behalf of the partnership. It was a term of the Listing Agreement that such Exclusive Authority was to be irrevocable until one minute before midnight on November 30, 1972.

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This pleading confines the respondent to an assertion that it dealt with the appellant March as a representative of a partnership. Hence, the prime issue in this appeal is whether or not the appellants were a partnership. This involves an answer to the elementary question of whether the appellants as co-owners of the property thereby became partners. A partnership is defined in The Partnerships Act, RSO 1970, c. 339, s. 2 as follows: Partnership is the relation that subsists between persons carrying on a business in common with a view to profit, but the relation between the members of a company or association that is incorporated by or under the authority of any special or general Act in force in Ontario or elsewhere, or registered as a corporation under any such Act, is not a partnership within the meaning of this Act.

The key words of the definition refer to “persons carrying on a business in common with a view to profit.” The mere fact that property is owned in common and that profits are derived therefrom does not of itself constitute the co-owners as partners. S. 3, para. 1 of the Partnerships Act reads as follows: In determining whether a partnership does or does not exist, regard shall be had to the following rules: Joint tenancy, tenancy in common, joint property, common property, or part ownership does not of itself create a partnership as to anything so held or owned, whether the tenants or owners do or do not share any profits made by the use thereof.

Whether or not the position of co-owners becomes that of partners depends on their intention as disclosed by all the facts of the case. It is necessary to determine whether the intention of the co-owners was to “carry on a business” or simply to provide by an agreement for the regulation of their rights and obligations as co-owners of a property. The test was stated by Roach JA in Thrush v. Read, [1950] OR 276 at 279, [1950] 2 DLR 392 (CA) as whether: … on a true construction of the agreement, and having regard to all the circumstances, it should be held that the parties to that agreement intended to become, and thereby became, partners in a joint venture and that therefore they were not merely co-owners of common property.

At p. 280 he said: In addition to the joint ownership created by the agreement, it becomes necessary therefore to find within that agreement an intention on the part of the parties thereto to carry on a business in common with a view of profit.

In that case it was clear that the purpose of a mining syndicate was not simply to hold claims as co-owners but to carry on the business of dealing in mining claims, rights and privileges and turn the same to account. There is no such intention to carry on a business in this case. This case is comparable to Robert Porter & Sons Ltd. v. Armstrong, [1926] SCR 328, [1926] 2 DLR 340, where on facts not too dissimilar from the present case, it was held that the co-owners of property were not partners. There Duff J dealt with the fundamental distinction between partnership and co-ownership at p. 330:

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III.  Definition and Existence of Partnership The real question is whether, from the evidence before us, one ought to infer an agreement in the juridical sense that the property these two persons intended dealing with was to be held jointly as partnership property, and sold as such. Is this what they contemplated? Had they in their minds a binding agreement which would disable either of them from dealing with his share—that is to say, with his share in the land itself—as his own separate property? A common intention that each should be at liberty to deal with his undivided interest in the land as his own would obviously be incompatible with an intention that both should be bound to treat the corpus as the joint property, the property of a partnership. English law does not regard a partnership as a persona in the legal sense. Nevertheless, the property of the partnership is not divisible among the partners in specie. The partner’s right is a right to a division of profits according to the special arrangement, and as regards the corpus, to a sale and division of the proceeds on dissolution after the discharge of liabilities. This right, a partner may assign, but he cannot transfer to another an undivided interest in the partnership property in specie.

The learned trial Judge considered that the intention of the co-owners to purchase the building, hold it as an investment and sell it for profit constituted them as partners in a business carried on for profit. With respect, I am of the opinion that the mere fact that co-owners intend to acquire, hold and sell a building for profit does not make them partners. … In this case the intention of the parties to maintain their rights as co-owners of the property is clear beyond doubt from the documents. In addition, it should be noted that the appellants wished to identify and keep separate their respective beneficial interests in the property for income tax purposes. Their intention would have been defeated if they were regarded as a partnership and the apartment building had become the property of the partnership. The fact that they are obliged by their agreement to offer a right of first refusal to the other co-owners in the event of sale is not inconsistent with their basic right to deal with their respective interests in the property. The claim against the appellants as partners must fail because no partnership existed and the subsidiary question whether March’s signature bound them as partners does not arise. … The appeal will be allowed with costs and the judgment below varied to dismiss the action against the appellants with costs. The cross-appeal will be dismissed without costs. Appeal allowed.

Volzke Construction Ltd v Westlock Foods Ltd 1986 ABCA 136, 45 Alta LR (2d) 97 MOIR JA (for the court):

[1]  The appellant is a general contractor doing business in Northern Alberta with its headquarters in the Town of Westlock. As general contractor it undertook to build in two phases an addition to the Westlock Shopping Centre. It was not paid its final billing. It

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accordingly sued the respondent company alleging that the respondent was in partnership with another limited company Bonel Properties Ltd. and was liable for the debt. [2]  The learned trial judge held that the appellant’s version of its verbal contract was as alleged by the appellant. He held that the balance owing was $76,928.88. The appellant claimed interest but as the action was dismissed the learned trial judge did not deal with the question of interest. The learned trial judge held that the respondent and Bonel Properties Ltd. were co-owners of the property but not partners. I would reverse that finding. [3]  The respondent had the I.G.A. franchise in the Town of Westlock. Bonel Properties Ltd. approached Horne & Pitfield, the franchisee, to take space in the expanded Westlock Shopping Centre which was to be built on to an existing mall. They were told to get in touch with David Shefsky, who was the main shareholder in the respondent Company. [4]  Mr. Shefsky was not content to be a tenant. He wanted to be an owner. As a result he made an offer to Bonel Properties Ltd. for a 20 per cent interest in the Westlock Shopping Centre. He agreed and did pay $32,000.00 for this interest. This is clearly shown in Exhibit 10. The opening paragraph is: This will confirm that Dave Shefsky is prepared to purchase an undivided twenty (20%) per cent interest of the Westlock Shopping Centre at and for a consideration of thirty two thousand ($32,000.00) dollars.

The letter closed as follows: Dave Shefsky is signing this agreement as an indication of his intent to complete the purchase of an undivided twenty (20%) per cent interest in the property as at June 15, 1977.

This offer was dated June 7, 1977 and was accepted on the same letter agreement on June 8, 1977. [5]  The plans for the expansion of the Westlock Shopping Centre had been prepared. Tenders were called for. However, Volzke went to Dave Shefsky and asked about obtaining the construction job. He was told by Shefsky that the contract would go out for tender but that Shefsky would introduce Volzke to his partners. He did so. When the tenders came in they were too high. Bonel Properties Ltd. discharged the architect. Volzke made certain suggestions to save costs. The contract was awarded to him on the basis of cost plus $30,000.00 on each of the two phases of the new construction. This led to the finding that the amount owing was $76,928.88. That finding is not challenged in this appeal. [6]  A bank account, with printed cheques, was opened in the name of Bonel Properties Ltd. and Westlock Foods Ltd. Only the principals of Bonel Properties Ltd. had signing authority. All accounts were submitted to Bonel Properties Ltd. Each of Volzke’s accounts was paid as rendered up to December 22, 1978. On that date Dave Shefsky died. The final account rendered after that date remained unpaid. [7]  After Dave Shefsky’s death Mrs. Shefsky carried on. She was refused signing authority on the bank account. She sent prospective tenants to Bonel Properties Ltd. Bonel Properties Ltd. negotiated all leases. Tenants made complaints re repairs etc. to the manager of Westlock Foods Ltd. store. Bonel Properties Ltd. arranged to complete the repairs and maintenance and paid the bills on the printed cheques of Bonel Properties Ltd. and Westlock Foods Ltd.

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III.  Definition and Existence of Partnership

[8]  The interim financing of the additions to the Westlock Shopping Centre were arranged through the Treasury Branch. Both Bonel Properties Ltd. and Westlock Foods Ltd. executed the debenture in March of 1978. They were jointly and severally liable. Later a mortgage was placed with Investor’s Syndicate which was signed by both companies, Bonel Properties Ltd. as to 80 per cent and the respondent as to 20 per cent. [9]  Unhappy differences soon arose between Bonel Properties Ltd. and Westlock Foods Ltd. Apparently Westlock Foods Ltd. as a tenant wanted things that Bonel Properties Ltd. as landlord did not want to give them. Disputes arose. Also the bank account did not provide for Westlock Foods Ltd. management as signing authorities. The title to the land on which the I.G.A. Store sat was transferred to show 80-20 ownership but title to the original Westlock Shopping Centre and the parking lot and the land on which phase 2 of the shopping centre was built remained in the name of Bonel Properties Ltd. only. [10]  Westlock Foods Ltd. started an action against Bonel Properties Ltd. They filed affidavits. The learned chambers judge held that there was either a partnership or joint venture between the parties. He gave to Westlock Foods Ltd. an interest in the entire operation, including the parking lot. He acted upon the affidavit of Mrs. Shefsky. When the matter went before the master to do an accounting Mrs. Shefsky filed a further affidavit outlining her activities in aiding the business in its operation. This affidavit was put to Mrs. Shefsky in cross-examination and entered as an exhibit. It showed activities entirely consistent with the partnership. [11]  In this case the learned trial judge examined the cases submitted by the appellant’s counsel and extracts from Lindley on Partnership presented by respondent’s counsel. He reached the conclusion he did by finding that there was no intention to enter into a partnership and that as Westlock Foods Ltd. had no control over the business it could not be a partnership. In this we are of the view that he erred in law. In our respectful opinion we think the learned trial judge should have proceeded by looking at the Partnership Act, RSA 1980, c. P-2. Partnership is defined in that Act as follows: 1.  In this Act,

•  •  •

(d)  “partnership” means the relationship that subsists between persons carrying on a business in common with a view to profit;

Nothing is said in the definition about control. We know that you can have silent partners or managing partners. Control has nothing whatever to do with the existence or nonexistence of a partnership. [12]  Secondly, there is no doubt that everyone agrees that the parties agreed that they would share the costs of developing the business of Westlock Shopping Centre on an 80-20 basis. Further, it was common ground that they would share the profits, if any, on an 80-20 basis. This is entirely clear. [13]  Thirdly, we know that they spoke of each other as partners. Westlock Foods Ltd. or Mr. and Mrs. Shefsky sent tenants to Bonel Properties Ltd. They received complaints and arranged for rectification of the complaints. They were to share both the cost of expanding the mall and the profits it would make as a business. [14] The Partnership Act deals with this question in s. 4(c) which reads:

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Chapter 2  Partnership 4.  In determining whether a partnership does or does not exist, regard shall be had to the following rules: •  •  •

(c)  the receipt by a person of a share of the profits of a business is prima facie proof that that person is a partner in the business, … .

[15]  Counsel for the respondent argues that there are two phases of the arrangements between the parties. The first is the construction of the shopping centre. The second is the running of the business of the shopping centre. We can find no authority for such a proposition nor is there anything in the actions of the parties or their words which leads to this highly unusual and very unfair result. This argument was not advanced before the learned trial judge and was first mentioned in oral argument before us. [16]  On all of the facts: the letter, Exhibit 10, which says he is buying a 20 per cent interest in Westlock Shopping Centre; the introduction of the principals of Bonel Properties Ltd. as his partners; the bank account and the printed cheques; the Treasury Branch and Investors Syndicate financing; the right to be consulted about new tenants; the sending of prospective tenants; the “on the spot” looking after the construction faults and repairs; the bank account and the admission that they were to share the costs on an 80-20 basis as well as the profits being divided on that same basis; and, finally, the previous action between the parties; drives us to the conclusion that Bonel Properties Ltd. and Westlock Foods Ltd. were partners in the business of operating the Westlock Shopping Centre. The learned trial judge did not deal with either the definition or with s. 4(c) of the Partnership Act. [17]  We do not find it necessary to deal with the second arm of the appellant’s argument on the holding out as it does not arise on our finding that there was a partnership. [18]  We would give judgment to the appellant for the sum of $76,928.88 together with interest at prime as proven at the trial. They are entitled to the costs of both the trial and the appeal on the appropriate scale.

Lansing Building Supply (Ontario) Ltd v Ierullo (1989), 71 OR (2d) 173 (Dist Ct) MURPHY DCJ:

Overview of Facts On April 18, 1986, an agreement was entered into whereby the plaintiff would supply building materials to a group called the Courtyard Joint Venture. The credit agreement, which was signed by William Barnett, indicated that the Courtyard Joint Venture was a partnership and that the partners were the three named defendants in this action. It should be noted that the action against Mr. Barnett has been discontinued. Materials were delivered to the Courtyard Joint Venture, and the plaintiff is seeking $18,749.35 in payment for the materials delivered.

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III.  Definition and Existence of Partnership

Issue Are the defendants personally liable for the outstanding interest charges? The defendants deny that they personally entered into a written agreement with the plaintiff or that they ever personally ordered any materials from the plaintiff. Thus, the question to be determined in this matter is whether the actions of Mr. Barnett are binding on the two remaining defendants. In my view, the answer to this question depends on whether the relationship between the individuals involved is to be characterized as a partnership or merely co-ownership. This determination is critical in light of s. 6 of the Partnerships Act, RSO 1980, c. 370, which reads as follows: 6.  Every partner is an agent of the firm and his other partners for the purpose of the business of the partnership, and the acts of every partner who does any act for carrying on in the usual way business of the kind carried on by the firm of which he is a member, bind the firm and his partners unless the partner so acting has in fact no authority to act for the firm in the particular matter and the person with whom he is dealing either knows that he has no authority, or does not know or believe him to be a partner.

Section 2 of the Act describes the nature of the partnership as follows: 2.  Partnership is the relation that subsists between persons carrying on a business in common with a view to profit, but the relation between the members of a company or association that is incorporated by or under the authority of any special or general Act in force in Ontario or elsewhere, or registered as a corporation under any such Act, is not a partnership within the meaning of this Act.

As well, s. 3 sets out several rules for determining whether a partnership exists … . In determining whether a partnership exists, one must look at the intention of the parties as disclosed in their agreement and their conduct: Adam v. Newbigging (1888), 13 App. Cas. 308 (HL), and A.E. LePage Ltd. v. Kamex Developments Ltd. (1977), 16 OR (2d) 193, 78 DLR (3d) 223, 1 RPR 331 (CA); affirmed 105 DLR (3d) 84n, [1979] 2 SCR 155 sub nom. A.E. LePage v. March. The defendants entered into the co-ownership agreement, a copy of which was filed as an exhibit. The defendants are relying on that agreement to establish the legal relationship. The defendant Lynn Ierullo gave the impression, when she gave evidence, that there was some magic in the term “joint venture” which affected her liability. She indicated that she asked her lawyer why the names of the companies were not set out on the cheques. She indicated that her lawyer told her that it was sufficient, most people would understand that it was just that, a joint venture. I will now consider the specific provisions of the co-ownership agreement in the case at bar to determine whether the intention of the parties was to form a partnership or merely to establish a co-ownership arrangement. First, the effect of cl. 2.02 of the agreement must be determined. This section provides: The co-owners agree and acknowledge that their relationship is that of co-owners and cotenants in respect of the Real Property and not that of partners nor is it intended that the relationship of partnership be created between the co-owners in respect of their ownership of the Real Property. Nothing contained in this Agreement shall constitute the co-owners as partners with any other or as agents for any other or render one liable for any debts or

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Chapter 2  Partnership obligations of any other which are outside the scope or authority granted pursuant to this Agreement.

The effect of this type of declaration was considered in Adam v. Newbigging, supra, in which Lord Halsbury stated at p. 315: If a partnership in fact exists, a community of interest in the adventure being carried on in fact, no concealment of name, no verbal equivalent for the ordinary phrases of profit or loss, no indirect expedient for enforcing control over the adventure will prevent the substance and reality of the transaction being adjudged to be a partnership …

This same point was dealt with by Collins MR at p. 290 of Weiner v. Harris, [1910] 1 KB 285 (CA): It is quite plain that by the mere use of a well-known legal phrase you cannot constitute a transaction that which you attempt to describe by that phrase. Perhaps the commonest instance of all, which has come before the Courts in many phases is this: Two parties enter into a transaction and say: “It is hereby declared there is no partnership between us.” The Court pays no regard to that. The Court looks at the transaction and says “Is this, in point of law, really a partnership? It is not in the lease [sic] conclusive that the parties have used a term or language intended to indicate that the transaction is not that which in law it is.”

Thus, the insertion of cl. 2.02 in the co-ownership agreement does not preclude me from finding that a partnership did in fact exist. Clause 4.04 provides that the income of each co-owner from the property is to be calculated separately for income tax purposes. In Kamex, supra, such a provision was held to be inconsistent with a partnership relationship. While this section may be considered to be an inconsistency, I do not believe it to be conclusive. Such a clause may be inserted solely to defeat a finding of partnership (much like the “No Partnership” clause dealt with above), or to obtain beneficial tax treatment, but it may not accurately reflect the true nature of the relationship between the parties. In my opinion, one should look at the agreement as a whole in characterizing the relationship as one of partnership or co-ownership. In my view, the co-ownership agreement has many of the attributes often associated with partnerships. In particular, parties to the agreement own property as tenants in common (cl. 2.01,) and are involved in the affairs of the business through the co-owner representatives (cl. 3.02). In addition, the profits from the venture are distributed among the co-owners (cl. 4.07). Further, the rights of the co-owners to deal with their interest in the land are severely restricted by the agreement. This factor is of extreme importance in relation to the distinction between partnership and co-ownership: A.E. LePage Ltd. v. Kamex, supra, and Robert Porter & Sons Ltd. v. Armstrong, [1926] 2 DLR 340, [1926] SCR 328. Specifically, the transfer, sale or other disposition of an interest in the Courtyard Pickering Village Project is dependent on the unanimous written approval of the coowners (cls. 3.03 and 6.02). As well, the co-owners are prevented from applying for the partition or sale of the property (cl. 6.01). In addition, pursuant to the agreement, a coowner wishing to sell its interest in the property is obliged to provide the other co-owners with a right of first refusal (cl. 6.03). It should be noted that the Court of Appeal in Kamex held [at p. 196] that:

III.  Definition and Existence of Partnership

71

The fact that they are obliged by their agreement to offer a right of first refusal to the other co-owners in the event of sale is not inconsistent with their basic right to deal with their respective interests in the property.

Finally, the co-owners are governed by what is commonly referred to as a “Shotgun Buy-Sell” provision (cl. 6.05). Pursuant to this clause, where one co-owner names a price, another co-owner is required to either buy or sell at that price. Although none of these clauses standing on its own is conclusive of partnership, it is my view that when considered in combination with one another, they are consistent with a partnership and not a mere co-ownership arrangement. The defendants have argued that any debt owing to the plaintiff is the responsibility of the numbered companies, and not the individual defendants. For the purpose of this lawsuit, it is important to resolve this issue as the numbered corporations are not defendants in the action. The three individuals, as well as the three numbered companies controlled by the individuals, are named as parties to the co-ownership agreement. Throughout the agreement references to “Co-owner” appear to be made interchangeably with references to “Co-owners.” In cl. 1.01 the former term is defined as “any one of the parties hereto, its successors and permitted assigns,” whereas the latter term is defined as “all of the owners from time to time of the undivided one hundred per cent tenancy in common interest in the Real Property.” As well, pursuant to cl.  4.10 the three named defendants are guarantors of the performance of the obligations of the three numbered companies under the agreement. In light of these provisions, it is arguable that the two remaining defendants have exposed themselves to personal liability through this agreement. In my view, the fact that the individuals are parties to the agreement is indicative of something more than a co-ownership arrangement, as the individuals do not own the land in their individual capacities; rather, the real property is owned by the three numbered companies. If, however, it is only the three numbered corporations which form the partnership, then the named defendants may escape liability. Finally, the conduct of the parties is consistent with the existence of a partnership. This is evidenced by the manner in which Mr. Barnett, a party to the co-ownership agreement, completed the plaintiff ’s credit application. He referred to the Courtyard Joint Venture as a partnership and listed himself and the two remaining defendants as the partners. In addition, invoices sent and cheques received were indicative of a joint business venture carried on under the name Courtyard Joint Venture. The Ontario Court of Appeal dealt with the issue of co-ownership versus partnership in A.E. LePage Ltd. v. Kamex Developments Ltd., supra. In that case, one co-owner of land entered into an exclusive listing agreement, and the court had to determine whether the other co-owners were liable as partners for the agent’s commission. At pp. 194-5, Mr. Justice Blair, in referring to s. 2 of the Partnership Act, stated: The key words of the definition refer to “persons carrying on a business in common with a view to profit.” The mere fact that property is owned in common and that profits are derived therefrom does not of itself constitute the co-owners as partners … . Whether or not the position of co-owners becomes that of partners depends on their intention as disclosed by all the facts of the case. It is necessary to determine whether the

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Chapter 2  Partnership intention of the co-owners was to “carry on a business” or simply to provide by an agreement for the regulation of their rights and obligations as co-owners of a property.

His Lordship found no intention on the part of the co-owners to carry on a business, and stated that “the mere fact that co-owners intend to acquire, hold and sell a building for profit does not make them partners” (p. 194). In my view, the facts in Kamex can easily be distinguished from those in the case at bar. In the former case, the intention of the co-owners was simply to invest in property and resell it at a profit, whereas in this case the parties to the co-ownership agreement formed the Courtyard Joint Venture for the purpose of developing real estate into commercial and residential condominium units. Thus, the arrangement in the present case, as contrasted with that in Kamex, is clearly one in which the parties are “carrying on business” within the meaning of s. 2 of the Partnerships Act. Furthermore, without doubt, the parties to the agreement entered into this joint venture with a view to profit. [Discussion of registration requirements omitted.] Whatever the relation between the parties, it is a separate issue from registration. Whether or not a partnership exists is not dependent on the registration requirements of the aforementioned legislation, but rather on the Partnerships Act and the common law. The only matter that remains to be considered is the application of s. 6 of the Partnerships Act to this case. Pursuant to this provision, the act of one partner binds the other partners: 6.  … unless the partner so acting has in fact no authority to act for the firm in the particular matter and the person with whom he is dealing either knows that he has no authority, or does not know or believe him to be a partner.

There appears to be an issue as to whether Mr. Barnett had the authority to enter into the credit agreement. Lynn Ierullo indicated that Barnett had authority to apply for credit up to $5,000. She also indicated that she did not know if Barnett applied for credit in amounts larger than $5,000. She indicated in her evidence that if Barnett did apply for credit beyond the $5,000 limit, that he would have done so on behalf of Barnett Construction. All the invoices and cheques indicate that Courtyard Joint Venture was involved with the plaintiff and not Barnett Construction in the ordering and paying of the materials from the plaintiff. It is clear that Barnett had authority to order the materials for the project and he was the man responsible for getting the materials and the supplies for the project. It would not be unusual for Barnett to enter into a credit application with a supplier on behalf of the joint venture. It is clear from the credit application itself that the plaintiff believed Mr. Barnett to be a partner in a joint venture known as the Courtyard Joint Venture. Thus, it is my opinion that the credit application entered into by Mr. Barnett is binding on the two remaining defendants as partners. The plaintiff will therefore have judgment against Lynn Ierullo and Ted Orton for the sum of $18,749.35.

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III.  Definition and Existence of Partnership NOTES AND QUESTIONS

1.  The distinction between partnership and co-ownership in Kamex turns in large part on the fact that the agreement between the co-owners contemplated that each could deal separately with their independent interest in the real estate. Where there is a partnership, the property of the partnership is held by all of the partners and there is no right to deal with it separately. How does the statute deal with partnership property? See, for example, s 21 of the Ontario Partnerships Act. 2.  Note how Justice Blair focuses on the intention of the parties as evidenced in the documents, and considers the manner in which they wished to structure their affairs for tax purposes, keeping separate and identifying separately their respective interests in the property. Should the intention of the parties matter? Should it be determinative? 3.  Is the mere intention to resell at a profit conclusive evidence that the enterprise is a partnership? How does the situation in Volzke compare with that in Kamex? Does being coowners of a rental property constitute a partnership? How and why is Kamex distinguished in Lansing Building Supply? 4.  Lansing demonstrates the fine line between co-ownership and partnership—if the enterprise is ongoing, and if there are restrictions on the right to deal with the interest independently, it may be a partnership notwithstanding the express desire of the parties to avoid partnership. Where does the balance tip? Where should it? 5.  Although the next decision is a tax case, it provides important consideration by the Supreme Court of Canada concerning the definition of partnership contained in the Partnership Acts in common law provinces. In reviewing Backman v Canada, consider the importance of tax considerations, the intention of the parties, and the relationship of profit realization with the existence of partnership.

Backman v Canada 2001 SCC 10, [2001] 1 SCR 367 IACOBUCCI and BASTARACHE JJ:

[1]  This appeal was heard with Spire Freezers Ltd. v. Canada, 2001 SCC 11, released concurrently. Both cases raise the basic question of whether a valid partnership has been established for income tax purposes. Facts [2]  In 1985, a limited partnership was created by US residents (the “American Partners”) under the laws of Texas, called “The Commons at Turtle Creek Ltd.” (the “Commons”). The Commons acquired land and constructed an apartment building on the land (the “Dallas Apartment Complex”). By August 1988, the cost of the land and the building far exceeded the fair market value. [3]  The appellant believed that, through a series of transactions, he could acquire and realize a portion of the losses arising from the difference between the original cost and the August 1988 market value of the Dallas Apartment Complex which he could then use as a deduction in computing his Canadian taxable income.

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Chapter 2  Partnership

[4]  In order to secure the losses, the appellant, 38 other Canadians, and an Alberta corporation (collectively referred to as the “Canadians”) arranged to become assignees of the interests of the original American partners in the Commons. [5]  A series of transactions took place on August 29, 1988, which were intended to secure the losses to the Canadians, all according to a predetermined closing agenda. The transactions were intended to result in:





(a) the Canadians becoming partners (with 99.97 per  cent general partnership interests and .03 per cent limited partnership interest) in the ongoing Commons limited partnership by assignment of partnership interests from the American partners for a total cost of US$180,000; (b) the disposition of the Dallas Apartment Complex by the Commons to the original American partners, and the acquisition and realization of accounting losses to the Canadians. The Canadians could then use the losses as deductions in computing their 1988 Canadian taxable income under s. 96 of the Income Tax Act, SC 1970-71-72, c. 63; (c) acquisition of a one per cent interest in a Canadian oil and gas property at a cost of C$5,000. [6]  Although the alleged partnership purchased an interest in the oil and gas property, it never produced a profit and production was halted owing to flooding shortly after its acquisition. Later, the alleged partnership purchased a Montana condominium, but this asset also never produced a profit. [7]  In the 1988 taxation year, each of the Canadians was allocated his proportionate percentage of the loss arising from the sale of the Dallas Apartment Complex by the Commons. By notice of reassessment, the taxation authorities disallowed the partnership losses claimed by the appellant. The appellant filed a notice of objection but the reassessment was confirmed. The appellant appealed to the Tax Court of Canada, then to the Federal Court of Appeal, and now to this Court. II.  Judgments Below 1.  Tax Court of Canada, 97 DTC 1468 [8]  Rip TCCJ found that the transactions in this case were legally effective and not a sham, and that the tax avoidance provisions of the Act had no application to the appeal at bar. [9]  The reasons for judgment of Rip TCCJ are primarily concerned with the issue of whether the Canadians became members of a valid partnership. The Tax Court judge concluded that the definition of a partnership requires a relationship or an association between persons carrying on a business with a view to profit. He also concluded that the “sole purpose” of the Canadians in entering into the transactions at issue was to acquire a potential tax loss. Relying on the since overturned Federal Court of Appeal decision in Canada v. Continental Bank Leasing Corp., [1996] 3 FC 713, the Tax Court judge found (at p. 1483) that neither the appellant nor any of the Canadians intended anything other than to obtain a tax loss from the venture. The purchases of the Canadian Oil and Gas Property and the Montana

III.  Definition and Existence of Partnership

75

Condominium were nothing more than window dressing. Their expectation of income from these two properties was minimal, never even approaching the amount of the loss that they hoped to deduct from their income. The relationship subsisting between the Canadians was not that of carrying on business in common with a view to profit. The Canadians were not associated to carry on a business for profit.

[10]  Thus, the Tax Court judge found that the Canadians were not members of a partnership with respect to the ownership of the Dallas Apartment Complex. The Tax Court judge also dismissed the argument that the Canadians did not have to meet the criteria for the creation of a partnership because they had acquired partnership interests in an existing partnership. He held that this relationship must exist between partners whether they create a new partnership or are admitted to an existing one. Having found that the criteria of a partnership relationship were not met in the case at bar, the Tax Court judge concluded that the appeal should be dismissed. 2.  Federal Court of Appeal, [2000] 1 FC 555, 178 DLR (4th) 126 [11]  The Federal Court of Appeal (Rothstein JA, Isaac CJ and Decary JA concurring) unanimously affirmed the result reached by the Tax Court judge. The Federal Court of Appeal addressed two major issues: first, was there any business being carried on with a view to profit which was ancillary to the Canadians’ tax minimization objective? Second, were the Canadians partners by reason of the assignment of partnership interests in an existing partnership? [12]  With regard to the first issue, the Federal Court of Appeal applied the principles enunciated by this Court in Continental Bank Leasing Corp. v. Canada, [1998] 2 SCR 298, 163 DLR (4th) 385. They considered the evidence of the Canadians’ intentions and conduct in relation to each of the assets owned by the Commons at the material times. They concluded that, after the Canadians took up their assignments, there was no business carried on by the Commons. In the Federal Court of Appeal’s view, once the Canadians became members of the Commons, all that took place was a series of transactions leading to the disposition of the Dallas Apartment Complex and the acquisition of the Canadian oil and gas property. Accordingly, the Federal Court of Appeal concluded that, unlike the facts in Continental Bank, supra, there was “no real, albeit ancillary, profit element” to permit the inference that a business was being carried on with a view to profit in order to satisfy the definition of partnership. [13]  With regard to the second issue, the Federal Court of Appeal held that the entry of new persons and the departure of existing partners will be considered to constitute the creation of a new partnership provided the requisite components of the definition of partnership are satisfied. Hence, the court concluded that the taking of an assignment of partnership interest does not obviate the need to comply with the definition of partnership, and that the Canadians’ failure to comply with that definition rendered the alleged partnership nothing more than a collection of co-owners of property. III. Analysis [14]  As noted at the outset, the resolution of this appeal turns on the application of principles of the law of partnership. The principal issue is whether the appellant was a

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member of a valid partnership such that he could deduct partnership losses from his income pursuant to s. 96 of the Act. The secondary issue is, notwithstanding the criteria for a valid partnership, whether the taking of an assignment constituted the appellant as a partner. •  •  •

1.  Was the Appellant a Member of a Partnership: Was He Carrying on Business in Common with a View to Profit? (a)  The Essential Ingredients of Partnership [17]  The term “partnership” is not defined in the Act. Partnership is a legal term derived from common law and equity as codified in various provincial and territorial partnership statutes. As a matter of statutory interpretation, it is presumed that Parliament intended that the term be given its legal meaning for the purposes of the Act: N.C. Tobias, Taxation of Corporations, Partnerships and Trusts (1999), at p. 21. We are of the view that, where a taxpayer seeks to deduct Canadian partnership losses through s. 96 of the Act, the taxpayer must satisfy the definition of partnership that exists under the relevant provincial or territorial law. … [18]  Each of the common law provinces has enacted its own partnership legislation based on the Partnership Act, 1890 (UK), 53 & 54 Vict., c. 39. However, partnership as a concept was recognized by the courts of law and equity long before the enactment of that statute. It is perhaps not surprising that common law jurisdictions generally, and the common law provinces of Canada in particular, define partnership as a relationship comprised of the same three essential ingredients. The three essential ingredients of partnership were recently described by this Court in Continental Bank, supra, at para. 22: Section 2 of the [Ontario] Partnerships Act defines partnership as “the relation that subsists between persons carrying on a business in common with a view to profit.” This wording, which is common to the majority of partnership statutes in the common law world, discloses three essential ingredients: (1) a business, (2) carried on in common, (3) with a view to profit.

[19]  In law, the meaning of “carrying on a business” may differ depending on the context in which it is used. Provincial partnership acts typically define “business” as including “every trade, occupation and profession.” The kinds of factors that may be relevant to determining whether there is a business are contained in the existing legal definitions. One simple definition of “carrying on trade or business” is given in Black’s Law Dictionary, 6th ed. (1990), at p. 214: “To hold one’s self out to others as engaged in the selling of goods or services.” Another definition requires at least three elements to be present: “(i) the occupation of time, attention and labour; (ii) the incurring of liabilities to other persons; and (iii) the purpose of a livelihood or profit”: see Gordon v. The Queen, [1961] SCR 592, per Cartwright J, dissenting but not on this point, at p. 603. [20]  The existence of a valid partnership does not depend on the creation of a new business because it is sufficient that an existing business was continued. Partnerships may be formed where two parties agree to carry on the existing business of one of them. It is not necessary to show that the partners carried on a business for a long period of time. A partnership may be formed for a single transaction. As was noted by this Court in

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Continental Bank, supra, at para. 48, “[a]s long as the parties do not create what amounts to an empty shell that does not in fact carry on business, the fact that the partnership was created for a single transaction is of no consequence.” Furthermore, to establish the carrying on of a business, it is not necessary to show that the parties held meetings, entered into new transactions, or made decisions: Continental Bank, supra, at paras. 31-33. A business may be established even in circumstances where the sole business activity is the passive receipt of rent, as was noted by L’Heureux-Dubé  J in Hickman Motors Ltd. v. Canada, [1997] 2 SCR 336, 148 DLR (4th) 1, at para. 46: Where machinery is rented out, the essential core operations may at times be limited to accepting rental revenue and assuming the business risk and other obligations. At any time during that period, any client could demand the execution of any of the contractual obligations, such as fixing an engine, for example. Where, because a rental business is fortunate enough to experience no mechanical breakdowns or accidents during a period of time, it “passively” accepts rental revenue and assumes business risk and obligations, it does not necessarily follow that it is not carrying on a business during that period. Holding otherwise would imply that rental businesses are “intermittent,” that is, that they carry on a business only when something goes wrong in the operations. Such a proposition is unacceptable.

[21]  In determining whether a business is carried on “in common,” it should be kept in mind that partnerships arise out of contract. The common purpose required for establishing a partnership will usually exist where the parties entered into a valid partnership agreement setting out their respective rights and obligations as partners. As was noted in Continental Bank, supra, at paras. 34-35, a recognition of the authority of any partner to bind the partnership is relevant, but the fact that the management of a partnership rests with a single partner does not mandate the conclusion that the business was not carried on in common. This is confirmed in Lindley & Banks on Partnership, 17th ed. (1995), at p. 9, where it is pointed out that one or more parties may in fact run the business on behalf of themselves and the others without jeopardizing the legal status of the arrangement. It may be relevant if the parties held themselves out to third parties as partners, but it is also relevant if the parties did not hold themselves out to third parties as being partners. Other evidence consistent with an intention to carry on business in common includes: the contribution of skill, knowledge or assets to a common undertaking; a joint property interest in the subject matter of the adventure; the sharing of profits and losses; the filing of income tax returns as a partnership; financial statements and joint bank accounts; as well as correspondence with third parties: see Continental Bank, supra, at paras. 24 and 36. [22]  A determination of whether there exists a “view to profit” requires an inquiry into the intentions of the parties entering into an alleged partnership. At the outset, it is important to distinguish between motivation and intention. Motivation is that which stimulates a person to act, while intention is a person’s objective or purpose in acting. This Court has repeatedly held that a tax motivation does not derogate from the validity of transactions for tax purposes: Shell Canada Ltd. v. Canada, [1999] 3 SCR 622, 178 DLR (4th) 26; Canada v. Antosko, [1994] 2 SCR 312; Stubart Investments Ltd. v. The Queen, [1984] 1 SCR 536 at p. 540, 10 DLR (4th) 1. Similarly, a tax motivation will not derogate from the validity of a partnership where the essential ingredients of a partnership are otherwise present: Continental Bank, supra, at paras. 50-52. The question at this stage is

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whether the taxpayer can establish an intention to make a profit, whether or not he was motivated by tax considerations. … [23]  Moreover, in Continental Bank, supra, this Court held that a taxpayer’s overriding intention is not determinative of whether the essential ingredient of “view to profit” is present. It will be sufficient for a taxpayer to show that there was an ancillary profitmaking purpose. This flows from the following observation made in Lindley & Banks on Partnership, supra, at pp. 10-11, and adopted in Continental Bank, supra, at para. 43: … if a partnership is formed with some other predominant motive [other than the acquisition of profit] e.g., tax avoidance, but there is also a real, albeit ancillary, profit element, it may be permissible to infer that the business is being carried on “with a view of profit.” If, however, it could be shown that the sole reason for the creation of a partnership was to give a particular partner the “benefit” of, say, a tax loss, when there was no contemplation in the parties’ minds that a profit … would be derived from carrying on the relevant business, the partnership could not in any real sense be said to have been formed “with a view of profit.”

[24]  An ancillary purpose is by definition a lesser or subordinate purpose. In determining whether there is a view to profit courts should not adopt or employ a purely quantitative analysis. The amount of the expected profit is only one of several factors to consider. The law of partnership does not require a net gain over a determined period in order to establish that an activity is with a view to profit. For example, a partnership may incur initial losses during the start up phase of its enterprise. That does not mean that the relationship is not one of partnership, so long as the enterprise is carried on with a view to profit in the future. Therefore, where a partnership is formed with the predominant motive of acquiring a tax loss, it is not necessary to show an intention to profit by the amount necessary to recoup the acquired losses or produce a net gain. (b)  The Approach to Determining Whether a Partnership Exists [25]  As adopted in Continental Bank, supra, at para. 23, and stated in Lindley & Banks on Partnership, supra, at p. 73: “in determining the existence of a partnership … regard must be paid to the true contract and intention of the parties as appearing from the whole facts of the case.” In other words, to ascertain the existence of a partnership the courts must inquire into whether the objective, documentary evidence and the surrounding facts, including what the parties actually did, are consistent with a subjective intention to carry on business in common with a view to profit. [26]  Courts must be pragmatic in their approach to the three essential ingredients of partnership. Whether a partnership has been established in a particular case will depend on an analysis and weighing of the relevant factors in the context of all the surrounding circumstances. That the alleged partnership must be considered in the totality of the circumstances prevents the mechanical application of a checklist or a test with more precisely defined parameters. (c)  Application to the Facts of the Case at Bar [27]  In the case at bar, taken by themselves, the partnership agreement and other documentation indicate an intention to form a partnership. But that is not sufficient because the fundamental criteria of a valid partnership must still be met.

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[28]  In this case, the alleged partnership held two assets: the Dallas Apartment Complex and a one per cent working interest in an Alberta oil and gas property. We agree with the Federal Court of Appeal that the facts in this case indicate that at the time they entered into the transactions at issue, the Canadians did not intend to carry on business with a view to profit in respect of the Dallas Apartment Complex. Once the Canadians acquired their interests in the alleged partnership, the apartment complex was owned only briefly before it was disposed of in accordance with the option granted to the American partners and according to a predetermined closing agenda. As was contemplated in Continental Bank, supra, a partnership can be formed for a brief period of time. It was also acknowledged in that case that the parties need not hold meetings or make decisions, and that the passive receipt of rent can constitute a business. However, in Continental Bank, supra, the business of the partnership was pre-existing and continued after the partnership was formed. In this case, there was no continuity of a business, in fact, one of the first acts of the alleged partnership was effectively to terminate the Commons’ former business of managing the apartment complex. Furthermore, there was no evidence provided to show that the Canadians intended to make a profit during the term of their involvement with the apartment complex. Consequently, in the time between the entry of the Canadians and the disposition of the Dallas Apartment Complex, the Canadians were not, judging from all the surrounding circumstances, carrying on business in common with a view to profit in respect of that asset. [29]  The appellant argues that he established an ancillary intention to carry on business with a view to profit by virtue of the purchase of a working interest in an oil and gas property. Here, again, the documentary evidence indicates an intention to form a partnership. Just prior to the transactions at issue in this appeal, the partnership agreement was amended to provide for investment in oil and gas as one of the purposes of the partnership. Shortly before the scheduled withdrawal of the American partners, the alleged partnership did purchase a one per cent interest in an Alberta oil and gas property for $5,000. However, as discussed above, this evidence of intention must be weighed against other factors in the context of the surrounding circumstances relating to the oil and gas property. In considering those circumstances, we are not convinced that the putative partners had the necessary intention to carry on business in common with a view to profit. It is difficult to accept that there was in fact a business being carried on when none of the factors relevant to the existence of a business supports that contention. The putative partners did not hold themselves out to others as providers of goods or services derived from their interest in the oil and gas property. They had no management duties in respect of the property. There is no evidence that the alleged partnership or its agents expended anything other than nominal time, attention or labour on the project; nor did they incur any liabilities to other persons in respect of it. [30]  Furthermore, when asked at trial, the appellant could not remember the name of the management company that was operating the oil and gas well. The only evidence of an expectation of profit was a vague and self-serving assertion at trial by the appellant of an expected return of between $1,000 and $1,500 per year. There was no evidence that a profit was ever realized, and no financial statements were produced. The one per cent interest in the oil and gas property was the sole asset of the alleged partnership and approximately two months after it was purchased it became flooded and production was

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suspended. No other interests in oil and gas properties were ever purchased. Not until 18 months after the shutdown of the oil and gas property did the alleged partnership purchase another asset, the Montana condominium. [31]  Given the above circumstances, we do not accept the appellant’s characterization of the Canadians’ activities in respect of the oil and gas investment as carrying on business with a view to profit, even as an ancillary purpose. As stated, the time, labour and money spent on the purchase and holding of the interest in the oil and gas property was nominal; indeed, it may be that that arrangement can be viewed as co-ownership of property as found by the Federal Court of Appeal or as an isolated event or adventure as opposed to the carrying on of a business: see Tara Exploration and Development Co. v. M.N.R., 70 DTC 6370 (Ex. Ct.). [32]  We agree with the trial judge that the transactions at issue were not a sham: see Stubart Investments, supra, at pp. 545-46. However, the trial judge also found that the purchase of the one per cent interest in an oil and gas property was “nothing more than window dressing.” We take that as a finding that there was no real ancillary profitmaking purpose behind the appellant’s involvement in the oil and gas property. Like the Federal Court of Appeal, we agree with that finding as well. In coming to this conclusion we do not adopt or employ a quantitative analysis, that is, we do not base our conclusion solely on the amount of the expected profit, although that is a factor to consider. In determining whether there is the necessary “view to profit” the courts must look at all the factors that relate to carrying on business in common with a view to profit. [33]  In contrast, the appellants in Spire Freezers, supra, made a considerable investment in a pre-existing business which they continued to operate after entering the partnership. Ultimately, they acquired an asset, an apartment building, requiring substantially more than nominal management effort. The common purpose requirement was met by the parties’ having entered into a valid partnership agreement, and by the fact that they were joint owners of the apartment building, albeit briefly. The appellants in Spire Freezers must have entered into the transaction with a view to profit since they were apprised of the potential to make a profit from the apartment building and they clearly intended to continue that business. In that case, the requirements of partnership were met. [34]  In summary, it is true that the trial judge in this case did not have the benefit of this Court’s reasons in Continental Bank, supra, and consequently, he applied the wrong law in finding against the appellant. However, after applying this Court’s decision in Continental Bank, supra, we agree that the trial judge’s finding was correct in this case. The appellant was not a member of a partnership because there was no business being carried on in common with a view to profit. •  •  •

[44]  Finally … , it is important to mention that, if a person or group of persons hold themselves out as partners in a partnership, but subsequently claim not to be partners for failure to meet the essential ingredients of a valid partnership, third parties dealing with such a non-entity may well have contractual and tortious remedies against the alleged partner(s). Thus, third parties need not look behind representations of partnership in order to be assured of a remedy against the alleged partners.

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IV. Disposition For the foregoing reasons, we would dismiss the appeal with costs. Appeal dismissed. NOTES AND QUESTIONS

1.  The court notes that whether a partnership has been established in a particular case will depend on an analysis and weighing of the relevant factors in the context of all of the surrounding circumstances. The court also notes that it is not a question of a “mechanical application of a checklist.” What factors does the court take into account here? How does that approach differ from the weighing undertaken in Pooley v Driver? 2.  Where does the intention of the parties factor into the analysis of whether a partnership exists? Should the intention of the parties matter? Should it be determinative? Should the answer differ if the issue arises in the context of tax as opposed to obligations owed to a third party?

The issue of whether a partnership exists has also been considered by the Supreme Court of Canada in the context of human rights legislation—namely, whether an “equity partner” in a law firm was engaged in an “employment relationship” for purposes of the application of a provincial Human Rights Code. In order to determine whether the BC Human Rights Tribunal had jurisdiction over the case, the court examined the nature of the relationship between the individual, Mr McCormick, and his law firm.

McCormick v Fasken Martineau DuMoulin LLP 2014 SCC 39, [2014] 2 SCR 108 (footnotes omitted) Abella J (for the court): [1]  John Michael McCormick became an equity partner at Fasken Martineau DuMoulin LLP in 1979. In the 1980s, the equity partners—those partners with an ownership interest in the firm—voted to adopt a provision in their Partnership Agreement whereby equity partners were to retire as equity partners and divest their ownership shares in the partnership at the end of the year in which they turned 65. A partner could make individual arrangements to continue working as an employee or as a “regular” partner without an equity stake, but such arrangements were stated in the Agreement to be “the exception.” [2]  In 2009, when he was 64, Mr. McCormick brought a claim alleging that this provision in the Partnership Agreement constituted age discrimination contrary to s. 13(1) of the British Columbia Human Rights Code. [3]  Fasken applied to have the claim dismissed on the grounds that the complaint was not within the jurisdiction of the tribunal and that there was no reasonable prospect that the complaint would succeed. In its view, Mr. McCormick, as an equity partner, was not in the type of workplace relationship covered by the Code.

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[4]  The issue before this Court, therefore, is how to characterize Mr. McCormick’s relationship with his firm in order to determine if it comes within the jurisdiction of the Code over employment. That requires us to examine the essential character of the relationship and the extent to which it is a dependent one. [5]  At the time this complaint was brought, Fasken had 650 lawyers worldwide, of whom 260 were equity partners. There were about 60 equity partners in Fasken’s Vancouver office. Responsibility for the day-to-day running of the partnership is delegated through the Partnership Agreement to the Partnership Board, consisting of 13 equity partners, including three from the British Columbia region, elected to three-year terms by the equity partners. Before the creation of the Board, this responsibility had been given to the “Executive Committee.” In 1998-1999, Mr. McCormick served for a year on that committee. The Board determines the compensation criteria for equity partners. The compensation criteria in place at the relevant time included the quality of the legal work, teamwork, generation of profitable business from new and existing clients, profitable maintenance of existing clients, contribution to the firm’s image, reputation and seniority, profitable personal production, businesslike personal practice management, contribution to firm activities, ancillary income generated for the firm, and peer review. A regional compensation committee, comprised of equity partners, allocates the firm’s profits to the equity partners in the region based on these criteria. There is a limited right of appeal back to the committee based on information not available at the time the initial allocation was made. [7]  The Board appoints and gives direction to the firm’s managing partner, who is responsible for the overall management of the firm and who is accountable to the Board. The duties of the managing partner include “managing and structuring the human resources of the Firm, including Partners, associates and staff ” and “delegat[ing] specific functions, responsibilities, authorities and accountabilities to Regional Managing Partners, committees, task forces, individual Partners or associates, as appropriate, and supervis[ing] the execution of those tasks.” Within the firm, all management and support staff report directly or indirectly to a chief operating officer. The chief operating officer reports through the firm’s managing partner to the Board. [8]  All written opinions given to a client are the opinion of the firm, and must be reviewed and approved by a partner other than the partner who prepared it. The firm appoints a “client manager” for each client, who may not be the lawyer who brought the client to the firm. Each matter the firm handles for a client is overseen by a “file manager,” who is responsible for ensuring that the matter is efficiently and properly dealt with. The client manager monitors the performance of the file manager for each matter. All content produced by lawyers, including equity partners, becomes the property of the firm. Any income earned by a partner that relates in any manner to the practice of law is deemed to be property of the firm. Partners are prohibited from entering into financial arrangements or contracts in the name of the firm without the authorization of the firm’s managing partner, Board Chair, regional managing partner or two members of the Board. [9]  A vote of the equity partnership as a whole is required for such matters as an amendment to the Partnership Agreement, the admission of a new equity partner, the expulsion of an equity partner, the dissolution of the firm, the removal of the managing

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partner, the opening of a new office, as well as the approval of certain significant expenses or debts. [10]  An equity partner also has a capital account with the firm, which is paid out when he or she leaves the firm. The aggregate of the partners’ capital accounts represents the funding of the partnership. Partners are liable for the debts of the partnership to the extent that they are not covered by insurance or which the Board elects to treat as an expense, and as limited by s. 104 of the Partnership Act. If the partnership is dissolved, partners are entitled to receive a share of the assets remaining after all of the partnership’s debts and obligations are satisfied. [11]  An equity partner like Mr. McCormick has an ownership interest in the firm. The terms of the Partnership Agreement require that equity partners divest their ownership shares in the partnership at the end of the year in which they turn 65. All equity partners are subject to this time limit on their ownership interests in the firm. A partner may make individual arrangements to continue working as an employee or as a “regular” partner without an equity stake, but such arrangements are stated in the Agreement to be “the exception rather than the rule.” [12]  Mr. McCormick brought a complaint to the British Columbia Human Rights Tribunal, arguing that this provision of the Partnership Agreement constituted age discrimination in employment, contrary to s. 13(1) of the Code. Fasken brought an application to dismiss Mr. McCormick’s claim on the grounds that the Tribunal did not have jurisdiction over the claim because Fasken was not in an employment relationship with Mr. McCormick. [13]  In assessing whether Mr. McCormick was in an employment relationship with the firm, the Tribunal relied on the factors it had developed in Crane v. British Columbia (Ministry of Health Services) (No. 1) (2005), 53 C.H.R.R. D/156, rev’d on other grounds (2007), 60 C.H.R.R. D/381 (B.C.S.C.): utilization, control, financial burden, and remedial purpose. Under the first factor, the Tribunal found that Fasken “utilized” Mr. McCormick to provide legal services to the firm’s clients and to generate intellectual property. Under the second, the Tribunal found that Fasken exercised control over Mr.  McCormick through the direction given by managing partners and client and file managers. With respect to remuneration, the Tribunal found that despite the fact that the partnership involves sharing profits rather than paying fixed wages, the firm nevertheless had the burden of determining and paying Mr. McCormick’s compensation. Finally, the Tribunal concluded that allegations that Fasken treated Mr. McCormick differently because of his age engaged the broad remedial purposes of the Code. It concluded that there was therefore an employment relationship and dismissed Fasken’s application. Fasken’s application for judicial review was dismissed by the B.C. Supreme Court. [14]  The B.C. Court of Appeal allowed Fasken’s appeal, concluding that Mr. McCormick, as a partner, was not in an employment relationship pursuant to the Code. It held that because a partnership is not, in law, a separate legal entity from its partners, it is a legal impossibility for a partner ever to be “employed” by a partnership of which he or she is a member. [15]  For the reasons that follow, I agree with the Court of Appeal that the Tribunal’s decision was incorrect and that the Tribunal had no jurisdiction over Mr. McCormick’s relationship with the firm, but do not accept that a partner can never be an employee for purposes of the Code. The key is the degree of control and dependency.

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[Discussion of the standard of review and analysis of the Human Rights Code test for “employment relationship” is omitted.] [29]  This brings us to partnerships generally. British Columbia’s Partnership Act is modeled on the U.K. Partnership Act 1890 (Alison R. Manzer, A Practical Guide to Canadian Partnership Law (loose-leaf), at p. 1-2). Section 1 states that “ ‘firm’ is the collective term for persons who have entered into partnership with one another.” Section 2 defines a partnership as “the relation which subsists between persons carrying on business in common with a view of profit.” Accordingly, a partnership is by its nature an entrepreneurial relationship among individuals agreeing to do business together. [30]  The conventional view of a partnership was famously described in Lindley & Banks on Partnership (19th ed. 2010) as a collection of partners, rather than a distinct legal entity separate from the parties who are its members: The law, ignoring the firm, looks to the partners composing it; any change amongst them destroys the identity of the firm; what is called the property of the firm is their property, and what are called the debts and liabilities of the firm are their debts and their liabilities. [para. 3-04]

[Citation references are omitted.] [31]  Among the distinctive features of a partnership is that partners generally have a right to participate meaningfully in the decision-making process that determines their workplace conditions and remuneration (J.  Anthony VanDuzer, The Law of Partnerships and Corporations (3rd ed. 2009), at p. 75; Partnership Act, s. 27(e)). This is reflected in, for example, the duty to render accounts to other partners in order to permit them to have the information they need to participate in workplace decisions and ensure that their interests are adequately considered. This duty is set out in s. 31 of the Partnership Act: 31.  Partners are bound to render true accounts and full information of all things affecting the partnership to any partner or his or her legal representatives.

[32]  Partnership agreements also typically create a high threshold for expulsion and, unless the agreement explicitly provides otherwise, a partner cannot be expelled by a simple majority of partners (Partnership Act, s. 28). The Fasken Partnership Agreement, for example, requires a special resolution passed by a meeting of all equity partners, as well as a regional resolution in the partner’s region. When partners do leave a partnership, they are entitled to be paid their share of the partnership’s capital account: VanDuzer, at p. 73; Partnership Agreement, s. 9.5. [33]  In other words, the control over workplace conditions and remuneration is with the partners who form the partnership. In most cases, therefore, partners are not employees of the partnership, they are, collectively, the employer. [34]  American courts have generally found that partnerships are not employment relationships under anti-discrimination legislation since even in a large partnership, partners are typically able to influence the running of the partnership to a significant extent: Largie v. TCBA Watson Rice, LLP, 2013 U.S. Dist. LEXIS 117688 (D.N.J.); Bowers v. Ophthalmology Group, LLP, 2012 U.S. Dist. LEXIS 118761 (W.D. Ky.), rev’d on other

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grounds 733 F.3d 647 (6th Cir. 2013); Kirleis v. Dickie, McCamey & Chilcote, P.C., 2009 U.S. Dist. LEXIS 100326 (W.D. Pa.), at [*82]. In Clackamas, however, the U.S. Supreme Court specifically left open the possibility that nominal “partners” could still be considered employees in exceptional circumstances based on an assessment of the substance of the relationship (p. 446; see also Equal Employment Opportunity Commission v. Sidley Austin Brown & Wood, 315 F.3d 696 (7th Cir. 2002), at pp. 702-7). [35]  Canadian and British courts have similarly held that partnerships are not relationships of employment for purposes of other forms of protective legislation, such as in the realm of workers’ compensation: Ellis v. Joseph Ellis & Co., [1905] 1 K.B. 324 (C.A.); Re Thorne and New Brunswick Workmen’s Compensation Board (1962), 33 D.L.R. (2d) 167 (N.B.S.C. (App. Div.)), aff ’d [1962] S.C.R. viii. [36]  This does not mean human rights legislation cannot apply to partnerships, it means that an express statutory provision is usually required, as is found in s. 44 of the U.K. Equality Act 2010, 2010, c. 15. The Explanatory Note to that provision states that a separate provision protecting partners from discrimination was necessary because their relationship with their partnership is not one of employment: Because partners are mainly governed by their partnership agreements, rather than by employment contracts, separate provisions are needed to provide protection from discrimination, harassment and victimisation for partners in ordinary and limited partnerships. [para. 158]

[37]  Partnership is also designated as a separate category from employer/employee relationships in anti-discrimination legislation in Australia and New Zealand: Sex Discrimination Act 1984 (Cth.), No.  4, s.  17; Disability Discrimination Act 1992 (Cth.), No. 135, s. 18; Age Discrimination Act 2004 (Cth.), No. 68, s. 21; Anti-Discrimination Act 1977 (N.S.W.), No. 48, ss. 10A, 27A and 49G; Anti-Discrimination Act 1991 (Qld.), No. 85, ss. 16 to 18; Equal Opportunity Act 1984 (S.A.), ss. 33, 55 and 70; Equal Opportunity Act 2010 (Vic.), No. 16, ss. 30 and 31; Equal Opportunity Act 1984 (W.A.), ss. 14, 40 and 66E; Human Rights Act 1993 (N.Z.), 1993, No. 82, s. 36. [38]  While the structure and protections normally associated with equity partnerships mean they will rarely be employment relationships for purposes of human rights legislation, this does not mean that form should trump substance. In this case, for example, the Court of Appeal appeared to focus exclusively on partnership as a legal concept, rather than examining the substance of the actual relationship and the extent to which control and dependency played a role. [39]  Turning to Mr. McCormick’s relationship with his partnership and applying the control/dependency test, based on his ownership, sharing of profits and losses, and the right to participate in management, I see him more as someone in control of, rather than subject to, decisions about workplace conditions. As an equity partner, he was part of the group that controlled the partnership, not a person vulnerable to its control. [40]  It is true that Fasken had certain administrative rules to which Mr. McCormick was subject, but they did not transform the substance of the relationship into one of subordination or dependency. Management and compensation committees are necessary mechanisms to implement and coordinate the firm’s policies, not limitations on a partner’s autonomy. Fasken’s Board, regional managing partners, and compensation committees

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were all directly or indirectly accountable to, and controlled by, the partnership as a whole, of which Mr. McCormick was a full and equal member. Under the Partnership Agreement, most major decisions, including those relating to the firm’s mandatory retirement policy, were subject to a vote of the partnership, in which all partners, including Mr. McCormick, had an equal say. Mr. McCormick was an equity partner when the current retirement policy was adopted, and was entitled to vote on the very policy that he is now challenging. [41]  In addition to the right to participate in the management of the partnership, as an equity partner Mr. McCormick benefited from other control mechanisms, including the right to vote for—and stand for election to—the firm’s Board; the duty that the other partners owed to him to render accounts; the right not to be subject to discipline or dismissal; the right, on leaving the firm, to his share of the firm’s capital account; and the protection that he could only be expelled from the partnership by a special resolution passed by a meeting of all equity partners and a regional resolution in his region, arguably giving him tenure since there is no evidence of any equity partners being expelled from this partnership. [42]  Nor was Mr. McCormick dependent on Fasken in a meaningful sense. It is true that his remuneration came exclusively from the partnership, but this remuneration represented his share of the profits of the partnership in accordance with his ownership interest. The partnership was run for the economic benefit of the partners, including Mr. McCormick. While the financial proceeds of Mr. McCormick’s work were pooled with those of other lawyers in the firm, and the distribution of profits was ultimately determined by internal committees, these committees applied criteria that were designed to measure the partner’s contribution to the firm. Mr. McCormick drew his income from the profits of the partnership and was liable for its debts and losses. In addition, he had a capital account and was entitled to share in the partnership’s assets if it dissolved. In effect, Mr. McCormick was not working for the benefit of someone else, as the Tribunal’s reasons suggest, he was, as an equity partner, in a common enterprise with his partners for profit, and was therefore working for his own benefit. [43]  Finally, it must be observed that in order to change the firm’s mandatory retirement policy, all of Fasken’s equity partners would have been entitled to vote. Responsibility for remedying any alleged inequity thus lay in the hands of Mr. McCormick as much as any other equity partner. Instead, he financially benefited for over 30 years from the retirement of the other partners. In fact, in no material way was Mr. McCormick structurally or substantively ever in a subordinate relationship with the other equity partners. [44]  I appreciate that the Tribunal sought, through the application of the Crane factors, to assess Mr. McCormick’s relationship with his firm, but in so doing, it paid insufficient attention to whether he was actually subject to the control of others and dependent on them. It assessed “control,” for example, in terms of some administrative restrictions on partners rather than examining the underlying power dynamics of the relationship. And it found that Mr. McCormick was “utilized” and “remunerated” by Fasken, while disregarding the fact that the firm was run for the benefit of, and by, its equity partners, including Mr. McCormick. [45]  In the absence of any genuine control over Mr. McCormick in the significant decisions affecting the workplace, there cannot, under the Code, be said to be an

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employment relationship with the partnership. Far from being subject to the control of Fasken, Mr. McCormick was among the partners who controlled it from 1979, when he became an equity partner, until he left in 2012. The Tribunal therefore erred in concluding that it had jurisdiction over his relationship with the partnership. [46]  This is not to say that a partner in a firm can never be an employee under the Code, but such a finding would only be justified in a situation quite different from this case, one where the powers, rights and protections normally associated with a partnership were greatly diminished. [47]  But the fact that a partner like Mr. McCormick has no remedy under the Code does not necessarily mean that partners have no recourse for claims of discrimination. One of the duties partners owe each other is the duty of utmost fairness and good faith, set out in s. 22 of the Partnership Act: 22(1)  A partner must act with the utmost fairness and good faith towards the other members of the firm in the business of the firm. (2)  The duties imposed by this section are in addition to, and not in derogation of, any enactment or rule of law or equity relating to the duties or liabilities of partners.

[48]  This duty is an important source of protection for partners: Hitchcock v. Sykes (1914), 49 S.C.R. 403, at p. 407; Cameron v. Julien (1957), 9 D.L.R. (2d) 460 (Ont. C.A.); Rochwerg v. Truster (2002), 58 O.R. (3d) 687 (C.A.). While this case does not require us to decide the point, the duty of utmost good faith in a partnership may well capture some forms of discrimination among partners that represent arbitrary disadvantage: see Manitoba Law Reform Commission, Good Faith and the Individual Contract of Employment, Report #107 (2001), at pp. 22 and 32-33; Emily M.S. Houh, “Critical Race Realism: ReClaiming the Antidiscrimination Principle through the Doctrine of Good Faith in Contract Law” (2005), 66 U. Pitt. L. Rev. 455. That said, absent special circumstances, it is difficult to see how the duty of good faith would preclude a partnership from instituting an equity divestment policy designed to benefit all partners by ensuring the regenerative turnover of partnership shares. The appeal is dismissed with costs. NOTES AND QUESTIONS

1.  Mandatory retirement clauses in law firm partnership agreements have also been considered in England and the United States. The key legal question has been essentially the same in all three countries—is a law firm partner an employee? With the general abolition of mandatory retirement for most workers in Canada, the United States, and the United Kingdom, the question of whether law firm partnership agreements would be covered by human rights codes provisions barring age discrimination also had potential consequences for accounting and consulting practices. Equity partners might be able to stay on as “counsel,” but firms have argued consistently that the entire structure is predicated on renewal that mandatory retirement (traditionally, at age 62 or 65) permits. 2.  The UK Supreme Court decided in 2012 (Seldon v Clarkson Wright and Jakes, 2012 UKSC 16) that the firm had “legitimate aims” in place that justified an exception to the application

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of human rights legislation: retention of staff (“ensuring that associates are given the opportunity of partnership after a reasonable period, thereby ensuring that associates do not leave the firm”); workforce planning (“facilitating the planning of the partnership and workforce across individual departments by having a realistic long-term expectation as to when vacancies will arise”); and “congeniality,” which Lady Hale’s judgment described as “limiting the need to expel partners by way of performance management, thus contributing to the congenial and supportive culture in the firm.” In May 2014, the Employment Appeal Tribunal held that a narrow age range—64-66—was “reasonably necessary” and the firm’s mandatory retirement age of 65 was upheld. 3.  Both the Canadian decision in McCormick and the UK decision in Seldon seem at first instance to run counter to the 2007 settlement reached by the US Equal Employment Opportunity Commission (EEOC) for $27.5 million on behalf of 32 former members of the Sidley Austin LLP law firm. A firm-wide “operational restructuring” in 1999 had reduced its mandatory retirement age from 65 to a sliding scale between 60 and 65; nearly three dozen Sidley partners older than 40 were forced to depart or accept demotions from equity partner to “counsel” or “senior counsel.” In addition to the monetary settlement, the EEOC and Sidley reached agreement on a consent decree that prohibited the firm from using age as a basis for terminating partners or changing their partnership status, and barred it from maintaining any formal or informal age-based retirement policies. In a key precursor, a 2002 decision by Judge Richard Posner from the US 7th Circuit Court of Appeals pointed to the firm’s highly centralized management structure, where partners did not vote on issues and a self-selecting executive committee made all major decisions. In essence, he held, an individual technically classified as a “partner-employer” under state partnership law might still be considered an “employee” for federal anti-discrimination purposes and therefore protected by the Age Discrimination in Employment Act: see Paul D Paton, “Ready for Retirement?” Lexpert (January 2015). 4.  Writing for the unanimous court in McCormick, Madam Justice Rosalie Abella held that the BC Human Rights Tribunal had no jurisdiction over the case, as the partner in question had status that allowed him to exercise too much control over his workplace to be considered an employee under the protection of the BC Human Rights Code: This is not to say that a partner in a firm can never be an employee under the Code, but in the absence of any genuine control of [the partner] in the significant decisions affecting the workplace, there was no employment relationship between him and the partnership under the provisions of the Code.

What might this case mean for “non-equity” partners in law firms?

IV.  THE LEGAL STATUS OF PARTNERSHIPS Once it is determined that a partnership exists, what is its legal status? What are the consequences of a partnership being recognized? Re Thorne and New Brunswick Workmen’s Compensation Board (1962), 33 DLR (2d) 167 (NBCA), aff’d [1962] SCR viii concerned compensation for a person injured at work, but at its essence the case was determined on the basis of the legal status of partnerships. The court had to consider whether a partner might also be an employee—can Thorne make a contract with himself?

IV.  The Legal Status of Partnerships

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A.  The Common Law

Re Thorne and New Brunswick Workmen’s Compensation Board (1962), 33 DLR (2d) 167 (NBCA), aff ’d [1962] SCR viii MCNAIR CJNB (for the court):  This is a special case stated by the Workmen’s Compensation Board under s. 34(8) of the Workmen’s Compensation Act in which our opinion is sought on a question made to the Board by one Osborne Thorne. The Act provides for an Accident Fund established and maintained by assessments made against employers in the industries within its scope out of which compensation may be paid by the Board to a workman and his dependants when personal injury or death is caused to him by accident arising out of and in the course of his employment in any such industry. The facts as stated by the Board may be summarized as follows: In February 1961 Thorne and one Jules Robichaud, both residents of New Brunswick, entered into an oral agreement to carry on in partnership within the Province a combined lumbering and sawmill business. It was agreed Robichaud would have charge of the woods operations, Thorne of the milling operations, and that each partner would personally work in his branch of the undertaking at a remuneration, termed wages, of $75 per week. They commenced business in early February 1961 and, in accordance with the requirements of the Act, duly notified the Board of the new undertaking, filed with it an estimate of wages for the current year and paid to the Board the provisional assessment applicable to the estimated payroll. On April 3rd 1961 Thorne suffered personal injuries by accident arising out of and in the course of the duties performed by him pursuant to the partnership agreement. He applied to the Board for payment of compensation, alleging he was a workman within the meaning of the Act and entitled thereunder to benefits. Clearly the business carried on by the partners constituted an industry within the scope of the Act and workmen in their employ would be eligible for compensation thereunder. The question submitted for the opinion of the Court reads: Based on the foregoing facts was Osborne Thorne, on April 3, 1961, a workman employed by the said partnership within the meaning of the Workmen’s Compensation Act so as to entitle him to compensation thereunder?

Partnerships are an emanation of the common law, the term “firm” to describe the relationship having been borrowed from mercantile law. The Partnership Act 1890 of the United Kingdom is essentially a codification of the rules of common law and equity. Admittedly under such pre-existing rules no person could enter into a contract with himself or be his own employer and, as a partnership was regarded as having no legal existence distinct from the individuals composing it, no person could be an employee of a firm of which he was a member. We were informed by counsel that from its inception the Workmen’s Compensation Board has followed that principle. It is now however contended by the claimant that by virtue of statute law in force in the United Kingdom and in New Brunswick partnerships should be regarded as legal

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entities or persons distinct from their component members and that, in consequence, the firm of which he is a member was capable of entering into a contract of employment with him. [Discussion of principles arising in cases relating to trade unions is omitted.] Our Partnership Act, now c. 167 RSNB 1952, is modelled on the Act of the United Kingdom. Its s. 56 reads: Persons who have entered into partnership with one another are for the purposes of this Act called collectively a firm, and the name under which their business is carried on is called the firm name.

Such enactment is identical with subs. (1) of s. 4 of the Act of the United Kingdom. Its s. 4 contains however, as subs. (2), this further enactment: (2) In Scotland a firm is a legal person distinct from the partners of whom it is composed.

The inclusion of those provisions in the parent Act deprives of all force the suggestion that by other provisions in the Act the Legislature intended to make of partnership firms generally legal entities or persons. The true principles are, we feel, correctly formulated in Pollock on Partnership, 15th ed., 1952, where it is said: The law of England knows nothing of the firm as an artificial person distinct from the members composing it, though the firm is so treated by the universal practice of merchants and by the law of Scotland. In England the firm name may be used in legal instruments both by the partners themselves and by other persons as a collective description of the persons who are partners in the firm at the time to which the description refers; and under the Rules of the Supreme Court actions may now be brought by and against partners in the firm name. An action between a partner and the firm, or between two firms having a common partner, was impossible at common law, and until 1891 it remained open to doubt whether such actions were possible since the Judicature Acts; but they are now expressly authorized by the Rules of Court. (Note 80 here follows reading: “Order XLVIII.A, r. 10. But not so as to enable a partner to be in substance both plaintiff and defendant: Meyer & Co. v. Faber, [1923] 2 Ch. 421, CA).” …

Ellis v. Joseph Ellis & Co., [1905] 1 KB 324, lends support to the views we entertain. The action, brought under the Workmen’s Compensation Act 1897 of the United Kingdom which contains a definition of “workman” corresponding closely to that found in the New Brunswick Act, was against the surviving members of a firm by the dependants of a deceased partner who under a mutual agreement worked in the colliery for wages and had, up to the time of his injury, been paid at the stipulated rate out of the proceeds of the business. It was held the Act contemplated the case of a workman employed by some other person or persons and that the deceased, having been himself one of the partners in the firm for which he was working, could not be said to have been employed by them. At p. 329 Collins MR says:

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IV.  The Legal Status of Partnerships It seems to me obvious, that a person cannot for the purposes of the Act occupy the position of being both employer and employee.

And Mathew LJ says, ibid.: The argument on behalf of the applicant … appears to involve a legal impossibility, namely, that the same person can occupy the position of being both master and servant, employer and employed. The deceased man in this case was a partner; and the arrangement made between him and his co-partners as to the payment of wages to him was really an agreement with regard to the mode in which accounts were to be taken between the partners, and to the share of profits to be received by him in excess of that received by the other partners in consideration of the work done by him.

Since the argument in the case at bar our attention has been drawn to two recent decisions of the English Court of Appeal in which the word “entity” was used as descriptive of a partnership firm. They are Davies v. Elsby Brothers Ltd., [1960] 3 All ER 672, [1961] 1 WLR 170 and Whittam v. W.J. Daniel & Co. Ltd., [1961] 3 All ER 796, [1961] 3 WLR 1123. In our view their language falls far short of a recognition in English jurisprudence of the doctrine that as a matter of substantive law a partnership is a legal entity or persona juridica separate and distinct from the individuals composing it. •  •  •

For the reasons stated the question presented for our opinion must be answered in the negative. Order accordingly. NOTES

1. In Kucor Construction & Developments & Associates v Canada Life Assurance Co (1997), 32 OR (3d) 548 (Gen Div), Justice Ground affirmed the position that a partnership is not a legal entity or a person “having a separate existence recognized in law and therefore capable of holding title to property.” Note his characterization of property ownership in the following passage: To revert to basic legal principles, the law regards as persons with distinct and separate legal rights only individuals and corporations. A partnership may be recognized in law as an association of persons with certain distinctive characteristics and one which, in accordance with Rule 8.01 of The Rules of Civil Procedure, RRO 1990, Reg. 194, is entitled to commence proceedings or have proceedings commenced against it in the name of the partnership. The concept of partnership property is also recognized in law but this does not mean that it is property owned by the partnership but rather property in which all of the partners have undivided interests. In a limited partnership, the legal title is held by the general partner for the benefit of all of the partners. None of these factors, in my view, constitutes a partnership a legal entity or person having a separate existence recognized in law and accordingly being capable of holding title to property and mortgaging or creating security on such property.

2.  There are several consequences of partnerships not being recognized as separate legal entities. First and foremost, each partner is liable to the full extent of his or her or its personal assets for debts and other liabilities of the partnership business. Second, a partner

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may not be an employee of the partnership business. Third, a partner cannot be a creditor of the partnership, except in the particular circumstances provided for in the Act.

B.  The Partnership as a “Firm” The partnership is not recognized as a separate legal entity despite the presence in Partnerships Acts of reference to an entity called a “firm”: see e.g. OPA s 5 and BCPA s 1. Section 7 of the Ontario Act provides that acts or instruments in the firm’s name bind the firm (and thereby all the partners). In addition, for income tax purposes the income of the business of the partnership is calculated for the partnership “firm.” However, under s 96 of the Income Tax Act, the partnership firm is not taxed; instead, the income is allocated between the partners and partners are taxed individually on their shares of the partnership income. Rules of court in each province provide for actions being commenced or defended in the name of the partnership. Consider the following sections of the Ontario Rules of Civil Procedure, RRO 1990, Reg 194 under the Courts of Justice Act, RSO 1990, c C-43 as illustrative: 8.01(1)  A proceeding by or against two or more persons as partners may be commenced using the firm name of the partnership. (2)  Subrule (1) extends to a proceeding between partnerships having one or more partners in common. 8.02  Where a proceeding is commenced against a partnership using the firm name, the partnership’s defence shall be delivered in the firm name and no person who admits having been a partner at any material time may defend the proceeding separately, except with leave of the court. 8.03(1)  In a proceeding against a partnership using the firm name, where a plaintiff or applicant seeks an order that will be enforceable personally against a person as a partner, the plaintiff or applicant may serve the person with the originating process, together with a notice to alleged partner (Form 8A) stating that the person was a partner at a material time specified in the notice. (2)  A person served as provided in subrule (1) shall be deemed to have been a partner at the material time, unless the person defends the proceeding separately denying that he or she was a partner at the material time. •  •  •

8.06(1)  An order against a partnership using the firm name may be enforced against the property of the partnership. (2)  An order against a partnership using the firm name may also be enforced, where the order or a subsequent order so provides, against any person who was served as provided in rule 8.03 and who, (a)  under that rule, is deemed to have been a partner; (b)  has admitted having been a partner; or (c)  has been adjudged to have been a partner, at the material time. (3)  Where, after an order has been made against a partnership using the firm name, the party obtaining it claims to be entitled to enforce it against any person alleged to be a partner other than a person who was served as provided in rule 8.03, the party may move before a judge for leave to do so, and the judge may grant leave if the liability of the person as a partner is not disputed or, if disputed, after the liability has been determined in such manner as the judge directs.

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Accordingly, an action may be brought or defended in the “firm name.” Any judgment can be enforced against the property of the partnership, and against any person who was served with notice of the action against the firm and who is a partner of the firm; and under s 8.06(3), after the order against the partnership has been made, against any person alleged to be a partner, and this partner is liable unless he or she disputes his partnership. The result is that all partners are bound by the judgment, even if they were not named in the action, and were not even served with notice of the action. A similar rule was considered in Thorne, extracted above. The court there said that the presence of this rule did not mean that a partnership was a separate legal entity. It simply provides a convenient means of commencing an action against partners concerning claims arising out of the conduct of the partnership business.

V.  RELATIONSHIP BETWEEN PARTNERS A.  Formation and Governance: The Partnership Act and a Partnership Agreement The Partnership Act provides a set of default rules that will govern the relationship between the partners to the extent that they have not either explicitly or implicitly agreed otherwise. In that respect, the Act might be viewed as a sort of standard form contract. This facilitates the formation of partnerships by allowing persons to create a partnership without having to create their own set of rules to govern the relationship, and thereby reduces transaction costs. Consider s 21 of the BC Partnership Act, which provides: The mutual rights and duties of partners, whether ascertained by agreement or defined by this Part, may be varied by the consent of all the partners and the consent may be either express or inferred from a course of dealing.

In addition, certain other statutory provisions expressly provide they are subject to any express or implied agreement between the partners. The ability of partners to create their own set of rules to govern the relationships between them makes partnership a flexible form of business association. This flexibility is viewed as one of the key advantages of partnership. The default rules provided in the statute are based on the assumption that the partners are equal with respect to their capital contributions, rights to participate in the management of the business, and rights to share in the profits of the business. However, this notion of equality does not reflect the way most partnerships work. Partners often make different contributions of capital, have different skills and different interests in the management of the partnership, and agree on sharing profits in an unequal manner that may be consistent with their contributions of capital and services to the firm. Because many partnerships do not fit with the assumptions underlying the default rules in the Act, it is important to be familiar with the statutory provisions and to expressly provide rules in a partnership agreement in a way that overrides the default rules where the default rules are inconsistent with what the partners desire. Even where the parties are content with the default rules provided for by the statute, it is nevertheless useful to set them out in a comprehensive agreement executed by the parties. Having a written agreement provides a source of information for the parties to determine their rights and entitlements. If the agreement is not comprehensive, the parties will have to

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look not only to the agreement but also to the Act, creating unnecessary complexity and potential confusion.

B.  The Default Provisions 1.  Partnership Property “Partnership property” is defined as property brought into the partnership, property acquired on account of the firm, or property acquired for the purposes of and in the course of the partnership business: see e.g. OPA s 21 and BCPA s 1.1. The statutes also provide that “partnership property” must be held and applied by the partners exclusively for the purposes of the partnership and in accordance with the partnership agreement. Land belonging to the partnership held in the name of an individual partner or one or more partners is held in trust for the partnership. Property bought with money belonging to the firm is deemed to be partnership property.

2.  Capital, Profits, Losses, Management, Admission of New Partners, and Record-Keeping Partnership statutes include provisions concerning the day-to-day running of the partnership business, “subject to any agreement express or implied between the partners”: see e.g. OPA s 24 and BCPA s 27. They include the following rules: • Partners share equally in capital and profits, and “must contribute equally towards the losses, whether of capital or otherwise, sustained by the firm.” • The firm must indemnify every partner for payments made and personal liabilities incurred in the ordinary and proper conduct of the business or for the preservation of the business or the property of the firm. • A partner who makes an advance of capital over and above the contribution that he or she or it agreed to make is entitled to receive a payment of interest at a fair rate. • A partner is not entitled to interest on the capital subscribed by the partner—that is, the return on contributed capital is in the form of profits and not payment of interest. • Every partner may take part in the management of the business. • Partners are not entitled to remuneration for working in the partnership business. • No new partner can be admitted to the partnership without the consent of all existing partners. • Decisions on ordinary business matters are to be determined by a majority of the partners. However, no change in the nature of the partnership business is permitted without the consent of all existing partners. • Partnership books are to be kept at the principal place of business of the partnership and every partner may have access to the books to inspect or copy them.

3.  Removal of Partners Section 28 of the BC Partnership Act and s 25 of the Ontario Partnerships Act provide that no majority of the partners can expel any partner “unless a power to do so has been conferred

V.  Relationship Between Partners

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by express agreement between the partners and the power is exercised in good faith.” Thus, the default rule is that a partner cannot be removed from the partnership without that partner’s consent. If the partners wish to alter this default rule, they must do so by express agreement.

4.  Fiduciary Duties Subject to restrictions on their authority, partners are treated as agents for each other in the carrying on of the business. The relationship is thus one in which the partners need to trust each other. This is reinforced by fiduciary obligations. The common law presumption was that partners owed fiduciary duties to one another. This is codified in statute: s 22 of the BC Partnership Act, for example, requires that a “partner must act with the utmost fairness and good faith towards the other members of the firm in the business of the firm.” Specific fiduciary duties are set out in ss 31 to 33: partners are “bound to render true accounts and full information of all things affecting the partnership to any partner or his or her legal representatives” (s 31); partners must account for any benefits derived without the consent of the other partners from transactions concerning the partnership or “from any use by the partner of the partnership property, name or business connection” (s 32); and if a partner, “without the consent of the other partners, carries on any business of the same nature as and competing with that of the firm, the partner must account for and pay over to the firm all profits made by him or her in that business” (s 33). Fiduciary duties of partners in Ontario have been confirmed in Rochwerg v Truster (2002), 58 OR (3d) 687, 23 BLR (3d) 107 (CA), where Cronk JA noted: [36]  It has long been established that partners owe a fiduciary duty to each other, and that equitable principles hold fiduciaries to a strict standard of conduct, encompassing duties of loyalty, utmost good faith and avoidance of conflict of duty and self-interest. These are well recognized, core principles of the law of partnership.

The application of fiduciary duties of partners was considered in McKnight v Hutchison 2002 BCSC 1373, 28 BLR (3d) 269. That case involved two lawyers who practised law in a law firm partnership between 1990 and 1999. The partnership ended when Mr  McKnight learned that Mr Hutchison had received earnings from part ownership in a private company, even though the partnership agreement provided that partners could conduct business other than the practice of law upon notice to the other partners, “provided that such activities shall not compromise the practice of law within the partnership by the partner or the partnership and provided further that such activities shall not prevent the full contribution of such partner to the business of the partnership.” Grist J found that Hutchison had not given notice of the activities being undertaken, that some of the activities may have been services related to the law firm or the giving of legal advice, and that Hutchison had not satisfied his “obligation to make full disclosure to his partner of matters affecting the partnership.” Further, certain of Hutchison’s connections may have placed him in a conflict of interest—specifically, collections of law firm bills for legal services rendered were left uncollected, perhaps in part because Hutchison was receiving other forms of remuneration from these clients. More than ten years later, the parties were still involved in litigation and the accounting and winding up of the firm had not yet been completed: see McKnight v Hutchison, 2002

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BCSC 1373, (2002), 28 BLR (3d) 269, affd 2013 BCCA 340; see also McKnight v Hutchison, 2014 BCCA 472; and McKnight v Hutchison, 2015 BCSC 1886.

5.  Assignment of Partnership Interests A partnership interest can be assigned, but this does not result in the assignee becoming a partner: see BCPA s 34 and OPA s 31. An assignee of a partner is entitled to a share of the profits and a share of the partnership assets on dissolution. However, the assignee is not entitled simply by virtue of the assignment to participate in the management or administration of the partnership business. Partners want to be in business with persons they know and trust. Consequently, the default rule is that they cannot be forced to accept a new partner just because a fellow partner has sold his or her interest.

6. Dissolution a.  By the Partners Themselves A partnership can be dissolved by the partners themselves. One way they can do this is by setting a fixed term for the partnership: see BCPA s  35(1)(a) and OPA s  32(a). At the expiry of the fixed term, the partnership will be dissolved unless the partners agree otherwise. Another way is for the partners to agree that the partnership will be dissolved at the end of a particular venture for which the partnership was created: BCPA s 35(1)(b) and OPA s 32(b). If there is no fixed term and the partnership is not formed for a particular venture, then the partnership may be dissolved by notice of the intention to dissolve. The dissolution will take effect from the date of the notice or the date specified in the notice: BCPA ss 29 and 35(1)(c) and OPA s 32(c)).

b.  On Death, Bankruptcy, or Dissolution of a Partner Under the Partnership Acts of most of the provinces, a partnership is dissolved automatically upon the death, bankruptcy, or dissolution of a partner: OPA s 33(1). This approach is consistent with the legal nature of partnership in that a partnership is no more than the collection of the individuals in it; when one individual is taken out, what remains is a new partnership because it now consists of a different group of individuals. Given the relationship of trust and the sharing of losses, it makes sense in such circumstances to dissolve the partnership. A partner does not want to be sharing losses with a partner no longer able to contribute to the losses—for example, a bankrupt partner or a corporate partner that has been dissolved. A partner may also not want to be in business with the executors or administrators of the estate of a now deceased partner. However, if the whole partnership is dissolved, then an entirely new partnership agreement among the remaining partners would be required in order to continue. If some partners use this opportunity to hold out for a reconfiguration of the partnership deal, this can lead to frustration and a further fracturing of the relationship. Thus this standard form provision is frequently overridden by express agreement between the

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partners that the death, bankruptcy, or dissolution of a partner does not result in the dissolution of the partnership as between the remaining partners. While the Ontario Partnerships Act, for example, simply provides that the partnership will be dissolved in these circumstances, the BC Partnership Act provides in s 36(1)(b) that, where there are more than two partners, the death, bankruptcy, or dissolution of a partner dissolves the partnership only as between the deceased, bankrupt, or dissolved partner and the remaining partners—that is, the partnership agreement continues to apply with respect to the remaining partners.

VI.  RELATIONSHIP BETWEEN PARTNERS AND THIRD PARTIES The relationship between the partners and the persons affected by contracts entered into in connection with the partners or torts committed in the conduct of the partnership business is also a critical aspect of the statutory regime. When are partners liable for the acts of their fellow partners in the conduct of partnership business? When might third parties be able to recover from partners not directly engaged in a breach of contract or personally in the commission of a tort?

A.  Liability of Partners in Contract and Tort 1.  Liability in Contract a.  Apparent Authority of Partners Section 6 of the Ontario Partnerships Act and s 7 of the BC Partnership Act provide that every partner is an agent of the firm and other partners for the purposes of the partnership business. Further, where a partner “does any act for carrying on in the usual way business of the kind carried on by the firm of which he or she is a member,” it binds the firm and his or her partners unless (1) the partner had no authority to act for the firm in the particular matter; and (2) the third party either knew the person dealt with had no authority or did not know or believe him or her to be a partner. This parallels ostensible authority in agency law. A third party might rely on the apparent authority of a partner to bind his or her fellow partners because the particular partner was carrying on business of the kind carried on by the firm in the usual way in which that business was being carried on by that firm. If the partner was doing something not associated with the business of the firm, reliance by the third party would not have been reasonable. The third party should be suspicious where the business is different from the type of business carried on by the firm and should confirm whether the particular partner had authority or not. Similarly, where the business is of the kind carried on by the firm but the partner is doing something inconsistent with the usual way in which that business is carried on, reliance by the third party would not be reasonable. The third party should be suspicious of the unusual behaviour and make inquiries to confirm that the particular partner has authority. If the partner had no authority and the third party knew this, it would not be reasonable for the third party to rely on all the partners being bound by the particular partner’s unauthorized act.

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b.  Actual Authority of Partners Section 7 of the Ontario Act and s 8(1) of the BC Act provide that “an act or instrument relating to the business of the firm and done or executed in the firm name, or in any other manner showing an intention to bind the firm by a person thereto authorized, whether a partner or not, is binding on the firm and all the partners.” This section does not limit the authority to actual authority. It thus appears to cover both actual and ostensible authority. In contrast to the previous section, which addresses a specific type of situation in which a partner may reasonably appear to have authority to bind his or her partners, this section appears to be broader. It covers actual or ostensible authority of partners or agents who perform an act or execute an instrument relating to the business of the firm and in the firm name, or in a manner showing an intent to bind the firm, where the person has been authorized to do so.

c.  Third-Party Notice of Restriction on Authority of Partner The statute (BCPA s 10 and OPA s 9) provides that if a third party has notice of a restriction on the power of a partner, then the partner’s actions in contravention of the restriction do not bind the firm. Where the earlier section says that the acts of a partner do not bind the firm where the person dealing with the firm “knows” that the partner has no authority, this section refers to “notice.” A person dealing with the firm may not have been given “notice” of a partner’s lack of actual authority but may nonetheless have knowledge of that partner’s lack of authority.

d.  Joint Liability for Debts of Partnership Every partner is jointly liable with the other partners for all debts and obligations of the firm as long as he or she is a partner. After the partner’s death, his or her estate is also severally liable subject to the prior payment of the partner’s separate debts: see BCPA s 11 and OPA s 10(1).

e.  Liability of New Partners and Retired Partners The statute also provides that a person who joins an existing partnership is not liable to creditors for debts of the partnership that arose before the person joined the firm. This is reasonable, since partners or agents acting on behalf of the partnership before the person joined the firm would presumably not be acting on behalf of that person at that time. Third parties would also not be relying on that person because they could easily check who was supposed to be a partner and would discover that the person who was to later join the firm was not a partner at the time: see BCPA s 19 and OPA s 18. On the other hand, once a person is a member of the firm and partners or agents of the firm enter into contracts that bind the firm, the person does not cease to be a party to those contracts just because he or she left the partnership. The statute confirms this. If a creditor, however, agrees to relieve a retiring partner from further liability, then that agreement will be binding, subject to the normal rules of contract law governing such waivers.

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2.  Liability in Tort a.  Liability for Wrongful Acts or Omissions The statute provides that the firm is liable for wrongful acts or omissions where a partner acted with the authority of the other partners or acted in the ordinary course of business of the firm: BCPA s 12 and OPA s 11. This liability for wrongs is joint and several: BCPA s 14 and OPA s 13. In Ernst & Young Inc v Falconi (1994), 17 OR (3d) 512 (Gen Div), the court addressed the scope of the statutory liability provisions. Falconi was a lawyer in the firm of Klein, Falconi and Associates (KFA). Falconi pleaded guilty to a charge under the then Bankruptcy Act, RSC 1985, c B-3 of assisting persons who were adjudged bankrupt in making fraudulent dispositions of their property. Klein had no personal involvement with the transactions. Each of the transactions involved the use of the legal services of KFA in the preparation of mortgage documents, documents transferring title to assets, corporate minutes, reporting letters, and other services normally performed by a law firm in the course of a real estate or commercial practice. Klein argued that the acts of Falconi in assisting clients in making fraudulent transfers could not be considered within the ordinary scope of the business of the law firm. Justice Ground held as follows on this issue: I agree with the submission of counsel for the plaintiff that the court need not find that it is within the ordinary course of business of a law firm for a partner for that firm to conspire with others to defeat creditors of the firm’s clients. It is sufficient if the partner used the facilities of the law firm to perform services normally performed by a law firm in carrying out the transactions as a result of which the creditors of the firm’s clients suffered loss … . I find that the activities of Falconi were of the nature of the normal legal services provided by a lawyer with a real estate and/or a commercial practice in that they consisted of the preparation and completion of mortgage documents, the preparation and completion of documentation for the transfer of title to assets and the preparation of corporate minutes and authorizing resolutions and that throughout these services were performed through the facilities of KFA making use of its support staff, trust account, letterhead and documents … . I accept the submission of counsel for the plaintiff that the fact that the various actions of Falconi were for improper purposes and with intent to defraud the creditors of the bankrupts does not take the acts themselves out of the ordinary course of business of the law firm if they are in the nature of acts normally performed by the law firm in carrying on its usual business.

3.  Other Matters a. Indemnification When a partner is found liable the partner is liable for the full amount. Tort victims or persons contracting with the partnership business can claim full compensation from any one or more of the partners. The liability of a partner is independent of any right of the partner to seek indemnification or contribution from the other partners. A partner who is required to satisfy such an obligation may seek contribution or indemnification from his or her fellow partners according to the terms of their partnership agreement.

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b.  “Holding Out” The statute provides that a person who represents himself or herself to be a partner (whether orally, in writing, or by conduct), or who knowingly allows himself or herself to be represented as a partner, will be liable to anyone who has given credit on the faith of the representation. This could apply even where there is no partnership: BCPA s 16 and OPA s 15(1). For example, a person with a reputation for good credit might permit the use of his or her name by a sole proprietor (perhaps if the sole proprietor is a relative or friend) to help the sole proprietor obtain credit more readily. However, if credit is advanced on the faith of such a use of the person’s name, the person may be liable to the sole proprietor’s creditor. The person allowing himself or herself to be represented as a partner does not have to make the representation himself or herself. The representation could be made by another person as long as the first person allowed himself or herself to be so represented.

4.  Retirement of Partners When a partner retires, persons who have advanced credit before the partner retires may have relied on that person being a partner. Thus, as noted earlier, under the default provisions of the statute the partner who retires does not cease to be liable for partnership debts or obligations incurred before his or her retirement. Further, when a partner retires, third parties dealing with the firm may not be aware that the partner has retired. They may rely on the retired partner as still being a partner. Accordingly, under the statute (BCPA s 19(2) and OPA s 18(2)), a retiring partner can also be liable for debts and obligations of the partnership even after the partner has left the partnership. A retiring partner can avoid such liability if he or she takes certain steps required under the statute, including: (1) providing actual notice to all those with whom the firm has had prior dealings; (2) placing a notice of the retirement in the Gazette: BCPA s 39(2) OPA s 36(2); (3) filing a revised registration statement removing the name of the retired partner from the list of partners of the firm. Providing actual notice to all persons who had prior dealings with the firm may be impractical. The statute allows for an agreement between a retiring partner, the remaining partners, and the creditors relieving the retiring partner from liability. In the ordinary course, this would be obtained as part of the contract under which credit was advanced to the partnership. It may be possible, and it is certainly practical in the context of large partnerships with frequent changes in membership, to put such arrangements in place with major creditors. As part of the partnership agreement it may also be desirable to include a provision providing a right to a retiring partner to require that specific steps be taken by the partnership to reduce the risk of continuing liability of the retiring partner. The partnership agreement could also provide that the remaining partners indemnify a retiring partner for post-retirement debts of the firm.

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VII.  LIMITED PARTNERSHIP A.  Introduction and Overview of Features For reasons noted above, persons investing as partners will often seek limited liability despite the unlimited liability of the partnership form of business organization. However, there is a risk that third parties can be deceived by an undisclosed limitation on liability. If there is a concern on the part of creditors that such a situation exists, they will assume that partnerships have limited liability and will charge higher explicit or implicit rates of interest to reflect this. Investors who would be willing to reduce the risk of loss for creditors by assuming personal liability will find it difficult to do so because creditors will assume they in fact have limited liability. There may, however, be situations in which the preferred arrangement between creditors and investors would be to allow the investors to have limited liability. If the investors and creditors agree to this in advance, creditors would not be deceived and could charge an appropriate amount to compensate them for the greater risk of loss they would bear in light of the investors’ ability to shelter themselves behind limited liability. Investors might find that there are other benefits to limited liability that more than compensate for the added cost of credit. Although creditors and investors could contract in each situation such that recourse to the personal assets of investors is precluded, the time and costs associated with individual creation and enforcement of such arrangements make them impractical in the context of ongoing business arrangements. The solution is a means of shifting the default rule from personal liability to limited liability, but in such a way that creditors are not deceived. Limited partnership provides such a solution. Unlike partnership, limited partnership is a creature of statute rather than the common law. Limited partnership statutes permit some of the partners (investors) to have limited liability, but only if the partnership conducts business under a name that adds the words “Limited Partnership” as a suffix. That “cautionary suffix” signals to third parties dealing with the partnership that some of the partners have limited liability. Limited partnerships must be registered pursuant to the requirements of the statute for the jurisdiction in which the partnership wishes to function. Limited partnership statutes generally also provide that the limited partners may not take part in the “management” or “control” of the business. This is perhaps the most critical feature of the limited partnership form; should a limited partner become engaged in “management” or “control,” the benefit of limited liability may be lost. Limited partnership is similar to partnership in that the limited partnership is not a legally recognized separate entity. Thus, the partners (both general and limited) collectively own the assets of the business. Contracts between the “limited partnership” and others are, unless otherwise provided, contracts between those others and all of the partners, both general and limited. As a result of their restricted involvement in the management or operation of the partnership business, limited partners may not be directly liable for torts committed in carrying on the business, but they may be vicariously liable for the acts of agents or employees engaged in carrying on the business. The limit of their liability is the amount of their investment.

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B.  Tax Considerations Limited partnership agreements are often used to finance start-up operations. Tax treatment is a key influence—the taxation of partnerships is such that any losses, which are more likely to accrue in the start-up phase of the business, can be passed on to the limited partners. Those losses can be used to offset other sources of income. The losses can be especially high in the early years of operation, particularly where there is some government incentive scheme of a type that permits fast write-off of initial capital investments—for example, accelerated depreciation of partnership assets. While limited liability may be an attractive feature of the limited partnership form, there are other ways of creating limited liability for investors, including the incorporation of a company. Although tax concerns might typically be the dominant reason for selecting the limited partnership, other reasons may also be important—for example, the limited partnership form has a greater degree of flexibility than does a corporation in terms of filing and registration requirements, or the ability to contract in respect of important features of its operation.

C.  Statutory Provisions and Features As noted above, unlike partnerships, limited partnerships are creatures of statute. In Ontario, the relevant provisions are contained in a separate statute, the Limited Partnerships Act, RSO 1990 c L 16. In contrast, in British Columbia the relevant provisions are contained in Part 3 of the Partnership Act. Whether one approach or the other is taken varies from province to province. Features are similar from province to province, but it is important to carefully read the statute in the applicable jurisdiction to ensure compliance with all the requirements.

1.  One or More Limited Partners and One or More General Partners A limited liability partnership consists of one or more general partners and one or more limited partners. The liability of the limited partners is restricted to the amount that the limited partner contributes or agrees to contribute to the limited partnership: see BCPA s 63. The liability of the general partners is not limited.

2.  Formation by Filing Certificate or Declaration Unlike an ordinary partnership, which may be formed despite the intention of the parties, in order to create a limited partnership, a certificate (or declaration) must be filed. The filing of the certificate is essential to the formation of the limited partnership; if it is not filed, there is no limited partnership. The clarity of the parties’ intentions, or the appropriateness of a limited partnership in the circumstances is irrelevant—unless the certificate or declaration is filed, the limited partnership will not be formed.

3.  Protection of Third Parties Certain statutory requirements may be attributed to the desire to ensure that third parties are protected against being deceived that one or more limited partners do not have

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limited liability. The addition of the “cautionary suffix” noted above will require that the name of the limited partnership ends in the words “Limited Partnership.” Subject to certain exceptions, the statute will require that the name of the limited partner must not appear in the name of the limited partnership. If a limited partner’s name does appear in the name of the limited partnership and it does not fall within one of the specified exceptions, that limited partner will no longer have limited liability. A limited partner’s contribution is restricted—for example, s 7(1) of the Ontario Limited Partnerships Act provides that a limited partner “may contribute money or other property to the limited partnership, but may not contribute services.” Section 64 of the BC Partnership Act provides that a limited partner is not to take part in the management of the partnership. Participating in the management of the partnership might deceive third parties into believing that the limited partner is a general partner. The certificate or declaration must set out the names of the general partners. This permits third parties dealing with the partnership to assess the creditworthiness of the general partners who do not have limited liability. Even if third parties have advanced credit to the partnership with full knowledge that there are limited partners, and with full knowledge of the identities of the general partners, there is still some risk that the third parties might be taken advantage of by the general or limited partners. The partners will have better access to information about any looming insolvency of the business. If they determine that insolvency is inevitable, they may begin to withdraw funds from the business, thereby reducing the assets of the business, which may be the only recourse for third-party creditors. The BC Partnership Act addresses this by providing in s 59 that no return of capital to partners is permitted if after the return of capital the partnership would be insolvent. In addition, third-party creditors may find helpful the requirement in BCPA s 51(2) that the certificate or declaration must state the contribution provided, or to be provided, by the limited partners. From this, third-party creditors may better be able to determine the amount of capital in the firm and thus the amount of excess there is in terms of the value of the assets of the business over its liabilities. The difficulty with relying on the stated contribution is that it provides only a snapshot of the situation when the business is starting; that may provide little or no useful information in respect of the business as a going concern. If the business has performed poorly since its inception, the net capital may have decreased and the assets of the business at that later point may well be worth less than its liabilities.

D.  Maintaining Limited Liability and Management of the Business As noted earlier, limited partners are precluded from taking part in the management of the business at the risk of losing the limitation on their liability. Accordingly, a common structure for a limited partnership is to have a corporation as the general partner. The promoters of the business will be made officers of the corporation and perform the management functions of the limited partnership business on behalf of the general partner corporation. This raises the question of whether limited partners who are officers in the general partner corporation are in fact liable as general partners on the basis that they have taken part in the management of the business. The two cases that follow have considered this issue.

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Haughton Graphic Ltd v Zivot [1986] OJ No 288, 33 BLR 125 (H Ct J) EBERLE J:  In this case, the plaintiff claims for payment of a debt for printing services supplied by it to a limited partnership called Printcast Publishing Network (hereafter called “Printcast”). The existence of the debt and the amount claimed of $128,251.79 are not in dispute. The plaintiff earlier obtained a default judgment against Printcast but that judgment has remained unsatisfied. The plaintiff sues the two named defendants as limited partners of Printcast on the ground that, in addition to exercising their rights and powers as limited partners, each took part in the control of the business of the limited partnership, within the meaning of s. 63 in Part 2 of the Alberta Partnership Act RSA, 1980, c. P-2, as amended by RSA 1980 (supp.), c. 2; SA 1981 c. 28. It is common ground that the Alberta law relating to limited partnerships applies in this case.

Facts In 1980 the defendant Gary S. Zivot (hereafter called “Zivot”) promoted Printcast as a limited partnership under Alberta law, for the purpose of launching a magazine called “Goodlife” to be published in the United States. Zivot’s concept was for a structure similar to a radio or television network. The limited partnership was to be the promoter of the concept. It would sign up local affiliates and supply them with common editorial material. Each affiliate would obtain local advertising and would be responsible for addition of local material to fill out the magazine. At the same time, Zivot incorporated Lifestyle Magazine Inc., (hereafter called “Lifestyle”) to be the sole general partner in Printcast. Lifestyle was controlled by Zivot, who was the sole limited partner in the company. During subsequent financing stages, other limited partners were added, including the defendant Herbert Marshall (hereafter called “Marshall”). Lifestyle obtained the concept and the necessary development expertise for Printcast from Century Media Incorporated. That too was a company controlled by Zivot, and used by him as a vehicle for his “media development business.” Century Media in turn employed Zivot, its president, as the live body to perform these services. Century Media’s role in the matter is not of particular importance, the principle players being: Printcast, (the limited partnership); Lifestyle (the general partner); and Zivot and Marshall (two of the limited partners). Through Zivot’s efforts, about $250,000 of seed money was obtained from investors in the latter part of 1981. At the beginning of January 1982, Printcast went into business. The first step was to sign up affiliates in various cities. In addition, the details of the magazine and its contents had to be worked out and arrangements made with suppliers, including printing. It is clear on the evidence and admitted by Zivot that commencing in January 1982 Zivot was known to suppliers as the “president” of Printcast. He used this title to introduce himself; he used business cards showing his relationship to Printcast; and when the magazine was published, its masthead showed Zivot as president and Marshall as

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executive vice-president of Printcast. Although the specific date on which Marshall joined the enterprise is unclear, there is no doubt that he played the role of executive vice-president of, and was also a limited partner in, Printcast throughout all the relevant time period. The arrangements for printing the magazine in Toronto were made between Nash, the president of the plaintiff, and Zivot, Marshall and two other employees of Printcast. I accept Nash’s evidence that Zivot was introduced to him as president of Printcast and Marshall as vice-president. Nash gained the impression that Zivot was the man at the top with complete and ultimate responsibility for putting the magazine together and getting it on to the market. He also gained the impression that Marshall was in charge of the administrative side of the business, including the sales and production aspects of the magazine. A deal was struck for the plaintiff to print the Toronto magazine and in late 1982, it printed the first five issues. Then Printcast went into bankruptcy, leaving the plaintiff unpaid for the printing of three issues. Before the plaintiff did any printing, it is clear that Nash knew that he was dealing with a limited partnership. This was part of the information obtained for him about the creditworthiness of Printcast, and is recorded in Exhibit 3. This information verified that the publishing venture had a capital of somewhere between $2,000,000 and $3,000,000, of which a substantial portion was held in certificates of deposit due to mature on July 1st and November 1st, 1982. Beyond this information, I am satisfied that Nash was neither given nor obtained further detail about the commercial nor the legal nature of Printcast. Nash admitted that he was not familiar with the structure of a limited partnership. He was not told of the existence or identity of the general partner, Lifestyle, nor of Zivot’s ownership and control of it. He was not told that both Zivot and Marshall were limited partners in Lifestyle. Thus, the contract for printing services could have been made by the plaintiff only with Printcast itself, and not with the general partner Lifestyle. Take Part in Control It was faintly pressed that the defendants could not be personally liable for the debt because they did not take part in the control of the limited partnership Printcast within the meaning of s. 63 of the Alberta Partnership Act. The evidence however is all to the contrary. Zivot admitted that he was the directing mind of Printcast, that he was responsible for it, and that he managed it. Whether or not he made all of the managerial decisions, he said that he was responsible for all of them. Marshall was one of those directly under Zivot who made many of the managerial decisions in the areas of sales and administration. Zivot signed cheques on behalf of Printcast; Marshall also had the authority to do so. In fact, Zivot and Marshall were in complete control of Printcast. In my opinion, the fact that both defendants were or may have also been acting as employees or officers of Lifestyle, all unknown to Nash, does not take the defendants outside the ambit of s. 63. The defendants’ submission to the contrary must be rejected on the basis of the evidence which I accept … . •  •  •

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Section 63 Alberta Partnership Act On that state of facts, and in view of the overwhelming evidence that both defendants took part in the control of the limited partnership, I come back to s. 63 of the Alberta Partnership Act [now s. 64]. It reads as follows: Liability to creditors

63.  A limited partner does not become liable as a general partner unless, in addition to exercising his rights and powers as a limited partner, he takes part in the control of the business.

Although elaborate arguments were made as to the meaning of the section, I take a simpler view of it. If a limited partner takes part in the control of the business, he becomes liable under the statute as a general partner, i.e. unlimited liability to the extent of his assets. That is what happened in this case, and it is, effectively speaking, the end of the matter. The elaborate arguments made only come into play if it should be found that the plaintiff somehow disclaimed reliance on that section. The arguments demonstrate that in the United States, where the limited partnership is also recognized, there are two lines of authority. One line of authority recognizes that in a statutory provision such as s. 63 of the Alberta Act, there is no room for consideration of whether or not the Plaintiff relied upon the personal liability of the limited partner. It is simply a question of whether or not the limited partner took part in the control of the business and this question becomes largely a quantitative matter. An example of this line of authority is commonly taken to be Delaney v. Fidelity Lease Limited (1975), 526 SW 2d 543 in the Supreme Court of Texas. On the other hand, there is a line of cases which espouses what is called the “specific reliance” test. An example commonly referred to is Frigidaire Sales Corporation v. Union Properties, Inc. (1975), 544 P2d 781 in the Court of Appeals of Washington State. This view may be more fully explained by stating that “liability for a partnership’s obligation to a creditor should not be imposed upon a limited partner who takes part in the control of the business unless, as a result of the limited partner’s conduct, the creditor believed that the limited partner was a general partner.” See Basile “Limited Liability for Limited Partners: An Argument for the Abolition of the Control Rule” (1985) 38 Vanderbilt Law Review 1199 at 1208. After explaining the “specific reliance” test as above, Basile asserts that the Delaney decision correctly points out that the American statutory provision under discussion, which is indistinguishable from s. 63 of the Alberta Act, does not by its terms require creditor reliance as a predicate for holding a limited partner liable. This comment identifies the problem in this case. Section 63 does not contain any requirement of reliance. If reliance was a necessary precondition to unlimited liability for a limited partner, appropriate words should be in the statute. To conclude that the words in the section require such a condition would not, in my view, be an interpretation of the words used in the section, but would be a clear addition of a second, distinct requirement to the only one currently found in the language of s. 63. In any event, mere knowledge by the plaintiff that a magazine was being promoted and published by a limited partnership does not assist the defendants at all. What engages the liability of the limited partner is his taking part in the control of the business.

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Accordingly in my view the defences must fail. I do not think the outcome would be any different if, contrary to my findings, Zivot had explained fully to Garwood the legal particulars of the limited partnership, the legal relationship of the persons and entities concerned, the precise nature of the liability of each of them, and to whom the liabilities were owed. I say this because under s. 63 of the Alberta Act it is clear that the legal relationships can be altered by activity on the part of the limited partner. Absent some unusual situation where it might be argued that the creditor had in some way estopped himself from relying on s. 63 the result in this case would have been the same even if Mr. Zivot’s evidence were to have been accepted. •  •  •

Finally it was submitted on behalf of the defendants that to hold them liable in this case means that a person who is an officer or director (or I suppose a senior employee) of the corporate general partner in a limited partnership would always be fixed with unlimited liability for the debts of the limited partnership by virtue of s. 63 of the Alberta Act on the ground that he is the person who has control of the corporate general partner. This conclusion does not logically follow. The section only applies to a person who, in addition to being an officer, director, senior employee, or other directing mind of the corporate general partner, seeks also to take advantage of personal limited liability as a limited partner in the limited partnership. In other words, s. 63 applies only if two conditions are met. One is that the person be a limited partner and the second is that he take part in the control of the business of the limited partnership. The section does not apply to someone whose sole role in and connection with the limited partnership is that of an officer, director or other controlling mind of the general partner. Conclusion It was for these reasons that at the conclusion of the argument, for reasons to be delivered, I entered judgment against both defendants for $128,251.79 with pre-judgment interest from November 15, 1983 at 11% per annum and with costs to the plaintiff on a partyand-party basis … .

Nordile Holdings Ltd v Breckenridge (1992), 66 BCLR (2d) 183 (CA) GIBBS JA (McEachern CJBC concurring) (orally):  This appeal has its genesis in a purchase of land in 1981 pursuant to an agreement dated April 7, 1981, which I will refer to as the sale agreement. The appellant Nordile was the vendor and Arman Rental Properties Limited Partnership, a limited partnership, was the purchaser. The purchase price was payable in part by a first mortgage for $216,000 to CMHC, and in part by a second mortgage back to Nordile for $600,089.54. Arman fell into default under the mortgages. CMHC foreclosed in 1985. Arman and Arbutus Management Ltd., the general partner of the limited partnership, were the mortgagors in the second mortgage to Nordile. On December 28, 1985 Nordile obtained

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judgment for $389,191 plus interest and costs against Arman and Arbutus pursuant to the terms of the second mortgage. The judgment has not been satisfied. Nordile commenced these proceedings on March 16, 1987, claiming a right to recover the amount of the unpaid judgment and costs from John Breckenridge and Hubert Rebiffe pursuant to the Partnership Act, RSBC 1979, c. 312. On December 17, 1990, proceeding on an agreed statement of facts, the parties applied under Rule 33 of the Rules of Court for an opinion from the Supreme Court as to the liability of Messrs. Breckenridge and Rebiffe. On February 21, 1991 Chief Justice Esson delivered an opinion as to liability and ordered the action dismissed with costs. We have before us both an appeal and a cross appeal against that order. It is my conclusion that the appeal fails and that the cross appeal succeeds in part. Nordile rests its case on s. 64 of the Partnership Act which provides: A limited partner is not liable as a general partner unless he takes part in the management of the business.

Breckenridge and Rebiffe were limited partners in the Arman limited partnership. They were minority shareholders in the general partner, Arbutus. They were also officers and directors of Arbutus. Breckenridge, and to a lesser extent, Rebiffe, managed Arbutus, and Arbutus managed Arman. However, paragraph 29 of the agreed statement of facts states unequivocally that when Breckenridge and Rebiffe participated in the management as directors they did so “solely in their capacities as directors and officers of the general partner, Arbutus.” That agreed fact alone is sufficient to exclude liability under the “unless” provision of s. 64 of the Partnership Act. Acting solely in one capacity necessarily negates acting in any other capacity. As well, I am of the opinion that liability on Breckenridge and Rebiffe is excluded, as found by Chief Justice Esson, by the wording of recital F in the sale agreement: The parties hereto acknowledge that Arman Rental Properties Limited Partnership (the “Limited Partnership”) is a limited partnership formed under the laws of British Columbia. The parties hereto agree that the obligations of the Limited Partnership shall not personally be binding upon, nor shall resort hereunder by [sic] had to, the property of any of the limited partners of the Limited Partnership or assignees of their interest in the Limited Partnership as represented by Units of the Limited Partnership but shall only be binding upon and resort may only be had to the property of the Limited Partnership or the General Partner of the Limited Partnership.

I agree with what was said by Chief Justice Esson about Haughton Graphic Ltd. v. Zivot et al. (1986) 33 BLR 125 (Ont. HC), and with the decision of the judge in that case, and in this case, not to follow the American decisions. The questions put to Chief Justice Esson in the stated case, and his answers to them, are as follows: Did the Defendants, John Breckenridge and/or Hubert Rebiffe in their capacities as directors and/or officers of Arbutus and limited partners in Arman, take part in the management of Arman pursuant to Section 64 of the Partnership Act so as to render them personally liable for the amounts which remain due and owing pursuant to the judgment of the Plaintiff obtained on September 27, 1985 against Arbutus and Arman?

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Can the Defendants rely upon the wording of the Sale and Purchase Agreement dated April 7, 1981 entered into by the Plaintiff as vendor and Arman as investor and in particular paragraph (f) thereof which specifically excludes the personal liability of the limited partners and further restricts liability to Arman as the limited partnership, or alternatively to Arbutus as the general partner of the limited partnership? YES.

Can the Defendants rely upon the Disclosure Statement dated March 30, 1981 wherein the personal liability of the limited partners was expressly excluded? NO ANSWER NEEDED.

I would not disturb the answers to questions two and three. Question one is badly worded. It consists of two questions. For the answer “yes” given by the Chief Justice I would substitute yes to the part about Breckenridge and Rebiffe taking part in management in their capacities as officers and directors of Arbutus, and no to the part about them taking part in management in their capacities as limited partners and thereby rendering themselves personally liable. For those reasons I would dismiss the appeal. I would allow the cross appeal to the extent indicated by the substitution of a yes and a no for the yes answer to question one. I would not interfere with the order dismissing the action against Messrs. Breckenridge and Rebiffe. [The concurring judgment of McEachern CJBC is omitted.] Appeal dismissed; cross appeal is allowed to the extent mentioned by Mr. Justice Gibbs. NOTES AND QUESTIONS

1. In Nordile, according to Chief Justice McEachern, it was “agreed that the limited partners acted solely in their capacity as officers of the general partnership” and thus they would not be liable under the Partnership Act, s 64. If they were made liable for acting solely in their capacities as officers of the general partner, it would be an exception to the Salomon principle that the corporation is a separate legal entity—that is, disregarding the separate corporate entity of Arbutus Management Ltd to make its officers personally liable. The question of the corporation’s separate legal identity and the Salomon principle is discussed in detail in Chapter 3. 2.  How is the distinction to be made between persons acting solely in their capacity as officers of the general partner and persons acting in their capacity as limited partners? 3.  Is the policy rationale for the limited partnership form defeated by permitting the result reached in Nordile? Should it be permitted for the general partner to be a corporation with few assets? 4.  For more recent consideration of Nordile, see Atlantic Waste Systems Ltd v Canada (Attorney General), 2014 BCSC 490.

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E.  Relations Among the Partners 1.  Separation of Ownership and Control Limited liability facilitates having a large number of investors, and many of them will have relatively small stakes in the business. They will accordingly have limited incentive to carefully monitor the management of the business. In limited partnerships, this incentive is decreased even further as a result of the provisions in the statute that make investors potentially liable as general partners if they take part in the management of the business. The limited partnership form of business organization therefore tends to create what is often referred to as a “separation of ownership from control.” The limited partners are usually major contributors of capital for the business. They do not (and cannot, because of the statutory restrictions) “control” the business. This can potentially place the limited partners at the mercy of the managers of the business. It might therefore be expected that limited partnership statutes would incorporate mandatory provisions including disclosure requirements that would assist limited partners in assessing the performance of managers and in removing managers when performance is poor. Other expected mandatory provisions might supplement the common law with respect to conflict-of-interest transactions in which managers of limited partnership businesses might divert business assets to themselves (discussed in a corporate context in later chapters). However, limited partnership statutes tend not to contain these sorts of provisions. Instead, it is left to the parties themselves to contract for the protections they see fit and appropriate for the particular context. This makes the drafting and review of limited partnership agreements critically important. Two statutory protections are illustrated by ss 56 and 58 of the BC Partnership Act. Section 56 provides that general partners cannot perform an act that makes it impossible to carry on the partnership business or consent to a judgment against the partnership. They cannot possess partnership property or dispose of it for other than a partnership purpose. These constraints are not subject to alteration in the partnership certificate. Varying these provisions requires the consent of all of the limited partners. Section 58(1)(c) provides a limited partner with the same right as a general partner to obtain dissolution and winding up of the limited partnership by court order. The general partner’s rights to obtain a court order and dissolution are contained in s 38, and that section sets out circumstances in which a court may make an order decreeing the dissolution of the partnership. Several of these involve situations in which the partnership agreement would be frustrated; there is also a catch-all provision permitting the court to make the order “whenever circumstances have arisen that, in the opinion of the court, render it just and equitable that the partnership be dissolved.” If the business of a limited partnership were being conducted by the general partner(s) in a way that was oppressive to one or more of the limited partners, then as a last resort a limited partner could apply to have the partnership dissolved and wound up.

2.  Other Aspects of the Relations Among Partners a.  Right to Inspect Books Given that limited partners are precluded from engaging in management of the business, it may be a particular challenge for them to assess its performance. Statutory provisions

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concerning limited partnerships provide for the “same right as a general partner” to “inspect and make copies of, or take extracts from the limited partnership books”: BCPA s 58(1) and OLPA s 10. The general partner’s right to inspect books is provided elsewhere in the statute and, in British Columbia, for example, is prefaced by the words “subject to any agreement express or implied between the partners.” If this right were waived or modified for the general partner, it would accordingly also be waived or modified for a limited partner. The general partner may not need such a right to inspect the books if the general partner itself keeps the books.

b.  Assignment of Limited Partnership Interests The limited partnership provisions in the BC Partnership Act continue the default rule of general partnership that a partner cannot assign his or her interest in the partnership without the consent of the other partners. Section 66 provides: 66(1)  A limited partner must not assign his or her interest, in whole or in part, in the limited partnership unless (a)  all the limited partners and all the general partners consent or the partnership agreement permits it, and (b)  the assignment is made in accordance with the terms of the consent or partnership agreement.

Where assignment of the limited partnership interest is permitted in the partnership agreement, s 51(4)(b) provides that the certificate must set out provisions concerning the right to make such an assignment, and the terms and conditions of the assignment. The Ontario Limited Partnerships Act, s 18(1) provides simply that a “limited partner’s interest is assignable.” The balance of s 18, however, sets out important rights and restrictions in respect of becoming a “substituted limited partner” and entitlements and liabilities on admission.

c.  Restriction on the Admission of Additional Partners The question of whether and how additional limited partners are to be admitted is important for the parties to discuss and settle in the partnership agreement. The usual practice is to permit the admission of additional limited partners in order to facilitate future financing needs of the business, but there may be reasons why individual limited partners wish to restrict either the number of additional partners or the timing of entry. Statutory provisions in each province are generally facilitative. Section 17 of the Ontario Limited Partnerships Act provides: 17.  After the formation of the limited partnership, additional limited partners may be admitted by amendment of the record of limited partners.

In British Columbia, s 56(d) of the Partnership Act provides that a general partner has no authority to admit a person as a general partner or a limited partner unless the right to do so has been given in the certificate. Section 51(4)(c) also requires that a right to admit additional limited partners must be set out in the limited partnership certificate. Section  65 provides that an additional limited partner is not to be admitted to a limited partnership

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except in accordance with the partnership agreement and by entry in the register of limited partners that must be kept pursuant to s 54(2)(a).

d.  Share of Profits Profit-sharing is another topic where it is important to consider both the statutory provisions and the agreement made between the partners. In British Columbia, for example, s 61 of the Partnership Act provides that limited partners share in the profits and in any return of capital in proportion to their contributions unless the limited partnership agreement provides otherwise. Section 11 of the Ontario Limited Partnerships Act provides that, subject to the Act, a limited partner has the right 11(1) … (a)  to a share of the profits or other compensation by way of income; and (b)  to have the limited partner’s contribution to the limited partnership returned.

VIII.  LIMITED LIABILITY PARTNERSHIPS A.  Introduction and Background Many professionals, including accountants, lawyers, engineers, doctors, dentists, and architects, have been subject to either express or implied restrictions on carrying on business through a corporate form. They were thus precluded from having limited liability in respect of their professional practices. Limited partnerships cannot be used to obtain limited liability because the professional partner needs to take part in the business. Where professional corporations have been permitted, they usually have not allowed the particular professional persons to have limited liability with respect to the professional services they provide. Thus, many professionals have not had access to limited liability forms of business association that would protect them against liability for professional negligence. The increasing scope of professional liability and increasingly large damage awards in the United States in the wake of the savings and loan scandal in the 1980s created a perceived crisis because it became difficult for professionals to obtain adequate insurance coverage. This increased the exposure of professionals to personal liability for both their own negligence and that of their professional partners. This led to political pressure in the United States for some form of liability shield while still permitting professional firms to organize as partnerships. The limited liability partnership or LLP differs from an ordinary partnership. In its original form in the United States in 1991, the LLP created what is known as a “partial shield”: a partner was shielded against liability for debts and obligations of the partnership that arose from negligence, omission, or wrongful acts of another partner. As the LLP spread throughout the United States, legislation was expanded to create what is referred to as “full shield” protection—the partial shield was broadened to include coverage of ordinary contractual debts of the partnership. Amendments to the American Uniform Partnership Act in 1996 provided for a full-shield LLP model.

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In Canada, the Senate Committee on Banking, Trade and Commerce released a report in March 1998 entitled “Joint and Several Liability and Professional Defendants,”3 which recommended that Canadian provinces and territories adopt the LLP model. In Part IV—Limited Liability Partnerships, the report states: The Committee questions whether there remain good and sufficient reasons for requiring certain professionals to practice within a traditional partnership structure. Why should partners who are not involved in a negligent act be personally exposed to liability arising from the activities of their negligent partners? Why must the traditional professions such as law, accounting and medicine continue to face exposure to personal liability for the activities of their negligent partners while other professionals can limit their exposure through incorporation or some other limited liability structure? •  •  •

The Committee believes that structures such as limited liability partnerships should be available to professionals who wish to limit their personal liability.

Ontario was the first Canadian jurisdiction to enact LLP legislation, doing so in 1998. Alberta followed in 1999. In August 1999, the Uniform Law Conference of Canada produced an issues paper on the topic, recommended the adoption of a full shield approach, and prepared a model LLP act.4 Since then, other provinces have adopted forms of LLP legislation, drawing to various degrees on the ULCC model act. This broad acceptance of the LLP in Canada and the United States has not been without controversy. As the following excerpts indicate, concerns were present at the start that professionals, particularly lawyers, were being privileged by the wide adoption of LLP protection. These concerns have lingered in the post-2001-2 period of scrutiny of professional misconduct in the context of massive corporate failures like Enron.

Robert W Hamilton, “Registered Limited Liability Partnerships: Present at the Birth (Nearly)” (1995) 66 U Colo L Rev 1065 (footnotes omitted) The registered limited liability partnership, also known as a “limited liability partnership,” or, more colloquially, as an “LLP,” is the newest form of modern business enterprise in the United States. Its birth date can be precisely identified as August 26, 1991, when Texas House Bill 278 became effective without Governor Ann Richards’ signature. Since then it has had almost exponential growth. As of the beginning of 1995, legislation recognizing LLPs has been enacted in twenty-four states (three of which limited their provisions to recognition of the existence of foreign LLPs) and similar legislation is pending in several other states. … The LLP has proved to be exceptionally popular wherever it has been enacted. In Texas, for example, more than 1,200 law firms, including virtually all of the state’s largest firms,

3 Online: . 4 Online: Uniform Law Conference of Canada .

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elected to become LLPs within one year after its enactment. On August 1, 1994, three of the nation’s “Big Six” accounting firms—Coopers & Lybrand, Ernst & Young, and Price Waterhouse—all simultaneously announced that they had decided to become LLPs under Delaware law. The three other “Big Six” accounting firms—Arthur Anderson & Co., Deloitte & Touche, and KPMG Peat Marwick—each indicated at the same time that they were also seriously considering changing their business structure to this new type of business form. The reason for this unexpected development was the enactment of an LLP statute in New York that recognized foreign LLPs. … The original conception of an LLP—and the conception that has been accepted by the great bulk of the LLP statutes—is that it provides what might be described as “peace of mind” insurance for innocent partners. The LLP is designed to avoid the fear by a partner that her personal assets may be at risk because of negligence or malpractice by a partner over whom she has no control and quite possibly whom she has never met. A basic principle of general partnership law is that each individual partner is personally liable for all partnership obligations to the extent they exceed the assets of the partnership. This means not only that innocent partners may be required to discharge partnership obligations from their personal assets, but also that they may be required to make contributions from their personal assets to the partnership to enable it to discharge all of its liabilities. In the original LLP concept, all partners have the benefits, responsibilities, and potential liability of general partners except that partners have no responsibility for malpractice claims or for liabilities arising from negligence or misconduct in which they were not personally involved. The protection provided innocent partners against personal liability is usually referred to as “the shield of limited liability.” •  •  •

The LLP is a direct outgrowth of the collapse of real estate and energy prices in the late 1980s, and the concomitant disaster that befell Texas’s banks and savings and loan associations. Texas led the nation in bank and savings and loan failures during the 1980s. More than one-third of all the bank failures in the United States occurred in Texas. Ever since the collapse of these financial institutions across the state, the Federal Deposit Insurance Corporation (“FDIC”) and the Resolution Trust Corporation (“RTC”) (and its predecessor, the Federal Savings and Loan Insurance Corporation (“FSLIC”)) have devoted a significant part of their total resources to the recovery of funds lost in the collapse of Texas institutions. Suit was brought against hundreds of shareholders, directors, and officers of failed financial institutions. However, the amounts recovered from the principal wrongdoers were only a tiny fraction of total losses and attention quickly turned to the roles of the lawyers and accountants who had represented the failed financial institutions before their collapse. “Where were the lawyers?” and “Where were the public accountants?” were cries figuratively heard across the state. Claims against lawyers and accountants for malpractice and breach of duty were attractive because the individual professionals sometimes had been deeply involved in the affairs of their clients. Also, these lawyers and accountants were usually associated with partnerships that had substantial malpractice insurance and numerous wealthy partners. As a result, several highly reputable law firms in Texas found themselves in deep trouble because of their bank and thrift work during the “salad days” of the 1980s. •  •  •

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[T]he idea of limiting personal liability of innocent partners in Texas law firms originated in … SB [Senate Bill] 302, introduced by a state senator from Lubbock. This bill provided limited liability from malpractice claims exclusively for certain named classes of professionals: lawyers, accountants, doctors, engineers, architects, and real estate brokers. The idea had been developed by a twenty-odd person law firm from Lubbock. … My first reaction was negative, but it was immediately and enthusiastically endorsed by the lawyers involved with the [Texas Business Law Foundation—a group of corporate lawyers from major law firms]. “A great idea” was the first comment; “Why didn’t we think of that?” was another. This was true even though the bill only applied prospectively and could not help those lawyers and accountants that  … were enmeshed with the Texas financial institution disaster. At its first legislative hearing, SB 302 received a very negative initial reception before a house committee. The idea of limiting liability within partnerships generally was received with great skepticism. Representative Steven Wolens, a Democrat from Dallas (and a lawyer with Baron & Budd, a litigation firm that conducted business as a professional corporation) viewed any change in the long-accepted general partnership to be a radical and undesirable proposal. Two other legislators argued to lawyer witnesses, “You want your cake and yet you want to eat it too,” and “If you want to swim with the sharks, you should recognize that you might get eaten by them.” Further, the argument was strongly made that the bill was not needed, since law firms could become professional corporations and thereby limit their liability. Finally, the bill was objected to because it discriminated in favor of professionals and was, in the final analysis, “a help-a-lawyer bill.”

Deborah L Rhode & Paul D Paton, “Lawyers, Ethics and Enron” (2002) 8 Stan JL Bus & Fin 9 (footnotes omitted) With or without such structural changes in bar regulatory processes, it would be possible, and desirable, to reconsider certain specific ethical rules that contribute to debacles like Enron. One is the absence of appropriate standards of third party liability for lawyers who passively acquiesce in client fraud. In some states, including Texas, privity requirements now bar non-clients from suing attorneys for “willful blindness” to client misconduct. At least under state law, Vinson & Elkins’ [Enron’s law firm] attorneys would be exempt from liability to third parties if a court found that they acted in good faith and that their activities did not constitute “conduct in furtherance of a fraud.” Given the important role that malpractice proceedings play in enforcing ethical standards, such liability restrictions require rethinking. Limited liability partnerships (“LLPs”) are another example of rules designed by and for the profession that deserve a closer look. Texas was the first state to enact legislation for LLPs for lawyers in the wake of the Savings and Loan scandals, and now such structures are permissible in nearly every state. The legislation effectively eliminated personal financial exposure for partners in firms implicated in malpractice proceedings. LLPs absolve nonsupervising lawyers of any financial responsibility for their colleagues’ ethical violations, and deprive victims of remedies if those who commit the violations lack

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adequate assets or insurance coverage. In essence, LLPs privilege professional over public interests. Moreover, the benefits of this system flow disproportionately to the largest law firms, which could most readily prevent and spread the costs of misconduct. Reducing this insulation from accountability could give the lawyers greater incentives to address collegial misconduct and to establish the internal oversight structures that can check abuses.

B.  LLP Structures and Statutory Provisions In the United States, LLP structures have varied widely. Some have provided that partners are not liable for the malpractice liabilities of their fellow partners. Others provided that partners are not liable for the ordinary debts of the firm. Some provide for full limited liability, but limit this form of association to professional partnerships. Others provide full limited liability, but are open to any form of enterprise. The Uniform Law Conference of Canada Model Act does not restrict the use of the Act to any particular type of business or profession. The ULCC noted that it “can see no cogent reason for limiting the availability of LLPs to certain types of enterprise,” although it recognized that a jurisdiction might want to do so. Canadian jurisdictions enacting LLP legislation have generally limited the use of LLPs to members of “eligible professions,” those that are regulated under an act, such as doctors, lawyers, and accountants. In those cases, professional partnerships are permitted to use the LLP structure only if the profession is expressly authorized by or under its governing act to carry on the practice of the profession through an LLP and if the partnership has met any prerequisites to the authorization established under the constating act. For example, s 44.2 of the Ontario Partnerships Act provides: 44.2  A limited liability partnership may carry on business in Ontario only for the purpose of practising a profession governed by an Act and only if, (a)  that Act expressly permits a limited liability partnership to practise the profession; (b)  the governing body of the profession requires the partnership to maintain a minimum amount of liability insurance; and (c)  the partnership complies with section 44.3 if it is not an extra-provincial limited liability partnership or section 44.4 if it is an extra-provincial limited liability partnership.

In contrast, in 2005, British Columbia amended its Partnership Act to include LLP provisions that place no restrictions on the types of businesses able to register. However, s 97 provides: 97.  If a partnership that wishes to register as a limited liability partnership is a professional partnership, that partnership must not register as a limited liability partnership unless (a)  members of that profession are expressly authorized under the Act by which that profession is governed to carry on the practice of the profession through a limited liability partnership, and (b)  any prerequisites to that authorization that have been established under that Act have been met by the partnership.

Responsibility for addressing the question of whether and on what terms and conditions a professional group uses the LLP structure is placed in the hands of the profession, its governing body, and the government department responsible for regulation of the profession.

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1.  Full Shield Liability Amendments to the Ontario Partnerships Act in December 2006 provided for full shield liability, as follows: Limited liability partnerships 10(2)  Subject to subsections (3) and (3.1), a partner in a limited liability partnership is not liable, by means of indemnification, contribution or otherwise, for, (a)  the debts, liabilities or obligations of the partnership or any partner arising from the negligent or wrongful acts or omissions that another partner or an employee, agent or representative of the partnership commits in the course of the partnership business while the partnership is a limited liability partnership; or (b)  any other debts or obligations of the partnership that are incurred while the partnership is a limited liability partnership. Limitations (3)  Subsection (2) does not relieve a partner in a limited liability partnership from liability for, (a)  the partner’s own negligent or wrongful act or omission; (b)  the negligent or wrongful act or omission of a person under the partner’s direct supervision; or (c)  the negligent or wrongful act or omission of another partner or an employee of the partnership not under the partner’s direct supervision, if, (i)  the act or omission was criminal or constituted fraud, even if there was no criminal act or omission, or (ii)  the partner knew or ought to have known of the act or omission and did not take the actions that a reasonable person would have taken to prevent it. Same (3.1) Subsection (2) does not protect a partner’s interest in the partnership property from claims against the partnership respecting a partnership obligation.

2.  Business Name Registration Requirements The Ontario Partnerships Act also provides in s 44.3 that a limited liability partnership is not allowed to carry on business unless the name of the firm has been registered under the Ontario Business Names Act, and unless that name contains the words “limited liability partnership,” “LLP,” or their French language equivalents. No other name can be used to carry on the business.

IX.  JOINT VENTURES Finally, it is worth noting that the nature of an enterprise is still subject to scrutiny, notwithstanding the apparent clarity and direction of both partnership law statutes and the ability to contract out of the statutory “standard form template” responsibilities articulated under them. One issue that often arises is whether an enterprise is a “joint venture.” The following case from 2015 considered this issue directly, and whether the parties formed a joint venture or a partnership.

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Woronuk v Woronuk 2015 ABQB 116 B.  Did the Parties Form a Joint Venture or Partnership? [315]  In determining whether the parties formed a joint venture or partnership, it is necessary to first consider the concepts of joint ventures and partnerships, and specifically, what they are in law. 1.  Law on Joint Ventures and Partnerships a.  What Is a Joint Venture? [316]  A joint venture is not itself a legal entity capable of entering into a contract. It takes one of three forms:  –  a corporate joint venture, where a separate company is set up for the joint venture;  –  a partnership among joint venture participants; or  –  a contractual joint venture where parties proceed with a joint venture based upon agreement. (See Barry J Reiter & Melanie A Shishler, Joint Ventures: Legal and Business Perspectives (Toronto: Irwin Law, 1999) (“Joint Ventures”) at 9) [317]  Joint venture relationships are governed by contract between the joint venture participants, whether that is in the form of establishing a new corporation to carry out the joint venture, joining together as partners, or agreeing contractually on how the parties will operate the joint venture. They will be subject to the applicable business corporations or partnership statutes. [318]  In its report on Joint Ventures in May 2012 (Final Report 99) (the “ALRI Report”), the Alberta Law Reform Institute (“ALRI”) defines “joint venture” as: …the relationship that subsists between persons who carry on, in common and with a view to profit, a business venture established by contract for a discrete project or undertaking or for a series of discrete business projects or undertakings: ALRI Report at vii.

[319] In Central Mortgage & Housing Corp v Graham (1973), 43 DLR (3d) 686 (NSSC) (“Graham”), Justice Jones discussed the factors present in a joint venture, citing Samuel Williston, Williston on Contracts, 3rd ed (New York: Baker Voorhis & Co, 1957) vol 2 at 563, at 706-707 of his decision: Besides the requirement that a joint venture must have a contractual basis, the courts have laid down certain additional requisites deemed essential for the existence of a joint venture. Although its existence depends on the facts and circumstances of each particular case, and while no definite rules have been promulgated which will apply generally to all situations, the decisions are in substantial agreement that the following factors must be present:

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(a) A contribution by the parties of money, property, effort, knowledge, skill or other asset to a common undertaking; (b) A joint property interest in the subject matter of the venture; (c) A right of mutual control or management of the enterprise; (d) Expectation of profit, or the presence of “adventure,” as it is sometimes called; (e) A right to participate in the profits; (f) Most usually, limitation of the objective to a single undertaking or ad hoc enterprise.

[320]  Graham has been cited with approval in a number of other decisions, including by this Court in Volzke Construction Ltd v Westlock Foods Ltd (1985), 62 AR 199 (QB), rev’d (1986), 70 AR 300 (CA) (“Volzke”) (without comment on Graham) and Pen-Bro Holdings Ltd v Demchuk, 2007 ABQB 282, and by numerous provincial appellate courts. In Volzke, while the Court of Appeal did not mention Graham, they considered the facts of that specific case. They disagreed with the trial judge that mutual control and management of the enterprise was a key consideration in determining that there was no partnership, and instead relied upon the statutory definition of “partnership” in the Partnership Act to conclude there was a partnership. Control was not necessary for the existence of a partnership where profits were to be shared, the parties spoke of each other as partners, and there was a right to consultation and involvement in the business: paras 12-14. [321] However, Graham is not without criticism. One legal scholar has asked whether the factors of a joint venture, as cited by Justice Jones in the Graham decision, “perfectly describe a model partnership”: Robert Flannigan, The Legal Status of the Joint Venture, (2009) 46 Alta L Rev 713-739 at para 18. Flannigan goes on to state: The Graham decision is a profoundly flawed exercise in judicial innovation. The analysis of the distinction between partnerships and joint ventures did not extend beyond quotation from American secondary sources. In the end, nothing in the decision justifies acceptance of the joint venture claim. Nevertheless, it is the key judgment in Canada. A large part of the subsequent Canadian jurisprudence on the topic is derived from or dependent on the decision: para 22.

[322]  Notwithstanding academic criticism of Graham, I accept it as authority on the characteristics of joint ventures in Canada. These characteristics are reiterated and discussed below in several cases that discuss partnership as well. b.  What Is a Partnership? [323]  Under the Partnership Act, “partnership” means “the relationship that subsists between persons carrying on a business in common with a view to profit”: s  1(g). A corporation is not a partnership: Partnership Act, s 3. A “person” may be an individual or a corporation. In its Joint Ventures report, the ALRI notes: As the status of partners is imposed by statute, the test for determining whether a partnership exists is objective and the weight of authority is to the effect that the parties cannot contract out of that status by a term in their contract: at 5.

[324]  In section 4 of the Partnership Act, guidance is provided for determining the existence of a partnership, the relevant excerpts of which include:

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(b)  the sharing of gross returns does not of itself create a partnership, whether the persons sharing the returns have or have not a joint or common right or interest in property from which or from the use of which the returns are derived; (c)  the receipt by a person of a share of the profits of a business is proof, in the absence of evidence to the contrary, that that person is a partner in the business, but the receipt of the share, or of a payment contingent on or varying with the profits of the business, does not of itself make the person receiving the share or payment a partner in the business, and in particular: (i)  the receipt by a person of a debt or other liquidated amount by instalments or otherwise out of the accruing profits of a business does not of itself make that person a partner in the business or liable as a partner; (ii)  a contract for the remuneration of a servant or agent of a person engaged in a business by a share of the profits of the business does not of itself make the servant or agent a partner in the business or liable as a partner; •  •  •

[325]  The Supreme Court of Canada provides guidance on when a relationship is a partnership in Continental Bank of Canada v R, [1998] 2 SCR 298 (“Continental”), setting out “three essential ingredients: (1) a business, (2) carried on in common, (3) with a view to profit”: para 22. In dissent, Justice Bastarache makes the following statements, with which the majority agreed, in paras 23 and 24: [23]  The existence of a partnership is dependent on the facts and circumstances of each particular case. It is also determined by what the parties actually intended. As stated in Lindley & Banks on Partnership (17th ed. 1995), at p. 73: “in determining the existence of a partnership  … regard must be paid to the true contract and intention of the parties as appearing from the whole facts of the case.” [24] The Partnerships Act does not set out the criteria for determining when a partnership exists. But since most of the case law dealing with partnerships results from disputes where one of the parties claims that a partnership does not exist, a number of criteria that indicate the existence of a partnership have been judicially recognized. The indicia of a partnership include the contribution by the parties of money, property, effort, knowledge, skill or other assets to a common undertaking, a joint property interest in the subject-matter of the adventure, the sharing of profits and losses, a mutual right of control or management of the enterprise, the filing of income tax returns as a partnership and joint bank accounts. (See A.R. Manzer, A Practical Guide to Canadian Partnership Law (1994 (loose-leaf)), at pp. 2-4 et seq. and the cases cited therein.)

[326] In Kulak v AG Clark Holdings Ltd, 2013 ABQB 360 (“Kulak”), Justice Verville discusses the elements of a partnership at paras 70-72: [70]  The parties agree that the three essential elements of a partnership are: 1) a business, 2) carried on in common, 3) with a view to profit. The Act provides guidance as to what factors may or may not be relevant in determining whether a partnership exists.

IX.  Joint Ventures [71]  In [Backman v R, 2001 SCC 10], the Supreme Court discussed the essential ingredients of partnership at paragraphs 17 to 24. With respect to whether a business is carried on in common, the Court stated: [21]  In determining whether a business is carried on “in common,” it should be kept in mind that partnerships arise out of contract. The common purpose required for establishing a partnership will usually exist where the parties entered into a valid partnership agreement setting out their respective rights and obligations as partners. As was noted in Continental Bank, supra, at paras. 34-35, a recognition of the authority of any partner to bind the partnership is relevant, but the fact that the management of a partnership rests with a single partner does not mandate the conclusion that the business was not carried on in common. This is confirmed in Lindley & Banks on Partnership (17th ed. 1995), at p. 9, where it is pointed out that one or more parties may in fact run the business on behalf of themselves and the others without jeopardizing the legal status of the arrangement. It may be relevant if the parties held themselves out to third parties as partners, but it is also relevant if the parties did not hold themselves out to third parties as being partners. Other evidence consistent with an intention to carry on business in common includes: the contribution of skill, knowledge or assets to a common undertaking, a joint property interest in the subject-matter of the adventure, the sharing of profits and losses, the filing of income tax returns as a partnership, financial statements and joint bank accounts, as well as correspondence with third parties: see Continental Bank, supra, at paras. 24 and 36. [72]  As to the approach to determining whether a partnership exists, the Court stated: [25]  As adopted in Continental Bank, supra, at para. 23, and stated in Lindley & Banks on Partnership, supra, at p. 73: “[I]n determining the existence of a partnership … regard must be paid to the true contract and intention of the parties as appearing from the whole facts of the case.” In other words, to ascertain the existence of a partnership the courts must inquire into whether the objective, documentary evidence and the surrounding facts, including what the parties actually did, are consistent with a subjective intention to carry on business in common with a view to profit. [26]  Courts must be pragmatic in their approach to the three essential ingredients of partnership. Whether a partnership has been established in a particular case will depend on an analysis and weighing of the relevant factors in the context of all the surrounding circumstances. That the alleged partnership must be considered in the totality of the circumstances prevents the mechanical application of a checklist or a test with more precisely defined parameters. [327] The indicia of a partnership, as set out in case law, are thoroughly discussed in the decision of Justice Tilleman in Elbow River Marketing Limited Partnership v Canada Clean Fuels Inc, 2012 ABQB 277, rev’d on other grounds 2012 ABCA 328. Justice Tilleman summarizes the indicia of a partnership in the context of a summary judgment motion, and discusses the meaning of each of the three essential ingredients from Continental, including (1) a business, (2) carried on in common, (3) with a view to a profit. He notes, at paras 82 and 83: [82]  Some factors are more important than others. One of the strongest indicia of partnership has always been the sharing of profits, though since the 1860 case of Cox v. Hickman

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Chapter 2  Partnership it is no longer completely determinative: Cox v. Hickman (1860), 11 E.R. 431, 8 H.L. Cas. 268 (U.K. H.L.), at 305 ), cited by Sproule v. McConnell, [1925] 1 D.L.R. 982, [1925] 1 W.W.R. 609 (Sask. C.A.). Sharing of profits is still, however, “proof [of partnership], in the absence of evidence to the contrary”: Partnership Act, s. 4(c). Para. (c) goes on to list exceptions to the presumptive rule that sharing profits proves partnership; the exceptions relate to debtor – creditor relationships, employment/agency relationships, and other situations that equally do not apply here. [83]  I am quick to point out that the best evidence of an agreement to carry on business together is a written partnership agreement. A written agreement is not compulsory, however, nor is it required that the parties have even expressed their intention to form the partnership. The Newfoundland and Labrador Court of Appeal considered the quotation from Bastarache J. at para. 23 of Continental, along with an excerpt from Manzer at ¶1.340, and observed that “neither indicates that it is necessary to find a specifically expressed intention, or a written agreement, to form a partnership in order to find that one has been established. That intention, and agreement, can be inferred from the conduct of the parties, on consideration of all of the evidence”: Green v. Harnum, 2006 NLCA 46, 19 B.L.R. (4th) 236 (N.L. C.A.) at para. 12. When a court is looking to the conduct of the parties to determine if a partnership agreement may be inferred, “[t]he course of dealings as between the parties, and their dealings with others, will be reasonably determinative as to whether there is a partnership.”: Manzer at ¶2.640.

[328] In Blue Line Hockey Acquisition Co v Orca Bay Hockey Ltd Partnership, 2008 BCSC 27 (“Blue Line”), aff ’d 2009 BCCA 34, leave to appeal to SCC refused, 33134 (July 16, 2009), the British Columbia Supreme Court considered whether the relationship between three people was a non-partnership joint venture or a partnership, and concluded it was neither. [329]  The trial judge in Blue Line reviewed the requirements for a partnership, noting that “[w]hile the statute does not mention contract, the existence of a contractual foundation of partnership is essential”: para 38. Further, “[w]hether oral or written, there must be a completed agreement before a partnership will be found to exist”: para  39. The contract underlying a partnership must meet the following prerequisites of a contract:

a) An offer containing all of the essential terms, and an acceptance of the offer (that is, a meeting of the minds or consensus ad idem); b) Certainty of the agreed terms; c) Consideration; and d) The intention to create legal relations: para 40. [330]  The Court considered the statutory ingredients of partnership, including carrying on business, in common, with a view to profit. Blue Line also included a discussion of the characteristics of a joint venture. Relying on the British Columbia Court of Appeal decision in Canlan Investment Corp v Gettling (1977), 37 BCLR (3d) 140 (CA), the Court noted, at para 57: The ingredients of a joint venture are the following: a) As is the case with partnerships, the joint venture must have a contractual basis; and b) There must be:

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(i) a contribution of money, property, effort, knowledge or other asset to a common undertaking; (ii) a joint property interest in the subject matter of the venture, which is usually a single or ad hoc undertaking; (iii) a right of mutual control or management of the venture; (iv) an expectation of profit and the right to participate in the profits;

[331]  In conclusion, the trial judge in Blue Line described the fundamental requirements in common to both partnerships and joint ventures as follows: In summary, while the constituent ingredients of a partnership differ slightly from that of a joint venture, both require as their foundation a binding contract among the partners or joint venturers which contains all of the essential terms of the agreement between the parties: para 67.

[332]  The British Columbia Court of Appeal approved of the trial judge’s legal analysis, reiterating that a partnership results from a contract between the partners (at para 9), and that a joint venture also has contractual underpinnings (at para 10). [333]  The notion that sharing in profits is not necessarily determinative of a partnership is supported by section 4(c)(ii) of the Partnership Act, excerpted above, which provides that the receipt of profits of a business in some circumstances does not itself make the recipient a partner in the business. [334]  The Supreme Court of Canada discussed the approach to be taken to determine whether a partnership exists in Backman v R, 2001 SCC 10 (“Backman”), at paras 25-26: [25]  As adopted in Continental Bank, supra, at para. 23, and stated in Lindley & Banks on Partnership, supra, at p. 73: “in determining the existence of a partnership … regard must be paid to the true contract and intention of the parties as appearing from the whole facts of the case.” In other words, to ascertain the existence of a partnership the courts must inquire into whether the objective, documentary evidence and the surrounding facts, including what the parties actually did, are consistent with a subjective intention to carry on business in common with a view to profit. [26]  Courts must be pragmatic in their approach to the three essential ingredients of partnership. Whether a partnership has been established in a particular case will depend on an analysis and weighing of the relevant factors in the context of all the surrounding circumstances. That the alleged partnership must be considered in the totality of the circumstances prevents the mechanical application of a checklist or a test with more precisely defined parameters.

[335]  A partnership, like a joint venture, is based on the existence of a contract among the parties. Unlike a joint venture, however, a partnership is a legal entity that owns assets and has liabilities. The cases and commentary examining joint ventures typically focus on whether the relationship among the parties creates a partnership. The existence of a partnership affects the parties’ obligations to each other and the remedies available for breach of those obligations. A partnership creates fiduciary obligations.

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2.  Application to Facts in this Case [336]  No separate corporation was formed by the parties in this case. There was, therefore, no corporate joint venture. Whether the partiers formed a contractual joint venture or a joint venture partnership (that is, a partnership) is a fact-driven determination, dependent upon the parties’ intentions. [337]  As is evident from the law discussed above, the indicia of a contractual joint venture and a joint venture partnership are similar. As well, both require a contractual basis. In determining whether the parties have such a contract, the facts must be examined to determine their true intent. The differences and similarities between contractual joint ventures and partnerships is of less significance in this case, as I am of the view that the facts do not support the conclusion that the parties formed a contractual joint venture with each other, nor were they in a partnership. There was no contractural basis for a partnership or joint venture relationship with the Plaintiffs.

X. CONCLUSION Although the apparent simplicity of formation, flexibility, tax treatment, and lack of formality of partnerships make them an attractive form of business organization, the review of the common law and statutory rules in this chapter demonstrates that partnership is a choice not to be undertaken lightly. The rules governing the relationships between the parties themselves, and between partners and third parties with whom they might deal, need to be considered precisely and carefully as partners organize their affairs and undertake the significant commitments that a partnership requires. Partnership permits individuals and small businesses wanting to share responsibility for business investment and operation a chance to engage in operations without the ordinary complications or expense of the corporate form. In contrast, the corporate form of association requires compliance with many mandatory statutory and regulatory requirements. These impose both compliance costs and what may be considered significant restraints on operational and decision-making flexibility. However, the apparent advantages of partnership over incorporation are often outweighed by one thing—the inability in a partnership to limit liability. The key is that partnership is a relationship of trust—partners are personally liable for the contracts entered into in respect of the partnership business and for torts committed in carrying on the partnership business. The limited liability available in a corporate form of association provides a significant advantage over partnership, especially where multiple equity investors are involved. Partnerships often run into difficulty attracting a significant number of investors because those investors risk having their personal assets exposed to unlimited liability if they become general partners. As the materials in this chapter have explored, statutes and the common law have created a series of default rules that may apply even where the parties intend something other than the existence of a partnership in the circumstances. While a province’s partnership statute provides a default template, the common law and the acts of the parties are key elements for determining their rights, duties, and entitlements. The challenge for lawyers advising clients considering partnership is to ensure that their needs are accurately and completely reflected in a partnership agreement. That agreement must acknowledge and consider the impact of the common law and statutory rules. Issues like the end of the partnership,

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whether a partnership can be formed for a single transaction, the difference between partnership and co-ownership, and the rights of the parties on dissolution are more than simply theoretical concerns. The consequences of implementing these choices in a partnership agreement—or perhaps in a situation where no formal agreement is entered into by the parties—are significant. As the cases in this chapter have demonstrated, the consequences of a finding that a partnership exists, even where the parties have specifically articulated that they do not wish one to be created, are also significant. An abundance of caution is warranted. Limited partnerships and limited liability partnerships may afford some limited protection to investors, and recent amendments (particularly to LLPs) may serve to transform the way they are used in Canadian business. They remain the only choice for certain kinds of professional businesses or other investment entities. They are also becoming increasingly important as an alternative to the corporate form, particularly where the partnership form of association makes sense for tax reasons. The corporate form came about as a historical development in large part because of concerns about personal liability. These concerns, and responses to them, are introduced and explored in greater detail in subsequent chapters on corporations. However, as you explore the material, keep in mind the practical advantages and disadvantages of partnerships as an alternative choice of business organization. Why do partnerships remain such a popular form of organization given the prevalence of corporations in Canada?

CHAPTER THREE

The Corporate Form







I.  Introduction: The Corporate Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 II.  Corporate Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 A.  History and Development of Corporate Legislation . . . . . . . . . . . . . . . . . . . . . . . . . 129 B.  Canadian Corporate Law: Three Models for Incorporation . . . . . . . . . . . . . . . . . . . 132 1.  Memorandum and Articles of Association . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133 2.  Letters Patent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 3.  Statutory Division of Powers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 C.  Mandatory Versus Enabling Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135 D.  The Relationship Between Federal and Provincial Corporate Legislation . . . . . 137 1.  The Constitutional Explanation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137 2.  Uniformity Versus Charter Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138 III.  The Process of Incorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144 A.  Articles of Incorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144 1.  The Name of the Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145 2.  Registered Office . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 3.  Classes and Maximum Number of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 4.  Restrictions on the Transfer of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 5.  Number of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 6.  Restrictions on the Business of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 IV.  Separate Legal Personality and Limited Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 A.  Economic Justifications and Policy Concerns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 B.  Doctrinal Implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 V.  Piercing The Corporate Veil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237

I.  INTRODUCTION: THE CORPORATE FORM This chapter introduces students to the corporate form. The corporation has assumed pre-eminent importance in Canada and other modern industrial societies. Business corporations statutes, both federal and provincial, along with the common law, provide a set of standard form rules and standards for people wishing to operate firms. As we saw in Chapter 1, under the statutory rules, the corporate form has six default features: separate legal personality, limited liability, perpetual existence, the transferability of shares without restriction, centralized management, and limited shareholder control over management. This chapter, after providing an overview of corporate legislation and the

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incorporation process, focuses on separate legal personality and limited liability. The nature of shares and other issues in corporate finance will be addressed in Chapters 6 and 7. Centralized management and limited shareholder control over management together constitute the default governance structure in corporations. These features, along with their implications, will be addressed in Chapters 10 through 14. This chapter begins by providing an historical overview of the creation of modern Canadian corporations law statutes. It moves into a brief review of constitutional considerations that are an essential part of the Canadian context, discussing why there are both provincial and federal corporations statutes in Canada. The chapter next looks at the process of how a corporation is created. The chapter proceeds to explain and illustrate two default features of corporations in the statutory rules: separate legal personality and limited liability. Separate legal personality means that a corporation is an entity distinct from all of its constituencies, including shareholders, directors and officers, creditors, and employees. It facilitates the firm being able to own assets, enter into contracts, and bring and defend legal actions in its own name. Limited liability means that a shareholder’s liability for corporate obligations is limited to the amount of his or her investment. It facilitates funding from external sources for business activity. All six default statutory features, including separate legal personality and limited liability, apply equally to both publicly traded firms and closely held firms. Separate legal personality and limited liability, while having economic justifications, raise policy concerns, especially in the context of closely held firms, corporate groups, and involuntary creditors. In response to these concerns, the courts have developed a legal principle called “piercing the corporate veil.”1 Chapter 5 canvasses issues arising from one key implication of a corporation’s separate legal personality—the ability to enter into contracts in its own name. The corporation’s ability to enter into contracts in its own name raises issues relating to pre-incorporation contracts, corporate capacity, compliance with internal procedures, and agent authority.

II.  CORPORATE LEGISLATION Unlike partnerships, structuring a business organization as a corporation has to be a deliberate choice and requires filing under relevant legislation—that is, a corporation cannot arise by operation of law. In Canada, there are no less than 14 general business corporations statutes—one federal2 and one for each province and territory. 3 The material in this

1 Courts and commentators have also referred to “lifting” or “drawing aside” the corporate veil. In spite of attempts to introduce a clear distinction, the terms continue to be used interchangeably to describe instances where the corporation’s asset-partitioning features are disregarded. 2 Canada Business Corporations Act, RSC 1985, c C-44 [CBCA]. 3 New Brunswick Business Corporations Act, SNB 1981, c B-9.1 [NBBCA]; Prince Edward Island Companies Act, RSPEI 1988, C-14 [PEICA]; Nova Scotia Companies Act, RSNS 1989, c 81 [NSCA]; Newfoundland and Labrador Corporations Act, RSNL 1990, C-36 [NFLCA]; Québec Business Corporations Act, CQLR, c S-31.1 [QBCA]; Ontario Business Corporations Act, RSO 1990, c B-16 [OBCA]; Manitoba The Corporations Act, CCSM, c C225 [MCA]; Saskatchewan The Business Corporations Act, RSS 1978, c B-10 [SBCA]; Alberta Business Corporations Act, RSA 2000, c B-9 [ABCA]; British Columbia Business Corporations Act, SBC 2002, c 57 [BCBCA]; Yukon Business Corporations Act, RSY 2002, c  20 [YBCA]; Northwest Territories and Nunavut Business Corporations Act, SNWT 1996, c 19 [NWTNBCA].

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section provides an overview of the history of corporate legislation, the different models for general business corporations statutes in Canada that exist today, mandatory versus enabling corporate law, and the relationship between the federal and provincial legislation.

A.  History and Development of Corporate Legislation It was not until the mid-1800s that the modern corporation began to take on the form we now recognize—that is, with separate legal personality and limited liability as default fundamental features. Partnerships were still the predominant legal form through which business was conducted. As explained above, although the first general corporations statute was passed in England in 1844, it did not provide limited liability for shareholders of the corporation. Limited liability was added as a possible default feature of corporations in 1855.4 The following extract by Nicholls explains the origin of the corporate form in the United Kingdom.

Christopher Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) at 8-14 (footnotes omitted) The business corporation has a long history, even if not a particularly inspired one. Its ancient roots may be traced to forms of business organization that existed in classical antiquity and developed throughout the Middle Ages and the Renaissance. However, the principal features of the modern Canadian business corporation (if not necessarily our corporate statutes) may be traced to two somewhat more recent English forms of business organization: (1) “regulated companies” and (2) joint stock companies, of which those formed by “deed of settlement” were especially influential. Regulated Companies One of the earliest British ancestors of the business corporation was the regulated company. The regulated company, a form of enterprise that arose in 13th century England, was a corporation formed by the grant of a charter from the Crown. The original impetus for incorporation appeared to be tied to the need for a legal entity that could be the grantee and repository of monopoly trading rights on behalf of merchants. In fact, the notion that there is some necessary link between incorporation and the grant of some kind of trading monopoly appears to have become quite strongly entrenched; and … it may have been 4 The Limited Liability Act 1855 (18 & 19 Vict c 133). Even after English companies legislation was consolidated in 1862, incorporating companies without limited liability remained an option. In Canada, Nova Scotia is the only jurisdiction to have always facilitated the incorporation of so-called unlimited companies; see generally Mohamed F. Khimji, “Shareholder Liability in Nova Scotia Unlimited Companies” (2014) 37 Dal LJ 787. More recently, corporate legislation in Alberta and British Columbia has also introduced the possibility of incorporating an entity with shareholders having unlimited liability. The economic utility of unlimited companies lies in certain tax advantages under US laws; see Barry D Home, “The Nova Scotia Unlimited Company: Surf and Turf” in Report of the Proceedings of the Fifty-seventh Tax Conference, 2005 Conference Report (Toronto: Canadian Tax Foundation, 2006) 26:1.

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this early association of the granting of a state “privilege” with the establishment of a corporation that led to the still common (but now mistaken) view that the conferring of incorporated status is itself a valuable state privilege, rather than a mere convenience for business people and government alike. [R]egulated companies did not carry on business themselves. It was the individual members of these companies, either acting alone or in partnership or association with one another, who carried on business, taking advantage of the monopoly rights that had been granted to the umbrella organization (that is, the regulated company). … [S]ome of the regulated companies did begin to operate with their own joint stock. Members of a company were at first permitted (but not obliged) to participate; but eventually, in the case of some leading companies, participation in the company’s joint stock became a requirement of membership. This evolution from umbrella organization to operating company occurred sometime during the 17th century. The East India Company’s development is the classic and perhaps earliest example of this process. [T]he East India Company, which was granted a monopoly over trade with the Indies, originally operated as a kind of hybrid. That is, the company had a joint stock to which members could, if they wished, subscribe. But if members preferred instead to carry on trade privately (taking advantage of the monopoly privilege the company enjoyed), they could certainly do that. Gradually, the company’s own joint stock supplanted the individual members’ trading. By 1692, members were not at all permitted to trade privately. Joint Stock Company The term “joint stock company” … was actually coined to distinguish one type of company (a firm formed to carry on private trade to profit its members) from another type of company (the “regulated company” in the original sense of an umbrella organization to which trading monopolies were granted). Joint stock companies were not, originally, corporations. … They were, instead, more like partnerships. What distinguished a joint stock company from an ordinary partnership was that members would contribute capital to a common fund that would then be managed on behalf of the members by a small management group, usually known as “governors,” but … the term “director” came into common use at the end of the 17th century, in place of the term “assistant,” another designated office in many joint stock companies. A member’s interest in a joint stock company could be bought and sold—rather like shares in a modern corporation—and indeed the shares of many joint stock companies, including very speculative ventures, were regularly bought and sold. Thus, when one reads of the mania of share speculation that culminated in the infamous South Sea Bubble in 1720, it should be remembered that while some of the shares being bought and sold at that time were shares of companies that had royal or government charters (some in good standing, some not) others were probably shares of unincorporated joint stock companies, rather than of business corporations as we know them today. The earliest English general incorporation statute, the Joint Stock Companies Act of 1844, represented … the first time the distinction between ordinary partnerships and joint stock companies received legislative recognition. [T]he term “joint stock company,” although it has generally been eliminated from most modern

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corporate statutes, is still occasionally used by commentators to refer to business corporations, and survives in other forms, as well. For example, in Nova Scotia, the long title of the Companies Act is An Act Respecting Joint Stock Companies, and the government office that administers incorporations in that province is still referred to as the Registrar of Joint Stock Companies. •  •  •

Deed of Settlement Companies So-called deed of settlement companies were a type of joint stock company that used the law of trusts to facilitate the pooling of capital and the division of share interests. The property of these unincorporated companies was held by trustees, and the corporate business was conducted by directors … •  •  •

Companies and the Corporate Law Interest What should be noticed from even this very simple historical sketch, is that the trading companies that developed in England were not necessarily corporations. The implications of “incorporation” may not, prior to the mid-19th century, have been fully recognized anyway, and business people did not appear to be clamouring for formal incorporated status before that period. Of course, some companies were incorporated, but incorporation was not readily available. There were only two ways for a company to become incorporated: by royal charter (companies incorporated in this way are sometimes called common law companies, evidently because the common law was the basis of the Crown’s authority to incorporate), and, later, by special act of Parliament (that is, a specific act incorporating a specific company). Needless to say, neither of these avenues of incorporation would likely be open to the small business entrepreneur or, indeed, to anyone without political ties. By the early 19th century, new pressures began to build for formalizing English company law. As Hunt notes, in the early 19th century the line between joint stock companies and true corporations was already beginning to blur, a development that pressed the need for corporate legislative reform: The new quasi-corporate company was … one of the main lines of advance towards freedom of incorporation. … [I]t had begun to establish itself between the old common-law partnership, on the one hand, and the corporation, strictly speaking, on the other. Unable to arrest, Parliament was eventually able to regulate this vehicle for the attraction and employment of the capital of investors who took no active part in management; and, still later, “by a sort of legislative hocus-pocus,” as McCulloch put it, “such associations were to be metamorphosed into corporations.”

There were, thus, a series of initiatives leading, at last, to the passage of the first socalled general incorporation statute in England—the Joint Stock Companies Registration and Regulation Act of 1844 (generally referred to today as the Joint Stock Companies Act of 1844). This Act made it possible for companies to incorporate without having to obtain a charter from the Crown or their own, tailor-made, act of Parliament. But the 1844 Act was not a great success. It called for a somewhat cumbersome incorporation procedure, and … did not provide limited liability to shareholders. Although limited liability does

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not appear to have been an overriding concern in earlier times, by the mid-19th century, its importance to business people had become well-recognized. Pressure began to build in England for an easily available form of business organization that would offer investors limited liability. Some of these pressures came from abroad. In France, it was possible to carry on business through a société en commandite. This is a form of business association that survives today, and that was replicated in the United States, the United Kingdom, and English Canada as the “limited partnership.” (Indeed, the English phrase “limited partnership” is today rendered into French as “société en commandite.”) The société en commandite (and, indeed, the modern limited partnership) is a business organization characterized by two classes of participants: those who operate and manage the business (known as general partners in Canadian limited partnership law) and other, mainly passive, investors who contribute money in exchange for a future share in the profits of the limited partnership’s business, but with no expectation (and indeed, typically, no legal right) to take an active part in control or management of the business. … The société en commandite was in wide use on the continent by the mid-19th century and had been adopted as well in a number of American states and in Ireland; but there was no comparable business vehicle in England. Indeed, an unsuccessful attempt had been made in 1818 to bring the limited partnership to England. A significant “lobbying” effort was undertaken to try to persuade Parliament to enact similar legislation that would allow for the creation of English limited partnerships. Through a curious (and fascinating) sequence of events, this lobbying culminated not in the immediate enactment of limited partnership law, but rather in the granting, in 1855, of “limited liability” to shareholders of companies incorporated under the Joint Stock Companies Act. … [T]he grant of limited liability to shareholders made the corporation an ideal vehicle for pooling the funds of passive investors to carry on business enterprises of significant scale.

B.  Canadian Corporate Law: Three Models for Incorporation The history of early Canadian corporate law is complex because the various jurisdictions in Canada borrowed from different aspects of English and American approaches as well as, in certain respects, taking a uniquely Canadian direction. A complete overview is beyond the scope of this chapter, but a brief introduction to particular developments will provide a sense of the directions that were taken, as well as help to dispel the notion that Canada slavishly adhered to the English legal model for all matters. This history becomes important when Canadian courts draw on both English and American precedents to understand and interpret Canadian corporate law. As explained in the above extract, it was not until the mid-1800s that the modern corporation began to take on the form we now recognize. Prior to 1844 in England, the creation through incorporation of a commercial entity with a legal personality independent of that of its owners or “members” could be obtained by only a Royal Charter or a special act of Parliament. Pressure grew for legislative reform. The first general corporations statute was the Joint Stock Companies Act of 1844, 7-8 Vict, c 110, under which promoters could file with the registrar a “deed of settlement” containing the corporation’s charter. The registrar would then issue a certificate granting to the corporation the powers and privileges detailed in the deed of settlement.

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Although the first general corporations statute was a significant development, it did not provide limited liability for shareholders of the corporation. Limited liability was widely available at the time in France through a vehicle known as a “société en commandite,” a form of organization akin to the limited partnership discussed in earlier chapters. Pressure mounted in England for the introduction of similar external investor protection, and those efforts resulted not in the adoption of limited partnerships but instead in the creation of “limited liability” as an option for shareholders of companies pursuant to the Limited Liability Act of 1855, 18-19 Vict, c 133. The limitation on liability was the critical feature: if a corporation’s assets proved insufficient to repay a debt, executions could be filed against individual shareholders, but only to the extent of the amount unpaid on their shares. Like England, pre-Confederation Canada also faced the impractical reality of requiring a special act of the legislature for the incorporation of every company. In 1850, the Parliament of the United Province of Canada passed a general incorporation act for joint stock companies with “Manufacturing, Mining, Mechanical or Chemical Purposes,” 13-14 Vict, c 28. Under that act, five or more persons could apply to incorporate a business, with disclosure of the objects, capital structure, and shareholders in the application. Incorporation followed automatically on filing the application, but was limited to a 50-year term. The act generally afforded limited liability to the shareholders—something adopted ahead of the 1855 reforms in England. Subsequent developments have resulted in three models for incorporation currently operating in Canada: (1) Memorandum and Articles of Association; (2) Letters Patent; and (3) Statutory Division of Powers.

1.  Memorandum and Articles of Association The English Companies Act of 1862, 25-26 Vict, c 89, consolidated and revised the various previous English enactments. Under the statute, if the organizers of the corporation wished the doctrine of limited liability to apply, they would file a “memorandum of association,” which recited the amount of the corporation’s capital and the manner in which shares were to be divided. The memorandum was to be accompanied by the “articles of association,” otherwise known as bylaws, which contained the internal regulations of the corporation. Both the memorandum and the articles were, and under English practice continue to be, public documents. Memorandum and articles of association was the model of corporate law later adopted by Canadian corporate statutes originally based on the UK model, notably in British Columbia5 and Nova Scotia. One feature that was and remains especially important in a memorandum jurisdiction is that, on an application for incorporation, the responsible government official, usually called the “registrar,” has little discretion to reject the incorporating documents. If the statutory criteria are met, particularly if the stated objects of the corporation are not illegal and if its proposed name is not already in use or reserved, the registrar must accept the documents and issue a certificate of incorporation. This was a dramatic shift from a system that created corporations as a matter of Royal or parliamentary privilege only. 5 In 2004, the British Columbia Companies Act was replaced with the British Columbia Business Corporations Act, which brought BC’s statutory scheme more into line with other Canadian jurisdictions. For more details, see Anthony Duggan, Jacob S Ziegel & Jassmin Girgis, “Six Months of the B.C. Business Corporations Act: Changes and Challenges” (2006) 43 Can Bus LJ 455.

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The premise under this model of incorporation is that the articles and the memorandum constitute a contract between the members (or shareholders) of the company both among themselves and between themselves and the corporation.6 Other persons become parties as they become members. The memorandum and articles set out the terms of that contract, and incorporation is in effect by registration of that agreement with the government. The basic allocation of power as between the directors and the shareholders is set out in the incorporating documents, and there is complete freedom to include in the memorandum and articles any condition, term, or provision not in conflict with the statute. Today, Nova Scotia continues to employ this model of incorporation in Canada.

2.  Letters Patent In 1864, the United Province of Canada passed a new general incorporation statute for corporations engaged in manufacturing and mining (27-28 Vict, c 23). Under this act, the incorporators would apply for “letters patent” under the seal of the Governor in Council. The letters patent format of incorporation had antecedents in both American statutes and in certain specialized types of incorporation in England. Unlike the 1850 Act, the issuance of letters patent was discretionary. There was also no requirement that the bylaws be filed, unlike memorandum jurisdictions where, as noted above, articles of association are public documents. After Confederation, the letters patent method became part of the new Dominion and Ontario acts. Eventually, Manitoba, Ontario, Québec, New Brunswick, Prince Edward Island, and Canada became “letters patent” jurisdictions, while British Columbia, Alberta, Saskatchewan, Nova Scotia, and Newfoundland became “memorandum and articles of association” jurisdictions. These differences remained until a round of significant statutory reform, which began in 1970 with the Ontario Business Corporations Act, RSO 1970, c 53. In theory, at least, letters patent jurisdictions differed from memorandum jurisdictions in two key respects—first, in the ability of the incorporators to create their own constating documents, and second, in the virtual absence of discretion of the government official to refuse to register them and issue a certificate of incorporation. The corporation in a letters patent jurisdiction derives its existence from the sovereign executive act of issuance of the letters patent.7 In a letters patent jurisdiction, the structure and allocation of power between the directors and the company flow from the statute—that is, the relationship between members and the company is not based in contract. In addition, the minister in a letters patent jurisdiction has absolute discretion in deciding whether to grant the letters patent, and may or may not impose conditions in making the grant that permits incorporation. Today, only Prince Edward Island employs this model of incorporation in Canada.

3.  Statutory Division of Powers In Ontario in 1967, the Lawrence Committee Report8 criticized the letters patent system on two principal grounds: first, that the granting of corporate status should not be regarded as a privilege, and second, that the paperwork involved created undue delay. The Lawrence 6 See e.g. the modern UK Companies Act 2006, c 46, s 14. 7 See Bonanza Creek Gold Mining Co v The King, [1916] 1 AC 566, 584, 26 DLR 273 (PC). 8 Ontario Legislative Assembly, 1967 Interim Report of the Select Committee on Company Law (1967).

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Report recommended the adoption of the American statutory division of powers9 model for incorporating companies, under which articles of incorporation, which roughly corresponded to the memorandum in memorandum jurisdictions, were filed. Under the American model, if the articles conformed to the provisions of the relevant business corporations statute, the registering government authority had no choice but to issue a certificate granting incorporation. Under this method, the bylaws, which are similar to the articles of association in memorandum jurisdictions, were not filed publicly. In 1970, Ontario adopted the Statutory Division of Powers model with its Business Corporations Act.10 In the following year, a federal task force submitted Proposals for a New Business Corporations Law for Canada (the Dickerson Report) to the federal government. The Dickerson Report recommended legislation for Canada that was broadly similar to the 1970 Ontario Act and this was enacted in 1975 as the Canada Business Corporations Act (CBCA). The CBCA became the template for all of the other provincial and territorial general business corporations statutes.11 In 1982, Ontario repealed its 1970 Act and replaced it with a new Business Corporations Act, SO 1982, c 4, the OBCA, which largely followed the CBCA template.12 Over subsequent years, patchwork amendments to both Acts and a significant reform to the CBCA in 2001 meant that the differences between the CBCA and the OBCA widened. The gap has been closed somewhat with amendments to the OBCA that were adopted in December 2006.13

C.  Mandatory Versus Enabling Corporate Law The issue of whether corporate statutes should be “mandatory” or “enabling” raises important policy choices for legislators and regulators. While these issues are canvassed in greater detail in Chapter 8, some introduction at this point is important for understanding the way in which corporate law statutes function. What does it mean to say that many provisions in corporate legislation are “enabling” in nature? Such provisions set out default rules that will apply unless the corporation specifies otherwise. For example, CBCA s 103(1)14 provides that the directors may make, amend, or repeal bylaws of the corporation “unless the articles, by-laws or a unanimous shareholder agreement otherwise provide.” Other provisions of the CBCA are “mandatory” in nature, setting out rules that the corporation must follow. For example, voting on fundamental changes15 and class voting rights16 are, with a few exceptions with respect to class voting, 9 The expression “statutory division of powers” refers to how, unlike in memorandum and articles of association statutes, the powers as between shareholders and directors are allocated in the statute itself. 10 See Christopher C Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) at 40-41. 11 All provinces and territories adopt the CBCA model except for Nova Scotia and Prince Edward Island which, as discussed above, employ other models for incorporation. 12 See also the Business Corporations Act, RSO 1990, c B.16. 13 SO 2006, c 34. 14 See also NBBCA s 61(1); NFLCA s 170(1); QBCA s 113; OBCA s 116(1); MCA s 98(1); SBCA s 98(1); ABCA s 102(1); BCBCA s 136(1); YBCA s 103(1); NWTNBCA s 103(1). 15 CBCA s 173(1); NBBCA s 113; NFLCA s 279; QBCA s 240; OBCA s168; MCA s 167; SBCA s 167; ABCA s 174; BCBCA s 259(1); YBCA s 75; NWTNBCA s 176. 16 CBCA s 176; NBBCA s 115(1); NFLCA s 284; QBCA s 191; OBCA s 170(1); MCA s 170(1); SBCA s 170(1); ABCA s 176(1); YBCA s 178(1); NWTNBCA s 178(1).

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mandatory in nature. The history of modern corporations law is one of reduction of management restrictions and shareholder rights in matters of investment and financial policy, including the term of the corporation’s existence, the businesses it might take up, selfdealing standards, share issuances and repurchases, dividend policy, and charter amendment. Corporate law barriers to business decisions have never been lower than under modern “enabling” corporate statutes such as the CBCA. This approach, however, has come under greater scrutiny as the role of government in responding to stakeholder concerns and a “democratic deficit” in corporate decision-making is questioned.17 It has also been engaged very directly as securities regulators and legislators implement mandatory requirements for corporate activity in the aftermath of the corporate scandals of the late 1990s.18 The imposition of requirements for the composition of audit committees and restrictions on their activities, for example, is a feature of corporate and securities law reforms that illustrates a shift from enabling to mandatory approaches in order to remedy what were perceived as the failings of the market in policing corporate misconduct.19 The essential theoretical question is whether corporate law should be primarily mandatory in nature, or should be primarily enabling in nature. Using an economic analysis, those who argue for a primarily enabling form of corporate law note that market mechanisms will create an incentive for managers to adopt corporate charter provisions that minimize selfdealing and shirking by management. Market mechanisms will cause corporate managers to bear the costs of failing to minimize agency costs by making the cost of finance and risk of takeover higher for such managers. The optimal corporate contract for all corporations is not likely to be obtained under a corporate statute consisting exclusively, or primarily, of mandatory provisions because the optimal corporate contract is likely to vary from one business enterprise to another. Thus, corporate law, which is enabling in nature, allows corporations to set their own corporate rules in a way that best allows the particular corporation to function efficiently. Under an enabling approach, a corporate statute serves as a set of standard form rules and standards that minimizes the transaction costs of incorporation. Much of the incorporating statute could be adopted by a corporation as it establishes itself, thereby avoiding costly negotiation over and drafting of many of the corporate law rules. The corporation would just have to deal with the more significant aspects of the particular corporation and opt out of 17 See e.g. Allan C Hutchinson, The Companies We Keep: Corporate Governance for a Democratic Society (Toronto: Irwin Law, 2005) at 8; Douglas Litowitz, “Are Corporations Evil?” (2004) 58 U Miami L Rev 81; and for a broader consideration, see Robert Yalden, “Competing Theories of the Corporation and Their Role in Canadian Business Law” in Anita I Anand & William F Flanagan, eds, The Corporation in the 21st Century (Kingston, Ont: Queen’s Annual Business Law Symposium, 2003). 18 See e.g. Roberta Romano, “The Sarbanes-Oxley Act and the Making of Quack Corporate Governance” (2005) 114 Yale LJ 1521, n 2 (citing Senator John Corzine’s statement that Congressional legislation enacted in response to the scandals in 2002 were the “most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt”); Lawrence A Cunningham, “The Sarbanes-Oxley Yawn: Heavy Rhetoric, Light Reform (And It Just Might Work)” (2003) 35 Connecticut L Rev 915; and Jill E Fisch, “The New Federal Regulation of Corporate Governance” (2005) 28 Harv JL & Pub Pol’y 39. 19 See Paul D Paton, “Rethinking the Role of the Auditor: Resolving the Audit/Tax Services Debate” (2006) 32 Queen’s LJ 135, for a discussion of the history of the post-Enron reform of the audit function in Canada and the United States.

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some provisions of the incorporating statute by drafting separate rules on certain matters, thereby minimizing the total amount of transaction costs for corporate charters.20 Several arguments have been made in response to the enabling corporate law argument that suggest that regulation of particular aspects of corporate governance is the more appropriate approach. These arguments include the inadequacy of market mechanisms with respect to incentivizing managers to adopt value-maximizing corporate charters, the adverse selection problem, the public good hypothesis, the innovation hypothesis, and the opportunistic amendment hypothesis.21 Canadian corporate law statutes are a balance of mandatory and enabling provisions, in part reflecting the legislative choices made and in part reflecting the tensions between legislation and market approaches noted throughout this volume. All of these issues are explored in greater depth in the chapters that follow, and constitute important policy choices that legislators have made about the rights and responsibilities of companies in Canadian law. The next section briefly canvasses the relationship between Canadian federal and provincial corporations statutes by explaining constitutional concerns unique to the Canadian federal context and considers the uniformity versus charter competition debate.

D.  The Relationship Between Federal and Provincial Corporate Legislation 1.  The Constitutional Explanation The fact that there are both federal and provincial corporations statutes at all is the result of Canadian constitutional considerations. Under the Constitution Act, 1867, the power to incorporate is given to both the federal and provincial governments. Although there is no specific federal incorporation power in the Constitution Act (except explicitly in respect of banks in s 91(15)), the federal government has a broad and well-established authority to incorporate companies. Any doubt about this was first resolved in the landmark 1881 decision in Citizens Ins Co of Canada v Parsons (1881), 7 App Cas 96 (PC). The Privy Council found that because the “Peace, Order and Good Government” clause in s 91 reserves to the federal government the right to make laws in respect of all matters not specifically assigned to the provinces, it follows that the Act assigns to exclusive federal competence the incorporation of corporations not “with Provincial Objects” or, more plainly, having objects to be carried out in more than one province.22 It is not necessary for the validity of a federal incorporation that the company in fact be carrying on business in more than one province. 23 The federal powers of 20 On the enabling corporate law approach, see e.g. Frank Easterbrook & Daniel Fischel, “The Economic Structure of Corporate Law” (Cambridge, Mass: Harvard University Press, 1996.) 21 See generally Jeffrey N Gordon, “The Mandatory Structure of Corporate Law” (1989) 89:7 Colum L Rev 1549-98; William Bratton & Michael Wachter, “Tracking Berle’s Footsteps: The Trail of the Modern Corporation’s Last Chapter” (2010) 33 Seattle UL Rev 849 at 865; Ige Omotayo Bolodeoku, “Contractarian and Corporate Law: Alternative Explanations to the Law’s Mandatory and Enabling/Default Contents” (2005) 13 Cardozo J Intl & Comp L 433; Lucian Arye Bebchuk, “Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments” (1989) 102 Harv L Rev 1820; Melvin Aron Eisenberg, “Bad Arguments in Corporate Law” (1990) 78:5 Geo LJ 1551. 22 See also John Deere Plow Co v Wharton, [1915] AC 330 (PC). 23 Colonial Bldg and Investment Ass’n v AG Québec (1883), 9 App Cas 157 (PC).

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incorporation are also not limited to corporations having objects confined to the enumerated powers of the federal government.24 Section 92(11) of the Constitution Act allocates to provincial legislatures the “Incorporation of Companies with Provincial Objects.” The phrase “with provincial objects” caused some uncertainty, however, about whether there were territorial or functional limits on companies incorporated under provincial statutes.25 The restriction to “provincial objects” might be thought at first glance to impose a substantial territorial limitation, thus preventing Ontario corporations, for example, from doing business in Alberta or the Yukon. However, this interpretation was rejected by the Privy Council in 1916 in Bonanza Creek Gold Mining Co v The King, [1916] 1 AC 566, 583-84 (PC), which held that while a provincial legislature is not competent to bestow on its corporate creation the right to engage in business outside the home province, it may grant it the capacity to engage in business in any other province that is willing to allow it to do business there. That such a capacity has been bestowed will be presumed in the absence of provisions in the letters patent that exclude it. 26 Further, the phrase does not restrict the activities of provincially incorporated corporations to substantive areas reserved to provincial legislative competence. Such corporations can engage in activities within the federal legislative sphere, but can do so only in compliance with applicable federal legislation.27 Outside its province of incorporation, a provincially incorporated company may exercise such powers as the host province allows it to exercise. Each of the provinces has enacted legislation requiring a corporation incorporated outside the province to register with an official in order to carry on business in the province. A CBCA corporation will therefore have to file at least one extra-provincial registration28 and possibly more depending on where it is doing business. The official may, in his or her discretion, issue a licence to the extra-provincial corporation allowing it to carry on business in the province. Certain of the provinces have reciprocal arrangements so that a company incorporated in either of the provinces may carry on business in the other without a licence.

2.  Uniformity Versus Charter Competition Uniformity is often promoted as a desirable goal in provincial or state legislation within a federal system. From an economic analysis perspective, the primary advantage of uniformity is greater standardization, which may arguably economize on information production in two ways. First, when a single standard is imposed, those seeking to make claims or assert their rights in national capital markets will find it easier to gauge what those rights are, and firms 24 See Canadian Pioneer Management v Labour Relations Board of Saskatchewan, [1980] 1 SCR 433, 107 DLR (3d) 1, [1980] 3 WWR 214 and Life Underwriters Association of Canada v Provincial Association of Quebec Life Underwriters, [1992] 1 SCR 449, 133 NR 223. 25 See the discussion in Peter Hogg, Constitutional Law of Canada, 5th ed (Toronto: Thomson Carswell, 2007) (loose-leaf ), ch 23 at § 23.1. 26 Honsberger v Weyburn Townsite Co (1919), 59 SCR 281. 27 See Alberta Government Telephones v (Canada) Canadian Radio-television and Telecommunications Commission, [1989] 2 SCR 225, 5 WWR 385; The Queen (Ont) v Board of Transport Commissioners, [1968] SCR 118, 65 DLR (2d) 425; and see the discussion in Hogg, supra note 25. 28 Corporations Canada: Steps to Incorporating, Step 3, online: .

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will find it easier to comply with their requirements or obligations. A second assertion is that uniformity will improve the quality of the law, with legal uncertainties resolved more quickly as courts of one jurisdiction make use of the judgments of other jurisdictions. On the other hand, uniformity may serve to impede or delay experimentation with new rules through which other improvements might be implemented or developed. Competition between provinces or jurisdictions in the supply of public goods may be beneficial if better quality “goods” come to be provided.29 If legal rules can be considered as a product or “good,” the competition principle can be extended to them, and so diversity of provincial legal systems under this perspective will be seen as resulting in better quality legal rules because of increased experimentation. 30 Take the example of a private contract. Parties to that contract have the right under private international law to choose which law of a particular offshore jurisdiction will be the one governing a contract; two parties in British Columbia might, for example, decide that the “governing law” of the contract is the law of England, even though any disputes might be settled in court in British Columbia or, if the parties decide, in court in England. Jurisdictions compete to provide “better” rules for contracts (and so to attract parties to resolve their disputes under those rules); this is an example of the competitive provision of public goods. So, too, is “facilitative” corporate legislation, which permits incorporation in a jurisdiction even if the principal business is located elsewhere. This creates potential for competition between different jurisdictions in providing corporate laws. Such competition to attract incorporations is said to be a particular feature of corporate law in the United States. There is no federal corporate law in the United States, and so states are said to “compete” to get out-of-state companies to incorporate under their laws in order to attract taxes, fees, and work for in-state service providers like lawyers and accountants. Indeed, there is a great deal of attention paid to the “Delaware phenomenon,” the concept that in the competition between US states to attract incorporations, Delaware among all states tends to be favoured by large, public corporations as a result of corporate law that is perceived to be in their interests. Approximately one-half of the largest US industrial firms are incorporated in Delaware. More firms listed on national securities exchanges are incorporated in Delaware than in any other state.31 In addition to having a corporate-friendly statute, Delaware also provides favourable tax treatment and a highly specialized and respected court that is able to draw on well-developed judicial precedent. A significant body of research literature in the United States is dedicated to analyzing the “Delaware phenomenon” and the competition (or lack thereof) from other states.32

29 Royal Commission on the Economic Union and Development Prospects for Canada Report (MacDonald Commission Report) vol 3 (Ottawa: Supply and Services Canada, 1985) at 486 (supplementary statement by Albert Breton). 30 See also Susan Rose-Ackerman, “Does Federalism Matter? Political Choice in a Federal Republic” (1981) 85 J Pol Econ 152 (discussing the importance of diversity in legislation of states in a federal system). 31 Roberta Romano, The Genius of American Corporate Law (Washington, DC: The AEI Press, 1993) at 6. 32 See Nicholls, supra note 10 at 32-35; William L Cary, “Federalism and Corporate Law: Reflections upon Delaware” (1974) 83 Yale LJ 663; Ralph K Winter, “State Law, Shareholder Protection, and the Theory of the Corporation” (1977) 6 J Leg Stud 251; Roberta Romano, “Empowering Investors: A Market Approach to Securities Regulation” (1998) 107 Yale LJ 2359; Marcel Kahan & Ehud Kamar, “The Myth of State Competition in Corporate Law” (2002) 55 Stan L Rev 679.

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The Canadian situation, in contrast, is focused more on uniformity than on competition. In the following excerpt, Professor Jameson reviews two important perspectives on corporate charter competition in Canada, and some of the reasons for why the Canadian situation is different from the American one.33

Glenford Jameson, “Competing With Ourselves: Supply-Side Competition for Corporate Charters in Canada” (2012) 50 Alta L Rev 843 at 851-57 (footnotes omitted) A.  Daniels: Should Provinces Compete? In 1991, [Ronald] Daniels, former Dean of the University of Toronto Law School, published a study that sought to assess whether competitive forces existed in Canada as in the US. Daniels’ study primarily focused on the modernization of Canadian corporate laws after the introduction of the CBCA in 1975. Plotting the provinces’ corporate statute amendments along a graph to indicate how adoptive the respective legislative regimes were, Daniels demonstrated that after the introduction of the CBCA, virtually every Canadian jurisdiction implemented significant changes to their own corporate laws within ten years of the federal Act, often mirroring the provisions contained in the CBCA. With each subsequent legislative amendment, the amending province adopted more CBCA reforms. Daniels suggested that the markedly responsive legislating tactics that provinces undertook after the CBCA was evidence that market forces were in effect in Canada, interpreting the amendments in corporate legislation as attempts to regain charter market shares that were lost to the comparatively modern CBCA. B.  Cumming and Macintosh: The Role of Interjurisdictional Competition Cumming and MacIntosh re-evaluated Daniels’ work in 2000 and presented an alternative hypothesis to describe the Canadian corporate law market: one of uniformity . . . . Cumming and Macintosh described corporate law as a product of legislators, who supply law to corporations. The more responsive legislators of a jurisdiction are to calls for reform, the higher quality the end product will be. Competition exists in the market between suppliers (that is, jurisdictions) to entice firms to incorporate in their jurisdiction, so the supplier may enjoy incorporation revenues, as well as legal and corporate service work that arises with incorporation, as described above. The assumption is generally that competition exists. However, it is possible that suppliers do not respond to demands for reform, but rather converge to offer little difference in product, and therefore, choice. Cumming and MacIntosh described the latter occurrence as making it difficult for a firm to shop around. Without a supply-side response, there is no market for charters. Accordingly, firms enjoy none of the efficiencies in corporate laws that accompany charter competition. … 33 See also RJ Daniels, “Should Provinces Compete? The Case for a Competitive Corporate Law Market” (1991) 36 McGill LJ 130, and JG MacIntosh & Douglas J Cumming, “The Role of Interjurisdictional Competition in Shaping Canadian Corporate Law: A Second Look” (2000) 20 Intl Rev L & Econ 141.

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Cumming and MacIntosh viewed Canadian jurisdictions as attempting to converge their corporate laws with federal ones, becoming indistinguishable from the CBCA and each other, rather than proactively attempting to create their own unique regimes. The uniformity hypothesis suggests that there is no supply-side competition in Canada for incorporation charters. Legislative adoption, arising from the uniformity theory, is advantageous to jurisdictions for several reasons: (1)  it is the least intensive form of legislation development; (2) it reduces transactional costs because lawyers are more or less familiar with more statutes; and (3) parties can expect similar treatment from the courts of various jurisdictions, increasing certainty. These work to reduce incorporation and subsequent costs arising from initial public offerings (IPOs), takeover bids, and takeover defences. If the law is the same from jurisdiction to jurisdiction in Canada, it will be less expensive to litigate, legislate, enforce, and navigate. Cumming and MacIntosh acknowledged that corporate laws across Canada are not uniform. They explained that “legislators in different jurisdictions will predictably adopt law reforms at different rates of speed, given that corporate law reform will compete for legislative time with other matters, and that these other matters will vary in content and urgency from province to province.” They compare the Canadian experience to the convergence of corporate laws that the US has experienced, which the authors suggested was a result of heated competition between states. Cumming and MacIntosh distinguished uniformity and convergence: The American charter market—in which states like Delaware and Nevada vigorously compete for incorporation business—is far more competitive than the Canadian charter market. This competitive dynamic has produced a great deal of uniformity in United States corporate laws. … It does not seem plausible that less rigorous competition in Canada over a much shorter period of time could have produced relatively great uniformity. Hence, the emergent uniformity of Canadian corporate law is in our view most likely to attribute more to the uniformity hypothesis than the competition hypothesis.

Cumming and MacIntosh supported this position with political, legal, and institutional arguments for the uniformity hypothesis, which can be broken into institutional and cultural barriers to interjurisdictional supply-side competition. … These arguments are discussed below. 1.  Limited Financial Incentives Delaware’s entire 2008 budget totaled $3.1 billion USD, and revenue derived from the incorporation business was $566.3 million USD. Because the charter business comprises such a significant share of Delaware’s annual operating capital, the state cannot afford to neglect the needs and wants of corporations. More resources are directed at the Chancery Courts and significant efforts are put towards a proactive examination of corporate law. Corporate interests are closely monitored and legislators are to be responsive to their demands. The largesse of the Delaware state government is directly tied to its continued success in the charter market. Cumming and MacIntosh argued that the revenue generated from provinces and the federal government indicates that it comprises less than one-tenth of 1 percent of annual federal revenues. The amount is so small, they argued, that even legislation that redirects

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most new incorporations would result in little financial gain for larger provinces. If gains are so small, why would a province proactively seek to enter into the charter market business when there are such menial stakes? Most provinces would surely prefer to allocate that capital to maintaining roads, hospitals, and schools. 2.  Limited Resources, Episodic Amendments The amendments to Canadian corporate law have traditionally been episodic in nature, coming in waves. Cumming, MacIntosh, and Daniels described the amending process as cumbersome and lengthy, but the Delaware process as continuous and fluid: “[Delaware corporate laws] are updated in a timely manner as needed.” Cumming and MacIntosh questioned whether there was demand for frequent reform, particularly when the charter market does not drive any particular economy. Compared to Delaware, no Canadian jurisdiction’s corporate law has a position of importance that gives the task of proactively modernizing any particular urgency. Because of the lack of urgency, there is no credible commitment to engaging in competition. 3.  Shared Legal Precedent The structure of the Canadian judiciary creates the Supreme Court of Canada, a binding court upon all lower courts in Canada. The structure of appellant courts in the US is distinct, allowing states to house courts of last resort on certain issues—including corporate law matters. This enables a unique body of corporate law to develop in each state. While courts often take notice of corporate law developments in other states, they do so as a Canadian court would consider an Australian or American approach to legal issues. In Delaware, corporations tend to reincorporate from other states under very specific circumstances: “[I]n anticipation of consummating three different types of transactions that might lead to litigation: going public, embarking on a merger and acquisition program and adopting antitakeover defences. The attraction to Delaware is the reduced likelihood that such litigation will succeed in the courts.” A primary advantage to being a Delaware corporation is the sophisticated and binding body of corporate law that has been developed in that state. 4.  A Small Body of Corporate Law Cumming and MacIntosh identified the paucity of Canadian corporate law as a unifying factor between the provinces, impeding competition. They write: Given the small stock of corporate law precedents in Canada compared to the United States, it is only natural for Canadian judges to turn to the courts of the other provinces for guidance. So long as the stock of precedents remains relatively small, this will likely continue to be the casealthough explosive growth in the jurisprudence under the corporate “oppression remedy” may well lead to the development of a more uniquely provincial jurisprudence.

This position makes sense. Teck Corporation Ltd. v. Millar is an example of how widely used a case can become in Canada. Arising from a junior mining takeover bid, Teck, a 1972 British Columbia Supreme Court decision, has since become an oft-cited case across Canada, arguably because there was not a higher court decision on director duties in takeover situations until Teck was enshrined as the authority on the subject.

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Cumming and MacIntosh noted that securities commissions are increasingly encroaching onto the corporate law domain: “While the rules of conflict of laws establish that the applicable corporate law is that of the incorporating jurisdiction, securities legislation applies to any firm with a nontrivial number of shareholders in the province, no matter where that firm is incorporated.” Securities acts provide wide latitude to securities commissions to pursue issues traditionally considered corporate law issues, under their statutory public interest and discretionary powers. 5.  The Inability to Create a Responsive and Skilled Corporate Judiciary The judiciary is identified as a critical institutional difference between the US and Canada, which serves to prevent Canadian jurisdictions from engaging competitively in the charter market. In Delaware, the appointment process is such that Chancery Court judges are state appointees, which “ensures that the state can choose judges who will be sympathetic to corporate managers. … [B]ecause judicial appointments are a state matter, the state can decline to renew the appointment of a judge who does not decide cases in a manner suitably sympathetic to corporate concerns.” Conversely, in Canada the federal government appoints judges, and those judges are appointees until the age of 75.” Because of the federal appointment process, and the long duration of a judge’s tenure on the bench, provinces have little ability to shape their corporate jurisprudence through the selection of judges. Realistically, provinces cannot remove judges for want of experience with corporate law matters. … Much has changed since the publication of Cumming and Macintosh’s “The Role of Interjurisdictional Competition.” Five out of 14 jurisdictions have amended or significantly overhauled their acts. British Columbia and Québec have designed statutes that do not attempt to unify with other provinces or the CBCA. British Columbia has chosen to continue to operate under a statute that is most influenced by the UK Companies Act 1948. Québec has expressly sought to become a competing supply-side jurisdiction for incorporating companies, engaging directly with the barriers presented by Cumming and MacIntosh.

NOTES AND QUESTIONS

1.  In Canada, the vast majority of companies are closely held, or “private” corporations. Under both provincial and federal statutes, private corporations are afforded greater leeway, through exemption from certain mandatory requirements—for example, the minimum number of directors under CBCA s 102(2).34 Allowing private corporations to contract out of the statutory defaults and design their own optimal structure reduces their need to “shop around” among provinces. Even if provincial governments were to engage in charter competition, it may have a reduced effect because it would create incentives for only a small number of companies. 34 NBBCA s 60(3); NFLCA s 168; QBCA s 106; OBCA s 115(2); MCA s 97(2); SBCA s 97(2); ABCA s 101(2); BCBCA s 120; YBCA ss 102(1) and (2); NWTNBCA ss 102(1) and (2).

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2.  Consider how mandatory and enabling legislation fit into the history of corporations. One of the significant features of the Joint Stock Companies Act of 1844 was that it allowed for incorporation as of right—that is, not subject to the discretion of Parliament. This feature reflected a shift from the paradigm wherein incorporation was a privilege toward one where incorporation was a vehicle for the free exercise of individual rights. Nearly 200 years later, should we revisit the idea that incorporation is a privilege, for which large corporations should give something back to their communities? Would such an approach make corporations more socially oriented, or would it just raise the cost of doing business?

III.  THE PROCESS OF INCORPORATION The essential requirements for incorporating are quite simple. Under statutes employing the statutory division of powers model,35 the corporation is formed by:

1. 2. 3. 4.

filing articles of incorporation, filing a notice of the registered office of the corporation, filing a notice of directors, and paying the prescribed fee.36

Once these requirements are satisfied, incorporation is achieved almost instantly. However, each of these steps raises a number of issues. When explaining these issues, reference will be made to provisions of the CBCA. As you read through the issues arising with respect to each requirement, keep in mind both the legal and the business aspects of each one. How is the business prerogative channeled into legal language? How do the legal requirements shape the business decisions that need to be made?

A.  Articles of Incorporation The articles of incorporation for simple CBCA corporations are prepared by filling out CBCA Form 1 (online: ). The present version of Form 1 requires that specific information be provided about the proposed incorporated entity, as set out in s 6(1) of the CBCA37: • the corporation’s proposed name; • the place in Canada where the registered office is to be situated; • the classes of shares and, where there is more than one class of shares, the rights and restrictions on the shares; • a statement of any restriction on the transfer of shares; • the number of directors (or the minimum and maximum number of directors); and • any restrictions on the kind of business that the corporation may carry on. 35 Naturally, the incorporation process varies slightly in statutes that do not employ the statutory division of powers model: see NSCA ss 9-13 and PEICA ss 6-12. 36 CBCA ss 7, 19, and 106; NBBCA ss 5 and 64; NFLBCA ss 14 and 174; QBCA ss 9 and 8; OBCA s 6; MCA s 7; SBCA ss 7 and 101; ABCA ss 7(1) and 106; BCBCA s 127; YBCA ss 9(1) and 107; NWTNBCA ss 7 and 107. 37 NBBCA s 4(1); NFLCA s 12(1); QBCA s 5; OBCA s 5(1); MCA s 6(1); SBCA s 6(1); ABCA s 6(1); BCBCA s 11; YBCA s 8(1); NWTNBCA s 6(1).

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Each of these issues, among others, is addressed in turn below. In addition, the articles may also include any provisions that may be found in the bylaws.38 If those incorporating the company wish to enumerate detailed bylaws governing the company, the articles may become a very lengthy document because there is little restriction on the scope of bylaws under CBCA s 103(1). However, in practice, the provisions in the articles will usually be kept to a minimum and it is the bylaws that typically set out detailed rules about internal governance. This simplifies the process of incorporation and also eliminates the need to amend the articles under CBCA s 173 if some change in the provisions is desired at a later date.

1.  The Name of the Corporation The CBCA requires that the articles of incorporation explicitly set out the name of the corporation (CBCA s 6(1)(a)). The incorporators may decide that they will use a number rather than a name, in which case they will ask the director to assign a number to the corporation. The company will then become, for example, “111111 Canada Limited.” When law firms incorporate “shelf companies” to have corporations immediately available for use by clients, they will incorporate them as numbered companies. There is nothing nefarious about using a numbered company, despite the occasional press story that suggests that someone is attempting to hide behind a number rather than a name. The CBCA explicitly permits a numbered company to carry on business under a business name or style,39 as long as the full corporate name is set out in all “contracts, invoices, negotiable instruments and orders for goods and services issued or made by or on behalf of the corporation.”40 When a company uses a business name or style—for example, if an entrepreneur used “Globex” in everyday practice, but officially incorporated as “111222 Canada Limited”—it will be referred to as 111222 Canada Limited “carrying on business” or “doing business as” Globex. For certain legal purposes, this will be abbreviated to “111222 Canada Ltd. c.o.b. Globex.” It is important to note that even though the statute permits the use of a business name or style, provincial legislation generally requires any corporation operating in the province under such a business name to register that name in a government roster that is readily accessible to the public in order to ensure that members of the public are able to easily determine the identity of the business with which they are dealing.41 If a business fails to register properly, that corporation will not be “capable of maintaining a proceeding in a court [in the province] in connection with that business except with leave of the court.”42 The biggest difference for practical purposes between using a regular name and using a number is the speed of incorporation. It is usually faster with a “shelf” company or numbered company incorporation because there is no need to be concerned about regulations concerning permitted names or names that might conflict with a name already in use; further, 38 CBCA s 6(2); NBBCA s 4(2); NFLCA s 12(2); QBCA s 6; OBCA s 5(3); MCA 6(2); SBCA s 6(2); ABCA s 6(2); BCBCA s 12(2); YBCA s 8(2); NWTNBCA s 6(2). 39 CBCA s 10(6); NBBCA s 8(6); NFLCA s 7(1); OBCA s 11(2); MCA s 10(5); SBCA s 10(1); ABCA s 10(9); YBCA s 10(8); NWTNBCA s 10(8). 40 CBCA s 10(5); NBBCA s 8(5); NFLBCA s 35(2); QBCA s 19; OBCA s 10(5); MCA s 10(4); SBCA s 267(1); ABCA s 10(8); BCBCA s 27(1); YBCA s 10(7); NWTNBCA s 10(7). 41 See e.g. the Ontario Business Names Act, RSO 1990, c B.17, s 2(1). 42 Ibid, s 7(1).

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using a numbered company means that an otherwise mandatory name search can be dispensed with. If the incorporators do not want to use a numbered name, a name search must be made to ensure that the name or style is not already in use. The federal government (or, more specifically, Industry Canada) owns and maintains a name search system and corporate name database, and searches are conducted through the “newly updated automated name search,” the NUANS system. The federal government permits incorporators to perform name searches themselves for a modest fee.43 Searches can be conducted using the services of a registered NUANS search house or, most often, the law firm will conduct the search itself. The computer printout will indicate any similarity between the proposed and existing names, and, together with the articles of incorporation, it is sent to the director appointed under the CBCA. If the proposed name is either prohibited or confusing with respect to existing trademarks or names under part II of the Canada Business Corporations Regulations, SOR/2001-512, s  17-34, the director may direct the corporation to change its name after incorporation.44 A corporation’s name is an important asset of its business. The officers of that business will seek to have the director instruct another corporation to change its name if the two names are likely to be confused. If the director refuses to do so, the first corporation can seek to protect its interests by appealing that decision.45 If the corporation proposes to carry on business in Québec, it will wish to set out its name in both a French and an English form in order to comply with the Charter of the French Language in that province. Incorporation statutes in Canada typically facilitate this by allowing the corporation to set out its name in an English form, a French form, an English form and a French form, or a combined English and French form.46 The name of the corporation must include a suffix such as “Ltd.,” “Inc.,” or “Corp.” (short for “Limited,” “Incorporated,” and “Corporation,” respectively). This suffix is required in order to ensure that members of the public dealing with the corporation are aware of its existence as a corporation with limited liability. As noted earlier and briefly introduced in Chapter 1, limited liability is the critical feature that distinguishes corporations from partnerships and other forms of business association. The liability of the shareholders in a corporation is typically limited to the amount of their investment in the corporation and no more; accordingly, including the suffix sends a signal to the marketplace that they are dealing with a limited liability entity. The corporate name with its accompanying suffix must be included in all contracts, invoices, negotiable instruments, and orders for goods or services issued or made by or on behalf of the corporation.47 43 Currently $13.80; for more information about direct name searches, see online: . 44 CBCA s 12(2); NBBCA s 10(2); NFLCA s 22; QBCA s 24; OBCA s 12(1); MCA s 12(7); SBCA s 12(2); ABCA s 13(1); BCBCA s 28(1); YBCA s 15(1); NWTNBCA s 13(1). 45 CBCA s 246; NBBCA s 171; NFLCA s 377; OBCA s 252; SBCA s 239(1); ABCA s 47(1); YBCA s 248; NWTNBCA s 248. 46 CBCA s 10(3); NBBCA s 8(3); NFLCA s 18; QBCA ss 16(1) and 22; OBCA s 10(2); MCA s 10(2); SBCA s 10(4); ABCA s 10(6); BCBCA s 25; YBCA s 10(5); NWTNBCA s 10(4); see also Canada Business Corporations Regulations, SOR/2001-512, s 34. 47 CBCA s 10; NBBCA s 8; NFLCA ss 17-25; QBCA s 19; OBCA s 10; MCA s 10; SBCA s 10; ABCA s 10; BCBCA s 27; YBCA s 12; NWTNBCA s 10.

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2.  Registered Office A corporation must maintain a registered office at which it can be served with legal documents and at which it may be required to maintain corporate records. The location of the registered office must be provided in the articles of incorporation.48 Under the CBCA, one must state the province of the registered office (not, as prior to the 2001 CBCA amendments, the specific municipality) in the articles, but not the street address. The street address need only be given in the notice of registered office, to be filed in a separate notice with the articles of incorporation.49 The street address may then be changed without amending the articles, as long as it is to another street address within the same province or territory that was specified in the articles.50 If the corporation wishes to change the province or territory in which its registered office is located, the articles must be amended.51 Such an amendment requires a special resolution52 of the corporation’s shareholders.53 The registered office need not be the place where the corporation actually carries on its business. In fact, it often is not, particularly for small corporations. Such companies will ordinarily designate their lawyer’s office as the corporation’s registered office, so that the lawyer will receive any notices or documents that need to be dealt with expeditiously. A CBCA corporation may have its registered office in any province or territory; provincially incorporated companies, in contrast, must have their registered office in the province in which they were incorporated.54

3.  Classes and Maximum Number of Shares Section 6 of the CBCA55 provides that the articles of incorporation must set out (1) the classes and any maximum number of shares that the corporation is authorized to issue; (2) the rights and privileges attaching to each class of shares if there is to be more than one class; (3) the authority to be given to directors to determine the rights and privileges attaching to shares in a particular series if classes of shares can be issued in series; and (4) any restrictions on the issue, transfer, or ownership of shares in the corporation (CBCA ss 6(1)(c) and (d)). Capitalization of the firm and the issuing of shares is discussed at length in Chapter 5, but it is worth noting two practical considerations here. 48 CBCA s 6(1)(b). 49 CBCA s 19(2); NBBCA s 17(2); NFLCA s 34(1); QBCA s 8(2); OBCA s 14(1); MCA s 19(4); SBCA s 19(2); ABCA s 20(2); BCBCA s 34; YBCA s 22(2); NWTNBCA s 19(2). 50 CBCA s 19(3); NBBCA s 17(3); NFLCA s 33(2); QBCA s 30; OBCA s 14(3); MCA s 19(3); ABCA s 20(3); BCBCA s 35; YBCA s 22(3); NWTNBCA s 19(3). 51 CBCA s 173(1)(b). 52 CBCA s 2(1) defines a “special resolution” as a “resolution passed by a majority of not less than two-thirds of the votes cast by the shareholders who voted in respect of that resolution or signed by all of the shareholders entitled to vote on that resolution.” 53 CBCA s 173(1); Other provinces also require a special resolution to change the location of the registered office: NBBCA s 113(1); NFLCA s 279(1); QBCA s 241; OBCA s 168(1); MCA s 167(1); SBCA s 167(1); ABCA s 173(1); YBCA s 175(1); NWTNBCA s 176(1). 54 OBCA s 14(1); NBBCA s 17(1); NFLCA s 33(1); QBCA s 29; OBCA s 14(1); MCA s 19(1); SBCA s 19(1); ABCA s 20(1); BCBCA s 34(1); YBCA s 22(1); NWTNBCA s 19(1). 55 Supra note 37.

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First, unless tax or business considerations dictate otherwise, small issuers will most often be incorporated with common shares only, with no special rights or privileges attaching to the shares, although there may well be restrictions on ownership or transfer—for example, where a family business is being incorporated and the family wants to ensure that all shareholders are family members. Second, at one time it was common practice to require a corporation to fix in the constating document the total number of shares that the corporation was authorized to issue. Under the CBCA, this limit was accomplished in the articles of incorporation. Other countries in the Commonwealth still require corporations to fix the authorized share capital at the time of incorporation, even though there is the risk that the company will underestimate its capital needs and therefore understate the number of shares it needs to issue. While this risk can be remedied by amending a corporation’s articles to increase the corporation’s authorized capital, it is a cumbersome and potentially expensive process to amend articles, requiring shareholder approval for such a decision, particularly for a large public company. Section 6 of the CBCA is now permissive, and does not require a CBCA corporation to specify the maximum number of shares that it is authorized to issue (although such a maximum may be specified if desired). Instead, to preserve maximum flexibility, the relevant section of the articles of incorporation might read as follows: “The Corporation is authorized to issue an unlimited number of [common/preferred/series X] shares.”

4.  Restrictions on the Transfer of Shares Substantial advantages may be available to “private companies” under Canadian securities legislation. Private companies are typically defined in Canadian securities legislation as corporations whose articles of incorporation or constating documents (1) restrict the right to transfer its shares; (2) limit the number of its shareholders to 50; and (3) prohibit any invitation to the public to subscribe for its securities.56 Share transfer restrictions are common in closely held corporations due to the incorporators having a personal relationship and having all agreed that all shareholders also participate in management going forward.57

5.  Number of Directors Under the CBCA, the articles of incorporation must set out the minimum and maximum number of directors.58 The exact size of the board of directors does not need to be set out when the articles of incorporation are filed, with one exception.59 Every CBCA corporation must have at least one director; when the corporation is a “distributing corporation,” or one 56 See e.g. Securities Act, RSO 1990 c S.5, s 1(1) 57 See generally Bernard F Cataldo, “Stock Transfer Restrictions and the Closed Corporation” (1951) 37 Va L Rev 229 58 CBCA s 6(1)(e); NBBCA s 4(1)(e); NFLCA s 12(1)(e); QBCA s (8); MCA s 6(1)(e); SBCA s 6(1)(e); ABCA s 6(1)(d); YBCA s 8(1)(d); NWTNBCA s 6(1)(e). 59 CBCA s 107(a) requires that where the articles of incorporation provide for cumulative voting, they “shall require a fixed number and not a minimum and maximum number of directors.” See also NFLCA s 176; QBCA s  111; OBCA s  120(h); MCA s  102(a); SBCA s  102(a); ABCA s  107(a); YBCA s  108(a); NWTNBCA s 108(a).

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that has sold its shares to the public, it is required to have at least three directors.60 At the time of filing Form 1, a second notice (Form 6) must be filed naming the people who are to serve as the inaugural or first directors of the corporation.61 Having first directors is important, because they will have the authority to issue the initial shares of the corporation and to take the other steps required to organize the corporation after the certificate of incorporation has been issued.62 The initial meeting of directors will ordinarily address the making of bylaws for the corporation, authorize the issuing of securities, make banking arrangements for the company, appoint officers, adopt forms of corporate records, appoint an auditor, and deal with other necessary business.

6.  Restrictions on the Business of the Company Any restrictions on the kind of business the company may carry on must be set out in the articles of incorporation (CBCA s 6(1)(f)). Historically, under the memorandum and articles association model of incorporation discussed earlier in this chapter, the question of what business the company would engage in was a matter of agreement between the incorporators and was so fundamental that corporations were required to specify the “objects” for which the company was being formed, and they could not be changed even with the unanimous consent of the shareholders. The CBCA no longer requires such a statement of corporate objects, or even that any restrictions on the company’s activities be articulated. However, if they wish, incorporators may include such restrictions.

IV.  SEPARATE LEGAL PERSONALITY AND LIMITED LIABILITY A.  Economic Justifications and Policy Concerns As mentioned at the beginning of this chapter, separate legal personality and limited liability are two fundamental features of general business corporations. Before setting out the doctrinal implications of separate legal personality and limited liability, the following two extracts explain the economic justifications for the two fundamental features of general business corporations. In the first extract, Hansmann and Kraakman argue that one of corporate law’s most important functions is “affirmative asset partitioning,” achieved through the principle of separate legal personality. Limited liability, by contrast, serves a “defensive asset partitioning” function. In the second extract, Easterbrook and Fischel provide six economic arguments for limited liability. Note that each of the six arguments applies only to widely held public corporations and not to closely held private corporations.

60 CBCA s 102(2); NBBCA s 60(3); NFLCA s 168; QBCA s 106; OBCA s 115(2); MCA s 97(2); SBCA s 97(2); ABCA s 101(2); BCBCA s 120; YBCA ss 102(1) and (2); NWTNBCA ss 102(1) and (2). 61 CBCA ss 7 and 106(1), and Form 6, “Notice of Directors, Notice of Change of Directors or Notice of Change of Address of Present Director.” 62 CBCA s 104(1); NBBCA s 62(1); NFLCA s171(1); QBCA s11; OBCA s117(1); MCA s99(1); SBCA s 99(1); ABCA s 104(1); YBCA s 105(1); NWTNBCA s 105(1).

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Henry Hansmann & Reinier Kraakman, “The Essential Role of Organizational Law” (2000) 110:3 Yale LJ 387 at 394-39 (footnotes omitted) A.  Affirmative Asset Partitioning The type of affirmative asset partitioning that we see in the business corporation can be termed “priority with liquidation protection.” It not only assigns to the corporation’s creditors a prior claim on corporate assets, but also provides that, if a shareholder becomes insolvent, the shareholder’s personal creditors cannot force liquidation of corporate assets to satisfy their claims upon exhausting the shareholder’s personal assets. Rather, a shareholder’s creditors at most can step into the shareholder’s role as an owner of shares—a role that generally offers the power to seek liquidation only when at least a majority of the firm’s shareholders agree. This type of affirmative asset partitioning is found not only in business corporations but also, for example, in cooperative corporations and limited liability companies, and for the limited partners in a limited partnership. A weaker type of asset partitioning, priority without liquidation protection, is afforded by the partnership at will, in which creditors of a bankrupt partner generally have the power to force liquidation of the partnership by foreclosing on the partner’s interest in the partnership—though if the partnership assets are insufficient to satisfy both individual and partnership creditors, then the creditors of the partnership itself have priority over the partner’s creditors in the assets of the partnership. A stronger type of affirmative asset partitioning is found among firms that are managed on behalf of beneficiaries who lack the complete earning and control rights of full owners, including nonprofit corporations, municipal corporations, charitable trusts, and spendthrift trusts. This form gives to a firm’s creditors not just a prior but (among creditors) an exclusive claim on the entity’s assets, in the sense that the creditors of a beneficiary have no claim even to the beneficiary’s interest in the firm. The beneficiaries can continue to be beneficiaries even after they have gone through personal bankruptcy, without passing to their creditors any portion of their expected benefits from the firm. Legal entities in which affirmative asset partitioning takes the form of priority for business creditors without liquidation protection we will term, for convenience, “weakform legal entities.” Entities exhibiting both priority and liquidation protection we will term “strong-form legal entities.” Strong-form legal entities in which entity creditors get an exclusive claim to the entities’ assets we will term “super-strong-form legal entities.” B.  Defensive Asset Partitioning There are various degrees of defensive asset partitioning, just as there are degrees of affirmative asset partitioning. Indeed, the range and variety we observe among forms of defensive asset partitioning is far greater than what we observe in affirmative asset partitioning. The strongest type of defensive asset partitioning is that found in the standard business corporation, in which creditors of the firm have no claim at all upon the personal assets of the firm’s shareholders, which are pledged exclusively as security to the personal

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creditors of the individual shareholders. This exclusive type of defensive asset partitioning, generally referred to simply as “limited liability,” also characterizes other standard types of corporations—nonprofit, cooperative, and municipal—as well as limited liability companies. At the other extreme lies the contemporary U.S. general partnership, in which there is no defensive asset partitioning at all; partnership creditors share equally with the creditors of individual partners in distributing the separate assets of partners when both the partnership and its partners are insolvent. Indeed, as the latter example indicates, defensive partitioning is not required for the formation of a legal entity. Between these two extremes lie a variety of intermediate degrees of defensive asset partitioning that are, or once were, in common use. One of these is illustrated by the traditional approach to partnerships prior to the 1978 Bankruptcy Act. Under that approach, partnership creditors could levy on the assets of individual partners, but their claims were subordinated to the claims of the partners’ personal creditors. A second is a rule of pro rata personal liability, under which owners are liable without limit for the debts of the firm, but bear this liability in proportion to their claims on the firm’s distributions. This rule—which was in fact applied to all corporations in California from 1849 until 1931—implies, for example, that a five-percent shareholder is personally liable, without limit, for five percent of any corporate debts that cannot be satisfied out of the corporation’s own assets. A third intermediate form is a rule of multiple liability, exemplified by the rules of double and triple liability that were applied to many U.S. banks in the late nineteenth and early twentieth centuries, under which the personal assets of a shareholder are exposed to liability for the firm’s unpaid obligations up to a limit equal to the par value (or, in the case of triple liability, twice the par value) of the shareholder’s stock in the firm. A fourth alternative, illustrated by the “companies limited by guarantee” provided for in the law of the United Kingdom and some other Commonwealth countries, permits individual owners to make specific pledges of the amount for which they will be personally liable for a firm’s unpaid debts.

Frank Easterbrook & Daniel Fischel, “Limited Liability and the Corporation” (1985) 52 U Chicago L Rev 89 at 93-101 (footnotes omitted) A.  Limited Liability and the Theory of the Firm People can conduct economic activity in many forms. Those who perceive entrepreneurial opportunities must decide whether to organize a sole proprietorship, general or limited partnership, business trust, close or publicly held corporation. Debt investors in all of these ventures possess limited liability. Equity investors in publicly held corporations, limited partnerships, and business trusts do too. Limited liability for equity investors has long been explained as a benefit bestowed on investors by the state. It is much more accurately analyzed as a logical consequence of the differences among the forms for conducting economic activity.

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Publicly held corporations typically dominate other organizational forms when the technology of production requires firms to combine both the specialized skills of multiple agents and large amounts of capital. The publicly held corporation facilitates the division of labor. The distinct functions of managerial skills and the provision of capital (and the bearing of risk) may be separated and assigned to different people—workers who lack capital, and owners of funds who lack specialized production skills. Those who invest capital can bear additional risk, because each investor is free to participate in many ventures. The holder of a diversified portfolio of investments is more willing to bear the risk that a small fraction of his investments will not pan out. Of course this separation of functions is not costless. The separation of investment and management requires firms to create devices by which these participants monitor each other and guarantee their own performance. Neither group will be perfectly trustworthy. Moreover, managers who do not obtain the full benefits of their own performance do not have the best incentives to work efficiently. The costs of the separation of investment and management (agency costs) may be substantial. Nonetheless, we know from the survival of large corporations that the costs generated by agency relations are outweighed by the gains from separation and specialization of function. Limited liability reduces the costs of this separation and specialization. First, limited liability decreases the need to monitor. All investors risk losing wealth because of the actions of agents. They could monitor these agents more closely. The more risk they bear, the more they will monitor. But beyond a point more monitoring is not worth the cost. Moreover, specialized risk bearing implies that many investors will have diversified holdings. Only a small portion of their wealth will be invested in any one firm. These diversified investors have neither the expertise nor the incentive to monitor the actions of specialized agents. Limited liability makes diversification and passivity a more rational strategy and so potentially reduces the cost of operating the corporation. Of course, rational shareholders understand the risk that the managers’ acts will cause them loss. They do not meekly accept it. The price they are willing to pay for shares will reflect the risk. Managers therefore find ways to offer assurances to investors without the need for direct monitoring; those who do this best will attract the most capital from investors. Managers who do not implement effective controls increase the discount. As it grows, so does the investors’ incentive to incur costs to reduce the divergence of interest between specialized managers and risk bearers. Limited liability reduces these costs. Because investors’ potential losses are “limited” to the amount of their investment as opposed to their entire wealth, they spend less to protect their positions. Second, limited liability reduces the costs of monitoring other shareholders. Under a rule exposing equity investors to additional liability, the greater the wealth of other shareholders, the lower the probability that any one shareholder’s assets will be needed to pay a judgment. Thus existing shareholders would have incentives to engage in costly monitoring of other shareholders to ensure that they do not transfer assets to others or sell to others with less wealth. Limited liability makes the identity of other shareholders irrelevant and thus avoids these costs. Third, by promoting free transfer of shares, limited liability gives managers incentives to act efficiently. We have emphasized that individual shareholders lack the expertise and incentive to monitor the actions of specialized agents. Investors individually respond to excessive agency costs by disinvesting. Of course, the price at which shareholders are able

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to sell reflects the value of the firm as affected by decisions of specialized agents. But the ability of individual investors to sell creates new opportunities for investors as a group and thus constrains agents’ actions. So long as shares are tied to votes, poorly run firms will attract new investors who can assemble large blocs at a discount and install new managerial teams. This potential for displacement gives existing managers incentives to operate efficiently in order to keep share prices high. Although this effect of the takeover mechanism is well known, the relation between takeovers and limited liability is not. Limited liability reduces the costs of purchasing shares. Under a rule of limited liability, the value of shares is determined by the present value of the income stream generated by a firm’s assets. The identity and wealth of other investors is irrelevant. Shares are fungible; they trade at one price in liquid markets. Under a rule of unlimited liability, as Halpern, Trebilcock, and Turnbull emphasized, shares would not be fungible. Their value would be a function of the present value of future cash flows and of the wealth of shareholders. The lack of fungibility would impede their acquisition. An acquiror who wanted to purchase a control bloc of shares under a rule of unlimited liability might have to negotiate separately with individual shareholders, paying different prices to each. Worse, the acquiror in corporate control transactions typically is much wealthier than the investors from which it acquires the shares. The anticipated cost of additional capital contributions would be higher to the new holder than the old ones. This may be quite important to a buyer considering the acquisition of a firm in financial trouble, for there would be a decent chance of being required to contribute to satisfy debts if the plan for revitalization of the firm should go awry. Limited liability allows a person to buy a large bloc without taking any risk of being surcharged, and thus it facilitates beneficial control transactions. A rule that facilitates transfers of control also induces managers to work more effectively to stave off such transfers, and so it reduces the costs of specialization whether or not a firm is acquired. Fourth, limited liability makes it possible for market prices to impound additional information about the value of firms. With unlimited liability, shares would not be homogeneous commodities, so they would no longer have one market price. Investors would therefore be required to expend greater resources analyzing the prospects of the firm in order to know whether “the price is right.” When all can trade on the same terms, though, investors trade until the price of shares reflects the available information about a firm’s prospects. Most investors need not expend resources on search; they can accept the market price as given and purchase at a “fair” price. Fifth … limited liability allows more efficient diversification. Investors can minimize risk by owning a diversified portfolio of assets. Firms can raise capital at lower costs because investors need not bear the special risk associated with nondiversified holdings. This is true, though, only under a rule of limited liability or some good substitute. Diversification would increase rather than reduce risk under a rule of unlimited liability. If any one firm went bankrupt, an investor could lose his entire wealth. The rational strategy under unlimited liability, therefore, would be to minimize the number of securities held. As a result, investors would be forced to bear risk that could have been avoided by diversification, and the cost to firms of raising capital would rise. Sixth, limited liability facilitates optimal investment decisions. When investors hold diversified portfolios, managers maximize investors’ welfare by investing in any project with a positive net present value. They can accept high-variance ventures (such as the

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development of new products) without exposing the investors to ruin. Each investor can hedge against the failure of one project by holding stock in other firms. In a world of unlimited liability, though, managers would behave differently. They would reject as “too risky” some projects with positive net present values. Investors would want them to do this because it would be the best way to reduce risks. By definition this would be a social loss, because projects with a positive net present value are beneficial uses of capital. Both those who want to raise capital for entrepreneurial ventures, and society as a whole, receive benefits from limited liability. The equity investors will do about as well under one rule of liability as another. Every investor must choose between riskless T-bills and riskier investments. The more risk comes with an equity investment, the less the investor will pay. Investors bid down the price of equity until, at the margin, the riskadjusted returns of stock and T-bills are the same. So long as the rule of liability is known, investors will price shares accordingly. The choice of an inefficient rule, however, will shrink the pool of funds available for investment in projects that would subject investors to risk. The increased availability of funds for projects with positive net values is the real benefit of limited liability. B.  Limited Liability and Firms’ Cost of Capital Limited liability does not eliminate the risk of business failure. Someone must bear that loss. Limited liability is an arrangement under which the loss largely lies where it falls. Loss is swallowed rather than shifted. Each investor has a guaranteed maximum on the loss he will bear. In a firm with debt, that guaranteed maximum is combined with a preference for the debtholder. The shareholder is wiped out first. To this extent risk is “shifted” from debt investor to equity investor. In a regime of unlimited liability still more risk would be shifted. Because someone must bear the entire risk of business failure under any rule, some have argued that the importance of limited liability has been exaggerated. The benefit to stockholders from limited liability, the argument runs, is exactly offset by the detriment to creditors. Stockholders are more secure and so demand a lower rate of return under limited liability, but creditors demand a higher rate; the opposite is true under unlimited liability. The firm’s cost of capital, the argument continues, is the same under either rule. … The validity of this argument depends on whether the risk that the value of the firm will be less than the value of the creditors’ claims can be borne equally well by creditors and stockholders. Several factors are pertinent to this question: the extent of common interests, relative monitoring costs, relative information and coordination costs, and attitudes toward risk. 1.  The Extent of Common Interests.  The argument that firms’ cost of capital does not vary with the liability rule depends on the assumption that the benefit to stockholders from limited liability is exactly offset by the detriment to creditors. This assumption is false. … Consider the relation between limited liability and takeover bids. Takeovers are beneficial for shareholders—takeovers are a mechanism for transferring assets to higher-valued uses, and even the threat of takeover provides managers with an incentive to operate

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efficiently and keep share prices high. The effect of takeovers on creditors is less clear. Managers who pursue an overly conservative investment strategy that benefits creditors but does not maximize the value of the firm, for example, may be ousted in a takeover. Thus some takeovers may cause creditors to be worse off ex post. But so long as takeovers increase the probability that the value of firms’ assets will be maximized, shareholders and creditors, joint claimants on a bigger pie, will be better off. Thus a regime including takeovers benefits creditors as well as shareholders. The other effects are straightforward, too. The capital market is more likely to be efficient under a rule of limited liability. An efficient capital market generates price signals that are useful to all investors in a firm, including creditors. Limited liability decreases the cost of searching for good investments for creditors as well as stockholders. 2.  Relative Monitoring Costs.  Shareholders have less reason to incur costs in monitoring managers and other shareholders under limited than under unlimited liability. The decreased incentive to monitor managers is arguably offset by the increased incentive of creditors to monitor managers’ actions. But this will not happen because of the preference among the investors. Because equity investors lose their investments first, they will have a greater interest in monitoring the firm. Indeed, this intra-investor preference is an important ingredient in a system of optimal monitoring. Concentrating the entire marginal gain and loss on one group of investors induces them to make the appropriate expenditures on monitoring (or to sell to someone who will), while enabling the more secure investors to avoid making redundant expenditures. The secured creditor has the safest claim of all and may elect to monitor only the state of its security rather than the state of the whole firm. Secured debt thus may be a way of reducing monitoring costs still further. So debt claimants do not increase their monitoring of managers to offset shareholders’ reductions exactly. Moreover, debt investors do not incur costs that offset the reduction of intra-shareholder monitoring under limited liability. The wealth of other creditors is irrelevant whether or not shareholders possess limited liability, because creditors possess limited liability under either rule. Thus monitoring costs are lower when both shareholders and creditors possess limited liability than when only creditors do. 3.  Relative Information and Coordination Costs.  Another reason why shareholders pay creditors to assume more of the risk of business failure might be that the creditors possess a comparative advantage in monitoring particular managerial actions. As we have stressed, individual shareholders, specialized suppliers of capital, do not actively monitor managers’ actions. They rely on third parties (such as large institutional holders or prospective contestants for control) to do so and buy shares at appropriate moments. Though the debt investors do not have the residual claim, and thus do not have optimal incentives to monitor day-to-day activities, they may be especially well suited to watch certain kinds of conduct. Banks and other institutional investors tend to have specialized knowledge about particular industries and may be good monitors of major decisions such as building new plants. The lender may provide financing to several firms in an industry and thus augment its knowledge. These debt investors commonly negotiate detailed contracts giving them the right to disapprove managers’ decisions that are important enough to create significant

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new risk for the firm, though perhaps not important enough to spark a contest for control. An investor’s possession of particular information does not, however, explain why an investment takes the form of debt rather than equity. Lower coordination costs might explain debt financing. Compare the situation of a sophisticated shareholder with a sophisticated creditor (or the indenture trustee for a group of creditors). Even if the sophisticated shareholder has the ability to monitor, he has little incentive to do so. He bears all the costs, but the benefits accrue to all other shareholders according to the size of their holdings. The creditor, by contrast, captures more of the benefits of his monitoring activity, because there are fewer other members of the same class of investor. When there are many creditors of the same class, the indenture trustee is the response to the free-rider problem. Because the costs of monitoring by the trustee are shared by all the bondholders of a particular class, the trustee is not plagued by the same coordination problems facing any individual investor. When creditors have lower coordination and information costs than shareholders, limited liability has a clear advantage. Because creditors bear more of the risk of business failure under a rule of limited liability, they have more incentive to employ their knowledge. 4.  Attitudes Toward Risk.  Both equity and debt investors can diversify their holdings, thus minimizing the risk of investing in any one firm. Economy-wide (systematic) risk, however, cannot be eliminated by diversification. Where two parties are risk averse, the optimal contractual arrangement is one in which each bears some risk. Limited liability is such a risk-sharing arrangement. Under limited liability, both shareholders and creditors risk the loss of their investments; under unlimited liability, shareholders would bear almost all risk. Risk sharing therefore might be a good explanation of limited liability. C.  Insurance as an Alternative to Limited Liability The advantages of limited liability suggest that, if it did not exist, firms would attempt to invent it. One close substitute is insurance. If firms could purchase insurance to cover their liabilities to debt investors, the firms’ structure would be much the same as now. Shareholders’ liability would be limited to the amount of their investment; creditors would receive a lower rate of return because of their greater security. The firm could purchase insurance for investors as a group. (The transaction costs of shareholders individually purchasing insurance would be prohibitive. Each shareholder would have to negotiate with the insurer. The insurer would have to monitor the wealth of the insured and all other shareholders to assess the riskiness of its own position.) The firm could buy its insurance from existing creditors, a separate insurer, or both. It would make a decision based on factors including relative information and coordination costs. In some circumstances creditors might have a comparative advantage in assessing the riskiness of a transaction initially and superior ability to monitor the conduct of the firm for the duration of the agreement. In that event, the firm would buy its insurance from the creditors. This is essentially what we observe. The creditors assume some risks of business failure, just as they would if they were “insurers” as well as creditors. The legal rule of limited liability is a shortcut to this position, avoiding the costs of separate transactions.

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One advantage of purchasing insurance from separate insurers is that some of the free-rider problems that face groups of creditors are avoided. Third-party insurers might have superior ability to monitor. Firms obtain insurance from the cheapest insurer regardless of the legal rule. Corporations commonly purchase insurance despite the existence of limited liability. But if third-party insurers frequently had a comparative advantage in bearing risk, we would expect to see corporate “debt insurance” commonly used. The debt investors would pay the firm to secure such insurance, receiving lower risk in return. We do not see such transactions. In light of the ability of firms to duplicate or at least approximate either limited or unlimited liability by contract, does the legal rule of limited liability matter? The answer is yes, but probably not much. Under the plausible assumption that creditors often are the most efficient risk bearers, a rule of limited liability economizes on transaction costs by eliminating the need for individual negotiations with every creditor. By contrast, limited liability will not cause a corresponding increase in the number of transactions with third-party insurers. Such transactions will occur whenever third parties are the cheapest insurers, no matter what the legal rule. Limited liability also makes a difference if the firm would purchase inadequate insurance or insurance would not be available in a competitive market. It is hard to imagine, for example, a market for insurance against all bankruptcy. Bankruptcies may be caused by economy-wide events against which the insurer cannot diversify. Moreover, complete bankruptcy insurance creates a moral hazard: it invites managers to take excessive risks. Both equity and debt investors would stop monitoring the managers, and insurers are not likely to provide optimal monitoring in the face of this moral hazard. Without complete bankruptcy insurance, some group must bear the risk of business failure. If shareholders bear all the risk, the problems of unlimited liability reappear; if creditors share some of this risk, the situation is identical to the rule of limited liability. The bankruptcy example illustrates a more general problem with insurance as an alternative to limited liability—who will insure the insurer? If insurers assume the risk of business failure, unpaid claims of the insured firms could exceed the capital of the insurer. This risk must be borne by someone. Shareholders of insurance companies might have unlimited liability, but this could inhibit the formation of large insurers, thus exacerbating the problem. Alternatively, both shareholders and creditors of the insured firm could bear the risk, and the same analysis would govern whether limited or unlimited liability is the superior institutional arrangement. In sum, the problem all along has been: is it better to allow losses to lie where they fall, or to try to shift those losses to some other risk bearer? This is an empirical question. The market’s answer is partial risk shifting. The equity investors bear more risk than the debt investors, but debt investors continue to bear substantial risk, and the risk of all investors is limited to the amount they sink at the start. This arrangement appears to have substantial survival value, for reasons we have discussed. If greater risk shifting were beneficial, we should have seen it evolve in the market. It is no answer to say that transaction costs are high, so the evidence from survival is ambiguous. It is easy to make contracts governing stockholders’ liability. Lenders to close corporations commonly require personal guarantees by investors or other modifications of limited liability. … For now the point is that if people frequently contract around limited liability for the smallest firms, it is

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impossible to attribute the failure to do likewise for larger firms to transaction costs. The survival of limited liability is indeed highly informative. While separate legal personality and limited liability provide valuable economic benefits in the forms of asset partitioning and lowering the cost of capital for widely held public corporations, they do generate costs in particular contexts. In response to the negative externalities raised, courts have developed a principle called “piercing the corporate veil,” “lifting the corporate veil,” or “drawing aside the corporate veil,” which defines situations where the separate legal personality of corporations and the limited liability of shareholders will be disregarded judicially. How courts exercise their discretion to pierce the corporate veil is examined later in this chapter. The following extract by Khimji and Nicholls provides an overview of the costs generated by these two fundamental features of corporations in the contexts of closely held private corporations, involuntary creditors, and corporate groups. When going on to examine corporate veil piercing, ask yourself the extent to which the legal principles developed by the courts address the costs generated by separate legal personality and limited liability.

Mohamed F Khimji & Christopher C Nicholls, “Corporate Veil Piercing and Allocation of Liability—Diagnosis and Prognosis” (2015) 30 BFLR 211 at 222-228 (footnotes omitted) While separate legal personality and limited liability serve valuable economic objectives, commentators have argued that these benefits may be offset by negative externalities in particular contexts. The principal policy concerns that scholars have identified are organized below into three categories: private corporations, involuntary creditors, and corporate groups. A.  Private Corporations This section focuses primarily on voluntary creditors dealing with private corporations with individual, rather than corporate, shareholders. Involuntary creditors in the context of both public corporations and private corporations and the allocation of liability amongst groups of companies are dealt with in the following two sections, respectively. The context involving voluntary creditors of public corporations will not be discussed as there is scholarly consensus that limited liability is justified in the context of voluntary creditors dealing with public corporations. Furthermore, empirical studies on veil piercing in several jurisdictions have suggested that veil piercing occurs almost exclusively in the context of private corporations. The rationales for limited liability identified above do not apply to private corporations in the same way that they apply to public corporations. Because the investors in a private corporation also often serve as managers directly involved in making and implementing business decisions, limited liability does not reduce monitoring costs for shareholders. Similarly, because shares in private corporations are not freely transferable, limited liability facilitates neither efficient risk bearing nor investor diversification. Furthermore, it has

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been suggested that private corporation shareholder-managers have an incentive to “transfer uncompensated business risks” to creditors and, therefore, some form of unlimited liability would be best for the contract creditors of private corporations. Nevertheless, it has been suggested that limited liability remains the default rule in the context of private corporations because it is easier to attach the rule to a form (i.e. the business corporation) than to a size (i.e. a large, public corporation vs. a small, private corporation). Once the rule is in place, parties can freely choose to bargain around it before the fact depending on their individual circumstances. In other words, voluntary creditors are able to assess the credit risk of the corporations they bargain with and negotiate terms accordingly. Therefore, if voluntary creditors do not achieve a suitable deal through bargaining, then the law should not step in to protect them. Though limited liability in the case of private corporations does not offer the economic benefits of investment diversification and positive managerial incentives, it does achieve defensive asset partitioning functions. Accordingly, together with the affirmative asset partitioning functions achieved by separate legal personality, creditors’ monitoring costs are reduced and entrepreneurs may isolate business assets and expose only specifically chosen assets to the risks of the corporation’s business. This tension between these benefits provided by asset partitioning and the risk of shareholder-managers externalizing risks to voluntary creditors seems to be recognized by the courts as a significant proportion of veil piercing cases involve private corporations and voluntary creditors. B.  Involuntary Creditors The case for extending limited liability to claims by involuntary creditors of public and private corporations is more controversial. Unlike voluntary creditors, involuntary creditors (usually tort claimants) have not chosen to enter into any formal relationship with the corporation. An involuntary creditor thus has no way to assess the risk associated with becoming a creditor of the corporation and cannot bargain in advance to have the cost of that risk passed on to the corporation. Corporations can, therefore, engage in risky activities that may result in tort claims but, because their liability (or, more precisely, the liability of their shareholders) is limited, the corporation and its shareholders are not forced to fully internalize these risks. With respect to public corporations, Hansmann and Kraakman have argued that allowing the amount recovered by a tort victim to be dictated by the form of the entity that is responsible for the tort, not only externalizes accident costs, but also incentivizes the externalization of these costs. In addition to what appears to be the inherent unfairness of this cost externalization, a regime of limited liability for involuntary creditors, in Hansmann and Kraakman’s view, does not appear to serve any efficiency enhancing purpose. Thus, they propose a scheme for imposing proportionate liablity upon shareholders in the case of firm ending corporate torts and argue that such a scheme should replace limited liability in this context so as to force corporate investors to internalize the risks incurred by the corporations in which they invest. They acknowledge that such a scheme would result in lower share prices but argue that this result would simply mean that share prices would be priced more accurately by reflecting tort costs. However, the view that investors should internalize the tort risk created by the corporations in which they choose to invest is far from universally accepted. In relation to the

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operationalization of a rule of unlimited, or proportionate, liability for corporate torts, it has been argued that the collection costs would be prohibitively high. In addition, in response to the claim that it would be “irrational” for investors to invest less under a rule of unlimited liability, behavioral economics has been relied upon to suggest that otherwise plausible behavior patterns cannot be dismissed simply because they are inconsistent with the predictions of the rational choice model and, therefore, an unlimited liability rule for tort claimants of public corporations may actually lead to less investment. Analytically, the claim that shareholders ought to be liable for corporate torts has also been challenged on the basis that, if the logic behind imposing liability on shareholders is that they provide the resources that facilitate corporate activity, then the same logic may be extended to apply to “constituents” who provide other equally necessary inputs such as credit and labour. Also, there appears to be no empirical evidence to suggest that mass torts are common and sound social policy does not necessarily require the internalization of all tort risk. Therefore, notwithstanding the important contribution of Hansmann and Kraakman, there appears to be general agreement that the social benefits of maintaining the limited liability of shareholders in the context of involuntary creditors of public corporations exceed the costs. The justification for limited liability in the case of claims of involuntary creditors of private corporations, however, is much more tenuous. However, it has been suggested that limited liability remains the rule even in this context because it avoids drawing legislators and courts into disputes that require them to draw distinctions between public and private corporations. In addition, although tort claimants, by definition, do not choose and so cannot monitor their prospective corporate creditors, voluntary creditors of the corporation would be expected to monitor the asset base of private corporations and tort creditors are able to free ride off of this monitoring. Also, though limited liability may well be the appropriate default rule in the case of public corporations where it is typically the tortious acts of non-shareholder employees or agents of the corporation that expose the corporation to liability vicariously, in the case of private corporations it is the shareholders themselves who are often directly involved in the corporate activity that results in the harm and so they are likely to be found liable directly with no need to invoke the doctrine of veil piercing. Therefore, few commentators support abolishing limited liability for private corporations with respect to tort claims. The more frequently-voiced suggestion is that the courts ought to pierce the veil more often in this context in order to incentivize shareholders to internalize tort risk. The case for a veil piercing claim made by an involuntary, rather than a voluntary, creditor is believed to be strengthened by the fact that, while the asset partitioning benefits of separate legal personality and limited liability apply to all corporate liabilities, in the case of involuntary creditors the incentive of the corporation to externalize risk is coupled with the inability of the claimant to bargain before the fact. Yet, empirical studies from other jurisdictions suggest that veil piercing litigation involves a significantly larger number of contract cases than it does tort cases. Possible explanations for this are the availability of liability insurance, that, in general, corporations enter into contractual relationships more often than they commit torts, or perhaps simply that tort-based claims are more frequently settled and so do not lead to judicial decisions. What is surprising, however, is that most empirical studies suggest that courts have actually pierced the corporate veil in cases involving involuntary creditors less often than in cases involving

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voluntary creditors. Naturally, counter-intuitive findings such as these have attracted criticism from commentators. C.  Corporate Groups Separate legal personality and limited liability also create incentives to organize business activity within groups of related corporations. What constitutes a group of corporations is not defined formally but is commonly understood as a structure whereby a parent or holding corporation, through shareholding or management, effectively controls subsidiary corporations. Such structures are driven by the basic New Institutional Economics principle that choices about institutional design have an effect on the value that is created. Specifically, organizing commercial activity into group structures facilitates distributing risks in a way that benefits the group as a whole, managerial autonomy for buying or selling particular activities, the separate management of geographically-dispersed firms, compliance with local laws, and tax advantages. While these are clearly legitimate uses of the group structure, the ability to organize business activity through parents and subsidiaries also facilitates the externalization of risk on to third parties. Therefore, the challenge for the law is in this context is to distinguish between legitimate and non-legitimate uses of the group structure. It has been argued that the considerations justifying limited liability seem far less persuasive when applied to corporate shareholders (and sibling corporations) as opposed to individual shareholders despite acknowledged legitimate uses of the corporate group structure. As with private corporations generally, many economic justifications for limited liability, such as facilitating investor diversification, are simply irrelevant when it comes to holding a corporation liable for the acts of its related corporate entities. Also, the risk that the acts of a subsidiary will have a negative business impact on the parent is no different than if one of the unincorporated divisions of the business in a single entity structure ran into difficultly. The problem with being able to use separate legal personality and limited liability to organize activity into corporate groups is that it facilitates judgment proofing. For this reason, commentators have argued that a more liberal approach should be taken with respect to veil piercing within corporate groups in order to allocate enterprise liability. However, empirical studies from other jurisdictions have suggested that courts have actually pierced the veil so as to impose liability on a corporation for the acts of an affiliated corporation (parent, subsidiary, or sibling) less often than when a human shareholder is involved. While these findings may lend credence to the concern that judgment proofing is facilitated by organizing economic activity into corporate groups, possible explanations for the counter-intuitive evidence include the possibility that cases settled without a trial (which therefore generate no written judgment) more frequently involve judgment proofing as well as the possibility that analytic difficulties are greater when attempting to ascribe blame for the actions of another to an artificial entity as opposed to a human shareholder.

B.  Doctrinal Implications Recall that the separate legal personality of a corporation means that it is distinct from the individuals who act as its officers, directors, agents, and employees and from the

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individuals who own its shares. While the separate legal personality of corporations was established and recognized by the courts long before the following case, Salomon v Salomon, this case is most often cited as the authoritative Anglo-Canadian declaration of the separate legal entity principle, particularly for de facto sole shareholder corporations. Salomon remains the watershed case in the history of modern corporate law as we know it in Canada. The excerpts below from the case provide a detailed account of how the principles of separate legal personality and limited liability in the modern corporation were discerned by the Lords. As you read the case, consider whether the corporation as an artificial creation of the legislature should have the characteristics and rights that enabled Mr. Salomon to do what he did and thereby avoid personal liability for his actions. Is this result what the legislature intended? What other key propositions about the personality of the corporation are articulated in the judgment? What consequences might flow from granting shareholders in private corporations limited liability?

Salomon v Salomon & Co, Ltd; Salomon & Co, Ltd v Salomon [1895-1899] All ER Rep 33 (HL) [Aron Salomon was a leather merchant and wholesale boot manufacturer. Together with his wife, four sons, and a daughter he formed a limited company under the English Companies Act of 1862. Under the company’s articles of association, the company had authorized capital of 40,000 shares, with each share having a par value of £1. In return for selling his business to this new company at a sale price of £38,800, Salomon was to be issued 20,000 shares (representing a consideration of £20,000) and payment of £16,000 in cash or debentures. The Companies Act required that each company have seven shareholders; Salomon’s wife, four sons, and daughter each held one share, leaving Salomon himself with 20,001 of the 20,007 issued shares. At the company’s first meeting of directors, it was decided that Salomon would be paid £6,000 cash, and would be issued £10,000 in debentures, secured against company assets, in satisfaction of the balance of the purchase price. The company failed and was wound up within a year. At that time it was determined that if the amount realized from the sale of the remaining assets of the company were to be applied against the debentures Salomon held, there would be nothing left to pay ordinary creditors of the company. The liquidator of the company claimed that the company was a mere alias or agent of Salomon, that Salomon personally was liable to indemnify the company against the claims made by the ordinary creditors, and that no payment should be made on the debentures until the ordinary creditors had been paid in full. At trial, Vaughan Williams J held that Salomon was personally liable to the company’s unsecured creditors. He held that the company was Salomon’s agent and that Salomon’s taking a security interest in it in the form of a debenture amounted to a fraudulent conveyance. Vaughan Williams J also stated that the purchase price was exorbitant. The Court of Appeal affirmed this decision. Lindley LJ stated that sole shareholder corporations were contrary to the spirit of the 1862 Companies Act. He added that

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[Mr. Salomon’s] liability does not arise simply from the fact that he holds nearly all the shares in the company … [It] rests on the purpose for which he formed the company, on the way he formed it, and on the use which he made of it. There are many small companies which will be quite unaffected by this decision. But there may possibly be some which, like this, are mere devices to enable a man to carry on trade with limited liability, to incur debts in the name of a registered company, and to sweep off the company’s assets by means of [secured] debentures which he has caused to be issued to himself in order to defeat the claims of those who have been incautious enough to trade with the company without perceiving the trap which he has laid for them. [[1895] 2 Ch. at 338-39]

The learned judge held that the sale of the business to the company was a mere sham to defraud creditors. Mr. Salomon appealed to the House of Lords.] LORD MACNAGHTEN:  I cannot help thinking that the appellant, Aron Salomon, has been dealt with somewhat hardly in this case. Mr. Salomon, who is now suing as a pauper, was a wealthy man in July 1892. He was a boot and shoe manufacturer, trading on his own sole account under the firm of “A Salomon & Co,” in High Street, Whitechapel, where he had extensive warehouses and a large establishment. He had been in the trade over thirty years. He had lived in the same neighbourhood all along, and for many years past he had occupied the same premises. So far things had gone very well with him. Beginning with little or no capital he had gradually built up a thriving business, and he was undoubtedly in good credit and repute. It is impossible to say exactly what the value of the business was. But there was a substantial surplus of assets over liabilities. And it seems to me to be pretty clear that, if Mr. Salomon had been minded to dispose of his business in the market as a going concern, he might fairly have counted upon retiring with at least 70,000 pounds in his pocket. Mr. Salomon, however, did not want to part with the business. He had a wife and a family consisting of five sons and a daughter. Four of the sons were working with their father. The eldest, who was about thirty years of age, was practically the manager. But the sons were not partners; they were only servants. Not unnaturally, perhaps, they were dissatisfied with their position. They kept pressing their father to give them a share in the concern. “They troubled me,” says Mr. Salomon, “all the while.” So at length Mr. Salomon did what hundreds of others have done under similar circumstances; he turned his business into a limited company. He wanted, he says, to extend the business and make provision for his family. In those words, I think, he fairly describes the principal motives which influenced his action. All the usual formalities were gone through; all the requirements of the Companies Act, 1862, were duly observed. There was a contract with a trustee in the usual form for the sale of the business to a company about to be formed. There was a memorandum of association duly signed and registered, stating that the company was formed to carry that contract into effect, and fixing the capital at 40,000 pounds in 40,000 shares of 1 pound each. There were articles of association providing the usual machinery for conducting the business. The first directors were to be nominated by the majority of the subscribers to the memorandum of association. The directors, when appointed, were authorised to exercise all such powers of the company as were not by statute or by the articles required to be exercised in general meeting; and there was express power to borrow on debentures,

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with the limitation that the borrowing was not to exceed 10,000 pounds without the sanction of a general meeting. The company was intended from the first to be a private company; it remained a private company to the end. No prospectus was issued; no invitation to take shares was ever addressed to the public. The subscribers to the memorandum were Mr. Salomon, his wife, and five of his children who were grown up. The subscribers met and appointed Mr. Salomon and his two elder sons directors. The directors then proceeded to carry out the proposed transfer. By an agreement dated 2 August 1892, the company adopted the preliminary contract, and in accordance with it the business was taken over by the company as from 1 June 1892. The price fixed by the contract was duly paid. The price on paper was extravagant. It amounted to over 39,000 pounds, a sum which represented the sanguine expectations of a fond owner rather than anything that can be called a businesslike or reasonable estimate of value. That, no doubt, is a circumstance which, at first sight, calls for observation, but when the facts of the case and the position of the parties are considered, it is difficult to see what bearing it has on the question before your Lordships. The purchase money was paid in this way. As money came in, sums amounting to 20,000 pounds were paid to Mr. Salomon, and then immediately returned to the company in exchange for fully-paid shares. The sum of 10,000 pounds was paid in debentures for the like amount. The balance, with the exception of about 1,000 pounds, which Mr. Salomon seems to have received and retained, went in discharge of the debts and liabilities of the business at the time of the transfer, which were thus entirely wiped off. In the result, therefore, Mr. Salomon received for his business about 1,000 pounds in cash, 10,000 pounds in debentures and half the nominal capital of the company in fully-paid shares for what they were worth. No other shares were issued except the seven shares taken by the subscribers to the memorandum, who, of course, knew all the circumstances, and had, therefore, no ground for complaint on the score of over-valuation. The company had a brief career; it fell upon evil days. Shortly after it was started there seems to have come a period of great depression in the boot and shoe trade. There were strikes of workmen too; and in view of that danger, contracts with public bodies, which were the principal source of Mr. Salomon’s profit, were split up and divided between different firms. The attempts made to push the business on behalf of the new company crammed its warehouses with unsaleable stock. Mr. Salomon seems to have done what he could: both he and his wife lent the company money, and then he got his debentures cancelled and re-issued to a Mr. Broderip, who advanced him 5,000 pounds, which he immediately handed over to the company on loan. The temporary relief only hastened ruin. Mr. Broderip’s interest was not paid when it became due. He took proceedings at once, and got a receiver appointed. Then, of course, came liquidation and a forced sale of the company’s assets. They realised enough to pay Mr. Broderip, but not enough to pay the debentures in full, and the unsecured creditors were consequently left out in the cold. In this state of things, the liquidator met Mr. Broderip’s claim by a counterclaim, to which he made Mr. Salomon defendant. He disputed the validity of the debentures on the ground of fraud. On the same ground he claimed rescission of the agreement for the transfer of the business, cancellation of the debentures, and repayment by Mr. Salomon of the balance of the purchase money. In the alternative, he claimed payment of 20,000 pounds on Mr. Salomon’s shares, alleging that nothing had been paid on them. When the trial came on before Vaughan Williams J, the validity of Mr. Broderip’s claim was admitted, and it was not disputed that the 20,000 shares were fully paid up. The case

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presented by the liquidator broke down completely. But the learned judge suggested that the company had a right of indemnity against Mr. Salomon. The signatories of the memorandum of association were, he said, mere nominees of Mr. Salomon, mere dummies. The company was Mr. Salomon in another form. He used the name of the company as an alias. He employed the company as his agent; so the company, he thought, was entitled to indemnity against its principal. The counterclaim was, accordingly, amended to raise this point, and on the amendment being made, the learned judge pronounced an order in accordance with the view he had expressed. The order of the learned judge appears to me to be founded on a misconception of the scope and effect of the Companies Act, 1862. In order to form a company limited by shares, the Act requires that a memorandum of association should be signed by seven persons, who are each to take one share at least. If those conditions are complied with, what can it matter whether the signatories are relations or strangers? There is nothing in the Act requiring that the subscribers to the memorandum should be independent or unconnected, or that they or any one of them should take a substantial interest in the undertaking, or that they should have a mind and will of their own, as one of the learned lords justices seems to think, or that there should be anything like a balance of power in the constitution of the company. In almost every company that is formed, the statutory number is eked out by clerks or friends, who sign their names at the request of the promoter or promoters without intending to take any further part or interest in the matter. When the memorandum is duly signed and registered, though there be only seven shares taken, the subscribers are a body corporate “capable forthwith” to use the words of the enactments, “of exercising all the functions of an incorporated company.” Those are strong words. The company attains maturity on its birth. There is no period of minority—no interval of incapacity. I cannot understand how a body corporate thus made “capable” by statute can lose its individuality by issuing the bulk of its capital to one person, whether he be a subscriber to the memorandum or not. 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, the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act. That is, I think, the declared intention of the enactment. If the view of the learned judge were sound, it would follow that no common law partnership could register as a company limited by shares without remaining subject to unlimited liability. Mr. Salomon appealed, but his appeal was dismissed with costs, though the appellate court did not entirely accept the view of the court below. The decision of the Court of Appeal proceeds on a declaration of opinion embodied in the order which has been already read. I must say that I, too, have great difficulty in understanding this declaration. If it only means that Mr. Salomon availed himself to the full of the advantages offered by the Companies Act, 1862, what is there wrong in that. Leave out the words “contrary to the true intent and meaning of the Companies Act, 1862” and bear in mind that “the creditors of the company” are not the creditors of Mr. Salomon, and the declaration is perfectly innocent. It has no sting in it. … Among the principal reasons which induce persons to form private companies as is stated very clearly by Mr. Palmer in his treatise on the subject, are the desire to avoid the

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risk of bankruptcy, and the increased facility afforded for borrowing money. By means of a private company, as Mr. Palmer observes, a trade can be carried on with limited liability and without exposing the persons interested in it in the event of failure to the harsh provisions of the bankruptcy law. A company, too, can raise money on debentures, which an ordinary trader cannot do; any member of a company acting in good faith is as much entitled to take and hold the company’s debentures as any outside creditor. Every creditor is entitled to get and to hold the best security the law allows him to take. If, however, the declaration of the Court of Appeal means that Mr. Salomon acted fraudulently or dishonestly, I must say that I can find nothing in the evidence to support such an imputation. The purpose for which Mr. Salomon and the other subscribers to the memorandum were associated was “lawful.” The fact that Mr. Salomon raised 6,000 pounds for the company on debentures that belonged to him seems to me strong evidence of his good faith and of his confidence in the company. The unsecured creditors of A Salomon & Co, Ltd may be entitled to sympathy, but they have only themselves to blame for their misfortunes. They trusted the company, I suppose, because they had long dealt with Mr. Salomon and he had always paid his way; but they had fair notice that they were no longer dealing with an individual, and they must be taken to have been cognisant of the memorandum and of the articles of association. For such a catastrophe as has occurred in this case some would blame the law that allows such a thing as a floating charge. But a floating charge is too convenient a form of security to be lightly abolished. I have long thought, and I believe some of your Lordships also think, that the ordinary trade creditors of a trading company ought to have a preferential claim on the assets in liquidation in respect of debts incurred within a certain limited time before the winding-up. But that is not the law at present. Everybody knows that when there is a winding-up, debenture holders generally step in and sweep off everything. And a great scandal it is. It has become the fashion to call companies of this class “one-man companies.” That is a taking nickname, but it does not help one much in the way of argument. If it is intended to convey the meaning that a company which is under the absolute control of one person is not a company legally incorporated, although the requirements of the Act of 1862 may have been complied with, it is inaccurate and misleading; if it merely means that there is a predominant partner possessing an overwhelming influence and entitled practically to the whole of the profits, there is nothing in that that I can see contrary to the true intention of the Act of 1862, or against public policy, or detrimental to the interests of creditors. If the shares be fully paid up it cannot matter whether they are in the hands of one or many. If the shares are not fully paid it is as easy to gauge the solvency of an individual as to estimate the financial ability of a crowd. … … I am of opinion that the appeal ought to be allowed and the counterclaim of the company dismissed with costs, both here and below. LORD HALSBURY LC:  The important question in this case, and I am not certain that it is not the only question, is whether the respondent company was a company at all— whether, in truth, that artificial creation of the legislature had been validly constituted in this instance; and, in order to determine that question, it is necessary to look at what the statute itself has determined in that respect. I have no right to add to the requirements of

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the statute, nor to take from the requirements thus enacted. The sole guide must be the statute itself. That there were seven actual living persons who held shares in the company has not been doubted. As to the proportionate amounts held by each, I will deal with them presently; but it is important to observe that this first condition of the statute is satisfied, and it follows as a consequence that it would not be competent to anyone, and certainly not to these persons themselves, to deny that they were shareholders. I must pause here to point out that the statute enacts nothing as to the extent or degree of interest which may be held by each of the seven, or as to the proportion of interest or influence possessed by one or the majority of the shareholders over the others. One share is enough. Still less is it possible to contend that the motive of becoming shareholder, or of making them shareholders, is a field of inquiry which the statute itself recognises as legitimate. If they are shareholders they are shareholders for all purposes. … Dealing with them in their relation to the company, the only relation which I believe the law would sanction would be that they were corporators of the corporate body. I am simply here dealing with the provisions of the statute, and it seems to me to be essential to the artificial creation that the law should recognise only that artificial existence, quite apart from the motives or conduct of individual corporators. In saying this I do not at all mean to suggest that if it could be established that this provision of the statute to which I am adverting had not been complied with, you could not go behind the certificate of incorporation to show that a fraud had been committed upon the officer intrusted with the duty of giving the certificate, and that by some proceeding in the nature scire facias you could not prove the fact that the company had no legal existence. But, short of such proof, it seems to me impossible to dispute that once the company is legally incorporated it must be treated like any other independent person with rights and liabilities appropriate to itself, and that the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are. I will, for the sake of argument, assume the proposition that the Court of Appeal lays down, that the formation of the company was a mere scheme to enable Aron Salomon to carry on business in the name of the company. I am wholly unable to follow the proposition that this was contrary to the true intent and meaning of the Companies Act. I can only find the true intent and meaning of the Act from the Act itself, and the Act appears to me to give a company a legal existence with, as I have said, rights and liabilities of its own, whatever may have been the ideas or schemes of those who brought it into existence. I observe that Vaughan Williams J held that the business was Mr. Salomon’s business and no one else’s, and that he chose to employ as agent a limited company, and he proceeded to argue that he was employing that limited company as agent, and that he was bound to indemnify that agent—the company. I confess it seems to me that that very learned judge becomes involved by this argument in a very singular contradiction. Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Mr. Salomon; if it was not, there was no person and nothing to be an agent at all; and it is impossible to say at the same time that there is a company and there is not. Lindley LJ, on the other hand, affirms that there were seven members of the company, but, he says, it is manifest that six of them were members simply in order to enable the seventh himself to carry on business with limited liability, so that the object of the whole arrangement was to do the very thing which the legislature intended not to be done.

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It is obvious to inquire where is that intention of the legislature manifested in the statute? Even if we were at liberty to insert words to manifest that intention, I should have great difficulty in ascertaining what the exact intention thus imputed to the legislature is or was. In this particular case it is the members of one family that represent all the shares; but if the supposed intention is not limited to so narrow a proposition as this, that the seven members must not be members of one family, to what extent may influence or authority or intentional purchase of a majority among the shareholders be carried so as to bring it within the supposed prohibition? It is, of course, easy to say that it was contrary to the intention of the legislature—a proposition which, by reason of its generality, it is difficult to bring to the test; but when one seeks to put as an affirmative proposition what the thing is which the legislature has prohibited, there is, as it appears to me, an insuperable difficulty in the way of those who seek to insert by construction such a prohibition into the statute. As one mode of testing the proposition it would be pertinent to ask whether two or three, or, indeed, all seven, may constitute the whole of the shareholders. Whether they must be all independent of each other in the sense of each having an independent beneficial interest—and this is a question that cannot be answered by the reply that it is a matter of degree. If the legislature intended to prohibit something, you ought to know what that something is. All it has said is that one share is sufficient to constitute a shareholder, though the shares may be 100,000 in number. Where am I to get from the statute itself a limitation of that provision that that shareholder must be an independent and beneficially interested person? I find all through the judgment of the Court of Appeal a repetition of the same proposition to which I have already adverted—that the business was the business of Aron Salomon, and that the company is variously described as a myth and a fiction. … The learned judges appear to me not to have been absolutely certain in their own minds whether to treat the company as a real thing or not. If it was a real thing, if it had a legal existence, and if, consequently, the law attributed to it certain rights and liabilities in its constitution as a company, it appears to me to follow as a consequence that it is impossible to deny the validity of the transactions into which it has entered. Vaughan Williams J appears to me to have disposed of the argument that the company, which for this purpose he assumed to be a legal entity, was defrauded into the purchase of Aron Salomon’s business, because, assuming that the price paid for the business was an exorbitant one as to which I am myself not satisfied, but assuming that it was, the learned judge most cogently observes that when all the shareholders are perfectly cognisant of the conditions under which the company is formed and the conditions of the purchase, it is impossible to contend that the company is being defrauded. … If there was no fraud and no agency, and if the company was a real one and not a fiction or a myth, every one of the grounds upon which it is sought to support the judgment is disposed of. The truth is that the learned judges have never allowed in their own minds the proposition that the company has a real existence. They have been struck by what they have considered the inexpediency of permitting one man to be, in influence and authority, the whole company, and assuming that such a thing could not have been intended by the legislature, they have sought various grounds upon which they might insert into the Act some prohibition of such a result. Whether such a result be right or wrong, politic or impolitic, I say, with the utmost deference to the learned judges, that we

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have nothing to do with that question if this company has been duly constituted by law, and, whatever may be the motives of those who constitute it, I must decline to insert into that Act of Parliament limitations which are not to be found there. I have dealt with this matter upon the narrow hypothesis propounded by the learned judges below, but it is, I think, only justice to the appellant to say that I see nothing whatever to justify the imputations which are implied in some of the observations made by more than one of the learned judges. The appellant, in my opinion, is not shown to have done, or to have intended to do, anything dishonest or unworthy, but to have suffered a great misfortune without any fault of his own. The result is that I move your Lordships that the judgment appealed from be reversed. … LORD WATSON: … I am not satisfied that the charge of fraud against creditors has any foundation in fact. The memorandum of association gave notice that the main object for which the company was formed was to adopt, and carry into effect, with or without modifications, the agreement of 20 July 1892, under the terms of which the debentures for 10,000 pounds were subsequently given to the appellant in part payment of the price. By the articles of association—art. 62(e)—the directors were empowered to issue mortgage or other debentures or bonds for any debts due, or to become due, to the company, and it is not alleged or proved that there was any failure to comply with [clauses of the Act] which relate to the protection of creditors. The unpaid creditors of the company, whose unfortunate position has been attributed to the fraud of the appellant, if they had thought fit to avail themselves of the means of protecting their interests which the Act provides, could have informed themselves of the terms of purchase by the company, of the issue of debentures to the appellant, and of the amount of shares held by each member. In my opinion the statute casts upon them the duty of making inquiry in regard to those matters. Whatever may be the moral duty of a limited company and its shareholders, when the trade of the company is not thriving, the law does not lay any obligation upon them to warn those members of the public who deal with them on credit that they run the risk of not being paid. One of the learned judges asserts, and I see no reason to question the accuracy of his statement, that creditors never think of examining the register of debentures. But the apathy of a creditor cannot justify an imputation of fraud against a limited company or its members, who have provided all the means of information which the Act of 1862 requires. And, in my opinion, a creditor who will not take the trouble to use the means which the statute provides for enabling him to protect himself must bear the consequences of his own negligence. LORD HERSCHELL: … In an action brought by a debenture-holder on behalf of himself and all the other debenture-holders including the appellant, the respondent company set up by way of counterclaim that the company was formed by the appellant, and the debentures were issued in order that he might carry on the said business and take all the profits without risk to himself, that the company was the mere nominee and agent of the appellant, and that the company or the liquidator thereof was entitled to be indemnified by him against all the debts owing by the company to creditors other than the appellant. This counterclaim was not in the pleading as originally delivered; it was inserted by way of amendment at the suggestion of Vaughan Williams J, before whom the action came on

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for trial. The learned judge thought the liquidator entitled to the relief asked for and made the order complained of. He was of opinion that the company was only an alias for Salomon: that, the intention being that he should take the profits without running the risk of the debts, the company was merely an agent for him, and, having incurred liabilities at his instance, was, like any other agent under such circumstances, entitled to be indemnified by him against them. On appeal the decision of Vaughan Williams J was affirmed by the Court of Appeal, that court “being of opinion that the formation of the company, the agreement of August 1892, and the issue of debentures to Aron Salomon pursuant to such agreement were a mere scheme to enable him to carry on business in the name of the company with limited liability contrary to the true intent and meaning of the Companies Act, 1862, and further, to enable him to obtain a preference over other creditors of the company by procuring a first charge on the assets of the company by means of such debentures.” … It is to be observed that both courts treated the company as a legal entity distinct from Salomon and the then members who composed it, and, therefore, as a validly constituted corporation. This is, indeed, necessarily involved in the judgment which declared that the company were entitled to certain rights as against Salomon. Under these circumstances, I am at a loss to understand what is meant by saying that A Salomon & Co, Ltd is but an alias for A Salomon. It is not another name for the same person; the company is ex hypothesi a distinct legal person. As little am I able to adopt the view that the company was the agent of Salomon to carry on his business for him. In a popular sense a company may in every case be said to carry on business for and on behalf of its shareholders, but this certainly does not in point of law constitute the relation of principal and agent between them or render the shareholders liable to indemnify the company against the debts which it incurs. Here, it is true, Salomon owned all the shares except six, so that, if the business were profitable, he would be entitled substantially to the whole of the profits. The other shareholders, too, are said to have been “dummies,” the nominees of Salomon. But when once it is conceded that they were individual members of the company distinct from Salomon, and sufficiently so to bring into existence in conjunction with him a validly constituted corporation, I am unable to see how the facts to which I have just referred can affect the legal position of the company, or give it rights as against its members which it would not otherwise possess. The Court of Appeal based their judgment on the proposition that the formation of the company, and all that followed it, was a mere scheme to enable the appellant to carry on business in the name of the company, with limited liability, contrary to the true intent and meaning of the Companies Act, 1862. The conclusion which they drew from this premise, was, that the company was a trustee and Salomon their cestui que trust. I cannot think that the conclusion follows even if the premise be sound. It seems to me that the logical result would be that the company had not been validly constituted, and, therefore, had no legal existence. But, apart from this, it is necessary to examine the proposition on which the court have rested their judgment, as its effect would be far reaching. Many industrial and banking concerns of the highest standing and credit have, in recent years, been, to use a common expression, converted into joint stock companies, and often into what are called “private” companies, where the whole of the shares are held by the former partners. It appears to me that all these might be pronounced “schemes to enable” them “to carry on

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business in the name of the company, with limited liability,” in the very sense in which those words are used in the judgment of the Court of Appeal. The profits of the concern carried on by the company will go to the persons whose business it was before the transfer, and in the same proportions as before, the only difference being that the liability of those who take the profits will no longer be unlimited. The very object of the creation of the company, and the transfer to it of the business, is that, whereas the liability of the partners for debts incurred was without limit, the liability of the members for the debts incurred by the company shall be limited. In no other respect is it intended that there shall be any difference; the conduct of the business and the division of the profits are intended to be the same as before. If the judgment of the Court of Appeal be pushed to its logical conclusion, all these companies must, I think, be held to be trustees for the partners who transferred the business to them, and those partners must be declared liable, without limit, to discharge the debts of the company. For this is the effect of the judgment as regards the respondent company. The position of the members of a company is just the same whether they are declared liable to pay the debts incurred by the company, or by way of indemnity to furnish the company with the means of paying them. I do not think that the learned judges in the court below have contemplated the application of their judgment to such cases as I have been considering, but I can see no solid distinction between those cases and the present one. It is said that the respondent company is a “one-man” company, and that in this respect it differs from such companies as those to which I have referred. But it has often happened that a business transferred to a joint stock company has been the property of three or four persons only, and that the other subscribers of the memorandum have been clerks or other persons who possessed little or no interest in the concern. I am unable to see how it can be lawful for three or four or six persons to form a company for the purpose of employing their capital in trading, with the benefit of limited liability, and not for one person to do so, provided in each case the requirements of the statute have been complied with, and the company has been validly constituted. How does it concern the creditor whether the capital of the company is owned by seven persons in equal shares, with the right to an equal share of the profits, or whether it is almost entirely owned by one person who takes practically the whole of the profits? The creditor has notice that he is dealing with a company the liability of the members of which is limited, and the register of shareholders informs him how the shares are held, and that they are substantially in the hands of one person, if this be the fact. The creditors in the present case gave credit to and contracted with a limited company; the effect of the decision is to give them the benefit as regards one of the shareholders, of unlimited liability. I have said that the liability of persons carrying on business can only be limited provided the requirements of the statute be complied with, and this leads naturally to the inquiry what are those requirements? The Court of Appeal has declared that the formation of the respondent company, and the agreement to take over the business of the appellant, were a scheme “contrary to the true intent and meaning of the Companies Act.” I know of no means of ascertaining what is the intent and meaning of the Companies Act except by examining its provisions and finding what regulations it has imposed as a condition of trading with limited liability. The memorandum must state the amount of the capital of the company and the number of shares into which it is divided, and no subscriber is to take less than one share. The shares may, however, be of as small a nominal

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value as those who form the company please; the statute prescribes no minimum, and though there must be seven shareholders it is enough if each of them holds one share, however small its denomination. The legislature, therefore, clearly sanctions a scheme by which all the shares, except six, are owned by a single individual, and these six are of a value little more than nominal. It was said that in the present case, the six shareholders other than the appellant were mere dummies, his nominees, and held their shares in trust for him. I will assume that this was so. In my opinion, it makes no difference. The statute forbids the entry in the register of any trust and it certainly contains no enactment that each of the seven persons subscribing the memorandum must be beneficially entitled to the share or shares for which he subscribes. The persons who subscribe the memorandum or who have agreed to become members of the company, and whose names are on the register, are alone regarded as, and, in fact, are, the shareholders. They are subject to all the liability which attaches to the holding of the share. They can be compelled to make any payment which the ownership of a share involves. Whether they are beneficial owners or bare trustees is a matter with which neither the company nor creditors have anything to do; it concerns only them and their cestuis que trust if they have any. If, then, in the present case all the requirements of the statute were complied with and a company was effectually constituted, and this is the hypothesis of the judgment appealed from, what warrant is there for saying that what was done was contrary to the true intent and meaning of the Companies Act? It may be that a company constituted like that under consideration was not in the contemplation of the legislature at the time when the Act authorising limited liability was passed; that if what is possible under the enactments as they stand had been foreseen, a minimum sum would have been fixed as the least denomination of share permissible, and it would have been made a condition that each of the seven persons should have a substantial interest in the company. But we have to interpret the law, not to make it; and it must be remembered that no one need trust a limited liability company unless he so please, and that before [he] does so he can ascertain, if he so please, what is the capital of the company, and how it is held. I have hitherto made no reference to the debentures which the appellant received in part payment of the purchase money of the business which he transferred to the company. These are referred to in the judgment as part of the scheme which is pronounced contrary to the true intent and meaning of the Companies Act. But if apart from this the conclusion that the appellant is bound to indemnify the company against its debts cannot be sustained, I do not see how the circumstance that he received these debentures can avail the respondent company. The issue of debentures to the vendor of a business as part of the price is certainly open to great abuse, and has often worked grave mischief. It may well be that some check should be placed upon the practice, and that at all events, ample notice to all who may have dealings with the company should be secured. But as the law at present stands there is certainly nothing unlawful in the creation of such debentures. For these reasons I have come to the conclusion that the appeal should be allowed. It was contended on behalf of the company that the agreement between them and the appellant ought, at all events, to be set aside on the ground of fraud. In my opinion, no such case has been made out, and I do not think that the respondent company are entitled to any such relief.

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[The concurring judgments of Lords Morris and Davey are omitted.] The House of Lords in Salomon legally legitimized the use of sole shareholder corporations—that is, the default features of separate legal personality and limited liability apply equally to both widely held public corporations and closely held private corporations. As illustrated by the case, in a sole shareholder corporation, the same individual can enter into legal contracts with the entity in different capacities—for example, as shareholder, director, and secured creditor. Furthermore, despite controlling the corporation in the capacity of director, the same individual may benefit from limited liability in the capacity of shareholder. The following extract illustrates further this important doctrinal implication.

Lee v Lee’s Air Farming Ltd [1961] AC 12 (PC) (footnotes omitted) [In 1954, the appellant’s husband, Mr. Lee, formed Lee’s Air Farming Ltd. for the purpose of carrying on the business of aerial top-dressing. Mr. Lee held 2,999 of the company’s 3,000 shares. He was also the company’s sole director, officer, and manager. Under art 33 of the company’s articles of association, he was employed as chief pilot of the company at a salary he arranged. Article 33 also provided that in respect of such employment, the rules of law applicable to the relationship of master and servant should apply between the company and himself. In March 1956, Lee was killed while piloting the company’s aircraft during the course of aerial top-dressing. His widow claimed compensation under the New Zealand Workers’ Compensation Act, 1922, s 3(1), under which an employer was liable to pay compensation if a “worker” suffered personal injury by accident arising out of and in the course of any employment to which the Act applied. Under s 2 of the Act, “worker” was defined as “any person who has entered into or works under a contract of service … with an employer, whether by way of manual labour, clerical work, or otherwise, and whether remunerated by wages, salary or otherwise.”] LORD MORRIS OF BORTH-Y-GEST: … The substantial question which arises is, as their Lordships think, whether the deceased was a “worker” within the meaning of the Workers’ Compensation Act, 1922, and its amendments. Was he a person who had entered into or worked under a contract of service with an employer? The Court of Appeal thought that his special position as governing director precluded him from being a servant of the respondent company. On this view, it is difficult to know what his status and position was when he was performing the arduous and skilful duties of piloting an aeroplane which belonged to the respondent company and when he was carrying out the operation of top-dressing farm lands from the air. He was paid wages for so doing. The respondent company kept a wages book in which these were recorded. The work that was being done was being done at the request of farmers whose contractual rights and obligations were with the respondent company alone. It cannot be suggested that, when engaged in the activities above referred to, the deceased was discharging his duties

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as governing director. Their Lordships find it impossible to resist the conclusion that the active aerial operations were performed because the deceased was in some contractual relationship with the respondent company. That relationship came about because the deceased, as one legal person, was willing to work for and to make a contract with the respondent company which was another legal entity. A contractual relationship could only exist on the basis that there was consensus between two contracting parties. It was never suggested (nor, in their Lordships’ view, could it reasonably have been suggested) that the respondent company was a sham or a mere simulacrum. It is well established that the mere fact that someone is a director of a company is no impediment to his entering into a contract to serve the company. If, then, it be accepted that the respondent company was a legal entity, their Lordships see no reason to challenge the validity of any contractual obligations which were created between the respondent company and the deceased. In this connexion, reference may be made to a passage in the speech of Lord Halsbury LC in Salomon v. Salomon & Co.: My Lords, the learned judges appear to me not to have been absolutely certain in their own minds whether to treat the company as a real thing or not. If it was a real thing; if it had a legal existence, and if consequently the law attributed to it certain rights and liabilities in its constitution as a company, it appears to me to follow as a consequence that it is impossible to deny the validity of the transactions into which it has entered.

A similar approach was evidenced in the speech of Lord Macnaghten when he said: It has become the fashion to call companies of this class “one man companies.” That is a taking nickname, but it does not help one much in the way of argument. If it is intended to convey the meaning that a company which is under the absolute control of one person is not a company legally incorporated, although the requirements of the [Companies] Act of 1862 may have been complied with, it is inaccurate and misleading: if it merely means that there is a predominant partner possessing an overwhelming influence and entitled practically to the whole of the profits, there is nothing in that that I can see contrary to the true intention of the Act of 1862, or against public policy, or detrimental to the interests of creditors.

Nor, in their Lordships’ view, were any contractual obligations invalidated by the circumstance that the deceased was sole governing director in whom was vested the full government and control of the respondent company. Always assuming that the respondent company was not a sham, then the capacity of the respondent company to make a contract with the deceased could not be impugned merely because the deceased was the agent of the respondent company in its negotiation. The deceased might have made a firm contract to serve the respondent company for a fixed period of years. If within such period he had retired from the office of governing director and other directors had been appointed his contract would not have been affected. The circumstance that, in his capacity as a shareholder, he could control the course of events would not in itself affect the validity of his contractual relationship with the respondent company. When, therefore, it is said that “one of his first acts was to appoint himself the only pilot of the company,” it must be recognised that the appointment was made by the respondent company and that it was none the less a valid appointment because it was the

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deceased himself who acted as the agent of the respondent company in arranging it. In their Lordships’ view, it is a logical consequence of the decision in Salomon v. Salomon & Co. that one person may function in dual capacities. There is no reason, therefore, to deny the possibility of a contractual relationship being created as between the deceased and the respondent company. If this stage is reached, then their Lordships see no reason why the range of possible contractual relationships should not include a contract for services and if the deceased, as agent for the respondent company, could negotiate a contract for services as between the respondent company and himself, there is no reason why a contract of service could not also be negotiated. It is said that therein lies the difficulty, because it is said that the deceased could not both be under the duty of giving orders and also be under the duty of obeying them. But this approach does not give effect to the circumstance that it would be the respondent company and not the deceased that would be giving the orders. Control would remain with the respondent company, whoever might be its agent to exercise the control. The fact that so long as the deceased continued to be governing director, with amplitude of powers, it would be for him to act as the agent of the respondent company to give the orders does not alter the fact that the respondent company and the deceased were two separate and distinct legal persons. If the deceased had a contract of service with the respondent company, then the respondent company had a right of control. The manner of its exercise would not affect or diminish the right to its exercise. But the existence of a right to control cannot be denied if once the reality of the legal existence of the respondent company is recognised. Just as the respondent company and the deceased were separate legal entities so as to permit of contractual relations being established between them, so also were they separate legal entities so as to enable the respondent company to give an order to the deceased. •  •  •

In the present case, their Lordships see no reason to doubt that a valid contractual relationship could be created between the respondent company and the deceased, even though the deceased would act as the agent of that company in its creation. If such a relationship could be established, their Lordships see no reason why it should not take the form of a master and servant relationship. The facts of the present case lend no support for the contention that, if a contract existed, it was a contract for services. Article 33 shows that what was designed and contemplated was that, after its incorporation, the respondent company would, as a master, employ the deceased, as a servant, in the capacity of chief pilot of that company. All the facts and all the evidence as to what was actually done point to the conclusion that what purported to be a contract of service was entered into and was operated. Unless this was an impossibility in law, then the deceased was a worker within the statutory definition as referred to above. It is said that the deceased could not both give orders and obey them and that no power of control over the deceased was in existence. It is true that an inquiry whether a person is or is not employed on the terms that he will, within the scope of his employment, obey his master’s orders may constitute an important inquiry if it is being tested in a particular case whether there is a contract of service as opposed to a contract for services. But in the present case their Lordships can find nothing to support the contention that there was, or may have been, a contract for services but not a contract of service.

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Ex facie there was a contract of service. Their Lordships conclude, therefore, that the real issue in the case is whether the position of the deceased as sole governing director made it impossible for him to be the servant of the respondent company in the capacity of chief pilot of that company. In their Lordships’ view, for the reasons which have been indicated, there was no such impossibility. There appears to be no greater difficulty in holding that a man acting in one capacity can give orders to himself in another capacity than there is in holding that a man acting in one capacity can make a contract with himself in another capacity. The respondent company and the deceased were separate legal entities. The respondent company had the right to decide what contracts for aerial topdressing it would enter into. The deceased was the agent of the respondent company in making the necessary decisions. Any profits earned would belong to the respondent company and not to the deceased. If the respondent company entered into a contract with a farmer then it lay within its right and power to direct its chief pilot to perform certain operations. The right to control existed even though it would be for the deceased, in his capacity as agent for the respondent company, to decide what orders to give. The right to control existed in the respondent company and an application of the principles of Salomon v. Salomon & Co. demonstrates that the respondent company was distinct from the deceased. As pointed out above, there might have come a time when the deceased would remain bound contractually to serve the respondent company as chief pilot though he had retired from the office of sole governing director. Their Lordships consider, therefore, that the deceased was a worker and that the question posed in the Case Stated should be answered in the affirmative.

NOTES AND QUESTIONS

1.  The principles laid down in Salomon and Lee can be used to protect both kinds of asset partitioning. In Rohani v Rohani (2004), BCCA 605, the plaintiff was using his company as a corporate vehicle for business, succession, and tax planning purposes. The court recognized that the corporation was no more than a “piggy bank” for family property, but still respected the Salomon principle of separate legal entity and would not make corporate assets available to Mr. Rohani’s creditors. 2.  Recall that limited liability developed to facilitate the raising of capital from external sources. When this factor is not present, should courts still mechanically honour the Salomon principle?

V.  PIERCING THE CORPORATE VEIL As the previous section explained, separate legal personality and limited liability are default features of general business corporations despite negative externalities generated in the contexts of private corporations, involuntary creditors, and corporate groups. In response to policy concerns raised by separate legal personality and limited liability, courts developed a concept called “piercing,” “lifting,” or “drawing aside the corporate veil”—that is, disregarding the separate legal personality of corporations and/or the limited liability of shareholders

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in order to reallocate liabilities or benefits as between shareholders and corporations.63 In the following extract, Khimji and Nicholls provide an overview of the legal principles associated with veil piercing and present some of the results of an empirical study of veil piercing cases in Canadian common law jurisdictions.64

Mohamed F Khimji & Christopher C Nicholls: “Piercing the Corporate Veil in the Canadian Common Law Courts: An Empirical Study” (2015) 41 Queen’s LJ 207 at 215-224 [footnotes omitted] Despite the apparent robustness of the Salomon decision, Canadian courts, like courts in other common law jurisdictions, began developing principles upon which it was presumed that judges could lift or pierce the corporate veil. Early Canadian decisions drew from UK cases. The early recognized grounds for piercing the corporate veil were agency and use of the corporate structure for an improper purpose. In addition to this, courts would also condemn those corporations deemed unworthy of enjoying the rights and privileges of incorporation with vague, pejorative labels such as alias, alter ego, simulacrum and cloak. In fact, vagueness characterizes much of veil piercing law. Even when the term “agent” is used in veil piercing cases, it is rarely clear whether courts have in mind the legally well-defined principal – agent relationship. Instead, they appear to use the word as a layperson might, adverting to some significant but ill-defined degree of control exercised by a shareholder over a corporation, prompting the court to denounce the corporate body as merely the shareholder’s alias or alter ego—entirely undeserving of the status of a separate legal person.

63 For the purposes of this section, the expression “piercing the corporate veil” refers only to situations where the court is being asked to disregard the asset partitioning function of separate legal personality and/or limited liability. In practice, veil piercing terminology is used in a wide variety of contexts that are not the subject of this section. These contexts range from cases concerning the direct liability of directors and officers to third parties (e.g. Hogarth v Rocky Mountain Slate Inc, 2013 ABCA 57, 542 AR 289); secondary picketing with respect to parent, subsidiary, and related corporations (e.g. Nedco Ltd v Clark and Communications Workers of Canada, Local Number 4 (1973), 43 DLR (3d) 714 (Sask CA)); family law cases where shareholdings in corporations were factored into the calculation of income for support purposes or the calculation of assets owned by a spouse for the purposes of division following a matrimonial breakdown (e.g. Ahpin v Ahpin, 2004 ABQB 492); conflict of laws and jurisdiction cases involving parent, subsidiary, and related corporations in different jurisdictions (e.g. Chevron Corp v Yaiguaje 2015 SCC 42, [2015] 3 SCR 69); and cases dealing with the scope of discovery with respect to shareholders and the extent to which corporations may be examinable or required to produce documents (e.g. Riviera Farms Ltd v Paegus Financial, [1988] 29 CPC (2d) 217). 64 For an empirical study on veil piercing in Quebec, see Stéphane Rousseau & Nadia Smaïli, “La ‘levée du voile corporatif’ en vertu du Code civil du Québec: des perspectives théoriques et empiriques à la lumière de dix années de jurisprudence” (2006) 47:4 C de D 815. Empirical studies of veil piercing have also been conducted in the United States, United Kingdom, and Australia: see Robert B Thompson, “Piercing the Corporate Veil: An Empirical Study” (1991) 76:5 Cornell L Rev 1036; Peter B Oh, “Veil-Piercing” (2010) 89:1 Tex L Rev 81; Charles Mitchell, “Lifting the Corporate Veil in the English Courts: An Empirical Study” (1999) 3 Company Finance & Insolvency L Rev 15; Ian M Ramsay & David B Noakes, “Piercing the Corporate Veil in Australia” (2001) 19 Company & Securities LJ 250.

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Justice Masten cautioned against this careless use of the term agency in what appears to be the first scholarly work on Canadian veil piercing. He argued that, only if the facts demonstrated that the corporation was genuinely an agent of the shareholder (under conventional principles of agency law) would it be appropriate to describe the corporation using colourful terms such as alias, alter ego, simulacrum and cloak. It is important, in other words, that such terms do not become independent grounds for veil piercing because of their lack of analytic content. Despite Masten J’s sensible warnings, provocative but analytically vacuous terms such as alias, alter ego and cloak have become a permanent part of the judicial veil piercing lexicon; “agency,” in a number of cases, is identified as a ground for piercing the veil that is somehow distinct and independent from amorphous concepts such as alias or alter ego. The standard for finding that the corporate form is being used for an improper purpose suffers from equal imprecision. Here too, courts resort to the use of vague pejorative terms such as “sham,” “facade concealing the true facts” and “conduct akin to fraud” to denote corporations not deemed worthy of enjoying the full benefits of incorporation. In addition, several specific forms of impropriety have sometimes been identified in veil piercing cases, including use of the corporation to avoid a pre-existing legal obligation; thin or inadequate corporate capitalization; and failure to observe proper corporate formalities. Scholars have criticized piercing the veil based on each of these supposed “improprieties.” Thin capitalization, as a ground for veil piercing, for example, assumes that it is appropriate for courts to effectively impose ad hoc initial or ongoing capital requirements upon corporations, even when the legislature has decided that such requirements are neither necessary nor desirable. Failure to observe corporate formalities, unless it constitutes or contributes to a misrepresentation, has been harshly criticized by commentators as a grounds for veil piercing because it is either simply irrelevant to the veil piercing question or, as Posner has tersely put it, merely “a nitpicking consideration.” Use of the corporate form to avoid pre-existing obligations is clearly the most egregious of the specifically identified abuses of the corporate form and has thus been regarded by some as the primary or even sole justification for piercing the corporate veil. However, even this putative justification for veil piercing has been criticized. Genuine concerns relating to the improper use of incorporation, it has been argued, could be dealt with adequately and more coherently through other specific legal rules—such as those governing fraudulent conveyances—rather than through vague veil piercing standards. Further adding to the lack of clarity, courts have never adopted a uniform or clear statement on the precise relevance or content of the standards to be applied in determining the requisite degree of control and impropriety to justify veil piercing. A number of recent judgements have attempted to articulate a veil piercing principle that appears to require both elements. For example, it has been stated [in Transamerica Life Insurance Co of Canada v Canada Life Assurance Co (1996), 28 OR (3d) 423 at 433 – 34] that “courts will disregard the separate legal personality of a corporate entity where it is completely dominated, controlled, and being used as a shield for fraudulent or improper conduct.” The problem for British and Canadian courts is that the vague standards for both control and impropriety said to justify veil piercing would appear to have been satisfied by the facts in Salomon itself. It is reasonable to suggest that, in the vast majority of private corporations, a small number of shareholders will exercise a high degree of control and their interests will coincide with those of the corporation. Yet Salomon, a case regularly and unanimously endorsed by British and Canadian courts, appears to condone precisely that sort of

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arrangement. Moreover, while reasonable people may differ on whether the arrangements undertaken by Mr. Salomon were improper, it is worth repeating that Lord Lindley of the English Court of Appeal did condemn Mr. Salomon’s actions as “a device to defraud creditors.” Accordingly, as Seaton JA [in BG Preeco I (Pacific Coast) Ltd v Bon Street Holdings Ltd (1989), 60 DLR (4th) 30 at 37] aptly observed: “If it were possible to ignore the principles of corporate entity when a judge thought it unfair not to do so, Salomon’s case would have afforded a good example for the application of that approach.” In any event, a vague standard for fraud or improper conduct allows courts to subjectively determine proper and improper uses of the corporate form on an unpredictable case by case basis. In addition to various references to control and impropriety, two other expressions have crept their way into veil piercing judicial rhetoric over the years: “interests of justice” and “single economic unit.” Courts have suggested that, even in the absence of any of the “specific” bases for veil piercing referred to above, they will pierce the veil when failing to do so would be “flagrantly opposed to justice” or when it is appropriate to treat a group of companies as a single economic unit. However, as these purported “interests of justice” and “single economic unit” grounds appear to have even less analytical content than the vague control and impropriety terms, their validity has been doubted by both the courts and commentators. While some of the empirical studies in other common law jurisdictions have suggested that “interests of justice” and “single economic unit” considerations can have an impact on the outcome of veil piercing cases, it appears that judicial reference to either of these grounds typically serve merely as shorthand for a combination of more specific justificatory factors (i.e., factors relating to significant control and/or impropriety). In terms of analytical content, the grounds given by courts for refusing to pierce the corporate veil seem even more elusive. Typically, a court’s refusal to pierce the veil is explained simply as an expression of respect for the Salomon principle. Sometimes, however, courts note the legitimacy of organizing economic activity through the use of a corporate structure, specifically for the purpose of allocating liability. There are three other common examples of when courts will refuse to pierce the corporate veil. First, the veil is not typically pierced in actions brought by voluntary creditors on the basis that the claimants chose to deal with an incorporated entity and, therefore, assumed the risk of the corporation not being able to satisfy its debts. Second, in cases where the veil piercing claim is brought by the shareholder or corporation itself (seeking to share a benefit, rather than a liability), courts frequently deny the claim on the basis that incorporators must accept the burden of incorporation as a quid pro quo for enjoying its various benefits. Finally, in denying claims, courts also sometimes cite the absence of compelling control or impropriety, factors that are said to be recognized, and perhaps necessary, grounds for piercing the veil. In sum, the veil piercing principles developed and applied in Canadian common law courts consist of a mishmash of indeterminate expressions that have been in a state of confusion since their inception. Indeed, similar criticism has been leveled at veil piercing principles in the US, UK and Australia, leading some commentators to call for the doctrine to be abolished. Other commentators have challenged whether, in the face of the unqualified statutory provisions providing for the separate legal personality of corporations and the limited liability of shareholders, Canadian courts even have the jurisdiction to pierce the corporate veil. However, although the questionable analytical bases upon which veil piercing occurs has been widely criticized, the view has also been expressed that the actual outcome of veil piercing cases may be explained descriptively as attempts

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by courts—perhaps unconsciously—to engage in a cost-benefit analysis that seeks to preserve separate legal personality and/or limited liability in those situations where the benefits outweigh the costs and to disregard them when they do not. Yet, the uncertainty with which the judicial standards are applied results in costs. Parties using the corporate form to organize commercial activity value predictability in the contexts of both transaction planning and litigation. •  •  •

The results of this study are presented below. Table 1:  Frequency with which Canadian common law courts have pierced the corporate veil Category

Number of Observations

Pierced

Not Pierced

% Pierced

All cases

619

223

396

36.03%

In the sample, Canadian courts have pierced the corporate veil in approximately 36% of the cases where the issue was explicitly addressed. By comparison, based on the similar studies in other jurisdictions, courts chose to pierce the veil 40% of the time in the US, 47% of the time in England and 38% of the time in Australia. As Mitchell pointed out in his study of the UK courts, it may be unwise to read too much into these differences due to the different sample sizes of the various studies. However, it is interesting to note that Canadian courts have occasionally expressed the assumption that veil piercing occurs more frequently in the US, and used this assumption to justify their consideration of UK cases as more persuasive than US cases. The comparative results of these various studies do not appear to support the assumption that successful veil piercing is more common in the US than in the UK. In addition, none of the cases in the data set involve piercing the corporate veil of a public corporation. In other words, the application of the doctrine by Canadian courts has been limited to private corporations controlled by individual shareholders or parent corporations. This aspect of the results is broadly consistent with findings in other jurisdictions and with the near universal theoretical view that a limited liability rule is more compelling in the context of public corporations. As explained above, limited liability serves a number of economic purposes including lowering monitoring costs for shareholders, allowing for portfolio diversification, and facilitating the creation of anonymous exchanges for the trading of shares. These specific benefits are not applicable to private corporations. Of course, separate legal personality and limited liability do provide certain economic benefits for private corporations as well, the most important of which is asset partitioning or “entity shielding.” As a separate legal entity, a corporation’s assets are shielded from the creditors of its shareholders, thereby eliminating the need for the corporation’s creditors to monitor the creditworthiness of those shareholders and accordingly make credit decisions exclusively on the basis of the corporation’s own assets. Limited liability similarly reduces costs for the shareholders’ own creditors by eliminating the need for them to monitor the creditworthiness of the corporate entity. Finally, the combined effect of separate legal personality and limited liability allows entrepreneurs to isolate business assets and expose only those chosen assets to the risks of the corporation’s business.

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V.  Piercing the Corporate Veil Table 2:  Frequency of veil piercing with respect to the classification of the case Category Liability of Shareholder for Corporate Obligations Liability of Corporation for Shareholder Obligations

Number of Observations

Pierced

Not Pierced

% Pierced

274

97

177

35.40%

71

37

34

52.11%

Liability of Related Corporation

77

32

45

41.56%

Corporate Benefit Attributed to Shareholder

135

39

96

28.89%

Shareholder Benefit Attributed to Corporation

37

8

29

21.62%

Benefit Attributed to Related Corporation

25

10

15

40.00%

Table 2 presents the overall rate of veil piercing for each of the six case classifications selected for this study. Approximately half of all the cases in the sample fell within the category of “liability of shareholder for corporate obligations.” As explained above, these cases involve a challenge to limited liability rather than to the distinct concept of separate legal personality. In addition, this data sample shows a statistically significant relationship between the classification of a veil piercing case and whether the corporate veil was pierced. With respect to the liability cases in the first three categories, the data indicates that courts have pierced the corporate veil more often when separate legal personality, as opposed to limited liability, was at stake, particularly when the matter involved the liability of a corporation for the obligations of its shareholder or shareholders. Courts have not usually drawn an explicit distinction between whether separate legal personality or limited liability is at stake in veil piercing cases. Occasionally, however, they have implied that the standard for piercing the corporate veil is, and ought to be, lower where limited liability is not at stake. Descriptively, the findings of this study do suggest that courts have been more willing to pierce the veil when limited liability is not threatened. As a normative matter, we note that this practice appears to ignore the fact that, historically, the corporate form was initially valued more for the function of protecting business assets from claims of individual shareholders’ creditors than for the function of protecting shareholders from debts and other obligations of the corporate entity. As both separate legal personality and limited liability perform equally important (though distinct) functions when it comes to asset partitioning, it seems difficult to justify differences in veil piercing rates linked to the different classifications of liability cases. The findings also suggest that courts have pierced the veil less often in shareholder or enterprise benefit cases and align with similar findings in previous US and UK empirical studies on veil piercing. These results are, to some degree, consistent with views expressed by both courts and commentators concerning reverse piercing cases. Reverse piercing cases arise where the party seeking to have the court disregard the corporation’s separate legal personality is not an arm’s length third party but is either the corporation itself, a

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shareholder or related corporation. Courts frequently reject such attempts and assert that one must accept the burdens of incorporation in exchange for enjoying its benefits. Some commentators have argued that veil piercing claims in such cases always ought to be rejected, since successful outcomes seem to reflect the judge’s personal perception of sympathetic claimants. In the sample for this study, courts pierced the corporate veil in approximately one out of every five reverse piercing cases. •  •  •

Table 6:  Frequency of veil piercing with respect to the nature of shareholder Category

Number of Observations

Pierced

Not Pierced

% Pierced

Individual (Human) Shareholder

458

171

287

37.34%

Parent Corporation

161

52

109

32.30%

The above table displays the veil piercing rates dependent upon whether the shares in the relevant corporation were held by individuals (human shareholders) or by parent corporations. The data suggests that veil piercing outcomes have not been affected by whether a shareholder is an individual or another corporation. Interestingly, this finding is contrary to the intuition of some practitioners who suggest that courts are more willing to pierce the veil in the case of corporate shareholders. Moreover, various commentators have suggested that the justifications for separate legal personality and limited liability are less compelling within the context of corporate groups. One of the key concerns with respect to use of the corporate group structure expressed by commentators is that it facilitates inappropriate judgment proofing. However, while there is no statistically significant relationship between the two variables, the rate of veil piercing in this study was actually found to be slightly higher with respect to corporations with human shareholders. Veil piercing studies in other common law jurisdictions had similar findings on this point. However, we should again note that it is very possible this counter-intuitive finding may just reflect the fact that settlement is more frequent in cases involving parent corporations. •  •  •

Table 8:  Frequency of veil piercing with respect to the identity of the claimant Category

Number of Observations

Pierced

Not Pierced

% Pierced

381

143

238

37.53%

Third Party—Government

118

54

64

45.76%

Corporation, Shareholder or Related Corporation

120

26

94

21.67%

Third Party—Private

The cases in the data set were coded with reference to the identity of the party seeking to pierce the corporate veil. With this variable, veil piercing cases were classified into three categories: • claims made by private third parties; • claims brought by government third parties; and

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• reverse piercing cases (i.e., where the claim is brought by the corporation itself, a shareholder or a related corporation). There was found to be a statistically significant relationship between the identity of the party seeking to pierce the corporate veil and whether the veil was pierced. Government entities were the most successful with their claims whereas shareholder, corporation and related corporation reverse piercing claims were least successful. Table 9:  Frequency of veil piercing with respect to the substantive nature of the claim Category

Number of Observations

Pierced

Not Pierced

% Pierced

Contract

378

141

237

37.30%

Tort Statute/Regulation

39

13

26

33.33%

202

69

133

34.16%

While veil piercing rates appeared to be relatively similar regardless of the substantive nature of the claim, the results varied significantly depending on the particular statutory context. Scholars have focused particular attention on two prominent statutory contexts in which veil piercing occurs: Income Tax Act obligations and obligations arising from family law legislation. Specifically, it has been suggested that the corporate veil will be pierced more liberally in both tax and family law cases. Interestingly, when the tax cases were separated out from the statute/regulation category in this data set, it was found that the success rate for veil piercing in such cases was 29.25%, which is lower than the overall 36.03% rate for the study. However, when the tax cases were further divided up based on the identity of the party making the claim, government entities were successful in 48.15% of the cases while reverse piercing claims were successful in only 9.62% of the cases. Therefore, the descriptive claim that courts pierce the veil more often in tax cases is instead more accurately characterized as courts piercing the veil more often in tax cases when it benefits the interest of the tax authority. The descriptive claim that courts pierce the veil more often in family law cases is also supported by the data, which shows that the veil piercing rate in family law cases was 60.71%. Along with the usual control and impropriety veil piercing standards, courts also tend to rely on support payment guidelines that allow them to consider a spouse’s shareholdings in corporations for the purposes of calculating income to justify veil piercing in this context. This justification for piercing the veil is questionable and was recently rejected by Lord Sumption of the Supreme Court of the United Kingdom [in Prest v Petrodel Resources Ltd, [2013] UKSC 34 at para 37], who reasoned that “[c]ourts exercising family jurisdiction do not occupy a desert island in which general legal concepts are suspended or mean something different.” After all, corporate shares are like any other type of asset, and factoring share ownership into the calculation of a spouse’s income is no different from factoring in the ownership of any other type of income generating asset. Therefore, as observed by Lord Sumption, the argument that because support guidelines allow courts to consider income generated by shares, courts are somehow also implicitly allowed or invited to pierce the corporate veil and make corporations directly liable for family obligations has no logical basis. Normatively, it is not evident that family

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claimants should hold a more privileged status than other types of third party claimants when it comes to these types of claims. The comparative veil piercing rates for contract and tort are also worthy of comment. Commentators have argued that limited liability is less justified in relation to tort creditors due to the inability of said creditors to bargain before the fact. However, similar empirical studies conducted in other jurisdictions have suggested that courts have actually pierced the corporate veil in cases involving tort claimants less often than in cases involving contract creditors. Not surprisingly, these counterintuitive findings have attracted criticism. It does appear that the common law courts in Canada have similarly pierced the veil less frequently in tort cases than in contract cases. However, these results might not be as surprising or as counterintuitive as they first appear. As noted earlier, shareholders often exercise a high degree of control in private companies and, by virtue of this effective operating control, may face direct liability for any torts they commit in the course of their business activity. Thus, though one may observe cases in which such corporate shareholders are exposed to personal tort liability, these cases need not involve any judicial piercing of the corporate veil and so do not appear in the data as incidents of veil piercing. The practical outcome in such cases, however, is the same: An individual shareholder is found personally liable for a tort for which the corporation is also liable (albeit in his or her capacity as officer, employee, or agent). Also of note, the tort cases in this study, as well as in those studies from other jurisdictions, constituted a relatively small proportion of the total number of cases. Possible explanations for this include the availability of liability insurance, the possibility that tort actions are settled more frequently than other claims and that, in general, corporations enter into contractual relationships more often than they commit torts. The remainder of this section consists of extracts from cases in which the court was asked to pierce the corporate veil. As you read the extracts, consider whether the outcomes in the cases are best explained by the legal reasoning articulated by the court itself, the contextual factors identified in the empirical study extracted above, or something else altogether.

Walkovszky v Carlton 26 NYS 2d 585, 223 NE 2d 6 (NY Ct App 1966) (footnotes omitted) FULD J:  This case involves what appears to be a rather common practice in the taxicab industry of vesting the ownership of a taxi fleet in many corporations, each owning only one or two cabs. The complaint alleges that the plaintiff was severely injured four years ago in New York City when he was run down by a taxicab owned by the defendant Seon Cab Corporation and negligently operated at the time by the defendant Marchese. The individual defendant, Carlton, is claimed to be a stockholder of 10 corporations, including Seon, each of which has but two cabs registered in its name, and it is implied that only the minimum automobile liability insurance required by law (in the amount of $10,000) is carried on any one

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cab. Although seemingly independent of one another, these corporations are alleged to be “operated … as a single entity, unit and enterprise” with regard to financing, supplies, repairs, employees and garaging, and all are named as defendants. The plaintiff asserts that he is also entitled to hold their stockholders personally liable for the damages sought because the multiple corporate structure constitutes an unlawful attempt “to defraud members of the general public” who might be injured by the cabs. The defendant Carlton has moved, pursuant to CPLR 3211(a), to dismiss the complaint on the ground that as to him it “fails to state a cause of action.” The court at Special Term granted the motion but the Appellate Division, by a divided vote, reversed, holding that a valid cause of action was sufficiently stated. The defendant Carlton appeals to us, from the nonfinal order, by leave of the Appellate Division on a certified question. The law permits the incorporation of a business for the very purpose of enabling its proprietors to escape personal liability (see, e.g., Bartle v. Home Owners Co-op., 309 NY 103, 106, 127 NE 2d 832, 833) but, manifestly, the privilege is not without its limits. Broadly speaking, the courts will disregard the corporate form, or, to use accepted terminology, “pierce the corporate veil,” whenever necessary “to prevent fraud or to achieve equity.” (International Aircraft Trading Co. v. Manufacturers Trust Co., 297 NY 285, 292, 79 NE 2d 249, 252.) In determining whether liability should be extended to reach assets beyond those belonging to the corporation, we are guided, as Judge Cardozo noted, by “general rules of agency.” (Berkey v. Third Ave. Ry. Co., 244 NY 84, 95, 155 NE 58, 61, 50 ALR 599.) In other words, whenever anyone uses control of the corporation to further his own rather than the corporation’s business, he will be liable for the corporation’s acts “upon the principle of Respondeat superior applicable even where the agent is a natural person.” (Rapid Tr. Subway Constr. Co. v. City of New York, 259 NY 472, 488, 182 NE 145, 150.) Such liability, moreover, extends not only to the corporation’s commercial dealings … but to its negligent acts as well. … •  •  •

In the Mangan case (247 App. Div. 853, 286 NYS 666, mot. for lv. to app. den. 272 NY 676, 286 NYS 666, …), the plaintiff was injured as a result of the negligent operation of a cab owned and operated by one of four corporations affiliated with the defendant Terminal. Although the defendant was not a stockholder of any of the operating companies, both the defendant and the operating companies were owned, for the most part, by the same parties. The defendant’s name (Terminal) was conspicuously displayed on the sides of all of the taxis used in the enterprise and, in point of fact, the defendant actually serviced, inspected, repaired and dispatched them. These facts were deemed to provide sufficient cause for piercing the corporate veil of the operating company—the nominal owner of the cab which injured the plaintiff—and holding the defendant liable. The operating companies were simply instrumentalities for carrying on the business of the defendant without imposing upon it financial and other liabilities incident to the actual ownership and operation of the cabs. … •  •  •

In the case before us, the plaintiff has explicitly alleged that none of the corporations “had a separate existence of their own” and, as indicated above, all are named as defendants. However, it is one thing to assert that a corporation is a fragment of a larger corporate combine which actually conducts the business. (See Berle, The Theory of Enterprise Entity, 47 Col.L.Rev. 343, 348-350.) It is quite another to claim that the corporation is a

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“dummy” for its individual stockholders who are in reality carrying on the business in their personal capacities for purely personal rather than corporate ends. (See African Metals Corp. v. Bullowa, 288 NY 78, 85, 41 NE 2d 366, 469.) Either circumstance would justify treating the corporation as an agent and piercing the corporate veil to reach the principal but a different result would follow in each case. In the first, only a larger corporate entity would be held financially responsible … while, in the other, the stockholder would be personally liable. … Either the stockholder is conducting the business in his individual capacity or he is not. If he is, he will be liable; if he is not, then it does not matter—insofar as his personal liability is concerned—that the enterprise is actually being carried on by a larger “enterprise entity.” (See Berle, The Theory of Enterprise Entity, 47 Col.L.Rev. 343.) At this stage in the present litigation, we are concerned only with the pleadings and, since CPLR 3014 permits causes of action to be stated “alternatively or hypothetically,” it is possible for the plaintiff to allege both theories as the basis for his demand for judgment. In ascertaining whether he has done so, we must consider the entire pleading, deducing therefrom “whatever can be imputed from its statements by fair and reasonable intendment.”  … Reading the complaint in this case most favorably and liberally, we do not believe that there can be gathered from its averments the allegations required to spell out a valid cause of action against the defendant Carlton. The individual defendant is charged with having “organized, managed, dominated and controlled” a fragmented corporate entity but there are no allegations that he was conducting business in his individual capacity. Had the taxicab fleet been owned by a single corporation, it would be readily apparent that the plaintiff would face formidable barriers in attempting to establish personal liability on the part of the corporation’s stockholders. The fact that the fleet ownership has been deliberately split up among many corporations does not ease the plaintiff ’s burden in that respect. The corporate form may not be disregarded merely because the assets of the corporation, together with the mandatory insurance coverage of the vehicle which struck the plaintiff, are insufficient to assure him the recovery sought. If Carlton were to be held individually liable on those facts alone, the decision would apply equally to the thousands of cabs which are owned by their individual drivers who conduct their businesses through corporations organized pursuant to section 401 of the Business Corporation Law, Consol. Laws, c. 4 and carry the minimum insurance required by [section 370 of the Vehicle and Traffic Law]. These taxi owneroperators are entitled to form such corporations (cf. Elenkrieg v. Siebrecht, 238 NY 254, 144 NE 519, 34 ALR 592), and we agree with the court at Special Term that, if the insurance coverage required by statute “is inadequate for the protection of the public, the remedy lies not with the courts but with the Legislature.” It may very well be sound policy to require that certain corporations must take out liability insurance which will afford adequate compensation to their potential tort victims. However, the responsibility for imposing conditions on the privilege of incorporation has been committed by the Constitution to the Legislature (NY Const., art. X, s. 1) and it may not be fairly implied, from any statute, that the Legislature intended, without the slightest discussion or debate, to require of taxi corporations that they carry automobile liability insurance over and above that mandated by the Vehicle and Traffic Law. This is not to say that it is impossible for the plaintiff to state a valid cause of action against the defendant Carlton. However, the simple fact is that the plaintiff has just not done so here. While the complaint alleges that the separate corporations were

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undercapitalized and that their assets have been intermingled, it is barren of any “sufficiently particular(ized) statements” … that the defendant Carlton and his associates are actually doing business in their individual capacities, shuttling their personal funds in and out of the corporations “without regard to formality and to suit their immediate convenience.” (Weisser v. Mursam Shoe Corp., 2 Cir., 127 F2d 344, 345, 145 ALR 467, …). Such a “perversion of the privilege to do business in a corporate form” (Berkey v. Third Ave. Ry. Co., 244 NY 84, 95, 155 NE 58, 61, 50 ALR 599,  …) would justify imposing personal liability on the individual stockholders. (See African Metals Corp. v. Bullowa, 288 NY 78, 41 NE 2d 466, …). Nothing of the sort has in fact been charged, and it cannot reasonably or logically be inferred from the happenstance that the business of Seon Cab Corporation may actually be carried on by a larger corporate entity composed of many corporations which, under general principles of agency, would be liable to each other’s creditors in contract and in tort. In point of fact, the principle relied upon in the complaint to sustain the imposition of personal liability is not agency but fraud. Such a cause of action cannot withstand analysis. If it is not fraudulent for the owner-operator of a single cab corporation to take out only the minimum required liability insurance, the enterprise does not become either illicit or fraudulent merely because it consists of many such corporations. The plaintiff ’s injuries are the same regardless of whether the cab which strikes him is owned by a single corporation or part of a fleet with ownership fragmented among many corporations. Whatever rights he may be able to assert against parties other than the registered owner of the vehicle come into being not because he has been defrauded but because, under the principle of Respondeat superior, he is entitled to hold the whole enterprise responsible for the acts of its agents. In sum, then, the complaint falls short of adequately stating a cause of action against the defendant Carlton in his individual capacity. … KEATING J (dissenting):  The defendant Carlton, the shareholder here sought to be held for the negligence of the driver of a taxicab, was a principal shareholder and organizer of the defendant corporation which owned the taxicab. The corporation was one of 10 organized by the defendant, each containing two cabs and each cab having the “minimum liability” insurance coverage mandated by section 370 of the Vehicle and Traffic Law. The sole assets of these operating corporations are the vehicles themselves and they are apparently subject to mortgages. From their inception these corporations were intentionally undercapitalized for the purpose of avoiding responsibility for acts which were bound to arise as a result of the operation of a large taxi fleet having cars out on the street 24 hours a day and engaged in public transportation. And during the course of the corporations’ existence all income was continually drained out of the corporations for the same purpose. The issue presented by this action is whether the policy of this State, which affords those desiring to engage in a business enterprise the privilege of limited liability through the use of the corporate device, is so strong that it will permit that privilege to continue no matter how much it is abused, no matter how irresponsibly the corporation is operated, no matter what the cost to the public. I do not believe that it is. Under the circumstances of this case the shareholders should all be held individually liable to this plaintiff for the injuries he suffered. (See Mull v. Colt Co., DC, 31 FRD 154,

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156; Teller v. Clear Serv. Co., 9 Misc. 2d 495, 173 NYS 2d 183.) At least, the matter should not be disposed of on the pleadings by a dismissal of the complaint. “If a corporation is organized and carries on business without substantial capital in such a way that the corporation is likely to have no sufficient assets available to meet its debts, it is inequitable that shareholders should set up such a flimsy organization to escape personal liability. The attempt to do corporate business without providing any sufficient basis of financial responsibility to creditors is an abuse of the separate entity and will be ineffectual to exempt the shareholders from corporate debts. It is coming to be recognized as the policy of law that shareholders should in good faith put at the risk of the business unincumbered capital reasonably adequate for its prospective liabilities. If capital is illusory or trifling compared with the business to be done and the risks of loss, this is a ground for denying the separate entity privilege.” (Ballantine, Corporations (rev.  ed., 1946), s.  129, pp. 302-303.) In Minton v. Cavaney, 56 Cal.2d 576, 15 Cal.Rptr. 641, 364 P2d 473, the Supreme Court of California had occasion to discuss this problem in a negligence case. The corporation of which the defendant was an organizer, director and officer operated a public swimming pool. One afternoon the plaintiffs’ daughter drowned in the pool as a result of the alleged negligence of the corporation. Justice Roger Traynor, speaking for the court, outlined the applicable law in this area. “The figurative terminology ‘alter ego’ and ‘disregard of the corporate entity,’” he wrote, “is generally used to refer to the various situations that are an abuse of the corporate privilege. … The equitable owners of a corporation, for example, are personally liable when they treat the assets of the corporation as their own and add or withdraw capital from the corporation at will …; when they hold themselves out as being personally liable for the debts of the corporation … [o]r when they provide inadequate capitalization and actively participate in the conduct of corporate affairs.” (56 Cal.2d, p. 579, 15 Cal.Rptr., p. 643, 364 P2d, p. 475; italics supplied.) Examining the facts of the case in light of the legal principles just enumerated, he found that “[it was] undisputed that there was no attempt to provide adequate capitalization. [The corporation] never had any substantial assets. It leased the pool that it operated, and the lease was forfeited for failure to pay the rent. Its capital was ‘trifling compared with the business to be done and the risks of loss.’” (56 Cal.2d, p. 580, 15 Cal.Rptr., p. 643, 364 P.2d p. 475.) It seems obvious that one of “the risks of loss” referred to was the possibility of drownings due to the negligence of the corporation. And the defendant’s failure to provide such assets or any fund for recovery resulted in his being held personally liable. In Anderson v. Abbott, 321 US 349, 64 S.Ct. 531, 88 L.Ed. 793, the defendant shareholders had organized a holding company and transferred to that company shares which they held in various national banks in return for shares in the holding company. The holding company did not have sufficient assets to meet the double liability requirements of the governing Federal statutes which provided that the owners of shares in national banks were personally liable for corporate obligations “to the extent of the amount of their stock therein, at the par value thereof, in addition to the amount invested in such shares” (US Code, tit. 12, former s. 63). The court had found that these transfers were made in good faith, that other defendant shareholders who had purchased shares in the holding company had done so in good

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faith and that the organization of such a holding company was entirely legal. Despite this finding, the Supreme Court, speaking through Mr. Justice Douglas, pierced the corporate veil of the holding company and held all the shareholders, even those who had no part in the organization of the corporation, individually responsible for the corporate obligations as mandated by the statute. “Limited liability,” he wrote, “is the rule, not the exception; and on that assumption large undertakings are rested, vast enterprises are launched, and huge sums of capital attracted. But there are occasions when the limited liability sought to be obtained through the corporation will be qualified or denied. Mr. Chief Judge Cardozo stated that a surrender of that principle of limited liability would be made ‘when the sacrifice is so essential to the end that some accepted public policy may be defended or upheld.’ … The cases of fraud make up part of that exception … But they do not exhaust it. An obvious inadequacy of capital, measured by the nature and magnitude of the corporate undertaking, has frequently been an important factor in cases denying stockholders their defense of limited liability.  … That rule has been invoked even in absence of a legislative policy which undercapitalization would defeat. It becomes more important in a situation such as the present one where the statutory policy of double liability will be defeated if impecunious bank-stock holding companies are allowed to be interposed as non-conductors of liability. It has often been held that the interposition of a corporation will not be allowed to defeat a legislative policy, whether that was the aim or only the result of the arrangement … . ‘[T]he courts will not permit themselves to be blinded or deceived by mere forms of law’ but will deal ‘with the substance of the transaction involved as if the corporate agency did not exist and as the justice of the case may require.’” (321 US, pp. 362-363, 64 S.Ct., p. 537; emphasis added.) The policy of this State has always been to provide and facilitate recovery for those injured through the negligence of others. The automobile, by its very nature, is capable of causing severe and costly injuries when not operated in a proper manner. The great increase in the number of automobile accidents combined with the frequent financial irresponsibility of the individual driving the car led to the adoption of section 388 of the Vehicle and Traffic Law which had the effect of imposing upon the owner of the vehicle the responsibility for its negligent operation. It is upon this very statute that the cause of action against both the corporation and the individual defendant is predicated. In addition the Legislature, still concerned with the financial irresponsibility of those who owned and operated motor vehicles, enacted a statute requiring minimum liability coverage for all owners of automobiles. The important public policy represented by both these statutes is outlined in section 310 of the Vehicle and Traffic Law. That section provides that: “The legislature is concerned over the rising toll of motor vehicle accidents and the suffering and loss thereby inflicted. The legislature determines that it is a matter of grave concern that motorists shall be financially able to respond in damages for their negligent acts, so that innocent victims of motor vehicle accidents may be recompensed for the injury and financial loss inflicted upon them.” The defendant Carlton claims that, because the minimum amount of insurance required by the statute was obtained, the corporate veil cannot and should not be pierced despite the fact that the assets of the corporation which owned the cab were “trifling compared with the business to be done and the risks of loss” which were certain to be encountered. I do not agree.

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The Legislature in requiring minimum liability insurance of $10,000, no doubt, intended to provide at least some small fund for recovery against those individuals and corporations who just did not have and were not able to raise or accumulate assets sufficient to satisfy the claims of those who were injured as a result of their negligence. It certainly could not have intended to shield those individuals who organized corporations, with the specific intent of avoiding responsibility to the public, where the operation of the corporate enterprise yielded profits sufficient to purchase additional insurance. Moreover, it is reasonable to assume that the Legislature believed that those individuals and corporations having substantial assets would take out insurance far in excess of the minimum in order to protect those assets from depletion. Given the costs of hospital care and treatment and the nature of injuries sustained in auto collisions, it would be unreasonable to assume that the Legislature believed that the minimum provided in the statute would in and of itself be sufficient to recompense “innocent victims of motor vehicle accidents * * * for the injury and financial loss inflicted upon them.” The defendant, however, argues that the failure of the Legislature to increase the minimum insurance requirements indicates legislative acquiescence in this scheme to avoid liability and responsibility to the public. In the absence of a clear legislative statement, approval of a scheme having such serious consequences is not to be so lightly inferred. The defendant contends that the court will be encroaching upon the legislative domain by ignoring the corporate veil and holding the individual shareholder. This argument was answered by Mr. Justice Douglas in Anderson v. Abbott, supra, pp. 366-367, 64 S.Ct. p. 540, where he wrote that: “In the field in which we are presently concerned, judicial power hardly oversteps the bounds when it refuses to lend its aid to a promotional project which would circumvent or undermine a legislative policy. To deny it that function would be to make it impotent in situations where historically it has made some of its most notable contributions. If the judicial power is helpless to protect a legislative program from schemes for easy avoidance, then indeed it has become a handy implement of high finance. Judicial interference to cripple or defeat a legislative policy is one thing; judicial interference with the plans of those whose corporate or other devices would circumvent that policy is quite another. Once the purpose or effect of the scheme is clear, once the legislative policy is plain, we would indeed forsake a great tradition to say we were helpless to fashion the instruments for appropriate relief.” (Emphasis added.) The defendant contends that a decision holding him personally liable would discourage people from engaging in corporate enterprise. What I would merely hold is that a participating shareholder of a corporation vested with a public interest, organized with capital insufficient to meet liabilities which are certain to arise in the ordinary course of the corporation’s business, may be held personally responsible for such liabilities. Where corporate income is not sufficient to cover the cost of insurance premiums above the statutory minimum or where initially adequate finances dwindle under the pressure of competition, bad times or extraordinary and unexpected liability, obviously the shareholder will not be held liable (Henn, Corporations, p. 208, n. 7). The only types of corporate enterprises that will be discouraged as a result of a decision allowing the individual shareholder to be sued will be those such as the one in question, designed solely to abuse the corporate privilege at the expense of the public interest. For these reasons I would vote to affirm the order of the Appellate Division.

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[Desmond CJ and Van Voorhis, Burke, and Scileppi JJ concurred with Fuld J; Bergan J concurred with Keating J in dissent.]

Rockwell Developments Ltd v Newtonbrook Plaza Ltd [1972] 3 OR 199 (CA) [Samuel Kelner, a lawyer from Toronto, had incorporated a number of companies to facilitate his real estate development investments, of which Rockwell was one. At the relevant time, Rockwell had 26 shares: 1 held by Kelner, 1 held by his business partner, 1 held by an employee, and the remainder held by Planet Development Corporation Ltd., a company of which Kelner was the sole beneficial owner. Rockwell made an offer (signed by Kelner as its secretary) to purchase property from Newtonbrook Plaza Ltd., which was owned by Abraham Parsham. Due to zoning difficulties, Rockwell asserted a right to close the transaction in the purchase price, while Newtonbrook asserted that Rockwell could either close the transaction in accordance with its terms, or call it off. Rockwell executed and registered a document described as an “assignment.” Rockwell subsequently sued Newtonbrook for specific performance with an abatement in price, and Newtonbrook (in a separate action) sued Rockwell for a declaration that the original agreement of purchase and sale was null and void, claimed an order expunging the registration of the assignment, and further claimed damages for slander of title. At trial, the judge ruled in favour of Newtonbrook, and ordered that the assignment be expunged from the Registry Office. When Rockwell failed to pay Newtonbrook’s costs (taxed at $4,800), Newtonbrook brought a substantive motion asking the judge to order Kelner to pay them personally.] ARNUP JA:  … There was no resolution of the directors of Rockwell authorizing Kelner to enter into the offer to purchase on its behalf; the deposit of $10,000 was advanced by Kelner and his partner Cooper from their own funds, direct to Newtonbrook or its agent, and did not go through the bank account of Rockwell nor was there any entry in Rockwell’s books of account respecting it. The tendered sum of $28,000 which preceded the action was also advanced by Kelner or Cooper, and did not go through the bank account or books of Rockwell. In due course both the deposit of $10,000 and the tendered amount of $28,000 found [their] way back to Kelner and Cooper. There was no resolution of the directors authorizing the institution of Rockwell’s action against Newtonbrook, nor the defence of the action of Newtonbrook against Rockwell. There was no resolution respecting the retainer of solicitors, although solicitors were retained to prosecute Rockwell’s action and to defend Newtonbrook’s action against it. Both in 1967 and subsequently, Rockwell had literally no assets except a small bank account which had dwindled from about $400 in 1964 to $31.85 in October, 1970, when Kelner was examined as an officer of Rockwell in aid of the judgment. On the last-mentioned date Rockwell’s solicitors had not been paid; by the time the motion was heard

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they had been paid, by Kelner and Cooper, again the moneys going direct from Kelner and Cooper to the solicitors, with no entry in the books of account of the company. Kelner described the putting up of the deposit, the tender money, and the amount required to pay Rockwell’s solicitors as being “shareholders’ loans,” and stated that “our accountant would pick this up in due course.” There is no reference anywhere in the books or records of Rockwell to any shareholders’ loans. In his affidavit Kelner swore as follows: 3.  In the case of the property in issue in the above action the two principal shareholders were to be my partner Irwin Cooper and myself but the land upon which it was intended that an apartment building be erected was to be owned by Rockwell Developments Limited. … 8.  The true purchaser was at all times Rockwell Developments Limited and such company was the true plaintiff in the action launched on behalf of Rockwell Developments Limited against Newtonbrook Plaza Limited in the action to enforce the agreement of purchase and sale. •  •  •

… Turning to the merits of the appeal … Parker J … found that “Kelner was the actual contracting party and the person who set this process in action …, he was the actual litigant and Rockwell was only a nominee to hold title.” With great respect, I am unable to agree with these conclusions. The use of a “one man company” for the carrying on of business transactions, authoritatively recognized and expressed in Salomon v. Salomon & Co., [1897] AC 22, and the correlative propositions that the property of the company is distinct from that of its members, and its transactions create legal rights and obligations vested in the company itself as opposed to its members, continue today. … I can find no basis for the finding that Mr. Kelner was the “actual contracting party.” He was undoubtedly the individual who would ultimately benefit, in whole or in part, from the contract, but the contract was made with the company alone. Mr. Kelner could not have sued upon it, nor could he himself have been sued. Both he and Mr. Parsham were pursuing the same course of action; they were quite content to enter into contracts made by the companies which they respectively controlled. It was undoubtedly the fact that Kelner was “the person who set this process in action,” in the sense that he was the individual who, on behalf of the company, gave instructions to its solicitors, but this does not, in my view, justify a finding that he was “the actual Litigant.” Nor can I find justification for the finding that “Rockwell was only a nominee to hold title.” This seems to imply that Rockwell was a trustee for Kelner, but it is contrary to all established principles of company law to suggest that a corporation is a trustee for its shareholders, or even for its single shareholder. On the evidence, there were to be other shareholders—certainly Mr. Cooper, according to Kelner’s evidence—and there is a reference in the judgment of Parker J at trial to the real estate agent who negotiated the transaction, and who was known to Kelner, and to the evidence that “at the time the deposit was paid there was an agreement between (the agent) and Mr. Kelner that (the agent) could have up to fifty per cent of the deal.” In argument Mr. Rolls conceded that “if this was a true corporate transaction, my case would be difficult or impossible.” He sought to avoid the Salomon principle by reference

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to the fact that there was nothing in the minute book or the books of account of the company concerning the transaction and indeed, apart from the fact that the company had made the offer to purchase, there was nothing in the corporate records as such, respecting the purchase. Unquestionably, the handling of the corporate records, both as to the minute book and as to the books of account, was slipshod, but no one connected with Rockwell was in a position to complain except Kelner himself. There was no allegation of fraud on the part of Kelner except one suggestion, not seriously pressed, that Kelner had “facilitated a fraudulent preference” by seeing to the payment of the account of the company’s solicitors, after the motion herein had been launched, so that those solicitors were paid in preference to “other creditors.” As already indicated, these fees were paid by Kelner and Cooper from their funds, allegedly as an advance on behalf of the corporation. If this was a fraudulent preference, it is still open to Newtonbrook to attack it if so advised. … Motion to quash dismissed; appeal allowed.

642947 Ont Ltd v Fleischer (2001), 56 OR (3d) 417 (CA) LASKIN JA:  The litigation arises out of a fight between two sophisticated developers— Burnac Corporation and George Halasi—to acquire a property in North York (the “Property”) considered key to the development of the North York corridor. The Property was owned by Jules Fleischer and Melvin Newton and leased to Sweet Dreams Delights Inc., a company controlled by Halasi and his partner Larry Krauss, a lawyer. Sweet Dreams’ lease contained a right of first refusal on any offer to buy the Property. In August 1989, 642947 Ontario Limited (“642947”), a nominee of Burnac, agreed to buy the Property for $2,000,000. Sweet Dreams exercised its right of first refusal, but later terminated the agreement. Then, in late September 1989, 642947 resubmitted its original offer to Fleischer and Newton, who accepted it and took the position that Sweet Dreams’ right of first refusal was spent. Sweet Dreams, however, obtained an interlocutory injunction restraining the sale. It gave the usual undertaking to pay any damages caused by the injunction. On the injunction application, 642947 and Burnac requested and were granted an extension of the closing date until after the injunction proceedings had concluded. In 1990, the real estate market in Metropolitan Toronto collapsed. The Property fell in value, and both Burnac and Halasi lost interest in it. Sweet Dreams’ injunction was dissolved in November 1990 and a new closing date for the sale to 642947 was fixed for December 1990. But 642947 refused to close, citing the downturn in the real estate market. 642947 sued for a declaration that its agreement with Fleischer and Newton had been terminated and for a return of its deposit. Fleischer and Newton counterclaimed for damages for breach of the agreement, and 642947 and Burnac sought to be indemnified by Sweet Dreams, Halasi and Krauss on the undertaking to pay damages. After a long trial heard in July of 1995 and 1996, Greer J held 642947 and Burnac liable for breach of the agreement of purchase and sale. She assessed damages at the date of

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closing in December 1990, though the Property fell in value afterwards. She also held that Sweet Dreams’ undertaking required it to indemnify 642947 and Burnac for their loss and she found Halasi and Krauss jointly and severally liable on the undertaking because Sweet Dreams had no assets and was simply their alter ego. All parties appealed the trial judgment. Burnac and 642947 raised several technical grounds why they were not liable to Fleischer and Newton. In turn, Fleischer and Newton contended that the trial judge erred in assessing damages at the date of closing instead of at or near the date of trial and, alternatively, that she erred in failing to order pre-judgment interest and post-judgment interest at the commercial rate instead of the statutory rate. Sweet Dreams, Halasi and Krauss submitted that they were not liable on the undertaking because 642947 and Burnac’s damages were not caused by the injunction. Finally, Halasi and Krauss submitted that even if Sweet Dreams was liable on the undertaking, the trial judge erred by piercing the corporate veil and making them liable as well. We found no merit in the appeal by 642947 and Burnac and did not call on Fleischer and Newton to respond to it. I would dismiss the appeal by Fleischer and Newton on damages. I would, however, allow the appeal by Sweet Dreams, Halasi and Krauss because, in my view, the damages awarded against 642947 and Burnac were not caused by the injunction but by the fall in the real estate market and by their deliberate refusal to close the transaction. Had I, however, found Sweet Dreams liable on its undertaking, I would have upheld the trial judge’s conclusion that Sweet Dreams’ principals, Halasi and Krauss, were also liable. •  •  •

D.  The Reasons of the Trial Judge •  •  •

[T]he trial judge dealt with 642947 and Burnac’s third party claim for indemnity based on Sweet Dreams’ undertaking. She held that the undertaking should be enforced because its non-performance is a contempt of court. She concluded that the damages she assessed, $870,000, “flow from the undertaking given by Sweet Dreams.” She also concluded that Halasi and Krauss were liable on Sweet Dreams’ undertaking because they “were the alter ego of Sweet Dreams and knew when the undertaking was given that Sweet Dreams had no assets from which to pay damages.” In her view, the undertaking was fraudulent and Halasi and Krauss misconducted themselves by offering it to the court. She thus considered it appropriate to pierce the corporate veil and hold Halasi, Krauss and Sweet Dreams jointly and severally liable both to 642947 and to Burnac, which she found was a party to the injunction. She fixed their liability at $770,000 (the amount of damages awarded to Fleischer and Newton less the deposit) together with pre-judgment interest. [After addressing the other grounds of appeal, Mr. Justice Laskin turned to the issue of whether Halasi and Krauss should be held personally liable for the damages flowing from the granting of the interlocutory injunction. In the ordinary course, an applicant seeking an interlocutory injunction provides an undertaking to pay money to compensate the responding party for any damages it suffers as a result of the granting of the injunction pending the resolution of the case. Note that the undertaking is not simply a matter of

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contract between the parties, but is an obligation given to the court. As the undertaking was given by Sweet Dreams, Halasi and Krauss, its principals, argued that the trial judge erred in holding them personally responsible for the damages.] 2.  Are Halasi and Krauss Personally Liable? Halasi and Krauss’ liability depended on finding Sweet Dreams liable on its undertaking. Because 642947 and Burnac’s claim against Sweet Dreams failed, so must their claim against the two principals of Sweet Dreams. Nonetheless, I propose to discuss the liability of Halasi and Krauss on the footing that Sweet Dreams was responsible for Burnac’s loss. I do so because the issue was fully argued before us and because I consider it relevant to the question of costs. Halasi and Krauss put forward three reasons why they should not have been held jointly and severally responsible for the damages Burnac and 642947 were ordered to pay Fleischer and Newton. First, they submitted that the trial judge erred in finding Sweet Dreams had insufficient assets to honour its undertaking if called on to pay. Second, they submitted that the adequacy of Sweet Dreams’ assets should have been raised by 642947 and Burnac on the injunction application. And, third, they submitted that the trial judge erred in piercing the corporate veil to hold them responsible. The trial judge found that, when its undertaking was given, Sweet Dreams had no assets from which to pay damages. Halasi and Krauss submitted that this finding cannot be supported on the evidence. I disagree. Sweet Dreams was used by Halasi and Krauss solely to hold their interest and their investors’ interest in the property. It had no other purpose. It had no income other than the rent it received on a sublease, a rent that was insufficient to pay its own rent to Fleischer and Newton. It had no assets other than the lease itself. Some evidence of the value of the lease, including the right of first refusal, is found in the offer made by Halasi and Krauss to sell the Property to Burnac for $50,000 more than the contract price. Even if that figure is not an accurate estimate of the lease’s value, the lease alone was inadequate to protect 642947 and Burnac from any damages they may have sustained because of the injunction. Sweet Dreams simply had no cash or liquid assets to honour its undertaking. Thus, the trial judge’s finding that Sweet Dreams did not have sufficient assets to pay a damages award is amply supported by the evidence. Indeed, Halasi admitted as much when cross-examined on his affidavit in support of the injunction. Hard cases may arise where the ability of a party to pay damages for an injunction wrongly granted may not be obvious. This is not one of those cases. Even if Sweet Dreams did not have any assets to pay a damages award, Halasi and Krauss contended that the adequacy of its assets should have been raised by Burnac on the injunction application, and that Burnac cannot, after the fact, extract what amounted to personal guarantees. Halasi and Krauss say that the adequacy of Sweet Dreams’ assets was relevant to the balance of convenience. If [it was] raised during the hearing, Sweet Dreams could have decided whether to proceed with its injunction application and, if it did, the court could have decided whether to require security or personal guarantees as a condition of granting the injunction. In substance, Halasi and Krauss’ submission puts the onus on the party seeking the undertaking—here 642947 and Burnac—to raise the adequacy of the assets of the party giving the undertaking.

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I do not accept this submission. I agree that on the injunction application Burnac could have questioned the sufficiency of Sweet Dreams’ assets. But Sweet Dreams itself had the primary obligation to disclose that its assets were inadequate to satisfy its undertaking if called on to pay. The undertaking was not given to 642947 and Burnac. It was given to the court. By undertaking to “abide by any Order concerning damages that the Court may make,” Sweet Dreams implicitly represented that it had sufficient assets to honour that undertaking. Both the court and Burnac were entitled to rely on that representation without making inquiries into its accuracy. If, as was the case here, Sweet Dreams did not have sufficient assets to honour its undertaking, it had an obligation to disclose that fact to the court. Sweet Dreams could then have asked to be relieved of its undertaking, or could have been asked to post security. Even so, Halasi and Krauss argued that the trial judge erred in law in going behind Sweet Dreams to hold them personally liable. In piercing the corporate veil and imposing personal liability, the trial judge held that Halasi and Krauss used Sweet Dreams as their alter ego and knew when the undertaking was given that Sweet Dreams had no assets from which to pay damages. She therefore concluded that “the undertaking was fraudulent and it was misconduct on the part of Krauss and Halasi as officers of Sweet Dreams to offer it to the Court.” Halasi and Krauss argued that the trial judge’s reasoning reflects two errors: Sweet Dreams was not their alter ego, indeed, they were not even shareholders of Sweet Dreams; and the corporate veil should not have been pierced because Halasi and Krauss incorporated Sweet Dreams for a valid purpose—to hold property—and did not use the company as a sham to perpetrate a fraud. The first argument is specious. Halasi and Krauss, through companies they owned or controlled, each held 40 per cent of the shares of Sweet Dreams. They described themselves as “partners” in trying to assemble land in the North York corridor. Whatever the legal form, they controlled Sweet Dreams and the interest it held in the property. The trial judge’s finding that “Sweet Dreams was merely the alter ego of both Halasi and Krauss” was open to her on this evidence and I would not interfere with it. Halasi and Krauss’ second argument is that the trial judge disregarded well-known principles of corporate law in holding them personally liable. In my opinion, however, the trial judge took the correct view in concluding that “Krauss and Halasi cannot hide behind the corporate veil.” To pierce the corporate veil is to disregard the separate legal personality of a corporation, a fundamental principle of corporate law recognized in Salomon v. Salomon & Co., [1897] AC 22, [1895-1899] All ER Rep. 33. Only exceptional cases—cases where applying the Salomon principle would be “flagrantly” unjust—warrant going behind the company and imposing personal liability. Thus, in Clarkson Co. v. Zhelka, [1967] 2 OR 565 at p. 578, 64 DLR (2d) 457 (HCJ), Thompson J held that instances in which the corporate veil has been pierced “represent refusals to apply the logic of the Salomon case where it would be flagrantly opposed to justice.” Similarly, Wilson J observed in Kosmopoulos v. Constitution Insurance Co., [1987] 1 SCR 2 at p. 10, 34 DLR (4th) 208, that the law on when the corporate veil can be pierced “follows no consistent principle. The best that can be said is that the ‘separate entities’ principle is not enforced when it would yield a result ‘too flagrantly opposed to justice, convenience or the interests of the Revenue’: L.C.B. Gower, Modern Company Law (4th ed. 1979), at p. 112.”

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Typically, the corporate veil is pierced when the company is incorporated for an illegal, fraudulent or improper purpose. But it can also be pierced if when incorporated “those in control expressly direct a wrongful thing to be done”: Clarkson Co. v. Zhelka at p. 578. Sharpe J set out a useful statement of the guiding principle in Transamerica Life Insurance Co. of Canada v. Canada Life Assurance Co. (1996), 28 OR (3d) 423 at pp. 433-34 (Gen. Div.), aff ’d. [1997] OJ No. 3754 (CA): “the courts will disregard the separate legal personality of a corporate entity where it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct.” These authorities indicate that the decision to pierce the corporate veil will depend on the context. They also indicate that the separate legal personality of the corporation cannot be lightly set aside. Yet, however restrictive corporate law principles for piercing the corporate veil may be, in the context of an undertaking to the court, the trial judge’s findings support going behind Sweet Dreams and imposing personal liability. She found that Sweet Dreams had no assets to honour its undertaking, that Halasi and Krauss controlled Sweet Dreams and that when Halasi and Krauss tendered the undertaking for Sweet Dreams they knew it had no assets. All of these findings are reasonably supported by the evidence. Moreover, Halasi was a sophisticated developer and Krauss was a lawyer. They tendered an undertaking to the court, which they knew was worthless, to gain an advantage. When called on to honour the undertaking, they tried to hide behind a shell company, which they controlled, to escape liability. In the words of Sharpe J in Transamerica Life, Sweet Dreams was “completely dominated and controlled” by Halasi and Krauss, and used by them “as a shield for … improper conduct.” The trial judge put it this way in a passage that I endorse: Undertakings cannot be lightly given to the Court to selfishly protect the self-interest of the parties giving the undertaking. It would be a mockery of injunction proceedings if that were so. It would effectively mean that worthless hollow undertakings could be given to the Court, leaving the Court powerless to grant effective sanctions by way of damages which, in the final analysis, could never be collected by the injured party.

Had I upheld the trial judge’s finding that Sweet Dreams was liable on its undertaking, I would have also upheld her finding that Halasi and Krauss were liable. But as I said at the outset of this discussion, Halasi and Krauss could be held liable only if Sweet Dreams were liable. Because Burnac and 642947 could not show a causal connection between the injunction and the damages they suffered, they cannot look to Sweet Dreams and therefore to Halasi and Krauss for indemnification. I would therefore allow the appeal by Sweet Dreams, Halasi and Krauss and dismiss the third party claim against them. I would, however, deprive them of their costs both at trial and on appeal. The trial judge took a dim view of their conduct and so do I. Indeed, in the dispute between 642947 and Burnac on the one side, and Sweet Dreams, Halasi and Krauss on the other, neither occupies the moral high ground. 642947 and Burnac refused to honour their bargain; Sweet Dreams, Halasi and Krauss exercised a right—the right of first refusal—that was spent after the first agreement in order to obtain the injunction. At the hearing of the injunction, they told the motions judge that they were willing to buy the Property for $2,000,000. Then they too abandoned the Property and the injunction when the market fell. Burnac and 642947 must bear full responsibility for the vendors’ loss. Although Sweet

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Dreams, Halasi and Krauss have been successful, because of their conduct I would not award them any costs.

De Salaberry Realties Ltd v Minister of National Revenue (1974), 46 DLR (3d) 100 (FCTD), aff ’d (1976), 70 DLR (3d) 706 (FCA) DECARY J:  The appeal is from income tax assessments for the years 1963, 1964 and 1965, confirmed by a judgment of the Tax Appeal Board on September 3, 1970, and pertaining to the profit realized by the appellant in selling land alleged to be purchased only for shopping centre purposes. … The Court requested counsel to establish the chain of authority for the final policy and decision-making for the two ultimate beneficial owners, the Bronfman and the Steinberg families. … The evidence discloses that, during the pertinent years, the way of proceeding for each group, was to cause to have a company incorporated per one or few purchases. It would be naive to believe that the multiplicity of companies ensuing was wanted for business reasons and not for tax reasons. Indeed each company sells one or a few parcels of land whereas the group sells many. The Court cannot confine itself, for passing judgment on the course of conduct, to the one of the appellant but must resort to the one of the groups. I do not conceive a medical doctor having to make a diagnosis on the general state of health of a patient that would examine only his right arm. Complete examination is required for the medical doctor and so is it needed in the present instance: the appellant is a member of the body of the Bronfmans and of the Steinbergs. Considering that finding, the rule of Salomon v. A. Salomon & Co. Ltd., [1897] AC 22 (HL), cannot be invoked for refraining the Court from passing judgment on the course of conduct of the groups of the sister companies and of the parent companies of the appellant. •  •  •

It is in evidence that Cemps Investments Ltd. is owned and controlled by trusts settled by the Bronfman family and that Steinberg’s Ltd. is owned and controlled by the Steinberg family. As to the Bronfman family, the Cemps Investments Ltd. owns all the shares of Cemps Holdings Ltd. now the Fairview Corporation of Canada Limited. The business of Cemps Holdings Ltd. is, inter alia, to manage the dealing in land of its wholly-owned or partlyowned subsidiaries which are sub-subsidiaries or grandchildren corporations of Cemps Investments Ltd. The sub-subsidiaries are the legal owners of land at the times relevant to this appeal. As to the Steinberg family, Steinberg’s Limited owns all the shares of Ivanhoe Corporation. The business of Ivanhoe Corporation is the same as the one of Cemps Holdings Ltd., it owns shares of subsidiaries that are legal owners of land at the times relevant to this appeal. After a careful study of the market possibility and the population growth, Cemps Holdings Ltd. or Ivanhoe Corporation causes a company to be incorporated to purchase

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a parcel of land. No attention is given to the matter of zoning before purchasing because it is assumed that any difficulty in that respect can be overcome. … The officers and directors of each of these sub-subsidiaries, sister companies, are the same persons; the objects of the companies are similar; they are managed by their parent company which in turn, on a general policy level, is governed by their grand parent company. The structure is the same in the Bronfman and in the Steinberg group. Though there may be only one or two purchases, the area being large, too big for the needs, there are many sales made by the sub-subsidiaries, sister companies of the appellant; in fact, it is in evidence that the two parent companies, Cemps Holdings Ltd. and Ivanhoe Corporation are often approached by people wanting to buy land though no advertisement is made by them. I deduce that it has to be known that their subsidiaries have excess land and that they are willing to sell. Notice should be taken that it is not the sub-subsidiaries that are approached but the subsidiaries, Cemps Holdings Ltd. and Ivanhoe Corporation. That indicates that the centre of policy and decision-making is not at the level of the sub-subsidiaries but closer to the grandparent companies, Cemps Investments Ltd. and Steinberg’s Ltd. The directors of Cemps Holdings Ltd. and Ivanhoe Corporation are nominees of their parent company and therefore under their influence. By purchasing, even if forced to, more land than reasonably required, it is evident that the appellant, like the group, has the intention to sell the excess which is of no other use. It is inventory for the appellant. The appellant is an instrument of his parent company and its grandparent company in purchasing and selling land. I do regard the appellant as a legal entity distinct from the other companies of each group but I look at each group to find out the course of conduct which stamps the one of the appellant, an instrument of the group. That the appellant is an instrument of the group is revealed by its thin capitalization: $1,000 divided in 100 shares of a par value of $10 each. With such a thin capitalization the appellant made two purchases amounting to nearly two million dollars. Funds had to be obtained from the two groups. That is a strong clue that the appellant is nothing but an instrument of its grandparent companies, of the two families, but a liability of such an amount warrants a certainty of available funds from the groups. The little, if any, attention paid to zoning and the assumption that any difficulty in that regard could be overcome, have been proven wrong in the present case for the two purchases of the appellant. In my opinion, such carelessness about zoning indicates strongly that the main objective is to acquire land that can always be disposed of if the plans are frustrated. To me, that and the thin capitalization are the birth of a sham or of a docile instrument. Primarily there is a slight desire of building a shopping centre and secondarily there is an intention to sell land. Such a way of doing, in my opinion, is not serious and is prompted only for possible tax advantages. To grasp the magnitude of the Bronfman and the Steinberg groups, I think it is required to know of the corporations of each group. In the Bronfman group, there are the trusts owning all the shares of Cemps Investments Limited and that company owns all the shares of Cemps Holdings Limited at times relevant to this appeal, now the Fairview Corporation of Canada Limited, and Cemps Holdings Limited owned 50% of the shares of the appellant at the time of purchase and sale of land by the appellant.

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The Fairview Corporation of Canada Limited owns all the shares of the Fairview Corporation Limited which, in turn, owns all the shares in two other companies; 51% of the shares of one company; 50% of the shares of five companies; 331/3% to 30.1% of the shares of three companies. There were 13 companies in the Bronfman group in 1972 after many subsidiaries were amalgamated during the years 1967 to 1969. There were about 10 companies so amalgamated. At the times relevant to this case the total of the companies in the Bronfman group was over 10 companies. In the Steinberg group, the family owns all the shares of Steinberg’s Limited which in turn owns all the shares of Ivanhoe Corporation. The latter company in turn owned all or a substantial part of the shares of 18 companies in the Montreal district. In the Bronfman group, we have a great-grandparent corporation, a grandparent corporation, a parent corporation and two wholly-owned sub-subsubsidiary corporations and eight companies where the interest of the parent corporation, Ivanhoe, is 50% or more. In the Steinberg group, there are the grandparent corporation, the parent corporation and 18 companies wholly or partially owned by the parent company. It is my opinion that such pyramiding of corporations, in each group, demonstrates the extent of the need not to restrict the scrutiny of the course of conduct to the one of the appellant which is only an instrument in the hands of the groups. In each group the directors of the subsidiaries, of the sub-subsidiaries and of the subsub-subsidiaries are nominees of the great-grandparent or grandparent corporation from where emanates the general policy-making and decision-taking of the group. The Court takes note that the sister-companies, those in each group of the same level as the appellant, do not deal with each other but deal only with their respective parent company, that is, Cemps Holdings Ltd. for those of the Bronfman group and Ivanhoe Corporation for those of the Steinberg group. Each of these sister companies has the same general objects and their business is essentially similar. Each one buys and sells land. If one is isolated from its sister-companies there is only one or two purchases and a few more sales. When they are reunited then their dealings are impressive and indicate that their business includes buying and selling in the ordinary course of events. Furthermore, these sister companies are all instruments of their parent companies, Cemps Holdings Ltd. and Ivanhoe Corporation, which have caused them to be incorporated; have determined their thin capitalization; have made the market and population growth surveys; have seen that pre-plans of architects be drafted that could be used for any supermarket; have been approached by people wanting to buy land owned by the appellant and its sister companies; have authorized the sale of land of the appellant and its sister companies; have dictated the course of conduct of the sister companies; have received and have obeyed the policy-making and the decision-taking of Cemps Investments Ltd. or Steinberg’s Limited, their parent company, and grandparent or greatgrandparent of the sister companies. In such a pattern there is no room for any free will on the part of the appellant and its sister companies; they are, directly, instruments of their parent corporation and, indirectly, of their grandparent or great-grandparent corporation. In view of these facts the course of conduct of the appellant must not be viewed in an isolated way but in taking into account the activities of its group. In such a light there is no doubt that the course of conduct of the appellant is the one of trader in land, and even

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in isolating the appellant, which should not be done, the course of conduct, then, is also that of a trader in land. I have perused the activities of both groups to ascertain their course of conduct and also to ascertain the course of conduct of one of their instruments, the appellant. I have disregarded the entity of the appellant in having recourse to the activities of both groups in order to judge the course of conduct of the appellant. There are precedents and authors that justify my collecting of the evidence. In Palmer and Prentice, Cases and Materials on Company Law, (1969), we find these remarks at p. 49: An attempt was made to specify the criteria which, if satisfied, would indicate that a subsidiary company was carrying on the business of the parent company by AVORY J [sic] in Smith, Stone and Knight Ltd. v. Birmingham Corporation, [1939] 4 All ER 116, noted (1939), 3 Mod. L Rev. 226: Were the profits treated as profits of the company?—when I say “the company” I mean the parent company—secondly, were the persons conducting the business appointed by the parent company? Thirdly, was the company the head and brain of the trading venture? Fourthly, did the company govern the adventure, decide what should be done and what capital should be embarked on the venture? Fifthly, did the company make the profits by its skill and direction? Sixthly, was the company in effectual and constant control?

Applying these criteria it can be said that the profits were treated as profits of the parent company: a prospectus for the issue of shares in the Ivanhoe company reveals that fact; the appointments of the persons conducting the business of the appellant were made by the two parent companies and are the same people and they also act in the parent company; the parent company is the head and brain of the trading venture; the policy is established by the parent company; the capital to be brought in the venture was decided by the parent company, whether or not, once and for all, or in each instance, and that makes no difference; it is by the skilled direction of the parent company that the profit was made; the parent company is in effectual and constant control of the appellant or the said officers of both companies are the same people paid by the parent. Ibid., on the same page, we read: In a similar vein the decision City of Toronto v. Famous Players Canadian Corporation Ltd., [1935] 3 DLR 685, [1935] 3 DLR 327 (CA), established that the business of one company can embrace the apparent or normal business of another where it can be said “that the second company is in fact the puppet of the first; when the directing mind and will of the former reaches into and through the corporate facade of the latter and becomes, itself, the manifesting agency. In such a case it is not accurate to describe the business as being carried on by the puppet for the benefit of the dominant company. The business is in fact that of the latter.”

In the present instance, the appellant is the puppet of the two parent companies, it being owned 50-50; the mind and will of the parent companies reach through the facade of the appellant. The parent companies carry, in fact, the business of the appellant. Ibid., same page:

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Chapter 3  The Corporate Form In Aluminum Company of Canada Ltd. v. City of Toronto, [1944] SCR 267, Rand J, commented that the Famous Players case [at p. 614]: … settled that the business of one company can embrace the apparent or nominal business of another company where the conditions are such that it can be said that the second company is in fact the puppet of the first; when the directing mind and will of the former reaches into and through the corporate facade of the latter and becomes, itself, the manifesting agency. In such a case it is not accurate to describe the business as being carried on by the puppet for the benefit of the dominant company. The business is in fact that of the latter. This does not mean, however, that for other purposes the subsidiary may not be the legal entity to be dealt with. The question, then, in each case, apart from formal agency which is not present here, is whether or not the parent company is in fact in such an intimate and immediate domination of the motions of the subordinate company that it can be said that the latter has, in the true sense of the expression, no independent functioning of its own.

The business of the appellant is not apparent unless recourse is to be had to the group to ascertain the over-all course of conduct, otherwise only a part of the course of conduct is apparent, the appellant being a shield; the appellant, being a subsidiary, has to be reckoned with as to the ownership of the land but its conduct must be ascertained by the course of conduct of the whole group; the appellant’s parent companies are in fact in an intimate and immediate domination of the appellant which has no independent functioning of its own. … •  •  •

In Gower, Principles of Modern Company Law, 3rd ed. (1969), we read at pp. 194-5 as to holding and subsidiary companies: The most striking limitation imposed by the Companies Acts on the recognition of the separate personality of each individual company is, however, in connection with associated companies within the same group enterprise. As we have seen, it has become a habit to create a pyramid of inter-related companies, each of which is theoretically a separate entity but in reality part of one concern represented by the group as a whole.

In the present case we have a pyramid of corporations and the appellant is part of the group of companies. Ibid., at p. 200, we read: It may therefore be said that not only has the veil been lifted in the interests of the Revenue but further steps have been taken in the interests of members towards recognizing “enterprise entity” rather than corporate entity.

As to group enterprises, which is the case we are concerned with, we read, ibid., at p. 213: Consideration of the cases in which the courts have treated a company as the agent of its controlling shareholder suggests that they are more ready to do so where the shares are held by another company. In other words, they are coming to recognise the essential unity

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V. Piercing the Corporate Veil of a group enterprise rather than the separate legal entity of each company within the group.

There is in the present case an essential unity of group enterprise which, for purposes of evidence of course of conduct, I recognize rather than the course of conduct of the separate legal entity of the appellant. [Justice DeCary then reviewed US doctrine on disregarding the corporate entity.] The matter of the lifting of the veil of the legal entity has been studied by Stone and by Friedmann. Julius Stone, Social Dimensions of Law and Justice (1966), p. 429: This second challenge is further complicated by the fact that, just as the corporate unit largely displaced the individual entrepreneur of the eighteenth century, so an institutional reality which may be called the “enterprise entity” may be displacing the legally granted corporate personality. A corporation spawns subsidiaries to extend its fields or for tax reasons; or legally separate corporations unite in substance under common controllers. While the enterprise entity is prima facie the legal corporate personality, even the law may sometimes recognise the underlying enterprise entity itself. For instance the doctrine of de facto corporations treats as the enterprise entity what has been created by agreement of the associates for the purpose at hand. Again, courts may sometimes treat more than one legal corporation as a single entity, where one has a controlling interest in the other or others and has integrated their respective affairs, for the purpose (for example) of finding a broader base for the subsidiary’s obligation. Whether reached through a theory of “agency,” or of “merger” of operations, the effect is that the enterprise entity is outlined by the Court in accordance with business or economic fact. •  •  •

Upon the evidence adduced, I find that the appellant, being a member of a horizontal group of sister companies incorporated for the same object and a member of a vertical group, there being a parent and a grandparent company for the Bronfman family and for the Steinberg family, must have its course of conduct determined by the one of its sister companies, its parent companies and its grandparent company because the appellant is only an instrument in the carrying on of the business of its parent companies and of its grandparent company, whose business of the parent and grandparent companies include, inter alia, directly or indirectly, the real estate one, under many forms and shapes, and the course of conduct of the appellant is hereby determined to be the one of a trader in land as a member of the horizontal business group and of the vertical business group of the member-companies, and the membership not being, in fact, for business reason as shown, inter alia, by the thin capitalization of the appellant and its dominance by its parent companies, consequently the profit realized in 1963, 1964 and 1965 on the sale of parcels of land is one made in the turning into account of inventory and is income of the appellant under the provisions of ss. 3 and 4 of the Income Tax Act. The appeal is dismissed with costs.

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BG Preeco I (Pacific Coast) Ltd v Bon Street Holdings Ltd (1989), 60 DLR (4th) 30, 37 BCLR (2d) 258 (CA) SEATON JA:

[1]  This litigation arises out of a contract by which the plaintiff agreed to sell property to Bon Street Developments Ltd. for $4,220,000. … [2]  … The Bon Street Developments Ltd. with whom the original discussions were held was a different company than the Bon Street Developments Ltd. that entered into the contract. The new Bon Street Developments Ltd. was a shell company. It had no assets. The company with whom they had originally dealt had changed its name to 262098 B.C. Ltd. and is now Bon Street Holdings Ltd. The defendants Kaplan and MacDonald are directors and the beneficial owners of the shares of each company. [3]  The new Bon Street Developments Ltd. was found liable for breach of contract and judgment for $1,746,336.40 was awarded against it. That company has no assets and does not appeal. [4]  The focus of the lawsuit, the appeal and the cross-appeal is on the liability of the defendants Bon Street Holdings Ltd. (the original Bon Street Developments Ltd.), Kaplan and MacDonald and the finding of the trial judge that “their actions constituted a deceit, a fraudulent misrepresentation.” Damages for fraud were assessed against those three defendants in the amount of $400,000. [5]  The plaintiff was anxious to dispose of property near Granville Island and hoped that it could be sold at a good price during the “window of opportunity” created by the imminence of Expo ‘86. There was reason to believe that this property could benefit from Expo if construction started during the summer of 1985. •  •  •

[8]  At the beginning of April 1985 Ortt met with Kaplan and MacDonald in the offices of Bon Street Developments Ltd. The business cards of Kaplan and MacDonald bore that name. That was the name on the offices, on the letterhead and in the telephone book. That was all proper at the beginning of April. Ortt was in truth dealing with the Bon Street Developments Ltd. that he thought he was. [9]  In mid-April Bon Street Developments Ltd. changed its name to 262098 B.C. Ltd. and the shell company, 286357 B.C. Ltd., on the same day changed its name to Bon Street Developments Ltd. Everything else remained the same: the business cards, the letterhead, the telephone number and the office premises.  … Even the banking arrangements remained the same. The cheques which were later paid in this transaction were in the name of Bon Street Developments Ltd. though that was the account of the original company of that name and no account has been opened for the new company. [10]  In May an interim agreement was entered into by the new company offering a $100,000 deposit and a $4,200,000 price. … [11]  It was the original company that the plaintiff dealt with at the beginning and thought it was dealing with throughout. It knew of no other company. It was the original company through its officers that led the plaintiff to that belief. It was the original company that paid the deposit of $100,000. It was the original company that bore all the expense of inquiring into the feasibility of the project. That the original company bore all the expense was said to be an accounting slip. •  •  •

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[13]  The purposes of the corporate name changes were several. A memorandum prepared by an accountant listed as the first objective: “(1) the protection of successful projects from losses arising as a result of unsuccessful projects.” [14]  According to Kaplan one of the principal functions of the corporate restructuring was to “tie down” properties. The idea was to enter into agreements using the shell company. If a project proved not to be feasible, it could be abandoned without risking the assets of the original company or the individuals. That is what was done here. •  •  •

[25]  Ortt thought he knew what company he was dealing with, Bon Street Developments Ltd., and he asked about the assets of that company. He did not know, and it was apparent to Kaplan and MacDonald that he did not know, of the switch of company names. On the evidence the conclusion is inescapable that Ortt was intentionally misled by the conduct and the statements of the defendants into believing he was dealing with the company that had the London Drugs property and other assets about which they were speaking. [Although the trial judge made a finding of fraud, the plaintiff cross-appealed, seeking compensation for the full amount, rather than the mere $400,000 in damages that had been awarded.] [31]  The plaintiff also sought … to fix liability for damages for breach of contract on the individuals and possibly the original Bon Street Developments Ltd. by an argument entitled “Lift the Corporate Veil.” The plaintiff says that company law does not protect principals of a company who acted fraudulently or dishonestly, and that in such cases, the corporate veil should be lifted to fix liability on the principals. [32]  The trial judge dealt with this question in this way: Sham

Plaintiff ’s counsel also made a submission expressed in rather general and sweeping terms that the (new) company was a mere “device and a sham” and the Court should “pierce the corporate veil” to hold the individual defendants liable on the agreement. However, the (new) company was a properly incorporated legal entity whose principals intended to operate through it for specific purposes which I have described. It had no significant assets—it was a “shell” company—but of course that per se does not mean it did not have the power to contract to purchase real estate. Indeed, I was told that that was not uncommon in the real estate industry. Furthermore, the fact that the principals of the company may have intended even at the time of undertaking the obligation on behalf of the company to take advantage of the limited liability of the company if it suited their purposes does not per se make the company a sham, i.e., does not expose its principals to liability for the company’s obligations.

[33]  There are cases in which the law will fix liability on the principals but they do not support the broad proposition put forward on the cross-appeal. •  •  •

[37]  I do not subscribe to the [doctrine] that permits the corporate veil to be lifted whenever to do otherwise is not fair. … That doctrine and the doctrine laid down in

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Salomon v. Salomon & Co.; Salomon Co. v. Salomon, [1897] A.C. 22, [1895-9] All E.R. Rep. 33 (H.L.), cannot co-exist. If it were possible to ignore the principles of corporate entity when a judge thought it unfair not to do so, Salomon’s case would have afforded a good example for the application of that approach. [38] In Kosmopoulos v. Constitution Ins. Co., [1987] 1 SCR 2 at 10-11] there is an obiter dictum that might be thought to support the [doctrine]: (a)  “Lifting the Corporate Veil”

As a general rule a corporation is a legal entity distinct from its shareholders: Salomon v. Salomon & Co., [1897] A.C. 22 (H.L.). The law on when a court may disregard this principle by “lifting the corporate veil” and regarding the company as a mere “agent” or “puppet” of its controlling shareholder or parent corporation follows no consistent principle. The best that can be said is that the “separate entities” principle is not enforced when it would yield a result “too flagrantly opposed to justice, convenience or the interests of the Revenue”: L.C.B. Gower, Modern Company Law (4th ed. 1979), at p. 112. I have no doubt that theoretically the veil could be lifted in this case to do justice, as was done in American Indemnity Co. v. Southern Missionary College, [260 S.W. 2d 269], cited by the Court of Appeal of Ontario. But a number of factors lead me to think it would be unwise to do so.

The concluding words in the chapter in L.C.B. Gower, Modern Company Law, 4th ed. (London: Stevens & Sons, 1979), from which Wilson J. quoted are these (at p. 138): The most that can be said is that the courts’ policy is to lift the veil if they think that justice demands it and they are not constrained by contrary binding authority. The results in individual cases may be commendable, but it smacks of palm-tree justice rather than the application of legal rules.

Professor Welling in Corporate Law in Canada (Toronto: Butterworths, 1984), put it more firmly. He referred to the American cases that apply the fair play rationale and said (at p. 129): Little need be said about this rationale, other than that it simply will not do. There are, so far as we know, no such broadly enforceable standards of “fair play and good conscience,” at least in Canadian corporate law.

[39] In Kosmopoulos, supra, the Court was considering an insurance question where a shareholder claimed an insurable interest in the assets of the company. That raises somewhat different problems and the Court did not lift the corporate veil in the course of its decision. •  •  •

[41]  The cases in which the corporate veil is pierced on the ground of “fraud or improper conduct” deal with instances where a corporation is used to effect a purpose or commit an act which the shareholder could not effect or commit. [42] In Gilford Motor Co. v. Horne, [1933] Ch. 935, [1933] All E.R. Rep. 109 (C.A.), the plaintiff sought an injunction to prevent the defendant, through a newly incorporated company, from breaching a restrictive covenant. The injunction was granted against both the individual and the company on the basis that the company was merely a device by which the individual defendant breached his restrictive covenant.

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[43]  Similarly, in Jones v. Lipman, [1962] 1 All E.R. 442, [1962], 1 W.L.R. 832 (Ch. D.), the plaintiff was granted specific performance of a contract entered into with the first defendant. In an attempt to avoid the contract, the first defendant sold the property in question to the second defendant, a company in which the first defendant and a clerk of his solicitor were sole shareholders. [44] In Lockharts Ltd. v. Excalibur Hldg. Ltd. (1987), 47 R.P.R. 8, 83 N.S.R. (2d) 181, 210 A.P.R. 181 (T.D.), a plaintiff was granted a declaration that its judgment against one company was binding on another company owned by the same individual, as assets had been conveyed to the second company in order to avoid the plaintiff ’s judgment. [45]  The Courts have also pierced the corporate veil so as to ignore the separate legal existence of related companies. This has been done in income tax cases. For example, see De Salaberry Realties Ltd. v. M.N.R., 46 D.L.R. (3d) 100, [1974] C.T.C. 295, 74 D.T.C. 6235 (Fed. T.D.), where the character of the company’s business was determined from a look at the business of its associated companies. •  •  •

[47]  While the group enterprise theory may be successful on certain facts, no cases were cited which would, through this theory, make one company liable for its associated company’s contracts. •  •  •

[49]  In this case the plaintiff knew it was dealing with a company. The fraud found by the trial judge caused the plaintiff to believe that the company had assets that it, in fact, did not have. That has nothing to do with the corporate veil. The use of a company as a means of avoiding bearing business losses is neither unusual nor a basis for lifting the veil. [50]  In my view, the proper remedy is not to lift the corporate veil, but to award damages for fraud against the individuals and the company that committed the fraud. … [51]  . . . Lifting the veil is no help—when it is lifted the old company is not to be seen. Neither company had shares in the other. •  •  •

[55]  The arguments of the plaintiff that would make the individual defendants or the old company liable for the damages assessed against the new company cannot succeed. NOTES AND QUESTIONS

1. In BG Preeco, the BC Court of Appeal held that the remedy awarded to the plaintiffs was on the basis of contractual fraud by the shareholders and company as opposed to piercing the corporate veil. Do you think that the court would have dealt with the veil-piercing issue differently if the plaintiffs had not been able to win their case on the basis of contractual fraud? 2.  In all of the above cases, the court was asked to consider whether a shareholder was liable for corporate obligations—that is, limited liability was at stake. In the remaining cases, only separate legal personality is at stake. In reading these cases, consider whether the fact that a shareholder’s liability is not at stake makes a difference in the reasoning or outcomes.

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Kosmopoulos v Constitution Insurance Co [1987] 1 SCR 2 [In the following case, the Supreme Court of Canada considered whether a sole shareholder holding an insurance policy on a company’s assets had an insurable interest.] WILSON J (Beetz, Lamer, Wilson, Le Dain, and La Forest JJ concurring):

[1]  The issue in this appeal is whether a sole shareholder of a corporation has an insurable interest in the assets of that corporation. The traditional view is that a sole shareholder has neither the legal nor the equitable interest in the corporate assets required for a valid insurance on those assets: Macaura v. Northern Assurance Co., [1925] AC 619 (HL). In examining the issue it will be necessary to consider first whether Macaura would provide the insurers with a valid defence in this case and, if so, whether Macaura is or should continue to be the law in Ontario. 1.  The Facts [2]  On February 7, 1972, the respondent, Andreas Kosmopoulos, entered into a commercial lease for premises located in the City of Toronto. From these premises he operated a business of manufacturing and selling leather goods under the name of Spring Leather Goods. This business was carried on as a sole proprietorship. [3]  On the advice of his solicitor Mr. Kosmopoulos incorporated Kosmopoulos Leather Goods Limited (“the company”) in order to protect his personal assets. Mr. Kosmopoulos was the sole shareholder and director of the company. Even though the business was thereafter technically carried on through the limited company, Mr. Kosmopoulos always thought that he owned the store and its assets. Virtually all the documentation required in the business, including bank accounts, sales tax permits and hydro and telephone accounts, made no reference to the company but rather to “Andreas Kosmopoulos carrying on business as Spring Leather Goods” (or some similar phrase). Although Mr. Kosmopoulos’ solicitor tried to obtain the approval of the landlord to an assignment of the lease of the premises from Mr. Kosmopoulos to the company, this approval was never obtained. The lessee at all material times was Mr. Kosmopoulos and not the company. [4]  Soon after Mr. Kosmopoulos started conducting his business in the leased premises he contacted the respondent, Aristides Roussakis, in order to obtain insurance for the contents of the business premises. The respondents, Aristides Roussakis and Art Roussakis Insurance Agency Limited (“the insurance agency”), obtained a fire insurance policy with the General Accident Group for coverage from March 14, 1972 to March 14, 1975. Even though the insurance agency was well aware of the fact that the business was being carried on by an incorporated company, the insured was described on the policy as “Andreas Kosmopoulos O/A Spring Leather Goods.” This policy was renewed but expired before the date of the loss and was replaced with subscription policies issued by Simcoe-Bay Group and Commercial Insurance Company. The appellant insurance companies are subscribing companies to the two replacement policies. Both of the replacement policies showed the insured as “Andreas Kosmopoulos O/A Spring Leather Goods.” [5]  On May 24, 1977 a fire broke out in the adjoining premises and caused fire, water and smoke damage to the assets of the company and to the rented premises. Mr.

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Kosmopoulos filed proofs of loss under the replacement policies on December 6, 1977 but the appellant companies refused payment and the present action was commenced. •  •  •

3.  The Issue [11]  Counsel for the appellant insurance companies submit that Mr. Kosmopoulos as sole shareholder had no legal or equitable interest in the company’s assets. They urge the Court to follow Macaura. Counsel for the respondents argue that the corporate veil should be lifted and, when this is done, it becomes clear that the company’s property was, in law, the property of Mr. Kosmopoulos. The Macaura case therefore provides no defence of lack of insurable interest to the insurers. Alternatively, it is submitted by the respondents that Mr. Kosmopoulos had an insurable interest as bailee of the company’s assets. Finally, the respondents urge that this Court should no longer follow Macaura. I shall deal with the respondents’ submissions in order. (a)  “Lifting the Corporate Veil” [12]  As a general rule a corporation is a legal entity distinct from its shareholders: Salomon v. Salomon & Co., [1897] AC 22 (HL). The law on when a court may disregard this principle by “lifting the corporate veil” and regarding the company as a mere “agent” or “puppet” of its controlling shareholder or parent corporation follows no consistent principle. The best that can be said is that the “separate entities” principle is not enforced when it would yield a result “too flagrantly opposed to justice, convenience or the interests of the Revenue”: L.C.B. Gower, Modern Company Law (4th ed. 1979), at p. 112. I have no doubt that theoretically the veil could be lifted in this case to do justice, as was done in American Indemnity Co. v. Southern Missionary College, supra, cited by the Court of Appeal of Ontario. But a number of factors lead me to think it would be unwise to do so. [13]  There is a persuasive argument that “those who have chosen the benefits of incorporation must bear the corresponding burdens, so that if the veil is to be lifted at all that should only be done in the interests of third parties who would otherwise suffer as a result of that choice”: Gower, supra, at p. 138. Mr. Kosmopoulos was advised by a competent solicitor to incorporate his business in order to protect his personal assets and there is nothing in the evidence to indicate that his decision to secure the benefits of incorporation was not a genuine one. Having chosen to receive the benefits of incorporation, he should not be allowed to escape its burdens. He should not be permitted to “blow hot and cold” at the same time. [14]  I am mindful too of this Court’s decision in the Aqua-Land Exploration Ltd. case, supra, in which the Court did not “lift the veil” in order to find that one of three shareholders in a corporation had an insurable interest in its asset. So also in the Wandlyn Motels Ltd. case, supra, the Court refused to regard a motel owned by a man who held all but two of the shares of the insured, Wandlyn Motels Ltd., as the property of that corporation. If the corporate veil were to be lifted in this case, then a very arbitrary and, in my view, indefensible distinction might emerge between companies with more than one shareholder and companies with only one shareholder. … In addition, it is my view that if the application of a rule leads to harsh justice, the proper course to

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follow is to examine the rule itself rather than affirm it and attempt to ameliorate its ill effects on a case-by-case basis. [15]  For all these reasons, I would not lift the corporate veil in this case. The company was a legal entity distinct from Mr. Kosmopoulos. It, and not Mr. Kosmopoulos, legally owned the assets of the business. [Madam Justice Wilson thereafter engaged in a review of the “Macaura Principle,” under which shareholders of a corporation had no insurable interest in the corporation’s assets. She declined to follow Macaura and the Supreme Court of Canada precedents implementing a restrictive definition of “insurable interest,” and held that a shareholder could have an insurable interest in the property of the corporation. She concluded that, since Mr. Kosmopoulos “was so placed with respect to the assets of the business as to have benefit from their existence and prejudice from their destruction,” he had an insurable interest and should be entitled to recover under the insurance policy. In a concurring judgement, Justice McIntyre would have maintained the Macaura principle, but allowed an exception for sole shareholders such as Mr. Kosmopoulos] Appeal dismissed. NOTES AND QUESTIONS

1.  Like the BC Court of Appeal in BG Preeco, the Supreme Court of Canada in Kosmopoulous refused to pierce the corporate veil, but still awarded the claimant seeking the veil to be pierced the desired remedy on the basis of other legal principles. Should courts generally seek to reason cases on the basis of legal principles other than piercing the corporate veil? Is such an exercise helpful or artificial? 2. In Kosmopoulous, the Supreme Court of Canada suggested that the corporate veil could be pierced by the court where the Salomon principle would lead to injustice. Do you think that the court should have a discretionary power to disregard separate legal entity or limited liability in certain cases? 3.  Granting such discretionary power to pierce the corporate veil whenever they found it equitable to do so would make application of the doctrine even more unpredictable than it already is. How would this effect the cost of doing business? To whom would those costs be passed on?

Clarkson Co Ltd v Zhelka [1967] 2 OR 565, 64 DLR (2d) 457 (H Ct J) [Selkirk was a land developer. He incorporated several companies, including Langstaff Land Developments Limited, Fidelity Real Estate Limited, Britannia Memorial Gardens Limited, St. George Developments Limited, Industrial Sites and Locations Limited, and at least two or three others. The court found that Industrial never had any money in its treasury. Its one and only asset was a parcel of 85 acres of land, which it purchased in 1959. Since Industrial had no funds, St. George and Langstaff advanced moneys in order to enable Industrial to pay for the asset. In March 1960,

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Industrial sold 45 acres to the Municipality of Metropolitan Toronto. On May 2, Industrial conveyed the rest to Zhelka, Selkirk’s sister, in return for a $120,000 promissory note. On January 21, 1961, Zhelka mortgaged the land to a third party, Gelberg. As Gelberg later began foreclosure proceedings on the property, part of the remaining parcel was sold and the cash applied to pay off both the Gelberg mortgage and a province of Ontario tax lien. An interest adjustment on the transaction in the amount of $9,249.32 “in some unexplained manner found its way into the general bank account of Fidelity Real Estate Ltd.” Selkirk petitioned for bankruptcy on June 21, 1960 and was adjudged a bankrupt on September 29, 1960. Despite this, he remained an employee or director of a number of the companies and was actively involved in their affairs. For example, the court found that despite his resignation as president of Industrial and disqualification as a director by reason of his bankruptcy, he signed the Gelberg mortgage in January 1961 as “president” of Industrial. Clarkson Co sought a declaration that the land in question was the property of Selkirk and that it should be vested in it as trustee in bankruptcy for Selkirk, for the benefit of Selkirk’s creditors.] THOMPSON J:  In this action for plaintiff as trustee of George Alexander Selkirk, a bankrupt (to whom for the sake of brevity, I shall refer as Selkirk), seeks a declaration that certain lands in the Township of North York in the Province of Ontario, described in the statement of claim, are held by the defendants, or one of them, as trustee for the plaintiff and that a certain mortgage thereupon from the defendant Zhelka to the defendant Industrial Sites and Locations Limited as mortgagee, bearing May 2, 1960, does not constitute a valid charge. The plaintiff prays for consequential judgment vesting the lands in it as such trustee in bankruptcy, free and clear of encumbrance. The determination of the issues involved revolves principally around a conveyance of the lands in question, which are of substantial value, by the corporate defendant to the individual defendant, dated May 2, 1960, and registered September 15, 1960, as No. 399806 for the Township of North York. The defendant, Zhelka, is a sister of Selkirk, the bankrupt, and resides with him, his wife and his family of four children, at 299 Russell Hill Rd. in the City of Toronto. In fact the title to this residential property is in her name. The plaintiff alleges that the corporate defendant, a private company incorporated under the laws of Ontario and promoted and organized by Selkirk was, and is to all intents and purposes, not an independent trading unit, but is and has been the mere agent of Selkirk and particularly with respect to the conveyance to Miss Zhelka. It is urged in the alternative that the company, which for the purposes of convenience I refer to as “Industrial,” is a mere sham, cloak, or front for or the alter ego of Selkirk, kept alive and operated by him for his own personal purposes and whose shareholders and directors, other than himself, are and have been his nominees and merely tools in his hands. The plaintiff goes further and argues that Industrial is but one of a group of some several similar corporations which constitute a Selkirk corporate family and whose business operations, interchange of assets, and interrelated dealings, are wholly controlled and directed by him personally to the prejudice and confusion of his personal creditors.

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In essence, the Court is asked to rend the corporate veil, to pass beyond the line which separates Industrial as an artificial person from its creator and controller Selkirk, and to declare it to be in reality Selkirk or his mere agent and without legal entity as distinct from him, at least with relation to the lands involved. The facts are complex and are made more so by the welter of contradiction throughout the evidence and the consistently inconsistent conduct of the bankrupt and the individual defendant. It was said of Selkirk in the case of Selkirk v. M.N.R., 63 DTC 108 at p. 110 that: . . . just about everyone who became associated with, or worked for, him suffered financially and would have been better off never to have met him.

In the instant case, had he deliberately set out on a course of perplexity, he could not have done better than he in fact has. Be that as it may, the plaintiff ’s allegations are akin to those of fraud and the onus of proof lies heavily upon it. The resolution of the present issues, in my view, can be arrived at only by a detailed consideration of the circumstances surrounding the attacked transaction between the defendants and the background facts relating to the relationship of Mr. Selkirk to Industrial. The plaintiff ’s allegations or theories with respect to the conveyance to Miss Zhelka are that the lands were conveyed to her to hold in trust for her brother and there thus is a resulting trust in him; that the mortgage back from her is not genuine and a mere pretence; and that the whole transaction was voluntary and without consideration and was entered into with a view to preventing the property from falling into the bankrupt’s estate and as a scheme between Selkirk and the defendants to that end. As previously intimated, the plaintiff contends that for the purposes of the impeached transaction, the grantor, although nominally Industrial, is in reality Selkirk, or alternatively, that Industrial was merely his agent therein acting upon his direction . . . . [Thompson J reviewed the history of the various corporations and transactions in detail, concluding that the mortgage “instrument was never intended to operate as a mortgage or as a genuine security upon the lands for any sum of money whatsoever.”] … I am satisfied that it was intended as a mere device, as was also the promissory note of the individual defendant, to be used in case of necessity for the purpose of defeating, hindering or delaying the creditors or prospective creditors of Industrial from recovery of their claims. •  •  •

I unhesitatingly conclude that the conveyance to Miss Zhelka and the entire transaction with her was without consideration and voluntary and entered into with the intention of protecting the lands against resort thereto by the creditors and others having claims against Industrial. Undoubtedly, Selkirk was the moving factor behind the whole plan. The weak attempt of Mrs. Selkirk to explain the reason for the mortgage and promissory note was deplorable in view of her previous affidavit in support of Industrial’s claim. Miss Zhelka’s many contradictory assertions as to the reason for the conveyance and as to the capacity in which she holds the lands served only to convince me that she had little idea of what the entire matter was about, but that she was prepared to go to any

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length to do her brother’s bidding and to meet what she considered to be his convenience or advantage. … [Thompson J then considered whether the conveyance would be open to attack by Industrial’s creditors as fraudulent and whether a finding of fraud would bring the property into Selkirk’s estate for purposes of the trustee in bankruptcy being able to use the proceeds to satisfy Selkirk’s creditors.] [T]he plaintiff does not attack the transaction as a settlement or otherwise under the Bankruptcy Act, nor as a conveyance fraudulent against the debtor’s creditors. The case is framed upon the premise that the property is held by the defendants or one of them as agent or trustee for the debtor and that it constitutes part of his estate or property passing to the plaintiff upon bankruptcy. Such considerations become still more academic in the light of the view I ultimately adopt as to the relationship between the debtor Selkirk and Industrial. There can be little doubt that the companies forming Selkirk’s corporate structure were interrelated in the sense that there were transfers of assets from one to another or advances of money as between them, although none of them was a subsidiary [of] another in the true sense of the word. It equally appears from the evidence that the only person to benefit financially from or to receive moneys arising from their operation was Selkirk himself. •  •  •

The evidence clearly demonstrates that George A. Selkirk always had and retained in fact complete control over all these companies upon which the evidence touches. He dictated the corporate policy in each case and was the moving and directing force in all of their business operations. The directors and officers, and particularly in the case of Industrial, were his nominees, including members of his immediate household and family, and were subject to his influence and I have no doubt to his domination. To all intents and purposes Industrial and its associated companies were one-man companies. In reaching such conclusions, I am, I may say, quite uninfluenced by any alleged admissions or statements said to have been made by Selkirk. There are instances throughout the evidence of statements alleged to have been made to others by him. He is not a party to the action and [as] such could not form admissible evidence for the plaintiff. Either one must consider them as entirely hearsay or as self-serving statements. We are here, of course, primarily concerned only with Selkirk’s relationship to Industrial. His connection with the other companies and their interconnection with Industrial is only of importance in so far as it may tend to establish a pattern of conduct. Industrial, despite its default in Government returns and irregularity in its proceedings, was regularly incorporated and has been kept alive as a corporate entity. Its charter has not been revoked under s. 326 of the Corporations Act, RSO 1960, c. 71, although, apparently, it has been under departmental investigation. In 1963, it was still being taxed and [had] some $14,000 levied against it under the Corporations Tax Act. There is no evidence to indicate that when Industrial was incorporated in 1958, that Selkirk was insolvent; and nowhere is evidence to be found tracing any of Selkirk’s personal assets into the hands of Industrial. The only indication that any of his personal assets passed into any of his companies is in the dictum in Selkirk v. M.N.R. earlier referred to.

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There is no intimation that at that time Selkirk was insolvent or that the transfer was in any way irregular or questionable. It does appear that later the Langstaff company advanced moneys to Industrial, but by the same token, it appears that Industrial still later advanced or repaid to Langstaff an approximately equal sum. I can see nothing unlawful or illegal per se, as against the personal creditors of Selkirk, in these interchanges of funds between companies. Even if there were an unlawful element, the only persons who were injured or damnified would be the shareholders or creditors of the companies involved. It is true that Selkirk has benefited personally from activities of his companies in dealings or transactions of questionable validity. Industrial seldom had a bank account. Rental from the buildings upon the lands in question was received by his nominee or nominees rather than by Industrial. None of it, however, has been traced into his own hands, although one might suspect that some of it at least did reach him. In any event, only a small portion of it accrued due and was paid before his bankruptcy. Fidelity Real Estate Ltd. appears recently to be the only one of the companies operating with a bank account and Industrial was indirectly the recipient of some of its funds. The moneys paid to Miss Zhelka upon the settlement of the Gelberg action, some $9,249, went into the Fidelity bank account. There [sic] were really the funds of Industrial. Out of that account were paid some of Selkirk’s personal bills for clothing, a retaining fee to a solicitor acting for him upon a criminal charge or charges of fraud pending against him and a sum offered by him by way of restitution in connection with such charge. Whether Selkirk was entitled to moneys by way of salary or otherwise from Fidelity does not appear. If he was, at the time of such payments, a director of Fidelity as he once was, and the moneys were merely a loan or an advance to him, the transaction of course would fall within the prohibition of the Corporations Act respecting loans to shareholders. The sum and substance of all this is that Selkirk has received some comparatively minor benefits from the operation of his companies and at times in a manner which, so far as regularity is concerned, is questionable. An aura of suspicion has been cast about him. I have no doubt that where his personal advantage is concerned he would go a long way. But the question remains, in what way has his association with his corporate offspring injured, defeated or prejudiced his personal creditors? Apart from a small portion of the rents which he may have received, … it would appear that all benefits have accrued since his bankruptcy and really fall into the category of after-acquired property, to which recourse by the trustee is under the provisions of the Bankruptcy Act. This is not a case where a debtor or a prospective debtor has transferred his own assets to a corporation of his making for the purpose of avoiding existing personal liabilities or obligations; nor is it a case where he has personally made a secret or clandestine profit by such a transfer. There is here no claim or complaint by any creditor, if such there now be, of Industrial or its associated companies, nor by any director or shareholder. In a critical analysis of the situation, one asks oneself just where is any fraud upon Selkirk’s personal creditors being perpetrated by the operation of his companies and his conduct with relation thereto? To me the evidence falls short of establishing that. No doubt his creditors are disappointed at their inability to have access to his corporate assets and particularly where he himself is reaping some financial benefit therefrom. But

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that must of necessity be, so long as the Legislature provides for and encourages the formation of private corporations. Without such, of course, enterprise and business adventure would be stiffed. Limited liability is one of the landmarks of incorporation. The plaintiff as trustee in bankruptcy for some reason apparently has not seen fit to follow any funds reaching the hands of his debtor as after-acquired property nor to intervene with respect thereto. The cases in which the Courts, both in this Province and in England, have seen fit to disregard the corporate entity or personality, and instead to consider the economic realities behind the legal facade, fall within a narrow compass. The Legislature, in the fields of revenue and taxation, and particularly with respect to true subsidiaries, has made much greater departure in this respect. Such cases as there are illustrate no consistent principle. The only principle laid down is that in the leading case of Salomon v. Salomon & Co. Ltd., [1897] AC 22; and in general such principle has been rigidly applied. Briefly stated, it is that the legal persona created by incorporation is an entity distinct from its shareholders and directors and that even in the case of [a] one-man company, the company is not an alias for the owner. The exceptions would appear to represent refusals to apply the logic of the Salomon case where it would be flagrantly opposed to justice. … In questions of property and capacity, of acts done and rights acquired or liabilities assumed, the company is always an entity distinct from its corporators. It is not an alias or a sham and the principle of the Salomon case stands unimpaired. If a company is formed for the express purpose of doing a wrongful or unlawful act, or, if when formed, those in control expressly direct a wrongful thing to be done, the individuals as well as the company are responsible to those to whom liability is legally owed. In such cases, or where the company is the mere agent of a controlling corporator, it may be said that the company is a sham, cloak or alter ego or his mere agent for the conduct of his personal business or for the purposes of the conveyance in question to the defendant Zhelka. In the result, the action must be dismissed.

Yaiguaje v Chevron Corporation 2017 ONSC 135 (some footnotes incorporated into text) [The plaintiffs were residents of Ecuador who sued Texaco over damage caused by exploitation and extraction activities from 1964 to 1992. The region suffered extensive environmental pollution that seriously disrupted the lives of its residents. Chevron merged with Texaco in 2003. The plaintiffs were successful, but Chevron had no assets in Ecuador with which to satisfy the judgement against them. Chevron is an incorporated company in Delaware that consolidates the financial results of its wholly owned subsidiaries (including Chevron Canada), but does not itself engage in the exploring, producing, refining or marketing of petroleum products. In an attempt to collect on the Ecuadorian judgement, the plaintiffs commenced an action in the Ontario Superior Court of Justice, seeking the Canadian equivalent of US$9,510,000,000 from Chevron Canada.

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Before the merits of the claim could be considered, the plaintiffs had to establish that an Ontario court had jurisdiction to recognize and enforce the judgment against these defendants. The jurisdictional issue went all the way to the Supreme Court of Canada, which confirmed that the case could be heard in Ontario . The Supreme Court made it clear that its decision did not determine the issue of whether Chevron Canada has a separate corporate personality, or whether its assets are available to satisfy the Ecuadorian judgment.] [23]  The parties agree that this is an appropriate case for summary judgment. Therefore, the only issues that I must decide on this motion are the following: (a) Are the shares and assets of Chevron Canada exigible and available for execution and seizure pursuant to the Execution Act [RSO 1990, c E.24] to satisfy the Ecuadorian judgment against Chevron? (b) If they are not, should Chevron Canada’s corporate veil be pierced so that its shares and assets are available to satisfy the Ecuadorian judgment against its indirect parent, Chevron? [The court found no basis to consider the assets or shares of Chevron Canada to be owned by Chevron. As a result, they were not exigible for the purpose of satisfying the judgement against Chevron. The court then dealt with the veil-piercing issue]: [50]  Chevron Canada submits that the plaintiffs’ claim against it is barred by the “bedrock legal principle of corporate separateness.” Under this principle, Chevron Canada maintains that the Ecuadorian judgment against Chevron cannot be visited upon it. [51]  According to the plaintiffs, the following principles which apply to the application of the principle of corporate separateness demonstrate that the principle should not apply to shield Chevron Canada’s assets from being available to satisfy the Ecuadorian judgment against Chevron:



(a) Corporate separateness will not be applied where it would result in an injustice or to default on a legal obligation. (b Corporate separateness will not be applied between a parent and a subsidiary where “there exists a sufficient degree of relationship between the different legal entities” or where there is “an economically significant relationship” such that the “true commercial and practical nature” of the relationship “is of one enterprise.” (c) Corporate separateness will not be applied to the issue of ownership. [52]  At para. 71 of their responding factum, the plaintiffs submit that these three principles apply to Chevron and Chevron Canada for the following reasons:



(a) To declare that the shares and assets of Chevron Canada are so separate by virtue only of its incorporation as a 100% subsidiary, so as to make them unavailable to satisfy the legitimate judgment debt of Chevron, would be an injustice to the 30,000 indigenous people whose way of life has been ruined by Chevron’s polluting activities. Such a declaration would undermine the legal obligation they

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fought for more than 20 years to achieve in both Ecuador and Ontario. It would undermine the whole process of reciprocity and comity. (b) As the facts amply demonstrate, Chevron has total effective control over Chevron Canada and immerses itself intimately in the affairs of Chevron Canada. None of Chevron Canada’s major projects was accomplished without approval from Chevron for each step from initiation of exploration to drilling, to operation to transportation. (c) Ownership is not a corporate separateness issue. Incorporation prevents a plaintiff from joining in an action, as a defendant, the uninvolved, innocent parent of a contract breaking or tortfeasing subsidiary. Corporate separateness has always been an issue answering the question: who is liable? But once judgment ensues against the guilty party, in this case Chevron, there is then no room for the application of corporate separateness. •  •  •

[57]  In my view, the plaintiffs have not established that Chevron Canada’s corporate veil should be pierced for the following reasons. [58]  Chevron and Chevron Canada are separate legal entities with separate rights and obligations. The principle of corporate separateness has been recognized and respected since the 1896 decision of the House of Lords in Salomon v. Salomon & Co. [59]  This principle applies equally to groups of companies such as Chevron’s group of companies of which Chevron Canada is a part. The English Court of Appeal made this clear in Adams v. Cape Industries Plc., [[1990] Ch 433 (CA), at pp 532, 536] as follows: There is no general principle that all companies in a group of companies are to be regarded as one. On the contrary, the fundamental principle is that “each company in a group of companies … is a separate legal entity possessed of separate legal rights and liabilities.” •  •  •

Our law, for better or worse, recognizes the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under the general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities.

[60]  The principle of corporate separateness provides that shareholders of a corporation are not liable for the obligations of the corporation. It also provides that the assets of the corporation are owned exclusively by the corporation, not the shareholders of the corporation. As a result, Chevron does not have any legal or equitable interest in the assets of Chevron Canada as an indirect shareholder seven-times removed. [61]  Further, the plaintiffs’ claim against Chevron Canada for its shares cannot succeed because its shares do not belong to Chevron Canada. Gascon J. made this clear in the Supreme Court of Canada’s decision, in this case, when he stated the following [at para 95]: Similarly, should the judgment be recognized and enforced against Chevron, it does not automatically follow that Chevron Canada’s shares or assets will be available to satisfy Chevron’s debt. For instance, shares in a subsidiary belong to the shareholder, not to the subsidiary itself. •  •  •

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[63]  Because the principle of corporate separateness applies to Chevron and Chevron Canada, the plaintiffs must satisfy the test for piercing Chevron Canada’s corporate veil, established in Transamerica Life Insurance Co. of Canada v. Canada Life Assurance Co [(1996), 28 OR (3d) 423 (Gen Div))]. In Transamerica, Sharpe J. (as he then was) held the following [at 433-34]: As just indicated, the courts will disregard the separate legal personality of a corporate entity where it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct. The first element, “complete control,” requires more than ownership. It must be shown that there is complete domination and that the subsidiary company does not, in fact, function independently. •  •  •

The second element relates to the nature of the conduct: is there “conduct akin to fraud that would otherwise unjustly deprive claimants of their rights”? In my view, while Transamerica has alleged fraud against C.L.M.S. there is no evidence to suggest that Canada Life has any involvement in that alleged fraud, apart from the fact that C.L.M.S. is its wholly owned subsidiary. The officers and employees of Canada Life were not involved in the dealings between C.L.M.S. and Transamerica, and no evidence has been advanced sufficient to give rise to a triable issue that Canada Life is somehow using C.L.M.S. as a shield for some nefarious purpose. •  •  •

[65]  The plaintiffs do not allege that the corporate structure of which Chevron Canada is a part was designed or used as an instrument of fraud or wrongdoing. In fact, they specifically plead that they “do not allege any wrongdoing against Chevron Canada.” As such, they cannot establish wrongdoing akin to fraud in the corporate structure between Chevron and Chevron Canada. They, therefore, do not meet this fundamental condition of piercing Chevron Canada’s corporate veil. [66]  However, the plaintiffs submit that corporate separateness should not be applied as a “strict, inflexible rule” where it will yield a result “too flagrantly opposed to justice.” I do not accept the plaintiffs’ submission that the corporate veil will be pierced when it is just and equitable to do so. Sharpe J. came to the same conclusion in Transamerica, as follows [at 431, 433]: In my view, the argument advanced by Transamerica reads far too much into a dictum plainly not intended to constitute an in-depth analysis of an important area of the law or to reverse a legal principle which, for almost 100 years, has served as a cornerstone of corporate law. It was conceded in argument that no case since Kosmopoulos has applied the preferred “just and equitable” test. •  •  •

[68]  I am satisfied on the strength of these decisions that there is not an independent “just and equitable” exception to the principle of corporate separateness as the plaintiffs suggest. This is not a basis for piercing Chevron Canada’s corporate veil in this case. [69]  As I have already indicated, the applicable jurisprudence makes it clear that even if the plaintiffs were able to establish that Chevron exercises total effective control over Chevron Canada, which they have not done, this would not satisfy the test for ignoring

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Chevron Canada’s corporate separateness and piercing its corporate veil. There would also have to be wrongdoing “akin to fraud” to meet the test. There is no such wrongdoing in this case. •  •  •

[72]  I am also satisfied that the plaintiffs have failed to meet the first part of the Transamerica test. D.M. Brown  J. summarized the jurisprudence on what constitutes complete domination and control in his reasons for decision, as follows: Complete control requires more than ownership, but necessitates a demonstration that there is complete domination of the subsidiary corporation and the sub does not, in fact, function independently—or, as put in one case, a demonstration that the subsidiary is a “puppet” of the parent.

[73]  The evidence does not establish that Chevron Canada is Chevron’s “puppet.” Rather, I find that Chevron and Chevron Canada have a typical parent/subsidiary relationship. Chevron does not exercise complete dominance or control over the affairs of Chevron Canada. I accept and adopt, for the purpose of this motion, the following findings and analysis of D.M. Brown  J. concerning the corporate relationship between Chevron and Chevron Canada, from his reasons for decision [2013 ONSC 2527]: [100]  As part of a worldwide “family” of companies, Chevron Canada is subject to certain “family” budget reporting requirements and large capital expenditure approval processes, but it initiates its own plans and budgets, it funds its own day to day operations, and the capital expenditures made by it in recent years for the major Athabasca Oil Sands Project, Hibernia Project and Hebron Project were funded from its own operating revenues. Mr. Wasko deposed: Chevron Canada is a fully capitalized corporation which funds its own day to day operations without financial contributions from Chevron Corp. or any other Chevron entity. This corporate structure has been in place since 1966; it was not a recent creation designed to blunt the effect of the Ecuadorean Judgment. I do not regard the existence of a central review and approval process for large capital expenditures, especially of the magnitude found in the resource extraction industry, as signifying a complete domination by the parent of the indirect subsidiary such as to dissolve the separate legal identity of the subsidiary, especially when, as the evidence showed in this case, the indirect subsidiary carries on its own business operations. . . . [101]  Nor does the fact that on several occasions Chevron guaranteed debt financings and project-related performance obligations of Chevron Canada indicate that the corporations possess a single legal identity. Certainly the lenders in those cases proceeded on the basis that parent and indirect sub were separate legal entities, otherwise they would not have asked for the guarantees of the ultimate parent. Moreover, inter-corporate guarantees are common-place in our commercial world. The granting of a guarantee by Company A does not merge its assets, in the eyes of the law, with those of borrower Company B. The guarantee does expose the separate assets of Company A to the risk of execution in the event of a default by Company B, but that result simply flows from the contractual terms agreed to by Company A, not some dissolution of its corporate separatedness.

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Chapter 3  The Corporate Form [102]  Chevron Canada files its own tax returns and corporate statements. That Chevron files a consolidated set of financial statements simply reflects the legal reporting requirements of its home jurisdiction, in particular the Sarbanes-Oxley Act of 2002 and the Securities and Exchange Act of 1934; it is not an indicia of the complete domination and control of the subsidiary by the parent. The same observation applies to the common reporting requirements found in the Chevron family of companies. At a time when legislators are insisting on higher standards of corporate governance for related groups of companies, including the disclosure of material information, efforts to comply with those requirements do not signify that the individual companies have lost their separate legal identities. [103]  Nor does the dividending-up by Chevron Canada of some of its operating profits to its parent, Chevron Canada Capital Company, which, in turn, may issue dividends up the chain signify, in itself, complete domination of the subsidiary’s operations. The distribution of profits from sub to parent via dividends is a standard fact of inter-corporate life. No evidence in this case suggested that the flow of dividends reflected complete domination in the sense used by the alter ego cases. [104]  In my view, when taken as a whole, the evidence filed on these motions supports a finding that the relationship between Chevron and Chevron Canada is, to echo the language of Sharpe J. (as he then was) in the Transamerica case, “that of a typical parent and subsidiary,” not an instance of a parent corporation exercising complete domination and control over the subsidiary. Or, to phrase that conclusion in the language of the Court of Appeal in the Canada Life Assurance case, the evidence demonstrates that Chevron Canada “looks as though it has its own business, rather than being completely subservient to and dependent upon its parent.”

[74]  For all of these reasons, I have concluded that the plaintiffs’ claim cannot succeed against Chevron Canada. Chevron Canada’s motion for summary judgment is granted. The plaintiffs’ claim against it is dismissed. [75]  As a result of my conclusion on this motion, Chevron’s motion for summary judgment is granted and the plaintiffs’ motion for summary judgment is dismissed. NOTES AND QUESTIONS

1.  The original Ecuadorian judgment was plagued by allegations of judicial corruption, such that the Federal Court in New York refused to enforce it in the United States (see Chevron Corp v Donziger, 11-CV-691 (USDC SDNY 2015)). This left the plaintiffs with no option but to seek compensation through Chevron Canada. 2.  At the time of writing, this decision may be appealed to the Ontario Court of Appeal. What policy arguments could the plaintiffs or their domestic intervenors make? What does it mean for corporate accountability and the legitimacy of the judicial system if orders for compensation of environmental harms cannot be enforced? Do the economic benefits of separate legal personality outweigh such concerns? 3.  Although, as we have seen, there is no evidence to suggest that courts have pierced the corporate veil more often for involuntary claimants, they have been more open to do so for family law plaintiffs where the defendant is a sole shareholder corporation. Family law has its own set of rules and procedures, which create obligations for separating spouses to support one another and any children of the relationship. Married partners are also

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required to share any increase in wealth that has occurred during the marriage,65 which in some cases motivates spouses to “hide” assets (especially property and investments) in corporations. The last three cases all involve a former spouse claimant seeking to hold a corporation in which the former spouse defendant is a sole shareholder liable for obligations under family law.

Wildman v Wildman (2006), 82 OR (3d) 401 (CA) [The Wildmans were married for 10 years and had two children before separating. Chris Wildman (the appellant) owned a high-end landscape construction business, which generated an annual income of approximately $700,000. Angela Wildman (the respondent) worked as a dental assistant when they were first married, but stopped working shortly thereafter. The divorce proceedings were long and acrimonious. When the judge finally granted the divorce, Mr. Wildman was found to owe hundreds of thousands of dollars in equalization payments, costs, and child and spousal support. Although he did not contest the amounts, Mr. Wildman appealed the judge’s decision to enforce and secure his obligations against his business interests.] MACPHERSON JA:

[20]  The trial judge ordered the appellant to pay large sums of money to the respondent and his children. He sought to enforce his order by ordering that the appellant not deplete or dissipate “any property under his control” (para. 17). In addition, the trial judge ordered that “all amounts owing” by the appellant were to be secured by way of charge against the appellant personally and his companies, including “Precision Landscape Construction Ltd, Precision Paving and Landscape Construction or Landscape by Precision” (para. 18). •  •  •

[22]  The appellant submits that the trial judge’s reasons and order are based on a violation of a fundamental and well-known legal principle—a corporation has a separate legal personality that must be respected. Accordingly, a court should not “pierce the corporate veil” and attach liability to persons associated with a corporate entity. [23]  The principle of the separate legal personality of a corporation is an important one. However, it is not an absolute principle. In my view, a particularly clear, concise and useful description of the principle and its limits was articulated by Laskin J.A. in 642947 Ontario Ltd. v. Fleischer (2001), 56 O.R. (3d) 417 at paras. 67-68 (“Fleischer”). …

65 See e.g. Ontario Family Law Act, RSO 1990, s 5(7); PEI Family Law Act, RSPEI 1988, c F-2.1, s 6(8); Nova Scotia Matrimonial Property Act, RSNS 1989, c 275, preamble; New Brunswick Marital Property Act, SNB 2012, c 107, s 2; Newfoundland and Labrador Family Law Act, RSNL 1990, c F-2, s 19; Quebec Civil Code, CCQ1991, § 2, s 416; Manitoba Family Law Act, CCSM c F25, s 13; Alberta Matrimonial Property Act, RSA 2000, c M-8, s 7; Saskatchewan Family Property Act SS 1997, c F-6.3, s 20; British Columbia Family Law Act, SBC 2011, c 25, s 81; Yukon Family Property and Support Act, RSY 2002, c 83, s 5; Northwest Territories and Nunavut, Child and Family Services Act, SNWT 1997, c 18, s 36(7).

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[The extract from Fleischer—omitted here—appears earlier in this text] [24]  I note, at the outset, that what the trial judge did in this case was not a typical piercing of the corporate veil. Most corporate veil cases involve an attempt by a claimant to look through a corporation to make the principal(s) liable for the obligations of the corporation. In this instance, however, the trial judge allowed the respondent wife to look to the corporation to satisfy the obligations of its principal and sole shareholder, the appellant husband. As a result, the usual concern regarding piercing the corporate veil— unanticipated personal liability—is not present. [25]  The crucial question in this appeal is whether the exception to the principle of separate legal personality for corporations set out in Fleischer and Transamerica Life Insurance should be injected into family law. Should the courts in appropriate family law cases disregard the separate legal personality of a corporate entity where, in the words of Sharpe J. in the latter case, “it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct”? In my view, the answer to this question is a resounding “Yes.” I say this for two reasons. [26]  First, s. 18 of both the federal and provincial Child Support Guidelines contemplates piercing the corporate veil in appropriate cases. … [27]  The purpose of s. 18 is to enable the courts to conduct a fair accounting of the money available for the payment of child support. Justice Martinson commented in Baum v. Baum (1999), 182 D.L.R. (4th) 715 at para. 128 (B.C.S.C.): Valid corporate objectives may differ from valid child support objectives. The purpose of s. 18 is to allow the court to “lift the corporate veil” to ensure that the money received as income by the paying parent fairly reflects all of the money available for the payment of child support. This is particularly important in the case of a sole shareholder as that shareholder has the ability to control the income of the corporation.

I agree with these observations. [28]  Second, in his reasons the trial judge explicitly referred to and adopted the analysis and conclusion of Wood J. in Arsenault v. Arsenault, [1998] O.J. No. 1423, 59 O.T.C. 232 (Gen. Div.). In my view, he was right to do so. Arsenault is a particularly well-reasoned and useful decision. [29] In Arsenault, the parties had a traditional marriage in which the husband provided all the income while the wife was the primary caregiver for their four children. Pursuant to a settlement agreement, the husband was to pay $1,800 per month in support. The husband was a software consultant who worked for a single employer, Soldier’s Memorial Hospital in Orillia. However, his income was paid to a numbered company of which he was the sole shareholder. As a result of this arrangement, child and spousal support payments were made in an inconsistent manner, causing frustration and financial difficulties for the wife, as well as the accrual of arrears. [30]  Justice Wood described Mr. Arsenault and his corporation in this fashion, at paras. 10-12: The respondent is a talented software consultant. Although he does work for more than one person or organization, his primary source of revenue is a permanent contract with the Soldier’s Memorial Hospital in Orillia. The funds which flow to him from this contract

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are more than sufficient to satisfy the support requirements of the separation agreement and are received at regular intervals. However, the contract with Soldier’s Memorial Hospital is not between that institution and the respondent. Rather it is with 1112705 Ontario Limited. This is a corporation of which the respondent is the sole shareholder, director, officer and employee. Since the respondent offers no evidence, the reason for the corporation’s existence is unknown. However, it would not be unreasonable to assume that it was incorporated for the tax flexibility and limited liability protection it might offer to what is in reality a sole proprietorship. The corporation carries on no activity outside personal ones of the respondent. It exists solely as a vehicle through which funds flow to him. It is this arrangement which frustrates the regular flow of support to the applicant and the children and prevents the Family Responsibility Office from being able to effectively enforce the terms of the agreement.

[31]  Against this backdrop, Wood J. shifted to his legal analysis. Because his analysis is especially clear and, in my view compelling, I set out in full paras. 24-30 of his reasons: In the area of corporate and commercial law, the Courts are generally reluctant to look behind the corporate veil unless there are circumstances in which it is appropriate that this be done. In general, the following circumstances must be present: 1. The individual exercises complete control of finances, policy, and business practices of the company.? 2. That control must have been used by the individual to commit a fraud or wrong that would unjustly deprive a claimant of his or her rights. 3. The misconduct must be the reason for the third party’s injury or loss. All of those criteria apply in this case. The respondent has absolute control of the company, as he is the sole shareholder, director and officer. His actions in determining when and how monies are to be paid by the corporation to him have resulted in the frustration of the operation of the Family Responsibility and Support Arrears Enforcement Act. The frustration of the operation of that Act has prevented support flowing in a regular and orderly fashion to the applicant and the children. While I am satisfied that the situation in this case meets even the most rigorous standards applied in corporate law to the lifting of the veil, I take some comfort in the fact that in the area of family law a somewhat more relaxed approach has been taken by the Courts. In M. (B.B.) v. M. (W.W.) (1994), 7 R.F.L. (4th) 255 (Alta. Q.B.), a general contractor was ordered to pay a portion of the monies owing to a solely held corporation operated by the respondent (payor) to satisfy arrears of support. A similar approach to closely held corporations’ assets has been taken by Courts in Ontario in Bregman v. Bregman (1978), 21 O.R. (2d) 722 (H.C.J.), affirmed by the Court of Appeal at (1979), 25 O.R. (2d) 254 (C.A.) and Crowe v. Crowe, [1985] O.C.P. 110 (H.C.J.). It should also be noted that a piercing of the corporate veil for the purpose of imputing income is not only mandated, but set out in detail in section 18 of both the Federal and Provincial Child Support Guidelines. It could be argued that section 18 of the Guidelines [is] a codification of a common practice in the Courts across Canada when imputing income for the purpose of setting the appropriate level of child or spousal support.

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Chapter 3  The Corporate Form There is also a strong public policy argument to be made for a review of closely held corporations in the context of support. Despite improvements in the rate of collection, an enormous number of support orders are in arrears. Non payment of support often results in support recipients and their families having to rely on public funds. The connection between non payment of support and the present levels of child poverty in Canada hardly needs to be underlined. The title of the Family Responsibility and Support Arrears Enforcement Act announces its intended purpose unequivocally. It is legislation designed specifically to improve the dismal support payment statistics in the Province of Ontario. However, in situations such as the one before the Court, the Act is frustrated in its purpose. There will be many situations in which funds flow through many hands from their ultimate source to a payor. Where this is so, for appropriate reasons the Director must look to the immediate source of funds as the income source. Where, however, the income source as defined in the Act is no more than the alter ego of the payor and has no function other than as a vehicle through which funds owing to the payor are channelled, it is appropriate to look through that entity to determine the relationship between the real income source and the payor. •  •  •

[38]  It is clear from [Fleischer] that a company need not have been created with an improper purpose in mind to justify piercing the corporate veil; it is sufficient that the corporation is used for an improper purpose. In a matrimonial context, what this must mean is that the snapshot of the company at the time of incorporation is probably nothing more than a starting point. The real focus must be on the relationship between the company and the controlling spouse and how the spouse is using the corporation after the parties have separated and before the financial issues are resolved. [MacPherson JA then proceeds to apply the Arseneault framework] [43]  First, the appellant is the sole owner of, and exercises complete control over, his various business enterprises. With respect to Precision Landscape Construction Ltd., the appellant is the sole shareholder and director. In the transcript of a motion before Clarke J. on May 10, 2005, the appellant called himself a “sole proprietor.” Furthermore, the appellant appears to make no distinction between his personal and business assets. For example, in the cash logs prepared by the appellant (and produced at trial by the respondent) the appellant did not differentiate between personal and business assets. In short, the appellant’s business enterprises are his alter ego; they are not distinct from him and have no connection to any third party. [44]  Second, there is no question that the appellant has controlled his business enterprises and structured his corporate assets in a way that diverts money from them to his own personal use. The most compelling evidence on this issue is probably the evidence gathered by the private investigator engaged by the respondent concerning the appellant’s business relationship with a client, Mr. Z. It is clear from this evidence that the appellant negotiated payment options with Mr. Z. in a manner designed to maximize the appellant’s personal cash intake and minimize the amount of money flowing to the company.

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[45]  Third, the losers in all of this have been the respondent and the children. They have not received, and continue to not receive, the money that various courts have found they should receive. [46]  In summary, on the facts of this case it would be flagrantly opposed to justice to allow the appellant to hide behind a corporate veil that he does not himself respect. [47]  The appellant makes one other argument on the corporate veil issue. He contends that the trial judge erred by making orders against the appellant’s companies because the companies were not named as parties and, therefore, had no notice of the matrimonial litigation. [48]  I disagree. This is matrimonial litigation, not commercial litigation. Importantly, the record establishes that the appellant and his companies are one and the same. No third party has any interest in any of the companies. The appellant was given notice of the proceedings and thus, the companies, his alter ego, were also given notice. [49]  In the end, although a business person is entitled to create corporate structures and relationships for valid business, tax and other reasons, the law must be vigilant to ensure that permissible corporate arrangements do not work an injustice in the realm of family law. In appropriate cases, piercing the corporate veil of one spouse’s business enterprises may be an essential mechanism for ensuring that the other spouse and children of the marriage receive the financial support to which, by law, they are entitled. The trial judge was correct to recognize that this was such a case. [MacPherson JA went on to amend the trial judge’s order that the costs and pre-judgement interest can be enforced as child and spousal support. In all other respects the appeal was dismissed]

Lynch v Segal (2006), 82 OR (3d) 641 (CA) BLAIR JA:

Overview [1]  Moses Segal is an extraordinarily wealthy man. By his own admission he has a net worth exceeding $100,000,000. Equally extraordinary, however, is his ability to organize his business affairs in a way that disguises his ownership (direct or beneficial) in the assets underlying this wealth. As far as his former spouses and his infant children are concerned, he would have it appear that he has no assets whatsoever. [2]  Cynthia Lynch—his second wife and the mother of his two pre-teenage children— sued Mr. Segal for spousal and child support, and other monetary relief. She also discovered two properties in Ontario held in the name of the appellant corporations, added the appellants as defendants in the action, and sought declarations that Mr. Segal is the beneficial owner of their shares and/or their property as well as a vesting order with respect to the shares and/or property.

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[3]  The assets Ms. Lynch discovered consist of development and farm lands in the Oakville area (“the Lands”). Justice Paisley found that there is no distinction in law between the appellant corporations and Mr. Segal and that Mr. Segal is the beneficial owner of the Lands. As a remedy to ensure that the sizeable lump sum awards for spousal and child support that he had made—and which were not challenged on appeal—were paid, Paisley J. directed that the Lands be transferred to, and vested in, Ms. Lynch. [4]  The issue on this appeal is whether the trial judge was justified in making that vesting order. In my view, for the reasons that follow, he was. Background and Facts The Parties’ Relationship and Lifestyle [5]  Cynthia Lynch and Moses Segal met in 1992. He is a moneyed self-employed businessman. She is a U.S. citizen, and when their relationship began, was a qualified lawyer practising at the Bar of New York. They started living together as spouses in 1994 and have two children, Emily and William, now aged twelve and eight. They separated in 2001. •  •  •

[7]  Ms. Lynch was reluctant to give up her career, but agreed to do so when Mr. Segal persuaded her in 1994 to move with him to London, England, to live together and have a family. In exchange for her loss of income, he agreed to pay her the sum of $100,000 (U.S.) plus $7,300 (U.S.) per month to enable her to purchase whatever luxury items she wanted. . . .The couple led a lavish lifestyle, as one would expect of a person of Mr. Segal’s wealth—expensive homes in the Bahamas and Canada, a private plane, farm property in Ontario where ponies and farm animals were available for the pleasure of the children. Mr. Segal’s Modus Operandi with Respect to His Assets [8]  Central to this action, and appeal, are what Mr. Bastedo referred to as the “extraordinary lengths [to which Mr. Segal went] to set up legal formulations which would have the effect of distancing himself in every possible way from any assets, corporations or trusts which could be connected to him.” Mr. Segal’s carefully honed practice is to set up intermediary vehicles in order to screen himself from creditors, including his spouses, and to use various aliases and pseudonyms to that end. … [9]  Ms. Lynch was not unaware of these practices on the part of Mr. Segal during their relationship. In fact, he boasted about them.  … Mr. Segal also explained his modus operandi to Ms. Lynch. It involved incorporating companies with only the bare necessities and formalities in place in order to make the incorporation valid. Directors would be named, but shares would not be issued and blank shares would be held by the incorporator and trustee. If a structure were ever challenged, the shares could be issued to create the impression that someone else owned the corporation and, thus, the asset in question. •  •  •

[12]  This was the same ploy utilised by Mr. Segal in respect of the corporation holding title to the parties’ matrimonial mansion on Warren Road, and in respect of a further

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corporation (Sondol Wireless Connectivity Inc.) holding title to a third development tract of land in the Milton area. In both of these cases, he was able to have the corporate structure of the companies altered quickly to make himself the president and controlling officer; he then effected the sale of the assets and transferred the sale proceeds into untouchable overseas accounts. The sale of the matrimonial home ($2,700,000) took place shortly after the separation of the parties. The Sondor sale ($2,500,000) took place later, in October 2003, and was in direct defiance of an order of Mesbur J. dated July 31, 2003 restraining Mr. Segal from depleting his assets. That order had been served on Mr. Dolson prior to the Sondor sale. [13]  At trial and on discovery, the appellants produced Mr. Fergus Anstock, an English solicitor, who testified that he was now the sole nominee shareholder of the appellant corporations and that he represented the beneficial owners. He said he knew who the beneficial owners were, and that Mr. Segal was not one of them, but that he could not reveal their identity without breaching his duty of confidentiality to his clients. … •  •  •

[15]  The trial judge quite properly declined to allow Mr. Anstock to testify as to other matters purportedly relating to the beneficial ownership of the shares of the appellants, when he refused to testify regarding the issues outlined above. Although he found Mr. Anstock to be a person of integrity, he concluded that Mr. Anstock had been deceived by Mr. Segal, and gave no weight to his evidence. The Claims in the Action [16]  Mr. Segal has paid little in the way of support for Ms. Lynch or the children since the separation, and nothing since December 2002. He made it clear that he was prepared to bankrupt the respondent, if necessary, to enforce his idea of what a reasonable financial settlement was. This action was commenced in July 2003. •  •  •

[19]  At trial, the main issues centred around the relief claimed by Ms. Lynch against the appellant corporations, Idyllic Acres Holdings Inc. and Ashoe High Speed Solutions Inc. Idyllic owns a tract of raw development property in the Oakville area, acquired in 1998 for $2.6 million. Ashoe owns the farm property in the same area that was used as a recreation retreat by Mr. Segal, Ms. Lynch and their children, and on which the ponies and farm animals were kept. This property was purchased in July 2000, at a cost of $1.636 million. Amongst other things, Ms. Lynch claimed a declaration that:

(a) Mr. Segal is the beneficial owner of the shares of Idyllic and Ashoe, and that he holds this beneficial ownership in trust for her to the extent of 50%, or alternatively, that he is the beneficial owner of the shares himself; (b) In the further alternative, that Mr.Segal has a beneficial ownership in the lands owned by the appellant corporations, and that he holds this ownership either in trust for her or wholly for himself; and (c) An order pursuant to s. 34(1)(c) of the Family Law Act, R.S.O. 1990, c. F.3 requiring the shares of Idyllic and Ashoe and the Lands, or the Lands only, to be transferred to her and vested in her absolutely.

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[20]  She succeeded. The trial judge found that “the limited companies and Mr. Segal are one and the same” and that “[Mr. Segal] is the beneficial owner of the property.” He ordered that the Lands be vested in Ms. Lynch in satisfaction of the monetary claims outlined above, and costs. •  •  •

Analysis •  •  •

[35]  The well-known corporate law principle, first enunciated in Salomon v. Salomon & Co., [1897] A.C. 22 (H.L,), that the shareholders of a corporation are separate and distinct from the corporate legal entity is—as MacPherson J.A. recently noted in Wildman v. Wildman, [2006] O.J. No. 3966 at para. 23 (C.A.)—”an important one” but not, however, “an absolute principle.” There is a line of jurisprudence establishing in very general terms that the courts will not enforce the “separate entities” notion where “it would yield a result ‘too flagrantly opposed to justice, convenience or the interests of the Revenue’”: Kosmopoulos v. Constitution Insurance Co., [1987] 1 S.C.R. 2 at 10, citing L.C.B. Gower, Principles of Modern Company Law, 4th ed. (London: Stevens & Sons, 1979) at 112. See also Debora v. Debora, [2006] O.J. No. 4826 at para. 24 (C.A.); Transamerica Life Insurance Co. of Canada v. Canada Life Assurance Co. (1996), 28 O.R. (3d) 423 at 432-434 (Gen. Div.), affirmed [1997] O.J. No. 3754 (C.A.); and 642947 Ontario Ltd. v. Fleischer (2001), 56 O.R. (3d) 417 at paras. 67-69 (C.A.). [36]  A more flexible approach is appropriate in the family law context, particularly where—as here—the corporations in question are completely controlled by one spouse, for that spouse’s benefit, and no third parties are involved. The same situation arose in Wildman, supra. In that case, Mr. Wildman operated a successful high-end landscaping business through a corporation and several sole proprietorships. There were no thirdparty investors in the companies and Mr. Wildman controlled them completely. In order to enforce the other parts of his order requiring Mr. Wildman to pay large sums of money for spousal and child support, the trial judge in that case directed that the amounts owing were to be secured by way of a charge not only against the appellant personally, but also against his companies. [An extract from Wildman v Wildman is omitted.] [38]  In my view, Justice Paisley, like the trial judge in Wildman, was correct in recognizing that this case is one in which it is appropriate to pierce the corporate veil. During argument he observed that Mr. Segal was not using the appellant corporations for permissible corporate arrangements, but rather “was using the corporate structure for one sole purpose, to disguise his property so that his spouse and children would have no claim against him should he ever have to defend against a claim.” In his reasons for judgment he referred to Mr. Segal’s scheme “to conceal his assets,” “to disguise [them] through every means possible,” and to create the impression that “someone other than he owned his property.” The record supported these observations and findings. In the circumstances, piercing the corporate veil, and finding that both the corporate shares and the Lands are beneficially owned by Mr. Segal, was—to adopt the language of MacPherson  J.A.

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above—”an essential mechanism for ensuring that [Ms. Lynch] and [the] children of the marriage receive the financial support to which, by law, they are entitled.” [39]  The “beneficial ownership” findings are central, because they provide the foundation upon which the trial judge was able to make the vesting order that is challenged on appeal. It is not because Mr. Segal was found to be the beneficial owner of the shares of Idyllic and Ashoe that the order may stand; it is because the trial judge found Mr. Segal to be the beneficial owner of the Lands. Once it is accepted that the Lands belong to Mr. Segal, they become a fair target for a vesting order under section 34(1)(c) of the Family Law Act or section 100 of the Courts of Justice Act, if such an order is otherwise appropriate in the circumstances. •  •  •

[44]  … [T]he trial judge made the following findings, which were amply supported on the evidence: In my view the limited companies and Mr. Segal are one and the same. He is the beneficial owner of the property. (Emphasis added.) •  •  •

[63]  Finally, the trial judge committed no reversible error in declining to vest the shares of the appellant corporations, rather than the Lands, in Ms. Lynch, or in refusing to make a charging order or grant some other remedy in lieu of a vesting order. Once the finding was made that Mr. Segal is the beneficial owner of the shares and of the Lands, the decision whether to grant a vesting order pursuant to the Family Law Act or the Courts of Justice Act became a matter within the broad discretion of the trial judge. Absent an error in principle or an error in law in the exercise of that discretion, this court will not interfere. [64]  There was no such error here. [65]  On the findings of the trial judge there are no third party investors or shareholders—”no secret offshore investor whose identity needs to be protected”—whose interests in the appellant corporations might be affected by treating Mr. Segal and the corporations as “one and the same,” and by the finding Mr. Segal to be the beneficial owner of the Lands. Any valid encumbrancers or registered execution creditors with an interest in the Lands at the time the vesting order was made are protected because Ms. Lynch takes title subject to such interests. The trial judge was very alert to the reality that “[t]here is simply no possibility that Mr. Segal would ever pay child or spousal support willingly.” He concluded Mr. Segal’s failure to comply with the interim support order of Justice Kitely in the proceedings and his deliberate evasion of Justice Mesbur’s order prohibiting him from dissipating his assets (the Sondor sale) were sufficient proof of that actuality. He was also aware of the need to provide finality to the litigation, to the extent possible. [66]  In these circumstances, it was clearly open to the trial judge to reject alternative solutions and to opt, as he did, for a remedy that would in effect swap the monetary spousal and child support parts of the claim against Mr. Segal for the Lands. This would ensure that at least a significant portion of Mr. Segal’s support obligations would be satisfied (on the evidence the trial judge was satisfied the value of the Lands would not be sufficient to meet those obligations fully). He was convinced that without the vesting order Ms. Lynch and the children would likely receive nothing. He concluded:

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Chapter 3  The Corporate Form In my view the claim for vesting of those lands, in lieu of any excess claim for spousal support, and in satisfaction of the claim for lump sum support is fair in the circumstances.

[67]  The trial judge was justified in the circumstances in arriving at that conclusion. While he could have awarded a different remedy, the vesting order was well within the range of reasonable options at his disposal. •  •  •

[69]  Similarly, while an order vesting the shares of the appellant corporations in Ms. Lynch would ultimately put control of the corporations in her hands, a series of corporate steps would have to be taken before that control would become a reality and, in any event, such a remedy might not be as effective in satisfying Mr. Segal’s support obligations because of the capital gains tax implications referred to above. As long as there are corporate steps that have to be taken, there are opportunities for Mr. Segal and the appellant corporations to be mischievous and to attempt to put obstacles in the way of Ms. Lynch’s attempts to enforce her spousal and child support orders. As to the tax considerations, Mr. Segal is obviously in a position to cope with any personal or corporate tax liabilities that he may be compelled to pay, whereas he will not willingly satisfy his support obligations. The choice of an order vesting the Lands, which he beneficially owns, instead of the shares, is justifiable on that ground alone. Disposition [70]  For the foregoing reasons, and given the circumstances of this case, I would not interfere with the trial judge’s discretionary choice to transfer the Lands to Ms. Lynch and to vest them in her in satisfaction of her spousal and child support claims, in the circumstances of this case. [71]  Accordingly, the appeal is dismissed. ?

Prest v Petrodel Resources Ltd [2013] UKSC 34 [P and his wife were married in 1993, and had their home in London. The Petrodel Group was a group of companies owned and controlled by P, who was not actually a party to this appeal. During the divorce proceedings, P failed to comply with the disclosure obligations, which meant that the judge could not compile an accurate schedule of assets. Working with the evidence before him, the judge estimated P’s net assets at £37.5 million. He ordered that P should procure the conveyance of the matrimonial home, which was legally owned by one of the Petrodel companies, and that he should make a lump sum payment to his wife of £17.5 million plus other payments. In partial satisfaction of this order the judge ordered P to procure the transfer of seven properties owned by some companies in the group. The judge concluded that, while there was no general principle of law which entitled him to pierce the corporate veil unless it was being abused for a purpose that was

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in some relevant respect improper, in applications for financial relief ancillary to a divorce, a wider jurisdiction to pierce the corporate veil was available under s 24 of the Matrimonial Causes Act 1973.] LORD SUMPTION:  Subject to very limited exceptions, most of which are statutory, a company is a legal entity distinct from its shareholders. It has rights and liabilities of its own which are distinct from those of its shareholders. Its property is its own, and not that of its shareholders. In Salomon v A Salomon and Co Ltd [1897] A.C. 22 , the House of Lords held that these principles applied as much to a company that was wholly owned and controlled by one man as to any other company. In Macaura v Northern Assurance Co Ltd [1925] A.C. 619 , the House of Lords held that the sole owner and controller of a company did not even have an insurable interest in property of the company, although economically he was liable to suffer by its destruction. Lord Buckmaster, at 626 – 627 said: [N]o shareholder has any right to any item of property owned by the company, for he has no legal or equitable interest therein. He is entitled to a share in the profits while the company continues to carry on business and a share in the distribution of the surplus assets when the company is wound up.

In Lonrho Ltd v Shell Petroleum Co Ltd [1980] 1 W.L.R. 627 the House of Lords held that documents of a subsidiary were not in the “power” of its parent company for the purposes of disclosure in litigation, simply by virtue of the latter’s ownership and control of the group. These principles are the starting point for the elaborate restrictions imposed by English law on a wide range of transactions which have the direct or indirect effect of distributing capital to shareholders. The separate personality and property of a company is sometimes described as a fiction, and in a sense it is. But the fiction is the whole foundation of English company and insolvency law. As Robert Goff L.J. once observed, in this domain “we are concerned not with economics but with law. The distinction between the two is, in law, fundamental”: Bank of Tokyo Ltd v Karoon [1987] A.C. 45, 64 . He could justly have added that it is not just legally but economically fundamental, since limited companies have been the principal unit of commercial life for more than a century. Their separate personality and property are the basis on which third parties are entitled to deal with them and commonly do deal with them. Against this background, there are three possible legal bases on which the assets of the Petrodel companies might be available to satisfy the lump sum order against the husband:

1. It might be said that this is a case in which, exceptionally, a court is at liberty to disregard the corporate veil in order to give effective relief. ? 2. Section 24 of the Matrimonial Causes Act might be regarded as conferring a distinct power to disregard the corporate veil in matrimonial cases. ? 3. The companies might be regarded as holding the properties on trust for the husband, not by virtue of his status as their sole shareholder and controller, but in the particular circumstances of this case. ? •  •  •

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Piercing the Corporate Veil I should first of all draw attention to the limited sense in which this issue arises at all. “Piercing the corporate veil” is an expression rather indiscriminately used to describe a number of different things. Properly speaking, it means disregarding the separate personality of the company. There is a range of situations in which the law attributes the acts or property of a company to those who control it, without disregarding its separate legal personality. The controller may be personally liable, generally in addition to the company, for something that he has done as its agent or as a joint actor. Property legally vested in a company may belong beneficially to the controller, if the arrangements in relation to the property are such as to make the company its controller’s nominee or trustee for that purpose. For specific statutory purposes, a company’s legal responsibility may be engaged by the acts or business of an associated company. Examples are the provisions of the Companies Acts governing group accounts or the rules governing infringements of competition law by “firms,” which may include groups of companies conducting the relevant business as an economic unit. Equitable remedies, such as an injunction or specific performance may be available to compel the controller whose personal legal responsibility is engaged to exercise his control in a particular way. But when we speak of piercing the corporate veil, we are not (or should not be) speaking of any of these situations, but only of those cases which are true exceptions to the rule in Salomon v A Salomon and Co Ltd [1897] A.C. 22 , i.e. where a person who owns and controls a company is said in certain circumstances to be identified with it in law by virtue of that ownership and control. Most advanced legal systems recognise corporate legal personality while acknowledging some limits to its logical implications. In civil law jurisdictions, the juridical basis of the exceptions is generally the concept of abuse of rights, to which the International Court of Justice was referring in Re Barcelona Traction, Light and Power Co Ltd [1970] I.C.J. 3 when it derived from municipal law a limited principle permitting the piercing of the corporate veil in cases of misuse, fraud, malfeasance or evasion of legal obligations. These examples illustrate the breadth, at least as a matter of legal theory, of the concept of abuse of rights, which extends not just to the illegal and improper invocation of a right but to its use for some purpose collateral to that for which it exists. English law has no general doctrine of this kind. But it has a variety of specific principles which achieve the same result in some cases. One of these principles is that the law defines the incidents of most legal relationships between persons (natural or artificial) on the fundamental assumption that their dealings are honest. The same legal incidents will not necessarily apply if they are not. The principle was stated in its most absolute form by Denning L.J. in a famous dictum in Lazarus Estates Ltd v Beasley [1956] 1 Q.B. 702, 712: No court in this land will allow a person to keep an advantage which he has obtained by fraud. No judgment of a court, no order of a Minister, can be allowed to stand if it has been obtained by fraud. Fraud unravels everything. The court is careful not to find fraud unless it is distinctly pleaded and proved; but once it is proved, it vitiates judgments, contracts and all transactions whatsoever. …

The principle is mainly familiar in the context of contracts and other consensual arrangements, in which the effect of fraud is to vitiate consent so that the transaction

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becomes voidable ab initio. But it has been applied altogether more generally, in cases which can be rationalised only on grounds of public policy, for example to justify setting aside a public act such as a judgment, which is in no sense consensual, a jurisdiction which has existed since at least 1775: Duchess of Kingston’s Case (1776) 2 Smith’s L.C. (13th edn) 644, 646, 651. Or to abrogate a right derived from a legal status, such as marriage: R. v Secretary of State for the Home Department, ex p. Puttick [1981] Q.B. 767. Or to disapply a statutory time bar which on the face of the statute applies: Welwyn Hatfield Borough Council v Secretary of State for Communities and Local Government [2011] 2 A.C. 304. These decisions (and there are others) illustrate a broader principle governing cases in which the benefit of some apparently absolute legal principle has been obtained by dishonesty. The authorities show that there are limited circumstances in which the law treats the use of a company as a means of evading the law as dishonest for this purpose. •  •  •

Almost all the modern analyses of the general principle have taken as their starting point the brief and obiter but influential statement of Lord Keith of Kinkel in Woolfson v Strathclyde Regional Council 1978 S.C. (HL) 90. This was an appeal from Scotland in which the House of Lords declined to allow the principal shareholder of a company to recover compensation for the compulsory purchase of a property which the company occupied. The case was decided on its facts, but at 96, Lord Keith, delivering the leading speech, observed that “it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere façade concealing the true facts.” [Lord Sumption reviewed the English case law up to the present point.] In my view, the principle that the court may be justified in piercing the corporate veil if a company’s separate legal personality is being abused for the purpose of some relevant wrongdoing is well established in the authorities. It is true that most of the statements of principle in the authorities are obiter, because the corporate veil was not pierced. It is also true that most cases in which the corporate veil was pierced could have been decided on other grounds. But the consensus that there are circumstances in which the court may pierce the corporate veil is impressive. I would not for my part be willing to explain that consensus out of existence. This is because I think that the recognition of a limited power to pierce the corporate veil in carefully defined circumstances is necessary if the law is not to be disarmed in the face of abuse. I also think that provided the limits are recognised and respected, it is consistent with the general approach of English law to the problems raised by the use of legal concepts to defeat mandatory rules of law. The difficulty is to identify what is a relevant wrongdoing. References to a “façade” or “sham” beg too many questions to provide a satisfactory answer. It seems to me that two distinct principles lie behind these protean terms, and that much confusion has been caused by failing to distinguish between them. They can conveniently be called the concealment principle and the evasion principle. The concealment principle is legally banal and does not involve piercing the corporate veil at all. It is that the interposition of a company or perhaps several companies so as to conceal the identity of the real actors will not deter the courts from identifying them, assuming that their identity is legally relevant. In these cases the court is not disregarding the “façade,” but only looking behind it to discover the facts which the corporate structure is concealing. The evasion principle is

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different. It is that the court may disregard the corporate veil if there is a legal right against the person in control of it which exists independently of the company’s involvement, and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement. Many cases will fall into both categories, but in some circumstances the difference between them may be critical. This may be illustrated by reference to those cases in which the court has been thought, rightly or wrongly, to have pierced the corporate veil. The first and most famous of them is Gilford Motor Co Ltd v Horne [1933] Ch. 935. Mr EB Horne had been the managing director of the Gilford Motor Co Ltd. His contract of employment precluded him being engaged in any competing business in a specified geographical area for five years after the end of his employment “either solely or jointly with or as agent for any other person, firm or company.” He left Gilford and carried on a competing business in the specified area, initially in his own name. He then formed a company, JM Horne & Co Ltd, named after his wife, in which she and a business associate were shareholders. The trial judge, Farwell J., found that the company had been set up in this way to enable the business to be carried on under his own control but without incurring liability for breach of the covenant. However the reality, in his view, was that the company was being used as “the channel through which the defendant Horne was carrying on his business.” In fact, he dismissed the claim on the ground that the restrictive covenant was void. But the Court of Appeal allowed the appeal on that point and granted an injunction against both Mr Horne and the company. As against Mr Horne, the injunction was granted on the concealment principle. Lord Hanworth M.R. said, at 961 – 962, that the company was a “mere cloak or sham” because the business was really being carried on by Mr Horne. Because the restrictive covenant prevented Mr  Horne from competing with his former employers whether as principal or as agent for another, it did not matter whether the business belonged to him or to JM Horne & Co Ltd provided that he was carrying it on. The only relevance of the interposition of the company was to maintain the pretence that it was being carried on by others. Lord Hanworth did not explain why the injunction should issue against the company, but I think it is clear from the judgments of Lawrence and Romer L.JJ., at 965 and 969, that they were applying the evasion principle. Lawrence L.J., who gave the fullest consideration to the point, based his view entirely on Mr Horne’s evasive motive for forming the company. This showed that it was “a mere channel used by the defendant Horne for the purpose of enabling him, for his own benefit, to obtain the advantage of the customers of the plaintiff company, and that therefore the defendant company ought to be restrained as well as the defendant Horne.” In other words, the company was restrained in order to ensure that Horne was deprived of the benefit which he might otherwise have derived from the separate legal personality of the company. … Jones v Lipman [1962] 1 W.L.R. 832 was a case of very much the same kind. The facts were that Mr Lipman sold a property to the plaintiffs for £5,250 and then, thinking better of the deal, sold it to a company called Alamed Ltd for £3,000, in order to make it impossible for the plaintiffs to get specific performance. The judge, Russell J., found that company was wholly owned and controlled by Mr Lipman, who had bought it off the shelf and had procured the property to be conveyed to it “solely for the purpose of defeating the plaintiffs’ rights to specific performance.” About half of the purchase price payable by Alamed was funded by borrowing from a bank, and the rest was left outstanding. The judge decreed specific performance against both Mr Lipman and Alamed

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Ltd. As against Mr  Lipman this was done on the concealment principle. Because Mr  Lipman owned and controlled Alamed Ltd, he was in a position specifically to perform his obligation to the plaintiffs by exercising his powers over the company. This did not involve piercing the corporate veil, but only identifying Mr Lipman as the man in control of the company. The company, said Russell  J. portentously at 836, was “a device and a sham, a mask which [Mr Lipman] holds before his face in an attempt to avoid recognition by the eye of equity.” On the other hand, as against Alamed Ltd itself, the decision was justified on the evasion principle, by reference to the Court of Appeal’s decision in Gilford Motor Co (above). … In Gencor ACP Ltd v Dalby [2000] 2 B.C.L.C. 734, the plaintiff made a large number of claims against a former director, Mr  Dalby, for misappropriating its funds. For present purposes the claim which matters is a claim for an account of a secret profit which Mr Dalby procured to be paid by a third party, Balfour Beatty, to a British Virgin Islands company under his control called Burnstead. Rimer J. held, at [26], that Mr Dalby was accountable for the money received by Burnstead, on the ground that the latter was “in substance little other than Mr Dalby’s offshore bank account held in a nominee name,” and “simply . . . the alter ego through which Mr Dalby enjoyed the profit which he earned in breach of his fiduciary duty to ACP.” Rimer J. ordered an account against both Mr Dalby and Burnstead. He considered that he was piercing the corporate veil. But I do not think that he was. … This is in reality the concealment principle. The correct analysis of the situation was that the court refused to be deterred by the legal personality of the company from finding the true facts about its legal relationship with Mr Dalby. It held that the nature of their dealings gave rise to ordinary equitable claims against both. The result would have been exactly the same if Burnstead, instead of being a company, had been a natural person, say Mr Dalby’s uncle, about whose separate existence there could be no doubt. The same confusion of concepts is, with respect, apparent in Sir Andrew Morritt V.-C.’s analysis in Trustor AB v Smallbone (No.2) [2001] 1 W.L.R. 1177; [2002] B.C.C. 795, which I have already considered. The Vice-Chancellor’s statement of principle at [23] that the court was entitled to pierce the corporate veil if the company was used as a “device or façade to conceal the true facts thereby avoiding or concealing any liability of those individual(s)” elides the quite different concepts of concealment and avoidance. … In Trustor, as in Gencor, the analysis would have been the same if Introcom had been a natural person instead of a company. The evasion principle was not engaged, and indeed could not have been engaged on the facts of either case. This is because neither Mr Dalby nor Mr Smallbone had used the company’s separate legal personality to evade a liability that they would otherwise have had. …The situation was not the same as it had been in Gilford Motor Co v Horne and Jones v Lipman, for in these cases the real actors, Mr Horne and Mr Lipman, had a liability which arose independently of the involvement of the company. These considerations reflect the broader principle that the corporate veil may be pierced only to prevent the abuse of corporate legal personality. It may be an abuse of the separate legal personality of a company to use it to evade the law or to frustrate its enforcement. It is not an abuse to cause a legal liability to be incurred by the company in the first place. It is not an abuse to rely upon the fact (if it is a fact) that a liability is not the controller’s because it is the company’s. On the contrary, that is what incorporation is all about. … I conclude that there is a limited principle of English law which applies when a person is under an existing legal obligation or liability or subject to an existing legal restriction

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which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control. The court may then pierce the corporate veil for the purpose, and only for the purpose, of depriving the company or its controller of the advantage that they would otherwise have obtained by the company’s separate legal personality. The principle is properly described as a limited one, because in almost every case where the test is satisfied, the facts will in practice disclose a legal relationship between the company and its controller which will make it unnecessary to pierce the corporate veil. Like Munby J. in Ben Hashem, I consider that if it is not necessary to pierce the corporate veil, it is not appropriate to do so, because on that footing there is no public policy imperative which justifies that course. I therefore disagree with the Court of Appeal in VTB Capital who suggested otherwise at [79]. For all of these reasons, the principle has been recognised far more often than it has been applied. But the recognition of a small residual category of cases where the abuse of the corporate veil to evade or frustrate the law can be addressed only by disregarding the legal personality of the company is, I believe, consistent with authority and with long-standing principles of legal policy. In the present case, Moylan J. held that he could not pierce the corporate veil under the general law without some relevant impropriety, and declined to find that there was any. In my view he was right about this. The husband has acted improperly in many ways. In the first place, he has misapplied the assets of his companies for his own benefit, but in doing that he was neither concealing nor evading any legal obligation owed to his wife. Nor, more generally, was he concealing or evading the law relating to the distribution of assets of a marriage upon its dissolution. It cannot follow that the court should disregard the legal personality of the companies with the same insouciance as he did. Secondly, the husband has made use of the opacity of the Petrodel Group’s corporate structure to deny being its owner. But that, as the judge pointed out at [219] “is simply [the] husband giving false evidence.” It may engage what I have called the concealment principle, but that simply means that the court must ascertain the truth that he has concealed, as it has done. The problem in the present case is that the legal interest in the properties is vested in the companies and not in the husband. They were vested in the companies long before the marriage broke up. Whatever the husband’s reasons for organising things in that way, there is no evidence that he was seeking to avoid any obligation which is relevant in these proceedings. The judge found that his purpose was “wealth protection and the avoidance of tax.” It follows that the piercing of the corporate veil cannot be justified in this case by reference to any general principle of law. [Although the court did not pierce the corporate veil in this case, they allowed Mrs. Prest’s appeal on the grounds that the husband was in fact the beneficial owner of the properties employing principles of trusts law. In their concurring judgements (here omitted), Lord Neuberger, Lady Hale, Lord Mance, Lord Clarke, and Lord Walker agreed with Lord Sumption that the doctrine should only be applied “as a final fall-back” in cases where other legal solutions are not applicable, but were less willing to accept the hard-and-fast distinction between “evasion” and “concealment.”]

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VI. Conclusion NOTES AND QUESTIONS

1.  The Supreme Court of the United Kingdom In Prest, unlike Canadian courts, suggests that family law claimants are no more deserving of a remedy through piercing the corporate veil than any other type of claimant. Do you agree? Is the Canadian approach preferable? 2. In Prest, Lord Sumption suggested that all prior cases in which English courts were asked to pierce the corporate veil may be categorized as “evasion” cases or “concealment” cases. These two concepts have been applied in subsequent English cases.66 Consider whether and the extent to which these two concepts address the problems associated with corporate veil-piercing and also whether Canadian courts should adopt them.

VI. CONCLUSION This chapter began with an overview of the history of the corporate form, explained the incorporation process, and surveyed separate legal personality and limited liability as fundamental features of general business corporations. The corporation emerged as a vehicle for the long-term commitment of capital in order to profit from trading opportunities. Today, the incorporation process is extremely simple and formation, once all of the relevant statutory requirements are complied with, may be achieved almost instantaneously. Once incorporated, two of the default fundamental features of corporations are separate legal personality and limited liability. While these two features serve valuable economic functions, they also raise policy concerns in particular contexts that courts try to address by “piercing the corporate veil,” “lifting the corporate veil,” or “drawing aside the corporate veil.” Having now provided an introduction to common forms of business organizations such as partnerships and corporations, Chapter 4 considers special issues arising in the context of First Nations business organizations.

66 See e.g. Antonio Gramsci Shipping Corp v Lembergs, [2013] EWCA Civ 730, [2013] 4 All ER 157; R v Sale, [2013] EWCA Crim 1306, [2014] WLR 663; Akzo Nobel NV v Competition Commission, [2013] CAT 13. For an analysis of evasion and concealment by Canadian practitioners and scholars, see Thomas G Heintzman & Brandon Kain, “Through the Looking Glass: Recent Developments in Piercing the Corporate Veil” (2013) 28 BFLR 525 and Mohamed F Khimji & Christopher C Nicholls, “Piercing the Corporate Veil Reframed as Evasion and Concealment” (2015) 48 UBC L Rev 401.

CHAPTER FOUR

First Nation Business Structures









I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 II.  History and Rationale of Use of the Corporate Form by Indigenous Peoples . . . . . . . . 243 A.  Legal Personality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244 B.  Restrictions on Ownership, and Protection of Rights and Title . . . . . . . . . . . . . . . 245 C.  Forms of Tax Exemption and Corporate Personhood . . . . . . . . . . . . . . . . . . . . . . . . 245 D.  Historical Reality and Future Economic Development for Indigenous Peoples . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251 III.  Legal Personality and the Need for Corporate Form and Identity . . . . . . . . . . . . . . . . . . . 257 IV.  Corporate Identity, Fiduciary Duty, and Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274 A.  Separation of Ownership and Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274 B.  Fiduciary Duties of Directors as Compared with First Nation Leaders . . . . . . . . . 282 V.  Business Structures and Economic Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292 A.  Legal Ethics and First Nation Economic Development: Representation, Conflicts, and Succession . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292 B.  Economic and Policy Challenges for Corporate Planning . . . . . . . . . . . . . . . . . . . . 297 1.  The Challenge of Own-Source Revenue for Corporate Planning . . . . . . . . . . . 297 2.  Structuring for Tax Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297 3.  Economic Development and the Separation of Business and Politics . . . . . . 301 C.  Corporate Structures Used for Economic Development by First Nations . . . . . . 309 1.  Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 310 2.  Partnerships/Limited Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311 3. Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311 4. Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311 5.  Co-operatives and Non-Profit Societies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312 VI.  Structuring Issues: Limited Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 318 A.  Names, “Holding Out As,” and Holding Assets: General Partners and Limited Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 318 B.  Creditor Protection Under the Indian Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329 VII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 341

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I. INTRODUCTION It is common knowledge that prior to European contact Indigenous peoples’ laws existed, and that many such legal traditions continue to be practised today.1 Indigenous laws are complex, vary between Indigenous groups,2 and, importantly for this chapter, include concepts of commerce, trade, and currency.3 Indigenous laws address the social, historical, political, biological, spiritual, and economic circumstances of each group.4 While recognizing that we, as the authors of this chapter, do not have the adequate cultural insight, experience, and knowledge to authoritatively address the various and complex Indigenous laws that exist throughout Canada, it is important to understand that such laws can have a deep impact on First Nation commerce and business decisions. For example, Alan Hanna argues that Tsilhqot’in laws establish Tsilhqot’in jurisdiction over their country and govern land use through principles of environmental protection.5 Principles of environmental protection may sometimes be at odds with certain approaches to economic development. For example, it could be argued that during the Tsilhqot’in Aboriginal title and rights trial,6 Tsilhqot’in witness Councillor David Setah was struggling to explain, to a nonTsilhqot’in audience, Tsilhqot’in laws related to sustainability, and how they were not consistent with a commercial clearcut logging practice.7 Tsilhqot’in Chief Ervin Charleyboy explained sustainability Tsilhqot’in dechen ts’edilhtan (“law”) as “you don’t kill what you’re not gonna use. Same with the fishing. You only [catch] what you need to carry you through the winter.”8 If there is an overarching Indigenous legal requirement to take only what one needs from the environs, how does that affect economic development conducted in the traditional territory of a First Nation? How does that affect who must have control of a corporate entity that conducts business in the traditional territory of a First Nation?

1 On the persistence of these traditions, see John Borrows, Canada’s Indigenous Constitution (Toronto: University of Toronto Press, 2010). 2 Alan Hanna, “Making the Round: Aboriginal Title in the Common Law from a Tsilhqot’in Legal Perspective” (2015) 45:3 Ottawa L Rev 365 at 369. Alan Hanna asserts that “there is no pan-Indigenous system of law.” 3 There are far too many examples of pre-contact Indigenous commerce, trade, and currency to mention in this chapter. However, the following two examples are cited in recognition of the Tsilhqot’in Nation and their success in establishing Aboriginal title and an Aboriginal right to trade, and the law firm of the authors, which participated in that action. See Edith Beeson, Dunlevy: From the Diaries of Alex P McInnes (Lillooet: Lillooet, 1971) at 65, where it is reported that in 1859 at a gathering of varying First Nations from the interior of British Columbia, Chief Dehtus of Anaham referenced an Indigenous medium of exchange when he stated that “white men who are coming up our rivers … are washing out little pieces of yellow stone which they call “gold,” and they use it for what we call sunia, to use as we use skins to trade for other goods.” See also Tsilhqot’in Trial, Exhibit 0165, Expert Report of Dr. Doug Hudson (20 December 2003) at 3: dentalium shells found on the West Coast were used for both ornamentation and as a medium of exchange between the Tsilhqot’in and Shuswap First Nations. 4 Borrows, supra note 1 at 23-24; see also Gerald Postema, “On the Moral Presence of Our Past” (1991) 36 McGill LJ 1153. 5 Hanna, supra note 2 at 370-71. 6 Tsilhqot’in Nation v British Columbia, 2007 BCSC 1700. 7 Ibid, Trial Transcript (1 March 2005), David Setah, Cross-Examination at 51-56. 8 Ibid, Trial Transcript (20 April 2005), Chief Ervin Charleyboy, Direct-Examination at 7.

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Undoubtedly in the context of a Tsilhqot’in law of sustainability, and possibly Tsilhqot’in laws related to stewardship, Tsilhqot’in Chief Roger William explained that the Xeni Gwet’in (one of the bands comprising the Tsilhqot’in Nation) are caretakers of the area and any joint venture to log would require a Tsilhqot’in majority ownership, so as to ensure Tsilhqot’in control for the purposes of “being able to make decisions that reflect what our issues and needs are to our lands … [A]s Xeni Gwet’ins or Tsilhqot’in we are responsible for our future generations.”9 The differences that arise between these two legal traditions (colonial corporate law and Indigenous law) consistently confront lawyers who work to reconcile the sustainability laws of a First Nation with the profit mandate of a corporation whose shares the First Nation owns. These differences also arise when a First Nation enters an agreement or joint venture with a non-Indigenous-owned commercial entity that is primarily focused on profit. John Borrows and Sarah Morales suggest that Indigenous laws inform the decision-making of Indigenous peoples, and that Indigenous peoples must engage in economic development in accordance with their deeper teachings and traditions.10 In addition to Indigenous law, are there other elements that affect the economic development and business structure choices of Indigenous peoples? Indigenous people across Canada are becoming engaged in self-owned and First Nation – owned businesses at five times the national rate of non-Indigenous businesses.11 Because of the flexibility of different business structures, coupled with the way Canadian law applies to Indigenous people in Canada, the kinds of business organizations are the same as we would find among nonIndigenous residents. However, the particular way in which these structures are used, and the reasons for their specific design, are different in a number of important ways. Historically, Indigenous people have not enjoyed the same benefits as their non-Indigenous counterparts in Canada, which is not an accident of law or its institutions but largely because of it. Because Canadian law did not enfranchise Indigenous people, certain ordinary aspects of daily economic life did not, and still do not, apply.12 For example, there is a distinction in law between reserve lands and fee simple lands, and the rights of Indigenous people to own land differ from the rights of non-Indigenous people. As will be explained within this chapter, with respect to reserve lands, the federal Crown owns reserve lands, for the benefit and use of First Nations and their communities.13 Therefore, Indigenous people cannot own fee simple interests in reserve lands.14 With respect to fee simple lands, First Nations cannot own fee simple lands because the applicable legislation does not recognize First Nations as a legal entity. Instead a First Nation must use a corporate or personal entity to purchase fee simple land. 9 Ibid, Trial Transcript (9 October 2003), Chief Roger William, Direct-Examination at 27-28. 10 John Borrows & Sarah Morales, “Challenge, Change and Development in Aboriginal Economies” in Joseph Eliot Magnet & Dwight A Dorey, eds, Legal Aspects of Aboriginal Business Development (Toronto: LexisNexis Canada, 2005) at 164. 11 Canadian Council for Aboriginal Business, From Promise to Prosperity: The Aboriginal Business Survey, 2016 (Toronto: CCAB, 2016) at 2-5. 12 Other barriers to successful economic development are canvassed in Borrows & Morales, “Challenge, Change and Development in Aboriginal Economies,” supra note 10 at 143-51. 13 Indian Act, RSC 1985, c I-5, as amended, ss 2(2) and 18. 14 There are interests in reserve lands that are similar to fee simple interests, referred to as Certificates of Possession and issued pursuant to s 20 of the Indian Act, but these interests are beyond the scope of this chapter.

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Today, there is an obligation on all Canadians to recognize the historical inequity that has resulted from the disenfranchisement of Indigenous people, and work must be done to shape legal institutions to work for, and not against, Indigenous people. This work involves both public and private legal institutions, and certainly includes business organizations. To understand the way that legal institutions work to either exclude or assimilate Indigenous peoples is not simple, but it does not lessen the obligation that lawyers, legal educators, and law students have to think about and deal with the fact that business organizations may often have that effect. Nor should one imagine that Indigenous people do not or cannot turn to the practices and mechanisms of business to pursue their economic livelihoods. The Truth and Reconciliation Commission’s “calls to action” have called upon lawyers, legal educators, and business people in the wake of the truths it witnessed.15 It should no longer be any secret that Indigenous people have suffered at the hands of Canadian institutions and laws: from bans on traditional forms of organizing and engaging in economic activity (from the potlatch to livelihood practices such as fishing), to the residential school system that detrimentally impacted Indigenous people to an extraordinary degree, and saw Indigenous children forcibly interned to have their languages and cultures intentionally suppressed—a practice called “cultural genocide” by First Nations, the Truth and Reconciliation Commission, Supreme Court of Canada’s Chief Justice Beverley McLachlin, and former Prime Minister Paul Martin, among others.16 The legacy of the Truth and Reconciliation Commission is to ensure that Canadians understand and face the reality of its government’s participation in that cultural genocide through its laws and institutions. To begin this work requires an understanding of some of the similarities and differences in the way that business organizations are used by Indigenous people, and by the non-Indigenous organizations that work with First Nations in Canada. The method in which business organizations are used by Indigenous people is heavily influenced by the historical circumstances that made their use legally necessary for economic development. Thus, “First Nation business organizations” refers not only to the variety of legal instruments and practices used by Indigenous people to pursue their livelihoods, but also to the economic development of First Nations as self-governing entities and to the legal arrangements that First Nations use with non-Indigenous residents of Canada. The study of First Nation business organizations concerns the legal institutions that have arisen because of the primary differences in the law’s treatment of Indigenous people with respect to legal personality and legal capacity, taxation of Canadian

15 Truth and Reconciliation Commission of Canada, “Introduction,” Final Report of the Truth and Reconciliation Commission of Canada, vol 1-6 (Ottawa: TRC Canada, 2015-16) at 1, and throughout. 16 The TRC’s Summary of the Final Report defines the residential school system in Canada as a form of “cultural genocide” in its opening paragraph. Mr. Justice Murray Sinclair stated that “cultural genocide” was a cornerstone of the TRC’s findings: “Truth and Reconciliation Commission Urges Canada to Confront ‘Cultural Genocide’ of Residential Schools,” CBC News (2 June 2015), online: . At the Global Centre for Pluralism’s annual lecture at the Aga Khan Museum in Toronto on May 28, 2015, Chief Justice McLachlin stated that Canada attempted cultural genocide against Aboriginal peoples ().

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residents, and ownership. Perhaps the most historically important pieces of legislation in this regard are the Indian Act, RSC 1985, c I-5, and the Income Tax Act, RSC 1985, c 1 (5th Supp) (the “ITA”), though there are certainly others. In this chapter, we begin by looking at the history and rationale for the use of the various forms of association available under Canadian law by Indigenous people and First Nations. We then turn to look at the requirements for legal personality and the need for a corporate form and identity by First Nations and “Indian bands.” Considering the fiduciary duties that arise in Aboriginal law generally, we will examine the important relationship between the fiduciary duties of leaders and of directors of corporations, and the concerns of structuring for liability protection, tax exemption, and economic development. We end with a survey of the structures used by Indigenous people and First Nations, and some of the common structuring issues encountered in practice. A brief note on terminology: although the word “Indian” is considered pejorative, it has several different legal meanings in Canada. In this chapter, we use the term only with reference to the Indian Act, and even then, place it in quotes. As noted by Jack Woodward, QC, in his definitive text Native Law: The individuals and groups who are recognized as aboriginal people under the law do not always correspond to those cultural or racial groups recognized by social science. In this book, “Indian” and other classifications of Indigenous peoples are used not as cultural or racial descriptions but as legal terms.17

In this chapter, we follow this practice and use the terms “Indian,” “Indian band,” and “band” only insofar as these remain defined terms under the Indian Act. We use the term “Indigenous” to refer broadly to the first peoples of Canada, which includes the Inuit and the Metis. We use the term “First Nation” to designate both “Indian bands” and Indigenous groups that recognize themselves and each other as self-determining nations or as “Aboriginal peoples of Canada” with rights protected under s 35(1) of the Constitution Act.18

II.  HISTORY AND RATIONALE OF USE OF THE CORPORATE FORM BY INDIGENOUS PEOPLES The particular way that business structures are used by Indigenous people in Canada stems from the historical circumstances of colonialism, and specifically as concerns (i) the legal status and legal personality of “Indians” and bands, (ii) restrictions on ownership and title to reserve lands while also having constitutional protection of Aboriginal rights and title, and (iii) subjection to and exemption from taxation. While s 91(24) of the Constitution Act, 1867 designates the federal government as having legislative authority with respect to “Indians, and Lands reserved for the Indians,” provincial governments have a residual authority with

17 Jack Woodward, QC, Native Law (Toronto: Carswell, 2016) at 1-5. See also Brian Slattery, “Understanding Aboriginal Rights” (1987) 66 Can Bar Rev 727 at 735; and Chapman v Treakle, 2014 BCSC 2127 at para 13. 18 Constitution Act, 1982, being Schedule B to the Canada Act 1982 (UK), 1982, c 11.

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respect to matters related to Indigenous people insofar as they are subject to “laws of general application.”19 Thus, First Nations may elect, where possible, to avail themselves of federal or provincial laws as they apply to associations and commercial transactions.

A.  Legal Personality “Indian bands” are not “legal persons” in the same way that corporate entities or individuals are. In addition, First Nations, “Indians,” and “Indian bands” can enjoy certain kinds of exemption from taxation.

Indian Act RSC 1985, c I-5, s 2 2(1) … band means a body of Indians (a)  for whose use and benefit in common, lands, the legal title to which is vested in Her Majesty, have been set apart before, on or after September 4, 1951, (b)  for whose use and benefit in common, moneys are held by Her Majesty, or (c)  declared by the Governor in Council to be a band for the purposes of this Act;? •  •  •

Indian means a person who pursuant to this Act is registered as an Indian or is entitled to be registered as an Indian; Indian moneys means all moneys collected, received or held by Her Majesty for the use and benefit of Indians or bands;? reserve (a)  means a tract of land, the legal title to which is vested in Her Majesty, that has been set apart by Her Majesty for the use and benefit of a band, … 2(2)  The expression band, with reference to a reserve or surrendered lands, means the band for whose use and benefit the reserve or the surrendered lands were set apart. Exercise of powers conferred on band or council (3)  Unless the context otherwise requires or this Act otherwise provides, (a)  a power conferred on a band shall be deemed not to be exercised unless it is exercised pursuant to the consent of a majority of the electors of the band; and (b)  a power conferred on the council of a band shall be deemed not to be exercised unless it is exercised pursuant to the consent of a majority of the councillors of the band present at a meeting of the council duly convened.

19 Constitution Act, 1867 (UK), 30 & 31 Vict, c 3, reprinted in RSC 1985, Appendix II, No 5. We will not delve into the specifics of jurisdiction in this chapter except as concerns certain regulatory issues. For more information, see Woodward, supra note 17, ch 1.

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B.  Restrictions on Ownership, and Protection of Rights and Title While “Indian bands” have beneficial interests in reserves and reserve lands, they are not possessed of legal title in fee simple to the land on reserves, nor are “Indians” who have possession of any parcels of land on reserves. “Reserves” or “reservations” are held by the Crown in right of Canada and managed according to the fiduciary duty that the Crown has with respect to Indigenous people, the jurisdiction of which resides with the federal government under s 91(24) of the Constitution Act.20 Further, under provincial land title legislation, typically bands are not recognized as having legal capacity to own land in fee simple because they are not “owners” in those regimes.21 It is important to qualify limits on legal capacity with respect to the existence and protection of Aboriginal title and rights under s 35 of the Constitution Act, 1982. These rights include treaty rights, Aboriginal title to unceded territory, rights of self-government, and certain other “existing rights.” The effect of having these rights means that the provincial and federal government cannot legally encroach on those rights without justification, and to do so necessitates consulting with Indigenous people regarding their rights and title. One positive aspect of consultation by governments and non-Indigenous businesses has been the translation of these rights into economic opportunities, which we discuss below.

C.  Forms of Tax Exemption and Corporate Personhood The historical basis of granting an exemption from taxation of Indigenous peoples was legislatively expressed by the enactment of an early version of s 87 of the Indian Act in the late 1800s, which pre-dates the inauguration of income tax in any form in Canada, the latter being introduced during the First World War as a temporary measure to increase government revenue. As Justice La Forest noted in Mitchell v Peguis Indian Band, the basis for the exemption is rooted in the historical relationship between Canada and Indigenous peoples since 1763. In summary, the historical record makes it clear that ss. 87 and 89 of the Indian Act, the sections to which the deeming provision of s. 90 applies, constitute part of a legislative “package” which bears the impress of an obligation to native peoples which the Crown has recognized at least since the signing of the Royal Proclamation of 1763. From that time on, the Crown has always acknowledged that it is honour-bound to shield Indians from any efforts by non-natives to dispossess Indians of the property which they hold qua Indians, i.e., their land base and the chattels on that land base.22

Despite this general statement, it should be noted that the exemption from taxation enjoyed by Indigenous peoples is, in practice, much narrower than is commonly believed, as

20 See also Indian Act, ss 2(2) and 18. 21 See the Land Titles Act, RSBC 1996, c 250, s 1; Land Titles Act, RSO 1990, c L-5, s 1. Note, however, that modern treaty First Nations do have legal personality, because of which they are able to own land in fee simple, and can often establish their own land registry systems. 22 Mitchell v Peguis Indian Band, [1990] 2 SCR 85. See also Maxime Faille, “First Nation Tax Immunity,” Building First Nation Economies: Tax, Governance & Business Structures, Affinity Institute Conference Papers (Vancouver: Affinity Institute, 2015).

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it is only available to “Indians” and “Indian bands” under the conditions of Indian Act s 87 as has been interpreted by the courts and by the Canada Revenue Agency (“CRA”), both of which narrowly construed this right until 2011 when the twin cases of Bastien Estate v Canada and Dubé v Canada changed the landscape.23

Income Tax Act RSC 1985, c 1 (5th Supp), s 81 81(1)  There shall not be included in computing the income of a taxpayer for a taxation year, (a)  an amount that is declared to be exempt from income tax by any other enactment of Parliament, other than an amount received or receivable by an individual that is exempt by virtue of a provision contained in a tax convention or agreement with another country that has the force of law in Canada;

Indian Act RSC 1985, c I-5, s 87 87(1)  Notwithstanding any other Act of Parliament or any Act of the legislature of a province, but subject to section 83 and section 5 of the First Nations Fiscal Management Act, the following property is exempt from taxation: (a)  the interest of an Indian or a band in reserve lands or surrendered lands; and (b)  the personal property of an Indian or a band situated on a reserve. (2)  No Indian or band is subject to taxation in respect of the ownership, occupation, possession or use of any property mentioned in paragraph (1)(a) or (b) or is otherwise subject to taxation in respect of any such property. (3)  No succession duty, inheritance tax or estate duty is payable on the death of any Indian in respect of any property mentioned in paragraphs (1)(a) or (b) or the succession thereto if the property passes to an Indian, nor shall any such property be taken into account in determining the duty payable under the Dominion Succession Duty Act, chapter 89 of the Revised Statutes of Canada, 1952, or the tax payable under the Estate Tax Act, chapter E-9 of the Revised Statutes of Canada, 1970, on or in respect of other property passing to an Indian. The income of an “Indian” or band has been held to be “personal property” under Indian Act s 87,24 but there are fairly narrow requirements regarding the earning of income by way of

23 Bastien Estate v Canada, 2011 SCC 38, [2011] 2 SCR 710; Dubé v Canada, 2011 SCC 39, [2011] 2 SCR 764. 24 Nowegijick v The Queen, [1983] 1 SCR 29 at 38.

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employment and investment. In the employment context, the courts look to the factors that would connect the property to a reserve—dubbed the “connecting factors test” by the Supreme Court of Canada in Williams v Canada.25 With respect to investment income, prior to 2011 it was fairly difficult for an “Indian” or band to earn exempt income on investments, even when the money for those investments had been earned in a tax-free manner and was held with banks or trust companies on reserve. After the Supreme Court of Canada’s twin decisions in Bastien Estate and Dubé, it was no longer necessary to be concerned with whether the investment income had entered the “commercial mainstream,” but rather to look at other connecting factors.26 The s 87 exemption from taxation does not apply to corporations owned by “Indians,” as these have a separate legal personality and are not “Indians” under the Indian Act. Beyond the Indian Act, there is another form of tax exemption enjoyed by bands and modern treaty First Nations, and is wholly contained in the ITA. The exemption for a “public body performing a function of government” and for wholly owned corporations of those public bodies is contained in s 149 of the ITA.

Income Tax Act RSC 1985, c 1 (5th Supp), s 149 149(1)  No tax is payable under this Part on the taxable income of a person for a period when that person was •  •  •

Municipal authorities (c)  a municipality in Canada, or a municipal or public body performing a function of government in Canada; •  •  •

Income within boundaries of entities (d.5)  subject to subsections (1.2) and (1.3), a corporation, commission or association not less than 90% of the capital of which was owned by one or more entities each of which is a municipality in Canada, or a municipal or public body performing a function of government in Canada, if the income for the period of the corporation, commission or association from activities carried on outside the geographical boundaries of the entities does not exceed 10% of its income for the period; •  •  •

25 Williams v Canada, [1992] 1 SCR 877. 26 Bastien Estate v Canada, supra note 23; Dubé v Canada, supra note 23. The notion of the “commercial mainstream” had evolved to make it very difficult for First Nations people to avail themselves of any tax exemption on interest earned in bank accounts located on-reserve, as it was previously held to be circulating in the commercial mainstream. See Martha O’Brien’s excellent review of the jurisprudence prior to Bastien: “Income Tax, Investment Income, and the Indian Act: Getting Back on Track” (2002) 50:5 Can Tax J 1570.

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Geographical boundaries—body performing government functions (11)  For the purpose of this section, the geographical boundaries of a municipal or public body performing a function of government are (a)  the geographical boundaries that encompass the area in respect of which an Act of Parliament or an agreement given effect by an Act of Parliament recognizes or grants to the body a power to impose taxes; or (b)  if paragraph (a) does not apply, the geographical boundaries within which that body has been authorized by the laws of Canada or of a province to exercise that function. [Emphasis added.] In order to obtain these tax exemptions, First Nations had to either proceed as if they were a “public body performing a function of government in Canada,” or its corporation, and take the risk that the CRA would disagree and apply taxes and penalties, or apply for an Advanced Income Tax Ruling from the CRA and proceed with certainty. Although the history of the s 149 tax exemption is relatively recent, modern treaty First Nations and bands now enjoy this exemption without having to apply for Advanced Income Tax Rulings with respect to their transactions or corporate structures so long as they fit within the criteria.27 Given this legislative framework, two early cases considered whether a First Nation, as an “Indian band,” was an entity that fell within the criteria set out in s 149. In Otineka Development Corp v Canada, [1994] 1 CTC 2424, [1994] 2 CNLR 83 (TCC), the Tax Court of Canada held that the term “municipality” in the ITA must be given its ordinary meaning, and not just that of the provincial legislation. Consequently, the court found that the Opaskwayak Cree Nation, both in the powers that it exercised and the services that it provided, was a municipality for the purposes of s 149(1)(d) (an early version of s 149(1)(d.5)), and that the income of its development corporation was thus exempt. In a footnote in Otineka, Justice Bowman noted that the question of the juridical status of the First Nation hovered at the edges: I use the word “entity” as it is used in paragraph 4 of the notice of appeal, which is admitted in the reply. It is common ground, however, that it is probably not an entity in the sense of being a juridical person. The term is used, I believe, in a somewhat looser and colloquial sense of a separate and identifiable but unincorporated body or group of persons. It is not necessary, for the purposes of these appeals, to reach a concluded view on the point.28

In Tawich Development Corp v Québec (Deputy Minister of Revenue), [2000] 3 CNLR 383, 55 DTC 5144, 2000 CanLII 9283 (Que CA), the Québec Court of Appeal held that the province did not intend to define a First Nation or “Indian band” as a municipality, and that the development corporation the First Nation used to carry out certain affairs was not exempt from provincial tax.

27 CRA Internal Technical Interpretation 2016-0645031I7 (27 July 2016). 28 Otineka Development Corp v Canada, [1994] 1 CTC 2424, [1994] 2 CNLR 83 (TCC), n 1.

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In 2014, the Canada Revenue Agency undertook a pilot project to ascertain the extent to which “Indian bands” could be classified as “public bodies performing a function of government” and whether such classification would continue to require Advanced Income Tax Rulings from the Rulings Directorate within the CRA. On July 27, 2016, the CRA issued an Interpretation Bulletin regarding the conclusions of the project.

CRA Internal Technical Interpretation 2016-0645031I7 (27 July 2016) Comments on Indian Act Bands as 149(1)(c) Entities [1]  This is to advise you that we have reviewed our policy with respect to the interpretation of paragraph 149(1)(c) of the Income Tax Act (“Act”) as it relates to Indian bands that are created under the Indian Act. [2]  In 1948, the Act was amended to include a tax exemption for “a municipality or a municipal or public body performing a function of government.” It appears likely that municipalities were considered part of the provincial Crown and were added to the list of tax exempt entities to make it explicit that they are not subject to income tax. There is no definition of “a municipal or public body performing a function of government” in the Act. However, it would seem logical, based on the wording, that it would appear to be an entity that is similar in nature to a municipality and governs people in a particular area. [3]  The federal government, through the Indian Act, specifically creates an Indian band. Under the Indian Act, these bands or First Nations may be able to levy property taxes and create by-laws that affect its members. Consequently, the very nature of an Indian band and its council under the Indian Act is that of a local government, similar in nature to a municipality. This means that their reserve lands, monies, other resources and governance structure are managed by the provisions in the Indian Act. When a band council makes a by-law under this section, it must be explicitly approved by the Minister of Indigenous and Northern Affairs Canada. [4]  In 2014 the Rulings Directorate instituted a service called Public Body Rulings as a pilot project. During this period Rulings has gathered even more extensive experience with determining whether a band qualifies as a municipal or public body performing a function of government in Canada. As a result, it is our view that all bands created under the Indian Act meet the criteria to be considered municipal or public bodies performing a function of government in Canada for the purpose of paragraph 149(1)(c) of the Act and are therefore exempt from income tax. In planning for the appropriate business structures for a First Nation it is important to note that the exemption from tax under s 149(1)(c) applies generally to First Nations and is not restricted to their reserve lands. Now, with CRA Internal Technical Interpretation 2016-0645031I7 (27 July 2016), “Indian bands” have more certainty that they can enjoy an exemption on income, and that the exemption is not restricted to territorial location. Thus, First Nations can earn income exempt from tax on or off reserve. Compare the

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situation with the Yukon First Nations, most of whom have self-government agreements that restrict the application of s 149(1)(c). 29 (Note that there is an additional clause in only a few of the Yukon Treaty First Nations’ self-government agreements that speaks to the application of s 149(1)(c), as seen in s 15.6 of the Yukon First Nation Self-Government Agreement, below.)

Yukon First Nations Self-Government Act SC 1994, c 35 18(1)  For the purposes of the Income Tax Act, a first nation named in Schedule II is deemed for a taxation year to be a public body performing a function of government in Canada as described in paragraph 149(1)(c) of that Act where, at all times during the year, the first nation satisfies the conditions set out in its self-government agreement relating to taxation of the first nation under that Act. (2)  No tax is payable under the Income Tax Act by a corporation described as a subsidiary in the self-government agreement of a first nation named in Schedule II on the corporation’s income, property or capital for a taxation year where, at all times during the year, the corporation satisfies the conditions for exemption from such tax set out in the self-government agreement.

Yukon First Nation Self-Government Agreement—Standard Terms30 15.1  The [Yukon Treaty First Nation] shall, for the purposes of paragraph 149(1)(c) of the Income Tax Act (Canada) be deemed to be a public body performing a function of government in Canada for each taxation year of the [Yukon Treaty First Nation] where, at all times during the year: 15.1.1  it did not carry on any business other than a business carried on by it on Settlement Land, the primary purpose of which was to provide goods or services to Citizens or residents of Settlement Lands; and 15.1.2  all or substantially all of its activities were devoted to the exercise of its powers of government authorized under this Agreement, Self-Government Legislation, its Final Agreement or Settlement Legislation, and for these purposes the taxation year

29 The self-government agreements are publicly available, and can be found by way of the Council of Yukon First Nations: . 30 There is no general Self-Government Agreement for Yukon First Nations that sets out standard terms. However, all Yukon First Nations with Final Agreements have Self-Government Agreements, and those all contain art 15.1 through 15.5, and some also contain art 15.6. Compare the various agreements listed by the Council of Yukon First Nations, supra note 29. For an example of a Yukon First Nation with art 15.6 in its Self-Government Agreement, see The Carcross/Tagish First Nation Self-Government Agreement, online: .

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of [Yukon Treaty First Nation] shall be the calendar year or such other fiscal period as the [Yukon Treaty First Nation] may elect. •  •  •

15.6  For greater certainty, nothing in 15.1 to 15.5 shall be construed so as to prevent the application of section 149 of the [ITA] to the [Yukon Treaty First Nation] or to a corporation referred to in 15.3. Article 15.6 is not found in most of the Yukon First Nations’ self-government agreements, but the relieving nature of the language of the provision has not been found effective at allowing Yukon Treaty First Nations to act commercially beyond the borders of their “settlement lands”—that is, lands set aside under the various treaties of Yukon First Nations. This difference in the application of exemption to First Nation governments is a situation of serious inequity for Yukon Treaty First Nations now that the CRA has issued Technical Interpretation 2016-0645031I7. NOTES AND QUESTIONS

1.  What is the difference between the CRA Interpretation Bulletin’s characterization of “Indian bands” and modern treaty First Nations? 2.  What could account for this difference in the treatment of “Indian bands” and treaty First Nations with respect to their corporate or legal personhood? 3.  Read the excerpt from Michael Welters, “Towards a Singular Concept of Legal Personality,” in Section III below, then return here and consider what Welters might make of this difference.

D.  Historical Reality and Future Economic Development for Indigenous Peoples As we will see, the combination of legal personality, restrictions on ownership of land coupled with Aboriginal rights and title, and tax exemptions produces very different focuses for Indigenous people and First Nations as they pursue economic development. This area of law is changing very rapidly, as First Nations are increasingly active in asserting their rights to develop economically and to secure a future for their members. The “private law” relations between Indigenous peoples and businesses are also evolving quickly, and many First Nations, bands, the Inuit, and other Indigenous peoples are asserting legislative authority over their reserve lands, settlement lands (that is, lands set apart under modern treaties), or other territories by creating a regulatory environment that is conducive to economic development in ways particular to Indigenous peoples.31 These developments present some of the most interesting and compelling issues in business law, and require the creativity and imagination of lawyers and leaders to use existing, and possibly new, structures and instruments in ways that express rather than repress Indigenous livelihoods.

31 See e.g. First Nations Land Management Act, SC 1999, c 24, which allows First Nations to opt out of 32 sections of the Indian Act that relate to the management of lands by First Nations.

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Truth and Reconciliation Commission of Canada, “We Are All Treaty People: Canadian Society and Reconciliation” Final Report of the Truth and Reconciliation Commission of Canada, vol 6 (Ottawa: TRC Canada, 2015-16) at 204-8 (footnotes incorporated) [1]  As Canada maps its economic future in regions covered by historical Treaties, modern land claims agreements, and unceded Aboriginal title, governments and industry must now recognize that accommodating the rights of Aboriginal peoples is paramount to Canada’s long-term economic sustainability. Governments aim to secure the economic stability and growth necessary to ensuring prosperity for all Canadians. [2]  Corporations invest time and resources in developing large-scale projects that create jobs and aim to produce profits for their shareholders. Although the corporate sector is not a direct party to the negotiation of Treaties and land claims agreements, industry and business play an extremely significant role in how the economic, social, and cultural aspects of reconciliation are addressed, including the extent to which opportunities and benefits are truly shared with Indigenous peoples and the environment of traditional homelands is safeguarded. •  •  •

[3]  Although the [Supreme Court of Canada] has ruled that the duty to consult rests solely with governments, it has also said that “the Crown may delegate procedural aspects of consultation to industry proponents seeking a particular development.” [Haida Nation v. British Columbia (Minister of Forests), 2004 SCC 73, para. 53.] On a practical level, the business risks associated with legal uncertainty created by the duty to consult have motivated industry proponents to negotiate with Aboriginal communities in order to establish a range of mechanisms designed to ensure that Aboriginal peoples benefit directly from economic development projects in their traditional territories. These may include, for example, joint venture business partnerships; impact and benefit agreements; revenuesharing agreements; and education, training, and job opportunities. [4]  Between 2012 and 2014, several reports highlighted the fact that Canada is once again facing significant challenges and potential opportunities related to land and resource development. Economic reconciliation will require finding common ground that balances the respective rights, legal interests, and needs of Aboriginal peoples, governments, and industry in the face of climate change and competitive global markets. In addition to the concrete remedial measures required, these reports emphasized that so-called soft skills— establishing trust, engaging communities, resolving conflicts, and building mutually beneficial partnerships—are important to advancing reconciliation. [5]  In 2012, Canada’s Public Policy Forum, a non-profit organization, held a series of six regional dialogues across the country, bringing together Aboriginal leaders; senior federal, provincial, and territorial government officials; and representatives from industry, business, and financial institutions. The dialogues were used to discuss issues, identify best practices, and make recommendations for action on how to ensure that Aboriginal communities benefit from large-scale resource development projects. The resulting report, “Building Authentic Partnerships: Aboriginal Participation in Major Resource Development Opportunities,” identified five key opportunities for action: (1) developing authentic partnerships among Aboriginal communities, industry, governments, and academic institutions by building trust; (2) developing human capital by removing barriers to

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education, training, and skills development for Aboriginal entrepreneurs, workers, and leaders; (3) enhancing community control over decision making; (4) promoting entrepreneurship and business development; and (5) increasing financial participation. The report concluded, Natural resource companies are recognizing that their operational success relies on strong, authentic community engagement. Private sector initiatives have already demonstrated positive examples in areas such as revenue sharing, skills training, and business development for Aboriginal communities. Now corporations and governments need to build on these successes to keep up with the rapid pace of development, moving beyond superficial consultations toward genuine engagement. Aboriginal communities must also play a leadership role to help forge these relationships, to develop local and adaptive solutions that will be essential to success. [Public Policy Forum, “Building Authentic Partnerships,” 6.]

[6]  In November 2013, after eight months of consultations with representatives from Aboriginal communities, industry, and local and provincial governments in British Columbia and Alberta, Douglas Eyford, Canada’s special representative on West Coast energy infrastructure, issued his report to the prime minister. Entitled “Forging Partnerships, Building Relationships: Aboriginal Canadians and Energy Development,” it focused on Aboriginal – Crown relations in the context of proposed energy infrastructure projects in British Columbia. He noted that although there are many differences among Aboriginal representatives, there was general consensus that development projects must respect constitutionally protected Aboriginal rights, involve Aboriginal communities in decision making and project planning, and mitigate environmental risks. [7]  Eyford made recommendations for taking action in three key areas: building trust, fostering inclusion, and advancing reconciliation. He noted in particular that “Aboriginal communities view natural resource development as linked to a broader reconciliation agenda.” [Letter of transmission from Douglas R. Eyford to Prime Minister, 29 November 2013, in Eyford, “Forging Partnerships,” 1] This is consistent with the Commission’s view that meaningful reconciliation cannot be limited to the residential school legacy, but must become the ongoing framework for resolving conflicts and building constructive partnerships with Aboriginal peoples. [8]  In December 2013, a group of current and former high-profile leaders from Aboriginal communities, business, banking, environment organizations, and federal and provincial governments released a report, “Responsible Energy Resource Development in Canada,” which summarizes the results of a year-long dialogue. They concluded that Canada is facing an “energy resource development gridlock.” In their view, the potential economic and social benefits derived from the exploitation of Canada’s rich natural resources must be weighed against the potential risks to Aboriginal communities and their traditional territories, and must also address broader environmental concerns associated with global warming. They emphasized that there are significant barriers to reconciliation, including conflicting values, lack of trust, and differing views on how the benefits of resource development should be distributed and adverse effects be mitigated. [9]The report identified four principles for moving forward on responsible energy resource development: (1) forging and nurturing constructive relationships, (2) reducing cumulative social and environmental impacts, (3) ensuring the continuity of cultures and

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traditions, and (4) sharing the benefits fairly. [The Charrette on Energy, Environment and Aboriginal Issues, “Responsible Energy Resource Development,” 8 – 14.] [10]  Writing about the 2014 Supreme Court of Canada decision in Tsilhqot’in Nation v. British Columbia, Kenneth Coates, Canada Research Chair in Regional Innovation at the University of Saskatchewan, and Dwight Newman, law professor and Canada Research Chair in Indigenous Rights in Constitutional and International Law at the University of Saskatchewan, concluded that although many challenges and barriers to reconciliation remain, [w]hat the Supreme Court of Canada has highlighted at a fundamental level is that Aboriginal communities have a right to an equitable place at the table in relation to natural resource development in Canada. Their empowerment through Tsilhqot’in and earlier decisions has the potential to be immensely exciting as a means of further economic development in Aboriginal communities and prosperity for all.  … [T]he time is now for governments, Aboriginal communities, and resource sector companies to work together to build partnerships for the future.  … We need to keep building a national consensus that responsible resource development that takes account of sustainability issues and that respects Indigenous communities, contributes positively—very positively—to Canada and its future. [Coates and Newman, “End Is Not Nigh,” 21.]

[11]  Internationally, there is a growing awareness in the corporate sector that the United Nations Declaration on the Rights of Indigenous Peoples is an effective framework for industry and business to establish respectful relationships and work collaboratively with Indigenous peoples. In 2013, the United Nations Global Compact published a business guide that sets out practical actions that corporations and businesses can undertake in compliance with the Declaration. It notes, Business faces both challenges and opportunities when engaging with Indigenous peoples. When businesses collaborate with Indigenous peoples, they are often able to achieve sustainable economic growth, for example, by optimizing ecosystem services and harnessing local or traditional knowledge. Positive engagement with Indigenous peoples can also contribute to the success of resource development initiatives—from granting and maintaining social licenses to actively participating in business ventures as owners, contractors and employees. Failing to respect the rights of Indigenous peoples can put businesses at significant legal, financial and reputational risk … . Continuing dialogue between business and Indigenous peoples can potentially strengthen Indigenous peoples’ confidence in partnering with business and building healthy relationships. [United Nations Global Compact, Business Reference Guide.]

[12]  In the Commission’s view, sustainable reconciliation on the land involves realizing the economic potential of Indigenous communities in a fair, just, and equitable manner that respects their right to self-determination. Economic reconciliation involves working in partnership with Indigenous peoples to ensure that lands and resources within their traditional territories are developed in culturally respectful ways that fully recognize Treaty and Aboriginal rights and title. [13]  Establishing constructive, mutually beneficial relationships and partnerships with Indigenous communities will contribute to their economic growth, improve community health and well-being, and ensure environmental sustainability, which will ultimately

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benefit Indigenous peoples and all Canadians. Unlike with the residential schools of the past, where Aboriginal peoples had no say in the design of the system and no ability to protect their children from intrinsic harms, First Nations, Inuit, and Métis peoples today want to manage their own lives. In terms of the economy, this autonomy means participation on their own terms. They want to be part of the decision-making process. They want their communities to benefit if large-scale economic projects come into their territories. They want to establish and develop their own businesses in ways that are compatible with their identity, cultural values, and world views as Indigenous peoples. They want opportunities to work for companies that are proactively addressing systemic racism and inequity. Corporations can demonstrate leadership by using the Declaration as a reconciliation framework. [14]  Call to action: 92.  We call upon the corporate sector in Canada to adopt the United Nations Declaration on the Rights of Indigenous Peoples as a reconciliation framework and to apply its principles, norms, and standards to corporate policy and core operational activities involving Indigenous peoples and their lands and resources. This would include, but not be limited to, the following: i.  Commit to meaningful consultation, building respectful relationships, and obtaining the free, prior, and informed consent of Indigenous peoples before proceeding with economic development projects. ii.  Ensure that Aboriginal peoples have equitable access to jobs, training, and education opportunities in the corporate sector, and that Aboriginal communities gain longterm sustainable benefits from economic development projects. iii.  Provide education for management and staff on the history of Aboriginal peoples, including the history and legacy of residential schools, the United Nations Declaration on the Rights of Indigenous Peoples, Treaties and Aboriginal rights, Indigenous law, and Aboriginal – Crown relations. This will require skills-based training in intercultural competency, conflict resolution, human rights, and anti-racism.

These calls express an obligation on non-Indigenous businesses to approach First Nations with particular care and attention to their circumstances, and to make room for specifically First Nation approaches to economic development. Some of these ideals had been previously expressed by the Royal Commission on Aboriginal Peoples in its final report, which was completed and published in 1996. The following extract summarizes the challenges for Indigenous businesses.

Royal Commission on Aboriginal Peoples (Canada), People to People, Nation to Nation: Highlights from the Report of the Royal Commission on Aboriginal Peoples (Ottawa: Supply and Services Canada, 1996) Business Development [1]  Governments have worked with Aboriginal entrepreneurs to help make business development one of the sparks of economic growth in Aboriginal communities. Many

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have demonstrated their capacity to master a wide range of commercial skills as individual entrepreneurs and as managers of community-owned businesses. • Levels of business formation have been high in recent years. About 10 per cent of Aboriginal people report business ownership or income from self-employment. • Self-employment has increased markedly in the last decade, particularly among Aboriginal women. [2]  Entrepreneurs face the same challenges everywhere: the need to plan, raise money, produce a good product and market it effectively. But Aboriginal entrepreneurs face other obstacles too: limited capital for investment, distrust from banks and other financial institutions, absence of local business services and advisers, tiny local markets, and sometimes even hostility at home and from nearby communities. [3]  Aboriginal nations have had perhaps their greatest successes through collectively owned enterprises—where shares in the company are held by the community or the nation government on behalf of its members. Through their companies, communities run regional airlines. They are involved in forestry management, silviculture, wood harvesting and processing. They run grocery stores and wholesale food distributing networks, motels, hotels, bowling alleys, golf courses and much more. [4]  Some have had a rough ride—making mistakes, losing investments, sometimes experiencing bankruptcy. But valuable lessons have been learned, and there are now scores of Aboriginal people with the skills and confidence to manage the operations of modern commercial enterprises. [5]  They, and those who would follow in their footsteps, still need support. We recommend that Aboriginal and non-Aboriginal governments work together to develop: • improved business services • improved access to loan and equity capital, including the creation of a national Aboriginal development bank • improved access to markets.

In sum, Indigenous peoples and First Nations pursue economic development according to the law and institutions of Canadian private law, and use its structures and instruments in very specific ways for historical reasons. Indigenous individuals, bands, and First Nation governments have all been affected by legal institutions that have restricted the legal personhood, ownership of land, and expression of Aboriginal rights, and exemptions from taxation. The economic relationships between First Nations, government, and non-Indigenous businesses in Canada will continue to be increasingly characterized by more and more sophisticated business structures and instruments as parties seek to give expression to the particular situation and laws of Indigenous peoples in Canada. NOTES AND QUESTIONS

1.  Can a First Nation only do business by utilizing the structures and instruments of Canadian law? Are there other sources of law, including Indigenous law, that might assist a First Nation in pursuing economic development?

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2.  When choosing between business structures, are First Nations limited only to entities that are either for-profit corporations or partnerships, or are not-for-profit societies available to them? Is commerce only about maximizing profit, or is there space for business structures that have other interests or priorities?32 3.  Given the legacy of treatment of Indigenous people in Canada, what proactive steps can the Indigenous and non-Indigenous business communities take to create economic opportunities for First Nations?

III.  LEGAL PERSONALITY AND THE NEED FOR CORPORATE FORM AND IDENTITY As noted, a band is not a “legal person” in certain circumstances, and indeed such personhood is implicated in the capacity that a band has to “act”—that is, to enter contracts, sue or be sued, own land, and be involved in commerce generally. There can be no doubt that bands do enjoy some kind of limited personhood and concomitant capacity despite these restrictions. Under the Indian Act and its regulations, bands can • make bylaws to appoint officials to conduct its business, provide for health of residents on reserve, tax reserve lands (ss 81(1) and 83 of the Indian Act); • own buildings (s 81(1)(h)) and otherwise have an interest in personal property held on reserve (ss 87 and 89); • enter agreements with financial institutions and auditors concerning “Indian moneys,” pledge or mortgage interests in reserve lands to an “Indian” or another band (s 89(1)), and otherwise borrow money for band projects; and • enter into conditional sales agreements (s 89(2)) and enter agreements with the Crown (s 90(1)(b)).33 Note that modern treaty First Nations are legal persons under the terms of their specific Final Agreements, which are passed into law under federal legislation. Conversely, there are differences among the provinces with respect to whether the shares of a corporation can be owned by a First Nation or “Indian band.” Usually, shares are held for the First Nation in one of two ways: in trust by the chief or each individual councillor. The reason for this is that the BC Business Corporations Act34 provides that a shareholder is, by definition, a “person,” and

32 As has been mentioned in earlier chapters, and is discussed in detail later, the “best interests” of the corporation are not simply confined to short-term profit, share value, or the interests of a specific group, but include the long-term interests of a corporation, which involve shareholders and stakeholders: “directors may look to the interests of, inter alia, shareholders, employees, creditors, consumers, governments and the environment to inform their decisions.” One would imagine this list of stakeholders could include First Nations. See BCE Inc v 1976 Debentureholders, 2008 SCC 69 at para 40 and at paras 37ff, [2008] 3 SCR 560. 33 For further discussion, see Jack Woodward, Q.C., “Chapter 1: G. Bands” in Native Law (Toronto: Carswell, 2016), at 1-22 to 1-31; Merrill Shepard & Marie Sophie Poulin, “Structuring for the Tax Exemption” in Managing Aboriginal Community Assets, J. Reynolds ed. (Vancouver: CLEBC, 2002); and Tracy MacKinnon & Michael Welters, “First Nations: Taxation and Business Structures” Canadian Tax Foundation 2014 Conference Report, vol 39 (Toronto: CTF, 1-29). 34 Business Corporations Act, SBC 2002, c 57, s 1(1).

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the BC Interpretation Act does not include a First Nation, unincorporated association, or government in the definition of “person.”35 This discrepancy raises the larger question, broached in Chapters 1 and 3 (together with subsequent chapters in this book), about the corporate nature of legal personhood and the stakeholder debate. As we will see in the following excerpt, one prominent tax and corporate lawyer has called for a different view, and claims that it would be needlessly complex to initiate a third kind of entity beyond government bodies and corporate bodies.

Michael Welters, “Towards a Singular Concept of Legal Personality” (2014) 92 Can Bar Rev 417 (footnotes incorporated into text) at 417-19, 428, 430, 445, 447-48, and 451-55 The general thesis of this paper is that “corporation” is the common law term for a legal person other than a natural person, and there is no third category of legal person. … This paper will also argue, based on the historical development of the corporation, that the essential attributes of a corporation are name, perpetual succession and state sanction. … [This approach can be] applied to First Nations. The Indian Act [RSC 1985, c I-5] does not explicitly state that Indian bands have legal personality or that they are corporations. That has led to longstanding questions as to the capacity of Indian bands to hold property and engage in certain activities. Based on the essential attributes approach put forward here, it will be seen that an Indian band has the essential attributes of a corporation and so should be considered a corporation. Legal Personality and the Corporation The proposition that a corporation is the common law word for a legal person other than a natural person is best understood by considering the history of the corporation in the common law. A study of that history leads to the proposition that the essential attributes of a corporation are perpetual succession and state sanction. •  •  •

It has recently been suggested that the meaning of the term “corporation” is opentextured and fluid. If true, for our purposes that would mean that the term corporation is not necessarily tied to its historical roots of state sanction and perpetual succession. It is undeniable that language is open-textured; it is often difficult to provide precise boundaries to the meaning of any particular word. The open-textured nature of language gives rise to many legal disputes. Based on the historical development of the corporation in the English common law, however, the definition of a corporation is fairly precise: it is something sanctioned by the Crown that has perpetual succession. That is evident from the canonist purpose of adopting the corporation into English law and from the early English cases and commentary. In contrast, the meaning of the term “share” is quite open-textured and historically fluid. Conventional usage is to refer to the share as a divisible unit representing a

35 Interpretation Act, RSBC 1996, c 238, s 29.

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proportional share in the capital of the corporation. When we speak of shares, we could easily speak instead of units. For tax purposes, the language of the Income Tax Act (ITA) is predicated on this conventional usage of the term share. “Share” is not defined in the B.C. Interpretation Act, or in corporate governance statutes. … It is trite law to say that a share is a bundle of rights against a corporation. There must be more than that given that society members have bundles of rights, but not “shares,” and given that creditors of a corporation have a bundle of rights against the corporation, but not “shares.” … The digression into the meaning of the term share hopefully illustrates how some terms are more open-textured and fluid than others. Defining a corporation as something with perpetual succession, and therefore legal personality, is a fairly precise and useful definition. •  •  •

No Need for a Third Category of Legal Person The history of the corporation in English law suggests that the concept of a corporation is synonymous with the concept of a non-natural legal person. That is reflected in the statement by Blackstone that “artificial persons [having perpetual succession] are called bodies politic, bodies corporate, or corporations.” … First Nations The issue is not relevant only with respect to classification of foreign entities for Canadian tax purposes. It is also relevant to the proper treatment of various “entities” under Canadian law. This section applies the essential attribute approach to First Nations to determine whether Indian bands, traditional First Nation governments, and modern treaty nations are corporations—that is, separate legal persons. •  •  •

Although the Indian Act does not state explicitly whether a band is a legal person, there are a number of provisions in the Indian Act that provide guidance on this point. Like business corporations, societies and municipalities, bands have rules for internal governance, a governing council, rules for populating the council, and a method of determining membership. While the Indian Act does not state that a band can own property, it implies it when it exempts from taxation the “personal property of … a band situated on reserve,” exempts such property from seizure by creditors, and refers to a band selling certain types of tangible personal property. The ability to own property in the name of the band must mean that there is a legal person. The essence of property is the right to exclude the world—if there is no one to hold those rights, there can be no ownership of property. Similarly, the ability of the band to enter into agreements with its members implies that the band has legal personality, as does the prohibition on the band entering into certain types of contracts. The Indian Act also imposes rights and obligations on the band itself, including the obligation to maintain roads, bridges, ditches, and so on. It seems unlikely that Parliament intended to impose that obligation on each of the individual band members, which would have to be the case if the obligations have not been imposed on a separate legal person known as the band. Some sections of the Indian Act draw a distinction between the band and the band council, but that is no different from the B.C. Business Corporations Act sometimes referring to the corporation and sometimes to the directors or board of directors. …

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In B.C., it is common for traditional chiefs to have more legitimacy in a particular community than does the band council. But do they have a status in the common law, and is that status that of a corporation? The fact that the British Crown enters into treaties with First Nations suggests that the Nation itself has some sort of standing as a legal person in the common law, as does the Canadian courts’ recognition of the vague concept of a right to self-government. In Pawis v The Queen, however, Marceau J of the Federal Court noted that the treaties are not treaties in the international law sense, but rather a treaty between the Crown and a group of her subjects. That being said, the treaty was with the collective group and not with each individual. The treaty gave rise to collective rights, but since the group had no separate legal personality, the rights could only be enforced by an action on behalf of the group, where particular individuals act as representatives of the group. The B.C. Court of Appeal had a chance to comment on the legal personality of the nation in Oregon Jack Creek Indian Band v CNR. The Court affirmed that the rights are communal, noting that the rights do not vest in an entity which “clearly does not exist today.” Accordingly, the Court confirmed that representative actions were appropriate for enforcing treaty rights. There is no doubt that Aboriginal rights, whether derived from a treaty or not, are collective rights (and can only be enforced through representative actions). That principle alone does not resolve whether the tribe or nation retains any legal status, other than to indicate that such rights are not vested in such tribe or nation itself, if it has any legal status. … If a First Nation were recognized as a legal person, it would lead to some interesting issues. Different First Nations had different government structures. For some, there was one government for the entire Nation. For other Nations, each chief was the highest authority. In the latter case, would the legal person still be the Nation as a whole, and if so, then who would speak for the Nation if the traditional law only allowed each chief to speak for his part of the Nation? Or would each chief occupy the corporate office for his part of the Nation, like the Crown is an office occupied by the Queen, such that each chief could be considered a corporation? In the wake of Delgamuukw, aboriginal rights cases continue to be brought as representative actions. Indeed, it may be more appropriate than Indian bands bringing such cases since bands are not necessarily successors to the Nation… Modern treaties specifically address self-government and the legal personality of the nation… It is interesting that the legislature has chosen not to describe modern treaty governments as corporations, even though they have invested them with all the attributes of a separate legal person and their closest analogy, municipalities, are recognized as corporations. However, on the basis that the modern treaty First Nations have “separate legal personality,” and have been invested with perpetual succession, they are properly seen as corporations. … Accepting that the corporation is the only category of non-natural legal persons does not resolve the issue of having to determine whether something fits within that category. In other words, what does it mean to be a separate legal person? Based on the historical development of the corporation in our common law, there are three essential attributes: name, state sanction, and perpetual succession. These attributes are based on the historical roots of the corporation in our common law. As was recognized by a number of jurists centuries ago, perpetual succession is the very core of what it means to be a corporation. Finding these three attributes under the foreign law provides a fairly clear, bright-line test that can provide

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consistency and predictability to the determination of whether something is a separate legal person. This test is preferable to an approach that would give primacy to the tax system of the foreign jurisdiction rather than Canada’s common law and income tax regime. It forms a sound, jurisprudential basis for concluding the LLCs, and other foreign entities, are corporations under Canadian law. It also assists in clarifying the legal status of Indian bands. NOTES AND QUESTIONS

1. According to Welters, what are the essential attributes of a corporation? Do First Nations or “Indian bands” possess these? 2.  What would be the advantages and disadvantages of deeming First Nations and “Indian bands” to be “corporate bodies”? How might these be constituted? 3.  Are there concerns that categorizing a First Nation as a corporation, for the sake of creating legal capacity or personhood, might conflict with Indigenous law and how Indigenous peoples view themselves and their surroundings? Many Indigenous systems of law imbue the natural world with forms of legal personhood,36 and recently this has been formalized in a legislative context. In Aotearoa (New Zealand) there is a national park known as “Te Urewera” that has its own personhood. Based on Crown assertions of ownership, Te Urewera was deemed a national park in 1954. However, in 2014, Te Urewera became a legal entity of its own, pursuant to the Te Urewera Act.37 When the Te Urewera Act took effect, the government gave up formal ownership, and the land became a legal entity with “all the rights, powers, duties and liabilities of a legal person.”38 Consider the following extract from the Te Urewera Act.

Te Urewera Act 2014 Public Act 2014 No 51, Date of Assent 27 July 2014 Section 11 Te Urewera Declared to Be Legal Entity (1)  Te Urewera is a legal entity, and has all the rights, powers, duties, and liabilities of a legal person. (2) However,— (a)  the rights, powers, and duties of Te Urewera must be exercised and performed on behalf of, and in the name of, Te Urewera— (i)  by Te Urewera Board; and (ii)  in the manner provided for in this Act; and 36 See John Borrows, “Living Between Water and Rocks: First Nations, Environmental Planning and Democracy” (1997) 47:4 UTLJ 417. 37 Te Urewera Act 2014, Public Act 2014 No 51, Date of Assent 27 July 2014. 38 Bryant Rousseau, “In New Zealand Lands and Rivers Can Be People (Legally Speaking)” (13 July 2016), What in the World, online: .

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(b)  the liabilities are the responsibility of Te Urewera Board, except as provided for in section 96. [Emphasis added.] The Tūhoe people identify Te Urewera as their place of origin and return, their homeland; an ancient and enduring fortress of nature, alive with history, its scenery abundant with mystery, adventure, and remote beauty; a place of spiritual value, with its own mana and mauri; a place that has an identity in and of itself, inspiring people to commit to its care.39 Now with its own personhood and similar to a corporation, Te Urewera has the means to, among other things, bring lawsuits on behalf of the land itself, with no need to show harm to a particular human.40 Similarly, an Aotearoa bill that was in its second reading as of November 24, 2016 seeks to establish personhood for Te Awa Tupua (the Whanganui River—an indivisible and living whole incorporating all its physical and meta-physical elements).41 The Bill establishes that Te Awa Tupua is a legal person, and has all the rights, powers, duties, and liabilities of a legal person,42 with Te Pou Tupua (the human face of the river) consisting of one Crown representative and one Whanganui iwi43 representative, who are responsible for the care and well-being of Te Awa Tupua, as well as maintaining relationships with all iwi and hapū with interests in Te Awa Tupua.44 This legislation is related to a 2014 settlement with the Whanganui iwi, historical treaties, Crown actions, and lands and environs sacred to the Whanganui iwi. NOTES AND QUESTIONS

1.  In what way do the Te Urewera Board and the Te Pou Tupua exhibit the tendencies of a corporate body? 2.  How does the legal personhood of Te Urewera and Te Awa Tupua provide a new way of thinking about how legal persons and corporate persons exist and interact? 3.  Could similar legislation be used in Canada, and if so, how might that affect planning what business structure to implement for a First Nation? With legal personhood comes the capacity to contract, and to thereby share in the allocation of risk according to terms of liability. Consider the different lines of reasoning in the following cases regarding whether “Indian bands” are “juridical persons” capable not only of contracting but of suing or being sued—an ostensible condition for finding liability in the first place.

39 Te Urewera Act 2014, s 3; see also Jacinta Ruru, “Tūhoe-Crown Settlement—Te Urewera Act 2014” (October 2014) Maori L Rev. 40 Rousseau, supra note 38. 41 Te Awa Tupua (Whanganui River Claims Settlement) Bill, Government Bill 129—2, s 14. 42 Ibid. 43 “Whanganui iwi” is defined in s 8 of the Bill as every individual who has exercised customary rights and responsibilities in respect to Whanganui River; and is descended from Ruatipua, Paerangi, or Haunui-āPāpārangi. It also includes the hapū and tūpuna rohe groups of Whanganui iwi. 44 Te Awa Tupua (Whanganui River Claims Settlement) Bill, ss 18 and 19.

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Telecom Leasing Canada (TLC) Ltd v Enoch Indian Band of Stony Plain Indian Reserves No 135 [1992] AJ no 845, [1994] 1 CNLR 206 (Alta QB) [1]  WACHOWICH J:  The plaintiff, Telecom Leasing Canada (TLC) Limited, sues the defendant, Enoch Indian Band of Stony Plain Indian Reserve No. 135, for payment under a contract of guarantee. The issue is whether the guarantee is valid and enforceable as against the defendant. The facts are not in dispute and may be summarized as follows. [2]  The defendant owns and controls Enoch Construction and Services Ltd. In March 1989 this construction company sought to acquire road construction equipment and approached the plaintiff for financing. The plaintiff agreed to purchase the needed equipment and lease it to the construction company on the condition that the defendant guarantee the construction company’s performance under the lease. The financing proposal was brought before a regular meeting of the band council of the defendant Indian band on May 10, 1989. To quote from the agreed statement of facts: The meeting was a duly convened meeting and all documents required by Telecom Leasing were formally before the meeting including the Lease Agreement, the Equipment Acceptance Certificate, and the Guarantee of the Enoch Indian Band. At that meeting a formal resolution was passed approving the financing and the purchase of the Equipment.

The relevant portion of the minutes of that meeting read as follows: 1)  BAND INVESTMENTS—RON AGAR

… Telecom Leasing has approved the financing over a 4 year period based on a down payment of $25,000 and 9 payments of $6,350 per year (no payments during the winter months). At the end of the leasing period, Enoch Construction would own the equipment. If Council approves, a B.C.R. [Band Council Resolution] is required to authorize a Band guarantee for the financing. MOT: MISC: ROMEO MORIN/RAYMOND CARDINAL Moved that Chief and Council approve the purchase/lease agreement with Telecom Leasing Canada Ltd. to lease 2 John Deer elevator scrapers, 1 Ingersoll packer, 1 Grade-all on tracks, subject to proper mechanical inspection. MOTION CARRIED A Band Council Resolution will be drafted to approve and guarantee the lease/purchase agreement and to give Telecom Leasing permission to enter onto Reserve lands to seize the equipment should Enoch Construction be in default.

The band council resolution to which the minutes refer was drafted on May 12, 1989, and reads in part as follows: AND FURTHERMORE: ROMEO MORIN and HOWARD PEACOCK are hereby authorized to sign the Guarantee dated May 10, 1989 between Enoch Indian Band and Telecom Leasing Canada (TLC) Limited in support of the lease agreement between Enoch Construction and Services Ltd. and Telecom Leasing Canada (TLC) Limited.

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[3]  The guarantee was signed by Howard Peacock (chief of the Enoch Indian Band) and Romeo Morin (counsellor). It provides, inter alia, that the defendant is obliged to perform the construction company’s obligations under the lease should the construction company fail to do so. Under the terms of the lease, in the event of default the plaintiff could elect to terminate the lease, whereupon the construction company would be liable to pay, as a genuine pre-estimate of liquidated damages, all amounts due or to become due under the lease. No question was raised before me as to the validity of the lease. [4]  It was noted in the agreed statement of facts that the Department of Indian and Northern Affairs was not sent a copy of the band council resolution, although it is the standard practice to do so, and that the Minister of Indian Affairs and Northern Development did not give approval to the execution of the guarantee. [5]  The equipment was delivered to the construction company. No payments were made by the construction company after at least July 1989. The plaintiff terminated the lease on September 20, 1989 and shortly thereafter seized the equipment. The plaintiff now seeks payment from the defendant of amounts due under the lease pursuant to the contract of guarantee. [6]  As an initial point, I am satisfied that it was within the power of the Enoch Indian Band to enter into the contract of guarantee. In the recent Supreme Court of Canada decision in Mitchell v. Peguis Indian Band, [1990] 2 S.C.R. 85, 1990 117 (SCC), [1990] 5 W.W.R. 97, 71 D.L.R. (4th) 193, [1990] 3 C.N.L.R. 46, 3 T.C.T. 5219, 110 N.R. 241, 67 Man. R. (2d) 81, La Forest J. states at p. 232 [D.L.R.]: When Indian bands enter the commercial mainstream, it is to be expected that they will have occasion, from time to time, to enter into purely commercial agreements with the provincial Crowns in the same way as with private interests.

I take this statement to entail that Indian bands have the power generally to contract and to enter into commercial agreements. In some circumstances this power is limited by the operation of the Indian Act, R.S.C. 1985, c. 1-5, requiring approval of the Minister of Indian Affairs (see, for example, ss. 61 and 81-86). However, outside of areas specified in the Indian Act, Indian bands are free to contract in the same way as any other party, subject to the laws of general application: see Cache Creek Motors Ltd. v. Porter reflex, (1979), 14 B.C.L.R. 13 (Co. Ct.). A contract of guarantee is not among those matters requiring ministerial approval pursuant to the Indian Act. The defendants argued that a practice has developed whereby the minister sets aside tribal funds to support guarantees; if this is the case, it is merely a practice and certainly not a requirement. Thus, the Enoch Band had the power to enter into the agreement and give the guarantee, and to do so without seeking the approval of the Minister of Indian Affairs. [7]  The more significant question is whether the band council had the power to enter into such an agreement on behalf of the band. The defendant submits that it did not. The defendant argues that the band council derives its powers solely from statute, and entering into a contract of guarantee is not among the powers enumerated in the Indian Act. Rather, the defendant argues, approval of the band as a whole and not just the council was needed. [8]  I disagree. Although the band council is clearly a creature of statute, deriving its authority solely from the Indian Act (Paul Band (Indian Reserve No. 133) v. R., 29 Alta. L.R. (2d) 310, [1984] 2 W.W.R. 540, (sub nom. R. v. Paul Indian Band) 50 A.R. 190, [1984] 1 C.N.L.R. 87 (C.A.), at p. 549 [W.W.R.]), it by necessity must have powers in addition to

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those expressly set out in the statute. This was recognized by the British Columbia Supreme Court in Lindley v. Derrickson (March 29, 1976) [unreported], wherein it was held that a “band council must have the implied power to bring legal proceedings on behalf of the band” (p. 84). In this regard I accept the suggestion Jack Woodward advances in his book Native Law (Toronto: Carswell, 1989), at p. 166: It may be said that band councils possess at least all the powers necessary to effectively carry out their responsibilities under the Indian Act, even when not specifically provided for. There is an implied power to contract, without the need for authority in the Indian Act.

[9]  Given that the band council had the power to give the guarantee on behalf of the band, the question then becomes whether this power was properly exercised. Section 2(3)(b) of the Indian Act governs, and reads as follows: 2(3)  Unless the context otherwise requires or this Act otherwise provides, (b)  a power conferred on the council of a band shall be deemed not to be exercised unless it is exercised pursuant to the consent of a majority of the councillors of the band present at a meeting of the council duly convened.

I am satisfied by the evidence that the provisions of this section are met, that is, that the guarantee was given “pursuant to the consent of a majority of the councillors of the band present at a meeting of the council duly convened.” It was stated in the agreed statement of facts that the council meeting was duly convened. The minutes show that a motion respecting financing was placed before the council by Romeo Morin, was seconded by Raymond Cardinal, and was passed. Although the minutes state that the motion was “to approve the purchase/lease agreement,” I am satisfied it included the question of the contract of guarantee: it is clear from the minutes that the need for a guarantee was discussed in the context of the motion, and that the members of the council understood that the execution of the guarantee was integral to the financing arrangement. Thus, when the members of the council passed the motion approving the purchase/lease agreement, they approved the execution of the guarantee. The band council resolution which was subsequently drafted is merely a formal document evidencing the resolution passed by the council. Leonard v. Gottfriedson 1980 585 (BC SC), (1980), 21 B.C.L.R. 326, [1982] 1 C.N.L.R. 60 (S.C.), raised by the defendant, is distinguishable on its facts from the matter before me. [10]  The defendant further argues that the guarantee is defective because the band did not obtain a notarized certificate as required by the Guarantees Acknowledgment Act, R.S.A. 1980, c. G-12. I am of the view that the Guarantees Acknowledgment Act does not apply to the guarantee in this case. “Guarantee,” for the purposes of the Act, is defined under s. 1: 1  In this Act, (a)  “guarantee” means a deed or written agreement whereby a person, not being a corporation, enters into an obligation to answer for an act or default or omission of another…

In the matter before me, the written agreement was not one “whereby a person, not being a corporation” entered into an obligation; it was a written agreement whereby an Indian band entered into an obligation. As worded, the Act only applies to guarantees

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given by natural persons, for legal persons (i.e., corporations) are expressly excluded. An Indian band is clearly not a natural person. [11]  I find that the contract of guarantee is enforceable against the Enoch Indian Band, and that pursuant to this guarantee the band is liable for the performance of the obligations of Enoch Construction and Services Ltd. under the lease. I therefore give judgment in favour of the plaintiff. The parties have said that in the event that judgment is for the plaintiff they will agree as to the amount, and so I will not address this issue. Action allowed.

Kwicksutaineuk/Ah-Kwa-Mish First Nation v Canada (Attorney General) 2012 BCCA 193 GARSON J:

•  •  •

[75]  It appears to now be settled law that Bands registered under the Indian Act have legal capacity to sue or be sued. Mr. Justice Johnston’s survey of the jurisprudence in Willson v. British Columbia (Attorney General), 78 B.C.L.R. (4th) 83 [sub nom West Moberley First Nations v British Columbia] at paras. 44-57, is most helpful to the question at hand: [Reproduced paragraphs from Willson J omitted.] [76]  I agree with Johnston J., and for the reasons he gives, in concluding that an Indian Act Band is a juridical person. The Ontario Superior Court of Justice has also confirmed in Kelly that “Indian bands” are “legal entities separate from their members with the status to sue or to be sued.”45 Note that in Telecom Leasing, Kwicksutaineuk, and Kelly, the courts interpreted the band to be a whole juridical person of its own, and not as any representative. Although it is possible for a band to be the named entity, actions or petitions are sometimes brought by the chief on behalf of the band, because there is concern that the band in and of itself may not have standing on a particular issue. Consider the following two cases that struggle with the question of the identity of a First Nation as a legal entity, and who can speak on its behalf. In Martin v British Columbia, the court struggles to make sense of the issue of representation in light of the question of a First Nation’s juridical status, and in Spookw v Gitxsan Treaty Society 45 Kelly v Canada (Attorney General), 2013 ONSC 1220 at para 112, citing Commandant v Wahta Mohawks, [2006] OJ No 22 (Sup Ct J); King v Gull Bay Indian Band, [1983] OJ No 2152, 38 CPC 1 (Co Ct); Bannon v Pervais (1989), 68 OR (2d) 276 (Dist Ct); Clow Darling Ltd v Big Trout Lake Band (1989), 70 OR (2d) 56 (Dist Ct); and Willson v British Columbia (Attorney General) (sub nom West Moberley First Nations v British Columbia), 2007 BCSC 1324, [2007] BCJ No 1929.

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the court considers the question of whether Elders or the directors of a society were appropriately or sufficiently representative.

Martin v British Columbia [1986] 3 CNLR 84, 3 BCLR (2d) 60 (SC) MCEACHERN CJSC (in Chambers):

•  •  •

[3]  As is well known, the action is to establish aboriginal or other rights to Meares Island. A reading of the pleadings discloses far-reaching allegations requiring the investigation of many historical facts, some of which are alleged to have occurred over 200 years ago, of which there is little or no conventional record. The plaintiffs in the original action were: MOSES MARTIN, suing on his own behalf and on behalf of all other members of the CLAYOQUOT BAND OF INDIANS; and CORBETT GEORGE, suing on his own behalf and on behalf of all other members of the AHOUSAHT BAND OF INDIANS

[4]  In June 1985 the plaintiffs purported to amend the statement of claim without leave or consent by filing an amended statement of claim. A number of amendments were made in that way but of particular concern was an amendment to the style of cause. This alteration was not underlined in red and was not noticed by the defendants until recently. If valid, this amendment has altered the parties by deleting the members of the named Indian bands as parties by substituting the bands themselves as plaintiffs. This was accomplished by dropping certain words from the description of the plaintiffs in the style of cause just quoted with the result that the plaintiffs named in the new style of cause were: MOSES MARTIN, suing on his own behalf and on behalf of the CLAYOQUOT BAND OF INDIANS; and CORBETT GEORGE, suing on his own behalf and on behalf of the AHOUSAHT BAND OF INDIANS •  •  •

[7]  What has happened is that Moses Martin and Corbett George, who were alleged to be elected chief councillors respectively of the band councils of the two bands mentioned in the style of cause, no longer hold those offices and the latter wishes to be relieved of his responsibilities as a representative plaintiff. The two band councils have passed resolutions authorizing Moses Martin, who is a member of the Clayoquot band, but not of the Ahousaht band, to represent their bands in this litigation. [8]  As a result, the plaintiffs seek a fresh amendment which will establish the plaintiffs’ style of cause as follows: MOSES MARTIN, suing on his own behalf and on behalf of the CLAYOQUOT BAND OF INDIANS and the AHOUSAHT BAND OF INDIANS

[9]  In other words, the plaintiffs seek to substitute Moses Martin as a representative of both bands and to continue the action with the bands, and not their members, as the beneficial plaintiffs.

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[12]  In Shaw v. Real Estate Bd. of Greater Vancouver, [1973] 4 W.W.R. 391, 36 D.L.R. (3d) 250 (B.C.C.A.) , Bull J.A. said at p. 395: I should add that the “common interest” must be in the sense that the plaintiff and those he purports to represent gain some relief by his success, although, if pecuniary, the proportions and degrees may be very different indeed. To my mind the principles of law set out in all the cases are the same—or a proper representative action there must be a “common interest” of the plaintiff with those he claims to represent, the exertion of a “common right” or “common grievance” … It appears to me that the many passages uttered by judges of high authority over the years really boil down to a simple proposition that a class action is appropriate where, if the plaintiff wins, the other persons he purports to represent win too …

[13]  Thus, although there is no reason Mr. Martin should not continue as representative of the Clayoquot band and as representative of the members of the group of which he is a member, a different person who is a member of the Ahousaht band must lend his name to these proceedings if they are to be properly constituted on behalf of the latter band. •  •  •

[15]  Secondly, Mr. Plant raises a much more serious question about the identity of the beneficial plaintiffs. Mr. Woodward says the action is for the determination and enforcement of group rights, while Mr. Plant says the proper plaintiffs are the individual members of the bands as the bands are not legal entities capable of suing and being sued. •  •  •

[20]  It is an open question whether Indian bands are juridical persons capable of suing and being sued even though bands are recognized by the Indian Act, R.S.C. 1970, c. I-6: Calder v. A.G.B.C., supra; Mintuck v. Valley River Band No. 63A, [1977] 2 W.W.R. 309, 2 C.C.L.T. 1, 75 D.L.R. (3d) 589 (Man. C.A.); Mathias v. Findlay, [1978] 4 W.W.R. 653 (B.C.S.C.); Cache Creek Motors Ltd. v. Porter (1979), 14 B.C.L.R. 13 (Co. Ct.); and King v. Gull Bay Indian Band (1983), 38 C.P.C. 1 (Ont. Dist. Ct.). [21]  Mr. Plant’s problem with all this is that these amendments, if made, delete the individual members of the bands, tribes or nations from the litigation and, if the action should fail on any ground, it may have to be litigated again in order to settle the rights of the individual members. In my view, all necessary steps must be taken to ensure the members will be bound by the result of this litigation. •  •  •

[50]  In Moon v. Atherton, [1972] 2 Q.B. 435, [1972] 3 W.L.R. 57, [1972] 3 All E.R. 145 (C.A.), Lord Denning M.R. at p. 441 said: In a representative action, the one person who is named as plaintiff is, of course, a full party to the action. The others, who are not named, but whom she represents, are also parties to the action. They are all bound by the eventual decision in the case. They are not full parties because they are not liable individually for the costs. That was held by Eve J. in Price v. Rhondda Urban District Council, [1923] W.N. 228. But they are parties because they are bound by the result.

[51]  Thus it seems to me that Mr. Moses is a full party and, subject to all just exceptions, he must answer all proper interrogatories delivered to him as required by R. 29(1).

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•  •  •

[102]  In conclusion, I wish to add that I regard the proper disposition of these questions of interrogatories to be crucial to the proper disposition of this action, and to make as certain as possible that the trial will be manageable. The parties are exploring novel and difficult questions and every effort must be made to ensure that the issues will properly be litigated. For that reason I invite counsel to return if there is any difficulty about any of the foregoing. Order accordingly.

Spookw v Gitxsan Treaty Society 2017 BCCA 16 HARRIS J:

•  •  •

[3]  The appellants are certain Gitxsan Hereditary Chiefs, Indian Bands, and the Gitksan Local Services Society. They filed their original writ and statement of claim in December 2008. For introductory purposes, it is sufficient to observe the thrust of their claim against the GTS. The action arises in the context of treaty negotiations between the Gitxsan First Nation, Canada and British Columbia. The GTS receives funding for and negotiates with the Crown(s) on behalf of the Gitxsan people. The appellants contend that the GTS does not have a proper mandate from the Gitxsan people, is not representative of them, has not acted in their best interests, has restricted consultation and opportunities for participation or involvement in treaty negotiations, all while assuming debt in excess of $21 million for which the Gitxsan people as a whole may ultimately be liable. [4]  The appellants are not members of the GTS. Their standing to seek remedies depended on being “proper persons” to do so under the applicable legislation. The chambers judge concluded, on an application for summary judgment brought by the GTS, that they were not proper persons and declined to grant them standing to pursue their claims. At the core of his reasoning is his conclusion that the Hereditary Chiefs had the opportunity to become members of the GTS and advance their concerns from within it, but did not do so, instead choosing to pursue their interests from the outside. One issue that divides the parties is whether he went further and found that, even if they had standing, their claim for relief was bound to fail. … [7]  The appellants allege the following errors in judgment: In finding that the Appellants are not “proper persons” for the purpose of standing to advance their claim on the basis of the following errors: i.  in finding the Appellants could and should have become GTS members, ii.  in failing to consider the purposes of GTS as a society in determining what is just in the circumstances, •  •  •

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[15] The appellants comprise five Hereditary Chiefs, four Indian Bands and the Gitksan Local Services Society. In the words of the appellants’ factum: The plaintiffs (the Appellants) are Gitxsan Hereditary Chiefs and members of Gitxsan Houses and Indian Bands. In these proceedings each Chief acts in his or her personal capacity as Hereditary Chief and also represent his or her House. The Appellant Spookw (Geraldine McDougall) represents herself, as well as other Gitxsan Chiefs, matriarchs and members of other Gitxsan Houses who have signed a declaration opposing the conduct of treaty negotiations by GTS. The Appellant Indian Bands, Gitanmaax, Glen Vowell, Gitwangak, and Kispiox, act in their capacity as elected governments and also represent their Band members. The Gitxsan Indian Bands have councils elected under the Indian Act, R.S.C. 1985 c.1?5 and hold 25 reserves totaling 6000 hectares and have over 5,000 Band members. The plaintiff Gitxsan Local Services Society (known as the Gitxsan Government Commission or “GGC”) is a non?profit society, which delivers programs and services to members of five Gitxsan Bands.

[16]  It appears that there is broad agreement between the parties about the structure of Gitxsan society and traditional governance, although, as I understand it, one point of contention within the Gitxsan First Nation lying behind the current dispute is the role and protection of the interests of those Gitxsan who are not members of Houses and the interests of Indian Bands. Nonetheless, I believe the following description, drawn substantially from the appellants’ factum, is uncontentious, at least for the purpose of the issues in this appeal. [17]  Gitxsan governance and social structure consists of Houses (Wilps), Clans (Pdeeks) and communities. Gitxsan governance includes both a hereditary system and elected Band governments. There are four Clans and between 60 to 65 Houses. Each House has a Head Chief and Wing Chiefs. Each House has its own history and territory. Each Head Chief is a “trustee” responsible for protecting their House members’ interests and managing the House’s traditional lands and resources. Each House is autonomous. Under Gitxsan law, the Head Chief has authority to speak for the House territories, but no Chief can speak to another House’s interests. Wing Chiefs are entitled to speak on behalf of the House but only in accordance with the direction of the Head Chief. [18]  There are six Gitxsan bands each with a band government elected under the Indian Act, R.S.C. 1985, c. I-5. Further, every person born of a Gitxsan woman is automatically a member of his or her mother’s House or Clan. Some, but not all, Gitxsan Band members are also House members. Roughly 20% to 30% of the appellant Gitxsan Bands’ members are not Gitxsan House members, because they do not have Gitxsan mothers. House membership is not required for a person to be considered Gitxsan. Persons may be recognized as Gitxsan if they are the father of a Gitxsan person, off-spring of a male Gitxsan or a registered status Indian with a Gitxsan Indian Band. Gitxsan Indian bands do not distinguish between members based on whether they belong to a Gitxsan House. All band members have equal rights whether they belong to a House or not. •  •  •

[19]  As noted, the existence of an entity such as the GTS is required if a First Nation is to enter into treaty negotiations. Under the BCTA, a First Nation is defined as:

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an Aboriginal governing body, however organized and established by Aboriginal people within their traditional territory in British Columbia, which has been mandated by its constituents to enter into treaty negotiations on their behalf with Canada and British Columbia.

[20]  The BCTC’s “Policies and Procedures” provide: The organization and establishment of a governing body for treaty negotiations is a decision to be made by the Aboriginal people it represents, namely the constituents of the First Nation.

[21]  For current purposes, and in terms of the definition of a First Nation, the governing body of the Gitxsan is the Hereditary Chiefs, the Simgiigyet, structured as we have seen along matrilineal lines in autonomous Wilps. [22]  The GTS was incorporated by the Hereditary Chiefs, as required by the Treaty Process. The details of its incorporation will be canvassed later, but the GTS and the First Nation are distinct. The Simgiigyet, as the traditional leaders of the Nation, hold and exercise the Nation’s Aboriginal rights, including title, on behalf of their Wilp, not the GTS. The Gitxsan Nation, as represented by the Simgiigyet, is the party, the principal, in treaty negotiations with the Crown. The GTS undertakes administrative tasks, at the request of the First Nation, but the Gitxsan Nation retains ultimate control over the treaty process, including not having the GTS act on its behalf. The GTS cannot ratify a treaty. Ratification, and the basis for it, is a matter ultimately for the Gitxsan people. •  •  •

[24]  These “structural” problems, which go to how the GTS is constituted within the Gitxsan Nation, is compounded, in the view of the appellants, by the way in which the GTS has acted and some of the agreements it is said to have reached. Of particular concern to the appellants is the Gitxsan Alternative Governance Model tabled by the GTS in negotiations. They contend this proposal would adversely affect Aboriginal and other rights and obligations of Gitxsan Hereditary Chiefs and House members, registered Gitxsan band members, band council and land holders on Indian reserve land. The appellants gave notice in 2008 to the Crown(s) and the BCTC of their concerns, attempting to stop negotiations until the GAGM was addressed in the community and their concerns met. •  •  •

[35]  Given that the appellants were not members of the GTS, the relief they sought depended on them being found to be “proper persons” to seek its winding-up. This issue was governed by provisions of the Society Act and the Company Act, R.S.B.C. 1996, c. 62, in place at the time this action commenced in December 2008. There have been amendments since. At times relevant to these proceedings, s. 71 of the Society Act incorporated portions of the Company Act, which had, for other purposes, been repealed. Section 71 of the Society Act read as follows: Despite the repeal of the Company Act, R.S.B.C. 1996, c. 62, Part 9 of that Act continues to apply to a society and an extraprovincial society as though Part 9 of that Act had not been repealed.

Part 9 of the Company Act includes s. 271(1):

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Section 271(4) reads: For the purposes of this section, a member includes (a)  a beneficial owner of a share in the company, and (b)  any other person who, in the discretion of the court, is a proper person to make an application.

Section 272 allows a court hearing a winding up application brought by a member to make an order for winding up or under s. 200, the oppression provision, “if [the court] is of the opinion that the applicant is entitled to relief either by winding up the company or under s. 200.” •  •  •

[37]  The GTS stressed that the Hereditary Chiefs chose not to become members despite the opportunity to do so, and the Indian Bands are statutory entities with no relationship to the GTS. Although the appellants are or might be affected by the activities of the GTS and are persons whose interests are among those sought to be advanced by it in negotiations, the appellants are not stakeholders in the GTS and have no direct interest in its assets or liabilities (including any loan debts). Granting standing would undermine the position of those who have actually participated in the GTS, effectively “hijacking” it. [38]  The appellants grounded their submission on an argument that any agreement negotiated by the GTS would have permanent effects on the Gitxsan people’s rights. •  •  •

[40]  The parties agree that the appellants’ standing to seek winding-up remedies is dependent on them being found to be “proper persons” under the then-in-effect s. 271(4) of the Company Act which states: For the purpose of this section, a member includes (a)  a beneficial owner of a share in the company, and any other person who, in the discretion of the court, is a proper person to make an application.

[41]  Equally, it is common ground that conferring standing on this basis involves an exercise of discretion, albeit one that must be exercised judicially. Moreover, the fundamental proposition articulated in the First Edmonton case is sound. The section confers a power on the court to grant standing where in the circumstances of a particular case justice and equity require it. But the exercise of that power must take into account the general principles of law governing companies and societies, such as the “indoor management rule” which exemplifies the reluctance of courts to become involved in internal issues or to permit outsiders of the legal entity whose interests may be affected by its conduct to acquire rights conferred on those who are shareholders or members. It seems clear that the power to recognize someone as a “proper person” is one to be exercised in limited circumstances. In effect, a grant of standing confers upon a person the rights they would have had if they were a shareholder or a member, because justice and equity require it. Evidently, this is an unusual, if not extraordinary, remedy. •  •  •

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[49]  The parties disagree about what the appellant Hereditary Chiefs could and should have done. On one hand, the GTS says, and the chambers judge agreed, it was open to the Hereditary Chiefs to submit an application to become, or to nominate someone to become, a member of the GTS as part of the s. 85 process (the “could”). Indeed, the chambers judge viewed the whole purpose of the s. 85 proceedings as directed towards making the GTS more inclusive and representative: Gitxsan Treaty Society, 2012 BCSC 452 (CanLII) at para. 43. The chambers judge viewed the s. 85 proceedings as an invitation for the appellant Chiefs to join if they wanted to voice their concerns about the GTS (the “should”). [50]  The appellant Chiefs do not deny it was open to them to submit an application. As I understand their argument though, they submit that they “could not approve the scheme by putting their names forward for membership because it violated Gitxsan law, tradition and practice.” Indeed, they submit that they “declined to apply for membership on grounds of this abuse of Gitxsan law.” [51]  In approaching this question, it is important to note the careful considerations that courts must bring to bear in cases dealing with the interaction between indigenous legal traditions and those of non?Aboriginal sources, such as the Company Act and Society Act, and related case law. [52]  Although primarily expressed in the context of claims of Aboriginal title and other property rights (e.g., fishing rights), the Supreme Court of Canada has encouraged courts to be sensitive to Aboriginal perspectives, and to take them into account alongside the perspective of the common law: see generally R. v. Sparrow, 1990 CanLII 104 (SCC), [1990] 1 S.C.R. 1075 at 1112; Delgamuukw v. British Columbia, 1997 CanLII 302 (SCC), [1997] 3 S.C.R. 1010 at paras. 148?149; R. v. Marshall; R. v. Bernard, 2005 SCC 43 (CanLII), [2005] 2 S.C.R. 220 at para. 48; R. v. Van der Peet, 1996 CanLII 216 (SCC), [1996] 2 S.C.R. 507 at para. 42; Tsilhqot’in Nation v. British Columbia, 2014 SCC 44 (CanLII) at paras. 34?35. [53]  With this in mind, I understand the appellant Hereditary Chiefs’ objections to the GTS membership structure. I also understand why they considered that they “could not” submit an application to join the GTS. [54]  Nonetheless, I am persuaded that the chambers judge was alive to these considerations. There was clearly a dispute, at least among certain Chiefs, about whether Gitxsan law precluded one from becoming a member of the GTS, as presently structured. The chambers judge’s extensive reasons in the proceedings related to these disputes reflect his concern about the representativeness and transparency of the GTS, including the notion of community involvement in and engagement with Gitxsan traditions. With this concern in mind, he rejected the first “restructuring proposal” in the s. 85 proceedings, directing more extensive, community-wide consultations and participation. The appellants did not appeal the chambers judge’s subsequent order approving the appointment of the 37 resulting members as members for the purposes of the extraordinary general meeting. •  •  •

[64]  In my view, underlying the approach taken by the judge in handling this litigation is the recognition that the way in which the Gitxsan nation organizes itself to engage in treaty negotiation is a matter of internal self-government. What role, if any, the Bands and the Gitksan Local Services Society play in that process is to be decided by the community itself. Granting standing to these organizations as proper persons

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would be inconsistent with this approach. The judge’s analysis of the Bands as being organizational manifestations of the relationship between government and the Gitxsan people is accurate, reflects the fact that the Bands do not form part of the traditional government of the Gitxsan nation, and in my view, was properly taken into account in denying them standing. •  •  •

[92]  Accordingly, I would dismiss the appeal. NOTES AND QUESTIONS

1.  In light of the different versions of legal personhood, and the implications of Indigenous law, indicated in these cases, can you think of any other ways to articulate the representative capacity of a band? Does a band form the “legal person” of a First Nation? How might the Maori notion of “personhood” as extended to the natural world affect the way the court considered the issues in these cases? 2.  If a band was to be construed a corporation, which Welters suggests would be more efficient, are there any other issues of corporate and Indigenous law or governance that would need to be examined? 3.  For solicitors, what sorts of considerations involving “representation” might be important when drafting constating documents of a corporate entity for a First Nation? How important would it be to understand a First Nation client, and the Indigenous laws that may or may not apply in any given circumstance? 4.  Tsilhqot’in Councillor Gilbert Solomon, a witness in the Tsilhqot’in Aboriginal title and rights trial, explained to the court that there is a duty to follow Tsilhqot’in law.46 Does this duty impact economic development?

IV.  CORPORATE IDENTITY, FIDUCIARY DUTY, AND LIABILITY A.  Separation of Ownership and Management A fundamental feature of the corporation is sometimes said to be the separation of the ownership and management of the business, captured in the idea of the separate legal identity of a corporate body from its shareholders. For First Nation governments, be they band councils or the executive council of the general assembly of a modern treaty nation, the leaders of government will often wish to direct the economic development of their nations. To this end, many First Nations use what are called “development corporations”: corporations wholly owned by the First Nation for the general purposes of encouraging economic development for the nation. In this way, development corporations are similar to Crown corporations. Most businesses in Canada are owner-managed businesses, either as

46 Tsilhqot’in Nation v British Columbia, 2007 BCSC 1700, Exhibit 0366, Affidavit #1 of Gilbert Solomon, January 2005, para 20. Dechen Ts’edilhtan are Tsilhqot’in laws set down by the ancestors that should be followed. Dechen Ts’edilhtan are things that have to be done, the rules that Tsilhqot’in people have been following since the beginning, when the land and animals were created, since night and day were created, since the time of the ancestors. They are unwritten laws that have been followed by Tsilhqot’ins through the generations up until today.

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sole proprietorships, in which there is no separation between ownership and management for liability or tax purposes, or as corporations, in which separation is a key planning feature. First Nation development corporations are “owner-managed” to an extent, but most nations use corporations as a way to shield their councils and members from liability. Note, however, that their use complicates what would otherwise be straightforward tax planning. Recall that under s 149(1)(c) of the ITA, a First Nation’s income, wherever earned, is exempt from taxation.47 Recall that under s 149(1)(d.5) of the ITA, First Nation corporate income earned on reserve is exempt from taxation. Therefore, the decision to use a corporation will shield the First Nation from liability by making it a shareholder, but it will also limit the corporate income tax exemption to income earned within its boundaries (for example, on the reserve). The corporation is run by directors who would be appointed or elected by shareholders, depending on the method for appointment set out in the corporation’s articles or bylaws. As we saw in Martin v British Columbia, the legal personhood of a band may make it difficult to know which party is the proper “owner” of a share, and how that share is voted and valued with respect to the members of the First Nation. In circumstances where the band does not have legal capacity to hold a share, the chief will hold the share by way of a bare trust in favour of the nation. As with the situation in Martin, this can become complicated when a change in the leadership occurs, as happened in the case of Gitga’at Development Corp.

Gitga’at Development Corp v Hill 2007 BCCA 158, [2007] BCJ No 536, 238 BCAC 205, 66 BCLR (4th) 349, 30 ETR (3d) 37, 156 ACWS (3d) 267 Huddart JA: [1]  This appeal is about the interpretation of a “Trust Agreement” made by each of four hereditary chiefs of the Gitga’at Tribe of the Tsimshian First Nation, also known as the Gitga’at First Nation (“GFN”). While this dispute arises in the context of a larger and more fundamental disagreement about the internal governance of the Gitga’at community, I am not persuaded this court must or should enter into that larger issue. In my view, the chambers judge erred when he stepped into that political fray after considering extrinsic evidence to find ambiguity where there was none in the Trust Agreements. •  •  •

[3]  The subject matter of each of the four Trust Agreements is 25 shares in Gitga’at Development Corporation (“GDC”), a company incorporated under the laws of British Columbia on 16 March 2001. Immediately after its incorporation, 25 shares were issued to each of four hereditary chiefs (respondents Albert Clifton and Ernie Hill Jr.), and two others now deceased (John Clifton and William Clifton). Following those deaths in May and November 2004, the surviving shareholders transferred half of GDC’s shares to the remaining two petitioners, Christopher Bolton and Patricia Sterritt. No Gitga’at community meeting was held with respect to either transfer.

47 Subject to what was said earlier with respect to Yukon Treaty First Nations.

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[4]  After the current Band Council took office in December 2005, it decided to take control of the GDC, believing it was necessary to do so for the benefit of the community. On 18 February 2006, it resolved to transfer legal ownership of the shares that had been assigned to Patricia Sterritt and Christopher Bolton in trust to Robert Hill, the Chief Councillor, and Theresa Lowther, a council member, and to appoint them and a third councillor, Wallace Bolton, as directors of GDC. Robert Hill and Theresa Lowther then signed Trust Declarations. These differed from the Trust Agreements in that they identified the beneficial owners of the shares as the “Hartley Bay Indian Band as represented by the Band Council,” clearly envisaging that the council would make all decisions for the Band. No Gitga’at community meeting was held with respect to this decision. [5]  Each of the four Trust Agreements was in these terms: 1. THAT I am the holder of twenty-five (25) shares (the “Shares”) of Gitga’at Development Corporation (the “Company”) in trust for the Hartley Bay Band, (the “Owner”). 2. THAT the Shares of the Company are fully owned by the Owner and I have no beneficial interest therein. 3. THAT the moneys required to purchase the Shares of the Company were supplied by the Owner in advance. 4. THAT I will not pledge, mortgage, hypothecate, sell or transfer the Shares of the Company except with the Owner’s consent in writing. 5. THAT I will vote the Shares of the Company as directed by the Owner and not otherwise. 6. THAT I hereby nominate and appoint the Owner as Attorney for and on behalf and in my name to sign, execute and deliver the certificate for the Shares of the Company as fully and to the same extent as I could do personally by reason of the Shares being registered in my name and this will constitute the Owner’s authority so to do. The Power of Attorney will be irrevocable and shall not be terminated by my decease. 7. THAT I will vote at all the meetings of Shareholders and Directors of the Company to enable the Owner or Owner’s nominee to become the recorded owner of the Shares of the Company. 8. THAT any dividends, profits, payments, advantages, or benefits received under the Shares of the Company shall be the Owner’s property and if received by me shall be forthwith paid to the Owner. 9. THAT this acknowledgement shall be binding on me, my heirs, executors, administrators, and assigns and be available to the Owner, the Owner’s executors, administrators, successors and assigns who shall have the right hereunder as Power of Attorney in connection with the Shares for me and on my behalf as the Owner now has.

[6]  The issue for this court to resolve on this appeal is the meaning of the words “Hartley Bay Band” in each of the four Trust Agreements and thus to determine the beneficial “Owner.” [7]  The personal petitioners raised the issue on their application to the Supreme Court to rectify the register of the Gitga’at Development Corporation (“GDC”) under ss. 229 and 230 of the Business Corporations Act, S.B.C. 2002, c. 57, the Indian Act, R.S.C. 1986, c. I-5, and that court’s inherent jurisdiction. They claim to represent the Hereditary Chief structure. The respondents to that petition (“appellants”) form the majority of the Village Council “chosen according to the custom of the band” (Indian Act, ss. 2(1) and 74).

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[8]  Ancillary to the determination of Owner under the Trust Agreements is the question how successor trustees may be appointed. [9]  The Trust Agreements do not make any provision for the appointment of a successor trustee. They do however purport to grant an irrevocable power of attorney to the Owner that survives the death of the trustee. A power of attorney dies with the grantor of that power. Thus, in the normal course of events under British Columbia law, the personal representative of each of the deceased trustees would acknowledge that trust and appoint a successor: Trustee Act, R.S.B.C. 1996, c. 464, s. 27(1), undoubtedly after consulting with the beneficiary. Failing such an appointment, the beneficiary could have resorted to ss. 31 and 68 of the Trustee Act for court assistance. None of the parties chose that route to a resolution of their dispute over who is the beneficial owner of the GDC shares and who has the right to speak on its behalf, nor is there any suggestion in the record any of them sought and were refused either ministerial assistance or ministerial consent for such a process under ss. 43 or 44 of the Indian Act, respectively. [10]  The personal respondents claimed on behalf of the Gitga’at First Nation the right of the two surviving trustees to name “caretaker trustee shareholders” to succeed the two deceased trustees in accordance with a decision by which they allege the Gitga’at established the ownership and governance of the GDC. The appellants claimed the right of the majority of the Village Council of the Hartley Bay Band to name the new trustees of the shares of the deceased trustees, representing the “Owner” under the two Trust Agreements. Each group exercised its purported powers. At the date of the petition, the company register reflected the Village Council’s decision. The chambers judge found both actions to be unauthorized by the Gitga’at community, ordered the rescission of any issuance of shares to the nominees of the two surviving trustees or to the nominees of the Band Council and remitted to the “Gitga’at First Nation for decision at a formal meeting” the question “whether the remaining shares are to be transferred in trust either to new Hereditary Chiefs, or to interim shareholders.” [11]  Effectively, the chambers judge found an over-arching trust established by the Gitga’at community (a term he chose to include all those who may be determined to be members of the Hartley Bay Band or the Gitga’at First Nation, registered, unregistered, resident on or off the reserve). The core of his reasoning is found in these portions of his reasons for judgment (Gitga’at Development Corporation v. Hill, 2006 BCSC 686): [2]  In my view, the essential issue raised on this petition is whether the Hereditary Chiefs of the Gitga’at clans or the respondents, who are members of the Village Council, are the lawful shareholders and directors of the GDC. The answer to this question breaks down into more narrow issues and requires a consideration of aboriginal governance under both the traditional clan system and the Indian Act, R.S.C., 1985, c. 1-5, as well as of the general application of trust and corporate law in the province. It is common ground that whoever holds the shares does so for the sole benefit of the community. •  •  •

[21]  Returning to the present case, acceding to the respondents’ broad legal argument would require a conclusion that the community was not entitled to decide on and implement whatever structure it chose. This would render listed band members powerless apart from

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Chapter 4  First Nation Business Structures election time and exclude any other legitimate members of the GFN from the decision making process entirely. I do not accept the respondents’ argument. [22]  Absent the suggestion that the Village Council has exclusive legal authority to decide matters relating to off reserve economic development and land use, the answer to the central issue I posed at the beginning of my reasons becomes solely factual. What did the community decide when the GDC was set up? Did the community decide that the Village Council or the Hereditary Chiefs would hold and vote the shares in trust on its behalf? Fortunately, the answer is relatively easy to determine on the evidence. •  •  •

[26]  I am not persuaded that the respondents’ assertion is correct. I accept the general proposition that extrinsic or parol evidence is not admissible to alter, vary or interpret unambiguous language in commercial documents but there is, in my view, some ambiguity in the reference to the Hartley Bay Band. It may refer to the Hartley Bay Indian Band, as defined under the Indian Act, or to the aboriginal community now sometimes known as the GFN. There is no ordinary dictionary meaning for the specific terminology used in the Trust Agreement, nor does the Indian Act offer definitions other than for the generic terms “band” and “member of a band.” It does not follow, in my view, that a single reference to the Hartley Bay Band in the agreement necessarily means only a band and members of that band as defined in the statute. [27]  I also accept the argument of the petitioners that oral evidence is permissible to establish the three certainties required for a trust. There is no requirement here that the trust be evidenced in writing. For a trust to be validly created, it must, however, be possible to clearly identify the subject matter of the trust, the intention to establish a trust and the object of the trust. See D. Waters, Waters’ Law of Trusts in Canada, 3rd ed. (Toronto: Thomson Canada Ltd., 2005). Ultimately, in the absence of written evidentiary requirements like those applicable to the transfer of certain kinds of property, such as land, the existence of a trust depends on the intention of the settler which must be determined from all the surrounding circumstances (Waters’ at 133). The Trust Agreements in the case at bar must be read in light of the intentions of the community, the Hereditary Chiefs and the Village Council at the time the trust was created. I turn next to the evidence leading up to the signing of the Trust Agreements. •  •  •

[50]  I am satisfied on the basis of the incorporation documents and the Trust Agreements that the first four Hereditary Chiefs held the shares in the GDC in trust for the GFN. On the whole of the evidence, I find that the community approved that arrangement and did not intend that the Village Council would then, or now, make decisions respecting the identity of the shareholders or voting the shares on its behalf. I indicated earlier that the community may yet decide to change the arrangements and if it does, the Hereditary Chiefs will be bound by that decision but until then the shareholders are those approved by the community in 1998. [12]  The legal result of this reasoning is that the two living trustees and the personal representatives of the deceased trustees are each entitled to be registered as the owner of 25 GDC shares, subject to the Company’s bylaws, and perhaps, the Minister’s discretion under the Indian Act. That conclusion resolves the issue placed before the Court under the Business Corporations Act.

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[13]  However, it does not resolve the parties’ dispute as to who has the beneficial interest in the shares registered in those names, nor does it determine who should succeed the deceased trustees. Discussion [14]  I see the issues somewhat differently than the chambers judge because I begin from a different premise. In my view, the terms of the trust are found in each of the Trust Agreements. Evidence extrinsic to that document is not relevant on this application. That is because, when the Gitga’at set up the GDC to assist them with their economic development, they chose to use a vehicle provided under provincial legislation. When they chose to control that corporation by means of trustee shareholders they chose a mechanism long known to Canadian law and now, in part, governed by the Trustee Act. By choosing to use existing commercial and legal structures, the Gitga’at chose to be governed by existing commercial laws of general application, to the extent Canadian law permits them to make those choices. [15]  It follows that, to the extent the regime they established to accomplish their economic development purposes did not provide expressly for certain possible events, including the death of trustee shareholders, they must be taken to have accepted the attributes of those structures set down in the Business Corporations Act and the Trustee Act. [16]  Thus, the shareholders of GDC can only be the two petitioners, who were original shareholders, and the personal representatives of the two deceased shareholders. Neither the personal representatives of the deceased shareholders, nor the Village Council, sought an order under the Trustee Act, nor is there any suggestion either looked to the personal representative of either deceased to appoint a “caretaker shareholder” while the Gitga’at considered the longer-term succession. [17]  Moreover, I find no ambiguity in the reference to the “Hartley Bay Band” in the trust declarations. I agree with the appellants that the ordinary meaning of the words “Hartley Bay Band” is the Band as defined by and constituted under the Indian Act. It is a body of Indians declared to be a band for the purposes of the Indian Act, whose members are those whose names appear on the Band List or who are entitled to have their name on the Band List. “Band” is an important legal term that has existed for over 100 years, and is well known to all First Nation and aboriginal peoples. It has no ordinary meaning other than the Indian Act meaning. [18]  There can be no other meaning because the Hartley Bay Band has no existence other than under the Indian Act. If the original shareholders or those whose wishes they were honouring had intended to benefit the Gitga’at First Nation or some broader community, those shareholders would not have named the Hartley Bay Band as the beneficiary of the trust they were establishing over the shares registered in their names. They would have said the “Gitga’at Tribe” or the “Gitga’at First Nation,” words that have had a special meaning, some say, since time immemorial. [19]  That there is only a single reference to Hartley Bay Band is not relevant. Its repetition was made unnecessary by the use of the defined term “Owner.” Similarly, it is not relevant that the word “Indian” is absent from the name of the Band. The parties commonly refer to the Band as the Hartley Bay Band, omitting the word “Indian.” Moreover,

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with respect to those who take a different view, I cannot see how the word “Owner” in the declaration evidencing the trust can refer to any entity other than the Hartley Bay Indian Band. The Trust Agreement demands an entity that can exercise, protect and enforce the collective rights it confers on the Owner. The declaration contemplates several functions that can be performed only by a representative. There is no means by which an undefined community without a legal representative could give “consent in writing” to the sale of shares, “sign, execute and deliver” the share certificates or receive dividends, actions set out in ss. 4, 5 and 8 of the Trust Agreement, respectively. [20]  The record persuades me the Gitga’at have worked hard, long and successfully to reconcile their traditions and laws with Canada’s traditions and laws; their dual governance system as a tribe or first nation and custom band is illustrative of that effort. The fact that the legal representatives of the Band (the Band Council) should choose, for political harmony, to take direction from hereditary leaders, does not change the nature of the legal authority of the Band Council, nor does it establish that there are two separate entities recognized in provincial law. In Hartley Bay Indian Band v. Hartley Bay Indian Band (Council) (2005), 277 F.T.R. 201, [2006] 2 F.C.R. 24, 2005 FC 1030 [“Hartley Bay Indian Band”], O’Keefe J. dealt with exactly this question at para. 55 and found that the Band Council’s: … participation in matters extending beyond those of a merely local nature is extensive. While the Clan Council might be the “directing mind” when dealing with off-reserve matters, it is the Village [Band] Council that has the legal authority to make the decisions that affect the rights of both on-reserve and off-reserve members.

[21]  Moreover, the decision to name the Hartley Bay Band as “Owner” in the Trust Agreements was sensible. The only mechanism in Canadian law by which collective property rights may be held and enforced is the Band structure established by the Indian Act. That structure is built on the foundation of collective property rights. The Indian Act permits the definition of a Band’s membership; it provides for a Band’s governance and it gives the Council the right to represent the Band where necessary to enforce those collective rights. [22]  This conclusion says nothing about the ultimate question dividing the parties: who may control the appointment of the trustees of the Band’s shares in GDC? Nor are these reasons intended to say anything about the aboriginal right to self-government, a question I do not consider is raised by this appeal. [23]  The chambers judge considered the question of who may appoint successor trustees as so fundamental to the petition that he looked to the circumstances surrounding the Gitga’at establishment of the GDC and trust regime to find ambiguity in the trust declarations. He seems to have found in the discussions among relatively few members of the Gitga’at community at meetings open to all Gitga’at and at Council meetings also open to all an intention that only the Gitga’at First Nation in general meeting could appoint successor trustees. In reaching that implicit conclusion, I find he erred. [24]  Under provincial laws, neither a settlor nor a beneficiary can replace a trustee unless the document evidencing the trust so provides. The Trust Agreements make no provision for replacing a deceased trustee, although the intention that the Hartley Bay Band have that power may be implicit in the provision for a continuing power of attorney. When the Gitga’at decided to incorporate GDC and to have members of the community

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become its shareholders, with each to hold an equal number of all issued shares in trust for the Band, it effectively agreed to be ruled by those laws, subject to any over-riding authority of the minister responsible for administering the Indian Act. [25]  In my view it is for the Village (Band) Council, representing the Hartley Bay Band, to determine how they should proceed. They may have recourse to the provisions of the Trustee Act if so advised. [26]  I do not accept the appellants’ submission that the Band Council, in the exercise of their general powers under the Indian Act, as interpreted in Mitchell v. Peguis Indian Band, [1990] 2 S.C.R. 85, 71 D.L.R. (4th) 193, and subsequently, can unilaterally nominate successor trustees. However, it can take whatever action is necessary to enforce the trust of which the Band is the beneficiary. [27]  A Band Council may sue and be sued and enter into contracts on behalf of the Band it represents: Joe v. Findlay (1987), 12 B.C.L.R. (2d) 166 (S.C.); Telecom Leasing Canada (TLC) v. Enoch Indian Band, [1993] 1 W.W.R. 373 (Alta. Q.B.) [“TLC”]; Assu v. Chickite, [1999] 1 C.N.L.R. 14 (B.C.S.C.); Hartley Bay Indian Band. In TLC, the Court wrote about a guarantee the Band had given: Although the Band Council is clearly a creature of statute, deriving its authority solely from the Indian Act (Paul Band v. R. [1984] 2 W.W.R. 540 (Alta. C.A.) at 549), it by necessity must have powers in addition to those expressly set out in the statute. This was recognized by the British Columbia Supreme Court in Norman Lindley et al. v. Derrickson [1976] B.C.J. No. 189 (29 March 1976) wherein it was held that a “Band Council must have the implied power to bring legal proceedings on behalf of the Band” [p. 84]. In this regard I accept the suggestion Jack Woodward advances in his book Native Law (Toronto: Carswell, 1989) at 166: It may be said that Band Councils possess at least all the powers necessary to effectively carry out their responsibilities under the Indian Act, even when not specifically provided for. There is an implied power to contract, without the need for authority in the Indian Act. Given that the Band Council had the power to give the guarantee on behalf of the Band, the question then becomes whether this power was properly exercised.” (Emphasis added.)

[28]  I accept that reasoning. For the purposes of this appeal, I need consider only whether the Band Council has the power to invoke the provisions of the Trustee Act (within the confines the Indian Act places on a testator) or take such other action as they may be advised to see to the appointment of a successor trustee. I am persuaded it does. For the Band to protect its collective beneficial interest in the shares registered in the name of the deceased trustees, the Band Council requires that power. That power is implied by the principles set down in the cited authorities. [29]  It follows from this reasoning that I would not admit the fresh evidence the appellants seek to introduce and that I would vary the order under appeal by deleting that portion remitting to the “Gitga’at First Nation for decision at a formal meeting” the question “whether the remaining shares are to be transferred in trust either to new Hereditary Chiefs, or to interim shareholders.” I would otherwise affirm the order. In view of the divided success, I would order that each side bear its own costs. NEWBURY JA:  I agree. LOWRY JA:  I agree.

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1.  Unlike situations where a parent corporation owns the shares of a subsidiary corporation and the directors of the parent corporation are responsible to their own shareholders as may be set out in a shareholders’ agreement, First Nation leaders’ “ownership” of shares in Gitga’at Development is understood according to the criteria set out in the trust agreement. Could the trust agreement be construed as a shareholders’ agreement? Why or why not? 2.  One of the most common reasons for using corporations is to provide a liability shield between the shareholders and the directors. However, liability for corporate tax will often involve ascertaining whether the corporations are affiliated or associated by looking at how they are controlled, both de jure and de facto. That is, a corporation’s shareholders can be shielded from civil liability while still being liable for the corporation’s income tax. This complication among corporate groups becomes all the more important for First Nations and Indigenous people as they structure for both tax exemption and liability protection. And as we have seen above, corporate planning becomes even more complicated as First Nation leaders become involved as both shareholders and directors, and where simultaneous governance structures exist, such as an elected council under the Indian Act and hereditary leaders under traditional Indigenous law. What other instruments or transactions can be engaged to provide for liability protection of First Nation leaders who serve as shareholders and directors of their development corporations? 3.  As many First Nations become engaged in industrial projects like forestry and natural resource exploration and development, it becomes very important that the articles or bylaws of the corporation are drafted in tandem with a shareholders’ agreement. Many First Nations will use ingenuity in drafting shareholders’ agreements to reflect the kinds of limits that shield them from liability while allowing a modicum of control and/or oversight of their development corporations. Considering these factors, and knowing that First Nations are increasingly engaged with governments and industry to take part in development, how might the various Aboriginal rights they have be expressed through their corporate bodies when, strictly speaking, the latter are distinct legal entities with no Aboriginal rights? 4.  The separation of ownership from the management of a corporation is sometimes said to be a fundamental feature of the corporation, with authority for the proposition often listed as Salomon v Salomon & Co, Ltd, [1895-1899] All ER Rep 33 (HL). However, Welters noted that the three main elements of a corporation are succession, state sanction, and name. In Gitga’at Development, what aspects of Huddart JA’s decision resonate with Welters’ view or the Te Urewera Act or Te Awa Tupua (Whanganui River Claims Settlement) Bill in New Zealand? What aspects remind us of Salomon? Are there elements here that suggest some other way of thinking of the essential attributes of a corporation in the First Nations context?

B.  Fiduciary Duties of Directors as Compared with First Nation Leaders As we saw in earlier chapters, the duties of directors are fiduciary in nature and are represented variously in legislation as such. First Nation leaders also have specific fiduciary duties that fall upon them by virtue of their position as leaders, through the Indian Act, the obligation and authorization to act on behalf of their community, through Indigenous law, and through modern treaties and self-government agreements. Unlike having two separate roles as directors and shareholders, First Nation leaders cannot simply switch roles, as it were.

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Keeping in mind the nature of directors’ duties outlined in previous chapters, consider the nature of the duties of First Nation leaders in the following two excerpts.

Blueberry Interim Trust (Re) 2011 BCSC 769 BOWDEN J:

Introduction [1]  The Trustees of the Blueberry Interim Trust (“Interim Trust”) and the Blueberry Not-for-Profit Trust (“Not-for-Profit Trust”) have brought a petition seeking directions regarding the proposed transfer of funds held by the Interim Trust to the Not-for-Profit Trust, then on to the Blueberry River First Nations Band Council (“Band Council”) and, ultimately, to the Blueberry Permanent Trust (“Permanent Trust”). [2]  The petitioner seeks declaratory relief in the form of an answer to the question whether the settlors of the Interim Trust, six Distribution Trusts and the Permanent Trust (the “Trusts”) were in breach of their fiduciary duties to members of the Blueberry Band by settling the Trusts on such terms that interest cannot be paid to minor members of the Blueberry Band who were entitled or may become entitled to distributions under the Trusts. [3]  The Public Guardian and Trustee of British Columbia (“Public Guardian”) is the guardian of a number of minors who are children of members of the Blueberry River First Nations Band (“Blueberry Band”). The Public Guardian seeks a declaration that the minors are entitled to the payment of interest on amounts ultimately distributed to them. •  •  •

Background Facts [5]  In 1985, a representative proceeding was brought in the Federal Court by Chief Joseph Apsassin on behalf of all members of the Blueberry Band and by Chief Jerry Attachie on behalf of all members of the Doig River Indian Band (“Doig River Band” and collectively, the “Bands”). After lengthy proceedings, the Government of Canada was held liable for breach of fiduciary duty with respect to the sale of mineral rights associated with reserve lands which later were found to contain large reserves of oil. In March 1998, a settlement was reached whereby the Government of Canada paid $147,000,000 to the Bands. The terms of the settlement did not provide for more favourable treatment of adults as opposed to minor children who were members of the Bands. •  •  •

[11]  To allow for further distributions of settlement funds to members, in accordance with section 4.2 of the Interim Trust, six distribution trusts were approved and established by the Band Council (“Distribution Trusts”). The terms of the Distribution Trusts were approved by a majority vote of the members of the Blueberry Band. Each of the Distribution Trusts provide that specified amounts were to be distributed to all members who were alive and had attained the age of 19 on specified dates. Deferred distributions were to be held within the Interim Trust as “Restricted Funds” and paid to the minor when

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they attained the age of 19. Each Distribution Trust contains a provision stating that no interest shall accrue on such restricted funds. •  •  •

[14]  The Band Council approved eight separate distributions totalling $125,000 to each member who was eligible at a specified date to receive the distribution. A member who was a minor on that date would receive their distribution upon attaining age 19 but no interest was payable on such deferred distributions. Amounts allocated to minors were added to the restricted funds held by the trustees for deferred distribution. •  •  •

[16]  The Public Guardian raised concerns with respect to the non-payment of interest on deferred distributions to minors and alleged that the settlors of the Interim Trust and Distribution Trusts may have breached their fiduciary duties in settling the trusts on terms that prohibited the payment of interest on deferred distributions. •  •  •

Issues [19]  The main issue to be resolved in this case is whether or not interest is payable to minors who become entitled to a distribution notwithstanding the terms of the Interim Trust and the Distribution Trusts. There are also subsidiary issues which will be referred to under the heading “Analysis” in these reasons. Submissions by the Blueberry Band •  •  •

[24]  … [T]he Blueberry Band says that payment of interest is not required since the entitlement of the Band members was collective rather than individual. The Federal Court has held that no individual entitlement arose with respect to the settlement funds, only a collective one: Blueberry River Indian Band v. Canada (Department of Indian Affairs and Northern Development), 2001 FCA 67(CanLII) at paras. 22-23 [Blueberry River]. The only individual entitlements arose upon the Band creating such entitlements through the settling of the Interim Trust and six Distribution Trusts. The Band argues that there is no individual entitlement beyond the specific amount provided in each trust since these trusts defined the scope of each person’s entitlement. Furthermore, the Band argues that the trustees do not have a legal obligation to pay out anything other than the amounts specified for distribution in the trust documents. Since the documents expressly state that no interest is payable to the minors, there is no legal basis for requiring the payment of interest. •  •  •

Submissions by the Public Guardian •  •  •

[30]  The Public Guardian states that Joseph Apsassin (the “Chief ”), as the representative plaintiff and Chief of the Blueberry Band, as well as the Band Council, owed fiduciary duties to the minors for two reasons.

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[31]  Firstly, the Chief owed a fiduciary duty as a result of his acting as the representative plaintiff in the action which gave rise to the receipt of the settlement funds. The Public Guardian argues that a representative plaintiff has an obligation to represent the class equitably and fairly: Richard v. British Columbia, 2007 BCSC 1107; Lau v. Bayview Landmark Inc. (2004), 71 O.R. (3d) 487 (S.C.J.), and that this gives rise to a fiduciary duty on the part of the representative plaintiff: City of San Jose v. Superior Court of Santa Clara County, S.F. No. 23055; H.B. Newberg, A. Conte, Newberg on Class Actions, 4th ed., (St. Paul, Minn.: Thomson West, 2002-). As a result of the representative proceeding, the representative plaintiff purported to act on behalf of all class members, including minors. It is the Public Guardian’s position that an ongoing fiduciary duty flowed from the launching of the representative action, through to the settlement and through to the distribution and administration of the funds. [32]  Secondly, based on general principles of First Nations law, a duly-elected chief and members of an elected band council are fiduciaries in relation to the members of the band: Assu v. Chickite, [1999] 1 C.N.L.R. 14 (B.C.S.C.) [Assu]; Gilbert v. Abbey, [1992] 4 C.N.L.R. 21 (B.C.S.C.). The Public Guardian argues that the three aspects of a fiduciary duty have been met to establish a duty owed to the minors: namely the band council holds power over the distribution of monies; it exercises this power in a way that directly impacts the minors’ interests; and the minors are particularly vulnerable. •  •  •

Analysis •  •  •

[42]  It is well established that a band council and chief owe a fiduciary duty to band members in relation to their acts as representatives of the band (Assu, at para. 33). Any minors who comprise this group would be owed a fiduciary duty as a result of their membership in the band. •  •  •

[45]  In the recent Supreme Court of Canada decision of Galambos v. Perez, 2009 SCC 48, [2009] 3 S.C.R. 247, the Court reviewed the fundamental principles of fiduciary relationships and at para. 67 and following stated: 67.  An important focus of fiduciary law is the protection of one party against abuse of power by another in certain types of relationships or in particular circumstances. … 69.  … a critical aspect of a fiduciary relationship is an undertaking of loyalty: the fiduciary undertakes to act in the interests of the other party. This was put succinctly by McLachlin J. in Norberg, at p. 273, when she said that “fiduciary relationships … are always dependent on the fiduciary’s undertaking to act in the beneficiary’s interests.” See also Hodgkinson, per La Forest J., at pp. 404-7. 70.  Underpinning all of this is the focus of fiduciary law on relationships. As Dickson J. (as he then was) put it in Guerin v. The Queen, [1984] 2 S.C.R. 335, at p. 384: “It is the nature of the relationship  … that gives rise to the fiduciary duty  … .” The underlying purpose of fiduciary law may be seen as protecting and reinforcing “the integrity of social institutions and enterprises,” recognizing that “not all relationships are characterized by a dynamic of mutual autonomy, and that the marketplace cannot always set the rules”: Hodgkinson, at p. 422 (per La Forest J.). The particular relationships on which fiduciary

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Chapter 4  First Nation Business Structures law focusses are those in which one party is given a discretionary power to affect the legal or vital practical interests of the other: see, e.g., Frame v. Smith, [1987] 2 S.C.R. 99, per Wilson J., at pp. 136-37; Norberg, per McLachlin J., at p. 272; Weinrib, at p. 4, quoted with approval in Guerin, at p. 384.

[46]  In my view, there is no question that the Band Council stood in a fiduciary relationship with respect to the minors of the Blueberry Band. The Band Council, acting as elected officials, undertook to act in the best interests of its members, including the minors. This duty extended to the manner of its control over the interests and assets of the Band, and in particular the Settlement Funds which it eventually undertook to distribute. As band members, the minors held an entitlement at law to the Settlement Funds. The Band Council was in a position to decide how to administer those funds. When the Band Council exercised its power over the Settlement Funds in a manner that affected the legal interests of the minors, it was obligated to do so in accordance with its fiduciary duties. [47]  I am further supported in my view by case law which has held that where a person or entity undertakes to distribute settlement funds, a trust relationship will arise whereby that person is required to ensure that the monies set aside for distribution are properly kept and distributed fairly to the appropriate recipients: Polchies at para. 56; Barry. •  •  •

[49]  With respect to the duties that arose upon authorizing a distribution, the court [in Polchies] held as follows: 56  Whenever a distribution of monies among a group of persons is undertaken by another person, whether it be by the Crown, the Band or any other entity or person, a trust is created whereby that person is required to ensure that the monies set aside for distribution are properly kept, and distributed fairly, to the appropriate recipients. •  •  •

[50]  In my view, even before the Band Council undertook to distribute the funds, they were, upon receipt of the Settlement Funds from the Government of Canada in 1998, impressed with a trust in favour of all members of the Blueberry Band. •  •  •

[52]  In any event, when the Band Council proceeded with its decision to distribute the settlement funds to the Blueberry Band, a duty founded in trust law arose: Polchies. The Band Council was then required to exercise its discretion to distribute the funds in accordance with its fiduciary obligations. These obligations preceded the settling of the terms of the Interim Trust and the Distribution Trusts. [53]  In summary, I have concluded that the Band Council was in the position of a fiduciary to ensure a fair distribution of settlement proceeds at a time prior to the settling of the terms of the Interim Trust and Distribution Trusts. Its duties flowed from the fact that: (a) it was in a fiduciary relationship with the Blueberry Band by virtue of its position of control over the settlement proceeds; (b) it was the express trustee of the Settlement Funds under the Joint Trust and, (c) it undertook to distribute the settlement funds to the Band Members. •  •  •

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[62]  As indicated above, it is my view that the Band Council and Chief owe a fiduciary duty to all band members, including minors, with respect to their exercise of discretion over the distribution of the Settlement Funds. This obligation arose either at the time the settlement funds were received by the Band from the Government of Canada and placed in the Joint Trust for the benefit of the Bands, or, at the latest, when the Band Council undertook to distribute the settlement funds. In either case, this duty pre-existed the settling of the Interim Trust. •  •  •

[63]  It is my view that the failure to provide for the payment of interest to minors in settling the terms of the Trusts did not result in a breach of the settlors’ fiduciary duties. No questions have been raised regarding the motives of the Band Council or Chief in acting as they did in this case. It has not been alleged, nor is there any evidence to suggest, that the Band Council or Chief acted dishonestly or disloyally to the band members or minors in particular. There is no evidence or allegation that the Band Council or Chief acted in pursuit of their own interests, or to confer an advantage on themselves … In my view, there has been no breach of the duty of loyalty and honesty that is necessary to establish a breach of fiduciary duty. [64]  However, as a result of my conclusion regarding the nature of the fiduciary duty owed by the Band Council, it is my view that the actual act of distributing the funds without providing for interest payable to minors would result in a breach of that duty. As the evidence is that the Interest Hold-Back represents an amount that would be sufficient to satisfy the interest entitlement of the minors, no breach of that duty has yet occurred. Order accordingly.

Louie v Louie 2015 BCCA 247 NEWBURY JA:

[1]  In early September 2009, the Lower Kootenay Indian Band received $125,000 from the Regional District of Central Kootenay as compensation for the District’s use of a road that crosses one of the Band’s reserves. The funds were deposited into the Band’s general operating account. A few days later, the Band Council held a meeting which was attended by the five personal defendants, who were elected councillors. Part of the meeting took part in camera. During the in camera session, they decided to pay themselves $5,000 each as a “retroactive honorarium” for their work as members of the Council. The following day, five cheques for $5,000 were duly issued, one to each of the five defendants, who took the precaution of signing each other’s cheques. [2]  The plaintiff Mr. Louie evidently became aware of the payments in late 2011. In July 2012, acting for himself and on behalf of the Band, he filed a Notice of Civil Claim against the defendants, alleging that the payments had been made in breach of their fiduciary duties and “without lawful authority or without juristic reason.” He also alleged

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that the defendants had “conspired together” by acting in bad faith in exercising their powers for an improper purpose and keeping the payments secret for over two years, and that they had failed to make proper disclosure and to follow “financial procedures pursuant to the Indian Act.” He sought a declaration that each of the defendants was guilty of breach of fiduciary duty and an order that each was individually liable to return $5,000 to the Band. Last, he sought punitive damages. [3]  In their response, the defendants denied that the payments had been made secretly or that any fiduciary duty arose in respect of them. They asserted that their decision was “within the scope of the Council’s duties, done in accordance with the Handbook and the customs, procedures and/or obligations of LKB governance, and was in the best interests of the Band.” In summary, they denied breaching any legal or equitable duty. [4]  For reasons indexed as 2014 BCSC 133, the summary trial judge below found that the claim of breach of fiduciary duty had not been proven, and dismissed the action. The plaintiff appeals. The Trial Judge’s Reasons [5]  The Band is a small Band of approximately 220 members, only 100 of whom live on the reserve, near Creston. Although there was evidence that the Band had a “draft” financial administration bylaw that “serves as a guide for the Band Council in dealing with Band Money,” the trial judge found that the Band did not have a constitution or a financial administration bylaw at the material time. Instead, he said, the Council acted in accordance with the custom and practices of prior Band Councils. The defendant Jason Louie deposed that: Honorariums, travel expenses, possible catch up payments have been discussed several times in the past at Council level. There has never been advance consultation with band members before any such discussions or before any acceptance or denial of any increase in payment to Council members. I have always considered the election to Council or (for myself) as Chief to be a mandate to ensure Council is paid for its work. There is a longstanding Council custom to approve pay to council members. The rate was $50 at one point, and has been raised over time. (Emphasis added.) •  •  •

[6]  … Evidently, councillors were receiving honoraria of $360 per month at the time of the impugned payments. This amount was regarded as inadequate, but any discussions of an increase had been met by the advice of the Band Administrator that Band funds did not permit an increase. [7]  When the $125,000 was received by the Band, the Council felt able to “address the issue of the honorarium” and with the concurrence of the Band Administrator, “voted to retroactively address the past low honorarium through a one-time payment.” Each councillor received $5,000 even though some had been councillors longer than others. There is no indication that any councillor abstained from voting, although as noted, councillors did not sign their own cheques. •  •  •

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Fiduciary Duty [15]  The trial judge began his analysis of the question of fiduciary duty with the proposition that since there was “no evidence” the Band Council could not make decisions regarding pay increases, the Band was bound by the Council’s decision (to pay $5,000 to each councillor) “unless they acted in bad faith.” (Para. 42.) (This appears to have been adopted from para. 30 of Assu v. Chickite 1990 CanLII 781 (BC SC), [1991] 1 C.N.L.R. 14 (B.C.S.C.), where the Court was discussing the scope of powers that had been conferred by a band on its council.) [16]  The judge then went on to discuss various circumstances that seemed to weigh in his analysis against a finding of breach of duty: • The disclosure of the “one-year increase in the honorarium paid” in the Band’s financial statements was “inconsistent with the allegations of secrecy made by the plaintiff.” (Para. 38); • All the defendants had deposed that the payments were not a secret, and an outside consultant to the Band, Mr. Wullum, had been aware of the retroactive honorarium. (Para. 39); • The defendants all believed that remunerating themselves was a “permissible use of own source funds” and there was no evidence of a policy, bylaw or direction to the contrary. (Para. 40); • The defendants took “the precaution of not signing their own cheques.” (Para. 43); • The amount of $5,000 was small compared to the amounts of honoraria discussed in other cases. (Para. 46); • The honoraria were not unrelated to Band Council services and did not carry the “stench of dishonesty.” (Para. 46); • The payments did not constitute “egregious personal benefits unrelated to decisions within the scope of a Band Council’s authority,” as had occurred in Annapolis Valley First Nations Band v. Toney 2004 FC 1728 (CanLII), Gilbert v. Abbey 1992 CanLII 921 (BC SC), [1992] 4 C.N.L.R. 21 (B.C.S.C.) or Louie v. Derrickson [1993] B.C.J. No. 1338 (S.C.). In those cases, the band councils had not followed their own “accepted governance practices. That is not the case here.” (Para. 44). [17]  Referring more directly to conflict of interest, the trial judge again emphasized at para. 45 the small size of the Band and the fact that many members of the Band and Council are related, meaning “it would be impossible for a Band Council to operate if courts applied strict rules regarding conflict of interest.” •  •  •

[19]  In addition to the summary trial judge’s emphasis on the impracticality of rigorous procedural rules, he also placed considerable weight on his finding that the plaintiff had not shown Council’s decision was in fact “to the detriment of the Band.” In his concluding paragraphs, he stated: •  •  •

I find that the claim of breach of fiduciary duty has not been proven. It has not been established that the defendants were not acting in the best interests of the Band. The plaintiff has failed to establish that it is more probable than not that the conduct of the Band Council amounts to a breach of their fiduciary duty. (At paras. 48-9; emphasis added.)

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On Appeal [20]  The plaintiff appeals on the grounds that the summary trial judge erred: •  •  •

2.  in finding that the [plaintiff] failed to establish that it is more probable than not that the conduct of the [defendants] amounts to a breach of their fiduciary duty. •  •  •

Fiduciary Duty [23]  I start with the two most fundamental and long standing obligations of fiduciaries—the “no conflict” rule and the “no profit” rule. These have been stated on many occasions over several centuries, but this passage from the judgment of the High Court of Australia in Chan v. Zacharia (1984) 154 C.L.R. 178, summarizes the historic approach succinctly: The first is that which appropriates for the benefit of the person to whom the fiduciary is owed any benefit or gain obtained or received by the fiduciary in circumstances where there existed a conflict of personal interest and fiduciary duty or a significant possibility of such conflict: the objective is to preclude the fiduciary from being swayed by considerations of personal interest. The second is that which requires the fiduciary to account for any benefit or gain obtained or received by reason of or by use of his fiduciary position or of opportunity or knowledge resulting from it: the objective is to preclude the fiduciary from actually misusing his position for his personal advantage. … [T]he two themes, while overlapping, are distinct. Neither theme fully comprehends the other and a formulation of the principle by reference to one only of them will be incomplete. (At 198-9.)

(Quoted with approval by the majority in Strother v. 3464920 Canada Inc. 2007 SCC 24 (CanLII) at para. 75; see also the discussion in L.I. Rotman, Fiduciary Law (2005) at ch. 6.) An even more succinct statement may be found in the words of Lord Herschell in Bray v. Ford [1896] AC 44 (H.L.): “It is an inflexible rule of a Court of Equity that a person in a fiduciary position … is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict.” (At 51.) [24]  I emphasize the words “unless otherwise expressly provided,” since they create the exception under which trustees, corporate directors, band councillors, municipal councillors, and other persons entrusted with the funds or property of others are empowered to make decisions regarding their own remuneration that would otherwise be regarded as breach of the “no profit” rule. (Indeed, before such powers became commonplace, trustees were required to act without pay: see Waters’ Law of Trusts in Canada (3rd ed., 2005) at 888-90.) Such trust clauses, bylaws or rules are generally required to be strictly complied with and often require publication of the bylaw or resolution to the members of the group (here, the Band) or to the public. [25]  In this case, the trial judge assumed that authority of this kind had been granted by virtue of past practice; but as earlier noted, there was in fact no evidence that s. 2(3) of the Indian Act had been complied with—i.e., that the consent of the majority of the

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Band had been obtained for the exercise of such power by the Council. While I agree that it is unrealistic to expect a band to comply strictly with all the rules and regulations of a sophisticated corporation or council, I see no basis on which this very fundamental statutory provision could be effectively ignored. (See Lac la Ronge Indian Band v. Canada 1999 SKQB 218 at para. 194.) … [26]  As far as the “no conflict” rule is concerned, I have noted the “prophylactic” approach enunciated in cases such as Bray v. Ford and Phipps v. Boardman [1967] 2 A.C. 46 (H.L.). Under this rule, the subjective motivations of the fiduciary, the absence of actual harm to the beneficiary, and even whether the fiduciary in fact profited, are irrelevant. As Rotman, supra, states: [The] objective standard of assessment does not concern itself with matters such as fiduciaries’ subjective motivations for their actions, whether they have acted in good or bad faith, if beneficiaries have suffered harm or loss, or whether the beneficiaries have earned profit from the actions in question. Fiduciaries’ subjective motivations may only come into play in determining appropriate measures of relief for breaches of fiduciary duty. (At 303.) •  •  •

[27]  If this approach applies, it seems clear that the trial judge’s suggestion that the defendants did not act “to the detriment” of the Band or that there was no “stench of dishonesty” was, with respect, not relevant. As Waters writes, the strict rule against conflicts exists so that there will be no ambiguity about the fiduciary’s motivation; he must act only in the beneficiary’s best interests. (At 914.) [28]  At the same time, I note a somewhat different approach which Waters detects in some Canadian cases, including Tornroos v. Crocker 1957 CanLII 44 (SCC), [1957] S.C.R. 151, Peso Silver Mines Ltd. v. Cropper 1966 CanLII 75 (SCC), [1966] S.C.R. 673, and Hawrelak v. Edmonton (City) 1975 CanLII 211 (SCC), [1976] 1 S.C.R. 387. The text describes this approach as follows: The second theory, suggested by some of the more recent cases, tends to merge the two levels of protection. Rather than finding a strict prohibition against conflicts of interest and duty, this approach may look directly to the underlying fiduciary duty, the duty to act in the best interests of the beneficiary. On this approach, if the trustee did so act, there may be no reason to require the disgorgement of a gain, even though a conflict of interest may have been apparent on the surface. If he did not actually compromise the beneficiary, why penalize him? This is why, on this approach, a court may be willing to consider such issues as whether the trustee was in good faith, and whether the gain (which the beneficiary now seeks) was one which could not possibly have accrued to the beneficiary. A number of Canadian cases seem to adopt this more relaxed attitude. •  •  •

[29]  Even if we were to adopt the more “flexible” approach, however, it simply cannot be said that the defendants did not act to the detriment of the Band in deciding to pay themselves $5,000 each out of Band revenues. This is not a case in which the benefit that accrued to the defendants “could not possibly have accrued to the beneficiary,” nor one in which the advantages gained by the fiduciaries were paltry. As we have seen, members of the Council in the past had been receiving $360 per month. The removal of $25,000 from Band funds and the payment of $5,000 to each of the defendants was a clear and significant personal benefit to them, and them only. As a one-time payment, it did not

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benefit future members of Council or of the Band. Rather, it was a detriment to the Band. The conclusion seems to me inescapable that this was a breach of fiduciary duty, even in the context of a relatively informal and custom-based governance structure. In my view, such a structure should not deprive members of the Band of the protection of the fiduciary principle. They were entitled to hold the defendants to the high standard to which other fiduciaries are held in this country. [30]  I would allow the appeal, grant Mr. Louie a declaration that the five personal defendants acted in breach of their fiduciary duties to the Band in purporting to remunerate themselves to the extent of $5,000, and order that each is liable to disgorge the amount of $5,000 to the Band. •  •  •

FRANKEL JA: I agree. GROBERMAN JA: I agree. NOTES AND QUESTIONS

1.  Recalling the issues set out in Martin and in Telecom Leasing, do these two decisions in Blueberry Interim Trust and in Louie expand the role that First Nation leaders play beyond mere representative capacity? 2.  Is the fiduciary duty owed by band council members in Blueberry Interim Trust a more or less stringent duty than that owed by directors of a corporation? Is it more or less stringent than the duties owed by any other public officials? 3.  Newbury JA notes that directors of corporations routinely provide for their own remuneration where this is expressly provided for in the articles or bylaws of the corporation. Is this restriction adequate or is there space for traditional practices? Are corporate directors any less likely to set rates of honorariums or remuneration any more reasonably? 4.  What are the differences between the fiduciary duty of a First Nation leader to his citizens and that of the directors of a corporation to shareholders? 5.  In light of (a) the complicated structuring that First Nation corporations must engage in to be protected from civil liability while also achieving tax exemption, (b) the conflicting and different kinds of fiduciary duty that accrue to the positions of First Nation leadership and the directorships of First Nation entities, (c) the implications of Indigenous law and traditional practices that may differ from strict trust law principles, and (d) the need for First Nations to negotiate with governments and industry concerning their Aboriginal and treaty rights and any developments that may infringe upon these, what features would you ensure are present (or not present) in the articles or bylaws and shareholders’ agreement?

V.  BUSINESS STRUCTURES AND ECONOMIC DEVELOPMENT A.  Legal Ethics and First Nation Economic Development: Representation, Conflicts, and Succession Similar to any shareholder of a corporation, a First Nation or Indigenous group of any kind will always have a separate legal identity from any corporate bodies it chooses to employ to pursue its economic or other ends. For non-Indigenous businesses, it will always be crucial

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to understand the precise Indigenous party with whom one engages as part of a lawyer’s ordinary due diligence in properly drafting documents that bind the appropriate parties. Because a First Nation or other Indigenous group must use other entities to carry out its economic development, and because one will not always have access to agreements between a First Nation and the federal and/or provincial governments, it can be difficult to know whether there are other legal or beneficial interests that can have an effect on a series of negotiations or transactions. The important question for lawyers representing First Nations or parties pursuing ventures with First Nations is: Who is the ultimate party with authority to legally bind the entity? While there are limits to the kind of due diligence that a First Nation must be subject to, it has been consistently seen to be good business practice for First Nations to evidence a strong regulatory environment that supports financing, investment, and other forms of capitalization.48 As the TRC Calls to Action for businesses demand, it is no longer sufficient for non-Indigenous businesses to rely on representations made about First Nations by governments or governmental agencies. Good business practice requires consultation regarding Aboriginal and treaty rights, and an open and clear set of communications regarding the parties involved. In practice, there are many different kinds of instruments and documents used to give structure to economic relations for First Nations—including, but not limited to, memoranda of understanding (both binding and non-binding), term sheets, and non-disclosure agreements. The careful lawyer will be alive to “boilerplate” issues, and recognize that the distinct aspects of the parties and the transactions often require fresh approaches to drafting or, in the case of disputes, rigorous attention to any documents that evidence the identification of and history of relations among the parties. The specific issues that lawyers practising in the area of First Nation business organizations must continually regard are (1) the proper identity of the party being represented, and (2) attention to possible conflicts. The law societies of every jurisdiction in Canada have rules that address client verification, and many offer draft procedures and retainer letters that aim to make this practice of carefully identifying clients much easier. With respect to conflicts, every jurisdiction has rules that regulate how lawyers must deal with representing clients where there are actual conflicts between parties adverse in interest, as well as how they may deal with clients who only have apparent conflicts of interest. Because First Nation businesses have a separate legal identity from the First Nation itself, it is prudent to clarify the nature and extent of work involved so that possible conflicts come to light early and can be managed appropriately. As was noted by the Supreme Court of Canada in R v Neil, 2002 SCC 70, [2002] 2 SCR 631:

48 The First Nation Tax Commission, First Nation Financial Management Board, and First Nation Finance Authority were established under the First Nations Fiscal Management Act, SC 2005, c 9. This legislation institutionalizes access to long-term capital financing (at preferred rates) for First Nations by pledging revenues akin to property tax for the issuance of bonds. First Nations must adopt a number of legislative and financial reporting mechanisms in order to avail themselves of these institutional arrangements, which they then use as financing for various infrastructure and community-based economic development. See Indigenous and Northern Affairs Canada, “Government of Canada Congratulates the First Nations Finance Authority on Its Third Bond Issuance,” News Release(1 June 2016), online: .

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[29]  … a lawyer may not represent one client whose interests are directly adverse to the immediate interests of another current client—even if the two mandates are unrelated—unless both clients consent after receiving full disclosure (and preferably independent legal advice), and the lawyer reasonably believes that he or she is able to represent each client without adversely affecting the other. [Emphasis in original.]

In Canadian National Railway Co v McKercher LLP, 2013 SCC 39, McLachlin CJ indicated, in a unanimous decision, that there were important limits to the bright line rule elaborated in Neil. In exploring the scope of the rule, McLachlin CJ noted (at para 33) that the rule only applies where the “immediate interests of clients are directly adverse in the matters on which the lawyer is acting.” Further, the relevant interests must be legal (not just strategic or commercial), which means that the rule cannot be invoked for a purely tactical purpose by another party whereby “institutional clients … spread their retainers among scores of leading law firms in a purposeful attempt to create potential conflicts” (at para 36). Finally, the bright line rule does not apply to unrelated matters where it is unreasonable for a client to expect that its law firm will not act against it. It is important to put this articulation of the rule in its converse formulation in order to understand what sorts of conflicts are prohibited. That is, the bright line rule applies to prohibit a lawyer from acting for two parties directly adverse in interest on a matter. This can be extended to situations where the confidential information gleaned from client #1 on a prior matter could be used for the benefit of client #2 in a matter in which client #1 is directly adverse in interest, and would thus disqualify the lawyer from acting for client #2. These rules are particularly important for lawyers to heed in working with First Nations on business structures and transactions. Because a corporate entity is a separate legal entity from the First Nation that owns its shares, it may evolve to have different legal interests, just as trustees who hold property for First Nations may have different obligations. As with change in the share ownership of any business corporation, a change in First Nation leadership can also mean changes to the management structure of its development corporations and other businesses. Beyond the importance of institutional memory for these organizations, it is crucial for lawyers to help clients understand the ordinary nature of changes to share ownership (even in the cases of nominee shareholders), directorships, and that the permanence of the organizations is meant to outstrip changes to its personnel. Succession planning for First Nation corporate entities involves ensuring that all parties understand the nature of corporate governance and the instruments and statutory processes required for smooth transitions. A change in the elected officials of a First Nation or of the directors of its entities does not mean that a lawyer can no longer work for the First Nation: the lawyer’s duty and role is as an advocate and legal adviser to the First Nation, and not to any of the individuals in their personal capacities while holding offices. This key distinction underlies one of the other rationales for using corporate entities indicated previously in Michael Welters’ article: the permanence of the organization withstands the changes to its rosters of directors and officers. Consider the challenges of working with the multiple entities of a First Nation in light of the following excerpt from the CBA’s Code of Professional Conduct (2009).

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Canadian Bar Association, “Chapter V: Impartiality and Conflict of Interest Between Clients” Code of Professional Conduct (Ottawa: Canadian Bar Association, 2009) at 25-30 Rule 1.  The lawyer shall not advise or represent both sides of a dispute and, except after adequate disclosure to and with the consent of the clients, preferably after receiving an independent legal advice, shall not act or continue to act in a matter when there is a conflicting interest. 2.  The lawyer may act in a matter which is adverse to the interests of a current client provided that: (a)  the matter is unrelated to any matter in which the lawyer is acting for the current client; and (b)  no conflicting interest is present. Commentaries Guiding Principles 1.  A conflicting interest is an interest which gives rise to substantial risk that the lawyer’s representation of the client would be materially and adversely affected by lawyer’s own interests or by the lawyer’s duties to another current client, a former client, or a third person. •  •  •

4.  The duties to other current clients, former clients and third persons which may give rise to a conflicting interest include, but are not limited to, the duties and loyalties of the lawyer or a partner or professional associate of the lawyer to another client, whether involved in the particular matter or not, including the obligation to communicate information. Disclosure of Conflicting Interest 5.  The Rule requires adequate disclosure to enable the client to make an informed decision about whether to have the lawyer act despite the existence or possibility of a conflicting interest. As important as it is to the client that the lawyer’s judgment and freedom of action on the client’s behalf should not be subject to other interests, duties or obligations, in practice this factor may not always be decisive. Instead it may be only one of several factors that the client will weigh when deciding whether to give the consent referred to in the Rule. … An example of this sort of situation is when the client and another party to a commercial transaction are continuing clients of the same law firm but are regularly represented by different lawyers in that firm.

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6.  Before the lawyer accepts employment from more than one client in the same matter, the lawyer must advise the clients that the lawyer has been asked to act for both or all of them, that no information received in connection with the matter from one can be treated as confidential so far as any of the others is concerned and that, if a dispute develops that cannot be resolved, the lawyer cannot continue to act for both or all of them with respect to the matter and may have to withdraw completely. Where a lawyer has a continuing relationship with a client for whom the lawyer acts regularly, before the lawyer accepts joint employment for that client and another client in a matter or transaction, the lawyer must advise the other client of the continuing relationship and recommend that the other client obtain independent legal advice about the joint retainer. … The lawyer should, however, guard against acting for more than one client where, despite the fact that all parties concerned consent, it is reasonably obvious that a contentious issue may arise between them or that their interests, rights or obligations will diverge as the matter progresses. 7.  Although commentary 6 does not require that, before accepting a joint retainer, a lawyer advise each client to obtain independent legal advice about the joint retainer, in some cases, especially those in which one of the clients is less sophisticated or more vulnerable than the other, the lawyer should recommend doing so to ensure that the less sophisticated or more vulnerable client’s consent to the joint retainer is informed, genuine, and uncoerced. •  •  •

Acting Against Former Client 12.  A lawyer who has acted for a client in a matter should not thereafter, in the same or any related matter, act against the client or otherwise act against the client where: (a)  the lawyer might be tempted to breach the Rule in Chapter IV—Confidential Information; or (b)  the lawyer’s duty to the other client would require the lawyer to attack the legal work done during the prior matter or, in effect, change sides on a central aspect of the prior legal work. The term “legal work” refers to the very legal advice, representation or work product that the lawyer provides to a client in a specific dispute, transaction or similar mandate. NOTES AND QUESTIONS

1.  Given the separate legal personality of First Nation corporate entities, what steps, if any, can a lawyer take to properly act not only for the First Nation but also for its entities? 2.  In disputes between members of a First Nation who happen also to hold offices in the First Nation and/or a First Nation-owned corporation, what steps must a lawyer take? What other steps might a lawyer consider so as to not become disqualified from acting for the First Nation? 3.  Could the same concerns arise for a lawyer representing one of the Maori groups, who might be advocating for protection of land or a river that has its own status as a separate legal entity under the Te Urewera Act or Te Awa Tupua Bill?

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B.  Economic and Policy Challenges for Corporate Planning 1.  The Challenge of Own-Source Revenue for Corporate Planning First Nations and Indigenous people avail themselves of many kinds of business corporate entities and arrangements, often combining multiple kinds into multiple levels. The reasons for this have been discussed, and involve shielding the First Nation from civil liability, tax exemptions, and tax deferrals. Another consideration when planning is the issue of the “own-source revenue” (OSR) calculation. OSR refers to revenue generated by First Nations other than by way of funds provided by Canada in the fulfillment of the Crown’s obligation to them under s 91(24) of the Constitution Act, 1867. Although not stated anywhere in legislation, regulation, or in any other legislative instrument, the Ministry of Indigenous and Northern Affairs Canada (“INAC”) has applied a policy with respect to its calculation of its financial obligations to First Nations, wherein the funding decreases as OSR increases. Although OSR originally only resulted in a funding decrease to the financial arrangements contemplated by modern treaties and the self-government agreements that flow from them, funding decreases appear to be applied to all OSR, and therefore have become relevant to all First Nation governments in Canada, mostly because it is not properly defined. While a description of the policy is beyond the scope of this chapter, it is important to note that First Nations are becoming as concerned about the structure of their business holdings with respect to OSR as they are about tax exemptions. Specifically, if certain revenues of a First Nation are considered to be included in the calculation of OSR, then a certain amount of the INAC funding ordinarily provided to the First Nation is clawed back. For the most part, ordinary business revenues that a First Nation generates on a tax-free basis are included in OSR, whereas previously taxed revenue or revenue that derives specifically from settlements, compensation payments, “Indian moneys,” the use of reserve land, and “portfolio dividends” is excluded from the OSR calculation. Further, attempts by a First Nation to duplicate (or, in some cases, augment) the programs delivered out of core funding from Canada with some of their excluded OSR will result in a clawback of funding by Canada in the amount of that contribution. The original point of the policy was to assist with the transition to self-government institutions and authority, but many critics have denounced the policy as regressive and a form of “back-door taxation.”

2.  Structuring for Tax Exemption While a sole proprietor registered with “Indian status” has the advantage of certain Indian Act income tax exemptions, a corporation is generally not exempt because it is not “an Indian.” However, the ITA does provide corporations with income tax exemptions where they are owned by a First Nation and carry out 90 percent of their activities within the geographical limits of the First Nation (usually interpreted to be its reserve).49 For individuals, as

49 Income Tax Act, RSC 1985, c 1 (5th Supp), s 149(1)(d.5).

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opposed to a First Nation government, corporations are helpful for liability protection, income-splitting among shareholders, and tax deferral much in the same way as for nonIndigenous residents of Canada. Assisting First Nations and Indigenous groups with the choice of the most appropriate business structure for a given venture involves a consideration of a number of different factors, including Indigenous laws, civil liability protection, management and control, and tax exemption. Because of the evolution of recent jurisprudence on Indian Act s 87 tax exemptions, there are opportunities for “Indians” to organize themselves commercially on reserves so as to continue to take advantage of the exemption. When structuring for tax efficiency (for income, sales, and commodity taxes), and in the case of bands or “Indians” subject to the Indian Act, it is important to take account of the different factors that would connect any of the business income to a reserve. In addition to numerous cases published over the past 15 years, the CRA has now updated its guidelines and published most of its CRA Technical Interpretations and Advance Income Tax Rulings (all anonymized) to provide guidance as to which factors will be given most consideration to connect income to a reserve for the purposes of the Indian Act s 87, or whether a First Nation qualifies for tax exemption pursuant to ITA s 149. In the following two extracts of CRA documents, note that a corporation does not qualify for the s 87 exemption, but keep in mind the alternative option pursuant to s 149(1)(d.5) of the ITA that may apply to a First Nation corporation. Additionally, the CRA is able to consider co-operatives, sole proprietorships, and limited partnerships as “Indians” or “Indian bands” because these entities are flow-through entities that are taxed according to the individual that holds or authorizes them. That is, co-operatives, sole proprietorships, and partnerships can qualify for the exemption under Indian Act s 87 where the member, proprietor, or partner is an “Indian” or “Indian band” because the income is earned directly by the “Indian” or “Indian band” if they are engaged in the business on reserve and are members of the co-operative, partners in a partnership, or sole proprietors. Otherwise “Indian bands,” tribal councils, and First Nations generally will qualify as “public bodies performing a function of government” under ITA s 149(1)(c). Consider the following two Advance Tax Rulings by the CRA, and what they would suggest for Indigenous peoples planning their business ventures.

CRA External Technical Interpretation, “Business Income of Self-Employed Indian Fishers” 2015-0585231E5 (20 October 2015) Re: Business Income of Self-Employed Indian Fishers This is in response to your correspondence of April 28, 2015, regarding the tax treatment of business income earned by self-employed Indian fishers. We also acknowledge additional information you provided in subsequent telephone conversations (XXXXXXXXXX/ Messore). Specifically, you would like to know whether the fishing income of a selfemployed Indian who lives on-reserve, keeps his books and records at his residence onreserve, but fishes off-reserve, would be exempt from tax under section 87 of the Indian Act. •  •  •

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Paragraph 81(1)(a) of the [Income Tax] Act, together with paragraph 87(1)(b) of the Indian Act, exempt from tax “the personal property of an Indian or a band situated on a reserve.” For the purposes of the exemption, an Indian is defined in subsection 2(1) of the Indian Act as a person who is registered as an Indian or is entitled to be registered as an Indian. The courts have determined that income, including business income, is personal property for purposes of section 87 of the Indian Act. Therefore, business income earned by an Indian will be exempt from tax if it is situated on a reserve. The determination of whether income is situated on a reserve, and thus exempt from tax, requires the identification and evaluation of factors connecting the income to a location on a reserve. The type of property is important in identifying the relevant connecting factors. In this case, the property is fishing business income. In the case of a self-employed Indian fisher’s business income, the courts have established certain criteria as relevant connecting factors in determining whether the income is situated on a reserve. In The Queen v. Robertson and Saunders, 2012 DTC 5077, the Federal Court of Appeal commented that since income is an intangible property and has no physical location, where it is situated is largely governed by the location of the business activities from which the income arises. In determining whether a self-employed Indian fisher’s commercial fishing business income is connected to a reserve, the factors that may connect the Indian’s business income to a reserve are: • the location of fishing activities—catching, preparing and transporting the fish, and • the location of selling activities—including the location of customers and the location of the sale of the fish. In addition, for the 2012 and following tax years, a self-employed Indian’s fishing income is connected to a reserve where the following conditions are met: • the Indian’s fishing activities are in waters near or abutting the reserve that have a significant historical and continuing important economic connection to the reserve, and • the Indian is a member of a cooperative of band members or a member of a band that owns and operates an organization located on the reserve that has a predominant role in the Indian’s fishing and selling activities and an important role in the general economic life of the reserve. Whether business income earned by an Indian fisher is taxable or exempt is a question of fact. However, the courts have established that the location of the residence and the location of the books and records are not considered to be decisive factors on their own merits in making a determination of whether or not the income earned by the selfemployed fishers is situated on-reserve. In the present situation, it is not clear whether there are any other connecting factors, such as the ones described in the previous paragraphs, which may assist in locating the income on-reserve.

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CRA Advance Tax Ruling, “First Nation—Limited Partnership” CRA Document 2012-0473041R3 E Principal Issues:  Is the income allocated to the First Nation from a limited partnership exempt from tax because the First Nation is a public body performing a function of government? Position: yes Reasons:  The First Nation is government by an elected chief and band council and has demonstrated that they perform several functions of government. Therefore, the income allocated from the limited partnership is exempt. Dear XXXXXXXXXX: Re: Advance Income Tax Ruling This is in reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-named taxpayer. •  •  •

Proposed Transactions 20.  Limited Partner 1 has subscribed for XXXXXXXXXX units of the Limited Partnership and will own XXXXXXXXXX% of the Limited Partnership. 21.  Limited Partner 1 does not carry on any operations or activities except as nominee, bare trustee and agent for and on behalf of the First Nation. The First Nation is the beneficial owner of all assets owned by Limited Partner 1. 22.  Limited Partner 2 has subscribed for XXXXXXXXXX units of the Limited Partnership and will be the beneficial owner of XXXXXXXXXX% of the Limited Partnership. 23.  The General Partner will be the beneficial owner of XXXXXXXXXX% of the Limited Partnership. 24.  The Limited Partnership agreement will provide that no new partnership units will be authorized and the only units authorized are the ones that are currently issued to Limited Partner 1, Limited Partner 2 and General Partner. 25.  The Limited Partnership agreement will not contain a provision for the admission of new partners. 26.  The Limited Partnership agreement will provide that the General Partner will receive fair market value compensation for management and other services it performs for the Limited Partnership. 27.  The Limited Partnership will own and operate a XXXXXXXXXX in the area of the XXXXXXXXXX. The estimated capital expenditure for the project is $XXXXXXXXXX. 28. The Limited Partnership will have a contract with the XXXXXXXXXX that provides a fixed return to the Limited Partnership based on the rate effective with the issuing of the XXXXXXXXXX contract.

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Purposes of Proposed Transactions 29.  The purposes of the proposed transactions are as follows: a)  To generate a long-term source of income for the First Nation to support the governance, public works and infrastructure needs of each community and to promote economic development such that the First Nation will become economically selfsufficient while maintaining a stewardship role over its lands. b)  To protect the First Nation from liability arising from activities related to the XXXXXXXXXX. c)  To provide employment and job training for Members of the First Nation. d)  To support projects and activities for the general benefit of the First Nation. Ruling Given Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purposes of the proposed transactions, we rule as follows: Because the First Nation is, and as long as it continues to be, a public body performing a function of government in Canada within the meaning of paragraph 149(1)(c) of the Act, and therefore exempt from tax under Part I of the Act, no tax will be payable under Part I of the Act by the First Nation on income allocated to the First Nation by the Limited Partnership, in respect of the XXXXXXXXXX operated by the Limited Partnership, as a result of the proposed transactions described above. 3.  Economic Development and the Separation of Business and Politics Even though it is a feature of corporations that they are sometimes said to separate the ownership function from the management function, an additional consequence of the use of corporate structures by First Nations has been to “separate business from politics.” The benefit of separating business from politics is that it ensures that the business entities can be responsive to economic imperatives and the demands of its business, while ensuring a modicum of protection from the political influence of First Nation governments. The disadvantage, however, is that First Nations often do wish to retain oversight and control of their economic development, must consider their fiduciary duty to their members and citizens, and must retain the right to be consulted about any developments that would significantly affect their Aboriginal rights or title or other interests. First Nation councils have a fiduciary duty (and possibly a duty sourced in Indigenous law) to ensure that the community’s collective Aboriginal rights and title are protected, and, depending on the severity of any proposed infringement, may actually require the approval of the entire community for certain infringements. Because corporate entities are used by First Nations for the purpose of economic development, it is important to structure corporate holdings in a way that considers the advantages of separate legal personality without sacrificing the aims of economic development, breaching any fiduciary duties, or contravening any Indigenous laws. Note that the call to

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“separate business from politics” happens within the Western legal paradigm where “conflicts of interest” are assumed between those who are related or are “interested” in each other’s business, whereas Indigenous legal traditions can often give priority to the historical and interested relations among kinship groups or other mutually interested peoples. In the 1980s in the United States, a series of studies and “experiments” with corporate structures in participation with Native Americans was conducted by scholars and Native American tribes through Harvard University, led by Stephen Cornell and the Harvard Project on American Indian Economic Development. The study showed that carefully separating the economic activities out of the main governing bodies had the effect of amplifying development. This model has since been used successfully in other jurisdictions, notably Canada, but with ongoing concern by some that this separation only results in the concentration of capital and the creation of wealthier elites within First Nations. Consider the following excerpts: the first is from the Tsilhqot’in trial on Aboriginal rights and title, the second is from one of Stephen Cornell’s earlier and foundational works, and the third is from the Final Report of the Royal Commission on Aboriginal Peoples (RCAP). In considering these approaches, ask yourself whether the notion of “separating business from politics” mentioned by Cornell could work in the terms set out by the RCAP. Consider whether a corporate entity whose shares are owned, but that is not controlled, by a First Nation, would have legal authority to negotiate and enter an agreement or joint venture with a third party for compensation to significantly infringe an Aboriginal right. Consider whether Indigenous law has an impact, in light of Councillor Gilbert Solomon’s assertion that there is a duty to follow Tsilhqot’in law, and the following words of Chief Roger William, who was explaining to the court the cultural significance of Tsilhqox Biny (Chilko Lake), the large alpine lake that feeds the Tsilhqox (the Chilcotin River) (the namesakes of the Tsilhqot’in people), words that were possibly based on Chief William’s teachings and understanding of Tsilhqot’in law.

Tsilhqot’in Nation v British Columbia 2007 BCSC 1700, Trial Transcript (9 October 2003), Chief Roger William, Direct-Examination at 25, lines 40-47; at 26, lines 1-13 and lines 36-40 00025 [40]  Q Have the Tsilhqot’in Nation—has it ever [41]  received royalties for logging on Crown land? [42]  A No. [43]  Q In the next paragraph of this letter, you make a [44]  reference to Chilko Lake. I’m going to read this. [45]  You say: •  •  •

[47]  We are especially concerned about protecting 00026 [1]  Chilko Lake, which is not only one of the [2]  major salmon-spawning grounds of the Fraser [3]  River watershed but a lake of such powerful

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[4]  importance to us that it can best be [5]  described, in English, as a sacred place that [6]  must not be violated. •  •  •

[8]  Can you tell us what you mean by “importance.” [9]  Are you talking about economic importance or other [10]  kind of importance? [11]  A Well, Tsilhqox Biny is, you know, a lake that’s, [12]  you know, very—our people see it as [13]  spiritual  –  •  •  •

[36]  You know, Tsilhqox Biny is a very powerful [37]  place to—you know, a lot of people, Xeni [38]  Gwet’in/Tsilhqot’ins, that it’s very spiritual, [39]  it’s—you know, you can feel the power from [40]  Tsilhqox Biny.

Stephen Cornell & Joseph P Kalt, “Reloading the Dice: Improving the Chances for Economic Development on American Indian Reservations” (2003) 02 Joint Occasional Papers on Native Affairs: The Harvard Project on American Indian Economic Development at 3-34 Our research objectives have been to explain why tribes differ in their economic development strategies and in the outcomes of those strategies, and to discover what it takes for self-determined economic development—development that meets tribal goals—to be successful. We make no assumption that all tribes share the same development goals, nor do we assume that they should embrace non- Indian definitions of development success. On the contrary, we think success itself ultimately must be evaluated on the basis of the tribes’ own criteria. It seems clear, however, that most tribes are deeply committed to improving the economic welfare of their peoples. At the same time, they are concerned that this be accomplished without losing political or social sovereignty, i.e., control over their own affairs and over the quality and nature of reservation life. •  •  •

Task 3: Establish a Political Environment Safe for Development American Indian reservations compete with other localities to attract economic activity, including not only the activity of outside investors, but that of their own citizens. To be successful in this competition, reservations generally must be able to offer the opportunity to earn economic returns commensurate with, or better than, the returns people and assets might earn somewhere else. Financial capital can readily migrate away from the reservation, and tribal labor can look for work off the reservation or, in a bad regional labor market, move away altogether. While personal ties and commitments may help to

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retain labor on the reservation, the greater the employment opportunities, the more likely people are to stay. •  •  •

Throughout the world, countries’ economic policies and governmental systems eat into the returns that investors can expect in two primary ways: by raising risks and by raising production costs. Investors’ risks are raised, for example, by uncertainty in tax and/or regulatory policy, and by insecurity in the enforcement of contracts and agreements. Investors’ costs can be raised by governmental actions such as hiring policies designed to shield certain workers from competition, inadequate provision of public services (roads, water systems, and waste disposal facilities, etc.), high taxes, or rules that change with every new administration. More subtly, investors’ returns can be squeezed by delays, legal hurdles, and political infighting. This is not to say that tribes should never tax, should never encourage hiring certain kinds of workers, or should provide every public service an enterprise demands. Nevertheless, it must be recognized that the power to govern can be the power to transfer wealth, at investors’ expense, to those who govern. Insisting on employment for the chair’s supporters, dipping into the cash reserves of the tribal enterprise to fund a popular project, or changing lease or royalty terms in midstream—these kinds of actions can discourage investment and effort to the point that they shrink the reservation economic pie. They thus work unambiguously against the tribal public’s interest in a healthy economy. •  •  •

The central problem is to create an environment in which investors—whether tribal members or outsiders—feel secure, and therefore are willing to put energy, time, and capital into the tribal economy. The successful tribes we see have solved, in one way or another, two critical aspects of this problem: [(1) The Separation and Limitation of Powers: Who Controls What? and (2) The Separation of Electoral Politics from Day-to-Day Management of Business Enterprises.] •  •  •

(2)  The Separation of Electoral Politics from Day-to-Day Management of Business Enterprises A second, related problem has to do with the direct role of tribal government in development projects. Tribal governments play—and should play—a critical role in tribes’ strategic decision-making. It is appropriate that strategic decisions regarding the disposition of reservation resources and the character of reservation life be brought into the political arena. Turning a reservation mountainside into a ski resort or a mine, inviting IBM or the Department of Defense onto the reservation—these decisions rightly are topics for political debate. This does not mean, however, that tribal governments should make all or even a significant number of the day-to-day business decisions on reservations. This is not always an easy pill for tribal governments—or any other governments—to swallow, particularly on reservations with tribally owned businesses. After all, the enterprises are the property of the people; shouldn’t the people’s representatives—the politicians— have a direct say in how business is run? Unfortunately, although this argument has some appeal, the reality is that it can only be made in the short run. In the long run, inserting politics into

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day-to-day business decisions invariably undermines efficiency and productivity, saps the resources of the organizations, and runs tribal enterprises into the ground. The primary economic task of a nation’s government is not to make day-to-day business decisions, but to create and sustain an appropriate economic environment for that nation, to lay in place the rules of the game that economic players then follow, and to make strategic decisions about the overall direction development should take. This is true from the United States to Poland or Japan, and from the Passamaquoddy Reservation to the Northern Cheyenne. For the tribe seeking economic development, however, day-to-day decisions on how to run a business are another matter: whom to hire at the tribal store, how many elk to take in the fall hunt, how to manage the payroll at the manufacturing plant. In fact, keeping tribal governments focused on strategic issues and out of the day-to-day affairs of reservation businesses is one of the keys to sustainable development. A staple of storytelling in Indian Country has to do with political interference in business activity. Over and over one hears of voided leases, hired or fired cousins, politicized management, and enterprises drained of funds by tribal council interference. Such problems are not unique to Indian Country—witness Chicago or Boston, or the Philippines or Mexico, where the politics of patronage and personal aggrandizement have memorable histories. While the details vary across reservations and other societies, their consequences are depressingly similar: costs are raised and competitiveness reduced; earnings are dissipated and capital is not replenished; investors fear being held hostage to politics and turn away. In a highly competitive world, there simply is no cushion to absorb costs that are higher than they have to be, production that is less efficient than it can be, or quality that is lower than customers can find elsewhere. Successful business enterprises in Indian Country, whether private or tribally owned, are typically distinguished by the insulation of their day-to-day affairs from political interference. In those cases where there is a strong private sector on the reservation, one of the keys is a capable, independent tribal judicial system that can uphold contracts, enforce stable business codes, settle disputes, and, in effect, protect businesses from politics. In some cases where tribes have attracted large outside investors to the reservation, enterprises are effectively insulated from political interference by formal agreements between the investors and the tribes, backed up by provisions for third- party arbitration and/or limited waivers of sovereign immunity (i.e., subjection to an outside court). Where businesses are tribally owned, it is more difficult to separate day-to-day enterprise management from politics, but the problem can—and must—be solved. [Our study showed] the results of a survey of the tribally owned businesses of eighteen tribes. As of 1990, these tribes owned a combined total of seventy-three enterprises, covering a wide range of sizes and activities, from agriculture to manufacturing. A total of thirty-nine of these enterprises were identified by their respective tribal leaders as being insulated formally from tribal politics, typically by a managing board of directors and corporate charter beyond the direct control of individual council members and the tribal chair. Some of these enterprises were operating profitably; others were losing money. However, the odds that an independently managed tribal enterprise was profitable were almost seven to one. On the other hand, the odds that a tribal enterprise that was not insulated from tribal politics was profitable were only 1.4 to one.

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The ways that tribally owned enterprises can be insulated effectively from politics vary. Those now apparent in Indian Country range from culture-based separations of powers and limits on self-interested behavior, as at Cochiti Pueblo, to constitutional or legal limits, as at Mescalero Apache. In recent years a number of tribes—for example, Salish-Kootenai, Lummi, Cochiti—have put together their own development corporations to manage tribal enterprises. The successful ones place such management in the hands of appointed boards of directors that are accountable to the tribal council in the long run, but are genuinely independent of it in the day-to-day management of business operations. Certainly the success of such operations still depends on a host of other factors, such as skilled personnel and adequate markets, but through such corporations tribes can insulate their enterprises from politics and allow them to go about the business of creating wealth and opportunity. In Canada, the Royal Commission on Aboriginal Peoples Final Report, completed in 1996, links economic development to self-government without any indication of “a separation of business from politics.” Consider the following statement based on the RCAP Final Report, and notice the very different approach counselled by the collective voices that went into the conclusions of the RCAP. Rather than draw attention to the separation of interests, the RCAP focuses on what can assist the capacity of First Nations in their quest for economic selfdetermination, and specifically identifies the need for capital and territory.

Royal Commission on Aboriginal Peoples, People to People, Nation to Nation: Highlights from the Report of the Royal Commission on Aboriginal Peoples (Ottawa: RCAP, Supply and Services Canada, 1996), online:

Financing for Self-Government The financing of Aboriginal governments will require new approaches—approaches that acknowledge that much of the wealth of this country comes from lands and resources to which, in many cases, Aboriginal people have a legitimate claim. If self-government is accompanied by fair redistribution of lands and resources—as we argue it must be— Aboriginal governments can become largely self-financing in the long term through greater access to what are called ‘own-source revenues.’ Own-source revenues flow to governments through familiar channels—taxation, investment, borrowing, business fees and royalties, public corporation revenues, proceeds from lotteries and gaming, and so on. These sources of revenue can and should be made available to Aboriginal governments. It is especially important for Aboriginal governments to develop their own taxation systems. Most Aboriginal people pay taxes now, but to provincial and federal governments. We are recommending that those who live on Aboriginal nation territories pay taxes primarily to their own governments. Those who live off Aboriginal territory would continue to pay taxes to federal and provincial governments. It will take time for Aboriginal nations to develop own-source revenues. Even then, transfer payments from other

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governments will be needed—but to a lesser extent. We expect that treaties and other agreements among governments will free transfer payments from some of the restrictions on their use that now frustrate Aboriginal people. •  •  •

Redistributing Lands and Resources All over the world and throughout history, collective control of lands and resources has been the key to prosperity and the basis of the powerful idea of ‘home’ that gives a people their common identity. Most Aboriginal people retain an intensely spiritual connection to the land of their ancestors—one that involves both continuity and stewardship. It is hardly surprising, then, that the most intense conflicts between Aboriginal and non-Aboriginal people centre on the use and control of land. Across Canada, Aboriginal people are pressing for an expanded share—a fair share—of lands and resources that were once theirs alone. They were promised as much by the Crown of England and its successor, the government of Canada. Some Aboriginal nations signed treaties only because of that promise. •  •  •

A new process for negotiating the fair distribution of lands and resources is long overdue. The Commission proposes that this be handled as part of a new treaty process (outlined later in the chapter). The process would result in three categories of land allocation: • Lands selected from traditional territories that would belong exclusively to Aboriginal nations and be under their sole control. • Other lands in their traditional territories that would belong jointly to Aboriginal and non-Aboriginal governments and be the object of shared management arrangements. • Land that would belong to and remain under the control of the Crown but to which Aboriginal people would have special rights, such as a right of access to sacred and historical sites. •  •  •

Economic Development Aboriginal people want to make a decent living, to be free of dependence on others, free of the social stigma and sense of personal failure that go with dependence, and free of the debilitating effects of poverty. Economic self-reliance will let them thrive as individuals and as nations and make their new governments a success. The historical self-sufficiency of Aboriginal people and nations was destroyed in several ways: • Their control over their lands and resources was diminished or usurped. • New forms of economic activity (agriculture, manufacturing) were monopolized by non-Aboriginal people and businesses. • Governments failed to live up to the spirit and intent of treaty promises to preserve traditional means of self-sufficiency—hunting, fishing, trapping, trading—and to help Aboriginal people take up the trades and occupations of the settlers if they wished.

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• Legislation, especially the Indian Act, interfered with economic activity on reserves by restricting the flow of capital and limiting the decision-making capacity of First Nations governments and entrepreneurs. • Businesses, industries and other workplaces have begun only recently and occasionally to welcome and accommodate Aboriginal people as employees. • Education and training facilities have begun only recently and occasionally to support Aboriginal people as students, with the result that few adults are equipped to compete for good jobs. Several factors will make revitalization of Aboriginal economies a big challenge: • Dependence: Most Aboriginal nations and communities are highly dependent on funds from other governments. Most offer only a limited range of job opportunities. Few can hold out the promise of jobs for the majority of their children. • Inequality: In 1991, 54 per cent of Aboriginal people had annual incomes of less than $10,000, as compared to 34 per cent of Canadians generally. Unemployment is high, and it has risen noticeably in the last decade as the size of the youth population has swelled. • Rapid labour force growth: Higher birth rates and life expectancy have produced a sharp increase in the Aboriginal population (see graph). The number of children under 16 is especially high, with sobering implications for future job needs. • Variability: Aboriginal nations are located all over the country, from east to west and north to south, from isolated villages to urban enclaves. Most have limited natural resources at their command, although many have riches under their feet. Economic activity in communities ranges from traditional harvesting to modern wage work. Economies may be restricted by the Indian Act, assisted by federal programs—or outside the reach of both. Because of this complexity, means and strategies to achieve self-reliance will vary. No single economic development plan or program will work. Ownership of lands and resources is essential to create income and wealth for Aboriginal individuals and nations. But ownership is not enough. Communities and nations that want to control the wealth available from their resources don’t want to leave operation of their economies to outside specialists. The challenge of skills development to meet the demands of both modern and traditional economic activity is just beginning to be met in Aboriginal communities. Federal, provincial and territorial governments should co-operate to stimulate economic vitality in both the traditional and the modern sector—so that all Aboriginal people have the chance to make a reasonable living, whether as a carver in Cape Dorset, a teacher in Saskatoon, or a part-time trapper and radio technician in Moose Factory. Recent progress in economic development gives rise to hope for a brighter future. But the challenge of turning pockets of progress into a broad transformation of economic life for Aboriginal people remains immense. Levers of Economic Change Transforming Aboriginal economies from dependence to self-reliance will not be easy. The greatest boost for most nations will come from access to a fair share of lands and

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resources. The results of recent land claims settlements suggest that nations will use their timber, minerals, fish, wildlife and other resources to create jobs, bring in revenue, and lay the foundation of a diversified economy. Access to resources is the key, but increasing the land and resource base is not enough. Other strategies are needed too. NOTES AND QUESTIONS

1.  The Royal Commission on Aboriginal Peoples expresses the urgent need to give control over economic development to First Nations, and yet the Harvard studies suggest that business and politics must remain separate. Can you see a middle ground? What distinction, if any, can be made between control and day-to-day management? Consideration and flexible planning may be required in order to allow First Nations to leverage Aboriginal rights and title into economic development, and at the same time allow a non-political board of directors to manage the day-to-day operations of a business. In what way are corporate entities and their instruments flexible enough to accommodate these aims? In what way are they deficient? 2.  Many claim that a strong regulatory environment on First Nation territory fosters economic development. How does this idea fit with the RCAP aim? Or the Harvard study? Or any applicable fiduciary duties or Indigenous laws that First Nation leaders must adhere to? 3.  If the RCAP encourages capital and territory, and the Harvard study encourages devolution of responsibility from Native American elites to “businesses,” how might a First Nation’s own commercial practices inform Western paradigms of economic growth? Do you think there may be a role for Indigenous legal traditions and commercial practices to shape the conditions of the economic self-determination of First Nations?

C.  Corporate Structures Used for Economic Development by First Nations First Nations in Canada use every kind of corporate structure, association, instrument, and relationship known at law to organize their economic activity, and often do so in combination for all of the reasons we have discussed: liability protection, tax efficiency, to separate or integrate business and politics, financing and capitalization, regulatory predictability, adherence to Indigenous laws, and other specified purposes. Once a First Nation decides that it wishes to use a particular corporate structure to reflect its legal status and relationships so as to pursue forms of economic development, it must attempt to reflect itself—by way of written explanations of the goals and purposes of a venture—in the written form of a legal instrument. This presents a quandary to First Nations, as the attempt to organize their economic development according to the dictates of Canadian corporate law involves at least some degree of factual organization and reorganization such that the First Nation’s activities can “mirror” the structure that is contemplated by the legal instrument that gives expression to its legal personhood at law. Respected practitioner Merrill Shepard has written that the simplest structure for First Nations to use is simply the unincorporated First Nation itself: while presenting problems of liability, fiduciary duty, legal capacity, and deficits of legal personhood, it has the advantage of always having the income tax exemption in ITA s 149(1)(c) available to it. Because this will inevitably be impractical, the “second simplest solution,” he writes, is a “society mirroring the First Nation.” He writes

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that “[a] society can be a corporate mirror of a First Nation, removing all the legal uncertainties related to a First Nation and providing the flexibility to meet the needs of the community and third parties.”50 Although it is true that there are advantages to using non-profit societies or non-share capital corporations to give expression to legal personhood, the use of such structures may not address all issues facing a First Nation that is trying to plan for its specific circumstances. Further, in principle, is it possible for the legal mechanisms of Canadian corporate law to properly mirror or express traditional forms of governance that may date back hundreds of years prior to that law? We will have occasion to return to the question of the extent to which a corporate entity can mirror the realities of First Nation political or economic practices, but for now just consider the following: to the extent that the legislation that governs the structure and procedures of corporate bodies may diverge from First Nation traditional practices of governing or procuring their livelihood, is it possible that such divergence is at odds with the right of that First Nation to self-government protected under s 35 of the Constitution Act, 1982, and if so, would it not render that law inapplicable? The problem of the “corporation as a mirror” of the social structure of First Nation’s economic or political practices is not as simple as it might seem. Another important consideration in choosing the appropriate structure for First Nation ventures involves the specific individuals who will be involved, the relationship between the leaders of the political unit and the business, and whether the relationship of an owner of shares to a manager will make sense. Unless questions concerning share ownership and management are addressed, there will be risks that First Nations that wish to control the operation and affairs of their business ventures end up acting as de facto directors or managers. As we have covered the kinds and attributes of many of the most prominent forms of business organization in Chapters 1 and 2, below we will only list some of them with brief commentary on their specific uses by Indigenous peoples and First Nations.

1.  Joint Ventures Previously joint ventures were an exceedingly common way for First Nations to pursue ventures with industry proponents. Essentially nothing more than a contract, a joint venture is not a legal person or entity known to law. It is intended mostly to protect against certain forms of liability and clarity about profit and loss attribution by virtue of setting out the specific obligations of each party, as well as the consideration they each bring to the venture and expect to receive from it. The most significant risk with pursuing a joint venture is that it can be deemed to be a partnership if the agreement looks to be a business venture pursued in common with a view to a profit. Care must be taken in drafting to ensure that the parties are not agents for each other.

50 Merrill Shepard & Marie Sophie Poulin, “Structuring for the Tax Exemption” in J Reynolds, ed, Managing Aboriginal Community Assets (Vancouver: Continuing Legal Education Society of British Columbia, 2002) at 6.1.9.

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2.  Partnerships/Limited Partnerships Partnerships are employed when the First Nation contributes much to the relationship, and are also often used when a number of First Nations work together in pursuit of a venture. The limited partnership is the most common form of business structure used by First Nations in Canada today. When structured properly, limited partnerships provide the benefit of civil liability protection and income tax exemption. Limited partnerships have been used successfully by First Nations across Canada to structure wholly owned ventures, but also as a way to participate with industrial business partners with expertise. In general, the industrial business partner will serve as the general partner of the limited partnership (to manage the day-to-day operations), and the two limited partners will be one business organization owned by the industrial partner and the First Nation or a First Nation – owned entity. This structure allows the First Nation to limit its civil liability exposure (often required by a First Nation’s Financial Administration Law), and to ensure all of the First Nation’s income from the enterprise is tax-exempt.51 The income that the First Nation receives as limited partner is exempt by virtue of s 149(1)(c) of the ITA.52 Last, the limited liability partnership (where legislatively available) is becoming more popular because of the way it (1) apportions profits so as to provide income tax exemptions for First Nations pursuant to ITA s 149(1)(c); (2) apportions civil liability such that the First Nation is not at risk; and (3) provides the additional benefit of apportioning certain kinds of operating expenses that are attributable to proportionate ownership of the partnership’s assets (more of which is covered below).

3. Corporations Section 87 of the Indian Act does not apply to corporations. However, s 149(1)(d.5) of the ITA exempts income of corporations that are owned by a First Nation and that conduct 90 percent of their business activities on reserve or settlement lands.

4. Trusts The common law does not recognize trusts as legal persons, and instead sees the relationship between the parties as a fiduciary one. However, under the ITA many kinds of trusts are deemed to be individuals for taxation purposes, and First Nations often use trusts as a form of effective tax planning. For example, it is common for First Nations to place any settlement or other compensation funds they receive into a “reversionary trust” whereby the income on trust property is taxed in the hands of the First Nation qua settlor by virtue of the attribution rule in s 75(2). Other First Nations arrange for shares of their corporations, limited partnership units, or other investments or corporate holdings to be held in a reversionary trust in

51 Because a limited partner is taxed on its share of the taxable income (under ITA s 96(1)), the exemption only applies to the First Nation’s share of the partnership set out in the limited partnership agreement. 52 There are other methods of obtaining tax exemption under ITA s 149 that do not include the First Nation becoming the limited partner of a limited partnership, such as inserting a society as the limited partner and creating a trust between the society and the First Nation. However, this structure is beyond the scope of this chapter.

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order to keep streams of revenue accounted for separately and to use as a kind of sovereign wealth fund.

5.  Co-operatives and Non-Profit Societies Like corporations, co-operatives and non-profit societies are very flexible corporate forms that confer legal personhood and liability protection. They are also very useful for bridging the divide between political activity and economic participation, as the goals, aims, and activities of non-profit societies can be crafted to capture a wide variety of aims. That said, the corporation is also flexible enough to have purposes beyond profit. In the following case, the court had the opportunity to consider the multitude of issues that converge when a First Nation decides to utilize the flexibility of a corporate structure to pursue the general economic welfare of its people instead of for the discrete and personal uses to which corporate bodies are ordinarily put. Justice Walsh gives careful consideration to this flexibility.

Gull Bay Development Corp v The Queen [1983] FCJ No 1133, [1984] 1 CNLR 74, [1984] 2 FC 3 WALSH J:

[1]  Plaintiff in these proceedings is a corporation incorporated by Province of Ontario Letters Patent on February 28, 1974, as a corporation without share capital having its head office on the Gull Bay Indian Reserve (No 55), at Gull Bay, Ontario, a reserve of some 16 square miles on the west shore of Lake Nipigon some 120 miles north of Thunder Bay. The Letters Patent of the corporation provide that the objects of the corporation include: To promote the economic and social welfare of persons of native origin who are members of the Gull Bay Indian Reserve (No 55) and to provide support for recognized benevolent and charitable enterprises, federations, agencies and societies engaged in assisting the development, both economic and social, of native people who are members of the Gull Bay Indian Reserve (No 55).

[2]  They further provide that the corporation may hire employees, maintain offices, and incur reasonable expenses in connection with its objects, that the corporation shall be carried on without purpose of gain for members and that any profits or other accretion to the corporation will be used in promoting its objects. It is further provided that the directors shall serve without remuneration and no director shall directly or indirectly receive any profit from his position, provided only that he may be paid reasonable expenses incurred by him in the performance of his duties. In the event of dissolution of the corporation all remaining property is to be distributed or disposed of to incorporated native peoples’ organizations in Ontario. [3]  Plaintiff contends that it has from its inception been involved in working for the social and economic development of the Gull Bay Indian Reserve and its members and in the improvement of the social and economic conditions of the members of the Band living there, which activities include the establishment of a viable commercial logging operation to provide employment for members of the Reserve, the training of Indian

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students from the Reserve to work both as loggers and as managers in the office facilities, the carrying out of maintenance work on the recreational and administrative buildings and facilities on the Reserve, providing funds to Reserve programmes established to give food, clothing and other necessities to needy members of the Gull Bay Indian Reserve, providing funds for travel expenses for school age children on the Reserve to enable them to take educational excursions that the school from time to time determines to be beneficial, providing of other assistance activities on the Reserve determined to be beneficial to the social and economic welfare of the members of the Reserve, and that it was therefore a non-profit organization within the meaning of that term as defined in paragraph 149(1)(l) of the Income Tax Act. [4]  While a further argument was raised at trial based on paragraph 149(1)(d) of the Income Tax Act to the effect that the members and directors of plaintiff are members of the Band Council which controls plaintiff and that the Band Council carries out the functions of municipal government on the Reserve, so that plaintiff is a municipal corporation, this was rejected by the Court at the trial. •  •  •

Paragraph 149(1)(l) reads as follows: 149.(1)  No tax is payable under this Part upon the taxable income of a person for a period when that person was •  •  •

(l)  a club, society or association organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit, no part of the income of which was payable to, or was otherwise available for the personal benefit of, any proprietor, member or shareholder thereof unless the proprietor, member or shareholder was a club, society or association the primary purpose and function of which was the promotion of amateur athletics in Canada.

[5]  On June 14, 1977 plaintiff was assessed for corporate income tax for the year 1975 in the amount of $3272.40 A notice of objection was made but plaintiff sent notice of confirmation. This action is an appeal from the assessment. [6]  Defendant contends that in its 1975 taxation year plaintiff carried out with a view to profit a logging business from which it earned a profit of at least $23,538, taking the position that plaintiff was not exempt from tax as it was not a non-profit organization within the meaning of paragraph 149(1)(l) of the Act nor a municipal corporation within the meaning of paragraph 149(1)(d) of the Act and that Plaintiff is not an organization described by subsection 149(1) of the Act. [7]  While the issue is a clearly defined one, the extensive jurisprudence to which the Court was referred by both parties indicates that it is very controversial and to a considerable extent depends on the facts of each case so that it was necessary to introduce considerable factual evidence. •  •  •

[8]  Chief Tim Esquega testified that he has lived on the Reserve all his life and has seven children. There are 323 people in all on the Reserve. Since 1962 he has worked as a caretaker employed by the Department of Indian Affairs and was elected Chief of the Band from 1972 to 1978 and again since 1980, as such being a member of the Band Council which administers the funds provided by the Department of Indian Affairs. The

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only work which could be done on the Reserve prior to the formation of the Gull Bay Development Corporation was some commercial fishing and trapping which is very poor and some seasonal work in firefighting. By 1972 membership on the Reserve was depleting and alcohol, vandalism and rape were prevalent. The Hudson Bay store in the community moved away as did the teachers. A few members of the Band worked outside the community in logging operations. The community had acquired a bad reputation so that the Government was taking the core funding back and administering it themselves. As Chief in 1972 he wanted to create some work in the community. He had helpful advice from John Blair, a professor at Lakehead University, who was working on a contract basis with other bands giving them advice on underbrushing and other forestry operations. The corporation was formed as a vehicle to provide employment. [9]  When questioned by the Court as to why the Band itself could not have carried on the lumbering operation he said that this would not be feasible because of the many social problems. The Government money was slow to come in. The by-laws of the corporation provided for nine directors, of whom the Chief and all three councillors of the Gull Bay Indian Reserve would hold office ex-officio. [10]  … The corporation had approximately 25 employees and initiated logging operations and gave work of a social nature, cleaning up the community, cutting wood for elderly residents, moving unsightly abandoned cars, moving a garbage dump which was not objectionable on windy days, making hockey rinks, improving the fencing around the cemetery, and painting old buildings. Younger women were engaged to help older ones who could not do washing for themselves. Some members were taken on tours of the logging operation to show them how the work was done. A generating system was built as there were frequent power failures and fuel was sometimes bought for persons on the Reserve who could not afford it … •  •  •

No directors were ever paid anything as such, but one who worked as a foreman in the logging operation was paid for this and another one was paid for looking after the office books. There are now about 72 employees of the corporation, some 49 engaged in logging and 22 others engaged in other activities paid by the Band. [11]  He testified that the head office of the corporation is in a building owned by the Band and the corporation pays for a share of the rent and heating. The logging contract from Northern Wood Preservers which was negotiated by Mr Blair and the Council is a standard contract given to all logging operators. •  •  •

[14]  Before setting up the corporation several community meetings were held. While it was enthusiastically received some concern was expressed by the trappers and guides who worked during the hunting and fishing season as to the damage which would be caused to the environment and wildlife by the logging operation. Moose hunting supplied a major source of food for the Band. He concluded that the logging must not be done in a conventional manner by large clear cuts but rather it was done by what might be described as a checker board pattern, areas of about six acres being cut with adjacent areas of similar size being left untouched. Cutting rights for the area in question belong to Northern Wood Preservers (Saskatchewan) Limited and an agreement was entered into with them to permit plaintiff to do the logging and sell the wood to Northern Wood Preservers at a price fixed by the agreement. …

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[15]  With respect to the argument based on paragraph 149(1)(l) of the Act plaintiff contends that the primary motive for setting up the corporation was to deal with problems on the Reserve and to create activity to raise funds to use for these purposes. The members (i.e., directors) were not themselves in a position to get any benefit from the corporation. •  •  •

[18]  In a recent Supreme Court case of the The Regional Assessment Commissioner et al v. Caisse Populaire de Hearst Limitée, a judgment pronounced on February 3, 1983, the issue was not income tax but the liability of the respondent credit union for assessment under the Assessment Act of Ontario for land it occupied and used in connection with its operation. At 9 of the typewritten copy of the decision McIntyre, J states: The preponderant purpose test is based upon a determination of the purpose for which an activity is carried on. If the preponderant purpose is the making of a profit, then the activity may be classified as a business. However, if there is another preponderant purpose to which any profit earned is merely incidental, then it will not be classified as a business.

At 18 he states: Many community and charitable organizations, relying from time to time on what would be termed commercial activity to raise funds for the fulfilment of their objectives, could be classed as businesses by such a test. To attach primary importance to the commercial aspect of an operation in question will offer, in my opinion, no sure or helpful guide. In my view, the commercial activity test is too indefinite to allow consistent application. I agree that, in deciding whether or not any activity may be classed as a business under the provisions of s 7(1)(b) of the Assessment Act, all relevant factors regarding an operation must be considered and weighed. However, they must be considered and weighed in order to determine not whether in some general sense the operation is of a commercial nature or has certain commercial attributes, but whether it has as its preponderant purpose the making of a profit. If it has, it is a business; if it has not, it is not a business.

[19]  Defendant would distinguish this case since plaintiff in the present case did actually receive the profits from the lumbering operations. Plaintiff concedes that if a company makes profits from a commercial operation it cannot avoid taxation on them by turning them all over to charity. There are limits to the charitable donations which a commercial corporation can make. However in the present case the corporation was not merely turning the profits over to someone else but was itself actively engaged in social objectives for which it was formed. In fact perhaps more than 50 per cent of the time of its actual employees was spent on these activities. [20]  Certainly plaintiff although incorporated for charitable purposes with a provision that none of its income was payable for the personal benefit of any member could nevertheless not claim exemption under paragraph 149(1)(g) since that subsection has a further requirement that the corporation must not carry on any business. For this reason plaintiff does not invoke paragraph 149(1)(g), but rather paragraph 149(1)(f) which deals with “charitable organizations” rather than “non-profit corporation” under paragraph 149(1)(g). In the St Catharines Flying Club case, (supra), Thorson, J had held that the word “association” is broad enough to include an incorporated company. •  •  •

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[23]  The same comment also applies in the case of Woodward’s Pension Society v Minister of National Revenue, [1959] C.T.C. 399, 59 D.T.C. 1253, in which the sole business of appellant, a non-profit organization was to acquire shares of the operating companies of Woodwards and sell them to employees, surplus funds going from time to time to appointed pension trustees to provide funds for payment of pensions. Thorson, P accepted the argument that exempting provisions of the taxing Statute must be applied strictly referring to the case of Lumbers v Minister of National Revenue, [1943] Ex. C.R. 202, [1943] C.T.C. 281, 2 D.T.C. 631. At 1260 he states: The section presupposes that if a club, society or association is to be exempt from tax under it it should be organized and operated exclusively for a purpose “except profit,” that is to say, for a purpose other than a profit one. That necessary condition does not exist in the present case.

and again on the same page: … The raising of money was its basic purpose and for that purpose, namely, the raising of money, it was directed to deal in shares of the various Woodward companies by acquiring and selling them and it was intended that its dealings should result in the raising of money so that it could provide the necessary monetary assistance to the pension trustees. Thus the purpose of the appellant’s actual organization was a profit one. It was certainly not organized for a purpose “except profit” within the meaning of the term “any other purpose except profit.”

The facts are clearly different in the present case, for the raising of money was not the basic purpose of the corporation, and its charter makes no reference to logging operations. [24]  Defendant points out that paragraph 149(1)(f) requires that the club, society, or association must be organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit. He refers to the case of British Launderers’ Research Association v. Central Middlesex Assessment Committee and Hendon Rating Authority, [1949] 1 All E.R. 21, in which Lord Denning stated at 23: There is one thing which is clear both on the wording of the statute and on the cases. The words “exclusively” must be given its full effect. It is not sufficient that the society should be instituted “mainly” or “primarily” or “chiefly” for the purposes of science, literature, or the fine arts. It must be instituted “exclusively” for those purposes.

In the Hutterian Brethren Church case, (supra), Ryan, J stated at 5478: I am satisfied, however, that the correct analysis of the evidence in this case is that the business purpose of the corporation was not merely an aspect of a single overriding religious purpose. The corporation had a business as well as a religious objection—farming on a commercial basis—and activity which was pursued on a large scale and pursued profitably. The motivation of the individuals who farmed may well have been religious. But the farming itself was conducted by the corporation as a business. The business profits were not, of course, available as such to the members of the corporation. They were, however, available for the future use of the corporation in the pursuit of its objectives, religious and commercial. In these circumstances, it can hardly be said that all of the resources of the corporation were

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devoted to charitable activities carried on by it, even assuming that its religious objects were for legal purposes charitable.

There is no doubt that in the present case the logging operations of plaintiff were extensive and provided considerable revenue much of which is still held in surplus, so these remarks may well be apt, but, as has been pointed out previously the farming operation was part of the objects set out in the memorandum of association of the church, while in the present case the letters patent make no reference to any business operations whatsoever. I believe that this is a substantial distinction. [25]  During the course of argument there was a generalized discussion as to the manner in which the Department deals with activities such as the sale of Christmas greeting cards and calendars by UNICEF or apples, candy bars, Christmas cakes and Christmas trees by organizations such as Rotary and Kiwanis clubs to raise funds for their welfare activities, and it was generally conceded that it is unlikely that tax would be claimed on the profits derived therefrom, although such operations are frequently quite substantial in nature and frequently competitive with businesses carrying on the same commercial activity. [26]  The real issue in the present case appears to be that the corporation was not set up, as its letters patent indicate, to carry on a commercial activity although it is no doubt true that the motive for forming the corporation may have been that it was desirable to provide employment and training to otherwise unemployed Indians on the Reserve by engaging in a commercial activity which would not only provide such employment but raise funds to be used for the very worthy social and charitable activities required on the Reserve. However, it was more efficient to carry on this activity through a corporation than to have the Band Council attempt to do it itself. Elections from time to time change the membership of the Band Council and different factions in the Band have different objectives, and while even the corporation was not immune from this, as appears from what happened during the brief period when Chief Esquega was replaced by another Chief and his associates, it was nevertheless more practical to operate as a corporation and negotiate as such with the company for whom the lumber was being cut. If this lumbering operation had been carried out by the Band Council itself it is unlikely that any attempt would have been made to tax the profits of the enterprise. It is certainly the policy of the Department of Indian Affairs to encourage Indian Bands to become selfreliant and to improve living and social conditions on the Reserves, and there is no doubt from the evidence in this case that a great deal has been accomplished in improving living conditions on the Reserve by the work done by employees of the Corporation with funds derived from the lumbering operations, and in providing gainful employment for members of the Band who would otherwise be on welfare. [27]  I do not believe that because a corporation was formed for these purposes this should alter the liability for income tax. [28]  The social and welfare activities of plaintiff are not a cloak to avoid payment of taxation on a commercial enterprise but are the real objectives of the Corporation. [29]  While the jurisprudence in this difficult area has led to varying results, depending on the facts applicable in each case. I have concluded that in the present case, whether by the application of paragraph 149(1)(f) or of paragraph 149(1)(l) plaintiff ’s appeal should be maintained. The Corporation is operated “exclusively” for the purpose set out in

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paragraph 149(1)(l) pursuant to its charter, even though it may raise funds for this purpose by its commercial lumbering enterprise. Walsh J—Order accordingly. NOTES AND QUESTIONS

1.  Recalling Merrill Shepard’s suggestion that one option might be to have a corporate entity “mirror” the First Nation, does the corporate entity described in Gull Bay Development Corp seem to reflect the First Nation? In what ways? And in what ways must it diverge? 2.  Imagine a situation in which a tribal council had traditionally governed over a number of geographically contiguous and related bands since time immemorial. Further, imagine that the tribal council had been advised by legal counsel to incorporate a society that would reflect this governance structure so that it could feasibly qualify for the exemption under s 149(1)(c). Do you think this is a prudent idea? Why or why not? What are the advantages and disadvantages of doing so?

VI.  STRUCTURING ISSUES: LIMITED PARTNERSHIPS A.  Names, “Holding Out As,” and Holding Assets: General Partners and Limited Partners As we saw in Chapter 2, limited partnerships are creatures of statute, and for their existence they depend upon certification by a provincial authority. Typically, a limited partnership has one or more general partners, and one or more limited partners—and a general partner can also be a limited partner so long as the form and function of the partnership agreement accords with the provincial statute. Limited partners are “silent partners” that are liable up to the value of their contribution to the partnership, even though they often stand to realize much more than that contribution. A key feature of limited partnerships, however, is that the limited partner is not an agent for the other partners and thus has no statutory authority to bind them. If a limited partner holds itself out as a partner or as able to bind the partnership, then the law will deem it to be a general partner, and it will have unlimited liability. The general partner, by contrast, is the active partner in the firm, and has the authority to represent and bind the partnership, and, as we will also see, to hold the assets of the limited partnership and on behalf of the limited partnership as well. As we saw in Chapter 2, limited partnerships are governed by provincial or territorial legislation. In general, a limited partner cannot have its name featured in the name of the partnership so as to ensure that no one thinks that the limited partner is an agent of the partnership. Further, a limited partner that takes part in the affairs of the business will lose its liability protection, and in the case of First Nations, will lose the benefits of the applicable tax exemption. Recall that there are subtle differences between the various provincial and territorial regimes, but in general all jurisdictions prohibit the involvement of limited partners in the control or management of the business. In Chapter 2 we also

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learned of the two principal cases on the question of a limited partner’s involvement in a partnership: Haughton Graphic Ltd v Zivot, [1986] OJ No 288, 33 BLR 125 (H Ct J) and Nordile Holdings Ltd v Breckenridge (1992), 66 BCLR (2d) 183 (CA). These cases both turned on the questions of whether the limited partners were involved in the business, and whether they held themselves out as agents of the partnership. For First Nation businesses that employ limited partnerships, this distinction is perhaps the most important legal principle to grasp because First Nations can receive income as limited partners on a tax-exempt basis and be shielded from liability so long as they do not take part in the management or affairs of the limited partnership. As we have seen, it is often desirable for First Nations to be involved—so lawyers need to be clear with instructions and creative in using business structures to ensure that First Nation interests are protected and given voice without attracting liability or eliminating the benefit of the exemption from tax under s 149(1)(c) of the ITA. The principle upon which the prohibition on naming a limited partnership after one of its limited partners stems is from agency law, and specifically with respect to the authority of any partner to bind the other partners by holding itself out as a partner with that authority. Often a First Nation will structure its economic activity using a limited partnership in which the First Nation is the limited partner as well as the 100 percent shareholder of the general partner, a corporation incorporated by the First Nation to operate and manage the limited partnership. Because of the importance of maintaining liability protection, and the statutory requirements prohibiting limited partners from participating in management of a limited partnership, it becomes crucial that the First Nation either does not take part in the management of the general partner, or if it does, ensures that it implements the use of a limited partner that is not controlled or managed by the First Nation. A First Nation cannot maintain control of the general partner and the limited partner simultaneously. Because the general partner in a limited partnership has the authority to enter agreements and take steps to bind the partnership, it is often the case that limited partnership agreements confer wide authority and discretion upon the general partner. One recent set of issues that has sprung up regarding this authority of the general partner, one that has definite effects for First Nations that use limited partnership structures, involves whether the general partner is routinely invested with the authority to possess and hold all the assets of the limited partnership. If so, it may mean that sales tax on purchases by the limited partnership cannot be allocated to limited partners. 53 For First Nations that enjoy an exemption from sales tax for goods that are purchased on or delivered to a reserve, this new jurisprudence on agency law will be quite compelling. Consider the following two cases in light of the authority that a general partner seems to be possessed of under provincial legislation.

53 For example, in 2013, the British Columbia Ministry of Finance issued Provincial Sales Tax Bulletin 319 (Victoria, December 2013). The bulletin essentially confirmed that it would take on the legal interpretation of the new case law, such that if a partnership is composed of a band as a limited partner, owning a 99 percent interest, and a band-owned corporation as the general partner, owning a 1 percent interest, the transactions of the partnership will not be exempt from transaction taxes.

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Edenvale Restoration Specialists Ltd v British Columbia (Finance) 2013 BCCA 85 Tysoe JA: Introduction [1]  At issue on this appeal is the extent to which sales tax under the Social Service Tax Act, R.S.B.C. 1996, c. 431, (the “Tax Act”) was payable in respect of a sale of tangible personal property from a vendor to a limited partnership which paid the purchase price, in part, by issuing the vendor units in the limited partnership representing 15% of the total units in the limited partnership. [2]  The vendor, which is bound by the legislation to collect the tax, says that, on the basis of the decision in Seven Mile Dam Contractors v. British Columbia (1979), 104 D.L.R. (3d) 274, 13 B.C.L.R. 137 (S.C.), aff’d (1980), 116 D.L.R. (3d) 398, 25 B.C.L.R. 183 (C.A.), the tax is only payable on 85% of the transferred property. The Crown says that under the wording of the legislation, the tax is payable on 100% of the value of the transferred property. [3] In Seven Mile Dam Contractors, one partnership, consisting of two companies, sold property to a second general partnership, of which the vendors were two of the four partners. This Court affirmed the decision of the chambers judge that sales tax was payable on one-half the value of the transferred property only because, under general partnership law, the assets of the partnership are owned by the partners. Therefore, the two vendors retained an ownership interest in one-half of the property and tax was only payable in respect of the other one-half interest transferred to the other two partners of the purchasing partnership. [4]  Here, the vendor, Edenvale Restoration Specialists Ltd. (“Edenvale”), was assessed sales tax on the full value of the transferred tangible personal property. Edenvale appealed the assessment to the Minister of Finance, who affirmed the assessment. Edenvale appealed the Minister’s decision to the Supreme Court of British Columbia by way of petition. In reasons for judgment indexed as 2011 BCSC 1748 (CanLII), the chambers judge held that the reasoning in Seven Mile Dam Contractors applied to a sale to a limited partnership as well as a sale to a general partnership. He allowed the appeal and ordered that sales tax was payable on only 85% of the value of the transferred property. The Crown now appeals this determination. Background [5]  By an agreement dated January 10, 2007, Edenvale sold certain assets to “EW Emergency Restoration L.P.,” which is the name of a limited partnership formed under the laws of Ontario (the “Limited Partnership”). The Limited Partnership was shown as the buyer in the agreement. The agreement was executed on behalf of the Limited Partnership by its general partner, 2123125 Ontario Inc. (the “General Partner”). [6]  The purchase price under the agreement was $35 million plus the assumption of certain liabilities. The purchase price was payable by the issuance of a specified number of units in the Limited Partnership, a certain amount of cash and a promissory note in the amount of $25,925,000. The units issued to Edenvale equalled 15% of the outstanding units in the Limited Partnership.

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[7]  Under the agreement, the parties allocated the purchase price among the various categories of the purchased assets. An aggregate of $1,637,000 was allocated to tangible personal property, which included restoration equipment and furniture, vehicles, application software and tools, and computer hardware. The sale took place in British Columbia, and tax was payable under the Tax Act in respect of the tangible personal property. Edenvale paid tax on the full amount of the value of the vehicles ($292,000) that were sold (presumably to ensure that the vehicles would be insured), but only paid tax on 85% of the balance of the value of the tangible personal property ($1,345,000). [8]  Limited partnerships are a creation of statute. In Ontario, the jurisdiction in which the Limited Partnership was formed, limited partnerships are governed by the Limited Partnerships Act, R.S.O. 1990, c. L.16 (the “Ontario Act”). In British Columbia, a jurisdiction in which the Limited Partnership began carrying on business after the acquisition of the assets from Edenvale, limited partnerships are governed by Part 3 of the Partnership Act, R.S.B.C. 1996, c. 348 (the “B.C. Act”). Section 80 of the B.C. Act provides that a limited partnership formed outside of British Columbia may carry on business in the Province if it is registered under the B.C. Act and that registered limited partnerships are subject to the same duties, restrictions, penalties and liabilities as are imposed on a limited partnership formed under the B.C. Act. [9]  The purpose of limited partnerships is to allow persons to make equity investments in a limited partnership without becoming jointly and severally liable for all of the obligations of the limited partnership, as is the case for partners in a general partnership. Limited partnerships are comparable to corporations, which have limited liability and do not expose their shareholders to obligations incurred by the corporation. As the partners of a partnership are jointly and severally liable at common law, the protection of limited liability is given by legislation. In order to be afforded the protection, the legislation requires that limited partners must cede control of the business of the limited partnership to a general partner, which is liable for all of the obligations of the limited partnership and which has all the rights and power of a partner in a general partnership subject to certain limitations specified in s. 8 of the Ontario Act and s. 56 of the B.C. Act. [10]  The Ontario Act and Part 3 of the B.C. Act contain roughly the same provisions. Section 9 of the Ontario Act provides that, subject to the Act, a limited partner is not liable for the obligations of the limited partnership except for contributions they have agreed to make, and s. 13(1) states that, “A limited partner is not liable as a general partner unless … the limited partner takes part in the control of the business.” Section 57 of the B.C. Act is similar to s. 9 of the Ontario Act, and s. 64 of the B.C. Act states that, “A limited partner is not liable as a general partner unless he or she takes part in the management of the business.” •  •  •

[12]  The affairs of limited partnerships are typically governed by a partnership agreement between the limited partners and the general partners. They are usually drafted in such a fashion to preserve the limited liability of the limited partners. In the present case, the partnership agreement for the Limited Partnership is a sophisticated document consisting of 48 pages plus schedules, amended and restated January 31, 2007 (the “Partnership Agreement”). Section 4.1  Management of the Limited Partnership.

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(2)  The Limited Partner in its status as such, shall not have the right to take part in the management or control of the business of the Limited Partnership or to act for or bind the Limited Partnership or otherwise to transact any business on behalf of the Limited Partnership. •  •  •

Section 4.3  Limited Liability of Limited Partners. Subject to the provisions of the Act or other applicable Laws, each of the Limited Partners shall have no liability whatsoever in its capacity as a limited partner, whether to the Limited Partnership, to the General Partner, to creditors of the Limited Partnership or to any other Person, for debts, liabilities, contracts or other obligations of the Limited Partnership, for any losses of the Limited Partners or otherwise in respect of the Limited Partnership … •  •  •

Section 4.5  Powers of General Partner. Without limiting the generality of Section 4.1, but subject to the other terms of this Agreement, the General Partner shall have the right, power and authority for and on behalf of and in the name of the Limited Partnership to: (a)  acquire, manage, administer and sell or otherwise dispose of any and all properties or assets of the Limited Partnership, both moveable and immovable, real and personal; •  •  •

(m)  do anything that is in furtherance of or is incidental to the business of the Limited Partnership … •  •  •

(Emphasis added.)

The Tax Legislation [13]  Under ss. 5 and 6 of the Tax Act in effect at the time of the transaction, a tax in the amount of 7% of the purchase price of the tangible personal property was payable by the purchaser at the time of the purchase of such property. The term “purchase” is not defined in the Tax Act, but there are definitions of the terms “sale” and “purchaser,” and there is also a definition of the word “use” which is contained in the definition of “purchaser.” [14]  The relevant portions of these definitions are as follows: “sale” includes (a)  a conditional sale, a transfer of title or possession, conditional or otherwise, a sale on credit or for which the price is payable by installments, an exchange, barter or any other contract by which, at a price or other consideration, a person delivers tangible personal property to another person … •  •  •

“purchaser” means (a)  a person who acquires tangible personal property at a sale in British Columbia (i)  for the person’s own consumption or use, (ii)  for consumption or use by another person at the expense of the person acquiring the property, or

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VI.  Structuring Issues: Limited Partnerships (iii)  on behalf of or as agent for a principal, if the property is for consumption or use by the principal or by another person at the expense of that principal … •  •  •

“use” includes (a)  the exercise of any right or power over tangible personal property incidental to the ownership of it other than the sale of the property …

Decision of the Chambers Judge •  •  •

[17]  The [chambers] judge then discussed whether the result would be different in the case of a limited partnership and he stated that the “question which arises is whether limited partners also have the same interest in the partnership property” (para. 27). [T] he judge said the following: [34]  The limited partners here have a beneficial interest in the property of the partnership held by EWLP. EWLP acts on behalf of the limited partners. The general partner is the agent for the limited partners. Pursuant to the Act, the general partner here is a “purchaser,” as it is acquiring tangible personal property “on behalf of or as agents for a principal.” Each limited partner has an undivided interest in the partnership property, and carries on the business of the partnership through its agent, the general partner.

[18]  The [chambers] judge then reasoned that nothing in the B.C. Act displaces the principle that the limited partners have a beneficial interest in the partnership property and that, despite the fact that the general partner received legal title to the property, Edenvale only transferred an 85% interest in the property because the general partner was acting as agent and trustee for the limited partners (paras. 35-38). In the result, Edenvale was only obliged to collect sales tax on 85% of the value of the property. Discussion •  •  •

[20]  … I note that in the case of the Limited Partnership in the present case, the limited partners do not have the ability to act in concert to sell a partnership asset. Only the General Partner or a liquidator has the ability under the Partnership Agreement to sell partnership assets. [24]  The more important point, however, is that the judge then stated that the general partner was a “purchaser” under the Tax Act, as it acquired the property “on behalf of or as agent for a principal.” Despite reaching this conclusion, the judge went on to hold that tax was payable on 85% of the value of the property only because the limited partners had a beneficial interest in the property. [25]  In my opinion, the judge erred in his approach by failing to apply the wording of the Tax Act and the provisions of the Partnership Agreement. Unlike a sale of property to a general partnership (of which the vendor is one of the partners), it is my view that nothing turns on whether the limited partners have an ownership interest in the partnership property. … [26]  In contrast, in the case at bar, the partners were not the purchasers of the property because s. 4.3 of the Partnership Agreement limited their ability to be involved in the

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business of the Limited Partnership and s. 4.5 of the Partnership Agreement gave the General Partner the right to acquire assets for the business of the Limited Partnership. [27]  In para. 34 of his reasons, the chambers judge correctly concluded that the General Partner was the purchaser of the property. The General Partner was a “purchaser” within the meaning of the definition in the Tax Act because it acquired the property “on behalf of or as agent for a principal” and the property was intended to be used by “the principal or by another person at the expense of that principal.” Under s. 4.5 of the Partnership Agreement, the General Partner was given the right to manage and administer all properties of the Limited Partnership and s. 4.8 of the Partnership Agreement provided that the General Partner was to be reimbursed for all costs and expenses incurred by it. The right given to the General Partner under s. 4.5 falls with the definition of “use” in the Tax Act. The transaction was a sale to the General Partner under the definition of “sale” in the Tax Act because the January 10, 2007 agreement was a “contract by which, at a price or other consideration, a person delivers tangible personal property to another person” (i.e., the General Partner). [28]  As a result, the General Partner was required under ss. 5 and 6 of the Tax Act to pay tax in the amount of 7% of the purchase price of the tangible personal property. The portion of the purchase price allocated to the tangible personal property under the January 10, 2007 agreement was $1,637,000. There is nothing in the agreement indicating that the General Partner was purchasing less than 100% of the tangible property from Edenvale. The General Partner was required to pay tax on 100% of the purchase price of the tangible property because it had not previously owned any interest in the property. Edenvale was required to collect and remit the tax the General Partner was liable to pay. [30]  I would allow the appeal, set aside the order of the chambers judge and reinstate the assessment affirmed by the Minister of Finance. Appeal allowed.

R v Tron Power Inc (Tron Power Limited Partnership) 2013 SKQB 179 DANYLIUK J:

[1]  This is an appeal by Tron Power Inc. (“Tron”) regarding a provincial sales tax (“PST”) assessment made against it by Her Majesty the Queen, Saskatchewan, as represented by the Ministry of Finance (“Saskatchewan Finance”), that assessment having been upheld by the Board of Revenue Commissioners for Saskatchewan. Tron argues that as a First Nation business entity, it should have been exempt from PST. Saskatchewan Finance argues that as the entity in question was a corporation, PST was payable. Facts [2]  These issues arise from the business dealings of a Saskatchewan First Nation. English River First Nation is a recognized band as is defined by s. 2(1) of the Indian Act,

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R.S.C. 1985, c. I-5. While the primary lands and the head office of English River First Nation are located at Patuanak, Saskatchewan, the band has reserve land in a number of locations in this province. One of those locations is Grasswood, just outside of Saskatoon. That land has been designated as the English River First Nation Grasswoods Reserve 192J (the “Grasswoods Reserve”). [3]  The council of English River First Nation caused to be incorporated Des Nedhe Development Inc. (“Des Nedhe”). Its offices are located at the Grasswoods Reserve. Its mandate is to conduct economic and social initiatives and enterprises. English River First Nation is the sole shareholder of Des Nedhe. All of Des Nedhe’s directors are members of English River First Nation. [4]  The appellant Tron is also a corporation with offices located at the Grasswoods Reserve. Des Nedhe owns all the shares of Tron. In turn, of course, English River First Nation owns all of Des Nedhe’s shares. Similarly, all of Tron’s directors are members of English River First Nation. [5]  There is another entity that is important to this matter, being Tron Power Limited Partnership (“the Partnership”). It is a limited partnership created under The Partnership Act, R.S.S. 1978, c. P-3. Its offices are at the Grasswoods Reserve. Its business is stated to be “management of economic development.” [6]  A limited partnership is legally obligated to have a general partner. Tron is the general partner of the Partnership. English River First Nation is the sole limited partner, with a 99.9% undivided interest in property of the Partnership. The partnership agreement is dated January 1, 1999, and is in evidence in this matter. The Partnership was given the rather broad mandate of managing the economic development activities of English River First Nation. In doing so, the Partnership was to train and employ First Nations persons in its various enterprises. Should the Partnership generate profit, that is transferred to English River First Nation so as to provide its members with education and skills training, health care, a community centre, youth sports initiatives, financial and health assistance to Elders, and residential and family care. [7]  As general partner, Tron has a number of duties, including buying and holding assets for the Partnership, acting as the Partnership’s agent for all business purposes, and carrying on the day-to-day operations of the business of the Partnership. •  •  •

[9]  Between January 1, 2004, and May 31, 2007, Tron purchased certain goods and took delivery of same. These goods were acquired on-reserve. It did not pay PST on those items. Its position was that the exemption from taxation allowed by s. 87 of the Indian Act applied to Tron. There is no contest between the parties that such an exemption exists; rather, the dispute is whether it applies to Tron. [After a formal audit by Saskatchewan Finance, Tron was assessed PST payable of $84,029.82.] [11]  … The position of Saskatchewan Finance remained that the recognized s. 87 Indian Act tax exemption—which applies to on-reserve purchases of goods or services by both Indians and Indian bands as those terms are defined by federal statute—does not extend to the benefit of a commercial corporation, even one wholly owned by a band. •  •  •

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[13]  The evidence called on behalf of Tron was to the effect that Tron was, at all material times, the agent for the Partnership. As general partner, there was no other reason for it to make purchases. The evidence showed that Tron purchased goods and services both on- and off-reserve. If off-reserve, PST was paid. But if the purchases were made or goods delivered on?reserve, it was felt the s. 87 tax exemption applied, and no PST was paid. •  •  •

[16]  The internal, non-public policy governing Saskatchewan Finance’s audit operations was multi-faceted. First, when dealing with limited partners, it was acknowledged that the general partner could at law be a corporation. However, it was also the position that as corporations are not generally entitled to the s. 87 tax exemption, corporations acting as general partners within limited partnerships were also not entitled to that exemption. Saskatchewan Finance did allow a tax exemption on purchases made by certain Indian-owned limited partnerships but only if the following three requirements were met: (a) all limited partners were Indians, Indian bands, or unincorporated Tribal Councils; (b) any incorporated general partner established for the purpose of carrying on the business of the limited partnership was wholly and only controlled by the Indian limited partners and limited partnership; and (c) the limited partnership cannot engage in commercial activities off-reserve. •  •  •

[19]  It appears that in developing this policy, Saskatchewan Finance held no consultations with any stakeholders. Indeed, no one was told of this policy, notably not Indian bands, more notably not the appellant. Disclosure of this policy during the hearing itself (in spite of previous requests for disclosure of same) placed the appellant in a position where it was fighting against an assessment based on a policy it had never seen. [20]  Further, it appears that at all material times the Province of Saskatchewan’s publicly-stated policy (driven by elected officials) was the encouragement of Indian bands’ and people’s development and diversification into a variety of commercial enterprises, so as to enhance the development of First Nations economic self-sufficiency. During that same time, the taxation of those same bands and peoples (in terms of PST) was governed by a secret policy (driven by non-elected officials) that Saskatchewan Finance failed to disclose to anyone affected, to and including the holding of an appeal hearing regarding such a PST assessment. [21]  That seems a remarkable way for Saskatchewan to conduct its mandate. •  •  •

Issue [24]  The issue in this appeal is: 1. Given Tron’s limited partnership arrangement with English River First Nation, did the Board err in determining that the corporation is not entitled to the benefit of the s. 87 Indian Act tax exemption?

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Analysis •  •  •

[31]  … In deciding that the general partner of this limited partnership would be a corporation instead of an individual from English River First Nation, the limited partners obtained all the benefits that corporate status bestows. That notional individual acting as general partner would be exposed to potential legal liability as a result of its commercial pursuits. Amongst other things, the corporation offered insulation from any such personal liability. Tron cannot obtain these benefits yet seek to have any potential legal or business detriments discarded. [32]  Certainly, it is clear from the evidence that Tron existed as the general partner for this limited liability partnership. But what the appellant cannot ignore, and what the Board did not ignore, was that the autonomous and independent existence of a corporation must be respected. While there are some circumstances where the corporate veil may be pierced to determine the true nature of the relationships, there is no authority cited to this Court permitting such piercing when the end objective is to obtain a financial benefit otherwise unavailable to a corporation. The mere fact that Tron buys goods and takes delivery on?reserve in its capacity as the general partner of a limited partnership does not allow Tron to shed its corporate mantle and obtain the benefits of an individual while retaining the benefits commensurate with corporate status. An individual general partner could bring with him or her the characteristics of race or ethnicity, upon which the s. 87 exemption necessarily depends. A corporation has no such characteristics. … [34]  The appellant next turns to Edenvale, supra, and relies upon the chambers decision of the British Columbia Supreme Court. That decision contained a consideration of the law relating to property owned by partnerships. The Court determined that each partner would have a pro rata share or interest in the partnership assets, in spite of each partner being individually unable to deal with such assets. Burnyeat J. also determined that this applied to limited partnerships. He found the legislature did not make a clear statement that the rules relating to limited partnerships were to be different than those relating to general partnerships, insofar as proportionate interests in partnership property were concerned. He went further, concluding that in a limited partnership the general partner holds (i.e. has title to) the property, but only as agent of that limited partnership. The beneficial interest in the property owned by the general partner was held to remain with the limited partners. [35]  Tron argued that as general partner, it was only the agent and fiduciary of the limited partner (English River First Nation) regarding any property acquired. That being so, the true nature of the ownership must be considered. Because the principal is a band within the meaning of the Indian Act, the s. 87 tax exemption must apply to purchases of such property by Tron. [36] However, Edenvale was appealed. Subsequent to argument on this appeal, the British Columbia Court of Appeal rendered its decision (on February 25, 2013). See Edenvale Restoration Specialists Ltd. v. British Columbia, 2013 BCCA 85 (CanLII), 40 B.C.L.R. (5th) 312. It overturned the chambers decision. [37]  Specifically at issue in Edenvale was whether (and to what extent) a provincial sales tax was payable on a sale of assets by a corporation to a limited partnership. It is virtually identical to the question in this case.

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[38]  The British Columbia Court of Appeal recognized that limited partnerships are unique creatures, pure creations of statute. There is a legitimate underlying purpose for limited partnerships—to allow persons to make equity investments in enterprises without becoming jointly and severally liable for the obligations of that partnership. In this sense, they are comparable to corporations. One distinction is that in exchange for this companylike protection, the limited partners give over control of the business to the general partner, who becomes liable for all of the partnership’s obligations. [39]  … When an asset is purchased for use in [a limited partnership], it is purchased and owned by the general partner. That is true irrespective of whether that general partner is corporate or individual. … [40]  In the case at bar, the agreement creating this limited partnership was before the Board and, consequently, before this court. The Tron Power Limited Partnership Agreement is Tab D.1 of the record from the Board. Article 8 thereof deals with the general partner. Section 8.1 states that the general partner has the power and authority to do certain things for the limited partnership. Section 8.1(a) states that the general partner has the power and authority to “acquire property, both real and personal, as may be necessary or desirable in the ordinary course of carrying on the business of the Partnership.” •  •  •

[44]  [The] appeal is hereby dismissed … and the decision of the Board of Revenue Commissioners for Saskatchewan affirmed. NOTES AND QUESTIONS

1.  Recall the two cases from Chapter 2 that discussed the restrictions placed on a limited partner’s involvement in the business of a partnership, and compare them to the way the limited partner is described in both Edenvale and Tron Power. What are the important differences between the way that Mr Zivot held himself out as representing the limited partnership in Haughton Graphic as opposed to the manner of Breckenridge in Nordile Holdings? What do you take to be the important lesson for limited partners everywhere? 2.  What degree of influence or control might a First Nation be able to legally have in the affairs of a limited partnership that it owns without abridging partnership law or losing its liability status? 3.  In both Edenvale and Tron Power, the respective courts held that the general partner owed tax on purchases by the limited partnership because of provisions in their respective limited partnership agreements that designated the general partner as having all the power to acquire and hold assets on behalf of the partnership. Is there some way that the partnership agreements might have been otherwise drafted? 4.  Considering the decisions of Edenvale and Tron Power, are there any ways a limited partnership might be carried on so that the sales taxes or other liabilities of the partnership could be assigned to limited partners without attracting any other liability? Would such an assignment constitute holding itself out or representing itself as a general partner? Would it constitute “taking part in the control or affairs of the business”? Why or why not? 5.  In certain circumstances where a First Nation venture will incur considerable sales tax expenses by virtue of purchases it is required to make in the course of its business, some First Nations opt to use “limited liability partnerships” (where allowed under provincial law) in order to assign some of the sales tax expenses to the First Nation as a limited partner, so that

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the First Nation can take advantage of the available tax exemptions. Is this kind of tax efficiency in conflict with any other objectives a First Nation might have in choosing the appropriate business structure?

B.  Creditor Protection Under the Indian Act As should be apparent, there is considerable ingenuity in the corporate structures used to ensure that the specific tax exemptions enjoyed by First Nation entities will apply to a wide range of transactions and economic activities. Because of the federal jurisdiction with respect to Indigenous people and First Nations, provincial legislation does not apply in some circumstances. However, provincial jurisdiction does apply generally to commerce and private affairs under ss 92(10), (11), (13), and (16) of the Constitution Act, 1867. Therefore, close attention is required when considering the affairs of Indigenous people on their lands, and what jurisdiction is applicable. Consider the following provisions of the Indian Act that govern the degrees to which the property of “Indians” and bands can be subject to provincial jurisdiction.

Indian Act RSC 1985, c I-5, ss 88-90 General provincial laws applicable to Indians 88.  Subject to the terms of any treaty and any other Act of Parliament, all laws of general application from time to time in force in any province are applicable to and in respect of Indians in the province, except to the extent that those laws are inconsistent with this Act or the First Nations Fiscal Management Act, or with any order, rule, regulation or law of a band made under those Acts, and except to the extent that those provincial laws make provision for any matter for which provision is made by or under those Acts. Restriction on mortgage, seizure, etc., of property on reserve 89(1)  Subject to this Act, the real and personal property of an Indian or a band situated on a reserve is not subject to charge, pledge, mortgage, attachment, levy, seizure, distress or execution in favour or at the instance of any person other than an Indian or a band. Exception (1.1) Notwithstanding subsection (1), a leasehold interest in designated lands is subject to charge, pledge, mortgage, attachment, levy, seizure, distress and execution. Conditional sales (2)  A person who sells to a band or a member of a band a chattel under an agreement whereby the right of property or right of possession thereto remains wholly or in part in the seller may exercise his rights under the agreement notwithstanding that the chattel is situated on a reserve.

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Property deemed situated on reserve 90(1)  For the purposes of sections 87 and 89, personal property that was (a)  purchased by Her Majesty with Indian moneys or moneys appropriated by Parliament for the use and benefit of Indians or bands, or (b)  given to Indians or to a band under a treaty or agreement between a band and Her Majesty, shall be deemed always to be situated on a reserve. Restriction on transfer (2)  Every transaction purporting to pass title to any property that is by this section deemed to be situated on a reserve, or any interest in such property, is void unless the transaction is entered into with the consent of the Minister or is entered into between members of a band or between the band and a member thereof. These provisions set forth both the application of provincial laws over “Indians” and “Indian bands,” but also restrict that application. Because a limited partnership is not a separate legal entity from its partners, the “Indian band” that holds or receives property as a limited partner may have some form of creditor protection simply by way of the limited applicability of provincial law. The Supreme Court of Canada considered the extent of the provincial application of laws that would require a band to “disgorge benefits” in satisfaction of a debt in Mitchell v Peguis Indian Band. Consider the extent to which provincial legislation applies to the collection of debts where a band acts on its own—that is, without a corporate body, or by way of a partnership.

Mitchell v Peguis Indian Band [1990] 2 SCR 85, 71 DLR (4th) 193, [1990] 5 WWR 97, 110 NR 241, [1990] 3 CNLR 46, [1990] ACS no 63, 67 Man R (2d) 81 DICKSON CJ:

[1]  The broad issue in this appeal is whether certain moneys agreed to be paid by the Government of Manitoba to 54 Indian bands, and garnished before judgment by the appellants, Mr. Mitchell and Milton Management Ltd., can be considered “personal property of … a band situated on a reserve” within the meaning of s. 89(1) of the Indian Act, R.S.C. 1970, c. I-6 (the Act), and therefore not subject to attachment. Section 89(1) reads: 89(1)  Subject to this Act, the real and personal property of an Indian or a band situated on a reserve is not subject to charge, pledge, mortgage, attachment, levy, seizure, distress or execution in favour or at the instance of any person other than an Indian.

[2]  The following section of the Act contains a “deeming” provision crucial in deciding the issue presented by this appeal: 90(1)  For the purposes of sections 87 and 89, personal property that was

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(a)  purchased by Her Majesty with Indian moneys or moneys appropriated by Parliament for the use and benefit of Indians or bands, or (b)  given to Indians or to a band under a treaty or agreement between a band and Her Majesty, shall be deemed always to be situated on a reserve.

[3]  Can the garnished moneys be said to be “personal property that was … given to … a band under … [an] agreement between a band and Her Majesty”? This gives rise to the further question whether the words “Her Majesty” in s. 90(1)(b) of the Act can include the provincial Crown or are referable only to the federal Crown. If the moneys in question are found to be “personal property” within the meaning of s. 90(1)(b), they would be deemed to be situated on a reserve and, therefore, protected from garnishment under s. 89(1). I  The Facts [4]  The appellants issued a statement of claim in which it was alleged that (i) the First Nations Confederacy Inc., as representative of its member bands, retained Mr. Mitchell to act on its behalf in negotiating a rebate from the Government of Manitoba of sales tax paid by the bands over several years to Manitoba Hydro; (ii) it was a term of the agreement that Mr. Mitchell would be paid fees equivalent to 20 percent of sales tax recovered, assessable to each band on a prorated basis, less such funds as might be received against fees from the Federal Department of Indian Affairs; (iii) Mr. Mitchell, through Milton Management Ltd., negotiated Hydro sales tax rebates with the Government of Manitoba and in the Fall of 1982, the Government of Manitoba agreed to pay the Indian bands sales tax rebates in the amount of $953,432, entitling Mr. Mitchell to a fee of $190,668. The Federal Department of Indian Affairs contributed $5,493 to Mr. Mitchell’s fees, leaving a claim against the bands of $185,175. [5]  The respondent bands, in their statement of defence, deny the retainer. They allege that the Government of Manitoba, on its own initiative, and not as a result of the appellants’ efforts, decided to refund to the Indian bands in Manitoba certain taxes which had been improperly collected from them. They say that the fee is so oppressive and excessive as to be unconscionable and, finally, that Mr. Mitchell is a member of the Institute of Chartered Accountants of Manitoba and as such is precluded from charging a fee contingent on the results of professional services. [6]  On March 9, 1983, the Lieutenant Governor in Council of Manitoba passed Orderin-Council No. 253, on the submission of the Minister of Finance, which reads in part: AND WHEREAS the Minister has received advice from a legal officer of the government advising him that taxes paid under The Revenue Act 1964 by Indians and Indian Bands were improperly collected since Section 87 of the Indian Act prohibited provinces from taxing electricity provided to Indians and Indian Bands which electricity was consumed by them on an Indian reservation; AND WHEREAS it has been determined by the staff of his department and agreed to by representatives of those Indians and Indian Bands that a settlement amount of money for the period December 1, 1964, the date of the inception of The Revenue Act 1964 Part I which imposed the tax on electricity, up to and including March 20, 1980, at which time Manitoba

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… the Minister recommends: THAT the amount of $994,840. be transferred in the books of the government from appropriation (VII) (Finance) (4) (Taxation Division) (c) (Mining & Use Taxes Branch) (3) (Refunds) to a trust account to be held by the Minister of Finance on behalf of those Indians and Indian Bands as described on Schedule “A” attached, and paid out by him upon being satisfied that each Indian Band provides the Minister with satisfactory releases and assignments of their claims to their respective organizations; THAT the Minister retain a holdback of 3% of the amount shown as payable in Schedule “A” from any payment made as provided above for a period of six years from March 9, 1983 to satisfy, if any, further claims made by Indians or Indian Bands for indemnification related to the payment of taxes on electricity for the above described period of time;

[7]  [T]he substance of the current appeal, as I have indicated, stems from garnishment proceedings prior to judgment. After agreeing to allow an original garnishing order (obtained on January 10, 1983) to lapse because it was tying up the flow of important funds designated for social purposes, the appellants (on March 10, 1983, the day after the Order-in-Council established the trust fund) obtained a second prejudgment garnishing order against the tax rebate funds held in trust by the government to the amount of the fee claimed by the appellants, that is, $185,175. In accordance with the garnishing order, the garnishee Government paid the garnished amount into court. The respondents applied to have the garnishing order set aside, and the moneys paid out of court, on the basis that such an order was inconsistent with ss. 89(1) and 90(1)(b) of the Indian Act. The respondents’ contention was that s. 3 of the Manitoba Garnishment Act, R.S.M. 1970, c. G20, C.C.S.M., c. G20, permitting garnishment of the government of Manitoba, was not a provincial law applicable to Indians within the terms of s. 88 of the Indian Act. … [8] In further support of their application to set aside the garnishing order, the respondents contend that the money disposed of in the Order-in-Council is a debt owing to the respondents and, as such, constitutes, within the meaning of s.  90(1)(b) of the Indian Act, “personal property that was … given to Indians or to a band under a treaty or agreement between a band and Her Majesty.” As a result, it is said, that debt is deemed by s. 90(1)(b) to be situated on a reserve and, therefore, by s. 89(1), cannot be the subject of attachment at the instance of a non-Indian. The respondents succeeded in their application before Morse J. ([1983] 5 W.W.R. 117 (Man. Q.B.)) The appellants now appeal from a decision of the Manitoba Court of Appeal ([1986] 2 W.W.R. 477), which upheld the judgment of Morse J. •  •  •

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V  Second Preliminary Issue: The Situs of a Debt [20]  It appears to have been conceded by all parties that, without s. 90, the respondents would fail, because the situs of a debt is the location of the debtor, which, in this case, is off the reserve: see the authorities cited by Morse J., supra, at p. 122. As no argument has been addressed on the point this rule will be assumed to be valid for purposes of this appeal. VI  The Main Issue—The Meaning of “Her Majesty” [21]  The main issue, as I have noted, is whether the criteria in s. 90(1)(b), have been met so as to deem the debt situated on the reserves of the respondents and therefore immune from attachment under s. 89(1). … By far the most contentious element, and that which occupied almost the entirety of each factum, is the question of whether “Her Majesty” in s. 90(1)(b) is limited to the federal Crown or also comprises the provincial Crowns, with Manitoba being thereby included. •  •  •

[26]  In my view, the trial judge adopted the correct approach. “Her Majesty” can refer to the province; the question is whether it does so refer. •  •  •

[39]  … The recent case of Guerin took as its fundamental premise the “unique character both of the Indians’ interest in land and of the historical relationship with the Crown.” (At p. 387, emphasis added.) That relationship began with pre-Confederation contact between the historic occupiers of North American lands (the aboriginal peoples) and the European colonizers (since 1763, “the Crown”), and it is this relationship between aboriginal peoples and the Crown that grounds the distinctive fiduciary obligation on the Crown. … [40]  … As long as Indians are not affected qua Indians, a provincial law may affect Indians, and significantly so in terms of everyday life. Section 88 of the Indian Act greatly increases the extent to which the provinces can affect Indians by acknowledging the validity of laws of general application, unless they are supplanted by treaties or federal law. This fluidity of responsibility across lines of jurisdiction accords well with the fact that the newly entrenched s. 35 of the Constitution Act, 1982, applies to all levels of government in Canada. [41]  I conclude, therefore, that “Her Majesty” in s. 90(1)(b) of the Indian Act is to be interpreted as referring to both the federal and provincial Crowns. VII  The Secondary Points at Issue •  •  •

[44]  Of course, the debt owing from the Manitoba government must also constitute “personal property” under s. 90(1)(b) for the respondents to succeed. … In my view, these cases have correctly held that the words “personal property” in s. 90(1)(b) include intangible property such as the right to payment of money at issue in this case. I would, again, endorse the reasoning of Morse J., supra, at p. 125:

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So far as s. 90(2) is concerned, that subsection is, I think, broad enough to cover not only tangible but intangible personal property such as a debt or a right to payment.

[49]  An additional point in favour of the respondents is that the money in question was a tax rebate. One can only assume that this money should never have been taxed in the first place (per s. 87 of the Indian Act) and should never have left Indian hands. It would be an odd result if that money could be garnished on its way back to where it never should have left. •  •  •

[51]  I would dismiss the appeal with costs in this Court and both courts below. WILSON J (Lamer, Wilson, and L’Heureux-Dubé JJ concurring):

[52]  Manitoba Hydro invalidly imposed a tax upon the Peguis Indians in respect of the sale of electricity on a reserve. The Government of Manitoba subsequently settled the Indians’ claim for the return of the taxes paid and the issue on this appeal is whether the proceeds of that settlement may be garnisheed by the appellant lawyers in payment of their fees for representing the Indians in the settlement negotiations. •  •  •

[54]  I agree with my colleague La Forest J.’s interpretation of s. 90(1)(b) and my only concern is with the application of the Garnishment Act, R.S.M. 1970, c. G20, C.C.S.M., c. G20 to those moneys which are, according to my colleague’s interpretation, not situate on a reserve or deemed to be so situate. On what basis then are they exempt from seizure? •  •  •

[56]  … The problem I have is how does one get to this admittedly very desirable result in the face of an intervening third party claim? Once it is held that the moneys are not in fact situate on the reserve or deemed to be so and that they do constitute a debt, why may that debt not be subject to garnishment at the hands of an innocent third party? I know of no legal principle (subject to what will be said hereafter about s. 3 of the Garnishment Act) that suggests that the way in which the debt arose can affect an innocent third party seeking to initiate garnishment proceedings with respect to that debt. [57]  Although the law in this area is somewhat anachronistic, I agree with my colleague [La Forest J.] that the Garnishment Act does not apply on the facts of this case. But it seems to me important to explain why this is so, particularly since the legislature may wish to reconsider aspects of the doctrine of Crown immunity that lead to this conclusion. •  •  •

[68]  These observations strongly suggest that the doctrine of Crown immunity in the context of garnishment proceedings is an anachronism when the Crown is the garnishee. However, I think it clear that it is for the legislature to effect the kind of fundamental reforms to the law of Crown immunity that it has become increasingly apparent are necessary. … Disposition [69]  I would dismiss the appeal on the basis that the Garnishment Act does not apply to the Crown so to permit the garnishment by the appellants of moneys owing by the Crown to the Indians under the settlement.

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[70]  LA FOREST J (Sopinka and Gonthier JJ concurring): [70]  I have had the advantage of reading the reasons of the Chief Justice. I agree with his proposed disposition of this case, but I do so for quite different reasons. With respect, I am unable to agree with his approach and, in particular, with his adoption of the trial judge’s interpretation of s. 90(1)(b) of the Indian Act, R.S.C. 1970, c. I-6. [71]  … [T]he issue to be determined involves funds in the hands of the Government of Manitoba, which it agreed to pay to the respondent Indians in settlement of a claim for the return of taxes paid by the Indians to Manitoba Hydro in respect of sales of electricity on reserves. The question is whether those funds may be garnisheed by the appellants who are suing the Indians for fees for representing the Indians in negotiating the settlement. •  •  •

It will be obvious that this provision [s 90 of the Indian Act] cannot be fully understood without reference to ss. 87 and 89, the first exempting lands and personal property on a reserve from taxation, and the second protecting real and personal property of Indians on a reserve from attachment. It is sufficient for me to show the interrelationship of these provisions to reproduce here only their first subsections. •  •  •

[82]  In summary, … an unqualified reference to “Her Majesty” in a federal statute can indeed refer to the provincial Crowns when to hold otherwise is not rationally defensible, or leads to an implausible result. But this conclusion has no bearing on the interpretative problem facing us in this appeal. There is no conceptual difficulty or implausibility in concluding that “Her Majesty” bears a uniform meaning throughout s. 90, and proceeding on the basis that the section applies solely to such personal property as the federal Crown confers on Indians in the course of fulfilling its obligations to native peoples, be it pursuant to its treaty commitments, or its responsibilities flowing from s. 91(24) of the Constitution Act, 1867. Indeed, for reasons to be developed later, I am of the view that any other interpretation does not concord with the tenor of the obligations the Crown has historically assumed vis-à-vis the property of native peoples. The Historical Record: Sections 87 and 89 [83]  Sections 87 and 89, the sections to which the deeming provision of s. 90 of the Indian Act applies, confer protection on certain categories of property held by Indians. An examination of the history of these sections is illuminating for it demonstrates that, while the Crown has traditionally recognized an obligation to protect the property of native peoples, this obligation has always been limited to certain well-defined classes of property. … [89]  As is clear from the comments of the Chief Justice in Guerin v. The Queen, [1984] 2 S.C.R. 335, at p. 383, these legislative restraints [historically present prior to and in the Indian Act] on the alienability of Indian lands are but the continuation of a policy that has shaped the dealings between the Indians and the European settlers since the time of the Royal Proclamation of 1763. … The sections of the Indian Act relating to the inalienability of Indian lands seek to give effect to this protection by interposing the Crown between the Indians and the market forces which, if left unchecked, had the potential to erode Indian ownership of these reserve lands.

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[90]  … The exemptions from taxation and distraint have historically protected the ability of Indians to benefit from this property in two ways. First, they guard against the possibility that one branch of government, through the imposition of taxes, could erode the full measure of the benefits given by that branch of government entrusted with the supervision of Indian affairs. Secondly, the protection against attachment ensures that the enforcement of civil judgments by non-natives will not be allowed to hinder Indians in the untrammelled enjoyment of such advantages as they had retained or might acquire pursuant to the fulfillment by the Crown of its treaty obligations. In effect, these sections shield Indians from the imposition of the civil liabilities that could lead, albeit through an indirect route, to the alienation of the Indian land base through the medium of foreclosure sales and the like … . [91]  In summary, the historical record makes it clear that ss. 87 and 89 of the Indian Act, the sections to which the deeming provision of s. 90 applies, constitute part of a legislative “package” which bears the impress of an obligation to native peoples which the Crown has recognized at least since the signing of the Royal Proclamation of 1763. From that time on, the Crown has always acknowledged that it is honour-bound to shield Indians from any efforts by non-natives to dispossess Indians of the property which they hold qua Indians, i.e., their land base and the chattels on that land base. •  •  •

[95]  … But I would reiterate that in the absence of a discernible nexus between the property concerned and the occupancy of reserve lands by the owner of that property, the protections and privileges of ss. 87 and 89 have no application. •  •  •

[97]  I draw attention to these decisions by way of emphasizing once again that one must guard against ascribing an overly broad purpose to ss. 87 and 89. These provisions are not intended to confer privileges on Indians in respect of any property they may acquire and possess, wherever situated. Rather, their purpose is simply to insulate the property interests of Indians in their reserve lands from the intrusions and interference of the larger society so as to ensure that Indians are not dispossessed of their entitlements. … [98]  If any additional evidence is needed to confirm this conclusion, it may be found in an examination of s. 89(2). By the terms of this provision, personal property sold to an Indian may still be subject to attachment, even when situated on a reserve, in that a person who sells to an Indian purchaser under a conditional sales agreement retains his right to the property pending completion of the agreement. There could be no clearer illustration of the fact that s. 89 is not meant to arm Indians with privileges they can exercise in acquiring and dealing with property in the general marketplace, but, rather, is simply limited in its purpose to preventing non-natives from interfering with the ability of Indians to enjoy such duly acquired property as they hold on their reserve lands. That, of course, is why s. 89 places no constraints on the ability of Indians to charge, pledge, or mortgage property among themselves. The Deeming Provision of s 90 •  •  •

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[101]  The reason why Parliament would have chosen to provide that personal property of this sort should be protected regardless of where that property is situated is obvious. Simply put, if treaty promises are to be interpreted in the sense in which one may assume them to have been naturally understood by the Indians, one is led to conclude that the Indian signatories to the treaties will have taken it for granted that property given to them by treaty would be protected regardless of situs. In the case of chattels, I am aware of no historical evidence that would suggest that Indians ever expected that their ability to derive the full benefit of this property could be placed in jeopardy because of the ability of non-natives to impose liens or taxes on it every time it was necessary to remove this property from the reserve. Similarly, when the Crown acquits treaty and ancillary obligations through the payment of moneys relating to assistance in spheres such as education, housing, and health and welfare, it cannot be accepted that Indians ever supposed that their treaty right to these entitlements could be compromised on the strength of subtle legal arguments that the property concerned, though undoubtedly property to which the Indians were entitled pursuant to an agreement engaging the honour of the Crown, was notionally situated off the reserve and therefore subject to the imposition of taxes or to attachment. It would be highly incongruous if the Crown, given the tenor of its treaty commitments, were permitted, through the imposition of taxes, to diminish in significant measure the ostensible value of the benefits conferred. [103]  In support of my view that Indians will have perceived that their treaty benefits were given unconditionally, I would point to the following extract from the report of the Treaty Commissioners in respect of Treaty No. 8. The passage is eloquent testimony to the fact that native peoples feared that the imposition of taxes would seriously interfere with their ability to maintain a traditional way of life on the lands reserved for their use, and, additionally, leaves no doubt that Indians were promised that their entitlements would be exempt from taxation: There was expressed at every point the fear that the making of the Treaty would be followed by the curtailment of the hunting and fishing privileges, and many were impressed with the notion that the Treaty would lead to taxation and enforced military service. We assured them that the Treaty would not lead to any forced interference with their mode of life, that it did not open the way to the imposition of any tax, and that there was no fear of enforced military service. [Treaty No. 8, 1899 (Queen’s Printer, Ottawa), as quoted in Bartlett, supra, at p. 5.]

Section 90(1)(b) Including the Provincial Crowns •  •  •

[109]  It follows inexorably that if an Indian band, pursuant to a purely commercial agreement with a provincial Crown, acquires personal property, that property will be exempt from taxation and distraint, regardless of its situs. Moreover, the protections of ss.  87 and 89 would apply in respect of any subsequent dealings by the Indian band respecting that property, even if those dealings were confined to ordinary commercial matters. This would have broad ramifications, and I cannot accept the notion that Parliament, in fulfilling its constitutional responsibility over Indian affairs, intended that the protective envelope of ss. 87 and 89 should apply on such a broad scale.

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[110]  My conclusion rests on the fact that such a result cannot be reconciled with the scope of the protections that the Crown has traditionally extended to the property of natives. As I stated earlier, a review of the obligations that the Crown has assumed in this area shows that it has done no more than seek to shield the property of Indians that has an immediate and discernible nexus to the occupancy of reserve lands from interference at the hands of non-natives. The legislation has always distinguished between property situated on reserves and property Indians hold outside reserves. There is simply no evidence that the Crown has ever taken the position that it must protect property simply because that property is held by an Indian as opposed to a non-native. [111]  Indeed, unless one were to take the view that there exist two laws of contract, one applying to Indians and one to non-Indians, it would be difficult to rationalize a result that saw exemptions against taxation and distraint apply in respect of property simply because the person acquiring it happened to be an Indian. But, as I have intimated above, the interpretation of s. 90(1)(b) advanced by the trial judge and affirmed by the Chief Justice must, in logic, lead precisely to this result. [112]  When Indian bands enter the commercial mainstream, it is to be expected that they will have occasion, from time to time, to enter into purely commercial agreements with the provincial Crowns in the same way as with private interests. The provincial Crowns are, after all, important players in the marketplace. If, then, an Indian band enters into a normal business transaction, be it with a provincial Crown, or a private corporation, and acquires personal property, be it in the form of chattels or debt obligations, how is one to characterize the property concerned? To my mind, it makes no sense to compare it with the property that enures to Indians pursuant to treaties and their ancillary agreements. Indians have a plenary entitlement to their treaty property; it is owed to them qua Indians. Personal property acquired by Indians in normal business dealings is clearly different; it is simply property anyone else might have acquired, and I can see no reason why in those circumstances Indians should not be treated in the same way as other people. [113]  There can be no doubt, on a reading of s. 90(1)(b), that it would not apply to any personal property that an Indian band might acquire in connection with an ordinary commercial agreement with a private concern. Property of that nature will only be protected once it can be established that it is situated on a reserve. Accordingly, any dealings in the commercial mainstream in property acquired in this manner will fall to be regulated by the laws of general application. Indians will enjoy no exemptions from taxation in respect of this property, and will be free to deal with it in the same manner as any other citizen. In addition, provided the property is not situated on reserve lands, third parties will be free to issue execution on this property. I think it would be truly paradoxical if it were to be otherwise. … [117]  I think it can be seen that any interpretation of s. 90(1)(b) that sees the purpose of that section as extending beyond that of preventing non-natives from interfering with property that enures to Indians as a result of the Crown’s obligations under treaties and ancillary agreements, gives a novel and unprecedented extension to the protections that have up to now been conferred by the Crown on the property of Indians. Property acquired pursuant to agreements with a provincial Crown and an Indian band will fall to be protected, regardless of situs, simply because it has been acquired by an Indian as opposed to a non-native citizen. The question whether the property has its paramount

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location on reserve lands, or is property to which Indians have an entitlement qua Indians will be irrelevant. As I see it, if Parliament had intended to cast aside these traditional constraints on the Crown’s obligations to protect the property of Indians, it would have expressed this in the clearest of terms. I am loathe to conclude that this result can be made to rest on the strength of a supposed ambiguity in s. 90(1)(b), which, as I have suggested above, can only arguably be an ambiguity if one turns a blind eye to compelling historical and textual arguments. •  •  •

[124]  I conclude that the statutory notional situs of s. 90(1)(b) is meant to extend solely to personal property which enures to Indians through the discharge by “Her Majesty” of her treaty or ancillary obligations. Pursuant to s. 91(24) of the Constitution Act, 1867, it is of course “Her Majesty” in right of Canada who bears the sole responsibility for conferring any such property on Indians, and I would, therefore, limit application of the term “Her Majesty” as used in s. 90(1)(b) to the federal Crown. •  •  •

[131]  The conclusion I draw is that it is entirely reasonable to expect that Indians, when acquiring personal property pursuant to an agreement with that “indivisible entity” constituted by the Crown, will recognize that the question whether the exemptions of ss. 87 and 89 should apply in respect of that property, regardless of situs, must turn on the nature of the property concerned. If the property in question simply represents property which Indians acquired in the same manner any other Canadian might have done, I am at a loss to see why Indians should expect that the statutory notional situs of s. 90(1)(b) should apply in respect of it. In other words, even if the Indians perceive the Crown to be “indivisible,” it is unclear to me how it could be that Indians could perceive that s. 90(1)(b) is meant to extend the protections of ss. 87 and 89 in an “indivisible” manner to all property acquired by them pursuant to agreements with that entity, regardless of where that property is held. What if the property concerned is property held off the reserve, and was acquired by the Indian band concerned simply with a view to further business dealings in the commercial mainstream? [132]  This brings me back to the objection I voiced earlier, and which was to the effect that on the interpretation of s. 90(1)(b) advanced by the trial judge, it must follow, as a matter of simple logic, that the section is meant to apply to the whole range of agreements between Indian bands and provincial Crowns. Once one accepts the assumption that “Her Majesty” includes the provincial Crowns, it would be more an exercise in divination than reasoned statutory interpretation to purport to be able to select from among the full spectrum of agreements that can be concluded between Indian bands and provincial Crowns and conclude that Parliament wished s. 90(1)(b) to apply in one case but not in another. I conclude that by necessarily taking in purely commercial dealings, the broad interpretation proposed by the trial judge would distort the very perception that Indians themselves can, in fairness, be expected to hold of the limits of the extraordinary protection conferred by s. 90(1)(b). [133]  … But when Indians deal in the general marketplace, the protections conferred by these sections [87, 89, and 90] have the potential to become powerful impediments to their engaging successfully in commercial matters. Access to credit is the lifeblood of commerce, and I find it very difficult to accept that Indians would see any advantage, when seeking credit, in being precluded from putting forth in pledge property they may

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acquire from provincial Crowns. Indians, I would have thought, would much prefer to have free rein to conduct their affairs as all other fellow citizens when dealing in the commercial mainstream. [134]  To elaborate, if Indians are to be unable to pledge or mortgage such personal property as they acquire in agreements with provincial Crowns, businessmen will have a strong incentive to avoid dealings with Indians. This is simply because the fact that Indians will be liable to be distrained in respect of some classes of property, and not in respect of others, will introduce a level of complexity in business dealings with Indians that is not present in other transactions. I think it safe to say that businessmen place a great premium on certainty in their commercial dealings, and that, accordingly, the greatest possible incentive to do business with Indians would be the knowledge that business may be conducted with them on exactly the same basis as with any other person. Any special considerations, extraordinary protections or exemptions that Indians bring with them to the marketplace introduce complications and would seem guaranteed to frighten off potential business partners. •  •  •

Disposition [141]  I would dismiss the appeal with costs throughout. NOTES AND QUESTIONS

1.  Many First Nations in Canada engage in ventures and transactions with other First Nations, bands, and Indigenous people. Would the principles in Mitchell apply to restrict access to remedies when such transactions fail? 2.  Consider the principles at work in Mitchell, and recall that the restrictions on transfers listed within in the Indian Act do not mention transfers that are engaged in to protect property from creditors. Would provincial legislation aimed at prohibiting certain forms of such transfers apply? How might bands organize their affairs to enjoy the benefits of such legislation while also restricting its application? 3.  Note that many Impact Benefits Agreements that First Nations conclude with provincial governments and industry proponents are achieved on the basis of Aboriginal or treaty rights, which “[enure] to Indians through the discharge by ‘Her Majesty’ of her treaty or ancillary obligations” (La Forest J in Mitchell, at para 124). Are such agreements within the “commercial mainstream” such that provincial laws of commerce would apply to them? 4. In Bastien Estate v Canada, 2011 SCC 38, Cromwell J stated that the idea of a commercial mainstream distinct from “Indian” ways of life is deeply problematic and no longer to be accorded much weight in ascertaining whether property attaches to a reserve. [27]  … A purposive interpretation goes too far if it substitutes for the inquiry into the location of the property mandated by the statute an assessment of what does or does not constitute an “Indian” way of life on a reserve. … [28]  … a purposive interpretation of the exemption does not require that the evolution of that way of life should be impeded. Rather, the comments in both Mitchell and Williams in relation to the protection of property which Indians hold qua Indians should be read in relation to the need to establish a connection between the property and the reserve such that it may be said that the

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VII. Conclusion property is situated there for the purposes of the Indian Act. While the relationship between property and life on the reserve may in some cases be a factor tending to strengthen or weaken the connection between the property and the reserve, the availability of the exemption does not depend on whether the property is integral to the life of the reserve or to the preservation of the traditional Indian way of life. •  •  •

[56]  [This factor is problematic] because it might be taken as setting up a false opposition between “commercial mainstream” activities and activities on a reserve. Linden J.A. in Folster was alive to this danger when he observed that the use of the term “commercial mainstream” might “… imply, incorrectly, that trade and commerce is somehow foreign to First Nations” (para. 14, note 27). He was also careful to observe in Recalma that the “commercial mainstream” consideration was not a separate test for the determination of the situs of investment property, but an “aid” to be taken into consideration in the analysis of the question (para. 9). Notwithstanding this wise counsel, the “commercial mainstream” consideration has sometimes become a determinative test.

Based on the limited conceptual fruitfulness of the notion of the “commercial mainstream,” how might we understand the application of provincial laws to Indigenous ventures that involve borrowings, capitalization, and debt? Is this lack of clarity hampering for First Nation ventures, as La Forest J indicates? 5.  In all provincial jurisdictions in Canada, there is statutory protection for creditors who deal with debtors who have sought to defeat creditor preferences by transferring or disposing of assets. In general, instruments and transactions undertaken to avoid creditors are deemed null and void by provincial legislation governing fraudulent conveyances and preferences: see e.g. Assignments and Preferences Act, RSO 1990, c A.33, ss 4-5; Fraudulent Conveyances Act, RSO 1990, c F.29; and Fraudulent Conveyances Act, RSBC 1996, c 163. In light of the wording of ss 89 and 90 of the Indian Act, can you think of necessary steps that a solicitor would take in properly structuring an industrial venture for a First Nation or Indigenous people in light of the protections indicated in Mitchell? 6.  In light of the complete exemption that “Indian bands” enjoy under s 149(1)(c), can you think of ways other than the use of corporate structures to pursue business ventures? Would this be consistent with the fiduciary duties or Indigenous law duties of First Nation leaders? 7.  In light of the historical situation of Canada’s Indigenous people—from the Indian Act to the TRC Calls to Action—explain the role that business organizations can play, in order to ensure that Indigenous people flourish by way of secure and prosperous economic livelihoods.

VII. CONCLUSION Senator Murray Sinclair, former Chair of the Truth and Reconciliation Commission, has remarked that businesses continue to approach Indigenous people with an impoverished understanding of who they are and how they live, and that this is founded on the “twin myths” that Indigenous people are inferior and Europeans are superior: “The business community needs to understand that and it needs to guard against it.”54 Similarly, the business community should try to understand that Indigenous laws not only play a role in economic

54 Melanie Walsh, “Businesses Have Work to Do on Reconciliation,” CBC News (15 June 2016), online: .

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development, and the structures that best serve that development, but “must stand alone … [not] be subsumed within the common law or civil code … [and] exist independent of, and at par with, state law. Indigenous legal traditions are law.”55 In this chapter we have tried to show the complexity involved in working with First Nations, and the need for making space for Indigenous voices, commercial practices, and laws. This chapter has canvassed a broad array of corporate structures and legal principles, and our hope is that it conveys some of the challenges and hard thinking required by lawyers working with First Nations, or their commercial partners, on issues of economic development. The steady assertion of Indigenous commercial practices and legal traditions, court cases on Aboriginal rights and title, the legal personhood of First Nation entities, and the drive for economic self-determination are all at work in conditioning how First Nations turn to and implement the available business structures of Canadian law. As so many different areas of law converge on the question of Indigenous legal personhood, it is incumbent on all of us to make room for alternative visions of corporate law and practice that allow lawyers to limit the reach of inappropriate colonial legal institutions and not otherwise obscure latent cultural traditions and practices. The flexibility of corporate entities and inclusion of Indigenous perspectives and laws would seem to allow the resurgence of Indigenous commercial traditions if legal practitioners would be willing to step aside, listen, and do what can be done to foster them.

55 Hanna, supra note 2 at 369.

CHAPTER FIVE

Corporate Contractual Liability





I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343 II.  Pre-Incorporation Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343 A.  The Common Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344 B.  Statutory Regime . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355 III.  Post-Incorporation Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377 A.  Corporate Capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377 B.  Compliance with Internal Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 381 C.  Agent Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382 1.  Actual Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382 2.  Apparent Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 383 IV. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 389

I. INTRODUCTION As explained in Chapter 3, one of the key implications of separate legal personality is that a corporation may enter into contracts in its own name. Naturally, however, the fact that a corporation is an artificial person means that the act of entering into contracts on behalf of the corporation must necessarily be undertaken by humans purporting to represent the corporation. Contracts may be entered into on behalf of a corporation both before and after the formal incorporation process has been completed. Contracts entered into before the formal incorporation process is complete are typically referred to as “pre-incorporation” contracts—that is, before the corporation legally exists. Contracts entered into after the formal incorporation process is complete are referred to in this section as “postincorporation” contracts—that is, after the corporation legally exists.

II.  PRE-INCORPORATION CONTRACTS Humans involved in the entering into of pre-incorporation contracts are referred to as “promoters.” In Canada, there are two alternative regimes governing legal issues arising in the context of pre-incorporation contracts: common law and statutory. If the statute enabling the general business corporation provides no regime for pre-incorporation contracts, then

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the common law will apply.1 The jurisdictions that set out statutory regimes in their corporate legislation sought to remedy deficiencies in the common law with respect to two key issues: (1)  defining the scope of promoter liability, and (2)  defining the legal mechanism pursuant to which the legal benefits and obligations of pre-incorporation contracts may be attributed to the firm post-incorporation. The following material consists of extracts from cases applying either the common law or a statutory regime. When reading the extracts, consider what particular deficiencies the statutory regimes seek to remedy and the extent to which they do, in fact, remedy them.

A.  The Common Law

Kelner v Baxter (1866), LR 2 CP 174 (Common Pleas) The plaintiff was a wine merchant, and the proprietor of the Assembly Rooms at Gravesend. In August, 1865, it was proposed that a company should be formed for establishing a joint-stock hotel company at Gravesend, to be called The Gravesend Royal Alexandra Hotel Company, Limited, of which the following gentlemen were to be the directors, viz. Mr. L. Calisher, Mr. T. H. Edmands, Mr. M. Davis, Mr. Macdonald, Mr. Hulse, Mr. N. J. Calisher (one of the defendants), and the plaintiff. The plaintiff was to be the manager of the proposed company, and Mr. Dales (another of the defendants) was to be the permanent architect. One part of the scheme was that the company should purchase the premises of the plaintiff for a sum of £5,000, of which £3,000 was to be paid in cash, and £2,000. in paid up shares, the stock, &c., to be taken at a valuation; and this was carried into effect and completed, the other defendant (Baxter) being the nominal purchaser on behalf of the company. In December a prospectus was settled. On the 9th of January, 1866, a memorandum of association was executed by the plaintiff and the defendants and others. Pending the negotiations the business had been carried on by the plaintiff, and for that purpose additional stock had been purchased by him; and on the 27th of January, 1866,

1 Some general business corporation statutes set out statutory rules for all pre-corporation contracts: Ontario Business Corporations Act, RSO 1990, c B.16, s 21 [OBCA]; New Brunswick Business Corporations Act, SNB 1981, c  B-9.1, s  12 [NBBCA]; British Columbia Business Corporations Act, SBC 2002, c  57, s  20 [BCBCA]. By contrast, others set out statutory rules only for written pre-incorporation contracts—i.e. the common law would apply to oral pre-incorporation contracts: Canada Business Corporations Act, RSC 1985, c C-44 s 14 [CBCA]; Newfoundland and Labrador Corporations Act, RSNL 1990, C-36, s 26 [NFLCA]; Manitoba, The Corporations Act, CCSM c C225, s 14 [MCA]; Saskatchewan, The Business Corporations Act, RSS 1978, c B-10, s 14 [SBCA]; Alberta Business Corporations Act, RSA 2000, c B-9, s 15 [ABCA]; Yukon Business Corporations Act, RSY 2002, c 20, s 17 [YBCA]; Northwest Territories and Nunavut Business Corporations Act, SNWT 1996, c  19, s  14 [NWTNBCA]. The remaining general business corporation statutes in Canada, the Nova Scotia Companies Act, RSNS 1989, c 81 [NSCA], Prince Edward Island Companies Act, RSPEI 1988, C-14 [PEICA], and Quebec Business Corporations Act, CQLR, c S-31.1 [QBCA], have no statutory rules on pre-incorporation contracts.

II.  Pre-Incorporation Contracts

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an agreement was entered into for the transfer of this additional stock to the company, in the following terms: January 27th, 1866. To John Dacier Baxter, Nathan Jacob Calisher, and John Dales, on behalf of the proposed Gravesend Royal Alexandra Hotel Company, Limited. Gentlemen,— I hereby propose to sell the extra stock now at the Assembly Rooms, Gravesend, as per schedule hereto, for the sum of 900£, payable on the 28th of February, 1866. (Signed) John Kelner.

Then followed a schedule of the stock of wines, &c., to be purchased, and at the end was written as follows: To Mr. John Kelner. Sir,— We have received your offer to sell the extra stock as above, and hereby agree to and accept the terms proposed. (Signed) J. D. Baxter, N. J. Calisher, J. Dales, On behalf of the Gravesend Royal Alexandra Hotel Company, Limited.

In pursuance of this agreement the goods in question were handed over to the company, and consumed by them in the business of the hotel; and on the 1st of February a meeting of the directors took place, at which the following resolution was passed: “That the arrangement entered into by Messrs. Calisher, Dales, and Baxter, on behalf of the company, for the purchase of the additional stock on the premises, as per list taken by Mr. Bright, the secretary, and pointed out by Mr. Kelner, amounting to 900£, be, and the same is hereby ratified.” There was also a subsequent ratification by the company, viz. on the 11th of April, but this was after the commencement of the action. The articles of association of the company were duly stamped on the 13th of February, and on the 20th the company obtained a certificate of incorporation under the 25 & 26 Vict. c. 89. The company having collapsed, the present action was brought against the defendants upon the agreement of the 27th of January. ERLE CJ:  … The action is for the price of goods sold and delivered: and the question is whether the goods were delivered to the defendants under a contract of sale. The alleged contract is in writing, and commences with a proposal addressed to the defendants, in these words: “I hereby propose to sell the extra stock now at the Assembly Rooms, Gravesend, as per schedule hereto, for the sum of 900£, payable on the 28th of February, 1866.” Nothing can be more distinct than this as a vendor proposing to sell. It is signed by the plaintiff, and is followed by a schedule of the stock to be purchased. Then comes the other part of the agreement, signed by the defendants, in these words,— ”Sir, We have received your offer to sell the extra stock as above, and hereby agree to and accept the terms proposed.” If it had rested there, no one could doubt that there was a distinct proposal by the vendor to sell, accepted by the purchasers. A difficulty

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has arisen because the plaintiff has at the head of the paper addressed it to the plaintiffs, “on behalf of the proposed Gravesend Royal Alexandra Hotel Company, Limited,” and the defendants have repeated those words after their signatures to the document; and the question is, whether this constitutes any ambiguity on the face of the agreement, or prevents the defendants from being bound by it. I agree that if the Gravesend Royal Alexandra Hotel Company had been an existing company at this time, the persons who signed the agreement would have signed as agents of the company. But, as there was no company in existence at the time, the agreement would be wholly inoperative unless it were held to be binding on the defendants personally. The cases referred to in the course of the argument fully bear out the proposition that, where a contract is signed by one who professes to be signing “as agent,” but who has no principal existing at the time, and the contract would be altogether inoperative unless binding upon the person who signed it, he is bound thereby: and a stranger cannot by a subsequent ratification relieve him from that responsibility. When the company came afterwards into existence it was a totally new creature, having rights and obligations from that time, but no rights or obligations by reason of anything which might have been done before. It was once, indeed, thought that an inchoate liability might be incurred on behalf of a proposed company, which would become binding on it when subsequently formed: but that notion was manifestly contrary to the principles upon which the law of contract is founded. There must be two parties to a contract; and the rights and obligations which it creates cannot be transferred by one of them to a third person who was not in a condition to be bound by it at the time it was made. The history of this company makes this construction to my mind perfectly clear. It was no doubt the notion of all the parties that success was certain: but the plaintiff parted with his stock upon the faith of the defendants’ engagement that the price agreed on should be paid on the day named. It cannot be supposed that he for a moment contemplated that the payment was to be contingent on the formation of the company by the 28th of February. The paper expresses in terms a contract to buy. And it is a cardinal rule that no oral evidence shall be admitted to shew an intention different from that which appears on the face of the writing. I come, therefore, to the conclusion that the defendants, having no principal who was bound originally, or who could become so by a subsequent ratification, were themselves bound, and that the oral evidence offered is not admissible to contradict the written contract. WILLES J:  … The contract is, in substance, this,—”I, the plaintiff, agree to sell to you, the defendants, on behalf of the Gravesend Royal Alexandra Hotel Company, my stock of wines;” and, “We, the defendants, have received your offer, and agree to and accept the terms proposed; and you shall be paid on the 28th of February next.” Who is to pay? The company, if it should be formed. But, if the company should not be formed, who is to pay? That is tested by the fact of the immediate delivery of the subject of sale. If payment was not made by the company, it must, if by anybody, be by the defendants. That brings one to consider whether the company could be legally liable. I apprehend the company could only become liable upon a new contract. It would require the assent of the plaintiff to discharge the defendants. Could the company become liable by a mere ratification? Clearly not. Ratification can only be by a person ascertained at the time of the act done,— by a person in existence either actually or in contemplation of law. …

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… Both upon principle and upon authority, therefore, it seems to me that the company never could be liable upon this contract: and … we must assume that the parties contemplated that the persons signing it would be personally liable. Putting in the words “on behalf of the Gravesend Royal Alexandra Hotel Company,” would operate no more than if a person should contract for a quantity of corn “on behalf of my horses.” … It is quite out of the question to suppose that there was any mistake. The document represents the real transaction between the parties. I think that the course taken at the trial was perfectly correct. [The concurring judgments of Byles and Keating JJ are omitted.]

Newborne v Sensolid (Great Britain) Ltd [1953] 1 All ER 708 (CA) LORD GODDARD CJ:  The plaintiff is a man of foreign extraction, whether a British subject or not, who has an imperfect acquaintance with the English language, and, I suppose, does not understand the implications of English company law. At the material time he had decided that he would go into the provision trade on his own account, and he had formed a company bearing his name, Leopold Newborne (London), Ltd., which he was on the point of registering. Apparently, he thought that there would be no objection to his using without further delay the stationery which he had had prepared in anticipation of the conduct of the business by the company, possibly because he did not think it mattered whether or not the company was actually registered. On Mar. 13, 1951, having discovered that he could buy a quantity of tinned ham from another company, J.C. Gilbert, Ltd., he found a customer, the defendants, to whom he could sell it. His method of business was to buy and sell at the same price, his profit being represented by the discount he received. On Mar. 13, 1951, a contract form, headed “Contract No. S.117” and bearing the name and address of Leopold Newborne (London), Ltd., 321, High Holborn, London, W.C.1, and giving as directors Leopold Newborne and M. Newborne, was addressed to Messrs. Sensolid (Great Britain), Ltd. It was as follows: “We have this day sold to you two hundred cases each containing six tins whole cooked boneless shoulders.” It sets out the price and terms of delivery, etc., and is signed: “Yours faithfully, Leopold Newborne (London), Ltd.” Underneath is written a hieroglyphic, which is interpreted in type as being “Leopold Newborne.” An acceptance slip was attached to the document: Received from Leopold Newborne (London), Limited, 321, High Holborn, London: Sale contract No. S.117 for two hundred cases each containing six tins whole cooked boneless shoulders.

The market went down and the defendants refused to take delivery of the goods when tendered on the ground that the contract was a sale by sample and no sample had been submitted. It was not a sale by sample, there is no word about samples in the contract,

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and Parker J found that sale by sample was no part of the contract. The plaintiff started an action against the defendants for breach of contract, viz., failure to accept the goods … . While, however, the case was in progress the solicitors for the plaintiff discovered that the company had not been registered at the time of the contract, and, therefore, the contract could not be said to have been made by the company. They took steps to substitute Mr. Leopold Newborne for the company as the plaintiff in the action, and thereupon the defendants pleaded that they had contracted with the company and not with Mr. Leopold Newborne, and so he could not recover. Parker J upheld that contention, and this appeal is against the judgment which he gave for the defendants on that ground. Counsel for the plaintiff has contended that the case is governed by a wellknown series of cases of which Kelner (Kelmer) v. Baxter is one. The plaintiff in that case intended to sell wine to a company which was to be formed, but under the contract he agreed to sell it to the proposed directors of the company. The proposed directors intended to buy the wine on behalf of the company, but, as it was not in existence when the contract was made or the goods were delivered, they personally took delivery. It was held that, as they had contracted on behalf of a principal who did not exist, they, having received the wine, must pay for it. It seems to me a very long way from saying that every time a prospective company, not yet in existence, purports to contract everybody who signs for the company makes himself personally liable. Counsel also relied strongly on Schmalz (Schmaltz) v. Avery, which lays down the principle, acted on in subsequent cases and notably Harper & Co. v. Vigers Brothers, that where a person purports to contract as agent he may nevertheless disclose himself as being in truth a principal and bring an action in his own name. Those cases are well established and we are not departing in any way from the principle they lay down, but we cannot find that the plaintiff purported to contract as agent or as principal. He was making the contract for the company, and, although counsel has argued that, in signing as he did, he must have signed as agent, for a company can only contract through an agent, that is not the true position. A company makes a contract. No doubt, it must do its physical acts through the directors, but their relationship is not the ordinary one of principal and agent. The company contracts and its contract is authenticated by the signature of one or more of the directors. This contract purports to be made by the company, not by Mr. Newborne. He purports to be selling, not his goods, but the company’s goods. The only person who has any contract here is the company, and Mr. Newborne’s signature is merely confirming the company’s signature. The document is signed: “Yours faithfully, Leopold Newborne (London), Ltd.,” and the signature underneath is that of the person authorised to sign on behalf of the company. In my opinion, as the company were not in existence when the contract was signed, there never was a contract, and the plaintiff cannot come forward and say: “It was my contract.” It seems to me, therefore, that the defendants can avail themselves of the defence which they pleaded and the appeal must be dismissed. [Concurring judgments of Morris and Romer LJJ are omitted.] Appeal dismissed.

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Black et al v Smallwood & Cooper (1966), 117 CLR 52 (HCA) BARWICK CJ and KITTO, TAYLOR, and OWEN JJ:  On 22nd December 1959 the appellants purported to enter into a contract for the sale of certain land at Ingleburn to Western Suburbs Holdings Pty. Limited. The contract incorporated the conditions of sale approved by the Real Estate Institute of New South Wales and was executed by the appellants as vendors and it bore the following subscription as the signature of the purchaser: Western Suburbs Holdings Pty. Ltd. Robert Smallwood Directors J. Cooper



It was subsequently found that Western Suburbs Holdings Pty. Limited had not at that time been incorporated but it is common ground that both the appellants and the respondents, Smallwood and Cooper, who subscribed the name Western Suburbs Holdings Pty. Limited to the form of contract and added their own signatures as directors, believed that it had been and that the latter were directors of the company. Thereafter the appellants instituted a suit for specific performance against the respondents alleging that by a written contract made between the appellants as vendors and the respondents who “described themselves therein as ‘Western Suburbs Holdings Pty. Limited’” agreed to purchase the subject land from the appellants. No attempt was made at the trial to make this allegation good but, without amendment, the case proceeded as one in which the appellants sought to impose a liability in accordance with the terms of the contract upon the respondents as agents contracting on behalf of a principal not yet in existence. Upon the trial the appellants were successful in obtaining a decree for specific performance but on appeal to the Full Court the decree was set aside and the suit dismissed. All members of the Full Court thought the case was covered precisely by the decision of the Court of Appeal in Newborne v. Sensolid (Great Britain) Ltd. and although one of their number was, perhaps, more than disposed to doubt the correctness of that decision, the Court as a whole decided that it should be followed. It is from this decision that this appeal is brought. At the outset of the case we should say that the decision in Newborne’s Case is directly in point but we propose to deal briefly with the arguments that were presented to us and which, if they were accepted, would establish that decision to be wrong. •  •  •

Kelner v. Baxter was cited as an authority for the proposition that there is a rule of law to the effect that where a person contracts on behalf of a non-existent principal he is himself liable on the contract. But we find it impossible to extract any such proposition from the decision. In that case it appeared from the contract itself that the defendants had no principal; they had purported to enter into a contract on behalf of the “proposed Gravesend Royal Alexandra Hotel Company,” and the fact that they had no principal was obvious to both parties. But it was not by reason of this fact alone that the defendants were held to be liable; the Court proceeded to examine the written instrument in order to see if, in these circumstances, an intention should be imputed to the defendants to bind themselves personally, or, perhaps, to put it in another way, whether, the intention being sufficiently clear that a binding contract was intended, there was anything in the writing inconsistent with the conclusion that the defendants should be bound personally. The

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decision was that, in the circumstances, the writing disclosed an intention that the defendants should be bound. We should add that we fully agree with the observations of Fullagar  J in Summergreene v. Parker [(1950), 80 CLR 304] concerning the basis of the decision in Kelner v. Baxter. He said: “I do not myself think that Kelner v. Baxter or any of the cases cited affords any assistance in the present case. Where A, purporting to act as agent for a non-existent principal, purports to make a binding contract with B, and the circumstances are such that B would suppose that a binding contract had been made, there must be a strong presumption that A has meant to bind himself personally. Where, as in Kelner v. Baxter, the consideration on B’s part has been fully executed in reliance on the existence of a contract binding on somebody, the presumption could, I should imagine, only be rebutted in very exceptional circumstances. But the fundamental question in every case must be what the parties intended or must be fairly understood to have intended. If they have expressed themselves in writing, the writing must be construed by the court. …” •  •  •

These reasons lead us to the respectful conclusion, not only that we should follow the decision in Newborne v. Sensolid (Great Britain) Ltd., but also that the decision in that case was correct. We would dismiss the appeal. WINDEYER J:  I agree that this appeal must be dismissed. I have come to that conclusion without hesitation but with regret. The law requires it, but I do not think that it accords well with a belief that bargains should be kept. If before the document sued upon was signed the registration of Western Suburbs Holdings Pty. Limited had been completed and it had emerged from the RegistrarGeneral’s office as a new-born entity in the law, no difficulty could have arisen. It could not then have been said that Smallwood and Cooper had contracted as agents on its behalf. It must have been said that it, not they, had made the contract. It, not they, would have been the purchaser entitled to a conveyance. Their putting the company’s name to the document would have been purely in execution of its corporate act and their added signatures would have no more bound them personally to perform the contract than would the signatures of the directors or secretary of a company authenticating the affixing of its seal. There is a difference between a man’s own acts and acts done for him by another man. The difficulty of the distinction in the case of a corporation is that a corporation must manifest its acts and intentions by the actions and declarations of human beings: and ambiguities and limitations of language make it difficult sometimes to express the distinction between acts done by a person as executant of the will of a corporation and acts done by a person as agent for a corporation, his principal. That the word “agent” is in each case apt to describe the actor helps to disguise their different legal characters. I appreciate the force of what Walsh J said in the Supreme Court concerning the narrow differences in language upon which the decision in Newborne v. Sensolid (Great Britain) Ltd. turned. But the distinction that differences in language reflect, sometimes not very clearly, is the distinction between the act of a man himself and acts done by another on his behalf. If in the case of a company the distinction is difficult to preserve, and may seem unreal, or merely verbal not conceptual, that is because the legal personality and capacity of the corporation are artificially created by law. Sometimes the result may be to

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allow a man to escape from an unprofitable bargain by a pure technicality, as has been said of Newborne’s Case: Treitel, Law of Contract (1962). In many cases courts have had to decide whether an agent had, in the particular case, incurred a personal liability on a contract in writing made by him on behalf of a principal. And these decisions have sometimes turned upon narrow differences in wording, which seem to be the progeny by miscegenation of early technical rules relating to the form of the execution of deeds. … But here that question does not really arise, for the document which the respondents signed does not purport to be a contract made by them as agents for the supposed company. They thought that the company existed and that they were in fact directors. It is therefore impossible to regard them as having used the name of the company as a mere pseudonym or firm name or as having intended to incur a personal liability. The reason for the formation of the company may have been to ensure that they would not be personally liable. It is however suggested that, notwithstanding the form of the document, a personal obligation to perform the contract has been imposed upon them by law, because at the time they inserted the name of the company as purchaser there was no such company in existence. So far as this proposition is based upon Kelner v. Baxter, it must fail. The facts of this case differ essentially from the facts of that. Some statements in textbooks and in judgments that abbreviate the effect of that decision can be at least misleading, unless they be read with the facts well in mind. … Doubtless in Kelner v. Baxter both the plaintiff and the defendants expected that payment for the goods would be made from the funds of the company that was in process of being formed. That, however, was not a term of the contract. And when the goods were bought it was well-known to all concerned that the company had not yet been formed. The plaintiff, in his letter to the defendants offering to supply the goods, had referred to it as the “proposed” company; and, as Asprey J has pointed out, the more ample report of the case in the Law Journal shews that the plaintiff was himself a participant in the project. The defendants were in fact the buyers of the goods. Their statement that they were buying on behalf of the proposed company was taken to mean, and could in the circumstances only mean, that they contracted to buy the goods with the intent and to the end that the company when formed might have the benefit of them. The words “on behalf of ” do not necessarily imply agency in the relevant legal sense, any more than does the word “for” when a man says “I am buying this for” someone whom he names. The words cannot be regarded as indicative of agency for a principal when it is known to the user of the words that there is no principal in existence. The defendants in Kelner v. Baxter therefore contracted as principals. They were not substituted as principals. They were the principals. The contrast with this case is obvious. Here, instead of both parties knowing that the company was not in existence, they both, appellants and respondents, thought that it was. However, counsel for the appellants contended that the respondents could nevertheless be liable to perform the contract as purchasers on the basis of a supposed rule that a person who contracts, professedly as agent, for a non-existent principal is always personally liable on the contract: and he contended that the respondents signed the contract as agents, and therefore they could be compelled to perform it, it being a type of contract specifically enforceable in equity. In my view neither the major nor the minor premiss of the argument can be accepted. The minor premiss, that the respondents contracted as agents, I have dealt with above and rejected.

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The major premiss, the supposed general rule, cannot I consider be supported.  … Questions such as are now before us have frequently arisen in America. The answer has in some jurisdictions been supplied by legislation; in others by the adoption of a rule that “organizers of a corporation who transact business in the corporate name before its organization has been completed will be deemed partners operating under the corporate name as a trade-name”; sometimes by treating the person who contracts as agent for or in the name of a projected corporation as himself liable on the contract. But we have no such rule. The error in its supposed derivation has been exposed by the other members of the Court in their judgment which I have had the advantage of reading. I entirely agree in what they have said. It would, I think, be contrary to now-established principle to hold a man personally liable on a contract when he did not intend personally to contract, and when, the transaction being in writing, the writing could not upon its true construction, when read in the light of what both parties took to be the facts, mean that he had done so. The purported contract in this case was a nullity, for the supposed purchaser did not exist when it was made. The suit for specific performance therefore must fail. •  •  •

Appeal dismissed.

Wickberg v Shatsky et al (1969), 4 DLR (3rd) 540 (BC SC) DRYER J:  In 1965 a corporation by the name of Rapid Addressing Systems Ltd. was carrying on business in Vancouver selling and servicing certain business machines and supplies. Three men named Kane, Grant and Weston were shareholders in this company and active in its management. Late in 1965 or early in 1966, the two defendants came into the picture along with a Mr. Spaner and purchased an interest in and became directors of Rapid Addressing Systems Ltd. It was then intended that with the new capital so brought into the company the business would be expanded to handle a wider range of machines and new premises were obtained and a wider franchise secured, though there is some question as to whether or not a written franchise agreement was executed on both sides. The directors decided to incorporate a new company under the name of Rapid Data (Western) Ltd. which would take over the assets and the disclosed liabilities of Rapid Addressing Systems Ltd. This proposed new company was not, in fact, incorporated but the business was carried on (quite improperly) under the name of Rapid Data (Western) Ltd., e.g., stationery was prepared and used with that name, the sign over the new premises bore that name, etc. In the spring of 1966, it was decided not to go ahead with the incorporation of Rapid Data (Western) Ltd. and a little later it was decided to incorporate a company known as Celer Data Ltd. which, again, would take over the assets and the disclosed liabilities of Rapid Addressing Systems Ltd. The incorporation papers regarding this company were sent to the Registrar of Companies on May 9, 1966, and the company’s certificate of incorporation is dated May 11, 1966.

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In the meantime the directors of Rapid Addressing Systems Ltd. decided they needed a new manager for their business and the plaintiff was approached through a hiring agency. The plaintiff had been engaged in sales or managerial activities for some years and at this time was so engaged by another firm. On May 6th, the plaintiff attended at the new premises of the business and met the two defendants and some of their associates and was offered employment as manager. On Monday, May 9, 1966, the terms were agreed upon and the plaintiff was hired as manager. He asked for a written contract and he was given a letter on the letterhead of Rapid Data (Western) Ltd. signed by the defendant L. Shatsky as president, saying that he was hired as general manager of the company at a salary of $15,000 per annum, “to be reviewed six months from this date.” … A few days later the defendant Lawrence Shatsky told the plaintiff that the business was to stop using the name Rapid Data (Western) Ltd. and to carry on under the name Rapid Data (Western), i.e., the word “Ltd.” was to be dropped. From then on, though the company still used some stationery bearing the name “Rapid Data (Western) Ltd.,” the business was, to all intents and purposes, carried on under the name “Rapid Data (Western).” The business was not successful and on August the 26, 1966, the plaintiff, after refusing to work on straight commission, was given a notice terminating his services. This notice … is on the letterhead of Rapid Data (Western) and is signed by Harold Shatsky as manager and director, but states, “It is my unpleasant duty to inform you that following a meeting of the directors of the Rapid Addressing Systems Ltd., that as of September 1st, you be relieved of your duties as manager of the above company.” The plaintiff now brings this action against the two defendants. Counsel for the plaintiff contends (1) that the defendant Lawrence Shatsky is liable as a party to the contract … since it was signed by him as agent for a non-existent principal; and (2) that Lawrence Shatsky and Harold Shatsky are each liable for breach of warranty of authority in that they warranted the existence of Rapid Data (Western) Ltd. and warranted Lawrence Shatsky’s authority to sign the contract on behalf of Rapid Data (Western) Ltd.; and (3) that the business by which the plaintiff was employed was a firm in which Lawrence Shatsky and Harold Shatsky were partners and that consequently each of them is liable for the losses suffered by the plaintiff arising from the non-performance of the contract, ex. 1. The first contention, viz., that Lawrence Shatsky is liable since he signed ex. 1 on behalf of Rapid Data (Western) Ltd., a non-existent corporation, is based upon the principle said to be established by Kelner v. Baxter (1866), LR 2 CP 174. In my opinion the plaintiff ’s claim under this heading cannot succeed by reason of the principle laid down in Black et al. v. Smallwood (1966), 39 ALJR 405. In Kelner v. Baxter both parties knew that the company was not in existence. In Black v. Smallwood both parties thought that the company in question was in existence. In the case at bar the plaintiff thought that Rapid Data (Western) Ltd. was in existence and the defendants knew that it was not. Counsel for the plaintiff contends that that distinction makes the rule laid down in Black et al. v. Smallwood inapplicable. No authority is cited in support of this distinction. In my opinion, the distinction between Kelner v. Baxter and Black et al. v. Smallwood is that in Kelner v. Baxter the decision was that in the circumstances the writing disclosed an intention that the defendant should be bound whereas that was not the case in Black et al. v. Smallwood. It follows that, in my opinion, the reasoning in Black et al. v. Smallwood is not inapplicable to the case at bar. Here the parties did not have the same view as to the facts at the time the contract was entered into. Nevertheless it was not the intention of the parties or either

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of them when the contract was made that Lawrence Shatsky who signed as a director should be personally liable on the contract and therefore, on the principle laid down in Black et al. v. Smallwood, he cannot be held liable on the contract. That does not mean, of course, that he could not be liable for breach of warranty of authority or for fraud if they were pleaded and proven. Breach of warranty of authority is pleaded and I will deal with it now. In my opinion, the defendants undoubtedly so acted as to warrant to the plaintiff that Rapid Data (Western) Ltd. was a legal entity and that they had the power to represent it and to speak for it when entering into ex. 1 with the plaintiff. At the same time I feel that the plaintiff knew very shortly after the date of ex. 1 that the business was not being carried on by an incorporated company known as Rapid Data (Western) Ltd. I cannot and do not accept the evidence of the plaintiff that he did not attach any significance to the dropping of the term “Ltd.” from the name of the business nor can I accept his evidence that he did not know of the existence of Rapid Addressing Systems Ltd. until that firm went into bankruptcy. On the other hand I feel I should say that in my opinion the conduct of the defendants in using the name Rapid Data (Western) Ltd. when they not only knew there was no corporation so named but had abandoned any intention of forming a corporation with that name, is reprehensible. I find it difficult to understand how any adult, even with less experience in the business world than the parties to this action, could be as ignorant of the significance of corporate names and their right to use such names and the effect of such [use] on other persons as has been alleged here. However, at the time of entering into ex. 1, the plaintiff did not know that Rapid Data (Western) Ltd. was not incorporated and the defendants did, but, I can see no causal connection between the damage suffered by the plaintiff and the breach of the warranty as to its existence. The fact that Rapid Data (Western) Ltd. was not incorporated and the fact that Rapid Data (Western) Ltd. was not the operator of the business did not cause the plaintiff ’s loss. Moreover, as pointed out above, shortly after he commenced working and shortly after the date of ex. 1 the plaintiff knew that the business was being carried on under the name Rapid Data (Western) which should have alerted any normal businessman to the fact that it was a firm rather than a corporation. If, as he says, he attached little significance to the omission of the word “Ltd.,” he would surely have attached little significance to the presence of that word in the name of the operator of the business originally presented to him. His loss, as I see it, resulted from the fact that the business was not a success, not from the breach of warranty. It may be that the plaintiff would be able to recover judgment for damages for wrongful dismissal against Rapid Data (Western) Ltd. if it existed, but, in the facts here, such a judgment would be no less an empty one than one recovered against Rapid Data (Western) since, although neither that firm nor its owner, Rapid Addressing Systems Ltd. (see below) has assets to pay it, the non-existent Rapid Data (Western) Ltd. is no less judgment proof. The plaintiff would be entitled to recover against the defendants under this head only that which he had lost by reason of the breach of warranty. See … Bowstead on Agency, 13th ed. At p. 392 Bowstead says: Where the agent is not personally liable on the contract, an action for breach of warranty of authority would only produce nominal damages, because since the company or association has no existence and so no funds, it would hardly be possible to prove a loss arising from

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II.  Pre-Incorporation Contracts the lack of authority: the case would be like that of an insolvent principal. Any effective liability would have to be in deceit, or possibly in negligence.

The plaintiff is therefore, as I see it, entitled only to nominal damages for this breach of warranty. He is entitled to such nominal damages against both defendants. •  •  •

I feel very sorry for the plaintiff because his entry into this business and its subsequent failure and his consequent loss of employment with it have caused a serious disturbance to his life and reduction of his earnings—but it does not follow that the defendants are liable for the loss. He is, as mentioned above, entitled to nominal damages which I fix at $10. Costs will follow the event. Judgment for plaintiff. NOTES AND QUESTIONS:

1.  Kelner v Baxter, Newborne v Sensolid, and Black et al v Smallwood can each be understood in terms of basic contract law, which interprets the contract based on the expressed intentions of the parties. In cases where the promoter expressed (through words or actions) an intention to be bound, the court found them personally liable. In cases where the promoter expressed, in good faith, an intention to be acting as agent for the company, the court deemed the contract a nullity, which aligns with the doctrine of mistake. In contractual terms, there could be no true “meeting of the minds” where one of the “minds” (albeit a corporate one) did not in fact exist. In Wickberg v Shatsky, however, the promoter knew that he was signing on behalf of a non-existent principal. How does that change the situation? Do you think that the court was right to show him the same leniency that it granted in the other cases? 2.  From these early cases, it is clear that judges were dissatisfied with the common law approach to pre-incorporation contracts, which encouraged opportunism and left many creditors uncompensated. It is equally clear that judges felt bound by the formalistic dicta of these cases, and were unwilling to use equitable discretion to change outcomes that they found unconscionable. These factors generated a pressure for legislative reform, which came through the development of modern business corporation statutes.

B.  Statutory Regime As explained above, some Canadian general business corporation legislation sets out statutory regimes for written and/or oral pre-incorporation contracts.2 The statutory regimes have two key features: (1) a default rule of promoter liability until the benefits and obligations under the pre-incorporation contract have been attributed to the firm post-incorporation,3 and (2)  a legal mechanism pursuant to which the firm may informally “adopt” a

2 Ibid. 3 CBCA s 14(1); OBCA s 21(1); ABCA s 15(2); BCBCA s 20(2); MCA s 14(1); SBCA s 14(1); YBCA s 17(2); NWTNBCA s 14(1); NFLCA s 26(1); NBBCA s 12(1)

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pre-incorporation contract.4 A default rule of promoter liability incentivizes promoters to carry out the incorporation process as quickly as possible, and allowing firms to “adopt” pre-incorporation contracts informally reduces transaction costs.5 The following extracts are from cases interpreting the statutory regimes.

Sherwood Design Services Inc v 872935 Ontario Ltd (1998), 3 OR (3d) 576 (CA) BORINS J (dissenting):  … On November 29, 1989, the individual respondents entered into an agreement of purchase and sale, “in trust for a Corporation to be incorporated,” with the appellant, Sherwood Design Services Inc. (“Sherwood”), to purchase the assets of its business for $300,000. The agreement was signed by the individual respondents and by Pino Tutino, in his capacity as the president of Sherwood, and provided for a closing date of January 15, 1990. In company law, an agreement of this nature is known as a “preincorporation contract.” The individual respondents retained the firm Miller Thomson to be their solicitors for the purpose of closing the transaction. An associate with the firm, Graham Nichols, was the actual solicitor responsible for performing the required legal work. It was the custom of Miller Thomson to incorporate a number of companies to have them available for use by their clients, particularly when a client required a corporation on short notice. These were known as “shelf companies.” Robert J. Fuller, a partner in the firm, was the sole director of each of the shelf companies, including the corporation. Following the execution of the agreement of purchase and sale, it was mutually agreed that the closing date would be extended from January 15, 1990, to January 22, 1990. The agreement did not close on January 22, 1990. Although Sherwood’s solicitor tendered, none of the individual respondents, the corporation, or the individual respondent’s solicitor was present. The failure of either the individual respondents, or the corporation, to close the transaction resulted in Sherwood’s claim against all of them for damages for breach of contract. On January 10, 1990, Mr. Nichols wrote a memorandum to Kellye Walker, a clerk in Miller Thomson’s corporate services department, on the subject: “McCreary et al. purchase of assets of Sherwood Design Services Inc.” The relevant part of the memo reads as follows: Further to my telephone call to Dianne Singer of yesterday afternoon in which I advised that we had undertaken an asset purchase on short notice, to close Monday [January 15, 1990], I require the following at your earliest convenience. … Our clients wish to use an Ontario corporation in order to complete the purchase of these assets. Accordingly would you please assign a shelf company (common shares only) to them and prepare organizational minutes for that company as follows: There are to be four directors:

4 CBCA s 14(2); OBCA s 21(2); ABCA s 15(3); BCBCA s 20(3); MCA s 14(2); SBCA s 14(2); YBCA s 17(3); NWTNBCA s 14(2); NFLCA s 26(2); NBBCA s 12(2); 5 See also Poonam Puri, “The Promise of Certainty in Pre-Incorporation Contracts” (2001) 80 Can Bar Rev 1051.

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II.  Pre-Incorporation Contracts William King Alex Pellizzari William McCreary Pino Tutino. The officers of the company are to be as follows: William McCreary Alex Pellizzari William King Pino Tutino

President and Secretary Chairman of the Board Vice-President Vice-President

I have not yet been advised as to the financial advisors to this company or as to the year end of the company. I will forward this information as soon as I have it. The shareholders and their respective shareholdings are to be as follows: William McCreary Alex Pellizzari William King Pino Tutino

30 common shares 30 common shares 30 common shares 10 common shares

•  •  •

Could you please ensure that I have the organizational minutes, etc. for execution by our clients on Friday morning. [Emphasis added.]

As requested by Mr. Nichols, on that day Ms Walker assigned a shelf company, the respondent 872935 Ontario Limited, to Messrs. McCreary, Pellizzari, King and Tutino. … By her memorandum of January 10, 1990, Ms Walker sent Mr. Nichols a number of organizational documents for signature. She advised him that a minute book and corporate seal had been ordered, and asked that he inform her of the date of the corporation’s financial year end at his earliest convenience. On January 11, 1990, Mr. Nichols wrote the following letter to Sherwood’s solicitors: Re. McCreary, King and Pellizzari Purchase of the assets of Sherwood Design Services Inc.

I wish to advise that 872935 Ontario Limited, which was incorporated on December 15, 1989 has been assigned by Miller Thomson as the corporation that will complete the asset purchase from Sherwood Design Services Inc. I have prepared organizational minutes and resolutions which provide for Messrs. McCreary, King, Pellizzari and Tutino to become the directors and shareholders of the corporation. The officers of the corporation shall be as follows: William McCreary Alex Pellizzari William King Pino Tutino

President and Secretary Chairman of the Board Vice-President Vice-President

I enclose herewith a certified copy of the Directors Resolution adopting the Asset Purchase Agreement, a Certificate of Incumbency and an Undertaking to Re-Adjust for your review and consideration. [Emphasis added.]

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Each of the enclosed documents was unsigned. The appellant’s position is that this letter constituted an action of the corporation signifying its intention to adopt the preincorporation contract within the meaning s. 21(2) of the OBCA. The relevant portion of “the Directors Resolution adopting the Asset Purchase Agreement” reads as follows: CERTIFIED COPY OF A RESOLUTION OF THE BOARD OF DIRECTORS OF 872935 ONTARIO LIMITED (THE “CORPORATION”) Adoption of Pre-Incorporation Contract WHEREAS by an Agreement of Purchase and Sale dated November 29, 1989 (the “Agree-

ment”) made between Sherwood Design Services Inc. (the “Vendor”) and William King, William McCreary, and Alex Pellizzari on behalf of a corporation to be incorporated (the “Purchaser”), the Vendor agreed to sell and the Purchaser agreed to purchase the assets of the Vendor (the “Property”) upon such terms and conditions as are more particularly set out in such Agreement; AND WHEREAS the Corporation is the corporation on behalf of which the purchaser entered into such Agreement; AND WHEREAS the Corporation wishes to adopt such Agreement as a contract made before it came into existence in its name or on its behalf; NOW THEREFORE BE IT RESOLVED that:

1.  the Agreement is hereby adopted as a contract made before the Corporation came into existence in its name or on its behalf; 2.  the Corporation is bound by the Agreement and is entitled to the benefits thereof as if the Corporation had been in existence at the date of the Agreement and had been a party thereto; 3.  William King, William McCreary and Alex Pellizzari, who purported to act in the name of or on behalf of the Corporation cease to be bound by or entitled to the benefits of the Agreement; 4.  the purchase of the Property by the Corporation is authorized and approved; and 5.  any director or officer of the Corporation is hereby authorized to sign and execute all documents and instruments and to do all things necessary or desirable to effect the adoption of such Agreement and complete the purchase of the Property, without limitation. The foregoing resolution is passed by all the directors of the Corporation pursuant to the Canada Business Corporations Act [sic], this 12th day of January, 1990. Alex Pellizzari [Emphasis added.]

William E. King William McCreary

None of the documents forwarded by Mr. Nichols to Sherwood’s solicitors were ever signed. Indeed, no steps were ever taken by Messrs. McCreary, Pellizzari and King to organize the corporation. None of the organizational documents which Ms Walker sent to Mr. Nichols for signature were signed. Clearly, there was never a resolution of the corporation adopting the pre-incorporation contract.

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On January 17, 1990, Ms Walker wrote a memorandum to Mr. Nichols which reads as follows: In connection with the organization of 872935 Ontario Limited, enclosed please find the Resignation of first director and Resolution of the sole director issuing the shares signed by Robert J. Fuller. Please insert same into the minute book of the Corporation.

Mr. Fuller’s resignation reads as follows: —RESIGNATION TO:  872935 ONTARIO LIMITED (the “Corporation”) AND TO:  The shareholders thereof.

I hereby tender my resignation as a director of the Corporation, such resignation to become effective upon the election or appointment of my successor. DATED the 15th day of December, 1989.

“Robert Fuller” Robert J. Fuller

Mr. Fuller was the corporation’s first, and only, director. It is significant to note that the resignation was dated the same date as the corporation was incorporated, as was the resolution which Mr. Fuller signed as sole director of the corporation, issuing the common shares of the corporation to Messrs. McCreary, Pellizzari, King and Tutino upon receipt by the corporation of full payment for them … . … [T]he transaction failed to close on January 22, 1990. As a result, Mr. Nichols wrote the following memorandum to Dianne Singer, Miller Thomson’s head of Corporate Services, on March 6, 1990: Re:  872935 Ontario Limited 9799-002

You will also recall that I requested that you set aside an Ontario corporation to be used to purchase the assets of Sherwood Design Services Inc. In response to my request you set aside 872935 Ontario Limited and prepared organizational resolutions for this company. The organizational resolutions were never executed by our client because, once again, the transaction contemplated was never completed. I am returning the Minute Book for 872935 Ontario Limited. I will keep the organizational resolutions, unexecuted in the asset purchase file. The corporation may be returned to the shelf for use of another of our clients. Any share ledgers or registers etc. will have to be removed from the Minute Book.

Because the transaction failed to close, and the corporation was never organized for the purpose of closing it, Mr. Fuller’s resignation as its sole director did not become effective. When Mr. Nichols returned the corporation to Ms.  Singer on March 6, 1990, Mr. Fuller continued to be its sole director, as he had been since its incorporation. Indeed, Mr. Fuller remained the corporation’s sole director until April 26, 1990. That was the date when Miller Thomson assigned the corporation to different clients to be used by them to purchase a commercial building.

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These clients became the sole officers and directors of the corporation. Since May 1, 1990, the business of the corporation has been the ownership of the commercial building. The evidence established that when the new clients became the owners of the corporation they were unaware of the pre-incorporation contract between Sherwood and the individual respondents and the fact that the transaction, contemplated by the contract, had not closed. The first time they learned of this was when Sherwood’s statement of claim was served on the corporation … . Findings of the Trial Judge Although Sherwood sued the individual respondents and the corporation, and acknowledged that under s. 21(1) of the OBCA the individual respondents were personally bound by the agreement, the position which it took at trial was that the corporation was bound by the pre-incorporation contract because the letter sent by Mr. Nichols to Sherwood’s solicitors on January 11, 1990, signified its intention to be bound by the contract within the meaning of s. 21(2). It is obvious that Sherwood had no desire to obtain a judgment against the individual respondents because they have no assets. Its intention, as evidenced by this appeal, was to obtain recovery from the corporation which, in the circumstances described above, had been acquired by strangers to these proceedings and had purchased a valuable commercial building. Thus, in the context of the position taken by Sherwood at trial, the primary issue to be decided by the trial judge was whether the corporation was bound, pursuant to s. 21(2) of the OBCA, by the terms of the agreement of purchase and sale executed by the individual respondents when the corporation had no legal existence. In holding that the corporation was not bound by the terms of the agreement under s. 21(2), and that the individual respondents were bound by its terms under s.  21(1), the trial judge made findings of fact which, in my view, fully support his decision. [Section 21 text and review of findings at trial omitted.] Pre-Incorporation Contracts The Common Law An analysis of the decision of the trial judge must necessarily encompass an examination of the common law position respecting rights and obligations arising from pre-incorporation contracts and the legislative response to the unsatisfactory state of the common law. In this province, the legislative response is found in s. 21 of the OBCA. … The starting point is the law of contract and the law of companies. It is a fundamental principle that the offeror may invite acceptance of his or her offer by one or more offerees, acting separately or together. Almost 150 years ago, Pollock CB stated: “It is a rule of law, that if a person intends to contract with A, B cannot give himself any rights under it.” … Thus, the general rule is that only an offeree can accept an offer. It is also a fundamental principle that a company has no existence before its incorporation. Whether an offeree can accept an offer on behalf of another person, thereby investing that person with the contractual rights and liabilities consequent to the contract created by the offeree’s acceptance of the offer, becomes the focus for a review of the common

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law rules pertaining to rights and liabilities emanating from a contract entered into on behalf of a corporation before its incorporation, and the legislative response to the common law position. It is necessary to acknowledge that, in the world of commerce, pre-incorporation contracts are a daily occurrence. They represent a necessary stage in the process of the incorporation of many companies. [B]usiness opportunities arise and often must be seized before the business person has had the opportunity to incorporate a company as the desired vehicle for the conduct of the business. This usually entails a person, described in the academic literature as “the promoter,” entering into a contractual relationship with a third party on behalf of the nascent corporation. In such circumstances, it can be said the pre-incorporation contract is intentional in the sense that the promoter knows that the corporation has not yet been formed, but wishes to contract in its name or on its behalf. However, there are other pre-incorporation contracts which occur by accident, when the promoter purports to contract for a corporation that he or she believes, or expects, already to be in existence. Whether a pre-incorporation contract is intentional or accidental, the determination of the rights and liabilities flowing from such a contract has been a source of difficulty for the common law for generations.  … [C]ourts in England and other Commonwealth countries have seemed to attach less importance to effecting justice and more to attempting to fit round pegs into square legal pigeon-holes, so that ultimately, in virtually all jurisdictions, it has been necessary to rescue the lawyers from the dilemma that their own fictions have created by having recourse to legislative solutions. [Review of Kelner, Newborne, and Black omitted.] For many years, the decision in Kelner v. Baxter was taken as authority for the proposition that, where an individual purports to contract on behalf of a named corporation before that corporation has come into existence, the individual is personally liable on the contract. However, subsequent cases, notably the decisions of the English Court of Appeal in Newborne v. Sensolid (Great Britain) Ltd. (1953), [1954] 1 QB 45 (Eng. CA), and the High Court of Australia in Black v. Smallwood (1966), 117 CLR 52 (Australia HC), have established that no such general principle exists. •  •  •

Thus, in Kelner v. Baxter the parties intended, or were deemed to have intended, that the promoters would be personally liable. In Newborne v. Sensolid and Black v. Smallwood, it was found to be the intention of the parties that the promoters would not be personally liable. The effect of these decisions was to challenge the long-held belief that Kelner v. Baxter laid down the categorical rule that a promoter is always personally liable on a pre-incorporation contract. Statutory Reform of the Common Law I have referred to these three cases in some detail to illustrate the unsatisfactory state of the common law of pre-incorporation cases. There are many other cases which also do so, and they are discussed in the academic literature. … The common law had reached a stage where it was uncertain, inconvenient and frequently unjust. It was fraught with

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difficulties for promoters, companies and the public at large. In many cases, third parties were denied relief based on highly artificial conclusions regarding the parties’ intentions. More importantly, the inability of the corporation, on coming into existence, to adopt a contract made for its benefit was often manifestly inconsistent with the parties’ intention. As a result, statutory reform has been attempted in many jurisdictions. … Reform of the common law in Ontario followed the recommendations of the Lawrence Committee: Interim Report of the Select Committee on Company Law, Legislative Assembly of Ontario, 1967. … The Lawrence Committee’s three basic propositions were:

(1) The corporation should be able to adopt or ratify a pre-incorporation contract made on its behalf; (2) Prior to any such adoption, the promoter should be personally liable on the contract and entitled to enforce it; and (3) The court should have discretion, in appropriate circumstances, to apportion liability between the promoter and the corporation. These propositions formed the basis of legislation introduced in the Business Corporations Act, RSO 1970, c. 53, s. 20 which was continued in RSO 1980, c. 54, s. 19. With some amendments, the Lawrence Committee’s propositions formed the basis for federal legislation in 1975: Canada Business Corporations Act, SC 1974-75 [-76], c. 33, s. 14, now RSC 1985, c. C-44, s. 14 (CBCA). In 1982, Ontario adopted a revised Business Corporations Act, based largely on the CBCA, which copied s. 14 of the CBCA almost verbatim: SO 1982, c. 4, s. 21, now RSO 1990, c. B.16, s. 21. The intent of the statutory reforms was to eliminate the problems of the common law of pre-incorporation contracts. The elements of s. 14 of the CBCA and s. 21 of the OBCA are as follows: • A promoter who enters into a contract, by or on behalf of a corporation before it comes into existence, is personally bound to perform the contract and is entitled to its benefits. • If a corporation comes into existence and adopts the contract  –  the corporation is bound by and is entitled to the benefits of the contract, and  –  the promoter is no longer bound by or entitled to the benefits of the contract. • The other contracting party may apply to a court for an order fixing both the corporation and the promoter with liability (joint, joint and several, or apportioned) regardless of whether or not the corporation has adopted the contract. • The other contracting party and the promoter may agree in the contract that the promoter is not bound by the contract in any event. Discussion Section 21 of the OBCA … reflects the inviolability of the corporate form. The corporation is given the option to adopt a contract entered in its name, or on its behalf, before coming into existence, instead of being bound automatically to pre-incorporation agreements upon incorporation. As such, the corporation is required to take positive steps if it wishes to adopt the contract. This requires that it have knowledge of the contract and its terms. In this way, s.  21 accepts and propagates the philosophical and legal fiction of the

363

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corporation as a separate and distinct personality. However, it does not do so at the expense of third parties, who are not without recourse in circumstances where the contract is breached. Although the corporation is not automatically bound by the contract at its inception, third party interests are protected. Section 21(1) ensures that the promoter is bound by the agreement until it has been adopted by the corporation, unless, under s. 21(4), the parties expressly provide that the promoter is not bound by the contract or entitled to its benefits. •  •  •

It is helpful to repeat the relevant language of s. 21(2): A corporation may, within a reasonable time after it comes into existence, by any action or conduct signifying its intention to be bound thereby, adopt an oral or written contract made before it came into existence in its name or on its behalf … . [Emphasis added.]

As the trial judge correctly recognized, central to a corporation’s adoption of a preincorporation contract by “action” or “conduct”—as contrasted with formal adoption of it by a resolution of the board of directors—is that the “action” or “conduct” must be that of the corporation. It must be “action” or “conduct” of an officer, director or employee of the corporation, or by an agent, or some other person, held out by it to act on its behalf. As I have stated, the issue in this appeal is what constitutes “action” or “conduct” by a corporation signifying its intention to be bound by a pre-incorporation contract within the meaning of s. 21(2), and, specifically, whether Mr. Nichols’ letter of January 11, 1990, comes within s. 21(2). … Where there has been no formal adoption, as in this appeal, the question thus becomes: what factors will the court take into consideration in deciding whether there was any action or conduct of the corporation, and whether it is sufficient to constitute its intention to be bound by the contract? In this appeal, the trial judge found it unnecessary to proceed beyond the first branch of the question. He found that the corporation did nothing and, therefore, there was no action or conduct of the corporation which signified its intention to be bound by the pre-incorporation contract. The essence of his finding is that the corporation did not write the letter of January 11, 1990, did not instruct Mr. Nichols to write it and was not Mr. Nichols’ client when it was written. This finding was fully supported by the evidence of Mr. Fuller, the salient aspects of which were: • the corporation was not incorporated for the purpose of completing the preincorporation contract; • the corporation was one of Miller Thomson’s roster of shelf companies available for the use of the firm’s clients as the need arose; • the corporation was assigned by Miller Thomson to be used by Mr. Nichols’ clients, who were the individual respondents; • when the corporation was assigned, Mr. Fuller was its sole directing mind and had no knowledge of the pre-incorporation contract. In my view, the result reached by the trial judge and the construction he placed on s. 21(2) fully accords with well accepted principles of company law. … … If a corporation is formed after the pre-incorporation contract is signed, it must be established that it is the corporation on behalf of which the promoter entered into the contract.

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Should this be established, fundamental principles of company law must be applied. A corporation has the freedom to choose whether to accept, or reject, the pre-incorporation contract. It must be given the option of rejecting it. It can neither accept, nor reject, the contract, nor can it take any action on it, without knowledge of the contract and its terms. •  •  •

Because the trial judge found the letter of January 11, 1990, from Mr. Nichols to Sherwood’s solicitors did not constitute action or conduct of the corporation, it is unnecessary to deal with the issue of whether the letter constituted action or conduct signifying the intention of the corporation to be bound by the contract. •  •  •

Sherwood cannot presume in its own favour that the letter of January 11, 1990, was an act of the corporation signifying its intention to be bound by the pre-incorporation contract, if an inquiry that it ought to have made would have disclosed that the corporation was unaware of the contract at that time. As I have pointed out, the unsigned draft resolution of the directors adopting the contract was sufficient to place Sherwood’s solicitors on notice that the corporation had not adopted the contract. This document, together with the other unsigned documents sent with the letter, made it obvious that the corporation had not been formed, and, thus, had not had the opportunity to direct its mind to whether it would adopt, or reject, the pre-incorporation contract. In contracting with the individual respondents in trust for a company to be incorporated, Sherwood assumed the risk that it might not be incorporated, or, if incorporated, might not adopt the pre-incorporation contract. One of the uncertainties of the common law which s. 21 was intended to remedy was to ensure that a party in Sherwood’s position was not left without a remedy should either circumstance occur, by making the promoters liable to perform the contract. Conclusion In my opinion, the trial judge did an admirable job of charting a course through an area of law which, at first blush, may appear to be disarmingly simple, but which, after an examination of the common law, legal treatises and legislative attempts to find an equitable solution to a seemingly insoluble legal problem, is very complex. For all of the above reasons, I would dismiss the appeal with costs. ABELLA JA (for the majority):  The issue in this appeal is the correct application and interpretation of s.  21 of the Ontario Business Corporations Act (SO  1982, c.  4). The underlying question is whether the respondent, 872935 Ontario Limited, adopted—and is thus liable for the breach of—the agreement for purchase and sale entered into by Sherwood and the individual respondents. The success of Sherwood’s claim against the numbered company is dependent upon its ability to bring itself within the language of s.  21(2). The trial judge dismissed Sherwood’s claim against the numbered company, finding that “there has been demonstrated on this record no intention [by the numbered company] to adopt or adoption in fact for the agreement of purchase and sale.” ([1994] OJ No. 2464 (Gen. Div.)) Sherwood appeals this finding.

[Review of facts omitted.]

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Analysis •  •  •

The essence of the argument made by the individual purchasers is that the purpose of the January 11, 1990 letter from their lawyer was merely to identify the corporation to be used on closing. When the letter was sent, the necessary documentation had not yet been completed to give the personal purchasers actual ownership of the company. In the absence of this formal evidence of ownership, the purchasers cannot be said to have had control of the company when the letter was sent. Accordingly, the letter could not have reflected an intention on the part of the individual purchasers that a company they controlled would complete the agreement. This argument is, with respect, more sophistry than analysis. The trial judge found that there was an agreement between Sherwood and the personal purchasers who were acting as trustees or agents “for a company to be incorporated.” Subsequent to the signing of that agreement, the lawyer acting for those purchasers wrote to inform the vendor’s lawyer that a company had in fact been incorporated “to complete the asset purchaser from Sherwood Design Services Inc.” This, it seems to me, is more than mere identification of the corporate vehicle. It is the signification of the company’s intention to be bound by, and accordingly to adopt, the contract. In these circumstances, it is difficult to see how the January 11, 1990 letter escapes a common sense interpretation of s. 21(2) of the Business Corporations Act. The provision allows a corporation, “by any action or conduct signifying its intention to be bound thereby,” to adopt a contract made before the corporation came into existence. There is nothing in the language of the section to suggest a requirement of formal documentation before any such intention can be extracted. Nor is there any suggestion emerging from the language that only on closing can one be certain that the prior contract has been adopted, or that there is any necessity that the ultimate shareholders and directors be in place. The solicitors were the directors and had authority from their clients to convey an intention to be bound. Section 21(2) does not set out the “manner of adoption,” and there is no principled basis for imposing a stringent requirement of formality. Parties should be able to take at face value letters such as the one sent—and received—in good faith by the purchasers’ lawyer on January 11, 1990. The January 11, 1990 letter was sent by the purchasers’ lawyer, someone who clearly had the authority to send it. It is irrelevant that at the moment the letter was sent, the company was not actually transferred to the individual purchasers. It was in existence, it was identified as being designated for the purpose of closing the purchase, and it awaited only the formal documentation transferring the shares. The letter was an unequivocal expression of 872935 Ontario Limited’s adoption and intention to complete the agreement of purchase and sale. These statutory provisions have a very practical purpose in contract negotiations and should be interpreted in light of the realities of what occurs on a day-to-day basis. Individuals may negotiate an agreement in which one or the other, or both, do not wish to incur personal liability. Importantly, one side agrees to forgo security and deal with a shell company. The corporate vehicle to replace the parties may not be immediately available, but it is agreed that once it is in place and adopts the agreement, the individuals on that

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side of the agreement will have no remaining liability. There is, in those circumstances, no reliance on the individual’s covenant, except in the interim. It is not a case of assignment or replacement of a covenant by that of a fresh entity requiring scrutiny. That is why a simple notification of intent is all that is required. It is known from the outset that a shell company will be on the other side of the closing and a minimum of formality is required, sufficient in essence to permit the parties to prepare for closing with certain knowledge of who the vendor and purchaser will be, and who will be responsible for a failure to close. Accordingly, I would allow the appeal. … [Concurring judgment of Carthy JA omitted.] Appeal allowed.

Shoppers Drug Mart Inc v 6470360 Canada Inc (Energyshop Consulting Inc/ Powerhouse Energy Management Inc) 2014 ONCA 85 PEPALL JA:

[1]  This appeal and cross-appeal address the intersection of corporate and personal liability in the operation and conduct of a corporation having only one officer, director and shareholder. •  •  •

[4] Shoppers is a drug store franchisor that has over 1,000 retail stores across Canada. [5]  In October 2005, Shoppers contracted with “Energyshop Consulting Inc.” (“Energyshop”) to manage and pay utility bills for Shoppers’ stores on a nationwide basis (the “2005 Contract”). The contract was negotiated by Beamish [647’s sole officer, director, and shareholder]. The 2005 Contract bore his typewritten name, described his position as “President,” and identified his email address at Energyshop. At the time, Energyshop was not incorporated. Several weeks after entering into the 2005 Contract, Beamish incorporated 647. [6]  The parties never formally executed the 2005 Contract but both Shoppers and 647 agree that it was binding upon them and they acted in accordance with its terms. [7]  In 2007, Energyshop announced that it had changed its name to Powerhouse. [8]  Shoppers believed it had contracted with a corporation and was unaware until after the ?litigation started that Energyshop and Powerhouse were not registered corporations. Furthermore, Shoppers was unaware of 647’s existence until after it had commenced this action. [9]  Under the 2005 Contract, Shoppers directed utility companies to send their bills for Shoppers to Energyshop (and later Powerhouse). 647 then collected and organized the bills and periodically sent a remittance summary to Shoppers. Each remittance

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summary specified the total amount of that period’s utility bills payable by Shoppers. Each also specified the processing fee for this service payable to 647. [10] On receiving a remittance summary, Shoppers would transfer the invoiced amount to a Toronto-Dominion Bank account which was in the joint names of 647 and Beamish (the “Clearing Account”). The Clearing Account was used to receive all funds from Shoppers, and in turn, to pay Shoppers’ utility bills. Beamish signed off and approved every transfer from the Clearing Account. [11]  If Shoppers did not transfer the required funds within five business days of receipt of the remittance summary, it was responsible for any late fees. Otherwise, 647 was responsible for late fees charged by the utility companies. By early 2007, the late fees for 647’s account had become very onerous. [12]  647 either used the funds received from Shoppers to pay Shoppers’ utility bills or transferred them to a separate Toronto-Dominion Bank account that was used to pay 647’s operating expenses (the “Operating Account”). That account was also in the joint names of 647 and Beamish. •  •  •

[14]  In August 2008, Shoppers received an anonymous telephone call and fax indicating that funds it paid into the Clearing Account were being used for activities other than the payment of utility bills. Ultimately, Shoppers came to the conclusion that something was amiss with its relationship. On February 2, 2009, Shoppers delivered a notice terminating 647’s services. [15]  On February 25, 2009, Shoppers and 647 signed a transition agreement whereby they mutually confirmed the termination of the contract (the “Transition Agreement”). It indicated that for the period prior to February 1, 2009, Shoppers had reconciled its payments and the parties acknowledged that as a result of the reconciliation, Shoppers had overpaid 647 by $47,000. Furthermore, 647 would cease to process and pay utility bills as of February 2, 2009. The parties also signed a mutual release as part of the agreement. [16]  In the week prior to delivering its termination letter on February 2, 2009, Shoppers had transferred $1,370,338.32 to the Clearing Account, intending that $1,366,558.20 be used for payment of utility bills and $3,780.12 for 647’s processing fees. Following receipt of the?termination letter, Beamish caused 647 to transfer $970,000 of this amount to the Operating Account. Consistent with the direction in the February 25, 2009 Transition Agreement not to pay any utility bills after February 2, 2009, 647 did not do so. On February 25, 2009, Shoppers began to receive notices of default from various utility providers in respect of outstanding invoices that, in its view, 647 ought to have paid. [17]  On March 9, 2009, Shoppers commenced an action to recover its funds. 647 and Beamish consented on March 11, 2009 to an order that all of the money that remained in both the Clearing and Operating Accounts, which totalled $796,434.11, be paid to Shoppers. [18]  Thereafter, Shoppers brought its motion for summary judgment against both respondents seeking payment of the remaining funds that it alleged had been misappropriated. Beamish responded with two motions to dismiss the action against him personally pursuant to Rules 20 and 21 of the Rules of Civil Procedure, R.R.O., Reg. 194.

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[Although the motions judge granted summary judgement against 647 in favour of Shoppers, he did not find Beamish personally liable for unjust enrichment in relation to the 2005 contract] Grounds of Appeal [28]  Shoppers advances three grounds of appeal as against Beamish. It argues that the motions judge erred in finding: (i) that Beamish was not personally liable under the 2005 Contract pursuant to s. 14 of the Canada Business Corporations Act, R.S.C., 1985, c. C-44; (ii) that Beamish had not been unjustly enriched by the misappropriation; and (iii) that the corporate veil should not be pierced. •  •  •

Shoppers’ Appeal (i)  Section 14 of the CBCA [31]  Firstly, Shoppers submits that the motions judge erred in not finding Beamish personally liable under the 2005 Contract pursuant to s. 14 of the CBCA. [32]  Section 14 provides that a person who enters into a contract on behalf of a nonexistent corporation is personally bound by the contract and entitled to its benefits. If a corporation within a reasonable time subsequently adopts the contract, the individual is released from liability and the corporation is bound. •  •  •

[34]  Shoppers argues that the motions judge failed to find that 647 had adopted the contract, and that there is no evidence to support such a finding. The reasoning of the motions judge suggests that Beamish escaped liability because of Shoppers’ belief that it had contracted with a corporate entity and due to the absence of any intention by Beamish to mislead Shoppers in this respect. [35]  In my view, this argument must be rejected. Pursuant to s. 14(2) of the CBCA, formal adoption is not required; it is enough for the corporation by its conduct to signify its intention to be bound. Section 14(2) is almost identical to s. 21(2) of the Ontario Business Corporations Act, R.S.O. 1990, c. B.16. In discussing that statute, Abella J.A. (as she then was) stated in Sherwood Design Services Inc. v. 872935 Ontario Ltd. (1998), 39 O.R. (3d) 576 (C.A.), at p. 581, that s. 21(2) does not set out the “manner of adoption” and there is no principled basis for imposing a stringent requirement of formality. [36]  At paragraph 7 of his reasons, the motions judge wrote: The evidence is equally clear that the flaws in 647’s incorporation and trade name process were errors of form, not substance. That is, Beamish was ignorant of the fact that his company’s trade names should have been formally registered and that 647, once incorporated, should have formally adopted the previously agree-upon (sic) Contract with Shoppers. There is no evidence that Beamish intended to, or ever did, hold himself out as contracting

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II.  Pre-Incorporation Contracts personally with Shoppers. Both sides at all times understood that they were dealing with a corporate party. (Emphasis added.) ?

[37]  It is implicit from the motions judge’s reasons that he considered that 647 had, by its conduct, signified its intention to be bound and in substance had adopted the contract. Indeed, at the time, both parties to the contract were also of that view. According to the motions judge’s findings, 647 performed the work of collecting utility bills, sending remittance summaries to Shoppers and paying the bills. In performing these contractual obligations, 647 effectively adopted the 2005 Contract. Additionally, the case is distinguishable from Pelliccione v. John F. Hughes Contracting and Development Co. (2005), 47 C.L.R. (3d) 104 (Ont. S.C.) where no new corporation came into existence after the parties entered the contract, so adoption under s. 21(2) was impossible. While I agree with Shoppers that the absence of an intention to mislead is not determinative, in my view, the motions judge did not rest his conclusion on that basis. I would not give effect to this ground of appeal. [The court went on to consider Shoppers’ other claims, and further issues advanced by Beamish and 647 in their cross-appeal.] NOTES AND QUESTIONS

1. In Sherwood Design, the court was divided over whether the unsigned lawyer’s letter constituted “action or conduct” signifying the corporation’s intention to be bound. While Justice Abella applied the plain language of the OBCA provision, Justice Borins interpreted it in light of the common law doctrines that came before. Which conclusion achieved the OBCA’s objective of clarifying and correcting the common law rules of pre-incorporation contracts? 2. In Shoppers Drug Mart, the court accepted evidence that 647 was acting on its contractual obligations as sufficient indication of an intent to adopt the contract, even in absence of clear documentation. Contrast this with Sherwood Design, where there was indicative documentation, but no action.

Szecket v Huang (1998), 42 OR (3d) 400 BY THE COURT:  The issue raised by this appeal is whether Conant J. correctly applied s. 21(1) of the Business Corporations Act, R.S.O. 1990, c. B.17 (the “OBCA”) in finding that the appellant, Geoffrey Huang, was personally liable to the respondents, Alexander Szecket and Alberto Geddo, for the breach of a contract which the appellant, and others, entered into with the respondents “on behalf of a company to be formed,” in circumstances where the company was not formed and the contract was not performed. It is the position of the appellant that under s. 21(4) of the OBCA he was not bound by the contract.

Facts Dr. Szecket, a research scientist, and his associate, Mr. Geddo, a consulting engineer, developed a process, or technology, for the bonding of dissimilar metals called

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“Dynamic Bonding,” for which Dr. Szecket held three patents. In the mid-1980s they lived, and were employed, in the Toronto area. About 1985 they were approached by Mr. Huang who represented that he was aware of specific opportunities in Taiwan for the development of the respondents’ technology, including the financing required to do so. Over the next three years, considerable discussion took place between the respondents and the appellant and his associates toward the goal of the formation of a business relationship to develop and market the respondents’ technology in Taiwan. … •  •  •

The evidence disclosed that it was the respondents’ wish that Mr. Mien and Mr. Huang personally guarantee the benefits the respondents were to receive under the contract. To that end, the respondents instructed their solicitor to include the following provision in the second draft of the proposed contract: The parties MIEN and HUANG personally guarantee the payment to the Licensor of the Licence and Technical Assistance Fees payable during the initial three year term of this agreement as set forth in Article 3 of this Agreement.

In addition, this draft provided that Mr. Mien and Mr. Huang were to execute the agreement “Personally and on behalf of a Company to be incorporated.” However, Mr. Mien and Mr. Huang were opposed to providing their personal guarantees. Consequently, when the final draft of the agreement was prepared it did not contain the above provision and the words “Personally and” below the signatures of Mr.  Mien and Mr.  Huang had been deleted. The agreement contained no provision expressly providing that Mr.  Mien or Mr.  Huang were not bound by the contract or entitled to its benefits. •  •  •

In general, this was a licence agreement pursuant to which the respondents granted the company to be formed a licence to use their technology to manufacture products and provide services in Taiwan for the three-year term of the agreement. The respondents were to reside in Taiwan and supervise the operations of the company. Mr. Lu was to provide capital of a minimum of Taiwan $20 million. Except for the provision in art. 3 for the payment of the respondents’ fees … , there is no need to review any of the other provisions of the agreement in any detail. This is because the contract was not performed. Mr. Lu did not provide the capital and Mr. Huang and his associates did not form the company. The respondents, who had given up their employment in Canada, moved to Taiwan in the autumn of 1988. Ultimately, they returned to Canada in March 1989, and began to seek employment. Because the appellant has taken issue with the trial judge’s assessment of the respondents’ damages, it is necessary to review the compensation they were to receive pursuant to art. 3 of the agreement. Dr. Szecket and Mr. Geddo each were to receive a weekly fee, living and travel expenses, the use of two cars, insurance coverage, an allowance for meals, an equity position in the company to be formed, 10 per cent of the company’s annual profit and a royalty of 10 per cent of the net sales of the company for a period of ten years. … •  •  •

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The Trial Judge’s Reasons Conant J. stated that the issues to be determined were:

1. Is Huang personally liable for the breach of contract when he signed “on behalf of a company to be incorporated”? 2. Is Huang liable for negligent misrepresentation? ? It would appear from the reasons of the trial judge that it was common ground that the agreement had been breached and that the only issue was whether Mr. Huang was personally liable for the breach. As the company had not been formed, Conant J. found Mr. Huang personally liable to compensate the respondents for the damages they suffered as a result of the breach by applying s. 21(1) of the OBCA and common law principles. It is to be noted that although the respondents sued all three individuals who had entered into the contract on behalf of the company to be formed, they subsequently discontinued their action against Mr. Mien and Mr. Lu because they did not know their whereabouts for the purpose of serving them with the statement of claim. •  •  •

Because of our view of this appeal, there is no need to deal further with Conant J.’s analysis which led to his finding of liability pursuant to s. 21(1) of the OBCA. As stated earlier our view of the appeal precludes any need to review the trial judge’s finding of liability based on the negligent misrepresentation of the appellant. •  •  •

Analysis Liability The only liability issue before this court is whether the trial judge was correct in his application of s. 21(1) of the OBCA in finding Mr. Huang liable for the non-performance of the contract. Counsel for Mr. Huang took the position that the trial judge erred in doing so and that he should have applied s. 21(4) of the OBCA and found that Mr. Huang had contracted out of the personal liability imposed by s. 21(1). Counsel for the respondents took the position that s. 21(4) has no application to the circumstances of this case as there was non-compliance with the strict requirements imposed by s. 21(4) for the limitation of personal liability of one who enters into a contract on behalf of a company to be formed. •  •  •

Counsel for the appellant argued that the trial judge erred in failing to invoke s. 21(4) to exclude the appellant from personal liability under s.  21(1) on the evidence that Mr.  Huang had expressed a clear intention not to assume personal liability for the obligations of the company to be incorporated. He pointed to the position taken by the respondents in their initial negotiations with Mr. Huang and his associates that they should assume personal responsibility for the obligations of the company. Counsel submitted that the respondents’ position was manifested by the second draft of the agreement, which contained a guarantee by Mr. Huang and Mr. Mien of the obligations

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of the company and required that they execute the agreement both in their personal capacity, and on behalf of a company to be incorporated. This guarantee was ultimately deleted from the draft of the agreement at the insistence of Mr. Huang and his associates, which they executed solely on behalf of the company to be incorporated. It was counsel’s position that this satisfied the requirements of s.  21(4) and relieved Mr.  Huang of personal liability under s.  21(1) when the company was not incorporated and the contract was not performed. Counsel for the respondents, on the other hand, submitted that s. 21(4) has no application to the circumstances of this appeal. He argued that s. 21(4) requires that an express term be included in a pre-incorporation contract to limit the liability of a person signing it on behalf of a company to be formed. As there was no express term in the contract limiting the appellant’s liability, this contract did not fall within the class of contracts contemplated by s. 21(4), with the result that Conant J. correctly found Mr. Huang liable for the breach of the contract pursuant to s. 21(1). In our view, the submission of counsel for the respondents is correct. Counsel for the appellant and the respondents directed us to the analysis of the law of pre-incorporation contracts found in the dissenting reasons of Borins J.A. in Sherwood Design Services Ltd. v. 872935 Ontario Ltd. (1998), 39 O.R. (3d) 576 at pp. 593-600, 158 D.L.R. (4th) 440 (C.A.) where he explored the common law position respecting rights and obligations arising from pre-incorporation contracts and the legislative response to the unsatisfactory state of the common law, with particular emphasis on the legislative history and evolution of s. 21 of the OBCA. •  •  •

In the Sherwood case, at the conclusion of his legal analysis, Borins J.A. summarized the elements of s.  21 of the OBCA and its counterpart, s.  14 of the Canada Business Corporations Act, R.S.C. 1985, c. C.44, at pp. 599-600: The intent of the statutory reforms was to eliminate the problems of the common law of pre-incorporation contracts. The elements of s. 14 of the C.B.C.A. and s. 21 of the O.B.C.A. are as follows:

• A promoter who enters into a contract, by or on behalf of a corporation before it comes into existence, is personally bound to perform the contract and is entitled to its benefits. ? • If a corporation comes into existence and adopts the contract  –  the corporation is bound by and is entitled to the benefits of the contract, and ?  –  the promoter is no longer bound by or entitled to the benefits of the contract. ? • The other contracting party may apply to a court for an order fixing both the corporation and the promoter with liability (joint, joint and several, or apportioned) regardless of whether or not the corporation has adopted the contract. • The other contracting party and the promoter may agree in the contract that the promoter is not bound by the contract in any event. ? He continued at p. 600:

Section 21 of the O.B.C.A., which is reproduced in para. 44 [p. 590 ante], reflects the inviolability of the corporate form. The corporation is given the option to adopt a contract entered in its name, or on its behalf, before coming into existence, instead of being bound

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II.  Pre-Incorporation Contracts automatically to pre-incorporation agreements upon incorporation. As such, the corporation is required to take positive steps if it wishes to adopt the contract. This requires that it have knowledge of the contract and its terms. In this way, s. 21 accepts and propagates the philosophical and legal fiction of the corporation as a separate and distinct personality. However, it does not do so at the expense of third parties, who are not without recourse in circumstances where the contract is breached. Although the corporation is not automatically bound by the contract at its inception, third party interests are protected. Section 21(1) ensures that the promoter is bound by the agreement until it has been adopted by the corporation, unless, under s. 21(4) the parties expressly provide that the promoter is not bound by the contract or entitled to its benefits.

The term “promoter” is used in the legal literature to identify the individual who has entered into a contract on behalf of a company to be incorporated, and in the circumstances of this appeal is the appellant, Mr. Huang. In our view, the final sentence in the above passage provides a complete answer to this appeal. Section 21(4) is clear and unambiguous. To limit the liability of a person who enters into a pre-incorporation contract, an express provision to that effect must be contained in the pre-incorporation contract. The contract in this appeal did not contain such an express provision. Whatever may have been the result of the negotiations between the parties preceding the execution of the contract about the personal responsibility of Mr. Huang for the obligations of the company to be incorporated, the contract itself contained no express provision relieving Mr. Huang from personal liability under s. 21(1) if the company was not incorporated, or if it was incorporated, and failed to adopt the contract. Had he wished to avail himself of s. 21(4), Mr. Huang could have sought the consent of the respondents to include an appropriate provision in the agreement. In the absence of such a provision, it follows, in our view, that Conant J. was correct in his application of s. 21(1) to the circumstances of this appeal and his conclusion that Mr.  Huang was personally liable for the breach of the contract. … •  •  •

Result For all of the above reasons, the appeal is dismissed with costs.

1394918 Ontario Ltd v 1310210 Ontario Inc (2002), 57 OR (3d) 607 (CA) CARTHY JA:

[1]  … The legal issue concerns the application of s. 21 of the Business Corporations Act, R.S.O. 1990, c. B.16, to the facts of a real estate transaction. The appellants are the vendor company and individuals associated with it. The purchaser under the agreement of purchase and sale was “Raymond Stern in trust for a company to be incorporated and not in his personal capacity.” When the vendor repudiated the contract, Stern accepted

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the repudiation and then incorporated the plaintiff to pursue damages. The motions judge, in reasons reported at [2001] O.J. No. 334, held that the plaintiff had status to pursue the action. [2]  A brief chronology of the real estate transaction follows: October 14, 1999  1310210 Ontario Inc. entered into an agreement to sell land to “Raymond Stern in trust for a company to be incorporated and not in his personal capacity” for $4.7 million with a deposit of $3,000. Ninety days was given for the purchaser to waive certain itemized conditions whereupon a further deposit of $27,000 was to be paid. Failure to waive conditions within the prescribed time would render the agreement null and void. Closing was fixed for April 16, 2000. December 27, 1999  “Raymond Stern in trust for a company to be incorporated and not in his personal capacity” signed an amending agreement extending the time for waiver of conditions and closing for one month. December 31, 1999  The amending agreement was signed on behalf of the vendor by David Cohen, one of the two officers of the vendor who had signed the original agreement. January 15, 2000  David Cohen passed away. February 11, 2000  In a letter to the purchaser’s solicitor, the vendor’s solicitor asserted that the amending agreement was null and void because, as Stern knew, it was never signed by authorized officers. The letter also stated that since the original waiver period had expired, the agreement of purchase and sale was terminated. March 1, 2000  Solicitor for “Raymond Stern in trust for a company to be incorporated and not in his personal capacity” wrote the vendor’s solicitor asserting an unlawful repudiation, his client’s acceptance of the repudiation, and his intent to pursue a claim for damages. March 15, 2000  Plaintiff company was incorporated. March 22, 2000  Raymond Stern purported to assign his rights under the contract to the plaintiff company. [3]  The question for the court is whether the respondent, 1394918 Ontario Ltd., has an assertable cause of action against 1310210 Ontario Inc. The answer depends on whether the respondent has effectively adopted the contract under s. 21 of the Business Corporations Act. The claims against the individual appellants for conspiracy would fall if the respondent lacked status to seek damages, but are not otherwise before this court for consideration. •  •  •

[5]  This is the third occasion this court has had to deal with s. 21 of the Act. Sherwood Design Services Inc. v. 872935 Ontario Ltd. (1998), 39 O.R. (3d) 576 (C.A.) and Szecket v Huang (1998), 42 O.R. (3d) 400 (C.A.) recite the history of difficulty the common law experienced in dealing with incorporated companies that were to be inserted into contracts and make it clear that s. 21 was intended to replace the common law. As such, that section should be read on its own terms and in an interpretative context of the purpose

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it was intended to fulfil. The statutory scheme for pre-incorporation contracts throws off the confusion of the common law and shouldn’t be thwarted to that end by concern, for instance, that a common law contract requires two parties with co-existent liabilities. If s. 21 calls for liability absent those features then those liabilities must flow and the “contract” referred to must be treated as a statutory creation. [6]  Commercial business concerns inform s. 21. The section is clearly directed at meeting the needs of a party who wishes, and has negotiated for, liability to be assumed by an as yet unincorporated corporation. In the circumstances described in s. 21(1), the promoter is personally bound by the contract and entitled to its benefits. Either party can sue on the other’s breach. After incorporation and notice of intention to adopt, s. 21(2) provides that the corporation is bound and entitled to the benefits retroactively to the date the agreement was signed. Thus, the corporation can be liable for any breach on the promoter’s part and can sue on any breach by the third party, regardless of when the breach occurred. [7]  Contracts under s. 21(4) differ from those under s. 21(1) in a few important ways. The wording of the subsection is awkward but its meaning can be restated as follows. If a promoter enters into an oral or written contract on behalf of a corporation to be incorporated and that oral or written contract expressly provides that the promoter is not bound by the contract or entitled to the benefits thereof, then the promoter is not in any event bound by or entitled to the benefits of the contract. •  •  •

[9]  The timeline of obligations under a s. 21(4) contract is as follows:



1. Prior to incorporation and adoption, the promoter is not personally bound or entitled to benefits of the contract. He might be described as a functionary, performing such duties as assuring that any necessary inspections of property or title are pursued, that deadlines are met, and defaults avoided which might excuse the third party from the obligations. At the same time, the corporation does not exist or has not adopted the contract and thus is not bound by it or entitled to its benefits. There is an entity called a “contract” under the statute, but no one is entitled to sue for its breach. That is not to say that ongoing obligations can be ignored. I would term this a nascent contract, its enforceability being suspended. 2. After incorporation and indication of intention to adopt, the corporation is both bound by and entitled to the benefits of the contract. One feature of the statutory scheme that is unknown to the common law is that, after adoption, the corporation is entitled retroactively as if it had been in existence at the time the contract arose. Thus, the corporation can be liable for any breach on the promoter’s part that occurred prior to adoption and can sue on any breach by the third party regardless of when it occurred. •  •  •

[11]  The next step is to take this understanding of s. 21(4) and apply it to the facts of this case. [12]  The recital of the name of the purchaser as “Raymond Stern in trust for a company to be incorporated and not in his personal capacity” is unaffected by the reference to a trust. There is nothing to be held in trust because Stern cannot benefit from the

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agreement and there is no beneficiary. It is no different in effect than if it read “on behalf of ” rather than “in trust for.” It is an agreement that fits squarely into s. 21(4). [13]  The agreement is for a sale at a price of $4.7 million dollars with a deposit of $3,000 and a further deposit of $27,000 upon waiver of conditions. The major condition was inspection of the property by the purchaser and was to be waived within 90 days or the agreement became null and void. This was effectively an option for ninety days because the vendor had no security except the small initial deposit and no agreement that could be enforced. [14]  The agreement either was or was not extended for one month by the amending agreement of December 31, 1999. I must assume that the amending agreement was valid and that the vendor’s letter of February 11, 2000 was a wrongful repudiation coming one day before the expiry of the extended waiver period. It is alleged that Stern intended to waive the conditions. On March 1, 2000 the solicitor for the purchaser wrote the vendor’s solicitor, informing him of his client’s acceptance of the repudiation and intention to commence an action for damages. Two weeks later, the respondent company was incorporated and on March 22nd Raymond Stern in trust, etc., purported to assign the agreement to the numbered company. This action was commenced the following day in the name of the numbered company. [15]  In electing to accept the repudiation, Stern was performing as what I have termed a functionary, just as he was when he sought out an extension agreement. Section 21(4) of the Act can only work if someone is responsible for carrying the contract forward pending incorporation of the corporate party. However, I disagree with the motions judge’s finding that the assignment was effective. By the very terms of s. 21(4), Stern had no entitlement to the benefits of the contract and thus had nothing to assign. [16]  The entitlement of the corporation must depend upon its adoption of the contract, if there was anything left to adopt. I am satisfied that the institution of the action was an indication of intention to adopt the contract and it remains to determine if the agreement had life at the time the action was commenced. [17]  The appellants take the position that there can be no adoption under s. 21(2) following the letter of March 1, 2000 accepting the repudiation and thus terminating the contract. Because s. 21 gives little guidance on the question of whether accepted repudiation terminates the contract, I think it useful to look to the common law on this point. •  •  •

[21]  … [T]he position in Canada is that contractual obligations continue to exist after accepted repudiation. In Guarantee Co. of North America v. Gordon Capital Corp. (1999), 39 C.P.C. (4th) 100 at 115, the Supreme Court of Canada found as follows: Contrary to rescission, which allows the rescinding party to treat the contract as if it were void ab initio, the effect of a repudiation depends on the election made by the non-repudiating party. If that party treats the contract as still being in full force and effect, the contract “’remains in being for the future on both sides. Each [party] has a right to sue for damages for past or future breaches’” (emphasis in original): Cheshire, Fifoot & Furmston’s Law of Contract (12th ed. 1991), by M.P. Furmston at p. 541. If, however, the non-repudiating party accepts the repudiation, the contract is terminated, and the parties are discharged from future obligations. Rights and obligations that have already matured are not extinguished. Furmston, supra, at pp. 543-44.

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[22]  Although the Court does say that accepted repudiation “terminates” the contract, the context reveals that only future obligations under the contract are extinguished. Accrued obligations under the contract continue to exist, at least in the form of a secondary obligation to pay damages. To the extent that there remain in existence contractual obligations, it cannot be said that the contract ceases to exist. •  •  •

[25]  … [R]eturning from the common law to this statutory “contract,” s. 21(2)(a) provides that the corporation is entitled to all the benefits as if it had been in existence at the date of the contract. The common law authorities cited above did not have before them this new breed of legislated “contract.” There were two parties to those contracts and the aggrieved party could always sue for damages, whatever the significance of termination might be. In the instant case, if the purchaser had been in existence at the outset, or at any time before March 1, 2000, it could have sued for damages. The company would be denied “all the benefits of the contract” if disentitled to sue in these circumstances. •  •  •

[27]  For all these reasons I would dismiss the appeal with costs. NOTES AND QUESTIONS

1. In Szecket, the court ignored objective evidence indicating a lack of intention on the part of the promoter to be bound personally. Should statutory pre-incorporation contract regimes be amended so as not to insist on express waivers? 2. In 1394918 Ontario Ltd v 1310210 Ontario Inc, the court interpreted the form of promoter’s signature as an express waiver of personal liability. Should a form of signature indicating simply that a promoter is signing on behalf a company to be incorporated and not in his or her personal capacity be sufficient to amount to an express waiver of liability?

III.  POST-INCORPORATION CONTRACTS After a corporation legally exists, contracts may be entered into by the corporation through its agents. The remainder of this chapter considers three issues that arise in the context of post-incorporation contracts: (1)  corporate capacity, (2)  compliance with internal procedures, and (3) agent authority.

A.  Corporate Capacity Historically, corporate statutes employing the memorandum model required incorporators to state the objects of the firm in the constating documents—that is, the business activities that the corporation had the capacity to carry out.6 When a corporation entered into a contract that fell outside its stated objects, the act was referred to as “ultra vires” the 6 Having any restrictions on business activities is now purely optional: see CBCA s 6(1)(f ); OBCA s 5(3); QBCA s 5(9); MCA s 6(1); SBCA s 6(f ); ABCA s 6(e); BCBCA s 12(2)(a)(i); YBCA s 8(1)(e); NWTNBCA s 6(1)(f ); NBBCA s 4(1)(f ); NFLCA s 12(1)(f ); NSCA ss 10(a)(ii), 11(a)(ii), and 12(a)(ii).

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corporation—that is, the corporation was acting beyond its powers. Absent statutory modification, ultra vires contracts are deemed invalid as a general rule—that is, not enforceable by either the corporation or the third party.7 As will be explained below, most Canadian general business corporation statutes have significantly reduced the impact of the ultra vires rule. The following extract, however, is from a leading 19th century case applying the rule to a general business corporation.

Ashbury Ry Carriage & Iron Co v Riche (1875), LR 7 HL 653 [The defendant had been incorporated in 1862 under a memorandum of association that stated its objects as “to make and sell, or lend on hire, railway-carriages and wagons, and all kinds of railway plant, fittings, machinery, and rolling-stock; to carry on the business of mechanical engineers and general contractors; to purchase and sell, as merchants, timber, coal, metals, or other materials; and to buy and sell any such materials on commission, or as agents.” In 1865, the corporation’s directors met with several Belgian businessmen, including Riche, to discuss constructing a railway from Antwerp to Tournai. It was agreed that the corporation would purchase the concession to build the line and contract out the construction work to Riche. The defendant corporation’s shareholders did not regard the project as a desirable investment, and the corporation repudiated the contract with Riche as ultra vires. Lord Cairns concluded that the contract to construct a railway did not fall within the objects of the corporation, reading the words “general contractors” to be confined by the other types of business set out in the objects of the corporation and thus not permitting the entering into of a contract for the construction of a railway. He also rejected the notion that shareholders could subsequently ratify an ultra vires act.] LORD CAIRNS: … [A] contract of this kind was not within the words of the memorandum of association. In point of fact it was not a contract in which, as the memorandum of association implies, the limited company were to be the employed, they were the employers. They purchased the concession of a railway—an object not at all within the memorandum of association; and having purchased that, they employed, or they contracted to pay, as persons employing, the Plaintiffs in the present action, as the persons who were to construct it. That was reversing entirely the whole hypothesis of the memorandum of association, and was the making of a contract not included within, but foreign to, the words of the memorandum of association. •  •  •

The provisions [of the 1862 Joint Stock Companies Act] under which that system of limiting liability was inaugurated, were provisions not merely, perhaps I might say not mainly, for the benefit of the shareholders for the time being in the company, but were 7 Such provisions appear to codify one of the principles articulated in Bonanza Creek Gold Mining Co v The King, [1916] 1 AC 566 (PC). That decision was interpreted as holding that a corporation incorporated in a letters patent jurisdiction has all of the powers of a natural person unless such powers are excluded by the particular letters patent or by the incorporating statute.

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enactments intended also to provide for the interests of two other very important bodies; in the first place, those who might become shareholders in succession to the persons who were shareholders for the time being; and secondly, the outside public, and more particularly those who might be creditors of companies of this kind. And I will ask your Lordships to observe, as I refer to some of the clauses, the marked and entire difference there is between the two documents which form the title deeds of companies of this description—I mean the Memorandum of Association on the one hand, and the Articles of Association on the other hand. With regard to the memorandum of association, your Lordships will find, as has often already been pointed out, although it appears somewhat to have been overlooked in the present case, that that is, as it were, the charter, and defines the limitation of the powers of a company to be established under the Act. With regard to the articles of association, those articles play a part subsidiary to the memorandum of association. They accept the memorandum of association as the charter of incorporation of the company, and so accepting it, the articles proceed to define the duties, the rights and the powers of the governing body as between themselves and the company at large, and the mode and form in which the business of the company is to be carried on, and the mode and form in which changes in the internal regulations of the company may from time to time be made. With regard, therefore, to the memorandum of association, if you find anything which goes beyond that memorandum, or is not warranted by it, the question will arise whether that which is so done is ultra vires, not only of the directors of the company, but of the company itself. With regard to the articles of association, if you find anything which, still keeping within the memorandum of association, is a violation of the articles of association, or in excess of them, the question will arise whether that is anything more than an act extra vires the directors, but intra vires the company … . •  •  •

The covenant, therefore, is not merely that every member will observe the conditions upon which the company is established, but that no change shall be made in those conditions; and if there is a covenant that no change shall be made in the objects for which the company is established, I apprehend that that includes within it the engagement that no object shall be pursued by the company, or attempted to be attained by the company in practice, except an object which is mentioned in the memorandum of association. Now, my Lords, if that is so—if that is the condition upon which the corporation is established—if that is the purpose for which the corporation is established—it is a mode of incorporation which contains in it both that which is affirmative and that which is negative. It states affirmatively the ambit and extent of vitality and power which by law are given to the corporation, and it states, if it is necessary so to state, negatively, that nothing shall be done beyond that ambit, and that no attempt shall be made to use the corporate life for any other reason than that which is so specified. Now, my Lords, with regard to the articles of association, observe how completely different the character of the legislation is. … Of the internal regulations of the company the members of it are absolute masters, and, provided they pursue the course marked out in the Act, that is to say, holding a general meeting and obtaining the consent of the shareholders, they may alter those regulations from time to time; but all must be done in the way of alteration subject to the conditions contained in the memorandum of association. That is to override and overrule any provisions of the articles which may be at variance with it. The memorandum of association is, as it were, the area beyond which

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the action of the company cannot go; inside that area the shareholders may make such regulations for their own government as they think fit. Corporations thereafter sought to avoid the consequences of Ashbury Ry Carriage and the ultra vires doctrine through the proper drafting of an objects clause. Corporate lawyers developed objects clauses with a great number of heads so as to catch a wide variety of businesses that a corporation might at a future date decide to carry on. A corporation ran the risk, however, that the court might find that the listed purposes were merely powers, relating only to a business ancillary to one of the main objects or purposes. But if the corporate draftspersons appended to a lengthy list of objects a clause stating that the ejusdem generis (“of the same kind”) canon of interpretation should not apply, then the court would likely hold that each object was in fact independent.8 A further technique for avoiding the ultra vires doctrine was provided in Bell Houses Ltd v City Wall Properties Ltd, [1966] 2 QB 656 (CA). In that case, the court upheld an extension to a new line of business on the basis of an objects clause that permitted the corporation “to carry on any other trade or business whatsoever which can, in the opinion of the board of directors, be advantageously carried on by the company in connection with or as ancillary to … the general business of the company.”9 In spite of the fact that a corporation could largely avoid the ultra vires doctrine, outside creditors still ran the risk that their debtor’s objects were restricted. The possibility that their contracts would not be enforced placed a greater burden of screening or information production on creditors. Since they took the risk of non-compliance with an objects clause, they had the incentive to verify that the contract was in fact covered by the purposes clause. Although this practice of verification reduced the risk of unenforceability, it also increased the cost of doing business. Shareholders could monitor for non-compliance with an objects clause at less cost than creditors. In the case of large public corporations carrying on business in a wide variety of industries, the inefficiencies would be even greater. Given the increase in transaction costs generated by the ultra vires rule, most Canadian general business corporation statutes sought to reduce the impact of the rule in three ways. One, the inclusion of objects clauses in constating documents is now purely optional.10 Second, corporation legislation typically provides that a firm has the capacity, rights, and powers of a natural person.11 Third, most legislation adds that no contract is deemed invalid “by reason only” that it is contrary either to the constating documents or the legislation itself.12 Despite the ambiguity created by the “by reason only” language, the Supreme Court of Canada has stated that provisions such as this in corporate legislation effectively abolish the ultra vires rule.13 In other words, ultra vires contracts are enforceable Cotnam v Brougham, [1918] AC 514 (HL). See also H & H Logging Co v Random Services Corp (1967), 63 DLR (2d) 6 (BCCA). Supra note 6. CBCA s 15(1); OBCA s 15; MCA s 15; SBCA s 15; ABCA s 16; BCBCA s 30; YBCA s 18; NWTNBCA s 15; NBBCA s 13; NSCA s 4(8); NFLCA s 27. 12 CBCA s 16(3); OBCA s 17(3); QBCA s 15; MCA s 16(3); SBCA s 16(3); ABCA s 17(3); BCCBA s 33(2); YBCA s 19(3); NWTNBCA s 16(4); NBBCA s 14(3); NFLBCA s 29. 13 Communities Economic Development Fund v Canadian Pickles Corp, [1991] 3 SCR 388 at 23; Continental Bank Leasing Corp v Canada, [1998] 2 SCR 298 at para 57. 8 9 10 11

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by both parties, and losses suffered as a result of such contracts are to be dealt with through other remedies.

B.  Compliance with Internal Procedures Beyond issues of corporate capacity, corporations may set out internal procedural requirements in their constating documents or bylaws for the entering into of particular types of contracts. The leading case on compliance with internal procedures in corporate law is Royal British Bank v Turquand (1856), 6 E & B 327, 119 ER 886 (Exch Ct). The plaintiff bank sued to collect on a demand note executed under seal by the defendant corporation and signed by two of its directors. The defence was that the company’s deed of settlement (memorandum of association) allowed the directors to borrow on behalf of the company “such sums as should from time to time be authorized by general resolution of the Company,” and that there had been in fact no such general resolution authorizing the borrowing in question. The defence was rejected, the court observing at 888: We may now take for granted that the dealings with these companies are not like dealings with other partnerships, and that the parties dealing with them are bound to read the statute and the deed of settlement. But they are not bound to do more. And the party here, on reading the deed of settlement, would find, not a prohibition from borrowing, but a permission to do so on certain conditions. Finding that the authority might be made complete by a resolution, he would have the right to infer the fact of a resolution authorizing that which on the face of the document appeared to be legitimately done.

The holding in Turquand has come to be known as “the indoor management rule.”14 There is no unanimity on how to formulate it, but one version is as follows: Where an outsider dealing with a corporation satisfies himself that the transaction is valid on its face to bind the corporation, he need not inquire as to whether all of the preconditions to validity that the corporation’s internal law might call for have in fact been satisfied.15

The indoor management rule has been both codified and expanded in two important ways in modern corporate legislation. The first is through a provision stating that a corporation may not assert against a third party that the articles or bylaws have not been complied with.16 The second is through a provision reversing the common law rule that the indoor management rule does not apply in cases of forgery.17 Therefore, an outsider dealing with a

14 When the court refers to how third parties dealing with the corporation are required to read the constating documents, it is applying what is known as the “constructive notice rule”—i.e. third parties are deemed to have notice of all information in publicly filed corporate documents. Modern corporate statutes have sought to minimize the impact of the constructive notice rule by provided that no third party is deemed to have constructive notice of the contents of any corporate document “by reason only” that it has been filed publicly: see CBCA s 17 OBCA s 18; QBCA s 12; MCA s 17; SBCA s 17; ABCA s 18; BCBCA s 421; YBCA s 20; NWTNBCA s 17; NBBCA s 15; NSCA s 31; NFLCA s 30. 15 Sheppard v Bonanza Nickel Mining Co of Sudbury (1894), 25 OR 305 at 310. 16 CBCA s 18(1)(a); OBCA s 19(a); QBCA s 15; MCA s 18(a); SBCA s 18(a); ABCA s 19(a); BCBCA s 146(1)(a); YBCA s 21(a); NWTNBCA s 18(a); NBBCA s 16(a); NSCA s 30(a); NFLCA s 31(a). 17 CBCA s 18(1)(e); OBCA s 19(e); QBCA s 13(4); MCA s 18(e); SBCA s 18(e); ABCA s 19(f ); BCBCA s 146(1)(d); YBCA s 21(f ); NWTNBCA s 18(f ); NBBCA s 16(e); NSCA s 30(e); NFLCA s 31(e).

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corporation through an officer does not need to be concerned with whether any internal procedures required for the entering into of contracts have been complied with.

C.  Agent Authority Beyond issues of corporate capacity and compliance with internal procedures, issues arise in the context of post-incorporation contracts relating to the authority of the relevant agent to enter into the contract in the first place. Chapter 1 introduced the concept of legal agency. Assuming that it is within the powers of the corporation to embark on a given transaction, questions arise as to who within the corporation has the authority to contract for it. This is a matter of agency law, applied to corporations. Agency may be created either by the actual conferral of authority on the agent by the principal (actual authority) or by representations made by the principal to a third party that give rise to a reasonable belief in the third party, on which the third party acts, that another is the agent of the principal, so that it would be inequitable to allow the principal to deny the agency (apparent or ostensible authority).18 Corporate transactions always give rise to agency questions because a corporation can act only through human agents.

1.  Actual Authority The actual authority of an officer of a corporation may be determined by the officer’s contract of employment or by a formal board resolution. Apart from this authorization, merely appointing a person to serve as an officer will clothe him or her with the actual authority to make the business decisions that a person in his position usually makes, unless that authority is expressly restricted in some way by the corporation. For example, the secretary of the corporation will be presumed to have the authority to certify corporate documents as being the documents of the corporation, while the treasurer or chief financial officer will ordinarily have the authority to sign certificates with respect to the financial affairs of the corporation. Neither these officers nor a director will ordinarily have actual authority to make business decisions, although the president or chief executive officer will generally be deemed to be authorized to make a broad range of investment decisions in the ordinary course of the corporation’s business. Implied actual authority will also be found to exist where an officer, without formal permission, exceeds the authority that usually attaches to his or her position, but does so with the knowledge and acquiescence of the corporation. For example, in Hely-Hutchison v Brayhead Ltd, [1968] 1 QB 549 (CA), the chairman of the board of directors of the defendant corporation entered into an agreement on its behalf to guarantee a debt by a related corporation. The chairperson of the board is not usually the chief executive officer, but the defendant was nevertheless held bound to the contract, since the chairman had been in the habit of committing the corporation to contracts without the knowledge of its board, to which he would afterward report the matter. The board was on notice of the chairman’s “wrongful contracting” and had acquiesced over time in the chairman’s mode of conducting himself as the chief executive officer who made the final decision on any matter concerning finance.

18 Freeman & Lockyer (A Firm) v Buckhurst Park Properties (Mangal) Ltd and Another, [1964] 2 QB 480 at 502.

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2.  Apparent Authority The default rule is, where an agent lacks the actual authority to bind a corporation contractually, the corporation will not be bound by that contract—that is, the third party dealing with the corporation is deemed to be the lowest cost-avoider and is deemed to be in a better position to prevent agent misbehaviour as compared to the corporation. However, where a corporation represents that an agent does have the authority, even though he or she, in fact, does not, to enter into the contract in question and the third party relies on that representation, the agent is deemed to have apparent authority and the corporation will be bound by that contract19—that is, the corporation is deemed to be the lowest cost-avoider and in a better position to prevent agent misbehavior as compared to the third party. More generally, the lowest cost-avoider is the party who is able to prevent a loss at the lowest cost. In this specific context, losses arising from the agent’s misbehaviour are allocated to either the corporation or the third party on the basis of who was able to prevent the misbehaviour more cheaply. The following is an extract from a case applying these principles of agency to a particularly complicated fact situation.

Canadian Laboratory Supplies v Engelhard Industries [1979] 2 SCR 787 LASKIN CJ, SPENCE and DICKSON JJ (dissenting in part):  … Both Canlab and Engelhard were victimised by one Cook, an employee in Canlab’s sales department (and later supervisor of inside sales), in respect of transactions in platinum and platinum scrap between the two companies. They had been doing business with one another since 1941. Engelhard, a refiner of precious metals, including platinum, sold to Canlab which supplied equipment and materials to hospitals, universities and various laboratories. Through a fraudulent scheme which became operative on May 23, 1962 and continued undetected for almost seven years, Cook procured purchases of platinum by Canlab from Engelhard for sale to a fictitious customer, one J. Giles who was Cook in another guise. The purchases so procured by Cook were made through regular purchase orders, properly authorized by Canlab. By a telephone arrangement with Engelhard, Cook persuaded that company to accept directly from Giles a return of the platinum as scrap and to pay Giles for it at the going price. Noges, the Engelhard employee in charge of scrap platinum, who agreed to the arrangement proposed by Cook, was told by the latter that Giles was a scientist working on a secret process and that it was not advantageous or convenient for Canlab to handle the return of scrap platinum from Giles. Platinum was in short supply during the period of the fraud and Engelhard made it a term of its sales orders that any platinum it sold would be returned to it as scrap unless, of course, it had been manufactured into articles, as for example, jewellery.

19 Modern corporate legislation codifies the concept of apparent authority by including a provision preventing the corporation from denying the authority of a person held out by the corporation as a director, officer, agent, or mandatary: see CBCA s 18(1)(d); OBCA s 19(d); MCA s 18(d); QBCA s 13(3); SBCA s 18(d); ABCA s 19(e) ; BCBCA s 146(1)(c); YBCA s 21(e); NWTNBCA s 18(e); NBBCA s 16(d); NSCA s 30(d); NFLCA s 31(d).

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The action against Engelhard was begun on October 8, 1969. It was founded, of course, on Canlab’s claim of title to the platinum ordered through Cook for Giles and in the unlawfulness of any claim of title by Engelhard to the platinum scrap which it received directly from Giles and for which it paid by cheques issued to Giles. … Engelhard appealed, and a five-member Court of Appeal, Lacourcière J.A. dissenting in part, set aside the judgment of O’Driscoll  J. and dismissed Canlab’s action. In his majority reasons, Blair  J.A. concluded that Cook had apparent authority upon which Engelhard relied. He put the matter in the following words: … [I]t seems to me that Canlab had permitted Cook to assume a position where he had apparent authority to conduct and arrange the three combined transactions with Engelhard. He represented to Engelhard that he had authority to purchase platinum, to sell it and to arrange for its repurchase by Engelhard directly from Canlab’s customer. Engelhard relied on these representations and, in my view, Canlab is estopped from denying them with the result that Canlab is bound by them and cannot dispute the validity of any part of Cook’s transactions with Engelhard. •  •  •

Lacourcière J.A. was of the opinion that Canlab was entitled to recover in conversion for the value of platinum for the years 1964, 1965 and to October, 1966. Up to this latter date there was, in his view, no holding out or representation made by Canlab that Cook had authority to arrange the transactions of purchase for Giles and for the return of the platinum scrap directly to Engelhard. Any representation by Cook himself (he not being in a senior managerial position) could not become, per  se, a representation of his principal. Lacourcière J.A. fixed the cut-off as of October, 1966 for the following reason. Engelhard had become concerned about the gap in time between its receipt of payments from Canlab (it was selling on a “net 30 days” basis and Canlab was taking sixty days to pay) and its immediate payments to Giles for returned platinum scrap. The vice-president and treasurer of Engelhard spoke of this to McCullough, the head of the inside sales at Engelhard and he telephoned one Snook at Canlab, a person he knew. Snook told McCullough to talk to Cook about the problem, and when McCullough telephoned Cook the latter suggested that McCullough write to Ferguson, the controller at Canlab. This McCullough did on October 11, 1966 and on October 26, 1966 he received a reply signed by Cook who wrote that the letter to Ferguson had been handed to him for reply. The trial judge found that Cook had intercepted McCullough’s letter to which he replied without anyone else at Canlab knowing of it. Lacourcière J.A. held that there was a holding out of Cook from October 11, 1966 as being authorized by Canlab to deal with the resale of platinum scrap by Giles directly to Engelhard and, consequently, Canlab was estopped from denying Cook’s authority in respect of subsequent transactions. •  •  •

… The main question in this case for me is whether Canlab must suffer all or part of the loss occasioned by Cook’s thefts and resale of the platinum scrap to Engelhard. In short, is this a case where the risk of loss of the value of the platinum bought by Engelhard from the thief should be shifted from Engelhard to Canlab from whom the platinum was stolen by one of its employees?

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Blair J.A., in proceeding from the base of an ostensible authority exercised by Cook to purchase platinum from Engelhard, founded it on what he said was “[Canlab’s] conduct in permitting [Cook] to act as he did in the conduct of [its] business with Engelhard.” This was his assessment based upon the application of principles taken from  Freeman & Lockyer v. Backhurst Park Properties (Mangal) Ltd,. quoting Diplock L.J., as he then was, at p. 502 and from Hely-Hutchinson v. Brayhead Ltd., per Lord Pearson, at p. 593. There is, of course, no doubt in my mind that if an agent, in the exercise of an admitted authority in him in respect of his ordinary duties acts for his own benefit, his principal cannot deny liability for contracts he purports to make on behalf of the principal. It is only in such circumstances or where there is a representation from the principal that puts the agent in a position to act beyond the authority reposed in him that the principal can be bound. There is no “permitting” in the sense of binding the principal where the agent is not in the course of his ordinary duties or where there is no representation at all from the principal or from someone in a directory capacity to act for a corporate principal. The Freeman & Lockyer case involved a claim for architects’ fees against the defendant company whose de facto managing director, one K, had engaged the architects to do work for the company. … … The relevant passage for the present case is at pp. 504-505 and is as follows: The second characteristic of a corporation, namely, that unlike a natural person it can only make a representation through an agent, has the consequence that in order to create an estoppel between the corporation and the contractor, the representation as to the authority of the agent which creates his “apparent” authority must be made by some person or persons who have “actual” authority from the corporation to make the representation. Such “actual” authority may be conferred by the constitution of the corporation itself, as, for example, in the case of a company, upon the board of directors, or it may be conferred by those who under its constitution have the powers of management upon some other person to whom the constitution permits them to delegate authority to make representations of this kind. It follows that where the agent upon whose “apparent” authority the contractor relies has no “actual” authority from the corporation to enter into a particular kind of contract with the contractor on behalf of the corporation, the contractor cannot rely upon the agent’s own representation as to his actual authority. He can rely only upon a representation by a person or persons who have actual authority to manage or conduct that part of the business of the corporation to which the contract relates. •  •  •

It seems to me, with respect, that if ostensible authority is sought to be established through the representation of an agent of a corporate principal, it is impossible to equate the position of a mere clerk with that of the managing director of the company sought to be bound by the agent’s representation. The latter, unlike the former, has some back-up in the position in which he has been put by the board of directors; the former, the clerk, can draw nothing from the nature of his position unless he has been expressly authorized to act in the kind of transactions into which he has entered for the company and in respect of which he may have exceeded the limits of the express authority. … [T]here is nothing in the record to show that Canlab as principal had placed Cook in a position to hold himself out as having authority to arrange any of the tripartite

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transactions (so characterized by the majority of the Ontario Court of Appeal), at least until October, 1966. … In saying this I do not subscribe to the proposition, in so far as it purports to be a general statement of the law, that a representation by an agent himself as to the extent of his authority cannot amount to a holding out by the principal. It will depend on what it is an agent has been assigned to do by his principal, and an overreaching may very well inculpate the principal. This, however, does not help Engelhard in the present case. •  •  •

I come hence to the crucial question whether Engelhard must answer for the whole of the loss suffered by Canlab. Lacourcière J.A., would have cut the loss at October 1966, by reason of the telephone conversation between McCullough of Engelhard and one Snook, an employee of Canlab, who directed his inquirer to get in touch with Cook. What militates against this, however appealing it may be as an equitable solution in a situation where Cook duped both his employer and a third party which did business with the employer, is that Snook like Cook had no managerial authority. He was merely a purchasing agent in the purchasing department and there was no evidence of any back-up authority by which he could hold Cook out … as having power to compose the difficulty, as raised by Engelhard, in settling accounts. This, indeed, points to the insuperable difficulty in Engelhard’s position in respect of the second and third representations said by Blair J.A. to be “representations of authority.” They were representations made by Cook to Engelhard without any support from Canlab management. The casualness with which Engelhard acted in respect of its transactions with the unknown Giles—indeed, the evidence does not disclose that Engelhard ever saw Cook—deserves the castigation which Lacourcière heaped upon it, as follows: … Canlab was swindled by the crafty manipulations of a trusted but dishonest employee. However, Engelhard should have been placed on guard by the bizarre request of Cook to deal with Giles, an eccentric secretive research scientist who returned, within a day or two, scrap platinum in a form which did not disclose any known use of the platinum sheets. In suspicious circumstances, Engelhard paid some $835,453.49 to an unknown scientist without any effort until 1966 to contact anyone in authority at Canlab. I do not regard Engelhard’s conduct as that of a prudent company. Where a transaction is of such an unusual nature that any reasonable person would be put on inquiry, a person cannot shelter under the doctrine of apparent authority. Houghton & Company v. Nothard, Lowe and Wills, Limited, [1927] 1 K.B. 246. Here Engelhard was put on inquiry by reason of the unusual nature of the transaction to ascertain from a person in authority at Canlab whether Cook had any authority to arrange for the direct resale of scrap. …

I wish to refer to a contact in 1968 between Canlab and Engelhard to see if it could have a bearing by way of limiting Engelhard’s liability. Engelhard’s president, one Scott, curious about the use made of the platinum by the unknown Giles, telephoned Canlab’s vice-president of operations, one Fabian. The trial judge found that Fabian, who said he did not remember receiving a call from Scott, had indeed received the call during which there was a discussion of the large number of transactions in platinum involving Canlab and Giles. Fabian, according to Scott, said he was unaware of the transactions and asked which employee of Canlab dealt with Engelhard. Informed it was Cook, Fabian undertook

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to investigate and call back. It was Cook who called back later that day, telling Scott he was asked to speak on Fabian’s behalf. Cook undertook to make enquiries to answer Scott’s question and to call back but never did. I am of opinion that Fabian was put on inquiry as a result of the call from Scott, and that any losses suffered by Canlab by the continued deception of Cook, that is from late September or early October 1968, must be borne by it. … In the result, I would allow the appeal, set aside the judgment of the Ontario Court of Appeal and restore the judgment of O’Driscoll J. but would vary it to limit the recovery of Canlab up to the time that Scott and Fabian had their conversation. ESTEY J (Martland, Ritchie, Pigeon, Beetz, Estey, and Pratte JJ concurring):  I have had the benefit of reading the reasons of the Chief Justice and with respect agree with his disposition of this appeal save in one respect. The computation of damages in the Chief Justice’s approach to the claims by the appellant commences in 1964 and continues until late 1968 when it was found that the respondent had alerted the appellant to the nature of the transaction so as to prevent any recovery beyond that date by the appellant. •  •  •

It therefore comes down to this. Did Snook occupy such a position in the organization of Canlab so that notice by Engelhard through McCullough was notice to Canlab through Snook as to the fact of the Giles transaction and so as to effectively hold out Cook as having the authority to deal with Engelhard in the matter of expediting payment to Engelhard for the platinum purchases so as to relieve Engelhard of the burden of financing Canlab’s customer, Giles, as well as Canlab itself in the Engelhard to Canlab to Giles to Engelhard platinum circuit. As was said by Pearson L.J. in Freeman and Lockyer (a firm) v. Buckhurst Park Properties (Mangal), Ltd. and Another, at p. 641: The identification of the persons whose knowledge and acquiescence constitute knowledge and acquiescence by the company depends on the facts of the particular case.

Here we have a supplier of raw material, Engelhard, seeking to rectify a lag in payment by its customer Canlab. The supplier sought out the purchasing agent of its customer. The purchasing agent, on hearing the situation described, heard at least enough to know that purchases by Canlab were being made by Cook, a Canlab employee in the internal sales department. The purchasing agent told its supplier, Engelhard, to discuss the payment problem with Cook. Engelhard did so. The situation about which Engelhard had complained was rectified immediately. This is in 1966, three years before Canlab detected the fraud of Cook. The manner in which a company can extend actual and apparent authority to an employee so as to be bound by the representations and actions of that employee is discussed by Diplock L.J. in the Freeman case, supra, at pp. 644-6: The representation which creates “apparent” authority may take a variety of forms of which the commonest is representation by conduct, i.e., by permitting the agent to act in some way in the conduct of the principal’s business with other persons. By so doing the principal represents to anyone who becomes aware that the agent is so acting that the agent has authority to enter on behalf of the principal into contracts with other persons of the kind which an agent so acting in the conduct of his principal’s business has normally “actual” authority to enter into.

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If the foregoing analysis of the relevant law is correct, it can be summarised by stating four conditions which must be fulfilled to entitle a contractor to enforce against a company a contract entered into on behalf of the company by an agent who had no actual authority to do so. It must be shown: (a) that a representation that the agent had authority to enter on behalf of the company into a contract of the kind sought to be enforced was made to the contractor, (b) that such representation was made by a person or persons who had “actual” authority to manage the business of the company either generally or in respect of those matters to which the contract relates; (c) that he (the contractor) was induced by such representation to enter into the contract, i.e., that he in fact relied on it; and (d) … (not relevant in these proceedings) (emphasis added).

Modern commerce at practically all levels and sectors operates through the corporate vehicle. That vehicle itself, by conglomerate grouping and divisionalization, has become increasingly complex. Persons, including corporate persons, dealing with a corporation must for practical reasons be able to deal in the ordinary course of trade with the personnel of that corporation secure in the knowledge that the law will match these practicalities with binding consequences. The law has long so provided. Both corporate sides to a contractual transaction must be able to make secure arrangements at the lowest level at which adequate business controls can operate. It is in the interest of both corporate and natural persons engaged in business that this be so. One alternative would be to retain corporate trading authority in the inner core of management; another would be to conduct the daily business of the undertaking on a committee basis. Neither law nor commerce has apparently found a practical alternative to the delegation of the corporate authority to agents, its employees. In undertakings of all but the smallest proportions, division of authority according to function is as necessary as it is commonplace. The day of the proprietor and the one man operation has, for better or for worse, long departed from the main stage of business, and the corporate vehicle with attendant business structures has taken over much of the commerce of the country. The law has altered old rules and developed new ones to facilitate the conduct of trade on this larger scale. Obviously some employee must be placed in charge of buying, another of selling, another of financing, and another in charge of accounting, and so on, and each must have the authority necessary to deal responsibly with his counterpart in other trading and governmental organizations. In this transaction, a senior employee in the sales sector of Engelhard seeks out the purchasing agent of his customer Canlab. The purchasing agent says he is not familiar with the particular purchases made by Canlab from Engelhard and so he refers him to an employee who is dealing with these matters, namely Cook. The President of Cook’s employer, Canlab, is not sure of Cook’s actual and real authority to revise the timetable for payment for these purchases but another employee in the accounting division of Canlab testified that Cook had such authority. So far as Engelhard, the customer, is concerned Cook was in the position or had the authority necessary to bring about the desired results by apparently making the necessary arrangements through appropriate Canlab officials, and then reporting his success by letter to Engelhard. Thereafter, as I have said, payments were on the expedited basis as requested. In these intercorporate dealings in 1966 Engelhard apprised the purchasing agent of at least part of the Giles affair.

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IV. Conclusion

Engelhard responded to the request of Cook, the employee to whom Canlab’s purchasing agent referred Engelhard, by setting out the entire story in a letter to the comptroller of Canlab. That this letter was somehow intercepted and stolen by Cook cannot be held against the position of Engelhard. The law does not put such a high standard of duty on a customer dealing with a corporation and the practices of modern commerce make it most unwise to do so now. … •  •  •

… I therefore would limit the recovery of Canlab up to the time of the conversation with Snook in October 1966 so that the plaintiff-appellant shall recover damages in respect of the years 1964 and 1965 and until the 11th of October 1966.

IV. CONCLUSION This chapter canvassed issues arising from the corporation’s ability to enter into contracts in it own name. When pre-incorporation contracts are entered into, the legal rules and standards attempt to deal with concerns about opportunistic behaviour by promoters and costs associated with the adoption of contracts after the corporaton comes into existence. When post-incorporation contracts are entered into, the legal rules and standards must address the fact that, even though a corporation is a legal person, it cannot contract in quite the same way as a natural person.

CHAPTER SIX

Capitalization of the Corporation









I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 391 II.  The Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395 A.  What Is a Share? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 396 B.  Formalities of Capitalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 402 1.  Authorized and Issued Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 402 2.  Common and Preferred Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403 3.  Subscriptions for Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 404 C.  Consideration on an Issue of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405 1.  The Need for Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405 2.  Discount Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405 3.  Watered Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409 4.  Unacceptable Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411 5. Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415 D.  Pre-Emptive Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 416 E.  The Nature of a Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 422 III.  Debt Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434 A.  Priority Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 437 B.  Varieties of Debt Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 437 IV.  Preferred Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 439 A. Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441 1.  What Is a Dividend? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441 2.  Types of Dividends: Cash, Specie, and Stock Dividends . . . . . . . . . . . . . . . . . . . 442 3.  Legal Aspects of Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 444 B.  Rights on Liquidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 449 1.  Participation on Liquidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454 2.  The Claim to Arrearages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454 V.  Convertible Securities, Rights, and Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455 A.  Rights and Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 456 B.  Valuation of Conversion Privileges and Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . 456 C.  Anti-Dilution Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 457 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459

I. INTRODUCTION Chapter Three considered issues that concern the formation of the corporation. This chapter examines questions that concern a corporation’s capital structure. The ability to raise capital 391

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is often critical to the success of a company. If there are no parties willing to invest in or lend money to a company, it may be difficult for that company to expand. The desire to facilitate the process of raising capital was one of the reasons why limited liability was introduced into corporate law. A business law regime that offers investors limited liability makes it much easier to raise capital from potential investors than a regime in which investors assume unlimited exposure to a business’s creditors. The mix of capital that it is most appropriate for a corporation to raise depends on a wide range of factors. These factors include the stage of a corporation’s development; its profitability, and therefore its ability to satisfy payment obligations to investors; and the extent to which the corporation needs to have regular access to the capital markets for ongoing financing. Inevitably, a corporation’s capital structure will include shares, but it may include more than one class of shares and a company may also choose to (or have no choice but to) fold different types of debt into the equation. Other kinds of securities may also be issued in response to specific demands from potential capital providers. Some of these demands may, of course, relate to the rate of return that the investor expects on its investment, but they may also include demands relating to the ability to have a say on certain fundamental business decisions, including decisions that may be expected to affect the company’s financial performance. As a company grows, decisions about how best to develop its capital structure can become complex. Difficult choices must often be made about such matters as how many and what kind of shares should be issued as well as how much debt to take on and on what terms. In addition to tax considerations, accounting rules governing what features a given security must have in order to be treated as debt or equity for accounting purposes can also come into play when designing innovative financing strategies. The way in which a country’s tax system treats payments made to different kinds of capital providers may also be highly relevant. A company that is doing well will have a reasonable amount of flexibility when making decisions about how best to design its capital structure. But a company that is facing financial challenges will find it harder to attract capital. It may therefore have to engage in considerable negotiation with investors about the terms that will govern their investment. Misjudgments about a company’s capacity to satisfy its obligations to investors may in turn give rise to unanticipated and unwelcome financial pressure, if not outright ruin. A significant question that arises when a company seeks to raise capital is therefore what rights different suppliers of capital are entitled to under the governing corporate statute and whether to supplement those rights in any way. It is extremely important that a company fully understand the legal rights and obligations that will form part of any investment relationship that it proposes to enter into. Moreover, how different investors’ rights are characterized will have a profound impact on the answer to the question whose rights and interests a corporation’s board of directors must take into account when making decisions that may affect the corporation’s future and its profitability. In this chapter, we therefore focus on the process of raising capital and the nature of the rights that corporate law statutes such as the Canada Business Corporations Act, RSC 1985, c C-44 (CBCA) provide to different suppliers of capital. After briefly reviewing the differences between debt and equity financing in Section I, we turn to issues associated with raising different kinds of capital. Section II deals with issues associated with the issuance of shares. Section III examines debt securities. Section IV focuses on preferred shares and includes a discussion on dividends, and, finally, Section V considers various kinds of convertible securities.

I. Introduction

393

You will recall from Section I.A of Chapter 1 that Aya decided to incorporate her business as Quick Buys Ltd because she needed more equity investors and the bank had restricted her ability to raise more capital through loans. When Quick Buys incorporated, Aya’s investment was valued at $1 million and she received 50,000 shares in return for the transfer of the business to the corporation. Tomi’s investment at the time of incorporation was worth $200,000, and he received 10,000 shares. Four other investors, Anjala Marshall, Ken Biway, Maria Toscana, and Enrico Slate, all friends or associates of Aya who had become interested in the business, had each also invested $500,000, and they acquired 25,000 shares each. All of them received common shares, except Enrico Slate, who received preferred non-voting shares. The bank agreed to allow the corporation to assume the loan previously provided to Aya on the same terms and conditions, including the condition that the loan be secured by Aya’s personal assets as well as the corporation’s business assets. As Aya’s business grows, so does her need for capital in order to sustain that growth. If her business is successful, much of that capital will be internally generated through sales. But Aya may feel that in order to move to the next stage in the evolution of her business, she also needs investors to provide additional capital—either because her business is not yet big enough to generate sufficient revenue to fuel further growth, or simply because she sees an opportunity to expand rapidly that is most effectively addressed with an immediate injection of additional capital. As the fact pattern revealed in Chapter 1, there were limits to how much capital Aya could attract from lenders. She therefore issued shares, including preferred shares. As her business grows, she will continue to have to make decisions about whether she can raise money through the issuance of debt or shares. Her decisions will be constrained by restrictions that lenders may have already imposed—for example, they may have constrained how much additional debt the business can take on. At the same time, working within these constraints, Aya will need to consider which of the available options are the most attractive financially. The challenges that Aya faces are typical of many emerging companies. As they grow, they may move from raising capital from family and friends to raising it from professional investors who focus on early-stage financing (sometimes referred to as “angel” investors or providers of “seed” capital). Companies that continue to grow may then become the object of attention from what is often called venture capital. A company at this stage may do one or more rounds of financing with providers of venture capital. The size of the investments in each round may in turn become more meaningful. Eventually, a company that is particularly successful may decide to broaden its investor base even more by offering its shares to the public at large through an initial public offering or subsequent public offerings. Furthermore, a company may at each one of these stages in its evolution also be considering whether to issue debt to investors (in addition to what kinds of financing lines it wishes to have in place with one or more banks). Some of this debt may be secured against the company’s assets, while some of it may be unsecured. This, along with the package of covenants that the company may be asked to agree to, can become the subject of protracted negotiations. It is therefore no surprise that the universe of professional investors focused on providing debt financing is every bit as large and complex as the world of equity investors. It is not hard, in turn, to see why in any country with developed capital markets there is typically a sizeable body of finance professionals working either for companies that must manage their capital needs or for organizations that are themselves professional investors or that act as

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intermediaries (such as investment banks) seeking to facilitate the flow of capital between investors and companies. Lawyers play an important role in all of this—they not only structure the legal underpinnings of many of these investment relationships but are also frequently involved in advising on disputes over the nature of the rights and obligations at play in a given investment relationship. The first extract below provides an introduction to some of the basic concepts relevant to this area, concepts that are developed more fully as the chapter unfolds.

Christopher Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) at 345-46 Debt and Equity When a corporation borrows money, the obligation to repay the money is a debt. Raising money by borrowing is referred to as debt financing. When a corporation raises money by offering new shares to purchasers, the shareholders’ interest in the corporation is referred to as equity. Raising money in this way is referred to as equity financing. It is often helpful to introduce the concepts of debt and equity by comparing the differences between them from the perspective of the corporation as well as from the perspective of investors. Some of the major differences are discussed below. Debt Ranks Ahead of Equity Perhaps the most fundamental difference between debt and equity is this: when a corporation that has borrowed money is wound up or liquidated, the assets of the corporation are sold. The proceeds of sale go first to satisfy the claims of outstanding creditors. Until all the creditors of the corporation have been repaid every penny they are owed, the corporation’s shareholders receive nothing at all. This is true even if the shareholders hold so-called preferred shares … . Debt Must Be Repaid When a corporation borrows money, it is under a legal obligation to repay it. However, when a corporation raises money by selling equity—at least in its humblest form, common or ordinary shares—the money received from investors never needs to be repaid. It becomes part of the corporation’s permanent capital. Interest Payment Deductibility When a corporation makes interest payments on any money it has borrowed, the amount of those payments may be deducted from the corporation’s income calculated for tax purposes. As a result, the corporation will pay less income tax. That means that, for a taxpaying corporation, every dollar distributed to a lender in interest actually costs the corporation something less than a dollar after taxes. By contrast, when a corporation makes a distribution to its shareholders, that distribution—a dividend—is not deductible by the corporation in calculating its income for tax purposes.

395

II.  The Share

Taxation of Interest Payments and Dividend Payments Interest payments received by debtholders are taxed as ordinary income. Dividend payments, on the other hand, benefit from the Income Tax Act’s “dividend tax credit.” The dividend tax credit attempts to integrate Canadian corporate income tax and Canadian personal income tax by taking account of the fact that, when a shareholder receives a dividend payment, that payment has come from income on which the corporation has already been required to pay tax. Because of the dividend tax credit, $1 received by a taxpayer in the form of a dividend is normally worth more, after tax, than $1 received by the same taxpayer in the form of interest. “Dilution” of Ownership Equity in its simplest form (common or ordinary shares) typically entitles the shareholder to voting rights—in particular, the right to vote at annual meetings to elect directors of the corporation. Thus, when a corporation raises money by issuing more shares, it is also issuing more votes. The effect of increasing the number of voting shares may be to undermine the existing shareholders’ control over the corporation. There are many ways, however, in which a corporation may raise equity capital without diluting the ownership or control of its existing shareholders. For example, shares may be issued that carry no voting rights except in exceptional circumstances. Or, the controlling shareholders may issue to themselves a separate class of shares that have enhanced voting rights so that they can maintain voting control even though they may not hold an overall majority of the corporation’s shares. The only point to remember here is that when a corporation has decided to raise equity, it must consider not only the financial implications of that decision, but also the potential impact that issuing new equity may have on control of the corporation. Concern about dilution of ownership or control is not typically an issue when a corporation is issuing debt— that is, borrowing money. It is rare for debt instruments, such as bonds or debentures, to carry rights to elect the corporation’s directors. Indeed, … in many Canadian jurisdictions, the governing statute requires that only shareholders can elect directors.

II.  THE SHARE Section II is divided into five subsections. Section II.A provides a preliminary view of the nature of a share. Section II.B then reviews the formalities associated with capitalizing a corporation. Section II.C considers issues with respect to the nature of the consideration that a corporation must receive in exchange for issuing a share. Section II.D explores pre-emptive rights, which are rights that can be given to existing shareholders to ensure that they will have shares issued to them on the same terms as those associated with shares being issued to new shareholders (thereby ensuring that existing shareholders will not find their interests diluted as a result of a new share issuance). Section II.E then returns to the question of how best to understand the nature of a share.

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A.  What Is a Share? In order to compare the obligations that a company is taking on when it issues debt or equity, it is important to understand what rights a company is granting the investor from whom it is receiving capital. The following extracts are intended to give you an initial sense of what rights an investor gets when subscribing for a share.

Christopher Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) at 354-56 A corporate “share” is a unique type of corporate investment, and a complex form of personal property. … Some traditional attributes of share ownership are also popularly understood. For example, it is well known that corporate shareholders may from time to time receive cash distributions (known as dividends) from the corporation, and that they are occasionally invited to attend shareholders’ meetings at which they are given an opportunity to vote on certain matters affecting the corporation. But the precise legal nature of a corporate share and the rights to which its owner is entitled are actually more difficult to describe or define than is the distinctive appearance of a typical paper share certificate. The concept of a corporate share (and indeed the word “share” itself) connotes a common, divided, participation interest in the corporation’s business—an interest ultimately connected in some way to an investment of money that has been made in the corporation. That investment may have been made by the current shareholder herself. But it need not have been. The current shareholder may have acquired her shares not from the issuing corporation itself, but from another shareholder. The money paid to acquire a transferred share would not have gone to the corporation. It would have gone to the former shareholder who sold the share. At some point in the past, however, when that share was first issued by the corporation to its original holder, that original holder would have paid the corporation the share price. One often hears the “capital” of a corporation described as being “divided into shares.” And it has been authoritatively declared that “[a] share is, therefore, a fractional part of the capital.” However, this description is of little explanatory value because the word “capital” is also a word with a somewhat elusive meaning. It is without doubt that share ownership does not represent a proportionate share in the assets owned by the corporation; the corporation, and only the corporation, owns those assets. Even when a corporation is dissolved, and its assets liquidated, shareholders do not have any right to receive a distribution of those specific assets. They are entitled only to receive a proportionate distribution of the value of those assets—and then only such value as remains after all of the corporation’s debts and other liabilities have been satisfied. So, for example, in United Fuel Investments Ltd. v. Union Gas Company of Canada Ltd., United Fuel Investments Ltd. (“United Fuel”) was being wound up. United Fuel was a holding company—that is, a corporation that does not carry on active business operations itself, but is created for the purpose of holding shares in other companies. United Fuel’s principal asset consisted of shares in its wholly owned subsidiary, United

397

II.  The Share

Gas. As part of the winding up, these shares in United Gas were to be sold. The proceeds of the sale were to be used first to satisfy any outstanding obligations of United Fuel. The balance remaining would then be distributed to United Fuel’s shareholders. The holders of a small number of United Fuel’s shares were not interested in receiving cash from United Fuel. They wanted, instead, to receive shares of United Gas. They therefore argued against the liquidation (that is, the sale) of the whole block of United Gas shares owned by United Fuel. They asked that only a small portion of the shares be sold—a portion just large enough to raise the cash needed to pay all of the outstanding debts of United Fuel. The remaining shares, they said, should then be distributed to the United Fuel shareholders. The Ontario Court of Appeal held that the minority shareholders had no right to call for the property of the corporation in which they held shares to be distributed directly to them. As Schroeder JA put it: The contention that the appellants are entitled to a distribution of the shares of United Gas in specie is based upon a complete misconception of the rights of corporate shareholders. They have no title to the assets of the company, but in common with all shareholders they are entitled on dissolution of the company to receive a pro rata share of the proceeds remaining in the hands of the liquidator after payment of debts, the costs of winding-up and the liquidator’s remuneration.

The minority shareholders were mistaken to think that they had any proprietary interest in the assets held by the corporation. The following case deals with reporting obligations under the CBCA that have since been repealed because securities law provides for analogous reporting obligations. However, the case remains the definitive statement from the Supreme Court of Canada on the nature of a share. As you review Justice La Forest’s decision, consider carefully the question of whether the rights that a shareholder gets through a share can in any way be said to amount to a proprietary interest in the assets of the corporation or, for that matter, in the corporation itself. Put another way, ask yourself whether the decision supports a proposition that one sometimes hears to the effect that shareholders are “owners” of the corporation. The answer to that question has important ramifications for how one thinks about the nature of the relationship between a corporation and its shareholders, as well as for the question of what obligations should boards of directors have to shareholders.

Sparling v Québec (Caisse de Dépôt et Placement du Québec) [1988] 2 SCR 1015 LA FOREST J:

[1]  The sole issue in this appeal is whether the Caisse de dépôt et placement du Québec, as an agent of the Crown in right of the Province of Québec, may invoke Crown immunity as provided in s. 16 of the Interpretation Act, RSC 1970, c. I-23, and put itself outside the purview of the provisions of the Canada Business Corporations Act, SC

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1974-75-76, c. 33, as amended, relating to the rights and obligations of shareholders, and in particular of ss. 121 to 125 of that Act, the insider trading provisions. Facts [2]  The appellant is a corporation created by An Act respecting the Caisse de dépôt et placement du Québec, RSQ 1977, c. C-2. Section 4 of that Act provides in part: 4.  The Fund [the Caisse] shall be an agent of the Crown in right of Québec.

The Caisse de dépôt et placement du Québec was created for the purpose of managing and investing funds received by the government under various statutory programs such as the Québec Pension Plan. It accordingly handles very substantial sums of public money. [3]  At the time the present motion was brought, the Caisse and the Société générale de financement du Québec jointly owned or controlled 44.3 per cent of the outstanding shares of Domtar Inc. The Caisse itself owned or controlled over 22.7 per cent of the issued common shares of Domtar, a publicly traded company governed by and continued under the Canada Business Corporations Act. [4]  Subsections 122(2) and (4) of the Canada Business Corporations Act provide: 122 … (2)  A person who becomes an insider shall, within ten days after the end of the month in which he becomes an insider, send to the Director an insider report in the prescribed form. •  •  •

(4)  An insider whose interest in securities of a distributing corporation changes from that shown or required to be shown in the last insider report sent or required to be sent by him shall, within ten days after the end of the month in which such change takes place, send to the Director an insider report in the prescribed form.

[6]  It is common ground that the Caisse by virtue of its ownership of more than 10 per cent of the shares of Domtar became an insider of that corporation for the purposes of ss. 121 and 122 of the Canada Business Corporations Act. Nevertheless, the Caisse refused to submit to the Director an insider report in the prescribed form. The Caisse contends that by virtue of Crown immunity as provided in s. 16 of the Interpretation Act it is exempt from the application of subss. 122(2) and (4) of the Canada Business Corporations Act. Section 16 of the Interpretation Act reads as follows: 16.  No enactment is binding on Her Majesty or affects Her Majesty or Her Majesty’s rights or prerogatives in any manner, except only as therein mentioned or referred to.

[7]  In response to the refusal by the Caisse to file the insider report, the respondent Director filed a motion for declaratory judgment declaring that the appellant is bound by the provisions of the Canada Business Corporations Act relating to the rights and obligations of shareholders and that the appellant is required to produce the insider report according to the terms of the Canada Business Corporations Act. •  •  •

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II.  The Share

Analysis [13]  I am in agreement with Tyndale JA that the benefit/burden exception to Crown immunity exists and that it applies in this case to render the insider reporting provisions of the Canada Business Corporations Act applicable to the Caisse. [14]  There can be no disputing the existence of the benefit/burden exception (sometimes referred to as the “waiver” exception) to Crown immunity. It is of ancient vintage; see Crooke’s Case (1691), 1 Show, KB 208, at pp. 210-11, 89 ER 540, at p. 42, where it is said: If they have any right, the King can only have it by this Act of Parliament, and then they must have it as this Act of Parliament gives it.

The exception has been applied by this Court as recently as The Queen v. Board of Transport Commissioners, [1968] SCR 118, and The Queen v. Murray [[1967] SCR 262]; see also Toronto Transportation Commission v. The King, [1949] SCR 510. •  •  •

[17]  The only question to be decided here, then, is whether the exception extends to this case. … •  •  •

[20]  Counsel for the appellant appears to admit the existence of the benefit/burden exception, but argues that by purchasing shares in Domtar, the Caisse did not invoke a benefit provided by the statute, but rather did nothing more than exercise a right conferred upon it by its charter. The Caisse, it is contended, could have purchased the shares in the absence of the Canada Business Corporations Act. As a consequence, no statutory benefit was acquired to which the burdens imposed by the Canada Business Corporations Act correspond. Only by taking particular advantage of a specific provision of the Act could the Crown subject itself to burdens attendant upon that provision. Counsel did not further elaborate on this claim. [21]  A question which immediately comes to mind is whether by taking advantage of one right conferred by the Act (e.g., voting the shares) the Crown would subject itself to all or only some of the other provisions of the Act. If only some, it is difficult to conceive how it could be determined which provisions would apply—indeed it is hard to see how most provisions, including those relating to insider reports, would ever apply to the Crown. If, on the other hand, all of the Act would apply upon the Crown taking affirmative advantage of one provision, then it is difficult to see why this result should not follow from the purchase of the shares alone. Upon purchasing the shares certain rights, e.g., the right to vote the shares and the right to receive dividends, accrue immediately to the purchaser. As will be discussed, the aggregate of these rights and their attendant obligations are indeed definitive of the notion of a share. With respect, I cannot see why some affirmative act with regard to one right acquired by the purchaser of a share changes the situation in any relevant way. [22]  Counsel for the Attorney General of Alberta put the same point somewhat differently, contending that there is not a sufficient “nexus” between the right claimed and the burden assumed. It is quite correct to conclude that whenever the question of the application of the benefit/burden exception arises, the issue is not whether the benefit and burden arise under the same statute, but whether there exists a sufficient nexus

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between the benefit and burden. As McNairn, [Colin H.H. McNairn, Governmental and Intergovernmental Immunity in Australia and Canada (Toronto: University of Toronto Press, 1977)], at p. 11, puts it: It is not essential … that the benefit and the restriction upon it occur in one and the same statute for the notion of crown submission to operate. Rather, the crucial question is whether the two elements are sufficiently related so that the benefit must have been intended to be conditional upon compliance with the restriction.

[23]  It is also true that the Caisse, as agent for the Crown in right of the Province, is not seeking affirmatively to take advantage of a provision of a statute or of the common law. It simply purchased shares in a corporation which happened to be governed by a statute, the Canada Business Corporations Act. It brought no action at law and sought no other advantage. [24]  To conclude from this, however, that the Crown is not bound by the obligations attendant upon the rights conferred by the statute requires that one presuppose a rather simplistic view of the nature of a share and its purchase. A share is not an isolated piece of property. It is rather, in the well-known phrase, a “bundle” of interrelated rights and liabilities. A share is not an entity independent of the statutory provisions that govern its possession and exchange. Those provisions make up its constituent elements. They define the very rights and liabilities that constitute the share’s existence. The Canada Business Corporations Act defines and governs the rights to vote at shareholders’ meetings, to receive dividends, to inspect the books and records of the company, and to receive a portion of the corporation’s capital upon a winding up of the company, among many others. A “share” and thus a “shareholder” are concepts inseparable from the comprehensive bundle of rights and liabilities created by the Act. Nothing in the statute, common sense or the common law indicates that this bundle can be parceled out piecemeal at the whim of the Crown. It cannot pick and choose between the provisions it likes and those it does not. To do so would be to permit it to define an entity which is the creature of federal legislation. What the Caisse obtained was an integral whole. [25]  The very act of purchasing a share, then, is an implicit acceptance of the benefits of this statutory regime. These benefits are indissolubly intertwined with the restrictions attendant upon them. [26]  Absent the statutory regime, the idea of a share as an object of commerce is meaningless. The relationship between benefit and restriction is sufficiently close that the Crown must be determined to have taken the law as it found it. The relationship between the benefits of share ownership and the obligations of insiders is particularly close. As Dickson J (as he then was) stated in another context in Multiple Access Ltd. v. McCutcheon, [1982] 2 SCR 161, at p. 179: The proper relationship between a company and its insiders is central to the law of companies and, from the inception of companies, that relationship has been regulated by the legislation sanctioning the company’s incorporation.

[27]  Hannan  J in the court of first instance distinguished this Court’s decision in Murray, supra, on the ground that the Court there held, at p. 268, that “… this is not a case in which a provincial legislature has sought to “bind” the federal Crown, in the sense

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of imposing a liability upon it or of derogating from existing Crown prerogatives, privileges or rights.” Hannan J concluded that this quotation … clearly implies that had the provincial legislation been intended to “bind” the Crown, it might well have been inapplicable. In the present case, the application by analogy of the words of Martland J would dictate that, as the [Canada Business Corporations Act] seeks to bind the agent of the Crown in right of Québec, it is inapplicable to such agent.

[28]  With respect, in my view the analogy between Murray and this case works to the benefit of the respondent. The Canada Business Corporations Act, like the Exchequer Court Act which was the subject of Murray, merely “established a relationship from which certain results might flow,” to use the words of Martland J in Murray. Just as in Murray the Crown was not bound by the prejudicial provisions of the law until it chose to take advantage of its beneficial aspects, here no right or prerogative of the Crown is affected by the Canada Business Corporations Act standing alone. It was only by seeking the benefits of the statute by purchasing shares that the Caisse chose to bring itself within the purview of the law relating to shareholders. In the words of Professor Hogg, [Peter W. Hogg, Liability of the Crown in Australia, New Zealand and the United Kingdom (Australia: Law Book Co., 1971)], at p. 183, “when the Crown claims a statutory right the Crown must take it as the statute gives it, that is, subject to any restrictions upon it.” Otherwise, the Crown would receive a “larger right than the statute actually conferred” (p. 183). [29]  Application of the benefit/burden exception does not result in subsuming the Crown under any and every regulatory scheme that happens to govern a particular state of affairs. Although some earlier authorities (see, e.g., Bank of Montreal v. Bay Bus Terminal (North Bay), Ltd. (1971), 24 DLR (3d) 13 (Ont. HC), at p. 20, aff ’d (1972), 30 DLR (3d) 24 (Ont. CA)) had been thought by some to support the view that the Crown was bound by any regulatory scheme of sufficient scope, this approach was rejected by Laskin CJ in the P.W.A. case [Her Majesty in right of the Province of Alberta v. Canadian Transport Commission, [1978] 1 SCR 61] (p.  69). The exception is not of such broad reach. Its application depends not upon the existence or breadth of a statutory scheme regulating an area of commerce or other activity, but, as noted earlier, upon the relationship or nexus between the benefit sought to be taken from a statutory or regulatory provision and the burdens attendant upon that benefit. The focus is not on the source of the rights and obligations but on their content, their interrelationship. As McNairn, op. cit., puts it at pp. 11-12: Reliance upon a statute may … be for such a limited purpose that the crown ought not, as a result, to be taken to have assumed the attendant burdens. Such is the case when a statute is resorted to for a purely defensive reason, for example to give notice under a registration scheme of the existence of a crown claim. The use of a statute in this way may be distinguished from active reliance to secure positive rights, the assumption of the burdens of a statute being a possible consequence only of the latter circumstance.

[30]  Here, the interrelationship between the rights and obligations acquired by the purchaser of a share is so close both conceptually and historically that there can be no question of the application of the benefit/burden exception. Indeed, as earlier mentioned, a share is an integral whole. Thus, the Crown, when it purchases a share of a company to

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which the Act applies, is bound by the entirety of the Canada Business Corporations Act in so far as it defines and regulates the rights and obligations of shareholders. Disposition [31]  I would accordingly dismiss the appeal.

B.  Formalities of Capitalization Justice La Forest describes a share as a “’bundle’ of interrelated rights and liabilities.” This proposition is an important statement about how to conceive of a share, since it makes clear that in issuing a share in exchange for capital, the question that the corporation and the investor will both be focused on is what rights and liabilities form the “bundle” being issued to the investor. We know that with the advent of the limited liability corporation, a share no longer brings with it unlimited liability—something that is important to investors and that accounts for the popularity of the limited liability corporation. Moreover, the CBCA provides considerable flexibility with respect to the rights that may form part of a share—an important feature because it allows companies to consider a wide range of options when designing their share structures. The rest of this chapter will regularly return to the question of what rights may form part of a share, as well as the question of what distinguishes the rights that form part of a share from the rights associated with other forms of investment. In turn, the nature of the rights in question is highly relevant to discussions in subsequent chapters concerning both what say, if any, shareholders and other investors should have with respect to important corporate acts and what obligations a corporation and its board of directors should have to shareholders.

1.  Authorized and Issued Capital On the organization of a corporation, several decisions must be made about its capital structure. How many shares will be issued, and for what consideration? Will the corporation have only one kind of shares, or will different classes with different rights and preferences be created? Should management of the corporation be restricted in the number of shares it may issue? The last question was answered prior to the advent of the CBCA by determining what the corporation’s “authorized” capital would be. The authorized capital, which had to be stated in the corporation’s articles, memoranda, or letters patent (as is still the case under a number of corporations statutes that are not based on the CBCA), indicated how many shares the corporation was authorized to issue. By contrast, the “issued” or “outstanding” capital referred to the shares actually issued. Decisions on when shares would be issued and how many shares would be issued were made by the directors under provisions similar to CBCA s 25(1). They could therefore issue shares up to the ceiling provided by the authorized capital without seeking the approval of the shareholders. But beyond that they could not issue shares without amending the corporation’s constitution to increase the authorized capital. This required a special resolution approved by two-thirds of the votes at a shareholders’ meeting.

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The principal function of authorized capital was therefore to restrict the directors’ discretion to issue shares. While it is not necessary to place an upward limit on the number of shares that the directors of a CBCA corporation can issue, it is still possible to enshrine such restrictions in the articles under s 6(1)(c). Of course, in many cases it makes little sense to limit that discretion. Thus, the authorized capital of many publicly held corporations was often far higher than the number of shares the directors would be likely to want to issue for a long time to come. Under CBCA s 6(1)(c), the articles of such corporations would simply omit to list any maximum number of shares that the corporation is authorized to issue. However, a substantial minority shareholder in a widely held corporation may desire such a restriction to ensure that its interest in the corporation is not diluted by a further public issue of shares. For this reason, some financial institutions prefer such restrictions in the articles of corporations in which they invest. In small issuers, minority shareholders may also be unwilling to leave decisions on issuing shares solely to the directors, and may insist on restrictions on issued capital. By itself, restrictions of this kind may be a relatively inefficient method of preventing abuses, and shareholders in small issuers might well be advised to seek further protection through pre-emptive rights or a shareholders’ agreement, topics discussed below in Section II.D and Chapter 12, respectively.

2.  Common and Preferred Shares On incorporation, a decision must also be made as to how many classes of shares may be issued, since such classes must be stated in the articles: see CBCA s 6(1)(c). These decisions are important because the relative rights of different classes of shares can be expected to have a direct bearing on the ease with which one will attract capital when issuing shares of a given class. These decisions may also affect the extent to which the original shareholders can expect to retain control of the company as it grows and searches for additional investors to help fuel growth. Frequently, small issuers have only one class of shares, although further classes may be created for tax-inspired or other motives. If two or more classes of shares are created, one class is often designated as “common shares,” while the other classes are described as “preferred shares.” Preferred shares bear special rights or restrictions with respect to such matters as voting rights, dividends, and distributions on liquidation. For example, the holders of preferred shares are not typically entitled to share in the proceeds of a winding up beyond the value of the amount initially invested and any accrued and unpaid dividends. By contrast, common shares are generally free of all preferences or conditions. Some corporations statutes formerly required at least one class of common shares with no special rights; however, there are no such restrictions in the CBCA, where the capital may consist solely of “Class A Common” and “Class B Common” shares, both with special rights. Preferred shares are often referred to as senior securities and entitle the holder to special rights. Such preferences may include a right to be paid dividends before the common shares. (The special rights of holders of such securities are discussed more fully later in this chapter.) Preferred shares may also be made redeemable by the corporation, which can then require the shareholders to surrender them back to the corporation for a particular price. The preferred shares may also be made retractable, in which case the decision to return them to the corporation for cash is made by the shareholder.

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The rights attached to preferred shares must be stated in the articles under CBCA s 6(1)(c)(i). If the directors wish thereafter to issue a class of shares not provided for in the articles, they must cause the articles to be amended. However, directors may determine the special rights attaching to preferred shares if the shares are issued in series under s 6(1)(c)(ii). The rights and restrictions may then be left unspecified until the shares are issued, when the needs of the corporation and the investors may more easily be determined. When the directors fix the special rights and issue the shares, articles of amendment must be prepared under CBCA s 27(4). Note that s 27(3) prohibits the issue of any such series of shares with rights to a payment of dividends or a return of capital that are prior to the rights of any other outstanding shares of the same class.

3.  Subscriptions for Shares A subscription agreement is a contract in which a corporation undertakes to issue shares to subscribers. Subscription agreements were at one time a rich source of litigation, but today such cases are rare. One reason for this is the abolition of partly paid shares in modern corporations statutes. Prior to provisions such as CBCA s 25(3), shares could be issued on credit with only part of the purchase price paid. The balance was due on a “call” by the corporation. On bankruptcy, the trustee would require subscribers to pay the unpaid purchase price for the benefit of creditors. This process raised the question whether a binding subscription agreement had been created through the corporation’s acceptance of the subscription offer. These difficulties were particularly acute in pre-incorporation subscriptions. Where the articles, memoranda, or letters patent required the incorporators to subscribe for shares, they could not withdraw thereafter.1 Apart from this restriction, subscriptions prior to incorporation suffered from the same defects as pre-incorporation contracts generally (see Chapter 5). When the corporation was formed, it was not bound by prior contracts and could decide not to issue the shares to subscribers. For their part, the subscribers were entitled to withdraw prior to acceptance by the issuer.2 Indeed, under Kelner v Baxter (1866), LR 2 CP 174 (Common Pleas), a corporation could not ratify a pre-incorporation subscription. However, Canadian courts resisted the orthodox view of pre-incorporation contracts in these cases when the issuer was in bankruptcy and where the subscriber had held himself out as a shareholder after incorporation. Subscribers were then held liable for the unpaid purchase price of their shares on three separate theories. First, the pre-incorporation subscription was interpreted as a continuing offer that the corporation could accept after incorporation. Second, the subscriber’s conduct after incorporation was found to constitute a new offer that the corporation might accept. Finally, the subscriber was held to be estopped by his or her conduct from denying his or her liability on the call by the trustee in bankruptcy.3 A pre-incorporation subscription will now be governed by CBCA s 14, and the corporation will be able to ratify the contract. Until then, the subscriber will undoubtedly not be held to be under any duty to the corporation. Would he or she, however, be liable to the other signatories to the agreement under s 14? 1 See Buff Pressed Brick Co v Ford (1915), 33 OLR 264, 23 DLR 718 (App Div). 2 See Re Canadian Tractor Co (Clarke’s case) (1914), 7 WWR 562 (Sask SC). 3 All three theories were discussed in Re Canadian Tractor Co, ibid.

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C.  Consideration on an Issue of Shares 1.  The Need for Consideration CBCA s 25(1) states that “shares may be issued … for such consideration as the directors may determine,” and similar provisions may be found in all other corporations statutes in Canada. “Bonus stock,” or shares issued for no consideration whatsoever, is not expressly prohibited, but these provisions have been interpreted to require that the corporation receive consideration in exchange for issuing a share. Few promoters were so bold as to issue shares without any stated consideration in exchange for issuing a share. Instead, problems of bonus stock arose when the consideration was entirely fictitious. In such cases, the allotments were uniformly set aside.

2.  Discount Stock A more subtle problem that courts have had to wrestle with is “discount stock,” or stock issued for inadequate consideration. For existing shareholders, the harm that flows from a corporation and its directors agreeing to issue new shares at a discount is serious—it results in the value of their existing shares being diluted since the company has not received equivalent value upon issuing the new shares. It is therefore an important issue that courts and legislators have dealt with since the early days of company law.

Ooregum Gold Mining Co v Roper [1892] AC 125 (HL) LORD HERSCHELL:  The Ooregum Gold Mining Company, Limited, was incorporated in October 1880 under the Joint Stock Companies Acts 1862 to 1880. The statement contained in the memorandum of association with reference to the capital of the company was as follows: “The capital of the company is £125,000 divided into 125,000 shares of £1 each, and the shares of which the original or increased capital may consist may be divided into different classes and issued with such preference, privilege, guarantee, or condition as the company may direct.” Forty thousand of the shares were allotted to the vendors to the company, the residue were issued to the public, and the full amount paid thereon. The operations of the company were not, in the first instance, successful, and a winding-up order was obtained. An application was subsequently made to the Court for an order to stay the winding-up, with a view to the introduction of fresh capital and a resumption of mining operations, and an order was made accordingly. In pursuance of this policy an extraordinary general meeting of the company was summoned in 1885, at which it was resolved that the capital should be increased by the issue of 120,000 preference shares of £1 each, to be credited in the capital and books of the company as having the sum of 15s. per share paid thereon, such preference shares carrying the right to a non-cumulative preference dividend up to 10 per cent on the nominal amount of such preference capital out of the profits of the undertaking each year, and to equal participation (share per share) with the ordinary shares in such further profits as should remain for distribution each year after the payment of the above 10 per cent preference dividend. The special

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resolution so passed was duly confirmed. At this time the market value of the ordinary shares was only 2s. 6d. per share. Upwards of 100,000 of these preference shares were allotted, with 15s. credited as paid thereon. Prior to the actual allotment an agreement was entered into between the company, of the one part, and an agent or trustee for the several persons whose names were entered in the schedule thereto, of the other part, whereby, after reciting the agreement to issue the shares at a discount of 15s. per share, and that 1s. had been paid on allotment, it was agreed that the shares to be allotted should be held as shares on which 16s. per share had been paid, and should be subject and liable to further payment of 4s. per share, and no more, and the company thereby undertook to cause the agreement to be registered at the Joint Stock Registration Office, pursuant to the Companies Act 1867, before the issue of the shares. The agreement was duly filed accordingly. The capital raised by means of the issue of the preference shares sufficed to discharge the obligations of the company, to extricate it from its difficulties, and to give it a new start. Gold to a considerable amount was shortly afterwards raised from the mines, and the company has since been prosperous, the market value of the ordinary shares having risen to about 40s. In February 1889 the Respondent, George Roper, purchased on the Stock Exchange and paid for ten fully paid-up ordinary shares in the company. On the 15th of July following on behalf of himself and the other ordinary shareholders Roper brought this action against the company and Wallroth (as an original allottee of the preference shares and as representing the other original allottees) to have it declared that the issue by the company of the 120,000 preferred shares, at a discount of 15s. per share, was ultra vires, and to have the register rectified accordingly and other consequent relief granted. The statement of claim contained the allegation that the company had in 1889 issued debentures to the amount of £20,000, which were charged on all the property of the company, and which were then outstanding. It further alleged as follows: “The defendant company had no power to issue the said preferred shares at a discount, and the entry of the preferred shares in the register book as fully paid-up should be rectified. The said preferred shares are now quoted on the Stock Exchange at a premium, and if the said entry is rectified the ordinary shares will benefit thereby, and the 15s. unpaid on the preferred shares will be available for paying off the said debentures as and when they fall due.” North J upon the authority of In re Almada and Tirito Company [38 Ch. D 415] without argument made an order declaring that the issue of the preferred shares of £1 each at a discount of 15s. per share was beyond the powers of the company, and that the said shares so far as the same were held by Wallroth or by original allottees represented by him were held subject to the liability of the holders to pay to the company in cash so much of the £1 per share as had not been paid on the same; and ordering that the company do rectify the register in accordance with the above declaration. This order was affirmed by the Court of Appeal without argument. Against these orders appeals were brought by the company and by Wallroth. [Counsel for the company and for Wallroth argued: These consolidated appeals raise the same question, viz. whether a limited company registered under the Companies Acts of 1862 and 1867 can issue shares as fully paid up upon which a less sum than the nominal value has been paid. … There is no question in the present

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case as to the bona fides of the transaction, and the issue was sanctioned both by the memorandum of association and the articles. … The only dispute is as to the issue being prohibited by the Companies Acts. This company was in difficulties: money was wanted; unless a large sum could be raised the undertaking must fail and the company be wound up. No other means of raising money were available except the issue of shares at a discount so as to place the new holders on the same footing as the old. A commercial company may do in the furtherance of its legitimate objects anything which is not prohibited, and there is no intrinsic impropriety in such a transaction as the present, either under the general law of partnership or under Companies Acts.] LORD HALSBURY LC:  My Lords, the question in this case has been more or less in debate since 1883, when Chitty J decided that a company limited by shares was not prohibited by law from issuing its shares at a discount. That decision was overruled, though in a different case, by the Court of Appeal in 1888, and it has now come to your Lordships for final determination. My Lords, the whole structure of a limited company owes its existence to the Act of Parliament, and it is to the Act of Parliament one must refer to see what are its powers, and within what limits it is free to act. Now, confining myself for the moment to the Act of 1862, it makes one of the conditions of the limitation of liability that the memorandum of association shall contain the amount of capital with which the company proposes to be registered, divided into shares of a certain fixed amount. It seems to me that the system thus created by which the shareholder’s liability is to be limited by the amount unpaid upon his shares, renders it impossible for the company to depart from that requirement, and by any expedient to arrange with their shareholders that they shall not be liable for the amount unpaid on the shares, although the amount of those shares has been, in accordance with the Act of Parliament, fixed at a certain sum of money. It is manifest that if the company could do so the provision in question would operate nothing. I observe in the argument it has been sought to draw a distinction between the nominal capital and the capital which is assumed to be the real capital. I can find no authority for such a distinction. The capital is fixed and certain, and every creditor of the company is entitled to look to that capital as his security. It may be that such limitations on the power of a company to manage its own affairs may occasionally be inconvenient, and prevent its obtaining money for the purposes of its trading on terms so favourable as it could do if it were more free to act. But, speaking for myself, I recognise the wisdom of enforcing on a company the disclosure of what its real capital is, and not permitting a statement of its affairs to be such as may mislead and deceive those who are either about to become its shareholders or about to give it credit. I think, with Fry LJ in the Almada and Tirito Company’s Case [38 Ch. D 415], that the question which your Lordships have to solve is one which may be answered by reference to an inquiry: What is the nature of an agreement to take a share in a limited company? and that that question may be answered by saying, that it is an agreement to become liable to pay to the company the amount for which the share has been created. That agreement is one which the company itself has no authority to alter or qualify, and I am therefore of opinion that, treating the question as unaffected by the Act of 1867, the company were prohibited by law, upon the principle laid down in Ashbury Company v. Riche [LR 7 HL 653], from doing that which is compendiously described as issuing shares at a discount.

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[The concurring judgments of Lords Watson, Herschell, MacNaghten, and Morris are omitted.] Appeal dismissed with costs. When Ooregum was decided, corporate statutes in England and North America required that a par value be given to each share. The articles, memoranda, or letters patent provided for authorized shares of a stated amount or par value. This amount was an arbitrary figure and shares could be issued for more than par. The issuer would then add the par value of each allotted share to the stated capital account on the equity side of the balance sheet. The premium over par was added to a separate contributed surplus account, under equity. Thus, a $5 par value share could be issued for $15, with $5 added to stated capital and $10 to contributed surplus. However, shares could not be issued for a consideration less than par—that is, at a discount below par. The judicial hostility to discount stock was nowhere so evident as in The North-WestElectric Co v Walsh (1898), 29 SCR 33, rev’g (1897) 11 Man LR 629 (QB). The plaintiff corporation had issued 160 $100 par shares for $20 each to the wife of one of its promoters, who was also its managing director. However, the corporation was seemingly near insolvency and the shares were apparently worth no more than their issue price. The Manitoba Court of Queen’s Bench distinguished the Ooregum decision in two ways. First, the Manitoba statute was a letters patent one, and it was not clear that the ultra vires rule applied in the same way to such companies, if it applied at all. Moreover, the Manitoba Joint Stock Companies Act, RSM 1891, c 25 appeared expressly to permit discount stock. Section 30(b) stated that directors could not issue shares at a greater discount or less premium than that authorized by the shareholders. The Supreme Court held the issue of shares to be ultra vires and illegal, though the interpretation given to s 30(b) is not easy to explain. In the United States, a corporation was permitted to issue discount stock. In Handley v Stutz, 139 US 417 (1891), the Clifton Coal Co required money to expand. The corporation’s initial attempt to issue bonds failed and shares were therefore added as a “sweetener.” Eventually, the corporation received $45,000 for an issue of $45,000 of bonds and an equal face value of shares. The US Supreme Court upheld the allotment. The transaction was fair and the parties were in good faith. The court stated that “[t]o say that a corporation may not, under the circumstances above indicated, put its stock upon the market and sell it to the highest bidder, is practically to declare that a corporation can never increase its capital by a sale of shares, if the original stock has fallen below par”: Handley v Stutz at 430. Is there any reason why an issue of shares deserves closer scrutiny than other transactions a corporation may enter into, such as an issue of debt securities? In Mosely v Koffyfontein Mines Ltd, [1904] 2 Ch 108, the defendant company sought an injection of capital at a time when its shares were trading at three-eighths to half of their par value. The company issued new debentures at a 20 percent discount, convertible immediately at their face amount to par value shares of a like amount, and it was argued that this was in effect an issue of discount stock. Buckley J upheld the allotment. Even if the debentures were converted immediately, the shares would be issued not for cash but for property. The prohibition against discount stock would not apply in such cases, and the transaction would not be impeached whatever the true value of the property. The Court of Appeal reversed this decision, holding

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that the issue of debentures was invalid since it might result in shares being issued at a discount. Because the debentures were convertible immediately into shares, there was “an obvious money measure” between the consideration received and the par value of the shares. In such circumstances, it was not sufficient that the bargain was made in good faith and that the shares were not in fact worth their par value. It appears that, without the conversion privilege, the issue of debentures would not have been set aside. Why is it illegal to issue discount stock, but not discount debt? If the prohibition of discount stock was meant primarily to protect creditors, as Lord Halsbury suggested, just how would they be prejudiced by it? A creditor’s claim is made more valuable by anything that increases the firm’s solvency, its value on default, or the creditor’s share of firm value on default. A further injection of equity, so long as any consideration is received, will increase solvency and firm value on default without creating new claims that rank equal to or ahead of the creditors. Existing creditors are then made better off by an issue of discount stock. This leaves open the possibility of a prejudice to existing shareholders or future creditors or shareholders.

3.  Watered Stock One of the reasons a rule prohibiting discount stock developed was perhaps the ease with which it could be applied. When, as in Mosely v Koffyfontein Mines Ltd, above, “an obvious money measure” existed, it was a simple matter to see whether the consideration was adequate at law. Discount stock would then be impeached even if the transaction had not prejudiced anyone, since a determination of the fairness of the exchange required a valuation of the shares from a financial point of view, a task that courts were loath to perform. A prohibition of discount stock would thus give the appearance of offering protection to creditors and shareholders without the hard, financial analysis required to see if anyone was really harmed. It soon became apparent that corporations that sought to avoid the prohibition of discount stock could do so in other ways: • The corporation could issue “no par value shares.” Since 1924, Canadian corporations statutes have permitted the creation of no par value shares, which, unlike par value shares, do not bear a monetary figure on their face. The movement to no par value shares, which began with a New York statute in 1912, offered three reasons for detaching the dollar sign from the share certificate. First, it would avoid cases like Ooregum, where an issue of discount stock is set aside even if the transaction is fair. Indeed, discount stock cases are, strictly speaking, restricted to issues of par value shares, though there are other prohibitions against an issue of no par value shares for an inadequate consideration. Second, it would emphasize that the true value of the share is a function of its right to participate in the earnings of a going concern, and is quite independent of par value. Retaining par value might even seem like a misrepresentation, if a gullible investor imagines that a $100 par value share in a worthless corporation must be worth something, and is likely a bargain at $20. Finally, all the consideration received by the corporation on an issue of no par value shares is normally added to stated capital, with artificial contributed surplus accounts eliminated: see CBCA s 26(1). For these reasons, par value shares are prohibited by CBCA s 24(1). However, no par value shares also do

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away with the “obvious money measure,” and early reactions to them suggested that they facilitated an issue of shares for an inadequate consideration.4 • The corporation could issue shares for a non-monetary consideration. Corporations statutes have always permitted an issue of shares for a non-monetary consideration. The consideration might still be inadequate, but without an “obvious money measure” it was more difficult to impeach the issue. Such shares are called watered stock, a term derived from the efforts of ranchers to increase the weight of their cattle before a sale. Watered stock will arise whenever no par value shares are issued for an inadequate consideration, whether in a monetary or non-monetary form.

a.  Valuation of Property or Services Anglo-Canadian decisions in the past, particularly in the 19th century, exhibited a great reluctance to impeach the directors’ valuation of property or services received on an issue of shares. Thus, Lord Watson said in Ooregum at 137 that “so long as the company honestly regards the consideration given as fairly representing the nominal value of the shares in cash, its estimate ought not to be critically examined.” The high water mark of this approach may be found in In re Hess Manufacturing Company (1894), 23 SCR 644.5 In Hess, a corporation had issued shares to a promoter for a consideration, in the form of a factory together with the land on which it was built, which the master found to be inadequate. Strong CJ, delivering the judgment of the Supreme Court, stated at 653-54: The only principle upon which the master could have acted in making the order he did was in assuming that no consideration whatever had been given for the shares. If any consideration was given it was beyond the master’s competence to enquire into the adequacy of it. •  •  •

So that unless a case of fraud was made and proved which could only be done in a formal action to rescind[,] it must be held that there was a valuable consideration given bona fide for the 126 shares in question.

b.  Modern Statutory Liability The cases above come close to holding that no liability arises on an issue of watered stock. However, one can no longer argue under modern corporations statutes in Canada that the use of no par value shares will insulate an issuer from liability. CBCA s 24(1) prohibits par value shares and s 25(3) requires that a consideration in property or services be “not less in value than the fair equivalent of the money that the corporation would have received if the share had been issued for money.” Moreover, s  118(1) imposes liability on directors who vote for an issue of shares that contravenes s  25(3). Do these sections require a judicial determination of the true value of the non-cash consideration when the transaction is impeached? In Ontario, when the directors determine by resolution the respective values

4 MB Jackson, “Some Random Reflections on No-Par Share Legislation” (1929) 7 Can Bar Rev 373 at 374-75; WK Fraser, “No-Par Shares” (1929) 7 Can Bar Rev 84 at 88; and AS Bruneau, “Dominion Companies and No-Par Shares” (1935) 13 Can Bar Rev 290 at 297-98. 5 See also Page v Austin (1884) 10 SCR 132 at l52-53 and Re Wragg Ltd, [1897] 1 Ch 796 (CA).

411

II.  The Share

of the shares and the consideration received on their issue, as they are required to do by s 23(4) of the Ontario Business Corporations Act, RSO 1990, c B.16 (OBCA), how ready will a court be to second-guess such valuations? Note the due diligence and reliance defences provided to directors with respect to CBCA s 118(1) under ss 118(6) and 123(4). Should the corporation retain outside professional valuers in such cases if the allotment is significant and the transaction is non-arm’s length? In addition, the s 118(1) liability is subject to a twoyear limitation period under s 118(7).

4.  Unacceptable Consideration Some kinds of consideration on a share issuance are flatly prohibited by Canadian corporations statutes. For example, CBCA s 25(3) requires a consideration of money, property, or past services. Other forms of consideration are not permitted even if they are not inadequate and the bargain is otherwise fair. Such consideration is “unacceptable,” whatever its real worth. Under the CBCA, three kinds of consideration are unacceptable: (1)  promissory notes or promises to pay, (2) non-property assets, and (3) future services. The unacceptability of promissory notes or promises to pay under s 25(5) supplements the prohibition of partly paid shares in s 25(3). On the other hand, were it not for the obligation to act in the corporation’s best interest, an issuing corporation might circumvent the prohibition of partly paid shares by lending the investor the money to make the purchase. The CBCA also prohibits non-property payments for a share issuance. What does “property” mean here? Can shares be issued in exchange for intangibles like accounts receivable, ideas, inventions, and patents? If not, why not? The following case considers whether shares may be issued on the basis that property contributed will generate future value in excess of the immediate value of that property. As you review this case, ask yourself why the CBCA allows some forms of non-monetary consideration, but not others.

See v Heppenheimer 61 A 843 (NJ Ch 1905) [The Columbia Straw Paper Co was incorporated in 1892 to acquire a monopoly over the manufacture of wrapping paper. Columbia’s promoters purchased 39 paper mills for $2,250,000, which they sold to Columbia for securities with a value of $5,000,000, of which $1,000,000 was in bonds and the balance in shares. The corporation failed in 1895 and its creditors sought to recover from its shareholders.] PITNEY VC: … The clients of Messrs. Lindabury and Marshall, as I interpret their argument, … contend that the valuation of $5,000,000 was arrived at after a careful calculation of the quantity of the paper, viz., 90,000 tons, which the 39 mills were able to produce per year, and the greatly increased price which would be realized from its sale by the suppression of the competition theretofore practiced between the several mill owners. They say that the cost of producing the paper was less than $20 per ton, and that its selling price had been reduced by competition to a trifle over $20 per ton, but that by a concentration of the ownership of the mills they found and believed that the price could be easily maintained, and the whole product of 90,000 tons a year could be marketed, at about $28

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Chapter 6  Capitalization of the Corporation

per ton, which would pay interest on the bonded debt, with 1 per cent per year for a sinking fund, and a dividend at 8 per cent per year on the preferred stock of $1,000,000, and leave a very large dividend, at least 15 per cent each year, for the common stock of the amount mentioned, $3,000,000. In short, they estimated the value of the property upon a capitalization of the profits expected to be made out of its use by control of the price of its product. So that, taking the aspect of the case most favorable to the defendants, the question which arises out of its ultimate analysis is whether, under our statute above cited, it is competent and lawful to make up the valuation of the visible property to be purchased for stock issued, by adding to the actual market value, or cost of its reproduction, a sum of money ascertained by the capitalization of the annual profits expected to be realized from a favorable marketing of the product of the company by a suppression of competition; or, as I believe I asked counsel in argument, can prospective profits, however promising, be considered as property, as that word is used in the statute above quoted? I repeat its language: “The directors of any company incorporated under this act may purchase mines, manufactories or other property necessary for their business … and issue stock to the amount of the value thereof in payment therefor.” There the word “property” must evidently be construed by its context, which refers to something visible and tangible and necessary for the business, and the amount of stock to be issued therefor is limited to the value thereof; that is, to the value of that property. If the question above put be the true one, it seems to me that it answers itself, and adversely to the contention of counsel of defendants. •  •  •

With regard to the defense based on the item of good will, advanced by the defendants, complainant replies that it is an entire misapplication of the term, and all the law growing out of it, to use it in that connection, and they point out that the conveyances and the contract preceding them, made by the original owners of the 39 mills, included by express terms the good will of the mills, which was included in the original valuation of the mills at $2,250,000, and, besides, that the original contracts were in each case accompanied by an undertaking on the part of the vendor not to engage in business for five years, and that the preliminary contract with Stein also included the good will. I shall deal with this element of good will at once. Lord Eldon, in Cruttwell v. Lye (1810) 17 Vesey, 335, at page 346, said: “The good will which has been the subject of sale is nothing more than the probability that the old customers will resort to the old place.” This definition, though often criticised, seems to me to contain the germ of all the more modern and complete definitions. I am willing to adopt, for present purposes, that written by Judge Lacombe, of the United States Circuit Court, and reported in Washburn v. National Wall Paper Co., 81 Fed. 17, 20, 26 CCA 312, 315, and cited in extenso in defendants’ printed argument: “Good will has been defined as ‘all that good disposition which customers entertain towards the house of business identified by the particular name or firm, and which may induce them to continue giving their custom to it.’ There is nothing marvelous or mysterious about it. When an individual, or a firm, or a corporation, has gone on for an unbroken series of years, conducting a particular business, and has been so scrupulous in fulfilling every obligation, so careful of maintaining the standard of the goods dealt in, so absolutely honest and fair in all business dealings, that customers of the concern have become convinced that their experience in the future will be as satisfactory as it has been in the past, while such customers’ good report of their own experience tends continually to bring

413

II.  The Share

new customers to the same concern, there has been produced an element of value quite as important as—in some cases, perhaps, far more important than—the plant or machinery with which the business is carried on. That it is property is abundantly settled by authority, and, indeed, is not disputed. That in some cases it may be very valuable property is manifest. The individual who has created it by years of hard work and fair business dealing usually experiences no difficulty in finding men willing to pay him for it, if he be willing to sell it to them.” This language was used in a case where the capital stock was issued, as here, for the value of several manufacturing establishments in which the individual good will of each separate factory was added to the value of its visible property (precisely as would have been the case here, if the stock had been issued for the amount of the sum of the valuations of the several mills with their good will added, to wit, $2,200,000), and the bill was filed by stockholders who received their stock in payment for a mill which they owned and conveyed to the corporation, and they sought by their bill to enjoin the payment of dividends on the stock so issued. It was held that they were estopped from setting up that the property had been overvalued and, further, that the evidence was insufficient to show such a depreciation in value as would warrant the relief prayed for. Turning to the present case we find, as before remarked, that the individual good will of the different properties was included in the individual valuations thereof and conveyed for the consideration above mentioned to the corporation. Further, the inference is irresistible that the corporation itself could not possibly, at the time of its organization, have acquired any good will in the proper sense of that word, or, indeed, in any sense of that word. It had made no business friends, nor any business reputation. Moreover, an examination in detail of the plan of business laid out and adopted by the promoters of the enterprise, from which they expected to reap such great profits, contemplated a complete destruction of the old good will of the individual establishments. Mr. Stein had, in fact, no good will to convey with the mills, except what he had acquired from the individual owners: hence the increase in price cannot be justified on that basis. It follows that we are driven back to the question first stated, whether prospective and contingent profits of any business, depending, as they always must and do, upon good management and the general course of business of the country, including always the element of competition, can be treated as property in the sense in which that word is used in the statute above cited. •  •  •

The present case is a painful illustration of the utter impossibility of giving the word “property” the construction claimed for it. The rose-coloured future, presently to be stated at length, for this enterprise, created with so much confidence by its promoters, failed entirely in the face of actual experience. In the first place the combination did not include all the mills which it was intended to include. There is some dispute and some indefiniteness in the evidence on this subject. The complainant contends that there were, in fact, 73 mills engaged in the manufacture of straw paper, and that the original plan and appraisement included all of them. The defendants admit 41, 2 of which they were unable to purchase, except at prohibitory prices. The proof is clear that there were several more, but just how many is in doubt. It appears from defendants’ printed argument, sustained by the proofs, that the failure of the enterprise was due to four causes: first, the financial depression of 1893; second, the starting up of old mills, and the building of new mills as

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soon as the corporation put up the price of paper; third, bad management of its affairs; and, fourth, the introduction of wood pulp as the basic material of wrapping paper such as was manufactured out of straw. •  •  •

The distinction between the contemplated issue of corporate stock for property and its issue for money lies, not in the rule for valuation, but in the fact that different estimates may be formed of the value of property. When such differences are brought before judicial tribunals, the judgment of those who are by law intrusted with the power of issuing stock [to the amount of the value of the property], and on whom, therefore, is placed the first duty of valuing the property, must be accorded considerable weight; but it cannot be deemed conclusive, when duly subjected to judicial scrutiny. Nor is it necessary that conscious overvaluation or any other form of fraudulent conduct on the part of these primary valuers should be shown to justify judicial interposition. Their honest judgment, if reached without due examination into the elements of value, or if based in part upon an estimate of matters which really are not property, or if plainly warped by self-interest, may lead to a violation of the statutory rule as surely as would corrupt motive. •  •  •

The intention of the Legislature, expressed in these sections in question, in my judgment manifestly was that the capital stock of all corporations should at the start represent the same value, whether paid for in property or money. That result can only be obtained by supposing that the property is to be appraised at its actual cash value, precisely as if a board of directors, with the whole capital stock actually paid in cash, is dealing at actual arm’s length as real purchasers with the owner of property proposed to be purchased as a real vendor, without any interest in the directors to overvalue the property, or other interests inconsistent with the real interest of the stockholders as such. I say “at the start,” because we all know that property purchased in good faith for cash is liable afterwards to depreciate in value, owing to circumstances not foreseen at the time of its purchase. After all, it seems to me that the true test, under this statute, as applied to the case here in hand, is this: If the company actually had to its credit in bank the sum of $5,000,000, would it have been willing to have paid that price in cash for the property in question for the uses and purposes to which it proposed to devote it? Would the property be worth that sum in cash to the company? Any less severe test will, it seems to me, fail to satisfy the letter and spirit of the two sections of the act before recited, which seem to me clearly to require that the shares of capital stock of any company organized under the act in force when this company was organized should be of equal value, whether paid for in cash or property purchased. NOTES AND QUESTIONS

An agreement to provide future services to an issuer is clearly a thing of value for which an employee may be rewarded by prepayments of his salary. But he may not be issued shares for future services. This restriction may create problems for small businesses that, upon incorporation, issue shares to a promoter in recognition of his or her expertise. Do you think it is appropriate to prohibit the issuance of shares in exchange for a promise to provide future services? Why does corporate law allow the issuance of stock options to employees, which in essence represents a promise that the employee can purchase stock at a discount

II.  The Share

415

to its market price if the option price is ultimately lower than the market price at the time of exercise?

5. Remedies a.  Who May Sue? An action for breach of CBCA s 25(3) or 118(1) may perhaps be brought by one or all of the following parties.





1. The corporation itself is expressly permitted to recover from the directors under s 118(1). Prior to modern corporations statutes, the liquidator of an insolvent corporation was permitted to bring an action against the shareholders on an issue of discount stock for the amount of the discount. This suggests that an issuer may recover from subscribers of watered stock in addition to the directors who authorized the allotment. 2. Shareholders might be permitted to sue under a variety of theories: a. Shareholders might first apply to bring a derivative action under CBCA s 239 on behalf of the issuer, asserting a breach of duties owed to it by the directors. b. Alternatively, shareholders who subscribed for shares after an issue of watered stock might argue that they had suffered direct personal loss by balance sheet misrepresentation, paying more for their shares than they would have had they known all the facts concerning the initial allotment. c. Finally, shareholders who held shares at the time of an issue of watered stock might, so long as they did not consent to the allotment, argue that their interests were thereby diluted. 3. Creditors might also be permitted to bring an action, although it is difficult to see how they are prejudiced by watered stock unless they can claim reliance on the attendant balance sheet misrepresentation.

Apart from s 118(1), causes of action for breach of CBCA s 25(3) are still hypothetical. Nearly all actions for discount stock were brought by liquidators, and it is not clear to what extent creditors or even shareholders would have standing to complain of watered stock.

b.  What Remedies Are Available? Most discount stock cases involved insolvent issuers. On bankruptcy, liquidators often sought to add the shareholders as contributories to the extent of the discount. This inclusion was done on the basis of a continuing obligation to pay the full amount of the required consideration. The liquidator would not have wished to have the issue set aside altogether, for the shareholder would then be not a contributory but a competing creditor to the extent that he did pay something on allotment. The corporation has a remedy against the directors under CBCA s 118(1). But are rights of recovery against shareholders restricted to the circumstances referred to in s 118(4), such that shareholders cannot be sued on an issue of watered stock for a property consideration?

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Chapter 6  Capitalization of the Corporation

D.  Pre-Emptive Rights A new issue of watered stock will dilute the financial interest of existing shareholders in the corporation, and may radically affect control positions even if the consideration is adequate. Existing shareholders may seek relief in either of these cases by an action to have the issue set aside. Alternatively, they may argue for a rule of equal opportunity, with the right to have a proportionate number of shares issued to them on the same terms. These options to purchase shares are called pre-emptive rights. As compared with an action to void an issue of watered stock under s 25(3), an assertion of pre-emptive rights may be an expensive remedy since the shareholder might have to purchase a large number of shares to prevent a dilution of his interest. Of course, he or she will end up with an equal portion of a more valuable venture, to the extent that it has been enriched by the contributions received on the new share allotments. However, the shareholder will have been required to transfer a portion of his or her assets to the firm when the shareholder might prefer to diversify his or her investments. But even if costly, absolute pre-emptive rights may at times be the shareholder’s preferred remedy, because they do not require a demonstration of stock watering, as would a claim under s 25(3). Absolute pre-emptive rights, whose exercise is not conditioned on a prior issuance of watered stock, may also be costly for a firm. Suppose that it has found a new investor willing to provide needed capital in exchange for a particular percentage of firm equity. Pre-emptive rights may frustrate the transaction by introducing a risk that the new investor will not obtain the percentage of shares he or she requires.

Stokes v Continental Trust Co 78 NE 1090 (NY Ct App 1906) [Stokes was a shareholder in the defendant banking corporation, and sought to compel it to issue to him a proportionate number of additional common shares. Alternatively, he asked for damages. On January 2, 1902, another bank, Blair & Co, offered to acquire a majority of the defendant’s shares through a subscription for 5,000 shares at $450 each. At this time, the book value of the shares was $310 and their par value was $100. Their market value increased from $450 in September 1901 to $550 in January 1902. The issue of shares to Blair & Co was approved on January 29, 1902 at a meeting of the defendant’s shareholders by a vote of 3,596 to 241. Stokes owned 221 of the shares held by the dissenters. The new shares were issued to Blair & Co on January 30, 1902. The trial court found that the plaintiff had the right to subscribe for his pro rata share of the number of shares issued to Blair & Co, and that he was entitled to $99,450, the difference between the market value of 221 shares on January 30, 1902 and their par value, together with interest. This judgment was reversed by the Appellate Division, and the plaintiff appealed.] VANN J (Cullen CJ and Werner and Hiscock JJ concurring):  … [T]he question presented for decision is whether according to the facts found the plaintiff had the legal right to subscribe for and take the same number of shares of the new stock that he held of the old?

417

II.  The Share

The subject is not regulated by statute, and the question presented has never been directly passed upon by this court, and only to a limited extent has it been considered by courts in this state.  … The leading authority is Gray v. Portland Bank, decided in 1807 and reported in 3 Mass. 364, 3 Am. Dec. 156. In that case a verdict was found for the plaintiff, subject, by the agreement of the parties, to the opinion of the court upon the evidence in the case whether the plaintiff was entitled to recover, and, if so, as to the measure of damages. The court held that stockholders who held old stock have a right to subscribe for and take new stock in proportion to their respective shares. As the corporation refused this right to the plaintiff he was permitted to recover the excess of the market value above the par value, with interest. … This decision has stood unquestioned for nearly a hundred years and has been followed generally by courts of the highest standing. It is the foundation of the rule upon the subject that prevails, almost without exception, throughout the entire country. •  •  •

If the right claimed by the plaintiff was a right of property belonging to him as a stockholder, he could not be deprived of it by the joint action of the other stockholders, and of all the directors and officers of the corporation. What is the nature of the right acquired by a stockholder through the ownership of shares of stock? What rights can he assert against the will of a majority of the stockholders, and all the officers and directors? While he does not own and cannot dispose of any specific property of the corporation, yet he and his associates own the corporation itself, its charter, franchises, and all rights conferred thereby, including the right to increase the stock. He has an inherent right to his proportionate share of any dividend declared, or of any surplus arising upon dissolution, and he can prevent waste or misappropriation of the property of the corporation by those in control. Finally, he has the right to vote for directors and upon all propositions subject by law to the control of the stockholders, and this is his supreme right and main protection. Stockholders have no direct voice in transacting the corporate business, but through their right to vote they can select those to whom the law intrusts the power of management and control. A corporation is somewhat like a partnership, if one were possible, conducted wholly by agents where the copartners have power to appoint the agents, but are not responsible for their acts. The power to manage its affairs resides in the directors, who are its agents, but the power to elect directors resides in the stockholders. This right to vote for directors, and upon propositions to increase the stock or mortgage the assets, is about all the power the stockholder has. So long as the management is honest, within the corporate powers, and involves no waste, the stockholders cannot interfere, even if the administration is feeble and unsatisfactory, but must correct such evils through their power to elect other directors. Hence, the power of the individual stockholder to vote in proportion to the number of his shares is vital, and cannot be cut off or curtailed by the action of all the other stockholders, even with the co-operation of the directors and officers. In the case before us the new stock came into existence through the exercise of a right belonging wholly to the stockholders. As the right to increase the stock belonged to them, the stock when increased belonged to them also, as it was issued for money and not for property or for some purpose other than the sale thereof for money. By the increase of stock the voting power of the plaintiff was reduced one-half, and while he consented to the increase he did not consent to the disposition of the new stock by a sale thereof to

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Chapter 6  Capitalization of the Corporation

Blair & Co. at less than its market value, nor by sale to any person in any way except by an allotment to the stockholders. The increase and sale involved the transfer of rights belonging to the stockholders as part of their investment. The issue of new stock and the sale thereof to Blair & Co. was not only a transfer to them of one-half the voting power of the old stockholders, but also of an equitable right to one-half the surplus which belonged to them. In other words, it was a partial division of the property of the old stockholders. The right to increase stock is not an asset of the corporation any more than the original stock when it was issued pursuant to subscription. The ownership of stock is in the nature of an inherent but indirect power to control the corporation. The stock when issued ready for delivery does not belong to the corporation in the way that it holds its real and personal property, with power to sell the same, but is held by it with no power of alienation in trust for the stockholders, who are the beneficial owners, and become the legal owners upon paying therefor. The corporation has no rights hostile to those of the stockholders, but is the trustee for all including the minority. The new stock issued by the defendant under the permission of the statute did not belong to it, but was held by it the same as the original stock when first issued was held in trust for the stockholders. It has the same voting power as the old, share for share. The stockholders decided to enlarge their holdings, not by increasing the amount of each share, but by increasing the number of shares. The new stock belonged to the stockholders as an inherent right by virtue of their being stockholders, to be shared in proportion upon paying its par value or the value per share fixed by vote of a majority of the stockholders, or ascertained by a sale at public auction. While the corporation could not compel the plaintiff to take new shares at any price, since they were issued for money and not for property, it could not lawfully dispose of those shares without giving him a chance to get his proportion at the same price that outsiders got theirs. He had an inchoate right to one share of the new stock for each share owned by him of the old stock, provided he was ready to pay the price fixed by the stockholders. If so situated that he could not take it himself, he was entitled to sell the right to one who could, as is frequently done. Even this gives an advantage to capital, but capital necessarily has some advantage. Of course, there is a distinction when the new stock is issued in payment for property, but that is not this case. The stock in question was issued to be sold for money and was sold for money only. A majority of the stockholders, as part of their power to increase the stock, may attach reasonable conditions to the disposition thereof, such as the requirement that every old stockholder electing to take new stock shall pay a fixed price therefor, not less than par, however, owing to the limitation of the statute. They may also provide for a sale in parcels or bulk at public auction, when every stockholder can bid the same as strangers. They cannot, however, dispose of it to strangers against the protest of any stockholder who insists that he has a right to his proportion. Otherwise the majority could deprive the minority of their proportionate power in the election of directors and their proportionate right to share in the surplus, each of which is an inherent, pre-emptive, and vested right of property. It is inviolable, and can neither be taken away nor lessened without consent, or a waiver implying consent. The plaintiff had power, before the increase of stock, to vote on 221 shares of stock, out of a total of 5,000, at any meeting held by the stockholders for any purpose. By the action of the majority, taken against his will and protest, he now has only one-half the voting power that he had before, because the number of shares has been doubled while he still owns but 221. This touches him as a stockholder in such a way as to deprive him of a right of

419

II.  The Share

property. Blair & Co. acquired virtual control, while he and the other stockholders lost it. We are not discussing equities, but legal rights, for this is an action at law, and the plaintiff was deprived of a strictly legal right. If the result gives him an advantage over other stockholders, it is because he stood upon his legal rights, while they did not. The question is what were his legal rights, not what his profit may be under the sale to Blair & Co., but what it might have been if the new stock had been issued to him in proportion to his holding of the old. The other stockholders could give their property to Blair & Co., but they could not give his. A share of stock is a share in the power to increase the stock, and belongs to the stockholders the same as the stock itself. When that power is exercised, the new stock belongs to the old stockholders in proportion to their holding of old stock, subject to compliance with the lawful terms upon which it is issued. •  •  •

We are thus led to lay down the rule that a stockholder has an inherent right to a proportionate share of new stock issued for money only and not to purchase property for the purposes of the corporation or to effect a consolidation, and while he can waive that right, he cannot be deprived of it without his consent except when the stock is issued at a fixed price not less than par, and he is given the right to take at that price in proportion to his holding, or in some other equitable way that will enable him to protect his interest by acting on his own judgment and using his own resources. This rule is just to all and tends to prevent the tyranny of majorities which needs restraint, as well as virtual attempts to blackmail by small minorities which should be prevented. The remaining question is whether the plaintiff waived his rights by failing to do what he ought to have done, or by doing something he ought not to have done. He demanded his share of the new stock at par, instead of at the price fixed by the stockholders, for the authorization to sell at $450 a share was virtually fixing the price of the stock. He did more than this, however, for he not only voted against the proposition to sell to Blair & Co. at $450, but, as the court expressly found, he “protested against the proposed sale of his proportionate share of the stock, and again demanded the right to subscribe and pay for the same which demands were again refused,” and “the resolution was carried notwithstanding such protest and demands.” Thus he protested against the sale of his share before the price was fixed, for the same resolution fixed the price, and directed the sale, which was promptly carried into effect. If he had not attended the meeting, called upon due notice to do precisely what was done, perhaps he would have waived his rights, but he attended the meeting and, before the price was fixed, demanded the right to subscribe for 221 shares at par, and offered to pay for the same immediately. It is true that after the price was fixed he did not offer to take his share at that price, but he did not acquiesce in the sale of his proportion to Blair & Co., and unless he acquiesced the sale as to him was without right. He was under no obligation to put the corporation in default by making a demand. The ordinary doctrine of demand, tender, and refusal has no application to this case. The plaintiff had made no contract. He had not promised to do anything. No duty of performance rested upon him. He had an absolute right to the new stock in proportion to his holding of the old, and he gave notice that he wanted it. It was his property, and could not be disposed of without his consent. He did not consent. He protested in due time, and the sale was made in defiance of his protest. While in connection with his protest he demanded the right to subscribe at par, that demand was entirely proper when made, because the price had not then been fixed. After the price was fixed it was the duty of the

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Chapter 6  Capitalization of the Corporation

defendant to offer him his proportion at that price, for it had notice that he had not acquiesced to the proposed sale of his share, but wanted it himself. The directors were under the legal obligation to give him an opportunity to purchase at the price fixed before they could sell his property to a third party, even with the approval of a large majority of the stockholders. If he had remained silent, and had made no request or protest he would have waived his rights, but after he had given notice that he wanted his part and had protested against the sale thereof, and defendant was bound to offer it to him at the price fixed by the stockholders. By selling to strangers without thus offering to sell to him, the defendant wrongfully deprived him of his property, and is liable for such damages as he actually sustained. The learned trial court, however, did not measure the damages according to law. The plaintiff was not entitled to the difference between the par value of the new stock and the market value thereof, for the stockholders had the right to fix the price at which the stock should be sold. They fixed the price at $450 a share, and for the failure of the defendant to offer the plaintiff his share at that price we hold it liable in damages. His actual loss, therefore, is $100 per share, or the difference between $450, the price that he would have been obliged to pay had he been permitted to purchase, and the market value on the day of sale, which was $550. This conclusion requires a reversal of the judgment rendered by the Appellate Division and a modification of that rendered by the trial court. •  •  •

HAIGHT  J (Willard Bartlett  J concurring) (dissenting):  I agree that the rule that we should adopt is that a stockholder in a corporation has an inherent right to purchase a proportionate share of new stock issued for money only, and not to purchase property necessary for the purposes of the corporation or to effect a consolidation. While he can waive that right he cannot be deprived of it without his consent, except by sale at a fixed price at or above par, in which he may buy at that price in proportion to his holding or in some other equitable way that will enable him to protect his interest by acting on his own judgment and using his own resources. I, however, differ with Judge Vann as to his conclusions as to the rights of the plaintiff herein. Under the findings of the trial court the plaintiff demanded that his share of the new stock should be issued to him at par, or $100 per share, instead of $450 per share, the price offered by Blair & Co. and the price fixed at the stockholders’ meeting at which the new stock was authorized to be sold. This demand was made after the passage of the resolution authorizing the increase of the capital stock of the defendant company and before the passage of the resolution authorizing a sale of the new stock to Blair & Co. at the price specified. After the passage of the second resolution he objected to the sale of his proportionate share of the new stock to Blair & Co., and again demanded that it be issued to him, and the following day he made a legal tender for the amount of his portion of the new stock at $100 per share. There is no finding of fact or evidence in the record showing that he was ever ready or willing to pay $450 per share for the stock. He knew that Blair & Co. represented Marshall Field and others at Chicago, great dry goods merchants, and that they had made a written offer to purchase the new stock of the company provided the stockholders would authorize an increase of its capital stock from $500,000 to $1,000,000. He knew that the trustees of the company had called a special meeting of the stockholders for the purpose of considering the offer so made by Blair & Co. He knew that the increased capitalization

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proposed was for the purpose of enlarging the business of the company and bringing into its management the gentlemen referred to. There is no pretense that any of the stockholders would have voted for an increase of the capital stock otherwise than for the purpose of accepting the offer of Blair & Co. All were evidently desirous of interesting the gentlemen referred to in the company, and by securing their business and deposits increase the earnings of the company. This the trustees carefully considered, and in their notice, calling the special meeting of the stockholders, distinctly recommended the acceptance of the offer. What, then, was the legal effect of the plaintiff ’s demand and tender? To my mind it was simply an attempt to make something out of his associates, to get for $100 per share the stock which Blair & Co. had offered to purchase for $450 per share; and that it was the equivalent of a refusal to pay $450 per share, and its effect is to waive his right to procure the stock by paying that amount. An acceptance of his offer would have been most unjust to the remaining stockholders. It would not only have deprived them of the additional sum of $350 per share, which has been offered for the stock, but it would have defeated the object and purpose for which the meeting was called, for it was well understood that Blair & Co. would not accept less than the whole issue of the new stock. But this is not all. It appears that prior to the offer of Blair & Co. the stock of the company had never been sold above $450 per share; that thereafter the stock rapidly advanced until the day of the completion of the sale on the 30th of January, when its market value was $550 per share; but this, under the stipulation of facts, was caused by the rumor and subsequent announcement and consummation of the proposition for the increase of the stock and the sale of such increase to Blair & Co. and their associates. It is now proposed to give the plaintiff as damages such increase in the market value of the stock, even though such value was based upon the understanding that Blair & Co. were to become stockholders in the corporation, which the acceptance of plaintiff ’s offer would have prevented. This, to my mind, should not be done. I, therefore, favor an affirmance. Pre-emptive rights developed in a very different way in American than in Anglo-Canadian law. In England and Canada, such rights were merely a matter of contract, with a presumption that they did not arise unless specifically bargained for. This policy is continued in CBCA s 28, which is merely permissive in nature. By contrast, early American decisions held that shareholders had a vested pre-emptive right. Given La Forest J’s analysis of the nature of a share in Sparling v Québec, [1988] 2 SCR 1015 (above, Section II.A), how much sense would it have made in Canada to speak of a shareholder having an “inherent right” to a proportionate share of an issuance of new stock? Is the language of “inherent rights” that is seen in Stokes v Continental Trust Co linked to ideas about shareholders as owners of the corporation? You will want to keep these questions in mind when we turn to the issues discussed in Section II.E, below. Although the Dickerson Committee recommended that the CBCA be drafted so as to provide that a pre-emptive right be one of the rights associated with owning a share, the legislature chose not to follow this recommendation. In part, the legislature was no doubt concerned to leave the corporation flexibility with respect to the way in which it raises capital and, accordingly, did not wish to put in place statutory guarantees respecting the size of a shareholder’s holdings relative to that of other shareholders.

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As the American economy expanded, absolute pre-emptive rights began to be seen as inconvenient relics of a less industrialized past. Large corporations required unfettered access to capital markets and pre-emptive rights were cumbersome to the extent that they inhibited capital formation and expansion. Shareholders with a small stake in a widely held corporation would not need such rights, and a strict insistence on vested rights might even result in a windfall to the shareholders, as Haight J suggested had occurred in Stokes. Exceptions to pre-emptive rights therefore developed. One of these exceptions, referred to in Stokes, involves the issue of shares for a non-cash consideration: see CBCA s 28(2)(a). Pre-emptive rights were also excluded on an issue of part of the initial authorized capital. If these exemptions made little sense in themselves, they at least provided a covert tool to avoid the result in cases like Stokes. More recent American cases have concentrated on whether the initial issue of shares involved a breach of fiduciary duties. So too, Canadian courts, unencumbered by American doctrines of vested rights, have found that pre-emptive rights may be asserted as a remedy against oppressive conduct by management.6 The pre-emptive rights doctrines in Canada and the United States, which began in very different ways, have therefore largely merged in recent years, with a likelihood that the same case would be decided in the same way in the two countries. To suggest that doctrines of pre-emptive rights are now assimilated to fiduciary principles does not, however, supply a content to such rights.

E.  The Nature of a Share One of the more challenging questions that courts have had to confront is how best to characterize the relationship between the purchaser of a share and the corporation whose share he or she now owns. In North America, a shareholder is frequently said to be an “owner” of the corporation. Indeed, a sizeable body of literature has emerged over the course of the 20th century that is devoted to exploring changes to the nature of the relationship between the corporation and its “owners.” Much of this literature focuses on a thesis advanced by Adolf Berle Jr. & Gardiner Means, The Modern Corporation and Private Property (New York: Harcourt Brace & World, 1968) (reprinted from the 1932 publication). Berle & Means claimed that at the same time that corporations were emerging as the dominant form of business organization, shares were becoming more and more widely dispersed among an ever-expanding pool of shareholders. They concluded that as a result these owners of the corporation were slowly but surely surrendering control of the corporation to its professional managers. The Berle & Means thesis has frequently been the focal point for discussion about the history and structure of corporate finance in North America. In many ways, however, the debate that has grown up around the Berle & Means thesis begs a critical question: has it ever made sense to think of shareholders as the owners of the corporation? Any answer to this question depends in part on an understanding of the legal relationship that results from purchasing a share. The outcome of an analysis of this

6 P Blais, “Shareholder’s Protection from Share Watering Caused by the Issue of Additional Shares: Preemptive Rights” (1961) 19 UT Fac L Rev 43.

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relationship will in turn have a significant impact on how one conceives of the corporation’s relationship with other constituencies, constituencies that might also be thought to have an interest in the way in which the corporation is run. Furthermore, one’s views on the right answers to these questions will also affect whether one thinks it makes sense to speak of directors and management as “agents” acting on behalf of shareholders—terminology that is central to much of the law and economics literature concerning corporate law. In turn, where one comes out on this matter will have a profound impact on the role that one thinks directors and management should play in responding to takeover bids—a subject taken up in Chapter 15. It is therefore important to spend some time better understanding the juridical nature of the all-important relationships among shareholders, the corporation, and the corporation’s directors and managers. In this regard, you may wish to reread the extract from Sparling v Québec, above Section II.A. At no point does the CBCA state that in purchasing a share a shareholder is acquiring a right of ownership with respect to the corporation. The CBCA simply tells us that a shareholder may be entitled to certain rights relating to such matters as voting for directors, the receipt of dividends, and the receipt of a portion of the corporation’s capital if and when that corporation is wound up: see CBCA s  24(3). Why then would Berle & Means (and many authors who have followed in their tracks) suggest that when a person has purchased a share, that person becomes an owner of the corporation? Does La Forest J suggest in his judgment in Sparling that the bundle of rights and obligations that is a share gives rise to a relationship that can be characterized as “ownership”?7 The thesis that La Forest J advanced in Sparling regarding the nature of a share is not new. There are many cases in England and Canada that have analyzed the nature of a share. These cases have usually involved disputes concerning different classes of shares and their relative rights. The rights that have typically been at the heart of these disputes are the very ones that La Forest J identified as part of the bundle of rights that is a share: the right to dividends,8 the right to a portion of the company’s assets on a winding up of that company,9 and the right to vote.10 These cases have also stressed that in order to determine the rights that make up a share, it is necessary to look to a company’s articles, because it is there that one will see the rights of a given class of shares spelt out. More recent case law, such as the Sparling decision, has gone on to make clear that these rights are also addressed in applicable business corporations acts. As a result, in ascertaining a shareholder’s rights it is essential to examine the interaction between the corporation’s articles and the corporate finance sections of the applicable corporations statute.

7 For different perspectives on whether it is appropriate to view shareholders as owners, see L De Alessi, “Private Property and Dispersion of Ownership in Large Corporations” (1973) 28 J Fin 839; EF Fama, “Agency Problems and the Theory of the Firm” (1980) 88 J Pol Econ 288; and K Greenfield, “The Place of Workers in Corporate Law” (1998) 39 BC L Rev 283. 8 Oakbank Oil Company v Crum, [1883] 8 AC 65 (HL). 9 Birch v Cropper, [1889] 14 AC 525 (HL); Scottish Insurance Corp v Wilsons & Clyde Coal Co, [1949] AC 462 (HL Scot); and Re The Canada Trust Company and The Guelph Trust Company, [1950] OR 245 (SC). 10 Bowater Canadian Ltd v RL Crain Inc (Ont CA) (reproduced below in text).

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Bowater Canadian Ltd v RL Crain Inc (1987), 62 OR (2d) 752 (CA) HOULDEN JA (for the court):  The appellant Bowater Canadian Limited (“Bowater”) filed an application in weekly court before McRae J challenging the voting provisions contained in the respondent R.L. Crain Inc.’s (“Crain”) articles of incorporation. McRae J held that the voting provisions offended the Canada Business Corporations Act, 1974-75-76 (Can.) c. 33 (“CBCA”), as amended, to the extent that the special common shares held by the respondent Craisec Ltd. (“Craisec”) carry ten votes per share in the hands of Craisec, but only one vote per share in the hands of a potential transferee. However, having regard to the knowledge and intentions of the parties and in light of the general principles of contract, and corporate law, he held that the “stepdown” provision of the special common shares was severable with the result that the special common shares carry ten votes irrespective of whether they are held by Craisec or by a transferee. The following are the provisions of the articles of amalgamation dealing with the capital of Crain: The Corporation is authorized to issue two million four hundred thousand (2,400,000) common shares and four hundred and seventy-one thousand (471,000) special common shares.

The special common shares carry and are subject to the following terms, conditions and restrictions: (1)  The said special common shares shall carry and the holder thereof shall be entitled to ten (10) votes per share at all meetings of the shareholders of the Corporation so long as such special common shares shall be held by the person or corporation to whom such shares were issued originally by the Corporation. In the event any such special common shares cease to be held by the person or corporation to whom such shares were issued originally by the Corporation, then such special common shares shall carry and the holder thereof shall be entitled to one (1) vote only per share at all meetings of the shareholders of the Corporation. (2)  Such special common shares may at any time be converted, either in whole or in part, into common shares of the Corporation on the basis of one (1) common share for each special common share held. Following any such conversion as aforesaid, the special common shares so converted shall be cancelled and shall not be released. In the event any such special common shares are presented for conversion as aforesaid the Corporation shall take all such steps as may be necessary, including, if necessary, the obtaining of Articles of Amendment, to effect such conversion. (3)  In the event of the liquidation, dissolution or winding-up of the Corporation, whether voluntary or involuntary, or in the event of any other distribution of assets among the Shareholders for the purpose of winding-up its affairs, the holders of the common shares and the special common shares shall be equally entitled, share for share, to receive the remaining property of the Corporation.

It will be noted that on liquidation, dissolution or winding-up of the Corporation the holders of the special common shares share equally with the other shareholders.

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Furthermore, we were informed by counsel for Crain that all shareholders, regardless of class, share equally in the distribution of dividends. On the argument of this appeal all counsel were agreed that although the step-down provision was created at a time when the Companies Act, RSC 1952, c. 53, was in force, the appeal could be decided on the basis of the CBCA, this being the procedure followed by McRae J. There is no doubt, as McRae J pointed out, that Bowater was not misled by the voting provisions of the Crain shares. Mr. Thomson conceded that Bowater, when it purchased its shares, was fully cognizant of the restrictions and conditions attaching to the two classes of shares. In his reasons for judgment, McRae J held that although there was no express prohibition in the CBCA against a step-down provision, s. 24(4) of the Act should be interpreted in accordance with the general principles of corporation law with the result that the rights which are attached to a class of shares must be provided equally to all shares of that class, this interpretation being founded on the principle that rights, including votes, attach to the share and not to the shareholder. Subsections (3) and (4) of s. 24 of the CBCA, as amended by 1978-79 (Can.), c. 9, s. 9, provide: 24(3)  Where a corporation has only one class of shares, the rights of the holders thereof are equal in all respects and include the rights (a)  to vote at any meeting of shareholders of the corporation; (b)  to receive any dividend declared by the corporation; and (c)  to receive the remaining property of the corporation on dissolution. (4) The articles may provide for more than one class of shares and, if they so provide, (a)  the rights, privileges, restrictions and conditions attaching to the shares of each class shall be set out therein; and (b)  the rights set out in subsection (3) shall be attached to at least one class of shares but all such rights are not required to be attached to one class.

Counsel for the appellant did not, of course, challenge McRae  J’s interpretation of s. 24(4). It was, however, challenged by counsel for the respondents; but, notwithstanding the able arguments that have been addressed to us, we are not persuaded that it is wrong. In our opinion if there was not equality of rights within a class of shareholders, there would be great opportunity for fraud, even though that is not a problem in this case. Section 24(5) of the Alberta Business Corporations Act, 1981 (Alta.), c. B-15, reflects what we take to be the applicable principle of corporate law, it provides: 24(5)  Subject to section 27, if a corporation has more than one class of shares, the rights of the holders of the shares of any class are equal in all respects.

Mr. Garrow contended that even if the step-down provision violates the provision of the CBCA, it was saved by s. 181(7) of the Act which reads: 181(7)  Subject to subsection 45(8), a share of a body corporate issued before the body corporate was continued under this Act is deemed to have been issued in compliance with this Act and with the provisions of the Articles of continuance irrespective of whether the share is fully paid and irrespective of any designation, rights, privileges, restrictions or conditions set out on or referred to in the certificate representing the share; and continuance under

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With respect, we do not agree with Mr. Garrow’s submission. We do not think that the subsection was intended to protect “rights, privileges, restrictions or conditions” that are unlawful. Having held that the step-down provision of the special common shares was invalid, McRae J turned his attention to the issue of severability. After a careful review of the submissions of counsel, he concluded that the step-down provision was severable, with the result, as we have stated, that special common shares now carry ten votes each regardless of whether they are held by Craisec or a transferee. Again, we agree with this ruling. In this connection, we are particularly impressed with the minutes of a meeting of shareholders of Crain held January 19, 1959. This is the meeting which authorized the creation of the special common shares. The portion of the minutes dealing with the special common shares reads as follows: On motion duly made by Mr. MacTavish and seconded by Mr. Plummer, it was resolved that the shareholders sanction, ratify and confirm By-law number 80 being a By-law sub-dividing the present 100,000 Common Shares into 400,000 Common shares, creating an additional 400,000 Common shares ranking pari passu in all respects with the existing Common shares as subdivided and creating 167,000 Special Common Shares which shall carry the right to ten votes per share, and authorizing an application to the Secretary of State of Canada for Supplementary Letters Patent confirming such changes.

It will be noted that no mention is made of the step-down provision, only that each special common share is to carry the right to ten votes per share. When the special common shares were created, Crain was making a very advantageous purchase of a majority interest in a company known as Business Systems Limited (“BSL”). Under the purchase agreement the vendors were to receive either four common shares of Crain or $40 cash. At the time of the purchase Craisec had effective control of Crain. Craisec agreed to exchange 41,750 common shares of Crain for BSL common and Class “C” preferred shares in consideration for which it received 167,000 special common shares of Crain enabling it to maintain control of Crain. The provisions for ten votes per share have now been in force for almost 30 years and, prior to this application, have not been questioned by shareholders, although the share capital of Crain has been rearranged on several occasions, the last being August, 1986. Mr. Thomson contended that because the step-down provision was invalid, the whole of cl. 1 of the articles of amalgamation was also invalid so that the special common shares and the subordinate voting shares would all carry only one vote. We do not agree. Rather, as we have said, we agree with McRae  J that the step-down provision can be severed without affecting the validity of the provision for ten votes for each special common share. We believe that this accords with the intention of the parties at the time that the shares were created. In the result, the appeal is dismissed with costs. The cross-appeals are also dismissed but in the circumstances without costs.

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1.  The decision in Bowater has been the source of some debate concerning the nature of the equality principles that apply to shareholders and shares. In particular, the debate centres on whether Bowater stands for the broad proposition that all shareholders of a class must be treated equally, or simply for the proposition that the rights that are constitutive of shares of a given class must be the same for all shares of that class. Is it possible to reach a definitive conclusion based on the decision in Bowater? Does La Forest J’s analysis in Sparling assist in resolving the debate? As you consider these questions, you may also wish to look at the decision in Jacobsen v United Canso Oil & Gas Ltd (1980), 113 DLR (3d) 427, [1980] 6 WWR 38, 11 BLR 313 (Alta QB) and McClurg v Canada, [1990] 3 SCR 1020, (1990), 76 DLR (4th) 217, extracts from which are to be found in Chapter 12. 2.  At first sight, the debate appears rather arcane. But, as Chapter 15 of this book makes clear, in practice it has important implications for such matters as the law concerning mergers and acquisitions. If the correct proposition is the narrower one relating to the nature of a share, then a corporation may be able to effect changes to its capital structure in ways that discriminate between shareholders, provided that there is no discrimination between the rights that are constitutive of shares of a class. If, on the other hand, the correct proposition is the broader one relating to shareholders, then it will be that much harder for a corporation to treat its shareholders differently when pursuing a given objective.11 3.  Regardless of which interpretation of Bowater you favour, your views on the broader question of whether shareholders may be said to be owners of the corporation are likely to have some effect on the equality principle that you believe should govern relations between the corporation and its shareholders. If you think that shareholders are owners, then you may well feel that, in addition to the bundle of rights that are constitutive of a share, shareholders are entitled to additional rights such as the right to equal treatment. If you are not inclined to view shareholders as owners, you may be more open to the suggestion that in certain circumstances it may be necessary for a corporation to discriminate between its shareholders. This in turn will affect your view of the legitimacy of certain defensive tactics such as poison pills, which clearly do not treat a shareholder seeking to acquire control of a company in the same way as other shareholders of that company.

Atco v Calgary Power Ltd [1982] 2 SCR 557 [Atco and Calgary Power owned 58.1 percent and 41 percent, respectively, of the shares of Canadian Utilities, which in turn owned virtually all the shares of three Alberta public utilities, including Alberta Power. Atco offered to buy 50.1 percent of the outstanding stock of Calgary Power. In an attempt to prevent the takeover bid, Calgary Power 11 For an example of the implications of this debate, see the different views expressed in Jeffrey MacIntosh, “Poison Pills in Canada: A Reply to Dey and Yalden” (1992) 17 Can Bus LJ 323 at 345; and R Yalden, “Controlling the Use and Abuse of Poison Pills in Canada: 347883 Alberta Ltd v Producers Pipelines Inc” (1992) 37 McGill LJ 887 at 897-903; see also Hart J’s decision in Primewest Energy Trust v Orion Energy Trust, (1999) 1 BLR (3d) 294 (Alta QB).

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successfully applied to the Public Utilities Board of Alberta for an interim order restraining Atco from proceeding. Section 98 of the Public Utilities Board Act provided that where an owner of a public utility proposed to unite with the owner of any other public utility, the union was subject to the board’s consent. The board, in making its interim order, found Atco to be an “owner of a public utility” for the purposes of the Act and therefore subject to its jurisdiction. The Court of Appeal upheld the board’s finding. In its appeal to the Supreme Court of Canada, Atco maintained that it was not an “owner of a public utility” and so not subject to the board’s jurisdiction. Wilson J’s reasons in this regard are of interest and, although forming part of a dissent, were not the source of the disagreement between the majority and the minority.] WILSON J (dissenting):  My colleague, Mr. Justice Estey, has set out in his reasons for judgment the context in which the issue before the Court on this appeal has arisen and it is not necessary to deal with it further. The issue is a very narrow one: does a parent company own the public utility of its subsidiary for purposes of The Public Utilities Board Act of Alberta?

[Section 2(i) of the Public Utilities Board Act read as follows: 2(i)  “owner of a public utility” means a person owning, operating, managing or controlling a public utility and whose business and operations are subject to the legislative authority of the Province, and the lessees, trustees, liquidators thereof or any receivers thereof appointed by any court, …] •  •  •

I agree with my colleague that the public utility as defined is the physical plant and associated service. I differ from him in my analysis of the definition of “owner of a public utility.” I do not believe that a parent company as a matter of law “owns” or “operates” or “manages” or “controls” the physical plant of its subsidiary. To so hold would be to completely ignore a well-settled and, I believe, quite fundamental principle of corporate law, namely, that shareholders have no proprietary interest in the assets of the company in which they hold shares. Their proprietary interest is in their shares only. It is submitted, however, on behalf of Calgary Power Ltd. (and the submission was successful before both the Public Utilities Board and the Alberta Court of Appeal) that a parent may “control” the assets of its subsidiary in fact if not in law and that de facto control of such assets brings the parent within the meaning of “owner of a public utility” as defined. I think that in considering the merits of that submission it is necessary to distinguish between the word “control” as a term of art in a corporate law context and the word “control” in its ordinary dictionary meaning. As I understand the word “control” as a term of art in a corporate law context, it is not directed to control of the physical assets of the underlying company but to control of the company itself. This is the kind of de facto control Atco may have over the public utility company if its offer is accepted. De facto control in this sense may obviously be obtained in a number of ways. It may be obtained by a majority holding of shares but it may be obtained by considerably less than a majority holding if the shares are widely held. It may be obtained through voting rights not commensurate with shareholding at all or through the right to appoint and remove directors.

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But it seems to me that when we are talking about this kind of de facto control we are always talking of control over the company and not over its assets. The company itself continues to own, operate, manage and control its assets regardless of who owns or controls it. This, as I understand it, is the essence of the separate legal personality of the incorporated company recognized by the House of Lords in the celebrated case of Salomon v. Salomon and Co., [1897] AC 22. Since the Salomon case the complete separation of the company and its members has never been doubted. It is true that there are instances in which the legislature and the courts have allowed the corporate veil to be lifted but when the legislature has done this it has done it by express statutory provision, for example, by expressly providing that the members of a company may become personally liable for the company’s debts if the company continues to do business at a time when the number of its members has fallen below a prescribed minimum. The courts have permitted the veil to be lifted if the corporate personality was being used as a cloak for fraud or improper conduct. The courts, however, have only construed statutes as permitting the corporate veil to be lifted if compelled to do so by the clear language of the legislation. The question, it seems to me, boils down to this. Even supposing that the acceptance of the appellant’s offer gives it de facto control over the public utility companies whose shares are the subject of the offer, does this give it control over the assets of those companies within the meaning of s. 2(i) of the Act? I do not think it does. I think the word “control” here is used in its ordinary dictionary meaning and means the person having the day to day control of the physical plant and its operations. This, in my view, means the public utility companies themselves. I am confirmed in this view by three things. The first is that the definition of owner includes lessees, trustees, liquidators and receivers and it seems to me that those are persons into whose hands the physical plant and its operation might fall. The second is that the obligations imposed on “owners” under the various sections of the statute are more appropriately discharged by persons having the day to day control of the physical plant and its operations, e.g. the filing of the required rates and schedules. But perhaps most important of all, I find it hard to believe that the legislature intended by inserting the word “controlling” in s. 2(i) to extend the definition of owner to shareholders and others controlling the company which owns the public utility plant and operation. I am persuaded that it is not necessary to give that meaning to the word “controlling” because its ordinary dictionary meaning is fully in accord with the other language of the section, particularly “operating” and “managing.” I think the common denominator of the persons identified as owners within the definition is that they are in charge of the plant. They either operate it, manage or control it. They are, in other words, in the corporate context the operating companies or public utility companies themselves. •  •  •

I may say that I do not view the task of the Court on this appeal as being to decide whether to give a narrow or a broad interpretation to the word “controlling” in s. 2(i), the narrow being allegedly the one which would exclude the appellant from being an owner and the broad being the one which would include it. In my opinion, the issue is whether the concept of control as a term of art should be injected into a definition which makes very good sense in its ordinary dictionary meaning. In other words, the question is whether the Court should find that the legislature intended, when it spoke of a person controlling the assets of a public utility company, to look through the public utility

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company itself to its shareholders and find that they controlled the assets. We are concerned with the intention of the legislature in using the word “controlling” in the context of the definition section. Does it simply mean “controlling” in an analogous sense to “operating” or “managing,” i.e. exercising physical control over the plant or does it have this more sophisticated meaning of control through share ownership? That, it seems to me, is the issue before us and I think that in resolving it the Court must have regard to well-settled principles of corporate law. I would respectfully adopt the reasons of Mr. Justice Spence in Her Majesty in Right of Alberta v. Canadian Transport Commission, [1978] 1 SCR 61, where he said at p. 82: To give the interpretation to regulation 19 sought by the respondent would have very far reaching effect in corporate shareholding and dealing in corporate shares. PWA is a public company. Its shares, therefore, may be traded freely on the market whether or not its stock is listed. The shares in a very large number of air carriers are similarly traded. It would be impossible to determine whether any particular sale and purchase of shares in an air carrier would affect the control of that air carrier let alone the commercial air service which it operates. It is often said that one may control a company with very much less than a majority of the issued stock and a shareholder who held X thousand shares of a particular air carrier could not possibly determine whether he would control the company were he to purchase an additional thousand shares or even an additional one share. It surely was not intended by this regulation that every transfer of shares in a public company which was an air carrier should be subject to the submission to the respondent of an application for approval before the share transaction should be consummated.

After quoting the above passage from the judgment of Spence J, Mr. Justice Clement, in giving the unanimous judgment of the Alberta Court of Appeal, said this: With respect, I do not think it useful to draw a distinction as to the means by which shareholder control of a public utility is gained. We start with the premise that a person (whether a company or not) has in fact gained shareholder control or is on a proclaimed course that, upon completion, will have that end result.

In my view, this comment discloses that the Court of Appeal failed to distinguish between de facto control of the company and de facto control of the company’s assets, the latter being the real concern on the appeal before it, and on this appeal. The appellant may well on the acceptance of its offer obtain de facto control of the public utility companies. Indeed, this was the finding of fact made by the Board. It said: For the purpose of this Decision, the Board finds as a fact that Atco is “managing and controlling” CUI and its subsidiaries and therefore is an owner of a public/gas utility.

The Board may be perfectly correct in its finding that the share transaction if consummated will give Atco de facto control of Canadian Utilities and its subsidiaries but, with respect, its conclusion does not follow and its conclusion is the issue before us. Will Atco by acquiring de facto control of Canadian Utilities and its subsidiaries acquire de facto control of the assets of Canadian Utilities and its subsidiaries? It seems to me that if the legislature had intended to cover control through share ownership, voting rights or powers to appoint and remove directors, it would not have done it in such an enigmatic fashion. I prefer to assume rather that the legislature was

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well aware of the basic principle of corporate law referred to earlier in these reasons, namely, that shareholders do not own or control the assets of the companies in which they hold shares. If this is a proper assumption and the legislature had intended to extend the reach of the Act to dealings in the shares of public utility companies, then I believe it would have done so in explicit terms. It would have been very easy for the legislature to prohibit dealings in the shares of company-owned public utilities without the prior approval of the Board. Indeed, it has expressly done so in the case of Alberta companies in s. 88 of the Act which in itself strongly suggests a “hands off ” approach to companies incorporated elsewhere. Section 88 would, of course, be quite superfluous if all parent companies were caught through the combined effect of the definition section and s. 98. In view of the conclusion I have reached that the appellants are not owners within the meaning of the definition section, it is unnecessary for me to consider whether the proposed transaction would result in a “union” within the meaning of s. 98. ESTEY J: … The outcome of this appeal revolves around the word “controlling.” If it means day-today factual control of persons and equipment comprising the public utility system, then Atco succeeds. If the word includes a person, however remote, who controls, in the broad sense of that term, a public utility system, then Atco loses the issue. The general canon of interpretation of course requires a court to ascribe some meaning to each word used by the legislature: Saine v. Beauchesne and Gobeil, [1963] S.C.R. 435, at p. 437. The words “owning” and “controlling” are sometimes employed synonymously, but here a person who either owns or controls a system is the owner of the system. Consequently, “control” must mean something more than or different from “own.” A person might control and not own a system and might also own, but not on a daily basis control, a system. But in either situation the person may be within the definition of an owner of a public utility. •  •  •

… Whatever the subsection means it does indicate some legislative realization of the possibility of a person not directly owning the assets of a system but having indirect control of the system by any means, including perhaps the ownership of shares of the corporate owner of the system. This result is consonant with the literal reading of the four principal words (owning, operating, managing, or controlling) employed in s. 2(i)(i) … , and the assignment to each of a separate and different meanin. •  •  •

… In my view, the words “owner of a public utility” must, by reason of s. 2 … , include a person without legal ownership in the system but having the power to control. This may give rise to innumerable difficulties and may indeed require further legislative attention to the problem, where, for example, corporate control is exercised from a minority position by reason of widely disseminated shareholdings. When this interpretation under s. 2 is brought to the examination of s. 98, it follows that a person in the position of Acto as a defined owner of a public utility must obtain the prior consent of the Board to combine that facility with that of another owner of a public utility, and this is so whether the union is brought about by the mechanics of merger, amalgamation or other corporate action, or whether it be the result of a physical merger of assets or by means of a contractual pooling including or falling short of the relationship ordinarily described as a partnership. Any of these structural alterations, to employ a neutral term, would require, by reason of s. 98 the prior consent of the Board.

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Chapter 6  Capitalization of the Corporation NOTES AND QUESTIONS

1.  Wilson  J suggests that one can meaningfully talk about a corporation owning its assets. She is clearly a good deal less convinced that it makes sense to talk about the shareholders of that corporation owning the corporation’s assets. While Wilson J dissented in Atco, the majority did not disagree with her objection to the notion that a holding company can be said to own its subsidiary’s assets (the majority finding instead that Atco could be said to control those assets). If the shareholders do not own the corporation’s assets, can they nonetheless be said to own the corporation? Does Wilson J provide us with a clear answer? 2.  The question whether shareholders may be said to own the corporation is important. As noted in connection with Bowater, if you conclude that ownership is a concept with a role to play in describing the relationship between shareholder and corporation, then you are more likely to think that some of the entitlements that we typically associate with ownership are also relevant to understanding this relationship. If, on the other hand, shareholders cannot be said to own the corporation, you may be inclined to distinguish between the rights and obligations that are constitutive of a share and any other rights that are typically said to belong to owners. 3.  The debate is also important in assessing the relative rights and entitlements that belong to shareholders and to other constituencies that might be thought to have some interest in the way in which the corporation is managed.

Robert WV Dickerson, John L Howard & Leon Getz, Proposals for a New Business Corporations Law for Canada, vol I, Commentary (Ottawa: Information Canada, 1971) at 9-10 Creditors, Employees and Others as Directors 31.  Suggestions have been made from time to time that corporation law focuses too narrowly on shareholders and ignores the reality that others, especially the corporation’s employees and creditors, are affected by and concerned with what corporations do. It follows from this, so the argument goes, that these groups should have some voice in the choice of corporate directors. Moreover, it is said, there is a broad public interest in corporations, and this interest should also be represented in corporate boardrooms. 32.  We are not disposed to quarrel here with the validity of the premise on which this argument is based, but we do not see any practical way, in the context of a corporations act, in which it can be implemented. The problem is one of establishing the electorate. How does one provide the machinery for giving notice of meetings to those who do not have a crystallized and identifiable interest in the corporation? How can votes be allocated fairly amongst those who do not have the kind of precise rights given by a share, and how could such voting rights be equitably balanced with those of the shareholders? 33.  The Draft Act does not prohibit a corporation from making arrangements with its creditors, employees or others under which directors representing those groups could be elected. The influence of such outside groups would have to be brought upon the shareholders, however, for it is only the shareholders who can cast the necessary votes. It is inconceivable, for example, that if a major creditor demanded representation on a

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II.  The Share

corporation’s board of directors, he would not be accommodated, because, presumably, he would not extend credit unless the shareholders did accede to his wishes. In fact, such representation by creditors is not uncommon today. Management has no difficulty making the point known to the shareholders; in practice, of course, management usually controls sufficient proxies to guarantee the election of the creditor’s representative anyway. There is no requirement in the Draft Act that directors hold qualifying shares, therefore this cannot be a barrier. 34.  Similarly, with employees, representation on the board could be bargained for in the collective agreement if the employees thought the matter important. In fact, trade unions have not shown much interest in having representation on the boards of corporations, but this could change. It is extremely unlikely that such a provision in a collective agreement would not be honoured when the shareholders’ votes were cast as, otherwise, the collective agreement would be broken. 35.  The public interest must be reflected through government. It is highly unlikely that governments would ever be interested in having representation on the boards of more than a few highly important or significant corporations. If government policy develops in this direction there should be little practical difficulty in implementing it, but through special legislation, not in a general corporations Act. NOTES AND QUESTIONS

1.  Which of the arguments, if any, set out in paras 32 to 35 of the Dickerson Committee’s report provide convincing reasons for treating constituencies other than shareholders differently from shareholders? Should the rights of groups like creditors or employees be seen as qualitatively different from the rights that business corporations acts provide to shareholders? Bearing in mind that in some countries—for example, Germany—the law requires worker representation on many companies’ boards of directors and provides a mechanism whereby workers may elect those representatives, how convincing is the Dickerson Committee’s suggestion that it is too complicated to require that constituencies of this kind be represented on the board of directors? 2.  The extent to which one finds the Dickerson Committee’s analysis convincing is likely to depend in part on where one stands on the ownership debate discussed earlier in this section. If you view shareholders as owners and other constituencies as having a qualitatively different relationship with the corporation, then there may be a convincing case to be made for the Dickerson Committee’s analysis. If you are not convinced that the rights that shareholders have are qualitatively different from those of other constituencies that have relationships with the corporation, then you may be more inclined to question the merits of the Dickerson Committee’s analysis. The question concerning the proper characterization of the relationship between the holder of a share and the corporation is therefore central to the broader debate concerning stakeholder theory discussed in Chapters 9 and 10.

As you review the rest of this chapter, consider how you would characterize the relationship between the corporation and debt-holders, preferred shareholders, and other kinds of security-holders.

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III.  DEBT SECURITIES

Christopher Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) at 349-54 Basic Elements of Debt Like any borrower—business or individual—a corporation will be concerned about the fundamental terms of the loans it negotiates: the interest rate; the timing of required payments (whether these are interest payments or repayments of the principal amount borrowed); any covenants or restrictions the loan agreement may impose on the corporation, especially because the violation of these provisions might constitute an event of default, which could entitle the lender to demand immediate repayment of the entire loan; and so on. A corporation’s decision to borrow money, rather than to issue shares, is a complex one. Much has been written about it by legal and finance academics as well as by legal and finance practitioners. Here, however, the principal focus is not on the business considerations but on the corporate law implications of the financing decision. Corporation’s Power To Borrow The CBCA and those Canadian corporate statutes similar to it provide, as a default rule, that the directors of the corporation have the authority to borrow money on the credit of the corporation, to issue debt securities, and to grant a security interest in the corporation’s property to secure any corporate obligations. This default position can, however, be varied by the articles, the bylaws, or the provisions of a unanimous shareholder agreement. Negotiated Loan or Debt Security When a corporation borrows money, it may either enter into a negotiated loan agreement with a bank or other lender, or it may sell corporate securities (such as bonds or debentures). From a corporate law perspective, there is no distinction between these two forms of debt, unless, in the case of debt securities, they are issued pursuant to a trust indenture, as discussed below. There are, however, important differences from a securities law perspective, because the sale of debt securities is subject to provincial securities laws, while borrowing money by way of a negotiated loan agreement is not. The securities law implications will not be dealt with here. The word “security” has a broad and somewhat complicated definition for the purposes of provincial securities regulation, but a fairly simple definition for corporate law purposes. So, for example, under the CBCA, “security” means: a share of any class or series of shares or a debt obligation of a corporation and includes a certificate evidencing such a share or debt obligation.

Debt securities include bonds, debentures, and notes. …

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III.  Debt Securities

Debt Securities and Trust Indentures A corporation may prefer to raise debt capital in the capital markets rather than borrow money from a lender. In other words, a corporation may issue and sell debt securities to the public, just as it might choose to issue and sell equity (shares) to the public. There are several conventional names for corporate debt securities, including bonds, debentures, and notes. Although it is sometimes claimed by people in the financial industry that each of these words has a well-understood meaning, as a matter of law there is no clearly settled legal distinction between these terms. However, for our purposes, all that matters is that, whatever name is used, a debt security represents a right to receive periodic payments of interest and return of principal on specified dates and in accordance with the other terms of their issue. The main advantage to a corporation in issuing debt securities, rather than negotiating a loan, is that very large amounts of money may be borrowed through the issue of securities without the need to identify a single lender (or a relatively small lending syndicate) that is prepared to advance the entire amount. There may be other advantages, too. By issuing an instrument in the capital markets, rather than negotiating with a financial institution, the borrowing corporation is, in effect, getting direct access to savers, rather than going through a financial intermediary such as a bank. The borrowing corporation may therefore be able to obtain funds at more attractive rates. When a large loan is carved up into smaller pieces by the issue of debt securities, it is more difficult for the “lenders” (that is, the holders of the debt securities) to act in concert to try to monitor or discipline the corporate borrower. Individual holders of debt securities—each holding a relatively modest amount of the corporation’s debt and perhaps living very far apart from other debtholders—may have insufficient incentive, insufficient information, or insufficient resources to act effectively to prevent or respond to defaults by the corporate borrower. This collective-action problem does not hurt only the debtholders. It can also hurt the borrowing corporations when they are trying to attract people to purchase debt securities from them in the first place. Thus, a device has been developed to try to address the collective-action problems facing corporate debt securityholders. That device involves the use of a “trust indenture” or “trust deed.” A trust indenture is an agreement entered into between a corporation that is issuing debt securities (such as debentures) and a trustee, normally a regulated trust company. The trust indenture sets out the financial terms of the debt securities. Those terms will include the interest rate, the repayment terms, and financial covenants (promises) similar to those that might be found in a loan agreement. The indenture trustee’s role is to protect the interests of the securityholders. In theory, then, the individual securityholders are no longer left to fend for themselves in the event of a default by the issuer. The indenture trustee can coordinate enforcement or take other actions. There is, however, a practical problem with this structure. The indenture trustee must be selected before any securities have been issued, because the securities cannot be created until the trust indenture, which contains the terms of the debt, has been finalized. Therefore, the securityholders cannot select the indenture trustee for themselves. It is the corporation issuing the securities that selects the indenture trustee. The fact that the issuing corporation engages the trustee inevitably leads to the possibility of a conflict of interest. There is more. The indenture trustee has little monetary

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Chapter 6  Capitalization of the Corporation

incentive to diligently enforce the trust indenture and, in fact, cannot reasonably be expected to expend its own resources to enforce the securityholders’ rights. Concerns such as these led legislators and regulators to propose specific rules governing trust indentures. Many Canadian corporate statutes—including the CBCA—include provisions governing the use of trust indentures. The CBCA’s trust indenture provisions are found in part VIII of the Act. Trust indenture provisions were introduced into the federal statute following a recommendation of the Dickerson committee. The committee was influenced in framing their recommendation by the earlier report of the Lawrence committee in Ontario. The Lawrence committee, in turn, had been inspired by the US federal Trust Indenture Act of 1939. Briefly summarized, the CBCA’s provisions, which apply only when debt securities are part of a distribution to the public, deal with the following matters: • Trustee conflict:  A trustee is not to be appointed, or continue to act, if it has a material conflict of interest. • Regulated trust company:  An indenture trustee must be a regulated trust company (or, if there is more than one trustee, at least one of the trustees must be a trust company). • Trustee’s fiduciary duties:  An indenture trustee is subject to the duties of care and good faith, and the trustee may not contract out of these duties. • Evidence by issuer of compliance:  The issuer must provide the trustee with evidence that the issuer has complied with all the conditions in the trust indenture before: (1) issuing any debt securities under the trust indenture, (2) releasing or substituting any security interest in property under the trust indenture, or (3) discharging the trust indenture. As well, the issuer must provide the trustee each year with a certificate indicating that the issuer is in compliance with all provisions of the trust indenture, the breach of which would trigger an event of default. As well, the issuer must provide the trustee with evidence of compliance at any other time that the trustee demands. • Trustee to notify holders of events of default:  An indenture trustee must notify the holders of debt securities within 30 days of learning of any events of default committed by the issuer, unless it is considered to be not in the best interests of the debtholders to do so. • List of debtholders:  A holder of debt may obtain from the trustee a list of all outstanding debtholders. This information may be used, among other things, to enable one debtholder to contact others in an effort to influence their voting at a meeting of debtholders. (Debtholders’ meetings, unlike shareholders’ meetings, are convened and conducted in accordance with the terms of the trust indenture itself, and not the corporate statute. Moreover, the issues considered at debtholders’ meetings relate entirely to the terms of their debt instrument—for example, whether to amend the trust indenture, whether to waive a default or enforce their debt obligations, etc.) Voting by Debtholders When common or ordinary shareholders of a corporation exercise their votes at a meeting of shareholders, they are normally permitted to vote in accordance with their own

III.  Debt Securities

437

self-interest. There is a suggestion in some older case law, however, that holders of debt securities might not enjoy such an unrestrained voting privilege when they vote on matters relating to the terms of their debt. In British American Nickel Corp. v. O’Brien, the Privy Council held that when a majority of bondholders vote on a matter that will bind all bondholders (majority and minority alike) pursuant to the powers granted under a trust indenture, “the power given must be exercised for the purpose of benefiting the class as a whole, and not merely individual members only.” The reasoning in the decision is subtle, and its nuances cannot be explored in detail here. Among other things, issues remain as to the applicability of this principle to votes of special classes of shares, as well as debt instruments. The only point here is that one must be mindful of the possibility that voting rights may, in certain circumstances, be subject to some constraint of this nature.

A.  Priority Rights The term “senior securities” refers to both preferred shares (discussed in Section IV) and long-term securities such as bonds and debentures. While “bonds” and “debentures” are not terms of art, they generally refer to different kinds of debt securities. Bonds are typically secured by a specific or fixed charge over land or chattels. Debentures are unsecured or secured by a floating charge over the issuer’s assets. A security interest will give the debt holder a measure of protection in the event of the issuer’s default of the terms of the loan agreement. Debt securities evidence a promise to pay a debt in the same way that a promissory note does. But unlike a typical promissory note, debt securities are normally issued to a large number of long-term creditors. Since a security interest over the issuer’s collateral cannot be conveniently given to each security-holder, the assignment is made to a trustee for bondholders or debentureholders. The trust indenture between the issuer and the trustee often contains many protective provisions, and the trustee is given the power to enforce these rights on behalf of the security-holders. Trust indentures are also used when there are disparate debt-holders, even if no security is being granted, and it is through these indentures, together with applicable provisions of the corporate statute governing the corporation issuing the debt, that many of the debt-holders’ rights will be spelled out. Senior debt securities are normally issued for a specified term, often between 5 and 20 years. Thereafter, the issuer undertakes to repay the moneys borrowed by redeeming the securities. There is normally no such duty for an issuer to redeem preferred shares. In addition, debt securities contain a promise by the issuer to pay out interest, and a failure to perform this obligation may result in a petition in bankruptcy. By contrast, the decision by directors as to dividend payments on shares is ordinarily one of business judgment, and courts are reluctant to impeach it.

B.  Varieties of Debt Securities Debt securities are normally classified according to the nature of their security interest. A mortgage bond is secured by a mortgage over the issuer’s fixed assets, particularly real estate, and is frequently the corporation’s most senior security. On default, the trustee may apply the property in payment of the debt by foreclosing, in the same way that a

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conventional mortgagee would. But in most cases the scrap value of the property is much less than its going concern value, and the bondholders’ rights in the collateral will merely establish their priority position on reorganization. The corporation’s assets may also be mortgaged more than once, in which case one speaks of “first mortgage bonds” and “second mortgage bonds.” The latter security is deferred to the former, even as a second mortgage in a house is to a first mortgage. Collateral trust bonds are secured by an interest in the issuer’s securities or accounts receivable. Subordinated debentures are not merely unsecured but also provide that other outstanding indebtedness has priority to repayment. These securities may be issued when the corporation has an excessive amount of debt and is unable to attract equity investors. Like conventional debentures, subordinated obligations are unconditional promises to pay interest and principal. But such payments are deferred until a distribution is made to the senior debt-holders to whom the debentures are subordinated. When an issuer in financial difficulties requires further moneys, bondholders may expressly agree to subordinate their claims to new lenders. Pre-filing creditors are often reluctant to advance further credit when their pre-existing claims may already be under water. The company will often seek new financing to continue operations, as well as try to persuade trade suppliers to continue to advance credit during the period of negotiations for a workout. At the same time, the debtor must seek new capital in the form of exit financing through new debt, new equity, the sale of assets, or some combination of these strategies, in order to ensure that it has sufficient capital to operate when it exits from the protection of the statutory stay period under the Bankruptcy and Insolvency Act, RSC 1985, c B-3, as amended (BIA) or the Companies’ Creditors Arrangement Act, RSC 1985, c C-36, as amended (CCAA). Interim financing refers primarily to the working capital that the debtor corporation requires in order to keep operating during restructuring proceedings. The premise underlying interim financing is that it is a benefit to all stakeholders, because it allows the debtor to protect going-concern value while it attempts to devise a plan of arrangement or proposal acceptable to creditors. Prior to 2009, there was no express language in the CCAA or BIA providing for interim financing, yet Canadian courts found they had the jurisdiction to order such financing. The provisions for interim financing are now codified in both statutes, with criteria that the court is to consider before approving such financing: see BIA s 50.6 and CCAA s 11.2. The criteria include the period during which the debtor company is expected to be in restructuring proceedings; how the company’s business and financial affairs are to be managed; whether management has the confidence of its major creditors; whether the loan would enhance the prospects of a viable proposal being made; the nature and value of the company’s property; whether any creditor would be materially prejudiced as a result of the security or charge; and the trustee’s or monitor’s opinion (BIA s 50.6(5), CCAA s 11.2(4)). Interim financing is important for companies in financial distress, as it may allow a corporation to keep operating in order to retain value while trying to negotiate a workout with creditors. Given that pre-filing creditors’ claims are often already not fully covered by remaining assets, the significance of interim financing is that it is given a super-priority charge over the assets of the debtor corporation and thus subordinates pre-filing creditors and their contractual agreements with the debtor corporation. However, the criteria the courts are to apply, including considering whether creditors are going to be materially prejudiced, serves as some protection of creditors’ rights when the company is trying to work its way through its financial distress.

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IV.  Preferred Shareholders

Not only are there many types of debt financing out there, but the provisions of different kinds of debt instruments have achieved considerable complexity as a reaction to the enormous shifts in interest rates during the second half of the 20th century. A purchase of a bond at a fixed interest rate represents a gamble on interest rates generally as well as on the solvency of the firm. For example, a purchaser of a high quality bond in 1970 might have been adequately compensated for the risk of default with a 10 percent rate of return. But with higher interest rates 10 years later, such securities would have traded at a discount. For example, if an investor had purchased an equivalent risk security promising a 20 percent rate of return in 1980, the first security would have traded at a 50 percent discount; if it had been issued at $100, promising yearly interest payments of $10, it would trade in 1980 at $50, promising a 20 percent return ($10). The rate of return on outstanding securities, based on current market values and expressed as a percentage, is called the securities’ yield. In the example, the security’s interest rate, based on face value, was 10 percent, while its yield in 1980 was 20 percent. The increase in interest rates during the 1960s and 1970s led to exotic debt provisions when such debt securities were issued in the 1980s. There was first a movement from long maturity terms (such as 20 years) to shorter periods (usually 5 to 10 years), since narrower fluctuations in interest rates will be anticipated in shorter time periods. Firms also issued “extendible” debt having a short maturity period, but giving its holders an option to convert to long-term debt in the event that interest rates fell. “Retractable” debt is usually long-term debt, but permits its holders to force redemption after a 5- or 10-year period as a hedge against any increase in interest rates. A further insurance against changes in interest rates is provided by variable interest rate debt. As an example of such securities, “floating rate” debt bears a rate of interest tied to the prime rate available to chartered banks, adjusted at specified intervals.12 Low-grade bonds have also grown in popularity since the 1980s. Such bonds lack an investment-grade rating (Baa or better) from bond raters like Standard & Poor’s and have a non-trivial chance of default. For this reason they are often referred to as junk bonds. Although characterized by a relatively high degree of risk, they also promise a higher income. Junk bonds are overwhelmingly held by institutional intermediaries and have become an important segment of the bond market.13

IV.  PREFERRED SHAREHOLDERS

P Hunt, C Williams & G Donaldson, Basic Business Finance 5th ed (Homewood, Ill: RD Irwin, 1974) at 358-61 The preferred stock represents a type of corporate financing which is somewhat paradoxical as between its nominal characteristics and its practical application. On the surface, it

12 See further D Sullivan, “Methods of Long-Term Corporate Financing” in Income Tax Aspects of Corporate Financing, Corporate Tax Management Conference, 1980 (Toronto: Canadian Tax Foundation, 1981) 1 at 14-27. 13 See Mark J Roe, “The Voting Prohibition in Bond Work-Outs” (1987) 97 Yale LJ 232 at 258-60—reportedly, 95 percent of the junk bond market was held by institutional investors in the 1980s.

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appears to provide the corporation with a security coupling the limited obligation of the bond with the flexibility of the common stock—a combination that would be unusually attractive to the issuer. Unfortunately, general experience does not bear out such expectations. From the purely legal point of view the preferred stock is a type of ownership and thus takes a classification similar to that of the common stock. Accounting practice recognizes this by placing preferred stock along with common stock in the net worth section of the balance sheet. … Unlike the bond, the preferred stock does not contain any promise of repayment of the original investment; and as far as the shareholders are concerned, this must be considered as a permanent investment for the life of the company. Further, there is no legal obligation to pay a fixed rate of return on the investment. The special character of the preferred stock lies in its relationship to the common stock. When a preferred stock is used as a part of the corporate capital structure, the rights and responsibilities of the owners as the residual claimants to the asset values and earning power of the business no longer apply equally to all shareholders. Two types of owners emerge, representing a voluntary subdivision of the overall ownership privileges. Specifically, the common shareholders agree that the preferred shareholder shall have “preference” or first claim in the event that the directors are able and willing to pay a dividend. In the case of what is termed a nonparticipating or straight preferred stock, which is the most frequent type, the extent of this priority is a fixed percentage of the par value of the stock or a fixed number of dollars per share in the case of stock without a nominal or par value. •  •  •

In most cases the prior position of preferred stock also extends to the disposition of assets in the event of liquidation of the business. Again, the priority is only with reference to the common stock and does not affect the senior position of creditors in any way. It has meaning and value only if asset values remain after creditors have been fully satisfied— a condition which is by no means certain in the event of liquidation following bankruptcy. … So far, we have considered the preferred stock in terms of the formal rights and responsibilities inherent in this type of security. The impression created is that of a limited commitment on dividends coupled with considerable freedom in the timing of such payments. In reality, experience with preferred stocks indicates that the flexibility in dividend payments is more apparent than real. The management of a business which is experiencing normal profitability and growth desires to pay a regular dividend on both common and preferred stock because of a sense of responsibility to the corporate owners and/or because of the necessity of having to solicit further equity capital in the future. The pressure for a regular common dividend in many cases assures the holder of a preferred stock that his regular dividend will not be interrupted, even in years when profits are insufficient to give common shareholders a comparable return, for it is very damaging to the reputation of a common stock (and therefore its price) if preferred dividend arrearages stand before it. The fact that most preferred issues are substantially smaller in total amount than the related common issue means that the cash drain of a preferred dividend is often less significant than the preservation of the status of the common stock. The result is that management comes to view the preferred issue much as it would a bond, establishing the policy that the full preferred dividend must be paid as a matter of course. The option of passing the dividend still exists, but it is seen as a step to be taken only in case of unusual financial difficulty. Under such a circumstance, the obvious question

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presents itself: Why, then, use preferred stock as a means of raising permanent capital? Why not use bonds instead? The primary advantage of the preferred stock becomes identical with that of a bond, namely, the opportunity to raise funds at a fixed return which is less than that realized when the funds are invested. On the other hand, the dividend rate on preferred stock is typically above the interest rate on a comparable bond and has the additional disadvantage of not developing a tax shield. Of course, the bond is more likely to have a sinking fund, so that the burden of bond and preferred stock may not be greatly different. The differential in cost between a preferred stock and an alternative debt issue may be considered a premium paid for the option of postponing the fixed payments. If management is reluctant to exercise this option, it is likely that the premium will be considered excessive. However, the closer a company gets to its recognized debt limits, the more management is likely to appreciate the option to defer the dividend on a preferred stock issue and be willing to pay a premium for this potential defense against a tight cash position. Note that in the extract above the authors refer to common and preferred shareholders as two types of owners. In your view, is this a productive way to describe common and preferred shareholders? If so, why? If not, how would you describe the difference between these types of shareholders? The special rights attached to a preferred share must be stated in the corporate charter: see CBCA s 6(1)(c)(i). These rights usually include prior rights to dividends and to a return of moneys on dissolution. Each of these rights is examined in further detail below. The contract may also contain restrictive covenants similar to those found in a trust indenture.

A. Dividends This subsection on dividends begins with a note on the meaning of the word “dividend.” This discussion is followed by an overview of types of dividends and a discussion of various legal aspects of the declaration of dividends, including how corporate statutes in Canada, particularly the CBCA, address the potential prejudice to creditors on the distribution of dividends. While the right to a dividend can form part of the bundle of rights that make up any share, preferred shares are frequently structured with an eye to providing an investor with a commitment to pay out a regular dividend to holders of those shares. Accordingly, preferred shares frequently contain a right to be paid a dividend in priority to any other class of shares.

1.  What Is a Dividend? One meaning given to the word “dividend” in the Oxford English Dictionary is “a number that is to be divided.” Another meaning given to the word “dividend” by that same dictionary is “a share of profits paid to shareholders.” Black’s Law Dictionary defines a “dividend” as “a portion of a company’s earnings or profits distributed pro rata to its shareholders.” In Re Carson, [1963] 1 OR 373, 37 DLR (2d) 292 (H Ct J), Wells J had this to say about the meaning of a dividend: The word “dividend” is not a word of art or one which under prior decisions of the Courts has any precise, definite or rigid meaning. As it has been said, it is a broad generic term and must be

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construed in its normal and ordinary meaning as one of the words of the English language. Primarily, the word “dividend” means that which is to be divided. The word apparently includes the action of dividing among a number of persons, distribution of profits or assets.

The word thus appears, in the context of a corporation, to normally refer to the distribution of profits to shareholders. It is not “a word of art,” nor is it one that “under prior decisions of the Courts has any precise, definite or rigid meaning.” In the broader sense of the word, it might thus refer, even in the context of a corporation, to some amount other than profits that is to be divided among the shareholders of the corporation. A “dividend” might thus include a distribution of an amount from the original contributions of capital made by shareholders. The discussion below focuses initially on a dividend as a distribution to shareholders of the profits of the corporation. It later notes why the broader notion of a dividend as “a number that is to be divided” may have come to be associated with the division of profits in the corporate context.

2.  Types of Dividends: Cash, Specie, and Stock Dividends A corporation can distribute its profits to shareholders by paying a dividend. Suppose Quick Buys Ltd has a single class of shares and that 1,000 of those shares are issued and outstanding. The shares are held by four shareholders with one shareholder owning 400 shares, a second shareholder holding 300 shares, a third shareholder holding 200 shares, and a fourth shareholder holding 100 shares. Quick Buys Ltd has accumulated profits over the past four years of $1,500,000 but has not previously distributed any of these profits to shareholders. Some time after the end of the fourth year a decision is made that it is a good time to distribute $1,000,000 as a dividend. A resolution is passed “declaring” a dividend of $1,000 per share. The first shareholder would get $400,000 (400 shares times $1,000 per share), the second $300,000, the third $200,000, and the fourth $100,000. Why did Quick Buys Ltd not distribute its profits in years one, two, and three? One reason may be that management saw opportunities to expand the business. For this they needed funds. They might have been able to raise funds by borrowing or by selling more shares. These methods of raising funds, however, usually involve greater costs than simply using the funds generated by the business. Thus they may have decided that the funds being generated through the operation of the business were the cheapest source of funds for expanding the business.

a.  Cash Dividends Dividends are usually paid in cash. This seems simple enough, but where does the cash come from? If, as suggested above, Quick Buys Ltd had decided in years one, two, and three not to pay dividends because it was using the funds to expand the business, then the cash generated from the operation of the business in years one, two, and three would no longer be in the form of cash. It would have been invested in the assets acquired to expand the business. It might, for instance, have been used to acquire a new building, to acquire new equipment, or to invest in additional inventory associated with operating on a larger scale. There might be more funds in the bank account than in year one, but these funds would be needed to operate the now expanded business (since there would be more expenses for

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which payment must be met on a daily basis, such things as increased inventory, increased payroll expenses for a larger staff, and increased maintenance expenses to care for the new building). If year four funds generated from the operation of the business were also spent on expansion, then there will be no pot of cash available to pay dividends. If that is the situation, then funds will have to be raised either from the continuing operation of the business or by another means, such as borrowing funds or perhaps even selling off one or more of the corporation’s assets. The accounting entry for a distribution of dividends will normally involve a reduction in an account called “Retained Earnings.” One should appreciate that this is simply an account—that is, a record—that keeps track of the profits of the business that have not been distributed. It does not mean that there is a pile of cash stored somewhere or that there is a bank account with funds equal to the amount recorded as retained earnings. Where did the funds reflected in the amount recorded in the retained earnings account go? They are, for the reasons noted above, in the assets of the corporation. The retained earnings account shows one of the sources of funds used in acquiring the assets of the corporation.

b.  Dividends in Specie Dividends can, occasionally, be paid by distributing property other than cash to shareholders. When a dividend is paid in property other than cash, the dividend is referred to as a “dividend in specie.” Quick Buys Ltd, for example, could (at least in theory) get rid of an excess inventory of running shoes by paying a dividend in the form of one pair of running shoes for every 100 shares owned by a shareholder. Such a use of inventory for dividends would be extremely rare. A more common type of in specie dividend might involve Quick Buys Ltd distributing shares it held as an investment in Ultra Mining Ltd. For example, for every 200 Quick Buys Ltd shares owned by a Quick Buys Ltd shareholder, she might receive 100 Ultra Mining Ltd shares as dividends in specie. Probably the most common dividend in specie situation involves the distribution of shares that the corporation holds in a subsidiary corporation. This transaction is known as a “spinoff.” For example, suppose Quick Buys Ltd owns 100 percent of the shares of Kokoa Chocolates Ltd. The management of Quick Buys has decided that it no longer makes sense to control Kokoa. Quick Buys might dispose of its ownership of Kokoa by selling the shares to another corporation or to an investor who is willing to buy all of the shares of Kokoa. Instead, however, it might be decided that the best way to dispose of Kokoa is to distribute the Kokoa shares held by Quick Buys to Quick Buys shareholders in the form of a dividend. The dividend would be a dividend in specie since it would be a dividend not in the form of cash but in the form of shares of Kokoa.

c.  Stock Dividend Sometimes, instead of paying a cash dividend, a corporation will pay a dividend by issuing more of the corporation’s shares to its existing shareholders. This is known as a “stock dividend.” For instance, Quick Buys Ltd might give its shareholders one additional share for every 10 shares they currently own. A holder of 100 shares would thus get 10 additional shares.

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As the discussion above suggests, a cash dividend or a dividend in specie will normally result in a change in the assets of the corporation. Even if the corporation had accumulated cash for the purpose of paying a cash dividend, the payment of the dividend would result in a reduction in the cash (an asset) held by the corporation. A dividend in specie involves the distribution of an asset held by the corporation and thus a reduction in the assets of the corporation. A stock dividend, however, will not result in a change in the assets of the corporation. No cash or any other asset is distributed to shareholders—they simply get more shares of the corporation. The corporation will have the same assets as it did before the stock dividend and these assets will presumably have the same value as they did before. Each shareholder will have more shares carrying residual rights to the proceeds from the same assets having the same value as before. What effect should such a transaction have on the value of the shares? Suppose Quick Buys Ltd has net assets—that is, net of liabilities—with a market value of $10,000,000 and has a single class of shares with 1,000,000 shares issued and outstanding. Each share should be worth $10. Suppose Quick Buys Ltd declares a stock dividend, giving one new share for every 10 shares a shareholder owns. After the stock dividend is distributed, 1,100,000 shares of Quick Buys Ltd will be issued and outstanding. Since the net assets are the same as they were before, they should still have a market value of $10,000,000. Thus the price of a Quick Buys Ltd share should be worth $10,000,000 divided by 1,100,000 shares, or approximately $9.09 per share. A Quick Buys Ltd shareholder who owned 100 shares before the stock dividend would have held $1,000 worth of Quick Buys Ltd shares (100 shares times $10 per share). On the distribution of the stock dividend she would get an additional 10 shares and thus will own 110 shares. The value of her 110 shares will be $1,000 (110 shares times $9.09 per share).

3.  Legal Aspects of Dividends Corporate statutes do not often say much about dividends. Indeed, the CBCA does not say much about dividends. Some questions do, however, need to be addressed. For instance, what types of dividends is the corporation permitted to declare? Who has the power to declare dividends on behalf of the corporation? Is the corporation legally obliged to declare a dividend? Are those who have the power to declare dividends on the corporation’s behalf legally obliged to declare a dividend? What is the corporation’s legal obligation with respect to dividends once they have been declared? What is the process for determining who is entitled to receive a dividend? Are there restrictions on the declaration of dividends?

a.  Legally Permitted Types of Dividends Section 43(1) of the CBCA provides that “a corporation may pay a dividend by issuing fully paid shares of the corporation and … a corporation may pay a dividend in money or property.” Thus, a CBCA corporation can pay a stock dividend since that is a dividend paid by “issuing fully paid shares of the corporation.” A CBCA corporation can also pay a cash dividend since that would be “a dividend paid in money,” and it may also pay a dividend in specie since that would be “a dividend in … property.”

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b.  Power of Directors to Declare Unless Otherwise Provided No section in the CBCA expressly allocates the power to declare a dividend. There is also no section that says it is a power of the shareholders. There is, however, one broad allocation of powers that might include the power to declare a dividend, and that is the power of the directors in s 102(1) to manage, or supervise the management of, the business and affairs of the corporation. Section 115(3) confirms that the declaration of dividends falls within the management powers of the directors, since s 115(3)(d) provides that the declaration of dividends is a decision that cannot be delegated to a managing director or committee of directors. As a power of directors under s  102(1), the declaration of dividends can only be reallocated to persons other than the directors in a unanimous shareholder agreement. In short, the power to declare dividends is a power of the directors subject only to a unanimous shareholders’ agreement. Is the allocation of the power to declare dividends to directors the only way in which such a power might be allocated? Might it instead be allocated to the shareholders or perhaps even to the corporation’s auditors, who might be better able to assess whether the corporation is financially able to pay a dividend? Corporate legislation in other jurisdictions has in fact allocated the dividend decision to shareholders, usually subject to a restriction based on a report from the auditors as to the amount the corporation is financially able to distribute. This was the approach in Germany and in Japan (which modelled its corporate law on Germany’s legislation). The legislation in both Germany and Japan was changed to allocate the power to declare dividends to the directors. Are there practical reasons for giving default allocation of the power to declare dividends to directors?

c.  Directors Are Not Obligated to Declare Dividends There is no duty on the corporation, or on the directors on behalf of the corporation, to declare dividends. The directors declare a dividend if they think it is appropriate to do so. Directors must exercise all their powers in the best interests of the corporation. They must also exercise their powers in a way that is not oppressive, or unfairly prejudicial toward one or more shareholders, or that unfairly disregards the interests of one or more shareholders. These constraints on the exercise of their powers may, in some circumstances, require the directors to pay dividends.

i.  Fiduciary Duty In the US case of Dodge v Ford Motor Co, 204 Mich 459, 170 NW 668 (1919), for example, the Ford Motor Co had amassed substantial retained earnings. The directors, led by Henry Ford, chose not to declare a dividend so that the company could use the funds for plant expansion. When questioned, however, about the reason for the plant expansion, Henry Ford responded that it was not to generate more profit for the company, but to expand his production system for the greater benefit of society. As a director, Ford’s duty was to act in the best interests of the company. The court held that the best interests of the company involved making profits for the company. If the reason given for the plant expansion and the decision not to declare a dividend had been to make more profit for the company, then the

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failure to pay dividends would have been all right. In Dodge v Ford Motor Co, however, the reason given by Henry Ford had the ring of some sort of a charitable benefit for society. The decision was thus, by Henry Ford’s admission, not made with a view to company profit, and therefore not with a view, in the court’s opinion, to the best interests of the corporation. It was thus a breach of the duty of the directors to act in the best interests of the corporation. A similar argument might be made with respect to a corporation incorporated in Canada. In CBCA s 122(1)(a), for example, the directors have a duty to act “honestly and in good faith with a view to the best interests of the corporation.” A decision of the directors as to whether to declare a dividend would have to be made honestly and in good faith in the best interests of the corporation.

ii. Oppression The decision in Re Ferguson and Imax Systems Corp (1983), 43 OR (2d) 128 (CA) provides an example of a situation in which directors might be obliged to pay a dividend where a failure to do so would be oppressive or unfairly prejudicial to, or would unfairly disregard the interests of, one or more shareholders. In Ferguson and Imax, Mr and Mrs Ferguson were shareholders in the corporation along with two other couples. The wives held preferred shares and the husbands held common shares. The marital relationship between Mr and Mrs Ferguson broke down. Mr Ferguson used his position of influence to see to it that no dividends were paid. Mr Ferguson and the other couples were paid salaries for work they did for the company. Mr Ferguson and the other couples thus got a return on their investment in the company in the form of salaries. Mrs  Ferguson no longer worked for the company and received no salary from the company. Without dividends she got no return on her investment. The court held that this refusal to pay dividends was oppressive to Mrs Ferguson and granted a remedy under the oppression remedy provision in the OBCA. Chapter 14 reviews cases on the oppression remedy in greater detail.

d.  Protection of Creditors Suppose a dividend could be based on any “number that is to be divided.” Suppose then that Quick Buys Ltd, on the day it was incorporated, issued 100 shares to 10 shareholders who took 10 shares each and paid $10 per share to the corporation for their shares, thus providing capital contributed by shareholders in the amount of $1,000. Then on the day after its incorporation it borrowed $999,000 from various persons who thereby became creditors of the corporation. Assume all of these funds were deposited in a bank account. On the third day after incorporation, a dividend of $1,000,000 was declared that would provide a dividend of $10,000 per share. Shortly thereafter, each shareholder was paid their $100,000 dividend, thereby bringing the bank account balance to zero. Since the creditors made their loans to Quick Buys Ltd, a corporation that is a separate legal entity, their claim for repayment would be against Quick Buys Ltd. Quick Buys Ltd would, however, have no assets to satisfy their claims. The creditors might be able to control for this risk in a number of ways. They might get personal guarantees from the directors of the corporation, but the directors would probably be reluctant to give such guarantees, and where a corporation is borrowing substantial sums, it is unlikely that the directors would be able to pay such debts if the corporation failed

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to do so. The creditors might seek guarantees from shareholders (and in closely held corporations they often do), but this would have the effect of reversing the limited liability that organizing in the corporate form had provided, and would be costly to arrange through individual negotiations where the corporation has a large number of shareholders. The creditors could arrange for security interests in assets of the corporation, and creditors that advance large amounts to corporations often do arrange for a security interest. The cost of negotiating a security interest in assets of the corporation would, however, be likely to discourage smaller amounts of borrowing, such as trade credit. Such smaller amounts of borrowing might not be possible if the corporation were able to engage in a distribution of funds to shareholders of the sort described above. Some larger amounts of borrowing might also be made more expensive because of the lender’s need to negotiate protection against a distribution of the sort described above. Once funds have been loaned to the corporation, any distribution of funds from the corporation would increase the risk that the corporation may not later be able to repay the debt. Thus, once funds have been loaned to the corporation, the creditor would prefer that no distributions be made to shareholders. Investors, however, would likely be unwilling to invest as shareholders unless they could, at some point, get a return on their investment. Consequently, some control over the distribution of dividends is needed that makes a tradeoff between allowing returns to shareholders while providing some degree of protection to creditors. Early corporate statutes in England and Canada generally did not address this need for control over dividends. Courts filled the gap by saying that “dividends must not be paid out of capital” or, similarly, that “dividends must only be paid out of profits.”14 Courts developed this concept by reading into the corporate statutes a principle that capital could not be reduced. In Flitcroft’s Case (1882), 21 Ch D 519 (CA), Jessel MR gave the following reason for the concept: The creditor has no debtor but that impalpable thing the corporation, which has no property except the assets of the business. The creditor, therefore, I may say, gives credit to that capital, gives credit to the company on the faith of the implied representation that the capital shall be applied only for the purposes of the business, and he has therefore a right to say that the corporation shall keep its capital and not return it to the shareholders.

Unfortunately, the simple rule that “dividends must only be paid out of profits” was not so simple to apply in practice. For instance, would an expense for the notional wear and tear on physical assets, such as a building or equipment, have to be deducted in the calculation of profit? If so, how would such an amount be determined given that there is no precise way of making such a calculation and accountants recognize several different methods? If a building and equipment were damaged by fire during the year, would they have to be replaced, or would, at least, an amount have to be deducted in calculating profits? Should profit be calculated on an annual basis? What if in the previous five years the corporation had lost $1,000,000 per year for the first four years, reducing its assets, and its net assets, by $4,000,000, but in the fifth year it made a profit of $1,000,000? Could the corporation pay a dividend in that fifth year? If assets of the corporation were sold, could

14 See Bond v Barrow Haematite Steel Co, [1902] 1 Ch 353 at 365.

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the revenues be included in calculating the profit of the corporation? These and many other questions were addressed by courts that were often relying on expert evidence from accountants. These difficulties created much uncertainty in the law on dividends and led the Dickerson Committee to describe the law on dividends as having been “in a confused mess for years.”15 In summarizing all the rules relating to dividends that courts had developed, LCB Gower noted that the overriding rule was that dividends could not be paid if it would result in the corporation being unable to pay its debts as they fall due. This is the general approach taken in the CBCA. Section 42 of the CBCA provides that dividends cannot be declared or paid if the corporation is insolvent at the time or if payment would make the corporation insolvent. Specifically, s 42 provides: A corporation shall not declare or pay a dividend if there are reasonable grounds for believing that (a)  the corporation is, or would be after the payment of the dividend, unable to pay its liabilities as they come due; or (b)  the realizable value of the corporation’s assets would thereby be less than the aggregate of its liabilities and stated capital of all classes.

The directors of the corporation are made the initial gatekeepers in ensuring that this requirement is met. Section 118(2)(c) of the CBCA provides that directors can be personally liable if they consent to a resolution declaring a dividend where there are reasonable grounds for believing that the corporation is insolvent or would become insolvent on the payment of a dividend. A shareholder may be compelled to return an improperly paid dividend. A director can apply to court under ss 118(4) and (5) for an order compelling a shareholder to pay or deliver to the director any money or property that was paid or distributed to a shareholder contrary to s 42. A breach of s 42 would also constitute an offence punishable on summary conviction under s 251. Section 42 sets out two tests. One is a liquidity test that focuses on whether the corporation will have enough cash, or assets readily convertible into cash, to continue to meet its liabilities as they come due. The other is a test of whether the corporation could pay all its liabilities and return all capital contributed by shareholders if the corporation were liquidated—that is, if its assets were sold for cash. This second test is based on the “realizable value” of the corporation’s assets, not the value of the assets as recorded on the corporation’s balance sheet (this is because these amounts represent “historical dollar” figures—that is, the amounts the corporation paid for the assets). Both tests must be met (1) at the time the dividend is declared and (2) at the time the dividend is paid. It may thus be prudent for directors to obtain an opinion from accountants as to whether these tests are satisfied both before declaring a dividend and before paying it. It has been held that when directors declare a dividend, it becomes a debt of the corporation.16 What happens if, when a dividend is declared, the tests in s 42 are met, but when it comes time for payment of the dividend, the tests in s 42 are not met? Can the declared 15 Robert WV Dickerson, John L Howard & Leon Getz, Proposals for a New Business Corporations Law for Canada, vol 1, Commentary (Ottawa: Information Canada, 1971) at para 140. 16 See e.g. The Custodian v Blucher, [1927] SCR 420 at 425; and Severn & Wye v Severn Bridge Railway Co, [1896] 1 Ch 559 (ChD).

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dividend still be a debt of the corporation, in accordance with these previous court decisions, or can it no longer be considered a debt because payment of the debt would constitute a breach of the statute?17 Does s 42 apply to a stock dividend? As the discussion above suggests, the concern that creditors have when a dividend is paid is that it reduces the assets of the corporation and therefore reduces the amount of assets available for payment of amounts owed to creditors. However, as indicated in Section IV.A.2.c, above, a stock dividend does not reduce the assets of the corporation. Consequently, the creditor protection concern that s 42 is presumably directed at does not arise. Arguably then, s 42 should not apply to stock dividends. Yet nothing in s 42, or s 43, which allows for a stock dividend, indicates that s 42 does not apply to a stock dividend.18

B.  Rights on Liquidation

International Power Co v McMaster University/In re Puerto Rico Power Co [1946] SCR 178, aff ’g [1945] 2 DLR 93 (Que CA) TASCHEREAU J (Estey J concurring): The Porto [sic] Rico Power Co. Ltd. was incorporated under the Dominion Companies Act of 1902, by letters patent dated the 29th of August, 1906. Its original authorized capital was $3,000,000 divided into 30,000 common shares of $100 each, all of which were issued and fully paid. In 1909, the Company increased its capital by creating and issuing $500,000 of preference stock, divided into 5,000 shares of $100 each, and again in 1911, a further increase of $500,000 raised the amount of preference stock to $1,000,000 and, as a result of which, the total capitalization of the company was $4,000,000. The provisions of both supplementary letters patent, dealing with the rights of preference shares are the following: The said increased capital stock of five hundred thousand dollars shall be preference stock entitled out of any and all surplus net earnings whenever ascertained to cumulative dividends at the rate of seven per cent. per annum for each and every year in preference and priority to any payment of dividends on common stock, and further entitled to priority on any division of the assets of the company to the extent of its repayment in full at par together with any dividends thereon then accrued due and remaining unpaid.

The main holdings, if not the only, of the Porto Rico Power Company, Limited were the shares of a certain Porto Rican subsidiary, the assets of which were expropriated by the Porto Rico Water Resources Authority, of the Porto Rican Government. As a result of this transaction, the Montreal Trust Company, in its quality of liquidator of Porto Rico Power Company, Limited, now in voluntary liquidation, had in its treasury more than 17 See the discussion in Christopher Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) at 376-77. 18 See the discussion in Christopher Nicholls, Corporate Law, ibid at 377-79.

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$6,000,000 available for distribution amongst both classes of shareholders. The present appellant owns 29,357 of the 30,000 common shares of the Porto Rico Power Company, Limited, and the respondents are the holders of a substantial number of preference shares. The Montreal Trust Company of Montreal was appointed liquidator on the 26th of January, 1944, and was authorized by the Court to make a preliminary distribution of $100 per share to the preference shareholders and $150 per share to the holders of common stock, and it also prayed the Court to determine how the surplus money amounting to $500,000 should be distributed. The Montreal Trust Company submitted that the holders of common shares are alone entitled to share in any surplus assets available for distribution after payment by priority of $100 per share to the preference shareholders, plus dividends thereon accrued due and remaining unpaid, and that the holders of preference shares are entitled only to said payment by priority of $100 per preference share and dividends thereon accrued and remaining unpaid, and that they are not entitled to share pro rata with the holders of shares of common stock in any surplus assets. The contention is that the rights of the holders of the preference shares of stock of the Porto Rico Power Company, Limited, in liquidation, are completely and exhaustively set out in the by-laws and supplementary letters patent and that, after having received cumulative dividends at the rate of 7 per cent. per annum, which in fact they have received, they are entitled to only $100 per share in the distribution of the assets of the company which is the repayment in full of their shares at par. The respondents intervened to contest the petition of the liquidator claiming that the preference shareholders are entitled to equal treatment in all respect with the common shareholders, except to the extent to which the said preference shares are given a priority by the supplementary letters patent and the by-laws of the company. They further alleged that no limitation whatsoever is placed upon the rights of the preference shareholders, and all that the said by-laws and supplementary letters patent provide is the extent of the priority given to the preference shareholders. The respondents further claimed that the company in liquidation has paid dividends to the common shareholders in excess of the 7 per cent. received by the preference shareholders, and that the said dividends paid to the common shareholders constitute an advance in respect of which the preference shareholders are entitled to be placed on an equal basis. Mr. Justice Boyer dismissed the contention of the McMaster University and directed that the $500,000 and all further assets subject to distribution should be distributed to the common shareholders only, and to the exclusion of the preferred shareholders. The Court of King’s Bench allowed the appeal of the McMaster University, ordered that the judgment a quo be modified to the extent of ordering, and ordered, the liquidator to distribute amongst the holders of preference shares the sum of $500,000 in proportion to their holdings of said shares, with interest at the rate of 5 per cent. per annum from the 2nd day of February, 1944. The Court of King’s Bench further ordered the liquidator to distribute amongst the holders of preference and common shares in proportion to their holdings of the said shares, without any distinction, any or all balance of surplus assets available for distribution, but dismissed the claim of preferred shareholders as regards dividends. The decision of this case depends upon the true construction of the essential words of the supplementary letters patent and by-laws already cited. It is clear, I think, that under

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the Dominion Companies Act, a preferred shareholder has all the rights and liabilities of a common shareholder. This proposition is found in section 49 of the Companies Act, RSC 1906, chap. 79, which reads as follows: “Holders of shares of such preference stock shall be shareholders within the meaning of this part, and shall in all respects possess the rights and be subject to the liabilities of shareholders within the meaning of this part.” The preferred shareholders are however entitled to additional preferences and rights which are authorized by section 47 of the Act, which is to the effect that the directors of the company may make by-laws for creating and issuing any part of the capital stock as preference stock, giving the same such preference and priority, as respects dividend and in any other respect, over ordinary stock as is by such by-laws declared, and this is confirmed by subsection 49, which, after stating that holders of shares of preference stock are shareholders within the meaning of the Act, says that they are, as against the ordinary shareholders, entitled to the preferences and rights given by the by-laws. Many judgments have been cited by both parties. As it will be seen the consensus of opinion appears to be that preference shareholders have all the rights and liabilities of common shareholders, and that the additional preferences and priorities, to which they may be entitled, must be found in the by-laws, and supplementary letters patent of the company. The oldest case is, I think, the case of Birch v. Cropper [(1889), 14 App. Cas. 525]. In that case, the articles of association of an English company incorporated under the Companies Act of 1862 provided that the net profits for each year should be divided pro rata upon the whole paid-up share capital, and that the directors might declare a dividend thereout on the shares in proportion to the amount paid up thereon. The articles contained no provisions as to the distribution of assets on the winding-up of the company. The original capital consisted of ordinary shares partly paid up. Afterwards, preference shares were issued entitling the holders to a dividend at a fixed rate with priority over all dividends and claims of the ordinary shareholders. The preference shares were fully paid up. The undertaking having been sold under an Act which made no provision for the distribution of the purchase money amongst the shareholders, the company was voluntarily wound up and assets remained for distribution. It was held by the House of Lords, reversing the decision of the Court of Appeal, that in distributing the assets “amongst the members according to their rights and interests in the company” and in adjusting “the rights of the contributors amongst themselves,” the liability of the ordinary shareholders for the unpaid balance of their shares must not be disregarded; and that, after discharging all debts and liabilities and repaying to the ordinary and preference holders the capital paid on their shares, the assets ought to be divided amongst all the shareholders, not in proportion to the amounts paid on the shares, but in proportion to the shares held. At page 531, Lord Herschell said: To treat them as partners receiving only interest on their capital and not entitled to participate in the profits of the concern, or to regard them as mere creditors whose only claim is discharged when they have received back their loan, appears to me out of the question. They are members of the Company, and as such shareholders in it as the ordinary shareholders are; and it is in respect of their thus holding shares that they receive a part of the profits. I think, therefore, that the first contention of the appellant wholly fails. •  •  •

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And at page 546, Lord Macnaghten says also: The ordinary shareholders say that the preference shareholders are entitled to a return of their capital, with 5 per cent. interest up to the day of payment, and to nothing more. That is treating them as if they were debenture-holders, liable to be paid off at a moment’s notice. Then they say that at the utmost the preference shareholders are only entitled to the capital value of a perpetual annuity of 5 per cent. upon the amounts paid up by them. That is treating them as if they were holders of irredeemable debentures. But they are not debenture-holders at all. For some reason or other the company invited them to come in as shareholders, and they must be treated as having all the rights of shareholders, except so far as they renounced those rights on their admission to the company. There was an express bargain made as to their rights in respect of profits arising from the business of the company. But there was no bargain—no provision of any sort—affecting their rights as shareholders in the capital of the Company.

[Taschereau J then approved several English decisions, including Re William Metcalfe and Sons Ltd, [1933] Ch  142 (CA). That company’s memorandum had provided that the cumulative shareholders should “rank, as to capital as well as dividends, in priority to the other shares.” It was held that, after the repayment of paid-up capital to all shareholders, the preferred shareholders were entitled to participate pari passu with the common shareholders on the distribution of surplus assets.] From all these numerous judicial pronouncements, and from a careful reading of the Companies Act, I believe that one may rightly gather that the rights of all classes of shareholders are on a basis of equality, unless they have been modified by the by-laws or the letters patent of the company, and, that the right to the return of invested capital, and the right to share in surplus assets are quite different and distinct matters. Holders of preference stock are shareholders within the meaning of the Act, and they possess in all respects the rights, and are subject to the same liabilities as the other classes of shareholders. Section 49 on this point is quite clear and unambiguous. It is in virtue of this section that the ordinary rights of preference shareholders are created. These rights put them on an equal footing with the common shareholders as to the sharing in surplus assets. It is in the letters patent and the by-laws of the company that have to be found the priorities that may be attached to preference shares, and which are clearly authorized by section 47. It may of course happen that these priorities are exhaustive of the rights of the preference shareholders, and therefore negative any additional rights, or it may be also that they create additional rights which coexist with the original rights inherent to all classes of shareholders. But in order to determine the true meaning and the legal effect of these preference and priority clauses, one must necessarily look at the creating clauses in order to find if there is or not an express or implied condition, which limits or adds to the ordinary rights of the shareholders. It is a mere question of construction of these clauses, which form part of the contract under which the shareholders hold their shares. I entirely agree with the Court of King’s Bench that the provisions of the by-laws of the company do not expressly or by necessary implication, limit the rights of the holders of preference shares. They do create priorities, but these priorities are in addition to the

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existing rights, and are not a declaration of all the rights of this class of shareholders. These priorities consist in a right for the preference shareholders to be repaid of the invested capital at par, together with any dividends accrued and remaining unpaid, but do not affect their right to share in the profits. For the sharing in the profits, which is the fundamental right to all shareholders, is a matter entirely different from the priority given to the preference shareholder which is the additional privilege given to him. In the present case the priority to repayment “on any division of the assets of the company to the extent of its repayment in full at par together with any dividends thereon then accrued due and remaining unpaid” is a definition of the existing priority as to the sharing of assets, and cannot, I believe, be construed as a bar or a limitation to any further rights. For these reasons, I come to the conclusion that the preference shareholders have a priority to be repaid at par, and that they are further entitled to share pari passu in the distribution of the assets of the company with the common shareholders, after the latter had received payment at par. The main appeal should therefore be dismissed. It is the contention of the cross-appellant that the stipulation for payment of cumulative dividends at the rate of 7 per cent. per annum for each and every year, in a preference and priority to any payment of dividends on common stock, was not limitative in its terms and that in the event of the common shareholders receiving, in any year, a dividend exceeding the said rate of 7 per cent. per annum, then, the preferred shareholders were entitled to be paid on a basis of equality. The preference shareholders have received each year the stipulated dividends of 7 per cent. until the winding-up of the company, and the common shareholders until 1931 have received dividends lower than 7 per cent. per year. However, from 1931 to 1942, the directors have declared for the benefit of the common shareholders an annual dividend of 8 per cent. and in 1943 this dividend was 491⁄2 per cent. The preference shareholders ask for equal treatment in the matters of dividends. I cannot agree with this proposition, and it seems that the cases cited by the respondents on the main appeal defeat this very contention. The question, I think, has been settled by the case of Will v. United Lankat Plantations Company, Limited [[1914] AC 11]. In that case the Court of Appeal [[1912] 2 Ch. 571] decided that, in the distribution of profits, holders of the preference shares were not entitled to anything more than a 10 per cent. dividend, and in the House of Lords Viscount Haldane said: Moreover, I think that when you find—as you do find here—the word “dividend” used in the way in which the expression is used in the resolution and defined to be a “cumulative preferential dividend” you have something so definitely pointed to as to suggest that it contains the whole of what the shareholder is to look to from the company.

The right to dividends, while the company is a going concern and the right to capital and surplus assets in the winding-up, are quite distinct. In the present case, the right of preference shareholders is to be paid an annual dividend of 7 per cent. and they have a priority for dividends accrued due and remaining unpaid. These dividends have been paid, and the preference shareholders, as to dividends, have therefore received all that they are legally entitled to.

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The by-laws give priority to the preference shareholders to obtain reimbursement of their invested capital, in addition to their right to share in the division of assets, but a similar privilege as to dividends is not given. In the latter case, the privilege is only to assure the payment of a dividend of 7 per cent. which has been declared, and which at the time of the winding-up accrued and remained unpaid. I should dismiss the cross-appeal. As agreed, all costs of the parties will be paid by the liquidator out of the mass of the estate. [The concurring judgments of Rand and Kerwin JJ and the dissenting judgment of Rinfret CJC are omitted.] Appeal and cross-appeal dismissed. 1.  Participation on Liquidation Problems of the kind posed in International Power may be easily prevented by proper draftsmanship. Difficulties arise only when the articles do not clearly state liquidation preferences. In interpreting a similar provision, the House of Lords came to a different conclusion in Scottish Insurance Corp v Wilsons & Clyde Coal Co, [1949] AC 462 (HL (Scot)). In overruling Metcalfe and Sons Ltd, [1933] Ch 142 (CA), Lord Simonds stated at 487 that “the last thing a preference stockholder would expect to get … would be a share of surplus assets, and … such a share would be a windfall beyond his reasonable expectations.” The Supreme Court held that preferred shares were presumed to be participating on a liquidation and, following Will v United Lankat Plantations Company, Limited, [1914] AC 11, non-participating as to dividends. Is this inconsistent? Lord Simonds stated in the Scottish Insurance case (at 489): “I do not find … in [Will] any suggestion that a different result would have followed if the dispute had been in regard to capital.” Do you agree with Taschereau J that “[t]he right to dividends, while the company is a going concern and the right to capital and surplus assets in the winding-up, are quite distinct”?

2.  The Claim to Arrearages What is the extent of a preferred shareholder’s priority on liquidation if cumulative dividends have not been paid in past years? Had the corporation continued as a going concern, such arrears would have had to have been paid before juniors could receive dividends. But is the claim to arrears lost on dissolution? Once again, this is a drafting problem, which can be cured by specific reference to arrears in the articles. In the absence of such a provision, clauses that stated that preferred shareholders should have “priority as to dividend and capital” on dissolution were interpreted as giving them arrears of dividends.19 On the other hand, a provision that shareholders had

19 Re F de Jong & Co, [1946] Ch 211.

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V.  Convertible Securities, Rights, and Warrants

priority to a payment of capital was presumed to exclude further rights to arrears on liquidation.20

V.  CONVERTIBLE SECURITIES, RIGHTS, AND WARRANTS The world of corporate finance is a complex one and so it is no surprise that in addition to shares, debt securities, and preferred shares, many other kinds of instruments have been developed that form part of investment relationships. This section reviews some of the more common instruments, such as shares, that can be converted or exchanged into securities.

George S Hills, “Convertible Securities: Legal Aspects and Draftsmanship” (1930) 19 Cal L Rev 1 at 2-4 Conversion may be broadly defined as the act of exchanging securities of one class for securities of a different class, the exchange being effected by a surrender of the original security and the issuance to the holder of a new security in its place. Convertible securities are corporate securities which may, pursuant to their terms, be changed into or exchanged for other securities, such as bonds or notes exchangeable for preferred or common stock, or preferred stock exchangeable for common stock. Except in isolated cases the privilege of conversion is optional with the holder of the security, and senior securities are convertible into junior securities of the same company. In each case the privilege of conversion is created or evidenced by a certificate of incorporation, trust indenture, deed of trust or other document setting forth in full the terms and conditions under which the privilege may be exercised. In this study all such documents are, for the sake of brevity, called the conversion instrument. The conversion privilege is inherently the same whether attached to corporate obligations or to shares of stock. Bonds, notes and shares of stock retain their respective characteristics upon being made convertible into other securities, the conversion privilege being an optional and alternative right of the holder in addition to and separate from the right to be paid a sum of money or to exercise the usual rights of a stockholder. Although the privilege may not be divorced from the holder of the security to which it is attached, it is no part of the security itself and must be construed as if embodied in a separate instrument. Fundamentally, it is an independent optional right. The privilege is, however, inseparably connected with the security which evidences it and is available only to the holder. It may not be exercised by, or transferred to, one who is not the holder of the security itself. A transfer of the security acts also as a transfer of the privilege. •  •  •

The holder of a convertible obligation is not a stockholder in equity or at law nor is he a subscriber to shares of stock of the issuing company. Being merely the holder of a contractual privilege pursuant to which he has the option of becoming a stockholder he

20 Re Canada Tea Co Ltd (1959), 21 DLR (2d) 90 (Ont H Ct J)—no cumulative dividends were ever paid in the 16-year life of the corporation.

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can acquire none of the rights of a stockholder unless and until he complies with all of the terms and conditions of his contract. It has therefore been held that such holder has no right to question the declaration or payment of cash or stock dividends, the authorization or issuance of additional shares of the class issuable upon conversion, or the change in par value of existing shares issuable upon conversion. Stock purchase warrants and convertible securities are closely related in that both are contractual options for the purchase of shares. A conversion instrument and a warrant instrument are substantially alike in principle and draftsmanship, and a warrant instrument will contain all the essential adjustments and other protective features later referred to as customary in conversion instruments. Taking them as a class the only essential difference is in the consideration payable. A warrant is exercised by the payment of cash, while a privilege of conversion is exercised by the surrender of a corporate obligation or a share of stock. In some cases, however, the obligation to which a warrant is attached upon original issue may be surrendered in lieu of cash, in which case the warrant is in effect a detachable conversion privilege as well as a true warrant. Practically all warrants are attached to corporate obligations or to shares of stock upon original issuance, and the company can select the type of security best suited to its corporate structure by determining whether it would prefer to receive cash upon the exercise of an option warrant or obtain the discharge of an obligation, or of stock carrying a fixed redemption and dissolution value, upon the exercise of a conversion privilege.

A.  Rights and Warrants Warrants are options to acquire shares for a cash consideration. They are often issued with debt securities, and are then similar to conversion privileges, save for the consideration payable on exercise of the option. Securities issued with a conversion privilege may be exchanged for other kinds of securities of the issuer. When securities are issued with a warrant, the warrant permits its holder to subscribe for a different class of securities for cash. The underlying security is then retained. If “attached” to the bonds, the warrants cannot be sold separately from them. But warrants are generally “detachable,” and can be transferred even if the bonds are retained. Rights are options to purchase shares that are usually offered to existing shareholders at current market value on a pro rata basis. While warrants generally give their holders the right to purchase shares over a period of several years, rights are seldom exercisable more than a few months after issue.21

B.  Valuation of Conversion Privileges and Warrants An option to acquire a security is a thing of value in itself, quite apart from the security it enables one to obtain. Thus an option, exercisable today, to purchase a share now trading at $100 at an exercise price of $80 is worth $20. By purchasing the option for $20 and exercising it for $80, its holder can acquire a $100 security. The valuation of a conversion privilege or warrant is, however, much more difficult, since the option may be exercisable at any time

21 See W Grover & D Ross, Materials on Corporate Finance (Toronto: De Boo, 1975) at 113-14.

V.  Convertible Securities, Rights, and Warrants

457

over the next few years at an exercise price that exceeds the share’s current market value. An option, exercisable at any time over the next three years, to purchase for $110 a share of X Corp, now trading at $100, represents a bet that the value of the share will rise above $110 during that period. That possibility makes the option valuable today. An option is a much more volatile security than the shares it entitles one to purchase. To illustrate, assume that the option in the above example is publicly traded, with a market value of $10. For $100, an investor can buy either one share or 10 options, each of which permits him to buy one share for $110 over the following three years. If the shares do not rise above $100 in value, the investor would still have a valuable security had he purchased the share, but would have lost his $100 investment had he bought the options. If the shares rise in value to $120, the investor would have made $20 had he chosen the share, and would not have made any profits had he purchased the options. In the latter case, he would have spent $100 to acquire the right to purchase $1,200 worth of shares for $1,100. Finally, if the shares rise to $200, he would have made $100 had he purchased the share and $800 had he bought the options. Options therefore magnify risks and returns, by comparison with shares.

C.  Anti-Dilution Provisions The value of a conversion privilege is based on the probability of the conversion price exceeding the market price of the share during the term of the option. Should the market price remain permanently below the conversion price because of the firm’s business losses or a generalized market decline, the privilege will be worthless, and the purchaser must be taken to have accepted this risk. However, he or she will not have accepted the risk of a decline in the market price through a reorganization of outstanding shares such as occurs in a stock split. For example, shareholders may be called on to exchange one old share with a market value of $100 for two new shares with a market value of about $50 each. To preserve the exchange ratio, “anti-dilution” clauses in trust indentures will usually reduce the conversion price from $110 to $55. Which other corporate transactions deserve anti-dilution protection may be a matter of some controversy. Conversion rights are protected in the case of an amalgamation, with the privilege extended to an equivalent number of shares in the new company. Stock dividends involve an issue of new shares to existing shareholders on a pro rata basis and, like stock splits, normally trigger an adjustment in conversion price.

Jerome S Katzin, “Financial and Legal Problems in the Use of Convertible Securities” (1969) 24 Bus Lawyer 359 at 365-66 These anti-dilution clauses are designed to treat the convertible holder as though he were a shareholder and protect his pro-rata position. But a problem is created when additional shares of common are issued for consideration which may be more or less than the conversion formula price. Ordinarily the existing common shareholder acquires no special rights when additional shares are issued for cash and modern corporate charters even permit waiver of pre-emptive rights in this situation. It has long been the practice, however, to protect the convertible holder against issuance of additional common shares at

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below the conversion price and to require some adjustment in the formula to take cognizance of it. Several approaches have evolved:

1. Adjust the conversion price to the lower price received for the common shares. This is a kind of “most favored nations clause” and is very beneficial to the convertible holder. It is little used today except in private placements where the investor can require this special type of protection. 2. Adjust the conversion price to the weighted average of the price of any securities sold below the conversion price and the conversion price then in effect. Identified as the “traditional” type of clause, it is in most common use. It does not provide for any adjustment upwards for sales above the conversion price. The formula is as follows:



Number of shares previously outstanding times conversion price Plus consideration for additional shares Divided by Number of shares outstanding after additional issue

3. A third approach uses the above adjustment formula, but does not apply when the new shares are sold to other than the present shareholders. Called the “market” type of clause, it protects only against the shareholders issuing to themselves shares at lower than the conversion price for whatever reasons. This clause is said to give more flexibility to the company in its financing and to recognize that markets fluctuate and the holder of the convertible is entitled to no protection because his purchase occurred at a higher price than the company at a later date is able to get for its stock in the market. There has been a good deal of discussion in the Journals on this subject [see Kaplan, “Piercing the Corporate Boilerplate: Anti-Dilution Clauses in Convertible Securities” (1966) 33 U Chicago L Rev. 1; Ratner, “Dilution and Anti-Dilution: A Reply to Professor Kaplan” (1966) 33 U Chicago L Rev. 494; Irvine, “Some Comments Regarding ‘AntiDilution’ Provisions Applicable to Convertible Securities,” The Business Lawyer, July 1958 at 729] and some more knowledgeable investors, particularly among institutions, have been known to read the long and complicated text of these provisions, but one cannot see any market difference in the pricing of issues because of different provisions.

In addition to adjusting the conversion price, indentures may provide at least two other ways to prevent dilution:



1. Prohibit the Company from taking any acts that would cause dilution. Provisions of this type are rarely used, since they unduly restrict the Company such as by making it impossible under certain circumstances for the Company to raise additional equity capital if needed. 2. Require the company to give advance notice to holders of convertible debentures of the taking of any acts that may cause dilution. This permits the holders to convert their debentures and as shareholders to receive the benefits of the proposed action. It does not protect the holder who does not wish to convert his debenture, especially when the market value of the common stock is substantially below the conversion price. (Commentaries on Model Debenture Indenture Provisions [American Bar Federation, 1971]).

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Where the trust deed does not feature a call provision giving the issuer an option to redeem bonds, management may wish to propose a triggering transaction to force their conversion. This will be especially desired when bondholders do not wish to convert, even though shares are trading above the conversion price, because the corporation is not paying dividends. They will then delay conversion until just before the expiry date, so that they may receive interest in the interim. With a large number of convertible bonds overhanging, equity securities will be difficult to value, and this will make a new issue of shares more costly. Management may then seek to induce conversion by providing bondholders with a notice of either a transaction to dilute the value of the convertible bonds or a dividend payment on the shares.22

VI. CONCLUSION As you finish this chapter, ask yourself how you now think the relationship between a company and its shareholders should be characterized, and how best to compare and contrast that relationship with the relationship that a company has with other kinds of investors—for example, investors who provide debt financing or loans. Similarly, given the importance of different types of capital to the ability of a company to expand, ask yourself what priority (if any) a board of directors making decisions about a company’s future should give to the interests of different kinds of investors, as opposed to the interests of other groups that might also be thought to make important contributions to the success of a company and to have an interest in the corporation’s long-term performance—for example, employees. These are some of the most important public policy questions that shape the design of business law frameworks, and the answers to these questions often differ from one country to another. This chapter has sought to provide you with some tools to consider these questions, questions that will continue to weave their way through the balance of this book. The chapter has also stressed that separate and apart from these public policy questions, there are important practical consequences to the way in which we describe the legal relationship between an investor and a company. It is important for any legal practitioner working with corporate law to appreciate the nature of the legal rights that form (and that do not form) part of the relationship with shareholders and any other investment relationship. This appreciation is just as important when first negotiating and structuring the relationship with a new investor as it is when considering what rights that investor is entitled to exercise at different points in a company’s life-cycle. Legal advisers play an important role in assisting business executives to understand the issues at play when dealing with investors. It should by now be clear that the legal rights that form part of the bundle of rights that constitute a share, and that are therefore fundamental to understanding a shareholder’s rights, are distinct from the legal rights provided to a holder of debt securities. Preferred shareholders often form another layer of a company’s capital structure, and it is again important to understand what legal rights they hold. The same is true of convertible securities, rights or options,

22 See Harold Bierman Jr, “Convertible Bonds as Investments” (1980) 36 Financial Analysts J 59.

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and warrants, to name but a few of the instruments that give rise to distinct legal rights and that can come to form part of investment relationships. Finally, note that the way in which the law conceives of the legal relationship with a shareholder in a for-profit company is often a starting point for how lawyers think of the relationship between a corporation and its shareholders in other settings, such as a not-forprofit setting. But the context and objectives underpinning relationships with shareholders in other settings may differ, and so it is important to consider carefully what can and cannot usefully be transposed onto how we think about and in turn structure relationships that may not fundamentally be about providing capital.

CHAPTER SEVEN

Distribution of Securities







I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 462 A.  Fact Pattern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 466 II.  Overview of Canadian Securities Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 466 III.  What Is a Security? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 473 IV.  Distribution of Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 478 V.  Prospectus Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482 A.  Contemporary Developments in Prospectus Form . . . . . . . . . . . . . . . . . . . . . . . . . . 482 B.  Prospectus Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 484 C.  Materiality and the Content of Prospectuses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485 D.  Sanctions for Non-Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486 1.  Failure to Deliver a Prospectus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486 2.  Failure to File . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487 VI.  Liability for Prospectus Misrepresentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487 A.  The Statutory Civil Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487 B.  The Definition of “Misrepresentation” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488 C.  The Potential Defendants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488 D.  The Available Defences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488 E. Limitation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 489 VII. Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 490 A.  Policy Objectives of Prospectus Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 490 B.  Sources of Law in the Exemptions Area . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 493 C.  Significant Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 493 1.  The Private Issuer Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 493 2.  The Family, Friends, and Business Associates Exemption . . . . . . . . . . . . . . . . . . 496 3.  The Crowdfunding Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 496 4.  The “Accredited Investor” Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 496 5.  The Minimum Amount Investment Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . 498 6.  Offering Memorandum Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 498 D.  Resale Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 499 VIII.  Continuous Disclosure Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 A.  “Reporting Issuers” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 B.  Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 501 C.  Management Discussion and Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 502 D.  Annual Information Forms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503 E.  Timely Disclosure of Material Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503 F.  Liability for Misrepresentations in Continuous Disclosure Documents . . . . . . . . 505

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G.  Academic Debate About the Need for Mandatory Disclosure . . . . . . . . . . . . . . . . 508 IX.  Enforcement of Securities Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 509 A.  Criminal Code Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 509 B.  Quasi-Criminal Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 510 C.  Administrative Orders Based on Public Interest Criteria . . . . . . . . . . . . . . . . . . . . . . 512 X. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 514

I. INTRODUCTION Businesses raise capital for a variety of reasons, including the purchase of assets used to produce goods and services, or to support research and development of new products or markets. A sole proprietor contributes some of her own funds to the business (equity capital) in addition to borrowing funds in, for instance, the form of a bank loan (debt). Partners in a partnership also typically contribute their own funds (equity capital) in addition to borrowing funds (usually in the form of a bank loan). Limited partnerships sell units in the limited partnership to raise capital. Corporations sell shares to raise equity capital. The shares sold can have any of a wide variety of rights, but the most typical types of shares are common shares and preferred shares. Corporations also borrow funds. Borrowed funds often come in the form of a bank loan, but may also come from selling bonds or debentures. More details on the characteristics of these various types of financial instruments are provided in Chapter 6, as well as some insight into why businesses might prefer to issue one kind of instrument as opposed to another. Shares, bonds, debentures, and units in a limited partnership are, in more general terms, referred to as “securities.” Securities are “distributed” to investors to raise the capital necessary to carry on business. Securities may be distributed at the inception of a business, or subsequently to take advantage of business opportunities where the funds available from the earnings of the business are insufficient. Thus, the requirements of securities regulation are part of the legal landscape for businesses requiring capital to begin or expand operations. It is important to remember that any time securities are distributed, including initially by a sole proprietor, the substantive requirements of securities law are engaged in principle, though exemptions may be available from some of these obligations. As explained later in this chapter, the major substantive requirement imposed on a business raising capital by way of the distribution of securities is to prepare and deliver to prospective investors a detailed document known as a “prospectus,” which provides information about the nature of the securities being sold and the business being invested in. This chapter addresses legal requirements with respect to the distribution of securities. Section II provides a brief overview of the history of Canadian securities regulation and the sources of law in the field. Section III introduces the foundational concept of a “security” on which all substantive regulation of the capital-raising process depends. Section IV discusses the nature of distributing securities and the relevant participants in the process. Section V details the requirements of prospectus disclosure and recent regulatory developments in this area. Section VI considers the discipline imposed on the prospectus preparation process by the availability of plaintiff-friendly statutory civil remedies for misrepresentation in a prospectus and the interpretation of these provisions by appellate courts. Section VII contains a brief discussion of the possibilities for legitimately raising capital without the requirement to provide a prospectus to potential investors. Section VIII discusses the ongoing

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disclosure obligations imposed on issuers once they have raised capital in the securities markets. Finally, Section IX provides an overview of the enforcement framework that supports the operation of the disclosure rules discussed in earlier sections, and Section X concludes. Securities law also governs in a detailed fashion the process of accomplishing an acquisition by soliciting the security-holders of the “target” business. The issues involved here are discussed in Chapter 15, dealing with mergers and acquisitions. By the end of this chapter, you should have a solid understanding of the framework of securities regulation and its applicability to the capital-raising process. Because it is a daunting task for teachers and students alike to compress an entire law school course on securities regulation into one casebook chapter, readers seeking more detail are encouraged to consult M Condon, A Anand, J Sarra & S Bradley, Securities Law in Canada, 3rd ed (Toronto: Emond, 2017). Before jumping into the detail of the myriad of substantive rules of securities law, it is worth pausing to address two issues. One is to consider the purposes served by this body of law. As suggested earlier, securities law governs the relationship between business enterprises and their investors. A number of Canadian provincial securities statutes have made the purposes served by these statutes explicit. A representative example is the formulation in the Nova Scotia Securities Act (NSSA), which provides that “[t]he purpose of this Act is to provide investors with protection from practices and activities that tend to undermine investor confidence in the fairness and efficiency of capital markets and, where it would not be inconsistent with an adequate level of investor protection, to foster the process of capital formation.”1 Information disclosure is a regulatory strategy that is consistent with both the goals of investor protection and market efficiency, and disclosure requirements imposed on capital raisers and directed toward investors are the major form of regulation imposed by securities law. However, it should also be obvious that the nature and intensity of these disclosure requirements impose costs on issuers of capital, so that a major public policy challenge in this area is to strike an appropriate balance between the costs and benefits of escalating disclosure obligations. Part of the debate here involves the question of the appropriate role of securities regulation in requiring disclosure about corporate governance matters, a topic canvassed in Chapter 10. A further dimension raised by the proposition that securities law governs the relationship between a business and its investors is that of the relationship between securities law and corporate law, which also purports to do this. A number of key differences between the foundational principles of corporate and securities law have the capacity to cause some tension in the relationship between these two bodies of law. First, as discussed in Chapter 3, corporate law is largely an enabling body of law, in the sense that it provides a template for the relationship between a corporation and security-holders that may be deviated from by an individual corporation with the agreement of those security-holders. In contrast, securities law is largely mandatory, in that it prescribes requirements that must be adhered to by capital raisers in order not to be the target of enforcement action by securities regulators. Related to this is the fact that corporate law is administered largely by courts once a dispute 1 RSNS 1989, c 418 [NSSA], s 1A(1); see also Ontario Securities Act, RSO 1990, c S.5 [OSA], s 1.1. For some additional objectives directed specifically to market “professionals,” see Québec Securities Act, RSQ, c V-1.1, [QSA], s 276.

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arises among interested parties to the corporation,2 while securities regulation is administered by an expert administrative agency, at least at first instance. Securities regulators devote considerable resources to generating and elaborating on delegated legislation, in the form of rules and policies, in order to achieve the statutory objectives prescribed for them.3 As should be clear from the discussion of the statutory objectives of securities law above, securities regulators are required to pay attention to the effects of particular securities transactions or the securities-related activities of a business on both investor confidence and the efficiency of capital markets as a whole. The second and related issue is to briefly consider the applicability of the variety of intellectual frameworks for examining corporate law, introduced in Chapter 9. It is not hard to imagine, given that the subject matter under discussion is the legal regulation of capitalraising, that economists have a good deal to say about the efficacy of various ways of regulating that process. One economic sensibility about how to evaluate securities law, authored by Frank Easterbrook and Daniel Fischel, is excerpted below. Another particularly vigorous economic critique of securities regulation involves a close analysis of the efficiency of mandatory disclosure requirements, which lie at the core of securities law. Meanwhile, as you will see in Chapter 9, it is possible to view the norms of corporate law as responding to a view of the corporation as a “mediating hierarchy” or, more radically, in terms of considering corporations as public institutions. As you are introduced to the content of securities regulation throughout this chapter, you may also wish to look at Chapter 9 and consider the extent to which these theories might be relevant or explanatory for securities law. As noted above, one feature that distinguishes corporate law from securities law is that the latter type of statute specifically identifies the protection of investors, as opposed to other corporate stakeholders, as a key objective to be achieved by regulators. Securities regulation is also concerned with the promotion of public confidence in securities markets. Thus, a question to consider is whether vigorous enforcement of the norms of securities law is at odds with particular understandings of how corporate law should mediate stakeholder relations.

Frank H Easterbrook & Daniel R Fischel, The Economic Structure of Corporate Law (Cambridge, Mass: Harvard University Press, 1991) at 276-79 We turn to the principal federal component of corporate law: the need to disclose information before selling securities or collecting proxies from investors. Fitting these mandatory rules into the contractual framework poses something of a challenge. Why are securities laws mandatory rather than enabling? Why do they govern disclosure rather than the price or contents of securities? Why are they federal? On the normative side, do the securities laws offer benefits for investors? …

2 Various corporate statutes provide a role for a director of corporations—for example, in connection with the launching of an oppression claim: see e.g. Canada Business Corporations Act, RSC, 1985, c C-44 [CBCA], s 241. 3 Patrick Moyer, “The Regulation of Corporate Law by Securities Regulators: A Comparison of Ontario and the United States” (1997) 55 UT Fac L Rev 43.

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The securities laws have had, since their enactment in 1933 and 1934, two basic components: a prohibition against fraud, and requirements of disclosure when securities are issued and periodically thereafter. The notorious complexities of securities practice arise from defining the details of disclosure and ascertaining which transactions are covered by the disclosure requirements. There is very little substantive regulation of investments … . Why have the laws survived when other regulatory schemes of that vintage have been transformed or eliminated? Those who enacted these statutes asserted that they were necessary to eliminate fraud from the market and ensure that investors would receive the returns they expected; otherwise, the argument ran, people would withdraw their capital and the economy would stagnate. This explanation seemed especially pressing in 1933, for there had been frauds preceding the Depression and much disinvestment during it. On this public interest story, the interests served by the laws are the same now as they were then, and so the laws have the same beneficial structure. No one should be comfortable with this simple tale. Fraud was unlawful in every state in 1933, and every state except Nevada then had an administrative apparatus for investigating and preventing securities fraud. Fraud in the sale of houses and education is more important to most people of moderate means (the supposed beneficiaries of the securities acts) than fraud in the sale of securities; these people have a much greater portion of their wealth invested in real estate and human capital than in the stock market. Yet there are no federal laws addressing these other assets. There were many securities frauds before 1933, and there have been many since … . The recognition that much legislation is the outcome of the interplay of pressure groups—and that only by accident will interest group laws serve the broader public interest—suggests another hypothesis. The securities laws may be designed to protect special interests at the expense of investors. They possess many of the characteristics of interestgroup legislation. Existing rules give larger issuers an edge, because many of the costs of disclosure are the same regardless of the size of the firm or the offering. Thus larger or older firms face lower flotation costs per dollar than do small issuers. The rules also help existing investment banks and auditing firms obtain an advantage because they acquire expertise and because rivals cannot compete by offering differentiated products. The securities laws’ routinization of disclosure reduces the number of paths to the market and insists that all firms give investors “the best,” stifling lower cost alternatives with higher risks. Some parts of the securities laws had obvious interest-group support. The foremost of these is the regulation of the exchanges, which until 1975 permitted the SEC to shore up a price-fixing cartel of brokers. We do not discuss these parts here, although it is conceivable that the regulation of the securities business is related to the regulation of investments in the sense that SEC enforcement of the cartel was the political price of obtaining regulation of investments. It is harder to find private interests behind the principal features of regulation, though. Lawyers specialize in corporate and securities work, and other market professionals depend on the intricacies of the law for much revenue. These favored groups (larger issuers, investment banks, the securities bar) have too many members to permit monopoly prices. Delaware’s bar has thousands of corporate lawyers, with lawyers in other states practicing its law too; the securities bar is much larger; in both cases, competition prevents monopoly returns. Yet these lawyers, investment bankers, and others have human capital at stake. Thus they have every reason to

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oppose the abolition of the regulatory system. And if the losses from existing laws are spread across a large number of people (individual investors), each of whom would benefit only slightly from abolition, regulation could survive even if it reduces social welfare. Unfortunately, no one knows why some pieces of legislation are enacted and survive while others do not. The interest-group explanation that might account for securities litigation also could explain airline and trucking regulation, yet these systems have been almost obliterated. The survival of securities regulation could be attributed to “stronger interest-group support,” but this smacks of tautology. Perhaps the laws endured because they are not predominantly interest-group legislation. We think it appropriate, therefore, to search for the “public interest” justifications of the securities laws.

A.  Fact Pattern Chapter 1 introduced us to Aya Nang and the corporation she founded, Quick Buys Ltd. Recall that at the time of incorporation of the business, Aya Nang, Tomi, and several other investors who were friends or associates of Aya invested money in the business in return for which they received shares. Assume now that in January 2017, the directors of Quick Buys concluded that additional capital was required in order to expand the corporation’s business into other provinces. They approached Oswald Inc, a venture capital firm, which agreed to invest $2 million in return for 100,000 shares of Quick Buys. That transaction was concluded in February 2017. In March 2017, Oswald Inc sold 10,000 shares to Damon, an unemployed lawyer who was trying to obtain a position with Oswald. By May 2017, the directors of Quick Buys had run through the capital injection provided by Oswald and needed a further injection of money. Following various meetings with ABC Capital, an investment banking house, the directors of Quick Buys resolved to issue five million additional shares, which would be sold to retail investor clients of ABC Capital and those of two other investment bankers. ABC Capital assisted Aya Nang, Ali Chen (Quick Buys’ in-house counsel), and the directors of Quick Buys to prepare a prospectus for submission to the securities regulators. The prospectus did not indicate that Aya Nang intended to liquidate her entire holdings in Quick Buys over the next year in order to resolve some personal financial problems. QUESTIONS

1.  As you read through the various sections of this chapter, identify the aspects of securities law that are engaged by the above facts. 2.  Are there any aspects of these facts that the securities regulators might be interested in investigating and pursuing?

II.  OVERVIEW OF CANADIAN SECURITIES REGULATION Canadian securities legislation began in 1912 with the Manitoba Sale of Shares Act, only one year after the first North American securities act in Kansas. In the United States, such acts were called “blue sky” statutes, because they sought to prevent eastern security dealers from selling to western farmers a fee simple in the heavens above. Since then, state

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legislation in the United States has been dwarfed by federal securities law, beginning with the Securities Act of 1933 and the Securities Exchange Act of 1934. Canadian securities regulation has remained provincial, although recent developments in this area are elaborated on below.4 All provincial statutes are broadly similar, requiring the registration of persons involved in the securities business, prospectus disclosure on the distribution of securities, continuous disclosure of information after the distribution of securities, insider trading regulation, and takeover bid regulation. Typically, securities statutes also provide remedies following liability for misrepresentation in disclosure documents and, in some cases, liability proceedings may be taken against so-called gatekeepers, such as the lawyers, investment bankers, and accountants who advise businesses, as well as the businesses themselves. Enforcement powers to be exercised by the relevant administrative officials are usually provided. As noted above, the ultimate goals for which securities law governs the capital-raising process—that is, investor protection, investor confidence, and market efficiency—are also similar throughout Canada, although not always explicitly articulated in governing legislation. In Canada, the topic of whether there should be federal or national securities legislation has been debated for more than 40 years. Such discussions entered a new phase in 2009 with the establishment of the Canadian Securities Transition Office. In 2011, the federal government referred draft legislation intended to establish its jurisdiction to regulate securities markets to the Supreme Court of Canada. The Supreme Court concluded that the federal government did not have jurisdiction to broadly regulate securities markets, though it confirmed its role in criminal enforcement of conduct in those markets, and acknowledged the federal government’s power to regulate with respect to systemic risk, including activities in derivatives markets. The Supreme Court advocated that jurisdictional change with respect to securities markets occur through a process of “cooperative federalism.” Following this decision, the federal government and a number of provinces and territories—British Columbia, Saskatchewan, New Brunswick, Ontario, Prince Edward Island, and Yukon—have signed a Memorandum of Understanding to establish a co-operative Capital Markets Regulatory Authority. In the meantime, all Canadian provinces and territories except Ontario have moved to develop a so-called passport system, involving the mutual delegation of provincial regulatory power to a designated “principal regulator.”5 In the absence of federal legislation or regulations, the Canadian Securities Administrators, an organization composed of representatives of all provincial regulators, has been active in promulgating a series of National Instruments (NIs) and National Policies (NPs) in an

4 Significant cases that have reiterated provincial authority to regulate securities markets in Canada include Mayland and Mercury Oils Limited v Lymburn and Frawley, [1932] 2 DLR 6, [1932] 1 WWR 578 (Alta JCPC); Smith v The Queen, [1960] SCR 776; R v W McKenzie Securities Limited (1966), 56 DLR (2d) 56, 55 WWR 157 (Man CA)(1; Multiple Access Ltd v McCutcheon, [1982] 2 SCR 161; and Global Securities Corp v British Columbia (Securities Commission), 2000 SCC 21, [2000] 1 SCR 494. 5 See Multilateral Instrument [MI] 11-102, Passport System, online: British Columbia Securities Commission ; see also Crawford Panel on a Single Canadian Securities Regulator, Blueprint for a Canadian Securities Commission: Final Paper (7 June 2006), online: Ontario Teachers’ Pension Plan .

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attempt to harmonize the details of securities regulation across Canada. A number of the major NIs are excerpted below. Note, however, that there are a number of examples of the provisions of these NIs creating substantively different requirements from provincial legislation. The question of whether this is appropriate, considered from an administrative law standpoint, has not been definitively addressed by Canadian appellate courts. As the discussion of NIs and the excerpt below on sources of law in the securities field make clear, ongoing contemporary regulation of securities markets in Canada relies heavily on delegated legislation, such as rules and policy statements, in part because of the challenges of amending legislation.

Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed (Toronto: Emond, 2017), ch 1 at 22-30 The legal regulation of securities markets and securities trading is accomplished by way of statute, regulations, rules, policy statements, and, of course, judicial decisions. Securities law in Canada is typically administered by an expert tribunal, such as the various provincial securities commissions, though self-regulatory organizations also play a key role in the delivery and implementation of regulation. We will see that significant power and autonomy is typically granted to regulators to interpret, elaborate on, and apply the statute, rules, and regulations. As discussed in Chapters 3 and 11, the Supreme Court decisions in Pezim [Pezim v British Columbia (Superintendent of Brokers), [1994] 2 SCR 557], Asbestos [Committee for the Equal Treatment of Asbestos Minority Shareholders v Ontario (Securities Commission), 2001 SCC 37, [2001] 2 SCR 132], and Cartaway [Cartaway Resources Corp (Re), 2004 SCC 26, [2004] 1 SCR 672] are illustrative in this regard. A key issue is that the scope of securities law does not end with the statute; various kinds of delegated legislation are crucial to understanding the nature and extent of the law. Thus, sources of securities law could be described in terms of the texts that are used to find and apply the law, or in terms of the various institutions and organizations that apply it. The authoritative texts of securities law comprise the following sources. A.  Provincial Securities Statutes All of the provinces and territories have legislation governing the issuance of securities and the operation of securities markets. Although Ontario’s Securities Act has been amended a number of times over the past few years, the basic structure of the underlying principles (to do with matters such as the disclosure of information to investors, the creation of the so-called exempt market, the prohibition on insider trading, and the regulation of takeovers) has remained unchanged since the last major overhaul of the statute in 1978. One more recent innovation, in 1994, has been the elaboration of specific objectives that securities regulators are required to achieve, along with a number of principles that elaborate on those objectives. See OSA, ss 1.1 and 2.1. A number of provinces have followed the Ontario model very closely (especially Saskatchewan and Alberta in the west and Newfoundland and Labrador and Nova Scotia in the east). In

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2004, British Columbia was planning to enact a new statute that would have shifted the philosophy of its securities legislation more toward a principles-based approach. That reform was not pursued at that time, although since then a number of substantive provisions of the BC Act have been removed or re-cast in more plain language as a result of the promulgation of various National Instruments (see, for example, Securities Act, RSBC 1996, c 418, Parts 10 and 12). Meanwhile, there continues to be a great deal of interest in moving securities regulation in Canada more toward an outcomes-based, as opposed to a process-based model. (See, for example, Cristie Ford, “Principles-Based Securities Regulation,” (Research study prepared for the Expert Panel on Securities Regulation January 2009), online: ). Yet, whether the approach taken in the statute is rule-oriented or principle-oriented, it is important to emphasize that a clear appreciation of the scope and content of securities law cannot be obtained without a thorough familiarity with the provisions of the statute. It should also be noted here that in response to the Supreme Court’s ruling in 2011, a number of provinces and the federal government have agreed in principle to regulate their securities markets co-operatively. These issues will be canvassed in more detail in the chapters to follow, but for now it should be noted that those provinces and the federal government have released for comment two draft pieces of legislation, one entitled Capital Markets Act (CMA) and the other Capital Markets Stability Act (Canada) (CMSA). As these pieces of legislation are still in draft form and subject to change, they cannot be considered authoritative sources of law, though they may be generally referenced in the chapters to follow. B.  Regulations and Rules Provincial securities acts typically include the power to make regulations under their authority. In Ontario, for example, this authority is exercised by the lieutenant governor in council. However, this form of delegated legislation is of decreasing importance in some of the bigger provinces, which have provided a rule-making power to the regulator itself, subject to a “notice and comment” procedure and the approval of the provincial minister responsible for overseeing the activities of the regulator. The power to make rules, which has been very significant for the securities regulators who have it, was first granted in Ontario in the mid-1990s. The power was granted as a result of a set of events that began with a legal claim by a market participant that the Ontario Securities Commission (OSC) was engaging in an unauthorized practice of promulgating policy statements elaborating on statutory provisions, and was enforcing those policies as though they were mandatory. Following the decision of the Ontario Court (General Division) in Ainsley (subsequently confirmed by the Court of Appeal) (Ainsley Financial Corp v Ontario (Securities Commission) (1994), 28 Admin LR (2d) 1, 18 OSCB 43; 21 OR (3d) 104 (CA)), the provincial government acted quickly to establish a task force to examine the situation, since it threatened to affect the power of the regulators to effectively respond to emerging regulatory problems. In accordance with the recommendations of the task force, the legislature expanded the powers of the regulators to include the power to make binding rules. (See Mary Condon, “Power Without Responsibility or Responsibility Without Power?”

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(1995) 10:2 BFLR 221.) Now, much of the detail of disclosure requirements, availability of prospectus exemptions, and corporate governance requirements among other matters, is to be found in these binding rules. In Ontario, s 143 of the OSA enumerates the scope of the rule-making power in the province. This section itemizes over 60 areas of securities law in respect of which the OSC is authorized to make rules. While this is an expansive list, from time to time the regulator is required to seek a legislative amendment in order to engage in rule-making on an issue that is not specifically identified in s 143. Other provinces, such as Alberta and British Columbia, accord a power to their regulator to make rules on matters not already contemplated in their governing legislation by way of a “basket provision” authorizing rules governing any other matters related to the carrying out of securities law. The Five-Year Review Committee, Reviewing the Securities Act (Ontario)—Final Report (Toronto: Queen’s Printer for Ontario, 2003), recommended in 2003 that the OSC receive such basket rule-making authority, identical to that conferred on the lieutenant governor in council in relation to regulations. Since the power to make binding rules confers considerable power on the regulator, it is accompanied by a detailed set of procedures that must be followed. These procedures are designed to ensure transparency and consultation in the process of making rules. There is some inconsistency among the provinces with rule-making power in terms of both the length of time required for a comment period on a proposed rule and whether ministerial approval is required before the adoption of a rule. In Ontario, the OSC is required to publish all proposed rules, along with specified accompanying material (including a description of the anticipated costs and benefits of the rule), and to provide at least a 90-day comment period for interested parties. If the regulator makes “material changes” to the proposed rule following submissions, it is required to republish the rule and give a further opportunity for comment. Once the rule is finalized, the regulator must deliver it to the minister, who has 60 days to either approve or reject it or to return it to the regulator for further consideration. As we have noted above, however, some provinces do not have this power at all. They are therefore dependent on the promulgation of policy to guide the behaviour of market participants in their province, or they must rely on the provincial legislature to enact amendments to legislation in a timely manner. This inconsistency in regulatory powers across the country is one of many arguments made by those who favour a coordinated national approach to securities regulation in Canada. C.  National and Multilateral Instruments Meanwhile, in an attempt to promote harmonization across the country, the Canadian Securities Administrators (CSA), an umbrella organization of provincial and territorial securities regulators, has begun the practice of promulgating national or multilateral instruments. These are an attempt to reduce the amount of duplication required of market participants in matters where the regulation of more than one province would apply (such as where an issuer wants to sell securities in more than one province). They also represent joint responses to problems in securities markets, with a view to making securities regulation more compatible from province to province. A national instrument (NI) is one that has been agreed to by all provinces and territories. As the name implies, a multilateral

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instrument (MI) has been agreed to by some but not all of the provinces, which again results in a lack of consistency in regulation across the country. These instruments are intended by the CSA to be binding on market participants in provinces or territories that have implemented them. But, because these CSA instruments do not themselves have legal force, they must be implemented by rule or policy in each participating province. As we will see in Chapter 5, it is also possible that some provisions of a National Instrument are not in fact enacted in all provinces. D.  National and Local Policies National and local policies typically provide additional information about how regulators interpret the provisions of legislation or rules, or are intended to provide guidance to market participants concerning the exercise of regulatory discretion. National policy (NP) statements are joint policy statements agreed to by the CSA (such as National Policy 62-202 on defensive tactics in takeover bids). As we have noted, the making of local policy statements has been the subject of controversy in the past, based on a lack of explicit power to make them granted in statutes such as the OSA. (See Ainsley, above.) Now, such a power is provided in Ontario’s legislation, at s 143.8(11). Provincial rules or CSA instruments often contain a “companion policy” (CP) that elaborates on the meaning of the accompanying rule or instrument, or provides examples of its application for the guidance of those subject to it. •  •  •

E.  Staff Notices Staff notices are a mechanism for the CSA or provincial regulatory staff to communicate with market participants in a less formal manner, often in relation to emerging regulatory problems that have not yet become the subject of a policy or a rule. Notices are also used to convey to the market the results of staff investigations into how specific issues are handled by market actors, such as executive compensation disclosure or specific accounting issues. F.  Self-Regulatory Organization Rules or Policies The day-to-day regulation of the capital markets in Canada relies heavily on the activities of self-regulatory organizations (SROs). In particular, SROs such as IIROC or the Mutual Fund Dealers Association (MFDA) have power to discipline their members for breaches of securities law, including the SRO’s own rules or policies. IIROC is also responsible for the self-regulation of the securities markets themselves, by way of the application of a set of universal market integrity rules (UMIRs). UMIRs deal with issues such as prohibitions on deceptive or manipulative trading, short selling, and the requirement for the “best execution” of a customer’s trade. Finally, stock exchanges such as the TSX also play a role in establishing and maintaining listing standards for issuers. G.  Appellate Court Decisions Decisions of appellate courts reviewing the decision-making or regulatory activities of provincial securities commissions are an authoritative and increasingly important

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source of law in this area. … The most prominent of these decisions include Pacific Coast Coin Exchange of Canada v Ontario Securities Commission, [1978] 2 SCR 112, 80 DLR (3d) 529 [Pacific Coast]; Pezim v British Columbia (Superintendent of Brokers), [1994] 2 SCR 557, 114 DLR (4th) 385 [Pezim]; Committee for the Equal Treatment of Asbestos Minority Shareholders v Ontario Securities Commission, 2001 SCC 37, [2001] 2 SCR 132 [Asbestos]; Cartaway Resources Corp (Re), 2004 SCC 26, [2004] 1 SCR 672 [Cartaway]; Global Securities Corp v British Columbia (Securities Commission), 2000 SCC 21, [2000] 1 SCR 494 [Global Securities]; Kerr v Danier Leather Inc, 2007 SCC 44, [2007] 2 SCR 331 [Kerr]; Theratechnologies Inc v 121851 Canada Inc, 2015 SCC 18, [2015] 2 SCR 106 [Theratechnologies]. It should also be noted that there are some areas where the judicial oversight of corporate law principles intersects with the concerns of securities regulators. An important area where this occurs is in relation to takeover bids, discussed in Chapter 15. H.  Regulatory Decisions, Orders, and Rulings Most provincial securities legislation grants to the provincial commission the power to hold hearings to review decisions made by regulatory staff. Most provincial acts also require a hearing to be held before various types of enforcement orders may be made by regulators. Accordingly, decisions rendered by commissions in these circumstances are a useful source of information about how the regulators interpret provisions of the legislation or rules, and the factors influencing their application of these rules to specific factual circumstances. … (See Mary G. Condon, “The Use of Public Interest Enforcement Powers by Securities Regulators in Canada,” in A. Douglas Harris, ed, WPC—Committee To Review the Structure of Securities Regulation in Canada: Research Studies (Ottawa: Department of Finance, 2003).) I.  International Organization of Securities Commissions An increasingly important source of justification for domestic regulatory activity is conformity with principles promulgated by the International Organization of Securities Commissions (IOSCO). The goals of IOSCO, in which Alberta, British Columbia, Ontario, and Québec are members or associate members, are to cooperate in developing and promoting adherence to internationally recognized standards of regulation, oversight, and enforcement in order to protect investors, maintain fair, efficient, and transparent markets, and seek to address systemic risks, as well as to exchange information with respect to market developments and enforcement (online: ). Much of IOSCO’s business is done through subcommittees, which engage in standard setting in specific areas such as regulation of secondary markets or multinational disclosure rules. In 1998, IOSCO promulgated a comprehensive set of principles of securities regulation. IOSCO has been particularly engaged in providing an international regulatory response to the global financial crisis, examining issues such as the regulation of credit rating agencies, disclosure requirements related to the sale of asset-backed securities, the deployment of behavioural economics as an aid to rule-making for retail investors and the meaning of systemic risk.

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III.  What Is a Security?

III.  WHAT IS A SECURITY? Before dealing with the practical and legal aspects involved in distributing securities, it is worth focusing first on the legal definition of a “security.” The importance of the definition is that if a financial instrument has the legal characteristic of being a “security,” the substantive requirements of securities legislation and rules will be applicable to its issue and trading. As the definition reproduced below from the OSA makes clear, the concept is characterized by being broadly inclusive of a range of financial instruments, including the most commonly used types such as shares, bonds, and debentures, captured under s 1(1)(e) of the definition, and discussed in more detail in Chapter 6. OSA s 1(1) states: “security” includes, (a)  any document, instrument or writing commonly known as a security, (b)  any document constituting evidence of title to or interest in the capital, assets, property, profits, earnings or royalties of any person or company, (c)  any document constituting evidence of an interest in an association of legatees or heirs, (d)  any document constituting evidence of an option, subscription or other interest in or to a security, (e)  any bond, debenture, note or other evidence of indebtedness, or a share, stock, unit, unit certificate, participation certificate, certificate of share or interest, preorganization certificate or subscription other than, (i)  a contract of insurance issued by an insurance company licensed under the Insurance Act, and (ii)  evidence of a deposit issued by a bank listed in Schedule I, II or III to the Bank Act (Canada), by a credit union or league to which the Credit Unions and Caisses Populaires Act, 1994 applies, by a loan corporation or trust corporation registered under the Loan and Trust Corporations Act or by an association to which the Cooperative Credit Associations Act (Canada) applies, (f)  any agreement under which the interest of the purchaser is valued for purposes of conversion or surrender by reference to the value of a proportionate interest in a specified portfolio of assets, except a contract issued by an insurance company licensed under the Insurance Act which provides for payment at maturity of an amount not less than three quarters of the premiums paid by the purchaser for a benefit payable at maturity, (g)  any agreement providing that money received will be repaid or treated as a subscription to shares, stock, units or interests at the option of the recipient or of any person or company, (h)  any certificate of share or interest in a trust, estate or association, (i)  any profit-sharing agreement or certificate, (j)  any certificate of interest in an oil, natural gas or mining lease, claim or royalty voting trust certificate, (k)  any oil or natural gas royalties or leases or fractional or other interest therein, (l)  any collateral trust certificate, (m)  any income or annuity contract not issued by an insurance company, (n)  any investment contract, (o)  any document constituting evidence of an interest in a scholarship or educational plan or trust, and (p)  any commodity futures contract or any commodity futures option that is not traded on a commodity futures exchange registered with or recognized by the Commission under the Commodity Futures Act or the form of which is not accepted by the Director under that Act, whether any of the foregoing relate to an issuer or proposed issuer.

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Typical definitions of “security” in provincial securities acts are also significantly openended, and therefore capable of sweeping a variety of novel financial transactions within their ambit. This is accomplished by a number of the enumerated subsections of the OSA definition, such as s 1(1)(b), but in particular s 1(1)(n), the “investment contract” branch. In discussing the meaning of this term, the Ontario Securities Commission (OSC) has generally referred to US cases that have interpreted the term under a very similar definition of “security” in US securities laws. In particular, it has adopted the tests for “investment contract” set out in SEC v WJ Howey Co, 328 US 293 (1946), excerpted below, and State of Hawaii v Hawaii Market Center Inc, 485 P 2d 105 (Hawaii 1971).6 See also Pacific Coast Coin Exchange v Ontario Securities Commission, [1978] 2 SCR 112, 80 DLR (3d) 529, 2 BLR 212.

Securities and Exchange Commission v WJ Howey Co et al 328 US 293 (1946) Suit by the Securities and Exchange Commission against W.J. Howey Company and Howey-in-the-Hills Service, Inc., to restrain alleged violations of the Securities Act. MURPHY J (delivering the opinion of the court) (Frankfurter J dissenting): This case involves the application of s. 2(1) of the Securities Act of 1933 to an offering of units of a citrus grove development coupled with a contract for cultivating, marketing and remitting the net proceeds to the investor.The Securities and Exchange Commission instituted this action to restrain the respondents from using the mails and instrumentalities of interstate commerce in the offer and sale of unregistered and nonexempt securities in violation of s. 5(a) of the Act … . The District Court denied the injunction … , and the Fifth Circuit Court of Appeals affirmed the judgment … . … The respondents, W.J. Howey Company and Howey-in-the-Hills Service Inc., are Florida corporations under direct common control and management. The Howey Company owns large tracts of citrus acreage in Lake County, Florida. During the past several years it has planted about 500 acres annually, keeping half of the groves itself and offering the other half to the public “to help us finance additional development.” Howey-in-theHills Service, Inc., is a service company engaged in cultivating and developing many of these groves, including the harvesting and marketing of the crops. Each prospective customer is offered both a land sales contract and a service contract, after having been told that it is not feasible to invest in a grove unless service arrangements are made. While the purchaser is free to make arrangements with other service companies, the superiority of Howey-in-the-Hills Service, Inc., is stressed. Indeed, 85% of the acreage sold during the 3-year period ending May 31, 1943, was covered by service contracts with Howey-in-the-Hills Service, Inc. The land sales contract with the Howey Company provides for a uniform purchase price per acre or fraction thereof, varying in amount only in accordance with the number of years the particular plot has been planted with citrus trees. Upon full payment of the purchase price the land is conveyed to the purchaser by warranty deed. Purchases are

6 See also Re Shelter Corporation of Canada Ltd, [1977] OSCB 6; and Re George Albino, [1991] 14 OSCB 365.

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usually made in narrow strips of land arranged so that an acre consists of a row of 48 trees. During the period between February 1, 1941, and May 31, 1943, 31 of the 42 persons making purchases bought less than 5 acres each. The average holding of these 31 persons was 1.33 acres and sales of as little as 0.65, 0.7 and 0.73 of an acre were made. These tracts are not separately fenced and the sole indication of several ownership is found in small land marks intelligible only through a plat book record. The service contract, generally of a 10-year duration without option of cancellation, gives Howey-in-the-Hills Service, Inc., a leasehold interest and “full and complete” possession of the acreage. For a specified fee plus the cost of labor and materials, the company is given full discretion and authority over the cultivation of the groves and the harvest and marketing of the crops. The company is well established in the citrus business and maintains a large force of skilled personnel and a great deal of equipment, including 75 tractors, sprayer wagons, fertilizer trucks and the like. Without the consent of the company, the land owner or purchaser has no right of entry to market the crop; thus there is ordinarily no right to specific fruit. The company is accountable only for an allocation of the net profits based upon a check made at the time of picking. All the produce is pooled by the respondent companies, which do business under their own names. The purchasers for the most part are non-residents of Florida. They are predominantly business and professional people who lack the knowledge, skill and equipment necessary for the care and cultivation of citrus trees. They are attracted by the expectation of substantial profits. It was represented, for example, that profits during the 1943 – 1944 season amounted to 20% and that even greater profits might be expected during the 1944 – 1945 season, although only a 10% annual return was to be expected over a 10-year period. Many of these purchasers are patrons of a resort hotel owned and operated by the Howey Company in a scenic section adjacent to the groves. The hotel’s advertising mentions the fine groves in the vicinity and the attention of the patrons is drawn to the groves as they are being escorted about the surrounding countryside. They are told that the groves are for sale; if they indicate an interest in the matter they are then given a sales talk. It is admitted that the mails and instrumentalities of interstate commerce are used in the sale of the land and service contracts and that no registration statement or letter of notification has ever been filed with the Commission in accordance with the Securities Act of 1933 and the rules and regulations thereunder. Section 2(1) of the Act defines the term “security” to include the commonly known documents traded for speculation or investment. This definition also includes “securities” of a more variable character, designated by such descriptive terms as “certificate of interest or participation in any profit-sharing agreement,” “investment contract” and “in general, any interest or instrument commonly known as a ‘security.’” The legal issue in this case turns upon a determination of whether, under the circumstances, the land sales contract, the warranty deed and the service contract together constitute an “investment contract” within the meaning of s. 2(1). An affirmative answer brings into operation the registration requirements of s. 5(a), unless the security is granted an exemption under s. 3(b) … . The lower courts, in reaching a negative answer to this problem, treated the contracts and deeds as separate transactions involving no more than an ordinary real estate sale and an agreement by the seller to manage the property for the buyer. The term “investment contract” is undefined by the Securities Act or by relevant legislative reports. But the term was common in many state “blue sky” laws in existence prior

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to the adoption of the federal statute and, although the term was also undefined by the state laws, it had been broadly construed by state courts so as to afford the investing public a full measure of protection. Form was disregarded for substance and emphasis was placed upon economic reality. An investment contract thus came to mean a contract or scheme for “the placing of capital or laying out of money in a way intended to secure income or profit from its employment.” This definition was uniformly applied by state courts to a variety of situations where individuals were led to invest money in a common enterprise with the expectation that they would earn a profit solely through the efforts of the promoter or of someone other than themselves. By including an investment contract within the scope of s. 2(1) of the Securities Act, Congress was using a term the meaning of which had been crystallized by this prior judicial interpretation. It is therefore reasonable to attach that meaning to the term as used by Congress, especially since such a definition is consistent with the statutory aims. In other words, an investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise. Such a definition necessarily underlies this Court’s decision in Securities Exch. Commission v. C.M. Joiner Leasing Corp., 320 US 344 … , and has been enunciated and applied many times by lower federal courts. It permits the fulfillment of the statutory purpose of compelling full and fair disclosure relative to the issuance of “the many types of instruments that in our commercial world fall within the ordinary concept of a security.” H. Rep. No. 85, 73rd Cong., 1st Sess., p. 11. It embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits. The transactions in this case clearly involve investment contracts as so defined. The respondent companies are offering something more than fee simple interests in land, something different from a farm or orchard coupled with management services. They are offering an opportunity to contribute money and to share in the profits of a large citrus fruit enterprise managed and partly owned by respondents. They are offering this opportunity to persons who reside in distant localities and who lack the equipment and experience requisite to the cultivation, harvesting and marketing of the citrus products. Such persons have no desire to occupy the land or to develop it themselves; they are attracted solely by the prospects of a return on their investment. Indeed, individual development of the plots of land that are offered and sold would seldom be economically feasible due to their small size. Such tracts gain utility as citrus groves only when cultivated and developed as component parts of a larger area. A common enterprise managed by respondents or third parties with adequate personnel and equipment is therefore essential if the investors are to achieve their paramount aim of a return on their investments. Their respective shares in this enterprise are evidenced by land sales contracts and warranty deeds, which serve as a convenient method of determining the investors’ allocable shares of the profits. The resulting transfer of rights in land is purely incidental. Thus all the elements of a profit-seeking business venture are present here. The investors provide the capital and share in the earnings and profits; the promoters manage,

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control and operate the enterprise. It follows that the arrangements whereby the investors’ interests are made manifest involve investment contracts, regardless of the legal terminology in which such contracts are clothed. The investment contracts in this instance take the form of land sales contracts, warranty deeds and service contracts which respondents offer to prospective investors. And respondents’ failure to abide by the statutory and administrative rules in making such offerings, even though the failure resulted from a bona fide mistake as to the law, cannot be sanctioned under the Act. This conclusion is unaffected by the fact that some purchasers choose not to accept the full offer of an investment contract by declining to enter into a service contract with the respondents. The Securities Act prohibits the offer as well as the sale of unregistered, non-exempt securities. Hence it is enough that the respondents merely offer the essential ingredients of an investment contract. We reject the suggestion of the Circuit Court of Appeals … that an investment contract is necessarily missing where the enterprise is not speculative or promotional in character and where the tangible interest which is sold has intrinsic value independent of the success of the enterprise as a whole. The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others. If that test be satisfied, it is immaterial whether the enterprise is speculative or non-speculative or whether there is a sale of property with or without intrinsic value. See S.E.C. v. C.M. Joiner Leasing Corp. … . The statutory policy of affording broad protection to investors is not to be thwarted by unrealistic and irrelevant formulae. FRANKFURTER J (dissenting): “Investment contract” is not a term of art; it is a conception dependent upon the circumstances of a particular situation. •  •  •

For the crucial issue in this case turns on whether the contracts for the land and the contracts for the management of the property were in reality separate agreements or merely parts of a single transaction. It is clear from its opinion that the District Court was warranted in its conclusion that the record does not establish the existence of an investment contract: the record in this case shows that not a single sale of citrus grove property was made by the Howey Company during the period involved in this suit, except to purchasers who actually inspected the property before purchasing the same. The record further discloses that no purchaser is required to engage the Service Company to care for his property and that of the fifty-one purchasers acquiring property during this period, only forty-two entered into contract with the Service Company for the care of the property. Simply because other arrangements may have the appearances of this transaction but are employed as an evasion of the Securities Act does not mean that the present contracts were evasive. I find nothing in the Securities Act to indicate that Congress meant to bring every innocent transaction within the scope of the Act simply because a perversion of them is covered by the Act. QUESTION

Which are the competing policy objectives that underlie the majority and minority judgments in Howey?

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Under most Canadian securities acts, the requirement to produce a prospectus depends on whether there is a “trade” in a “security” that constitutes a “distribution.” There are two aspects of the definition of trade that are of most significance in the context of the prospectus requirement. First, under most Canadian securities acts, a “trade” is defined to include “any sale or disposition of a security for valuable consideration”: see e.g. the Alberta Securities Act, RSA 2000, c S-4 (ASA), s 1(jjj)(i); the British Columbia Securities Act, RSBC 1996, c 418 (BCSA), s 1(1) “trade” (a), ; and OSA s 1(1) “trade” (a).7 Second, pre-sale activities with respect to a distribution of securities are included in the definition of “trade” because a trade is typically defined to include “any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of” any sale or disposition of a security for valuable considera-tion: see ASA s 1(jjj)(vi), BCSA s 1(1) “trade” (e), and OSA s 1(1) “trade” (e). Consequently, almost any attempt to distribute securities to the public will involve a “trade” in the security. Enforcement action has been taken against those who have acted “in furtherance of trading securities” in circumstances where respondents deposited investor cheques, mailed promotional materials, and made phone calls to prospective investors: see Limelight Entertainment Inc (2008) 31 OSCB 1727 at para 133.

IV.  DISTRIBUTION OF SECURITIES As the definition from the OSA reproduced below makes clear, the definition of “distribution” under most Canadian securities acts is cast in very wide terms. Most distributions of securities will be subject to the prospectus requirement imposed by securities law by virtue of the branch of the definition that refers to “a trade in securities of an issuer that have not been previously issued”: see e.g. ASA s 1(p)(i), BCSA s 1(1) “distribution” (a), and OSA s 1(1) “distribution” (a). OSA s 1(1) states: “distribution,” where used in relation to trading in securities, means, (a)  a trade in securities of an issuer that have not been previously issued, (b)  a trade by or on behalf of an issuer in previously issued securities of that issuer that have been redeemed or purchased by or donated to that issuer, (c)  a trade in previously issued securities of an issuer from the holdings of any control person, (d)  a trade by or on behalf of an underwriter in securities which were acquired by that underwriter, acting as underwriter, prior to the 15th day of September, 1979 if those securities continued on that date to be owned by or for that underwriter, so acting, (e)  a trade by or on behalf of an underwriter in securities which were acquired by that underwriter, acting as underwriter, within eighteen months after the 15th day of September, 1979, if the trade took place during that eighteen months, and (f)  any trade that is a distribution under the regulations, and on and after the 15th day of March, 1981, includes a distribution as referred to in subsections 72(4), (5), (6) and (7), and also includes any transaction or series of transactions involving a purchase and sale or a repurchase and resale in the course of or incidental to a distribution and “distribute,” “distributed” and “distributing” have a corresponding meaning.

7 Note that the QSA does not contain a definition of trade.

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Prospectus disclosure is also required where there is a sale of securities by persons having a controlling interest in the securities of an issuer. As discussed below, it is assumed that those shareholders in control of an issuer may have heightened access to information about that issuer, and that therefore disclosure requirements should be specifically imposed on their transactions. The prospectus is required by virtue of the branch of the definition of “distribution” that refers to “a trade in a previously issued security of an issuer from the holdings of a control person”: see ASA s 1(p)(iii), BCSA s 1(1) “distribution” (c), and OSA s 1(1) “distribution”  (c). A “control person” is defined as a person (or a group of persons acting together) holding a sufficient number of the voting rights attached to all outstanding voting securities of an issuer to materially affect the control of the issuer. A person (or a group of persons acting together) holding more than 20 percent of the voting rights attached to all outstanding voting securities of an issuer is deemed, in the absence of evidence to the contrary, to hold sufficient voting rights to materially affect the control of the issuer: see ASA s 1(l), BCSA s 1(1) “control person,” and OSA s 1(1) “control person.” The sale of securities by persons having a controlling interest in an issuer is considered to have potentially important ramifications. For instance, it is argued that (1) the fact that the control person may be departing the corporation may be material to the corporation’s affairs; (2) if a large block of shares is to be disposed of, that fact is material to the market for the issuer’s shares; (3) the control person may be choosing to trade precisely when he or she is in possession of undisclosed material information concerning the issuer; and (4) the control person may be a conduit for a distribution of securities to members of the public who would not qualify for an exemption from the prospectus requirement. However, sales by a control person are a distribution even where there is no possibility that he or she is acting as an underwriter on a primary distribution—for example, a sale by a control person requires a prospectus even where that person acquired the securities in secondary markets. While a presumption arises that a 20 percent interest in voting securities will give its holder control of the issuing corporation, no corresponding presumption seems to arise that a smaller holding does not make one a control person. In In the Matter of Deer Horn Mines Ltd, [1968] OSCB 12, the OSC held that a 14.5  percent interest sufficed when the shareholder nominated the board of directors. The OSC held (at 13) that it was “of the opinion that the question of whether or not a block of shares materially affects control is not one capable of arithmetic measurement alone.” The market in which securities are distributed by the issuer to investors is referred to as the “primary market.” Once the securities have been distributed to investors, the investors can normally trade the securities among themselves. These trades are referred to as trades in the “secondary market.” The issuer of the securities is not itself involved in these trades. Secondary market trades of shares are often effected through a stock exchange such as the Toronto Stock Exchange (TSX), the TSX Venture Exchange (TSXV), the Canadian Stock Exchange (CSE), or Aequitas. However, shares do not have to be listed on a stock exchange and, consequently, trades in some shares are not effected through a stock exchange. Trades in unlisted shares are referred to as “over-the-counter” trades. Investors in the primary and secondary markets for securities include both institutions and individuals. The institutions involved in the trading of securities in Canadian securities markets include banks, trust companies, life insurance companies, pension funds, investment companies, mutual funds, and exchange-traded funds. Institutions are by far the major players in Canadian capital markets, although there is a resurgence of retail investor interest

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in securities market investing as a result of broad changes in employer-based pension policies that have de-emphasized collective “defined benefit” pension plans in favour of “defined contribution” pension plans. The latter type of plan often allows employees to make choices themselves about where pension contributions will be invested.8 Although in the age of the Internet it is somewhat more feasible for issuers to make direct appeals to a broad range of prospective investors,9 issuers of all sizes tend to enlist the assistance of securities market professionals, such as investment bankers, to market their securities issue for them and provide advice about the structure and pricing of an offering. As the discussion of a “firm commitment underwriting” below makes clear, underwriters may go further to provide a form of insurance against fluctuations in the price that an issuer can get for its securities.

Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed (Toronto: Emond, 2017) at 235-36 and 237-38 III.  Underwriting an Offering There are three main parties in the offering process: the issuer, the underwriter, and the investor. In this section, we discuss the underwriter’s function as a critical link between issuers and investors. We also discuss why issuers employ underwriters. Underwriting is the process of selling securities in the market. Underwriters offer credibility to issuers, using their reputation as experienced market participants to bolster the claims of the issuer regarding its present profitability and/or future prospects. The due diligence investigation undertaken by an underwriter usually results in enhanced quality of disclosure in the prospectus, and the underwriter can provide valuable advice regarding the pricing and marketing of securities. Most public offerings are underwritten by investment banking firms. The underwriter usually determines the terms and price of the offering, given the market demand. It also provides some governance advice, in terms of changes to the business plan that the issuer should make in order to make the securities more attractive. Although an underwriter is a private market participant in that it assists the issuer, the underwriter has public obligations to ensure that the required assurances and covenants are obtained and that the integrity of the system is maintained. The issuer must provide extensive representations and warranties to the underwriter as to the authorization of the issuance of the securities, as well as agree to complete the prospectus process in a timely manner. The underwriting agreement may also contain a period in which the issuer is prohibited from issuing similar securities as those that the underwriter has agreed to underwrite. Underwriters also perform a number of functions relating to information transfer for investors and are therefore often referred to as “gatekeepers” of the securities law system.

8 See Mary Condon, “The Feminization of Pensions? Gender, Political Economy and Defined Contribution Pensions” in L Assassi, A Nesvetailova & D Wigan, eds, Global Finance in the New Century: Beyond Deregulation (Basingstoke, UK: Palgrave Macmillan, 2006) at 89-101. 9 See Anita Anand, “The Efficiency of Direct Public Offerings” (2003) 7:3 J Small & Emerging Bus L at 1.

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There are several types of underwriting arrangements. A common type is an agency agreement in which the underwriter agrees to use its “best efforts” to sell the securities as an agent of the issuer. The underwriter takes a commission for those securities it is able to sell to purchasers in the market. There is a range of fees, and underwriters can charge up to 7 percent of the offering price. Another form of underwriting is a “firm commitment,” in which the underwriter makes an agreement to purchase the securities and resell them. Firm commitment agreements occur where the underwriter is confident that it can make a profit between the issue price from the issuer and the price that it will receive from sale of the securities. The profit between the issue price and the sale price is also known as the underwriter’s “spread.” One form of firm commitment arrangement is a “bought deal” underwriting agreement … . However, the underwriter can also agree to sell at the issue price and charge an underwriting fee linked to the issue price, a practice that occurs with the sale of equities … . A prospectus must contain a certificate signed by the underwriter(s) in a contractual relationship with the issuer or security holder whose securities are being offered by the prospectus that to the best of the underwriter’s knowledge, information, and belief, the prospectus constitutes full, true, and plain disclosure of all material facts relating to the securities offered by the prospectus (NI 41-101; see also e.g. OSA s 59(1), amended by SO 2007, c 7, Schedule 38, s 5; NSSA s 63(6); NBSA s 74(3)). OSA s 59(1) is illustrative: 59(1) Subject to subsection 63(2), where there is an underwriter, a prospectus shall contain a certificate in the prescribed form, signed by the underwriter or underwriters who, with respect to the securities offered by the prospectus, are in a contractual relationship with the issuer or securityholder whose securities are being offered by the prospectus. This certificate is distinguishable from the issuer’s certificate, … in that the standard is higher for the issuer as it has direct access to all information. Every prospectus must contain a statement of the rights given to a purchaser (see e.g. OSA s 60). While such provisions were historically set out in securities legislation, many jurisdictions repealed the provisions when they adopted NI 41-101. Those who sign the certificate and all of the directors are potentially liable for any misrepresentation in the prospectus. •  •  •

A.  “Bought Deal” Underwriting Agreements A variation on the firm commitment arrangement is a “bought deal” underwriting agreement, in which the underwriter makes a firm commitment early in the process, at the preliminary prospectus stage, where a short form prospectus process is contemplated. … The advantage of a bought deal is that the underwriter typically provides a firm commitment to purchase a large block of securities, signed before the preliminary prospectus is filed. It must be an enforceable agreement and a preliminary short form prospectus must be filed within two business days of signing the agreement, accompanied by a media release announcing the transaction. The underwriter then has two days to solicit expressions of interest prior to filing the preliminary prospectus NI 44-101, Short Form Prospectus Distributions (2000), as amended 2015. This exception to general prospectus rules is to facilitate the distribution of securities and to reduce the risk of the offering to the

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underwriter by allowing it to canvass potential purchasers early in the prospectus process. … A bought deal arrangement also has implications for purchaser remedies under securities legislation. Unlike agency agreements where the issuer is still the party selling the securities, under a bought deal, the underwriter is selling the securities. In Kerr v Danier Leather, [2001] OJ no 950 (Sup Ct), the Ontario Superior Court held that a bought deal process meant that the purchaser had no remedy of rescission against the issuer for misrepresentations based on the issuer’s financial forecasts, although the court held that it was enough to found a claim for damages. While the judgment on damages was subsequently overturned on appeal, the Superior Court’s finding in respect of rescission is informative.

V.  PROSPECTUS DISCLOSURE The requirement to prepare a prospectus pursuant to a distribution of securities has been considered to be the paradigmatic substantive requirement of Canadian securities law. Under most provincial securities acts, the requirement is expressed as follows: No person or company shall trade in a security on his, her or its own account or on behalf of any other person or company where such trade would be a distribution of such security, unless a preliminary prospectus and a prospectus have been filed and receipts therefore obtained from the Director.10

A.  Contemporary Developments in Prospectus Form Historically, the prospectus has been intended to provide information about the security being sold and about the issuer of the security for the purpose of assisting investors in valuing the security. Regulations passed pursuant to securities acts in Canada have typically set out forms for prospectuses of different types of issuers, such as industrial issuers, finance companies, natural resource companies, and mutual funds, with these forms containing lists of items that must be disclosed in the prospectus. The disclosure requirements associated with the so-called long-form prospectus for industrial issuers applied both to issuers conducting initial public offerings (IPOs)—that is, issuers raising capital in a non-exempt transaction for the first time—and subsequent offerings of new securities. For at least 40 years, there has been extensive debate among academic economists and securities lawyers as to the ultimate usefulness of the detailed disclosure requirements imposed by long-form prospectus content regulations.11 Perhaps in response to this, Canadian regulators have gradually been diminishing the extent of the disclosure required in a prospectus issued at the time of distributing securities. This process began with the promulgation of several national policies by the CSA, and later the introduction of NI 44-101, Short Form Prospectus Distributions, which introduced the possibility of short-form prospectus (SFP) distributions for issuers that

10 OSA s 53(1); see also ASA s 110(1) and BCSA s 61. 11 See Mark Gillen, Securities Regulation in Canada, 3rd ed (Toronto: Carswell, 2007), ch 9, for a full account of this debate and the empirical research underlying it.

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were able to meet established eligibility requirements. These eligibility requirements revolved around the issuer’s qualifying as an established “reporting issuer” (an issuer that has previously filed a prospectus) for an appropriate period of time and having a high aggregate market capitalization. Thus, the effect of the short-form prospectus rules was to separate the provision of information about the securities to be issued from the provision of information about the issuer itself, and the rule was premised on the existing, timely availability of information about the issuer in the secondary markets. The CSA then moved to expand the opportunities for issuers to use the SFP process by removing the market capitalization eligibility requirements for reporting issuers. This opens up to several thousand more issuers the possibility of using the SFP process. The significance of the de-emphasis on “point of sale” disclosure is in part an attempt to reduce the regulatory burden on issuers raising capital, especially small and medium-sized businesses. It also acknowledges the reality that over 90  percent of transactions in securities markets take place in the secondary rather than the primary market. The effect of the expansion of NI 44-101 is that the traditional long-form prospectus document is retained for IPOs only. The foundation for the SFP process is the assumption that issuers who are already reporting issuers are abiding by the continuous disclosure obligations of securities law (discussed below in Section VIII). In particular, they are filing annual information forms (AIFs) that provide extensive information to investors about the history, business lines, and finances of the issuer. With that information backdrop available, reporting issuers may provide to the regulators a much more streamlined prospectus document, which basically describes the characteristics of the securities being offered in the distribution, as well as the use to which the proceeds will be put, at the time the offering takes place.

National Instrument 44-101, Short Form Prospectus Distributions (2005) 28 OSCB 10385 Part 2  Qualification to File a Prospectus in the Form of a Short Form Prospectus 2.1  Short Form Prospectus (1)  An issuer shall not file a prospectus in the form of Form 44-101F1 of this Instrument unless the issuer is qualified under any of sections 2.2 through 2.6 to file a prospectus in the form of a short form prospectus. (2)  An issuer that is qualified under any of sections 2.2 through 2.6 to file a prospectus in the form of a short form prospectus for a distribution may file, for that distribution, (a)  a preliminary prospectus, prepared and certified in the form of Form 44-101F1; and (b)  a prospectus, prepared and certified in the form of Form 44-101F1. 2.2  Basic Qualification Criteria An issuer is qualified to file a prospectus in the form of a short form prospectus for a distribution of any of its securities in the local jurisdiction, if the following criteria are satisfied:

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(a)  the issuer is an electronic filer under NI 13-101; (b)  the issuer is a reporting issuer in at least one jurisdiction of Canada; (c)  the issuer has filed with the securities regulatory authority in each jurisdiction in which it is a reporting issuer all periodic and timely disclosure documents that it is required to have filed in that jurisdiction (i)  under applicable securities legislation, (ii)  pursuant to an order issued by the securities regulatory authority, or (iii)  pursuant to an undertaking to the securities regulatory authority; (d)  the issuer has, in at least one jurisdiction in which it is a reporting issuer, (i)  current annual financial statements, and (ii)  a current AIF; (e)  the issuer’s equity securities are listed and posted for trading on a short form eligible exchange and the issuer is not an issuer (i)  whose operations have ceased, or (ii)  whose principal asset is cash, cash equivalents, or its exchange listing. The definition section of the NI indicates that a “short form eligible exchange” means each of the TSX, Tier 1, and Tier 2 of the TSX Venture Exchange, CSE, and Aequitas NEO Exchange Inc. QUESTIONS

Does the move to increase the availability of the short-form prospectus suggest, in your view, a greater reliance on the market itself to price securities accurately, rather than a reliance on “point of sale” information disclosure to entice investors to contribute capital? Should there be a more robust reliance on caveat emptor in this area, backed up, perhaps, by liability provisions?

B.  Prospectus Review In the context of reviewing preliminary prospectus documents to ascertain whether the regulators should provide the final receipt necessary to allow the distribution to take place, regulators in Ontario have indicated that they will stream the preliminary prospectuses they receive into one of three possible categories: basic review, full review, and issue-oriented review. All prospectuses will be subjected to a basic review, which involves applying a standard set of criteria to determine if the filing will be subject to a more detailed review. These criteria include matters related to the issuer’s corporate structure and underlying business, its financial condition or results, the nature of the offering, or matters related to advisers or corporate governance. Based on the application of these criteria, regulatory staff may proceed to a full review of the entire prospectus and any documents incorporated by reference into it, or alternatively to an issue-oriented review of specific legal or accounting issues identified by the initial screening. When this vetting process is complete, the securities administrator issues a “comment letter” or “deficiency letter,” which informs the issuer of any problems the securities

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administrator has with the preliminary prospectus. The issuer will then have to respond to or clear up the deficiencies identified by the securities administrator. Once the deficiencies are cleared to the satisfaction of the securities administrator, the issuer can file the final prospectus together with supporting documents and obtain a receipt for the prospectus. When the receipt is given for the final prospectus, the issuer can begin to distribute the securities. It is important to note that the prospectus review process described above is not considered to draw any conclusions as to the merits of the securities to be offered nor is it a representation that the process in fact contains full disclosure. Nonetheless, Canadian securities statutes do retain discretion for the regulator to refuse to issue a receipt for a prospectus based on merit-type criteria. In some Canadian statutes, for example, securities administrators may refuse to issue a receipt for a prospectus where: (1) an unconscionable consideration has been, or will be, paid or given for services, promotional purposes, or the acquisition of property; (2) any escrow or pooling agreement the administrator considers necessary has not been entered into; (3) the proceeds of the issue and the resources of the issuer are insufficient to accomplish the purpose of the issue; (4) the issuer cannot reasonably be expected to be financially responsible in the conduct of its business because of the financial condition of the issuer or of its officers, directors, promoters, or control persons; (5) the interests of the issuer cannot be expected to be conducted with integrity in the best interests of securityholders because of the past conduct of its officers, directors, promoters, or control persons; or (6) a person who has prepared or certified any part of the prospectus or who is named as having prepared a report or valuation used in or with the prospectus is not acceptable.12 The retention of this residual discretionary role for the regulator, to be exercised on “public interest” grounds, is regarded as consistent with an underlying investor protection rationale for securities law, although it is more controversial when viewed from the perspective of those who consider that markets are most efficient when transactions are unimpeded by bureaucratic delay or interference.

C.  Materiality and the Content of Prospectuses In relation to prospectuses, the requirement under most Canadian securities statutes is for the prospectus to provide “full, true and plain disclosure of all material facts” relating to the securities being distributed, as well as to comply with all applicable statutory requirements.13 There has been a high degree of harmonization among provincial regulators concerning the substantive content for an acceptable long-form prospectus. NI 41-101 contains a very detailed form requiring some 38 items of information to be included in a prospectus. The form canvasses issues such as a description of the securities being offered, the plan for distributing the offering, the corporate structure and narrative description of the business seeking capital, the use to which the proceeds of the offering will be put, financial statements for each of the preceding three years, risk factors associated with the business, the

12 See e.g. ASA s 120(2), BCSA s 65(2), OSA s 61(2), and NSSA s 66(2). 13 See ASA s 113(1), BCSA s 63(1), OSA s 56(1), NSSA s 66(2), and QSA s 13.

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identity of the principal shareholders of the issuer, information about the directors and officers of the issuer and their compensation, significant legal proceedings or material contracts in which the issuer is involved, and information concerning the purchasers’ rights in connection with the offering. The overarching requirement, as noted above, is to provide “full, true and plain disclosure of all material facts.” The term “material fact” is defined in provincial securities statutes, though the definition is not identical in all cases.14 Typically, however, a “material fact” is defined as a fact that significantly affects, or could reasonably be expected to significantly affect, the market price or value of the securities. Equally, the definition of “material fact” is formulated somewhat differently to that of “material change.” This is typically defined as meaning “a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer.”15 The latter is relevant to the assessment of when a reporting issuer needs to update the information available to the secondary market about its securities. The definitional difference between material facts and material changes was central to the resolution of the legal issues in Kerr v Danier Leather, 2007 SCC 44, [2007] SCR 331, summarized below.

D.  Sanctions for Non-Compliance The seriousness with which fulfilling the prospectus requirement is regarded by legislators is indicated by the fact that a failure to deliver a prospectus or to obtain a receipt for a prospectus where one is required can lead to penal sanctions, administrative sanctions, or civil sanctions. These consequences may follow even where the breach arises not through fraud but through an honest but mistaken belief that an exemption from the prospectus requirement exists.

1.  Failure to Deliver a Prospectus Failure to deliver a prospectus can lead to a penal sanction of fine or imprisonment.16 For example, under the OSA it can lead to a fine of up to $5 million or, for an individual, a fine of up to $5 million and up to five years’ imprisonment.17 A range of administrative orders may also be available. For instance, failure to deliver the prospectus could result in an order directing compliance; an order that trading in the securities of any person or by any person cease; a denial of exemptions from the requirements of the securities act and regulations; or,

14 For a discussion of the statutory wording differences here, see Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed (Toronto: Emond Montgomery, 2017) at 265ff; for a thorough discussion of the issues here, see Janis Sarra, “Modernizing Disclosure in Canadian Securities Law: An Assessment of Recent Developments in Canada and Selected Jurisdictions” in Canada Steps Up, vol 2 (Toronto: Investment Dealers Association, October 2006) at 1, online: Task Force to Modernize Securities Legislation in Canada . 15 OSA s 1(1), ASA s 1(ff ), and BCSA s 1; see also Janis Sarra, supra note 14. 16 See ASA s 194(1), BCSA s 155(1)(a), and OSA s 122(1)(c). 17 The relevant sanctions in British Columbia are a fine of not more than $3 million, imprisonment for not more than three years, or both: see BCSA s 155(2).

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487

in the case of a registered dealer, a reprimand or suspension, cancellation, or restriction of registration for trading in securities.18 There is also a statutory civil sanction for failure to deliver a prospectus. If the prospectus has not been delivered, the purchaser of the security has a right of action for rescission or damages.19 Under the securities acts in most jurisdictions in Canada, the right of rescission must be exercised within 180 days of the date of the transaction that gave rise to the cause of action. An action for damages must be brought within the earlier of 180 days after the purchaser first had knowledge of the facts giving rise to the action, or within three years of the purchase.20

2.  Failure to File Failure to obtain a receipt for a prospectus where it is required can lead to a fine or imprisonment.21 It can also lead to administrative orders, such as an order that trading in the security cease until the prospectus is filed and a receipt is obtained, or a denial of exemptions under the securities act or regulations.22 Not all provinces or territories provide a specific statutory civil sanction for a failure to file a prospectus. It might be thought that the statutory civil sanction for a failure to deliver a prospectus would apply where no prospectus has been filed. However, the provisions requiring the delivery of a prospectus typically require the delivery of “the latest prospectus filed respecting the security,”23 and it has been held that the effect of this is that the statutory civil sanction for a failure to deliver a prospectus does not apply to a failure to file a prospectus.24

VI.  LIABILITY FOR PROSPECTUS MISREPRESENTATION A.  The Statutory Civil Action In addition to the remedies for a failure to deliver a prospectus and a failure to file a prospectus, Canadian securities acts contain a statutory civil remedy for misrepresentations in a prospectus. A remedy of rescission or damages is available against the issuer, selling security-holder, or underwriter and a remedy of damages is available against certain other

18 See ASA ss 198 and 199, BCSA ss 161 and 162, and OSA s 127. 19 See ASA s 206, BCSA ss 135 and 135.1, and OSA s 133. Some policy consideration has been given to the question of whether, in the current era of accessing information via the Internet, the delivery requirement is still relevant: see Dimity Kingsford-Smith, “Importing the e-World into Canadian Securities Regulation” in Canada Steps Up, vol 5 (Toronto: Investment Dealers Association, October 2006) 289, online: Task Force to Modernize Securities Legislation in Canada . 20 See ASA s 211, BCSA s 140, and OSA s 138. 21 See ASA s 194(1), BCSA s 155, and OSA s 122(1)(c). 22 See ASA ss 198 and 199, BCSA ss 161 and 162, and OSA s 127. 23 See e.g. ASA s 129, BCSA s 83(1), and OSA s 71(1). 24 See Jones v FH Deacon Hodgson Inc (1986), 56 OR (2d) 540, 31 DLR (4th) 455 (H Ct J).

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named defendants.25 The statutory civil action for a misrepresentation in a prospectus goes beyond the common law action of negligent misrepresentation under Hedley Byrne & Co v Heller & Partners Ltd, [1964] AC 465 (HL). Under the statutory civil action, the plaintiff need only show that (1) he or she purchased the security offered under the prospectus; (2) the purchase was made during the period of distribution; and (3) there was a misrepresentation in the prospectus.26 The plaintiff does not have to prove either the existence of a duty of care or reliance on the misrepresentation. Instead, the plaintiff is deemed to have relied on the misrepresentation if it was a misrepresentation at the time the security was purchased.27 However, the defendants are entitled to the defence that the plaintiff had knowledge of the misrepresentation. Unlike in the common law action, the plaintiff also does not have to show that the defendant failed to meet the standard of care or that the misrepresentation caused the loss incurred. Instead, the exercise of due diligence and showing that the misrepresentation did not cause the loss are defences under the statutory civil liability provision.

B.  The Definition of “Misrepresentation” A “misrepresentation” is broadly defined to mean an untrue statement of a material fact or an omission to state a material fact that is either required to be stated or is necessary to prevent a statement that is made from being false or misleading in the circumstances in which it was made.28 As noted above, the distinction between “material fact” and “material change” as it relates to the definition of misrepresentation was a central aspect of the Supreme Court of Canada decision in Kerr v Danier Leather, 2007 SCC 44, [2007] 3 SCR 331, summarized below.

C.  The Potential Defendants The provisions also set out the potential defendants under the statutory civil action. The action can be brought against the issuer or, in the case of a sale by a control person, against the selling security-holder. The action can also be brought against the underwriter, every director of the issuer at the time the prospectus was filed, every expert who gave his or her consent to the use of all or part of his or her opinion or report, and every person who signed the prospectus. This potential for gatekeeper liability in connection with a prospectus signals the importance of the role assigned to gatekeepers in the prospectus preparation process. Normally, the chief executive officer and the chief financial officer of the issuer must sign the prospectus, along with any promoters of the issuer.

D.  The Available Defences The statutory civil liability provisions set out certain defences. As noted above, there are the defences of showing that the plaintiff had knowledge of the misrepresentation and that the

25 26 27 28

See e.g. ASA s 203, BCSA s 131, and OSA s 130. See e.g. ASA s 203(1), BCSA s 131(1), and OSA s 130(1). Ibid. See e.g. ASA s 1(ii), BCSA s 1(1), and OSA s 1(1).

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misrepresentation did not cause the loss.29 There is also the defence that the misrepresentation was not made by the particular defendant and that the defendant had no reason to believe and did not believe that the statement was false. For instance, a director or officer may be able to argue that the misrepresentation was contained in a part of the prospectus that consisted of an opinion or report of an expert. A further defence is that the defendant either did not consent to the filing of the prospectus or withdrew his or her consent prior to the purchase of the securities by the purchaser. By far the most important defence is the defence of due diligence. Under the due diligence defence, the defendant must show that he or she conducted a reasonable investigation to provide reasonable grounds for a belief that there was no misrepresentation and that he or she did not believe that there was misrepresentation.30 The defendant can take steps to set up the due diligence defence beforehand by conducting a “reasonable investigation” to avoid misrepresentations in the prospectus. The standard of reasonableness is that required of a prudent person in the circumstances of the particular case.31 Experts are held to a duty of reasonable investigation with respect to that part of the prospectus prepared on their own authority as experts. While the distinction between experts and non-experts is of great importance in due diligence defences, these terms are not defined. The expertised portion of a prospectus—that is, the portion of the prospectus prepared by an expert—appears to include the audited financial statements as well as those parts of the “company story” prepared by engineers or geologists, but it is not clear who else might be considered an expert. This issue is discussed in detail in the US decision of Escott v BarChris Construction Corp, 283 F Supp. 643 (1968) (BarChris). A further issue canvassed in BarChris is whether some non-experts, such as inside directors, are held to a higher standard of care than others. BarChris is considered to be a foundational case for the interpretation of s 11 of the US Securities Act, which creates civil liability for a false registration statement. The case had a significant effect on corporate practices with respect to prospectus preparation in both the United States and Canada as soon as it was handed down. But as the trial judge in Kerr v Danier Leather, (2004) 46 BLR (3d) 167 (Ont Sup Ct J) pointed out, the statutory provisions concerning burden of proof with respect to demonstrating due diligence are different as between the United States and Canadian provinces such as Ontario.

E. Limitation There is a relatively short limitation period for an action based on the statutory civil liability provisions. An action for rescission must be brought within 180 days from the date of the transaction that gave rise to the cause of action. In the case of an action for damages, the action must be brought from the earlier of 180 days from the date the plaintiff had knowledge of the facts giving rise to the cause of action and three years from the date of the transaction.32 The Supreme Court decision in Kerr v Danier Leather is widely understood to be the first case to go to trial in Ontario on the issue of prospectus misrepresentation, especially as applicable to

29 30 31 32

See ASA ss 203(4) and (9), BCSA ss 131(4) and (10), and OSA ss 130(2) and (7). See ASA ss 203(5) to (7), BCSA ss 131(5) to (7), and OSA ss 130(3) to (5). See e.g. BCSA s 133 and OSA s 132 (there is no corresponding ASA provision). See e.g. ASA s 211, BCSA s 140, and OSA s 138.

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forward-looking information. At trial, Lederman  J held that an actionable misrepresentation existed in Danier’s prospectus, and awarded damages to the plaintiffs. In a unanimous decision delivered by Laskin J, the Court of Appeal reversed the decision of the trial judge. The plaintiff investors were granted leave to appeal to the Supreme Court of Canada and the Supreme Court decision was issued in October 2007. The Supreme Court concluded that there had been no misrepresentation in the Danier Leather prospectus. Because OSA s 57(1) required only that the prospectus be updated before the end of the distribution in the event of a material change occurring in the business, operations, or capital of the company, there was no obligation on the company to disclose emerging negative quarterly financial results. The court reasoned that financial results were not changes in the business, operations or capital of the company. This decision is significant for a number of reasons. It reiterates a clear distinction between the concept of “material fact” and “material change” in the context of prospectus disclosure and holds that the causes of poor financial results, rather than the results themselves, are relevant to a finding of whether a material fact or material change has occurred. Kerr v Danier Leather illustrates well the complications that result from the shifting standards of materiality found within most Canadian securities statutes, complications that are compounded by the fact that other relevant actors, such as the TSX, employ a standard of “material information” when designing the obligations imposed on issuers to maintain a listing of their securities on the stock exchange.33 The case may also illustrate the uncertainties associated with using civil remedies to seek redress for deficient disclosure practices used by securities issuers. As discussed below, the use of these remedies is expected to increase in many provinces and territories, both because enhanced causes of action have been provided to investors in connection with secondary market disclosures34 and because class action litigation has become more feasible for plaintiff investors. From a policy point of view, La Porta et al argue that private remedies for investors are much more closely associated with the overall growth and development of stock markets than is vigorous enforcement action by government regulators.35 On the other hand, John Coffee has expressed much more jaundiced views about the consequences of class actions in the US capital markets context and views enforcement by public authorities in a more positive light than do La Porta et al.36

VII. EXEMPTIONS A.  Policy Objectives of Prospectus Exemptions The preceding sections dealt with the legal requirements imposed on issuers seeking capital from investors generally on a first or subsequent occasion. This section briefly addresses the circumstances in which it is legitimate to avoid these requirements in a capital-raising

33 See Janis Sarra, supra note 14. 34 See OSA Part XXIII.1. 35 See e.g. Rafael La Porta, Florencio Lopez-de-Silanes & Andrei Shleifer, “What Works in Securities Laws?” (2006) 61 J Finance 1 at 1. 36 See John Coffee, “Reforming the Securities Class Action: An Essay on Deterrence and Its Implementation” (2006) Center for Law & Economic Studies, Columbia Law School Working Paper No 293, and “Law of the Market: The Impact of Enforcement” 156 U PA Law Rev 229 (2007).

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transaction. The possibility of using an exemption from the prospectus requirement to raise capital is of major practical importance to issuers, most especially small and medium-sized business enterprises. Again, the existence of these legislative and rule-based exemptions are a recognition of the balancing required in the securities regime between protecting investors using a variety of tools, on the one hand, and facilitating more flexible and cost-effective capital raising, on the other. More detail about the policy objectives to be achieved by the prospectus exemption provisions is provided in the following excerpt.

Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed (Toronto: Emond, 2017) at 301-2 II.  Policy Objectives of Prospectus Exemptions Four primary policy objectives underlie the complex variety of traditional prospectus exemptions. 1.  The first is the perceived regulatory need to address the specific problems of startup, small, or medium-sized issuers, by allowing them more flexibility than the prospectus system provides to generate initial amounts of working capital. A large number of recommendations with respect to easing the regulatory burdens on small and medium-sized business enterprises (SMEs) were made by Ontario’s Task Force on Small Business Financing in the mid-1990s. (See Ontario Securities Commission, Task Force on Small Business Financing: Final Report (Toronto: Queen’s Printer for Ontario, October 1996).) The recommendations included liberalizing the rules in relation to future-oriented financial information for SMEs and changes to escrow requirements (that limit how soon after an initial public offering (IPO) significant shareholders of an issuer can sell their shares). The most significant recommendations, however, concerned the creation of new prospectus exemptions for “closely held business issuers” and an expanded category of “accredited investors.” The “closely held issuer” exemption in OSC Rule 45-501 was omitted from NI 45-106, but the “private issuer” and “family, friends and business associates” exemptions in NI 45-106 represent efforts to implement those recommendations, in an attempt to solve some persistent regulatory problems in the SME sector. More recently, governments in many jurisdictions—inside and outside Canada—have been preoccupied with low rates of economic development in the wake of the GFC. This political concern has led to renewed focus by securities regulators on developing innovative responses to the need to stimulate economic activity. As we will see below, existing exemptions have been expanded in scope in the last several years. A new one, the crowdfunding exemption, has been implemented in provincial and territorial jurisdictions across Canada, as well as in the United States and the United Kingdom. Overall, these exemptions are a response to the concern that established financial institution creditors or sophisticated investors such as pension funds or mutual funds may be unwilling or legally discouraged from investing in startup or small business enterprises. 2.  The second objective is the acknowledgment that some wealthy and/or sophisticated investors are capable of making the decision to bear investment risk without the information that a prospectus provides. It is considered to be unduly paternalistic of regulators

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to require issuers to provide extensive prospectus disclosure to a class of investors that is composed of sophisticated financial institutions or pension funds with billions of dollars under their administration, as well as “high net worth” individuals. In the interests of market efficiency, prospectus disclosure rules can be relaxed where the buyers of the securities fall into such a category. The assumption here is that such investors are capable of acting rationally in their own economic self-interest and will seek out directly from the issuer or its representatives any information they consider relevant to their investment decision making. The material provided about the findings of behavioural economics in the introduction to this book might be relevant to assessing this premise. (See Donald C Langevoort, “Selling Hope, Selling Risk: Some Lessons for Law from Behavioural Economics About Stockbrokers and Sophisticated Customers” (1996) 84:3 Cal L Rev 627.) Note that, in contrast to the policy rationale above, exemptions in this second category are based on the characteristics of the buyer of securities, not the seller. 3.  Third, where issuers are issuing securities to those with whom they have a preexisting relationship, it is considered that the prospectus requirement may be relaxed. The basic assumption here is that in these cases, the investor either has or has access to adequate current information about the issuer and its financial prospects. This justification is at the root of exemptions such as rights offerings, where additional securities are offered to existing security holders; trades to senior executives; more general employee-related exemptions (NI 45-106, ss 2.22-2.26, 28 OSCB (Supp-4) 3) as amended 21 July 2016; and also the “family, friends and business associates” exemption in NI 45-106. These exemptions may also be justified on the ground of reducing costs to issuers where no countervailing concern about investor protection exists. One issue to consider is whether each of these constituencies is in fact in the same position with respect to an ability to make investment decisions in the absence of the prospectus requirement. See e.g. SEC v Ralston Purina, 346 US 119 (1953), which considered whether employees should be regarded as members of the public for purposes of obtaining a prospectus. In 1953, the US Supreme Court answered yes to this question. 4.  Finally, some types of securities are so safe that a prospectus is considered to be redundant. Thus, should a government default on payments related to its own bond issues, there is little risk that the investor in the bonds will ultimately not be repaid. The same is considered to be true of a variety of financial institutions (but see Re Standard Trustco (1992), 15 OSCB 4322). The list of such securities is contained in NI 45-106, ss 2.34-2.38 and includes bonds, debentures, or other evidence of indebtedness of or guaranteed by the government of Canada, any province or territory of Canada, governments of foreign jurisdictions, Canadian municipal corporations, Ontario school boards, financial institutions governed by other legislation, securities issued by charitable issuers, among others. Some of these exemptions rely on the availability of “a credit rating from a designated rating organisation,” an issue that became controversial during the asset-backed commercial paper crisis in fall 2007 (IOSCO Technical Committee, “Consultation Report: The Role of Credit Rating Agencies in Structured Finance Markets” (March 2008), online International Organization of Securities Commissions ). In conclusion, it can be seen that each of the policy rationales makes a set of assumptions about the relationship between disclosure and the risk involved in investing in

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493

particular securities, as well as the tradeoffs that can occur between the two regulatory concerns. Where the risk to the investor is low, disclosure can be dispensed with to some extent, if not entirely. It should be noted, however, that the policy rationales enumerated above refer to a variety of levels or kinds of risk. Thus, the investment risk faced by a sophisticated pension fund is likely different in quality from that faced by a close friend of an entrepreneur. One question to ask yourself, therefore, as you proceed through the section to follow, is whether the nature of the risk assumed by a purchaser in a particular exempt transaction is matched by an appropriate level of information disclosure.

B.  Sources of Law in the Exemptions Area The regulation of the exempt market has been in considerable flux over the last several years. While the theme of the first decade of the 21st century was a gradual convergence of provincial norms around appropriate prospectus exemptions, there remained differences among those norms in a few key areas. With renewed attention to the importance of economic growth in the wake of the global financial crisis, more opportunities have opened up for capital raising. Even though NI 45-106 has rationalized the application of prospectus exemptions across the various provinces to some extent, there are a large number of potential exemptions available, some of which are more practically useful than others to businesses raising capital. Several of the major exemptions will be described here; however, readers are encouraged to consult NI 45-106 itself for a full account of the available exemptions in Canada.

C.  Significant Exemptions 1.  The Private Issuer Exemption Section 2.4 of NI 45-106 defines a “private issuer” as follows: 2.4(1)  In this section, “private issuer” means an issuer (a)  that is not a reporting issuer or an investment fund, (b)  the securities of which, other than non-convertible debt securities, (i)  are subject to restrictions on transfer that are contained in the issuer’s constating documents or security holders’ agreements, and (ii)  are beneficially owned, by not more than 50 persons, not including employees and former employees of the issuer or its affiliates, provided that each person is counted as one beneficial owner unless the person is created or used solely to purchase or hold securities of the issuer in which case each beneficial owner or each beneficiary of the person, as the case may be, must be counted as a separate beneficial owner, and (c) that (i)  has distributed its securities only to persons described in subsection (2), or (ii)  has completed a transaction and immediately following the completion of the transaction, its securities were beneficially owned only by persons described in subsection (2) and since the completion of the transaction has distributed its securities only to persons described in subsection (2).

As the definition suggests, especially with respect to the restriction on securities transfer and the cap on the number of security-holders, the intention is to circumscribe the use of

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this exemption to issuers where a small number of security-holders are involved and concerns about the liquidity of the securities are overridden by an interest in consensus or majority decision-making about the identity of security-holders. Note that, unlike earlier versions of the so-called seed capital exemptions, there is no restriction on the number of investors to whom securities may be offered, as long as the restriction on the number of ultimate security-holders is not exceeded. However, the restriction on commissions or finder’s fees in s 2.4(4) may have a dampening effect on widespread offers to purchase private issuer securities. Note that there is also something of an anti-avoidance provision built into the exemption dealing with the allowable number of security-holders, with respect to creating entities for the sole purpose of masking broader beneficial ownership of the relevant securities. The substance of the private issuer exemption in NI 45-106 is crafted as follows: 2.4(2)  The prospectus requirement does not apply to a distribution of a security of a private issuer to a person who purchases the security as principal and is (a)  a director, officer, employee, founder or control person of the issuer, (b)  a director, officer, or employee of an affiliate of the issuer, (c)  a spouse, parent, grandparent, brother, sister, child or grandchild of a director, executive officer, founder or control person of the issuer, (d)  a parent, grandparent, brother, sister, child or grandchild of the spouse of a director, executive officer, founder or control person of the issuer, (e)  a close personal friend of a director, executive officer, founder or control person of the issuer, (f)  a close business associate of a director, executive officer, founder or control person of the issuer, (g)  a spouse, parent, grandparent, brother, sister, child or grandchild of the selling security holder or of the selling security holder’s spouse, (h)  a security holder of the issuer, (i)  an accredited investor, (j)  a person of which a majority of the voting securities are beneficially owned by, or a majority of the directors are, persons described in paragraphs (a) to (i), (k)  a trust or estate of which all of the beneficiaries or a majority of the trustees or executors are persons described in paragraphs (a) to (i), or (l)  a person that is not the public.

The meaning of the category “accredited investor,” to whom private issuer securities may be sold without engaging the prospectus requirement, is considered below. Other notable categories of individual to whom private issuer securities may be sold are “close personal friends” and “close business associates” of directors, executive officers, founders, or control persons of the issuer. The assessment of whether a friend or business associate is “close” enough is inherently a qualitative one. The Companion Policy to NI 45-10637 notes that a close personal friend is an “individual who knows the director, executive officer, founder or control person well enough and has known them for a sufficient period of time to be in a position to assess their capabilities and trustworthiness.” However, an individual is not a close personal friend solely because the individual is a relative; a member of the same organization, association, or religious group; or a client, customer, former client, or former customer. Finally, private 37 Companion Policy 45-106CP, Prospectus and Registration Exemptions (2005) 28 OSCB (Supp 4) 81.

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issuer securities may be sold to a person who is “not the public.” This residual category of investor to whom private issuer securities may legitimately be sold makes clear the policy underpinnings of the exempt market. Thus, securities may circulate in such a market in the absence of information disclosure about those securities as long as members of the public, who, it is assumed, would require such information to make rational investment decisions, are not involved. However, as the excerpt below makes clear, it is notoriously tricky to decide who is, or is not, a member of the public for the purposes of securities law.

Mark R Gillen, Securities Regulation in Canada (Toronto: Carswell, 2007) at 240-41 Although courts did occasionally grapple with the meaning of the words “to the public,” they were unable to give them a precise meaning. One of the leading cases addressing the meaning of the words “to the public” was Securities and Exchange Commission v. Ralston Purina Co. [346 US 119 (1953 USSC)]. Ralston Purina instituted an employee share ownership plan under which shares of the company were made available to “key employees.” However, shares were offered to any employee who expressed an interest in the shares. Shares were sold to employees in several different states and included such employees as a chuck loading foreman, a clerical assistant, a stock clerk and a production trainee. The United States Supreme Court held that the sales constituted a distribution to the public and thus were subject to the Securities Act of 1933. In discussing the meaning of “to the public” the court noted that the security need not be made available to the whole world and that “to the public” applies whether the offer is made to many persons or to only a few persons. The key question, in the view of the court, was whether the persons who are offered the security need to know the kind of the information that the prospectus would provide. In R v. Piepgrass [(1959), 29 WWR 218 (Alta. CA)], a leading Canadian case, $50,000 worth of capital was sought by soliciting farmers, most of whom were known by the promoter from previous business dealings. The Alberta Court of Appeal upheld the trial decision which held that sales to the persons solicited constituted a distribution to the public. The Court of Appeal noted that the persons sold to “were not in any sense friends or associates of the accused, or persons having common bonds of interest or association.” The court did not expand on the reason for this test. However, the concept appears to be that one is not likely to take advantage of friends, associates or persons who have common bonds of interest or association. Also, persons having common bonds of interest or association may have access to the kind of information that would appear in a prospectus. Such persons would thus not need the protection provided by prospectus disclosure accompanied by withdrawal rights and statutory civil liability. The tests set out in these cases are known respectively as the “need to know” test and the “common bonds” test. Although these two tests provided some guidance as to the meaning of the expression “to the public,” there remained considerable ambiguity as to whether a distribution constituted a distribution “to the public.” Thus it was often not clear whether a prospectus was required. Cautious solicitors resolved this doubt by seeking an exemption order from the securities commission. There were numerous applications to securities commissions for clarifying orders.

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2.  The Family, Friends, and Business Associates Exemption A specific exemption for securities distributed to “family, friends and business associates” is now available by virtue of NI 45-106 s  2.5 in all provinces, since Ontario joined other provinces in offering this exemption in 2015 (s  2.6.1). Additionally, in both Ontario and Saskatchewan, the person making the distribution must obtain a “signed risk acknowledgement” from the purchaser in a format specified in the rule. The advantage of using this exemption as compared with the private issuer exemption is that it does not carry the same restriction on the number of investors to whom securities may be distributed. However, the Companion Policy to NI 45-106 indicates that “if … an issuer advertises or pays a commission or finder’s fee to a third party to find purchasers under the family, friends and business associates exemption, it suggests that the precondition of a close relationship between the purchaser and the issuer may not exist and therefore the issuer cannot rely on this exemption.”

3.  The Crowdfunding Exemption A potentially more innovative way of raising equity financing in the future is the so-called crowdfunding exemption. A number of provinces have adopted MI 45-108 (Manitoba, Ontario, Québec, New Brunswick, and Nova Scotia), which establishes a detailed crowdfunding regime, though other provinces have also introduced other versions of the same opportunity. The key element here is the use of the Internet and social media to source financing from the “crowd,” which by definition includes retail investors. Key to the operation of the regime is that the entity requesting the funds needs to qualify as an “eligible crowdfunding issuer” and the process of matching investors with funding opportunities must be conducted by a “funding portal.” The former must be incorporated, and have its head office in Canada, with the majority of directors resident in Canada. It may be, but does not have to be, a reporting issuer. The latter must be registered as an investment dealer in the provinces in which it operates. Issuers may not raise more than $1,500,000 in a 12-month period using the crowdfunding exemption, and non-accredited investors may not invest more than $2,500 in a single crowdfunded opportunity. Issuers are required to provide to purchasers, through the funding portal, a “crowdfunding offering document” before the purchaser enters into the purchase agreement. Limited ongoing disclosure requirements are also imposed on the issuer. Investors are required to sign risk acknowledgement forms.

4.  The “Accredited Investor” Exemption NI 45-106 s 2.3 provides that a prospectus requirement does not apply “to a distribution of a security if the purchaser purchases the security as principal and is an accredited investor.” Meanwhile there are some 22 types of organizations or individuals who may fit the criteria to be an accredited investor. The lengthy definition in Part 1 of NI 45-106 reads as follows: accredited investor means (a)  except in Ontario, a Canadian financial institution, or a Schedule III bank, (b)  except in Ontario, the Business Development Bank of Canada incorporated under the Business Development Bank of Canada Act (Canada),

VII. Exemptions (c)  except in Ontario, a subsidiary of any person referred to in paragraphs (a) or (b), if the person owns all of the voting securities of the subsidiary, except the voting securities required by law to be owned by directors of that subsidiary, (d)  except in Ontario, a person registered under the securities legislation of a jurisdiction of Canada as an adviser or dealer, , (e)  an individual registered or formerly registered under the securities legislation of a jurisdiction of Canada as a representative of a person referred to in paragraph (d), (e.1)  an individual formerly registered under the securities legislation of a jurisdiction of Canada, other than an individual formerly registered solely as a representative of a limited market dealer under one or both of the Securities Act (Ontario) or the Securities Act (Newfoundland and Labrador), (f)  except in Ontario, the Government of Canada or a jurisdiction of Canada, or any crown corporation, agency or wholly owned entity of the Government of Canada or a jurisdiction of Canada, (g)  a municipality, public board or commission in Canada and a metropolitan community, school board, the Comité de gestion de la taxe scolaire de l’île de Montréal or an intermunicipal management board in Québec; (h)  except in Ontario, any national, federal, state, provincial, territorial or municipal government of or in any foreign jurisdiction, or any agency of that government, (i)  except in Ontario, a pension fund that is regulated by either the Office of the Superintendent of Financial Institutions (Canada), a pension commission or similar regulatory authority of a jurisdiction of Canada, (j)  an individual who, either alone or with a spouse, beneficially owns financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $1 000 000, (j.1)  an individual who beneficially owns financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $5 000 000, (k)  an individual whose net income before taxes exceeded $200 000 in each of the 2 most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300 000 in each of the 2 most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year, (l)  an individual who, either alone or with a spouse, has net assets of at least $5 000 000, (m)  a person, other than an individual or investment fund, that has net assets of at least $5 000 000 as shown on its most recently prepared financial statements, (n)  an investment fund that distributes or has distributed its securities only to (i)  a person that is or was an accredited investor at the time of the distribution, (ii)  a person that acquires or acquired securities in the circumstances referred to in sections 2.10 [Minimum amount investment], or 2.19 [Additional investment in investment funds], or (iii)  a person described in paragraph (i) or (ii) that acquires or acquired securities under section 2.18 [Investment fund reinvestment], (o)  an investment fund that distributes or has distributed securities under a prospectus in a jurisdiction of Canada for which the regulator or, in Quebec, the securities regulatory authority, has issued a receipt, (p)  a trust company or trust corporation registered or authorized to carry on business under the Trust and Loan Companies Act (Canada) or under comparable legislation in a jurisdiction of Canada or a foreign jurisdiction, acting on behalf of a fully managed account managed by the trust company or trust corporation, as the case may be, (q)  a person acting on behalf of a fully managed account managed by that person, if that person is registered or authorized to carry on business as an adviser or the equivalent under the securities legislation of a jurisdiction of Canada or a foreign jurisdiction,

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(r)  a registered charity under the Income Tax Act (Canada) that, in regard to the trade, has obtained advice from an eligibility adviser or an adviser registered under the securities legislation of the jurisdiction of the registered charity to give advice on the securities being traded, (s)  an entity organized in a foreign jurisdiction that is analogous to any of the entities referred to in paragraphs (a) to (d) or paragraph (i) in form and function, (t)  a person in respect of which all of the owners of interests, direct, indirect or beneficial, except the voting securities required by law to be owned by directors, are persons that are accredited investors, (u)  an investment fund that is advised by a person registered as an adviser or a person that is exempt from registration as an adviser, (v)  a person that is recognized or designated by the securities regulatory authority or, except in Ontario and Quebec, the regulator as an accredited investor, or (w)  a trust established by an accredited investor for the benefit of the accredited investor’s family members of which a majority of the trustees are accredited investors and all of the beneficiaries are the accredited investor’s spouse, a former spouse of the accredited investor or a parent, grandparent, brother sister, child or grandchild of that accredited investor, of that accredited investor’s spouse or of that accredited investor’s former spouse.

Where Ontario is excluded from a definition above, it is because identical provisions are found in OSA s 73.3(2). As the definition demonstrates, a wide variety of sophisticated financial institutions, levels of government, and “persons  … other than individuals” with net assets of Cdn$5 million can qualify for accredited investor status. The advantage to issuers and investors alike here is that capital-raising can be conducted on a more efficient basis without the need to provide a regulatory-sanctioned prospectus. The policy rationale for allowing this is that sophisticated investors can seek for themselves the information they would find useful to evaluate the investment opportunity. In practice, however, many accredited investors obtain from the issuer a so-called offering memorandum that contains a good deal of prospectus-like information. An innovation of the accredited investor definition is that it allows individuals to obtain the designation as well. Branches (j), (k), and (l) of the definition outline the various tests of wealth that can be used to ground a determination that an individual qualifies as an accredited investor. The alternatives are a “financial assets” test, a “net income” threshold, or a “net assets” threshold. It is important to note that the accredited investor exemption provides more flexibility to issuers than does the “private issuer” exemption in the sense that the former is available to all issuers, provided that the purchaser meets the exemption criteria.

5.  The Minimum Amount Investment Exemption This exemption, provided in NI 45-106 s 2.10, allows for a prospectus exemption if the security has “an acquisition cost to the purchaser of not less than $150,000 paid in cash at the time of the trade” and the purchaser is purchasing as principal. In 2015, an important modification was made to this exemption in all provinces such that it may no longer be accessed by individuals.

6.  Offering Memorandum Exemption In a number of provinces, an exemption from the prospectus requirement attendant on the distribution of securities was available if the issuer provided the purchaser instead with an

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offering memorandum (OM), the content of which is prescribed in NI 45-106. Regulators do not purport to review the OM before the distribution. Until 2016 this exemption was not available in Ontario. There are still varying requirements associated with the use of this exemption in each province, a detailed analysis of which is beyond the scope of this book. Some provinces require that the purchaser be an “eligible investor”38 or is not paying more than a specific amount for the securities. Most provinces require that the purchaser sign a “risk acknowledgement” in a prescribed form. The OM must provide either a statutory or contractual right of action against the issuer for misrepresentation.

D.  Resale Rules It is important to be clear that, in principle, provided the restrictions of the specific exemption are met, some exemptions may be used by both issuers who have never before distributed securities widely and those who have, but who now need additional financing for business projects. This is certainly the case with the accredited investor exemption, discussed above, although it is more than likely that the private issuer exemption is useful only to issuers who have not previously distributed securities widely. No matter what the nature of the issuer, however, securities regulation is just as concerned about subsequent transactions in securities issued without a prospectus as it is about the initial issuing of the securities under an exemption. In other words, securities regulation also governs the subsequent resale of securities originally issued under an exemption, where the investors who are subsequent buyers may not themselves qualify for exemptions. The concern about so-called backdoor underwriting, where securities are initially issued using a prospectus exemption, and then broadly distributed to a wide variety of retail investors free of the prospectus requirement that would have been necessary to distribute to them initially, is addressed by the system of resale rules, currently promulgated in Canada in NI 45-102. 39 The resale rule, which identifies the conditions under which initially exempt securities may be resold without a prospectus, relies heavily on the principles of (1) reporting issuer continuous disclosure, and (2)  a system of hold periods that restricts the liquidity of the securities purchased pursuant to a prospectus exemption. Thus, for example, accredited investors who purchase securities exempt from disclosure requirements because of the purchaser’s status will have to trade off the liquidity of those securities for the presumably lower cost of acquiring them from the issuer. The prospectus exemption rules, working together with the resale rules, create what is known in provincial securities regulation as the “closed system,” which means that the rules contemplate that all possibilities for issuing securities have been canvassed, and securities may not be distributed or resold outside this process.

38 CP 45-106, ibid, s 1.1 contains a definition of an “eligible investor” that revolves around the amount of net assets or income available to the investor, but the thresholds of which are different from those of the accredited investor definition or, in the alternative, refers to the obtaining of advice from an “eligible advisor.” 39 NI 45-102, Resale of Securities (2005) 28 OSCB (Supp 4) 121.

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VIII.  CONTINUOUS DISCLOSURE REQUIREMENTS Continuous disclosure consists of periodic reports, such as financial reports, annual information forms (AIFs), management discussion and analysis documents (MD&A) (see below, Section VIII.C), proxy circulars40 and insider trading reports, and timely reports of material information concerning the issuer by way of press releases. Continuous disclosure has been an important theme of securities regulation in Canada over the past 25 years, and this commitment has recently been enhanced in specific ways. For example, one novel direction in which disclosure requirements have been taken has been with respect to disclosure of the corporate governance practices of reporting issuers. The issues raised by the introduction of NI 58-101, Disclosure of Corporate Governance Practices, which requires disclosure of certain corporate governance elements of a reporting issuer’s operations, are discussed in Chapter 11. Continuous disclosure requirements were introduced in Canadian securities acts following the recommendations of the Kimber Report.41 According to the Merger Report,42 the purpose of continuous disclosure is to provide all investors in the marketplace with equal access to information and thus equal access to the opportunities that information provides. Continuous disclosure is central to the concept of the closed system (mentioned above) and to the short-form prospectus system (discussed above). The rules respecting continuous disclosure in Canadian securities regulation have now been harmonized by the CSA, and may be found in NI 51-102, Continuous Disclosure Obligations. Again, note that the substantive disclosure provisions present in NI 51-102 can differ from those found in an individual provincial statute—for example, the rules concerning the time frame for filing financial statements—providing a trap for the unwary student or practitioner. The issue of the efficacy and appropriateness of detailed continuous disclosure requirements imposed on securities issuers, and the usefulness of this material to investors, is intensely debated in the academic literature. Some sources for obtaining a flavour of this debate will be provided later in the chapter.

A.  “Reporting Issuers” Most securities acts in Canada distinguish between so-called reporting issuers (RIs) and all other issuers. It is reporting issuers that are subject to the continuous disclosure requirements under most Canadian securities acts. Normally, a reporting issuer is an issuer that has issued securities under a prospectus in the applicable jurisdiction, or has securities listed and posted for trading on a stock exchange in the jurisdiction.43 The definition is intended to identify those issuers whose securities are available for trading by the general investing

40 Proxy circulars are discussed in Chapter 12. 41 Report of the Attorney General’s Committee on Securities Legislation in Ontario (Toronto: Queen’s Printer, 1965), Part I at paras 1.11, 1.12, and 1.16; Parts II; IV; and VI. 42 Report of the Committee of the Ontario Securities Commission on the Problems of Disclosure for Investors by Business Combinations and Private Placements (Toronto: Department of Financial and Commercial Affairs, 1970) at 15. 43 See e.g. ASA s 1(ccc), BCSA s 1(1), and OSA s 1(1).

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public who are presumed to need to know the kind of information that would be contained in continuous disclosure documents.

B.  Financial Statements The following sections from NI  51-102 capture the requirements on reporting issuers to provide annual and quarterly financial statements of various kinds to investors and the regulators. Note that while annual financial statements must be audited, interim statements need not be, although there needs to be disclosure of that fact. Note also the shifting filing requirements for both annual and interim financial statements depending on whether the issuer is a venture or a non-venture issuer. The instrument defines a venture issuer as a reporting issuer that does not have any of its securities listed on the TSX, a US marketplace, or a marketplace outside Canada and the United States.

National Instrument 51-102, Continuous Disclosure Obligations (2004) 27 OSCB 3439, (2005) 28 OSCB 4975 4.1  Comparative Annual Financial Statements and Auditor’s Report (1)  Subject to subsection 4.8(6), a reporting issuer must file annual financial statements that include (a)  an income statement, a statement of retained earnings, and a cash flow statement for (i)  the most recently completed financial year; and (ii) the financial year immediately preceding the most recently completed financial year, if any; (b)  a balance sheet as at the end of each of the periods referred to in paragraph (a); and (c)  notes to the financial statements. (2)  Annual financial statements filed under subsection (1) must be accompanied by an auditor’s report. 4.2  Filing Deadline for Annual Financial Statements The annual financial statements and auditor’s report required to be filed under section 4.1 must be filed (a)  in the case of a reporting issuer other than a venture issuer, on or before the earlier of (i)  the 90th day after the end of its most recently completed financial year; and (ii)  the date of filing, in a foreign jurisdiction, annual financial statements for its most recently completed financial year; or (b)  in the case of a venture issuer, on or before the earlier of (i)  the 120th day after the end of its most recently completed financial year; and (ii)  the date of filing, in a foreign jurisdiction, annual financial statements for its most recently completed financial year.

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4.3  Interim Financial Statements (1)  A reporting issuer must file, (a)  if it has not completed its first financial year, interim financial statements for the interim periods of the reporting issuer’s current financial year other than a period that is less than three months in length; or (b)  if it has completed its first financial year, interim financial statements for the interim periods of the reporting issuer’s current financial year. (2)  Subject to subsections 4.7(4), 4.8(7) and 4.8(8), the interim financial statements required to be filed under subsection (1) must include (a)  a balance sheet as at the end of the interim period and a balance sheet as at the end of the immediately preceding financial year, if any; (b)  an income statement, a statement of retained earnings and a cash flow statement, all for the year-to-date interim period, and comparative financial information for the corresponding interim period in the immediately preceding financial year, if any; (c)  for interim periods other than the first interim period in a reporting issuer’s financial year, an income statement and cash flow statement for the three month period ending on the last day of the interim period and comparative financial information for the corresponding period in the preceding financial year, if any; and (d)  notes to the financial statements. (3)  Disclosure of Auditor Review of Interim Financial Statements (a)  If an auditor has not performed a review of the interim financial statements required to be filed under subsection (1), the interim financial statements must be accompanied by a notice indicating that the financial statements have not been reviewed by an auditor. (b)  If a reporting issuer engaged an auditor to perform a review of the interim financial statements required to be filed under subsection (1) and the auditor was unable to complete the review, the interim financial statements must be accompanied by a notice indicating that the auditor was unable to complete a review of the interim financial statements and the reasons why the auditor was unable to complete the review. (c) If an auditor has performed a review of the interim financial statements required to be filed under subsection (1) and the auditor has expressed a reservation in the auditor’s interim review report, the interim financial statements must be accompanied by a written review report from the auditor.

C.  Management Discussion and Analysis Part 5 of NI 51-102 requires that a reporting issuer must file an MD&A relating to its annual and interim financial statements, with filing deadlines that are consistent with those required for financial statements. Form 51-102FI, which itemizes the type of information required to be included in the reporting issuer’s annual or interim MD&A, describes an MD&A as “a narrative explanation, through the ideas of management, of how your company performed during the period covered by the financial statements, and of your company’s financial position and future prospects.” Thus, the idea is that since the financial information

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presented in the issuer’s financial statements is compacted, numerical, and complex, the MD&A can make that information meaningful to investors by providing narrative discussion of the issuer’s results of operations and overall financial condition. The MD&A is required to discuss the dynamics of the issuer’s business and the nature and reasons for any material changes in the issuer’s performance during the reporting period.44

D.  Annual Information Forms Part 6 of NI 51-102 prescribes that reporting issuers that are not “venture issuers”45 are required to file annual information forms (AIFs). Form 51-102F2 itemizes the content of an AIF; it begins with the explanation that an AIF “is a disclosure document intended to provide material information about your company and its business at a point in time in the context of its historical and possible future development. Your AIF describes your company, its operations and prospects, risks and other external factors that impact your company specifically.” There is a high degree of similarity between the information to be disclosed annually in an AIF and that required in a long-form prospectus, indicating that the regulators are moving close to the idea of a so-called evergreen prospectus, which was first mooted in reform proposals in the 1970s, but not pursued at that time. It has been noted already that an up-to-date AIF is required to access the short-form prospectus option.

E.  Timely Disclosure of Material Changes In addition to the periodic disclosure requirements required by statute and NI 51-102, all provincial statutes in Canada require reporting issuers to make timely disclosure of material changes in their affairs by way of a news release issued “forthwith” and a material change report filed with the regulators.46 A typical definition of the concept of material change may be found in the British Columbia Securities Act where it is defined as (i)  a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of a security of the issuer, or (ii)  a decision to implement a change … made by (A)  the directors of the issuer, or (B)  senior management of the issuer who believe that confirmation of the decision by the directors is probable … .47

44 See Condon, Anand, Sarra & Bradley, supra note 14 at 362-64. 45 According to the definitions provided in the rule, a venture issuer is essentially a reporting issuer that is not listed on the TSX, a US marketplace, or a marketplace outside Canada and the United States. 46 OSA ss 75(1) and (2), BCSA s 85, ASA s 146, QSA s 73, NSSA s 81, and NI 51-102 s 1.1 and Part 7. Both the various provincial statutory requirements and the provisions of NI 51-102 Part 7 allow for a reporting issuer to make confidential disclosure of the material change to the regulator but not to the public if the reporting issuer is of the opinion (arrived at in a reasonable manner) that public disclosure would be unduly detrimental to the interests of the issuer. 47 BCSA s 1(1); and also OSA s 1(1), NSSA s 2(1)(v), and ASA s 1(ff ). The QSA does not contain an explicit definition of a material change.

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The excerpt below from the Supreme Court’s decision in Pezim v British Columbia (Superintendent of Brokers) provides an illustration of the interpretative exercise in which decisionmakers are required to engage in order to apply the broadly worded definition of material change to specific factual contexts. The case concerns transactions engaged in by a resource company named Prime, which managed a number of other resource companies, including one called Calpine.

Pezim v British Columbia (Superintendent of Brokers) [1994] 2 SCR 557 [86]  As already mentioned, the determination of what constitutes a material change for the purposes of general disclosure under s. 67 of the Act is a matter which falls squarely within the regulatory mandate and expertise of the Commission. Consequently, when the majority of the Court of Appeal rejected the Commission’s findings on this matter, it fell into error. Furthermore, the majority’s view on this point is, in my opinion, clearly wrong and is inconsistent with the economic and regulatory realities the Act sets out to address. Counsel for the respondents conceded this point, during the hearing of this appeal, and stated that “information from a drilling program can be tantamount to a material change.” •  •  •

[88]  Can the Court really suggest that there has not been a change in a company’s assets when, following adequate sampling, a discovery is made on a portion of its property that had been previously categorized as having no known mineralization? Surely, given the basic aim of the Act—to protect the investing public through full, true and plain disclosure of all material facts relating to securities—one could conclude (as did Mr. Justice Locke, the dissenting judge) that the Commission did not make a “plain and vital mistake” in the application of the words in s. 67 of the Act to the facts before it. … [89]  Consequently, I am of the view, as found by the Commission and Locke JA, that the assay results constituted a change with respect to or in the companies’ assets and is “material” for the purposes of the Act. There has been much academic, policy, and judicial debate on various issues with respect to the definition of a material change in provincial regulation. Some of those issues are the inconsistency between the definition of a material fact and material change; whether the definition of a material change should be based, as it currently is, on a so-called market impact test or, alternatively, on a reasonable investor test, as it is in the United States; and whether Canadian securities regulatory requirements should move to a consolidated market information test, which would combine elements from the definitions of both material fact and material change, and which is the materiality standard required of TSX-listed issuers. Readers interested in pursuing these definitional issues further should consult Professor Sarra’s research study for the Task Force to Modernize Securities Legislation, prepared in May 2006.48 The urgency of resolving some of these issues is increased by the introduction in

48 Janis Sarra, supra note 14.

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some Canadian provinces of statutory provision for investors to sue reporting issuers for misrepresentations in continuous or timely disclosure documents, or for failure to make timely disclosure of material changes. The next section of this chapter considers these developments.

F.  Liability for Misrepresentations in Continuous Disclosure Documents An important development in securities regulation across all provinces in the last several years has been the creation of new statutory civil remedies for investors arguing that the continuous or timely disclosure provided by reporting issuers to the secondary market has been deficient. A variety of policy objectives are being sought by the introduction, for example, of ss 138.1 to 138.14 to the OSA in late 2005, including increased levels of compensation to plaintiffs,49 deterrence of poor disclosure practices, and consistency with similar, but not identical, remedies in the United States. The following excerpt briefly describes the elements of the recent provisions.

Mary Condon, “Rethinking Enforcement and Litigation in Ontario Securities Regulation” (2006) 32 Queens LJ 1 at 36-40 Several causes of action are being created. These include actions in relation to (i) documents released by a responsible issuer that contain a misrepresentation [s.  138.3(1)]; (ii) public oral statements containing misrepresentations, if they are made by a person “with actual, implied or apparent authority to speak on behalf of a responsible issuer” [s. 138.3(2)]; and (iii) failure to make timely disclosure [s. 138.3(4)]. Those obtaining a cause of action include “a person or company who acquires or disposes” of the issuer’s securities between the time the document was released or public oral statement made which contained the misrepresentation and the time the misrepresentation was publicly corrected, and in the case of failure to make timely disclosure, a person or company who acquired or disposed of the securities between the time the material change was required to be disclosed and its subsequent disclosure. Notably there is no requirement for the plaintiff(s) to demonstrate reliance on the misrepresentation, or on the issuer having complied with timely disclosure requirements, in making the decision to trade the securities. … Similarly, the class of defendants to these new causes of action is broader than the equivalent liability provisions for misrepresentations in offering documents, in provisions like s. 130 of the OSA. The class includes not only the responsible issuer, its directors and officers, but also “influential persons” and, in the case of written or oral statements, experts. The definition of the class of “influential person” with respect to a responsible issuer includes control persons, promoters, and insiders who are not directors or senior officers [that is, those who own or exercise control or direction over more than 10 percent 49 It is contemplated by the provisions that compensation may be limited to less than the full amount of the damages assessed. See below.

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of the voting securities of the issuer]. The addition of this group of interested parties as possible defendants to a s. 138.1 action is potentially revolutionary. … It appears to be derogating from long-held assumptions about the relationship of shareholders qua shareholders to a corporation, and may have the effect of imposing additional monitoring duties on key corporate shareholders. However, unless the influential person released the impugned document or made the public oral statement, “knowing influence” on the responsible issuer will be required to ground an action [ss. 138.3(1) and (2)]. Finally, if the person who made the public oral statement that is impugned is not already captured in the above list, they may also be liable. Furthermore, the new provisions make a distinction between core and non-core documents [the latter category basically comprises material change reports], and require a higher burden of proof to be discharged by plaintiffs where non-officer directors and influential persons are being sued with respect to non-core documents. A similarly elevated burden of proof is also required where directors and influential persons are being sued for failure to make timely disclosure. A number of defences are made available by the provisions. These include a defence that the plaintiff knew of the misrepresentation, a “reliance on experts,” or the making of confidential disclosure to the regulator. The most significant in practice is likely to be the “due diligence” defence. With respect to both the due diligence and “plaintiff knowledge” defences, the burden of proof shifts to the defendants. The legislative provisions enumerate a variety of factors that should be considered by a court in determining whether the defendant(s) undertook a reasonable investigation (or alternatively were guilty of gross misconduct). One factor that is likely to be most significant in future litigation is “the existence, if any, and the nature of any system designed to ensure that the responsible issuer meets its continuous disclosure obligations” [s. 138.4(7)(e)]. Thus, issuers wishing to position themselves favourably with respect to possible litigation under Part XXIII.1 are likely to establish written disclosure policies featuring the establishment and implementation of procedures for reviewing disclosure documents, for identifying those responsible for reviewing them, and for determining whether material changes have occurred. If the foregoing could fairly be described as plaintiff-friendly features of these amendments, a number of other aspects tend in the opposite direction. Chief among these is the so-called “gatekeeper provision.” [Jeffrey S. Leon and Sarah J. Armstrong, “Preparing for the Road Ahead: Bill 198 and Secondary Market Disclosure.” Insight Information, Securities Litigation Forum, June 13-14, 2005] which requires plaintiffs to obtain leave of the court to proceed with the action [s. 138.8]. Leave is to be granted only where the court is satisfied that the action is being brought “in good faith” and that there is a “reasonable possibility” that the action will be resolved at trial in favour of the plaintiff. A key issue is how robust this merit-based leave assessment will be in practice [Garry Watson, “Class Actions and the Dilemma of ‘Entrepreneurial Lawyering’: The Good and the Not So Good Aspects of Class Actions” (2005) (unpublished paper, on file with author)] … . Of further significance is the “liability limit” established in the new provisions [s.  138.7]. This limits the damages payable by a defendant issuer or a non-individual influential person to the greater of $1 million or 5% of the issuer’s market capitalization. Those payable by an individual influential person, officer or director are limited to the greater of $25,000 or 50% of aggregate compensation received during the 12-month period immediately preceding the day on which the misrepresentation was made or the failure to make timely disclosure occurred. Liability is also to be proportionate with respect to

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each defendant’s responsibility for the damages assessed [s. 138.6]. These liability limits make it clear that the compensation goal usually associated with private litigation is being kept within bounds, since it is conceivable that plaintiffs might not be able to recover to the full extent of their losses. On the other hand, the fact that liability can be assessed against individual defendants is presumably designed to contribute to the deterrence objective of private remedies. [See Keith Johnson, “Deterrence of Corporate Fraud Through Securities Litigation: The Role of Institutional Investors” (1997) 60 Law and Contemporary Problems 155.] It is also significant that the liability limits are inapplicable (except for the responsible issuer) where the plaintiff can prove the defendant’s knowledge of the misrepresentation or failure to make timely disclosure. As Leon and Armstrong argue, (t)his provision may well have the effect of encouraging plaintiffs to allege fraud so as to put pressure on defendants to settle in order to avoid unlimited exposure to damages. This pressure becomes even more formidable given the potential negative effect on the ability of directors and officers to depend on insurance to respond to a successful claim. [Leon and Armstrong, supra, at 6]

Strategically, then, it will become important whether a court will enter into a determination of the likelihood of success on the issue of the defendant’s knowledge at the leave stage … . [Rubin, National Post, September 7, 2005, FP9] With respect to the calculation of losses in order to compute damages, it should be noted that the provisions do not require plaintiffs to crystallize those losses by selling the security [s. 138.5(1)]. A 2005 US Supreme Court decision on this issue has generated a lot of attention because of its stricter approach to the requirement for plaintiffs in US cases to prove a causal connection between the alleged misrepresentation and the economic loss suffered [Dura Pharmaceuticals Inc. v. Broudo, 125 US 1627 (2005)]. The US Supreme Court made it clear that in its decision it was seeking to achieve the policy goal of avoiding “abusive” litigation. However, it should be noted that in Canada that onus will rather be on the defendant to prove that losses were unrelated to the misrepresentation [s. 138.5(3)]. This is likely to involve a “battle of experts” on the issue of what caused the issuer’s stock price to decline [Douglas Worndl, “Opening the Door to Shareholder Class Actions.” BLG National Client Seminar Series, Directors’ and Officers’ Liability: A New World Order, October 19, 2005]. NOTES AND QUESTIONS

1.  Which of the alternative policy objectives for this type of civil liability provision do you find most compelling, and why? 2.  Given the description of the provisions provided above, can you assess whether the policy objectives will be achieved? 3.  See also Theratechnologies Inc v 121851 Canada Inc, 2015 SCC 18, [2015] 2 SCR 106. If they wish to avoid the hurdles of obtaining leave to bring the actions, or the limits on liability, investors may also base a claim concerning a misrepresentation in continuous disclosure documents on common law actions such as negligent misrepresentation. A significant hurdle for investors in such an action would be proving that they relied on the

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misrepresentation. In similar actions in the United States, courts have accepted proof of reliance on the basis of a “fraud-on-the-market” theory. The fraud-on-the-market theory is based on the assumption that the market is efficient in the semi-strong form. Thus the market price will quickly reflect information contained in continuous disclosure documents. The investor is said to rely on the market price and thus implicitly relies on any misrepresentations in continuous disclosure documents that are reflected in the market price. 50 It has been argued that the theory should not be based on the efficiency of the market, but on whether a misstatement distorted the price of the security. 51

G.  Academic Debate About the Need for Mandatory Disclosure Securities regulation in both Canada and the United States mandates disclosure when securities are distributed to the investing public. This approach to securities regulation has been subject to question. First, studies of the effects of the introduction of mandatory disclosure under the US Securities Act of 1933 suggest that mandatory disclosure in a prospectus on the distribution of securities had no statistically significant effect on the prices of new issues of securities. These studies also found that the risk of new issues of securities went down after the enactment of the Securities Act of 1933.52 While the reduction in risk might be considered a benefit derived from the Securities Act of 1933, it has been suggested that this reduction in risk was largely the result of rejections of new issues of securities in riskier industries such as mining, oil and gas, and merchandising, with no evidence that these issues were overpriced before the enactment of the Securities Act of 1933. Similarly, there appeared to be a shift of riskier bond issues to the unregulated market of private placements.53 A study of the effects of mandated disclosure of financial information also suggested that there were no statistically significant effects on the prices. The study compared firms that had voluntarily disclosed sales information prior to the US Securities Exchange Act of 1934 with firms that had not disclosed sales information. It was hypothesized that if mandatory disclosure under the Securities Exchange Act of 1934 was beneficial, the prices of securities of the non-disclosing firms would go up relative to firms that had voluntarily disclosed the information. However, there was no statistically significant difference in the effects on the prices or risk of securities in the two groups of firms.54

50 See e.g. Peit v Speiser, 806 F2d 1154 (1986); Blaikie v Barrack, 524 F2d 891 (9th Cir 1975); and Basic v Levinson, 108 S Ct 978, 99 L Ed 2d 194 (US Ohio 1988). 51 See JR Macey, GP Miller, ML Mitchell & JM Netter, “Lessons from Financial Economics: Materiality, Reliance, and Extending the Reach of Basic v Levinson” (1991) 77 Va L Rev 1017. 52 See GJ Stigler, “Public Regulation of Securities Markets” (1964) 37 J Bus 117; GA Jarrell, “The Economic Effects of Federal Regulation of the Market for New Security Issues” (1981) 24 JL & Econ 613; and CJ Simon, “The Effect of the 1933 Securities Act on Investor Information and the Performance of New Issues” (1989) 79 Am Econ Rev 295. For a critical comment on the study by Stigler, see I Friend & ES Herman, “The S.E.C. Through a Glass Darkly” (1964) 37 J Bus 382. 53 See Jarrell, supra note 52. 54 See George J Benston, “Required Disclosure and the Stock Market: An Evaluation of the Securities Exchange Act of 1934” (1973) 63 Am Econ Rev 132. For a critical comment on Benston’s study, see I Friend & R Westerfield, “Required Disclosure and the Stock Market: Comment” (1975) 65 Am Econ Rev 467.

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For a sample of the academic literature on mandatory disclosure, see William H Beaver, The Nature of Mandated Disclosure, S Report of the Advisory Committee on Corporate Disclosure to the SEC, 95th Cong, 1st Sess 618, 637-39 (House Comm Print 95-29, 1977); Cynthia Williams, “The Securities and Exchange Commission and Corporate Social Transparency” (1998-99) 112 Harv L Rev 1197 at 1209-12, 1227, and 1233-35; Homer Kripke, “The Myth of the Informed Layman” (1973) 28 Bus Law 631-38; FH Easterbrook & DR Fischel, “Mandatory Disclosure and the Protection of Investors” (1984) 70 Va L Rev 669; and JC Coffee Jr, “Market Failure and the Economic Case for a Mandatory Disclosure System” (1984) 70 Va L Rev 717; O Ben-Shahar & CE Schneider, “The Failure of Mandated Disclosure” (2011) 159 U Pa L Rev 647.

IX.  ENFORCEMENT OF SECURITIES LAW A significant difference between the philosophical underpinning of corporate and securities law is that norms of corporate law are largely intended to be either self-executing or enforced by private shareholder action, such as the oppression remedy, discussed in Chapter 14. In contrast, securities law is characterized by broad enforcement powers for public regulators, both in the sense of practical support to the criminal authorities, and by the availability of administrative sanctioning powers. These enforcement powers are intended to support the attainment of the statutory objectives of securities law, which revolve around investor protection and the fostering of fair and efficient capital markets. An important theme in contemporary Canadian securities regulation has been a heightened attention to the effective exercise of criminal and regulatory enforcement powers, with the sophistication and size of dedicated enforcement divisions within regulatory agencies increasing rapidly in a number of provinces.

A.  Criminal Code Provisions A recent innovation with respect to the involvement of the Criminal Code in securities regulatory issues was the enactment of the specific Criminal Code offence of insider trading in 2004. The following excerpt provides a brief overview of the general Criminal Code context of securities regulatory matters.

Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed (Toronto: Emond, 2017) at 595-97 Prosecution under Criminal Code provisions has not to date been a prominent feature of the enforcement of securities law in Canada. However, it is important to remember that there are a number of provisions therein dealing with securities law infractions, including a more recent prohibition against insider trading. Sections 380-384 as well as s 400 of the Code are relevant in this context. For example, s 380(1) makes it an indictable offence to “by deceit, falsehood or other fraudulent means” defraud the public or any person of “property, money, or valuable security or any service” where the subject matter exceeds five thousand dollars. Section 380(2) creates the offence of affecting the public market

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price of “stocks, shares, merchandise or anything that is offered for sale to the public” with intent to defraud. Section 382 makes it an offence to fraudulently manipulate stock exchange transactions by engaging in various strategies, such as matched orders and wash trading to “create a false or misleading appearance of active public trading.” Meanwhile s 400 indicates that anyone who “makes, circulates or publishes a prospectus … that he knows is false in a material particular, with intent” to induce someone to become a shareholder or partner, or to deceive or defraud members, shareholders, or creditors of a company is guilty of an indictable offence. … Insider trading has recently been established as a Criminal Code offence. Section 382.1(1) makes it an indictable offence to directly or indirectly buy or sell a security “knowingly using inside information” that the accused possesses by virtue of various relationships to the issuer. Section 382.1(2) creates the Criminal Code offence of tipping. It is also notable that Bill C-13 (An Act To Amend the Criminal Code (Capital Markets Fraud and Evidence-Gathering), SC 2004, c 3), recently proclaimed into force in September 2004, increased the maximum term of imprisonment for those convicted of some of these indictable offences from 10 to 14 years. The same revisions also enumerated a set of “aggravating circumstances” that may be considered in imposing a sentence. These include the considerations that (1) the value of the fraud exceeded $1 million; (2) “the offence adversely affected, or had the potential to adversely affect, the stability of the Canadian economy or financial system or any financial market in Canada or investor confidence in such a market”; (3) the offence involved a large number of victims; and (4) in committing the offence, the offender took advantage of the high regard in which the offender was held in the community. The enumeration of these aggravating circumstances clearly reflects the genesis of the Criminal Code revisions in the perceived crisis of investor confidence in North American capital markets after the tumultuous events involving companies such as Enron, Tyco, WorldCom, and Adelphia. In 2011, the federal government passed Bill C-21, titled Standing up for Victims of White Collar Crime Act, which, among other things, imposes a minimum prison sentence of two years for fraud-related offences whose value is in excess of one million dollars. If the past is any guide, however, there appear to have been few prosecutions under the longer-standing Criminal Code provisions. For example, one of the rare prosecutions involving a false prospectus was R v Hawrish (1991), 95 Sask R 100 (QB), aff ’d (1993), 113 Sask R 214, 52 WAC 214 (CA). See also R v Fast, 2014 SKQB 84, aff ’d 2015 SKCA 86.

B.  Quasi-Criminal Provisions A quasi-criminal prosecution for wrongdoing with respect to securities market transactions is a more viable possibility than the use of the Criminal Code. Most provincial securities statutes contain provisions creating quasi-criminal offences that may refer to specific types of wrongdoing (such as fraud or misrepresentation), or may refer more generally to it being an offence to “contravene” securities law.55 For example, OSA s 122(1) provides the following:

55 OSA ss 122 and 126.1, BCSA s 155, NSSA s 129, and ASA s 194.

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Offences, general 122(1)  Every person or company that, (a)  makes a statement in any material, evidence or information submitted to the Commission, a Director, any person acting under the authority of the Commission or the Executive Director or any person appointed to make an investigation or examination under this Act that, in a material respect and at the time and in the light of the circumstances under which it is made, is misleading or untrue or does not state a fact that is required to be stated or that is necessary to make the statement not misleading; (b)  makes a statement in any application, release, report, preliminary prospectus, prospectus, return, financial statement, information circular, take-over bid circular, issuer bid circular or other document required to be filed or furnished under Ontario securities law that, in a material respect and at the time and in the light of the circumstances under which it is made, is misleading or untrue or does not state a fact that is required to be stated or that is necessary to make the statement not misleading; or (c)  contravenes Ontario securities law, is guilty of an offence and on conviction is liable to a fine of not more than $5 million or to imprisonment for a term of not more than five years less a day, or to both.

In 2005, Ontario created an additional quasi-criminal offence of “fraud and market manipulation.”56 There appears to be an increased appetite in a number of provinces for dealing with contraventions of securities law by way of quasi-criminal prosecution as opposed to administrative sanction (discussed below). This is in spite of the consequences for investigative room to manoeuvre57 and the greater procedural protections available to defendants where criminal charges are involved. The excerpt below discusses this phenomenon in the Ontario context.

Mary Condon, “Rethinking Enforcement and Litigation in Ontario Securities Regulation” (2006) 32 Queen’s LJ 1 at 25-27 There has been some increase in Ontario in the use of quasi-criminal remedies in cases like Harper [In the matter of Glen Harvey Harper (2004) 27 OSCB 3937; R v. Harper, [2000] OJ no. 2791 (CJ), [2003] OJ no. 4196 (CA)], Atlas Cold Storage [Re Atlas Cold Storage Income Trust (2001) 24 OSCB 6969], and more recently, Rankin [R v. Rankin, [2005] OJ no. 3202], Discovery Biotech [Re Discovery Biotech Inc. (2003) 26 OSCB 4322] and the von Anhalt matter [OSC v. Anhalt, OJ no. 247 (Sup. Ct.)]. This development is contrary to the alleged “disappearance” of corporate crime in other contexts, [Laureen Snider, “The Sociology of Corporate Crime: An Obituary (or: Whose Knowledge Claims Have Legs?)” (2000) 4 Theor Criminol 2] though the prior baseline of criminal disposition

56 See OSA s 126.1. The revised but unproclaimed British Columbia Securities Act contained a similar offence and a further lengthy list of contraventions of BC securities law that would have been considered to be offences: see proposed BCSA s 81. 57 For example, according to a number of provincial securities statutes, it is possible to compel testimony pursuant to an administrative hearing, but not where a criminal trial is contemplated: see R v Jarvis, 2002 SCC 73, [2002] 3 SCR 757.

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in Ontario securities matters was very low. As indicated earlier, the current Chairs of both the OSC and SEC have indicated a pre-commitment to the strategy of exacting criminal penalties for securities-market related infractions. In practice, there are a number of difficulties associated with using criminal or quasicriminal provisions to ground sanctions. One is the perennial problem of the time it takes to get a resolution in a criminal matter. It is a staple of deterrence-based thinking that punishment has to come swiftly and sharply for maximum effect. Yet difficulties of investigation, such as accessing and interpreting large quantities of documents, and obtaining court dates for a variety of pre-trial matters, often preclude this. A notorious example is the Livent matter, where several charges have been dropped and the trial is not expected to start until the spring of 2007, some nine years after allegations of fraud and inaccurate financial reporting first surfaced. [Paul Waldie and Richard Blackwell, The Globe and Mail, 23 September 2005, B5.] Similarly, Mr. J. Khawly noted in his decision in Rankin that “justice for the public or Mr. Rankin has not been swift as this matter has taken four years to come to trial.” [Rankin, supra, at para. 7.] Another pervasive strategic issue for enforcement staff, of course, is the evidentiary protection provided in the OSA surrounding the use that may be made of compelled testimony. OSA s. 13 allows enforcement staff to compel testimony in the course of an investigation, but s. 18 goes on to provide that this testimony may not be admitted in evidence in a prosecution under s. 122. These provisions offer a lot more scope to gather evidence pursuant to a s. 127 hearing than to a quasi-criminal action. Relatedly, the Rankin case illustrates how prosecutors may expose themselves to criticism in the effort to obtain the cooperation of witnesses in trials so as to sustain a criminal burden of proof. [See R v Drabinsky, 2009 CanLII 12802 (Ont Sup Ct J).]

C.  Administrative Orders Based on Public Interest Criteria For practical purposes, the authority given to securities regulators in most provincial securities acts to impose sanctions following an administrative hearing or settlement process is the most important dimension of the securities enforcement enterprise in Canada. Much attention has been paid in recent years to the legitimacy, scope, and challenges of the availability of these powers in Canadian securities regulation.58 Briefly, note that the standard for applying an administrative sanction under the provisions of Canadian securities acts is typically that a sanction should be applied because it is in the “public interest” to do so. The concept of the public interest is not a defined term in securities statutes, although a variety of meanings for it have been explicated in regulatory jurisprudence.59 The provisions 58 See Committee for the Equal Treatment of Asbestos Minority Shareholders v Ontario (Securities Commission), 2001 SCC 37, [2001] 2 SCR 132; Re Cartaway Resources Corp, 2004 SCC 26, [2004] 1 SCR 672; In the Matter of Paul Donald, [2012] 35 OSCB 7383, 4 BLR (5th) 252; Mary Condon, “Rethinking Enforcement and Litigation in Ontario Securities Regulation” (2006) 32 Queen’s LJ 1 at 7-20 (extracted above in this chapter); Poonam Puri, “Enforcement Effectiveness in the Canadian Capital Markets: A Policy Analysis” (Toronto: Capital Markets Institute, University of Toronto, June 14, 2005); and Anita Anand, “Carving the Public Interest Jurisdiction in Securities Regulation: Contributions of Justice Iacobucci” (2007) 57 UTLJ 293. 59 See Mary Condon, “The Use of Public Interest Enforcement Orders by Securities Regulators in Canada” in A Douglas Harris, ed, WPC—Committee to Review the Structure of Securities Regulation in Canada: Research Studies (Ottawa: Department of Finance, 2003).

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according authority to securities regulators to make public-interest – based orders have also been interpreted to mean that no specific breach of securities law is required to ground many of the orders that may be made.60 Examples of orders that may be made include an order that registration may be suspended or restricted; an order that trading in any securities cease permanently or temporarily; an order that market participants must submit to a review of their practices and procedures and institute changes; reprimands; resignation as an officer or director of an issuer; an administrative penalty of not more than $1 million per failure to comply with Ontario securities law; and disgorgement of any amounts obtained as a result of non-compliance with securities law. The same set of events may ground a quasicriminal prosecution as well as an administrative sanction.61 Meanwhile, in Cartaway, below, the Supreme Court has supported the use of administrative sanctioning powers to achieve goals of general deterrence of wrongdoing in securities markets.

Re Cartaway Resources Corp 2004 SCC 26, [2004] 1 SCR 672 LEBEL J:

[55]  In this appeal we are asked whether it is reasonable to decide that general deterrence has a role to play in the policing of capital markets. The conventional view is that participants in capital markets are rational actors. This is probably more true of market systems than it is of social behaviour. It is therefore reasonable to assume, particularly with reference to the expertise of the Commission in regulating capital markets, that general deterrence has a proper role to play in determining whether to make orders in the public interest and, if they choose to do so, the severity of those orders. •  •  •

[60]  In my view, nothing inherent in the Commission’s public interest jurisdiction, as it was considered by this Court in Asbestos [Committee for the Equal Treatment of Asbestos Minority Shareholders v Ontario (Securities Commission), 2001 SCC 37, [2001] 2 SCR 132], prevents the Commission from considering general deterrence in making an order. To the contrary, it is reasonable to view general deterrence as an appropriate, and perhaps necessary, consideration in making orders that are both protective and preventative. Ryan JA recognized this in her dissent: “The notion of general deterrence is neither punitive nor remedial. A penalty that is meant to generally deter is a penalty designed to discourage or hinder like behaviour in others” (para. 125). •  •  •

[65]  In my opinion, increasing the amount of the fine is not “a vexatious and capricious exercise of the Commission’s discretion” but sends a clear message to other actors in the British Columbia securities market that a breach of s. 61 will be dealt with severely, and it is rational to assume that this conduct will accordingly be deterred. The Commission stressed the seriousness of the respondents’ conduct and the damage done to the integrity of the capital markets, and found that when making an order that is in the public interest, 60 This is not the case with respect to an administrative penalty under the BCSA and the OSA. 61 See In the Matter of Glen Harvey Harper (2004), 27 OSCB 3937.

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“[w]e are obliged to take whatever remedial steps we determine are appropriate to maintain the public’s confidence in the fairness of our markets” (para. 14). QUESTIONS

1.  From the point of view of a business entity considering various ways to raise capital, what is the significance of the existence of the broadly based enforcement powers that may be exercised by securities regulators? 2.  More generally, given all that you have read in this chapter about the disclosure requirements imposed by securities law and the risks of being sued or being the target of enforcement action, why do you think issuers are willing to enter the capital markets at all? 3.  Do you think the interests being served by current norms of securities law are the right ones?

X. CONCLUSION This chapter has summarized some of the major securities law considerations associated with establishing and running a business enterprise. It has canvassed the various opportunities provided therein for capital to be raised from investors with minimal legal obligations. It has also provided an overview of the “going public” process and the ongoing requirements imposed by securities law on public companies.

CHAPTER EIGHT

Social Enterprises









I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515 II.  Origins of Social Enterprise Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 524 A.  Co-operative Associations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 527 B.  Not-for-Profit Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 533 C.  For-Profit Social Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542 III.  International Developments in Social Enterprise Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549 A.  United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550 1.  Community Interest Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550 B.  United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 552 1.  Low-Profit Limited Liability Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 552 2.  Benefit Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 554 C.  Other Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 562 IV.  Social Enterprise Law in Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569 A.  Co-operative Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 571 1.  Solidarity Co-operative (Québec) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 571 2.  Renewable Energy Co-operative (Ontario) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 572 3.  New Generation Co-operative (Prairies) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 572 4.  Community Service Co-operative (British Columbia) . . . . . . . . . . . . . . . . . . . . . 573 B.  Community Contribution Company/Community Interest Company . . . . . . . . . . 573 1.  Community Contribution Company (British Columbia) . . . . . . . . . . . . . . . . . . . 574 2.  Community Interest Company (Nova Scotia) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 576 V.  Introduction to Social Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578 A.  Responsible Investment/Socially Responsible Investment . . . . . . . . . . . . . . . . . . . 579 B.  Impact Investing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 585 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 587

I. INTRODUCTION The cross-sectoral expansion of corporate social responsibility (CSR) is becoming apparent on the global stage. Businesses are evolving to better incorporate stakeholder approaches in their strategic management, and are facing mounting expectations to engage in sustainable practices.1 Yet increasingly complex economic, societal, geopolitical, environmental, and technological challenges have accelerated the search for new and sustaining relationships to bind our global community. Although societies and not-for-profit corporations, 1 Chapter 10 provides further discussion on the stakeholder debate and issues in CSR.

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discussed briefly in Chapter 1, have traditionally been regarded as the main corporate legal forms to address social needs, social entrepreneurship is gaining momentum. Innovative business is being regarded as a powerful tool in confronting social and environmental challenges. This chapter addresses the proliferation of social enterprises and subsequent law that has developed alongside this phenomenon. To date, there is no official legal form solely attributed with the term “social enterprise,” allowing considerable room for businesses to selfidentify. There is some disagreement within and among nations as to what constitutes a social enterprise. The term has been used quite broadly, with the tendency to encompass (1) enterprising non-profits, meaning societies or not-for-profit corporations that engage in business activities for the dual purposes of generating revenue and furthering their social mandates; (2) corporations whose primary purpose is the common good; or (3) a corporate group formation of the two. However, the term is not limited to these corporate vehicles, and has been applied to businesses using other legal forms as well, such as co-operative associations, partnerships, etc. In fact, co-operative associations have long been associated with socio-economic development in communities. In Canada, the outcropping of new strains of co-operative associations, such as solidarity co-operatives in Québec, new generation co-operatives in the Prairies, and community service co-operatives in British Columbia, only emphasizes the importance of this old legal form to the revitalization of local industries and socially innovative business. In addition, Canada has begun to implement other new legal forms specifically designed to address social enterprise, notably the community contribution company in British Columbia in 2013, and the community interest company in Nova Scotia in 2016. These legal forms are discussed in Section IV of this chapter. Governments are beginning to provide general definitions and guidelines on social enterprises, and consistently affirm that there is no single legal form for social enterprises. The European Commission, for example, has defined social enterprise as “an operator in the social economy whose main objective is to have a social impact rather than make a profit for their owners or shareholders” and has noted that its usage of the term covers the following types of business: • Those for who the social or societal objective of the common good is the reason for the commercial activity, often in the form of a high level of social innovation; • Those where profits are mainly reinvested with a view to achieving this social objective; • Those where the method of organisation or ownership system reflects the enterprise’s mission, using democratic or participatory principles or focusing on social justice.2

In 2002, the United Kingdom’s Department of Trade and Industry (now the Department for Business, Energy & Industrial Strategy) provided the following definition: A social enterprise is a business with primarily social objectives whose surpluses are principally reinvested for that purpose in the business or in the community, rather than being driven by the need to maximise profit for shareholders and owners. Social enterprises tackle a wide range of social and environmental issues and operate in all parts of the economy. By using business solutions to achieve public good, the Government

2 European Commission, “Social Enterprises,” online: .

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believes that social enterprises have a distinct and valuable role to play in helping create a strong, sustainable and socially inclusive economy. Social enterprises are diverse. They include local community enterprises, social firms, mutual organisations such as co-operatives, and large-scale organisations operating nationally or internationally. There is no single legal model for social enterprise. They include companies limited by guarantee, industrial and provident societies, and companies limited by shares; some organisations are unincorporated and others are registered charities. 3

The Canadian federal government has also defined social enterprise. In 2016, the Ministry of Innovation, Science and Economic Development provided the following definition: A social enterprise seeks to achieve social, cultural or environmental aims through the sale of goods and services. The social enterprise can be for-profit or not-for-profit but the majority of net profits must be directed to a social objective with limited distribution to shareholders and owners.4

At the same time, the federal government began developing a national Directory of Canadian Social Enterprises on its Canadian Company Capabilities database. Organizations that self-identify as social enterprises are permitted to register and be featured on the directory. Social Enterprise Canada (now the Social Enterprise Council of Canada) has offered four reasons why there has been a rapid growth of social enterprises across the nation: • the general understanding that there are some needs the market will never meet on its own; • the opportunity for entrepreneurs to advance mission-related goals; • the diminished and changing nature of government funding; and • the promise of social enterprise as a vehicle for social innovation.5 The growing popularity of several organizations dedicated to social entrepreneurship such as Ashoka and MaRS Discovery District, and notable journals including the Stanford Social Innovation Review, which began in 2003, showcase a rising interest in the integration of business with social activism. The field of social enterprises is continually evolving. While the definitions provided by governments in the United Kingdom and Canada do not limit social enterprises to particular corporate legal forms, social entrepreneurs have begun to test the limits on governing and financing features when selecting the appropriate legal infrastructure to house their social businesses. Although traditional forms of business organizations have served as the legal base for social enterprises, critics have found the self-labelling of businesses problematic. The branding advantages of being labelled as a social enterprise are not currently accompanied by appropriate regulation. Legislators have responded by creating new corporate legal

3 United Kingdom, Department of Trade and Industry, “Social Enterprise: A Strategy for Success” (2002) at 7, online: . 4 Government of Canada, “Directory of Canadian Social Enterprises,” online: . 5 Social Enterprise Canada, The Canadian Social Enterprise Guide, 2nd  ed (Vancouver: Enterprising NonProfits, 2010) at 4, online: .

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forms to meet growing demands, with mixed results. These new corporate forms offer a hybridization of both for-profit and non-profit legal characteristics to govern businesses pursuing dual economic and social mandates. This hybrid form of business law is referred to in this chapter as social enterprise law. This chapter provides an overview of the development of social enterprise law that has transpired alongside the burgeoning field of social enterprise and its impact on Canada. Section II offers a brief history of the origins of social enterprise and focuses on co-operative associations, not-for-profit corporations, and the growing transition toward for-profit social enterprises. Section III examines international developments in social enterprise law, which informs much of the progress in Canada. This section looks specifically at the community interest company in the United Kingdom, and the low-profit limited liability company and benefit corporation in the United States. The section also provides a brief overview of other legal structures designed for social enterprise that are developing across the globe. Section IV then sets out the current social enterprise laws in Canada, including new co-operative forms appearing across the country, and in particular the community contribution company and community interest company enacted in British Columbia and Nova Scotia, respectively. Section V provides a brief introduction to social finance, and Section VI concludes.

In the excerpt that follows, McMurtry and Brouard provide a conceptual overview of the development and role of social enterprises in Canada, taking into account diverse histories across the country. They categorize the common legal structures accompanying social enterprises as co-operatives, non-profit organizations, community development/interest organizations, First Nation businesses, and various legal forms representing businesses with a social mission. First Nations business structures are discussed at greater length in Chapter 4.

JJ McMurtry & François Brouard, “Social Enterprises in Canada: An Introduction” (2015) 6:1 Can J Nonprofit & Soc Econ Research 6 at 10-16 (citations omitted) Conceptual As a result of the wide range of cultures, regions, and influences in the Canadian social enterprise context, it should be no surprise that there are debates and tensions around the conceptualization of social enterprise in Canada. The ways in which these debates play out often reflect the historical and cultural contexts that are specific to Canada. There are consequently tensions in the patterns of emergence of these concepts that range from social movement articulation (e.g., the emergence of social economy in Québec, or placebased business in Eastern Canada) to government imposition through policy (e.g., Ontario’s creation of “community cooperatives” for alternative energy or its Impact Plan for Social Enterprise) that often happens without consultation of established organizations and movement players. Finally, the concept of social enterprise has in certain cases been “hijacked” by established for-profit businesses that enjoy the “branding” advantage that the idea of social enterprise brings. All of these disagreements create a climate of

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contestation and confusion in the public sphere, which does, and will continue to have, an impact on the practice of social enterprise as it develops. In other words, what forms a social enterprise “should” or “could” take are not yet fully articulated (and perhaps should not be), and the idea of a standard typology is not firmly established nationally, despite the fact that there are strong regional understandings and practices. Despite all of these tensions however the undeniable reality across Canada is that social enterprise is a concept and practice that is taking hold “on the ground,” and is a creative, emerging sector of the economy. Further, while not dominant, it is a concept that is explicitly used in every area of the country and has been formalized in legislation in a variety of jurisdictions. Academics and civil society activists have also taken up the term in a variety of ways, but the fact is that policy makers, academics, and activists are just starting to catch up to the innovations on the ground. … •  •  •

Identification of Social Enterprise (SE) Models … [W]e highlight five types of practice in the country that are emblematic of social enterprise and are present—although unevenly developed—in all cultural contexts. We have taken this approach to get past the “noise” of social enterprise discussion and look at how it is actually practiced on the ground. From these practices we have identified certain values within social enterprise in the Canadian context. We must remember that given the different histories and practices of the various social enterprises in Canada, these organizations have a desire to be classified in a number of different ways, depending on the audience and what is at stake in the classification (funding, public perception, regulatory rules, political climate, etc.). For example, cooperatives in Canada will variously identify as: social enterprises, social economy organizations, cooperatives, successful for-profit businesses, and sustainable, “green,” and “good” enterprises. The issue for researchers is to penetrate these discourses by identifying the cultural, economic, and political contexts within which they are employed and look to how cooperatives actually practice their values and undertake their business. … Despite the different theories of social enterprise mentioned above, we identified five main sets of social enterprise practice that cut across the cultural and policy regimes: cooperatives, market-oriented nonprofit organizations, community development/interest organizations, Indigenous businesses, and business with a social mission. We identify these five models because they have clear, if diverse, fields of activity, distinct social missions and target groups, legislative supports, and governance models. Perhaps most importantly, they are almost exclusively the organizational forms that social enterprises take in the Canadian context. We will discuss each in turn. The cooperative movement in Canada touches almost every economic sector (with the manufacturing sector being the major exception) and has developed six distinct forms to address the different needs of these economic activities. Crucial to the cooperative form are the values of member ownership and control through democratic processes and the economic betterment of members through product quality, price and/or dividend. First, and most common, are consumer cooperatives (including housing, and goods and services cooperatives), which are focused on the delivery of specific consumer goods to members at affordable prices—the key examples being in natural and organic food,

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outdoor equipment, cooperative advocacy groups, and full-service supermarkets in rural and urban underprivileged areas (Neechi Foods in Winnipeg, Manitoba, is an excellent example of this type of social enterprise). Secondly, there is the historically important form of producer cooperatives, which link up producers (usually agricultural producers, including fisheries) to marketing cooperatives to bring goods to market, thereby creating economies of scale for smaller producers as well as significant economic dividends for producers. In every region of Canada, producer cooperatives have emerged (historically in farm marketing), and continue to emerge, especially in niche and high-quality food sectors like organic food. They have also been particularly important to the development of the economies in each region and cultural group, and continue to be an important part of the identity of these regions. Thirdly, worker cooperatives have emerged to provide the social good of work and economic security for their members. While there are historical worker cooperatives in resource extraction (in fishery or forestry for example), in many parts of Canada, the key areas of emergence in the last thirty years are in goods and services such as fair trade products (namely coffee, tea, chocolate, and sugar) and retail, construction, and a variety of specialty services and goods. Fourthly, financial (credit unions) and insurance cooperatives are technically a type of consumer cooperative, but have developed into their own unique type of cooperative, with specific legislation and economic clout beyond any other cooperative sector. While these cooperatives have been experiencing increasing mergers and acquisitions over the past decade, with very few new financial cooperatives emerging, they are important players as financers and facilitators of other forms of cooperatives and, potentially, social enterprise. For example, Vancity Credit Union and other British Columbia – based finance cooperatives have underwritten much of the social enterprise sector development in the province. Fifthly, cooperatives have also innovated over their long history in their governance structures, creating new forms of cooperatives, specifically federations and other amalgamated organizations, which have become facilitators of cooperative social enterprises. Perhaps the most famous international organization of this type is Mondragon in the Basque region of Spain. In Canada, the most famous forms of federated cooperatives are the Co-operators Insurance Co-operative and Desjardins Credit Union. There are also new forms of cooperatives emerging in both the service (for example the provincial and national cooperative organizations) and product sectors (federations of cooperative foodbuying clubs for example), as well as cooperatives that have their own specific legislative frameworks (such as renewable energy cooperatives in Ontario), which focus on achieving new and emerging social goals, member economic benefit, and regional economic development. The sixth and final form of cooperative enterprise in Canada are the multi-stakeholder or, in Québec, solidarity cooperatives, which combine different member groups (for example consumers and workers) in one cooperative to achieve the broad social goals articulated by those member groups within a single economic organization. So far, these have been very hard to develop but could become increasingly popular. The cooperative “set” of social enterprises (including the nonprofit cooperatives— although inclusion of them under the umbrella of social enterprise is contested) in Canada

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can be therefore seen to be active in a variety of fields of economic activity, to serve a broad and diverse series of social goals, and to employ a range of governance structures, depending on the membership and stakeholders with which the cooperative is concerned. It would not be an overstatement to claim that cooperatives have the most developed legislative frameworks and practical experience of all social enterprises in Canada, even if they are often not considered by policy makers, or the public at large, as the most interesting form of social enterprise. Non-profit organizations in Canada are also active in every region of Canada and have a long and varied history in the social enterprise realm. Despite provincial regulation of incorporation (e.g., via various provincial “society acts”), the fact that the federal government can award them charitable status (which comprise about half of registered nonprofits in Canada) means that they are much more closely connected to the federal government, as opposed to provincial or municipal entities, and therefore their organizational form is far less variant. This is not to say that the range of activities with which non-profits are involved is in any way singular. In fact, they are remarkably diverse in activity, even if their governance structures tend to be similar, with an independent management team and a volunteer board responsible for strategic decisions. This diversity is expanding with the recent tendency for non-profits to be engaged not just in service delivery, which would not, under most definitions, be considered social enterprise proper, but also in incubating and becoming reliant upon income-generating enterprises, either as part of the core activities of the nonprofit or as wholly-owned subsidiaries of these entities. Community development/interest (CD/CI) organizations in Canada form an emergent (although they began to emerge in the 1960s) set of social enterprises that are often on the cutting edge of policy and practice in Canada. Again, like cooperatives and non-profit organizations, CD/CI enterprises have a variety of fields of activities, social missions, and target groups. However, unlike the previous two types of social enterprise, they are not as well articulated in policy, legislation, or governance at the national level as CD/CI organization (although many are incorporated as non-profits or cooperatives). Indeed, outside of Québec and the Atlantic region, these organizations are largely self-regulating as CD/CI entities and entrepreneurial in their social goals and organizational structure. These are essentially organizations born of social movements or social movement actors. A good exemplar of these types of organization across Canada is the unregulated “fairly traded” or “level trading” organizations (as opposed to the certified “fair trade” and largely cooperative businesses). These businesses undoubtedly have a social mission; however, the regulation of their mission by the state, or an independent NGO-regulating body, is entirely absent. They therefore rely on trust and the belief of their clientele in their authenticity, and the quality of their boards or staff, which raises questions about the guarantee of their social mission and their status as social enterprises. This type of unregulated and unauthenticated social enterprise loosely associated with a social mission or social movement is becoming more and more prevalent in an increasingly crowded “social business” marketplace and raises the question of the role of the state and NGOs in ensuring verifiable social content. Indigenous business forms the fourth set of social enterprises in the Canadian context. Again these social enterprises have a broad field of activity, including work integration, tourism, basic good provision, culturally specific goods and services, resource extraction, and trade in commercial goods. However, what distinguishes this

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form of social enterprise from other social enterprise forms, such as cooperatives, nonprofits, and community development/interest corporations, is their specific focus on Indigenous community well-being as their primary social goal. In some cases (Membertou First Nation in Cape Breton being one), the economic activities that the First Nation is involved in are almost indistinguishable from capitalist businesses (such as brand name hotels, restaurants, and gas stations), except for the fact that they are incorporated and owned by Indigenous communities, usually through their band councils, who use the profits to develop community resources such as schools and infrastructure. In the context of ongoing economic colonialization, these social enterprises are distinct and challenge dominant understandings of social enterprises. For example, many Indigenous economic entities are, both in law and practice, collectively owned if they are located on band land or use band resources. Many of the sources of capital and resources that facilitate individual businesses are also directly connected to Indigenous government or treaty rights. For example, the tax exemptions, as a result of treaty rights, can facilitate Indigenous businesses (often in “sin” businesses such as casinos, gas stations, and cigarette and alcohol retailers) that can use the profits from these activities to fund social projects for the good of the community. As the youngest and fastest growing demographic group in Canada, Indigenous people have enormous potential as sites of social entrepreneurship and social enterprise activity. Finally, businesses with a social mission form a distinct type of social enterprise, mainly in the central and western provinces of Canada, although the inclusion of these entities within the social enterprise family is contested. These are often, but not exclusively, traditional sole-proprietorship or even publically traded corporations that articulate a strong social mission in one area of their businesses. They can also be part of, or strongly associated with, foundations or other granting agencies. Again, the types of activity that these organizations can be involved in are widely variable, because inclusion requires simply some kind of publically recognized social mission. What distinguishes them from the first three forms is that they are traditional for-profit businesses first. The fact that they are incorporated to achieve, or focus on, or are “retrofitted” to target an identifiable social mission is what their proponents argue makes them social enterprises. It is likely that, if the definition of social enterprise remains an open category in the public’s minds and in policy circles, this type of social enterprise will become increasingly popular as businesses try to “social-wash” their activities. Table A [provided on the next page] summarizes the five social enterprise models in Canada along the legal structure and ownership dimensions and provides a few examples of social enterprises for each model.

The social enterprise phenomenon has emerged among local, national, and international trends in sustainability and business, and continues to grow. Canada’s early developments in social enterprise law offer a live experiment on the intersection of law and social entrepreneurship. To help situate Canada’s position in an international context, Section II explores the broader history of social enterprise around the world and its early formations in cooperative associations and not-for-profit corporations.

Cooperative

Individuals

MEC, Agropur, Atlantic, Desjardins, Alterna, Sumac Worker Cooperative, Neechi Foods

Ownership

Examples

Cooperative

Legal structure

Models

FoodShare, SABRI

Members

Non-profit corporation; Charities (charitable organization, foundation (private, public) Association; Informal Group

Non-profit organization

Carrefour Jeunesse Emploi, ZEC

Community, Government (local, provincial, federal)

Community enterprise; Community-owned organizations; Associations

Community development/ interest organization

First Nation businesses

KUTERRA, Membertou

First Nation

Non-profit corporation; For-profit corporation; Partnership; Unincorporated business

Table A: Summary of Canadian Social Enterprise Models

Groupe Convex, Communauto

Public Individuals

For-profit corporation; Partnership; Unincorporated business; Community Interest Company (CIC); Community Contribution Company (CCC)

Business with a social mission

I. Introduction 523

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II.  ORIGINS OF SOCIAL ENTERPRISE LAW

Jacques Defourny & Martha Nyssens, “Social Enterprises” in K Hart, J-L Laville & D Cattani, eds, The Human Economy: A Citizen’s Guide (Cambridge, UK: Polity Press, 2010) 284 at 284-87 (citations omitted) 1.  Historical Backgrounds Field organizations, corresponding to what is now called “social enterprises,” have existed since well before the mid-1990s when the term began to be increasingly used in both Western Europe and the United States. Indeed, the third sector, be it called the nonprofit sector, the voluntary sector or the social economy (which includes cooperatives according to a European tradition), has long witnessed entrepreneurial dynamics which resulted in innovative solutions for providing services or goods to persons or communities whose needs were neither met by private companies nor by public providers. However, for reasons which vary according to specificities of national or regional contexts, the concept of social enterprise is now gaining a fast growing interest across the world along with two closely related terms, namely “social entrepreneur” and “social entrepreneurship.” 1.1.  Western Europe In Europe, the concept of “social enterprise” as such seems to have first appeared in Italy, where it was promoted through a journal launched in 1990 and entitled Impresa sociale. In the late 1980s indeed, new co-operative-like initiatives had emerged in this country to respond to unmet needs, especially in the field of work integration as well as in the field of personal services. As the existing legislation did not allow associations to develop economic activities, the Italian Parliament passed a law in 1991 creating a new legal form of “social cooperative” which proved to be very well adapted to those pioneering social enterprises. The remarkable development of the latter also inspired various other countries during the following two decades, across Europe and outside the latter (for instance in South Korea). Indeed, several other European countries introduced new legal forms reflecting the entrepreneurial approach adopted by this increasing number of “not-for-profit” organizations, even though the term of “social enterprise” was not always used as such in the legislation. In many European countries, beside the creation of new legal forms or frameworks, the 1990s have seen the development of specific public programs targeting the field of work integration. Social enterprises may be active in a wide spectrum of activities, as the “social purpose” they pursue may refer to many different fields. However, since the mid-1990s, one major type of social enterprise has been dominant across Europe, namely “work integration social enterprises” (WISEs). The main objective of work integration social enterprises is to help low qualified unemployed people who are at risk of permanent exclusion from the labour market and to integrate these people into work and society through a productive activity. This has even led, in several cases, to

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the concept of social enterprise being systematically associated with such employment creation initiatives. 1.2.  The United States In the US, the first root regarding the debate on social entrepreneurship and social enterprises refers to the use of commercial activities by non-profit organizations in support of their mission. Although such behaviour can be traced back to the very foundation of the US, when community or religious groups were selling homemade goods or holding bazaars to supplement voluntary donations, it gained a particular importance in the specific context of the late 1970s and 1980s. The downturn in the economy in the late 1970s led to welfare retrenchment and to important cutbacks in federal funding. Nonprofits then began to expand their commercial activities to fill the gap in their budget through the sale of goods or services not directly related to their mission. Based on a broader vision of entrepreneurship, the second root of this debate can be traced back to B. Drayton and Ashoka, the organization he founded in 1980, as its primary driving forces. The mission of Ashoka was (and still is) to identify and support outstanding individuals with pattern setting ideas for social change. Ashoka focuses on the profiles of very specific individuals, first referred to as public entrepreneurs, able to bring about social innovation in various fields, rather than on the forms of organisation they might set up. Various foundations involved in “venture philanthropy,” such as the Schwab Foundation and the Skoll Foundation, among others, have embraced the idea that social innovation is central to social entrepreneurship and provide support to social entrepreneurs. 2.  Major Conceptualizations of Social Enterprise and Social Entrepreneurship When looking at the US landscape, what is striking is the diversity of concepts which have been used since the early 1980s to describe entrepreneurial behaviours with social aims that developed in the country, mainly although not exclusively within the non-profit sector: “non-profit venture,” “non-profit entrepreneurship,” “social-purpose endeavour,” “social innovation,” “social-purpose business,” “community wealth enterprise,” “public entrepreneurship,” “social enterprise” … Although the community of non-profit studies early identified trends towards commercialization, the bulk of this conceptual debate has been shaped by scholars belonging to business schools. To classify the different conceptions, Dees and Anderson have proposed to distinguish two major schools of thought. The first school of thought on social entrepreneurship refers to the use of commercial activities by non-profit organizations in support of their mission. Organizations like Ashoka fed a second major school, named the “social innovation” school of thought. •  •  •

2.1.  The “Earned Income” School of Thought The first school of thought set the grounds for conceptions of social enterprise mainly defined by earned-income strategies. The bulk of its publications was mainly based on nonprofits’ interest to become more commercial and could be described as “prescriptive”: many of them came from consultancy firms and they focused on strategies for starting a

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business that would earn income in support to the social mission of a non-profit organization and that could help diversify its funding base. In the late 90s, the Social Enterprise Alliance, a central player in the field, defined social enterprise as “any earned-income business or strategy undertaken by a non-profit to generate revenue in support of its charitable mission.” Such a market-oriented conception of social enterprise crossed the ocean when a “Social Enterprise Unit” was created by the UK government to promote social enterprise across the country. Although no reference was made to the percentage of market resources in the definition adopted by the Social Enterprise Unit or in the Community Interest Company (CIC) law, it is widely accepted that a significant part (usually 50% or more) of the total income must be market-based for an organization to qualify as a “social enterprise.” In such a perspective, it is straightforward to name that first school the “earned income” school of thought. Within the latter however, we suggest a distinction between an earlier version, focusing on nonprofits, that we call the “commercial non-profit approach,” on the one hand, and a broader version, embracing all forms of business initiatives, that may be named the “mission-driven business approach,” on the other hand. This latter approach also refers to the field of social purpose venture as encompassing all organizations that trade for a social purpose, including for-profit companies. 2.2.  The “Social Innovation” School of Thought This second school puts the emphasis on social entrepreneurs in the Schumpeterian meaning of the term, in a perspective similar to that adopted earlier by the pioneering work of Young. Along such lines, entrepreneurs in the non-profit sector are change makers as they carry out “new combinations” in at least one the following areas: new services, new quality of services, new methods of production, new production factors, new forms of organizations or new markets. Social entrepreneurship may therefore be a question of outcomes and social impact rather than a question of incomes. Moreover, the systemic nature of innovation brought about and its impact at a broad societal level are often underlined. Dees has proposed the best known definition of social entrepreneurs. He sees the latter as “playing the role of change agents in the social sector by adopting a mission to create and sustain social value, recognizing and relentlessly pursuing new opportunities to serve that mission, engaging in a process of continuous innovation, adaptation and learning, acting boldly without being limited by resources currently in hand, and finally exhibiting a heightened sense of accountability to the constituencies served and for the outcomes created.” Although many initiatives of social entrepreneurs result in the setting up of non-profit organizations, most recent works of this school tend to underline blurred frontiers and the existence of opportunities for entrepreneurial social innovation within the private for-profit sector and the public sphere as well. By the way, the concept of social entrepreneurship is increasingly described as a very wide spectrum and often appears as the broadest of the three “SE concepts.” The divergence between the “social innovation” school and the “earned income” school should not be overstated, though. Viewing social entrepreneurship as a mission-driven business is increasingly common among business schools and foundations which foster

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more broadly business methods, not just earned-income strategies, as a path towards social innovation. Recent works increasingly stress a “double bottom line” vision as well as the creation of a “blended value” in an effort to really balance and better integrate economic and social purposes and strategies. The overview by Defourny and Nyssens offers only a brief glimpse into the dynamic and complex social enterprise movement that has appeared on the world’s stage. While the term “social enterprise” has been employed for some time, co-operative associations and not-forprofit corporations have been around far longer, and have often served as a bridge in providing social goods and services unmet by the public and private sectors.

A.  Co-operative Associations The co-operative association (also known as “co-operative ownership”) is one of the oldest corporate legal forms in the world. As noted in Chapter 1, co-operative associations have several legal characteristics that are similar to those of corporations. Federally incorporated co-operative associations are governed by the Canada Cooperatives Act,6 and provinces have similar provincial statutes. Federal incorporation is available only to those co-operatives that operate in two or more provinces and have a fixed place of business in more than one province. The co-operative model allows members the flexibility to pursue social, environmental, and/or economic mandates in a particularly collaborative manner. The co-operative is highly adaptable to meet a variety of community development needs because of its institutional flexibility. The McMurtry and Brouard article excerpted in Section I identifies six different forms of co-operatives that have extended across industries in Canada, and Section  IV.A highlights new governance forms that have taken shape within co-operative laws. Generally, co-operatives can be created for a wide range of purposes and activities, from purely commercial to charitable. While primarily driven to achieve member benefits, co-operatives can make community benefits their first priority, or they can combine member and community benefits as they choose. The main difference between the co-operative association and the corporation is that the roles of members and stakeholders are closely connected in a co-operative. A member is an individual who shares control of the co-operative and who is also a user of the co-operative in some way. This arrangement is distinct from that of a shareholder in a corporation. While the shareholder holds shares in the business—and thereby the possibility of control—the shareholder is not by definition a user of the business. In 1937, the International Co-operative Alliance adopted the following seven principles of the co-operative movement:

1. voluntary and open membership; 2. democratic member control and equal voting rights; 3. member economic participation to the capital of their co-operative;

6 Canada Cooperatives Act, SC 1998, c 1.

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Chapter 8  Social Enterprises 4. autonomy and independence to preserve the democratic power; 5. education, training, and information on the nature and the advantages of the co-operative; 6. cooperation among co-operatives locally, nationally, and internationally; and 7. concern for the sustainable development of the community.

Section 7 of the Canada Cooperatives Act draws upon these universal principles, codifying the following conditions in which a co-operative “is organized and operated, and carries on business, on a cooperative basis”: (1) membership is open; (2) each member has only one vote; (3) no member may vote by proxy; (4) there is limited interest on member loans; (5)  there are limited dividends on member shares; (6)  to the extent feasible, members provide the capital required by the co-operative; (7)  surplus funds are distributed to develop the business, improve common services, provide reserves to pay interest on member loans, for community welfare, or as a distribution among members as a patronage return; and (8)  the co-operative educates its members on the principles and techniques of co-operative enterprise. By pooling their resources and working together, members can satisfy a common need through the co-operative. Joint democratic membership means that all members are at least notionally equal decision-makers. Members share the benefits of the co-operative based on how much they use its services. Success is not necessarily defined as profitability, but by other metrics as well, such as the improved well-being of the members and the communities that they inhabit. The ability to quantify value beyond simply economic return in response to members’ needs is regarded as one of the strengths of the co-operative model. In the excerpt that follows, Fici introduces some of the core tenets of co-operative law that distinguish co-operative associations from other legal entities.

Antonio Fici, “Introduction to Cooperative Law” in Dante Cracogna, Antonio Fici & Hagen Henr¨y, eds, International Handbook of Cooperative Law (Berlin: Springer-Verlag, 2013) at 16-25 (footnotes omitted) 1.3  Functions of Cooperative Law and Cooperative Identity Cooperative law falls within organizational law, thus sharing, in principle, the latter’s general objectives. Does, however, cooperative law perform any specific function? Or rather, is there an essential function of cooperative law as compared to the law of other legal entities, and company law in particular? In a highly inspiring article, professors Hansmann and Kraakman assign to organizational law the essential role of providing for a form of “asset partitioning” that could not practicably be established otherwise. [Extracts of this article are provided in Chapter 3.] Asset partitioning comprises both the limited liability of the owners or other beneficiaries of the entity (which is the strongest type of what the Authors term “defensive asset partitioning”), and above all “the shielding of the assets of the entity from claims of the creditors of the entity’s owners or managers,” which is the reverse of limited liability and is termed “affirmative asset partitioning.” As there are various types of defensive asset partitioning, of which limited liability is the strongest, there are various types of affirmative asset partitioning: “priority with

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liquidation protection”; a weaker type termed “priority without liquidation protection”; and “exclusive claim on the entity’s assets,” which is the strongest type of affirmative asset partitioning. According to these Authors, the types of asset partitioning that are generally found in a cooperative are priority with liquidation protection and member limited liability, which characterize a business corporation (i.e., a company), as well. In effect, this corresponds to what the majority of cooperative laws provide for. This also means that cooperative law does not operate differently from company law in this respect. Hence, if an essential role of cooperative law is to be found, it must be sought elsewhere. In the same article, professors Hansmann and Kraakman address the issue of whether the “formal separation of control rights from distribution rights whereby those who control the firm are barred from appropriating the firm’s net earnings,” which is a defining feature of nonprofit entities, is an attribute that these entities may enjoy without the benefit of specially designed organizational law. They conclude that that would not be feasible, thus considering the provision of the non-distribution constraint an essential function of the law of nonprofit organizations. Of course, the preceding argument refers to nonprofit entities and not to cooperatives, which moreover cannot be considered nonprofit entities. … Nevertheless, it is relevant to cooperative law, because cooperatives, like nonprofit entities, are characterized by a specific purpose that cooperative law, like the law of nonprofit entities, is expected to recognize and preserve. In other words, when a legal entity, or category of legal entities, has a defining feature that relates to the objective pursued—whether negative (the profit non-distribution constraint that qualifies nonprofit entities) or positive (the mutual purpose that qualifies cooperatives, as will shortly be discussed and delineated in the text)—the organizational law of that entity, or category of entities, plays the essential role of defining their particular identity in light of the objective pursued. This applies yet to a greater extent to cooperatives, since their identity is complex and consists of several, at times interrelated, aspects, which do not only pertain to their purpose. This may be confirmed by the comparison between a cooperative act and a company act, as the former may contain provisions on the organization’s objective, the way to fulfill it and other related aspects, which might not appear in the latter. For example, while in the regulation of the European Company (Societas Europaea—SE)—the European Union law equivalent to a company (or business corporation) established under national law— nothing is stated with regard to the purpose of an SE, in the regulation of the European Cooperative Society (Societas Cooperativa Europaea—SCE)—the European Union law equivalent to a cooperative established under national law—the objective of an SCE is stipulated, and accordingly there are specific rules on the allocation of profits. To put it differently, while there are legal entities that are “neutral” as regards the purpose pursued, as is the general case with companies, there are other legal entities, including cooperatives (and nonprofit entities, as already noted), that are not “neutral” in this respect. Accordingly, company law scholars identify, from and with a view to a comparative analysis, five basic legal characteristics of the company (or business corporation), which are legal personality, limited liability, transferable shares, delegated management under a board structure, and investor ownerships, and argue that company (or corporate) law everywhere must, of necessity, provide for them. As one may observe, they do not include

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among these characteristics the pursuit of a particular objective, still less profit distribution to shareholders. •  •  •

Stipulating the cooperative identity and preserving their distinguishing features should therefore be considered the primary objective of cooperative law. On a more general level, this is a precondition for a plurality of legal forms to exist within a jurisdiction, to the benefit of the interests served by market pluralism, and more particularly, of the interests of the very founders and members of a cooperative. Indeed, the rigidity of the cooperative form, which results from its identity being (more or less) carefully defined by law, enhances—within a jurisdiction recognizing a choice among several types of legal entities—a founder’s or member’s “ability to signal, via her choice of form, the terms that the firm offers to other contracting parties, and to make credible [her] commitment not to change those forms.” If it is true, as some economists maintain, that the cooperative form, under certain circumstances and due to its distinguishing features, has a comparative advantage over for-profit investor-owned business organizations, especially in times of crisis; and if it is true, as others argue, that the mainstream portrait of the self-interested homo oeconomicus does not always correspond to the reality, which calls for an enterprise form suitable for a different model of individual whose behavior is (also) driven by social preferences (altruism, reciprocity, justice, or equity); if one agrees on that, by mandating a precise cooperative identity cooperative law does not perform a prescriptive function but an enabling function. On a political level, this should suffice to push the cooperative movement and its advocates to continue to protect the cooperative identity in spite of, and against any attempt to approximate cooperatives to companies. As already stated, however, the identity of cooperatives is multi-faceted, comprising several aspects, not only related to the objective pursued, but to their financial and organizational structure as well. Moreover, if examined from a transnational and comparative perspective, this identity varies considerably, to the point that—paraphrasing the title of a famous legal article and adapting it to our subject—one can argue that the history of (comparative) cooperative law has yet to begin. For this to happen, the essential elements of cooperative identity must assume a primary role within legal scholarship, which is the very perspective adopted in this chapter to explore cooperative law and present and discuss its principal aspects. 1.4  Cooperative Objective 1.4.1  Classification of a Legal Entity’s Possible Purposes The purpose is the principal, albeit not exclusive, element of identification of an organizational type and classification of the different types of entities provided for by the legislature within a given jurisdiction. One may identify three general purposes that legal entities may assume as their ultimate goal: for-profit, not-for-profit, and mutual purpose. The for-profit purpose—which in many jurisdictions is the objective explicitly assigned by law to companies—implies conducting business with the aim of making profits to distribute, afterwards, to the legal entity’s participants. Therefore, for-profit entities have a purpose that, in legal terms, has an “economic” and “internal” nature at the same time,

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inasmuch as they are oriented toward their members whose wealth they seek to increase or maximize. In contrast, the not-for-profit purpose—which in many jurisdictions is the objective explicitly assigned by law to associations and foundations—implies conducting an activity without the aim of making profits and distributing them to the legal entity’s members (and/ or founders, directors, officers, etc.). This purpose is thus identified in negative terms and merely in opposition to the for-profit purpose. It must be noted, however, that the not-forprofit purpose is broader than the for-profit purpose. Indeed, unlike the latter, it is in principle compatible with the legal entity conducting an economic or a non-economic activity, which means that the nature of the activity, whether entrepreneurial or not, is not relevant for conceptualizing not-for-profit (or “nonprofit,” as sometimes they are referred to in legal literature, and likewise are termed in this chapter with the same meaning) entities. What is essential for the configuration of the not-for-profit purpose is only that profits arising from the economic activity, if any, are not (and may not be) distributed to the entity’s members (and/or founders, directors, officers, etc.). On the other hand, the way in which these profits are used may determine the further, and more specific, qualification of a nonprofit entity as a private benefit or a public benefit entity, depending on whether profits are used in the interest of the entity’s members or in the interest of beneficiaries who are not members, including the general interest of the community. The purpose of nonprofit entities, therefore, may have either an “internal” or an “altruistic” nature, depending on whether these entities aim at benefiting members or non-members. The mutual purpose is that which characterizes cooperatives and constitutes the focus of the following analysis. As we shall see, it must be distinguished by both the for-profit and the not-for-profit purpose, although from a theoretical point of view it shares some traits of both. Consequently, cooperatives are private legal entities that in principle must be distinguished from both for-profit and not-for-profit (or “nonprofit”) entities. Before discussing the mutual purpose of cooperatives and the main related aspects, a few other general preliminary remarks are necessary. First, as all general taxonomies, also the one above admits hybrids or blended forms of entities, which in fact may be found either as a consequence of the law directly providing for them or as the result of an entity’s concrete choice not prohibited by law. This, as we shall see, may also regard cooperatives, to the extent that some jurisdictions detach them totally or partially from the pursuit of a mutual purpose. Second, if it is true that in general companies are a type of legal entity shaped and made available by legislatures to the public for the pursuit of a for-profit purpose, legislatures are increasingly enacting special company acts providing for the establishment of companies without a for-profit purpose, including companies pursuing the general interest of the community. This process of “neutralization” of the company form is, as already observed, confirmed even to a greater extent by the fact that some general company acts do not attribute to companies a specific institutional purpose. Finally, as in part already pointed out, nonprofit entities are not necessarily to be considered “social” or “general interest” entities, as the not-for-profit purpose is a pure negative concept, silent in regard to the entity’s final orientation. By way of contrast, a (partial) “social” or “general interest” orientation may be found (even) in (fully mutual) cooperatives, as the result of their overall regulation, which as we shall see, includes concern for the community in their global purpose.

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1.4.2  The Cooperative Mutual Purpose The Rochdale Society of Equitable Pioneers—which was registered on 24 October 1844 and opened its first store on 21 December of the same year in Rochdale, near Manchester, UK—is almost universally regarded as the first structured manifestation of that kind of business organization which the title and substance of “cooperative” have been referred to until today. The Rochdale Society began its operations by selling basic foodstuffs to and in the interest of its members. In the declaration of its objects, it was stated that the Society acted “for the pecuniary benefit, and improvement of the social and domestic condition of its members” by performing several economic activities, beginning with “the establishment of a store for the sale of provisions,” and including the manufacture of articles for the employment of the unemployed or underemployed members, as well as the purchase or rent of estates of land to be cultivated by the members. The Rochdale Society’s objectives substantially coincide with those that existing cooperative law attributes to cooperatives. Indeed, although differences of various extent and nature may be found across jurisdictions, it may be affirmed that cooperatives are conceived by law as entities running an enterprise in the interest of their members as consumers, providers or workers of the cooperative enterprise. This organizational objective may be referred to as “mutual purpose,” although it must be clear that only in some countries is this precise formula employed by legislatures and/or legal scholarship to identify the cooperative objective and distinguish it from that of other legal entities. More precisely, the cooperative objective (or “mutual purpose”) comprises two elements: the ultimate purpose of benefiting members and the carrying out of a particular activity to fulfill this purpose; namely, an enterprise with the members as consumers of the goods or services provided by the cooperative enterprise, as providers of the goods or services employed by the cooperative for running the enterprise, or as workers of the cooperative enterprise. Given that the final purpose of benefiting members may be found in other legal entities as well, namely, in all those that pursue an “internal” purpose, the specificity of the mutual purpose (and of cooperatives pursuing it) lies in the particular activity that is essential for both the cooperative to achieve its ultimate goal and for its members to satisfy the individual interests behind the establishment of the cooperative. This particular activity with the members—which may be termed “cooperative enterprise”—is a characteristic of cooperatives that, when properly understood, significantly contributes to their distinction from companies. In companies, like in any other for-profit entity, the economic activity is simply an instrument for pursuing the entity’s final objectives, and it is irrelevant whether this activity is conducted with the members. By way of contrast, cooperatives are formed and exist to run an enterprise that might directly satisfy the interests of their consumer-, provider- or worker-members (who, together, may be referred to as “user members,” since in fact they are the direct recipients of a service provided by the cooperative enterprise). •  •  •

In principle, nothing precludes a cooperative from being formed by more than one category of user-members and thus from being directed at satisfying the needs of more than one class of stakeholders, such as consumers and workers, for example.

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In contrast, a cooperative that is comprised of only members who provide capital and the qualifying activity of which consists (mainly or exclusively) in employing this capital for running a profitable enterprise that might remunerate the capital, would not be conceivable. Cooperative law is clear in excluding this possibility, which seems obvious as it corresponds to what companies do in pursuing their for-profit purpose. Cooperatives, unlike companies, are not means for remunerating and accumulating capital, but for satisfying needs of a different type. Despite the co-operative association’s long history, the International Co-operative Alliance (ICA) contends that the model is being utilized well below its potential. In 2013, the ICA published its “Blueprint for a Co-operative Decade” with the vision for 2020 to be the year when the co-operative form of business becomes “the acknowledged leader in economic, social and environmental sustainability[,] the model preferred by people[, and] the fastest growing form of enterprise.”7 The United Nations has recognized the important role that co-operative associations play in the achievement of social policy objectives, and declared 2012 to be the “International Year of Cooperatives” in order to highlight the importance of co-operatives to economic development and social innovation around the world.8 As mentioned in the introduction to this chapter, there have been a number of new strains of co-operatives that have appeared within Canada that offer differing governance structures in order to commit the co-operative to its mandate. Some of these forms have been created using flexible provisions within existing co-operative laws, others are selftitled by the co-operative, and still others have been explicitly created through co-operative laws. A selection of these new co-operative associations is discussed in Section IV.A. QUESTIONS

1.  The co-operative association is not the dominant form of business organization in Canada. What do you think are some of the major impediments to the co-operative association attaining status as the most utilized legal form for business? 2.  Fici compares how some legal forms, particularly companies, are “neutral” with regard to the purpose pursued, but others, including co-operative associations and not-for-profit corporations, are not “neutral” in this respect. What are some ways that the purpose in utilizing a particular legal form is identified in the law?

B.  Not-for-Profit Corporations Not-for-profit corporations, also known as non-profit organizations (NPOs), are not required to pay income tax (and charities are able to issue tax receipts), so they are subject to certain restrictions. All charities are non-profits, but not all non-profits are charities. 7 International Co-operative Alliance, “Blueprint for a Co-operative Decade” (January 2013) at 3, online: . 8 United Nations, Department of Economic and Social Affairs, Division for Social Policy and Development, Social Perspective on Development Branch, “International Day of Cooperatives,” online: .

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Charities must fall within four defined heads of charity.9 In order to maintain their taxexempt status under s 149.1 of the Income Tax Act,10 they must also adhere to a number of restrictions, such as refraining from engaging in political activities (ss 149.1(6.1) and (6.2)). The interpretation of “political activities” has historically been a contentious one. In 2003, the Canada Revenue Agency (CRA) issued Policy Statement CPS-022 detailing the differences between political and charitable activities. The CRA updated its policy with Guidance GC-017 on the general requirements for charitable registration in 2012. An NPO must be organized and operated exclusively for “social welfare, civic improvement, pleasure or recreation or for any other purpose except profit” under ITA s 149(1)(l). An NPO is not, however, prohibited from engaging in “incidental” or “ancillary” business activities, which means that, officially, an NPO should only make a profit if it is unintentional. In 2012, the CRA issued two technical interpretations that were in line with a more restrictive position on revenue generation. The interpretations indicate that if an NPO carries on a business activity with the intent to make a profit beyond what is ancillary or incidental, or anything other than on a cost-recovery basis, the NPO’s net profits will be disqualified from tax exemption.11 Followed strictly, this rule means that an NPO is allowed little to no growth in capital to reinvest into the organization. While the theoretical premise behind the nature of the corporation in neoclassical law and economics has developed for decades and is briefly discussed in Chapter 9, the formation of an economic theory behind the nature of NPOs began much later. Since there are multiple motivations behind the creation of NPOs, it is possible for several theoretical lines of inquiry to coexist. In 1974, Burton Weisbrod’s pivotal work explained how governmental entities provided public goods to the point of satisfying the median voter, meaning there will always be a residual unsatisfied demand for public goods by those voters that need or prefer goods that are greater than the median.12 NPOs satisfy this residual demand by offering public goods in addition to those provided by government, thus correcting a form of both government failure and market failure. Henry Hansmann expanded on the concept of market failure by developing a theory of contract failure in his pivotal 1980 article, “The Role of the Nonprofit Enterprise,” arguing that NPOs also arise as a response to issues of asymmetric information facing consumers.13 Hansmann describes the main difference between the corporation and the NPO as the NPO’s “nondistribution constraint,” meaning its inability to distribute the firm’s net earnings to its members. He identified two problems with the public goods theory: (1)  How does one explain the services provided by many NPOs that do not seem to be public goods but rather appear to be private ones? and (2) How does one explain why an NPO rather than a for-profit corporation arises to fill an unsatisfied demand for public goods? He later summarized the dominant economic theories on NPOs. 9 The four heads of charity are taken from the common law—specifically, from Commissioners for Special Purposes of the Income Tax v Pemsel, [1891] AC 531 (HL). 10 Income Tax Act, RSC 1985, c 1 (5th Supp) [ITA]. 11 CRA doc nos 2012-0454251E5 and 2012-0468581E5; Interpretation Bulletin IT-496R, “Non-Profit Organizations” (2 August 2001) at para 9. 12 Burton A Weisbrod, “Toward a Theory of the Voluntary Non-Profit Sector in a Three-Sector Economy” in Edmund Phelps, ed, Altruism, Morality, and Economic Theory (New York: Russell Sage, 1975). 13 Henry Hansmann, “The Role of the Nonprofit Enterprise” (1980) 89 Yale LJ 835.

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Henry B Hansmann, “Economic Theories of Nonprofit Organization” in WW Powell, ed, The Nonprofit Sector: A Research Handbook (New Haven, Conn: Yale University Press, 1987) (footnotes omitted) The Role of Nonprofit Organizations Several theories have been advanced to date to explain the economic role of nonprofit organizations. These theories are sometimes competing and sometimes complementary. The Public Goods Theory The first general economic theory of the role of nonprofit enterprise was offered by [Burton] Weisbrod, who suggested that nonprofits serve as private producers of public goods (in economists’ sense of that term). Governmental entities, Weisbrod argued, will tend to provide public goods only at the level that satisfies the median voter; consequently, there will be some residual unsatisfied demand for public goods among those individuals whose taste for such goods is greater than the median. Nonprofit organizations arise to meet this residual demand by producing public goods in amounts supplemental to those provided by government. Weisbrod’s theory captures an important phenomenon. Many nonprofit firms provide services that have the character of public goods, at least for a limited segment of the public. This is conspicuously true, for example, of those donative nonprofits (such as the American Heart Association, the National Cancer Society, and the March of Dimes) that collect private donations to finance medical research. As originally presented, however, the public goods theory left two questions open. First, the services provided by many nonprofits do not seem to be public goods but rather appear to be private ones. This is true especially of commercial nonprofits, whose share of the nonprofit sector has increased impressively in recent years. For example, the appendectomy performed in a nonprofit hospital, the child care provided by a nonprofit preparatory school, the nursing care provided by a nonprofit nursing home, and the entertainment provided by a nonprofit symphony orchestra are all difficult to characterize as public goods in the usual sense. Second, Weisbrod’s theory stops short of explaining why nonprofit, rather than for-profit, firms arise to fill an unsatisfied demand for public goods. What is it about nonprofit firms that permits them to serve as private suppliers of public goods when proprietary firms cannot or will not? The Contract Failure Theory The elements of a somewhat different theory of the role of nonprofits were set forth in an essay on day care by Nelson and Krashinsky, who noted that the quality of service offered by a day-care center can be difficult for a parent to judge. Consequently, they suggested, parents might wish to patronize a service provider in which they can place more trust than they can in a proprietary firm, which they might reasonably fear could take advantage of them by providing services of inferior quality. The strong presence of nonprofit firms in the day-care industry, they argued, could perhaps be explained as a response to this demand. Similar notions have been hinted at in an earlier essay on health care by Arrow,

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who suggested in passing that hospitals may be nonprofit in part as a response to the asymmetry in information between patients and providers of health care. The theme advanced by Nelson and Krashinsky was fleshed out and generalized in an article by Hansmann, where it is argued that nonprofits of all types typically arise in situations in which, owing either to the circumstances under which a service is purchased or consumed or to the nature of the service itself, consumers feel unable to evaluate accurately the quantity or quality of the service a firm produces for them. In such circumstances, a for-profit firm has both the incentive and the opportunity to take advantage of customers by providing less service to them than was promised and paid for. A nonprofit firm, in contrast, offers consumers the advantage that, owing to the nondistribution constraint, those who control the organization are constrained in their ability to benefit personally from providing low-quality services and thus have less incentive to take advantage of their customers than do the managers of a for-profit firm. Nonprofits arise (or, rather, have a comparative survival advantage over for-profit firms) where the value of such protection outweighs the inefficiencies that evidently accompany the nonprofit form, such as limited access to capital and poor incentives for cost minimization (see below). Because this theory suggests, in essence, that nonprofits arise where ordinary contractual mechanisms do not provide consumers with adequate means to police producers, it has been termed the “contract failure” theory of the role of nonprofits. Donative Nonprofits Although the contract failure theory has its roots in the work of authors who are primarily concerned with the role of commercial nonprofits, its most obvious application is in fact to donative nonprofits. A donor is, in an important sense, a purchaser of services, differing from the customers of commercial nonprofits (and of for-profit firms) only in that the services he or she is purchasing are either (1) delivery of goods to a third party (as in the case of charities for the relief of the poor or distressed) or (2) collective consumption goods produced in such aggregate magnitude that the increment purchased by a single individual cannot be easily discerned. In either case, the purchaser is in a poor position to determine whether the seller has actually performed the services promised; hence the purchaser has an incentive to patronize a nonprofit firm. For example, individuals commonly contribute to CARE in order to provide food to malnourished individuals overseas. A for-profit firm could conceivably offer a similar arrangement, promising to provide a specified quantity of food to such people in return for a contribution of given amount. The difficulty is that the purchaser (donor), who has no contact with the intended beneficiaries, has little or no ability to determine whether the firm performs the service at all, much less whether the firm performs it well. In such circumstances, a proprietary firm might well succumb to the temptation to provide less or worse service than was promised. The situation is similar with public goods. If an individual contributes to, say, a listenersponsored radio station, then, unlike the situation with CARE, she is at least among the recipients of the service and can tell whether it is being rendered adequately. What she cannot tell is whether her contribution of fifty dollars in fact purchased a marginal increment of corresponding value in the quantity or quality of service provided by the station or simply went into somebody’s pocket. A for-profit firm that operated such a radio station

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would have an incentive to solicit payments far in excess of the amounts necessary to provide their programming. In situations such as these, the nonprofit organizational form, owing to the nondistribution constraint, offers the individual some additional assurance that her payment is in fact being used to provide the services she wishes to purchase. As this example suggests, the contract failure theory is complementary to the public goods theory described above. Indeed, the public goods theory can be seen as a special case of the contract failure theory. For the reasons described by Weisbrod, there may be residual demand for public goods—such as noncommercial broadcasting—that is unsatisfied by government. Yet even if individuals are prepared to overcome their incentive to free ride and will donate toward financing of a public good, they will have an incentive to contribute to a nonprofit rather than a for-profit firm because of the monitoring problems just described. We have been proceeding here on the implicit assumption that the donors to the nonprofit firm will be private persons. In many cases, however, the government is an important donor, and in some cases it is the only donor. Sometimes government donations are direct, as in the case of grants made by the National Endowment for the Arts to nonprofit performing arts companies or (now discontinued) Hill-Burton Act capital grants to nonprofit hospitals. In other instances, government donations are indirect, as in the case of tax exemption or reduced postal rates for nonprofits. Regardless of the way in which such donations are made, however, the government is often subject to the same problems of contract failure that face a private donor: it cannot easily determine directly whether its donation is being devoted in its entirety to the purposes for which it was made. Consequently, the government, like a private donor, has an incentive to confine its subsidies to nonprofit rather than for-profit firms, and it commonly does so. And this, in turn, creates further demand for the services of nonprofit firms. Commercial Nonprofits The contract failure theory can also help explain the role of commercial nonprofits. The types of services that commercial nonprofits commonly provide—such as daycare, nursing care, and education—are often complex and difficult for the purchaser to evaluate. Further, the actual purchaser of the service is often not the individual to whom the service is directly rendered and thus is at a disadvantage in judging the quality of performance: parents buy daycare for their children, and relatives or the state buy nursing care for the elderly. Finally, the services provided by commercial nonprofits are commonly provided on a continuing long-term basis, and the costs to the recipient of switching from one firm to another are often considerable. Consequently, purchasers are to some extent locked in to a particular firm once they have begun patronizing it, and thus the firm, if unconstrained, is in a position to behave opportunistically. For all these reasons, patrons might have an incentive to patronize a firm subject to a nondistribution constraint as additional protection against exploitation. Where commercial nonprofits are concerned, contract failure is presumably a less serious problem than with donative nonprofits. Consequently, it is not surprising that commercial nonprofits nearly always share their market with for-profit firms providing similar services. For example, roughly 20 percent of all private hospitals, 60 percent of all private daycare centers, and 80 percent of all private nursing homes are for-profit

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enterprises. If the contract failure theory explains the presence of commercial nonprofits in these industries, then the presence of both types of firms may reflect some division of the market: patrons who are reasonably confident of their ability to police the quality of the services they receive patronize the for-profit firms, whereas those who are less confident in this respect patronize the nonprofit firms, perhaps paying a premium for the service on account of the productive inefficiencies associated with the nonprofit form. Although this theory is plausible as applied to most types of commercial nonprofits, it does not, interestingly, seem particularly persuasive when applied to hospitals, which constitute (in terms of GNP) the largest class of nonprofit institutions. There are two reasons for this. First, the hospital itself does not provide the patient care services that are the most sensitive and difficult to evaluate—namely, the services of the attending physicians. Rather, the physicians are usually independent contractors who deal separately with the patients. The hospital itself is largely confined to providing relatively simple services such as room and board, nursing care, and medicines. Second, the patient herself does not order the hospital services she receives; rather, they are ordered and monitored for her by a skilled and knowledgeable purchasing agent, namely, her physician. Consequently, it is not at all obvious that the nondistribution constraint offers the hospital patient any special protection that she would clearly be lacking without it. Why, then, are hospitals nonprofit? It may be that, if we allow for a little historical lag, the contract failure theory in fact explains it. Until the end of the nineteenth century, hospitals were almost exclusively donative institutions serving the poor; the prosperous were treated in doctors’ offices or in their own homes. The nonprofit form was therefore efficient for the reasons of contract failure discussed above with respect to donative institutions in general. Then, however, a revolution in medical technology turned hospitals into places where people of all classes went for treatment of serious illness. Subsequently, the development of public hospitals took from the nonprofit hospitals much of the burden of caring for the poor. Finally, the spread of private, and more recently public, health insurance made it possible for the great majority of patients to pay their hospital bills without the aid of charity. The result is that today—which is to say, since the appearance of Medicare and Medicaid in 1965—most nonprofit hospitals have become more or less pure commercial nonprofits, receiving no appreciable portion of their income through donations and providing little or no charity care. The continuing predominance of nonprofit firms may simply be the consequence of institutional lag and of the various subsidies and exemptions that continue to be available to nonprofit but not to for-profit hospitals. Indeed, since the late 1960s there has been substantial entry of large for-profit firms into the industry. The non-profit sector is subject to a number of challenges that affect its future vitality. Historically, the bulk of NPO and charitable funding has come through governmental, corporate, and other types of donations, and donative NPOs in particular have difficulty growing once their funding sources have been exhausted. The considerable strain on NPOs and charities has led many within the sector to rethink their business plans in order to survive, continue to make a societal impact, and maintain their influence as advocates for social change.

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Yet the commercialization of NPOs is not without its critics. Burton Weisbrod has addressed some of the risks in the wave of commercialization among NPO’s. Other critics have noted that the commercialization of NPOs may harm the traditional role that NPOs hold in public policy advocacy, or simply perpetuate a neo-liberal agenda.

Burton Weisbrod, “The Nonprofit Mission and Its Financing: Growing Links Between Nonprofits and the Rest of the Economy” In Burton Weisbrod, ed, To Profit or Not to Profit: The Commercial Transformation of the Nonprofit Sector (Cambridge University Press, 2000) at 1-12 (footnotes omitted) Massive change is occurring in the nonprofit sector. Seemingly isolated events touching the lives of virtually everyone are, in fact, parts of a pattern that is little recognized but has enormous impact; it is a pattern of growing commercialization of nonprofit organizations. … Commercialism in the nonprofit sector sounds like a paradox: Nonprofits are supposed to be different from private firms, for whom commercialism is their very lifeblood. To some people, though, the uniqueness of nonprofit organizations is by no means selfevident; perhaps they are really not different from private firms, but are just as influenced by business motives and opportunities for self-aggrandizement. Late in 1997 two apparently unrelated events brought front-page headlines. One involved a contract between the American Medical Association and the Sunbeam Corporation, a manufacturer of consumer electronic products, with the AMA promising to endorse Sunbeam products, such as heating pads and vaporizers, in return for payments expected to yield millions of dollars. The other involved the purchase by Chicago’s Field Museum of Natural History of “Sue,” the largest complete Tyrannosaurus rex fossil in existence—the $8.3 million cost being financed largely by McDonald’s and the Walt Disney Company. McDonald’s will get several “life-size replicas of the ferocious dinosaur, one of the most widely recognized dinosaurs and a powerful promotional tool,” and one of the replicas will be displayed at McDonald’s DinoLand USA attraction at Disney’s new (1998) Animal Kingdom theme park. In addition, the museum will display the original in its new McDonald’s Fossil Preparatory Laboratory, and there is talk of miniatures, with the Field Museum name, being included in hamburger Happy Meals. Both the AMA and Field Museum cases involved nonprofit, tax-exempt organizations contracting to receive multimillion-dollar payments from private firms. Both arrangements generated money but also criticism. The criticism of the AMA was so intense that its top leadership resigned and the AMA broke the agreement with Sunbeam, resulting in a $20 million breach-of-contract lawsuit …. As the nonprofit sector grows in size and commercial activities, is it becoming indistinguishable from the private sector? The fundamental issue is how, if at all, does revenue source affect an organization’s behavior? This question is significant because at root is whether the organizations in the rapidly growing nonprofit sector deserve the subsidies and tax exemptions they receive from individuals and from federal, state, and local governments. … In some instances the drive for revenue is bringing nonprofits into

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headlong competition with private enterprise; this is most apparent in the [US] hospital industry, where increasing pressure to contain health-care costs is bringing massive industry reorganization and intense price competition. In other cases, nonprofits are collaborating with these other sectors—as in biotechnology research, where universities and private enterprise are forming joint ventures, finding ever more complex ways of cooperating in the interest of generating revenues and facilitating scientists’ mobility between the academy and private firms. •  •  •

Nonprofits have discovered that there are massive potential financial benefits from such symbiotic relationships with private firms—benefits that are not occasional and random, but are systematic consequences of powerful economic forces. Universities and other nonprofits such as hospitals, museums, and charities receive many subsidies that can be converted into something salable to private firms or consumers. How should we look at all these market-oriented changes? Are they helping to strengthen nonprofits and make them more effective contributors to meeting society’s needs, or are they weakening nonprofits, diverting their efforts, leading them into economic behavior that is counterproductive—perhaps even undermining public support, financial and political? The tension between a nonprofit’s focus on raising revenues and on its public-serving social mission is well illustrated by universities’ partnerships and alliances with private firms involving research in the life sciences, which are increasingly common, lucrative, and contentious. Over a decade ago, A. Bartlett Giamatti, then president of Yale University, noted this tension and pointed to “the academic imperative … to seek knowledge objectively and to share it openly and freely, while the industrial imperative is to garner a profit, which frequently creates the incentive to treat knowledge as private property.” The subsequent growth of university – industry research collaboration may be exacting a price in the form of pressure from private firms to suppress discoveries that are adverse to their interests and profits. Conflicts over the dissemination of adverse findings have occurred in a number of recent cases, involving researchers at the University of California at San Francisco (UCSF) and at the University of Washington at Seattle. At UCSF, a researcher, operating under a grant from a private pharmaceutical firm, found that the effectiveness of a brand-name thyroid drug was no greater than that of generic versions that were considerably less costly—a finding that led the researcher to withdraw the paper, under threat of a lawsuit by the funder, on the eve of its publication in the Journal of the American Medical Association. At the University of Washington, research findings that were unfavorable for private firms— that a popular form of spine surgery might not be effective, and that a popular drug for lowering blood pressure was associated with increased risk of heart attacks— were, according to the researchers, greeted by political pressure to eliminate the Federal agency that paid for the spine research and “harassment from drug companies and their academic consultants.” The “invasion of commerce into medical care” has been seen as “an epic clash of cultures between commercial and professional traditions. …” Others, though, see nonprofits’ emulation of, and involvement with, private firms as a sign of efficient resource utilization. •  •  •

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New commercial activities are the major path open to nonprofits to generate additional revenue; and once nonprofits enter the realm of finding salable outputs, they are in the domain of private enterprise, where selling goods and services is the preeminent source of private-sector revenue. Nonprofits that pursue revenue in the same ways that private firms do are likely to emulate those firms, and by becoming more like them may undermine the fundamental justification for their own special social and economic role. To what extent this occurs is important for public policy, since the justification for the subsidies and tax exemptions to nonprofit organizations hinges on nonprofits’ differentiation from private firms. When nonprofits enter a new industry in search of revenues—for example, as hospitals are doing by establishing profit-seeking athletic clubs—it is natural to ask what distinguishes their weight rooms, saunas, and fitness clubs from those at traditional for-profit gyms and, hence, what justifies their tax advantages. It should be noted, though, that if a nonprofit becomes more commercial in its pursuit of revenue, it does not necessarily imply a forsaking of “core” values or mission…. This increase in commercial activities in the nonprofit sector raises the question of whether nonprofit organizations are merely “for-profits in disguise”…. To consider them as such might well be a mistake, however, because there is some evidence that the way nonprofits use their opportunities to sell services reflects their social-service missions to reach particular target populations, not simply to maximize profit. There is also evidence that when contrasted in the same industry, nonprofits and for-profits behave in systematically different ways. For instance, pricing, including price discrimination, by nonprofits can be used not simply to generate revenue, but to achieve the organization’s distributional mission. Thus, while nonprofits may charge user fees to generate revenue to support their preferred, mission-oriented activities, they may and do establish price below marginal cost— even at zero—for certain consumers, such as the homeless, schoolchildren at zoos, or indigent sick people at hospitals. It is not clear, though, whether universities are acting differently than would a profit maximizer when they offer price discounts to students who use services during off-peak hours (weekends, evenings, and summers). •  •  •

Nonprofit organizations confront a dilemma, as does public policy toward them: how to balance pursuit of their social missions with financial constraints when additional resources may be available from sources that might distort mission. When the mission is to provide collective services of the sort typically identified with government, but with taxing power not available, what are the consequences of using other forms of financing? When, as is increasingly the case, the finance mechanisms involve selling other things to finance the collective outputs, what are the effects? Can nonprofits simultaneously emulate private enterprise and yet perform their social missions? Are public-interest goals and private-enterprise money-raising measures compatible? Nonprofits are generally well aware of the issues.… The dilemma was voiced recently by I. Michael Heyman, Secretary of the Smithsonian Institution, who, while discussing the decision to seek “corporate sponsorships” to raise additional money, noted that maintaining the nonprofit’s “integrity” was important, but that “the costs are outweighed by the benefits.” Whether “costs” are seen in terms of adverse effects on an organization’s mission or on prospective donors’

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perceptions of such effects on that mission, or both, is an open issue; that is, the actual impact of a particular fund-raising mechanism on organizational behavior may differ from that perceived by outsiders. QUESTIONS

1.  In 1989, Hansmann described the commercial NPO as “the great puzzle of the nonprofit sector today.”14 What reasons do you think motivated that statement? Do you believe his statement is relevant and/or true now? 2.  Are the economic restrictions imposed on NPOs, such as the inability to raise equity capital, justified given certain income tax and other advantages provided to NPOs? Consider Weisbrod’s questions above: “Can nonprofits simultaneously emulate private enterprise and yet perform their social missions? Are public-interest goals and private-enterprise moneyraising measures compatible?” 3.  In 2015, Mark Zuckerberg, the chief executive officer of Facebook, Inc, and his wife, Dr  Priscilla Chan, a philanthropist and pediatrician, announced that they would donate 99 percent of their Facebook shares to charity. They elected to use an American limited liability company as the legal vehicle of choice—not an NPO—because of certain limitations they believed would lessen the social impact. If one of the purposes behind the non-profit sector is to operate as an organizing framework for advancing social benefit, why do you think some social entrepreneurs avoid the NPO structure?

C.  For-Profit Social Enterprises With a growing number of entrepreneurs seeking to pursue dual economic and social mandates in their businesses, the limitations within existing legal forms are being tested. In the following excerpt, Katz and Page outline some of the priorities and tensions identified in the development of for-profit social enterprises.

Robert Katz & Antony Page, “The Role of Social Enterprise” (2010) 35 Vt L Rev 59 at 85-97 (footnotes omitted) II.  The For-Profit Social Enterprise A threshold challenge for aspiring social entrepreneurs is selecting and crafting the best legal structure for their social enterprise. A recent survey showed that 71% of [American] social entrepreneurs believed that the choice of legal structure was the single greatest challenge for their ventures. Legal practitioners and academics in increasing numbers have begun struggling with the issue. Although the nonprofit form is inherently conducive to socially-beneficial

14 Henry Hansmann, “The Economic Role of Commercial Nonprofits: The Evolution of the U.S. Savings Bank Industry” in Helmut Anheier & Wolfgang Seibel, eds, The Third Sector: Comparative Studies of Nonprofit Organizations (Berlin and New York: De Gruyter, 1989) at 74.

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undertakings, it nonetheless also has drawbacks. Additionally, some social entrepreneurs and proponents perceive problems with conventional for-profit forms, such as legal and structural limits on their ability to pursue social aims at shareholders’ expenses or to entrench the entity’s long-term pursuit of social ends. For-profit social enterprises can address some of the real or perceived shortcomings associated with commercial and donative nonprofits. With the right organizational form, a social enterprise can have both greater access to equity capital and a deeply embedded, sustainable commitment to social purposes. This Part proceeds as follows. First, we identify the key features of for-profit social enterprise. These features might be contested (or relaxed); if they are, then other organizational forms already exist to accommodate their characteristics. Second, we identify certain problems with nonprofit organizations and show how for-profit social enterprise may address these problems. Third, we look at new problems that for-profit social enterprise might create. A.  What Is For-Profit Social Enterprise? For-profit firms seek to produce and sell goods and services for personal consumption. A for-profit social enterprise seeks to do so in a manner that generates more public benefit or positive externalities than would a conventional for-profit firm. In contrast to an ordinary commercial business, it expressly measures its success both in terms of its financial performance (e.g., pecuniary profits, shareholder value, return on investment, etc.) and its success in advancing a social mission or addressing social concerns. It is thus said to have a “double bottom line.” This is another way of saying that it seeks to “do well” for its owners while “doing good” for society. Profits are not a for-profit social enterprise’s sole objective. Although it shares the profit-making goal of a business corporation, it embraces the duty to sometimes make decisions that will not maximize profit. A for-profit social enterprise also shares some of the social aims of a public benefit nonprofit organization. It must have at least one express purpose to confer social benefits (i.e., supply public goods or mixed goods/private goods with significant positive externalities) above and beyond those conferred by the typical business. Alternatively, it could seek to impose less social harm on third parties and the environment (i.e., negative externalities) than the typical business. To formally distinguish a for-profit social enterprise from an ordinary business, its controllers must have lawful discretion to transparently reduce shareholder wealth in order to make presumably larger improvements in social welfare. This means that the firm may sometimes make trade-offs between social and financial performance that preference social performance over profit. This commitment, although difficult to legally enforce, goes beyond the promise of corporate social responsibility to make decisions that, all things being equal (i.e., where wealth-maximizing shareholders ought to be indifferent), will confer more benefits on society rather than less. Typically, a social enterprise attempts to address some market failure but it could also seek to address distributional inequality. For example, a for-profit social enterprise may attempt to increase the suboptimal supply of a public good, which might then improve the welfare of a population or community that constitute a “charitable class” under charity law (e.g., an economically disadvantaged population). It might also seek to generate goods or outcomes that are deemed environmentally or morally superior, such as reducing

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wealth disparity, even without increasing net social wealth. The social purpose may be legally charitable, but it could be broader. “Social purpose” is not a legal term of art like “charitable purpose,” whose meaning has been elaborated by the common law over the course of centuries and by tax law for a century. The purposes and activities that can qualify as legally “charitable” are more predictable than those that a social entrepreneur might deem pro-social. For example, paying a higher than market salary to a small class of employees (or subcontractors, like Guatemalan tea growers) may not qualify as charitable but would be a legitimate social purpose. Social purpose undoubtedly includes non-pecuniary factors. For example, people may well prefer a society that has a more equal distribution of wealth. Consider a business that pays its poorest employees higher than market wages—it distributes to one set of economically disadvantaged stakeholders a greater share of its profits than they could obtain through market transactions. Thus, the promotion of greater equity or fairness, also referred to as distributive justice, in the distribution of a corporation’s profits fits within the rubric of a social purpose. The United Kingdom recognized the potential breadth of a for-profit social enterprise’s purpose in its enactment of a legal form tailored to them: a Community Interest Company (CIC). A Community Interest Company must pursue a social purpose (“community interest”), which is defined as an activity that a reasonable person might consider as being “carried on for the benefit of the community.” There are, however, some limits on what qualifies as a social purpose. Most notably, personal pecuniary enrichment by itself does not qualify— notwithstanding the potential social value that can result from a self-interested person’s pursuit of enrichment. Similarly, a firm’s pursuit of higher profits for its owners and controllers is not by itself a social purpose. Thus, companies that follow weaker forms of corporate social responsibility (i.e., they follow pro-social practices because, or insofar as, they maximize profits) are not for-profit social enterprises. These practices are uncontroversial, and there is nothing about a company following such practices that would distinguish them from the traditional for-profit business. Moreover, founders or institutions that wish to generate higher profits already have various incorporated forms that suit this purpose. Individuals who wish to maximize their personal wealth can simply stay investors in such incorporated forms. Guayakí, a small California-based beverage company, approaches the ideal of a for-profit social enterprise. The company, in order to help preserve rain forests, sells yerba maté, a South American caffeinated plant whose dried leaves, steeped in hot water, create a drink with a strong, distinctive, and slightly bitter flavor. Guayakí buys yerba maté from indigenous and underprivileged farmers, pays above-market prices, and enlists the farmers in reforestation projects. Simultaneously, it intends to generate profits for its owners. In order to sharpen focus, we use the term for-profit social enterprise to denote an organization that unlike a nonprofit, does not have a complete asset lock (or non-distribution constraint), and unlike a for-profit corporation, is not bound by a norm or legal requirement to maximize shareholder wealth. Such an organization is: (a) a business (b) housed in a single legal entity (c) that is at least partly owned by equity investors, and that simultaneously seeks (d) to advance a social mission while also (e) generating acceptable returns for investors.

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Broadly speaking, doing well and doing good can be combined in various organizational forms, but as suggested some combinations are already accommodated by existing organizational forms. The archetypal for-profit social enterprise, however, is legally organized as something other than a conventional nonprofit organization because of the nondistribution constraint. Absent a special form for social enterprise, it will be organized as a business corporation or limited liability company. Even so, the for-profit social enterprise tries to emulate many characteristics of nonprofit organizations and partly fill the same niche. But the question remains: How could or should an enterprise’s core commitment to a social mission be “embedded in its organizational structure”? This also is sometimes referred to as “baking in” the social mission or “embedding” it into the organization’s DNA. Would the model or archetypal for-profit social enterprise have distinctive legal characteristics that meaningfully differentiate it from conventional for-profit organizational forms? Can we formulate some legal characteristic that distinguishes for-profit social enterprises, similar to the way the nondistribution constraint marks out nonprofit organizations? That constraint, as Steinberg writes, “provides a clear distinction [between nonprofit and for-profits firms] that affects how the [nonprofit] organization obtains resources, how it is controlled, how it behaves in the marketplace, how it is perceived by donors and clients, and how its employees are motivated.” The archetypal social enterprise “makes” the additional social value instead of “buying” it. “Make” refers to generating this additional social value as a consequence of operating its revenue-generating activity itself, as opposed to using some portion of its profits to make charitable donations. (This is partly functional: A corporation that simply wants to donate money to charity is, generally speaking, statutorily permitted to do so.) The commercial activities directly advance the mission instead of simply providing a source of revenue to subsidize the mission (e.g., Starbucks pays fair wages to coffee growers; Ben & Jerry’s primarily uses hormone-free milk bought from family farms; and Seventh Generation produces environmentally friendly cleaning products). The distinction is analogous to the assertion, made by Judge Frank Easterbrook and Professor Daniel Fischel, that a corporation can be “characterized by a statement of capital contributions as formal claims against the firm’s income that are distinct from participation in the firm’s productive activities.” In a for-profit social enterprise, participation in the firm’s productive activities is more basic or integral to the firm’s identity than donations from the corporate treasury. The more successful the business is as a business, the more social good it generates. It embodies the social entrepreneur’s way of addressing the world’s problems, which is to ask, “what can I do, that the more I do the more good it does?” This distinguishes the for-profit social enterprise from an entity that uses profits to cross-subsidize its mission-related activity, such as a law school that operates a pasta factory and uses the resultant revenue towards its social mission. This distinction is admittedly not air-tight. When Guayakí pays South American farmers double or triple the market price for their yerba maté, it is engaged in a kind of in-house philanthropy towards those farmers, one that can be partly measured as the difference between market wages and above market wages. It subsidizes this inhouse philanthropy with profits from its revenue-generating activities and with the

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savings it gains by paying below market wages to its employees in Northern California. Absent one or more of the above characteristics, the organization is more likely to be either unsustainable as a social enterprise in the long term or readily served by traditional corporate or non-profit forms. Put more succinctly, a for-profit social enterprise is organized and operated for some purpose other than to maximize the wealth of investors. It adopts organizational forms, structural devices, and contractual arrangements that reflect its rejection of profit as the sole maxim and that formally commit the organization to (sometimes) making improvements to social welfare at its shareholders’ expense. One might say that insofar as a social enterprise is a purposive institution, it is bound by a shareholder non-primacy norm. What would the for-profit social enterprise ideal organization form look like? At a minimum, the structure would enhance the entity’s ability and prospects for identifying, fostering, and expanding a sustainable, embedded social technology to achieve a desirable social mission. In order to achieve this goal, the form should have several attributes. To facilitate the entity’s expansion, or “scaling up,” the form should ease access to capital investors without simultaneously jeopardizing or compromising the mission. This includes both short-term operational risk and longevity to address the social problem or market failure. There should, however, be enough flexibility so that resources can be deployed away from social missions that are ineffective or no longer necessary. Ideally, the form itself would communicate something valuable to mission-sympathetic parties who are also potential donors such that they and any other stakeholders are more willing to contribute. This includes, of course, mission-sympathetic investors who might accept below-market returns in order to promote the social good, but it could also help attract employees willing to accept below-market compensation. It could also cultivate demand among consumers (or consumer-donors) and increase their willingness to pay a premium for, say, sustainable goods and services. It should encourage director performance beyond the mere absence of venality, which suggests at a minimum there should be active monitoring and accountability. Finally, the social enterprise form itself should be enticing to prospective entrepreneurs, increasing their desire to engage in social entrepreneurship and to express and entrench this desire by selecting the social enterprise form for their business. Although there is already some demand for an effective for-profit social enterprise form, preferably the creation of such an organizational form would augment the demand itself. The enactment in several states (and the United Kingdom) of new off-the-rack organizational forms tailored to for-profit social enterprises illustrates the perceived need. These forms include those mentioned earlier—the L3C, the Benefit Corporation, the Community Interest Corporation, etc.—as well as the private sector “B  Lab” accreditation. B.  What Problems Might For-Profit Social Enterprise Solve? Nonprofit enterprises suffer from several problems. These problems include limits on a nonprofit’s ability to do many things—obtain capital, compensate founders and controllers, and mitigate agency costs between founders and donors on the one hand and

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controllers on the other. These features limit a nonprofit firm’s ability to achieve its goals and more broadly to redeploy its resources to more socially efficient uses. The for-profit social enterprise has the potential to mitigate each of these problems. As we have seen, nonprofit law restricts the ability of a nonprofit organization’s controllers to control its resources. These restrictions are designed to ensure that all the resources conveyed to or generated by charitable organizations remain dedicated to benefiting society in perpetuity. These restrictions are imposed in the first instance by the nondistribution constraint—the über asset lock. If the organization is sold, the fair market value of its resources must remain in charitable channels. Donors, founders, and controllers can impose additional restrictions on the organization and its resources. The founder also selects the initial board of directors or trustees and can screen them carefully for commitment to her vision. These restrictions, though designed to increase social welfare, impose social costs of their own. A social enterprise’s ability to issue equity or ownership shares has important consequences for the entity’s ability to expand or scale up in response to increased demand or to contract in response to shrinking demand. Because it can sell shares to investors, a for-profit social enterprise has access to an important source of capital unavailable to nonprofits. Nonprofits, by contrast, are generally restricted to retained earnings, debt, and donations. A social enterprise’s ability to issue equity also has important consequences for the compensation of social entrepreneurs, which in turn affects their financial incentives to increase social welfare. A nonprofit cannot issue stock options or other forms of equity compensation. As a result, if a commercial nonprofit is successful and poised for greatness (or at least bigness), its founder and controllers cannot readily cash out their sweat equity or appropriate some of the social value the entity is expected to generate post-sale. Rather, nonprofit compensation is calculated retrospectively and not prospectively. As a result, founder and controllers may decline to sell (or “convert”) a nonprofit organization to a for-profit entity—even if such sale would increase social welfare—where the sale will not substantially improve their personal well-being. In a for-profit social enterprise, by contrast, investor-owners are entitled to a proportional share of the venture’s net earnings—including the proceeds from selling the venture or from an initial public offering. Even where nonprofit law does not prohibit profit-responsive compensation, concerns over seemliness may have a similar impact. Commentators have discussed (and criticized) the prevalence of a “nonprofit ideology” whereby many think it is evil for people who seek to do good in the world to get rich in the process. Not only may there be a problem of incentives in a nonprofit organization, there may also be inadequate monitoring. There are neither shareholders who will monitor behavior nor a stock price for measurement. Nor is there a market for corporate control, and thus no possibility of would-be acquirers monitoring the enterprise. In theory, state attorneys general are to serve as monitors, but in practice they lack the resources to properly pursue managerial weaknesses. As a practical matter, many nonprofit directors can essentially satisfy their fiduciary duties by not stealing and are generally free from effective scrutiny. By contrast, for-profit social enterprises have owners with personal pecuniary incentives to monitor.

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C.  Managing Tradeoffs Between Mission and Profit The archetypal for-profit social enterprise seeks to generate both extraordinary returns for society and acceptable returns for its owners and investors. The tension between these two aims gives rise to a distinct set of agency costs. The risk that the for-profit social enterprise may subordinate social mission to profits is most likely to occur following a change in ownership. Attorney and author Susan Mac Cormac refers to this risk as “the legacy problem.” “Many socially oriented for-profits,” she writes, “find that their social mission is dependent on founders’ fervor, and when founders retire or sell, their social legacy is often lost as more traditional owners and managers take over.” Similarly, entrepreneur and journalist Marjorie Kelly worries that a social enterprise’s social mission may be squeezed out when the founders leave, sell, or go public. The sale of Ben & Jerry’s is perhaps the most prominent example of this. The legacy problem arises in part from the risk that a founder’s commitment to creating social value will lessen over time. This can be seen as an inter-temporal agency problem between an idealist founder (principal) and his older and perhaps more acquisitive self (agent). In response, the founder of a new for-profit social enterprise may seek devices— a.k.a., precommitment strategies—to protect the social mission from his own selfregarding attempts to dilute it down the road. Donating company shares to a charitable foundation, for example, will prevent the donor from later benefiting from any price increase. The founder can also enlist a third party to monitor the controllers. The leading example of this is B Labs, the private organization which verifies a B Corporation’s compliance with social enterprise norms. This formulation of the legacy problem in for-profit social enterprises likens it to the agency problem faced by the founding donor (settlor) of a charitable trust—namely, that successive controllers (agents) will stray from the specific charitable mission selected by the settlor (principal). In truth, a for-profit social enterprise is more likely to stray from the founder’s original social mission than a charitable trust. The controllers of a charitable trust, the trustees, have some lawful leeway to redeploy trust assets away from the settlor’s specific charitable purposes, but any alternative purposes must be legally charitable. A for-profit social enterprise, by contrast, will have at least some owners who are entitled to appropriate some portion of the firm’s assets for their private benefit. For them, this is part of the for-profit social enterprise’s allure. What makes the so-called “legacy problem” problematic, and for whom? A for-profit social enterprise, after all, has private owners, and some of them may be outside investors whose aims and interests diverge from the founder’s original vision. They may prefer greater short-term profitability and less aggressive pursuit of that vision. In this respect, the enterprise’s controllers (typically a board of directors) are agents of multiple principals—the founder and outside investors, among others—whose interests may diverge. When a for-profit social enterprise shifts away from mission and towards greater profitability, some stakeholders may experience a windfall. At the time of purchase, an outside investor’s expectations of profits are tempered by her awareness of the enterprise’s simultaneous pursuit of a social mission. This does not imply that the investors are expecting or agreeing to a below market return—it may simply mean that the original owners subsidized the social mission by selling equity at a lower price. If the enterprise later abandons or reduces the social mission, these investors would receive a greater than expected return.

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Attempts to address the “legacy problem” in for-profit social enterprises can harm the interests of investors who seek robust financial returns. Their investments may generate a lower return if the organization’s controllers too zealously pursue the founder’s social mission. The magnitude of these investors’ losses is a function of their reasonable expectations. These investors’ agency costs vis-à-vis the controllers can be mitigated with approaches that resemble those used in conventional for-profit organizations. The founder and outside investors can share control over the enterprise (e.g., both sit on the board of directors), which dramatically reduces the information asymmetries that aggravate agency costs. These control rights can be increased if, for example, the enterprise does not meet certain financial targets. The outside investors can also negotiate for the right to bring lawsuits against the controllers. They also have the right to exit the enterprise altogether by selling their equity shares, and can negotiate for other rights, such as the ability to put their shares back to the company. QUESTIONS

1.  Katz and Page note how the development of for-profit social enterprises has raised interesting questions about whether off-the-rack legal forms are necessary. From a policy standpoint, what are some of the advantages and disadvantages of having social entrepreneurs utilize existing legal forms? In adopting new legal forms specifically designed for social enterprise? 2. What are some considerations social entrepreneurs may take into account when choosing an appropriate legal form? 3.  Do you have suggestions for how a social entrepreneur could attempt to combat the “legacy problem”? What would be some of the potential benefits and costs resulting from the implementation of your suggestions?

III.  INTERNATIONAL DEVELOPMENTS IN SOCIAL ENTERPRISE LAW The field of social enterprise is developing across the world. Lawmakers are attempting to determine whether existing laws in their home nations are sufficient to support this burgeoning field, whether modifications are necessary, or whether new laws are appropriate. Many countries have provided some form of governmental recognition and/or support for social enterprises—including manuals, directories, committee reports, targeted grants, web pages, etc. Other countries have crafted new laws governing dual economic and social mandates. This section considers the community interest company in the United Kingdom, after which two Canadian provinces have modelled their new laws, and the low-profit limited liability company and benefit corporation in the United States. Legal developments in these Anglo-American countries are the focus of this section, given their influence on and relevance to Canada. But while these two countries are often regarded as the most prominent in social enterprise, they are not the only participants within the movement. Several other countries are actively seeking ways to support social enterprises. These countries have employed a number of mechanisms, with varying degrees of success. Section III.C provides an excerpt of research conducted by Lambooy et al that offers insight into the development

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of social enterprise law in Belgium, Greece, and the Netherlands within the context of those nations’ legal systems. Canadian social enterprise laws are considered in Section IV.

A.  United Kingdom 1.  Community Interest Company The community interest company (CIC) has been a prominent example of a new hybrid legal form for social enterprise. Implemented in the United Kingdom under the Companies (Audit, Investigations and Community Enterprise) Act 2004 [Companies Act], the CIC is designed to enable the investment of private wealth into community projects, with governing mechanisms to ensure that the CIC is working for the benefit of the community. The particular novelty of CICs is that they are able to do what societies and not-for-profit corporations cannot, which is raise equity capital in exchange for shares. Any interested parties can apply for CIC status, including any other legal forms seeking to convert into CICs. A CIC is a limited company or public limited company with all the usual duties and obligations of a company accorded under the UK Companies Act, in addition to those specifically assigned to CICs. CICs receive no preferential tax treatment; they are taxed like regular companies.

a.  CIC Regulator The Regulator of Community Interest Companies is an independent statutory office-holder appointed by the secretary of state who plays a seminal role in administering and maintaining CICs. In addition to having the power to investigate complaints, the regulator may act if a CIC is found to be violating its community purpose or asset lock provisions, change the makeup of the board, or even terminate a CIC when necessary. In addition to overseeing the registration and regulation of CICs, the regulator has also been a figurehead for addressing public concerns related to the CIC and developing the CIC brand.

b.  Community Interest Test and Community Interest Statement To qualify for CIC status, interested parties must first pass a community interest test administered by the regulator. An interested party satisfies the community interest test if a reasonable person might consider that its activities (or proposed activities) are carried on for the benefit of the community (Reg 5, as amended by the Community Interest Company (Amendment) Regulations 2009). All interested parties applying for CIC status must provide the regulator with evidence that they will satisfy the community interest test, including a declaration that they are not engaged in political activities and a “community interest statement.” The community interest statement must indicate that the company will carry on its activities for the benefit of the community and explain how those activities will indeed create a benefit (Reg 2). The regulator may elect not to allow a party to become a CIC if any of its activities benefit only the members of a particular body or the employees of a particular employer, without bringing any benefits (directly or indirectly) to a wider community (Reg 4). It is expected that the community will usually be wider than just the members of the CIC, and can include either the community or population as a whole, or a definable sector or group of people in the United Kingdom or elsewhere.

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The stated community purpose of the CIC becomes the primary focus for its directors. Once a company has been registered as a CIC, it must continue to satisfy the test for as long as it remains a CIC. The regulator may take enforcement action against a CIC if the regulator forms the view that the CIC no longer satisfies the test.

c.  Asset Lock A significant feature of the CIC is its asset lock. This feature helps to ensure that assets that are intended for community benefit remain in that realm. Entrepreneurs interested in establishing a CIC need to pay particular attention to this feature because it means that once a business is established as a CIC, there are permanent consequences. Specifically, subject to the CIC meeting its obligations, its assets must either be retained within the CIC to be used for the community purposes for which it was formed, or, if the assets are transferred out of the CIC, the transfer must be made:

1. for full consideration (that is, at market value) so that the CIC retains the value of the assets transferred; 2. to another asset-locked body (a CIC or charity, a permitted registered society, or a non-UK-based equivalent) that is specified in the CIC’s articles of association; 3. to another asset-locked body with the consent of the regulator; or 4. otherwise for the benefit of the community.

The asset lock feature must be included in a CIC’s articles of association. CICs can individually implement even more stringent asset lock provisions if they choose. Note that the asset lock does not prevent a CIC from normal business activities and meeting its financial obligations.

d.  Dividend Cap Dividends on CIC shares are capped to ensure that profits are either retained by the CIC or used for a community benefit purpose. The dividend cap purports to maintain a reasonable balance between the interests of shareholders and the community interest, ensuring that dividends are not disproportionate to invested amounts and profits. The dividend cap has three elements: (1) the maximum dividend per share limits the amount of dividend that can be paid on any given share;15 (2) the maximum aggregate dividend limits the total dividend declared in terms of the profits available for distribution;16 and (3)  the ability to carry forward unused dividend capacity from year to year to a limited extent.17 The cap amounts are set by the regulator after consultation with and with the approval of the secretary of state. The amounts are not suggested rates of

15 The limit for shares in issue between 1 July 2005 and 5 April 2010 is 5 percent above the Bank of England base lending rate of the paid-up value of a share. The limit for shares issued on or after 6 April 2010 is 20 percent of the paid-up value of a share. 16 As of 2017, the limit is 35 percent of the distributable profits. 17 As of 2017, the limit is 5 years.

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return on investment; rather, they set the upper limit of those returns, if any. A CIC may choose to lower amounts in its articles of association, prospectuses, or offer documents. A CIC is permitted to carry forward any unused dividend capacity for four years, allowing the CIC to pay a larger dividend per share than it otherwise would be able to pay, but it is not allowed to pay a larger aggregate dividend than the maximum aggregate dividend for the relevant year.

e.  Interest Cap CICs have the same borrowing powers as companies and generally will be able to borrow and pay normal commercial rates of interest to creditors. However, in rare instances when interest payable on debts is linked to performance, the ability to pay uncapped interest on such debt would circumvent the purpose behind the dividend cap and thus interest payments are also subject to a cap. This cap is a percentage rate on the average amount outstanding on any given debt at the date the agreement for payment of the interest was made, or, for existing debt, the date the company became a CIC. The rate for a particular debt is fixed for the life of that debt, and will not change if the rate generally is changed, unless the rate is tied to the Bank of England rate.

f.  Annual CIC Report In addition to the asset lock and dividend cap, CICs have annual reporting requirements under which they must account for how their CIC has benefited the community and engaged stakeholders. CICs are recommended to form stakeholder advisory groups for the CIC’s benefit, and each CIC crafts its own individualized stakeholder process. The CIC is required to describe its stakeholder efforts in an annual report, which is placed on a public register at Companies House and reviewed by the regulator. The regulator can reject a CIC’s report or require revisions before it is accepted.

B.  United States 1.  Low-Profit Limited Liability Company Difficulties in accommodating particular federal tax laws was the main motivator behind the development of the first American legal form of social enterprise, the low-profit limited liability company (L3C), which began in the state of Vermont in April 2008. The L3C model was designed to house program-related investments (PRIs) under existing Internal Revenue Service (IRS) rules to enable foundations to better invest in PRIs without fear of compromising their tax-exempt status. The L3C takes the form of a flowthrough partnership, with owners considered members and an “operating agreement” outlining its social mandate.

a. Purpose In the United States, foundations are NPOs or charitable trusts that provide grants to unrelated organizations or individuals for charitable purposes. Under IRS rules, private

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foundations are required to pay out a “distributable amount” of their assets each fiscal year in order to maintain their tax-exempt status. This distributable amount is determined in accordance with § 4942 of the Internal Revenue Code18 and applicable regulations. Foundations may elect to spend their funds in two ways: through grants, which provide no financial return on their investment, or through PRIs, which may provide a potential return. To qualify as a PRI, the investment must be related to the foundation’s mission and the risk-to-reward ratio must exceed that of a standard market-driven investment, meaning the risk must be higher and the return lower. “Jeopardizing investments” under IRS rules can subject private foundations to considerably high excise taxes.19 A PRI is sheltered from designation as a jeopardizing investment if its primary purpose “is to accomplish one or more of the [organisation’s exempt] purposes … and no significant purpose of which is the production of income or the appreciation of property” (IRC § 4944(c)) or expenditures for political purposes (§ 4845). Many foundations are reluctant to invest in for-profit entities given the uncertainty of whether they would qualify as PRIs, despite the potential return. The L3C is designed to make it easier for foundations to make PRIs by bridging the gap between for-profit and non-profit agendas. The limited liability company (LLC) in the United States offers a great deal of flexibility in ownership and governance rules, and LLC state laws provide the base for L3C laws to build upon. It is clear from the wording of the L3C laws that the entity was created solely to meet PRI criteria. All the limitations accompanying an L3C essentially mirror the language set forth in the IRS rules, including that the L3C would not have been formed but for its charitable or educational purpose, which is meant to assure foundations that their tax-exempt status will remain secure if they make a PRI in an L3C model.

b.  Lack of IRS Assurances Despite the wording of the L3C laws, foundations sought further assurances from the IRS to ensure that their tax-exempt status would not be compromised if they invested in L3Cs. Although IRS private letter rulings (PLRs) are not required before a foundation makes a PRI, many prefer the comfort of one given the risks. In the early years following the passing of L3C legislation, advocates sought legislative support and/or a blanket PLR from the IRS identifying L3Cs as entities that automatically qualified for PRIs. The proposed Program-Related Investment Promotion Act of 2008 attempted to have L3Cs entitled to a rebuttable presumption that below-market investments from foundations qualified as PRIs.20 The proposal did not end up being introduced to US Congress and thus was not successful in producing new federal legislation or IRS

18 Internal Revenue Code of 1986, as amended [IRC]. 19 Internal Revenue Manual, “Taxes on Investments Which Jeopardize Charitable Purposes,” ch  27, s  18, online: ; see also Internal Revenue Service, “Private Foundation Excise Taxes,” online: . 20 Mannweiler Foundation Inc, “The Program-Related Investment Promotion Act of 2008: A Proposal for Encouraging Charitable Investments,” online: Council on Foundations .

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rulings. Similarly, a subsequent attempt with the proposed Philanthropic Facilitation Act of 201121 was tabled before Congress. It attempted to provide a simple IRS registration and approval process to prevent foundations from spending considerable time and money obtaining PLRs each time a PRI was sought by an L3C. The proposed legislation also did not result in any federal action. In May 2012, the IRS released proposed regulations that provided nine additional examples of investments that qualify as PRIs.22 These regulations made no mention of the L3C but served to better illustrate the application of the existing regulations. The organization behind the L3C, Americans for Community Development, has often found themselves on the defensive regarding the viability of the model. It is unlikely that the L3C will have international influence given its specificity and close adherence to US federal tax rules. L3C legislation is available in eight states and two federally recognized Native American tribes.23

2.  Benefit Corporation The states of Maryland and Vermont were the first to pass benefit corporation legislation in 2010, and since then 29 other states have enacted this type of legislation. The steady rise in numbers is attributable to aggressive lobbying efforts by the founders of B Lab, a Philadelphia-based non-profit organization behind the creation of the private “B Corporation” certification. It is therefore helpful to better understand the benefit corporation by first examining the private B Corporation certification. In the 1980s, the corporate takeover boom saw several states implement “other constituency” (also known as “non-shareholder constituency” or “corporate constituency”) legislation, which expressly permits (and, in at least one state, requires) directors to consider interests of groups in addition to shareholders in their corporate decision-making. A large majority of US states are now “other constituency” states. As of 2017 only six states have not implemented such legislation.24 In 2008, B Lab, a Philadelphia-based NPO, created its own privately regulated B Corporation certification. Taking advantage of the other constituency statutes, B  Lab’s private B Corporation certification process (which has changed significantly over the years) required interested companies to amend their governing documents in order to require the consideration of stakeholder interests in board decision-making. After the first few years of its certification process, the number of companies interested in becoming B Corporations in

21 Philanthropic Facilitation Act of 2011 (HR 3420); Americans for Community Development, “Proposed Federal Legislation” (15  November 2011), online: ; GovTrack, “HR 3420 (112th) Philanthropic Facilitation Act,” online: . 22 Internal Revenue Bulletin 2012-21, “Notice of Proposed Rulemaking Examples of Program-Related Investments,” REG-144267-11 (21 May 2012), online: . 23 Legislation has been passed in the states of Illinois, Louisiana, Maine, Michigan, North Carolina, Rhode Island, Utah, Vermont, and Wyoming and in the federal jurisdictions of the Crow Indian Nation of Montana and the Oglala Sioux Tribe. North Carolina repealed its L3C legislation in 2014. 24 These states are Alabama, Alaska, Kansas, Michigan, North Carolina, and Oklahoma.

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the United States began to plateau, and B Lab began actively marketing its branding internationally, including in Canada. Canadian companies choosing to certify as B Corporations are also required to amend their governing documents to address the consideration of stakeholder interests. This is despite the fact that Canadian laws already hold such a requirement (see Chapter 7 for more discussion), creating a puzzling redundancy in the certification process for Canadian companies. To become a certified B Corporation, a company is first required to take a “B Impact Assessment,” which surveys issues relating to accountability, employees, consumers, community, and the environment. A corporation is certified once an acceptable score is obtained under B  Lab’s rating system (80 out of 200), and the company is required to submit supporting documents for a portion of the answers. B Lab relies on the assessment and a separate auditing system to ensure that B Corporations are pursuing and achieving their social mandates. Within an allotted time following certification, B Corporations are required to enforce the consideration of stakeholder interests in their governing documents. Given the enactment of benefit corporation legislation across several states, B Lab has amended its legal requirement depending on the state in which existing companies are incorporated:





1. Companies incorporated in states with benefit corporation legislation must elect benefit corporation status within four years of the enactment of the legislation or two years after the company’s B Corporation certification. 2. Companies incorporated in states without benefit corporation legislation, but with other constituency legislation, must amend their articles of incorporation with language provided by B Lab that indicates directors shall consider stakeholder interests within one year of certification. 3. Companies incorporated in states without benefit corporation legislation and other constituency legislation must sign a term sheet stating that they will consider stakeholder interests within the current corporate laws of their state, and that they will help support B Lab’s lobbying for benefit corporation laws in their state.

The B Corporation certification by B Lab and the subsequent enactment of benefit corporation legislation across states has created considerable confusion for many entrepreneurs seeking to navigate through the options available to them in addition to traditional legal forms. To clarify, while the founders behind B Lab lobbied state governments for benefit corporation legislation, they are private actors and separate from the states that oversee benefit corporation laws. Interested parties can elect to become benefit corporations without being certified as B Corporations, bypassing the B Impact Assessment and any involvement with B Lab. Benefit corporations receive no preferential tax treatment and are taxed like regular corporations. The governing features in benefit corporations vary somewhat from state to state, including some states that have chosen the name “public benefit” corporations and “social purpose” corporations. Benefit LLCs have also appeared in some state laws, which mirror most of the features of the particular state’s benefit corporation laws but use an LLC legal base. B Lab employs a model benefit corporation legislation that it uses as a starting point for state legislators, which states have adopted with various modifications. The main common features across several of the states generally echo those that were first enacted in Maryland

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and Vermont. These two state benefit corporation laws are used as the primary example, though there are variants among states.25

a.  Public Benefit The purpose of a benefit corporation is to create a general public benefit, defined as “a material positive impact on society and the environment, as measured by a third-party standard, through activities that promote [some] combination of specific public benefits” (Maryland Act, § 5-6C-01(c); Vermont Act, § 21.03(4)). The model benefit corporation legislation provides some examples of what constitutes a specific public benefit: (1) providing low-income or underserved individuals or communities with beneficial products or services; (2)  promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business; (3) protecting or restoring the environment; (4)  improving human health; (5)  promoting the arts, sciences, or advancement of knowledge; (6) increasing the flow of capital to entities with a purpose to benefit society or the environment; and (7) conferring any other particular benefit on society or the environment.

A third-party standard is defined as “a standard for defining, reporting, and assessing overall corporate social and environmental performance,” and states have allowed benefit corporations to self-determine how that third-party standard is conceived and met. Benefit corporations are not required to be audited or certified by any particular third-party standard. An interested party seeking benefit corporation status would follow standard incorporation procedures set out in a state’s corporate laws, but its articles of incorporation must state that it is a benefit corporation. There are no specific criteria to qualify as a benefit corporation so long as proper company approvals have been met; that is also the case if a company wishes to withdraw from being a benefit corporation. Shareholders would follow normal voting requirements to amend a company’s articles of incorporation in order to remove the “benefit corporation” statement (typically a supermajority vote). Existing state corporate laws serve to fill any gaps remaining in the benefit corporation laws.

b.  Board Consideration of Stakeholder Interests A significant aspect of the benefit corporation laws is the codification of stakeholder interests in directorial decision-making. A director is required to consider the effects of any action or decision not to act on its shareholders (“stockholders” in certain states), employees, subsidiaries, suppliers, customers, community and societal considerations, and the local and global environment (Maryland Act, § 5-6C-07(a)(1)). Vermont has an additional sixth factor, encompassing “the long-term and short-term interests of the benefit corporation, including the possibility that those interests may be best served by the continued independence of 25 Corporations and Associations, Md Code Ann tit 5 § 5-6C-01 [Maryland Act]; Vermont Benefit Corporations, Vt Stat tit 11A § 21 [Vermont Act].

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the benefit corporation” (Vermont Act, § 21.09(a)(1)(F)). In contrast to the perceived standard articulated from the Delaware court decision of Revlon, Inc v MacAndrews & Forbes Holdings, Inc26 (excerpts of the judgment are provided in Chapter 15), this additional statutory provision provides substantially the same protection as the similar provision offered by the B Corporation model by relieving directors of the duties to maximize shareholder value in a takeover situation. Some state social purpose corporations offer an even lighter alternative to the mainstay corporation than the benefit corporation because their legal provisions only ensure the permissibility of considering social and environmental issues rather than requiring it. This presumably is already the case in states with “other constituency” statutes, so there is a question whether their creation may be in response to a general need for a social enterprise brand of corporation rather than any specific legal need. The treatment of fiduciary duties to general public beneficiaries can also be contrasted in different state legislation. For example, in Maryland, the director has no duty (fiduciary or otherwise) to a person who is a general public beneficiary of the benefit corporation. Vermont, however, has taken the step in expanding the definition of fiduciary duties for their directors (Vermont Act, § 21.09(a)). Vermont directors have fiduciary responsibilities only to those persons entitled to bring about a benefit enforcement proceeding against the benefit corporation. This provision also appears in the model benefit corporation legislation.

c.  Benefit Director In Vermont and certain other states, one independent director of the board is required to be designated as a benefit director. This benefit director feature also appears in the model benefit corporation legislation. The benefit director must prepare an annual statement detailing whether, in the opinion of that director, the company acted in accordance with its benefit purpose, and, if not, why (Vermont Act, § 21.10). The statement and the annual benefit report are to be delivered to and approved by the shareholders and also made public (posted on the company website or available for those who request it).

d.  Benefit Enforcement Proceeding A benefit enforcement proceeding is a claim or action against a director or officer of a benefit corporation for failing to pursue the public benefit purpose set forth in the benefit corporation’s articles of incorporation, or for violating any duty in the statute. Parties that are able to commence a benefit enforcement proceeding are shareholders, directors, persons or group of persons that own 10 percent or more of the equity interests in an entity where the benefit corporation is a subsidiary, or any other persons specified in the articles of the benefit corporation (Vermont Act, §  21.13(b)). Directors are not subject to a different or higher standard of care when decisions may affect the control of the benefit corporation (Vermont Act, § 21.09(a)(4)). In addition, a director is not liable for the failure of a benefit corporation to create general or specific public benefit. Directors have the same immunity

26 Revlon, Inc v MacAndrews & Forbes Holdings, Inc, 506 A (2d) 173 (Del SC 1986).

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from liability as directors of those states’ corporations generally. Therefore, unless the director or officer did not act diligently, or their acts constitute fraud or negligence, the courts are unlikely to intrude upon their business judgment.

e.  Annual Benefit Report A benefit corporation is responsible for creating an annual benefit report, with some states requiring board approval before the report is sent out to shareholders (Maryland Act, § 5-6C-08(a)). Reporting requirements, as with other provisions, can vary across states, but generally they require (1)  a description of how the benefit corporation pursued a public benefit during the year and the extent to which the public benefit was created; (2) any circumstances that hindered the creation of the public benefit; and (3) an assessment of the societal and environmental performance of the benefit corporation, prepared in accordance with a third-party standard. Vermont includes more explicit instructions on how the report must be constructed, such as outlining specific goals or outcomes and disclosing the amount of compensation paid to each director and the name of each shareholder owning 5 percent or more of the shares (Vermont Act, § 21.14(a)(4)-(7)). These additions add a heightened level of transparency and accountability that is similar to some of the disclosure requirements of public companies. The annual benefit report must be provided to each shareholder within 120 days after the end of the benefit corporation’s fiscal year, and must also be made public along with the benefit director’s report, either by posting on the company website or by having copies available for those who request it. Information on director compensation can be removed from publicly available documents.

Dana Brakman Reiser, “Benefit Corporations— A Sustainable Form of Organization?” (2011) 46 Wake Forest L Rev 591 at 606-7, 610-14 (footnotes omitted) II.  Assessing the Benefit Corporation The range and diversity of emerging hybrid organizational forms raises the question of which is best. It is likely impossible to answer this question for all social enterprises in all situations, but this Part will undertake a preliminary assessment of how the benefit corporation serves the needs and goals of these entities and their founders. Fundamentally, founders and operators of social enterprises unsatisfied with traditional nonprofit or for-profit forms seek a type of organization that will legally establish their sense of a dual profit-making and social mission and enforce it over time. They would also like a hybrid form to expand the range of funding streams they can effectively access. Further, they seek to use the hybrid form as part of their effort to brand their social enterprises to enable them to market their products and services to consumers, business partners, and others as special and different from those offered by typical nonprofit charities and for-profit businesses. Many believe that achieving all or some combination of these three goals is the only way to make their endeavors sustainable. This Part evaluates whether and to what extent the benefit corporation form will accomplish these various and often overlapping

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goals. The exercise here is a limited case study of one form of organization. But, this effort will begin the important work of theorizing more generally the value hybrid forms offer to social enterprises. •  •  •

2.  The Benefit Corporation and Dual Mission Articulation The benefit corporation statutes not only permit, but require, articulation of an expressly dual mission. These are corporations formed for profit and to pursue a “general public benefit.” This express dual mission mandate contrasts starkly with traditional nonprofit forms, which prohibit entities from acting to pursue profits for owners. It also represents a significant change from for-profit forms in which some pursuit of social good is certainly within legal bounds, but significant sacrificing of profits to further social goals engenders real risks. When one thinks more deeply about how a dual mission will be articulated in a benefit corporation, however, doubts emerge. The requirement of general public benefit is vague and undefined. The determination of whether a particular organization’s goals pursue a general public benefit is left to an unregulated third-party standard-setter. Moreover, the statutes provide no baseline or guidance for the standards these third parties should use to make this determination; they require only transparency and independence. If a standard-setter clearly and transparently sets low standards, it may qualify unrelated entities to form as benefit corporations just as would a standard-setter with higher standards, leaving the door open to greenwashing or even fraud. Perhaps transparency will enable consumers and investors to judge the mix of profit and social good individual benefit corporations serve based on which standard-setter is used. This, however, would require highly motivated consumers and investors to engage in significant research. At the moment, benefit corporations require only formal articulation of a dual mission, and oversight over the genuineness of these statements is lacking. 3.  The Benefit Corporation and Dual Mission Enforcement Third-party standard-setters, fiduciaries, and shareholders all play enforcement roles in the benefit corporation. … As noted earlier, these standard-setters play this certification role bounded by neither standards nor oversight. Moreover, the role of the standardsetters themselves in ongoing enforcement is less clear. All of the statutes envision public benefit assessments in annual benefit reports will be made with reference to the thirdparty standard. But, none of the statutes specify whether or how standard-setters should be involved in vetting public-benefit provision after incorporation. Standard-setters may choose to engage in auditing or other monitoring functions to boost enforcement or they may consider their role complete when initial certification is granted or denied. Shareholders are also involved at the initial adoption of benefit corporation status and on any exit from that status. Shareholders must be granted express notice of the change and must vote by a supermajority to approve it. These provisions may have been drafted to protect unsuspecting investors from being surprised by a benefit corporation’s dual mission orientation. Yet, the notice and voting requirements apply in both directions. Thus, they also protect the benefit corporation and enforce its dual mission against termination without a strong consensus among shareholders. Outside the context of transformation to fully for-profit status, though, the statutes offer little guidance to shareholders

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or fiduciaries on the thorny issue of how profit and social good should be balanced. They allow directors to forego profit maximization in favor of social good production or vice versa, but they do not instruct directors on how to exercise this broad discretion. Directors are not told to err on the side of social good in every decision, to pursue more profit than social good across the enterprise, or the opposite of either instruction. Rather, directors are merely instructed to consider the impact of every decision on nonshareholder constituencies. In addition, the statutes provide directors with a broad range of interests that they may act to benefit, and the role of benefit corporation director is constructed to be highly discretionary. Thus, the statutes impose no clear framework for directorial decision making. Without one, it is difficult to identify a metric by which shareholders might enforce fiduciaries’ compliance with dual mission. Shareholders of all benefit corporations retain the informational, voting, and litigation rights of ordinary shareholders. Any of these rights could, theoretically, be used to enforce dual mission. Benefit corporation shareholders may demand to inspect corporate books and records beyond the benefit report to determine how a particular mission conflict was resolved. They may vote out directors who fail to sufficiently pursue their favored balance of profits and mission. They may even sue directors for a failure to meet their special fiduciary obligations under the statute, and the later-enacted statutes also provide for the benefit enforcement proceeding. Still, shareholders are unlikely to be assiduous and consistent enforcers. Their ability to obtain damages to redress faulty directorial decisions is significantly limited by ordinary fiduciary liability concepts like the business judgment rule and will be further frustrated by benefit directors’ broad and unguided discretion and immunity. Moreover, benefit corporation shareholders have an additional reason not to engage in enforcement of dual mission—or at least a serious potential bias toward one-half of it. If a benefit corporation begins veering away from its dual mission to achieve greater profits, shareholders stand to gain financially from this decision. Thus, although many routes exist for shareholder enforcement, shareholders are uniquely hamstrung as enforcers in the benefit corporation context. The statutes uniformly exclude other potential parties from engaging in enforcement through litigation. Beneficiaries and the public will not have standing to challenge actions by benefit corporation directors. This position resonates with the traditionally extremely limited standing to challenge actions by nonprofit corporate directors. This policy is justified as necessary in order to recruit directors, which are most often uncompensated, to serve on nonprofit boards. However, the nonprofit context provides for government enforcement by state attorneys general and, for exempt nonprofits, the IRS. There is no regulatory role for any public official in the benefit corporation. Other hybrid forms of organization take very different stances on enforcement than the benefit corporation. The United Kingdom adopted public enforcement, launching a specialized CIC regulator in addition to allowing shareholder enforcement of dual mission. The regulator possesses broad authority to investigate, remove fiduciaries, and even terminate CICs found out of compliance. L3Cs rely solely on private enforcement, and the contours of this enforcement remain somewhat unclear. LLC members have internal means to challenge fiduciary actions and legal standing to enforce managers’ fiduciary obligations. The exact scope of these duties, and the means of their enforcement, is not addressed by the L3C statute and the nature of LLC fiduciary duties is both contested and jurisdictionally diverse. Moreover, as a

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species of LLC, an L3C operating agreement may tailor fiduciary duties to a significant degree, generally including reducing those obligations when “not manifestly unreasonable.” Drawing on the language of the L3C statutes, John Tyler has suggested that the fiduciary duty of L3C managers should be understood to require prioritization of charitable and educational purposes over their profit-making ones. Further, he has argued that enforcement mechanisms borrowed from for-profit forms should suffice to enforce these obligations. Whether or not these views of L3C fiduciary obligation and enforcement become widely accepted, the statutes certainly offer no regulatory or other enforcement vehicles. Like the benefit corporation, the B Corp retains the existing enforcement mechanisms of a for-profit corporation, including shareholder informational and voting rights as well as derivative suits. This private certification form, however, does not add benefit directors, benefit officers, or benefit enforcement proceedings found in some benefit corporation statutes. B Corp status also subjects adopters to potential audit by B Lab, which B Lab and other standard-setters may require for benefit corporations, but the statutes do not require by their terms. 4.  The Benefit Corporation’s Disclosure Model The benefit corporation form relies significantly on disclosure, both to amplify dual mission articulation and to lubricate enforcement. The benefit report gives shareholders and the public an opportunity to view how the entity reacts to situations in which profit and social mission conflict. Of course, the benefit report need not address these questions specifically. It must only report on public benefits achieved and circumstances that have hindered public benefit production. The Vermont, New Jersey, and Hawaii statutes demand that benefit corporations provide somewhat greater information in their benefit reports. They also compel them to charge a benefit director with a monitoring role, including preparing an opinion of the entity’s public benefit performance. The New Jersey and Vermont statutes also provide for potentially greater review of the annual report, demanding filing with a government agency and shareholder approval, respectively. Whether these recipients of disclosure will actively enforce is not yet known. Empowering individuals required to engage activity in the process of creating and approving disclosures, however, may at least somewhat improve the likelihood that enforcement action will be taken based upon them. In terms of disclosure, benefit corporations occupy a sort of middle ground between the situations of traditional nonprofit and for-profit entities. On the one hand, benefit corporations must issue self-styled disclosures about public benefit provision to shareholders and allow for public review, a different kind of transparency than would be required of a nonprofit. Nonprofits must provide standardized annual reports on their charitable activities to state attorneys general and, if they are tax-exempt, they must submit annual informational tax returns to the IRS and make them public. The level and contents of required disclosures for benefit corporations should provide greater transparency on how a dual mission is being managed than would be available from a standard for-profit corporation, partnership, or LLC. Corporations may have annual reporting obligations to shareholders and the secretary of state, and LLCs may be required to report annually to state authorities as well. For-profits regulated by federal securities law may have additional reporting obligations. None of these

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required reports, however, must contain information regarding the social goals and achievements of the disclosing organization. Benefit corporation disclosures are thus fairly robust and are certainly more closely tailored to address dual mission performance than either nonprofit or for-profit disclosures. Benefit corporations also require more disclosure on the question of social and profitmaking activity than any other hybrid forms currently available in the U.S. L3C statutes require no disclosures beyond the annual reporting obligations derived from related LLC statutes, which include no requirement of reporting on the entity’s furtherance of charitable and educational purposes. Investor-members in an L3C could certainly demand such reporting, but it is not statutorily mandated. The B Corp certification requires B Lab to have access to certified entities for potential audits but does not require any periodic disclosures to it, to investors, or to the public. QUESTIONS

1.  As of 2017, there are over 13,000 registered CICs in the United Kingdom. A significant number of these CICs were originally the UK equivalent of not-for-profit corporations that later converted to the CIC form. What do you think are critical factors in determining whether a new legal form for social enterprise is utilized within a particular jurisdiction? 2.  Brakman Reiser highlights how benefit corporations may be subject to very weak or non-existent enforcement mechanisms in ensuring that they adhere to the “general public benefit” purpose requirement. What consumer and policy concerns may arise from the lack of oversight in benefit corporations? What are potential solutions, and the related costs and implications of those solutions?

C.  Other Countries In addition to the United Kingdom, the United States, and Canada (discussed in Section IV), there have been significant developments to support and grow social enterprises worldwide. In the following excerpt, Lambooy et al describe the current status of social enterprise laws in Belgium, Greece, and the Netherlands to provide some flavour of the various stages of social enterprise development occurring beyond Anglo-American countries. The existing legal system of each country is highly relevant in understanding the context in which supporting laws are being introduced, and beyond legal systems, there are political, social, cultural, and historical contexts that often should be taken into account. These descriptions are therefore brief. The list is also far from exhaustive. For example, Lambooy et al note that in Finland, there has been legislation considering social enterprises as vehicles to alleviate unemployment, and in Portugal, laws have been introduced to address social enterprises as organizations with the goal of satisfying the social needs and the social integration of disadvantaged and marginalized populations. Australia has actively pursued the promotion of social enterprise, including in the context of access to justice. The United Kingdom’s CIC regulator has noted that lawmakers in Japan and South Korea have reached out and expressed interest in the UK CIC model. The field of social enterprise is continuing to evolve as countries grapple with how best to advance the integration of business with social and environmental interests.

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Tineke Lambooy, Aikaterini Argyrou & Rosemarie Hordijk, “Social Entrepreneurship as a New Economic Structure That Supports Sustainable Development” University of Oslo Faculty of Law Legal Studies Research Paper Series No 2013-30 at 11-14, 18-25 (footnotes omitted) 2.2.  Legal System of Belgium 2.2.1. Introduction In Belgium, specific legislation was adopted concerning legal structures for social enterprises. In 1995, the “vennootschap met social oogmerk” or “VSO” (the company with a social purpose) was introduced. It is not a separate legal form, as all corporate forms of business organisations (as mentioned in article 2, paragraph 2, of the Belgian Company Law) can adopt the social purpose company label. Besides the VSO, there are two other legal forms provided by Belgian corporate law which could possibly be used in the social economy, ie the “vereniging zonder winstoogmerk” or “VZW” and the cooperative. However, in this article, we will only focus on the company form, ie the VSO, because of our research goal to compare interesting innovative corporate forms that have a specific social enterprise objective. Since 1 July 1996, a commercial company may qualify as a “company with a social purpose” if: (i) “it is not dedicated to the enrichment of its members” and (ii) its articles of association respect a series of conditions. These requirements are included in article 661 of the Belgian Company Law. The most important aspects will be set out below. The articles of association of a VSO must:

(i) State that the members are only seeking a limited profit or no profit; (ii) Describe the aim of the social purpose of the activities. The main aim may not be to provide direct or indirect economic benefit for the members (the payment of dividends may not exceed a rate of return specified by law); (iii) Set out a policy for the distribution of profits which is appropriate to the internal and external purposes of the company; (iv) State that no one taking part in a vote at the general assembly may exercise a number of votes exceeding one tenth of the votes deriving from the shares represented; (v) Set out practical procedures whereby each worker has the legal right to become a member, one year after joining the company at the latest. Although this legal structure seems very innovative for the time of adopting (1995) and also offers very interesting opportunities for workers (see requirement (v) above), research by Defourny and Nyssens has demonstrated that the VSO has had little success over the years. They argue that “This may be explained by the fact that they [VSO] involve a considerable number of requirements which add to those associated with traditional legal forms, without bringing a real value added for the concerned organisations.” On the same page is the research of Mertens and Dujardin, who point out that only a limited number of VSOs has been registered: 457 VSOs were registered in 2008. The VSO will be further analysed in accordance with the legal variables selected by us.

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2.2.2.  Legal Variables A.  Establishment Objectives (Profit or Non-Profit?) Historically, companies in Belgium have to pursue a profit purpose. An exception has been made for the VSO: the articles of association have to provide that the VSO has not been incorporated with the purpose of enriching the members. They must describe the aim of the social purpose of the company’s activities. However, social finality is not defined in the Belgian Company Law. Consequently, it is not clear what is considered to be a social purpose. As stated, the legislator has formulated this in a negative way; the law only explains what does not qualify as a social purpose, ie: the main aim may not be providing direct or indirect economic benefit for the members. B.  Governance (Participation of Stakeholders) There is no specific provision that deals with the governance structure of the VSO, hence, ordinary Belgian Company Law applies. However, there are two specific requirements related to the governance of the VSO:

(i) The legal right of workers to become a member of the VSO after a year. This is an interesting aspect of the multi-stakeholder ownership dimension of the social enterprise; (ii) The articles of association must provide that no one taking part in a vote at the general assembly may exercise a number of votes exceeding one tenth of the votes deriving from the shares represented. This is not the “one member, one vote” principle but it is different from the traditional capital and decision-making correlation. C.  Accountability and Responsibility (External and Internal) Directors must annually issue a special report concerning the way the social finality has been pursued. This report must indicate that the costs of investment are earmarked to stimulate the social finality. There are also strict constraints in terms of sanctions and control. Article 663(2) of the Belgian Corporate Law interestingly holds VSO directors liable for any allocation of the company’s reserves to objectives which are different from the social goals as stated in the articles of association of the VSO. The law requires that the directors provide the appropriate restitution and the payment of damage. The law further provides the VSO shareholders with the right to claim for restitution against the receivers of the company’s reserves if it is proved that they knew or should have known about the irregularity of the distribution. At this point, it is appropriate to elaborate on the important role of third parties in the Belgian legislation regarding VSOs. Their powerful role is very much related to the characteristic of the Belgian legislation which is to control the function of the social finality via the Courts instead of using administrative authorities. Primarily, this important role is obvious with reference to the shareholders’ eligibility to sue third parties before the Belgian Courts if they prove that these third parties knew or should have known about irregular behaviour within the VSO while they had a relevant interest in the case.

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Furthermore, a direct reference can also be made to the dissolution of a VSO by a Court order following a request filed by third parties who have a relevant interest in the case. This particular right is only provided if the company’s articles of association do not comply with legal requirements or if, though complying, they are violated by the company. Therefore, considering that the social objectives of a VSO are stated in its articles of association, any violation or deviance from these objectives could result in the company’s dissolution. Apparently, the law requires from third parties the existence of a relevant interest in the case, meaning their information and good knowledge of relevant facts about the management and administration of the social enterprise. D.  Finance structure (legal minimum capital and funding) As the VSO can take different legal forms, hence, the capital requirements also vary. For some legal forms, there is a requirement to have a legal minimum capital and a financial plan at the moment of incorporation. The requirement for the cooperative’s minimum legal capital is the lowest, being 6,150€. In regard of the question whether the funding requirements constitute an obstacle for social entrepreneurs to use the VSO form, we refer to a study by two Belgian researchers. They have examined the legal requirements for the VSO to attract funding. They considered this to be “neutral.” However, they mentioned that it is difficult for a VSO to apply for subsidies because government subsidies usually assume the cooperative legal structure rather than the VSO. [A] VSO needs to have a policy on how the distribution of profits will be organised in accordance with the purposes of the company. The payment of dividends may not exceed a specified rate of return, which is currently set at 2.75 per cent. E. Incentives The tax system for the VSO has no special features. A VSO is subject to company tax law like any other company in Belgium. •  •  •

2.4.  Legal System of Greece 2.4.1. Introduction In Greece, the new Law on Social Economy and Social Entrepreneurship (Law 4019/2011; hereinafter “the Law”) institutionalises social entrepreneurship in the Greek legislation as the most important part of the social economic sector. In this section, this Law will be outlined. The social economic sector or otherwise the “social economy” has been evolving in Greece in the last 20 years as a third economic sector between a wide public sector and a weak private sector. Traditionally, Greek social enterprises emerged as organisational models for collective or individual entrepreneurial initiatives, basically working on a non-profit basis. They were mostly structured as schemes from the private sector pursuing revenue gains to secure their self-sufficiency either by reinvesting their profits in the organisation, or by using them to satisfy social needs and to provide social benefits. The Greek legislative environment for social enterprises (ie cooperatives, local unions and associations, civil societies and foundations) before the new “Law” provided for the establishment of private or collective schemes governed by commercial legislation,

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civil legislation or socially-oriented regulation. Efficient legal private schemes for social enterprises in the Greek Civil Code were the nonprofit society/partnership, the nonprofit association, the private foundation and the non-profit public benefit foundation. However, compar[ed] to the private schemes, the collective schemes were prevailing in the field of social economy in Greece. Particularly, cooperatives were the most frequent vehicles for social enterprises. Thus, before the enactment of the new Law, a social enterprise could be formed using the legal structure of a civil cooperative which is an association of legal or natural persons aiming either at “for profit” or “not for profit” financial activities maintaining agricultural, rural, credit or social goals. The frequent use of civil cooperatives with social objectives for the start-up of a social enterprise in Greece led to the introduction of the Law on Social Entrepreneurship and Social Economy which was enacted in 2011. The Law principally institutionalised the third sector of social economy clarifying which legal entities belong to this new field. Furthermore, in the Law it is stipulated that the sole type of cooperative which belongs to the field of the Social Economy is the new form of “Social Cooperative Enterprise” (SCE). The Law defines the SCE in Article 2(1) stating that “the Social Cooperative Enterprise is established as an entity of Social Economy. It is a civil cooperative with a social cause possessing entrepreneurial capacity by law. The SCE members can be either individuals or juridical entities. Its members participate with one vote regardless of the cooperative shares they possess.” Additionally, all existing cooperatives can qualify as social enterprises if and when meeting the definition and the following criteria:

(i) Their statutory purpose aims at social benefit while they provide goods and services of a collective and social character; (ii) They give priority to individuals and labour over capital; (iii) They are autonomous in terms of managerial activities; (iv) They apply a democratic system of one man one vote in decision-making; (v) Their profits satisfy primarily their statutory goal and secondarily any profit distribution; and (vi) They operate according to the principle of sustainable development. Furthermore, the Law stipulates that the exclusive fields of operation in Greece for Social Cooperative Enterprises are: (i) Social Cooperative Enterprises of Integration; (ii) Social Cooperative Enterprises of Care; and (iii) Social Cooperative Enterprises of Collective and Productive Purpose. Along these lines, a new Social Economy General Registry (hereinafter “the Registry”) has also been introduced by the new Law. According to the Law registration is mandatory for the newly incorporated SCEs in Greece. The Registry is [an] administrative authority maintained by the competent Ministry of Employment and Social Security. It is responsible for mapping, coordinating and supervising (under particular circumstances addressed below) all SCEs in the field of the social economy. Up until 29 May 2013, only 190 SCEs had been registered to the Social Economy General Registry.

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2.4.2.  Legal Variables A.  Establishment Objectives (Profit or Non-Profit?) The overarching objective of an SCE could be characterised as a “collective” and it is the fulfilment of collective or societal interests or the performance of activities which aim to enhance local and regional development as a part of a broader society. Further objectives of an SCE should be the encouragement of social solidarity, social cohesion and the inclusion of socially vulnerable groups. In particular, the Law regulates three organisational forms of the SCE. Each one of them aims to fulfil a different goal:

(i) Social Cooperative Enterprises of Integration mainly aim to accommodate the integration of individuals belonging to volatile and vulnerable groups of the population into economic and social life. (ii) Social Cooperative Enterprises of Care have the objective of providing goods and services of a social character or social care to certain vulnerable groups of the population such as the elderly, the disabled, children and the chronically ill. (iii) Social Cooperative Enterprises with a Collective and Productive Purpose which aim at providing goods and services to accommodate the social needs or social benefits of society (such as environmental, cultural, ecological concerns). They promote local and collective interests in the alleviation of unemployment and the invigoration of social cohesion. B.  Governance (Participation of Stakeholders) Applicable to the SCEs is a democratic model of representation which requires the equal representation of the SCEs members on the basis of the rule “one man, one vote.” This principle lies in article 4(2) of the Law concerning Civil Cooperatives which also applies to the SCEs according to article 5(1) of the new Law. The “one man, one vote” principle requires that every member has only one vote at the General Meeting of the Members regardless of his/her capital contribution in the cooperative. For the establishment of a SCE, a minimum number of five members are required. Additionally, Article 4(6) of the Law provides the legal right of workers to become members of the SCE in any case without any explicit limitation. Articles 5 and 6 of the Law regulate the duties and the rights of the SCE’s general meeting of members and management board (hereinafter “the Board”). In SCEs with more than 25 members the establishment of a mandatory supervisory board after the order of the general assembly is required. The supervisory board is obliged to audit and supervise the activity of the management. Furthermore, SCEs are required to adopt operational independence by law. Therefore, the Board is obliged to decide independently without any interventions by third parties such as governmental administrative bodies, individuals or any other kinds of external representatives. The participation of regional administrative organisations or other legal entities which belong to the public sector is not allowed.

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C.  Accountability and responsibility (external and internal) There are no provisional or regular auditing requirements for SCEs. At the end of their accounting period a balance sheet and a profit-loss account are prepared by the Board. The Board submits the SCE’s financial statement to the supervisory board for audit and then requires the statement’s approval by the general meeting of members. One month after the approval the balance sheet and the profit and loss account should be published in a local newspaper circulated at the location where the seat of the cooperative is situated. Having the capacity to monitor or coordinate SCEs, the Registry conducts audits of SCEs’ records and documents, unless they are explicitly protected by professional confidentiality. If the Registry discovers any infringements or unlawful acts against the provisions of the new Law, auditing agencies proceed with the imposition of penalties, as prescribed by the law. D.  Finance structure (legal minimum capital and funding) The SCE is typically a not-for-profit entity. The SCE’s capital primarily consists of its members’ contributions. Any existing surpluses or profits are not distributable to the managers or founders or the financiers of the SCE. Exceptionally, the employees are eligible to annually receive 35 per cent of the enterprise’s profits as remuneration for their productivity; this amount is subject to withholding tax according to the on-going legal percentage. Only 5 per cent of the revenues can be used as company reserves. The remaining 60 per  cent of the revenues are reinvested in the enterprise for job creation. This amount (60 per cent) is tax exempt. According to article 9 of the new Law, SCEs could be also supported financially by the newly established “Social Economy Fund” and the “National Fund of Entrepreneurship and Development” (The Funds). Due to the financial crisis the sources of the Funds are not accessible so far to the SCEs. This is why existing inconsistencies and grey areas of the Law in this respect have not been clarified yet eg the law does not clearly explain whether all the legal entities in the field of social economy are also beneficiaries of the Funds’ sources while the Law does not provide the means of distribution of the Funds’ financial support to the SCEs. E. Incentives As of January 2013, a list of tax incentives for the SCEs was provided in Article 10 of the new Law. The article in subsection 10(3) particularly produced a lenient tax framework for the SCEs applicable also to the SCE’s employees. According to the provision, SCEs were not subject to income tax on the share of profits available for the formation of reserves while SCE’s share of profits distributed to employees was subject to withholding income tax, according to the current tax rate of the first income scale. This tax was the only tax liability on the profits of a SCE and on the profits of the employees of a SCE who belong to vulnerable groups. In January 2013 stricter tax legislation came into force in Greece, adjusting the existing income taxation to fiscal necessities for the alleviation of the Greek financial crisis. The new legislation abolished the lenient tax framework provided for the SCEs in subsection 10(3) of the Law on Social Economy and Social Entrepreneurship. Therefore, SCEs are subject to ordinary income tax liabilities for the new fiscal year.

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2.5.  Legal System of the Netherlands There is no specific regulation in the Netherlands on the topic of social enterprises. The traditional Dutch legal forms for commercial ventures, the BV (“Besloten Vennootschap” is the Dutch term for the private limited liability company), the NV (“Naamloze Vennootschap” is the Dutch term for the public limited liability company) and the cooperative, could theoretically be used for conducting a social enterprise. However, in regard of these legal forms, it is assumed that the profits will be distributed to the shareholders or members. Dutch corporate law also provides for the establishment of a foundation. This legal form is often used as a legal vehicle to host charity activities. Income generated may typically not be distributed to the founders of the foundation. Since Dutch corporate law does not provide for any special legal structure for social entrepreneurial activities, some social entrepreneurs employ a foundation for their activities, others use the BV structure, and again others just stick to the “ZZP” form, ie “Zelfstandige zonder personeel” (entrepreneur without personnel). Generally, it was considered a gap that Dutch law did not provide for any not-for-profit legal vehicle. Hence, in 2009, the Dutch government proposed to introduce a new legal form, the “maatschappelijke onderneming” for community interest companies. The bill stated that a “maatschappelijke onderneming” should be incorporated as a foundation or an association. It should adopt additional features to guarantee that the enterprise is conducted for the benefit of the community (such as a mandatory supervisory board). In addition, the bill proposed that third parties may invest in social enterprises, but it limited their control and dividend rights. However, unfortunately, on 23 January 2013, the Dutch government withdrew the proposal because it was considered controversial in the political arena and the process had made no progress since 2009. Consequently, social entrepreneurs in the Netherlands still have to be creative in finding a suitable legal structure for their social entrepreneurial activities. QUESTIONS

1.  What factors do you think play a role in the formation of social enterprise laws within particular countries? 2.  There are a number of social enterprise laws that have seemingly “failed” in that there has been limited usage. What external factors do you think contribute to their limited use? What lessons could be learned for future lawmakers?

IV.  SOCIAL ENTERPRISE LAW IN CANADA Canada is currently a live Petri dish of experimentation in social enterprise law. Several new strains of co-operative forms have been designed to address social needs and/or the needs of particular industries. The provincial governments of British Columbia and Nova Scotia have enacted laws supporting a hybrid form modelled after the UK CIC. Other provinces such as Ontario have expressed interest in exploring their options in the field. In 2009 and 2010, the House of Commons Standing Committee on Industry, Science and Technology conducted a statutory review of the Canada Business Corporations Act (CBCA) and explored the issue of special incorporation structures for hybrids. On that issue, the committee

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recommended that the government conduct a broad public consultation within two years as to whether the CBCA should be amended and a separate regulator created to support a special kind of hybrid with both profit-making and non-profit goals. The committee noted that the hybrid could be similar to an American L3C or a UK CIC.27 Alternatively, the committee questioned whether such an enterprise could already be created under the existing CBCA. Submissions were invited to explore the utility of socially responsible enterprises in the Canadian context and the extent to which current CBCA incorporation provisions and structures facilitate their creation. In 2013, the long-awaited consultation process on revisions to the CBCA by Industry Canada opened. Industry Canada included an invitation for comments on implementing new incorporation structures for socially responsible enterprises, particularly “hybrid enterprises (entities with both profit-making and non-profit goals)” and further consultation “as to whether existing CBCA provisions are sufficient to enable these corporations or whether amendments are necessary to support the development of such enterprises.”28 Comments closed in 2014 and proposed amendments to the CBCA were released in 2016 that did not include any proposed laws in that regard. Federal and provincial governments seem proactive in exploring legal solutions for the future and may also feel the need to be responsive to pressure from social entrepreneurs and activists. In the past, B Lab has partnered with Canadian organizations and actively lobbied Canadian lawmakers to adopt the American benefit corporation model. Critics of B Lab have noted that Canadian business laws have developed in a manner that distinguishes its laws from those of the United States, and these distinguishing features (such as the role of stakeholder interests in governance) make the benefit corporation model a questionable addition to existing Canadian legal forms. The first step in implementing new social enterprise laws is gaining a comprehensive understanding of the legal system in the country for which those laws are proposed. At this stage in the development of social enterprise law in Canada, it is unclear whether the answers should come from new laws, or whether improving infrastructure in governmental agencies supporting social enterprise, amending tax laws, capitalizing on business trends, improving access to social finance, or developing or revising other mechanisms would prove more effective—and of course these options are not mutually exclusive. The question of whether Canada will adopt more laws governing social enterprises remains open for the future. This section explores the landscape of social enterprise law in Canada. It is divided into two parts. The first part builds on Section II.A on co-operative associations to consider a number of new developments in co-operative law across Canada. The second part provides an overview of the community contribution company and community interest company, implemented in British Columbia and Nova Scotia in 2013 and 2016, respectively. These legal forms are chronologically ordered to provide some context in which these laws developed.

27 House of Commons, Standing Committee on Industry, Science and Technology, Statutory Review of the Canada Business Corporations Act, Meeting No 43, 40th Parl, 3rd Sess, 25. 28 Industry Canada, “Consultation on the Canada Business Corporations Act,” online: .

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A.  Co-operative Developments A number of new forms of co-operative associations have developed that extend governance beyond its general mutual purpose elucidated in law, as discussed by Fici in Section II.A. Canadian jurisdictions have witnessed significant innovation in the co-operative ownership structure. Although provinces have taken different steps, in large part the innovation can be summarized as expanding the defined boundaries of who can participate. Typically, the ownership structure of co-operatives can be grouped into four main categories: worker, producer, consumer, and multi-stakeholder. 29 Various provincial statutes have expanded the definition of who can participate to assist development that was once constrained by those categories. Other forms, such as the community service co-operative, provide features aimed at ensuring that social mandates remain intact for the life of the co-operative. The following four co-operative models are examined briefly in this section: the solidarity co-operative in Québec, the renewable energy co-operative in Ontario, the new generation co-operative in the Prairies, and the community service co-operative in British Columbia. These four forms and other recognized forms of co-operatives can differ in their origination. Some co-operative models have developed by adapting flexible provisions within existing co-operative laws. Other models are self-titled and regarded as distinct solely by their business practices, yet have garnered considerable public recognition and interest. Still others have been explicitly created through co-operative laws. The McMurtry and Brouard article excerpted in Section I provides an overview of the wide variety of co-operatives in existence; they themselves note six different kinds, and, indeed, scholars have classified co-operative models in a number of ways based on differing factors. Thus, while the four co-operative models described below show a range of forms that have developed within Canada, it would be erroneous to regard this as an exhaustive list.

1.  Solidarity Co-operative (Québec) As with a traditional co-operative association, the solidarity co-operative in Québec, which was implemented in 1997, may consist of user members and worker members. The notable difference is that solidarity co-operatives may also include “supporting members” under s 226.1(3) of Québec’s Cooperatives Act,30 which are defined as “any other person or partnership that has an economic, social or cultural interest in the pursuit of the objects of the cooperative.” Supporting members can also receive participating preferential shares, which differs from the common co-operative principle of “one member, one vote.” Each member group is entitled to elect at least one director to the board, while supporting members are capped at electing up to a third of the board of directors (s 226.6). Furthermore, a member’s contribution to the capital stock of a solidarity co-operative may vary according to the group to which the member belongs (s  226.4). For example, a solidarity co-operative could

29 Timothy Petrou, “Canada” in Dante Cracogna, Antonio Fici & Hagen Henrÿ, eds, International Handbook of Cooperative Law (Berlin: Springer-Verlag, 2013) 298. 30 Cooperatives Act, CQLR c C-67.2.

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organize itself in such a manner that user members elect one director to the board, worker members elect five directors, and supporting members elect three directors. The variety of membership creates a hybrid form in which stakeholders are assured of some board representation, as well as a greater capacity to raise capital and garner board expertise while staying true to co-operative principles and purpose.

2.  Renewable Energy Co-operative (Ontario) Renewable energy co-operatives in Ontario are often used interchangeably with “community ownership co-operatives” or “community investment co-operatives”; however, there are no explicit laws establishing the latter two names of co-operative association. The renewable energy co-operative closely resembles Québec’s solidarity co-operative in that it broadens the permitted membership comprising the co-operative. The first renewable energy co-operative dates back to 1998; McMurtry and Brouard touch upon this form briefly. It differs from the typical co-operative structure in that the common connection is to a geographic location rather than to members who share a specific need. Renewable energy co-operatives became more widespread with the start of the feed-intariff (FIT) program in 2009 as part of the Green Energy and Green Economy Act, 2009.31 The FIT program allowed private developers to create renewable energy facilities and sell power produced at a fixed (and partially subsidized) price over a specific contract term. The cooperative form allowed people wanting to promote solar energy but lacking land or capacity to be able to invest, and allowed developers to obtain alternative financing to maintain their projects. Schedule I of the Green Energy and Green Economy Act amended portions of the Ontario Co-operative Corporations Act32 to enable the creation of renewable energy co-operatives.

3.  New Generation Co-operative (Prairies) New generation co-operatives (NGCs) are another innovative model that has garnered interest in the Prairie provinces of Alberta, Saskatchewan, and Manitoba. Saskatchewan was the first to enact its New Generation Co-operatives Act; subsequently, Manitoba and Alberta amended their legislation with enabling provisions for NGCs.33 The three main features that set NGCs apart from traditional co-operative associations are restricted or closed membership, the ability to make greater capital investments, and delivery rights. Delivery rights give members the right and obligation to deliver products to, or acquire services from, the NGC, often in proportion to the number of shares held or the units of investment contributed. The NGC share structure is characterized by three classes of shares: membership, equity, and preferred. Membership shares are voting shares with the right to purchase equity shares, which are attached to delivery rights. Thus, NGCs are capable of maintaining a

31 Green Energy and Green Economy Act, 2009, SO 2009, c 12. 32 Co-operative Corporations Act, RSO 1990, c C.35. 33 The New Generation Co-operatives Act, SS 1999, c N-4.001; The Cooperatives Act, CCSM c C223; Cooperatives Act, SA 2001, c C-28.1.

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restricted membership policy while also structuring investment shares to have special delivery rights. Often, a portion of control is vested externally and members are usually expected to invest more capital in the NGC. Only producers of the commodity can hold membership shares, thereby ensuring that control remains with the producers.

4.  Community Service Co-operative (British Columbia) In 2007, British Columbia amended its Cooperative Association Act34 to enable the creation community service co-operatives. Section 178.1(1)(c) defines an association to be a community service co-operative if its purpose is a charitable purpose or is otherwise to provide health, social, educational, or other community services (other than housing). One of the most distinctive characteristics of the community service co-operative is its asset lock feature, which is similar to that of the UK CIC and of the BC and Nova Scotia forms of that hybrid. Assets of the community service co-operative may be used only to support the co-operative. A community service co-operative cannot issue nor have any outstanding investment shares (s 178.1(7)). If a community service co-operative is dissolved or wound up, its property (after satisfaction of its liabilities) must be transferred to or distributed among either another community service co-operative or a charitable organization registered under the ITA (s 178.1(4)), in order to ensure that the assets continue to be used for the purpose of that community service co-operative.

B.  Community Contribution Company/Community Interest Company The surge of CICs in the United Kingdom caught the attention of Canadian lawmakers and social entrepreneurs, and eventually led to several public consultations and inquiries at both the federal and provincial levels as to whether such a model would be feasible in Canada. Likely in reaction to these federal inquiries as well as in response to growing demands from local social enterprises in both the for-profit and non-profit sectors, the BC government established an advisory committee in 2010 to explore the possibility of creating a new hybrid form within the province. Following these meetings, in January 2011, the Ministry of Social Development and Social Innovation appointed the BC Social Innovation Council to make recommendations “on how best to maximize social innovation, with an emphasis on social finance and social enterprise.”35 In 2012, the BC Social Innovation Council presented 11 action items, including that the provincial government should complete the work to establish community contribution companies (C3s) as a new corporate structure. The council noted how the C3 “could have widespread application in BC ranging from environmental service companies to business development platforms for Aboriginal and rural communities.”36 In 2016, the Nova Scotia

34 Cooperative Association Act, SBC 1999, c 28. 35 BC Social Innovation Council, “Action Plan Recommendations to Maximize Social Innovations in British Columbia” (March 2012) at 3, online: . 36 Ibid at 11.

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government introduced its own form of community interest company with features similar to those of the UK CIC and the BC C3.

1.  Community Contribution Company (British Columbia) Coming into effect in 2013, amendments to the BC Business Corporations Act37 and the introduction of the new Community Contribution Company Regulation38 facilitated the creation of the community contribution company. The C3 is subject to all extant provisions of the BCBCA in addition to the C3 Regulations. Modelled after the UK CIC, the C3 is similar to the UK CIC most notably in its asset lock, dividend cap, and annual reporting requirements, with slight variations to account for the lack of a designated regulator. The expected appeal of the C3 is to allow those traditionally situated in the non-profit sector to raise equity capital while ensuring that social mandates remain intact. Neither the C3 nor the Nova Scotia CIC (discussed below) receives preferential tax treatment; they are both taxed like regular corporations. There is currently limited use of the C3 model by the general public.

a.  No Regulator The BC and Nova Scotia governments have taken different approaches to the regulation of the C3 and CIC forms, beyond existing oversight for regular corporations. In British Columbia, there is no regulator in place as there is with the UK CIC. C3s are administered and governed entirely through self-regulation beyond normal channels available to regular BC corporations.

b.  Incorporation and Community Purpose Rather than passing a community interest test with regulatory approval, as in the United Kingdom, interested parties are able to become C3s through the usual incorporation procedures under the BCBCA and a statement in its notice of articles that it is a C3 and, as such, has purposes beneficial to society and is restricted in its ability to pay dividends and distribute its assets (BCBCA s 51.91). If a company is seeking to convert to a C3, unanimous shareholder approval is required to amend the company’s articles to include such a statement. Because of the restrictive nature of the asset lock (and the lack of a regulator), BC legislators want to ensure that all shareholders (including non-voting shareholders) are aware of the change and approve of it. Unanimous approval means that no minority shareholder can be forced into a C3 model. C3s must include “Community Contribution Company” or “CCC” as part of its legal name. One or more of the primary purposes of a community contribution company must be the community purposes set out in its articles of incorporation (BCBCA s 51.92). Section 51.91 defines “community purpose” as

37 Business Corporations Act, SBC 2002, c 57 [BCBCA]. 38 Community Contribution Company Regulation, BC Reg 63/2013 [C3 Regulations].

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a purpose beneficial to (a) society at large, or (b) a segment of society that is broader than the group of persons who are related to the community contribution company, and includes, without limitation, the purpose of providing health, social, environmental, cultural, educational or other services, but does not include any prescribed purpose.

A C3 may have more than one community purpose and may have purposes in its articles that would not qualify as community purposes, so long as one of the primary purposes set out in the articles is a community purpose. There is no further legislative guidance regarding the language or scope of community purposes available to a C3. Since there is no designated regulator review of a proposed community purpose prior to incorporation, it seems that only the courts have jurisdiction to determine whether a given purpose meets the statutory definition of “community purpose.” It is also unclear which parties, other than shareholders and the attorney general, would have standing to bring forth such a claim. Perhaps an interpretation of the oppression remedy put in the context of a C3 may suffice as a stopgap measure.

c. Directors Despite s 120 of the BCBCA, which allows for only one director, a C3 must have a minimum of three directors at all times (s  51.93), similar to BCBCA public companies. Directors and officers have a fiduciary duty to act with a view to the community purposes of the C3 set out in its articles.

d.  Asset Lock The asset lock provisions of the C3 are modelled on those found in the UK CIC, with some exceptions. All assets held by or contributed to a C3 can only be used primarily for public benefit, except as expressly permitted by the BCBCA. The C3 is prohibited from transferring its assets other than (1) for fair market value; (2) to a “qualified entity,” which is defined in the BCBCA to include community service co-operatives, registered charities, and, by regulation, qualified donees; (3)  in furtherance of the company’s community purposes; (4) for certain other transfers, such as the form of dividends or distributions on dissolution, redemptions or purchases of shares, or other reductions of capital; or (5)  for transfers allowed by the C3 Regulations (BCBCA s 51.931). There is no restriction on the transfer of assets in the C3’s ordinary course of business if the value of the assets transferred could reasonably be expected to be equal to the fair market value of the goods or services acquired in return. The distribution of assets on dissolution is also restricted. Either all or 60 percent of the assets of the C3 remaining after liabilities are met must be transferred to one or more qualified entities (BCBCA s 51.95(2)(b); s 8 of the C3 Regulations). It should be noted that the definition of “qualified entity” does not include another C3 in either the BCBCA or the C3 Regulations, unlike the UK CIC model, which provides that the transfer of assets to another CIC is exempt from its asset lock.

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e.  Dividend Cap As with the UK CIC, C3 dividends are capped to ensure that profits are either retained by the C3 or used for a community benefit purpose.39 While UK CICs are permitted to carry forward any unused dividend capacity for four years, C3s are permitted to carry forward any unused dividend capacity indefinitely. Furthermore, the dividend cap does not apply to a share or class of shares where the articles provide that only qualified entities can hold or beneficially own shares of that class. It should also be noted that C3s that have restricted ownership to qualified entities (community service co-operatives, registered charities, and qualified donees) are permitted to pay dividends in excess of the capped amount if they are otherwise in compliance with BCBCA part 2.2 (s 5 of the C3 Regulations).

f.  Interest Cap A C3 may not pay a rate of interest, in relation to debt, that is related to the company’s profits unless the C3 Regulations authorize such payments (BCBCA s 51.94).

g.  Annual Community Contribution Report C3s must meet annual reporting requirements. The C3 directors must produce and publish a community contribution report that, among other things, details the manner in which the company’s activities during that financial year benefited society, the assets transferred during that year in furtherance of the C3’s community purposes, the amounts of declared dividends, and includes its financial statements. “Publish” has the meaning provided in s 1(1) of the BCBCA, meaning the report must be placed on record at the shareholders’ annual general meeting or be held in the company’s records office. In addition, C3s must post the report on their publicly accessible website, if any (BCBCA s 51.96).

2.  Community Interest Company (Nova Scotia) In 2016, the Nova Scotia provincial government introduced its new Community Interest Companies Act40 and Community Interest Companies Regulations,41 creating its own form of community interest company (NS CIC). The features of the NS CIC are similar to those of the UK CIC and the BC C3, with notable differences highlighted below.

a.  CIC Registrar Similar to what the United Kingdom has done, Nova Scotia has designated a registrar of community interest companies, who is appointed in accordance with the Community Interest

39 As of 2017, the maximum distributable amount of shareholder dividends as set by the C3 Regulations is 40 percent of the C3’s profit for the year. 40 An Act Respecting Community Interest Companies, SNS 2012, c 38 [CICA]. 41 Community Interest Companies Regulations, NS Reg 121/2016 [NS Regulations].

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Companies Act (CICA s 4). This is markedly different from British Columbia, which has no regulator, and may reflect a greater level of commitment by Nova Scotia to establish its CIC model.

b.  Incorporation and Community Purpose As with a BC C3, an NS CIC must contain a statement in its memorandum of association stating that the company is a CIC, has a community purpose, and is restricted in its ability to pay dividends and distribute assets on dissolution or otherwise (CICA s 9(1)). The CICA definition of community purpose is almost identical to the BCBCA definition, with the main difference being that the CICA definition explicitly excludes political purposes (CICA s 2(1)(c)). The CICA does not go on to define “political purposes” further, so it is unclear whether the CRA definition of “political activities” (see Section II.B above) would be employed as a test for NS CICs violating the provision. In addition to taking the usual incorporation steps, interested parties in Nova Scotia must also include in their application “designation documents” in order to be designated as a CIC considered by the registrar. These include the following documents, which must be signed by each of the company’s directors:



1. a community interest plan, containing (a) a statement that the company will carry on its activities for a community purpose, and (b) a description of the company’s community purpose and how it proposes to carry out activities in support of that community purpose; 2. a declaration that the company does not (or will not) carry on activities with a political purpose; and 3. a declaration that each of the directors will perform his or her function as a director in accordance with the company’s community purpose (s 3 of the NS Regulations).

Any company that wants to convert to CIC status must obtain unanimous shareholder approval from all voting and non-voting shareholders when altering its memorandum of association. An NS CIC must include “Community Interest Company” or “société d’intérêt communautaire” or “CIC” or SIC” in its name. Finally, the registrar must approve of the NS CIC’s community purpose.

c. Directors An NS CIC must have a minimum of three directors (CICA s 11), similar to the C3 requirement. Directors and officers have a fiduciary duty to act with a view to the community purposes of the CIC as set out in its memorandum of association.

d.  Asset Lock The asset lock provisions for an NS CIC are identical to those for a BC C3 (CICA s 13) (see Section IV.B.1.d above). On dissolution, the assets of a CIC may be distributed only to one or more qualified entities established for a similar community purpose. This means that the qualified entity must either

1. benefit the same segment of society that benefits from the NS CIC;

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Chapter 8  Social Enterprises 2. have its community purpose be in the same general category as the community purpose of the NS CIC; or 3. benefit the same community or geographical area that benefits from the NS CIC (s 9(1) of NS Regulations).

e.  Dividend Cap The dividend cap employed by the NS CIC is virtually identical to that of the BC C3 (see Section IV.B.1.e above), with the significant exception being that any unused dividend capacity may not be carried forward to subsequent years. This rule is more stringent than even the UK rule, which allows unused dividend capacity to be carried forward for four years (see Section III.A.1.d above).

f.  Interest Cap Like the BC C3, an NS CIC may not pay a rate of interest, in relation to debt, that is related to the company’s profits unless the NS Regulations authorize such payments. In addition, an NS CIC cannot pay interest under a debenture in any given year that exceeds 15 percent of the average amount of the CIC’s draft or the sum outstanding under a debenture issued by the CIC during the 12-month period immediately before the interest becomes due (s 6 of the NS Regulations).

g.  Annual Community Interest Report As with the UK CIC, the BC C3, and most other legal forms for social enterprise, an NS CIC has annual reporting requirements. The NS CIC must place before its shareholders a community interest report that includes details on the manner in which the company’s activities during that financial year benefited society, assets transferred during that year in furtherance of its community purposes, amounts of declared dividends, and its financial statements. The community interest report must be signed by at least two directors and filed with the registrar within 90 days after the NS CIC’s annual general meeting, along with its financial statements. QUESTIONS

1.  How do Canada’s social enterprise laws compare with those internationally? Why do you think British Columbia and Nova Scotia have chosen the UK CIC, and not other legal forms, as their model? 2.  If you could design a new legal form for social enterprise, what would be its features?

V.  INTRODUCTION TO SOCIAL FINANCE Thus far, this chapter has focused on the various legal forms that house social enterprises, including new forms aimed specifically at governing the dual economic and social mandates

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within those businesses. Part and parcel of selecting an appropriate corporate vehicle is considering how it may affect one’s ability to raise capital. As discussed in Chapter 6, cultivating the right mix of capital may be critical to the success of a business. This section focuses on the supply side of capital, particularly new approaches to investment that are providing social entrepreneurs with access to like-minded investors and pools of capital that align with their business values. In the last decade, there has been accelerated global participation in the field of social finance. Social finance is a mechanism for channelling private capital toward businesses that enhance public benefit. Like CSR, the typology within social finance is continually evolving, and includes activities such as responsible investing, socially responsible investing, community investing, microfinance, social enterprise lending, venture philanthropy, and impact investing, among others. An assessment of a company’s finances with regard to environmental, social, and governance (ESG) criteria is often viewed as critical in determining a company’s long-term financial returns and positive societal impact. Figure 8.1 offers a way of understanding the different investment philosophies encapsulated in social finance. Although the figure delineates the differences among investment strategies, many of these defining characteristics are blurred both in theoretical analysis and in practice. This section provides a brief introduction to social finance by focusing on two broad areas of interest: (1)  responsible investment (RI)/socially responsible investment (SRI) and (2)  impact investing. These categories tend to be fluid in scope; some investors may depict their approach as falling within the ambit of existing typology, while others may prefer to differentiate themselves on the basis of innovative strategies. Nevertheless, these broad concepts offer some bearings on how social finance is developing in Canada. RI and SRI tend to focus on negative or positive screening based on ESG factors for companies with publicly listed securities, with a passive “do no harm” approach. Impact investing, on the other hand, targets capital investment in businesses aiming to provide a specific social benefit.

A.  Responsible Investment/Socially Responsible Investment The year 2006 marked the launch of the United Nations Principles for Responsible Investment (UNPRI), an initiative supported by, but not a part of, the United Nations that encourages investors to utilize responsible investment to enhance returns and better manage risks. In 2017, the UNPRI had over 1,700 signatories from over 50 countries comprising asset owners, investment managers, and service providers representing US$62 trillion assets under management. The principles are regarded as voluntary and aspirational. There is no accompanying regulation ensuring signatories’ compliance with the principles, although signatories do have an obligation to report on their responsible investment activities through the UNPRI Reporting Framework, which, according to the UNPRI, allows signatories to (1) demonstrate to stakeholders and the public how they incorporate ESG issues; (2)  understand where their organization sits in relation to local and global peers; and (3) learn and develop year over year. The “Signatories’ Commitment” and the principles are set out below.

ESG risk management

ESG opportunities

• Impact-only Focus on issue areas where social and environmental need requires 100% financial trade-off

• Focus on issue areas where social and environmental need requires some financial trade-off

• Focus on issue areas where social and environmental need creates a commercial growth opportunity for market-rate or market-beating returns

• Focus on ESG opportunities through investment selection, portfolio management and shareholder advocacy

• Focus on ESG risks ranging from a wide consideration of ESG factors to negative screenings of harmful products

High impact solutions

Philanthropy

Impact-First

Sustainable

Responsible

Source: Adapted from Lisa Brandstetter & Othmar M Lehner, Impact Investment Portfolios: Including Social Risks and Returns (Oxford, UK: ACRN Oxford Publishing House, 2014), online: .

Competitive returns

• Finance-only, limited or no use of ESG factors

Traditional

Impact Investment Thematic

Responsible Investment

The New Paradigm

Figure 8.1 The Spectrum of Capital

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United Nations Principles for Responsible Investment, “The Six Principles: Signatories’ Commitment”

As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognise that applying these Principles may better align investors with broader objectives of society. Therefore, where consistent with our fiduciary responsibilities, we commit to the following: Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes. Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices. Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest. Principle 4: We will promote acceptance and implementation of the Principles within the investment industry. Principle 5: We will work together to enhance our effectiveness in implementing the Principles. Principle 6: We will each report on our activities and progress towards implementing the Principles. The UNPRI focuses on RI and specifically differentiates itself from SRI, noting that there are similarities between the two and other approaches, including impact investing, sustainable investment, ethical investment, and green investment. However, while these approaches seek to combine financial return with a moral or ethical return, responsible investment can and should be pursued even by the investor whose sole purpose is financial return, because … to ignore ESG factors is to ignore risks and opportunities that have a material effect on the returns delivered to clients and beneficiaries. Also, many of these investment approaches target specific themes, such as focusing solely on environmental issues, whereas responsible investment is a holistic approach that aims to include any information that could be material to investment performance.42

One aim of the UNPRI, therefore, is that all investors employ RI principles. In terms of Figure 8.1, this would mean eliminating the “Traditional” category of investors, where ESG factors have limited to no use in investment decisions, and shifting the minimum standard to one where ESG factors are always considered, even by investors interested solely in financial returns.

42 United Nations Principles for Responsible Investment, “What Is Responsible Investment?” online: .

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While the UNPRI is firm in its division between RI and SRI, these concepts are undeniably connected and often intertwined. The growth of the SRI movement may have gained some impetus from the 2006 launch of the UNPRI. Like CSR, the RI and SRI movements face formidable challenges in moving toward a longer-term investment system within existing infrastructure, given the lack of sufficient market leverage and heavy reliance on voluntary codes of conduct. Scholars such as Benjamin Richardson have noted that fiduciary law is a significant obstacle to SRI, especially in institutional funds such as pension plans, which are governed on the assumption that obtaining greater financial returns is the only lawful objective of fund management.43 The business case for SRI is intimately intertwined with its success. Louche and Hebb have remarked on how “a large part of SRI literature has focused on demonstrating the link between SRI and financial performance” but “not all positive [ESG] changes can be argued simply from the perspective of the business case.” 44 In the excerpt below, Richardson describes how actors in the SRI movement may subscribe to differing business and ethical motivations.

Benjamin J Richardson, Socially Responsible Investment Law: Regulating the Unseen Polluters (New York: Oxford University Press, 2008) at 1-2, 12-14, 20-22 (footnotes omitted) Imagine. A bank declines finance to a profitable mining company, as its new venture is fraught with unacceptable environmental risks. A pension fund increases its investment positions in agricultural businesses that specifically adhere to leading international labor standards. And a mutual fund boycotts a lucrative pharmaceutical company infringing Indigenous medicinal knowledge. While we know that these decisions are not currently ordinary, everyday occurrences in the financial world, how much closer would we be to a socially just and ecological sustainable economy if they were? Encouragingly, an ebullient movement known as “socially responsible investment” (SRI) is rising in international financial markets. Having evolved from its obscure beginnings of church-based, single-issue activism, it now represents a broad constellation of interests campaigning for socially, ethically, and environmentally responsible financing. Unlike philanthropy, SRI seeks its desired changes through investments. Among SRI adherents are pension plans interested in sustainable, long-term investment, mutual funds selling SRI portfolios to households, and banks requiring that their borrowers’ projects minimize environmental degradation. While no authoritative definition of SRI exists, and investors often market the concept promiscuously, SRI has become increasingly recognized as primarily a means to further sustainable development. … Sustainable development, the most widespread concept in modern environmental law and policy, seeks to ensure that economic growth does not diminish the capacity of the natural environment to meet the needs of future life. Sustainability, as the ultimate goal, is a fundamentally necessary element of healthy natural and 43 Benjamin J Richardson, Fiduciary Law and Responsible Investing: In Nature’s Trust (New York: Routledge, 2015). 44 Céline Louche & Tessa Hebb, eds, Socially Responsible Investment in the 21st Century: Does It Make a Difference? (Bingley, UK: Emerald, 2014) at 282, 285.

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human systems. It concerns the integrity of natural systems (global climate, evolutionary viability of ecosystems, and other vital life-supporting services) and societal and economic issues that may impinge upon environmental management (e.g., health, human rights, poverty). As explained by the International Court of Justice (ICJ) in the case concerning the Gabčikovo-Nagymaros Project (Hungary/Slovakia), implementation of the concept of sustainable development requires integration of ecological considerations into all aspects of economic decision-making, including presumably financial markets. SRI is a potential way to meld environmental, social, and economic considerations in investment decisions, raising them to a higher sustainability standard. •  •  •

A.  The Business and Ethical Motivations of SRI 1.  Business-Case SRI SRI reflects a potpourri of investment philosophies and methods, not all of which may be ambitious enough to address sources of corporate environmental harm. There are two primary forms, of which one is merely evolutionary, and the other is perhaps revolutionary. They are the business case and the ethical case for SRI. The business case caters to value-seeking investors. The ethical case serves values-based investors. Both reflect a similar division in the motivations for corporate social responsibility (CSR) found at the corporate level. The dominance of the business case partly reflects how investment companies, pension trusts, banks, and most other financial institutions view their legal fiduciary obligations solely for their financial performance. Even SRI retail investors, investing for themselves without fiduciary obligations to others, commonly prioritize short-term financial goals. Without coincidence, ethically-motivated SRI is more likely to prosper in institutions more closely tethered to civil society, such as churches, charitable foundations, credit unions, and cooperative banks, where the governing legal principles and prevailing culture more readily accommodate non-financial considerations. Pragmatic business case investors tend to treat social, environmental, and corporate governance issues as factors that can affect the financial condition of companies, rather than as valuable ends in their own right. Specifically, the business case considers environmental and social issues primarily to the extent that they are perceivable as financially “material.” Materiality is assessed by significant financial risks or investment opportunities in relation to other financial measures. For example, an environmental hazard priced at $1 million may be immaterial to a multi-billion dollar corporation. It is a relative measure. These risks and opportunities range from the tangible (e.g., litigation and regulatory sanctions) to the intangible (e.g., reputational risks and damage to brand names). While business case SRI may be construed as “ethical,” in the sense that ultimately all human decisions including investment choices reflect some set of social values, this form of SRI implies a narrow “homo economicus” conceptualization of individuals: the human agent is a rational utility maximizer with a restricted and predictable range of predominately economic interests. This concept of financial materiality informs a range of financial governance mechanisms, including fiduciary responsibilities, financial accounting, and corporate reporting systems. Most business case SRI involves light-touch screens that filter out only the most pernicious companies where it is financially advantageous, polite engagement with corporate

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management, and technical assessments revealing financial risks and profitable opportunities inhering in corporate social and environmental behavior. In the post-Enron world of corporate scandals, investors seek better ways to identify risk, and to his end, SRI is increasingly relied on as a key strategy. There is however no bright-line distinction between “ordinary” investment and business case SRI. Conventional investment practices certainly consider financially acute environmental, social, and governance (ESG) issues. The main difference with business case SRI is that such matters should be taken into account routinely, and such investors should actively seek out ESG information and thereby enhance financial analysis. Such investors may see SRI as a way to achieve “alpha”—a measure of the incremental return added by a fund manager through active management. Business case SRI thus takes some cues from the philosophy of ecological modernization, which sees a synergy between environmentally efficient and frugal businesses and enhanced profitability. •  •  •

2.  Ethical Investment The main alternative style of SRI is principally a matter of ethical necessity and a means of social and political change. In some sectors, the ethical case for SRI is also known as mission or values-based investing. Consequential motives in ethical investment treat SRI as a means to change the criteria of capital allocation and motivate firms to improve their environmental and social behavior. It is associated with teleological ethics. This contrasts with the traditional deontological (or self-referential) type of ethical investment, involving investors who do not want to profit from unethical activities rather than placing a priority on leveraging change through investment. Critics of both forms of ethical investment describe them as negative and defensive in style, narrow in scope, and insufficiently linked to financial performance. While these observations are certainly problematic, their influence is a key reason why ethical investment is waning. References to “ethical” in the SRI disclosure are becoming scarcer, such as in 2007 when Australia’s Ethical Investment Association renamed itself as the Responsible Investment Association of Australasia. Ethical investment has the potential to more fully align the financial system with the requirements of sustainable development. In the ethical approach, investors (and corporations) have a moral obligation to act in ethically responsible ways, which should not be constrained by profit motives. It sees investors as having concerns beyond enhancing their private economic welfare. These concerns include North – South inequalities, climate change, labor rights, and Indigenous peoples’ land claims. Also among the concerns are the traditional objections to tobacco, armaments, and pornography. The ethical case however does not ignore the bottom line nor discard the business case justifications for SRI, as financial considerations often remain of vital concern. Ethical investors are not donating to charity but investing in enterprises which seek to create wealth while protecting and enhancing the social values of investors. Yet, ethical investment diverges from business case justifications by insisting on the consideration of ethical issues for their own sake and not only for financial benefit. It presumes that an individual or organization remains moral when faced with any decision, including financial management: there is no dichotomy. While the market may value ethical conduct when embodied in regulation or social pressures expressed through the lens of reputational risk, ethics has not traditionally been integral to investment decisions. Just as we expect individuals

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to respect various ethical standards as members of society, regardless of any individual benefit, so too corporations and financiers should behave with regard to broader social values beyond their immediate financial self-interest. These considerations are not attractive to most financial institutions. Such institutions that invest on behalf of thousands or millions of investors have often dismissed calls that they should choose investments on ethical grounds, contending that as their fund members likely hold such diverse ethical views on social and environmental issues, it would be impossible to achieve a consensus of values to guide financial decision-making. Alternatively, the maximization of financial returns is considered a clear and easily measureable benchmark to which fund managers should be held accountable. This stance relegates ethics to a matter of subjective, personal taste, compared to the supposed hard objectivity of financial returns. Certainly, there will always be some room for individuals to choose lawful investments according to their own moral scruples, such as eschewing financial ties to companies that engage in activities they find personally offensive, whether it be manufacturing alcohol or operating a casino. But where financial institutions manage the assets of many people and have the capacity to exert huge economic influence and potential social and environmental harm, the ethical investment movement demands adherence to specific social standards.

B.  Impact Investing Impact investing is a growing area of social finance that is particularly relevant to social enterprises seeking capital. Impact investors aim to direct their funds to new business models that provide positive societal benefits in addition to financial returns. Described in a variety of ways such as “profit with purpose” or “blended value,” one of the challenges in impact investing is how to effectively measure the social return on one’s investment. In the excerpt below, Harji et al provide a brief overview of the impact investing landscape in Canada.

Karim Harji et al, “Introduction to Impact Investing in Canada” State of the Nation: Impact Investing in Canada (Toronto: MaRS Centre for Impact Investing and Purpose Capital, 2013) at 11, 12-13, 16, 17 (footnotes omitted) Defining Impact Investing The term “impact investing” was coined in 2007, and has been used quite broadly to date. The most widely cited definition comes from a 2010 report by J.P. Morgan, the Global Impact Investing Network (GIIN) and the Rockefeller Foundation, which described impact investments as “investments intended to create positive impact beyond financial returns.” Impact investment is differentiated from traditional investment by:

1. Investor intention: Investors seek to allocate capital (debt, equity or hybrid forms) to investments where they expect both to receive a financial return (ranging from return of principal to market-beating returns) and a defined societal impact. 2. Investee intention: Business models for investees (whether they are for-profit or non-profit enterprises, funds or other financial vehicles) are intentionally constructed to seek financial and social value.

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3. Impact measurement: Investors and investees are able to demonstrate how these stated intentions translate into measurable social impact. •  •  •

Building on a Rich History in Canada While impact investing is a relatively new term, the practice of intentionally investing for financial returns and positive social impact is not new in Canada. Traditionally, this activity has been grounded in local trends and needs, in response to pressing national social or environmental challenges. Examples of Canadian social investment reach back to the birth of the credit union movement in the early 1900s and continue through to

[Figure 8.2: Impact Investing in Canada] Credit unions •  1901 •  1946

North America’s first credit union, Caisse populaire de Lévis, is founded Vancouver City Savings Credit Union is founded

Co-operatives •  1861 Stellarton Co-operative, a mutual fire insurance company, is formed •  1971 Caisse d’économie solidaire Desjardins is founded Social economy •  1986 Development of Aboriginal Financial Institutions •  2007 Fiducie du Chantier de l’Économie sociale is created in Québec Community economic •  1987 development •  1990

Government of Canada creates Community Futures Program Community Economic Development Investment Funds (CEDIFs) are created

Microfinance •  1990

The first Canadian microfinance institution, Montreal Community Association is established

Socially responsible investing •  1997 •  2006

Global Reporting Initiative (GRI) is launched The UN Principles of Responsible Investment (PRI) are launched

Impact investing •  2007 Rockefeller Foundation coins the term “impact investing” •  2010 Canadian Task Force on Social Finance recommendations issued Enabling legislation •  2012 •  2012

Nova Scotia introduces the Community Interest Companies Act British Columbia recognizes “Community Contribution Company”

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more recent community economic development initiatives supported by various levels of government, such as Community Futures Development Corporations and Aboriginal Finance Institutions. For decades, individual Canadians have established practices of investing through social responsible investing (SRI), through private or community foundations, or by investing in community economic development funds, either directly, with their personal wealth, or collectively, through labour unions, faith organizations and pension funds. [Figure 8.2] is a snapshot of milestones that have contributed to impact investing as we know it today. •  •  •

Challenges remain in several important areas Looking beyond established sectors and regions, there is still much work to be done to create supportive infrastructure for impact investing. At a basic level, there is a misalignment between capital and opportunity; more often than not, entrepreneurs continue to identify finance as a key barrier to growth, and investors continue to rank deal-flow and investment readiness as a fundamental issue. The search and transaction costs of deals remain relatively high, even without accounting for issues such as impact measurement and a restrictive regulatory system. These and other issues require concerted and sustained effort in order to stimulate more activity. Industry building will require coordinated action and leadership Even if the practice of impact investing is not new—and there are certainly good examples of successful organizations—there is much work to be done to nurture and celebrate Canadian exemplars. Creating the conditions for all market actors to harness the potential of impact investing will require coordinated action within and across sectors and regions.

VI. CONCLUSION It is quite understandable for one to regard the development of social enterprise law as simply addressing a niche sector of the market. At this point in history, new legal forms specifically designed for social enterprise do not threaten to overtake the mainstream corporate model any time soon. There are also inherent challenges in measuring social value. Unlike the units of economic value, the units of social value can be subjective, variant, and dependent on a number of localized issues. Furthermore, any implementation of a new corporate alternative has the possibility of affecting other potential solutions in the forprofit and non-profit arenas. Disregarding jurisdiction-specific issues only increases the chance that new legislation will be underutilized or utilized in a manner for which it was not intended. A common argument levelled against new legal forms for social enterprise is whether they are necessary to achieve positive results, and there are reasons to be cautious. Legislators need to consider the challenges facing each sector within a particular jurisdiction, and the status of existing reform efforts. On a smaller scale, social enterprise laws may have the potential to influence communities toward positive social change, and address marginalized needs. There is

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considerable appeal in the growth of do-gooding enterprises connecting responsible business with the demands of the social economy. Social entrepreneurs and legislators will continue to grapple with these issues as the urgency for a more sustainable world grows.

CHAPTER NINE

Theories of the Firm



I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 589 II.  Economic Theories of the Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 590 A.  Wealth Maximization and Rational Choice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 591 B.  Nexus of Contracts Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 594 C.  Transaction Cost Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600 D.  Agency Cost Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 602 III.  Socio-economic Theories of the Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 606 IV. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 618

I. INTRODUCTION This chapter provides an introduction to theories of the firm that are highly relevant to the study of business organizations.1 The conceptual approaches highlighted in this chapter are only a few of many theories of business organizations law that scholars, practitioners, and business people have developed.2 They reflect, however, a range of different approaches and different principles that are included in considerations of how businesses are organized and the legal rules and standards that apply to them. Section II of this chapter provides a primer on economic analysis of business organizations law. Key concepts in economic theories of the firm are canvassed, including nexus of contracts theory, transaction cost theory, and agency cost theory. In Section III, samples of more progressive scholarship are presented, which advocate for a more social, publicly minded conception of business organizations law. Key concepts in socio-economic theories of the firm include communitarianism and the idea of business organizations law as public law.

1 For a concise overview canvassing theories of the firm, see Robert Yalden, “Canadian Mergers and Acquisitions at the Crossroads” (2014) 55 Can Bus LJ 389 at 392-403. 2 Much theoretical scholarship about business organizations law has focused on the corporation and employs a wide variety of perspectives; see e.g. John Dewey, “The Historic Background of Corporate Legal Personality” (1926) 35:6 Yale LJ 655; Morton Horwitz, “Santa Clara Revisited: The Development of Corporate Theory” (1985) 88:2 W Va L Rev 173; Kent Greenfield, “New Principles for Corporate Law” (2005) 1 Hastings Bus LJ 87; Harry Glasbeek, Wealth by Stealth: Corporate Crime, Corporate Law, and the Perversion of Democracy (Toronto: Between the Lines, 2002); Zohar Goshen & Richard Squire, “Principal Costs: A New Theory for Corporate Law and Governance,” Columbia Public Law Research Paper No  14-462, DOI: .

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II.  ECONOMIC THEORIES OF THE FIRM Law and economics is a school of legal thought that employs the tools of microeconomics to analyze legal rules and standards. Like all schools of thought, law and economics has both a descriptive (or positive) and normative methodology. Descriptive economic analysis seeks to predict how people are likely to behave under a particular legal regime. Normative economic analysis seeks to make policy recommendations based on the economic consequences of a particular legal regime. The economic theory of the firm has provided much of the language and concepts to the discourse of the law and governance of business organizations. The material in this chapter presents a framework for analyzing legal rules and standards as they apply to partnerships and corporations, and should provide you with some analytic tools for thinking about the issues in subsequent chapters. Arguably, the foundational work on the modern economic theory of the firm is the article written by Nobel Prize laureate Ronald Coase, “The Nature of the Firm.”3 The economist Adam Smith famously described the ideal market economy under which the price mechanism allocates resources in society.4 In other words, resources are allocated through the self-interested choices of sellers and buyers. Coase’s key insight was that firms come to exist when the costs of bargaining under the price mechanism are higher than the costs of allocating resources within a firm. Within a firm, resources are allocated under a command and control model through direction by the entrepreneur to his or her employees. According to Coase, the essence of a firm is the entrepreneur’s management of resource allocation. Naturally, firms also engage in market transactions. For example, in a sole proprietorship, the business organization is managed by a single person who carries on the business in part through market transactions such as purchasing equipment or borrowing capital. However, the key distinguishing aspect of a firm is the sole proprietor’s exclusive authority to direct business policy and to hire and fire employees. In firms with multiple equity investors such as partnerships and corporations, the resource-allocating functions of the entrepreneur are undertaken through a chosen governance structure. Business organizations with a very small number of equity investors are typically referred to as “closely held” and those with a very large number of equity investors are typically referred to as “publicly traded” because investments in such firms are traded through stock exchange markets accessible to the public. Since Coase’s article was published in 1937, economic analysis has evolved and become the dominant paradigm within which issues surrounding the law of business organizations are analyzed in Anglo-American countries. Section II.A briefly introduces two key assumptions made in the economic analysis of law: wealth maximization and rational choice. The remainder of the section canvasses three components of economic theory that are particularly relevant to the law of business organizations. Section  II.B introduces nexus of contracts theory as one conception of the firm. Section  II.C elaborates on why firms come into existence by explaining transaction cost theory. Transaction cost theory is relevant to both the choice of form of business organizations and the design of applicable legal rules and standards. Section II.D focuses on a particular type of transaction cost that arises from the separation of ownership and control in

3 Ronald Coase, “The Nature of the Firm” (1937) 4 Economica (NS) 386. 4 Adam Smith, The Wealth of Nations (New York: Modern Library, 1937).

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firms: agency costs. Agency cost theory is particularly relevant to the discussions in Chapters 10 to 14 of corporate governance.

A.  Wealth Maximization and Rational Choice The key normative assumption in law and economics is wealth maximization. In other words, legal rules and standards should be efficient and maximize social wealth.5 In the following extract, Judge Posner of the United States Court of Appeals for the Seventh Circuit explains the content and normative basis for this assumption.6

Richard A Posner, “Wealth Maximization Revisited” (1980) 2 Notre Dame JL Ethics & Pub Pol’y 85 at 85-88 (footnotes omitted) To most people who are not economists, the word “wealth” suggests money. But to an economist, it refers to weighting preferences for the things that people want, either by willingness to pay for a thing, if you do not own it, or by unwillingness to part with it voluntarily, if you do own it. So, if I am unwilling to part with my house for less than $100,000, and no one is willing to pay more than $90,000 for it, society’s wealth is $10,000 greater than it would be if the house were taken from me and given to the highest bidder (I am not a bidder, because I am the owner). This would be so even if I were paid $100,000 for the house (which would require taxation, since no one will voluntarily pay $100,000 for it). I would be no wealthier than before, and the rest of the community would have $100,000 less, incompletely offset by a house worth only $90,000 to its new owner. Now suppose that I want a car and would pay $10,000 for it, and the present owner would sell it for $5,000. Society’s wealth will be increased if I am allowed to buy the car from him for any amount between $5,000 and $10,000 (ignore selling costs). Suppose the price is $7,500. After the transaction I will have $2,500 plus a car worth $10,000 to me. I will thus have total wealth (ignoring the house and any other wealth I have) of $12,500, and he $7,500, for a total of $20,000, whereas before the transaction our combined wealth was only $15,000. Granted, both examples ignore a fundamental problem—how it is that I initially came to have the house, and he the car. I shall come back to that problem, but for now, I just want to explain what wealth means. Wealth is not limited to market commodities such as houses and cars. As a matter of fact, the value of houses and cars is not always reducible to market values. The house I value at $100,000 might not be valued at more than $90,000

5 For a discussion on the relationship between wealth maximization and other justice norms in the economic analysis of law, see Richard Posner, The Economics of Justice (Cambridge, Mass: Harvard University Press, 1983). 6 For criticism of wealth maximization as the normative goal, see Jules Coleman, “Efficiency, Utility and Wealth Maximization” (1980) 8 Hofstra L Rev 509; Richard Dworkin, “Is Wealth a Value?” (1980) 9 J Leg Stud 191; Anthony T Kronman, “Wealth Maximization as a Normative Principle” (1980) 9 J Leg Stud 227; Ernest J Weinrib, “Utilitarianism, Economics, and Legal Theory” (1980) 30 UTLJ 307.

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by anyone else because it has sentimental associations for me, and likewise with the car. In this case, the real value would exceed market value. Or, I might work for a lower salary than I could make, simply because I liked the work I did for that lower salary so much; that would mean that I derived part of my wealth from working and part from the pecuniary income that I earned by working. These examples help to show that money, to an economist, is not wealth, but just a measure of one’s entitlement to houses, cars, rewarding work, leisure, privacy, and countless other “things” that constitute a person’s wealth; everyone’s wealth added together constitutes the nation’s wealth. The wealth of a nation is the present value of the flow of benefits, measured as suggested above, from the consumption of goods and services, tangible and intangible, by its people. Monetary measures of social income or wealth such as Gross National Product or National Income are inadequate and inaccurate measures of a nation’s wealth. When I used money as a component of wealth earlier, it was just a shorthand term for the things that money can buy. The economist uses the concept of income or wealth in this broad sense all the time, but calls it “utility,” meaning, however, something quite different from what utilitarian philosophers mean. To compound the confusion, the economist uses the word “wealth” to mean something different from the economic concept of “utility.” To the economist, “utility” differs from “wealth” because utility is adjusted for people’s preference for risk or (more commonly) aversion to risk, in the sense of the variance of possible outcomes of an uncertain event. If you were given gratis a fifty percent chance of winning ten dollars (and an equal chance of winning nothing), your “wealth” (in the narrow economic sense) would rise by five dollars, which is the expected utility of the chance to someone who is risk neutral. But if you were risk averse, the increment in your expected utility would be less than five dollars, so you would sell the ticket to someone less risk averse, or risk neutral, or risk preferring, if you could, and you would thereby increase your utility. If you were risk preferring, the chance would be worth more than five dollars to you. Thus “wealth,” in my sense, is a synonym for expected utility. Bear in mind that wealth is a function of willingness to pay (or unwillingness to part with, but for present purposes, the difference is unimportant). If you will pay more for the fifty percent chance than its certain equivalent (because you are a risk preferrer), then it is worth more to you; its expected utility determines your willingness to pay, and hence describes the effect of the chance on your wealth. For example, if you would pay six dollars for the chance, the gift of it would increase your wealth by six dollars. Wealth, in my sense, equates to utility in the economic sense but is distinct from the utilitarian concept of utility as happiness, however broadly (or narrowly) happiness is defined, though wealth and happiness are positively correlated. (Ask anyone whether he or she would turn down an unconditional gift of money!) I might be made deliriously happy by being given a ticket to a Notre Dame football game, but if I am outbid by another football fan, it means that wealth maximization requires that I not get the ticket, even though the person who outbids me might derive less pleasure from the game than I would have derived. The refusal of modern economists to make “interpersonal comparisons of utility” means in effect that they use wealth rather than happiness as the criterion for an efficient allocation of resources.

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The key assumption about human behaviour in law and economics is rational choice. The basic idea is that human beings respond to incentives and individual preferences by selecting whichever option, out of a range of possible alternatives, maximizes wealth or expected utility. The concept is applied to predict how large numbers of people are likely to behave in exchange transactions. The following extract by Thomas Ulen explains the relevance of rational choice when it comes to predicting the likely behaviour of participants under a particular legal regime.

Thomas S Ulen, “Rational Choice Theory in Law and Economics” (2000) 1 Encyclo L & Econ 790 at 797 (citations and footnotes omitted) The answer is that many legal decisions are indeed market-like choices. They may be said to be so on the ground that legal rules create implicit prices on different behaviors and that legal decision makers conform their behavior to those prices in much the same way as they conform their market behavior to the relative prices there. For example, the law imposes a monetary sanction (called “compensatory money damages”) on those who unjustifiably interfere with another’s property, breach a contract, or accidentally injure another person or his property. These money amounts may be taken to be the “prices” of engaging in certain kinds of behavior, such as a failure to take due care or to perform a contractual obligation. Presumably, rational decision makers will compare those legal prices with those of the alternatives and will comply with the law’s duties (that is, not interfere with another’s property without their permission, perform a contractual obligation, or take due care) if the price for doing so is greater than the price of not doing so. For example, if the benefit of breaching a contract is $10,000 and the money damages that the breacher can anticipate paying to the innocent party are $5,000, then there is likely to be breach of contract. It is the central innovation of law and economics to have recognized that many legal decisions have this market-choicelike quality and that, therefore, rational choice theory is an appropriate model of much legal decision making. Rational choice as a microeconomic tool to analyze human behaviour comes from the neoclassical school of economics. Other schools of economic thought challenge the neoclassical conception of rational choice. Under new institutional economics, human rationality is regarded as “bounded”; that is, individuals cannot always be counted on to make perfectly rational decisions. Decision-makers may be susceptible to lack of information, bias, inexperience, or other factors that hinder their ability to (1) discover all possible alternatives, (2) accurately compute their consequences, or (3) make valid comparisons among them. The fact that rationality is limited in this way raises transaction costs because individuals cannot be counted on to behave in the most predictable, value-maximizing way. This is discussed in more detail in Section II.C of this chapter, in the extract by Oliver Williamson on transaction cost theory. Under behavioural economics, the claim is that the predictions under the neoclassical conception of rational choice may fail to account for behaviour actually observed because individuals often base their decisions on systemic misperceptions. In particular, individuals are “myopic” (they incline toward short-term benefits in spite of long-term costs)

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and overly optimistic in the face of uncertainty.7 Both the new institutional and behavioural schools accept the concept of bounded rationality but apply it in different ways. While a behavioural economist thinks that bounded rationality makes for a flawed rationing procedure, a new institutional economist would say that rationality is only bounded in the substance of its conclusions.8 NOTES AND QUESTIONS

1.  Law and economics scholarship is often criticized for focusing on the narrow goal of financial gain, but, as Posner explains, “wealth maximization” is about more than just making money. The definition of wealth is expansive enough to include more progressive values like global development, social programs, and environmentally responsible practices. Over time, the nature of what people value may change, but their need to achieve greater efficiency in attaining what they value does not. 2.  Law and economics has also been applied in tort law, where the same utilitarian approach was used to balance the costs and benefits of common law doctrines.9 Do you think that the assumptions and conclusions from this section translate well into the law of involuntary obligations? What would it look like if all areas of law privileged efficiency and wealth maximization?

B.  Nexus of Contracts Theory In Chapter 1, it was explained that one of the fundamental features of a corporation as a form of business organization is separate legal personality; that is, in law, a corporation is reified as a person. The utility of this legal fiction was elaborated upon in Chapter 3. Nexus of contracts theory does not model the firm as an entity but instead as an aggregate of inputs working together to produce goods or services. Unlike the Coasean conception of the firm, the distinction between firms and markets is not emphasized under this model. Instead, the focus is on the relationships between all of the firm’s constituencies. The following extract by Easterbrook and Fischel explains the model as applied to corporate law.

Frank H Easterbrook & Daniel R Fischel, “The Corporate Contract” (1989) 80 Colum LR 1416 at 1426-28 (footnotes omitted) The arrangements among the actors constituting the corporation usually depend on contracts and on positive law, not on corporate law or the status of the corporation as an entity. More often than not a reference to the corporation as an entity will hide the essence of the transaction. So we often speak, following Jensen and Meckling, of the corporation

7 See Richard M Cyert & James G March, A Behavioral Theory of the Firm (Englewood Cliffs, NJ: Prentice-Hall, 1963). 8 Herbert A Simon, “Behavioral Economics and Bounded Rationality” in Models of Bounded Rationality, vol 3, Empirically Grounded Economic Reason (Cambridge, Mass: MIT Press, 1997) 266 at 291-94. 9 See Richard Posner, “Instrumental and Noninstrumental Theories of Tort Law” (2013) 88 Ind LJ 469.

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as a “nexus of contracts” or a set of implicit and explicit contracts. This reference, too, is just a shorthand for the complex arrangements of many sorts that those who associate voluntarily in the corporation will work out among themselves. The form of reference is a reminder that the corporation is a voluntary adventure, and that we must always examine the terms on which real people have agreed to participate. The agreements that have arisen are wonderfully diverse, matching the diversity of economic activity that is carried on within corporations. Managers sometimes hold a great deal of the firm’s stock and are rewarded for success through appreciation of the prices of their investments; other employees may be paid on a piece-work basis; sometimes compensation is via salary and bonuses. Corporations sometimes are organized as hierarchies, with the higher parts of the pyramid issuing commands; sometimes they are organized as dictatorships; sometimes they are organized as divisional profit centers with loose or missing hierarchy. The choice of organization and compensation devices will depend on the size of the firm, the identity of the managers, and the industry (or spectrum of industries) in which the corporation participates. Organization and compensation in an investment bank are vastly different from organization and compensation in an industrial conglomerate, as industrial firms that have acquired investment banks have learned to their sorrow. The organization of finance and control is equally variable. Small, close corporations may have only banks as outside investors, and these banks hold “debt” claims that carry residual rights to control the firm; highly leveraged public firms may concentrate equity investments in managers while issuing tradable debt claims to the public. The public investors in these firms have no effective control, because debt conventionally does not carry voting rights. Public utilities and national banks may have more traded equity but still no effective shareholders’ control, given both regulatory structures and the nature of the risks in the business. Many growing firms have almost no debt investment, and the equity investment pays no dividends; these firms are under the dictatorial control of the entrepreneur. Mature firms may be more bureaucratic, with boards of directors “independent” of managers and answerable to equity investors. Some managerial teams attempt to insulate themselves from investors’ control in order to carry out programs that they view as more important than profits. Both the New York Times and the Wall Street Journal have established structures that give the managers substantial freedom to produce news at the (potential) expense of profit. The way in which corporations run the business, control agency costs, raise money, and reward investors will change from business to business and from time to time within a firm. The structure suited to a dynamic, growing firm such as Xerox in 1965 is quite unsuited to Exxon in 1965 (or to Xerox in 1989). The participants in the Venture need to be able to establish the arrangement most conducive to prosperity, and outsiders are unlikely to be able to prescribe a mold for corporations as a whole or even a firm through time. The history of corporations has been that firms failing to adapt their governance structures are ground under by competition. The history of corporate law has been that states attempting to force all firms into a single mold are ground under as well. Corporations flee to find more open-ended statutes that permit adaptations. This is the reason for the drive toward enabling laws that control process but not structure. To say that a complex relation among many voluntary participants is adaptive is to say that it is contractual. Thus our reference to the corporation as a set of contracts. Voluntary

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arrangements are contracts. Some may be negotiated over a bargaining table. Some may be a set of terms that are dictated by managers or investors and accepted or not; only the price is negotiated. Some may be fixed and must be accepted at the “going price” (as when people buy investment instruments traded in the market). Some may be implied by courts or legislatures trying to supply the terms that would have been negotiated had people addressed the problem explicitly. Even terms that are invariant—such as the requirement that the board of directors act only by a majority of a quorum—are contractual to the extent that they produce offsetting voluntary arrangements. The result of all of these voluntary arrangements will be contractual. Note that the expression “contract” in the economic sense means something different from what it means in law. Economic contractual relationships do not require any formal legal requirements such as privity or consideration. For example, in a corporation, the constituencies include shareholders who provide equity capital, creditors who provide debt capital, employees who provide labour, and directors and officers who provide management. Under nexus of contracts theory, all of these constituencies have a contractual relationship with each other. Of course, these are not formal legal contractual relationships, given that the firm, by virtue of being incorporated, has a separate legal personality; that is, there is no privity between them and, instead, all of these constituencies legally contract with the firm itself. However, all of the constituencies are linked through their distinct claims to the assets and future earnings generated by the firm. It is in this economic sense that these relationships are contractual. Under nexus of contracts theory, the law governing business organizations is thought of as a standard form contract between all of these constituencies. The following extract by Ayres and Gertner provides a theory for setting wealth maximizing default contractual terms as legal rules and standards.

Ian Ayres & Robert Gertner, “Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules” (1989) 99 Yale LJ 87 at 87-95 (footnotes omitted) The legal rules of contracts and corporations can be divided into two distinct classes. The larger class consists of “default” rules that parties can contract around by prior agreement, while the smaller, but important, class consists of “immutable” rules that parties cannot change by contractual agreement. Default rules fill the gaps in incomplete contracts; they govern unless the parties contract around them. Immutable rules cannot be contracted around; they govern even if the parties attempt to contract around them. For example, under the Uniform Commercial Code (U.C.C.) the duty to act in good faith is an immutable part of any contract, while the warranty of merchantability is simply a default rule that parties can waive by agreement. Similarly, most corporate statutes require that stockholders elect directors annually but allow the articles of incorporation to contract around the default rule of straight voting. Statutory language such as “[u]nless otherwise provided in the certificate of incorporation” or “[u]nless otherwise unambiguously indicated” makes it easy to identify statutory default, but common-law precedents can also

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be divided into the default and immutable camps. For example, the common-law holding of Peevyhouse v. Garland Coal & Mining Co., which limited damages to diminution in value, could be contractually reversed by prospective parties. In contrast, the common-law prerequisite of consideration is largely an immutable rule that parties cannot contractually abrogate. There is surprising consensus among academics at an abstract level on two normative bases for immutability. Put most simply, immutable rules are justifiable if society wants to protect (1) parties within the contract, or (2) parties outside the contract. The former justification turns on parentalism; the latter on externalities. Immutable rules displace freedom of contract. Immutability is justified only if unregulated contracting would be socially deleterious because parties internal or external to the contract cannot adequately protect themselves. With regard to immutable rules, the disagreement among academics is not over this abstract theory, but whether in particular contexts parentalistic concerns or externalities are sufficiently great to justify the use of immutable rules. When the preconditions for immutability are not present, the normative legal analysis devolves to the choice of a default rule. Yet academics have paid little attention about how to choose among possible default rules. The law-and-economics movement has fought long and hard to convince courts to restrict the use of immutable rules, but has lost most of its normative energy in constructing a theory of default choice. Economists seem to believe that, even if lawmakers choose the wrong default, at worst there will be increased transaction costs of a second order of magnitude. Few academics have gone beyond one-sentence theories stipulating that default terms should be set at what the parties would have wanted. Frank Easterbrook and Daniel Fischel have championed the “would have wanted” theory in a number of articles suggesting that “corporate law should contain the [defaults] people would have negotiated, were the costs of negotiating at arms’-length for every contingency sufficiently low.” Similarly, Richard Posner has argued that default rules should “economize on transaction costs by supplying standard contract terms that the parties would otherwise have to adopt by express agreement.” Douglas Baird and Thomas Jackson have argued that the default rules governing the debtor-creditor relationship “should provide all the parties with the type of contract that they would have agreed to if they had had the time and money to bargain over all aspects of their deal.” While this literature has vigorously examined what particular parties would have contracted for in particular contractual settings, it has failed to question whether the “would have wanted” standard is conceptually sound. Thus, although the academy recognizes the analytic difference between default and immutable rules, a detailed theory of how defaults should be set has yet to be proposed. Indeed, the lack of agreement over even what to call the “default” concept is evidence of the underdeveloped state of default theory. Default rules have alternatively been termed background, backstop, enabling, fallback, gap-filling, off-the-rack, opt-in, opt-out, preformulated, preset, presumptive, standby, standard-form and suppletory rules. This Article provides a theory of how courts and legislatures should set default rules. We suggest that efficient defaults would take a variety of forms that at times would diverge from the “what the parties would have contracted for” principle. To this end, we introduce the concept of “penalty defaults.” Penalty defaults are designed to give at least one party to the contract an incentive to contract around the default rule and therefore to choose affirmatively the contract provision they prefer. In contrast to the received wisdom,

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penalty defaults are purposefully set at what the parties would not want—in order to encourage the parties to reveal information to each other or to third parties (especially the courts). This Article also distinguishes between tailored and untailored defaults. A “tailored default” attempts to provide a contract’s parties with precisely “what they would have contracted for.” An “untailored default,” true to its etymology, provides the parties to all contracts with a single, off-the-rack standard that in some sense represents what the majority of contracting parties would want. The Restatement (Second) of Contracts’ approach to filling gaps, for example, provides tailored defaults that are “reasonable in the circumstances.” “Reasonable” defaults usually entail a tailored determination of what the individual contracting parties would have wanted because courts evaluate reasonableness in relation to the “circumstances” of the individual contracting parties. In contrast, Charles Goetz and Robert Scott have proposed that courts should set untailored default rules by asking “what arrangements would most bargainers prefer?” This Article provides a general theory of when efficiency-minded courts or legislatures should set penalty defaults and how they should choose between tailored and untailored default rules. Some common-law and statutory defaults are flatly at odds with the “would have wanted” principle. Although this Article does not make the full-blown positivist claim that current default rules are efficient, it does offer a more complete explanation of the current diversity of defaults. An essential component of our theory of default rules is our explicit consideration of the sources of contractual incompleteness. We distinguish between two basic reasons for incompleteness. Scholars have primarily attributed incompleteness to the costs of contracting. Contracts may be incomplete because the transaction costs of explicitly contracting for a given contingency are greater than the benefits. These transaction costs may include legal fees, negotiation costs, drafting and printing costs, the costs of researching the effects and probability of a contingency, and the costs to the parties and the courts of verifying whether a contingency occurred. Rational parties will weigh these costs against the benefits of contractually addressing a particular contingency. If either the magnitude or the probability of a contingency is sufficiently low, a contract may be insensitive to that contingency even if transaction costs are quite low. The “would have wanted” approach to gap filling is a natural outgrowth of the transaction cost explanation of contractual incompleteness. Lawmakers can minimize the costs of contracting by choosing the default that most parties would have wanted. If there are transaction costs of explicitly contracting on a contingency, the parties may prefer to leave the contract incomplete. Indeed, as transaction costs increase, so does the parties’ willingness to accept a default that is not exactly what they would have contracted for. Scholars who attribute contractual incompleteness to transaction costs are naturally drawn toward choosing defaults that the majority of contracting parties “would have wanted” because these majoritarian defaults seem to minimize the costs of contracting. We show, however, that this majoritarian “would have wanted” approach to default selection is, for several reasons, incomplete. First, the majoritarian approach fails to account for the possibly disparate costs of contracting and of failing to contract around different defaults. For example, if the majority is more likely to contract around the minority’s preferred default rule (than the minority is to contract around the majority’s rule), then choosing the minority’s default may lead to a larger set of efficient contracts.

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Second, the received wisdom provides little guidance about how tailored or particularized the “would have wanted” analysis should be. Finally, the very costs of ex ante bargaining may encourage parties to inefficiently shift the process of gap filling to ex  post court determination. If it is costly for the courts to determine what the parties would have wanted, it may be efficient to choose a default rule that induces the parties to contract explicitly. In other words, penalty defaults are appropriate when it is cheaper for the parties to negotiate a term ex ante than for the courts to estimate ex post what the parties would have wanted. Courts, which are publicly subsidized, should give parties incentives to negotiate ex ante by penalizing them for inefficient gaps. This Article also proposes a second source of contractual incompleteness that is the focus of much of our analysis. We refer to this source of incompleteness as strategic. One party might strategically withhold information that would increase the total gains from contracting (the “size of the pie”) in order to increase her private share of the gains from contracting (her “share of the pie”). By attempting to contract around a certain default, one party might reveal information to the other party that affects how the contractual pie is split. Thus, for example, the more informed party may prefer to have inefficient precaution rather than pay a higher price for the good. While analysts have previously explained incomplete contracting solely in terms of the costs of writing additional provisions, we argue that contractual gaps can also result from strategic behavior by relatively informed parties. By changing the default rules of the game, lawmakers can importantly reduce the opportunities for this rent-seeking, strategic behavior. In particular, the possibility of strategic incompleteness leads us to suggest that efficiency-minded lawmakers should sometimes choose penalty defaults that induce knowledgeable parties to reveal information by contracting around the default penalty. The strategic behavior of the parties in forming the contract can justify strategic contractual interpretations by courts. Our analysis therefore moves beyond the received wisdom that default rules should simply be what the majority of contracting parties would have wanted. In choosing among default rules, lawmakers should be sensitive to the costs of contracting around, and the costs of failing to contract around, particular defaults. We show that different defaults may lead to different degrees of “separating” and “pooling.” In “separating” equilibria, the different types of contracting parties, by bearing the costs of contracting around unwanted defaults, separate themselves into distinct contractual relationships. In “pooling” equilibria, different types of contracting parties fail to contract around defaults, thus avoiding transaction costs but bearing the inefficiencies of the substantive default provisions. In contrast to the majoritarian analysis, our analysis shows that it may be efficient to choose a rule that a majority of people actually disfavor. To set defaults efficiently, lawmakers must not only know what contracting parties want, but how many are likely to get it and at what cost. We recommend a greater and more explicit legal sensitivity toward the ways in which different defaults will affect the resulting contractual “equilibrium.” Finally, before deciding how to fill gaps, courts must decide whether the contract even has a gap. In other words, courts must decide whether the contract already allocates a particular risk or duty. We show that this issue of whether a gap exists is identical to the issue of what is sufficient to contract around a particular default. While the received wisdom is that lawmakers should minimize the costs of contracting around default rules, we suggest that efficiency-minded courts and legislatures may want to intentionally

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increase these transaction costs to discourage parties from contracting around certain defaults.

C.  Transaction Cost Theory In the previous extract, Ayres and Gertner make reference to the concept of transaction costs. A transaction cost is any impediment to bargaining that reduces efficiency. Transaction cost analysis is relevant both to the choice of business organization form and to the setting of default rules. With respect to the former, as Coase explained, firms emerge when the transaction costs of organizing economic activity as a firm are lower than under the price mechanism. With respect to the latter, setting appropriate default legal rules and standards is especially important when parties cannot bargain around the law at reasonable cost; that is, when transaction costs are high. The following extract by Oliver Williamson highlights two sources of transaction costs, bounded rationality and opportunism, that are especially relevant to the study of business organizations.

Oliver Williamson, “The Economics of Organization: The Transaction Cost Approach” (1981) 87 Am J Sociology 548 at 552-56 (citations and footnotes omitted) A transaction occurs when a good or service is transferred across a technologically separable interface. One stage of activity terminates and another begins. With a well-working interface, as with a well-working machine, these transfers occur smoothly. In mechanical systems we look for frictions: do the gears mesh, are the parts lubricated, is there needless slippage or other loss of energy? The economic counterpart of friction is transaction cost: do the parties to the exchange operate harmoniously, or are there frequent misunderstandings and conflicts that lead to delays, breakdowns, and other malfunctions? Transaction cost analysis supplants the usual preoccupation with technology and steadystate production (or distribution) expenses with an examination of the comparative costs of planning, adapting, and monitoring task completion under alternative governance structures. Some transactions are simple and easy to mediate. Others are difficult and require a good deal more attention. Can we identify the factors that permit transactions to be classified as one kind or another? Can we identify the alternative governance structures within which transactions can be organized? And can we match governance structures with transactions in a discriminating (transaction-cost-economizing) way? These are the neglected issues with which organizational design needs to come to grips. These are the issues for which transaction cost analysis promises to offer new insights. Behavioral Assumptions It is widely recognized—by economists, lawyers, and others who have an interest in contracting—that complex contracts are costly to write and enforce. There is a tendency,

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however, to accept this fact as given rather than inquire into the reasons for it. As a result, some of the consequences of and remedies for costly contracting are less well understood than would otherwise be the case. What is needed, I submit, is more self-conscious attention to “human nature as we know it.” The two behavioral assumptions on which transaction cost analysis relies that both add realism and distinguish this approach from neoclassical economics are (1) the recognition that human agents are subject to bounded rationality and (2) the assumption that at least some agents are given to opportunism. Bounded rationality needs to be distinguished from both hyperrationality and irrationality. Unlike “economic man,” to whom hyperrationality is often attributed, “organization man” is endowed with less powerful analytical and data-processing apparatus. Such limited competence does not, however, imply irrationality. Instead, although boundedly rational agents experience limits in formulating and solving complex problems and in processing (receiving, storing, retrieving, transmitting) information, they otherwise remain “intendedly rational.” But for bounded rationality, all economic exchange could be efficiently organized by contract. (The economic theory of comprehensive contracting for unboundedly rational agents has been elegantly worked out.) Given bounded rationality, however, it is impossible to deal with complexity in all contractually relevant respects. As a consequence, incomplete contracting is the best that can be achieved. Ubiquitous, albeit incomplete, contracting would nevertheless be feasible if human agents were not given to opportunism. Thus, if agents, though boundedly rational, were fully trustworthy, comprehensive contracting would still be feasible (and presumably would be observed). Principals would simply extract promises from agents that they would behave in the manner of steward when unanticipated events occurred, while agents would reciprocally ask principals to behave in good faith. Such devices will not work, however, if some economic actors (either principals or agents) are dishonest (or, more generally, disguise attributes or preferences, distort data, obfuscate issues, and otherwise confuse transactions), and it is very costly to distinguish opportunistic from nonopportunistic types ex ante. A different way of putting this is to say that while organizational man is computationally less competent than economic man, he is motivationally more complex. Thus, whereas economic man engages in simple self-interest seeking, opportunism makes provision for self-interest seeking with guile. Problems of contracting are greatly complicated by economic agents who make “false or empty, that is, self-disbelieved threats or promises,” cut corners for undisclosed personal advantage, cover up tracks, and the like. That economic agents are simultaneously subject to bounded rationality and (at least some) are given to opportunism does not by itself, however, vitiate autonomous trading. On the contrary, when effective ex ante and ex post competition can both be presumed, autonomous contracting will be efficacious. Of these two, effective ex ante competition is a much easier condition to satisfy: it merely requires that there be large numbers of qualified bidders at the outset. The subsequent transformation of an exchange relation involving large numbers to one involving small numbers during contract execution is what causes problems. Whether ex post competition is equally efficacious or breaks down as a result of contract execution depends on the characteristics of the transactions in question, which brings us to the matter of dimensionalizing.

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Dimensionalizing As set out elsewhere, the critical dimensions for describing transactions are (1) uncertainty, (2)  the frequency with which transactions recur, and (3)  the degree to which durable, transaction-specific investments are required to realize least cost supply. Only recurrent transactions are of interest for the purposes of this paper; hence attention will hereafter be focused on uncertainty and asset specificity, especially the latter. Asset specificity is both the most important dimension for describing transactions and the most neglected attribute in prior studies of organization. The issue is less whether there are large fixed investments, though this is important, than whether such investments are specialized to a particular transaction. Items that are unspecialized among users pose few hazards, since buyers in these circumstances can easily turn to alternative sources and suppliers can sell output intended for one buyer to other buyers without difficulty. Nonmarketability problems arise when the specific identity of the parties has important cost-bearing consequences. Transactions of this kind may be referred to as idiosyncratic. Asset specificity can arise in any of three ways: site specificity, as when successive stations are located in cheek-by-jowl relation to each other so as to economize on inventory and transportation expenses; physical asset specificity, as where specialized dies are required to produce a component; and human asset specificity that arises from learning by doing. The reason asset specificity is critical is that, once an investment has been made, buyer and seller are effectively operating in a bilateral (or at least quasi-bilateral) exchange relation for a considerable period thereafter. Inasmuch as the value of specific capital in other uses is, by definition, much smaller than the specialized use for which it has been intended, the supplier is effectively “locked into” the transaction to a significant degree. This is symmetrical, moreover, in that the buyer cannot turn to alternative sources of supply and obtain the item on favorable terms, since the cost of supply from unspecialized capital is presumably great. The buyer is thus committed to the transaction as well. Accordingly, where asset specificity is great, buyer and seller will make special efforts to design an exchange that has good continuity properties. The site-specific assets referred to here appear to correspond with those Thompson describes as the “core technology.” Indeed, the common ownership of site-specific stations is thought to be so “natural” that alternative governance structures are rarely considered. In fact, however, the joining of separable stations—for example, blast furnace and rolling mill, thereby to realize thermal economies—under common ownership is not technologically determined but instead reflects transaction-cost-economizing judgments. It will nevertheless be convenient, for the purposes of this paper, to assume that all site-specific stations constitute a technological core the common ownership of which will be taken as given. Attention is thus focused on earlier stage, later stage, and lateral transactions. The efficient governance structure for these turns on physical asset and human asset specificity.

D.  Agency Cost Theory In the previous extract, Williamson argues that efficient governance structures are necessary in the context of asset specificity; that is, where assets are not redeployable. Naturally, every

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business organization will have its own governance structure that is tailored to meet its specific needs. In order to facilitate this process, legislation provides default rules for the governance of partnerships and corporations. Recall from Chapter 1 that, in large corporations with many shareholders, the governance structure typically features some form of centralized management. Berle and Means famously described the key organizational problem in publicly traded corporations as the separation of ownership and control; that is, the interests of management and the firm may diverge.10 In economic literature, this is referred to as the principal – agent problem. This divergence of management’s interests from those of the firm are referred to agency costs. The following extract by Jensen and Meckling elaborates on how agency costs arise in the context of firms.

Michael C Jensen & William C Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure” (1976) 3:4 J Fin Econ 305 at 308-9, 312-13 (footnotes omitted) We define an agency relationship as a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent. If both parties to the relationship are utility maximizers there is good reason to believe that the agent will not always act in the best interests of the principal. The principal can limit divergences from his interest by establishing appropriate incentives for the agent and by incurring monitoring costs designed to limit the aberrant activities of the agent. In addition in some situations it will pay the agent to expend resources (bonding costs) to guarantee that he will not take certain actions which would harm the principal or to ensure that the principal will be compensated if he does take such actions. However, it is generally impossible for the principal or the agent at zero cost to ensure that the agent will make optimal decisions from the principal’s viewpoint. In most agency relationships the principal and the agent will incur positive monitoring and bonding costs (non-pecuniary as well as pecuniary), and in addition there will be some divergence between the agent’s decisions and those decisions which would maximize the welfare of the principal. The dollar equivalent of the reduction in welfare experienced by the principal due to this divergence is also a cost of the agency relationship, and we refer to this latter cost as the “residual loss.” We define agency costs as the sum of:

(1) the monitoring expenditures by the principal, (2) the bonding expenditures by the agent, (3) the residual loss. Note also that agency costs arise in any situation involving cooperative effort (such as the co-authoring of this paper) by two or more people even though there is no clear cut principal-agent relationship. Viewed in this light it is clear that our definition of agency costs and their importance to the theory of the firm bears a close relationship to the

10 Adolf A Berle & Gardiner C Means, The Modern Corporation and Private Property (New York: Macmillan, 1933).

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problem of shirking and monitoring of team production which Alchian and Demsetz (1972) raise in their paper on the theory of the firm. Since the relationship between the stockholders and manager of a corporation fit the definition of a pure agency relationship it should be no surprise to discover that the issues associated with the “separation of ownership and control” in the modern diffuse ownership corporation are intimately associated with the general problem of agency. We show below that an explanation of why and how the agency costs generated by the corporate form are born leads to a theory of the ownership (or capital) structure of the firm. Before moving on, however, it is worthwhile to point out the generality of the agency problem. The problem of inducing an “agent” to behave as if he were maximizing the “principal’s” welfare is quite general. It exists in all organizations and in all cooperative efforts—at every level of management in firms, in universities, in mutual companies, in cooperatives, in governmental authorities and bureaus, in unions, and in relationships normally classified as agency relationships such as are common in the performing arts and the market for real estate. The development of theories to explain the form which agency costs take in each of these situations (where the contractual relations differ significantly), and how and why they are born will lead to a rich theory of organizations which is now lacking in economics and the social sciences generally. •  •  •

2.  The Agency Costs of Outside Equity 2.1. Overview In this section we analyze the effect of outside equity on agency costs by comparing the behavior of a manager when he owns 100 percent of the residual claims on a firm to his behavior when he sells off a portion of those claims to outsiders. If a wholly owned firm is managed by the owner, he will make operating decisions which maximize his utility. These decisions will involve not only the benefits he derives from pecuniary returns but also the utility generated by various non-pecuniary aspects of his entrepreneurial activities such as the physical appointments of the office, the attractiveness of the secretarial staff, the level of employee discipline, the kind and amount of charitable contributions, personal relations (“love,” “respect,” etc.) with employees, a larger than optimal computer to play with, purchase of production inputs from friends, etc. The optimum mix (in the absence of taxes) of the various pecuniary and non-pecuniary benefits is achieved when the marginal utility derived from an additional dollar of expenditure (measured net of any productive effects) is equal for each non-pecuniary item and equal to the marginal utility derived from an additional dollar of after tax purchasing power (wealth). If the owner-manager sells equity claims on the corporation which are identical to his (i.e., share proportionately in the profits of the firm and have limited liability) agency costs will be generated by the divergence between his interest and those of the outside shareholders, since he will then bear only a fraction of the costs of any non-pecuniary benefits he takes out in maximizing his own utility. If the manager owns only 95 percent of the stock, he will expend resources to the point where the marginal utility derived

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from a dollar’s expenditure of the firm’s resources on such items equals the marginal utility of an additional 95 cents in general purchasing power (i.e., his share of the wealth reduction) and not one dollar. Such activities, on his part, can be limited (but probably not eliminated) by the expenditure of resources on monitoring activities by the outside stockholders. But as we show below, the owner will bear the entire wealth effects of these expected costs so long as the equity market anticipates these effects. Prospective minority shareholders will realize that the owner-manager’s interests will diverge somewhat from theirs, hence the price which they will pay for shares will reflect the monitoring costs and the effect of the divergence between the manager’s interest and theirs. Nevertheless, ignoring for the moment the possibility of borrowing against his wealth, the owner will find it desirable to bear these costs as long as the welfare increment he experiences from converting his claims on the firm into general purchasing power is large enough to offset them. As the owner-manager’s fraction of the equity falls, his fractional claim on the outcomes falls and this will tend to encourage him to appropriate larger amounts of the corporate resources in the form of perquisites. This also makes it desirable for the minority shareholders to expend more resources in monitoring his behavior. Thus, the wealth costs to the owner of obtaining additional cash in the equity markets rise as his fractional ownership falls. We shall continue to characterize the agency conflict between the owner-manager and outside shareholders as deriving from the manager’s tendency to appropriate perquisites out of the firm’s resources for his own consumption. However, we do not mean to leave the impression that this is the only or even the most important source of conflict. Indeed, it is likely that the most important conflict arises from the fact that as the manager’s ownership claim falls, his incentive to devote significant effort to creative activities such as searching out new profitable ventures falls. He may in fact avoid such ventures simply because it requires too much trouble or effort on his part to manage or to learn about new technologies. Avoidance of these personal costs and the anxieties that go with them also represent a source of on the job utility to him and it can result in the value of the firm being substantially lower than it otherwise could be. NOTES AND QUESTIONS

1.  Although these excerpts are mostly concerned with the effect that agency and transaction costs have on corporations, it is important to bear in mind that corporations inevitably pass these costs on to their customers. Minimizing costs and maximizing effective interaction among corporate inputs has direct benefits for consumers, who ultimately bear the burden of poorly run organizations and inefficient policy. 2.  Unpredictability is a significant source of costs for corporations, because it forces them to simultaneously prepare for multiple contingencies and insure against “worst-case” scenarios. Recall the discussion of enabling and mandatory rules in Chapter  3, and consider some of the recent jurisprudence that has created open-ended “fairness” obligations in corporate governance. Do these rules help or hinder the ability of corporations to predict legal outcomes? What kinds of costs do they generate?

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III.  SOCIO-ECONOMIC THEORIES OF THE FIRM While economic theories of the firm have been very influential in the law and policy of business organizations, socio-economic theories of the firm have also contributed significantly to an understanding of the firm. Socio-economic theories tend to advocate for a more communitarian, as opposed to contractarian, conception of the firm. In addition, social theories of the firm view the regulation of firms, especially those that are publicly traded, as a matter of public law. In the first extract, David Millon argues that the basic divide between communitarians and contractarians is ideological. In the second extract, Kent Greenfield suggests that corporate law should be regarded as an area of public, rather than private, law. In the third extract, Blair and Stout argue that the principal – agent conception of the firm is too narrow and, instead, present a mediating hierarchy model. In the final excerpt, Spencer Thompson challenges some of the assumptions of economic scholarship by suggesting that individuals work more productively and efficiently when serving communal goals, and that legal rules should encourage the development of more cooperative models of business organizations.

David Millon, “Communitarians, Contractarians, and the Crisis in Corporate Law” (1993) 50:4 Wash & Lee L Rev 1373 at 1382 (footnotes omitted) Contractarians start from the presumption that people ought to be free to make their own choices about how to live their lives (subject to an overriding duty not to harm others). Legal rules that redistribute wealth, mandate particular forms of behavior, or prevent people from making bargains they would otherwise choose to make are presumptively objectionable because they interfere with people’s ability to live their own lives according to their own preferences, structuring their relationships with others and defining their duties toward them by means of consent. This idea focuses on the individual as an autonomous being and is based on a particular vision of human liberty as freedom from external, unconsented to restraint. Contractarians are willing to admit the legitimacy of certain mandatory rules, but such restraints on individual liberty must themselves be justified in terms of the liberty interests of those who may be harmed by the conduct restrained. Communitarians approach these questions from a different perspective. Their view of society contrasts sharply with the contractarians’ animating vision, emphasizing the social arena in which individual activity occurs. Simply by virtue of membership in a shared community, individuals owe obligations to each other that exist independently of contract. We are born into civil society and thereby inherit the benefits of life in a community. The value of those benefits depends in large part on the quality of the social environment. That in turn is determined by the behavior of one’s fellow citizens, which is largely a matter of their values and goals. If we are to discharge our obligation to preserve and strengthen the social fabric that is our heritage, we cannot ignore those aspects of the material and cultural landscape that shape those values and goals. Acknowledging our interdependence, we must recognize our responsibility for the quality of the lives of all community members. The state acts appropriately when it enforces such duties.

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State action of this sort necessarily involves restrictions on freedom. Nevertheless, the communitarian idea is also based on a vision of liberty, but it is one that includes a positive component. Liberty is empty without taking into account those primary needs upon which adequate conceptions of individual dignity and human flourishing depend. Basic physical comforts, facilities for intellectual and emotional growth, and enriching social environments are necessary if individuals are to have meaningful opportunities to define and pursue their own life-plans and to participate with civility in a community of interdependence. Many communitarians, including the corporate law communitarians referred to in this essay, share the contractarians’ commitment to individual autonomy and choice as foundational moral values, but they insist that meaningful choice requires a social framework that cannot itself be constructed entirely out of private, bilateral transactions. The market alone cannot adequately fulfill basic human needs for everyone because many people lack the resources to participate effectively in the market. Insistence on the market’s sufficiency for the sake of individual liberty therefore ignores those civic obligations that flow from the social aspect of human existence. To communitarians, life chances should not depend entirely on accidents of birth and bargaining power: people are entitled to more out of life than what they can pay for.

Kent Greenfield, “Corporate Law as Public Law” In The Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities (Chicago and London: University of Chicago Press, 2006) at 30-32, 36-39 (most footnotes omitted) Because corporations are seen as private creations, corporate law is insulated from politics and concerns about the public interest. According to the mainstream view, the public interest should be protected, if at all, by pressure applied on corporations from the outside, rather than by changing the nature of corporate governance inside the firm. Those who are concerned with corporate misdeeds should “seek redress through the political process and [should] not … attempt to disrupt the voluntary arrangements that private parties have entered into in forming corporations.” [Daniel Fischel, “The Corporate Governance Movement” (1982) 35 Vand L Rev 1259 at 1271.] The underlying assumptions of the contractarians can be teased out of Fischel’s argument that any problem with corporate scandals and corporate social irresponsibility, “assuming that one exists,” should be remedied through the “political process, not in changing the governance of corporations.” This statement assumes a Lochner-like line between the public and private, with politics on the public sided and corporate governance on the private side, insulated from political oversight. [Lochner v New York, 198 US 45 (1905), a landmark labour law case that held that limits to working time violated the 14th Amendment).] Adjustments to corporate governance on public interest grounds are illegitimate because they invade the private law sphere or “disrupt … voluntary arrangements.” Public policy responses to corporate corruption are misguided because “the issue is not one of public policy but of contract law.” In the view of the contractarians, if social activists want to reform the activities of corporations, they must seek redress through the political process, and their options are

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limited to public law options, not rules of corporate governance. Fischel accuses social reformers of focusing on rules of corporate governance only because they have “largely failed in implementing their objectives through the political processes.” Only because of their failure have they “attempt[ed] to achieve these same objectives by altering the governance of corporations.” These comments only make sense if Fischel believes corporate governance is a matter of private agreement rather than public law. Fischel’s views embody an assumption that underlies much of the mainstream scholarship in corporate law … that politics is separate from corporate governance. Ignored is the possibility that changes in corporate governance may be the very thing that politics could propose changing. This possibility does not seem to be a valid one to these scholars because they assume that when people think of political redress they think of employment law, tax law, or worker safety regulation. Corporate law is private law, rightly insulated from politics. In the light of these arguments and assumptions, the rights-based nature of the contractarian theory is obvious. A set of legal relationships exists, namely those between shareholders and managers, that should be insulated from the political process. The contractual relationships within the corporation occupy a prelegal, prepolitical, and perhaps even super-constitutional status. The internal affairs of corporations are not, and should not be, subject to the political process. •  •  •

Corporations are such unique creations that scholars have long searched for the correct metaphor to explain them. At various time in our history, a corporation was analogized to a kind of fiduciary relationship or discussed in language used to speak about property. For the last twenty-five years or so, corporations are seen as contractual entities. All of these metaphors are distinctly private and rights-based in character. But if the corporation really should have a public dimension, these metaphors are misleading. The question then becomes how the discussion about the nature and proper purpose of corporations should move forward. There is no lack of difficulty here. How do we engage in a conversation about possible changes in corporate governance if the language of rights is off limits? One useful way to think of these issues is to look at corporate law as regulation. Lochner’s mistake was to consider the employment relationship as wholly private. With the New Deal came the insight that such a relationship was not private at all but was instead the proper subject of government attention. Now, this New Deal insight should be extended beyond the employment relation to the heart of the corporation, its governance. Instead of being seen as a set of private law rules contained within itself, corporate law should be subject to the same analysis as environmental law, labour law, tax law, and the like. There are a number of ways to characterize what this analysis should be, of course, and there are many grounds for vigorous disagreement about what “counts” in regulatory theory. But behind all the complexity, at a high level of generality, the analysis with regard to corporate law rules should be the same as the analysis for other kinds of statutes and regulations. That is, corporate law, just like every other area of common and statutory law, is predicated upon our collective political decisions about what we want our society to look like. Only after we recognize the place of corporate law as one small element of a larger political landscape can we then craft a bundle of legal rules and regulatory programs that are likely to move us toward our collective goals.

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Though this construction is admittedly at a high level of abstraction, it forces the conversation about corporate governance to change quite dramatically, at least at the beginning. Instead of looking at the outset to common law principles and notions of contract, we are forced to state our assumptions about the purposes of law and our vision for society. Then, the project of constructing corporate law ought to depend on a broader and ongoing project that sets social goals and analyzes the capacity of law, including corporate law, to get us closer to those ideals. Of course, once we move away from rights-based arguments toward more hard-nosed empirical judgements about the effects of corporate governance on public policy goals, one would not expect much initial consensus about either the goals or the value of corporate law to help meet them. Despite its difficulty, this is a debate we should be having. Perhaps there is reason to believe that corporate law should remain focused primarily on shareholder profits. Shareholders might belong on the pinnacle of corporate law in order to facilitate raising capital and to maximize the incentives for making profit. And perhaps when profits are maximized, social utility is maximized. Such a claim is dubious at best. Once corporate law moves from the realm of metaphor and rights-based debate to the terrain of regulatory theory, reasons to doubt the simple, profit-oriented utilitarian argument abound. It cannot seriously be claimed that social utility will be maximized if corporations are unrestrained by law. Even if one assumes that a maximization of utility should be the end goal, government intervention is often necessary to repair market defects in order to maximize utility. Even free-market economists acknowledge that market defects such as externalities, collective action problems, “prisoners’ dilemmas,” inadequate information, “tragedies of the common” and natural monopolies may make it impossible to maximize social utility absent government regulation. Thus, government regulation of corporations is necessary even under a utilitarian social calculus. Additionally, if we expand our view of the permissible grounds for regulation to include public-regarding reasons not based in utilitarianism, … nonutilitarian values such as equality or human dignity should influence and inform corporate law just as they inform and influence other areas of law. The implications of this point for corporate governance may not be immediately obvious. Contractarians will admit the occasional need for regulation to correct market defects, and some may even allow for other regulatory rationales as well. … [T]hey would almost certainly argue that such regulation should be external to the corporate form (such as regulations requiring plant-closing notification) rather than internal to it (such as a requirement that employees have representatives on boards of directors). … Some arguments might plausibly support such a distinction. Giving corporate managers more than one legal duty may increase the agency costs of their supervision; it is less costly to monitor the performance of an agent if the agent has one task than if the agent has two. Perhaps managers have no expertise with respect to social concerns, so giving them more power to address such concerns may be unlikely to have a significant positive effect and will provide a deadweight cost on the corporation, its shareholders, and society in general. Perhaps a loosening of management’s fiduciary duty to shareholders will make shareholders less likely to invest, because they will lose some of the legal power to monitor and constrain management. Perhaps these corporate reforms will be pointless, because shareholders will simply invest their capital in companies organized in states and countries

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that allow corporations to benefit shareholders at the expense of other stakeholders or the public interest. Some may be convinced by these arguments (though ultimately I am not). For those who are persuaded, it is not because of the use of the language of rights and duties. Instead, the success of such arguments turns on relative costs and benefits, effectiveness, and the relative strength of other options. In other words, the discussion depends not on rights and duties but on regulatory theory. Once regulatory theory becomes the battleground, however, the victory of the mainstream arguments is not so certain. There are also reasons to believe that changes in corporate law should be part of the bundle of legal responses to correct market defects or to address other public policy objectives. Indeed, corporate law may have comparative advantages over other kinds of law in addressing certain kinds of concerns. … Changes in corporate governance and expansion of legal duties to include more than profit maximization might allow corporations to be proactive in addressing issues of social concern, which in turn might be more efficient than relying on the mostly reactive power of government regulation. Reforms within the corporation might create more trust among the various stakeholders, thereby encouraging reciprocal actions (such as workers being more productive because they feel they are being fairly treated) so as to reduce the costs of the regulatory initiatives. Finally, reforms within corporate law would follow the corporation wherever it goes, whereas regulatory reforms largely stop at the border of the state or country trying to enforce them. There is reason to think hard about the possibility of using corporate law as a regulatory tool. Indeed, there are major public policy problems that otherwise seem intractable, and reforms in corporate governance may prove to be powerful and efficient mechanisms to address them. Insofar as our society does not look like our ideal, there is every reason to think that changes in corporate governance should be squarely on the table when we discuss possible legal responses to social imperfections.

Margaret M Blair & Lynn A Stout, “A Team Production Theory of Corporate Law” (1999) 85 Va L Rev 247 at 319-28 (footnotes omitted) In recent years it has become common for both economic and legal theorists to view a corporation as a “nexus of contracts,” explicit and implicit. In this Article, we propose an approach to thinking about public corporations that does not reject such contractarian thinking, but builds on it by acknowledging the limits of what can be achieved by explicit contracting. Many kinds of joint production are simply too complex and fluid to be governed by explicit contracts. Thus, an extensive literature has emerged, arguing that the gaps in explicit contracts can be filled by assigning residual control rights (“property rights”) to one of the parties to the transaction. Here we explore another possibility: assigning control rights not to shareholders nor to any other stakeholder in the firm, but to a third party—the board of directors—which is largely insulated from the direct control of any of the various economic interests that constitute the corporation. Thus, we argue that an essential but generally overlooked “contract” fundamental to the nature of public

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corporations is the “pactum subjectionis” under which shareholders, managers, employees, and other groups that make firm-specific investments yield control over both those investments and the resulting output to the corporation’s internal governing hierarchy. The mediating hierarchy model we propose explains many important aspects of corporate law much more robustly than its alternatives, especially principal – agent theories premised on the notion that shareholders “own” corporations. In particular, the notion that corporate law follows a shareholder primacy norm appears to be based on two aspects of American law that seem to give shareholders unique rights to exercise control over the board of directors: derivative suits for breach of fiduciary duty and shareholder voting rights. Careful analysis reveals, however, that these rights are so limited as to be almost nonexistent. Expansive judicial interpretation of the business judgment rule generally limits shareholders’ abilities to sue successfully to rare cases of blatant self-dealing or taking of corporate opportunities. Similarly, shareholder voting rights are of such limited value in both theory and practice that they are unlikely to influence outcomes except in extreme cases. Corporate law accordingly leaves boards of directors largely free to pursue whatever projects and directions they choose, subject only to the limitation that they not use their positions for their own personal enrichment. This result has sparked criticism from contractarian supporters of shareholder primacy who complain that corporate law fails to grant shareholders sufficient protection from the depredations of their own “agents,” the board of directors. Thus scholars of the law and economics school have pushed for stricter interpretations of directors’ fiduciary duty, in effect revisiting the Berle – Dodd debate. At the same time, progressives who reject the shareholder primacy norm in favor of a stakeholder approach also complain about existing corporate law and argue that employees as well as shareholders should be given voting rights, explicit representation on corporate boards, or standing to bring suits for breach of fiduciary duty. A team production analysis of the public corporation suggests that both types of criticism miss the mark. If corporate law is not designed primarily to protect shareholders—if, instead, it is designed to protect the corporate coalition by allowing directors to allocate rents among various stakeholders, while guarding the coalition as a whole only from gross self-dealing by directors—then the rules of corporate law begin to make more sense. In particular, the mediating hierarchy approach suggests that shareholders’ voting rights should be extremely limited, and that shareholders should be allowed to sue directors only when this serves the interest of the corporation as a whole, rather than serving shareholders’ interests at the expense of other stakeholders. The mediating hierarchy model thus explains important aspects of modern corporate law that have puzzled and provoked both the law and economics school and their progressive opponents. The mediating hierarchy approach offers other valuable lessons as well. First, it highlights the importance of team production dynamics in the rise of the public corporation as a vehicle for doing business. When the central contracting problem investors face is the principal – agent problem, they do not need public corporations. Instead, they can organize and manage their businesses using explicit contracts and alternative organizational forms—including partnerships, limited liability companies, and privately-held corporations—that permit them to retain far more control over managers and employees. The fact that the lion’s share of our nation’s largest firms have opted to do business as public corporations rather than private companies or partnerships thus suggests there

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may be significant economic advantages to the public corporation form in spite of (or, as we suggest, because of) the requirement of ceding control to an independent board of directors. … A second lesson to draw from team production theory concerns the fundamentally political nature of the corporation. Scholarly and popular debates about corporate governance need to recognize that corporations mediate among the competing interests of various groups and individuals that risk firm-specific investments in a joint enterprise. These groups will inevitably use political tools, in addition to economic and legal tools, to try to capture a larger share of the rents produced by team production. … This brings us to our final lesson. It is widely perceived that during the late 1960s and 1970s, the performance of US firms deteriorated markedly, and some have argued that boards of directors of American companies may have been both overly generous to employees and top management and insensitive to the wishes of the shareholders. Corporate America became fat and lazy, and returns from share ownership declined. Eventually (according to the conventional wisdom), these “inefficiencies” became so great that they sparked the 1980s takeover movement and a decade and a half of corporate restructurings and downsizings. This restructuring process has produced “leaner and meaner” corporations that are more attentive than ever to shareholders’ desires, and returns from share ownership have correspondingly increased. At the same time, directors’ new focus on shareholders’ interests has adversely affected other corporate constituencies—especially rank-and-file employees—whose relative returns from participating in the corporate enterprise seem to have shrunk even as shareholders have prospered. How should corporate scholars interpret, and lawmakers respond to, these events? The mediating hierarchy approach suggests two intriguing possibilities. First, corporate directors as mediating hierarchs enjoy considerable discretion in deciding which members of the corporate coalition receive what portion of the economic surplus resulting from team production. Although the board must meet the minimum demands of each team member to keep the coalition together, beyond that threshold any number of possible allocations among groups is possible. Thus, the returns to any particular corporate stakeholder from participating in the corporation will be determined not only by market forces, but by political forces. This analysis in turn suggests that the rise in the 1980s of institutional shareholders such as investment companies and pension funds (which control sizeable blocks of shares in many firms) has tipped the political balance of power toward shareholders by reducing obstacles to collective investor action. It further suggests that the decline of labor unions during the same period has made it more difficult for labor to protect its stake in the corporate enterprise. The net result is that shareholders as a class have acquired additional political power that allows them to capture a larger share of the rents from the corporate enterprise, and have thus grown richer, while employees as a class have lost political power, and have thus grown relatively poorer. Yet the mediating hierarchy model also suggests a second possible interpretation of this redirection of corporate wealth from employees to shareholders. In particular, the shift can be explained as a response to changing market forces which have altered various team members’ opportunity costs and thus, the minimum rewards they must receive to have an incentive to remain in the team. Technological change and an increasingly globalized economy have exerted downward pressure on US workers’ wages while increasing investors’ opportunities to seek higher returns abroad. Recognizing this reality, corporate

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boards have also recognized that they must redirect some of the surplus produced by corporate team production from employees to shareholders in order to prevent the flight of capital and keep the coalition together. In other words, corporate boards’ recent focus on shareholder wealth may be an appropriate and economically efficient response to changes in the underlying markets for capital and labor. In either case, we do not think it is an accident that the idea of shareholder primacy has become increasingly popular among academics during this period. Our theory suggests that the shift in the balance of power in boardrooms toward shareholders is the result not of directors’ sudden recognition that shareholders are in fact “owners” of the corporation, however, but of changing economic and political forces that have improved shareholders’ relative bargaining power vis-à-vis other coalition members. If the driving forces are political, whether shareholders or employees receive a greater share of the rewards of the corporate enterprise may be a matter that raises primarily distributional concerns. If the shift reflects economic factors, however, it represents an efficient readjustment essential to continued team production. Thus, at a normative level our story cautions against attempts to “reform” corporate law either by contractarians who want to enhance shareholders’ power over directors, or progressives who want to give other stakeholders greater control rights. Strikingly, corporate law itself has proven remarkably immune to both sorts of proposals, and continues to preserve directors’ discretion to act as mediators among all relevant corporate constituents.

Spencer Thompson, “Towards a Social Theory of the Firm: Worker Cooperatives Reconsidered” (2015) 3:1 J Coop Org & Mgmt 3 at 3, 5-8 (citations emitted) Despite the firm’s central role in society and the economy, there is little consensus regarding its purpose, function, and nature. While contract-based theories conceive the firm as an arena of exchange that purports to minimise transaction costs by achieving cooperation, competence-based theories conceive the firm as an arena of production that purports to develop productive capabilities by achieving coordination. These rival schools appear irreconcilable, with attempts to bridge them tending to treat one as subsidiary to the other. Nevertheless, a common implication of both schools is that cooperative firms are generally inefficient. •  •  •

Contract-based theories focus on the function of cooperation, but assume that behaviour is universally characterised by market-like transactions between instrumentallymotivated “contractual men” (what I call “individualistic behaviour”), and consequently that cooperation is achieved only by rearranging the opportunities and incentives facing individuals. This “surface-level cooperation” is insufficient when it comes to non-tradable knowledge, which, unlike tradable information, cannot be assigned property rights or monetary value. Although this is most obvious in cases requiring initiative, teamwork, and innovation, even the most “deskilled” tasks contain “some residual element of discretion” that cannot be efficiently contracted or monitored. This is evidenced by the fact that strict obedience to contracts (“work-to-rule”) is a form of industrial sabotage. Thus, if the

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firm exists to develop and apply productive knowledge, its “very nature and rationale” involves achieving cooperation on a “deeper level.” The firm can therefore be defined as a social institution dedicated to production. 2.3.  Behaviour and cooperation What, then, is this “deep-level” cooperation, and how does the firm achieve it? To answer this question, we must first distinguish between the cognitive and relational aspects of behaviour, which, due to their interdependency, entail two distinct “behavioural modes”: as envisaged by contract-based theories, behaviour can be individualistic, characterised by market-like transactions between instrumentally-motivated individuals, but on the other hand, behaviour can also be solidaristic, characterised by social relationships between substantively-motivated individuals. This duality is evident in the work of Adam Smith, who, despite referring repeatedly in The Wealth of Nations to “a certain propensity in human nature … to truck, barter, and exchange” and assuming that “the butcher, the brewer, [and] the baker” all perform their jobs out of purely instrumental motivation (1904 [1776], Book I, Chapter 2, paragraphs 1 and 2), begins The Theory of Moral Sentiments with the statement: “How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it” (1790 [1759], Section I.I.1). After establishing these behavioural modes, we can generalise that whereas surfacelevel cooperation is achieved through organisational structures (such as property rights, pay schemes, and monitoring systems), which constrain individualistic behaviour, deeplevel cooperation is achieved through an organisational culture, which enables solidaristic behaviour. An organisational culture can be defined as a set of cognitive frames and social norms shared across the organisation. In particular, the firm must cultivate a cognitive frame of organisational loyalty, such that individuals identify with the firm to the point of subordinating their immediate interests to the goals of the firm and ‘’accept[ing] … responsibilities beyond any specific contracted function.” It must also cultivate a social norm of trust, such that members expect that others will act in accordance with organisational loyalty. Just as individual behaviour involves cognitive and relational aspects, organisational structures and organisational culture can be respectively conceived as the cognitive and relational aspects of organisational behaviour. Organisational structures and organisational culture, however, affect behaviour in a more fundamental way than simply acting on whatever mode of behaviour (individualistic or solidaristic) happens to prevail; they also influence which mode prevails in the first place. Contrary to the rationalist methodology of contract-based theories, individuals are not fully determined prior to any institutional realities. Rather, to deal with their cognitive limitations (“bounded rationality”), they rely on institutions such as the firm to “constitute” their behavioural foundations. On the cognitive side, an emphasis on social approval and reputation can activate intrinsic work motivations, just as an emphasis on material rewards and punishments can crowd them out by propagating an instrumental perception of work. On the relational side, leaving room for job discretion can facilitate reciprocity that engenders norms of trust, just as minimising discretion through extensive specification and intensive

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enforcement of responsibilities can configure the employment relation to be a mere transaction. 2.4.  The trade-off between cooperation and coordination Although deep-level cooperation is “the very nature and rationale of organization,” production also requires coordination, as competence-based theories have stressed. Furthermore, as demonstrated by game theory, it is reasonable to presume that problems of coordination will apply even if cooperation has already been achieved. This implies that, at least for advanced technologies, “bureaucratic” organisational structures like complex divisions of labour and hierarchical management systems may be required for the purpose of coordination, even if cooperation has been achieved on the deep-level through organisational culture. Given the endogeneity of behaviour, however, this presents somewhat of a predicament: bureaucratic organisational structures, implemented for the purpose of coordination, might stimulate individualistic behaviour, thus undermining deep-level cooperation. Indeed, this trade-off may be so critical that it competes with, or at least supplements, other answers to the perennial question of why firms do not expand indefinitely, such as the proliferation of “bureaucratic costs” and other sources of scale diseconomies. As the firm expands, and as production becomes more complex, the trade-off becomes more acute, because coordination becomes increasingly essential while organisational culture becomes increasingly difficult to maintain. The range of theoretical and empirical literatures showing that the size of the firm is correlated with either the degree of worker alienation or the fomentation of class consciousness, to the neglect of organisational trust and loyalty, are germane. •  •  •

3.  Worker cooperatives reconsidered 3.1.  Managerial hierarchies and cooperatives The “social” theory of the firm … can be expediently applied to cooperative firms, which both of the predominant schools have generally dismissed as inefficient. In particular, both schools emphasise the importance of hierarchical management systems, which they associate with the capitalist firm. However, they diverge in a subtle yet consequential way over precisely why managerial hierarchies are required, and why they are associated with the capitalist firm. Contract-based theories maintain that managerial hierarchies are required to achieve surface-level cooperation by constraining the opportunistic behaviour that would otherwise result from a complex division of labour. First, managers can monitor, reward, and punish workers, who would otherwise free-ride on each other’s efforts (“shirk”) due to the asymmetries of information inherent in joint labour (“team production”). Second, managers can authoritatively make investment decisions that would otherwise be subject to inefficient rent-seeking (“hold-up”) due to the inextricability of assets from the production process (“asset specificity”). Competence-based theories, on the other hand, maintain that managerial hierarchies are required to achieve the coordination that would otherwise be lacking in a complex division of labour. In particular, by

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facilitating specialisation in the management function, managerial hierarchies can efficiently control the flow of information and the allocation of skills and resources between stages of production, taking into account risk, uncertainty, and change. They can also provide symbolic leadership in order to ensure that deep-level cooperation is channelled productively. … Turning firstly to contract-based theories, the case for managerial hierarchy based on surface-level cooperation leads almost axiomatically to the conclusion that workers cannot own/control the firm, because non-worker ownership/control is an intrinsic part of how managerial hierarchies are supposed to achieve cooperation. Indeed, Coase equated managerial hierarchies (which he saw as the defining feature of the firm in general) with the capitalist firm. For instance, the most efficient way to incentivise managers to monitor workers is to award them the property rights to the “residual,” which represents the product left over after all individually contractible returns have been paid. Workers, however, could not be thus incentivised, because they would merely free-ride on each other’s monitoring in addition to their work. Likewise, worker-owners could not efficiently implement rewards and punishments on themselves, because ex post they would always have an incentive not to incur debt or to waste output (“break the budget”), which may be required for an optimal incentive scheme. Meanwhile, a series of models based on the “Labour-Managed Firm” have asserted that worker-ownership incurs a range of perverse investment incentives due to the bundling of wealth and work. What makes ownership by capital efficient in these models is precisely that non-workers, whose wealth is not tied up in their job, make investment decisions—in other words, that investment decisions are made through managerial hierarchies. Is the contract-based rationale for managerial hierarchy valid? On the one hand, the notion that managerial hierarchies (coupled with capitalist ownership) are required to achieve surface-level cooperation can be disputed on the grounds that cooperatives may be able to attain surface-level cooperation without managerial hierarchies. For instance, worker-management may entail less asymmetry of information and costs of bureaucracy than hierarchical management, while worker-ownership may entail superior incentives for work and investment than non-worker ownership. More important, however, is the assumption that individualistic behaviour prevails universally and unconditionally, and therefore that cooperation is achieved only on the surface level. In reality, managerial hierarchies may induce (or at least reinforce) that very behaviour, precluding the solidaristic behaviour that enables deep-level cooperation. In any case, due to the distributive dilemma, capitalist firms will be severely limited in substantiating an organisational culture of deep-level cooperation, and may therefore rely on managerial hierarchies to achieve surface-level cooperation. By contrast, non-hierarchical management and worker ownership/control may not only contribute to solidaristic behaviour and deep-level cooperation directly, but also allow decision-makers (namely worker-members) to enjoy the productive benefits of deep-level cooperation. Indeed, numerous studies have found higher levels of trust and loyalty in cooperatives than in comparable capitalist firms. Crucially, the incidence of deep-level cooperation precludes the need for managerial hierarchies to achieve surfacelevel cooperation. Indeed, worker-owned and -managed firms have been empirically shown to feature less managerial supervision than traditional firms, in part due to the prevalence of “mutual monitoring.”

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If the contract-based rationale for managerial hierarchy is unfounded, what about the competence-based rationale? Some radical authors dispute the notion that managerial hierarchies are required to coordinate production, contending that less complex divisions of labour, accompanied by less hierarchical management systems, are feasible for any given technology. They further contend that “de-skilled” divisions of labour are not more productive, prevailing only because they justify the role of managers. However, while maximally partitioned divisions of labour are likely to be inefficient, as Adam Smith (1776) himself acknowledged (for instance, because they stifle teamwork, learning, and innovation), some degree of specialisation—and thus managerial hierarchy—is likely to be required for coordination, as mentioned above. Unlike the contract-based rationale for managerial hierarchy, however, the competence-based rationale does not disqualify the cooperative firm. Indeed, Chandler appears to associate managerial hierarchies with the capitalist firm merely due to historical happenstance. It may be assumed that cooperatives are precluded from implementing complex divisions of labour and managerial hierarchies because they espouse egalitarian principles. However, ownership and control by labour does not necessarily entail functional equivalence or equal pay among the workforce; it is possible in theory, and common in practice, for worker-owners to democratically consent to complex divisions of labour and to elect managers to coordinate that division of labour if they perceive (net) economic benefits of doing so. Such managers would exercise only delegated (or “formal”) rather than ultimate (or “real”) authority; as envisaged by competence-based theories, they would essentially be just another cog in the division of labour. In fact, when deep-level cooperation is considered, worker-owned firms may be more propitiously situated to implement managerial hierarchies (along with complex divisions of labour) for the sake of achieving coordination than conventional firms. As explained in Section 2.4, a potential trade-off exists between coordination and deeplevel cooperation, which can be alleviated by an organisational culture that tolerates bureaucratic organisational structures. However, that organisational must still be substantiated in organisational structures; and if the division and labour and the management system must be bureaucratic for the purpose of coordination, structural consistency must be achieved in the realm of ownership and control—that is, the system of governance. The distributive dilemma will therefore prevent capitalist firms from overcoming the cooperation/coordination trade-off, as any managerial hierarchies they implement for the purpose of coordination are likely to stimulate individualistic behaviour, thus bringing to fruition the need for hierarchy to achieve surface-level cooperation. … Cooperatives, by contrast, do not face the distributive dilemma, and so contain the potential to mitigate the cooperation/ coordination trade-off by separating the dual functions of managerial hierarchy: with deep-level cooperation achieved through participation in governance, coordination can be achieved through managerial hierarchies in the workplace. Furthermore, because managers are elected by workers (they are “representative”) and do not purport to achieve cooperation but only coordination (they are not “punishment-centred”), their adverse behavioural effects are likely to be diminished; as Marx recognised, “In a co-operative factory the antagonistic nature of the labour of supervision disappears, because the manager is paid by the labourers instead of representing capital counterposed to them.”

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1.  Socio-economic theories of the firm seek to promote values of equality and social responsibility rather than wealth maximization and efficiency. Consider what a general business corporations statute informed by socio-economic theories of the firm would look like. What kind of rules would you expect to find in it? 2.  In “A Team Production Theory of Canadian Corporate Law,”11 Stephanie Ben-Ishai applies Blair and Stout’s theory to the treatment of public corporations in Canada. She considers three features of Canadian corporate law: (1) corporate personality and the derivative action, (2) the statutory fiduciary duty and duty of care, and (3) the limits on shareholder voting. She concludes that “[a] review of the derivative action, the statutory duties of boards, and shareholder voting reveals that directors are not constituted as shareholders’ agents by Canadian corporate law. Rather, these three central aspects of Canadian corporate law allow boards to pursue the mediating hierarchy model envisioned by Team Production Theory” (at 306). 3.  Consider what you have learned so far about corporate governance. Is it really true that shareholder primacy is based on their “ownership” of the corporation? What does it mean for Blair and Stout’s Team Production Theory if shareholder primacy is justified in terms of mutual benefit and improved efficiency rather than ownership? 4.  As Thompson discusses elsewhere in his paper, co-operative corporate structures will only be effective if participants also buy into the culture, which may involve setting aside their rational, self-interested tendencies. Are socio-economic theories of the firm based on different assumptions about human nature than economic theories? Which do you find more convincing? 5.  Advocates for more socially minded corporate law would like to expand the range of interests for whom corporations are run. The logic is that companies that enjoy the privilege of incorporation should give back to the communities and environment where they are located. From the law and economics perspective, the practical result of these high-minded aspirations is to raise transaction costs by creating unpredictable grounds of liability and handicapping efficiency by adding a new set of considerations for decision-makers. These costs will ultimately be dispersed among consumers, employees, subsidizing governments, and investors.

IV. CONCLUSION The material in this chapter was designed to provide an introduction to theories of the firm and their application to the law of business organizations. There is an enormous amount of literature and debate on all of the concepts and principles canvassed. It is also important to note that there is no complete theory of the firm. Business organizations are extraordinarily complex and diverse and theories are necessarily simplified models to be used as tools of analysis. As you study the doctrinal material in the book, consider whether the relevant legal rules and standards in partnership and corporate law

11 Stephanie Ben-Ishai, “A Team Production Theory of Canadian Corporate Law” (2006) 44 Alta L Rev 299.

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• pursue the objective of wealth maximization, or whether there are other justice norms at play; • are default or immutable, and what legal and economic factors explain the choice; • are majoritarian, tailored, or penal in their nature, and the legal and economic factors explaining the choice; and • provide default governance structures that are effective at minimizing transaction costs (including agency costs). Finally, the material in this chapter is just as relevant to the practising lawyer as it is to the law and policy maker. It must be remembered that one of the key roles of a business organizations lawyer is transaction planning. All else being equal, parties to transactions prefer private ordering ex ante to litigation ex post. A transactional lawyer must be able to determine the extent to which legal rules and standards are merely default positions and, if applicable, suggest more efficient alternatives that account for transaction costs, such as bounded rationality, opportunism, and information asymmetry.

CHAPTER TEN

Corporate Governance: The Stakeholder Debate I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 621 II.  Shareholder Primacy as One Approach to the Stakeholder Debate . . . . . . . . . . . . . . . . . 622 III.  Widening the Lens to Consider Broader Stakeholder Interests . . . . . . . . . . . . . . . . . . . . . 629 IV.  Shareholder Primacy Narrowly Cast . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 634 V.  Stakeholder Interests Are More than Part of a Mediating Hierarchy . . . . . . . . . . . . . . . . . 636 VI.  Best Interests of the Corporation Requires Considering All Stakeholder Interests . . . 637 A.  Corporate Social Responsibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 640 B.  Socially Responsible Investing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 646 VII.  The Stakeholder Debate and Corporations’ International Human Rights Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650 A.  Corporations and Human Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 651 B.  Corporate Groups and Limits on Drawing Aside the Corporate Veil to Satisfy Stakeholder Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 664 VIII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 672

I. INTRODUCTION A corporation can only act through the decisions of real people, and the broad mandate given to directors and officers to oversee and manage the business and affairs of the corporation means that these corporate officers are ultimately responsible for the actions of the corporation and its various employees who engage in productive activity on behalf of the corporation. Corporate governance is the structure by which corporate decisions are made so that capital can be raised cost-effectively, assets are used in the effective generation of wealth and with a view to sustainability of the corporation, and by which corporate decisionmakers are held accountable. There are three key issues in thinking about governance: (1) for whom is the corporation to be governed; (2) what are the respective rights and duties of corporate directors and officers in their relationships with the corporation and its shareholders, creditors, and other corporate constituencies; and (3) what rights do shareholders have to participate in governance of the corporation? This chapter addresses the first question, while Chapters 11 and 12 examine the second and third questions, respectively. Recall that Chapter 9 discussed theories of the firm, highlighting that there is a rich history of differing views on the purpose, goals, and functioning of the corporation. Within that larger theoretical framework is an important and longstanding public policy debate regarding for whom the corporation should be governed. While Canadian corporate law statutes and Supreme 621

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Court of Canada jurisprudence clearly specify that directors and officers have an obligation to act in the best interests of the corporation, the question is the extent to which directors should be concerned with the interests of stakeholders that have investments in the firm, such as equity investors, capital lenders, trade suppliers, and employees. In making decisions on behalf of the corporation, should directors be concerned with what it means for the long-term employment of employees, or for the suppliers with which the company has an ongoing trade relationship? Given the enormous growth in corporate activity, both in generating wealth and, in some instances, causing harm to communities from environmentally unsound activities, this question is important. This debate is often referred to as the corporate stakeholder debate. Shareholders are one group of stakeholders in the corporation, along with other stakeholders such as creditors, employees, suppliers, and customers. The answer to for whom should the corporation be governed depends on whether the corporation is viewed in terms of obligations to equity investors under corporate statutes or whether one adopts a more holistic conception of the corporation, in the sense that it operates in a community, complies with domestic laws in relation to a whole range of activities, and has a complex and overlapping set of relationships with its employees, customers, suppliers, banks, and the local communities in which the corporation’s offices or production facilities are located. Directors and officers have an obligation, in exercising their duties, to act honestly and in good faith with a view to the best interests of the corporation, and to exercise the care, diligence, and skill that a reasonably prudent person would exercise in comparable circumstances.1 Integral to that obligation is an understanding of what are the best interests of the corporation.

II.  SHAREHOLDER PRIMACY AS ONE APPROACH TO THE STAKEHOLDER DEBATE Adolf Berle and E Merrick Dodd, in their famous exchange in the 1930s, drew attention to the stakeholder debate.2 Both argued that corporate directors act as trustees; however, Dodd’s view was that the corporation is an economic institution that has a social service as well as a profit-making function, and that corporations should operate as “good citizens.” Berle’s view was that shifting away from a duty exclusively to shareholders, without substituting a reasonably clear alternative mandate, would grant too much discretion to management and lead to uncontrolled power that could be used irresponsibly. The stakeholder debate is not a clean choice between shareholder primacy and stakeholder interests. For more than 30 years, management theory has advanced the notion that considering non-shareholder stakeholder interests was an effective means of advancing shareholder wealth.3 Directors’ and officers’ protection of the health and safety of their

1 Canada Business Corporations Act, RSC, 1985, c C-44 [CBCA], s 122 is illustrative of similar provisions in provincial corporations statutes. 2 Adolf Berle, “Corporate Powers as Powers in Trust” (1931) 44 Harv L Rev 222; E Merrick Dodd, “For Whom are Corporate Managers Trustees?” (1932) 45 Harv L Rev 1145 at 1148; Adolf Berle, “For Whom Corporate Managers Are Trustees: A Note” (1932) Harv L Rev 1365. 3 R Edward Freeman & John McVea, “A Stakeholder Approach to Strategic Management” in Michael A Hitt, R Edward Freeman & Jeffrey S Harrison, eds, The Blackwell Handbook for Strategic Management (Oxford: Blackwell, 2006).

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employees, paying employees decent wages to assure their continued employment, and bonding suppliers to them as a means of assuring continued supply of raw materials are all viewed as effective management strategies directed toward maximizing firm wealth creation. Shareholders benefited from that wealth creation in the form of dividends. Theories of corporate management have conceptualized stakeholders as any group or individual affected by, or that can affect, the corporation’s objectives, values, and operation. Freeman & McVea suggest, for example, that corporate managers should integrate the relationships and interests of shareholders, employees, customers, suppliers, communities, and other groups in a way that ensures the long-term success of the firm.4 Fenner Stewart has reflected on the stakeholder debate between Berle and Dodd so many years ago, suggesting that Berle’s approach to shareholders and other stakeholders is often taken out of context:

Fenner Stewart, “Berle’s Conception of Shareholder Primacy: A Forgotten Perspective for Reconsideration During the Rise of Finance” (2015) 34 Seattle UL Review (footnotes omitted) Berle advocated for shareholder control of the corporation, but he wanted to change who populated the shareholder class. According to his article, if he had his way, the deserving “staff of the plant” would replace the undeserving exploiter – gambler shareholders. That said, he did see a place in the shareholder class for manager – investor shareholders who, although rare, were of value to the corporation. He wrote: The legitimate side to the operation of traditional shareholders in corporate governance lies in the fact that these stockholders have a power of management … . As matter of plain fact however they usually do not manage … [but a] small group do manage and earn much of what they receive. In summary, Berle not only advocated for keeping the corporate structure of the business organization, but also for repopulating the shareholder class. He wanted to remove those shareholders who merely bought, hoped, held, and cashed in “when they [could] reap where they did not sow.” These shareholders did not deserve more than “the current rate of interest” because “the value of their management was nil.” Berle concluded that his argument was: No … attack on private property; on the contrary, it [was] the emphasis of the strength of property. It was not a blow at our settled economic institutions; it was the sane use of them. After this article, Berle shifted his position slightly. He began to focus on how the American economy was evolving. He witnessed the greater dispersion of share ownership out of the hands of business elites and into the hands of the middle and working classes. Berle viewed this transfer of power as a positive development, which could achieve the same ends as his previously devised scheme: the democratization of economic power. To his disappointment, the legal community was compensating for this change in ownership by advocating for less shareholder control and more managerial control over the corporation. Berle thought that this advocacy of managerialism would compromise this transfer of power. In his more personal and candid writings, he revealed that these concerns motivated him to promote shareholder primacy. 4 Ibid at 192.

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Berle envisioned how an empowered shareholder class, with its expanded working- and middle-class membership, could transform American society … . Berle became convinced that the key to unlocking the potential of the corporation as a tool of economic revolution was to firmly establish the property and fiduciary rights of shareholders within the governance mechanism. This governance mechanism would be a safeguard against the action of powerful elite interests that would want to counteract the threats of the egalitarian operation of the corporation. … Berle’s theory of the Corporate Liberal Revolution is significant to understand because it makes clear that his motivation for endorsing shareholder primacy was to shape the corporation to be a tool to democratize the American economy. Understanding this motivation helps one appreciate Berle’s later shift away from shareholder primacy toward other strategies to bring economic power under democratic controls. Shareholder primacy was not an end for Berle, it was merely a means to an end … . Confident in the direction the market was moving, Berle constructed arguments based on property rights, justifying shareholder authority over corporate management. Each article followed a similar logic: the corporation was the private property of its shareholders, and because managers had a fiduciary relationship with these owners, managers owed a duty of care to owners. This relationship was captured in law by contract and, as Berle noted in later works, by equity as well. Each article noted how corporate management was granted discretion over the administration of shareholder rights, which prima facie appeared quite broad. But each area of discretion was held in check by a broad interpretation of shareholder rights, and thus the range of managerial choice that actually existed was more restricted than an observer might have assumed. •  •  •

Dodd’s Response to Berle: For Whom Are Corporate Managers Trustees? Both authors had different views on to whom duties should be owed. Dodd argued that the managers’ duty ought to be extended to other stakeholders. From his perspective, managers were granted many freedoms, whether through law or factual circumstance, to conduct business in a manner that would not necessarily maximize profits. Dodd observed that this freedom appeared to have agitated Berle to place undue emphasis on the fiduciary relationship between managers and shareholders. Dodd’s assumption regarding Berle’s motivations was incorrect, even at face value: Berle was clearly attempting to prevent managerial opportunism. In other words, he wanted to bring managerial discretion under legal control, not line shareholders’ pockets regardless of the consequences. •  •  •

Although the sole function of the corporation was still profit-making, Dodd’s perspective was jamming a wedge between ownership and control, aligning managerial discretion with the best interests of the corporation rather than the shareholders. This opened a debate as to what was in the best interests of the corporation. Such ambiguity was what Berle was attempting to eradicate, so as to limit managerial opportunism—at least in the interim. Dodd hoped that if this theoretical tweak were accepted, it would free management enough to take into consideration the interests of other stakeholders, even at the expense of maximizing profits.

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Dodd was aware that he was placing power into the hands of management. He argued for placing faith in management rather than shareholders to guide the corporation, asserting that the fiduciary relationship, as Berle conceived it, would create a serious obstacle to achieving socially responsible managers. He suggested that one must look to the managers, not to the owners, for professionalized corporate conduct, for it was “hardly thinkable” that absentee owners, who have little or no contact with their business other than collecting a dividend, would be filled “with a professional spirit of public service.” Moreover, if corporate managers had a duty solely to shareholders, all other stakeholders with a vested interest in the corporation (including employees, consumers, and the community) would have to find protection from corporate power when their interests were contrary to maximizing profits for shareholders. Therefore, to promote socially responsible behavior, corporate managers needed to be the guardians of all interests that the corporation affected, and this result could only happen if corporate managers were freed to be able to employ the corporation’s “funds in a manner appropriate to a person practicing a profession and imbued with a sense of social responsibility without thereby being guilty of a breach of trust.” If freed from the constraints of a shareholder primacy agenda, why would managers use this broad discretion for the betterment of the community when they could use it to enrich themselves instead? Dodd acknowledged the problem of opportunism and then stated that it was not the concern of his article to question “whether the voluntary acceptance of social responsibility by corporate managers was workable, but whether experiences in that direction ran counter to fundamental principles of the law of business corporations. The following case is a classic statement regarding the purpose for which a corporation is to be managed.

Dodge v Ford Motor Company 204 Mich 459, 170 NW 668 (1919) [This lawsuit was commenced to compel the declaration and payment of dividends by, and to enjoin the expansion of the physical facilities of, the defendant Ford Motor Company. The plaintiffs, brothers John F. and Horace B. Dodge, owned 10 percent of the shares of Ford Motor. The defendant Henry Ford owned 58 percent of the shares and was de facto in sole control of the management of the corporation. The corporation was formed in 1903 and was highly successful. By 1916, when the suit was brought, it had a paid-up capital of $2 million, on which a regular dividend of 60 percent per annum had consistently been paid. Special dividends amounting to several million dollars per year were also paid through 1915. In the summer of 1916, Henry Ford announced that no further special dividends would be paid and that the company’s retained earnings would henceforth be used exclusively to finance expansion of the business. At July 31, 1916, the company had cash and marketable securities on hand of about $54 million and retained earnings of about $112 million, of which some $60 million had been earned in the year just ended. The trial court ordered that approximately two-fifths of the cash on hand be

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paid out as a special dividend and enjoined the defendants from carrying out their expansion plans. The defendants appealed to the Supreme Court of Michigan.] OSTRANDER J (Steere, Fellows, Stone, and Brooke JJ concurring):

When plaintiffs made their complaint and demand for further dividends, the Ford Motor Company had concluded its most prosperous year of business. The demand for its cars at the price of the preceding year continued. It could make and could market in the year beginning August 1, 1916, more than 500,000 cars. Sales of parts and repairs would necessarily increase. The cost of materials was likely to advance, and perhaps the price of labor; but it reasonably might have expected a profit for the year of upwards of $60,000,000. It had assets of more than $132,000,000, a surplus of almost $112,000,000, and its cash on hand and municipal bonds were nearly $54,000,000. Its total liabilities, including capital stock, was a little over $20,000,000. It had declared no special dividend during the business year except the October, 1915, dividend. It had been the practice, under similar circumstances, to declare larger dividends. Considering only these facts, a refusal to declare and pay further dividends appears to be not an exercise of discretion on the part of the directors, but an arbitrary refusal to do what the circumstances required to be done. These facts and others call upon the directors to justify their action, or failure or refusal to act. In justification, the defendants have offered testimony tending to prove, and which does prove, the following facts: It had been the policy of the corporation for a considerable time to annually reduce the selling price of cars, while keeping up, or improving, their quality. As early as in June, 1915, a general plan for the expansion of the productive capacity of the concern by a practical duplication of its plant had been talked over by the executive officers and directors and agreed upon: not all of the details having been settled, and no formal action of directors having been taken. The erection of a smelter was considered, and engineering and other data in connection therewith secured. In consequence, it was determined not to reduce the selling price of cars for the year beginning August 1, 1915, but to maintain the price and to accumulate a large surplus to pay for the proposed expansion of plant and equipment, and perhaps to build a plant for smelting ore. It is hoped, by Mr. Ford, that eventually 1,000,000 cars will be annually produced. The contemplated changes will permit the increased output. •  •  •

Mr. Henry Ford is the dominant force in the business of the Ford Motor Company. No plan of operations could be adopted unless he consented, and no board of directors can be elected whom he does not favor. One of the directors of the company has no stock. One share was assigned to him to qualify him for the position, but it is not claimed that he owns it. A business, one of the largest in the world, and one of the most profitable, has been built up. It employs many men, at good pay. [Said Mr. Ford:] My ambition is to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this we are putting the greatest share of our profits back in the business. With regard to dividends, the company paid sixty per cent on its capitalization of two million dollars, or $1,200,000, leaving $58,000,000 to reinvest for the growth of the company. This is Mr. Ford’s policy at present, and it is understood that the other stockholders cheerfully accede to this plan.

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He had made up his mind in the summer of 1916 that no dividends other than the regular dividends should be paid, “for the present.” Q.  For how long? Had you fixed in your mind any time in the future, when you were going to pay—  A.  No. Q.  That was indefinite in the future?  A.  That was indefinite; yes, sir.

The record, and especially the testimony of Mr. Ford, convinces that he has to some extent the attitude towards shareholders of one who has dispensed and distributed to them large gains and that they should be content to take what he chooses to give. His testimony creates the impression, also, that he thinks the Ford Motor Company has made too much money, has had too large profits, and that, although large profits might be still earned, a sharing of them with the public, by reducing the price of the output of the company, ought to be undertaken. We have no doubt that certain sentiments, philanthropic and altruistic, creditable to Mr. Ford, had large influence in determining the policy to be pursued by the Ford Motor Company—the policy which has been herein referred to. •  •  •

There is committed to the discretion of directors, a discretion to be exercised in good faith, the infinite details of business, including the wages which shall be paid to employees, the number of hours they shall work, the conditions under which labor shall be carried on, and the price for which products shall be offered to the public. It is said by appellants that the motives of the board members are not material and will not be inquired into by the court so long as their acts are within their lawful powers. As we have pointed out, and the proposition does not require argument to sustain it, it is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary purpose of benefiting others, and no one will contend that, if the avowed purpose of the defendant directors was to sacrifice the interests of shareholders, it would not be the duty of the courts to interfere. We are not, however, persuaded that we should interfere with the proposed expansion of the business of the Ford Motor Company. In view of the fact that the selling price of products may be increased at any time, the ultimate results of the larger business cannot be certainly estimated. The judges are not business experts. It is recognized that plans must often be made for a long future, for expected competition, for a continuing as well as an immediately profitable venture. The experience of the Ford Motor Company is evidence of capable management of its affairs. It may be noticed, incidentally, that it took from the public the money required for the execution of its plan, and that the very considerable salaries paid to Mr. Ford and to certain executive officers and employees were not diminished. We are not satisfied that the alleged motives of the directors, in so far as they are reflected in the conduct of the business, menace the interests of shareholders. It is enough to say, perhaps, that the court of equity is at all times open to complaining shareholders having a just grievance. Assuming the general plan and policy of expansion and the details of it to have been sufficiently, formally, approved at the October and November, 1917, meetings of directors, and assuming further that the plan and policy and the details agreed upon were for the best ultimate interest of the company and therefore of its shareholders, what does it amount to

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in justification of a refusal to declare and pay a special dividend or dividends? The Ford Motor Company was able to estimate with nicety its income and profit. It could sell more cars than it could make. Having ascertained what it would cost to produce a car and to sell it, the profit upon each car depended upon the selling price. That being fixed, the yearly income and profit was determinable, and, within slight variations, was certain. •  •  •

[W]e do not ignore, but recognize, the validity of the proposition that plaintiffs have from the beginning profited by, if they have not lately, officially, participated in, the general policy of expansion pursued by this corporation. We do not lose sight of the fact that it had been, upon an occasion, agreeable to the plaintiffs to increase the capital stock to $100,000,000 by a stock dividend of $98,000,000. These things go only to answer other contentions now made by plaintiffs, and do not and cannot operate to estop them to demand proper dividends upon the stock they own. It is obvious that an annual dividend of 60 per cent. upon $2,000,000, or $1,200,000, is the equivalent of a very small dividend upon $100,000,000, or more. The decree of the court below fixing and determining the specific amount to be distributed to stockholders is affirmed. In other respects, except as to the allowance of costs, the said decree is reversed. Plaintiffs will recover interest at 5 per cent. per annum upon their proportional share of said dividend from the date of the decree of the lower court. Appellants will tax the costs of their appeal, and two-thirds of the amount thereof will be paid by plaintiffs. No other costs are allowed. According to the evidence, the market for automobiles in 1919 was not competitive; Ford Motor Company was not a price-taker, forced to sell at average cost so as to eliminate economic profits. Instead, it could set its own prices, and in fact chose to sell its cars at $360 each when it could have sold all of them at $440 each. If the competitive price of the cars had been $360, the exercise in corporate altruism (were it that) would have had the effect of transferring monopolistic profits from shareholders to customers in the same way that it would have happened in competitive markets. On the other hand, it might be argued that pricing at less than the traffic would bear was a sophisticated strategy by an oligopolist to drive competitors out of business or prevent their entry into the market. Some scholars, such as Lynne Stout, have suggested that Dodge v Ford Motor Company was wrongly decided, particularly the court’s finding that a corporation is primarily organized for the profit of shareholders.5 She argues that Dodge v Ford is best viewed as a case that deals not with directors’ duties to maximize shareholder wealth but with controlling shareholders’ duties not to oppress minority shareholders. QUESTIONS

1.  Would the case have been decided differently without Henry Ford’s testimony that the corporation would not declare anything other than regular dividends for the indefinite future?

5 Lynne Stout, “Why We Should Stop Teaching Dodge v Ford” (2008) 3:1 Va L & Bus Rev 164, online: .

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2.  Would the case have been differently decided if the goals had been solely distributive—that is, making cars more accessible for consumers, rather than an expansion of operations?

III.  WIDENING THE LENS TO CONSIDER BROADER STAKEHOLDER INTERESTS In Canada, directors owe their duties to the company. There are some judicial dicta that indicate a broader consideration of various stakeholder interests could form part of directors’ fiduciary duties. In Teck Corporation Limited v Millar (1972), 33 DLR (3d) 288 (BCSC), a case involving management’s defensive tactics to a takeover bid, Berger J stated at 314: If today the directors of a company were to consider the interests of its employees, no one would argue that in doing so they were not acting bona fide in the interests of the company itself. Similarly, if the directors were to consider the consequences to the community of any policy that the company intended to pursue, and were deflected in their commitment to that policy as a result, it could not be said that they had not considered bona fide the interests of the shareholders. I appreciate that it would be a breach of their duty for directors to disregard entirely the interests of a company’s shareholders in order to confer a benefit on its employees: Parke v. Daily News Ltd. … But if they observe a decent respect for other interests lying beyond those of the company’s shareholders in a strict sense, that will not, in my view, leave directors open to the charge that they have failed in their fiduciary duty to the company.

The Supreme Court of Canada cited Teck Corp v Millar with approval in Peoples Department Stores Inc (Trustee of) v Wise, 2004 SCC 68, [2004] 3 SCR 461. Takeovers are discussed at length in Chapter 15: see also the discussion of fiduciary obligation in BCE Inc v 1976 Debentureholders, 2008 SCC 69, [2008] 3 SCR 560, discussed at length in Chapters 13 and 15, which has affirmed the permissibility of directors considering broader stakeholder interests in exercising their fiduciary duties. Some parts of the judgment seem to suggest that directors are obligated to consider such interests in some circumstances. Recognition of stakeholders also means considering the composition and role of the corporate board of directors. Consider the excerpt below in terms of how governance of the corporation could be enhanced.

Kent Greenfield, The Third Way: Beyond Shareholder or Board Primacy (2015) 37 Seattle UL Rev 749-73 The second specific regulatory change I propose would be to change the actual structure of company boards to allow for the nomination and election of board members who embody or can credibly speak for the interests of stakeholders. Currently, the board of U.S. companies embodies the interests of two groups: senior management and large shareholders. Once we recognize that a variety of stakeholders make essential contributions to the firm, we must face the reality that the current structure does not serve most of those stakeholders well. The way to change this is to require boards to reflect a broader cross section of those who contribute to their companies’ success.

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How to do this? Figuring out which stakeholders deserve representation and how much they deserve would undoubtedly be tricky. But it need not be impossible. Employee representatives would be fairly straightforward to elect—either we could use the German model, in which employee representatives are selected by the company workforce, or we could simply issue each employee one share of a special class of stock and have a number of board seats elected by that class. If we wanted other stakeholders represented, there are various ways it could be done. Community leaders in the localities where the company has a major presence could nominate a director; long-term business partners and creditors could be represented as well. We could even draw on the Dutch experience and require companies to include a “public interest director,” whose special obligation would be to vet company decisions from the standpoint of the public. •  •  •

In comparison, changes in corporate fiduciary duties and the makeup of the board would mean that the allocation of the financial surplus created by successful corporations is likely to be fairer to all concerned. Because the allocation of corporate surplus is one of the most important decisions for boards and senior management, a change in their duties and their composition is bound to make a difference. Moreover, executives presently receive the compensation they do in part because directors and executives are members of what amounts to a private club of financial elites, all of whom look after one another. Adding fiduciary duties to interests outside the group will diminish this tendency, and the inclusion of employee representatives and other stakeholder advocates at the board level will make such “insiderism” transparent and less pervasive. This improvement in the initial allocation of wealth is bound to be more efficient in lessening inequality than having government redistribute wealth after the fact. Fairness in the initial distribution will cause less resentment than post hoc redistribution using the tax system. Further, employees receiving a fair wage will reciprocate good will toward their employers, increasing productivity and decreasing the need for strict monitoring. These effects do not exist with a regimen of government redistribution. In comparison to increases in the minimum wage, a stake- holder-oriented corporate governance system would benefit stakeholders up and down the economic hierarchy and earlier in the wealth creation process. B.  Better Decision Making Through Pluralism The benefit of requiring corporations to take into account the interests of a broader range of stakeholders in corporate decision making is that the quality of the decisions themselves will improve. To be sure, group decision making is thought to be a significant reason for the success of corporations as a business form, in part because of a group’s ability to improve on the decision making of individuals by exposing and mitigating bias and mistake. These benefits, however, can vanish and, indeed, transform into costs if the group reinforces bias and submerges mistakes, worsening irrationalities. Group decision makers that are homogeneous in perspective, experience, and values fall easily into “groupthink”— a label attached to mistakes made by institutional decision makers when the presence of similarly thinking participants in a group results in biases being reinforced rather than challenged and mistakes validated rather than exposed. •  •  •

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Including broader stakeholder concerns at the senior level of corporate decision making will help roll back the pervasive short-termism of corporations. Stakeholders in general, and employees and communities in particular, know their interests are not well served by prioritizing the short-term. They hope to have their jobs and their neighborhoods for more than a year; they are unwilling to assume away risk when they are the ones who would bear the costs if those risks play out. A more technical way of describing this is that there is less moral hazard with boards that include a diversity of interests. A less technical way of describing this is that people don’t play with fire when it’s their own house that will burn. In modern Canadian and international business law and practice, there has been a shift to a broader concern for stakeholders, even for organizations that support the priority of shareholders’ interests. One example is the International Corporate Governance Network (ICGN), an investor-led organisation of governance professionals that promotes “effective standards of corporate governance to advance efficient markets and economies.”6 ICGN’s principles for good governance suggest: Sustainability implies that the company must manage effectively the governance, social and environmental aspects of its activities as well as financial operations. In doing so, companies should aspire to meet the cost of capital invested and generate a return over and above such capital. This sustainability is achievable if the focus on economic returns and strategic planning includes the effective management of company relationships with stakeholders such as employees, suppliers, customers, local communities and the environment as a whole.7

While still advocating a shareholder primacy view, the ICGN principles specify: “The board of directors should act on an informed basis and in the best interests of the company with good faith, care and diligence, for the benefit of shareholders, while having regard to relevant stakeholders.”8 More evidence of the shift to considering stakeholder interests is in respect of the growing role of international non-profit advocacy organizations. For example, the Coalition for Environmentally Responsible Economies (CERES) is a non-profit organization advocating for sustainability leadership through a network of investors, companies, and public interest groups interested in accelerating and expanding the adoption of sustainable business practices to build a healthy global economy.9 In 2010, it published the Ceres Roadmap for Sustainability, 20 expectations in the areas of governance, stakeholder engagement, disclosure, and performance that companies should seek to meet by 2020 in order to transform into truly sustainable

6 International Corporate Governance Network [ICGN], “Global Corporate Governance Principles,” online: at 3. See also Janis Sarra, “Convergence Versus Divergence: Global Corporate Governance at the Crossroads—Governance Norms, Capital Markets & OECD Principles for Corporate Governance” (2001) 33 Ottawa L Rev 177 at 208. 7 ICGN, supra note 6 at 5. 8 Ibid at 6. 9 Online: CERES .

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enterprises.10 It recognizes that business impacts of wide-ranging environmental and social threats are significant and cannot be ignored, and recommends that companies regularly engage in robust dialogue with stakeholders across the entire value chain, integrating stakeholder feedback into strategic planning and operational decision-making. It calls on corporations to systematically identify a diverse group of stakeholders and regularly engage with them in a manner that is formalized, ongoing, in-depth, timely, and involves all appropriate parts of the business; disclose how they are incorporating stakeholder input into corporate strategy and business decision-making; and demonstrate that they will collaborate within and across sectors and civil society to innovate, scale, and open source sustainability solutions. This notion of considering stakeholder interest within a shareholder primacy model is reflected in company law developments in the United Kingdom. The UK Companies Act 2006, c 46 introduced the concept of “enlightened shareholder value” (ESV). Section 172 of the Act defines the fiduciary duties of directors: 172(1)  A director … must act … in good faith … to promote the success of the company for the benefit of its members as a whole, and in doing so have regard to (a) the likely consequences of any decision in the long term, (b) the interest of the company’s employees, (c) the need to foster the company’s business relationships with suppliers, customers and others, (d) the impact of the company’s operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company.

Hence the Companies Act still places emphasis on shareholders, called “members” in the United Kingdom, but suggests that corporations should pursue shareholder wealth with a longer-term orientation that seeks sustainable growth and profits based on attention to the full range of relevant stakeholder interests. Ultimately, shareholders still have the power to appoint directors, but by requiring corporations to consider these other interests, it tempers the pressure for short-term returns.11 Cynthia Williams and John Conley have suggested that ESV shifts the focus of corporations to longer-term interests of extended stakeholder constituencies.12 However, Andrew Keay has observed that an obstacle to ESV moving to a true stakeholder approach is the fact that no stakeholder, other than a shareholder, has the right to enforce any breach by the directors of s 172.13 10 Online: CERES . 11 See David Millon, “Enlightened Shareholder Value, Social Responsibility, and the Redefinition of Corporate Purpose Without Law” (June 2010), online: ; Gordon Clark & Eric Knight, “Implications of the UK Companies Act 2006 for Institutional Investors and the Market for Corporate Social Responsibility” (2009) 11 U Pa J Bus & Employment L 1; see also Janis Sarra, “Oversight, Hindsight, and Foresight: Canadian Corporate Governance through the Lens of Global Capital Markets” in Janis Sarra, ed, Corporate Governance in Global Capital Markets (Vancouver: UBC Press, 2003). 12 Cynthia Williams & John Conley, “An Emerging Third Way? The Erosion of the Anglo-American Shareholder Value Construct” (2005) 38 Cornell Intl LJ 493 at 495, 499-523. 13 Andrew Keay, The Enlightened Shareholder Value Principle and Corporate Governance (Oxford: Routledge, 2013) at 210.

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As we will see in Chapter 12, there has been a concerted move in both corporate and securities law in Canada in the past decade to increase shareholder participation in the corporation. There has also been a global call for socially responsible investment, as discussed below in Section VI.B. Kent Greenfield’s vision of the corporation as a public corporation, rather than purely private interests, suggests that a corporation’s wealth should be shared fairly among all the stakeholders who contribute to its creation, and participatory, democratic corporate governance is the best way to ensure the sustainable creation and equitable distribution of corporate wealth.14 Lawrence Mitchell has also suggested that directors act in good faith, taking all stakeholder interests into account, arguing that shareholders will still enjoy a positive return on their investment.15 The nature of the public corporation as it was described by Adolf Berle and Gardiner Means16 consists of managers controlling corporations in which they have little or no ownership interest and are subject to little or no control by the large and dispersed group of shareholders. This lack of control over managers by shareholders, or shareholder passivity, was later explained as “rational shareholder apathy.” Shareholder apathy is rational where there is a large and dispersed group of shareholders, because their individual small stakes in the corporation make the gains from monitoring the managers small relative to the costs. Further, the rational shareholder would rather “free ride” on the monitoring efforts of others, receiving the benefits of monitoring without incurring the costs. Different visions of corporate governance and the stakeholder debate are driven by different normative conceptions of the role of the state in intervening in the business and affairs of the corporation, and by different normative views of any public responsibility that corporations should have to different stakeholders that have an interest in its activities. The following comment reflects on these different views.

Robert Yalden, “Competing Theories of the Corporation and Their Role in Canadian Business Law” in A Anand & B Flanagan, eds, The Corporation in the 21st Century (Kingston, Ont: Queen’s Annual Business Law Symposium, 2003) at 2 If one stands back and looks at the parameters of this debate, one cannot help but be struck by the fact that each side starts from a very different set of assumptions about whose interests most need protection. If these perspectives are to avoid simply talking past each other, then we need to develop a richer understanding of the theory of the firm that each is starting from and the extent to which our business law framework already reflects ideas fundamental to one or more of these competing theories. Only if we get a

14 Kent Greenfield, “New Principles for Corporate Law” (2005) 1 Hastings Bus LJ 87. 15 Lawrence Mitchell, “The Board as a Path Toward Corporate Social Responsibility” in Doreen McBarnet, Aurora Voiculescu & Tom Campbell, eds, The New Corporation Accountability: Corporation Social Responsibility and the Law (Cambridge: Cambridge University Press, 2007) at 537. 16 Adolf Berle & Gardiner Means, The Modern Corporation and Private Property, revised ed (New York: Harcourt Brace & World, 1967).

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clearer sense of the assumptions underlying these perspectives, as well as of the extent to which public policy choices that shape our business law reflect assumptions of this kind, can we then hope to move forward toward both a shared understanding of those choices and a genuinely fruitful debate about the choices that need to be made in the future.

IV.  SHAREHOLDER PRIMACY NARROWLY CAST Recall from Chapter 9 that one theory of the corporation is the firm as a nexus of contractual relationships,17 those scholars advancing the argument that markets and private contractual relations should govern the corporation, as opposed to public regulation, which should be facilitating only. Under this model, shareholders are given primacy as the residual claimants to the corporation’s assets and as the parties that are least able, according to the theory’s proponents, to contract to protect their inputs into the corporation.18 As early as Adam Smith, economic theory has suggested that the fundamental purpose of the corporation should be to maximize the wealth of its shareholders, which in turn will increase the wealth of society.19 Some scholars have argued for a much narrower conception of shareholder primacy. Eugene Fama and Michael Jensen have argued that shareholders should be the beneficiaries of corporate activity because they are better able to bear risk of loss than workers or managers of the firm.20 In many cases, particularly for publicly traded companies, shareholders can exit the firm easily, they can sell their shares. They can also diversify their investment portfolios to minimize risk. Fama & Jensen also note that as residual risk bearers, shareholders have the greatest incentive to monitor managers, as shareholders profit when the corporation is well managed and they risk losses when it flounders. Henry Hansmann and Reinier Kraakman have also argued that managers should manage the corporation in the best interests of its shareholders; that ultimate control over the corporation should rest with the shareholder class; and that other corporate stakeholders such as creditors and employees should have their interests protected through private contractual relations.21 The difficulty with this argument is that often non-shareholding stakeholders do not have the economic bargaining power to secure fair contracts, and in the case of employees, they are often unable to diversify their risk or easily move to other employment. Hansmann & Kraakman answer this concern by suggesting that there can be regulatory means of protecting such stakeholders where society chooses to do so. Similarly, they argue that non-controlling shareholders should receive strong protection from the exploitation of controlling shareholders.

17 See Frank Easterbrook & Daniel Fischel, The Economic Structure of Corporate Law (Cambridge, Mass: Harvard University Press, 1991) at 15. 18 See JR Macey & GP Miller, “Corporate Stakeholders: A Contractual Perspective” (1993) 43 UTLJ 401 at 423. 19 Adam Smith, Causes of the Wealth of Nations (1776). 20 Eugene F Fama & Michael C Jensen, “Separation of Ownership and Control” (1983) 26:2 JL & Econ 301; see also Michael Jensen, “Value Maximization, Stakeholder Theory, and the Corporate Objective Function” (2001) 22:1 J Applied Corp Fin 32. 21 Henry Hansmann & Reinier Kraakman, “The End of History for Corporate Law” (2001) 89 Geo LJ 439 at 440-42.

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However, the shareholder primacy approach often results in corporations externalizing particular costs of corporate activity, such as environmental or consumer harms, because the corporation may not be held accountable for such harmful activities.22 Frank Easterbrook and Daniel Fischel describe the shareholder primacy norm in the following way: Yet voting rights are universally held by shareholders, to the exclusion of creditors, managers, and other employees. … The reason is that shareholders are the residual claimants to the firm’s income. Creditors have fixed claims, and employees generally negotiate compensation schedules in advance of good performance. The gains and losses from abnormally good or bad performance are the lot of shareholders, whose claims stand last in line. As the residual claimants, the shareholders have the appropriate incentives (collective choice problems notwithstanding) to make discretionary decisions.23

Under the nexus of contractual relations theory of the corporation, managers are agents of the corporation. Shareholders, as the residual claimants, need to control the agency costs of managerial self-dealing or shirking, since increased agency costs detract from return to shareholders. Although this approach to corporate law has the advantage of creating a simple paradigm, it fails to take account of other stakeholders who are equally unable to fully contract their relationship with the firm and who, depending on the firm’s solvency, may be the residual claimholders rather than the shareholders. Contractarian theorists have expressly refuted any need for corporate officers to act in the interests of parties other than shareholders.

Daniel Fischel, “The Corporate Governance Movement” (1982) 35 Vand L Rev 1259 at 1273 Those who argued that corporations have a social responsibility and, therefore, that managers have the right, and perhaps the duty, to consider the impact of their decisions on the public interest assume that corporations are capable of having social or moral obligations. This is a fundamental error. A corporation … is nothing more than a legal fiction that serves as a nexus for a mass of contracts which various individuals have voluntarily entered into for their mutual benefit. Since it is a legal fiction, a corporation is incapable of having social or moral obligations much in the same way that inanimate objects are incapable of having these obligations. Only people can have moral obligations or social responsibilities, and only people bear the costs of non-wealth-maximizing behaviour.

22 Janis Sarra, “Oversight, Hindsight, and Foresight: Canadian Corporate Governance through the Lens of Global Capital Markets” in Janis Sarra, ed, Corporate Governance in Global Capital Markets (Vancouver: UBC Press, 2003) at 42. 23 Frank Easterbrook & Daniel Fischel, The Economic Structure of Corporate Law (Cambridge, Mass: Harvard University Press, 1991) at 68.

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Under the nexus of contractual relations theory, the role of directors and officers is to maximize the wealth of shareholders. This approach does not align well with the notion in our corporate law framework that directors have an obligation to act in the best interests of the corporation as a whole.

V.  STAKEHOLDER INTERESTS ARE MORE THAN PART OF A MEDIATING HIERARCHY Recall from Chapter 9 that Margaret Blair and Lynn Stout developed the team production theory of the corporation, which suggests that the scope of beneficiaries is broader than shareholders. They view the corporation as a team that includes managers, shareholders, employees, and creditors who pool their resources to produce goods or services for mutual gain. Under this model, corporate officers are a “mediating hierarch” in advancing the productive activities and interests of team members. With respect to the stakeholder debate, they suggest the following.

Margaret M Blair & Lynn A Stout, “A Team Production Theory of Corporate Law” (1999) 85 Va L Rev 247 at 285 Thus, the primary job of the board of directors of a public corporation is not to act as agents who ruthlessly pursue shareholders’ interests at the expense of employees, creditors, or other team members. Rather, the directors are trustees for the corporation itself—mediating hierarchs whose job is to balance team members’ competing interests in a fashion that keeps everyone happy enough that the productive coalition stays together. The notion of a mediating hierarchy attempts to take account of multiple parties to the corporate relationship and to recognize the needs and interests of parties other than shareholders. Critiques of team production theory have suggested that under the theory, the allocation of the surplus is a matter of power, as participants compete to strike the best bargain with the board of directors; hence parties that are already vulnerable are likely to continue to be vulnerable to any misconduct by corporate officers. Kellye Testy has observed that corporate law has a substantive job, rather than only enabling private bargaining; it should support stakeholders over shareholders:

Kellye Testy, “Capitalism and Freedom: For Whom? Feminist Legal Theory and Progressive Corporate Law” (2004) 67 Law & Contemp Probs 87 at 100 The first is a challenge to shareholder primacy and an argument that corporate decision making should consider a wider array of constituents without the hierarchy of the shareholder primacy model. The second is a critique of the shortcomings of existing fiduciary

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duty law, and an argument that feminist insights into concepts of care and connection can and should give increased substantive context to director and officer duties. The third argument is more wide ranging, but through different tacks is at its core a critique of concentrations of undemocratic corporate power together with an argument that to the extent that power works hardships on individuals in society, those hardships fall disproportionately on women (especially third-world women).

VI.  BEST INTERESTS OF THE CORPORATION REQUIRES CONSIDERING ALL STAKEHOLDER INTERESTS

Kent Greenfield, “The Third Way: Beyond Shareholder or Board Primacy” (2015) 37 Seattle UL Rev 749-73 [T]here is more openness to revisiting the core questions about what corporations are, to whom they owe obligations, and how best to conceptualize them and their regulation than at any time in a generation. This moment has been engendered because of the increasing skepticism the public is showing toward corporations and the people who manage them. The skepticism springs from shocks in the economic and political fields that revealed the risks of unbridled corporate power, short-termism, managerial opportunism, and shareholder (read Wall Street) supremacy. •  •  •

Managerial obligation could be increased without the obligation running solely to the holders of equity. Fiduciaries of companies could be subject to meaningful constraints and obligations, enforceable by courts, without disabling their ability to use the corporate form for economic gain. The conceptual innovation of this third way—I use “innovation,” though the idea is actually quite ancient—is for the fiduciary obligations of management to run to the firm as a whole, which would include an obligation to take into account the interests of all those who make material investments in the firm. Within this framework, it would continue to be a violation of fiduciary duties for management to self-deal, act carelessly, or exercise something less than good faith judgment. It would also be a violation of their duties to prioritize one stakeholder over others consistently and persistently or to fail to consider the interests of all stakeholders in significant corporate decisions. •  •  •

The Global Financial Crisis of 2007 – 08 (GFC) provided that context and finally marked the end of the glory days of homo economicus. The collapse pulled back the curtain, revealing the Great Oz of the rational market behind the curtain to be a fraud, along with its subsidiary dependence on the rational actor model. If a stalwart of the rationality school, such as former Chairman of the U.S. Federal Reserve Alan Greenspan, was forced to admit that he had “found a flaw” in his theory of the free market, then few absolutists were left indeed. •  •  •

Within the Court’s reasoning was embedded a law-and-economics view of corporations as a private entity, rightly insulated from the constraints of public regulation of

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their political influence. Previously, the Court and commentators had given credence to an argument that corporations should be limited in their political activities to protect shareholders from having their resources used by management to further views inconsistent with those of shareholders. But in Citizens United, the Court argued that shareholders could protect themselves through the normal mechanisms of corporate governance. This was simply a conventional application of contractarianism. The needs of shareholders need not be considered within the First Amendment calculus because their involvement in corporations is voluntary, and they have the power to protect themselves from any encroachment of their interests. What was remarkable about Citizens United was that it used these contractarian notions found in mainstream corporate law in service of an effort to expand corporate prerogatives in constitutional law. •  •  •

A.  The Conceptual Shift What specific reforms are needed? The most crucial one, I believe, is conceptual rather than legal or political. We should cease thinking of corporations as pieces of property owned by shareholders, whose ownership in any event is recognized only in the breach. Instead, we should conceptualize businesses as team-like collective economic enterprises making use of a multitude of inputs from various kinds of investors. As I have said elsewhere, “Corporations are collective enterprises, drawing on investments from various stakeholders who contribute to the firm’s success.” The success of corporations depends on the contributions of many different stakeholders, and the governance of corporations should recognize those contributions. Fixating on the contributions of only one of these groups—shareholders—blinds us to the essential investments of the others and encourages management to prioritize shareholder interest alone. But for a business to succeed, people and institutions must invest financial capital; other people must invest labor, intelligence, skill, and attention; and local communities must invest infrastructure of various kinds. None of these investors makes its contribution out of altruism or obligation. What they are doing is contributing in hopes of potential gain if things go well. They expect management to gather inputs from other contributors, put them together in a way that will enable the company to produce goods or services for a profit, and then distribute the wealth that is created. The benefits can come in various forms—goods and services for consumers, jobs for employees, tax bases for communities, financial returns for investors. Each of the contributors has a stake in the company, and the company depends on the contributions of each stakeholder. •  •  •

The law of corporate governance should expand the fiduciary duties of management to include an obligation to consider the interests of all stakeholders in the firm. For decades, the fiduciary obligations of management have been categorized as including a duty of care and a duty of loyalty. Under current judicial interpretation in the United States, both mean something less than one might assume—“care” has essentially become the duty to gather information and avoid gross negligence; “loyalty” has devolved into a mere ban on undisclosed self-dealing, such as managers doing special deals with the company on the side.

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While it wouldn’t hurt if both of these duties were more robust with regard to shareholders, what I’m suggesting here is that they run to all the stakeholders of the company, not just shareholders. With regard to the duty of care, this would mean that when senior management or the board makes decisions on the strategic course of the company, they would need to gather and consider information on the effects of the decision on the company’s stakeholders. They would not be able to meet their obligation simply by evaluating the impact of the decision on the company balance sheet but by assessing the longterm impact of the decision on the company as a whole, including its implications for employees, consumers, and other stakeholders. As to the duty of loyalty, little would change except to whom the duty would run, meaning there would be a greater number of people interested in monitoring the possible malfeasance of management. And, by the way, if a broader duty also meant that the duties were more seriously enforced, the shareholders, too, would be happier. Admittedly, this change would be more in terms of process than in required results. But process matters, especially when we are talking about the choices of some of the most powerful group decision makers in the world. At the very least, corporate directors (and the executives who putatively report to them) would not be able to make decisions in which the only metric that matters is stock price, measured day-to-day, or even quarter-by-quarter. Besides, this broader fiduciary duty would benefit the company over time. Fiduciary obligations build trust in those who contribute because they know management has a duty to look after their interests. If management owes obligations of care and loyalty to all the firm’s important stakeholders, they are both more likely to invest in the first place and more likely to leave their investment in place over time. This has long been thought to be true of shareholders, but it is true for other kinds of “investors” as well. For example, employees who do not fear that their interests will be shoved aside any time they are in conflict with short-term profitability will be more loyal and more willing to develop firmspecific skills that benefit the company over time, and they will take less of an us-versusthem attitude toward management. Lynne Dallas suggests that the corporation should consider the interests of all stakeholders in any decision it makes; it should not be the case that for all decisions, the interests of one stakeholder group takes priority. That consideration should involve getting input from all of the affected stakeholders. Each business firm should establish procedures designed to ensure that relations among the stakeholders are governed by principles of justice that have been developed with a view to the interests of all stakeholders, and have received the endorsement of representatives of all stakeholders.24 Professor Dallas has written extensively on the stakeholder debate. Drawing on a number of sources from sociology, corporate law, and organizational theory, Dallas views existing governance structures as a function of historical, cultural, political, and economic factors, where stakeholders are all trying to position themselves for power within the corporate structure.

24 Lynne L Dallas, Law and Public Policy: A Socioeconomic Approach (Durham, NC: Carolina Academic Press, 2005) at 143.

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Lynne Dallas, “Two Models of Corporate Governance: Beyond Berle and Means” (1988) 22 U Mich JL Ref 19 at 19 and 31 Corporate governance structures persist (1) because they are demanded by those in positions of power, (2) because they have become the traditional or accepted ways of doing things, (3) because changing structures would require the adoption of values not reinforced by existing structures that tend to generate their own value system; or (4) because they are buffered from the effects of competition. Canadian business groups are frequently organized as pyramids, in that a controlling shareholder owns an apex firm, often a family firm, which in turn holds control blocks of a first tier of listed firms.25 Each of these firms holds control blocks in one or more further tier of companies, with tiers added as needed by the corporate group. Morck and Yeung observe that in the late 1990s, almost half of the assets of the top 100 listed Canadian firms belonged to firms that were part of a corporate pyramid of business entities. They observe that supervoting shares and pyramiding give blockholders control rights that vastly exceed their actual ownership.26 This insight is significant in that controlling shareholders and directors of the largest Canadian firms are highly interconnected, and they often speak with one voice in pressing governments for legislative reform in their interests. QUESTIONS

1.  What approach to corporate governance do you believe makes the most sense and why? 2.  What elements should be contained in a corporations statute to advance your vision of corporate law?

Keep these questions in mind as you read the next two parts of this chapter, which discuss corporate social responsibility and socially responsible investing.

A.  Corporate Social Responsibility Increasingly, corporations advertise their socially responsible behaviour as a means of attracting customer loyalty. Examples include “fair trade” business ethics, reduction of greenhouse gas emissions, and equitable labour policies. In some instances, the companies are making an effort to comply with broad international principles, such as United Nations declarations on human rights and transnational corporations and other business

25 See Randall Morck & Bernard Yeung, “Some Obstacles to Good Corporate Governance in Canada and How to Overcome Them,” Research Report Commissioned by the Task Force to Modernize Securities Legislation in Canada (Toronto: IDA, 2006). 26 See Morck & Yeung, ibid at 299-300.

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enterprises.27 Corporations are also responding to calls by investors to be more sustainable and socially responsible. For example, the United Nations Principles for Responsible Investment urge the integration of environmental, social, and governance concerns into investment processes and decision-making.28 There has been debate in respect of whether corporate social responsibility (CSR) is really a public relations exercise, or whether it has substantive content. “Greenwashing” is a risk; it is a term that describes the practice of corporations expending more time and money on advertising that they are concerned with the environment than on spending directed toward actual environmentally sound practices. The following excerpt is an example of this concern about CSR as a public relations ploy in the context of US corporate governance.

Cheryl Wade, “Comparisons Between Enron and Other Types of Corporate Misconduct: Compliance with Law and Ethical Decision Making as the Best Form of Public Relations” (2002) 1 Seattle J for Social Justice 97 at 105-6 In the aftermath of the September 11 attack on the United States, an ostensibly heightened sense of corporate social responsibility emerged. The chief executive officer (CEO) of Cantor Fitzgerald, one of the companies formerly located in the World Trade Center, wept while he gave a television interview describing the devastating losses suffered by his company, the employees who perished, and their families. Every New York area newspaper in the days and weeks after the attack carried full-page messages expressing profound sorrow. What purpose did this outpouring of corporate emotion serve? Did these “advertisements” comfort the public? Were the sentiments expressed sincere? Cynicism regarding the sincerity of corporate managements’ public responses to the attack seemed justified. After all, the newspaper messages, while carefully designed not to look like advertising, all contained the companies’ logos or names. Moreover, shortly after his tearful television appearance, and within two weeks after the attack, Cantor Fitzgerald’s CEO stopped salary payments and suspended medical benefits for the survivors of perished employees. The families affected by this decision responded publicly, granting television interviews complaining about the severed salaries and benefits. In the aftermath of this bad publicity, Cantor Fitzgerald’s CEO rescinded his decision to stop salaries and benefits. Whether the corporate responses were sincere or not, the nation needed to read the newspaper and billboard messages expressing sorrow and patriotism from corporate citizens. They expressed sentiments we all shared, but as individuals, few of us were able to afford to pay for such public displays of sadness and grief. Corporations, acting as agents for the flesh and blood people who compose them, had the money and the incentive

27 UN Office of the High Commissioner, Working Group on the issue of human rights and transnational corporations and other business enterprises, 2011, online: United Nations Human Rights . 28 UN Principles for Responsible Investment, Statement on Investor Obligations and Duties, online: PRI .

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to provide this public and very expensive form of mourning. The observation illustrates the very public important role played by private enterprise. Corporate reactions to the September 11 attack militate in favor of a broader theory of what corporate social responsibility should be. Contractarian goals of shareholder wealth-maximization were achieved to the extent corporate managers made the right public relations moves. The right corporate response could engender favorable public sentiment for a company, leading to long-term profits derived from loyal consumers to whom the subliminal messages were aimed. Corporate managers used the broadest of communitarian goals—the healing of a nation—to accomplish the contractarian goal of eventual long-term shareholder wealth-maximization …. Post-tragedy publicity highlighted the interconnectedness of shareholders, officers and directors on [the] one hand, and non-shareholding constituencies such as employees, suppliers, creditors, customers and the communities in which the companies do business on the other. The need for corporate social responsibility has been reflected in numerous policy statements globally. Janis Sarra has noted that the OECD Principles for Corporate Governance focus on the key themes of equitable treatment of shareholders; disclosure and transparency to enhance accountability; the relationship between the corporate and diverse stakeholders; and the responsibility of corporate boards. 29 The OECD Principles are aimed at assisting governments to improve the regulatory frameworks for corporate governance. 30 There has been a debate in Canada as well regarding the nature and extent of corporate social responsibilities that corporations should adopt, and how best to achieve any change. The following excerpt illustrates how board composition is implicated in these discussions.

Carol M Liao, “A Canadian Model of Corporate Governance” (2014) 37:2 Dalhousie Law Journal 559 at 596-600, online: (footnotes omitted) Corporate governance is in a constant state of evolution, deriving from various laws, customs, and processes, with legal, regulatory, and institutional pressures as well as issues tied specifically to particular product and service markets. It is undeniable that there are significant normative underpinnings. The exercise of outlining a Canadian model of corporate governance is a tricky one: comparative analysis can be drawn from not only

29 Janis Sarra, “Convergence Versus Divergence, Global Corporate Governance at the Crossroads: Governance Norms, Capital Markets and OECD Principles for Corporate Governance” (2001) 33 Ottawa L Rev 177 at 208. 30 Organisation for Economic Co-operation and Development, “OECD Principles for Corporate Governance” (2004 ed), online: OECD .

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theoretical definitions but real world national comparisons as well, based on a variety of selected factors. One practitioner in the study reflected on how corporate governance “is one of those things that people struggle to define,” and another noted that corporate governance “is a never-ending process … standards today are different than they were ten years ago, twenty years ago, and so on … .” Outlining a national model may be a daunting task, and part and parcel of staking a position is that it is particularly vulnerable to alternative viewpoints, exceptions, and criticisms. •  •  •

Practitioners’ views on an overall Canadian model tended to depend in large part on what each practitioner found most compelling: the constancy of the corporate statutes and trajectory of the common law, or the power and influence held by the regulators. Leaving aside change of control transactions for the moment, the building blocks of Canadian corporate law have some notable differences when compared with the academic definition of Anglo-American shareholder primacy, and common law developments have emphasized those differences. The legislation requires management to act in “best interests of the corporation” and makes available the oppression remedy, and taken with the 2004 Peoples decision and the 2008 BCE decision, practitioners tended to agree that Canada corporate law has “overtones of a broader stakeholder model.” •  •  •

The common law has made the process of considering stakeholders in the best interests of the corporation more overt, well beyond what is assumed in AngloAmerican corporate legal scholarship. Layered onto this corporate legal base, the securities commissions have provided other measures to bolster the field of corporate governance in Canada, while seeking to protect the integrity of the capital markets and the interests of investors within those markets. These efforts, along with those from other organizations, have raised and normalized governance standards, increased checks and balances, and helped to develop a stronger voice in the corporate governance movement within the last several decades. •  •  •

The way in which Canadian corporate laws have been formed by the legislature, and have been interpreted by the courts, indicates that Canada has a more flexible model of governance which incorporates the consideration of non-shareholder stakeholder interests in corporate decision making. Landmark decisions by the Supreme Court of Canada have emphasized these statutory differences, particularly in BCE, causing many practitioners to inform boards that they can—and indeed should—take into account non-shareholder value issues. Stakeholder interests may have always had a role in governance under Canadian statutory laws, but the courts have now generated a need for boards to document their process of considering those interests. The scope and limits of corporate governance continue to be actively debated. The excerpt below illustrates that allowing corporations to make normative decisions regarding society may not necessarily lead to greater social and environmental responsibility.

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andré douglas pond cummings, Steven A Ramirez & Cheryl Lyn Wade, “Toward a Critical Corporate Law Pedagogy and Scholarship” (2015) 92:2 Wash UL Rev at 408-19, online (footnotes omitted) The subprime crisis caused the most massive destruction and transfer of wealth in U.S. history. That wealth transfer—from Main Street taxpayers to Wall Street bankers, executives and investors—ultimately led to the highest recorded racial wealth gap in recent U.S. history. “By one measure, the white-to-black median wealth ratio increased from eleven to one in 2005 to twenty to one in 2009. By this same measure, the white-to-Hispanic median wealth ratio increased from seven to one in 2005 to eighteen to one in 2009.” Naturally, these devastating changes in household wealth caused by the subprime mortgage fiasco result in fewer educational opportunities, less secure retirements, less economic mobility, and a lower quality of life in minority communities. The financial crisis also spawned differential outcomes in income status. “[B]y one measure, African Americans and Hispanics as a whole were downwardly mobile and net losers in terms of their income status during the period of 2001-2011, while whites were net winners.” And, the gap between white unemployment and minority unemployment reached higher levels after the crisis than before the crisis. More Americans of color live in poverty today as a direct result. When compared to white Americans, twice as many Americans of color live in poverty. Even more troubling is the fact that 37.9 percent of African American children now live in poverty and 33.8 percent of Hispanic children live in poverty. A more economically senseless destruction of human capital is difficult to imagine. This economic inequality was no accident. Flawed corporate law, governance and policy played a major role. For example, executives were able to harvest huge gains at the expense of shareholders and the disempowered, as well as society in general. Predatory lenders targeted the most unsophisticated borrowers, who, historically, have been denied access to capital and credit, for noxious home loans. A Federal Reserve study found that predatory lenders frequently targeted less educated Americans. Another study by the Wall Street Journal found that of all subprime borrowers, 61 percent of them actually qualified for prime loans. The most nefarious of the subprime lending was concentrated largely in areas that had sizeable minority populations. The high up-front fees and interest costs associated with subprime loans accelerated executive compensation even while leading to higher borrower-default levels. Overwhelming evidence demonstrates that much of the crisis was rooted in widespread race-based subprime lending to non-subprime borrowers of color. All the while, corporations and their executives profited from this subprime lending. Take Countrywide Financial Corp., for example. Countrywide paid CEO Angelo Mozilo $102 million in 2006 and $229 million in 2007, including $127 million that Mozilo reaped from exercising stock options in 2007, the same year that Countrywide announced massive mortgage losses. The Financial Crisis Inquiry Commission (“FCIC”), a congressionally authorized commission charged with investigating the financial crisis, found that as early as 2006, Mozilo termed Countrywide’s subprime loans “poison” and “toxic,” and stated they were likely to lead to bankruptcy. Countrywide ultimately settled predatory lending claims for $8.4 billion, the largest predatory

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lending settlement in history. Meanwhile, Angelo Mozilo and others settled securities fraud claims with the Securities and Exchange Commission (“SEC”) for over $70 million—essentially for selling shares to the investing public without disclosing the “poisonous” lending at Countrywide. Mozilo, however, personally only paid $22.5 million of the settlement. The Mozilo and Countrywide fraud demonstrate the flawed legal structure of the public firm that permitted, even facilitated, the ability of CEOs and other senior executives to profit mightily from predatory and race-based lending while defrauding the public. What would have happened if corporate leadership in America embraced and reflected diversity? Could these kinds of catastrophic losses for society, communities of color, and shareholders have been averted? Recent empirical studies demonstrate that firms with diverse boards suffered fewer subprime losses during the mortgage meltdown. Still, despite evidence that meaningfully diverse boardrooms improve corporate governance and bestow significant financial benefits, the apex of corporate leadership remains a bastion of white male supremacy. •  •  •

On January 10, 2010, the United States Supreme Court rendered its decision in Citizens United v. Federal Election Commission. The Court ruled that corporations enjoy the same free speech rights as individuals, and therefore, governmental restrictions on a corporation’s political speech must survive strict scrutiny, the most demanding level of judicial review of governmental actions. More specifically, the Court held that corporations are entitled to first amendment free speech protections, and as a result, corporate money spent on political electioneering independent of a campaign cannot be limited by campaign finance restrictions. Previously, corporate funds could not be used for electioneering purposes, forcing CEOs and corporate leaders to finance politicking for their chosen candidates from their own capital (typically through Political Action Committees (“PACs”)). Now, CEOs and corporate leadership can essentially use corporate monies in an unfettered manner to campaign for and help elect the political candidates of their choice. This change in law represents a massive transfer of political power from ordinary citizens to the CEOs of the most colossal capital aggregations in the history of the world. Modern public corporations in America hold value approaching $20 trillion. One U.S. Senator stated that the Citizens United ruling has moved the U.S. toward an economic and political oligarchy whereby a small handful of “billionaire families” control the economy and political system. Another former Senator reflected upon the scale of resources available to public corporations and described the decision’s implications as “scary.” A leading election law scholar called the day the opinion was issued “a very bad day for American democracy.” CEOs’ power over the political activities of the corporation is now unlimited. Surprisingly, there is no mandatory disclosure obligation of a public firm’s political activities. There is no enforceable mandate that the CEO consider shareholder interests when deploying for political ends the extraordinary capital available to the public firm. It is virtually impossible for shareholders to hold corporate leaders accountable in this context, even if executives put their personal interests before those of the corporation and its shareholders. In order to enforce fiduciary duties owed to the corporation, a shareholder must proceed derivatively and can generally only do so upon a showing of bad faith. Indeed, state law provisions that effectively abolished the duty of care for most public

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corporations fail to provide means to hold directors accountable even when they act recklessly. These statutes typically require a showing of “conscious disregard” of duty. Thus, the Supreme Court through Citizens United expanded the power of CEOs, already insulated under statutory law, to use shareholder wealth—and to thereby coerce shareholder speech—to further management’s political goals with little or no accountability. NOTES AND QUESTIONS

1.  Considering the stakeholder debate, what do you think “best interests of the corporation” means, and is it a sufficient standard for guiding directors’ and officers’ conduct? 2.  Should there be statutory language in Canadian law that expressly allows directors and officers to consider employee and other stakeholder interests? 3.  If so, should there be enforceable remedies for those stakeholders where their interests are not taken into account? 4.  Should corporate law statutes and rules integrate environmental, labour and other public interest concerns, or should such considerations be left to separate statutes and rules? 5.  An alternative approach to having the interests of non-shareholder constituents taken into account would be to have other stakeholders represented on the board of directors, which could provide a means for non-shareholder constituents to better protect their interests.31 When you read Chapter 11, consider whether such an approach would take better account of stakeholder interests. 6.  As discussed in Chapter 8, there are new developments in respect of social enterprises, such as creation of the community contribution company in British Columbia, effective 2013, and the community interest company in Nova Scotia, 2012.32 These provincial hybrids are modelled on the community interest corporation in the United Kingdom, and are aimed at allowing entities the ability to make a profit while advancing social, environmental, or other objectives that benefit society. The Canadian government is also considering whether such a hybrid model is needed at the federal level. Do you think the governance of these social enterprises will be more responsive to broader stakeholder interests? Why or why not?

B.  Socially Responsible Investing Another approach to corporate governance is through the mechanism of socially responsible investing (SRI). Grounded somewhere between shareholder primacy and stakeholder interest, the idea is that investors start making their investment decisions in a manner that is socially responsible and that advances the long-term sustainability of the corporation. Benjamin Richardson views SRI as representing “a broad constellation of interests campaigning

31 Lynne L Dallas, “The Relational Board: Three Theories of Corporate Boards of Directors” (1996) 22 J Corp L 1. 32 See Bill 23—2012: Finance Statutes Amendment Act, 2012, online: Legislative Assembly of British Columbia ; and Service Nova Scotia and Municipal Relations, “New Opportunities for Social Entrepreneurs (28 November 2012), online: Nova Scotia Canada .

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for socially, ethically, and environmentally responsible financing.”33 However, as currently conceptualized, it has limited effect. As you read the excerpt below, consider the potential benefits and limitations of this approach.

Benjamin J Richardson & Maziar Peihani, “Universal Investors and Socially Responsible Finance: A Critique of a Premature Theory” (2015) 30 BFLR 405-55, online: In the early twenty-first century, a broader, global movement for socially responsible investing (SRI) has mushroomed and attracted interest from diverse quarters such as pension funds, banks, insurance companies and other mainstream financiers. The biggest of these institutions have been described by some commentators as “universal investors” (UIs), who supposedly possess structural qualities that sensitize them to the imperative of sustainable development (as the general purpose of SRI is often described), and have the means to discipline the market towards this goal in a manner that can complement the legal system. SRI seeks to align investments with the personal values of investors and to harness the resources and power of the financial sector to improve corporate social and environmental behaviour. SRI not only targets individual companies through divestment or shareholder activism, it also seeks systemic change through investment codes of conduct. As with the fair trade movement and the slow food campaign, SRI can be theorized as a reaction to the impacts of the economic system and the failure of states to adequately regulate them. The theory of UIs suggests that the largest and most diversified investment funds should have an intrinsic financial motivation to practice SRI. Thus, rather than SRI being just an ethical imperative for boutique investors, the emergence of UIs as the dominant actor in the financial economy suggests a way to transform SRI from niche to mainstream. The notion of “universal investor” (sometimes also known as “universal owner”) was coined in the early 2000s to denote the presence of pension funds, insurance companies and other institutional investors holding big portfolios that give them major stakes in the productive economy. The UI theory essentially holds that an institutional investor benefiting from a company that externalizes its social and environmental costs might ultimately suffer financially when these externalities adversely affect other assets in its portfolio. Therefore, UIs should have an incentive to practice SRI, such as by reducing negative externalities (e.g., pollution or corruption) and increasing positive externalities (e.g., robust corporate governance or greater social justice) across their investment portfolios. The emergence of UIs promises a beneficial transformation of the financial economy into an instrument that leverages positive change, rather than being a source of cyclical booms and busts, and speculative and unsustainable investment, as epitomized by the Global Financial Crisis (GFC) of 2008-09. •  •  •

33 Benjamin J Richardson, “Financial Markets and Socially Responsible Investing” in Beate Sjåfjell & Benjamin Richardson, eds, Company Law and Sustainability: Legal Barriers and Opportunities (Cambridge: Cambridge University Press, 2015) [Sjåfjell & Richardson] at 233.

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First, the theory is not yet an accurate description of the investment practices of UIs, in Canada or other jurisdictions. There are certainly pockets of innovation among some UIs embracing SRI, but most financial institutions appear to do so only superficially or sporadically; they might have signed relevant SRI voluntary codes, published investment policies that suggest that they “take into account” social and environmental concerns, and established SRI advisory committees or similar bodies, but they are not yet making serious and fundamental changes to the composition of their investment portfolios or their day-to-day investing practices. Thus, it is more accurate to describe the UI theory as aspirational rather than reflective of current practices or dominant trends in the financial industry. •  •  •

First, financial markets cannot readily internalize the social and environmental costs of the economy in aggregate, just as individual companies may overlook their externalities. When markets cannot understand the financial materiality of such costs, they are vulnerable to being ignored by investors. Furthermore, there are distinctions between the materiality of social and environmental issues that need to be recognized. Human rights, labour standards or public health are qualitatively different and arguably more difficult for investors to address than environmental concerns such as water scarcity or air pollution, for which there are better tools to quantify, compare and price impacts. Second, in a competitive market, institutional investors have difficulties coordinating their activities towards common altruistic purposes, such as fighting climate change. Although, ostensibly, there has pleasingly been more collaboration among UIs and other financial institutions, such as through codes of conduct for SRI, such collaboration has yet to outweigh the countervailing market pressures to act self-interestedly and for the short-term. Third, the relationship between beneficiary investors and the managers of UIs requires greater attention. The UI theory’s assumption about the growing democratic roots of financial institutions in a mass investor society overlooks how the governance and management of financial institutions has been elitist. The financial economy excludes some segments of society, and those who participate in it tend to lack a voice in fund management. Investor participation in fund management is not necessarily feasible or desirable, but its absence can, if other accountability mechanisms such as fiduciary law or regulatory oversight are not working effectively, undermine the capacity of UIs to be considerate of their societal impacts. Finally, the theory needs to conceptualize more overtly the role of law and governance in enabling or influencing the behaviour of UIs. Law shapes both the financial markets in which UIs operate and their inner governance such as relationships between trustees and beneficiaries. Fiduciary and trusts law, securities regulation, corporate governance and environmental regulation may influence how UIs consider environmental issues and often blunt their incentive to act as “universal” investors. Consequently, some law reform is crucial to realize the potential of investors to fulfill the theory’s predictions. •  •  •

Canadian pension plans, insurers and banks are adopting policies that seemingly sensitize them to the financial risks of corporate environmental performance, and they

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are implementing more sophisticated due diligence procedures to manage those risks. These financial institutions have ratified leading global SRI codes of conduct, committed to engagement and dialogue with corporate clients to promote best practices, and some are introducing niche financing to support sustainability initiatives such as clean technologies and renewable energy projects. The sheer size of these Canadian financial institutions may also have the beneficial effect of creating performance benchmarks for smaller financiers to emulate. Unfortunately, however, a smattering of discrete innovations that leave largely untouched the broader landscape of the financial and productive economy is probably not sufficient. Funding a green venture capitalist is hardly redeemable when the same institution bankrolls an oil sands project or a major gas pipeline, as commonly occurs with the examples just discussed. Canadian UIs do not provide the depth of due diligence and positive financing needed to fundamentally shift the economy towards sustainability. •  •  •

The reforms embraced by Canadian investors essentially aim for better identification and consideration of financially material ESG issues, with only limited positive financing to support a transition towards sustainability. Defensive measures to neutralize the most environmentally egregious companies are not enough; an entire economy whose prosperity is based on sustainable development is needed. •  •  •

Many Canadian financiers now support the renewable energy sector, such as by purchasing stocks of companies that make solar power equipment and wind turbines. These investors are not overtly responding to worries about global warming, but from the recognition that alternative, clean energy is becoming financially lucrative because of growing market demand. In other words, investors are calculating the financial risks and rewards of investing in clean energy because of market cues. Yet, concomitantly, there has been little divestment by mainstream financiers from the fossil fuel industry such as Alberta’s oil sands. The lag is because of uncertainty among investors regarding whether, when and how governments will intervene in the market to curb greenhouse gas emissions. •  •  •

A shift towards relationship investing in environmentally progressive businesses not only requires changing aspects of the core financial models, market norms and voluntary codes; legal reform is also desirable. Although the legal system generally does not overtly hinder SRI, it fails to consciously encourage it. The remaining legal barriers to clear are the quantitative investment portfolio restrictions on some institutions, especially insurance companies and banks, as well as outmoded regulatory restraints to the capacity of corporate securities holders to collaborate and participate in corporate governance. A positive message to stimulate the sustainability investor also needs to be legislated and developed through the courts; some progressive Supreme Court of Canada rulings on corporate directors’ duties should extend to trustees of financial institutions, as Ed Waitzer and others have argued. The propagation of corporate hybrids with a dual mission to make profits and contribute to community welfare, as recently legislated for in British Columbia following international precedents, is another welcome innovation that should be expanded in order to enlarge the pool of socially responsible businesses for investors.

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VII.  THE STAKEHOLDER DEBATE AND CORPORATIONS’ INTERNATIONAL HUMAN RIGHTS OBLIGATIONS The United Nations has worked with stakeholder organizations to develop principles of responsible investment (UNPRI).

United Nations Principles of Responsible Investment PRI We believe that an economically efficient, sustainable global financial system is a necessity for long-term value creation. Such a system will reward long-term, responsible investment and benefit the environment and society as a whole. As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognise that applying these Principles may better align investors with broader objectives of society. Therefore, where consistent with our fiduciary responsibilities, we commit to the following: Principle 1: We will incorporate ESG issues into investment analysis and decisionmaking processes. Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices. Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest. Principle 4: We will promote acceptance and implementation of the principles within the investment industry. Principle 5: We will work together to enhance our effectiveness in implementing the principles. Principle 6: We will each report on our activities and progress towards implementing the principles. See also the report by the UNPRI, “Canada Roadmap for Fiduciary Duty in the 21st Century” (January 2017), online: PRI . To date, over 1,500 signatories representing over $45 trillion in assets under management have signed the UNPRI. Implementation is voluntary and there is no enforcement mechanism. Yet signatories have an obligation to report on their responsible investment activities through the UNPRI Reporting Framework to demonstrate to stakeholders and the public how they incorporate ESG issues, understand where their organization aligns with global peers, and learn and develop annually. Benjamin Richardson and Beate Sjåfjell have observed that voluntary codes of conduct pose significant barriers to socially responsible investing contributing to governance in a meaningful

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way.34 Disclosures are not sufficient to induce effective environmental governance, and standards for effective decision processes rarely democratize investment policy-making, which remains dominated by fund managers, investment consultants, and other “experts.” Arguably, in some instances, the movement toward socially responsible investing and CSR is an effort by the corporate sector to prevent regulators from enacting stricter standards that are enforceable.

A.  Corporations and Human Rights There are a number of international initiatives in respect of socially responsible corporate governance. For example, the Global Compact is a network initiated by the United Nations that seeks to promote responsible corporate citizenship by having business act responsibly in partnership with other social actors. The Global Compact’s ten principles in the areas of human rights, labour, the environment, and anti-corruption enjoy universal consensus and are derived from the Universal Declaration of Human Rights; the International Labour Organization’s ILO Declaration on Fundamental Principles and Rights at Work; the Rio Declaration on Environment and Development, and the UN Convention Against Corruption. The Global Compact asks companies to embrace, support, and enact, within their sphere of influence, a set of core values in the areas of human rights, labour standards, the environment, and anticorruption. Its ten principles include that businesses should support and respect the protection of internationally proclaimed human rights and ensure they are not complicit in human rights abuses; recognize the right to collective bargaining and eliminate all forms of forced and compulsory labour and abolish child labour; eliminate discrimination in respect of employment and occupation; take a precautionary approach to environmental challenges and promote greater environmental responsibility; encourage the development and diffusion of environmentally friendly technologies; and work against all forms of corruption, including extortion and bribery: see “The Ten Principles of the UN Global Compact, online: United Nations . Another initiative is a co-operative effort involving a number of multinational corporations and the United Nations to establish appropriate norms regarding the responsibilities of business enterprises regarding human rights.

Norms on the Responsibilities of Transnational Corporations and Other Business Enterprises with Regard to Human Rights UN Doc E/CN.4/Sub.2/2003/12/Rev.2 (2003), online: University of Minnesota

A.  General Obligations 1.  States have the primary responsibility to promote, secure the fulfilment of, respect, ensure respect of and protect human rights recognized in international as well as national law, including ensuring that transnational corporations and other business enterprises 34 Benjamin J Richardson & Beate Sjåfjell, “Capitalism, the Sustainability Crisis, and the Limitations of Current Business Governance” in Sjåfjell & Richardson, supra note 33 at 2-3.

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respect human rights. Within their respective spheres of activity and influence, transnational corporations and other business enterprises have the obligation to promote, secure the fulfilment of, respect, ensure respect of and protect human rights recognized in international as well as national law, including the rights and interests of indigenous peoples and other vulnerable groups. B.  Right to Equal Opportunity and Non-Discriminatory Treatment 2.  Transnational corporations and other business enterprises shall ensure equality of opportunity and treatment, as provided in the relevant international instruments and national legislation as well as international human rights law, for the purpose of eliminating discrimination based on race, colour, sex, language, religion, political opinion, national or social origin, social status, indigenous status, disability, age—except for children, who may be given greater protection—or other status of the individual unrelated to the inherent requirements to perform the job, or of complying with special measures designed to overcome past discrimination against certain groups. C.  Right to Security of Persons 3.  Transnational corporations and other business enterprises shall not engage in nor benefit from war crimes, crimes against humanity, genocide, torture, forced disappearance, forced or compulsory labour, hostage-taking, extrajudicial, summary or arbitrary executions, other violations of humanitarian law and other international crimes against the human person as defined by international law, in particular human rights and humanitarian law. 4.  Security arrangements for transnational corporations and other business enterprises shall observe international human rights norms as well as the laws and professional standards of the country or countries in which they operate. D.  Rights of Workers 5.  Transnational corporations and other business enterprises shall not use forced or compulsory labour as forbidden by the relevant international instruments and national legislation as well as international human rights and humanitarian law. 6.  Transnational corporations and other business enterprises shall respect the rights of children to be protected from economic exploitation as forbidden by the relevant international instruments and national legislation as well as international human rights and humanitarian law. 7.  Transnational corporations and other business enterprises shall provide a safe and healthy working environment as set forth in relevant international instruments and national legislation as well as international human rights and humanitarian law. 8.  Transnational corporations and other business enterprises shall provide workers with remuneration that ensures an adequate standard of living for them and their families. Such remuneration shall take due account of their needs for adequate living conditions with a view towards progressive improvement. 9.  Transnational corporations and other business enterprises shall ensure freedom of association and effective recognition of the right to collective bargaining by protecting

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the right to establish and, subject only to the rules of the organization concerned, to join organizations of their own choosing without distinction, previous authorization, or interference, for the protection of their employment interests and for other collective bargaining purposes as provided in national legislation and the relevant conventions of the International Labour Organization. E.  Respect for National Sovereignty and Human Rights 10.  Transnational corporations and other business enterprises shall recognize and respect applicable norms of international law, national laws and regulations, as well as administrative practices, the rule of law, the public interest, development objectives, social, economic and cultural policies including transparency, accountability and prohibition of corruption, and authority of the countries in which the enterprises operate. 11.  Transnational corporations and other business enterprises shall not offer, promise, give, accept, condone, knowingly benefit from, or demand a bribe or other improper advantage, nor shall they be solicited or expected to give a bribe or other improper advantage to any Government, public official, candidate for elective post, any member of the armed forces or security forces, or any other individual or organization. Transnational corporations and other business enterprises shall refrain from any activity which supports, solicits, or encourages States or any other entities to abuse human rights. They shall further seek to ensure that the goods and services they provide will not be used to abuse human rights. 12.  Transnational corporations and other business enterprises shall respect economic, social and cultural rights as well as civil and political rights and contribute to their realization, in particular the rights to development, adequate food and drinking water, the highest attainable standard of physical and mental health, adequate housing, privacy, education, freedom of thought, conscience, and religion and freedom of opinion and expression, and shall refrain from actions which obstruct or impede the realization of those rights. F.  Obligations with Regard to Consumer Protection 13.  Transnational corporations and other business enterprises shall act in accordance with fair business, marketing and advertising practices and shall take all necessary steps to ensure the safety and quality of the goods and services they provide, including observance of the precautionary principle. Nor shall they produce, distribute, market, or advertise harmful or potentially harmful products for use by consumers. G.  Obligations with Regard to Environmental Protection 14.  Transnational corporations and other business enterprises shall carry out their activities in accordance with national laws, regulations, administrative practices and policies relating to the preservation of the environment of the countries in which they operate, as well as in accordance with relevant international agreements, principles, objectives, responsibilities and standards with regard to the environment as well as human rights, public health and safety, bioethics and the precautionary principle, and shall

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generally conduct their activities in a manner contributing to the wider goal of sustainable development. H.  General Provisions of Implementation 15.  As an initial step towards implementing these Norms, each transnational corporation or other business enterprise shall adopt, disseminate and implement internal rules of operation in compliance with the Norms. Further, they shall periodically report on and take other measures fully to implement the Norms and to provide at least for the prompt implementation of the protections set forth in the Norms. Each transnational corporation or other business enterprise shall apply and incorporate these Norms in their contracts or other arrangements and dealings with contractors, subcontractors, suppliers, licensees, distributors, or natural or other legal persons that enter into any agreement with the transnational corporation or business enterprise in order to ensure respect for and implementation of the Norms. 16.  Transnational corporations and other businesses enterprises shall be subject to periodic monitoring and verification by United Nations, other international and national mechanisms already in existence or yet to be created, regarding application of the Norms. This monitoring shall be transparent and independent and take into account input from stakeholders (including non-governmental organizations) and as a result of complaints of violations of these Norms. Further, transnational corporations and other businesses enterprises shall conduct periodic evaluations concerning the impact of their own activities on human rights under these Norms. 17. States should establish and reinforce the necessary legal and administrative framework for ensuring that the Norms and other relevant national and international laws are implemented by transnational corporations and other business enterprises. 18.  Transnational corporations and other business enterprises shall provide prompt, effective and adequate reparation to those persons, entities and communities that have been adversely affected by failures to comply with these Norms through, inter alia, reparations, restitution, compensation and rehabilitation for any damage done or property taken. In connection with determining damages in regard to criminal sanctions, and in all other respects, these Norms shall be applied by national courts and/or international tribunals, pursuant to national and international law. 19.  Nothing in these Norms shall be construed as diminishing, restricting, or adversely affecting the human rights obligations of States under national and international law, nor shall they be construed as diminishing, restricting, or adversely affecting more protective human rights norms, nor shall they be construed as diminishing, restricting, or adversely affecting other obligations or responsibilities of transnational corporations and other business enterprises in fields other than human rights. The United Nations Human Rights Council has established and approved guiding principles on business and human rights, which offer a guide for companies to report on how they respect human rights. It examines the role of business enterprises as specialized organs of society performing specialized functions, required to comply with all applicable laws and to respect

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human rights.35 The guiding principles apply to all states and to all business enterprises, both transnational and others, regardless of their size, sector, location, ownership, and structure. They state that the principles should be understood as a coherent whole, in terms of their objective of enhancing standards and practices with regard to business and human rights so as to achieve tangible results for affected individuals and communities, and thereby also contribute to a socially sustainable globalization. The responsibility to respect human rights is a global standard of expected conduct for all business enterprises wherever they operate. It exists independently of states’ abilities or willingness to fulfil their own human rights obligations, and does not diminish those obligations.36 Some excerpts follow.

United Nations Human Rights Office of the High Commissioner, Guiding Principles on Business and Human Rights: Implementing the United Nations “Protect, Respect and Remedy” Framework (New York & Geneva: United Nations: Office of the High Commissioner, 2011), online: OHCHR at 8-9; 14-27 Supporting Business Respect for Human Rights in Conflict-Affected Areas 7.  Because the risk of gross human rights abuses is heightened in conflict affected areas, States should help ensure that business enterprises operating in those contexts are not involved with such abuses, including by:

(a) Engaging at the earliest stage possible with business enterprises to help them identify, prevent and mitigate the human rights-related risks of their activities and business relationships; (b) Providing adequate assistance to business enterprises to assess and address the heightened risks of abuses, paying special attention to both gender-based and sexual violence; (c) Denying access to public support and services for a business enterprise that is involved with gross human rights abuses and refuses to cooperate in addressing the situation; (d) Ensuring that their current policies, legislation, regulations and enforcement measures are effective in addressing the risk of business involvement in gross human rights abuses. •  •  •

35 United Nations Human Rights Office of the High Commissioner, Guiding Principles on Business and Human Rights: Implementing the United Nations “Protect, Respect and Remedy” Framework (New York & Geneva: United Nations: Office of the High Commissioner, 2011), online: OHCHR at 6. 36 Ibid at 10.

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II.  The Corporate Responsibility to Respect Human Rights A.  Foundational Principles 11.  Business enterprises should respect human rights. This means that they should avoid infringing on the human rights of others and should address adverse human rights impacts with which they are involved. •  •  •

12.  The responsibility of business enterprises to respect human rights refers to internationally recognized human rights—understood, at a minimum, as those expressed in the International Bill of Human Rights and the principles concerning fundamental rights set out in the International Labour Organization’s Declaration on Fundamental Principles and Rights at Work. •  •  •

13.  The responsibility to respect human rights requires that business enterprises:

(a) Avoid causing or contributing to adverse human rights impacts through their own activities, and address such impacts when they occur; (b) Seek to prevent or mitigate adverse human rights impacts that are directly linked to their operations, products or services by their business relationships, even if they have not contributed to those impacts. •  •  •

14.  The responsibility of business enterprises to respect human rights applies to all enterprises regardless of their size, sector, operational context, ownership and structure. Nevertheless, the scale and complexity of the means through which enterprises meet that responsibility may vary according to these factors and with the severity of the enterprise’s adverse human rights impacts. •  •  •

15.  In order to meet their responsibility to respect human rights, business enterprises should have in place policies and processes appropriate to their size and circumstances, including:

(a) A policy commitment to meet their responsibility to respect human rights; (b) A human rights due diligence process to identify, prevent, mitigate and account for how they address their impacts on human rights; (c) Processes to enable the remediation of any adverse human rights impacts they cause or to which they contribute. •  •  •

B.  Operational Principles 16.  As the basis for embedding their responsibility to respect human rights, business enterprises should express their commitment to meet this responsibility through a statement of policy that:

(a) Is approved at the most senior level of the business enterprise; (b) Is informed by relevant internal and/or external expertise;

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(c) Stipulates the enterprise’s human rights expectations of personnel, business partners and other parties directly linked to its operations, products or services; (d) Is publicly available and communicated internally and externally to all personnel, business partners and other relevant parties; (e) Is reflected in operational policies and procedures necessary to embed it throughout the business enterprise. •  •  •

17.  In order to identify, prevent, mitigate and account for how they address their adverse human rights impacts, business enterprises should carry out human rights due diligence. The process should include assessing actual and potential human rights impacts, integrating and acting upon the findings, tracking responses, and communicating how impacts are addressed. Human rights due diligence:

(a) Should cover adverse human rights impacts that the business enterprise may cause or contribute to through its own activities, or which may be directly linked to its operations, products or services by its business relationships; (b) Will vary in complexity with the size of the business enterprise, the risk of severe human rights impacts, and the nature and context of its operations; (c) Should be ongoing, recognizing that the human rights risks may change over time as the business enterprise’s operations and operating context evolve. •  •  •

18.  In order to gauge human rights risks, business enterprises should identify and assess any actual or potential adverse human rights impacts with which they may be involved either through their own activities or as a result of their business relationships. This process should:

(a) Draw on internal and/or independent external human rights expertise; (b) Involve meaningful consultation with potentially affected groups and other relevant stakeholders, as appropriate to the size of the business enterprise and the nature and context of the operation. •  •  •

19.  In order to prevent and mitigate adverse human rights impacts, business enterprises should integrate the findings from their impact assessments across relevant internal functions and processes, and take appropriate action.

(a) Effective integration requires that: (i) Responsibility for addressing such impacts is assigned to the appropriate level and function within the business enterprise; (ii) Internal decision-making, budget allocations and oversight processes enable effective responses to such impacts.



(b) Appropriate action will vary according to: (i) Whether the business enterprise causes or contributes to an adverse impact, or whether it is involved solely because the impact is directly

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linked to its operations, products or services by a business relationship; (ii) The extent of its leverage in addressing the adverse impact. •  •  •

20.  In order to verify whether adverse human rights impacts are being addressed, business enterprises should track the effectiveness of their response. Tracking should:

(a) Be based on appropriate qualitative and quantitative indicators; (b) Draw on feedback from both internal and external sources, including affected stakeholders. •  •  •

21.  In order to account for how they address their human rights impacts, business enterprises should be prepared to communicate this externally, particularly when concerns are raised by or on behalf of affected stakeholders. Business enterprises whose operations or operating contexts pose risks of severe human rights impacts should report formally on how they address them. In all instances, communications should:

(a) Be of a form and frequency that reflect an enterprise’s human rights impacts and that are accessible to its intended audiences; (b) Provide information that is sufficient to evaluate the adequacy of an enterprise’s response to the particular human rights impact involved; (c) In turn not pose risks to affected stakeholders, personnel or to legitimate requirements of commercial confidentiality. •  •  •

22. Where business enterprises identify that they have caused or contributed to adverse impacts, they should provide for or cooperate in their remediation through legitimate processes. •  •  •

23.  In all contexts, business enterprises should:

(a) Comply with all applicable laws and respect internationally recognized human rights, wherever they operate; (b) Seek ways to honour the principles of internationally recognized human rights when faced with conflicting requirements; (c) Treat the risk of causing or contributing to gross human rights abuses as a legal compliance issue wherever they operate. •  •  •

24.  Where it is necessary to prioritize actions to address actual and potential adverse human rights impacts, business enterprises should first seek to prevent and mitigate those that are most severe or where delayed response would make them irremediable. •  •  •

25.  As part of their duty to protect against business-related human rights abuse, States must take appropriate steps to ensure, through judicial, administrative, legislative or other appropriate means, that when such abuses occur within their territory and/or jurisdiction those affected have access to effective remedy. [Commentary omitted]

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NOTES AND QUESTIONS

1.  The UN principles are for guidance only; they do not have the force of legal regulation. Do you think it is possible to change corporate conduct where international rules are not mandatory? 2.  The principles also contain a set of recommendations as to how states should provide timely and effective judicial and non-judicial mechanisms to allow individuals and communities that have been harmed to request remedies for business-related human rights abuse. Will the availability of remedies and timely and accessible mechanisms to determine the cases help remediate human rights abuses? 3.  Is there a business case for advancing human rights? Do you think that there needs to be a business case before corporations can undertake human rights initiatives? Where does domestic human rights law fit into corporate law? 4.  In looking at the Global Compact’s ten principles for corporate governance, do you see an underlying theme or objective that informs the principles?

Canadian corporations are often related to other corporate entities both in Canada and across the globe. Although technically, corporations registered in Canada are separate legal entities, often the assets and governance of multinational business enterprises are comingled. In such instances, Canadian corporations may be vulnerable to challenges based on the activities of a related entity in a foreign jurisdiction and consequent claims on the assets of the Canadian corporation. The following lawsuit, which is ongoing as this book goes to press, concerns allegations of use of slave labour and crimes against humanity against a Canadian company, Nevsun Resources Limited, for activities at Nevsun’s Bisha mine in Eritrea. The judgment below is a landmark, because the court approved the lawsuit being brought in Canada. As you read, consider what circumstances might result in a Canadian company being held accountable for harms to stakeholders from related business entities in another country. Consider the importance that the court attaches to the ability to receive a fair trial regarding claims against the corporation in the foreign jurisdiction.

Araya v Nevsun Resources Ltd 2016 BCSC 1856 ABRIOUX J: [In 2014, three Eritrean men filed a civil lawsuit before the BC Supreme Court against Nevsun Resources Limited over the use of slave labour. A second civil claim, with 27 additional plaintiffs, was filed in November 2016. The case alleges that Nevsun engaged two Eritrean state-run contractors and the Eritrean military to build the mine’s facilities and that the companies and military deployed forced labour under abhorrent conditions. The case alleges that Nevsun expressly or implicitly approved the use of conscripted labour, a widespread practice constituting crimes against humanity. Nevsun, which owns a majority share of the Bisha mine, is headquartered in Vancouver and is incorporated

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under the laws of British Columbia. The lawsuit advances claims based on the international law prohibitions on forced labour, slavery, torture and crimes against humanity, one of the first human rights lawsuits in Canada to assert claims based directly on international law.] [226]  This Court has presumptive jurisdiction over this proceeding since Nevsun is a British Columbia company. •  •  •

[229] Section 11 of the CJPTA [Court Jurisdiction and Proceedings Transfer Act] outlines how the court may exercise its discretion with respect to territorial competence and provides: 11(1)  After considering the interests of the parties to a proceeding and the ends of justice, a court may decline to exercise its territorial competence in the proceeding on the ground that a court of another state is a more appropriate forum in which to hear the proceeding. (2)  A court, in deciding the question of whether it or a court outside British Columbia is the more appropriate forum in which to hear a proceeding, must consider the circumstances relevant to the proceeding, including (a) the comparative convenience and expense for the parties to the proceeding and for their witnesses, in litigating in the court or in any alternative forum, (b) the law to be applied to issues in the proceeding, (c) the desirability of avoiding multiplicity of legal proceedings, (d) the desirability of avoiding conflicting decisions in different courts, (e) the enforcement of an eventual judgment, and (f) the fair and efficient working of the Canadian legal system as a whole.

[230] In Garcia v. Tahoe Resources Inc., 2015 BCSC 2045 [Garcia], Justice Gerow summarized certain applicable principles: [32]  The factors set out in s. 11(2) of the CJPTA are not exhaustive: Laxton v. Anstalt, 2011 BCCA 212, at para. 44. … Huang v. Silvercorp Metal Inc., 2015 BCSC 549 at para. 33, discussed the additional factors set out in Spar Aerospace Ltd. v. American Mobile Satellite Corp., 2002 SCC 78, which include: (a) (b) (c) (d) (e) (f) (g) (h) (i)

the residence of the parties, witnesses, and experts the location of material evidence; the place where the contract was negotiated and executed; the existence of proceedings pending between the parties in another jurisdiction; the location of the defendant’s assets; the applicable law; advantages conferred on the plaintiff by its choice of forum, if any; the interests of justice; and the interests of the parties.

[33]  The weight to be attributed to the various factors is a matter of discretion. The analysis does not require that all the factors point to a single forum or involve a simple numerical tallying up of the relevant factors. However, it does require that one forum ultimately emerge as clearly more appropriate: Breeden v. Black, 2012 SCC 19 at para. 37.

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[34]  The defendant must establish an alternate forum is clearly more appropriate and should be preferred. … •  •  •

[35]  The objective of the court in deciding a forum non conveniens application is to ensure fairness to the parties and a more efficient resolution of their dispute. … •  •  •

[233]  Furthermore, as Gerow J. noted in Garcia: [105]  In my view, the public interest requires that Canadian courts proceed extremely cautiously in finding that a foreign court is incapable of providing justice to its own citizens. To hold otherwise is to ignore the principle of comity and risk that other jurisdictions will treat the Canadian judicial system with similar disregard. •  •  •

[237]  I will now consider both the CJPTA and additional factors referred to in the authorities bearing in mind that: (a) the analysis is highly individualized and contextualized to the circumstances of this case; (b) the list is non-exhaustive, that all factors need not point to a single forum; (c) that the process is not to be a “tallying up” of the various factors, as per Garcia. It is for Nevsun to establish that Eritrea is clearly the more appropriate forum. [238]  First, the Court must determine when the analysis should occur of whether a fair and impartial trial is possible in Eritrea. [239]  The plaintiffs point out that the enumerated factors in s. 11(2) of the CJPTA do not specifically address the rare circumstances where the foreign court is not available to plaintiffs because of a fear of persecution or lack of judicial independence. Such factors are not easily captured under the notion of comparative convenience which tends to focus on such traditional factors as the location of the parties and the witnesses. •  •  •

[243]  I intend to take a broad interpretation of the term “convenience” since a real risk of an unfair trial is likely not convenient for the plaintiffs [244]  There is no doubt this will be a complicated proceeding whether it takes place in British Columbia or Eritrea. •  •  •

[248]  The events forming the basis of the plaintiffs’ claims occurred in Eritrea. While allegations of primary and secondary liability are advanced against Nevsun regarding decisions in its Canadian corporate offices, those decisions are all related to events the plaintiffs say occurred in Eritrea, allegedly in concert with Eritrean entities and SENET. [249]  I commence my analysis by noting that to the extent an ordinary or typical case exists, the numbers of witnesses and documents and their location in Eritrea would be granted significant weight. [250]  But this is far from being a typical case. It will be challenging to manage and conduct a trial fair to all the parties no matter the jurisdiction.

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[251]  For the following reasons, I have concluded: (a) Nevsun has not established that comparative convenience and expense favours Eritrea as the appropriate forum; and (b) there is a real risk of an unfair trial occurring in Eritrea. [252]  It is for Nevsun to establish that it would be fairer and more efficient for this action to be stayed and heard in Eritrea: Van Breda at para. 109. [253]  Nevsun relies on a line of English authorities and submits it is for the plaintiffs to establish that “there is a real risk that justice will not be obtained in the foreign court by reason of incompetence or lack of independence or corruption” and this must be supported by “positive and cogent” evidence, anecdotal evidence being insufficient … . •  •  •

[256]  In my view, the correct approach is that while Nevsun must satisfy the court that the comparative convenience and expense for the parties favours Eritrea, the plaintiffs must provide sufficient evidence such that the court can conclude that there is a real risk that they will not receive a fair trial in that forum. •  •  •

[258]  … There is sufficient cogent evidence from which I can conclude that there is a real risk that the plaintiffs could not be provided with justice in Eritrea. •  •  •

[286]  With respect, it would defy common sense for this Court to accept that the plaintiffs, as a pre-condition to returning to Eritrea, would have to: ( a) pay a tax or fine as punishment for having left the country illegally; (b) render a written apology for their conduct; and (c) possibly attend a six week course designed to enforce their patriotic feelings and not find that there is a real risk that the plaintiffs would not receive a fair trial in Eritrea. This is particularly the case if they then chose to commence legal proceedings in which they make the most unpatriotic allegations against the State and its military, and call into question the actions of a commercial enterprise which is the primary economic generator in one of the poorest countries in the world. •  •  •

[295]  Taking all these factors into account, I have concluded that Nevsun has not established that the comparative convenience and expense favours Eritrea as the appropriate forum. [296]  In reaching this decision, I have also concluded that there is a real risk to the plaintiffs of an unfair trial occurring in Eritrea. •  •  •

[338]  I have concluded that Nevsun has not established that the factors in the CJPTA or the case law clearly establish that Eritrea is the more appropriate forum. [339]  The Forum Application is dismissed. •  •  •

[368]  … Nevsun is neither a foreign sovereign state nor an official of that state or the home state. Rather, it is a British Columbia company which is alleged to have committed various human rights abuses and common law torts in furthering its commercial interests, being the development, construction and operation of the Bisha Mine. •  •  •

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[419]  On this preliminary application, I am not prepared to accept that a doctrine which: (a) has yet to form the basis of a decision at any level of court in Canada; (b) has been described by a senior appellate court in Australia as being of “uncertain application” and “beyond the certainty that [it] exists there is little clarity as to what constitutes it”; and (c) on Nevsun’s own submission, has been described differently by two different divisions of the English Court of Appeal, and if applied in the manner submitted by Nevsun, should result in the plaintiffs’ claims being stayed or dismissed pursuant to either Rule 21-8 or Rule 9-5. … [420]  As Chief Justice Black stated in Habib at para. 13: It is not to the point that Mr. Habib’s proceeding is a civil claim for damages and not a criminal proceeding under the Crimes (Torture) Act, the Geneva Conventions Act or the Criminal Code. The point is that, if a choice were indeed open, in determining whether or not the act of state doctrine operates to deny a civil remedy contingent upon breach of those Acts, the common law should develop congruently with emphatically expressed ideals of public policy, reflective of universal norms.

[421]  In my view, the same considerations apply here. After all, this is British Columbia, Canada; and it is 2016. [422]  The Act of State Application is dismissed. •  •  •

[439]  The prohibitions on slavery, forced labour, torture and crimes against humanity are part of CIL [customary international law], and all have the status of jus cogens. •  •  •

[458]  I conclude that Nevsun’s argument on this point does not establish that the CIL claims are bound to fail. •  •  •

[462]  … The fact Parliament has enacted the JVTA [Justice for Victims of Terrorism Act] and has considered but has not yet enacted more comprehensive legislation in this field is not synonymous with there being an express derogation by Parliament as was found in relation to the SIA [State Immunity Act] in Kazemi [Kazemi Estate v Iran, 2014 SCC 62, [2014] 3 SCR 176]. •  •  •

[466]  It is not necessary for me to decide on this application whether one or more new nominate torts should be recognized. The plaintiffs may face significant obstacles at the trial in establishing the need for these new torts but at this stage of the proceeding, I cannot conclude that they are bound to fail. [467]  That is because these claims are said to arise as the result of social or technological change posing a novel harm for which there is no existing remedy. The Hon. Ian Binnie, C.C., Q.C., has written about these issues and potential solutions: When the reach of business operations was more or less coextensive with the nation states in which they resided, there was no doubt which state was in charge, although in practice the control may have been imperfectly exercised. Today, however, transnational companies

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[473]  While I agree with Nevsun that the American jurisprudence may be of limited assistance to the plaintiffs and that there is merit to many of its submissions, I also agree with the plaintiffs that the history of corporate liability under international law “is a complex and layered narrative that spans centuries and draws from many different fields of law, countries, and types of materials.” •  •  •

[484]  Since there is merit to the submissions of both Nevsun and the plaintiffs, I have concluded: (a) Nevsun has not established that the inclusion of the CIL claims in the NOCC constitutes a radical defect, has no reasonable chance of success and is bound to fail; (b) rather, a real issue exists, one which has a reasonable chance of success. The issue is whether such claims are permitted based on the common law as it currently stands or constitute a “reasonable development” of the common law; and (c) the CIL claims raise arguable, difficult and important points of law and should proceed to trial so that they can be considered in their proper factual and legal context. This is necessary such that the common law and the law of tort may evolve in an appropriate manner. [485]  Accordingly the CIL Application is dismissed. QUESTIONS

1.  Do you think the court in Araya v Nevsun Resources Ltd correctly decided that the lawsuit should proceed in Canada? Why or why not? 2.  Where a corporation makes decisions in Canada about governance practice in another country that may harm a particular stakeholder group, should those stakeholders be able to access the assets of the Canadian company through claims in Canada? 3.  Should Canadian stakeholders of a firm that harms employees or other stakeholders through the conduct of its related entities in a foreign jurisdiction have the ability to bring a claim against the Canadian company?

B.  Corporate Groups and Limits on Drawing Aside the Corporate Veil to Satisfy Stakeholder Claims Another aspect of the stakeholder debate is the extent to which Canadian companies within a multinational corporate group could or should be held liable for the activities of related entities in other countries. Unlike the judgment above, in which parties are seeking to have

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a matter heard and decided in Canada, the judgment below addresses the situation where stakeholders have already sought and received a judgment for compensation for environmental harms in another country, and are seeking access to the Canadian subsidiary’s assets to help satisfy the judgment. As you read the excerpt below, consider how difficult it is to draw aside the corporate veil when corporations are part of a large multinational enterprise. Consider also the cost of litigating these issues, both financial and social costs.

Yaiguaje v Chevron Corporation 2017 ONSC 135 (footnotes omitted) HAINEY J:

[5]  The plaintiffs are residents of Ecuador who hold a judgment of US$9.5 billion against Chevron (“Ecuadorian judgment”). The Ecuadorian judgment was obtained against Chevron in February 2011. It was originally in the amount of approximately US$18 billion. The judgment was upheld by an Ecuadorian intermediate appellate court in 2012. The National Court of Justice of Ecuador partially varied the judgment in November 2013 by reducing it to US$9.5 billion. [6]  The dispute underlying the Ecuadorian judgment originated in the Oriente region of Ecuador. This oil-rich area attracted exploitation and extraction activities by oil companies, including Texaco Inc., from 1964 to 1992. As a result of these activities, the region suffered extensive environmental pollution that seriously disrupted the lives of its residents. The 47 plaintiffs in this proceeding represent approximately 30,000 indigenous Ecuadorian villagers who live in the region and who have been affected by the environmental pollution. [7]  The plaintiffs commenced proceedings against Texaco in 1993 in New York. That proceeding was eventually dismissed on the grounds of international comity and forum non conveniens. This decision was upheld on appeal, in part, because Texaco agreed to submit to the jurisdiction of the Ecuadorian courts. [8]  The plaintiffs commenced proceedings against Chevron in Ecuador in 2003. By then Texaco had merged with Chevron. [9]  Chevron is a Delaware corporation with its head office in California. It is a public company. Its principal business is the holding of shares in subsidiary corporations and managing those investments. [10]  Chevron Canada is a seventh level, indirect subsidiary of Chevron. It was originally incorporated in 1966. It has since amalgamated under the Canada Business Corporations Act (“CBCA”). Its head office is in Calgary, Alberta. [11]  Chevron Canada is an operating company. It has no connection to the legal proceedings in Ecuador that led to the Ecuadorian judgment. [12]  Chevron Canada’s major business activities involve petroleum and natural gas exploration in Canada. It has never carried on business in Ecuador and played no role in the events leading up to the Ecuadorian judgment. [13]  Chevron Canada’s shares are wholly owned by CCCC, which is currently not a defendant in these proceedings. However, as indicated above, the plaintiffs have brought a motion to add CCCC as a defendant. I will deal with this motion separately.

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[14]  Chevron has refused to acknowledge or pay the Ecuadorian judgment. It has no assets in Ecuador. As a result, in 2012, the plaintiffs commenced an action in the Ontario Superior Court of Justice for the recognition and enforcement of the Ecuadorian judgment against Chevron, Chevron Canada and Chevron Canada Finance Limited (“CCFL”). The action against CCFL has since been discontinued (“Ontario Action”). [15]  In the Ontario Action, the plaintiffs seek the following relief against Chevron Canada: (a) the Canadian equivalent of US$9,510,000,000 resulting from the Ecuadorian judgment against Chevron; (b) the Canadian equivalent of costs to be determined by the Ecuadorian court; (c) a declaration that the shares of Chevron Canada are exigible to satisfy the Ecuadorian judgment, should it be enforced in Ontario; (d) the appointment of an equitable receiver over the shares and assets of Chevron Canada; and (e) interest and costs. [16]  The plaintiffs do not allege that Chevron Canada was a party to the Ecuadorian action or that it is an agent of Chevron. In their amended statement of claim, the plaintiffs plead that they do not allege any wrongdoing against Chevron Canada. [17]  Further, the plaintiffs do not allege that the corporate structure of which Chevron Canada is a part was designed or used as an instrument of fraud or wrongdoing. [18]  The plaintiffs do, however, plead the following, in paras. 17-26 of their amended statement of claim: [17]  Chevron no longer has assets in Ecuador. [18]  In Canada, Chevron has two wholly-owned subsidiaries: Chevron Canada Limited and Chevron Canada Financial Limited (collectively, “Chevron Canada”). The assets of Chevron Canada are significant and are located in many provinces and territories throughout Canada. The assets are beneficially-owned by Chevron and, through it, by the shareholders of Chevron. [19] In its required Form 10-K filing with the United States [Securities] and Exchange Commission for the fiscal year ended December 31, 2011, Chevron declares and the fact is that it manages its investments in subsidiaries, provides administrative, financial, management and technology support to its US and international subsidiaries that engage in fully-integrated petroleum operations, chemical operations, mining operations, power generation and energy services. In its Annual Report, Chevron states and the fact is that its operating segments (subsidiaries) are managed by segment managers who report to the CODM (Chief Operating Decision Maker), which is Chevron’s Executive Committee. [20]  Chevron wholly owns and controls Chevron Canada. Chevron consolidates the financial results of its wholly owned subsidiaries including Chevron Canada and reports them as its own. Chevron raises capital in the equities markets based on the assets, operations and results of its wholly owned subsidiaries including Chevron Canada. Chevron Canada does not have an independent Board of Directors. Chevron provides a parent guarantee for the debts of its wholly owned subsidiaries including Chevron Canada.

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[21]  As a condition of obtaining the dismissal of the action in New York, Texaco promised not only to submit to the jurisdiction of the Ecuadorean Court, but also to satisfy the Judgment. [22]  After the Judgment, Chevron has resiled from that position. Chevron now repudiates its undertaking to the New York Court to respect and pay the Judgment rendered in the jurisdiction of its own choosing and, through its general counsel, has stated that “[w]e’re going to fight this until Hell freezes over and then fight it out on the ice.” [23]  As a result of the allegations in paragraphs 4, 5, 17-20 and the fact that the great majority of its assets are held in 73 subsidiaries (as set out in Schedule “A” hereto), Chevron Canada is a necessary party to this action in order to achieve equity and fairness between parties and to yield a result that is not “too flagrantly opposed to justice … .” [24]  The plaintiffs do not allege any wrongdoing against Chevron Canada. The action is for collection of a judgment debt. The plaintiffs will execute against Chevron Canada any legal, equitable or other right, personal property, interest, whether direct or indirect, or equity of redemption that Chevron, the judgment debtor, has in Chevron Canada. [25]  The plaintiffs plead and rely on the Execution Act, R.S.O. 1990, c. E.24 and the Securities Transfer Act, 2006, S.O. 2006, c. 8. [26]  The plaintiffs seek the appointment of an equitable Receiver to seize the shares and assets of Chevron Canada, the entire beneficial ownership of which belongs to the JudgmentDebtor, Chevron.

Judicial History in Canada [19]  In 2013, Chevron and Chevron Canada challenged the jurisdiction of the Ontario Superior Court of Justice to recognize and enforce the Ecuadorian judgment. The motion judge, D.M. Brown J. (as he then was), dismissed their motion and concluded that the Ontario court has jurisdiction to recognize and enforce the judgment against these defendants. D.M. Brown J. also concluded that this was an appropriate case in which to exercise the court’s power to stay the proceedings on its own initiative pursuant to s. 106 of the Courts of Justice Act. [20]  The Court of Appeal for Ontario overruled his imposition of a discretionary stay of the proceedings and upheld his decision on the jurisdictional issue. The court concluded that an Ontario court has jurisdiction to determine whether the Ecuadorian judgment against Chevron may be recognized and enforced in Ontario. The Court of Appeal also upheld D.M.  Brown  J.’s jurisdictional decision with respect to Chevron Canada concluding (as the Supreme Court of Canada observed) that an Ontario court “has jurisdiction to adjudicate a recognition and enforcement action against Chevron that also names Chevron Canada as a defendant.” The Supreme Court of Canada upheld the Court of Appeal for Ontario’s decision with respect to the Ontario court’s jurisdiction. The Supreme Court made it clear, however, that its decision did not determine the issue of whether Chevron Canada has a separate corporate personality from Chevron and whether its assets are available to satisfy the Ecuadorian judgment against Chevron. Gascon J. stated the following: Further, my conclusion that the Ontario courts have jurisdiction in this case should not be understood to prejudice future arguments with respect to the distinct corporate personalities of Chevron and Chevron Canada. I take no position on whether Chevron Canada can

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Chapter 10  Corporate Governance: The Stakeholder Debate properly be considered a judgment-debtor to the Ecuadorian judgment. Similarly, should the judgment be recognized and enforced against Chevron, it does not automatically follow that Chevron Canada’s shares or assets will be available to satisfy Chevron’s debt. For instance, shares in a subsidiary belong to the shareholder, not to the subsidiary itself. Only those shares whose ownership is ultimately attributable to the judgment debtor could be the valid target of a recognition and enforcement action. •  •  •

Issues [23]  The parties agree that this is an appropriate case for summary judgment. Therefore, the only issues that I must decide on this motion are the following: (a) Are the shares and assets of Chevron Canada exigible and available for execution and seizure pursuant to the Execution Act to satisfy the Ecuadorian judgment against Chevron? (b) If they are not, should Chevron Canada’s corporate veil be pierced so that its shares and assets are available to satisfy the Ecuadorian judgment against its indirect parent, Chevron? •  •  •

[34]  I do not accept the plaintiffs’ submission that Chevron Canada’s shares and assets are exigible pursuant to the Execution Act to satisfy the Ecuadorian judgment against Chevron, for the following reasons. [35]  Chevron Canada’s incorporating statute, the CBCA, gives it all the rights, powers and privileges of a natural person. Section 15(1) of the CBCA provides the following: A corporation has the capacity and, subject to this Act, the rights, powers and privileges of a natural person.

[36]  Chevron Canada is not an asset of Chevron. It is a separate legal person. It is not an asset of any other person including its own parent, CCCC. The Supreme Court of Canada confirmed this in BCE Inc. v. 1976 Debentureholders, where the court stated, “While the corporation is ongoing, shares confer no right to its underlying assets.” [37] The Execution Act, which is a procedural statute, does not create any rights in property but merely provides for the seizure and sale of property in which a judgmentdebtor already has a right or interest. It does not establish a cause of action against Chevron Canada. Chevron Canada is not the judgment-debtor under the Ecuadorian judgment and, therefore, the Execution Act does not apply to it with respect to that judgment. The Execution Act does not give Chevron any right or interest, equitable or otherwise, in the shares or assets of Chevron Canada. •  •  •

[57]  In my view, the plaintiffs have not established that Chevron Canada’s corporate veil should be pierced for the following reasons. [58]  Chevron and Chevron Canada are separate legal entities with separate rights and obligations. The principle of corporate separateness has been recognized and respected since the 1896 decision of the House of Lords in Salomon v. Salomon & Co.

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[59]  This principle applies equally to groups of companies such as Chevron’s group of companies of which Chevron Canada is a part. The English Court of Appeal made this clear in Adams v. Cape Industries Plc., as follows: There is no general principle that all companies in a group of companies are to be regarded as one. On the contrary, the fundamental principle is that “each company in a group of companies … is a separate legal entity possessed of separate legal rights and liabilities.” •  •  •

Our law, for better or worse, recognizes the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under the general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities.

[60]  The principle of corporate separateness provides that shareholders of a corporation are not liable for the obligations of the corporation. It also provides that the assets of the corporation are owned exclusively by the corporation, not the shareholders of the corporation. As a result, Chevron does not have any legal or equitable interest in the assets of Chevron Canada as an indirect shareholder seven-times removed. •  •  •

[63]  Because the principle of corporate separateness applies to Chevron and Chevron Canada, the plaintiffs must satisfy the test for piercing Chevron Canada’s corporate veil, established in Transamerica Life Insurance Co. of Canada v. Canada Life Assurance Co. In Transamerica, Sharpe J. (as he then was) held the following: As just indicated, the courts will disregard the separate legal personality of a corporate entity where it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct. The first element, “complete control,” requires more than ownership. It must be shown that there is complete domination and that the subsidiary company does not, in fact, function independently. •  •  •

The second element relates to the nature of the conduct: is there “conduct akin to fraud that would otherwise unjustly deprive claimants of their rights”? …

[64]  The Court of Appeal for Ontario upheld Sharpe J.’s decision in Transamerica. In the more recent case of Indcondo Building Corporation v. Sloan, the Court of Appeal for Ontario further clarified the test in Transamerica, holding that the corporate veil will not be pierced even where complete domination is present in the absence of wrongdoing akin to fraud in the establishment or use of the corporation. [65]  The plaintiffs do not allege that the corporate structure of which Chevron Canada is a part was designed or used as an instrument of fraud or wrongdoing. In fact, they specifically plead that they “do not allege any wrongdoing against Chevron Canada.” As such, they cannot establish wrongdoing akin to fraud in the corporate structure between Chevron and Chevron Canada. They, therefore, do not meet this fundamental condition of piercing Chevron Canada’s corporate veil. [66]  However, the plaintiffs submit that corporate separateness should not be applied as a “strict, inflexible rule” where it will yield a result “too flagrantly opposed to justice.” I

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do not accept the plaintiffs’ submission that the corporate veil will be pierced when it is just and equitable to do so. Sharpe J. came to the same conclusion in Transamerica, as follows: In my view, the argument advanced by Transamerica reads far too much into a dictum plainly not intended to constitute an in-depth analysis of an important area of the law or to reverse a legal principle which, for almost 100 years, has served as a cornerstone of corporate law. It was conceded in argument that no case since Kosmopoulos has applied the preferred “just and equitable” test. •  •  •

There are undoubtedly situations where justice requires that the corporate veil be lifted. The cases and authorities already cited indicate that it will be difficult to define precisely when the corporate veil is to be lifted, but that lack of a precise test does not mean that a court is free to act as it pleases on some loosely defined “just and equitable” standard. …

[67]  The Court of Appeal for Ontario agreed with Sharpe J.’s conclusion in Parkland Plumbing & Heating Ltd. v. Minaki Lodge Resort 2002 Inc., in which E.A. Cronk J.A. stated the following, “But this does not mean that the courts enjoy ‘carte blanche’ to lift the corporate veil absent fraudulent or improper conduct whenever it appears ‘just and equitable’ to do so.” [68]  I am satisfied on the strength of these decisions that there is not an independent “just and equitable” exception to the principle of corporate separateness as the plaintiffs suggest. This is not a basis for piercing Chevron Canada’s corporate veil in this case. [69]  As I have already indicated, the applicable jurisprudence makes it clear that even if the plaintiffs were able to establish that Chevron exercises total effective control over Chevron Canada, which they have not done, this would not satisfy the test for ignoring Chevron Canada’s corporate separateness and piercing its corporate veil. There would also have to be wrongdoing “akin to fraud” to meet the test. There is no such wrongdoing in this case. •  •  •

[73]  The evidence does not establish that Chevron Canada is Chevron’s “’puppet.’ “ Rather, I find that Chevron and Chevron Canada have a typical parent/subsidiary relationship. Chevron does not exercise complete dominance or control over the affairs of Chevron Canada. I accept and adopt, for the purpose of this motion, the following findings and analysis of D.M.  Brown  J. concerning the corporate relationship between Chevron and Chevron Canada, from his reasons for decision: [100]  As part of a worldwide “family” of companies, Chevron Canada is subject to certain “family” budget reporting requirements and large capital expenditure approval processes, but it initiates its own plans and budgets, it funds its own day to day operations, and the capital expenditures made by it in recent years for the major Athabasca Oil Sands Project, Hibernia Project and Hebron Project were funded from its own operating revenues. Mr. Wasko deposed: Chevron Canada is a fully capitalized corporation which funds its own day to day operations without financial contributions from Chevron Corp. or any other Chevron entity. This corporate structure has been in place since 1966; it was not a recent creation designed to blunt the effect of the Ecuadorean Judgment. I do not regard the existence of a central review and approval process for large capital expenditures, especially of the magnitude

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found in the resource extraction industry, as signifying a complete domination by the parent of the indirect subsidiary such as to dissolve the separate legal identity of the subsidiary, especially when, as the evidence showed in this case, the indirect subsidiary carries on its own business operations. Put another way, the centralized strategic planning and allocation of large amounts of capital, by itself, does not undermine the separate legal entity of a company down the corporate chain which operates a tangible business managed by separate directors, officers and senior managers. [101]  Nor does the fact that on several occasions Chevron guaranteed debt financings and project-related performance obligations of Chevron Canada indicate that the corporations possess a single legal identity. Certainly the lenders in those cases proceeded on the basis that parent and indirect sub were separate legal entities, otherwise they would not have asked for the guarantees of the ultimate parent. Moreover, inter-corporate guarantees are common-place in our commercial world. The granting of a guarantee by Company A does not merge its assets, in the eyes of the law, with those of borrower Company B. The guarantee does expose the separate assets of Company A to the risk of execution in the event of a default by Company B, but that result simply flows from the contractual terms agreed to by Company A, not some dissolution of its corporate separatedness. [102]  Chevron Canada files its own tax returns and corporate statements. That Chevron files a consolidated set of financial statements simply reflects the legal reporting requirements of its home jurisdiction, in particular the Sarbanes-Oxley Act of 2002 and the Securities and Exchange Act of 1934; it is not an indicia of the complete domination and control of the subsidiary by the parent. The same observation applies to the common reporting requirements found in the Chevron family of companies. At a time when legislators are insisting on higher standards of corporate governance for related groups of companies, including the disclosure of material information, efforts to comply with those requirements do not signify that the individual companies have lost their separate legal identities. [103]  Nor does the dividending-up by Chevron Canada of some of its operating profits to its parent, Chevron Canada Capital Company, which, in turn, may issue dividends up the chain signify, in itself, complete domination of the subsidiary’s operations. The distribution of profits from sub to parent via dividends is a standard fact of inter-corporate life. No evidence in this case suggested that the flow of dividends reflected complete domination in the sense used by the alter ego cases. [104]  In my view, when taken as a whole, the evidence filed on these motions supports a finding that the relationship between Chevron and Chevron Canada is, to echo the language of Sharpe J. (as he then was) in the Transamerica case, “that of a typical parent and subsidiary,” not an instance of a parent corporation exercising complete domination and control over the subsidiary. Or, to phrase that conclusion in the language of the Court of Appeal in the Canada Life Assurance case, the evidence demonstrates that Chevron Canada “looks as though it has its own business, rather than being completely subservient to and dependent upon its parent.”

Conclusion on Summary Judgment Motions [74]  For all of these reasons, I have concluded that the plaintiffs’ claim cannot succeed against Chevron Canada. Chevron Canada’s motion for summary judgment is granted. The plaintiffs’ claim against it is dismissed.

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The judgment goes on to decide a number of issues relating to defences pleaded by Chevron to the action for the recognition and enforcement of the foreign judgment, striking some of them and leaving some defences intact. The case is ongoing as this book goes to press. QUESTIONS

1. The Chevron case highlights the complex challenges associated with a stakeholder conception of the corporation when corporate groups operate in many jurisdictions. Do you think that the 30,000 Indigenous Ecuadorian villagers affected by the environmental pollution should be able to seek a remedy from Chevron’s subsidiaries, including the Canadian entity? 2.  The judgment illustrates the difficulty in drawing aside the corporate veil to hold a multinational corporation accountable for environmental harms, particularly where the corporation leaves no assets in the jurisdiction in which the harm has been caused. What is your view of the tests developed by the Canadian courts for allowing the corporate veil to be drawn aside? 3.  Large multinational corporations have tremendous resources to defend against such claims. Is there a better means of holding such corporations accountable for their actions that harm communities?

VIII. CONCLUSION As noted in this chapter and earlier chapters, there is a continuing debate over governance of the corporation, and the appropriate balance between the interests of its various stakeholders. The chapter illustrates that the stakeholder debate reaches far beyond simply the interests of shareholders, creditors, and other stakeholders within Canada. Given the predominance of multinational corporations, the stakeholder debate engages how corporations operate in multiple jurisdictions and how corporate governance decisions can affect multiple stakeholders. As Chapter 11 will illustrate, with the increased codification of corporate law in the past 30 years, there is also the issue of whether the statute has moved from being largely enabling to becoming much more directive. Codification can create greater certainty and predictability for corporate stakeholders in terms of their respective rights and responsibilities. Does it constrain economy activity or, perhaps as illustrated in the final judgment discussed in this chapter, does it allow corporations to use the separate legal personality to potentially avoid being responsible corporate citizens in their overall economic activities? Although directors have a fiduciary obligation to the corporation, it is the shareholders that, at least technically, have the ability to replace directors if they are not satisfied with the performance of the board. In reality, however, it is difficult for shareholders to exercise such rights unless they are controlling shareholders. Hence, an unresolved question is whether current corporate law is sufficiently responsive to shareholders, as well as to other interested stakeholders. These themes are canvassed further in the next two chapters. Once again, it is important to recall that other countries, such as Germany, Japan, and the Netherlands, construct their board and governance structures differently, and arguably in a manner that is more directly responsive to the interests of employees and other stakeholders.

CHAPTER ELEVEN

Board Composition and the Role of Directors I.  The Duties of Directors and Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 674 II.  Independence of Corporate Boards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 687 A.  Outside Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 687 B.  The Need for Board Diversity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 691 C.  Board Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 695 III.  Director Appointment, Replacement, and Removal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 696 A.  Few Minimum Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 696 B.  Residency Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 698 C.  Election of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 699 D.  Term of Office . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700 E.  Filling of Vacancies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701 F.  Increasing the Size of the Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701 G.  Ceasing to Hold Office . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701 H.  Removal of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701 IV.  Authority of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707 A.  Adoption, Amendment, or Repeal of the Bylaws . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707 B.  Borrowing Powers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 707 C.  Declaration of Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 708 V.  Appointment and Compensation of Officers and the Delegation of Powers . . . . . . . . . . . . 708 VI.  Directors’ Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 709 VII.  The Business Judgment Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 709 VIII.  Closely Held Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 711 IX.  Different Treatment Under Modern Canadian Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 715 X.  Shareholder Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 716 XI.  Binding the Directors’ Discretion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 718 XII.  Share Transfer Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 720 A. Types . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 720 B. Validity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 722 XIII.  The Choice Between a Closely Held and a Widely Held Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 723 XIV.  Creating National Corporate Governance Guidelines for Publicly Traded Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 724 XV.  Securities Laws Disclosure Requirements in Respect of Corporate Governance . . . . . . . 730 A.  Voluntary Guidelines, Mandatory Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 730 B.  Financial Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 734

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C.  Auditing of Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 735 D.  Certification of Disclosure and Fair Presentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 739 E.  Reporting on Internal Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 741 XVI.  The Role of Audit Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 742 A.  Independence of Audit Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 744 B.  Temporary Exceptions to Independence Requirements . . . . . . . . . . . . . . . . . . . . . . 745 C.  Financial Literacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 745 D.  Non-Audit Services to Be Approved . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 746 E. Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 747 XVII.  Corporate Charity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 747 XVIII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 749

The previous chapter explored the stakeholder debate in respect of how corporations should be governed. This chapter examines in detail the role of directors and officers, including their statutory obligations; election, removal, and compensation of directors; and their authority and power. The courts, in assessing any impugned conduct of directors, will assess whether the directors made a reasonable decision, rather than a perfect decision, as discussed below. The chapter also discusses the composition of boards of directors, including requirements under both corporate law and securities law in Canada. It examines the need to consider more diverse boards of directors if we are to create sustainable corporate governance. It is important to note, as you work your way through the materials, that the Canadian governance structure is only one of several models of corporate governance. Countries such as Japan and Germany have different governance structures under their corporate laws, developed based on different social, political, and economic histories.

I.  THE DUTIES OF DIRECTORS AND OFFICERS Under corporations statutes, directors are responsible for governance of the corporation. Section 102(1) of the Canada Business Corporations Act, RSC 1985, c C-44 (CBCA) specifies that “Subject to any unanimous shareholder agreement, the directors shall manage, or supervise the management of, the business and affairs of a corporation.” 1 Section 136(1) of the British Columbia Business Corporations Act, SBC 2002, c 57 (BCBCA) specifies that the directors manage or supervise, subject to the articles of the company. Section 112 of the Québec Business Corporations Act, CQLR c S-31.1 (QBCA) specifies that the board of directors supervise management of the company subject to a unanimous shareholder agreement. This separation of powers is set out in the corporation’s constating documents; the directors manage, not the shareholders. Directors have fiduciary obligations both at common law and under corporations statutes to act in the best interests of the corporation. They also have a statutory duty of loyalty and duty of care. Chapter 13 discusses the scope of these duties and specific remedies that shareholders or others may have if those duties are breached. In addition to these duties, the directors of issuing corporations must meet a series of other obligations under securities law 1 See also the Alberta Business Corporations Act, RSA 2000, c B-9 [ABCA], s 101(1). The Ontario Business Corporations Act, RSO 1990, c B.16 [OBCA], s 115(1) specifies that directors manage or supervise.

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and the national instruments promulgated by securities regulators. The directors must also not act in a manner that is oppressive to, unfairly prejudicial to, or unfairly disregards the interests of security holders and, in some cases, other parties. The contours of these obligations are discussed in Chapter 13 on fiduciary obligation and Chapter 14 on stakeholder remedies. While for many years there was the suggestion that the directors and officers of a corporation had a fiduciary obligation to act in the best interests of shareholders, that view was disavowed in a series of judgments rendered by the Supreme Court of Canada (SCC). The SCC has held that the fiduciary obligation is owed exclusively to the corporation. (See Peoples Department Stores Inc (Trustee of) v Wise, extracted below at para 42; and BCE Inc v 1976 Debentureholders, 2008 SCC 69, [2008] 3 SCR 560.) In the context of determining an insolvency law question, the Supreme Court of Canada in Peoples Department Stores Inc (Trustee of) v Wise discussed the scope of duties of directors and officers, both for the financially healthy and financially distressed corporation. It held that the best interests of the corporation should not be read simply as the best interests of the shareholders; rather, from an economic perspective, the “best interests of the corporation” means the maximization of the value of the corporation.

Peoples Department Stores Inc (Trustee of) v Wise 2004 SCC 68, [2004] 3 SCR 461 MAJOR and DESCHAMPS JJ:

[31]  The primary role of directors is described in s. 102(1) of the CBCA: 102(1)  Subject to any unanimous shareholder agreement, the directors shall manage, or supervise the management of, the business and affairs of a corporation.

As for officers, s. 121 of the CBCA provides that their powers are delegated to them by the directors: 121.  Subject to the articles, the by-laws or any unanimous shareholder agreement, (a)  the directors may designate the offices of the corporation, appoint as officers persons of full capacity, specify their duties and delegate to them powers to manage the business and affairs of the corporation, except powers to do anything referred to in subsection 115(3); (b)  a director may be appointed to any office of the corporation; and (c)  two or more offices of the corporation may be held by the same person.

Although the shareholders are commonly said to own the corporation, in the absence of a unanimous shareholder agreement to the contrary, s. 102 of the CBCA provides that it is not the shareholders, but the directors elected by the shareholders, who are responsible for managing it. This clear demarcation between the respective roles of shareholders and directors long predates the 1975 enactment of the CBCA: see Automatic Self-Cleansing Filter Syndicate Co. v. Cuninghame, [1906] 2 Ch. 34 (CA); see also art. 311 CCQ. [32]  Section 122(1) of the CBCA establishes two distinct duties to be discharged by directors and officers in managing, or supervising the management of, the corporation:

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Chapter 11  Board Composition and the Role of Directors 122(1)  Every director and officer of a corporation in exercising their powers and discharging their duties shall (a)  act honestly and in good faith with a view to the best interests of the corporation; and (b)  exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

The first duty has been referred to in this case as the “fiduciary duty.” It is better described as the “duty of loyalty.” We will use the expression “statutory fiduciary duty” for purposes of clarity when referring to the duty under the CBCA. This duty requires directors and officers to act honestly and in good faith with a view to the best interests of the corporation. The second duty is commonly referred to as the “duty of care.” Generally speaking, it imposes a legal obligation upon directors and officers to be diligent in supervising and managing the corporation’s affairs. [33]  The trial judge did not apply or consider separately the two duties imposed on directors by s. 122(1). As the Court of Appeal observed, the trial judge appears to have confused the two duties. They are, in fact, distinct and are designed to secure different ends. For that reason, they will be addressed separately in these reasons. A.  The Statutory Fiduciary Duty: Section 122(1)(a) of the CBCA [34]  Considerable power over the deployment and management of financial, human, and material resources is vested in the directors and officers of corporations. For the directors of CBCA corporations, this power originates in s. 102 of the Act. For officers, this power comes from the powers delegated to them by the directors. In deciding to invest in, lend to or otherwise deal with a corporation, shareholders and creditors transfer control over their assets to the corporation, and hence to the directors and officers, in the expectation that the directors and officers will use the corporation’s resources to make reasonable business decisions that are to the corporation’s advantage. [35]  The statutory fiduciary duty requires directors and officers to act honestly and in good faith vis-à-vis the corporation. They must respect the trust and confidence that have been reposed in them to manage the assets of the corporation in pursuit of the realization of the objects of the corporation. They must avoid conflicts of interest with the corporation. They must avoid abusing their position to gain personal benefit. They must maintain the confidentiality of information they acquire by virtue of their position. Directors and officers must serve the corporation selflessly, honestly and loyally: see K.P. McGuinness, The Law and Practice of Canadian Business Corporations (1999), at p. 715. [36]  The common law concept of fiduciary duty was considered in K.L.B. v. British Columbia, [2003] 2 SCR 403, 2003 SCC 51. In that case, which involved the relationship between the government and foster children, a majority of this Court agreed with McLachlin CJ who stated, at paras. 40-41 and 49: Fiduciary duties arise in a number of different contexts, including express trusts, relationships marked by discretionary power and trust, and the special responsibilities of the Crown in dealing with aboriginal interests … . What … might the content of the fiduciary duty be if it is understood … as a private law duty arising simply from the relationship of discretionary power and trust between the

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[37]  The issue to be considered here is the “specific substance” of the fiduciary duty based on the relationship of directors to corporations under the CBCA. [38]  It is settled law that the fiduciary duty owed by directors and officers imposes strict obligations: see Canadian Aero Service Ltd. v. O’Malley, [1974] SCR 592, at pp. 60910, per Laskin J (as he then was), where it was decided that directors and officers may even have to account to the corporation for profits they make that do not come at the corporation’s expense: The reaping of a profit by a person at a company’s expense while a director thereof is, of course, an adequate ground upon which to hold the director accountable. Yet there may be situations where a profit must be disgorged, although not gained at the expense of the company, on the ground that a director must not be allowed to use his position as such to make a profit even if it was not open to the company, as for example, by reason of legal disability, to participate in the transaction. An analogous situation, albeit not involving a director, existed for all practical purposes in the case of Phipps v. Boardman [[1967] 2 AC 46], which also supports the view that liability to account does not depend on proof of an actual conflict of duty and self-interest. Another, quite recent, illustration of a liability to account where the company itself had failed to obtain a business contract and hence could not be regarded as having been deprived of a business opportunity is Industrial Development Consultants Ltd. v. Cooley [[1972] 2 All ER 162], a judgment of a Court of first instance. There, the managing director, who was allowed to resign his position on a false assertion of ill health, subsequently got the contract for himself. That case is thus also illustrative of the situation where a director’s resignation is prompted by a decision to obtain for himself the business contract denied to his company and where he does obtain it without disclosing his intention. [Emphasis added.]

A compelling argument for making directors accountable for profits made as a result of their position, though not at the corporation’s expense, is presented by J. Brock, “The Propriety of Profitmaking: Fiduciary Duty and Unjust Enrichment” (2000), 58 UT Fac. L Rev. 185, at pp. 204-5. [39]  However, it is not required that directors and officers in all cases avoid personal gain as a direct or indirect result of their honest and good faith supervision or management of the corporation. In many cases the interests of directors and officers will innocently and genuinely coincide with those of the corporation. If directors and officers are also shareholders, as is often the case, their lot will automatically improve as the corporation’s financial condition improves. Another example is the compensation that directors and officers usually draw from the corporations they serve. This benefit, though paid by the corporation, does not, if reasonable, ordinarily place them in breach of their fiduciary duty. Therefore, all the circumstances may be scrutinized to determine whether the

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directors and officers have acted honestly and in good faith with a view to the best interests of the corporation. •  •  •

[42]  This appeal does not relate to the non-statutory duty directors owe to shareholders. It is concerned only with the statutory duties owed under the CBCA. Insofar as the statutory fiduciary duty is concerned, it is clear that the phrase the “best interests of the corporation” should be read not simply as the “best interests of the shareholders.” From an economic perspective, the “best interests of the corporation” means the maximization of the value of the corporation: see E.M. Iacobucci, “Directors’ Duties in Insolvency: Clarifying What Is at Stake” (2003), 39 Can. Bus. LJ 398, at pp. 400-1. However, the courts have long recognized that various other factors may be relevant in determining what directors should consider in soundly managing with a view to the best interests of the corporation. For example, in Teck Corp. v. Millar (1972), 33 DLR (3d) 288 (BCSC), Berger J stated, at p. 314: A classical theory that once was unchallengeable must yield to the facts of modern life. In fact, of course, it has. If today the directors of a company were to consider the interests of its employees no one would argue that in doing so they were not acting bona fide in the interests of the company itself. Similarly, if the directors were to consider the consequences to the community of any policy that the company intended to pursue, and were deflected in their commitment to that policy as a result, it could not be said that they had not considered bona fide the interests of the shareholders. I appreciate that it would be a breach of their duty for directors to disregard entirely the interests of a company’s shareholders in order to confer a benefit on its employees: Parke v. Daily News Ltd., [1962] Ch. 927. But if they observe a decent respect for other interests lying beyond those of the company’s shareholders in the strict sense, that will not, in my view, leave directors open to the charge that they have failed in their fiduciary duty to the company.

The case of Re Olympia & York Enterprises Ltd. and Hiram Walker Resources Ltd. (1986), 59 OR (2d) 254 (Div. Ct.), approved, at p. 271, the decision in Teck, supra. We accept as an accurate statement of law that in determining whether they are acting with a view to the best interests of the corporation it may be legitimate, given all the circumstances of a given case, for the board of directors to consider, inter alia, the interests of shareholders, employees, suppliers, creditors, consumers, governments and the environment. [43]  The various shifts in interests that naturally occur as a corporation’s fortunes rise and fall do not, however, affect the content of the fiduciary duty under s. 122(1)(a) of the CBCA. At all times, directors and officers owe their fiduciary obligation to the corporation. The interests of the corporation are not to be confused with the interests of the creditors or those of any other stakeholders. [44]  The interests of shareholders, those of the creditors and those of the corporation may and will be consistent with each other if the corporation is profitable and well capitalized and has strong prospects. However, this can change if the corporation starts to struggle financially. The residual rights of the shareholders will generally become worthless if a corporation is declared bankrupt. Upon bankruptcy, the directors of the corporation transfer control to a trustee, who administers the corporation’s assets for the benefit of creditors.

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[45]  Short of bankruptcy, as the corporation approaches what has been described as the “vicinity of insolvency,” the residual claims of shareholders will be nearly exhausted. While shareholders might well prefer that the directors pursue high-risk alternatives with a high potential payoff to maximize the shareholders’ expected residual claim, creditors in the same circumstances might prefer that the directors steer a safer course so as to maximize the value of their claims against the assets of the corporation. [46]  The directors’ fiduciary duty does not change when a corporation is in the nebulous “vicinity of insolvency.” That phrase has not been defined; moreover, it is incapable of definition and has no legal meaning. What it is obviously intended to convey is a deterioration in the corporation’s financial stability. In assessing the actions of directors, it is evident that any honest and good faith attempt to redress the corporation’s financial problems will, if successful, both retain value for shareholders and improve the position of creditors. If unsuccessful, it will not qualify as a breach of the statutory fiduciary duty. [47]  … In resolving these competing interests, it is incumbent upon the directors to act honestly and in good faith with a view to the best interests of the corporation. In using their skills for the benefit of the corporation when it is in troubled waters financially, the directors must be careful to attempt to act in its best interests by creating a “better” corporation, and not to favour the interests of any one group of stakeholders. If the stakeholders cannot avail themselves of the statutory fiduciary duty (the duty of loyalty, supra) to sue the directors for failing to take care of their interests, they have other means at their disposal. [48]  The Canadian legal landscape with respect to stakeholders is unique. Creditors are only one set of stakeholders, but their interests are protected in a number of ways. Some are specific, as in the case of amalgamation: s. 185 of the CBCA. Others cover a broad range of situations. The oppression remedy of s. 241(2)(c) of the CBCA and the similar provisions of provincial legislation regarding corporations grant the broadest rights to creditors of any common law jurisdiction: see D. Thomson, “Directors, Creditors and Insolvency: A Fiduciary Duty or a Duty Not to Oppress?” (2000), 58 UT Fac. L Rev. 31, at p. 48. One commentator describes the oppression remedy as “the broadest, most comprehensive and most open-ended shareholder remedy in the common law world”: S.M. Beck, “Minority Shareholders’ Rights in the 1980s,” in Corporate Law in the 80s (1982), 311, at p. 312. While Beck was concerned with shareholder remedies, his observation applies equally to those of creditors. [49]  The fact that creditors’ interests increase in relevancy as a corporation’s finances deteriorate is apt to be relevant to, inter alia, the exercise of discretion by a court in granting standing to a party as a “complainant” under s. 238(d) of the CBCA as a “proper person” to bring a derivative action in the name of the corporation under ss. 239 and 240 of the CBCA, or to bring an oppression remedy claim under s. 241 of the CBCA. •  •  •

B.  The Statutory Duty of Care: Section 122(1)(b) of the CBCA [54]  As mentioned above, the CBCA does not provide for a direct remedy for creditors against directors for breach of their duties and the CCQ is used as suppletive law. [55]  In Quebec, directors have been held liable to creditors in respect of either contractual or extra-contractual obligations. Contractual liability arises where the director

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personally guarantees a contractual obligation of the company. Liability also arises where the director personally acts in a manner that triggers his or her extra-contractual liability. See P. Martel, “Le ‘voile corporatif ’—l’attitude des tribunaux face à l’article 317 du Code civil du Québec” (1998), 58 R du B 95, at pp. 135-36; Brasserie Labatt ltée v. Lanoue, [1999] QJ No. 1108 (QL) (CA), per Forget JA, at para. 29. It is clear that the Wise brothers cannot be held contractually liable as they did not guarantee the debts at issue here. Extra-contractual liability is the remaining possibility. [56]  To determine the applicability of extra-contractual liability in this appeal, it is necessary to refer to art. 1457 CCQ: Every person has a duty to abide by the rules of conduct which lie upon him, according to the circumstances, usage or law, so as not to cause injury to another. Where he is endowed with reason and fails in this duty, he is responsible for any injury he causes to another person by such fault and is liable to reparation for the injury, whether it be bodily, moral or material in nature. He is also liable, in certain cases, to reparation for injury caused to another by the act or fault of another person or by the act of things in his custody. [Emphasis added.]

Three elements of art. 1457 CCQ are relevant to the integration of the director’s duty of care into the principles of extra-contractual liability: who has the duty (“every person”), to whom is the duty owed (“another”) and what breach will trigger liability (“rules of conduct”). It is clear that directors and officers come within the expression “every person.” It is equally clear that the word “another” can include the creditors. The reach of art. 1457 CCQ is broad and it has been given an open and inclusive meaning. See Regent Taxi & Transport Co. v. Congrégation des Petits Frères de Marie, [1929] SCR 650, per Anglin CJ, at p. 655 (rev’d on other grounds, [1932] 2 DLR 70 (PC)): … to narrow the prima facie scope of art. 1053 CC [now art. 1457] is highly dangerous and would necessarily result in most meritorious claims being rejected; many a wrong would be without a remedy.

This liberal interpretation was also affirmed and treated as settled by this Court in Lister v. McAnulty, [1944] SCR 317, and Hôpital Notre-Dame de l’Espérance v. Laurent, [1978] 1 SCR 605. [57]  This interpretation can be harmoniously integrated with the wording of the CBCA. Indeed, unlike the statement of the fiduciary duty in s. 122(1)(a) of the CBCA, which specifies that directors and officers must act with a view to the best interests of the corporation, the statement of the duty of care in s. 122(1)(b) of the CBCA does not specifically refer to an identifiable party as the beneficiary of the duty. Instead, it provides that “[e]very director and officer of a corporation in exercising their powers and discharging their duties shall … exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.” Thus, the identity of the beneficiary of the duty of care is much more open-ended, and it appears obvious that it must include creditors. This result is clearly consistent with the civil law interpretation of the word “another.” Therefore, if breach of the standard of care, causation and damages are established, creditors can resort to art. 1457 to have their rights vindicated. The only issue thus remaining is the determination of the “rules of conduct” likely to trigger extracontractual liability. On this issue, art. 1457 is explicit.

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[58]  The first paragraph of art. 1457 does not set the standard of conduct. Instead, it incorporates by reference s. 122(1)(b) of the CBCA. The statutory duty of care is a “duty to abide by [a] rule of conduct which lie[s] upon [them], according to the … law, so as not to cause injury to another.” Thus, for the purpose of determining whether the Wise brothers can be held liable, only the CBCA is relevant. It is therefore necessary to outline the requirements of the duty of care embodied in s. 122(1)(b) of the CBCA. [59]  That directors must satisfy a duty of care is a long-standing principle of the common law, although the duty of care has been reinforced by statute to become more demanding. Among the earliest English cases establishing the duty of care were Dovey v. Cory, [1901] AC 477 (HL); In re Brazilian Rubber Plantations and Estates, Ltd., [1911] 1 Ch. 425; and In re City Equitable Fire Insurance Co., [1925] 1 Ch. 407 (CA). In substance, these cases held that the standard of care was a reasonably relaxed, subjective standard. The common law required directors to avoid being grossly negligent with respect to the affairs of the corporation and judged them according to their own personal skills, knowledge, abilities and capacities. See McGuinness, supra, at p. 776: “Given the history of the case law in this area, and the prevailing standards of competence displayed in commerce generally, it is quite clear that directors were not expected at common law to have any particular business skill or judgment.” [60]  The 1971 report entitled Proposals for a New Business Corporations Law for Canada (1971) (“Dickerson Report”) culminated the work of a committee headed by R.W.V. Dickerson which had been appointed by the federal government to study the need for new federal business corporations legislation. This report preceded the enactment of the CBCA by four years and influenced the eventual structure of the CBCA. [61]  The standard recommended by the Dickerson Report was objective, requiring directors and officers to meet the standard of a “reasonably prudent person” (vol. II, at. p. 74): 9.19(1)  Every director and officer of a corporation in exercising his powers and discharging his duties shall •  •  •

(b)  exercise the care, diligence and skill of a reasonably prudent person.

The report described how this proposed duty of care differed from the prevailing common law duty of care (vol. I, at p. 83): 242.  The formulation of the duty of care, diligence and skill owed by directors represents an attempt to upgrade the standard presently required of them. The principal change here is that whereas at present the law seems to be that a director is only required to demonstrate the degree of care, skill and diligence that could reasonably be expected from him, having regard to his knowledge and experience—Re City Equitable Fire Insurance Co., [1925] Ch. 425—under s. 9.19(1)(b) he is required to conform to the standard of a reasonably prudent man. Recent experience has demonstrated how low the prevailing legal standard of care for directors is, and we have sought to raise it significantly. We are aware of the argument that raising the standard of conduct for directors may deter people from accepting directorships. The truth of that argument has not been demonstrated and we think it is specious. The duty of care imposed by s. 9.19(1)(b) is exactly the same as that which the common law imposes on every professional person, for example, and there is no evidence that this has dried up

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Chapter 11  Board Composition and the Role of Directors the supply of lawyers, accountants, architects, surgeons or anyone else. It is in any event cold comfort to a shareholder to know that there is a steady supply of marginally competent people available under present law to manage his investment. [Emphasis added.]

[62]  The statutory duty of care in s. 122(1)(b) of the CBCA emulates but does not replicate the language proposed by the Dickerson Report. The main difference is that the enacted version includes the words “in comparable circumstances,” which modifies the statutory standard by requiring the context in which a given decision was made to be taken into account. This is not the introduction of a subjective element relating to the competence of the director, but rather the introduction of a contextual element into the statutory standard of care. It is clear that s. 122(1)(b) requires more of directors and officers than the traditional common law duty of care outlined in, for example, Re City Equitable Fire Insurance, supra. [63]  The standard of care embodied in s. 122(1)(b) of the CBCA was described by Robertson JA of the Federal Court of Appeal in Soper v. Canada, [1998] 1 FC 124, at para. 41, as being “objective subjective.” Although that case concerned the interpretation of a provision of the Income Tax Act, it is relevant here because the language of the provision establishing the standard of care was identical to that of s. 122(1)(b) of the CBCA. With respect, we feel that Robertson JA’s characterization of the standard as an “objective subjective” one could lead to confusion. We prefer to describe it as an objective standard. To say that the standard is objective makes it clear that the factual aspects of the circumstances surrounding the actions of the director or officer are important in the case of the s. 122(1)(b) duty of care, as opposed to the subjective motivation of the director or officer, which is the central focus of the statutory fiduciary duty of s. 122(1)(a) of the CBCA. [64]  The contextual approach dictated by s. 122(1)(b) of the CBCA not only emphasizes the primary facts but also permits prevailing socio-economic conditions to be taken into consideration. The emergence of stricter standards puts pressure on corporations to improve the quality of board decisions. The establishment of good corporate governance rules should be a shield that protects directors from allegations that they have breached their duty of care. However, even with good corporate governance rules, directors’ decisions can still be open to criticism from outsiders. Canadian courts, like their counterparts in the United States, the United Kingdom, Australia and New Zealand, have tended to take an approach with respect to the enforcement of the duty of care that respects the fact that directors and officers often have business expertise that courts do not. Many decisions made in the course of business, although ultimately unsuccessful, are reasonable and defensible at the time they are made. Business decisions must sometimes be made, with high stakes and under considerable time pressure, in circumstances in which detailed information is not available. It might be tempting for some to see unsuccessful business decisions as unreasonable or imprudent in light of information that becomes available ex post facto. Because of this risk of hindsight bias, Canadian courts have developed a rule of deference to business decisions called the “business judgment rule,” adopting the American name for the rule. [65] In Maple Leaf Foods Inc. v. Schneider Corp. (1998), 42 OR (3d) 177, Weiler JA stated, at p. 192: The law as it has evolved in Ontario and Delaware has the common requirements that the court must be satisfied that the directors have acted reasonably and fairly. The court looks

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to see that the directors made a reasonable decision not a perfect decision. Provided the decision taken is within a range of reasonableness, the court ought not to substitute its opinion for that of the board even though subsequent events may have cast doubt on the board’s determination. As long as the directors have selected one of several reasonable alternatives, deference is accorded to the board’s decision. This formulation of deference to the decision of the Board is known as the “business judgment rule.” The fact that alternative transactions were rejected by the directors is irrelevant unless it can be shown that a particular alternative was definitely available and clearly more beneficial to the company than the chosen transaction. [Emphasis added; italics in original; references omitted.]

[66]  In order for a plaintiff to succeed in challenging a business decision he or she has to establish that the directors acted (i) in breach of the duty of care and (ii) in a way that caused injury to the plaintiff: W.T. Allen, J.B. Jacobs and L.E. Strine, Jr., “Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law” (2001), 26 Del. J Corp. L 859, at p. 892. [67]  Directors and officers will not be held to be in breach of the duty of care under s. 122(1)(b) of the CBCA if they act prudently and on a reasonably informed basis. The decisions they make must be reasonable business decisions in light of all the circumstances about which the directors or officers knew or ought to have known. In determining whether directors have acted in a manner that breached the duty of care, it is worth repeating that perfection is not demanded. Courts are ill-suited and should be reluctant to second-guess the application of business expertise to the considerations that are involved in corporate decision making, but they are capable, on the facts of any case, of determining whether an appropriate degree of prudence and diligence was brought to bear in reaching what is claimed to be a reasonable business decision at the time it was made. The second definitive judgment rendered by the Supreme Court of Canada in respect of director obligations was in BCE Inc v 1976 Debentureholders. The SCC held, in that case, that although directors must consider the best interests of the corporation, it may be appropriate, although not mandatory, to consider the impact of corporate decisions on shareholders or particular groups of stakeholders. This judgment is discussed in Chapters 14 and 15 in the context of the oppression remedy and a takeover transaction. For purposes of this chapter, of note is the following excerpt.

BCE Inc v 1976 Debentureholders 2008 SCC 69, [2008] 3 SCR 560 THE COURT (MCLACHLIN CJ and BINNIE, LEBEL, DESCHAMPS, ABELLA, and CHARRON JJ):

[37]  The fiduciary duty of the directors to the corporation originated in the common law. It is a duty to act in the best interests of the corporation. Often the interests of shareholders and stakeholders are co-extensive with the interests of the corporation. But if they conflict, the directors’ duty is clear—it is to the corporation: Peoples Department Stores.

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[38]  The fiduciary duty of the directors to the corporation is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is an ongoing concern, it looks to the long-term interests of the corporation. The content of this duty varies with the situation at hand. At a minimum, it requires the directors to ensure that the corporation meets its statutory obligations. But, depending on the context, there may also be other requirements. In any event, the fiduciary duty owed by directors is mandatory; directors must look to what is in the best interests of the corporation. [39] In Peoples Department Stores, this Court found that although directors must consider the best interests of the corporation, it may also be appropriate, although not mandatory, to consider the impact of corporate decisions on shareholders or particular groups of stakeholders. As stated by Major and Deschamps JJ., at para. 42: We accept as an accurate statement of law that in determining whether they are acting with a view to the best interests of the corporation it may be legitimate, given all the circumstances of a given case, for the board of directors to consider, inter alia, the interests of shareholders, employees, suppliers, creditors, consumers, governments and the environment.

As will be discussed, cases dealing with claims of oppression have further clarified the content of the fiduciary duty of directors with respect to the range of interests that should be considered in determining what is in the best interests of the corporation, acting fairly and responsibly. [40]  In considering what is in the best interests of the corporation, directors may look to the interests of, inter alia, shareholders, employees, creditors, consumers, governments and the environment to inform their decisions. Courts should give appropriate deference to the business judgment of directors who take into account these ancillary interests, as reflected by the business judgment rule. The “business judgment rule” accords deference to a business decision, so long as it lies within a range of reasonable alternatives: see Maple Leaf Foods Inc. v. Schneider Corp. (1998), 42 O.R. (3d) 177 (C.A.); Kerr v. Danier Leather Inc., [2007] 3 S.C.R. 331, 2007 SCC 44. It reflects the reality that directors, who are mandated under s. 102(1) of the CBCA to manage the corporation’s business and affairs, are often better suited to determine what is in the best interests of the corporation. This applies to decisions on stakeholders’ interests, as much as other directorial decisions. Hence, in Canada, the Supreme Court has clarified that the duties of directors and officers are to the corporation, not to a particular set of stakeholders such as shareholders or creditors. While directors may consider the interests of particular stakeholders in their strategic planning and decision-making, their fiduciary obligation is limited to acting in the best interests of the corporation. Directors may, however, owe a duty of care to particular stakeholders, and the contours of this duty are still developing. Directors can have two relationships with the same investor. In Sharbern Holding Inc v Vancouver Airport Centre Ltd, 2011 SCC 23, [2011] 2 SCR 175, the Supreme Court of Canada held that a corporation had a non-fiduciary issuer– investor relationship with the investor (principal) who was alleging misconduct, and a fiduciary principal– agent relationship with the principal once it became a manager. The latter relationship gave rise to an obligation to act in the interests of the principal. However, this relationship was entered into with the knowledge that there would be common management of two hotels; thus, the fiduciary

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relationship was circumscribed by the contractual bargain and the knowledge that the corporation would be simultaneously balancing fiduciary obligations; essentially the principal consented to the agent’s conflict of interest (at paras 143, 150). On the facts, the court held that the principal had failed to demonstrate that a failure to disclose compensation differences was material in the circumstances, and the appeal was dismissed. NOTES AND QUESTIONS

1.  The Supreme Court of Canada in Peoples Department Stores Inc (Trustee of) v Wise held that “best interests of the corporation” means the maximization of the value of the corporation, citing Teck Corp v Millar (1972), 33 DLR (3d) 288 (BCSC), and that directors can consider the interests of employees and communities in acting in that best interest. In your view, does that give directors sufficient direction as to how they should exercise their decision-making powers? 2.  The Supreme Court of Canada also held that there was a duty of care to various stakeholders. In your view, what kinds of decisions by directors might breach that duty of care? 3.  Section 119 of the new QBCA now includes a statutory duty of care “to act with prudence and diligence, honesty and loyalty and in the interest of the corporation” in addition to obligations imposed by the Civil Code of Québec, CQLR c CCQ-1991. Considering the reasoning in the Peoples Department Stores Inc (Trustee of) v Wise judgment, how does the court address the interplay of Canadian common law corporations statutes and Québec civil law? In Nielsen (Estate of) v Epton, below, the issue was whether a corporate director owes a personal duty of care to corporate employees. An employee, Nielsen, was killed while operating a hoist to lift a spreader beam at the shop of his employer, Fabtec. The beam was designed in a manner in which it could not safely latch onto the type of hoist used, and the beam fell and struck Nielsen. Epton, Fabtec’s president and chief executive, was not present at the time of the accident, but had issued specific instructions to Fabtec’s onsite supervisor to install the beam. The company did not have a safety policy with regard to operating the hoist. Nielsen’s estate sought to hold Epton personally liable in negligence for acts and omissions in his capacity as a director. The plaintiff alleged that Epton failed to ensure that the accident did not occur when he knew or ought to have known that the beam could not safely latch onto the hoist, and that Epton failed to set out proper workplace safety measures. Epton had not purchased coverage for himself as a director under Alberta’s Workers’ Compensation Act, RSA 2000, c W-15. Had he done so, any claim would have been dealt with under that statute and a separate tort action against Epton would have been precluded. In comprehensive reasons reported at Nielsen (Estate of) v Epton, 2006 ABQB 21, the trial judge concluded that Epton owed a personal duty of care to Nielsen. The court apportioned 50 percent of the blame to Epton and found Epton vicariously liable for the blame apportioned to another corporate employee, Edworthy, and a volunteer crane operator, Atwood. The judgment was appealed. On appeal, Epton argued that the trial judge erred in applying the law of directors’ liability by failing to distinguish between Epton’s actions as a director, his actions as a worker, and the actions of Fabtec; erred in finding that Epton breached the relevant standard of care in the absence of evidence establishing that standard of care; and erred in finding Epton vicariously liable as a director for the acts of Atwood and Edworthy. The Alberta Court of Appeal held the following.

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Nielsen (Estate of) v Epton 2006 ABCA 382 COSTIGAN JA (for the court):

[20]  It is settled law that a corporate director may have a personal duty of care and may be liable for acts that are in themselves tortious: Montreal Trust Co. of Canada v. ScotiaMcLeod Inc. (1995), 129 D.L.R. (4th) 711, 26 O.R. (3d) 481 (C.A.); Blacklaws v. 470433 Alberta Ltd. (2000), 84 Alta. L.R. (3d) 270, 2000 ABCA 175. [21]  The trial judge was careful to distinguish between acts, duties and standards attributable to Epton and those attributable to Fabtec. He found that Epton had a personal duty to oversee workplace safety and that he did nothing to design or implement acceptable workplace safety standards. Those findings, coupled with the findings that Epton was involved in the first lift attempt and knew the spreader beam did not properly fit the hoist hook and safety latch, amply support the conclusion that Epton’s acts were tortious in themselves. [22]  Viva voce evidence of the appropriate standard of care is not invariably necessary. In this case the trial judge referenced statutory authority for the standard of care and, in any event, found that Epton’s conduct fell short of any reasonable standard. We discern no reviewable error in those conclusions. [23]  Nor did the trial judge apply the wrong test in apportioning liability. It is clear, on the whole of his reasons, that he assessed comparative blameworthiness of the parties and that his percentage allocations are reasonable. [24]  However, the trial judge erred in law in finding Epton vicariously liable for the tortious acts of Edworthy, a Fabtec employee, and Atwood, the volunteer crane operator. [25]  Historically, vicarious liability was imposed on masters for the acts of their servants. Liability arose because the master exercised control over the servant: G.H.L. Fridman, The Law of Torts in Canada, 2nd ed. (Toronto: Carswell, 2002) at 277. Two policy reasons support vicarious liability: the provision of a just and practical remedy and deterrence of future harm: Bazley v. Curry, [1999] 2 S.C.R. 534, (1999), 174 D.L.R. (4th) 45 at paras. 26-36. We are not aware of any cases that have imposed vicarious liability on a corporate director for the tortious acts of a corporate employee or volunteer. [26]  The respondents suggest three bases for Epton’s vicarious liability. First, they argue that Epton can be considered an employer because the definition of “employer” in the Occupational Health and Safety Act, R.S.A. 1980, c.O-2 includes some corporate directors. This statutory definition is not sufficient to establish the requisite factual underpinnings for vicarious liability. [27]  Second, they cite Blackwater v. Plint, [2005] 3 S.C.R. 3, 2005 SCC 58 [Blackwater] and argue that Epton need not be an employer as long as he is a “controlling agent.” In Blackwater, the United Church of Canada was found vicariously liable for sexual assaults perpetrated by a dormitory supervisor at a residential school. The Church hired, fired and directly supervised the perpetrator. The court imposed vicarious liability on the Church because it was an employer of the perpetrator in every sense of the word. [28]  Epton was not the employer of Edworthy or Atwood. Moreover, the indicia used in Blackwater to support the finding that the Church had sufficient control over the

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perpetrator to be found vicariously liable are absent on the facts of this appeal. Accordingly, Epton was not an employer or controlling agent as those terms are used in Blackwater. [29]  Finally, the respondents say Epton is vicariously liable because he had a nondelegable duty as a director to ensure the health and safety of Fabtec’s workers. But that is a basis for Epton’s direct liability. It cannot also be a basis for imposing vicarious liability. [30]  There is no doubt that Fabtec employed Edworthy and could be vicariously liable for Edworthy’s tortious acts. It is less clear, but arguable, that Fabtec could also be vicariously liable for Atwood’s tortious acts. Fabtec’s potential vicarious liability satisfies the two policy reasons for the imposition of vicarious liability. The fact that the Workers’ Compensation Act prevents Fabtec from being vicariously liable in this case is not a principled reason for imposing vicarious liability on Epton. Some compensation for Nielsen’s death is available under the scheme of that legislation. [31]  Therefore, on the facts of this appeal, Epton was not an employer or controlling agent and there is no principled policy reason for imposing vicarious liability on him. Accordingly, Epton is not vicariously liable for 49% of the blame. [32]  In the result, the appeal is allowed in part and Epton’s liability is reduced to 50% of the loss. QUESTIONS

1.  Do you think that the court in Nielsen (Estate of) v Epton articulated the appropriate test for finding a duty of care by directors? 2.  Are there any other factors that should comprise the duty of care?

II.  INDEPENDENCE OF CORPORATE BOARDS A.  Outside Directors CBCA s 102(2) requires that at least two directors of a publicly traded corporation be outside directors.2 BCBCA s 120 requires at least three directors for a publicly traded corporation, but does not have an outside director requirement. However, it is important to remember that under securities legislation, issuers are required to have independent directors, as discussed below. The Toronto Stock Exchange report Where Were the Directors? (Toronto: TSX, 1994) recommended that boards of exchange-listed corporations consist of a majority of “unrelated” directors. An unrelated director is a director who is free from any interest in any business or other relationship which could, or could reasonably be perceived to, materially interfere with the director’s ability to act with a view to the best interests of the corporation, other than interests and relationships arising from shareholding.

2 ABCA s 101(2). Ontario requires at least one-third of directors to be outsiders: OBCA s 115(3).

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The report noted that a management director would not be an unrelated director. The corporation should describe its system of corporate governance in its annual report or information circular, including the analysis of who constituted an unrelated director. The report also suggested that the audit committee should consist exclusively of outside directors. It further recommended that the corporation should enable individual directors to engage outside advisers at the expense of the corporation in appropriate circumstances. In May 1995, the TSX adopted a bylaw requiring disclosure of corporate governance practices for TSX-listed companies.3 Under securities law, there are disclosure requirements for director independence in issuing corporations, as is discussed at length below. “Independent” outside directors now comprise the majority of board memberships in Canadian public corporations, and only one-quarter of board members of firms of all asset sizes are employees of the firm.4 The larger the firm, the higher the proportion of outside directors. On a narrower definition of outside director, excluding non-employee directors with a business or family relationship to the firm, they still amount to 55 percent of board membership, with a higher proportion for Canadian-owned, widely held corporations.5 As of 2011, another study found that the percentage of Canadian firms where all outside directors are independent has risen to 71 percent.6 Outside directors will frequently have had some business relationship with the firm prior to their appointment. Pursuant to CBCA s 102(2), the statutory standard of what constitutes an outside director is persons who are “not officers or employees of the corporation or its affiliates,” and a requirement that would be met by the corporation’s retired executives, by its outside counsel, and by other retained advisers such as investment bankers. Such directors may not be wholly independent of management’s influence. However, a useful kind of outside director is likely one with some relation to the firm, since the flow of information between the firm and its bankers, underwriters, and lawyers is thereby facilitated. If board composition might affect firm wealth, it should not be supposed that one kind of board is optimal for every firm. The best board composition may be more easily achieved with a minimum of mandatory rules. Outside directors have an important role in protecting the interests of stakeholders in a corporation, particularly one that is widely held, such that shareholders and others are not closely monitoring the activities of inside directors. An important function of the board is to supervise the officers of the company; hence a certain number of directors must be independent to allow this oversight and monitoring. Professors Gilson and Kraakman have suggested that the role of outside director should be recast as a full-time professional director who would have the requisite expertise and would serve on the boards of perhaps six corporations. These professional directors would be chosen by institutional investors who might organize a separate clearing house to

3 See TSX Bylaw s 19.17, now incorporated into TSX Company Manual s 472 and referenced to NI 58-101, Disclosure of Corporate Governance Practices. 4 Thomas H Mitchell, Canadian Directorship Practices: A Profile 1984 (Ottawa: Conference Board of Canada, 1984) at 19-21. 5 Ibid. 6 Karla Thorpe, 2011 Canadian Directors’ Compensation and Board Practices (Ottawa: Conference Board of Canada, 2011).

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coordinate action among institutional investors for the selection of directors.7 This proposal is contested by Professors Rock and Coffee, who question the effectiveness of having institutional investors choose and monitor professional directors, arguing that they may not have sufficient incentive to monitor the professional directors and would also face a conflict of interest because the boards on which professional directors would serve would often be clients or potential clients of the institutional investor.8 One issue is whether the risk of personal liability for outside directors will act as a deterrent to attracting such directors. A study by Black, Cheffins & Klausner suggests not.9 They analyzed the out-of-pocket liability risk facing outside directors, and concluded that this risk is very low, far lower than many commentators and board members believe. Their research found only 13 cases in 25 years in which outside directors of public companies have made out-of-pocket payments, most involving fact patterns that they conclude are not likely to recur today for a company with a state-of-the-art directors and officers (D&O) insurance policy. They suggest that if a corporation has a D&O policy with appropriate coverage and sensible limits, outside directors will be potentially vulnerable to out-ofpocket liability only when (1) the company is insolvent and the expected damage award exceeds those limits, (2) the case includes a substantial claim under securities legislation, and (3) there is an alignment between outside directors’ or other defendants’ culpability and their wealth. They also observe that the principal threats to outside directors who perform poorly are the time, aggravation, and potential harm to reputation that a lawsuit can entail, not direct financial loss. The need for board independence is discussed in the following excerpt.

Janis Sarra & Vivian Kung, “Corporate Governance in the Canadian Resource and Energy Sectors” (2006) 43 Alta L Rev 905 at 910-11 The first indicator of effective corporate governance is the necessity of board independence. If directors are to engage in effective oversight, they need to be able to critically and independently assess the actions of managers. Independence is implicated in all ten indicators because without board independence, the rest of the governance measures are likely to be less effective. However, independence as an indicium of effective governance should be defined as not only unrelatedness in terms of financial interest (other than shareholdings); it should also include the ability of a director to critically examine, and where necessary challenge, the strategic and operational decisions of corporate officers where the director believes a particular decision or strategy is or may not be in the overall

7 RJ Gilson & R Kraakman, “Reinventing the Outside Director: An Agenda for Institutional Investors” (1991) 43 Stan L Rev 863 at 872-76. 8 B Rock, “The Logic and (Uncertain) Significance of Institutional Shareholder Activism” (1991) 79 Geo LJ 445 at 453-78; and JC Coffee, “Liquidity Versus Control: The Institutional Investor as Corporate Monitor” (1991) 91 Colum L Rev 1277 at 1329-36. 9 Bernard S Black, Brian R Cheffins & Michael D Klausner, “Outside Director Liability” (2006) 58 Stan L Rev 1055, online: .

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best interests of the corporation. Inside directors have information advantages that may assist in critical assessment of corporate performance, although their critique may be tempered given their economic dependence on continued employment and concern about reputational capital. Hence, while they are not “unrelated,” they bring information to the board room that can contribute to overall board independence. All of the advantages and disadvantages of outside and inside directors need to be considered in constructing the optimal mix of board membership that encourages independent oversight. While the authors sought to unearth this facet of independence in the surveys, it was impossible to truly measure. Hence, the results reported here are those that meet securities and stock exchange criteria in terms of the meaning of independence or unrelatedness. The TSX Corporate Governance Guidelines recommend that every corporation’s board of directors should comprise a majority of “unrelated” individuals, defined as a nonmanagement director that is free from any interest or relationship that either could or could reasonably be perceived to materially interfere with the director’s capacity to act in the corporation’s best interests, other than interests and relationships emanating from shareholding. The NYSE Rules require that listed companies have a majority of independent directors with no material relationship with the company. Material relationships may encompass “commercial, industrial, banking, consulting, legal, accounting, charitable, and familial affiliations.” These definitions have been tightened in the US in the past two years, in the wake of Enron, WorldCom and other recent corporate failures that highlighted the challenges for independence. Those companies met statutory definitions of independence; however, indirect financial benefits, corporate climate and failure to effectively engage in oversight resulted in a complete failure of governance to the detriment of investors, employees and creditors alike. The challenge for new independence criteria is not so much the prohibition of undisclosed self-dealing transactions, for which there is greater vigilance, but rather, whether the rules create the appropriate incentive effects in terms of truly engaged and independent oversight. One feature of this increased board independence is whether the board has a non-management board chair or a lead director, in order to offer some independence from the CEO or president of the corporation. Good governance practice also suggests that non-management directors convene sessions in the absence of inside directors on a relatively regular basis. This practice has become a requirement of the NYSE Rules and is recommended by the Canadian Securities Administrators (CSA) in its new corporate governance guidelines. The meetings of independent directors without inside directors and senior managers allow directors to speak candidly about issues or strategies that are of concern. Whereas five years ago, the notion of independent directors meeting separately was highly contested, it is now viewed as one more element to ensure real, and not just statutorily defined, independence. The audit committee of a board of directors is particularly important as it has specific duties to review the corporation’s financial statements prior to their approval by the board, and that acts as a liaison between the board of directors and the corporation’s outside auditors. For publicly-traded corporations, a majority of the members of the audit committee must be independent—they must be neither officers nor employees of the corporation. The hoped-for independence of the audit committee is thought to provide an additional check on the audit process. Previously there was accounting scandals, in which

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auditors were fashioning reporting where corporate officers were in a position to award lucrative consulting contracts to the same accounting firms appointed as the firm’s auditors. Now regulatory provisions require most reporting issuers to establish an audit committee and include rules as to the composition and responsibilities of such committees.

B.  The Need for Board Diversity Canadian boards are also overwhelmingly male, even though, arguably, board diversity enhances corporate governance, as illustrated in the following two excerpts.

Janis Sarra, “Class Act: Considering Race and Gender in the Corporate Boardroom” (2005) 79 St John’s L Rev 1121 at 1125 (footnotes incorporated into text) Although there are no precise figures, a recent survey found that only 7.4% of Canadian corporate board seats are held by women, with 353 women holding 431 directorships (Catalyst Perspective 2002). This is less than half the percentage in the United States and well below the 47% participation rate of women in the Canadian workforce (Statistics Canada, Employment by Age, Sex, Type of Work, Class of Worker and Province). Once public sector enterprises and non-profit corporations are included, women account for 16% of board members. Yet two in seven Canadian boards are still all-male. The number of racial minorities on Canadian boards is unknown, although one limited survey found that the figure was less than 2% (D. Brown, A Quantum Leap: Canadian Directorship Practice (1997); David Brown & Debra Brown, Success in the Boardroom (1998). •  •  •

Diversity on the corporate board can enhance corporate governance, in turn increasing enterprise wealth maximization. The Conference Board of Canada has reported that there are both practical and symbolic reasons to have diverse boards. Using gender as a proxy for diversity, it conducted a study aimed at measuring the results of gender diversity on boards. The Conference Board tracked corporations for six years and found that boards with two or more women directors in 1995 were far more likely to be industry leaders in profits six years later. It found that 94% of boards with three or more women explicitly monitor the implementation of corporate strategy, compared with 66% of all-male boards; 74% of boards with three or more women explicitly identify criteria for measuring strategy, compared with 45% of all-male boards; and 86% of boards with three or more women adopted a corporate code of conduct, compared with 66% of non-diverse boards. Where corporations had three or more women on the corporate board, the study found that 94% of boards ensured compliance with internal conflict of interest guidelines compared with 68% of all-male boards. Seventy-two percent of boards with two or more women conduct formal board performance evaluation, compared to 49% of all-male boards. These boards are more likely to have formal orientation and training programs and formal written limits to authority (Conference Board, “Women on Boards: Not Just the Right Thing, but the Bright Thing” (2002)).

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Overall, the study concluded that an increased number of women on corporate boards is likely to enhance the oversight and monitoring activities of corporate boards. Its research found that “diversity on boards … does change the functioning and deliberative style of the board in clear and consistent ways” and that “good governance improves organizational performance over the long term, financially and non-financially.” Important from an enterprise wealth maximization perspective, the Conference Board found that 86% of boards with three or more women have two-way communication between the corporation and its stakeholders, compared with 71% of all-male boards. It found that women are more likely to consider measures of innovation, and social and community responsibility; and that there is a correlation between women on boards and higher levels of customer and employee satisfaction. Finally, it concluded that women directors make a practical difference to the independence and activism of boards, and are more likely to implement and monitor the indicia of good governance developed by international organizations. A more recent study found that boards have made little progress in the past decade in terms of diversity. The percentage of female directors is 10 percent, an increase from 8 percent in 2008. Currently, 18 percent of corporate boards have at least one director who is a member of a visible minority, an increase from 13 percent in 2008.10 While, arguably, more diverse boards can enhance decision-making, there is some debate about just how effective outside directors, whatever their gender, race, or background, are in monitoring corporate management. First, outside directors are often not truly independent of management because they are often selected by management. Outside directors are themselves often executives of other businesses and thus share similar perspectives to management on just how closely managers should be monitored. Many outside directors will have similar backgrounds to management and share similar views. Outside directors can also lack the information, staff, expertise, or time to monitor management effectively. While the outside directors are expected to monitor the managers, an issue is: who monitors the outside directors? The market is unlikely to monitor outside directors any better than it monitors the inside directors.11 Bill C-25, An Act to amend the Canada Business Corporations Act, etc., 1st Sess, 42nd Parl (second reading and referral to Committee in the House of Commons 9 December 2016), if enacted, will require corporations to disclose annually to shareholders information on diversity among the directors and members of senior management. The proposed language is one of “comply or explain,” requiring corporations to disclose representation and policies to address diversity, or to explain where there are no policies in place. This approach is consistent with the approach of Canadian securities regulators, and does not adopt an approach of mandating levels of representation, as required in some European jurisdictions.

10 Thorpe, supra note 6. 11 Gilson & Kraakman, supra note 7 at 872-76.

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Aaron A Dhir, “Towards a Race and Gender-Conscious Conception of the Firm: Canadian Corporate Governance, Law and Diversity” (2010) 35 Queen’s LJ 569, online: (footnotes omitted) The representation of women and racialized persons on Canadian corporate boards is strikingly low and does not reflect Canada’s current demographics and labour market availability. Women constitute just over 50 percent of the Canadian population, yet in 2007 they held only 13 percent of the director positions of Financial Post 500 companies (only a slight improvement of 1 percent from 2005). More than 40 percent of these corporations employed no female directors at all in 2007, and just 3.4 percent had women chairing the board. Another recent study found the proportion of Canadian female board members to be “15% less than the comparable U.S. boards.” In fact, the reality is even more severe than these statistics indicate, given that some women occupy multiple board seats. Racialized groups account for over 16 percent of Canada’s population. From 2001 to 2006, these groups grew at five times the overall growth rate. Persons born outside Canada represent 19.8 percent of the overall populace—the largest proportion in the last 75 years. Over the next three years, it is anticipated that immigrants “will account for 100 percent of Canada’s net labour force growth.” This is especially relevant as 75 percent of immigrants are racialized, with the majority of recent immigrants having been born in the Middle East and Asia. Despite these figures, studies indicate that racialized directors occupy a dismal 1.7 percent of Canadian corporate directorships, and that U.S. firms noticeably outperform comparable Canadian firms on issues of racial and ethnic board diversity. •  •  •

At a conceptual level, key aspects of the market-based rationale for enhanced board heterogeneity can be rooted in the organizational behaviour and economic theories of agency, transaction costs and resource dependence and have been summarized as follows: (1)  diversity improves the ability of the board to monitor managers due to increased independence; (2)  diversity improves the decision making of the board due to unique new perspectives, increased creativity, and non-traditional innovative approaches; (3)  diversity improves the information provided by the board to managers due to the unique information held by diverse directors; (4)  diverse directors provide access to important constituencies and resources in the external environment; (5) board diversity sends important positive signals to the labour market, product market, and financial market, and (6)  board diversity provides legitimacy to the corporation with both external and internal constituencies. •  •  •

[I]n running the affairs of the corporation, Canadian directors (and officers) are required by statute to “act honestly and in good faith with a view to the best interests of the corporation.” Recent developments in corporate law jurisprudence suggest that

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in discharging this fiduciary obligation, directors may consider the interests of nonshareholder constituents such as creditors, employees, consumers, suppliers, the environment and the broader community. As I have discussed elsewhere, numerous practical and conceptual difficulties accompany this development. However, leaving these difficulties aside, the reality is that while directors are not under a legal obligation to act on such considerations, they will not be in violation of their fiduciary duty if they do so. This case law represents a shift in how fiduciary obligations have been conceptualized under Canadian corporate law—a shift away from interpreting the “best interests of the corporation” as necessarily being synonymous with maximizing shareholder return. This, I think, should be of real interest to human rights advocates. The overseas operations of some Canadian corporations, primarily within the extractive industry, are continually impugned for their impact on human rights. Canada has more mining firms listed on its stock exchanges than any other country, and these exchanges represent “the world’s largest source of equity capital for mining exploration and production both in Canada and abroad.” When one disaggregates board composition statistics by industry, extractive companies are among the worst in terms of gender representation. This is particularly noteworthy, given the suggestion in some studies that boards with a critical mass of female directors are more likely to be attuned to non-shareholder interests. In other words, boards with broader levels of representation may be better situated to address the environmental, social and human rights impacts of transnational corporate conduct. Although disclosure of board composition falls short of requiring boards to diversify, requiring greater transparency can create at least some marginal change as corporations seek to protect reputational capital. In 2015, the Canadian Securities Administrators published a study on the gender composition of publicly traded corporations,12 finding that of 722 issuers, 49 percent of these issuers had at least one woman on their board, with more than a third of those companies having added a woman in the year prior; 60 percent had at least one woman in an executive officer position; and almost a third of the issuers with a market capitalization above $2 billion had adopted a written policy for identifying and nominating women directors. NOTES AND QUESTIONS

1.  Do you think it is necessary to regulate the number of unrelated or outside directors, or should this decision be made by shareholders? 2.  Professor Dhir points out the importance of board diversity in board decision-making. Recall the judgment in Yaiguaje v Chevron Corporation, 2017 ONSC 135 at the end of Chapter 10. A diverse board may have been more attuned to issues of fundamental human rights of companies operating in foreign jurisdictions.

12 CSA Multilateral Staff Notice 58-307, Staff Review of Women on Boards and in Executive Officer Positions— Compliance with NI 58-101 Disclosure of Corporate Governance Practices (28 September 2015).

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The structure of Canadian corporations suggests that some regulatory intervention may be necessary to ensure that directors, officers, and controlling shareholders do not engage in self-dealing transactions to the detriment of investor interests. Corporate governance mechanisms are the means to ensure that this conduct does not occur, as directors are responsible for oversight and for acting in the best interests of the corporation. How a board structures its activities may have a direct impact on the level of accountability by officers for their overall strategic and risk management decisions. In Canada, such structures have not been regulated generally, although, as this section of the chapter reveals, in areas such as audit committees, regulators have imposed independence and financial literacy requirements as investor protection measures. For other aspects of governance, regulation has intervened largely to require disclosure of corporate governance practices.

C.  Board Committees Boards of directors function in a number of ways. Board committees, composed of several directors, can be a very important means of keeping careful oversight of particular corporate activities, or undertaking important tasks on behalf of the board. For example, a board’s strategic planning committee works with officers to discern upside and downside market risks and help craft or approve long-term strategies for coping with or taking advantage of these risks. A board compensation committee undertakes research and makes recommendations with respect to compensation for the corporation’s senior officers. The board will also have an audit committee, whose role is to work with the external auditors to ensure effective oversight of the corporation’s financial records. Frequently, corporate law statutes do not require an audit committee unless the corporation is an issuer. Board committees bring their recommendations to the board of directors as a whole for approval or further discussion. The committees allow individual directors to focus their efforts in particular areas of corporate activity, based on the skills that they bring to the board. Where a board comprises a small number of directors, these functions are frequently undertaken by the board as a whole. Board committees allow for some tasks, such as that of the compensation committee, to be undertaken by those directors who are independent, as they are not economically dependent on the CEO for their continued livelihood. Note that CBCA s 102(2) refers to the required number of directors for issuing corporations,13 and s 158 refers to directors approving the financial statements. Board committees are not regulatory requirements, although some aspects are viewed as best practice. Similarly, there is no statutory or regulatory requirement that the CEO and the board chair be different individuals, although best practice suggests that this separation of roles enhances corporate governance. In Canada, given the closely held nature of corporations, the controlling shareholder is often both the CEO and chair of the board. Some corporations have addressed the inevitable conflicts of interest that such a structure creates by also creating the position of lead director, whose role is to ensure that the board of directors

13 Section 102(2) specifies: “A corporation shall have one or more directors but a distributing corporation, any of the issued securities of which remain outstanding and are held by more than one person, shall have not fewer than three directors, at least two of whom are not officers or employees of the corporation or its affiliates.”

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is operating with independent oversight and is not unduly influenced by the CEO/chair. While this strategy has been effective in a number of cases, it is easy to see how appointing a lead director in itself will not assure that a board operates effectively to provide an independent accountability check on inside directors. Yet, the enabling nature of corporate law means that it is for those individuals creating the corporation to make those decisions, and for shareholders, in their periodic voting for directors, to affirm such governance choices. Publicly traded corporations must disclose information on their board committees and other governance practices, which in turn may pressure corporations into assessing whether their board structure and practices are as effective as they can be.

III.  DIRECTOR APPOINTMENT, REPLACEMENT, AND REMOVAL A.  Few Minimum Requirements While directors are encouraged to engage in good corporate governance practices, including strategic planning, upside and downside risk assessment, oversight and monitoring of the finances of the corporation, and monitoring of the decision-making activities of the corporation’s officers, there are no mandated standards of corporate governance. However, there are an increasing number of regulatory instruments that require disclosure of corporate governance practices, as discussed later in this chapter. Directors also have an obligation to dissent where they do not agree with board decisions, and recording of such dissent may act as a liability shield in some circumstances, if actions are brought against the directors for a decision that is contrary to law. In modern corporations legislation, directors’ mandatory qualification requirements are minimal. They must be natural persons, over 18 years of age, not bankrupt, and not of unsound mind, or, in the language of the BCBCA, “incapable of managing the individual’s own affairs.”14 The draft amendments to the CBCA, if enacted, will also change the qualification language to “incapable,” defined to mean “that the individual is found, under the laws of a province, to be unable, other than by reason of minority, to manage their property or is declared to be incapable by any court in a jurisdiction outside Canada” (proposed s 2(1), Bill C-2515). While for many years, directors had to be shareholders of the corporation— hence the expression “director’s qualifying share”—most Canadian statutes no longer impose such a requirement.16 QBCA s 109 specifies that “[u]nless otherwise provided in the articles, a director is not required to be a shareholder.” However, in practice, directors are

14 CBCA s 105(1); ABCA s 105(1); BCBCA s 124(2)(b); and OBCA s 118(1). The OBCA was amended effective in 2007 to specify that “[a] person who has been found under the Substitute Decisions Act, 1992 or under the Mental Health Act to be incapable of managing property or who has been found to be incapable by a court in Canada or elsewhere” is ineligible to be a director: OBCA, s 118(1), as amended by SO 2006, c 34, Schedule B, effective 1 August 2007. The QBCA s 108 specifies: “Any natural person may be a director of a corporation, except persons disqualified for the office of director under the Civil Code or persons declared incapable by decision of a court of another jurisdiction.” 15 Bill C-25, An Act to amend the Canada Business Corporations Act, the Canada Cooperatives Act, the Canada Not-for-profit Corporations Act, and the Competition Act, 1st Sess, 42nd Parl (second reading and referral to Committee in the House of Commons (9 December 2016). 16 CBCA s 105(2); ABCA s 105(2); BCBCA s 125; and OBCA s 118(2).

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often compensated through a mix of stipends and shares or share options. Publicly held corporations must have at least three directors, while closely held corporations may have as few as one.17

Janis Sarra & Vivian Kung, “Corporate Governance in the Canadian Resource and Energy Sectors” (2006) 43:4 Alta L Rev 905 at 906-7 Enterprise wealth maximization is an objective that is aimed at long-term sustainability of the corporation, not merely short-term return to investors. It also takes account of multiple stakeholders in terms of inputs to the corporation, including equity investors, secured and unsecured lenders, trade suppliers, employees and the communities in which corporations operate. … Best practice now suggests that corporations should establish a nominating committee that is composed entirely of unrelated directors. This committee should be responsible for identifying qualified candidates, selecting or recommending to the board selection of director nominees, and retaining outside advisers and search firms to locate candidates. A key aspect is to develop and approve a set of criteria for potential directors, in terms of the board’s strategic needs and requirements. Board diversity is generally thought to enhance the capacity of the board to engage in critical oversight and to bring diverse relational and other assets to the oversight task, in turn maximizing enterprise wealth. Boards should manifest an array of skill sets and backgrounds in order to have oversight expertise in all aspects of the corporation’s operations. Moreover, sufficient minority group representation is arguably linked to good corporate governance. This diversity may be particularly relevant where corporations are operating in multiple jurisdictions with different cultural and economic norms. However, there would be substantial information costs for constituency representatives to become informed participants on the board. Participation by various constituencies, especially employees, may direct the attention of the board to day-to-day operating-level concerns at the expense of focus on strategic concerns. However, it may also identify production and other strategic synergies that only those who have direct experience can offer. There may also be potential for opportunistic behaviour by constituencies that have contractual arrangements with the corporation. However, this risk already exists with directors that have commercial contracts with the company on whose board they sit. Hence, there are both benefits and costs associated with stakeholder representation on corporate boards. The most frequently cited example of employee representation on the board of directors is the approach to employee co-determination in Germany. In Germany, public corporations, called Aktiengesellschaften in German, have a mandatory two-tiered board system consisting of a management board and a supervisory board of non-management directors. In

17 CBCA s 102(2); ABCA s 101(2); BCBCA s 120; and OBCA s 115(2) specify that there not be fewer than three directors. QBCA s 106 specifies that publicly held corporations must have at least three directors, two of whom are not employees of the corporation.

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businesses other than the coal, iron, and steel industries, for which there is a separate codetermination statute, one-third of the supervisory board must consist of employee representatives in firms having fewer than 2,000 employees, and one-half of the supervisory board must be employee representatives in Aktiengesellschaften with more than 2,000 employees. There is no requirement for employee co-determination in corporations statutes in Canada. However, s 101(8)(b) of the Saskatchewan Business Corporations Act provides that the articles can provide for the election or appointment of directors by creditors or employees of the corporation.18 Participation on the board of directors may be an effective technique for protecting employees where, as noted above, they make firm-specific human capital investments. An employee representative on the board of directors may also assist in overcoming informational asymmetries between corporate management and employees. Creditors of the corporation might also be represented on the board of directors; however, creditors typically have defined terms for their loans and can protect their interests through a variety of contractual devices such as taking security interests in assets of the corporation or creating various legal rights when the corporation fails to meet tests of financial soundness. Hence, they may have less need for the protection that representation on the board of directors may afford. This situation can change when a firm is in financial stress and creditors become involved as the residual claimants. Under a different approach, Dutch corporate law specifies that the board is to act in the interest of the company and all its stakeholders; and it reserves positions on the board for social interests and social responsibility.19 Finally, one could consider consumer representation on the board as a way to possibly assist consumers in addressing problems such as the health hazards associated with a corporation’s products. However, there are difficulties in determining who would be representative of consumers. Alternatively, consumer concerns can be addressed through advisory committees and may not require board representation.

B.  Residency Requirements Previously, corporate law statutes specified that a majority of directors must be resident Canadians; see e.g. the previous s 118(3) of the OBCA. Under the 2006 amendments to OBCA s 118(3), effective 2007, at least 25 percent of the directors of a corporation other than a

18 SBCA s 101(8) reads: “The articles may provide for the election or appointment of a director or directors: … (a) for terms expiring not later than the close of the third annual meeting of shareholders following the election; … (b) by creditors or employees of the corporation or by a class or classes of those creditors or employees.” Section 97(2) of that statute specifies that a corporation shall have one or more directors, and a publicly held company is to have not fewer than three directors, at least two of whom are not officers or employees of the corporation or its affiliates. 19 Waheed Hussain, “The Law Should Make Boards More Diverse,” New York Times (4 July 2012), online: . J van Bekkum, JBS Hijink, MC Schouten & JW Winter, “Corporate Governance in the Netherlands,” (December 2010) 14.3 Electronic Journal of Comparative Law, online: .

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non-resident corporation must be resident Canadians, but where a corporation has fewer than four directors, at least one director must be a resident Canadian.20 The CBCA and ABCA have the same requirements, demonstrating a move away from Canadian residency requirements. The underlying notion for residency requirements appears to be that Canadian citizens will be more responsive to Canadian national interests in the operation of a corporation’s affairs than non-citizens would be. However, directors are to manage the corporation for the purpose of maximizing firm wealth consistent with the dictates of the law, not to promote national interests, and hence the trend away from stringent residency requirements. The BCBCA has no director residency requirements. British Columbia’s decision not to include a residency requirement in its corporations statute was aimed at making it competitive in attracting firms, and was made in recognition of the global nature of many Canadian-based corporations.

C.  Election of Directors When a corporation is formed, a notice of the first directors of the corporation is sent to the director or other administrative official responsible for the administration of the corporations statute.21 The first directors hold office from the date of incorporation to the date of the first meeting of shareholders, which must be held within 18 months of incorporation.22 Thereafter, directors are elected by an “ordinary resolution” of the shareholders.23 An ordinary resolution is a resolution passed by a majority of the votes cast by shareholders who voted on the resolution.24 CBCA s 106(3) specifies that shareholders must elect directors at each annual meeting of the corporation, and CBCA s 133 requires the directors to call an annual meeting not later than 15 months after the last preceding annual meeting.25 The requirement of shareholder election of directors apparently may not be waived, not even where the authority of the board of directors has been reduced by a unanimous shareholder agreement under s 146(1). The election of directors is one of the most important matters on which the shareholders vote. Since the directors have oversight of the corporation, the election of directors is a significant method by which shareholders can exercise some control over the way in which the corporation is managed. The potential for such a change in control of the voting rights gives management an incentive to act in the interests of shareholders. If one considers adopting a normative view of the corporation that the directors and officers, in acting in the best interests of the corporation, should consider the interests of a broad range of stakeholders, then this incentive to act in the interest of one stakeholder group can be problematic.

20 OBCA, as amended, SO 2006, c 34, Schedule B, adding s 19(3). 21 CBCA ss 106(1) and 133; see also ABCA s 106(1) and s 94(1) of the Companies Act, RSNS 1989, c 81 [NSCA]. 22 CBCA ss 106(2) and 133(1)(a); ABCA ss 106(2) and 132(1)(a); OBCA ss 94(1)(a) and 119(1); BCBCA s 182(1); and NSCA, First Schedule, s 74. 23 CBCA s 106(3); ABCA s 106(3); and OBCA s 119(4). 24 CBCA s 2(1); ABCA s 1(w); and OBCA s 1(1). 25 See also ABCA ss 106(3) and 132(1)(a); OBCA ss 94(1)(a) and 119(4); BCBCA s 182(1)(b); and NSCA s 83(1).

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Note that Bill C-25, An Act to amend the Canada Business Corporations Act, etc., which received second reading in December 2016, proposes changes to the election of directors under the CBCA. It proposes that shareholders of a corporation shall, by ordinary resolution at the first meeting of shareholders and at each succeeding annual meeting at which an election of directors is required, elect directors to hold office for a term ending not later than the close of the third annual meeting of shareholders following the election. It proposes a shorter period for distributing corporations—directors are to hold office for a term ending not later than the close of the next annual meeting of shareholders following the election, allowing for some exceptions. The proposed amendments also provide, for a prescribed corporation, a separate vote of shareholders with respect to each candidate nominated for director. If enacted, it will effectively prohibit slate elections, consistent with existing requirements applicable to TSX-listed CBCA corporations. The Bill proposes majority voting, whereby, under specified circumstances, if there is only one candidate nominated for each position available on the board, each candidate is elected only if the number of votes cast in their favour represents a majority of the votes cast for and against them by the shareholders who are present in person or represented by proxy, unless the articles require a greater number of votes. Currently CBCA s 106(3), however, remains in effect as described above.

D.  Term of Office Commonly, the term of a director begins with the annual shareholders’ meeting at which she or he is elected and runs until the next annual meeting. However, the articles may provide for directors’ terms of up to three years.26 Under BCBCA s 128(1), the term of office is usually set out in the articles, memoranda, or bylaws.27 Directors may also be re-elected without limit. If no directors are elected at a meeting where directors should be elected, the incumbents remain in office until successors are chosen.28 Rather than providing that all of the directors are to be elected at the same time, the corporation’s articles may provide that directors’ terms are staggered. This strategy ensures that there is continuity on the board after any given election, and also serves as a benefit to existing management because it prevents the complete ousting of a board by shareholders in one meeting. However, in a number of corporations, the constating document now requires annual election of the entire board as a means of providing another accountability check on the activities of directors. This issue is discussed further in Chapter 15 on mergers and acquisitions. A corporation, shareholder, or director may apply to court to resolve any controversy with respect to an election or appointment of a director, and the court may make “any order it thinks fit,” including one restraining the person whose election or appointment is disputed from serving and ordering a new election under judicial supervision.29

26 CBCA ss 106(3) and (5); ABCA ss 106(3) and (6); and OBCA ss 119(4) and (6). 27 QBCA s 110 states: “The directors are elected by the shareholders, in the manner and for the term, not exceeding three years, set out in the by-laws.” 28 CBCA s 106(6); ABCA s 106(7); OBCA s 119(7); QBCA s 143; and NSCA, First Schedule, s 117. 29 CBCA s 145; see also ABCA s 144 and OBCA s 107.

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E.  Filling of Vacancies Generally, directors have the power to fill vacancies on the board.30 However, this rule is subject to numerous exceptions. For instance, the directors may not fill a vacancy in their number that results from an increase in the number or minimum number of directors or from the failure by the shareholders to elect the number or minimum number of directors required by the articles.31

F.  Increasing the Size of the Board The board has the ability to increase its size by up to one third, and thus add directors if the articles allow it. For example, CBCA s 106(8) specifies that “[t]he directors may, if the articles of the corporation so provide, appoint one or more additional directors, who shall hold office for a term expiring not later than the close of the next annual meeting of shareholders, but the total number of directors so appointed may not exceed one third of the number of directors elected at the previous annual meeting of shareholders.”

G.  Ceasing to Hold Office A director ceases to hold office during her or his term of office when he or she dies, resigns, becomes disqualified, or is removed from office by a resolution of the shareholders.32

H.  Removal of Directors Under most corporations statutes, shareholders have the right to remove directors by ordinary resolution. 33 Under BCBCA s 128(3), shareholders may remove a director by special resolution, or in accordance with the memorandum or articles, which can specify a lesser vote than a special majority. 34 The shareholders’ meeting that approves the removal of a director may also fill the vacancy that results from the removal of a director. 35 The directors may fill the vacancy caused by the removal in the event that shareholders fail to do so. Shareholders can also seek to have directors removed under the oppression remedy provisions of corporations statutes. In Aurum, LLC v Calais Resources Inc, the British Columbia Supreme Court ordered removal of directors. Its reasoning is set out below.

30 31 32 33

CBCA s 111(1); ABCA s 111(1); BCBCA s 131, and OBCA s 124(1). CBCA s 111(1); ABCA s 111(1); and OBCA s 124(1). CBCA s 108; ABCA s 108; BCBCA s 128(1); OBCA s 121; and NSCA, First Schedule, s 114. CBCA s 109(1); ABCA s 109(1); and OBCA s 122(1). QBCA s 144 specifies that “[u]nless the articles provide for cumulative voting, the shareholders may by ordinary resolution at a special meeting remove any director or directors.” 34 See also NSCA, First Schedule, s 119. 35 CBCA s 109(3); ABCA s 109(3); OBCA s 122(3); and BCBCA s 131(a).

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Aurum, LLC v Calais Resources Inc 2016 BCSC 1173 THE COURT:

[2]  Aurum is a limited liability company with a registered and records office in Cheyenne, Wyoming. The company is involved in investing and mining operations in North America. Aurum is the majority shareholder in Calais. [3]  Calais is a company incorporated in British Columbia with a registered and records office in Vancouver, British Columbia, and an office in Nederland, Colorado. Calais’ business is mineral exploration. It is engaged in the acquisition of properties and the exploration of mineral and metals, primarily gold and silver. Calais has interests in mine operations in Colorado and Nevada. [4]  Mr. Young and Mr. Hendricks are officers, as well as directors, of Calais. Mr. Hendricks is the vice-president and general manager; Mr. Young the president, chief operating officer and acting chief executive officer of Calais. Both men reside in Colorado. Mr. Daher, the third director, lives in Chilliwack, British Columbia. Mr. Young has been a director of Calais since 2005 and Mr. Hendricks since 1998. •  •  •

[13]  On August 13, 2015, through counsel, Aurum sent a requisition to Calais and the directors requiring them to call a general meeting within four months and to provide notice within 21 days pursuant to section 167 of the BCA. The requisition sets out the purpose of the proposed meeting as follows: 1. Passing a special resolution to remove all the existing directors with the exception of Tom Hendricks; and 2. Electing or appointed Michael Markiewicz and Bryan Read as directors.

[14]  Calais’ articles and the BCA require the company to hold an annual general meeting at least once every calendar year and not more than 15 months after the annual reference date for the preceding calendar year. Calais has not held an AGM for many, many years. [15]  Section 128 of the BCA and article 14.10 allows for the removal of directors and the election or appointment of new directors by way of special resolution. The petition record suggests the directors did not take any action in response to the requisition. Much later in their formal response to the petition filed in February 2016 they stated they had taken steps to “make arrangements to call a general meeting to be held as soon as reasonably possible given the logistical and other requirements that must be met to properly call such a meeting.” Their evidence provided no details about what steps they may have taken up to that time. •  •  •

[33]  [In an earlier judgment with respect to these parties,] Justice Greyell rejected all of those positions and found Aurum paid proper consideration for the shares issued in the three transactions referred to above. [34]  At paragraph 24 and following he wrote: [24]  Article 3.4 of Calais’ Articles of Association provides that no share shall be issued until (my emphasis) it is fully paid. The share certificates issued by Calais were each signed

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by Mr. Young and Mr. Hendricks as President and Secretary as “fully paid and non-accessible common stock.” The Board resolution approving the issuance of the shares set the share prices of .0005 cents and .0007 cents per share as, in each instance “the board of directors believes it to be in the best interests of the company” to issue shares at that price. [25]  The stock subscription agreements attached to each transfer provided that each transfer set out the “purchase price for the shares.” I am satisfied from the material before me Aurum paid for the shares in Calais by paying a number of Calais’ outstanding debts. Aurum has demonstrated that in the material before me and the schedule of payments made on behalf of Calais. [26]  While the respondents complain about the payments made by Aurum, they have not produced any substantive evidence that such payments were improper or contrary to the agreement initially reached with Aurum for the stock purchase. [27]  This application has been outstanding for a number of months. The respondents have had more than ample time to produce substantive evidence to support their position. There simply is no evidence. In fact, the evidence before me is to the contrary, that is that Aurum was to invest funds as described earlier. There is no evidence Aurum was to invest more funds into Calais than the funds it paid in exchange for the shares it received in 2014.

[35]  The order he granted not only set aside Mr. Young’s 3,750,000,000 shares and validated Aurum’s shares, but it also specified the petitioner was entitled to attend the general shareholders meeting set for June 2016 and vote in accordance with its shareholdings. Further, the order set the record date for May 6, 2016. •  •  •

Analysis [77]  Bearing in mind the legal rights of Aurum as a shareholder and a majority shareholder under the BCA and Calais’ articles, and the chronology of events set out above, including the findings of fact made by Greyell J., his order and others, it is clear that Aurum held a number of reasonable expectations that were breached by various unfairly prejudicial, if not oppressive, acts of the respondents. [78]  Turning to the BCE analytical framework, the first question is whether the stated expectations are reasonable based on an objective and contextual analysis. The petition itself identified the combination of conduct by the respondents that Aurum regards as oppressive or unfairly prejudicial. During the hearing the petitioner made submissions about its expectations based on that conduct. I will discuss some, but not all, of those expectations •  •  •

[81]  This case is somewhat unusual insofar as it involves a majority as opposed to a minority shareholder alleging oppression and unfairly prejudicial conduct. Both the articles and the BCA provide that Calais must hold an annual general meeting and not more than 15 months after the annual reference date for the preceding calendar year, subject to specific exceptions which do not arise here such as waiver or deferral by a unanimous resolution of the shareholders entitled to vote at such a meeting. Section 167 of the BCA provides that a shareholder with an aggregate of at least 5% of the issued shares of the company that carry the right to vote may requisition a general meeting for the purpose of transacting any business that may be transacted at a general meeting. Upon

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receiving a valid requisition the company must hold a meeting within four months of receiving the requisition to transact the business set out in that requisition regardless of the articles, and must notify the shareholders and the directors of the meeting subject to a number of exceptions, none of which are supported by the evidence here. •  •  •

[84]  All shareholders have the right to vote in some circumstances. Section 173(2) of the BCA provides that unless the memorandum or articles provide otherwise, a shareholder has one vote for each share held. For the most part ordinary resolutions are passed at general meetings by a simple majority of votes passed, and special resolutions are passed by a special majority. Article 11.2 sets out that special majority at two-thirds of the votes cast. In Aurum’s requisition, it sought to pass a special resolution removing two of three directors. Again, given the findings of Greyell J., and bearing in mind the petitioner’s efforts to assert its right, their expectation that its position as a majority shareholder not be diluted for this purpose was entirely reasonable. [85]  Speaking more broadly, it is difficult to imagine how any company could reasonably avoid holding an AGM for what is now over 12 years. Voting at shareholders’ meetings is the primary means by which any shareholder participates as an owner of a company. While the cases indicate some delay in the holding of required meetings will be accepted if it is for a legitimate business reason, the historic circumstances here are extreme and Mr. Young’s explanation of financial hardship is simply not adequate. The only further explanation for the failure to schedule a meeting since the petitioner sent its requisition is essentially the same, the shortage of funds. The respondents blame the petitioner for that shortage but that notion has been dismissed by Greyell J. [86]  To summarize, I find the petitioners held, and continue to hold, reasonable expectations that it will be acknowledged as a shareholder and permitted to exercise its legal rights under the articles and the BCA, which given the validity of its shareholdings and the size of those shareholdings include the right to compel the holding of an annual general meeting and the bringing of a special resolution seeking the removal of existing directors, as well as the election of new directors. [87]  In my view, the evidence makes it clear that the respondents have repeatedly breached the petitioner’s reasonable expectations. What is particularly troubling is the absence of evidence to justify the various positions they have taken and the allegations they have made throughout this proceeding to explain their conduct, as well as their ongoing breaches of those expectations contrary to the court’s findings and orders, as well as steps they have agreed to with the petitioner. [88]  After denying Aurum was a valid shareholder, refusing to produce its shareholders list for a period of time, on unreasonable grounds, causing shares to be issued to Mr. Young for the purpose of diluting Aurum’s majority shareholding interest so as to prevent it from exercising its legal rights discussed above, and in particular to vote in a new slate of directors, Calais did not respond to the petitioner’s requisition. After the petition was brought the respondents called a general shareholders’ meeting and set a record date that would have precluded the petitioner from being notified and voting. Then they issued a list recognizing the petitioner as a shareholder, but maintaining Mr. Young’s majority position. They agreed that the date of the AGM would be changed and held instead in June 2016, and to deliver notice of the meeting to all members with a record date falling after the dates upon which the application was set to be heard, which they further agreed

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would be in May 2016. They also agreed the notice would advise all shareholders that a directorship vote was to occur at the meeting and reference would be made to the candidates proposed by Aurum after the hearing before Greyell J. occurred. [89]  His order essentially confirmed the meeting for June 14, 2016, specified the petitioner was entitled to attend and vote in accordance with its shareholdings, and set the record date for May 6, 2016. Despite his reasons for decision and the terms of the order, and the arrangements they had agreed to, the respondents then filed another response to the petition that stated all shares issued to Aurum should be set aside. It made new allegations related to the validity of the share issuance. It further stated Calais considered the record date for the AGM in June to be May 1, 2014 and that Aurum not be permitted to vote in breach of the order, what they had agreed to through counsel and article 10.6 which provides the record date must not be set more than two months before the meeting, or in the case of an AGM, four months. The provision further specifies the record date must not precede the meeting date by fewer than 21 days if the company is a public company. [90]  Prior to this hearing the respondents filed affidavit evidence in which Mr. Young acknowledged the petitioner’s ongoing request for notice of the AGM and then raised for the first time concerns about the nominees for directorship proposed by Aurum in August 2015, as well as a third nominee, on the grounds they were not independent given their involvement with Pure Path. [91]  At the hearing itself, Mr. Hendricks submitted the cost of notifying the shareholders was prohibitive, given the absence of any funding from Aurum. He also argued that the proposed nominees were not independent. Nothing in the BCA or the articles supports the asserted requirement for independence. [92]  In the result, the respondents did not provide notice of the AGM as agreed in March 2015 and as contemplated by Greyell J.’s order, and then they again asserted a record date contrary to the order that would, again, disentitle Aurum to notice and to vote at the AGM as well as continuing to insist Aurum was not a valid shareholder. [93]  Apart from reiterating positions that have been previously dismissed before Greyell J., Mr. Hendricks focused very much on the personal sacrifices both he and Mr. Young had made in terms of time and money as opposed to the interests of Calais itself. That is also the thrust of the submissions contained in his letter to the court that followed the hearing. It is abundantly clear that both men are pre-occupied with the personal impact of losing their roles as directors and officers in the event Calais’ application to remove them and replace them is granted. [94]  In my view the circumstances of this case are similar, but worse, than those in Burdeny v. K & D Gourmet Baked Foods and Investments Inc., [1999] B.C.J. No. 953 (S.C.) where Justice Levine, as she then was held: [39]  There is no question that Donald was entitled, as a shareholder of the company, to have access to the company’s financial records (Company Act, section 171) and to receive the latest financial statement and auditor’s report upon request (Company Act, section 172(3)). He was also entitled to attend or consent to the business to be conducted at an annual general meeting (Company Act, sections 139-40), and to receive the annual financial statement and auditor’s report (Company Act, sections 145 and 178), unless the audit has been waived by unanimous resolution of the shareholders (Company Act, section 179).

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Chapter 11  Board Composition and the Role of Directors [40]  In considering whether the failure of the company to comply with these provisions of the Company Act is “oppressive” or “unfairly prejudicial” to Donald, the question is not simply whether his legal rights have been breached, but whether his equitable rights have been detrimentally affected [citations omitted]. •  •  •

[47]  I conclude from the failure of the company to comply with the provisions of the Company Act “that the affairs of the company [were] being conducted … in a manner oppressive to one or more of the members.” It is clear that at the time Donald filed the petition he had no means to confirm or dispel his suspicions concerning the company’s finances. He was prevented from reviewing the company’s financial records, he had not been given any financial statements, the company’s finances had never been audited, and the company had not held annual general meetings as required by the Company Act. There is no evidence that Donald had consented to waiving the statutory requirements concerning annual general meetings or the appointment of an auditor. In my view a shareholder who is put in such a situation is dealt with unfairly “in the matter of his proprietary rights as a shareholder.”

[95]  I conclude that the respondents’ ongoing conduct outlined above and in particular its failures to comply with the provisions of the BCA and the articles, its attempt to dilute Aurum’s shareholdings for the sole purpose of interfering with the exercise of its legal rights as a majority shareholder, and their persistence in this conduct, contrary to the court’s decision and orders, is unfairly prejudicial, if not oppressive to the petitioner. [96]  As noted above, section 227(3) of the BCA provides the court with express authority to remove and replace directors. This is considered an exceptional remedy. The court is also empowered to make any interim or final order it considers appropriate. This very broad discretion is tempered by the statutory requirement that the court must act with a view to bringing the matters complained of to an end. [97]  In regarding the circumstances here as exceptional. They justify the removal of the existing directors. It is very clear Mr. Young and Mr. Hendricks together will continue to engage in the conduct outlined above directed at preventing their replacement as directors. However, I regard a somewhat more modest remedy as sufficient to prevent any such further conduct. [98]  Given the permits and licences held personally by Mr. Hendricks, in the absence of a concrete transition plan, I am not ordering his removal. Instead, I order Mr. Young and Mr. Daher removed (if he has in fact not formally resigned). I also order the appointment of Aurum’s three nominees as directors of Calais on an interim basis. [99]  I further require Mr. Hendricks, the interim directors, and Calais, to schedule an AGM for a date no more than 90 days from today at which an election of directors will be held. The record date remains the date set by Greyell J. This company must begin a new era of compliance with the legal requirements that govern the holding of AGMs. [100]  The notice to the shareholders will include copies of the orders made in this proceeding, the reasons of Greyell J., and my reasons for decision which I will endeavor to release as soon as possible upon a request for a transcript being received. [101]  The petitioner’s further request for an order requiring the handing over of the material set out at paragraph 1(c) of their petition is also granted.

707

IV.  Authority of Directors NOTES AND QUESTIONS

1.  On what basis did the court in Aurum, LLC v Calais Resources Inc remove the directors? Do you think the remedy ordered was effective? 2.  Consider again for a moment the fact pattern that has been used throughout this text. Aya Nang has built the company from its beginning, yet now she holds only 50,000 shares out of a total of 160,000 shares, which means that the shareholders could vote to remove Aya as a director of the corporation. What do you think the policy rationale is for giving shareholders the power to remove, if they so decide, the founder of a corporation?

IV.  AUTHORITY OF DIRECTORS As noted above, it is the directors who have the authority to manage or to oversee management of the corporation. 36 Corporate statutes often specifically allocate other powers to the directors. CBCA s 115(3) provides that the directors cannot delegate their powers with respect to certain matters such as filling a vacancy among the directors, issuing securities, declaring dividends, purchasing, redeeming, or otherwise acquiring the shares issued by the corporation, or adopting, amending, or repealing bylaws of the corporation. 37

A.  Adoption, Amendment, or Repeal of the Bylaws The CBCA and other corporate statutes also give the directors the power to adopt, amend, or repeal bylaws.38 The power of the directors to adopt, amend, or repeal bylaws is subject to the articles, the bylaws, or a unanimous shareholder agreement. The power of the directors with respect to the bylaws is also qualified by the requirement that any change the directors make in the bylaws must be put before the shareholders at the next annual meeting of shareholders. A change in the bylaws made by the directors is effective until the shareholders’ meeting and is effective thereafter only if approved by the shareholders or approved as amended.39

B.  Borrowing Powers The directors also have the power to borrow, subject to the articles, the bylaws, or a unanimous shareholder agreement.40 The directors may also delegate the power to borrow to a director, a committee of directors, or an officer, subject to any restriction on this power to delegate in the articles, the bylaws, or a unanimous shareholder agreement.41

36 37 38 39 40 41

CBCA s 102; ABCA s 101(1); BCBCA s 136(1); and OBCA s 115(1). See also ABCA s 115(3) and OBCA s 127(3). CBCA s 103(1); ABCA s 102(1); OBCA s 116; and QBCA s 113. Under the BCBCA, a special resolution is still needed: BCBCA s 259(2). CBCA s 189(1); ABCA s 103(1); and OBCA s 184(1). CBCA s 189(2); ABCA s 103(2); OBCA s 184(2); and NSCA, First Schedule, s 71.

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C.  Declaration of Dividends Directors have the power to declare dividends and, under most corporate statutes, this power cannot be delegated.42 CBCA s 115 specifies that the company may declare a dividend and s 134(1) adds that the directors can set the record date for dividends.43 The declaration of dividends is subject to a solvency test.

V.  APPOINTMENT AND COMPENSATION OF OFFICERS AND THE DELEGATION OF POWERS Some of the most significant powers of directors are designating and appointing officers of the corporation, determining the compensation of officers, and delegating management powers to officers.44 These powers are exercised subject to the articles, the bylaws, or a unanimous shareholder agreement. Widely held corporations are typically managed by officers appointed by the directors, leaving the directors in a largely supervisory role. However, the power of directors to appoint officers who manage the corporation remains a significant authority, since shareholders can exercise their voting powers to replace the directors, who can then replace the officers of the corporation. Many issuing corporations now have a committee of the board of directors that has the responsibility for recruitment and retention of officers, and succession planning. The committee is frequently composed of all or a majority of outside directors, with the purpose of recruiting the best possible officers with minimal interference or influence by inside directors. Directors may also remove officers. The power to remove officers is key to the effectiveness of the election and removal of directors as a shareholder control device, because shareholders can express their dissatisfaction with the directors where the directors do not remove in a timely manner officers who are shirking or engaged in inappropriate conduct. However, removing the officers may permit them to assert actions for wrongful dismissal. There is a trade-off between preserving the removal of managers as a shareholder control device and providing managers with long-term contracts and compensation in the event that the long-term contract is terminated. The corporation may benefit if the officer is willing to accept less compensation in return for the security of a long-term contract. With the hope of long-term reward, managers may be more willing to invest their human capital in the firm. Offering managers a long-term employment contract, with damages for premature termination, can be efficient, since the managers have a greater incentive to seek longterm rewards in the firm.

42 CBCA s 115(3)(d); ABCA s 115(3)(d); OBCA s 127(3)(d); and NSCA s 158. 43 CBCA ss 115 and 171(1). 44 CBCA s 121. See also ABCA s 121; BCBCA s 141; OBCA s 133; and QBCA ss 115, 116, and 117.

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VI.  DIRECTORS’ MEETINGS The mechanics of calling and holding board meetings are usually specified in the corporation’s bylaws. Subject to the articles or bylaws, the quorum is a majority of the board or a majority of the minimum number of directors in the articles.45 In Nova Scotia, a quorum is two or more directors, or as the directors think fit.46 Notice to the directors is mandated, but can be waived under most corporate statutes.47 Meetings by conference call are permitted.48 No meeting need be held to transact business where all of the directors sign a written resolution in lieu of the meeting.49 Meetings of one-person boards are validated, without which a meeting would require at least two persons.50

VII.  THE BUSINESS JUDGMENT RULE Directors have responsibility for oversight of the corporation’s activities. Shareholder views and voting can sometimes clash with the views of directors regarding the future direction of the corporation. Directors and officers have an obligation to act in the best interests of the corporation and that fiduciary obligation requires directors to be duly diligent in their activities and decision-making. Directors also owe a duty of care and loyalty. The courts have held that where there are complaints regarding alleged failure of the directors to meet their common law or statutory duties, the court will defer to the business judgment of the directors where they have been duly diligent and have made decisions that were informed in all the circumstances. While business judgment is discussed at length in Chapter 13, it is important to consider how it fits with the notion of the relationship between the corporate board and the corporation’s stakeholders. The deference by the courts to business judgments is an important aspect of the law, because the courts frequently do not have the business or commercial expertise to assess all decisions made by directors and officers. Moreover, well-functioning boards have diverse types of directors with different skills and backgrounds, and, collectively, their business expertise is much greater than that of the courts, even where a particular judge has some commercial expertise. If directors and officers are acting in a good-faith and duly diligent manner in their decision-making, but they err in some way that causes a financial loss or a specific harm to the corporation or its stakeholders, there is a risk that courts may assess their decisions after the fact using the benefit of hindsight that was not available to the officers at the time of their decision. Often business and managerial decisions are timesensitive and made with less than ideal information, directors assessing the upside and downside risks of the decision and having to act expeditiously and responsibly.

45 46 47 48 49 50

CBCA s 114(2); ABCA s 114(2); and OBCA s 126(3). NSCA, First Schedule, s 129. CBCA s 114; ABCA s 114; and OBCA s 126. CBCA s 114; ABCA s 114; BCBCA s 140(1)(b); and OBCA s 126(13). CBCA s 117; BCBCA s 140(3); ABCA s 117; and OBCA s 129. ABCA s 114(8); CBCA s 114(8); OBCA s 126(12); and BCBCA s 140(4).

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A failure to give deference to business judgments that are made in good faith and on a duly diligent basis could encourage shareholder or creditor actions where they are unhappy with officers’ decisions in hindsight and could create inappropriate incentive effects for such stakeholders. Moreover, directors and officers may be unwilling to act or to make particular decisions out of fear that those decisions will be overturned by the courts, in turn creating an ineffective or paralyzed governance structure. However, deference to business judgments cannot be completely unfettered. In the disclosure context, for example, where directors and officers of issuing corporations are required to disclose material changes, if deference to business judgments is too great, it will create incentives for issuers not to disclose and then seek the protection of the business judgment rule to justify that business decision.51 In turn, it may prevent material information from being disclosed in a timely manner, creating barriers for investors in establishing claims of breach of statutory disclosure requirements. In the takeover context, as discussed in Chapter 15, the courts will assess the process of board decision-making in order to assess the level of deference to be accorded to their business judgments in the circumstances. Hence, directors and officers must be duly diligent in their decision-making, which includes ensuring that they are informed, have considered various courses of action, and have made the decision in the best interests of the corporation. Assessment of this decisionmaking is largely, but not exclusively, a process inquiry by the courts, as there are instances in which the court will assess the substantive decision based on a standard of reasonableness in the circumstances. The courts will assess the reasonableness of the decision, not whether it was a perfect one; and if directors have acted within a range of reasonableness, the court will not substitute its own opinion for that of the board, even though subsequent events may have raised doubts about the validity of the decision (see Peoples Department Stores Inc (Trustee of) v Wise, below). On finding that directors owe a duty of care under CBCA s 122, the Supreme Court of Canada in Peoples Department Stores Inc (Trustee of) v Wise made a strong statement regarding deference by the courts to directors’ and officers’ business judgments.

Peoples Department Stores Inc (Trustee of) v Wise 2004 SCC 68, [2004] 3 SCR 461 MAJOR and DESCHAMPS JJ:

[64]  The contextual approach dictated by s. 122(1)(b) of the CBCA not only emphasizes the primary facts but also permits prevailing socio-economic conditions to be taken into consideration. The emergence of stricter standards puts pressure on corporations to improve the quality of board decisions. The establishment of good corporate governance rules should be a shield that protects directors from allegations that they have breached their duty of care. However, even with good corporate governance rules, directors’ decisions can still be open to criticism from outsiders. Canadian courts, like their counterparts in the United States, the United Kingdom, Australia and New Zealand, have tended to

51 Janis Sarra, “Disclosure as a Public Policy Instrument in Global Capital Markets” (2007) 42 Tex Intl LJ 231.

VIII.  Closely Held Corporations

711

take an approach with respect to the enforcement of the duty of care that respects the fact that directors and officers often have business expertise that courts do not. Many decisions made in the course of business, although ultimately unsuccessful, are reasonable and defensible at the time they are made. Business decisions must sometimes be made, with high stakes and under considerable time pressure, in circumstances in which detailed information is not available. It might be tempting for some to see unsuccessful business decisions as unreasonable or imprudent in light of information that becomes available ex post facto. Because of this risk of hindsight bias, Canadian courts have developed a rule of deference to business decisions called the “business judgment rule,” adopting the American name for the rule. In UPM-Kymmene Corp v UPM-Kymmene Miramichi Inc (2004), 250 DLR (4th) 526, 32 CCEL (3d) 68 (Ont CA), the Ontario Court of Appeal endorsed the lower court finding that the business judgment rule “recognizes the autonomy and integrity of a corporation and the expertise of its directors” since they are “in the advantageous position of investigating and considering first-hand the circumstances that come before it and are in a far better position than a court to understand the affairs of the corporation and to guide its operation” (at para 6). On the facts, the Ontario Court of Appeal held that the director’s deliberations fell far short of the exercise of prudent judgment (at para 7). The Ontario Superior Court in UPM-Kymmene Corp v UPM-Kymmene Miramichi Inc (2002), 214 DLR (4th) 496 (Ont Sup Ct J) held the following in respect of how the business judgment rule is to be applied: [156]  However, directors are only protected to the extent that their actions actually evidence their business judgment. The principle of deference presupposes that directors are scrupulous in their deliberations and demonstrate diligence in arriving at decisions. Courts are entitled to consider the content of their decision and the extent of the information on which it was based and to measure this against the facts as they existed at the time the impugned decision was made. Although Board decisions are not subject to microscopic examination with the perfect vision of hindsight, they are subject to examination.

The issue of business judgment and where it fits into the court’s consideration of shareholder remedies and deference to the business decisions is discussed further in Chapter 13.

VIII.  CLOSELY HELD CORPORATIONS The majority of corporations in Canada are closely held corporations, ranging from very small family businesses to large enterprises controlled by a few shareholders. As of 2012, small businesses employed 7.7 million employees in Canada, comprising 69.7 percent of the total private sector labour force, and Industry Canada reports that 98 percent of the 1.08 million small businesses in Canada in 2013 had 1 to 99 employees.52

52 Janis Sarra, “An Opportune Moment—Retooling the Bankruptcy and Insolvency Act to Address Micro, Small and Medium Enterprise (MSME) Insolvency in Canada” in Janis P Sarra & BE Romaine, eds, Annual Review of Insolvency Law 2016 (Toronto: Carswell, 2017) 119.

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There is no universally accepted definition of a closely held corporation. However, a closely held corporation is normally considered to have the following characteristics: (1)  there are relatively few shareholders; (2)  most or all of the shareholders participate actively in the management of the corporation; (3) there is no established market for the shares of the corporation; and (4)  frequently, there is a restriction on the transfer of the shares of the corporation. This form of incorporation is very popular in Canada because sole proprietors or partnerships that begin to expand their businesses often seek the protection offered by the limited liability provisions of corporate statutes, while being able to continue the management and control of the business. Closely held corporations can take advantage of the enabling provisions of corporate statutes because they do not have the transaction costs of bargaining basic divisions of powers, shareholder rights, and remedies. This corporate form allows for administrative efficiencies through the use of provisions such as waiver of notice to shareholders’ meetings and resolutions by unanimous consent in lieu of meetings. It can also assist in controlling agency costs, because shareholders of closely held corporations are able to control the actions of directors through unanimous shareholder agreements where they determine that such decisions should be made by the shareholders themselves. Closely held corporations also frequently have restrictions on share transfers and issuing of capital in order to protect the interests of existing shareholders, given that there is often not a market for their shares. These unique features of the closely held corporation are discussed below. Given the nature of closely held corporations, the corporate governance structures suitable for such corporations may be different from structures suitable for widely held corporations. With fewer shareholders and most or all of the shareholders taking part in the management of the corporation, there may be less need for monitoring devices imposed in the context of widely held corporations, such as mandatory proxy solicitation. The efficiencies achieved by allocating the management of the business and affairs of the corporation to directors and their delegated officers are not as significant where there are only a few shareholders. A small group of shareholders may more readily assemble to deal with an array of matters of a management nature. With relatively few shareholders in a closely held corporation, the individual shareholders usually have a significant stake in the corporation and have an incentive to protect their investments through more active participation in the day-to-day affairs of the corporation. Because of these differences, corporate laws typically provide for different treatment for closely held corporations. When “private corporation” was originally defined in Canadian corporations statutes, the upper limit on the number of shareholders was often set between 25 and 50. However, the ceiling on the number of individual shareholders that a corporation might have and still maintain a substantial identity between owners and managers is probably more like 10 or 12. Most closely held corporations have a lower value than widely held ones, but that is not universally true. Many other countries have a separate statute for closely held corporations. In Canada, the early corporate statutes did not distinguish between closely held corporations and widely held corporations. However, in 1910, British Columbia adopted a “private company” concept that had been adopted a few years earlier in England. The term “private company” attempted to define corporations having characteristics of closely held corporations and generally provided relief from financial disclosure requirements. Subsequently, most Canadian jurisdictions also adopted this approach. When changes were made to Canadian

713

VIII.  Closely Held Corporations

corporate statutes in the 1970s and 1980s, the private company concept was eliminated in most jurisdictions on the basis that it was difficult to precisely define a closely held corporation. The “private company” distinction was generally replaced with a series of permitted modifications to the basic legislative framework that were of a kind most likely to be used only by a closely held corporation. The courts have been reluctant to interfere with closely held companies and the arrangements made among shareholders to protect their interests. The following case is an example.

Re Barsh and Feldman (1986), 54 OR (2d) 340 (H Ct J) VAN CAMP J:  This is an application under s. 106(1) of the Business Corporations Act, 1982 (Ont.), c. 4, for the following: 1. an order requiring a meeting of the shareholders of the corporation; 2. an order to vary the requirements of a quorum as set out in By-law 1 so that only two shareholders, holding at least 51% of the issued shares, are required to be present instead of the present requirement of the three shareholders who each hold one share.

Section 106 of the Business Corporations Act, 1982 is as follows: 106(1)  If for any reason it is impracticable to call a meeting of shareholders of a corporation in the manner in which meetings of those shareholders may be called or to conduct the meeting in the manner prescribed by the by-laws, the articles and this Act, or if for any other reason the court thinks fit, the court, upon the application of a director or a shareholder entitled to vote at the meeting, may order a meeting to be called, held and conducted in such manner as the court directs and upon such terms as to security for the costs of holding the meeting or otherwise as the court deems fit. (2)  Without restricting the generality of subsection (1), the court may order that the quorum required by the by-laws, the articles or this Act be varied or dispensed with at a meeting called, held and conducted under this section. (3)  A meeting called, held and conducted under this section is for all purposes a meeting of shareholders of the corporation duly called, held and conducted.

Under s. 94 of the Business Corporations Act, 1982 the directors are required to call an annual meeting of shareholders not later than 15 months after holding the last preceding annual meeting and may, at any time, call a special meeting of shareholders. The last meeting of shareholders and of directors was held on April 8, 1966. On May 27, 1985, Barsh, holding one of the three shares, requisitioned the directors under s. 105 of the Business Corporations Act, 1982 to call a meeting of shareholders for the certain purposes stated. Under s. 105, the directors were required to call the meeting of shareholders. No such meeting has been called. Feldbar Construction Company Limited was incorporated in November, 1954, as a private company with restrictions on the transfer of shares. Hyman Feldman, Benjamin Barsh and his son, Harvey Samuel Barsh, each subscribed for one common share. Hyman Feldman and Benjamin Barsh each invested $20,000. Harvey Samuel Barsh made no

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investment of capital, but was to perform services for the corporation in lieu of a capital investment. The services were to be those of a builder and developer. The corporation carried on the business of acquiring real property and building houses on portions thereof. The two tracts of land that it now owns are vacant parcels which were acquired over 20 years ago. Some 40 houses were built and sold on one parcel of land between 1960 and 1966. At that time, the corporation became relatively inactive and ceased to hold meetings. Benjamin Barsh died in 1983. His son, Harvey Samuel, exercised an option under the will to purchase his father’s share. He now holds his father’s share in the corporation as a bare trustee for S. & E. Consultants Limited as to a one-half interest and each of Stella Rudolph, his sister, and Joseph Barsh, his brother, as to a one-quarter interest. The shares of S. & E. Consultants Limited are owned by him and his wife. Since 1983, Harvey Samuel Barsh has wished to see the two tracts of land developed and has formed certain plans to this effect. Mr. Feldman had shown little, if any, interest in these plans until at least August, 1985. In late 1984, Barsh proposed buying out Feldman’s interest. Feldman did not return to Barsh the resolutions to effect the transfer of the share of the deceased or the resolution of the shareholders electing the corporate solicitor as a director. It was at this time that Barsh requisitioned the special meeting of shareholders. Negotiations continued for the purchase of Feldman’s interest and for the amendment of By-law 1 which would have the effect of eliminating the need for his attendance or vote at a meeting of shareholders and directors and his removal as a signing officer. A new general by-law is required to conform with the requirements of the Business Corporations Act, 1982. Although Feldman states that he is now willing to meet with the applicants to formulate a joint policy for the development or disposition of these properties, the prior delay makes it doubtful that the parties can agree. However, Feldman has given an undertaking through his counsel to sign a resolution for the annual meeting, approving the annual financial statements, electing the officers, appointing a director to replace the deceased and to approve the transfer of the share of the deceased to Barsh, in trust. This obviates the necessity of the meeting of shareholders. I am of the opinion that the facts do not support the exercise of discretion to change the quorum. The result would be that one of three equal shareholders was effectively locked into a company in which he had no control. The quorum here was not to permit attendance of a shareholder, but to ensure that there would be no corporate action, except on the consent of all. Each shareholder has an equal interest. If there is no such consent obtainable, then there are provisions for the winding-up of the Corporation. None of the shareholders wish a winding-up, but unless they can agree it is the only alternative. The corporation was carefully structured so that no shareholder could control it. The affidavit of Feldman shows that because the other two shares were held by father and son, to give Feldman protection all decisions of directors and shareholders would require his consent and all cheques drawn on the corporate account would require his signature. That agreement was reflected in the provisions of ss. 3 and 4 of By-law 1 providing for a quorum of three persons at meetings of shareholders and directors. The banking resolution of the directors was enacted to require the signature of Feldman on the company cheques. The letters patent give one vote for each share held, but there can be no meetings unless all are present, that is, unless all agree. The obligation to have a general meeting can be met by an agreed agenda. The answer to the problem of disagreement among the shareholders

IX.  Different Treatment Under Modern Canadian Statutes

715

is not to compel a meeting whereby two of the three equal shareholders may outvote the third. The answer is the winding-up of the corporation. When none of them wish that winding-up, they can find a compromise. •  •  •

The corporation in this application was carefully structured to require agreement of the three equal shareholders. This court should not intervene to effectively remove the need for agreement by the third shareholder. The application is dismissed. In the circumstances, there should be no costs.

IX.  DIFFERENT TREATMENT UNDER MODERN CANADIAN STATUTES The following modifications are available to closely held corporations: 1. Waiver of notice to shareholders’ meetings.  A shareholder can waive notice to a shareholders’ meeting.53 While shareholders in widely held corporations can waive notice to meetings under this provision, it is most likely to be used by closely held corporations, where shareholders can be more readily contacted with respect to a meeting. 2. Resolutions by unanimous consent in lieu of meeting.  In lieu of having shareholder resolutions passed at a meeting of shareholders, shareholders’ resolutions can be passed by having the resolution in writing signed by all the shareholders entitled to vote on the resolution.54 Unanimous consent to the resolution in writing would be difficult to obtain in the context of a widely held corporation and is thus an option that is normally limited to a closely held corporation. 3. Avoiding proxy solicitation requirements.  The expense of proxy solicitation and the preparation of a proxy circular is likely to outweigh substantially any possible gains for shareholders in closely held corporations when the shareholders have a sufficient stake in the corporation to keep themselves well informed and to exercise their voting rights. Thus, some statutes specify that corporations that have not made a distribution of their shares to the public are not subject to the mandatory proxy solicitation requirements.55 4. Dispensing with an auditor.  The shareholders of a corporation that has not made a distribution of its shares to the public can also dispense with the requirement of having an auditor, limited to corporations with assets not exceeding $2.5 million and gross operating revenues not exceeding $5 million.56 This provision will most often be used by closely held corporations where it is possible to avoid what can be substantial costs of having a full audit conducted.

53 CBCA s 136; ABCA s 135; BCBCA s 170; and OBCA s 98. QBCA s 168 states that “[a] shareholder or director may waive notice of a shareholders meeting. Their attendance at the meeting is a waiver of notice of the meeting unless they attend the meeting for the sole purpose of objecting to the holding of the meeting on the grounds that it was not lawfully called or held.” 54 CBCA s 142; ABCA s 141; BCBCA s 182(2); OBCA s 104; NSCA s 92(1); and QBCA s 178. 55 See e.g. CBCA s 149(2). 56 CBCA s 163; ABCA s 163; BCBCA ss 203(2) and (3); and OBCA s 148. QBCA s 239 specifies that shareholders of a corporation other than a reporting issuer may decide to not have an auditor.

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5. Financial disclosure.  A corporation that has not made a distribution of its shares to the public can also avoid having to publicly file its financial statements. Corporate statutes also explicitly recognize single shareholder corporations and provide that where the corporation has only one shareholder, the shareholder’s presence in person or by proxy constitutes a meeting.57

X.  SHAREHOLDER AGREEMENTS The most significant modifications for closely held corporations are the statutory provisions that allow a closely held corporation to modify the default allocation of the power to manage the business and affairs of the corporation to the directors. CBCA s 102 allocates the power to manage to the directors, but this authority is subject to a unanimous shareholder agreement.58 Shareholders can enter into agreements whereby they agree as to how they will vote their shares. Shareholders can unanimously agree to remove management powers from directors and allocate them to the shareholders.59 Unanimous agreement among the shareholders is not an agreement that is likely to be achieved in the context of a widely held corporation. The explicit authority given in CBCA s 146(2) for the use of a shareholder agreement to reallocate the powers assigned to directors responded to the concern raised by the following case.

Ringuet v Bergeron [1960] SCR 672, 24 DLR (2d) 449 at 680-82, 683-84, 685 (footnotes omitted) JUDSON J (Abbott and Ritchie JJ concurring):  The respondent sued the appellants for a declaration that against each of them, he was entitled to certain shares of the St. Maurice Knitting Mills Limited registered in their names. In the Superior Court the learned trial judge dismissed the action. The Court of Queen’s Bench (Appeal Side) allowed the appeal and maintained the action. The two unsuccessful shareholders now appeal to this Court. The action was brought on an agreement dated August 3, 1949, between the respondent and the appellants. At that time these parties and four other persons each held 50 shares of the St. Maurice Knitting Mills Limited, a company incorporated by letters patent under Part I of the [then] Québec Companies Act. These shares constituted all the issued capital stock of the company. The purpose of the agreement was to provide for the acquisition of 50 shares from one Frank Spain and the division of these shares among the parties. With these 50 shares divided among them the parties then had control of the company and they agreed, among other matters to vote for their election to the Board of Directors; to ensure the election of the appellant Ringuet as president of the company, of the appellant Pagé as vice-president and general manager, and of the respondent Bergeron as

57 CBCA s 139(4); ABCA s 138(4); BCBCA s 172(3); and OBCA s 101(4). 58 See also ABCA s 101 and OBCA s 115. 59 CBCA s 146; ABCA s 146(1)(c); and OBCA s 108(2).

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X.  Shareholder Agreements

secretary-treasurer and assistant general manager of the company, all at stated and agreed salaries. They also agreed to vote unanimously at all meetings of the company and provided for a penalty for breach of the contract. •  •  •

Two or three months later the parties also purchased the shares of another shareholder Robert Sevigny and divided them among themselves in accordance with the agreement. On the completion of this purchase, there remained only five shareholders in the company: the two appellants, the respondent, the mis-en-cause Gerard Jean, and Zénon Bachand. On February 3, 1950, the three parties to the first agreement entered into another agreement and included in this one the mis-en-cause Gerard Jean. The purpose of this agreement was to provide for the admission of Gerard Jean into the controlling group and for the acquisition of the shares of Zénon Bachand, the last of the minority shareholders. Two shares were issued from the treasury and the total issued shares were equally divided among the four individuals with the result that each held 88 shares. The contract of February 3, 1950, to which Jean was a party, contains no provision corresponding to clause 12 of the contract of August 3, 1949. It does not purport to replace or alter the earlier contract, which remains in full force and effect. From August 3, 1949 to June 14, 1952 the three parties to the first contract observed its terms. There had during this period been certain increases in salary which were properly authorized and fixed by mutual consent. On June 14, 1952, the appellant Maurice Pagé, at a directors’ meeting, began to take steps to oust the respondent from the management of the company, and at a shareholders’ meeting held on July 21, l952, the appellants and Jean voted themselves in as a new board of directors. The respondent says that he had no notice of this meeting and did not attend. He was not nominated and no votes were cast for his election as director of the company. The new board of directors held a meeting following the shareholders’ meeting. Ringuet was elected president, Pagé was elected vice-president and Jean, secretary-treasurer. The respondent was thus completely excluded from the management of the company. He brought his action alleging that the appellants in failing to vote for his election to the board of directors and in not ensuring that he be appointed assistant general manager and secretary-treasurer, had violated the contract of August 3, 1949, and that he was entitled to enforce the penalty provided in clause 12 of the agreement. He claimed a transfer of 88 shares from each defendant. The facts were admitted in the pleadings and the sole defence was that the contract was contrary to public order. •  •  •

The point of the appeal is therefore whether an agreement among a group of shareholders providing for the direction and control of a company in the circumstances of this case is contrary to public order, and whether it is open to the parties to establish whatever sanction they choose for a breach of such agreement. Did the parties of this agreement tie their hands in their capacity as directors of the company so as to contravene the requirements of the Québec Companies Act, which provides (s. 80) that “the affairs of the company shall be managed by a board of not less than three directors”? [now QBCA s. 176] I agree with the reasons of the learned Chief Justice that this agreement does not contravene this or any other section of the Québec Companies Act. It is no more than an agreement among shareholders owning or proposing to own the majority of the issued shares of a company to unite upon a course of policy or

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action and upon the officers whom they will elect. There is nothing illegal or contrary to public order in an agreement for achieving these purposes. Shareholders have the right to combine their interests and voting powers to secure such control of a company and to ensure that the company will be managed by certain persons in a certain manner. This is a well-known, normal and legal contract and one which is frequently encountered in current practice and it makes no difference whether the objects sought are to be achieved by means of an agreement such as this or a voting trust. Such an arrangement is not prohibited either by law, by good morals or public order. It is important to distinguish the present action, which is between contracting parties to an agreement for the voting of shares, from one brought by a minority shareholder demanding a certain standard of conduct from directors and majority shareholders. •  •  •

I have the greatest difficulty in seeing how any question of public order can arise in a private arrangement of this kind. The possibility of injury to a minority interest cannot raise it. If this were not so, every arrangement of this kind would involve judicial enquiry. Minority rights have the protection of the law without the necessity of invoking public order. This litigation is between shareholders of a closely-held company. The agreement which the plaintiff seeks to enforce damages nobody except the unsuccessful party to the agreement. No public interest or illegality is involved. I would dismiss the appeal with costs. One device that alerts prospective investors to the existence of a shareholder agreement is to print on any share certificates a legend indicating that the shares are subject to restrictions on transfer in a shareholder agreement. The transferee of shares is bound by the agreement if the share certificate bears a legend referring to the shareholder agreement, or if he or she has actual notice of it.60 When the certificates bear a restrictive legend, the shares are called “letter stock.” If a shareholder agreement is not unanimous, however, it is not so clear that actual notice of it will bind the purchaser of the shares. In Greenhalgh v Mallard, [1943] 2 All ER 234 (CA), certain of the corporation’s shareholders had entered into an agreement to vote so as to give the plaintiff effective control of the corporation. Shortly thereafter, certain of the parties sold their shares to someone not a party to the agreement. The plaintiff sued for a declaration that the purchaser was bound by the voting agreement. The court held that no intention was revealed on the face of the agreement either that its duration should be longer than the period during which a particular party would continue to own his or her shares, or that a party was to be restrained from selling his or her shares.

XI.  BINDING THE DIRECTORS’ DISCRETION While shareholders are generally free to agree on how they will vote to elect directors, an agreement that fettered the discretion of directors might be impeached. The underlying

60 CBCA ss 146(3) and 49(8).

XI.  Binding the Directors’ Discretion

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notion is that the directors’ fiduciary duty to advance the best interests of the firm requires that the directors be free to assess that interest and to act on their assessment. However, officers’ discretion is fettered by any long-term contract—for example, one retaining the services of a senior executive in a multi-year contract, with a right of damages for wrongful dismissal. These contracts are upheld on the basis that the decision whether firm value will be advanced through a long-term contract is one of business judgment best left to directors and officers. These agreements are not very different from shareholder agreements that provide for the appointment of officers or for their remuneration. Under BCBCA s 137, the directors manage or supervise the affairs and business of the company subject to the articles. The standard form articles give the directors the powers of the company subject to those powers that the statute or the articles assign to the shareholders in a general meeting. Thus, the powers of the directors can be prescribed and assigned to shareholders in the articles—a unanimous shareholder agreement is not necessary. BCBCA s 137 reads: Powers of directors may be transferred 137(1)  Subject to subsection (1.1) but despite any other provision of this Act, the articles of a company may transfer, in whole or in part, the powers of the directors to manage or supervise the management of the business and affairs of the company to one or more other persons. (1.1)  A provision of the articles transferring powers of the directors to manage or supervise the management of the business and affairs of the company is effective (a)  if the provision is included in the articles at the time of the company’s recognition or if the company resolved, by special resolution, to add that provision to the articles, and (b)  if the provision clearly indicates, by express reference to this section or otherwise, the intention that the powers be transferred to the proposed transferee. (2)  If the whole or any part of the powers of the directors is transferred in the manner contemplated by subsection (1), (a)  the persons to whom those powers are transferred have all the rights, powers, duties and liabilities of the directors of the company, whether arising under this Act or otherwise, in relation to and to the extent of the transfer, including any defences available to the directors, and (b)  the directors are relieved of their rights, powers, duties and liabilities to the same extent. (3)  If and to the extent that the articles transfer to a person a right, power, duty or liability that is, under this Act, given to or imposed on a director or directors, the reference in this Act or the regulations to a director or directors in relation to that right, power, duty or liability is deemed to be a reference to the person. (4)  A company may resolve to alter its articles, by special resolution, to alter a provision referred to in subsection (1.1).

However, it is common to use a unanimous shareholder agreement for companies incorporated on the basis that the unanimous shareholder agreement is easier and cheaper to amend, is not publicly filed, and can also be used to control how shareholder votes will be exercised. NOTES AND QUESTIONS

1.  Could CBCA s 146 be interpreted as an exclusive safe harbour in the case of a shareholder agreement? In other words, would a court refuse to enforce a non-unanimous shareholder agreement of the kind that was upheld in Ringuet v Bergeron?

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2.  Is there any risk under BCBCA s 137, in terms of prescribing the powers of directors and assigning them to shareholders in the articles instead of a unanimous shareholder agreement, or is this provision another example of administrative efficiency that the statute allows for closely held corporations?

XII.  SHARE TRANSFER RESTRICTIONS Where shareholders are not passive investors but are expected to take part in management, the identity of the shareholders will affect firm value. Even where active management duties are not contemplated, shareholders in closely held corporations will be greatly interested in the identities of the other members of the group because of the heightened possibility of hold-out strategies when decisions are made in small groups. For these reasons, a closely held corporation’s charter will frequently provide for share transfer restrictions. Transfer restrictions can achieve other aims. They may make it possible for the owners to maintain their relative share ownership, and therefore relative power, within the entity. In this way, they are analogous to pre-emptive rights upon a new share issuance. Transfer restrictions are also required if a firm is to take advantage of securities law private issuer exemptions, as discussed in Chapter 6, hence avoiding costly prospectus requirements. In addition, they may be drafted so as to provide liquidity to the estate of a deceased owner or to an owner who simply wishes to retire from the corporation, or where shareholders are deadlocked.

A. Types At least five types of transfer restrictions can be identified: 1. Absolute restrictions.  Under these restrictions, shareholders simply cannot sell. These restrictions are rarely used, except possibly in the start-up phase of a new corporation. 2. Consent restrictions.  With these restrictions, a transfer of shares may be made only on approval of the corporation’s board. 3. First option restrictions.  This restriction is the most common type. The shareholder may not sell his or her shares or may not sell them to any person not already a shareholder of the corporation without first offering them to the corporation or to the remaining shareholders. The remaining shareholders would then have an option to buy the shares, either at the price that has been offered or at the price fixed by a valuer, who is often the corporation’s auditor. 4. Buy-sell agreements.  This restriction is similar to a first option restriction except that, as the name implies, the corporation or the other shareholders must buy the shares of the selling shareholder when the triggering event occurs. These provisions are very popular as a form of protection against the death of a shareholder. The estate of the deceased shareholder would then be obliged to sell his or her shares, and the corporation or the other shareholders would be obliged to buy them. In this way, a shareholder is able to make better provision for his or her family on death than were he or she simply to leave them shares in the firm. The transaction will frequently be financed through an insurance policy taken out on the life of the shareholder.

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5. Buyback rights.  Here, the corporation is given the right to repurchase shares on the occurrence of certain events, even if the shareholder does not want to sell. A typical event would be the termination of the shareholder’s employment with the firm. In general, a share transfer restriction may not be adopted by a firm that has made a public distribution of its shares.61 However, under the CBCA, a public corporation may constrain the issuance or transfer of shares to, or their ownership by, persons who are not resident Canadians, in order to qualify under any federal or provincial law making a specified level of Canadian ownership a prerequisite for receipt of a licence, permit, or other benefit.62 Section 46(1) specifies: 46(1)  A corporation that has constraints on the issue, transfer or ownership of its shares of any class or series may, for any of the purposes referred to in paragraphs (a) to (c), sell, under the conditions and after giving the notice that may be prescribed, as if it were the owner of the shares, any of those constrained shares that are owned, or that the directors determine in the manner that may be prescribed may be owned, contrary to the constraints in order to (a)  assist the corporation or any of its affiliates or associates to qualify under any prescribed law of Canada or a province to receive licences, permits, grants, payments or other benefits by reason of attaining or maintaining a specified level of Canadian ownership or control; (b)  assist the corporation to comply with any prescribed law; or (c)  attain or maintain a level of Canadian ownership specified in its articles. Obligations of directors in sale (2)  Where shares are to be sold by a corporation under subsection (1), the directors of the corporation shall select the shares for sale in good faith and in a manner that is not unfairly prejudicial to, and does not unfairly disregard the interests of, the holders of the shares in the constrained class or series taken as a whole. Effect of sale (3)  If shares are sold by a corporation under subsection (1), the owner of the shares immediately before the sale shall by that sale be divested of their interest or right in the shares, and the person who, but for the sale, would be the registered owner of the shares or a person who satisfies the corporation that, but for the sale, they could properly be treated as the registered owner or registered holder of the shares under section 51 shall, from the time of the sale, be entitled to receive only the net proceeds of the sale, together with any income earned on the proceeds from the beginning of the month next following the date of the receipt by the corporation of the proceeds of the sale, less any taxes on the proceeds and any costs of administration of a trust fund constituted under subsection 47(1) in relation to the constitution of the fund. Subsections 51(4) to (6) apply (4)  Subsections 51(4) to (6) apply in respect of the person who is entitled under subsection (3) to receive the proceeds of a sale of shares under subsection (1) as if the proceeds were a security and the person were a registered holder or owner of the security.

A constrained share provision can be quite drastic in its operation because the directors are authorized to sell, as if they were the owner of the shares, any of those constrained shares

61 CBCA s 49(9). 62 See CBCA ss 46, 47, 49(9) to (11), and 174.

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that are owned, as specified by s 46(1), above. The directors must select the shares to be sold in good faith and in a manner that is not unfairly prejudicial to, and does not unfairly disregard the interests of, the holders of the shares in the constrained class or series taken as a whole: s 46(2). On sale of the shares, the share owner is divested of interest or right in the shares, and is entitled to receive only the net proceeds of the sale, together with some income earned on the proceeds, as specified in s 46(3) above.

B. Validity US courts, when confronted with share transfer restrictions, tend to emphasize shares-asproperty and therefore to view transfer restrictions as falling into the suspect legal category of restraints on the alienation of property. English courts, in contrast, tend to view shares as predominantly contractual in nature, and have been relatively untroubled by doubts as to the validity of transfer restrictions.63 In Edmonton Country Club v Case, [1975] 1 SCR 534, the club was incorporated as a public corporation because its articles did not restrict to 50 the maximum number of shareholders, and one of its articles prohibited the transfer of shares to anyone without the consent of the directors, who might withhold consent “in their unfettered discretion.” A shareholder claimed that the article was ultra vires. At 550, Justice Dickson rejected the attack, but with the observation that: Before we move to strike down such a power on the ground that it is unreasonable, we should, in my view, have some factual support for that conclusion. There is no evidence before us, nor is it alleged, that the directors have at any time in the almost 30-year history of the company acted in bad faith or arbitrarily or otherwise abused the power.

Laskin J, dissenting, would have struck out the article. At 550-51 he explained the difference of opinion between himself and Dickson J as follows: The difference between us is whether this arbitrary power, not related to any standard for the exercise of an unfettered discretion, should be controlled only in the context of a particular case requiring its exercise (as he would have it), or whether it should be struck out simply because it is on its face utterly arbitrary (as I would have it).

Today in Alberta, as federally, the statute does not permit a share transfer restriction in a public corporation. A CBCA corporation that desires share transfer restrictions must include them in its articles (CBCA s 6(1)(d)). The restriction thereby becomes part of the corporation’s internal law, and transfers in contravention of it will not be registered by the corporation or its transfer agent. In addition, the restriction or a reference to it must be noted conspicuously on all share certificates. Otherwise, the restriction is ineffective against transferees without actual knowledge of it (CBCA s 49(8)).

63 See generally LCB Gower, “Some Contrasts Between British and American Corporation Law” (1956) 69 Harv L Rev 1369 at 1377-78.

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XIII.  THE CHOICE BETWEEN A CLOSELY HELD AND A WIDELY HELD CORPORATION Whether a firm is closely or widely held will depend on a variety of economic considerations. A firm will go public only when doing so increases the value of the shares that were issued prior to the public distribution. If, instead, the firm is worth more as a closely held corporation, it will refrain from a public issue of its shares, or if it has already made a public issue of shares, it will seek to repurchase them from outside shareholders in a buyout transaction. The techniques by which a public firm may eliminate minority shareholders, and legal restrictions on such transactions, are discussed in Chapter 15. The cost of regulation of publicly traded companies also now acts as a factor in decisions regarding whether to become a publicly traded corporation or, increasingly, with the regulatory requirements discussed later in this chapter, the decision to go private to avoid the transaction costs associated with continuous disclosure and officer certification. The availability of a resale market in securities of widely held firms is, of course, an advantage to investors. Shares in a closely held corporation are often made inalienable by the firm’s charter. Moreover, even if the firm agrees to permit a resale, the shares will be very difficult to dispose of. A further advantage of publicly traded corporations is easier access to capital markets. As a firm grows in value, it becomes harder to obtain financing solely through injections of equity from present shareholders. They may lack the assets to finance the acquisition of all available opportunities, and even were they able to do so, they might prefer to diversify their investments, rather than concentrate investment with a single firm. So long as a management’s private funds plus the firm’s internally generated funds do not enable it to accept all opportunities with a positive net present value, public markets in securities facilitate wealth creation. Against these advantages of going public, one primary reason to remain or to become a closely held corporation is to economize on agency costs. Such costs arise as a consequence of the separation of ownership and control. One technique for reducing them is to assign to management a portion of the firm’s residual value as part of its compensation package—for example, in the form of stock options. While agency costs will normally be greater in widely held firms, a special concern arises for the protection of minority shareholders in closely held corporations—their inability to sell their shares. Even if a market is available, shareholders in a closely held corporation might reasonably wish to restrict share transfers, since firm value will be tied to the identity of shareholders. Management opportunism is a risk as a consequence of the greater valuation uncertainties surrounding closely held corporations, one reason small firms adopt broadly based governance structures in which all shareholders participate in management decisions. For example, shareholders in a closely held corporation will often agree to restrict the power of a majority of the board of directors, even giving veto rights to individual shareholders on some decisions. Although this strategy introduces a possibility of shareholder opportunism, it will also lower the agency costs of management misbehaviour. Closely held corporations also face lower costs of disclosure given the reduced proxy solicitation and disclosure obligations. There are also tax advantages to closely held corporations.

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How much judicial intervention in business affairs is justifiable?

XIV.  CREATING NATIONAL CORPORATE GOVERNANCE GUIDELINES FOR PUBLICLY TRADED CORPORATIONS Canadian securities regulators have adopted a national policy (NP) on corporate governance, NP 58-201, Corporate Governance Guidelines, which contains recommendations for good governance practice, as opposed to prescriptive requirements. They have also promulgated NI 58-101 for disclosure of corporate governance practices. The key elements of these documents are set out below. The policy choice is to require corporations that trade publicly to disclose their corporate governance practices; yet in respect of those practices, the guidelines are non-prescriptive. The guidelines recognize that there are some board practices, in terms of director and officer recruitment, education, committee structure, and codes of conduct, that assist in ensuring independent, informed, and diligent corporate governance. As you read through the guidelines, consider whether mandatory disclosure will encourage corporate boards to assess their current governance practices. Consider whether the disclosure itself, while not mandatory, imposes particular normative directions on how corporations should structure their governance and, if so, whether it is an appropriate role for securities regulators. Consider also whether such disclosures are meaningful for investors, in terms of whether they will have the time and resources to monitor the governance practices of the corporations in which they invest.

National Policy 58-201, Corporate Governance Guidelines (2005) 28 OSCB 5383 (footnote incorporated into text) Part 1  Purpose and Application 1.1  Purpose of this Policy—This Policy provides guidance on corporate governance practices which have been formulated to: • achieve a balance between providing protection to investors and fostering fair and efficient capital markets and confidence in capital markets; • be sensitive to the realities of the large numbers of small companies and controlled companies in the Canadian corporate landscape; • take into account the impact of corporate governance developments in the US and around the world; and • recognize that corporate governance is evolving. The guidelines in this Policy are not intended to be prescriptive. •  •  •

XIV.  Creating National Corporate Governance Guidelines for Publicly Traded Corporations 725

Part 2  Meaning of Independence 2.1  Meaning of Independence—For the purposes of this Policy, a director is independent if he or she would be independent for the purposes of National Instrument 58-101 Disclosure of Corporate Governance Practices. Part 3  Corporate Governance Guidelines Composition of the Board 3.1  The board should have a majority of independent directors. 3.2  The chair of the board should be an independent director. Where this is not appropriate, an independent director should be appointed to act as “lead director.” However, either an independent chair or an independent lead director should act as the effective leader of the board and ensure that the board’s agenda will enable it to successfully carry out its duties. Meetings of Independent Directors 3.3  The independent directors should hold regularly scheduled meetings at which non-independent directors and members of management are not in attendance. Board Mandate 3.4  The board should adopt a written mandate in which it explicitly acknowledges responsibility for the stewardship of the issuer, including responsibility for: (a)  to the extent feasible, satisfying itself as to the integrity of the chief executive officer (the CEO) and other executive officers and that the CEO and other executive officers create a culture of integrity throughout the organization; (b)  adopting a strategic planning process and approving, on at least an annual basis, a strategic plan which takes into account, among other things, the opportunities and risks of the business; (c)  the identification of the principal risks of the issuer’s business, and ensuring the implementation of appropriate systems to manage these risks; (d)  succession planning (including appointing, training and monitoring senior management); (e)  adopting a communication policy for the issuer; (f)  the issuer’s internal control and management information systems; and (g)  developing the issuer’s approach to corporate governance, including developing a set of corporate governance principles and guidelines that are specifically applicable to the issuer [Issuers may consider appointing a corporate governance committee to consider these issues. A corporate governance committee should have a majority of independent directors, with the remaining members being “non-management” directors]. The written mandate of the board should also set out:

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(i)  measures for receiving feedback from stakeholders (e.g., the board may wish to establish a process to permit stakeholders to directly contact the independent directors), and (ii)  expectations and responsibilities of directors, including basic duties and responsibilities with respect to attendance at board meetings and advance review of meeting materials. In developing an effective communication policy for the issuer, issuers should refer to the guidance set out in National Policy 51-201 Disclosure Standards. For purposes of this Policy, “executive officer” has the same meaning as in National Instrument 51-102 Continuous Disclosure Obligations. Position Descriptions 3.5  The board should develop clear position descriptions for the chair of the board and the chair of each board committee. In addition, the board, together with the CEO, should develop a clear position description for the CEO, which includes delineating management’s responsibilities. The board should also develop or approve the corporate goals and objectives that the CEO is responsible for meeting. Orientation and Continuing Education 3.6  The board should ensure that all new directors receive a comprehensive orientation. All new directors should fully understand the role of the board and its committees, as well as the contribution individual directors are expected to make (including, in particular, the commitment of time and resources that the issuer expects from its directors). All new directors should also understand the nature and operation of the issuer’s business. 3.7  The board should provide continuing education opportunities for all directors, so that individuals may maintain or enhance their skills and abilities as directors, as well as to ensure their knowledge and understanding of the issuer’s business remains current. Code of Business Conduct and Ethics 3.8  The board should adopt a written code of business conduct and ethics (a code). The code should be applicable to directors, officers and employees of the issuer. The code should constitute written standards that are reasonably designed to promote integrity and to deter wrongdoing. In particular, it should address the following issues: (a)  conflicts of interest, including transactions and agreements in respect of which a director or executive officer has a material interest; (b)  protection and proper use of corporate assets and opportunities; (c)  confidentiality of corporate information; (d)  fair dealing with the issuer’s security holders, customers, suppliers, competitors and employees; (e)  compliance with laws, rules and regulations; and (f)  reporting of any illegal or unethical behaviour.

XIV.  Creating National Corporate Governance Guidelines for Publicly Traded Corporations 727

3.9  The board should be responsible for monitoring compliance with the code. Any waivers from the code that are granted for the benefit of the issuer’s directors or executive officers should be granted by the board (or a board committee) only. Although issuers must exercise their own judgement in making materiality determinations, the Canadian securities regulatory authorities consider that conduct by a director or executive officer which constitutes a material departure from the code will likely constitute a “material change” within the meaning of National Instrument 51-102 Continuous Disclosure Obligations. National Instrument 51-102 requires every material change report to include a full description of the material change. Where a material departure from the code constitutes a material change to the issuer, we expect that the material change report will disclose, among other things: •  the date of the departure(s), •  the party(ies) involved in the departure(s), •  the reason why the board has or has not sanctioned the departure(s), and •  any measures the board has taken to address or remedy the departure(s). Nomination of Directors 3.10  The board should appoint a nominating committee composed entirely of independent directors. 3.11  The nominating committee should have a written charter that clearly establishes the committee’s purpose, responsibilities, member qualifications, member appointment and removal, structure and operations (including any authority to delegate to individual members and subcommittees), and manner of reporting to the board. In addition, the nominating committee should be given authority to engage and compensate any outside advisor that it determines to be necessary to permit it to carry out its duties. If an issuer is legally required by contract or otherwise to provide third parties with the right to nominate directors, the selection and nomination of those directors need not involve the approval of an independent nominating committee. 3.12  Prior to nominating or appointing individuals as directors, the board should adopt a process involving the following steps: (A)  Consider what competencies and skills the board, as a whole, should possess. In doing so, the board should recognize that the particular competencies and skills required for one issuer may not be the same as those required for another. (B)  Assess what competencies and skills each existing director possesses. It is unlikely that any one director will have all the competencies and skills required by the board. Instead, the board should be considered as a group, with each individual making his or her own contribution. Attention should also be paid to the personality and other qualities of each director, as these may ultimately determine the boardroom dynamic. The board should also consider the appropriate size of the board, with a view to facilitating effective decision-making. In carrying out each of these functions, the board should consider the advice and input of the nominating committee.

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3.13  The nominating committee should be responsible for identifying individuals qualified to become new board members and recommending to the board the new director nominees for the next annual meeting of shareholders. 3.14  In making its recommendations, the nominating committee should consider: (a)  the competencies and skills that the board considers to be necessary for the board, as a whole, to possess; (b)  the competencies and skills that the board considers each existing director to possess; and (c)  the competencies and skills each new nominee will bring to the boardroom. The nominating committee should also consider whether or not each new nominee can devote sufficient time and resources to his or her duties as a board member. Compensation 3.15  The board should appoint a compensation committee composed entirely of independent directors. 3.16  The compensation committee should have a written charter that establishes the committee’s purpose, responsibilities, member qualifications, member appointment and removal, structure and operations (including any authority to delegate to individual members or subcommittees), and the manner of reporting to the board. In addition, the compensation committee should be given authority to engage and compensate any outside advisor that it determines to be necessary to permit it to carry out its duties. 3.17  The compensation committee should be responsible for: (a) reviewing and approving corporate goals and objectives relevant to CEO compensation, evaluating the CEO’s performance in light of those corporate goals and objectives, and determining (or making recommendations to the board with respect to) the CEO’s compensation level based on this evaluation; (b)  making recommendations to the board with respect to non-CEO officer and director compensation, incentive compensation plans and equity-based plans; and (c)  reviewing executive compensation disclosure before the issuer publicly discloses this information. Regular Board Assessments 3.18  The board, its committees and each individual director should be regularly assessed regarding his, her or its effectiveness and contribution. An assessment should consider (a)  in the case of the board or a board committee, its mandate or charter, and (b)  in the case of an individual director, the applicable position description(s), as well as the competencies and skills each individual director is expected to bring to the board. Pursuant to National Instrument (NI) 52-110, Audit Committees,64 an audit committee member is independent if he or she has no direct or indirect material relationship with the issuer. The 64 NI 52-110, Audit Committees (17 November 2015), online: .

XIV.  Creating National Corporate Governance Guidelines for Publicly Traded Corporations 729 definition of material relationship is very detailed, capturing a number of relationships and situations. NI 52-110 s 1.4(3) specifies that a “material relationship” is a relationship that could be reasonably expected to interfere with the exercise of a member’s independent judgment, and includes (a)  an individual who is, or has been within the last three years, an employee or executive officer of the issuer; (b)  an individual whose immediate family member is, or has been within the last three years, an executive officer of the issuer; (c)  an individual who: (i)  is a partner of a firm that is the issuer’s internal or external auditor, (ii)  is an employee of that firm, or (iii)  was within the last three years a partner or employee of that firm and personally worked on the issuer’s audit within that time; (d)  an individual whose spouse, minor child or stepchild, or child or stepchild who shares a home with the individual: (i)  is a partner of a firm that is the issuer’s internal or external auditor, (ii)  is an employee of that firm and participates in its audit, assurance or tax compliance (but not tax planning) practice, or (iii)  was within the last three years a partner or employee of that firm and personally worked on the issuer’s audit within that time; (e)  an individual who, or whose immediate family member, is or has been within the last three years, an executive officer of an entity if any of the issuer’s current executive officers served at that same time on the entity’s compensation committee; and (f)  an individual who received, or whose immediate family member who is employed as an executive officer of the issuer received, more than $75,000 in direct compensation from the issuer during any 12 month period within the last three years.

NI 52-110 s 1.4(6) states that direct compensation does not include: (a)  remuneration for acting as a member of the board of directors or of any board committee of the issuer, and (b) the receipt of fixed amounts of compensation under a retirement plan (including deferred compensation) for prior service with the issuer if the compensation is not contingent in any way on continued service.

NI 52-110 s 1.4(7) states that an individual is not considered to have a material relationship with the issuer solely because the individual or his or her immediate family member (a)  has previously acted as an interim chief executive officer of the issuer, or (b)  acts, or has previously acted, as a chair or vice-chair of the board of directors or of any board committee of the issuer on a part-time basis.

Under NI 52-110 s 1.5, additional independence requirements include that an individual who (a)  accepts, directly or indirectly, any consulting, advisory or other compensatory fee from the issuer or any subsidiary entity of the issuer, other than as remuneration for acting in his or her capacity as a member of the board of directors or any board committee, or as a part-time chair or vice-chair of the board or any board committee; or (b)  is an affiliated entity of the issuer or any of its subsidiary entities, is considered to have a material relationship with the issuer.

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Chapter 11  Board Composition and the Role of Directors NOTES AND QUESTIONS

1.  One purpose of NP 58-201 is to provide guidance on corporate governance practices that is sensitive to the realities of the large number of smaller companies and closely controlled companies in Canada; do you think that the guidelines accomplish this objective? 2.  The guidelines recommend that certain board committees, such as the nomination committee and the compensation committee, be composed entirely of independent directors; what is the policy rationale for such a suggested practice? 3.  What is the process suggested in the guidelines by which new candidates can be identified as potential directors? In your view, does this process answer some of the questions raised earlier in this chapter about the lack of diversity on Canadian corporate boards? 4.  What is the purpose of independent directors meeting on a regular basis without nonindependent directors and corporate officers?

XV.  SECURITIES LAWS DISCLOSURE REQUIREMENTS IN RESPECT OF CORPORATE GOVERNANCE A.  Voluntary Guidelines, Mandatory Disclosure The corporate governance guidelines promulgated by Canadian securities regulators are not mandatory. However, effective 2005, there has been a national instrument, National Instrument 58-101, Disclosure of Corporate Governance Practices, which requires issuing corporations to disclose their governance measures. This requirement aligns with Canadian securities legislation, in which disclosure is the underpinning of investor protection and enhances the efficiency and integrity of capital markets.

National Instrument 58-101, Disclosure of Corporate Governance Practices (2005) 28 OSCB 5377, as amended 17 November 2015 Part 2  Disclosure and Filing Requirements 2.1  Required Disclosure— (1)  If management of an issuer, other than a venture issuer, solicits a proxy from a security holder of the issuer for the purpose of electing directors to the issuer’s board of directors, the issuer must include in its management information circular the disclosure required by Form 58-101F1. (2)  An issuer, other than a venture issuer, that does not send a management information circular to its security holders must provide the disclosure required by Form 58-101F1 in its AIF. 2.2  Venture Issuers— (1)  If management of a venture issuer solicits a proxy from a security holder of the venture issuer for the purpose of electing directors to the issuer’s board of directors, the venture issuer must include in its management information circular the disclosure required by Form 58-101F2.

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(2)  A venture issuer that does not send a management information circular to its security holders must provide the disclosure required by Form 58-101F2 in its AIF or annual MD&A. 2.3  Filing of Code— If an issuer has adopted or amended a written code, the issuer must file a copy of the code or amendment on SEDAR no later than the date on which the issuer’s next financial statements must be filed, unless a copy of the code or amendment has been previously filed. Part 3  Exemptions and Effective Date 3.1 Exemptions— (1)  The securities regulatory authority or regulator may grant an exemption from this rule, in whole or in part, subject to any conditions or restrictions imposed in the exemption. (2)  Despite subsection (1), in Ontario, only the regulator may grant an exemption. 3.2  Effective Date— (1)  This Instrument comes into force on June 30, 2005. (2)  Despite subsection (1), sections 2.1 and 2.2 only apply to management information circulars, AIFs and annual MD&A, as the case may be, which are filed following an issuer’s financial year ending on or after June 30, 2005. Form 58-101F1 for issuers sets out the scope of what must be disclosed, including the structure and independence of the board, its mandate, the continuing education received by directors, recruitment and compensation, and whether the board has adopted a code for ethical business conduct.

Form 58-101F1, Corporate Governance Disclosure (2005) 28 OSCB 5379, as amended 25 October 2011 1.  Board of Directors— (a)  Disclose the identity of directors who are independent. (b)  Disclose the identity of directors who are not independent, and describe the basis for that determination. (c)  Disclose whether or not a majority of directors are independent. If a majority of directors are not independent, describe what the board of directors (the board) does to facilitate its exercise of independent judgement in carrying out its responsibilities. (d)  If a director is presently a director of any other issuer that is a reporting issuer (or the equivalent) in a jurisdiction or a foreign jurisdiction, identify both the director and the other issuer.

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(e)  Disclose whether or not the independent directors hold regularly scheduled meetings at which non-independent directors and members of management are not in attendance. If the independent directors hold such meetings, disclose the number of meetings held since the beginning of the issuer’s most recently completed financial year. If the independent directors do not hold such meetings, describe what the board does to facilitate open and candid discussion among its independent directors. (f)  Disclose whether or not the chair of the board is an independent director. If the board has a chair or lead director who is an independent director, disclose the identity of the independent chair or lead director, and describe his or her role and responsibilities. If the board has neither a chair that is independent nor a lead director that is independent, describe what the board does to provide leadership for its independent directors. (g)  Disclose the attendance record of each director for all board meetings held since the beginning of the issuer’s most recently completed financial year. 2.  Board Mandate—Disclose the text of the board’s written mandate. If the board does not have a written mandate, describe how the board delineates its role and responsibilities. 3.  Position Descriptions— (a)  Disclose whether or not the board has developed written position descriptions for the chair and the chair of each board committee. If the board has not developed written position descriptions for the chair and/or the chair of each board committee, briefly describe how the board delineates the role and responsibilities of each such position. (b)  Disclose whether or not the board and CEO have developed a written position description for the CEO. If the board and CEO have not developed such a position description, briefly describe how the board delineates the role and responsibilities of the CEO. 4.  Orientation and Continuing Education— (a) Briefly describe what measures the board takes to orient new directors regarding (i)  the role of the board, its committees and its directors, and (ii)  the nature and operation of the issuer’s business. (b)  Briefly describe what measures, if any, the board takes to provide continuing education for its directors. If the board does not provide continuing education, describe how the board ensures that its directors maintain the skill and knowledge necessary to meet their obligations as directors. 5.  Ethical Business Conduct— (a)  Disclose whether or not the board has adopted a written code for the directors, officers and employees. If the board has adopted a written code: (i)  disclose how a person or company may obtain a copy of the code;

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(ii)  describe how the board monitors compliance with its code, or if the board does not monitor compliance, explain whether and how the board satisfies itself regarding compliance with its code; and (iii)  provide a cross-reference to any material change report filed since the beginning of the issuer’s most recently completed financial year that pertains to any conduct of a director or executive officer that constitutes a departure from the code. (b)  Describe any steps the board takes to ensure directors exercise independent judgement in considering transactions and agreements in respect of which a director or executive officer has a material interest. (c)  Describe any other steps the board takes to encourage and promote a culture of ethical business conduct. 6.  Nomination of Directors— (a)  Describe the process by which the board identifies new candidates for board nomination. (b)  Disclose whether or not the board has a nominating committee composed entirely of independent directors. If the board does not have a nominating committee composed entirely of independent directors, describe what steps the board takes to encourage an objective nomination process. (c)  If the board has a nominating committee, describe the responsibilities, powers and operation of the nominating committee. 7. Compensation— (a)  Describe the process by which the board determines the compensation for the issuer’s directors and officers. (b)  Disclose whether or not the board has a compensation committee composed entirely of independent directors. If the board does not have a compensation committee composed entirely of independent directors, describe what steps the board takes to ensure an objective process for determining such compensation. (c)  If the board has a compensation committee, describe the responsibilities, powers and operation of the compensation committee. 8.  Other Board Committees—If the board has standing committees other than the audit, compensation and nominating committees, identify the committees and describe their function. 9. Assessments—Disclose whether or not the board, its committees and individual directors are regularly assessed with respect to their effectiveness and contribution. If assessments are regularly conducted, describe the process used for the assessments. If assessments are not regularly conducted, describe how the board satisfies itself that the board, its committees, and its individual directors are performing effectively.

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There is a separate form for corporate governance disclosure for venture issuers, Form 58-101F2.65 Hence, while the corporate governance guidelines are not prescriptive, securities regulators require extensive disclosure of corporate governance practices, particularly where they do not align with best practices. One issue is whether the disclosure is really meaningful for investors, as they may not have the time or resources to effectively monitor governance practices. However, institutional investors do have considerable interest in these disclosures, and given the volume of their investments, have a direct interest in monitoring corporate governance. An important policy question is, thus, whether the benefits of enhanced disclosure and thus ability to assess governance practice outweigh the additional costs to corporations. The requirement to report means that the board of directors must turn its mind to its governance practices, which may ultimately result in the board taking action to enhance its governance. A further important question is how these securities law requirements, which are aimed more generally at the public interest in protecting security holders, align with corporate law requirements, in which directors and officers are given considerable scope and discretion to make governance decisions in the best interests of the entity as a whole, and not merely for one party with a financial stake in the corporation. Recall the discussion in Chapter 10 with respect to directors concerning themselves with other stakeholders with a direct or indirect investment in the firm. While such stakeholders may benefit from the increased transparency that securities governance disclosure requirements offer, there can be an inherent tension in how corporate governance advances their individual interest in the corporation’s activities. NOTES AND QUESTIONS

1.  Why should disclosure of governance practices differ between privately held corporations and issuing corporations? 2. In your view, what is the right balance between common law and statutory approaches to corporate governance; specifically, should the interventions of regulators and courts be limited to ensuring that appropriate processes are followed? 3.  Do securities regulatory governance requirements conflict with the interests of other stakeholders such as creditors and employees?

B.  Financial Reports Financial statements for the preceding year must be placed before the shareholders at every annual meeting, and they must also be sent to shareholders in advance of the meeting. Under the CBCA and several other corporate statutes, the period for sending out these documents is not less than 21 days before the meeting.66 In the case of widely held corporations, the financial statements will be included in the proxy circular and will contain a

65 Form 58-101F2, Corporate Governance Disclosure (Venture Issuers) (2005) 28 OSCB 5382, as amended 25 October 2011. 66 CBCA ss 155 and 159; ABCA ss 155 and 159; and OBCA s 154.

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balance sheet, income statement, statement of retained earnings, and statement of changes in financial position.67 These financial statements must be prepared in accordance with the standards of the Canadian Institute of Chartered Accountants.68 If the corporation is an issuing corporation, the financial statements must be filed and thus available for public scrutiny. Securities legislation contains similar financial statement filing requirements. See also the discussion in Chapter 6 regarding continuous disclosure requirements. Publicly traded companies must disclose in their Annual Information Form (AIF) their social and environmental policies, as well as risk factors such as environmental and health, as set out below: Form 51-102F2, Annual Information Form, effective 30 June 2015 5.1 General  (1) Describe the business of your company and its operating segments that are reportable segments as those terms are described in the issuer’s GAAP. For each reportable segment include: (k)  Environmental Protection The financial and operational effects of environmental protection requirements on the capital expenditures, profit or loss and competitive position of your company in the current financial year and the expected effect in future years. (4)  Social or Environmental Policies If your company has implemented social or environmental policies that are fundamental to your operations, such as policies regarding your company’s relationship with the environment or with the communities in which it does business, or human rights policies, describe them and the steps your company has taken to implement them. 5.2 Risk Factors Disclose risk factors relating to your company and its business, such as cash flow and liquidity problems, if any, experience of management, the general risks inherent in the business carried on by your company, environmental and health risks, reliance on key personnel, regulatory constraints, economic or political conditions and financial history and any other matter that would be most likely to influence an investor?s decision to purchase securities of your company. If there is a risk that securityholders of your company may become liable to make an additional contribution beyond the price of the security, disclose that risk. (i)  Disclose the risks in order of seriousness from the most serious to the least serious. (ii)  A risk factor must not be de-emphasized by including excessive caveats or conditions.

C.  Auditing of Financial Statements The use of auditors antedates statutes mandating their use. It can be explained in terms of the concept of bonding—the auditor’s report serves as a signal of the accuracy of the financial statements.69 CBCA s 161 now requires the financials to be reported on by an auditor that

67 Canada Business Corporations Regulations, 2001, SOR/2001-512 [CBCR] s 72; Alberta Business Corporations Regulation, Alta Reg 118/2000 [Alberta BCR] s 21(1); and General, RRO 1990, Reg 62 [OBCA Reg] s 42. 68 CBCR ss 70 and 71; Alberta BCR s 21; and OBCA Reg ss 40 and 41. 69 Ross L Watts & Jerold L Zimmerman, “Agency Problems, Auditing, and the Theory of the Firm: Some Evidence” (1983) 26 JL & Econ 613.

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is “independent” of the corporation.70 There is, however, an exemption for small firms that permits corporations that are not publicly held to dispense with the requirement of an auditor with the unanimous consent of shareholders.71 It is important to remember that while the financial statements are reported on by the auditor, they are the corporation’s statements, and are not issued by it until they have been approved by its directors.72 Unless exempted, the board of directors of an issuing corporation must appoint an audit committee, a majority of whose members must not be employees of the corporation or an affiliate.73 The audit committee serves generally as a go-between for the board and the auditors, and is charged with examining the financial statements before they are submitted to the board for approval. For issuing corporations, securities regulators have issued new audit committee independence requirements. Although the CBCA-based statutes do not specify what manner of report the corporation’s auditor is to make regarding the corporation’s financial statement, the following, or words of similar purport, is the customary form of a “clean” auditor’s report: We have examined the [list of financial statements]. Our examination included a general review of the accounting procedures and such tests of accounting records and other supporting evidence as we considered necessary in the circumstances. In our opinion these financial statements present fairly the financial position of the company as at [year end] and the results of their operations for the year then ended in accordance with generally accepted accounting principles.

In a clean opinion, the auditor generally opines as to two matters: that the financial statements have been set out in accordance with International Financial Reporting Standards (IFRS) or “generally accepted accounting principles” (GAAP) and that they “present fairly” the financial position of the corporation. Generally accepted accounting principles and the International Financial Reporting Standards include at least those principles so recognized in the CPA Canada Handbook.74 There is often more than one accounting principle that could be applied to a given situation, and the results may differ depending on which principle is used. Usually it is management’s prerogative in such a case to choose among applicable principles, and an auditor is not obliged to qualify its opinion simply because it does not

70 See also ABCA s 161; BCBCA ss 204, 205, and 206; OBCA s 152; and NSCA ss 117 and 119A. QBCA ss 23139 discuss the role of the auditor. 71 CBCA s 163; ABCA s 163; BCBCA ss 203(2) and 203(3); OBCA s 148; NSCA s 118; and QBCA s 239. 72 CBCA s 158; ABCA s 158; BCBCA s 225; OBCA s 159; and NSCA s 122(2). 73 CBCA s 171; ABCA s 171; BCBCA s 224; and OBCA s 158. 74 The Canadian Accounting Standards Board (AcSB) has adopted the mandatory use of International Financial Reporting Standards (IFRS) by all publicly accountable enterprises, replacing previous Canadian generally accepted accounting principles as the acceptable set of accounting standards, with implementation dates over a period from 2015 to 2019, and ongoing assessment and revision of standards as the implementation proceeds. While the Canada Revenue Agency does not specify that financial statements must be prepared following any particular type of accounting principles or standards, the AcSB requires publicly accountable enterprises to use IFRS in the preparation of all interim and annual financial statements. Most private companies also have the option to adopt IFRS for financial statement preparation: see International Financial Reporting Standards, online: Canada Revenue Agency .

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believe that the most appropriate principle was chosen. At some point, however, the issue of choosing among accounting principles begins to shade into the “fairness” with which the financial position is being presented. For a discussion of what constitutes fair presentation, see the judgment of the British Columbia Court of Appeal in Kripps v Touche Ross & Co, an excerpt of which is set out below.

Kripps v Touche Ross & Co [1997] 6 WWR 421, 33 BCLR (3d) 254 (CA) FINCH J (Rowles J concurring):

[62]  In my respectful view, the statement that “financial statements present fairly the financial position of the company in accordance with generally accepted accounting principles” is ambiguous. It is neither a clear statement of opinion by the professional auditor that the financial statements present fairly the financial position of the company, nor that the financial statements are in accordance with generally accepted accounting principles. In the case at bar, the defendant argued that while the financial statements may present unfairly the financial position of the company (i.e., misrepresent that position), they are nevertheless in accordance with GAAP. Therefore, the defendant says, it is true to say that the financial statements present fairly the financial position according to GAAP. Therefore, it has made no misrepresentation in its auditor’s report and is not liable. [63]  In my view, the critical issue is the effect of the auditor’s report. The learned trial judge concluded that the failure to disclose the amount of arrears was an omission of a piece of material information, but that the capitalization of unpaid interest was the universal practice at the time and was in accordance with GAAP. He therefore concluded that since the capitalization of arrears was in accordance with GAAP, the defendant could not refuse to sign the standard form of auditor’s report, regardless of whether the practice was misleading (at para. 93): If it was only a question of whether there was a fair presentation of the financial position, the qualifying words “in accordance with GAAP” would serve no purpose. But, as the Handbook provides, GAAP is the standard against which fair presentation is to be judged. The opinion auditors give is that the financial position is, in accordance with accepted principles, fairly presented. It is, in that sense, a qualified opinion of fair presentation, and the qualification cannot be ignored. [emphasis in original]

[64]  It is my view that the aim of an auditor’s report is to allow auditors to provide their professional opinion which may be relied upon as a guide to business planning and investment. GAAP may be their guide to forming this opinion, but auditors are retained to form an opinion on the fairness of the financial statements, not merely on their conformity to GAAP. A person to whom the auditor owes a duty of care who reads a standard auditor’s report and concludes in reliance on it that the financial statements are fair is acting reasonably. [65]  I find support for this view in Section 5400 of the Handbook. 5400.14 sets out the standard form of auditor’s report. 5400.16 states, in part:

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Chapter 11  Board Composition and the Role of Directors To permit all auditors to judge in a consistent manner whether financial statements “present fairly,” there must be a standard against which those judgments can be made; generally accepted accounting principles provide such a standard.

In a given situation, the auditor may not feel able to give a clean opinion, in which case it may note that the opinion is “subject to” one or more qualifications. These qualifications may be required either because the auditor was unable to verify certain accounts in accordance with the standards for testing ordinarily applied to an audit, or because of the existence of certain “contingencies.” The latter are customarily the subject of footnote disclosure. In an extreme case, the auditor might refuse to issue any opinion at all. Of course, it will be very damaging to the corporation’s reputation if the auditor fails to issue an opinion or issues one subject to serious qualifications. A negative report by an auditor can have negative effects on a corporation’s share price. When PricewaterhouseCoopers LLP resigned in February 2005 as Mamma.com Inc’s independent auditor after refusing to sign off on the small Internet search company’s financial results for 2004, it was a signal to the market that there were problems with the financial records of the corporation. The corporation’s share price dropped immediately by 32 percent as the market reacted.75 The auditor may also put a “going concern qualification” into its report, indicating that the auditor has some concern about the corporation’s viability. Such a qualification can quickly and seriously erode share price as investors exit the corporation to preserve their investment. Like a director, the auditor may be removed by ordinary resolution of the shareholders. The vacancy may be filled either by the shareholders at the meeting where it is created or, if not filled then, by the directors. At the end of its term, an auditor may in effect be removed by the directors if they fail to renominate the auditor. The CBCA-based statutes attempt to preserve some measure of true independence for the auditor, in light of management’s practical ability to remove the auditor, by giving the auditor the right to attend and to speak at all meetings of the audit committee and of the shareholders. Whenever it is proposed to remove the auditor or to nominate another instead, or whenever the auditor proposes to resign, the auditor may submit to management a written statement of position that must be sent to the shareholders with management’s proxy solicitation materials. In addition, corporations statutes often provide that no person is to accept an appointment as a corporation’s auditor until the auditor has received from the predecessor auditor a written statement of the circumstances surrounding the predecessor’s departure. Canadian Securities Administrators (CSA) have also promulgated National Instrument (NI) 52-108, Auditor Oversight.76 The express purpose of NI 52-108 is to contribute to public confidence in the integrity of financial reporting of reporting issuers by promoting high quality, independent auditing. Where a reporting issuer files its financial statements accompanied by an auditor’s report, the instrument requires the reporting issuer to have the auditor’s

75 Simon Avery, “Mamma.com Shares Fall 32%,” Globe and Mail (16 February 2005), online: . 76 (2004) 27 OSCB 874, as amended 30 September 2014.

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report signed by a public accounting firm that is a participant in the Canadian Public Accountability Board (CPAB) oversight program for public accounting firms that audit reporting issuers, and in compliance with any restrictions or sanctions imposed by the CPAB.

D.  Certification of Disclosure and Fair Presentation There has been considerable debate regarding how best to make corporations accountable for the fairness and accuracy of annual filings, including financial statements of the issuing corporation. Canadian securities regulators have now made a policy choice that corporate officers will be responsible for financial statements. The chief executive officer (CEO) and the chief financial officer (CFO) are required to give assurances about the quality of disclosure, rather than requiring corporate boards to have express systems in place to monitor the financial disclosures of management. Canadian securities regulators have promulgated certification requirements to enhance the integrity of corporate disclosures. Pursuant to NI 52-109, Certification of Disclosure in Issuers’ Annual and Interim Filings (2008) 31 OSCB 7949, as amended 17 November 2015 and accompanying Form 52-109F1, certifying officers must certify the integrity of their disclosures. NI 52-109 created a new national instrument on officer certification. The instrument replaced a multilateral instrument that had previously been effective for all jurisdictions except British Columbia. NI 52-109 sets out disclosure and filing requirements for all reporting issuers, other than investment funds. The objective of the requirements is to improve the quality, reliability, and transparency of annual filings, interim filings, and other materials that issuers file or submit under securities legislation. The instrument applies to both corporate and non-corporate entities. NI 52-109 requires an issuer’s chief executive officer and chief financial officer, or persons performing similar functions to a CEO or CFO (certifying officers), to personally certify that the issuer’s annual filings and interim filings do not contain any misrepresentations; that the financial statements and other financial information in the annual and interim filings fairly present in all material respects the financial condition, results of operations, and cash flows of the issuer; that they have designed or supervised design of disclosure controls and procedures (DC&P) and internal control over financial reporting (ICFR); that they have caused the issuer to disclose in its MD&A any change in the issuer’s ICFR that has materially affected the issuer’s ICFR; and, on an annual basis, that they have evaluated the effectiveness of the issuer’s DC&P and caused the issuer to disclose their conclusions about the effectiveness of DC&P in the issuer’s MD&A. Thus, the certifying officers are required to certify that the financial statements fairly present the financial condition of the issuer, that there are internal controls in place to ensure that material information is conveyed to decision-makers, and that they have disclosed to the auditor and audit committee any significant deficiencies in internal control and any fraud, material or not, that involved managers or other employees who have a significant role in the company’s internal controls. Canadian issuers listed in the United States must also comply with the Sarbanes-Oxley Act of 2002.77

77 Ibid.

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The Companion Policy to NI 52-10978 sets out the rationale: PART 4—FAIR PRESENTATION, FINANCIAL CONDITION AND RELIABILITY OF FINANCIAL REPORTING 4.1  Fair presentation of financial condition, financial performance and cash flows (1)  Fair presentation not limited to issuer’s GAAP—The forms included in the Instrument require each certifying officer to certify that an issuer’s financial statements (including prior period comparative financial information) and other financial information included in the annual or interim filings fairly present in all material respects the financial condition, financial performance and cash flows of the issuer, as of the date and for the periods presented. This certification is not qualified by the phrase “in accordance with generally accepted accounting principles” which is typically included in audit reports accompanying annual financial statements. The forms specifically exclude this qualification to prevent certifying officers from relying entirely on compliance with the issuer’s GAAP in this representation, particularly as the issuer’s GAAP financial statements might not fully reflect the financial condition of the issuer. Certification is intended to provide assurance that the financial information disclosed in the annual filings or interim filings, viewed in its entirety, provides a materially accurate and complete picture that may be broader than financial reporting under the issuer’s GAAP. As a result, certifying officers cannot limit the fair presentation representation by referring to the issuer’s GAAP. Although the concept of fair presentation as used in the annual and interim certificates is not limited to compliance with the issuer’s GAAP, this does not permit an issuer to depart from the issuer’s GAAP in preparing its financial statements. If a certifying officer believes that the issuer’s financial statements do not fairly present the issuer’s financial condition, the certifying officer should ensure that the issuer’s MD&A includes any necessary additional disclosure. (2)  Quantitative and qualitative factors—The concept of fair presentation encompasses a number of quantitative and qualitative factors, including: (a)  selection of appropriate accounting policies; (b)  proper application of appropriate accounting policies; (c)  disclosure of financial information that is informative and reasonably reflects the underlying transactions; and (d)  additional disclosure necessary to provide investors with a materially accurate and complete picture of financial condition, financial performance and cash flows. 4.2  Financial condition—The Instrument does not formally define financial condition. However, the term “financial condition” in the annual certificates and interim certificates reflects the overall financial health of the issuer and includes the issuer’s financial position (as shown on the statement of financial position) and other factors that may affect the issuer’s liquidity, capital resources and solvency. 4.3  Reliability of financial reporting—The definition of ICFR refers to the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the issuer’s GAAP. In order to have reliable financial reporting and financial statements to be prepared in accordance with the issuer’s GAAP, the amounts and disclosures in the financial statements must not contain any material misstatement.

The System for Electronic Document Analysis and Retrieval (SEDAR) is the central repository of public securities documents and information filed by public companies and investment funds with the Canadian Securities Administrators. The objective of the filing system and its

78 Companion Policy 52-109CP, Certification of Disclosure in Issuers’ Annual and Interim Filings reflecting amendments made effective 1 January 2011 in connection with Canada’s changeover to IFRS.

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Internet access is to allow public access to information on issuing corporations, without a fee to investors, in order to enhance investor awareness of the business and affairs of public companies and investment funds and to promote confidence in the transparent operation of capital markets in Canada.79 Electronic filing has allowed issuing corporations to reduce the time and cost of filing documents with each provincial securities regulator separately, as it provides a central repository of the information. The following excerpt explains the notion of fair presentation of the issuer’s financial condition under the new certification requirements.

Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada: Cases and Commentary, 3rd ed (Toronto: Emond, 2017) A.  Fair Presentation The certification that the financial information fairly presents the issuer’s financial condition is an important aspect of the assurances given by the issuer’s officers, because it is broader than affirming that documents comply with GAAP (soon to be IFRS). “Fairly present” means a materially accurate and complete picture of the issuer’s financial condition. Fair presentation includes but is not necessarily limited to selection of appropriate accounting policies; proper application of appropriate accounting policies; disclosure of financial information that is informative and reasonably reflects the underlying transactions; and inclusion of additional disclosure necessary to provide investors with a materially accurate and complete picture of financial condition, results of operations, and cash flows (NI 52-109CP). Where an issuer is of the view that there are limitations to the issuer’s GAAP-based financial statements as an indicator of its financial condition, the issuer should provide additional disclosure in its MD&A necessary to provide a fair and complete picture of the issuer’s financial condition, financial performance, and cash flows (NI 52-109CP, s 4.1).

E.  Reporting on Internal Controls The CSA had developed MI 52-111, Reporting on Internal Control over Financial Reporting, which securities regulators in every Canadian jurisdiction except British Columbia had published for comment in February 2005. Proposed MI 52-111 was substantially similar to the requirements for internal control rules set out in s 404 of the Sarbanes-Oxley Act (S-Ox 404). If it had been enacted, management of an issuer would have been required to evaluate the effectiveness of the issuer’s internal control over financial reporting, as at the end of the issuer’s financial year, against a suitable control framework. The issuer would have been required to file a report of management on its assessment of the effectiveness of the issuer’s internal control over financial reporting, including a statement as to whether the internal

79 SEDAR welcome page: .

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control over financial reporting is effective; and a report of the issuer’s auditor prepared in accordance with the CICA’s auditing standard for internal control audit engagements. After considerable public discussion, and in light of developments in the United States that appear to have backed away from some certification requirements under S-Ox 404 for smaller corporations, on 10 March 2006, the CSA reported that it was not going to proceed with MI 52-111.80 In late 2006, the Securities and Exchange Commission issued a number of deregulatory orders and proposals intended to loosen requirements for smaller companies and lower reporting costs for issuing corporations in the United States.81

XVI.  THE ROLE OF AUDIT COMMITTEES As discussed above, the external auditor provides an opinion that the financial statements present fairly the financial position of the company and the results of its operations for the period in accordance with generally accepted accounting principles or the International Financial Reporting Standards. External auditors are retained by, and are ultimately accountable to, the shareholders. Hence, auditors have a right and duty to provide their views directly to the shareholders if they disagree with an approach being taken by the audit committee. Practically, however, auditors are usually recommended by the audit committee or corporate officers. The regulatory requirements aimed at independence of audit committees are designed as an investor protection device, but serve more generally as an accountability check for all stakeholders. An audit committee is a committee of the board of directors that has responsibility for oversight of the financial reporting process, which includes accountability checks on managers’ financial decisions and the solvency of the corporation; helping directors meet their responsibilities; providing better communication between the directors and the external auditors; enhancing the independence of the external auditor; increasing the credibility and objectivity of financial reports; and strengthening the role of the directors by facilitating indepth discussions among directors, management, and the external auditor. Shareholders and other stakeholders face collective action problems in that they are dispersed and frequently hold too small a stake in the corporation to invest the time and energy required to monitor effectively the finances of the corporation. The audit committee of a corporate board, if its members are independent from the corporation’s officers, can provide some assurance to stakeholders of the quality, integrity, and timeliness of disclosures. In the aftermath of corporate scandals in the United States and concern that audit committees truly provide an independent assessment of the financial status of the corporation, Canadian regulators adopted NI 52-110, Audit Committees82 to ensure that external audits are

80 BCSC 52-313, Status of Proposed Multilateral Instrument 52-111, Reporting on Internal Control over Financial Reporting and Proposed Amended and Restated Multilateral Instrument 52-109, Certification of Disclosure in Issuers’ Annual and Interim Filings, CSA, , effective 10 March 2006, online: . 81 S Labaton, “SEC Eases Regulations on Business,” New York Times (14 December 2006), online: . 82 NI 52-110, Audit Committees, effective 17 November 2016. The national instrument was formerly a multilateral instrument, MI 52-110, (2003) 26 OSCB 4884.

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conducted independently of the issuer’s management by assigning these duties to an independent audit committee. The objective of NI 52-110 is to encourage reporting issuers to establish and maintain strong, effective and independent audit committees that will enhance the quality of financial disclosure made by reporting issuers. It establishes requirements for the responsibilities, composition, and authority of audit committees. An audit committee of a reporting issuer must be made up of a minimum of three directors of the issuer.83 NI 52-110 requires that the audit committee must also be responsible for managing, on behalf of the shareholders, the relationship between the issuer and the external auditors.84 In particular, it provides that an audit committee recommend to the board of directors the nomination and compensation of the external auditors.85 An audit committee must be directly responsible for overseeing the work of the external auditors engaged for the purpose of preparing or issuing an auditor’s report or performing other audit, review, or attestation services for the issuer, including the resolution of disagreements between management and the external auditors regarding financial reporting.86 The audit committee must also be satisfied that adequate procedures are in place for the review of the issuer’s public disclosure of financial information, including periodic assessment of the adequacy of those procedures. The audit committee must establish procedures for the receipt, retention, and treatment of complaints received by the issuer regarding accounting, internal accounting controls, or auditing matters; and for the confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters.87 This latter requirement is a form of whistle-blowing protection, so that employees who believe that there is a problem with the integrity of the financial statements have a mechanism to report the problem to an independent committee that can then investigate. The responsibilities are set out in NI 52-110, s 2.

NI 52-110, Audit Committees effective 17 November 2016 Part 2  Audit Committee Responsibilities 2.1  Audit Committee Every issuer must have an audit committee that complies with the requirements of the Instrument. 2.2 Relationship with External Auditors Every issuer must require its external auditor to report directly to the audit committee.

83 84 85 86 87

NI 52-110, Audit Committees, s 3.1(1). Ibid, part 2. Ibid. NI 52-110, Audit Committees, s 2.3(3). Ibid, s 2.3(7).

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2.3 Audit Committee Responsibilities (1)  An audit committee must have a written charter that sets out its mandate and responsibilities. (2)  An audit committee must recommend to the board of directors: (a)  the external auditor to be nominated for the purpose of preparing or issuing an auditor’s report or performing other audit, review or attest services for the issuer; and (b)  the compensation of the external auditor. (3)  An audit committee must be directly responsible for overseeing the work of the external auditor engaged for the purpose of preparing or issuing an auditor’s report or performing other audit, review or attest services for the issuer, including the resolution of disagreements between management and the external auditor regarding financial reporting. (4)  An audit committee must pre-approve all non-audit services to be provided to the issuer or its subsidiary entities by the issuer’s external auditor. (5)  An audit committee must review the issuer’s financial statements, MD&A and annual and interim profit or loss press releases before the issuer publicly discloses this information. (6)  An audit committee must be satisfied that adequate procedures are in place for the review of the issuer’s public disclosure of financial information extracted or derived from the issuer’s financial statements, other than the public disclosure referred to in subsection (5), and must periodically assess the adequacy of those procedures. (7)  An audit committee must establish procedures for: (a)  the receipt, retention and treatment of complaints received by the issuer regarding accounting, internal accounting controls, or auditing matters; and (b)  the confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters. (8)  An audit committee must review and approve the issuer’s hiring policies regarding partners, employees and former partners and employees of the present and former external auditor of the issuer.

A.  Independence of Audit Committees Every member of an audit committee is required to be independent.88 Independence means the absence of any direct or indirect material relationship between the director and the issuer that could, in the view of the issuer’s board of directors, reasonably interfere with the exercise of a member’s independent judgment.89 Section 1.4 sets out a list of relationships with an issuer that would reasonably interfere with the exercise of the person’s independent judgment and a list of related persons who are not eligible to serve on the issuer’s audit committee, including an individual who is, or has been, or whose immediate family member is, or has been, an employee or executive officer of the corporation;

88 Ibid, ss 1.4 and 1.5. 89 Ibid, s 1.4(2).

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and an individual who is or was affiliated with a current or former external auditor within a prescribed period. Also set out in s 1.4 are a host of other relationships that may give rise to a lack of independence. A person or company is considered to be an affiliated entity of another person or company if one of them controls or is controlled by the other or if both persons or companies are controlled by the same person or company, or the person or company is both a director and an employee of an affiliated entity, or an executive officer, general partner, or managing member of an affiliated entity.90 “Control” in the context of this instrument means the direct or indirect power to direct or cause the direction of the management and policies of a company, whether through ownership of voting securities or otherwise. A person is not considered to be an affiliated entity of an issuer if the person owns 10 percent or less of any class of voting equity securities of the issuer and is not an executive officer of the issuer.91 There are also provisions dealing with replacement of audit committee members where they cease to be independent, resign, or die, and for appointing new members.92 An audit committee must have the authority to engage independent counsel and other advisers as it determines necessary to carry out its duties, to set and pay the compensation for any advisers employed by the audit committee, and to communicate directly with the internal and external auditors.93

B.  Temporary Exceptions to Independence Requirements Temporary exceptions to the independence requirements are available if the member is able to exercise the impartial judgment necessary for the member to fulfill his or her responsibilities as an audit committee member.94 The individual granted the exemption cannot be the chair of the committee, and the exemption is not available unless the majority of the audit committee members are still independent.95 The board of directors must first determine that reliance on the exemption will not materially adversely affect the ability of the audit committee to act independently.96

C.  Financial Literacy Canadian regulators have also now imposed financial literacy requirements for audit committee members. An individual is financially literate if he or she has the ability to read and understand a set of financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of the issues that can reasonably be expected to be raised by the issuer’s financial statements.97 A

90 91 92 93 94 95 96 97

Ibid, ss 1.3(1) and (2). Ibid, s 1.3(4). Ibid, ss 3.4 and 3.5. Ibid, s 4.1. Ibid, s 3.6. Ibid, s 3.7. Ibid, s 3.9. Ibid, s 1.5.

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comprehensive knowledge of international financial reporting standards and generally accepted auditing standards (GAAS) is not part of the definition of financial literacy. Reporting forms require an issuer to disclose in its Annual Information Form (AIF) any education and/or experience of audit committee members that will provide the members with an understanding of the accounting principles used by the issuer to prepare its financial statements, as well as the ability to assess the general application of such accounting principles in connection with the accounting for estimates, accruals, and reserves.98 The issuer must also disclose any experience that the audit committee member has had in actively supervising persons engaged in preparing, auditing, analyzing, and evaluating financial statements. A director that is not financially literate can be appointed to the audit committee provided that the member becomes financially literate within a reasonable period of time following the appointment and the board of directors has determined that the appointment will not materially adversely affect the ability of the audit committee to act independently.99 NI 52-110 does not require, as does the US Sarbanes-Oxley Act of 2002, Pub L no 107-204 Stat 745, that there be at least one “financial expert” on the committee. A number of Canadian issuers must, however, meet these requirements because they are crosslisted in the United States and subject to the requirements of the Sarbanes-Oxley Act.

D.  Non-Audit Services to Be Approved NI 52-110 requires the pre-approval of non-audit services by the audit committee.100 Audit committees must adopt policies and procedures for the engagement of non-audit services, which include monetary limits and other factors relating to the independence of the auditor that allow the audit committee to make an informed decision regarding the impact of the service on the auditor’s independence.101 There are also provisions for de minimis non-audit services in which an audit committee satisfies the pre-approval requirement if the aggregate amount of the non-audit services is reasonably expected to constitute no more than 5 percent of total fees paid by the issuer and its subsidiary entities to the issuer’s external auditor during the fiscal year in which the services are provided.102 The integrity of audit committee requirements in respect of audit services is also augmented by professional codes of conduct for auditors, promulgated previously by the Canadian Institute of Chartered Accountants and now by Chartered Professional Accountants (CPA) Canada, aimed at ensuring responsibility to clients for the integrity and quality of professional services delivered, including the objectives of competence, ethical conduct, and impartiality.103

98 99 100 101 102 103

Ibid, ss 1.6 and 3.8; and Form 52-110F1 (1 January 2011), ss 2 and 6. NI 52-110, Audit Committees, ss 3.8 and 3.9. Ibid, s 2.3(4). Ibid. Ibid, s 2.4. Canadian Institute of Chartered Accountants, Code of Conduct, available online: .

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E. Exemptions Venture issuers are exempt from some of the audit committee composition and reporting obligations, but must complete a separate form for disclosure.104 A US-listed issuer is also exempt from the audit committee composition, responsibilities, and reporting obligations if it is in compliance with the requirements of the US marketplace. If it is incorporated or continued in a jurisdiction in Canada, it must include the required disclosures in its AIF.105

XVII.  CORPORATE CHARITY A final issue in respect of boards of directors and corporate governance is the extent to which corporations can engage in charitable activities, including philanthropic donations and support of particular charitable organizations. Given the huge profits that many corporations earn, the question is whether charitable support comes within directors’ obligations to act in the best interests of the corporation. The courts have consistently upheld the power of corporations to make charitable contributions on the basis of “enlightened self-interest.” See e.g. AP Mfg Co v Barlow, 98 A.2(d) 581 (NJ 1953), where the court upheld the propriety of a gift of $1,500 to Princeton University over the objection of a minority shareholder. In Canada, corporate charity is limited compared with many other countries. Corporate operating profits in Canada were $388.7 billion in 2014.106 Total charitable donations were $13.3 billion,107 Statistics Canada reporting that over $8.8 billion of these charitable donations were made by individuals,108 meaning that at most, Canadian businesses donated $6.4 billion, or approximately 1.3 percent of their profits, to charitable causes. Low rates of giving by Canadian corporations may be a consequence of their accountability in competitive capital and product markets. Given the low rates of corporate charity, legal rules facilitating charitable contributions by corporations may have little effect. Harry Arthurs offers another explanation for the lower rate of corporate charitable contributions in Canada than in the US and other countries. He argues that the unique form of “localized globalism” experienced by Canada has resulted in Canadian corporations operating as disempowered subsidiaries of large, primarily US-based, multinational enterprises. This disempowerment has not only economic consequences in terms of production and employment decisions, but also negative social consequences in terms of lost financial and other support for non-profit and charitable activities.

04 NI 52-110 Audit Committees, ss 6.1 and 6.2; and Form 52-110F2, effective 30 June 2015. 1 105 NI 52-110 Audit Committees, s 7.1; and Form 52-110F1, effective 1 January 2011. 106 Statistics Canada, “Financial and Taxation Statistics for Enterprises, 2014,” The Daily (17 March 2016), online: . 107 Canada Revenue Agency, Report on the Charities Program 2015-2016, online: . 108 Statistics Canada, “Charitable Donors, 2014,” The Daily (22 February 2016), online: .

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Harry Arthurs, “The Hollowing Out of Corporate Canada?” in J Jenson & B de Sousa Santos, eds, Globalizing Institutions: Case Studies in Regulation and Innovation (Aldershot, UK: Ashgate, 2000) at 44-45 The essence of the problem is that transnational companies and their subsidiaries constitute a considerable presence in Canada—a social, political and cultural presence as well as an economic presence. They are major consumers of producer services, powerful participants in policy networks and public debates, benefactors or sponsors of artistic, educational, sporting and humanitarian organizations and events, shapers of land markets, urban skylines and popular culture and, through the example they set in their employment practices, influential in defining local attitudes concerning gender, race and class … . [E] ach time a transnational corporation rejigs its organization chart, each time the role and structure of its subsidiaries is redefined, not just an enfeebled and vulnerable Corporate Canada but all Canadians are put at risk. Laureen Snider has offered a critique of the influence of powerful corporate elites in Canada and their ability to influence corporate law policy. She has suggested that corporate crime has been argued into obsolescence through knowledge claims advanced through specific discourses by powerful elites; and that the acceptance of these knowledge claims cannot be understood without examining their relationship to the corporate lobbying that has, over the last two decades, legitimized virtually every acquisitive, profit-generating act of the corporate sector.

Laureen Snider, “The Sociology of Corporate Crime: An Obituary (or: Whose Knowledge Claims Have Legs?)” (2000) 4 Theoretical Criminology 169 at 171 However, when it comes to crimes of the powerful—marketing unsafe products, maintaining unsafe workplaces, defrauding workers by insisting on unpaid overtime or demanding “voluntary” labour, dumping toxic waste, misrepresenting the benefits or not disclosing the risks of products—criminal law does not work. It is expensive, inefficient, ineffective, a club over the head when a whisper in the ear would suffice. The individuals and organizations that engage in what used to be called corporate crime, it seems, respond best to reasoned persuasion and rewards, to tax breaks and market incentives. Increased punitiveness only “works,” it appears, for the impoverished, non-white, individual criminals who fill and overfill the prisons of modern democratic states. •  •  •

Key elites in the new world economy have heavy vested interests—billions of dollars, world reputations, the power of nation-states and entire regions—in getting some interpretations accepted and others rejected. Interpreting the “laws” of the market in accord with neo-liberal tenets, for example, reinforces efforts by dominant classes in the first world to extend their privilege in a number of ways. Interpreting scientific data in ways that “prove” genetically engineered plants are safe is worth trillions to the transnational companies that hold the patents on this genetic material, and to the nation-states which

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guarantee their legitimacy. Increasingly, dominant interests sponsor science directly (as publicly funded government and university laboratories are closed down), so certain kinds of questions are more likely to be asked, certain knowledges produced. Hence, Snider views interest group pressure as a global phenomenon that affects the development of corporate law across multiple jurisdictions.

XVIII. CONCLUSION This chapter has canvassed how directors are appointed and what their respective duties and obligations are. It examined the need for independence and diversity on boards of directors if there is to be meaningful governance oversight of the corporation. It also explored the role of board committees, including audit committees and their importance to effective governance oversight. For closely held businesses, shareholder agreements can shift the duties of directors to the shareholders themselves. The chapter also canvassed the developments in corporate governance by securities regulators, who have adopted a “comply or explain” approach. The next chapter examines shareholder participation rights as another important aspect of corporate governance.

C H A P T E R T W E LV E

Shareholder Participation in Corporate Governance









I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 752 II.  Shareholder Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 753 A.  Election of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 755 B.  Amendment of Bylaws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 755 C.  Unanimous Shareholder Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 756 D.  Fundamental Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 757 E.  Class Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 758 III.  The Distribution of Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 760 A.  Development of the Use of “Restricted” (Non-Voting, Non-Preferred) Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 761 B.  Voting Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 762 C.  Equal Treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 767 D.  Cumulative Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 776 IV.  The Significance of Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 777 A.  Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 778 V.  Shareholder Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 779 A.  Annual Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 779 B.  Special Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 779 C.  Ordinary and Special Resolutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 780 D.  Place of Meeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 780 E. Quorum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 781 F.  The Principle of Notice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 781 G.  Conduct of Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 782 VI.  Shareholder Voice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 785 A.  Meetings Requisitioned by Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 785 B.  Meetings by Order of the Court . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 786 C.  Intervention on the Basis of Fault . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 787 D.  Meetings in Widely Held Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 787 E.  Constitutionality Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 791 F.  Beneficial Owners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 793 VII.  Access to Records and List of Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 796 A.  Access to Records . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 796 B.  Mechanics of Access . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 798

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VIII.  Institutional Investor Monitoring and Activism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 799 IX.  Proxy Solicitation and Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 803 A.  Legal Developments in the Proxy Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 805 B.  Proxy Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 806 C.  Who Must Solicit Proxies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 807 D.  Sample Proxy Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 808 E.  Compliance with More Than One Set of Proxy Solicitation Rules . . . . . . . . . . . . . 817 F.  Restrictions on Soliciting Proxies and Exceptions to Allow for Shareholder Communication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 818 G.  Objecting Beneficial Owners and Non-Objecting Beneficial Owners . . . . . . . . . 819 H.  The Adequacy of Disclosure and Materiality Standards . . . . . . . . . . . . . . . . . . . . . . 822 I.  Express Statutory Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 826 X.  Proposals by Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 827 A. Eligibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 827 B.  Scope of Proposals Has Been Broadened . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 830 XI.  The Role of Regulators in Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 833 XII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 836

I. INTRODUCTION Notwithstanding both the stakeholder debate in corporate governance and the obligations of directors and officers to act in the best interests of the corporation, discussed in Chapters 10 and 11, shareholders have a unique position in the corporate governance structure. They have the power to elect and remove the corporation’s directors, and they hold a proportionate share of the residual economic interest in the corporation, after all the company’s debts and other obligations are satisfied. In publicly traded corporations, most securities holders today are beneficial, as opposed to registered, security-holders; the shares are held by intermediaries who are the registered shareholders. In Canada, many corporations are pyramid-shaped business groups. A controlling shareholder, often a wealthy family, holds voting control blocks in a first tier of listed firms, which in turn holds voting control blocks in a second, third, and fourth tier of listed firms. Pyramidal groups of this sort in Canada contain up to 16 tiers of intercorporate ownership, and the largest encompass hundreds of corporations, both listed and unlisted: Randall Morck & Bernard Yeung, Some Obstacles to Good Corporate Governance in Canada and How to Overcome Them, Research Study for the National Task Force to Modernize Securities Legislation in Canada (Toronto: Investment Dealers Association of Canada, 2006) at 287. Morck & Yeung suggest that pyramiding allows a wealthy individual or family to magnify control over a large firm into control over a huge constellation of firms, giving rise to many corporate governance problems and risk of self-dealing. Thus greater shareholder rights can work as an accountability check. This chapter examines the relationship between shareholder participation rights and governance structures. It examines shareholders’ voting rights and how they are distributed. It explores the significance of shareholders’ ability to vote. The chapter sets out the requirements for shareholder meetings, when and how they can be held, and the business that can be conducted at such meetings.

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The potential for shareholder “voice” and participation in governance has been enhanced, and the chapter discusses both the benefits for shareholders and the challenges these changes present for other stakeholders. It briefly examines the potential role of institutional investors. The chapter examines the rules for proxy solicitation for both closely held and publicly traded companies, including how beneficial owners have been given the opportunity to voice their views. It also explores developments in the scope of shareholder proposals.

II.  SHAREHOLDER VOTING RIGHTS Shareholders do not normally have the power to manage the corporation. It is the directors of the corporation who “manage the business and affairs of the corporation”: Canada Business Corporations Act, RSC 1985, c C-44 (CBCA) s  102(1). As the following case suggests, this division of rights and responsibilities is codification of a long-accepted practice.

Automatic Self-Cleansing Filter Syndicate Co v Cunninghame [1906] 2 Ch 34 (CA) [The plaintiff company was incorporated in 1896, with objects in its memorandum that included the sale of the undertaking of the company. Article 81 provided that “[t]he company may by special resolution remove any director before the expiration of his period of office and appoint another qualified person in his stead.” The plaintiff, McDiarmid, wished the assets of the company to be sold, and he arranged a contract for that purpose with a purchaser. At a meeting of the shareholders of the company, requisitioned by McDiarmid and others, a resolution to sell the assets on the terms of the proposed contract was passed by a vote of 1502 for and 1198 against. The directors were of the opinion that the proposed contract was not in the company’s best interests, and they declined to carry out the resolution. The plaintiff company and McDiarmid brought a motion to compel the defendant directors to cause the resolution to be carried out. Warrington J held for the defendants. The plaintiff appealed.] COLLINS MR:  This is an appeal from a decision of Warrington J, who has been asked by the plaintiffs, Mr. McDiarmid and the company, for a declaration that the defendants, as directors of the company, are bound to carry into effect a resolution passed at a meeting of the shareholders in the company on January 16. There are a number of other incidental reliefs asked—for instance, that they be ordered to affix the seal of the company, and that they may be restrained by injunction from dealing with the assets of the company in any manner inconsistent with the agreement. The point arises in this way. At a meeting of the company a resolution was passed by a majority—I was going to say a bare majority, but it was a majority—in favour of a sale to a purchaser, and the directors, honestly believing, as Warrington J thought, that it was most undesirable in the interests of the company that that agreement should be carried into effect, refused to affix the seal of the company to it, or to assist in carrying out a

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resolution which they disapproved of; and the question is whether under the memorandum and articles of association here the directors are bound to accept, in substitution of their own view, the views contained in the resolution of the company. Warrington J held that the majority could not impose that obligation upon the directors, and that on the true construction of the articles the directors were the persons authorized by the articles to effect this sale, and that unless the other powers given by the memorandum were invoked by a special resolution, it was impossible for a mere majority at a meeting to override the views of the directors. That depends, as Warrington J put it, upon the construction of the articles. First of all, there is no doubt that the company under its memorandum has the power in clause (3)(k) to sell the undertaking of the company or any part thereof. In this case, there is some small exception, I believe, to that which is to be sold, but I do not think that that becomes material. We now come to clause 81 of the articles, which I think it is important to refer to in this connection. [His Lordship read the clause.] Then come the two clauses which are most material, 96 and 97, whereby the powers of the directors are defined. [His Lordship read clause 96 and clause 97(1.).] Therefore in the matters referred to in article 97(1.) the view of the directors as to the fitness of the matter is made the standard; and furthermore, by article 96 they are given in express terms the full powers which the company has, except so far as they “are not hereby or by statute expressly directed or required to be exercised or done by the company,” so that the directors have absolute power to do all things other than those that are expressly required to be done by the company; and then comes the limitation on their general authority— ”subject to such regulations as may from time to time be made by extraordinary resolution.” Therefore, if it is desired to alter the powers of the directors that must be done, not by a resolution carried by a majority at an ordinary meeting of the company, but by an extraordinary resolution. In these circumstances, it seems to me that it is not competent for the majority of the shareholders at an ordinary meeting to affect or alter the mandate originally given to the directors, by the articles of association. •  •  •

I am of opinion that this appeal fails. Automatic Self-Cleansing Filter Syndicate is a leading case sustaining the authority of the board of directors as against the shareholders-in-meeting.1 Within its realm of authority, as established in the incorporating statute or unanimous shareholder agreement, the board may act independently of the views of the majority of shareholders, and, indeed, in a manner opposed by a majority. CBCA s  102(1) therefore codifies the result in Automatic SelfCleansing Filter Syndicate.2 Although the CBCA and its sister provincial and territorial corporations statutes permit directors to manage, it is more usual for the corporation’s senior officers to manage, and for directors at most to supervise the officers. The Ontario Business Corporations Act, RSO 1990,

1 See also Kelly v Electrical Construction Co (1907), 16 OLR 232 (H Ct J); and Scott v Scott, [1943] 1 All ER 582 (Ch). 2 See also Alberta Business Corporations Act, RSA 2000, c B-9 [ABCA], s 101(1), British Columbia Business Corporations Act, SBC 2002, c 57 [BCBCA], s 136(1), and OBCA s 115(1).

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c B.16 (OBCA), s 115 acknowledges the fact that directors typically “supervise the management of the business and affairs of a corporation,”3 but even that standard is not entirely descriptive of what many boards do. In fact, directors of many public corporations exercise only the most general oversight. This limitation has started to shift as directors are given new responsibilities in a post-Enron era under securities legislation, as discussed in Chapter 11. Nevertheless, CBCA ss  102 and 122 are of continuing importance, because the formal grant of authority to directors implicitly removes power from shareholders, as was held in Automatic Self-Cleansing Filter Syndicate. These sections focus contests for control of the corporation around the shareholders’ right to elect directors. While specialization suggests that it is normally preferable to leave most decisions concerning the business of the corporation to management, does it mean that shareholders should not retain any ability to make decisions? Shareholder voting on a wider range of day-to-day business decisions may lead to inappropriate costs, such as shareholders pursuing private interests not consistent with the interests of the corporation, or seeking side payments from management to discourage one or more shareholders from pursuing a particular resolution.4 Limits on shareholder decisions concerning day-to-day management may also influence stock market liquidity and facilitate takeovers that operate to control management behaviour.5

A.  Election of Directors Although shareholder voting rights do not normally extend to a residual power to manage the corporation, shareholders do have other significant voting rights. Perhaps most important is the right of shareholders to elect directors of the corporation. The shareholders also have a right to vote in other situations, discussed below.

B.  Amendment of Bylaws The default rule under the CBCA is that the directors have the power to initiate changes in the bylaws.6 However, this authority is subject to the articles, the bylaws, or a unanimous shareholder agreement.7 Consequently, it is possible under the CBCA to put the power to change the bylaws in the hands of the shareholders. Even where the power to initiate changes in the bylaws is left in the hands of the directors, the shareholders can make proposals for changes in the bylaws8 and, as noted above, changes initiated by the directors must be approved by the shareholders.9 Under the British Columbia Business Corporations Act, SBC 2002, c 57 (BCBCA) s  1(1), a “special majority” is

3 See also BCBCA s 136(1), ABCA s 101(1), CBCA ss 102(1) and 112. 4 See Jeffrey N Gordon, “Shareholder Initiative: A Social Choice and Game Theoretic Approach to Corporate Law” (1991) 60 U Cin L Rev 347. 5 See PV Letsou, “Shareholder Voice and the Market for Corporate Control” (1992) 70 Wash ULQ 755. 6 CBCA s 103(1); see also ABCA s 102(1) and OBCA s 116(1). 7 Ibid. 8 CBCA s 103(5), ABCA s 102(5), and OBCA s 116(5). 9 CBCA s 103(2), ABCA s 102(2), and OBCA s 116(2).

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required to pass a special resolution if the articles specify “at least 2 ⁄ 3 and no more than 3 ⁄ 4 of the votes cast on the resolution”; however, other rules apply where the articles are silent. The BCBCA specifies: 1(1)  … “special majority” means, in respect of a company, (a)  the majority of votes that the articles specify is required for the company to pass a special resolution at a general meeting, if that specified majority is at least 2 ⁄ 3 and not more than 3 ⁄ 4 of the votes cast on the resolution, or (b)  if the articles do not contain a provision contemplated by paragraph (a), 2 ⁄ 3 of the votes cast on the resolution or, if the company is a pre-existing company that has not complied with section 370(1)(a) or 436(1)(a) or that has a notice of articles that reflects that the Pre-existing Company Provisions apply to the company, 3 ⁄ 4 of the votes cast on the resolution;

Typically it is the directors who would put amendments to the articles before a meeting of shareholders.

C.  Unanimous Shareholder Agreements Before turning to specific voting requirements, it is important to note that corporate law allows for unanimous shareholder agreements. Shareholders can agree to remove authority from the board of directors and give primary managerial responsibility to shareholders, pursuant to CBCA s 146.10 The directors are then absolved from these managerial responsibilities, which devolve to the shareholders, who then acquire the statutory liabilities along with the duties. The requirement that the shareholder agreement be unanimous effectively restricts its scope to small issuers.11 Under our fact pattern, Aya Nang could protect her interests as the founding investor at the point of incorporation through a unanimous shareholder agreement (USA) that requires that a number of specified decisions can be made only by unanimous consent of all shareholders. Such agreements are common among very closely held corporations. However, if the shareholders take decisions away from directors, they themselves acquire all the responsibilities and liabilities of the directors in respect of those decisions. Moreover, there needs to be a mechanism to resolve disputes when there is not unanimity among the shareholders. Apart from CBCA s 146, it is not clear to what extent, if any, a corporation’s articles may alter the statutory allocation of authority between directors and shareholders.12 For example, can the articles provide for additional types of action that may not be taken by the directors until they have submitted them to the shareholders? CBCA s 6(2) states that “[t]he articles may set out any provisions permitted by this Act or by law to be set out in the bylaws of the corporation.”13 While many substantive provisions of the CBCA include the phrase “unless the articles otherwise provide,” s 102 seems to contemplate that the only exception to it will be a unanimous shareholder agreement. This exception is likely because directors’

10 11 12 13

See also ABCA s 146 and OBCA s 108. British Columbia’s legislation refers to articles of the company: BCBCA s 137. See also ABCA s 146 and OBCA s 108. See also ABCA s 6(2) and OBCA s 5(3).

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duties and decision-making cannot be fettered and, absent a USA that allocates these responsibilities to shareholders, directors and officers are liable for a number of decisions they make in the course of exercising their duties to the corporation. Effective January 1, 2007, the OBCA was amended (SO 2006, c 8, s 119(2)) to clarify the effect of a transfer of shares where there is a unanimous shareholder agreement in place: Issuance or shares subject to unanimous shareholder agreement 108(7)  If a unanimous shareholder agreement is in effect at the time a share is issued by a corporation to a person other than an existing shareholder, (a)  that person shall be deemed to be a party to the agreement whether or not that person had actual knowledge of it when the share was issued; (b)  the issue of the share does not operate to terminate the agreement; and (c)  if that person is a purchaser for value without notice of the agreement, that person may rescind the contract under which the shares were acquired by giving notice to that effect to the corporation within 60 days after the person actually receives a complete copy of the agreement. Transfer of shares subject to unanimous shareholder agreement (8)  If a unanimous shareholder agreement is in effect when a person who was not otherwise a party to the agreement acquires a share of the corporation, other than under subsection (1), (a)  the person who acquired the share shall be deemed to be a party to the agreement whether or not that person had actual knowledge of it when he or she acquired the share; and (b)  neither the acquisition of the share nor the registration of that person as a shareholder operates to terminate the agreement. Notice of objection (9)  If a person referred to in subsection (8) is a purchaser for value without notice of the unanimous shareholder agreement and the transferor’s share certificate, if any, did not contain a reference to the unanimous shareholder agreement, the transferee may, within 60 days after he or she actually receives a complete copy of the agreement, send to the corporation and the transferor a notice of objection. Rights of transferee (10)  If a person sends a notice of objection under subsection (9), that person is entitled to, (a)  rescind the contract under which the shares were acquired by giving notice to that effect to the corporation and the transferor within 60 days after the transferee actually receives a complete copy of the unanimous shareholder agreement; or (b)  demand that the transferor pay the transferee the fair value of the shares held by the transferee, determined as of the close of business on the day on which the transferor delivers the notice of objection to the corporation, in which case subsections 185(4), (18) and (19) apply, with the necessary modifications, as if the transferor were the corporation. Deficiency (11)  A transferee who is entitled to be paid the fair value of the transferee’s shares under clause (10)(b) also has the right to recover from the transferor the amount by which the value of the consideration paid for those shares exceeds their fair value.

D.  Fundamental Changes Shareholders are given the right to vote in respect of certain changes concerning the corporation that are considered “fundamental.” CBCA s 173(1) provides that a “special resolution,” two-thirds of the votes cast at a meeting of shareholders (CBCA s 2(1)), is required to amend

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the articles.14 For example, a special resolution is required to change the name of the corporation; change any restriction on the business that the corporation may carry on; change the registered office of the corporation; create a new class of shares; increase or decrease the number of directors or the minimum or maximum number of directors; or change restrictions on the issue, transfer, or ownership of shares of the corporation.15 Other fundamental changes also require shareholder approval. For instance, a special resolution of shareholders is required to approve • • • •

an amalgamation of the corporation with another corporation;16 the sale or lease of all or substantially all of the corporation’s assets;17 a continuance of the corporation under the laws of another jurisdiction;18 or a liquidation and dissolution of the corporation.19

On these particular fundamental changes, shareholders are generally entitled to vote whether or not the shares of the class they hold otherwise carry the right to vote.20 Amalgamations are discussed in Chapter 15 in the discussion on mergers and acquisitions. Shareholders who dissent from a resolution to amalgamate, sell, lease, or exchange all or substantially all of the corporation’s assets; have the corporation continued under the laws of another jurisdiction; or change any restriction on the business that the corporation may carry on are entitled have their shares purchased by the corporation at an appraised value. 21

E.  Class Voting Rights Recall the discussion in Chapter 6 in respect of the capitalization of the corporation and the nature of shares and the bundle of rights that accompany them. Some changes in the corporation require approval from individual classes of shares or, in some instances, a particular series of shares. These class voting rights generally apply where the proposed change is a change in the rights or restrictions attached to a particular class of shares or series of shares, or where the change can have a significant impact on the particular class of shares. CBCA s 176 sets out several situations in which a class of shares is entitled to vote separately as a class: 14 See also Companies Act, RSNS 1989, c 81 [NSCA], s 23(1), ABCA s 173(1), and OBCA s 168(1). 15 Under BCBCA s 1(1), a “special majority” required to pass a special resolution is “at least 2⁄ 3 and not more than 3⁄ 4 of the votes cast on the resolution.” 16 CBCA s 183(5), ABCA s 183(5), BCBCA s 271(1), NSCA ss 134(4) and (6), OBCA s 176. Section 279 of Québec Business Corporations Act, CQLR c S-31.1 [QBCA] specifies that “[t]he amalgamation agreement must be approved by a separate special resolution of the shareholders of each amalgamating corporation.” 17 CBCA ss 189(3) and (8), ABCA s 190(1), OBCA ss 184(3) and (7), and BCBCA s 301(1). 18 NSCA s 133(5), CBCA s 188, ABCA s 188, BCBCA s 308, and OBCA s 181. 19 CBCA s 211, ABCA s 211(2), BCBCA ss 314 to 318 and 319, and OBCA s 193. 20 CBCA ss 183(3), 188(4), 189(6), and 211(3); ABCA ss 182(3), 183(3), 189(4), and 211(3); and OBCA ss 176(3) and 184(6). 21 CBCA s 190; see also ABCA s 191 and OBCA s 185. The BCBCA has no provisions regarding the shares.

II.  Shareholder Voting Rights Class vote 176(1)  The holders of shares of a class or, subject to subsection (4), of a series are, unless the articles otherwise provide in the case of an amendment referred to in paragraphs (a), (b) and (e), entitled to vote separately as a class or series on a proposal to amend the articles to (a)  increase or decrease any maximum number of authorized shares of such class, or increase any maximum number of authorized shares of a class having rights or privileges equal or superior to the shares of such class; (b)  effect an exchange, reclassification or cancellation of all or part of the shares of such class; (c)  add, change or remove the rights, privileges, restrictions or conditions attached to the shares of such class and, without limiting the generality of the foregoing, (i)  remove or change prejudicially rights to accrued dividends or rights to cumulative dividends, (ii)  add, remove or change prejudicially redemption rights, (iii)  reduce or remove a dividend preference or a liquidation preference, or (iv)  add, remove or change prejudicially conversion privileges, options, voting, transfer or pre-emptive rights, or rights to acquire securities of a corporation, or sinking fund provisions; (d)  increase the rights or privileges of any class of shares having rights or privileges equal or superior to the shares of such class; (e)  create a new class of shares equal or superior to the shares of such class; (f)  make any class of shares having rights or privileges inferior to the shares of such class equal or superior to the shares of such class; (g)  effect an exchange or create a right of exchange of all or part of the shares of another class into the shares of such class; or (h)  constrain the issue, transfer or ownership of the shares of such class or change or remove such constraint. Exception (2)  Subsection (1) does not apply in respect of a proposal to amend the articles to add a right or privilege for a holder to convert shares of a class or series into shares of another class or series that is subject to a constraint permitted under paragraph 174(1)(c) but is otherwise equal to the class or series first mentioned. Deeming provision (3)  For the purpose of paragraph (1)(e), a new class of shares, the issue, transfer or ownership of which is to be constrained by an amendment to the articles pursuant to paragraph 174(1)(c), that is otherwise equal to an existing class of shares shall be deemed not to be equal or superior to the existing class of shares. Limitation (4)  The holders of a series of shares of a class are entitled to vote separately as a series under subsection (1) only if such series is affected by an amendment in a manner different from other shares of the same class. Right to vote (5)  Subsection (1) applies whether or not shares of a class or series otherwise carry the right to vote. Separate resolutions (6)  A proposed amendment to the articles referred to in subsection (1) is adopted when the holders of the shares of each class or series entitled to vote separately thereon as a class or series have approved such amendment by a special resolution.

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Corporations statutes across Canada contain similar language.22 BCBCA s 61 specifies that there must be a “special resolution” of the shareholders of a class or series of shares whose special rights will be “prejudiced or interfered with.” For instance, a separate vote of a class is required where it is proposed to amend the articles to increase or decrease the number of authorized shares of the class; to add, change, or remove the rights, privileges, restrictions, or conditions attached to the class of shares; to increase the authorized number of shares of a class having rights equal or superior to the particular class; to increase the rights or privileges of any class or to create a new class of shares having rights or privileges equal or superior to the shares of the particular class; or to make a class of shares having inferior rights or privileges equal or superior to the particular class. A separate vote of a series of shares is required where the series of shares is affected differently from other shares of the same class.23 Where there is a right of a class or series of shares to vote separately, the right applies whether or not the shares otherwise carry the right to vote.24 Where separate class or series voting rights apply, a proposed amendment to the articles is not adopted unless each class or series of shares entitled to vote separately has approved the amendment by a special resolution.25 Class voting rights also apply to certain other fundamental changes. For instance, a class or series voting right may apply in the context of an amalgamation, where the amalgamation agreement contains a provision that would entitle a class or series of shares to vote separately as a class or series if the provision were contained in a proposed amendment to the articles.26 Similarly, a sale, lease, or exchange of all or substantially all of the assets of the corporation requires separate class or series voting where the rights of a class or series will be affected in a way that is different from another class or series.27 A liquidation and dissolution of the corporation also requires a special resolution of each class of shares of the corporation, whether or not they otherwise carry the right to vote.28 Shareholders entitled to vote separately as a class or series may also be entitled to a right to have the corporation purchase their shares at an appraised value where they dissent to the resolution.29 Dissent and appraisal rights are discussed at length in Chapter 15.

III.  THE DISTRIBUTION OF VOTING RIGHTS There is no requirement that equity interests must always bear voting rights. Preferred shares are frequently non-voting shares, and even common shares may be disenfranchised. There must, however, be at least one class of shares with the right to vote. Moreover, there are some corporate decisions on which all shareholders are permitted to vote. As noted

22 23 24 25 26 27 28 29

See e.g. ABCA s 176 and OBCA s 170. See also ABCA s 176 and OBCA s 170. CBCA s 176(5), ABCA s 176(3), and OBCA s 170(3). CBCA s 176(6), ABCA s 176(4), and OBCA s 170(4). See CBCA s 183(4), ABCA s 183(4), BCBCA s 271(6)(b), and OBCA s 176(3). CBCA s 189(7), ABCA s 190(5), and OBCA s 184(6). CBCA s 211(3), ABCA s 212(3), and BCBCA ss 60(6)(b) and 61. See CBCA ss 190(2) and (3), ABCA ss 191(2) and (3), OBCA ss 185(2) and (4), and BCBCA ss 238 and 244(1)(a).

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above, corporations statutes typically provide that, irrespective of their voting rights generally, the holders of each class of shares are entitled to vote on fundamental structural changes.

A.  Development of the Use of “Restricted” (Non-Voting, Non-Preferred) Shares Although corporate statutes permit a firm to restrict the voting rights of a class of common shares, in recent years the use of dual class shares, with one class of voting and one of nonvoting common shares, has been viewed with suspicion. Non-voting common shares are not preferred; they have no priority claim to earnings or assets, but they also do not carry voting rights or, at best, have limited voting rights. This type of equity security was frequently issued after the late 1970s as a result of legislation such as the National Energy Policy and statutes governing the banking and communications industries that encouraged corporations to keep voting control firmly in Canadian hands, as well as a desire on the part of some corporations to go (or remain) public while keeping voting power exclusively in the hands of existing control groups. Non-voting shares must be clearly described in selling documents as “restricted” and not as common shares. The creation of restricted shares must be approved by a majority of the votes of minority shareholders—that is, shareholders who are not affiliated with the issuer and who do not effectively control the issuer. Securities regulators have also issued rules regarding restricted shares for issuing corporations, particularly in respect of disclosure of restrictions on the voting rights of shares and the rights of restricted shares on occurrence of a takeover bid.30 After a highly publicized dispute in 1987 concerning the coattail provisions in the share conditions of the restricted shares of Canadian Tire, the Toronto Stock Exchange (TSX) mandated coattail provisions as a condition of listing on the exchange. Coattail rights allow restricted shares to be converted into voting shares on a takeover bid for the voting shares unless an offer is made for all the restricted shares on terms identical to the offer for the voting shares.31 Should restricted shares in fact be prohibited? Frank Easterbrook and Daniel Fischel suggest that voting rights should be allocated to the group that holds the residual claim at any given time so as to align management incentives with the goal of maximizing firm value; and unless these shares have a vote, a needless agency cost of management will arise.32 Even where different incentives might be observed, as where voting shares are held by an inside group of managers, the Easterbrook & Fischel argument focuses on ex post agency costs

30 Rule 56-501, Restricted Shares (2003) 26 OSCB (Supp 3), as amended 17 November 2015. 31 See Toronto Stock Exchange, Policy Statement on Restricted Shares (Toronto: TSX, 2006), s 1.09. This policy does not apply to firms with dual class stock that were listed on the exchange prior to August 1, 1987. For the current requirements, see TSX Company Manual s 624, online: TSX , and applicable securities laws. 32 Frank H Easterbrook & Daniel R Fischel, “Voting in Corporate Law Corporations and Private Property” (1983) 26 JL & Econ 395 at 409.

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rather than the ex ante decision to issue non-voting shares. However, the benefits that some firms will find in non-voting shares are detailed in a subsequent article by Fischel, who concludes that firms should not be hindered in their allocation of voting rights, and a retention of control by management may encourage investments by managers in firm-specific human capital.33 A dual class recapitalization, however, may seem less benign than a dual class issuance. In a recapitalization, the share condition provisions of outstanding voting shares are amended to restrict voting rights. Here, it may be feared that the recapitalization will transfer wealth from outside public shareholders to an inside group of voting shareholders or managers, as existing common shareholders forgo possible takeover bid premiums when they lose their voting rights. Managers in some firms may simply value control more highly than outsiders, particularly true of family firms, many of which issue restricted shares when they need new equity financing. In reality, dual class shares are not common in Canadian corporations, although they are an instrument for majority shareholders in closely held corporations to retain control while raising new capital.

B.  Voting Restrictions One person, one vote policies are also violated when special voting rights are attached to one group of shares within a special class of shares. Such provisions might either limit the voting rights of large shareholders (capped voting rights) or endow a class of shares held by firm insiders with more than one vote per share (supervoting rights). These provisions are often even more clearly directed at preventing a successful takeover bid than are non-voting shares, and are called “shark repellents” for that reason. While reading Jacobsen v United Canso, below, consider the three questions posed at the end of the extract.

Jacobsen v United Canso Oil & Gas Ltd (1980), 113 DLR (3d) 427, [1980] 6 WWR 38, 11 BLR 313 (Alta QB) FORSYTH J:

[1]  This matter came before me for determination of a preliminary point of law on a peremptory basis to determine the following question: Does the Defendant’s By-Law (By-Law No. 6) which provides that no person shall be entitled to vote more than 1,000 shares of the Defendant notwithstanding the number of shares actually held by him contravene the provisions of the Canada Business Corporations Act.

[2]  The determination of this issue involves not only consideration of the present provisions of the Canada Business Corporations Act, 1974-75-76 (Can.) c. 33, but also the provisions of the applicable legislation at the time the by-law was enacted.

33 Daniel R Fischel, “Organized Exchanges and the Regulation of Dual Class Common Stock” (1987) 54 U Chicago L Rev 119.

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[3]  The defendant United Canso Oil & Gas Ltd. (hereinafter referred to as “United Canso”) was incorporated by letters patent on April 13, 1954, pursuant to the Companies Act, RSC 1952, c. 53. By-law No. 1, the general by-law of the company, was duly enacted on April 15, 1954, and provided, inter alia, as follows: Upon a show of hands each shareholder present in person shall have one vote and upon a poll each shareholder present in person or by proxy shall have one vote for each share held by such shareholder unless the letters patent, supplementary letters patent or by-laws of the Company otherwise provide in respect of the shares of any particular class.

[4]  I would note here that there is no dispute between the parties that at the time of incorporation and up to the present time United Canso has had only one class of shares, the present capitalization being 12 million common shares. [5]  By-law No. 6 of the company was duly enacted on March 19, 1964, and provided, inter alia, as follows: With respect to any matter to be voted upon at any meeting of shareholders called after the final adjournment of the meeting at which this By-Law Number 6 is ratified, any one person as hereinafter defined shall be entitled to vote: (i)  with respect to shares registered in his name on the books of the Company which are beneficially owned by him, the number of such shares, but in no event more than 1,000; (ii)  with respect to shares registered in his name on the books of the Company which he holds as a trustee other than as a nominee, the number of such shares but in no event more than 1,000; and (iii)  with respect to shares registered in his name as nominee and on instructions from each one person who is the owner thereof a number of shares owned by each such one person but in no event more than 1,000 with respect to each such one person, provided that no such one person shall vote or give instructions as to the voting of more than 1,000 shares in the aggregate.

[6]  The relevant legislation applicable at the time that by-law was enacted was again the Companies Act [superseded by the Canada Corporations Act, 1964-65 (Can.), c. 52 [now RSC 1985, c. C-44]]. This change of by-law with respect to voting procedure, however, was not reflected in any supplementary letters patent until July 25, 1974, when supplementary letters patent were issued to United Canso amending the letters patent of the company by adding thereto the voting limitations contained in By-law No. 6. These supplementary letters patent were issued by the Minister of Consumer and Corporate Affairs by virtue of the powers vested in him by the Canada Corporations Act, which Act replaced the Companies Act. The Canada Corporations Act itself was subsequently replaced [in part] by the Canada Business Corporations Act. •  •  •

[12]  The issue before the Court raises certain fundamental questions with respect to the rights of shareholders of a corporation. It was argued by the plaintiff that there is a presumption of equality between shareholders and the voting restriction in question contravenes this presumption. In this regard reference was made to Palmer’s Company Law (22nd ed., 1976), vol. 1, p. 334, where the learned author states:

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Chapter 12  Shareholder Participation in Corporate Governance Prima facie the rights carried by the shares rank pari passu, i.e., the shareholders participate in the benefits of membership equally. It is only when a company divides its share capital into different classes with different rights attached to them that the prima facie presumption of equality of shares may be displaced. •  •  •

[33]  … A certificate of continuance for United Canso was issued on October 24, 1979, pursuant to s. 181 of the Canada Business Corporations Act and the articles of continuance contained, attached as Sched. 2, the same voting restriction previously set forth in By-law No.  6. Accordingly, it is necessary to consider the provisions of the Canada Business Corporations Act and, in particular, whether or not by virtue of the fact that the limitation was contained in the articles of continuance, that limitation became effective on the issuance of the certificate of continuance and is, accordingly, still in force. [34]  It should be first noted that the authority for continuance of United Canso under the Canada Business Corporations Act is contained in s. 261. [35  Section 181 [am 1978-79, c 9, s 57, now renumbered under s 187 of RSC 1985, c C-44] of the Canada Business Corporations Act provides in part as follows: (1.1)  A body corporate that applies for continuance under subsection (1) may, without so stating in its articles of continuance, effect by those articles any amendment to its Act of incorporation, articles, letters patent or memorandum or articles of association if the amendment is an amendment a corporation incorporated under this Act may make to its articles. (2)  Articles of continuance in prescribed form shall be sent to the Director together with the documents required by sections 19 and 101. (3)  Upon receipt of articles of continuance, the Director shall issue a certificate of continuance in accordance with section 255. (4)  On the date shown in the certificate of continuance (a)  the body corporate becomes a corporation to which this Act applies as if it had been incorporated under this Act; (b)  the articles of continuance are deemed to be the articles of incorporation of the continued corporation; and (c)  the certificate of continuance is deemed to be the certificate of incorporation of the continued corporation. •  •  •

… It is to be noted, however, that it is clear pursuant to subs. (1.1) of s. 181 that an amendment to the letters patent can be effected in the articles of continuance with respect to any corporation applying for continuance under the Canada Business Corporations Act, if the amendment is an amendment a corporation incorporated under this Act may make to its articles. Does the Canada Business Corporations Act contemplate an amendment of the nature set forth in the articles of continuance? Section 6 [am. 1978-79, c. 9, s. 3] of the Act provides in part as follows: 6(1)  Articles of incorporation shall follow the prescribed form and shall set out, in respect of the proposed corporation, •  •  •

(c)  the classes and any maximum number of shares that the corporation is authorized to issue, and

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III.  The Distribution of Voting Rights (i)  if there will be two or more classes of shares, the rights, privileges, restrictions and conditions attaching to each class of shares, and (ii)  if a class of shares may be issued in series, the authority given to the directors to fix the number of shares in, and to determine the designation of, and the rights, privileges, restrictions and conditions attaching to, the shares of each series; •  •  •

(2)  The articles may set out any provisions permitted by this Act or by law to be set out in the by-laws of the corporation. (3)  Subject to subsection (4), if the articles or a unanimous shareholder agreement require a greater number of votes of directors or shareholders than that required by this Act to effect any action, the provisions of the articles or of the unanimous shareholder agreement prevail.

Again it is to be noted that particular provisions come into play where there are two or more classes of shares requiring the setting forth of rights, privileges, etc., attaching to such shares. Thus, the distinction is clearly made between that situation and the situation where there is only one class of shares where it must be assumed there are no rights, restrictions, etc., attaching to such shares. Section 134(1) [now s. 140] is similar to the previously quoted provisions of the Canada Corporations Act and the Companies Act and provides as follows: 134(1)  Unless the articles otherwise provide each share of a corporation entitles the holder thereof to one vote at a meeting of shareholders.

[36]  However, that section must be read in relation to s. 24 [am 1978-79, c 9, s 9] of the Act which provides as follows [ss (3) and (4)]: (3)  Where a corporation has only one class of shares, the rights of the holders thereof are equal in all respects and include the rights (a)  to vote at any meeting of shareholders of the corporation; (b)  to receive any dividend declared by the corporation; and (c)  to receive the remaining property of the corporation on dissolution. (4)  The articles may provide for more than one class of shares and, if they so provide, (a)  the rights, privileges, restrictions and conditions attaching to the shares of each class shall be set out therein; and (b)  the rights set out in subsection (3) shall be attached to at least one class of shares but all such rights are not required to be attached to one class.

It seems abundantly clear on a reading of s. 24(3) as well as the reading of the entire Act that again Parliament has even more clearly specified that it is only when there is more than one class of shares that different rights, privileges, restrictions and conditions attaching to shares may arise. [37]  It is argued that subs. (3) of s. 24 must be read as being subject to subs. 168(5)(c) [now s. 261(1)] of the Act which reads as follows: (5)  Subject to subsections 254(2) and (3), the Governor in Council may make regulations with respect to a corporation that constrains the issue or transfer of its shares prescribing •  •  •

(c)  the limitations on voting rights of any shares held contrary to the articles of the corporation.

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In short, s. 24(3) must not be read in the absolute sense but is subject to other provisions in the Act which may change the basic position established by s. 24. Section 168(5)(c), however, clearly has a very restricted application and only applies to corporations which constrain the issue or transfer of their shares for the particular purposes as set out in s. 168. [38]  It is also argued that s. 24(3) is not inconsistent with the provisions of By-law No. 6 as continued under the articles of continuance of United Canso in that it deals with the right to vote but not in any way with the number of votes. The voting limitations in the articles of continuance clearly do not affect the right of a shareholder to vote and apply equally to all shareholders. It is only when their shareholdings exceed 1,000 shares that they are restricted from voting any shares in excess of 1,000. I am not satisfied this is an interpretation which can be put on s. 24(3). In effect, it is argued that the rights of the holders of the shares are equal in that all shareholders can only vote a maximum of 1,000 shares regardless of the number of shares held. It might similarly be argued that they would be equal if all shareholders could only receive dividends to a maximum of 1,000 shares regardless of the number of shares held or receive the remaining property of the corporation on the basis of a 1,000 share maximum regardless of the number of shares held. It seems to me reading s. 24 as a whole, each shareholder has the right to vote at any meeting of shareholders on the basis of the number of shares held where the corporation only has one class of shares and that this presumption can only be upset where there are more [than] one class of shares established in which case the provisions of subs. (4) come into play. That position in this regard is in my opinion fortified by the provisions of subs. 4(b) of s. 24 which makes it clear that all of the rights set forth in subs. (3) must, where there is more than one class of shares, be attached to at least one class of shares. [39]  In the result for the reasons aforesaid the answer to the preliminary point of law put before the Court is that the defendant’s By-law No. 6 which provides that no person shall be entitled to vote more than 1,000 shares of the defendant notwithstanding the number of shares actually held by him does, in fact, contravene the provisions of the Canada Business Corporations Act and is invalid. Order accordingly. For some period prior to the Jacobsen litigation, United Canso had been the object of numerous pitched battles for control, and the threat of losing control cannot have been far from management’s mind in enacting bylaw no 6. A matter of days before the judgment in Jacobsen was rendered, United Canso had surrendered its charter as a CBCA corporation and had been continued under the Nova Scotia Companies Act: see Jacobsen v United Canso Oil & Gas Ltd (1980), 12 BLR 313 (NS), where the court declined to rule on the validity of the voting restriction under the Nova Scotia statute. NOTES AND QUESTIONS

1.  As Forsyth J states, different voting rights may be attached to different classes of shares. Would United Canso, by using different classes of shares, have been able to prevent an aggregation of voting power in the hands of a single person?

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III.  The Distribution of Voting Rights

2.  Could United Canso have prohibited any single person from owning more than 1,000 shares of a class to which voting rights were attached? See CBCA s 49(9).

In Bowater Canadian Ltd v RL Crain Inc (1987), 62 OR (2d) 752 (CA), the articles gave ten votes per share to a class of special common shares as long as the shares were held by the person to whom they were originally issued, but only one vote per share if the shares were held by any other person. The Ontario Court of Appeal upheld the decision of the trial court to the effect that this “step-down” provision in the voting rights attached to the shares was invalid but severable, with the result that the special common shares carried ten votes per share regardless of whether they were held by the person to whom they were originally issued or by a transferee. There is a debate concerning whether Bowater stands for the proposition that the rights of a given class of shares must be equal in all respects, subject to the separate rights that may be assigned to series within a class of shares, or for a broader proposition that all shareholders of a class of shares must be treated equally: see the discussion of Bowater in Chapter 6.

C.  Equal Treatment The following case addresses the broader question of equal treatment of shares in the same class. Recall from the discussion in Chapter 6 on capitalization of the corporation that corporate law’s equality principle is focused on shares and not on who holds the shares. Although the Supreme Court of Canada judgment deals with dividend rights, the judgment of La Forest J also raises the question of equal treatment in the context of voting rights:

McClurg v Canada [1990] 3 SCR 1020, 76 DLR (4th) 217 DICKSON CJC (Sopinka, Gonthier, and Cory JJ concurring):  This is an income tax case. The question in the appeal is whether certain dividends received by the wife of the respondent, Jim A. McClurg, in the years 1978, 1979 and 1980 in respect of Class B common shares of Northland Trucks (1978) Ltd. (hereafter Northland Trucks) should be attributed in part to the respondent, an officer and director of Northland Trucks and the holder of the controlling Class A common shares in the capital stock of that company.

I. Background 1.  Relevant Legislation Income Tax Act, SC 1970-71-72, c. 63:

56(2)  A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person  … shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.

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Chapter 12  Shareholder Participation in Corporate Governance

Saskatchewan Business Corporations Act, RSS 1978, c. B-10:

24(4) The articles may provide for more than one class of shares and, if they so provide, (a)  the rights, privileges, restrictions and conditions attaching to the shares of each class shall be set out therein; and (b)  the rights set out in subsection (3) shall be attached to at least one class of shares but all such rights are not required to be attached to one class. •  •  •

40.  A corporation shall not declare or pay a dividend if there are reasonable grounds for believing that: (a)  the corporation is, or would after the payment be, unable to pay its liabilities as they become due; or (b)  the realizable value of the corporation’s assets would thereby be less than the aggregate of its liabilities and stated capital of all classes. •  •  •

97(1)  Subject to any unanimous shareholder agreement, the directors of a corporation shall: (a)  exercise the powers of the corporation directly or indirectly through the employees and agents of the corporation; and (b)  direct the management of the business and affairs of the corporation. •  •  •

234(1)  A complainant may apply to a court for an order under this section. (2)  If, upon an application under subsection (1), the court is satisfied that in respect of a corporation or any of its affiliates: (a)  any act or omission of the corporation or any of its affiliates effects a result; (b)  the business or affairs of the corporation or any of its affiliates are or have been carried on or conducted in a manner; or (c)  the powers of the directors of the corporation or any of its affiliates are or have been exercised in a manner; that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director, or officer, the court may make an order to rectify the matters complained of.

2.  The Facts The respondent is president of Northland Trucks, a company incorporated under the Saskatchewan Business Corporations Act. The company was established in 1978 upon purchase of an ongoing business, a dealership in International Harvester trucks. The respondent and his partner, Veryle Ellis, are the only directors of the company. The articles of incorporation provide for three categories of shares: Class A which are common, voting and participating shares; Class B which are common, non-voting and participating where authorized by the directors; and Class C which are preferred, non-voting shares. The articles deal with the entitlement to dividends as follows: Class A Common:

Common, voting and shall be participating shares carrying the distinction and right to receive dividends exclusive of the other classes of shares in the said corporation.

769

III.  The Distribution of Voting Rights Class B Common:

Common, non-voting and shall be participating shares where authorized to be participating shares by unanimous consent of the Directors and the said shares shall carry the distinction and right to receive dividends exclusive of other classes of shares in the said corporation. Class C Preferred:

Preferred, non-voting shares which carry the distinction and right to receive dividends exclusive of other classes of shares in the said corporation, if the said dividends are authorized by unanimous resolution of the directors. Each class of shares has the right to receive dividends exclusive of other classes of shares in the company and the company is authorized to issue an unlimited number of shares in each class.

The clause “the distinction and right to receive dividends exclusive of other classes of shares in the said corporation” in the definition of the share classes is crucial to the analysis in this case; a primary question is whether the clause, which gives to the directors unfettered discretion as to the allocation of dividends among classes of shares, constitutes a valid derogation to the common law rule of equality of distribution of dividends. For the sake of simplicity, I will refer to it as the “discretionary dividend class” throughout these reasons. Shares in the company were issued at a price of $1 each, and the distribution of shares demonstrates the closely-held nature of the company: Name

Class A Common

Class B Common

Class C Preferred

Jim McClurg

400

—

37,500

Veryle Ellis

400

—

37,500

Wilma McClurg (wife of Jim Clurg)

—

100

—

Suzanne Ellis (wife of Veryle Ellis)

—

100

—

In the years 1978, 1979 and 1980, the directors, McClurg and Ellis, voted a declaration and distribution of dividends as follows: Name

1978

1979

1980

Jim McClurg

—

—

—

Veryle Ellis

—

—

—

Wilma McClurg

$10,000

$10,000

$10,000

Suzanne Ellis

$10,000

$10,000

$10,000

The form of resolution declaring the dividends was as follows: It was noted and unanimously agreed by all the Directors that Class “B” Shareholders receive dividends in the amount of $100.00 per share for each issued share they hold. Be It Resolved that payment of dividends to Class “B” Shareholders are made as follows:

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Chapter 12  Shareholder Participation in Corporate Governance Class “B” Shareholder

Number of Issued Shares

Dividend Per Share

Total Paid

Wilma McClurg

100

$100.00

$10,000.00

Suzanne Ellis

100

$100.00

$10,000.00

•  •  •

On January 14, 1982, by notices of reassessment, the Minister of National Revenue reassessed the respondent’s income for 1978, 1979, and 1980. The basis for the reassessment was that in each of those years $8,000 of the $10,000 dividends attributed to Wilma McClurg on her Class B shares was properly attributable instead to the respondent pursuant to s. 56(2) of the Income Tax Act. The Minister made this reallocation on the basis of the number of Class A shares owned by the respondent in relation to the number of Class B shares owned by Wilma McClurg. The position of the Minister is that the dividends declared in each of the years in question should be attributed equally to all of the common shares, no matter of what class and notwithstanding the express condition attaching to the Class B shares that they shall carry the right to receive dividends exclusive of other classes of shares in the company. •  •  •

With the advent of statutory regulation of corporations, the authority to pay dividends, recognized at common law as part of the internal management of the company, has been given statutory recognition. In the case at bar, the governing legislation is the Saskatchewan Business Corporations Act (hereafter SBCA). In my view, it cannot be disputed that the power to pay dividends is an internal component of the broad grant of managerial power for directors found in s. 97(1) of the Act, cited earlier. I take it, both from an observation of the workings of corporations, and from other provisions in the statute, that the section embraces the common law power of directors. The power to declare dividends is expressly limited in the Act, in much the same way as it was at common law. For example, s.  40 of the SBCA, also cited earlier, prohibits the declaration of a dividend if there exists reasonable grounds to believe that to do so would leave the corporation unable to pay its debts (s. 40(a)); or, if the payment of a dividend would render the realizable value of the assets of the corporation less than the aggregate of its liabilities and stated capital of all classes of shares (s. 40(b)). Although these restrictions are not brought into play by the declarations of dividends in issue in this appeal, the presence of those limitations in the Act suggests that the power to declare dividends is statutorily limited only by restrictions expressly stated. Of course, the power to declare dividends is further qualified by the fact that the law has for many years recognized that the general managerial power which rests in the directors of a company is fiduciary in nature. The declaration of dividends, which is subsumed within that power, therefore is limited legally in that it must be exercised in good faith and in the best interests of the company[.] •  •  •

Having reviewed the legal basis for the payment of a dividend by a company, another fundamental principle of corporate law can be restated. The appellant argues, and it is conceded by the respondent, that the rights carried by all shares to receive a dividend declared by a company are equal unless otherwise provided in the articles of

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III.  The Distribution of Voting Rights

incorporation. This principle, like the managerial power to declare dividends, has been well accepted at common law. The principle, or more accurately, the presumption of equality amongst shares and the prerequisites required to rebut that presumption, are described in Palmer’s Company Law, 23rd ed., vol. 1 (London: Stevens & Sons, 1982), C.M. Schmitthoff, Ed., at p. 387, para. 33-06: Prima facie the rights carried by the shares rank pari passu, i.e. the shareholders participate in the benefits of membership equally. It is only when a company divides its share capital into different classes with different rights attached to them that the prima facie presumption of equality of shares may be displaced.

In my view, a precondition to the derogation from the presumption of equality, both with respect to entitlement to dividends and other shareholder entitlements, is the division of shares into different “classes.” The rationale for this rule can be traced to the principle that shareholder rights attach to the shares themselves and not to shareholders. The division of shares into separate classes, then, is the means by which shares (as opposed to shareholders) are distinguished, and in turn allows for the derogation from the presumption of equality: Bowater Canadian Ltd. v. R.L. Crain Inc. (1987), 46 DLR (4th) 161 at p. 163, 39 BLR 34, 62 OR (2d) 752 (CA), per Houlden JA. The concept of share “classes” is not technical in nature, but rather is simply the accepted means by which differential treatment of shares is recognized in the articles of incorporation of a company. As Professor Welling [Bruce Welling, Corporate Law in Canada (Toronto: Butterworths, 1984)] succinctly explains, “a class is simply a sub-group of shares with rights and conditions in common which distinguish them from other shares” (p. 583). Indeed, the use of the share class is recognized in the SBCA as the means by which derogation from the principle of equality is to be achieved. The statute thus explicitly requires that “the rights, privileges, restrictions and conditions attaching to the shares of each class” must be expressly stated in the articles of incorporation: s. 24(4)(a). •  •  •

… In my opinion, the discretionary dividend clause is both a valid means of allocating declared dividends and is sufficient to rebut the presumption of equality amongst shares. I find this determination, with respect to the presumption of equality, to be a simple factual inquiry. In my view, the presence of a discretionary dividend clause can only be interpreted as creating differences between share classes, since that is the rationale for the clause. As far as the statutory requirements are concerned, the purpose of s. 24(4)(a) is to ensure that shareholders are fully aware of their entitlements and privileges to the extent that the presumption of equality is rendered inapplicable. To my mind, that purpose has been met since the dividend entitlements are clearly set out in the description of the share classes. … •  •  •

… In my opinion, the fact that dividend rights are contingent upon the exercise of the discretion of the directors to allocate the declared dividend between classes of shares does not render entitlement to a dividend any less a “right.” Rather, it is the entitlement to be considered for a dividend which is more properly characterized in those terms. I agree with the respondent that the Class B common shareholders of the company have an entitlement comparable to that of a fixed dividend holder to receive a dividend if the company’s directors declare one. As well, the appellant’s argument that there is no

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Chapter 12  Shareholder Participation in Corporate Governance

corresponding “duty” on directors as regards the “right” of shareholders is, in my view, specious. The directors are bound by their fiduciary duty to act in good faith for the best interests of the company in the declaration and allocation of any dividend. That duty is in no way circumvented by the presence of a discretionary dividend clause. Finally, I think that it should be borne in mind that many shareholder rights may be qualified and contingent (voting rights, the right to transfer shares, preferential rights to dividends, participation rights); yet the mere fact that these rights are fettered does not render them anything less than shareholder rights. In a similar vein, I do not agree that the absence of a mathematical formula for the allocation of declared dividends in the articles of incorporation of the company is dispositive of the issue of the validity of the discretionary dividend clause. As the decision to declare a dividend and the determination of the funds available for a dividend are already within the discretion of the directors, it seems to me that a discretionary dividend clause is not a significant departure or extension of that discretion: De Vall v. Wainwright Gas Co., [1932] 2 DLR 145, [1932] 1 WWR 281, 26 Alta. LR 274 (CA). If shares are divided into separate classes, one of which contains a preferred entitlement to dividends declared by the company, the directors effectively have the discretion to allocate dividends only to that preferred class. Thus, the respondent could have achieved precisely the same allocation of dividends by structuring the company so that Wilma McClurg and Suzanne Ellis constituted a preferred class of shareholders with first entitlement to dividends. Such a structure would be unimpeachable in terms of the principles of corporate law. Furthermore, it cannot reasonably be maintained that the presence of a discretionary dividend clause inherently leads to a conflict of the duty of directors and their self-interest any more than does the discretion to declare a dividend in any company. … In other words, the clause simply divides conceptually into two components—declaration and allocation—what has been, traditionally, one decision. In substance, though, the discretion which lies in the hands of the directors has always included both, subject to the provisions of the articles of incorporation. In this regard, the only other limitation upon the directors of which I am aware is that “if a dividend is declared by a corporation … there must be some shares entitled to receive the dividend”: Welling [supra], at pp. 588-89. The principle has been given statutory recognition in s. 24(4)(b) of the SBCA. In my view, this rule is not defeated by the presence of the discretionary dividend clause because the identity of the class eligible for a dividend simply remains unknown until the allocation takes place. This conceptual division into declaration and allocation is not substantively different from any derogation from the presumption of equality in the payment of dividends. Consequently, for this court to find that the use of a discretionary dividend clause on these facts was an invalid exercise of the discretion of the directors would be to defeat the substance of what was achieved solely on the basis of its form. Finally, I question whether it would be appropriate for this Court to determine that the use of a discretionary dividend clause is invalid in the context of an income tax appeal. The purpose of the governing statute, the SBCA, is facilitative—that is, it allows parties, with certain explicit restrictions, to structure bodies corporate as they wish. As well, the Act provides the means for an aggrieved party—security holder, creditor, director or officer—whose interests have not been regarded fairly by the corporation, to seek redress through the oppression remedy in s. 234 of the Act. No such complaint has been lodged by any interested party in this case, presumably because all those

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III.  The Distribution of Voting Rights

involved in this company are satisfied with the way in which the directors are conducting its affairs. Furthermore, at common law it is a well-established principle that where shareholders are unanimously agreed to a transaction, inequality of treatment does not render it ultra vires the company: F.W. Wegenast, The Law of Canadian Companies (Toronto: Carswell, 1979), at pp. 321-22. As I have found that the use of a discretionary dividend clause is not prohibited expressly by the Act, nor contrary to common law or corporate law principles, I think the permissive spirit of the Act demands that a conclusion be reached that the use of the clause is valid. •  •  •

Given that the legislature has not chosen to disallow the discretionary dividend clause, and no shareholder has taken remedial action against its use (presumably because shareholder expectations have been realized by its exercise), it would be paternalistic in the extreme for this Court to invalidate the clause at the behest of the appellant Minister of National Revenue. If the legislature determines that the use of the discretionary dividend clause undermines the reasonable expectations of shareholders or is in some way unfair to an interested party, then it is up to the legislature to limit the use of this means of structuring corporate affairs. In conclusion, then, I find nothing untoward in the use of the discretionary dividend clause in the allocation of corporate dividends. There is nothing in the SBCA or at common law that prohibits this dividend allocation technique. •  •  •

LA FOREST J (L’Heureux-Dubé and Wilson JJ concurring) (dissenting): •  •  •

In a certain sense, the term “discretionary dividend” is a misnomer, since it is a wellaccepted principle of common law that the directors of a corporation have the discretion to determine if and when a dividend should be declared, and in what amount. This discretion is, of course, subject to certain reasonable limitations. For example, s. 40(a) of the Saskatchewan Business Corporations Act provides that a dividend may not be declared if there are reasonable grounds to believe such declaration would render the corporation unable to pay its debts. As well, there is the overriding principle that the discretion must always be exercised in a manner which is in the best interests of the corporation: see Bruce Welling, Corporate Law in Canada: The Governing Principles (Toronto: Butterworths, 1984), at p. 614. •  •  •

The independent legal existence of the corporation means that, while the shareholder remains a proportionate owner of the corporation, he does not actually own its assets. These assets belong to the corporation itself, as a separate legal entity; Clive M. Schmitthoff, Palmer’s Company Law, 23rd ed., vol. 1 (London: Stevens & Sons, 1982), at p. 384, para. 33-01. Management of the corporation is entrusted to its officers and directors with the shareholder’s interest protected through the distribution of shareholder votes. Thus, the corporate entity is unique in that it allows the shareholder to alienate ownership of property by placing it in a structure where the ownership of the property is separated from the effective control over that property: see Welling, supra, at p. 81. The sole link between the shareholder and the company is the share, which provides both a measure of the shareholder’s interest in the company, as well as of the extent of the shareholder’s

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Chapter 12  Shareholder Participation in Corporate Governance

liability for the actions of that company: see Borland’s Trustee v. Steel Brothers & Co. Ltd., [1901] 1 Ch. 279 at p. 288. This separation of ownership and control provides the basis for many of the fundamental principles of corporate law. One example is the principle that the directors and officers of a corporation owe a fiduciary duty to the corporation: see Canadian Aero Service Ltd. v. O’Malley (1973), 40 DLR (3d) 371, 11 CPR (2d) 206, [1974] SCR 592. •  •  •

Another principle that I believe also stems logically from the separation of ownership and control inherent in the corporation is the principle of equality of shares. Since the shareholders are only proportionate owners of the company, if their interest is to be adequately and fairly protected, those in the position of control must treat all the shareholders, or more accurately, all the shares, equally. … •  •  •

In my opinion, the principle of equality of shares, like the principle of fiduciary duty, developed as more than just a mere contractual right—it was a measure of protection for the shareholder that arose as a practical consequence of the unique nature of the corporate structure itself. This is so even though the parties could contract out of it to the extent that shares could be created that did not themselves have equal rights. In such a situation, the shareholder was still protected by virtue of the common law rule that shareholder rights had to be attached to the share itself, and not to the individual shareholder. Thus, while the shares had differentiated rights depending upon the particular class to which they belonged, the shareholder himself could not be discriminated against. For example, even when different classes of shares were created, the shares within the various classes themselves still had to be treated on an equal basis. •  •  •

The few Canadian cases that appear to have considered the issue have all held that, even when the shareholders agree to do so, a company may not validly be structured so as to derogate from the common law principle that shareholder rights must attach to the shares themselves. When I speak of shareholder rights, I include at least those three categories of rights that are considered to be fundamental: the right to a dividend, the right to vote, and the right to participate in the distribution of assets upon dissolution of the corporation. •  •  •

In my opinion, a second reason why the discretionary dividend clause is invalid at common law is because it places the director in a position where he cannot fulfill his fiduciary obligations to the corporation as a whole. The interests of different classes of shareholders, where a discretionary declaration of dividends is concerned, are necessarily divergent, since a dividend will be declared for the benefit of one class of shareholders at the expense of the others. •  •  •

Any difference between the shares concerning their right to receive dividends that does exist clearly does not derive from any differentiation between the shares, but would have to stem from the actions of the directors of the corporation. This would, however, be a right that does not derive from the share itself, and as such would be invalid at common law.

775

III.  The Distribution of Voting Rights

Having found that the discretionary dividend clause contained in the articles of incorporation of Northland Trucks was an invalid allocation of power at common law, it remains to examine the Saskatchewan Business Corporations Act to see if the statute changes this result. •  •  •

A more reasonable interpretation of the statute is that it contemplates that shareholders will be protected from changes being made to the rights attached to different classes of shares by virtue of the fact that such rights may only be amended by altering the corporate constitution. Section 170(1)(c) of the Saskatchewan Business Corporations Act provides that: 170(1) … the holders of shares of a class or … of a series are entitled to vote separately as a class or series upon a proposal to amend the articles to: •  •  •

(c)  add, change or remove the rights, privileges, restrictions or conditions attached to the shares of such class …

The protection afforded by s. 170 for dividend rights can only be meaningful if the mode of distribution must itself be set out in the articles of incorporation. Otherwise, the section can effectively be circumvented because the directors will have the power to change each class’s allocation of dividends at will, without the need for a shareholder vote. The importance of s. 170(1) as a mechanism for protecting shareholder interests is evidenced by the fact that each class of shares is entitled to vote, regardless of whether the shares normally carry this right or not: s. 170(3). I also find the use of the discretionary dividend clause in the present case to be inconsistent with the requirement of the Act that at least one class of shares must be entitled “to receive any dividend declared by the corporation”: s. 24(3)(b). •  •  •

The need for shareholder protection from abuse of the discretionary dividend clause becomes all the more apparent when one considers the possibility that such a clause could be inserted in the articles of incorporation of a large, publicly held corporation. I recognize that in this case we are dealing with a closely-held corporation, where there has been no allegation of a breach of fiduciary duty by the directors, but the Saskatchewan Business Corporations Act applies to large and small corporations equally. One rule of law must stand for both. I hasten to add that, in my view, the primary reason that the discretionary dividend clause is invalid is that it offends the principle that the corporation has a separate legal existence from the shareholder. Since the shareholders of closely-held corporations are given preferential treatment, such as limited liability, based upon the notion of this separation between corporation and shareholder, it is not unreasonable for the state to require them to respect this separation by structuring their corporation accordingly. Against the weight of these arguments, I can think of no socially useful purpose, and counsel for the respondent could point to none, behind the employment of a discretionary dividend clause. The only apparent purpose of such a clause is to facilitate tax avoidance through “income-splitting,” which does little to persuade me of the need to allow corporations to be structured in this manner… •  •  •

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Chapter 12  Shareholder Participation in Corporate Governance

Disposition In the result, I would allow the appeal and uphold the Minister’s reassessment. The judgments by Dickson CJC on the one hand and La Forest J on the other reflect two quite different approaches to corporate law. Dickson’s approach sees corporate law as “facilitative—that is, it allows parties, within certain explicit restrictions, to structure bodies corporate as they wish.” La Forest J, on the other hand, takes a more public policy approach, claiming that “corporate law has not yet evolved to the point where the freedom of contract at any cost has become paramount to all other concerns.” NOTES AND QUESTIONS

1.  Which approach discussed in the judgments above is the appropriate one for Canadian corporate law, and why? 2.  Amendments to the OBCA effective 2007 allow for two classes of shares that are identical in all respects. Section 22(7) now specifies: “The articles may provide that two or more classes of shares or two or more series within a class of shares may have the same rights, privileges, restrictions and conditions.”34 What do you think the policy rationale for such a change is? Does it raise the question of whether it will be permissible under the CBCA?

D.  Cumulative Voting US legislation has occasionally required, sometimes as a matter of state constitutional law, that corporations have a system of proportional representation, referred to as cumulative voting. The system of cumulative voting for director elections is designed to guarantee that the minority will be able to elect some members of the board of directors. In a cumulative voting regime, a shareholder may allocate all of the votes that he or she would be entitled to cast for the election of all directors, the number of shares owned times the number of directors to be elected, assuming one vote per share, among the different candidates in any manner that he or she wishes. Since reducing the number of directors to be elected at one time dilutes the benefit that cumulative voting can confer on the minority, it follows that if a board of any given size is classified by staggered terms, that will tend to dilute the effect of cumulative voting. CBCA corporations that permit cumulative voting are not permitted to stagger their boards: CBCA s 107(f). The CBCA specifies: Cumulative voting 107.  Where the articles provide for cumulative voting, (a)  the articles shall require a fixed number and not a minimum and maximum number of directors; (b)  each shareholder entitled to vote at an election of directors has the right to cast a number of votes equal to the number of votes attached to the shares held by the

34 SO 2006, c 34, Schedule B, s 5, effective 1 August 2007.

IV.  The Significance of Voting Rights

777

shareholder multiplied by the number of directors to be elected, and may cast all of those votes in favour of one candidate or distribute them among the candidates in any manner; (c)  a separate vote of shareholders shall be taken with respect to each candidate nominated for director unless a resolution is passed unanimously permitting two or more persons to be elected by a single resolution; (d)  if a shareholder has voted for more than one candidate without specifying the distribution of votes, the shareholder is deemed to have distributed the votes equally among those candidates; (e)  if the number of candidates nominated for director exceeds the number of positions to be filled, the candidates who receive the least number of votes shall be eliminated until the number of candidates remaining equals the number of positions to be filled; (f)  each director ceases to hold office at the close of the first annual meeting of shareholders following the director’s election; (g)  a director may be removed from office only if the number of votes cast in favour of the director’s removal is greater than the product of the number of directors required by the articles and the number of votes cast against the motion; and (h)  the number of directors required by the articles may be decreased only if the votes cast in favour of the motion to decrease the number of directors is greater than the product of the number of directors required by the articles and the number of votes cast against the motion.

Cumulative voting may give minority blocks representation on the board, but majority shareholders will remain in control as long as they cast their votes wisely. Of course, management might wish to give board representation to a significant minority shareholder, but cumulative voting turns representation into an entitlement. Cumulative voting may impose costs on a firm when the minority shareholder’s interests are imperfectly correlated with those of the firm—for example, when the shareholder is a competitor of the firm. As noted in Chapter 11, Bill C-25, An Act to amend the Canada Business Corporations Act, which received 2nd reading in December 2016,35 proposes changes to the election of directors under the CBCA, including, for a prescribed corporation, a separate vote of shareholders with respect to each candidate nominated for director. The bill proposes majority voting, whereby, under specified circumstances, if there is only one candidate nominated for each position available on the board, candidates are elected only if the number of votes cast in their favour represents a majority of the votes cast for and against them by the shareholders who are present in person or represented by proxy, unless the articles require a greater number of votes.

IV.  THE SIGNIFICANCE OF VOTING RIGHTS In a closely held corporation, shareholders are often relatively well informed about the firm and intensely interested in its governance and affairs. Indeed, many closely held corporations are managed by shareholders, with a substantial identity between them and management. In such cases, shareholder voting rights will certainly be exercised.

35 Bill C-25, An Act to amend the Canada Business Corporations Act, the Canada Cooperatives Act, the Canada Not-for-profit Corporations Act, and the Competition Act (second reading and referral to committee in the House of Commons (9 December 2016).

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However, in widely held corporations, most shareholders are passive. Shareholders must absorb the costs of informing themselves of the corporation’s activities, and will not wish to do so if the marginal benefits are exceeded by the marginal costs. Since the benefits are shared with all other shareholders, most public shareholders will prefer to free ride on monitoring by major investors or investment intermediaries. This phenomenon has been described as “rational apathy.”36 When shareholders are mere rentiers of capital, management can be said to control the firm and the shareholders’ meeting will in most cases be an empty ritual. Management’s nominees to the board will be elected and management’s proposals uniformly approved by the shareholders. This tendency has led to demands for greater “shareholder democracy,” a subject taken up in the following sections. However, disaffected holders of shares in publicly traded corporations have a much easier and faster route than corporate suffrage to express their displeasure with management—they can sell their shares. Even when the shares of a Canadian corporation are widely traded, many large Canadian corporations are dominated by either a foreign parent or another significant holder of a controlling block of shares, such as an institutional shareholder.37

A.  Transaction Costs Transactions impose costs that include the expenses of negotiating and preparing an agreement and also costs associated with opportunism by the parties. One risk of opportunism arises where one of the parties has invested assets in the bargain itself, such as the cost associated with the production of information concerning the transaction—for example, creditors’ costs in determining a debtor’s creditworthiness. This information is a “transaction-specific” asset, inasmuch as it cannot be transferred to another transaction and will be lost if one of the parties abandons the bargain. Participation in the voting process can provide a source of information that can allow one to anticipate future developments and plan investments in transaction-specific assets accordingly. It can also give a measure of control against changes that would substantially reduce the value of transaction-specific assets. However, voting can be a costly governance mechanism to control against changes that substantially lower the value of transactionspecific assets. To be used effectively, the participants will have to incur the costs of becoming well informed about the corporation. There is also the risk that someone who has committed transaction-specific assets will use participation in voting as leverage to capture a greater degree of the gain to be derived from use of the transaction-specific asset. Thus voting will not be the preferred technique where other less costly techniques to protect transaction-specific assets are available. Voting may be particularly useful to shareholders who, unlike some other corporate constituencies, do not have their relationship with the corporation regularly come up for renewal. The risk of non-renewal and the development of a reputation for opportunistic behaviour can

36 Ronald J Gilson, “The Case Against Shark Repellent Amendments: Structural Limitations on the Enabling Concept” (1982) 34 Stan L Rev 775 at 829. 37 Ronald J Daniels & Jeffrey G MacIntosh, “Toward a Distinctive Canadian Corporate Law Regime” (1991) 29 Osgoode Hall LJ 863 at 884.

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discourage management from making decisions that reduce the value of transaction-specific assets. Also, unlike a creditor who can take a security interest in an asset of the corporation to protect itself, the shareholder has no claim to the assets of the corporation and is the last to be compensated out of the assets of the corporation on liquidation. Thus, other controls to protect against management opportunism may be less readily available for shareholders, and some participation in decision-making through voting rights may be a more important device for shareholders in controlling against management opportunism. Voting rights can be significant in the market for corporate control, as will be evident in the discussion of obligations in a takeover situation in chapter 15. Among the techniques for winning control of a corporation, takeovers or tender offers for voting shares have, to a great extent, replaced proxy battles, in which two sides compete for the votes of current shareholders. On a takeover, the acquiror assumes control of the target corporation by purchasing a majority or a significant block of its voting shares, with the right to displace incumbent management by exercising the votes attached to the acquired shares. Such acquisitions are usually made at a substantial premium over market price.

V.  SHAREHOLDER MEETINGS A.  Annual Meetings Canadian corporate law requires that an annual general meeting (AGM) of shareholders be convened, at which time shareholders elect directors,38 appoint auditors,39 and receive the financial statements of the corporation.40 The meeting must be called not later than 18 months after the corporation comes into existence and subsequently not later than 15 months after the last annual meeting.41 Where a challenge to management’s control is expected, its ability to choose the date of the annual meeting gives it an important strategic advantage for existing directors. While corporate officers manage the operations and directors engage in oversight of the firm, shareholders are able to express their dissatisfaction with the governance or accountability of the company by appointing new directors or auditors. Although the timing of annual meetings seems straightforward in the legislation, there has been some issue as to the timing of such meetings after two corporations amalgamate, an issue canvassed in Chapter 15.

B.  Special Meetings Shareholders’ “special meetings,” called at other times, are usually to approve some transaction not in the ordinary course of business and for which the incorporating statute or the

38 CBCA s 106(3), QBCA s 110, ABCA s 106(3), OBCA s 119(4), and NSCA s 83(1) and NSCA 1st Schedule s 84. 39 CBCA s  162(1), ABCA s  162(1), OBCA s  149(1), BCBCA s  204(2) (“annual reference date”), and BCBCA s 198(2). 40 CBCA s 155(1), ABCA s 155(1), and OBCA s 154(1). 41 CBCA s 133(1)(a), ABCA s 132(1)(a), OBCA s 94(1)(a), and BCBCA s 182(1).

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corporation’s constitutive documents requires shareholder approval.42 Shareholders also have the right to participate in special general meetings, where issues such as changing the capital structure of the corporation or other “fundamental” changes are addressed.43 The Québec Business Corporations Act specifies: 59.  A corporation may, by a unanimous resolution of all the shareholders, whether or not their shares otherwise carry the right to vote, validate an irregular issue of shares that is in excess of the corporation’s authorized share capital or is otherwise inconsistent with the articles of the corporation. By that resolution, the shareholders authorize a director or officer of the corporation to sign the articles of amendment.

C.  Ordinary and Special Resolutions The terms “ordinary resolution” and “special resolution” are used to describe the quantum of majority approval required for different shareholder votes. An ordinary resolution is one for which the requisite approval is a simple majority, while a special resolution requires the affirmative vote of more than a simple majority of the votes cast—usually two-thirds in Canada.44 Under BCBCA s 1(1), the amount required must be between two-thirds and threequarters, depending on what the corporate articles specify, and if silent, the statute specifies two-thirds or three-quarters depending on when the corporation was registered. Generally, matters dealt with at the annual meeting call for an ordinary resolution, and matters customarily the subject of a special meeting of shareholders require special resolutions for passage. The latter are fundamental changes, as discussed above, such as an amendment to the articles of incorporation, a restructuring of capital, a sale of assets, an amalgamation, or a dissolution. However, the correlation between special meetings and special resolutions is not exact because a proposal recommending a fundamental change, which requires a special resolution, may be made at the annual meeting. Finally, one proposal that is almost always the subject of a special rather than an annual meeting of shareholders—removal of directors before their terms are up—can be approved by ordinary resolution.45 BCBCA s  128(3) requires a special resolution or the method provided in the articles.

D.  Place of Meeting The CBCA provides that the meeting is to be held at a place within Canada designated in the bylaws or, in the absence of such a provision, in the place determined by the directors.46 Under BCBCA s 166, the meeting may take place either in British Columbia or outside the province if (1)  the articles provide so; (2)  the articles do not restrict the company from approving a location outside British Columbia and approved by the resolution required by

42 43 44 45 46

CBCA s 133(2), ABCA s 132(1)(b), and OBCA s 94(1)(b). NSCA s 84. CBCA s 2(1); ABCA s 1(w); OBCA s 1(1); and NSCA s 87(1), which specifies “not less than three fourths.” CBCA s 109, ABCA s 109, and OBCA s 122. CBCA s 132; ABCA s 131 specifies within Alberta; see also OBCA s 93, which specifies in or outside Ontario.

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the articles for that purpose, or if no resolution is required by the articles, ordinary resolution; or (3) the location is approved in writing by the registrar.47

E. Quorum Typically, the bylaws of a CBCA corporation will provide a quorum requirement for a shareholders’ meeting. Otherwise, the CBCA provides that, subject to the bylaws, a quorum is present at a meeting of shareholders if holders of a majority of the shares entitled to vote at the meeting are present or are represented by proxy.48 Unless the bylaws otherwise provide, it is not necessary that the quorum continue to be present throughout the meeting in order for business to be transacted at the meeting. It is sufficient that there be a quorum at the start of the meeting.49 Where a quorum is not present at the opening of a meeting, the shareholders present may adjourn the meeting to a fixed time and place, but cannot transact any other business.50 In British Columbia, the quorum requirement is as set out in the articles, or is two persons where the articles do not provide; however, if there is only one eligible voter, then that person is the quorum.51

F.  The Principle of Notice When the directors call a meeting of shareholders, they will generally first fix a “record date,” not more than 50 days nor less than 21 days before the meeting is to be held, for determining who is entitled to receive notice of the meeting.52 For Québec registered companies, the period is not more than 60 days and not less than 21 days before the meeting.53 Notice of the meeting is then mailed to all shareholders listed in the records of the corporation on the record date. The actual notice of the meeting must be sent to shareholders between 50 and 21 days before the meeting is to be held.54 The notice must specify “the nature of that business in sufficient detail to permit the shareholder to form a reasoned judgment thereon.”55 “Special business” includes all business to be transacted at a special meeting and all business to be transacted at an annual meeting except consideration of the financial statements and the auditors’ report, reappointment of the incumbent auditor, and election of directors.56 If the

47 QBCA s 163 specifies that the meeting is to be held in Québec in a place determined by the articles or board of directors. Meeting can be held outside Québec if so allowed in the articles or if the shareholders entitled to vote at the meeting agree. 48 CBCA s 139(1); see also ABCA s 138(1) and OBCA s 101(1). 49 CBCA s 139(2), ABCA s 138(2), and OBCA s 101(2). 50 CBCA s 139(3); ABCA s 138(3); NSCA 1st Schedule s 85: a quorum is two people; and OBCA s 101(3). 51 BCBCA s 172. 52 CBCA s 134: “within the prescribed period”; ABCA s 133; OBCA s 95, specifying at least 10 days previously and by ad in the newspaper. 53 QBCA s 169. 54 CBCA s 135(1): “prescribed period”; ABCA s 134(1); and OBCA s 96(1). 55 CBCA s 135(6), ABCA s 134(7), and OBCA s 96(6). 56 CBCA s 135(5), ABCA s 134(6), and OBCA s 96(5).

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notice is defective, then the action taken at the meeting may be set aside at the instance of a dissenting shareholder. Under BCBCA notice of general meetings provisions, s 169 requires notice of “at least the prescribed number of days but not more than 2 months before the meeting.” Regulation part 1, s  3 defines prescribed number of days as 21 days for a public company unless the articles state longer; and for a private company at least 10 days if specified in the articles, or, if no period is specified, 21 days. Where directors are to be elected at the meeting, a notice inviting nominations must be given at least 56 days before the meeting. 57 In most publicly held corporations, it will appear from the corporation’s record that a securities depository institution or stock brokerage firm own large numbers of shares. Since the corporation is concerned with shareholders as identified in its records, notice will go to the securities depository institution or brokerage firm. In reality, however, the securities depository institution is usually a nominee owner for brokerage firms, and brokerage firms, for the most part, are mere nominee owners of their customers, the beneficial non-registered holders of the shares. The customers of the brokerage firms leave the shares registered in the name of the broker or the securities depository institution for custodial purposes and to facilitate trading in the securities. Securities regulators have now issued a national instrument (NI) regulating how communication with beneficial owners is to occur, and how they may exercise control rights, as discussed below in Section IX.G.

G.  Conduct of Meetings The chair of the meeting of shareholders, who is often the president or CEO of the corporation, is under a general duty to assist the meeting in achieving its objectives. To this end, the chair’s duties are (1)  to preserve order; (2)  to see that the proceedings are regularly conducted; (3) to take care that the sense of the meeting is properly ascertained with regard to any question properly before it; and (4) to decide incidental questions arising for decision during the meeting. In exercising his or her duties, the chair is to act in good faith and in an impartial manner. Ordinarily, concerns about the conduct of meetings will arise only where control is disputed. Because control at a shareholders’ meeting in a public corporation will vest in the party that has secured the most proxies, the chair’s conduct has most often been challenged where he or she has rejected proxies. There are a number of formalities in the execution of proxies that must be complied with. For example, the board of directors of a corporation that owns shares in another corporation must either itself determine how to vote those shares or delegate such decision to a committee or an officer. A question then may arise about whether the chair may or should attempt to ascertain whether a proxy appointed by a corporate shareholder or by a stockbroker has been lawfully appointed. This determination may be difficult because the chair, who is usually the corporation’s president and a director, is not a neutral party if at the particular meeting an effort was being made to unseat management.

57 BCBCA Regulations part S7.1.1.

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Blair v Consolidated Enfield Corp (1993), 15 OR (3d) 783 (CA) [Blair was the president and chair of Consolidated Enfield. Blair took legal advice with respect to proxies submitted on behalf of Canadian Express Ltd. The solicitors expressed the view that the proxies could only be voted for the management slate of directors and could not be voted to replace Blair. At the meeting the majority of votes were cast in favour of replacing Blair. Blair asked the solicitors for Consolidated Enfield whether he could make a ruling where his own election would be affected. The solicitors said that Blair had a duty to make a ruling. Blair, acting on the advice given by the solicitors for Consolidated Enfield, then declared that he and the rest of the management slate of directors had been elected. Canadian Express then brought an action for a declaration that the ballot cast for Canadian Express was validly cast in favour of the replacement slate of directors. The court determined that the ballot was legally cast in favour of the replacement slate and ordered costs against both Consolidated Enfield and Blair. Since Canadian Express now had control of Consolidated Enfield, it sought recovery of costs in the amount of over $165,000 against Blair only. Blair then sought indemnity for costs from Consolidated Enfield under s  136(1) of the OBCA. Under s  136(1) of the OBCA a director can be indemnified against the costs of an action if the director acted honestly and in good faith with a view to the best interests of the corporation. The indemnity was refused and Blair then applied to court for a declaration that he was entitled to indemnification. The court refused the declaration on the basis that Blair had not acted in the best interests of the corporation. Blair appealed. The judgment of the court was delivered by Carthy JA, who made the following comments on the good faith duties of the chair of a meeting in the situation in which Blair found himself.] CARTHY JA:  In the present case there is nothing controversial about Blair’s ballot directed to preserve his control by voting in favour of himself—that was fully expected. At issue is his ruling on the overall balloting, and to conclude that his ruling was made male fide because the result favoured him is to conclude that he was compelled to rule the other way, or give up the chair, no matter what advice he received. Aside from the question of giving up the chair, the real test should be whether the ruling was made with the bona fide intent that the company have a lawfully elected board of directors. •  •  •

There is thus little guidance in the Canadian authorities on the extent to which legal advice affects the assessment of good faith conduct. Nor have we been directed to any settled views expressed in other jurisdictions. I have already concluded that, on a proper reading of ss. 130 to 136 of the Ontario Business Corporations Act, legal advice does not automatically sanctify conduct based upon it as honest and in good faith for purposes of claiming indemnity under s. 136. It is, however, an ingredient to be considered and one should not be dismissive of it simply because it favours the election of the chairperson or, as in many such situations, because it comes from a law firm whose own retainer is at stake. It must be considered in the context in which it was given and alongside the duty of the chairperson to act fairly. The authorities referred to above generally describe the chairperson’s duty as quasijudicial without defining what that means in this context. It is confusing to me to use,

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and seek to define, the word judicial or quasi-judicial in this context because an adjudicator or judge can never have a personal interest in the issue. A chairperson who is more than a nominal shareholder of a public company, on the other hand, always has a personal interest in everything that affects the company, which includes all of the rulings of the chair. If that distinction is not recognized the reflex reaction is to assume that a decision which benefits the chair personally is non-judicial and thus not bona fide. In my view, it is preferable to describe the duty as one of honesty and fairness to all individual interests, and directed generally to the best interests of the company. The events that led up to the meeting of July 20 created an aggressively competitive atmosphere. Blair felt very strongly that the shareholders as a whole should be fully informed of a change in control. He undoubtedly resented the surprise nomination of Price and was pleased with Osler’s advice. That makes him very much a protagonist in the duel for control. However, that is the position of any chairperson dependent for his position upon proxy support and threatened by contrary votes. The ballots cast were in accordance with the instructions in the proxies or they were not. An experienced team of lawyers gave an opinion the evening before and, broadening their inquiries to even more lawyers when the event occurred, they remained of the same view. They also told Blair that it was his duty to make the ruling despite his interest in the outcome. Following the sequence of events, I do not see that he had a choice. It would have appeared more fair if he had not closed debate, but the result could not have been different. If lawyers for Canadian Express had expressed a contrary view, he would then have two opinions on a complicated legal problem. Given the necessity of determining who the legal directors of the company were, so that business could be carried on in a regular fashion, some decision had to be made. Even if a disinterested chairperson could have been found in the room, he or she would, in the circumstances, have had to look to the corporation’s solicitors for an answer to this purely legal issue of interpretation. •  •  •

No matter what debate might have ensued on July 20 and no matter who the chairperson might have been, there was no obvious error or oversight which would enable the chairperson to turn away from the advice of the company’s solicitors. No one suggested that the Osler opinion and advice was other than totally professional or that there was any qualification in that advice. Osler was fully advised of all facts bearing on the issuer. A layperson reading the rather confused language of Note 3 would, in my view, treat the opinion as ostensibly credible and thus, I am satisfied that Blair was acting honestly and in good faith and in the best interests of the corporation in accepting and implementing that advice. Counsel for Canadian Express focused on the lack of fairness shown by Blair in knowing that a mistake had been made and giving no opportunity to correct it. They argue that when the nomination of Price was made from the floor that Blair, in fairness, should have alerted Walt and Boult bee that they would not be able to vote for Price. Presumably, Walt would then have executed a new proxy on behalf of Canadian Express but Boult bee would have had to return to the shareholders he represented to obtain new proxies, on the assumption that it would be their desire to change them. It must be remembered that there is another faction deserving fairness from the chairman—the 15 per cent of shareholders who decided not to be represented on the basis of what they read in the management information circular, or for whatever other reason. If the meeting was to be

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adjourned to accommodate Walt and Boultbee, should these shareholders not be informed that a battle for control was on and that their votes could determine the result? In my view, it goes too far to say that the duty of fairness means that Blair must selectively assist those who attend to vote in the process leading to the vote. His duty of fairness relates to the decision-making process and the conduct of a proper corporate meeting. His taunting remark to Timothy Price did not distinguish him, but I am satisfied that the evidence shows that he properly performed his duty as chairman of the meeting. In the shareholders’ meeting process itself, corporate management has several advantages. It controls the meeting agenda. It can solicit votes in the proxy solicitation process from apathetic shareholders who simply sign and return the proxy form in favour of the management nominee without considering the issues involved. Management nominees also decide on the acceptance or non-acceptance of proxies and tabulate the votes at shareholders’ meetings.

VI.  SHAREHOLDER VOICE Shareholders are entitled to speak to any matter before the meeting of shareholders. However, if the right to speak at the meeting were unconstrained, it could frustrate the completion of the business of the meeting. That frustration could be particularly problematic in the case of meetings for widely held corporations if it led to adjournments of the meeting, since it could significantly add to the cost of the meeting. Thus, the chair of the meeting, acting in good faith and in an impartial manner, must allow shareholders to speak to the matters properly before the meeting, but need not allow more than a reasonable time for reasonable arguments.58 However, control over the agenda and the power of the chair to recognize speakers can have a significant effect on the outcome of voting.59

A.  Meetings Requisitioned by Shareholders Meetings of shareholders, whether annual or special, are generally called by the directors. However, corporate statutes permit the holders of a certain proportion of voting shares to requisition the board to call a shareholders’ meeting. Without such a right, it would be difficult to remove the board of directors before the end of its term, since the directors might be expected to refrain from calling a shareholders’ meeting for such a purpose. Under CBCA s 143(1), the holders of not less than 5 percent of the shares that carry the right to vote may requisition a meeting of the shareholders for the purposes stated in the requisition.60 The directors then have a duty to call a meeting, and if they do not do so, then any one of the requisitioning shareholders may call it. Where the shareholders themselves are forced to call the meeting in this way, the corporation must reimburse the requisitioning 58 See e.g. Wall v London and Northern Assets Corporation, [1898] 2 Ch 469 (CA). 59 See Saul Levmore, “Parliamentary Law, Majority Decisionmaking, and the Voting Paradox” (1989) 75 Va L Rev 971. 60 See also ABCA s 142, BCBCA s 167, and OBCA s 105.

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shareholders for expenses reasonably incurred by them “in requisitioning, calling and holding a meeting,” unless the shareholders resolve otherwise at the meeting. What proposals may be dealt with at a requisitioned meeting? CBCA s 102 sets out a fundamental principle of corporate constitutionality, with management of the business and affairs of the corporation removed from the purview of shareholders’ meetings. One issue is whether the right of shareholders under CBCA s 143 to requisition a meeting “for the purposes stated” in the requisition reverses the division of powers in such meetings. If not, the scope of shareholder initiatives at requisitioned meetings would be limited to removal and replacement of directors, which is in fact almost always the purpose for which such meetings are called, and possibly those non-binding resolutions whose purpose is not to require, but rather to request, the directors to consider a specific business decision.

B.  Meetings by Order of the Court On an application by shareholders under CBCA s  144, a court may order a shareholders’ meeting to be called.61 Such order may be made either if it is “impracticable” to call or conduct a meeting in another way or “for any other reason a court thinks fit.” It is not always easy to say what “impracticable” means in these provisions. In Aurum, LLC v Calais Resources Inc, 2016 BCSC 1173, the failure of directors to call a shareholders’ meeting was a factor in the court removing two directors, as well as ordering a meeting of shareholders. When ordering the calling of a meeting or directing the conduct of a meeting, the court is careful to disrupt as little as possible, and hence will order that any meeting should be called and conducted in conformity with such articles or regulations as far as practicable. In Re Morris Funeral Service Ltd (1957), 7 DLR (2d) 642 (Ont CA), the court held that except in extraordinary circumstances, none of which were present in that case, the corporate statute may not be invoked successfully for the express and sole purpose of placing in control of the company’s directorate and affairs one of two or more contending factions among the shareholders. A court in exercising its discretion to call a shareholders’ meeting will do so in a manner consistent with the corporation’s rules so far as possible. However, the court has jurisdiction to alter quorum and notice requirements. This case might be thought to ignore the possibility of strategic behaviour by the party who relies on veto rights. While veto rights offer useful protection to shareholders, they also introduce a possibility of shareholder opportunism. If veto rights lower firm value and the burden of the loss falls unequally on the parties, the party with less to lose may then threaten to assert such rights unless he or she is given his or her way. The possibility of strategic behaviour is in fact a principal reason to eschew veto rights in corporate governance. However, it is not to say that veto rights should always be enforced. The parties will adopt a variety of techniques to avert strategic behaviour, and might for this reason prefer to deal only with people in whom they repose confidence, such as family members.62

61 See also ABCA s 143, BCBCA s 186, and OBCA s 106. 62 See Anthony T Kronman, “Contract Law in the State of Nature” (1985) 1 JL Econ & Org 5 at 20-24.

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C.  Intervention on the Basis of Fault One issue is whether a court should be more ready to intervene in circumstances where one of the parties seems more at fault than the other. It is not always difficult to apportion blame. In Re Routley’s Holdings Ltd, (1960) 22 DLR (2d) 410, [1960] OWN 160, the corporation had four holders of its 158 outstanding shares: JF Boland—26, Bertha Boland—1, Clara May Routley—1, and Routley’s Ltd—130. The three individual shareholders were the directors and JF Boland was the president. No annual meeting had been held for many years until Clara Routley and Routley’s Ltd threatened litigation unless a meeting was called. Boland then called a shareholders’ meeting to be held at the corporation’s headquarters, which was his law office. At the meeting, he rejected the proxies of Routley’s Ltd and of Clara Routley, despite the fact that they were valid. Boland then continued with the meeting even though there was no quorum once the proxies were rejected, because a quorum was three shareholders with at least 50 percent of the shares. The court ordered a meeting to be convened at a neutral locale, and lowered the quorum to two shareholders with 50  percent of the shares lest the Bolands attempt to thwart the meeting by refusing to attend. The court emphasized Boland’s clear breaches of law in his conduct of the previous shareholders’ meeting. So, too, an application for a court-ordered meeting succeeded in B Love Ltd v Bulk Steel & Salvage Ltd (1982), 141 DLR (3d) 621 (Ont H Ct J), where the applicant also obtained an interlocutory injunction restraining a director from certain breaches of fiduciary duty. In ordering the shareholders’ meeting, Gray J, at para 35, gave serious consideration to “the substantial case of prejudice” to the corporation occasioned by the director’s improper conduct. Another issue is whether a court should refuse to order a meeting under CBCA s  144 where the applicant possesses a sufficient number of shares to requisition a meeting himself or herself under s 143. In Athabasca Holdings Ltd v ENA Datasystems Inc (1980), 30 OR (2d) 527 (H Ct J), it was held that a meeting might be ordered where the requisition procedure would be futile to secure a meeting that would actually be held, as opposed to merely called.

D.  Meetings in Widely Held Corporations The cases discussed thus far have all involved closely held corporations, but CBCA s 144 and similar corporate law provisions are not so limited, and courts have ordered shareholders’ meetings in publicly held corporations. In Canadian Javelin Ltd, below, the corporation, whose shares were widely held in Canada and the United States, effectively had two boards of directors. At the June 1975 annual meeting, 11 people were elected to the board. A deep split of six versus five developed. At a meeting of the six, those among the five that were officers were dismissed from such positions. A meeting of the five directors was then held at which some of the six were found no longer to be qualified to serve as directors and others were appointed in their place, so as to make a quorum. Affairs proceeded in this manner with the two boards each purporting to act for the corporation. It was important that the corporation have an annual meeting in order to satisfy US securities law requirements. On application to court by one of the five, a meeting of shareholders was ordered for the purpose of electing a board of directors. Even though the petitioning shareholders owned a sufficient number of shares to entitle them to requisition a meeting, the court still found that it would be “impracticable” to conduct a meeting fairly except under court order. The court

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appointed a neutral chair and made numerous orders as to the solicitation and receipt of proxies, including that no person or group would be allowed to solicit proxies under the name of “management.”

Re Canadian Javelin Ltd and Boon-Strachan Coal Co Ltd (1976), 69 DLR (3d) 439 (Que Sup Ct) There is no doubt from the evidence that the situation is not only abnormal but detrimental to the best interests of the Company and of its shareholders. The role of directors is to act in a fiduciary capacity for the benefit of the Company. They must spend all their efforts and energy to study all the problems that are related with the good management and to take the most appropriate decisions that will safeguard the assets and promote the development of the Company. Directors should not try to take over the control of the Company for their own personal advantage and with the hope that they will consolidate their power by creating a climate of uncertainty that places the Company in a suspicious position. On April 22, 1976, a letter (ex. P-7) was sent by petitioner Boon-Strachan asking that a special general meeting of the shareholders be called. No response has been given to said petitioner. An explanation was given at the hearing for not calling the said general meeting of shareholders in that the financial statements were not ready. The Court is of the opinion [that] the mere fact of the financial statements not being ready is not a valid reason to preclude the holding of a special meeting of the shareholders. In Re El Sombrero Ltd., [1958] Ch. 900 at pp. 906-7, Mr. Justice Wynn-Parry of the Chancery Division states that: There is a clear statutory duty on the directors to call the meeting whether or not the accounts, the consideration of which is only one of the matters to be dealt with at an annual general meeting, are ready or not. It cannot possibly serve as an excuse for failing to perform that statutory duty. It is quite obvious that the only reason why the respondents refuse to call an annual general meeting is because the inevitable result of convening and holding that meeting would be that they would find that they had ceased to be directors.

Although the facts in this motion differ considerably from those of the El Sombrero case, the Court can apply a similar conclusion in that it is quite evident that the March 6th board and management of the mis-en-cause does not feel ready to ask the shareholders for a renewal of their mandate. Much has been said about the requirements of the SEC. This Court is not compelled by the regulations of the SEC but may direct the person to be named as chairman of the proposed meeting to call and hold it in conformity with such regulations as far as is practicable. Section 106 of the Canada Corporations Act reads as follows: 106.  Where for any reason it is impracticable to call a meeting of shareholders of the company in any manner in which meetings of shareholders may be called, or to conduct the meeting in [the] manner prescribed by the letters patent, supplementary letters patent, the by-laws or this Part, the court in the province in which the head office of the company is

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VI.  Shareholder Voice situated, may, either of its own motion, or on the application of any director or any shareholder who would be entitled to vote at the meeting, order a meeting to be called, held and conducted in such manner as the court thinks fit and, where any such order is made, may give such ancillary or consequential directions as it thinks expedient; and any meeting called, held and conducted in accordance with any such order shall for all purposes be deemed to be a meeting of shareholders of the company duly called, held and conducted. •  •  •

CONSIDERING that the evidence has shown that it is urgent that a general meeting of

the shareholders be called and held in order to stop the damage that may be caused to the assets of the Company at the detriment of the shareholders, on account of the contradictory decisions that are taken by the two parallel boards of directors presently purporting to act on behalf of the company and on account of the uncertainty as to the control of the management of the company; CONSIDERING that the Company will be in default of holding an annual general meeting after June 30, 1976, and the Company has not prepared and is not in preparation of any notice and proxy statements and other relevant documents for such an annual meeting and it is obvious that the present management does not intend to call a meeting in the near future; CONSIDERING that in view of the tactics adopted by certain of the directors of the Company and the evident animosities existing, certain shareholders and directors of the company cannot hope to be fairly treated if the meeting is conducted by any one of the present officers and directors of the Company and thus the Court is of the opinion that in the present case it is obvious that there are no means available to the petitioners which will provide any assurance that the business of the meeting will be properly conducted except under an order of this Court (cf. Re Routley’s Holdings Ltd. (1960), 22 DLR (2d) 410 at p. 415, [1960] OWN 160); CONSIDERING that it is in the best interest of the Company that a special general meeting of the shareholders be called as soon as possible for the purpose of giving a clear mandate to those persons whom the shareholders wish to manage the Company; CONSIDERING that in order to put an end to the litigations presently pending and any future litigation and to have the decision of the shareholders accepted by all factions, it is necessary that the meeting be conducted by a disinterested person of high repute; CONSIDERING that Mr. Michel Robert, the past Batonnier General of the Province of Québec, being a disinterested person of high repute has manifested his readiness to act as chairman of such meeting and to cause notices to be sent to the shareholders; CONSIDERING that the Court, when ordering the calling of the meeting or directing the conduct of the meeting, has to be careful to do as little violence as possible to the corporate articles or regulations and should in fact be careful to see that any meeting ordered to be held should be called and conducted in conformity with such articles or regulations as far as practicable; CONSIDERING that the attorneys of petitioners have mentioned that if a date is chosen for the holding of the meeting, it should be at the end of the month of July so as to give sufficient time for the preparation of the required documentation and of the meeting; FOR THESE REASONS, THE COURT DOTH ORDER that a special general meeting of the shareholders of the mis-en-cause, Canadian Javelin Limited be held in Montréal, Canada, at the Windsor Hotel, on Thursday, July 29, 1976, or if more convenient to the

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chairman of the meeting, on Friday, July 30, 1976, at the cost of the Company, and order Mr. Michel Robert to cause notice of such meeting of the shareholders to be sent to all shareholders of record as of July 2, 1976, at least five clear days prior to the date fixed for such meeting; DOTH ORDER that all shareholders of record on the books of the transfer agent and Registrar of the Company as of July 2, 1976, be conclusive evidence of eligibility to vote at said meeting; DOTH ORDER that all brokerage companies and partnerships or individuals, holding shares of the Company as nominees for beneficial owners, forward all material concerning the meeting, inclusive but not exclusive of notice of meeting, proxy forms and material, to the beneficial owners, and that such brokerage companies, partnerships and individuals be allowed to vote only if a signed direction of the beneficial owners accompanies the proxies submitted in their names; DOTH ORDER that, where a brokerage company holding shares in its name as nominee, is no longer active as a stock exchange member, or as a licensed active broker or brokerdealer, such shares may be voted by proxy through description of the shares by number and quantity as attestation as to beneficial ownership before a Commissioner of Oaths or any other person authorized to receive affidavits in the jurisdiction where it is given, such document to be conclusive evidence of their right to vote by proxy or in person. DOTH ORDER that banks and trust companies, acting in a fiduciary capacity, sign an appropriate form as to their authority to direct the proxy in favour of whom they wish to vote for and the signing by such banks or trust companies of this form, will be conclusive evidence of the right to vote; DOTH ORDER that the notice of the meeting be accompanied by a proxy form conforming with the rules and regulations of the Canada Corporations Act and as far as is practicable, in the opinion of Mr. Michel Robert, with the SEC regulations; DOTH ORDER that no proxy solicitation be made by any group or persons representing themselves as management of the Company and that any solicitation of proxies be made under the rules and regulations of Canada Corporations Act and as far as is practicable, in the opinion of Mr. Michel Robert, with the SEC regulations and that any solicitor of such proxies present itself as a dissident; DOTH ORDER and appoint the said Michel Robert, to preside over the special general meeting of shareholders and doth order that his decisions be final and binding over all parties concerned; DOTH ORDER and authorize Michel Robert, to appoint two independent scrutineers for the purpose of counting and preparing proxies for voting and the further counting of votes of shareholders appearing in person at the meeting; DOTH ORDER that the directors elected at the special general meeting of shareholders hold office until the next annual general meeting of shareholders of the Company and their qualification and duties be governed by the by-laws of the Company; DOTH ORDER that no additional new shares or convertible debentures or share options of the company be issued or allotted or transacted by the Company until after the next annual general meeting of shareholders; DOTH ORDER that all costs, charges and fees of the special general meeting of shareholders be at the expense of the Company;

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DOTH RESERVE to petitioners a right to seek such other conclusions as may in the circumstances be necessary; DOTH ORDER and grant provisional execution of this judgment notwithstanding any appeal. THE WHOLE, with costs.

Order accordingly.

E.  Constitutionality Requirements Could a court-ordered meeting consider a matter assigned to the competence of the board by CBCA s 102(1)? This question is considered in the following case, which may also provide a suggestion as to how constitutionality requirements would be interpreted in the case of shareholder-requisitioned meetings under CBCA s 143.

Re British International Finance (Canada) Ltd Charlebois v Bienvenu [1968] 2 OR 217, 68 DLR (2d) 578 (CA) AYLESWORTH JA:  Appellants appeal from the order of Fraser J, dated November 17, 1967, ordering the calling, holding and conducting of a general meeting of the shareholders of British International Finance (Canada) Limited (which was incorporated in 1960) for the principal purpose of electing directors of the company, hereinafter referred to as “B.I.F.” The order was made in reliance upon the provisions of s. 310 of the Corporations Act, RSO 1960, c. 71, as amended [now s. 106], which section reads: 310.  If for any reason it is impracticable to call a meeting of shareholders or members of the corporation in any manner in which meetings or shareholders or members may be called or to conduct the meeting in the manner prescribed by this Act, the letters patent, supplementary letters patent or by-laws, the court may, on the application of a director or a shareholder or member who would be entitled to vote at the meeting, order a meeting to be called, held and conducted in such manner as the court thinks fit, and any meeting called, held and conducted in accordance with such an order shall for all purposes be deemed to be a meeting of shareholders or members of the corporation duly called, held and conducted. •  •  •

The personal appellants were shareholders and directors of B.I.F. for some years prior to July 28, 1967, when an annual meeting of the company purportedly was held at which a new board of directors, omitting the personal appellants, purportedly was elected. Members of the old board other than appellants were purportedly re-elected and an existing vacancy filled; the “new” directors purportedly elected were the respondents Brillant, Hamilton, Woods and Morissette. In August, 1967, the plaintiff-appellants instituted this action challenging the validity of the July meeting and of the election of directors thereat, claiming an injunction and interim injunction restraining the then elected directors from acting as such, claiming a declaration of such invalidity and

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damages and other relief. Fraser J, on September 8, 1967 [[1967] 2 OR 635, 64 DLR (2d) 683], granted plaintiff-appellants an interim injunction until trial and directed expedition of the trial; little success in such expedition has been achieved. … There really are only two issues in the appeal, namely (1) are the provisions of s. 310 wide enough to sanction an order for the calling and conducting of a shareholders meeting to achieve some purpose thereat beyond the powers of shareholders at a meeting called in any other manner “in which meetings of shareholders may be called,” and (2) on the facts of the case and the law applicable thereto, is the proposed election of directors for which the meeting is called such a purpose beyond the powers of the shareholders. As to the first of these issues, s. 310, in my view, is incapable of the broad construction for which the respondents contend. The section is aimed at and limited to the removal of difficulties militating against the calling of a shareholders meeting or militating against the conducting of business which lawfully might come before the meeting. When such difficulties render lawful action in securing a meeting or in conducting it “impracticable” unless the difficulties are solved by an order of the Court, then such an order properly may be made. Once such difficulties have been removed by the provisions of the order however, it is open to the shareholders present at the meeting to conduct only such business thereat which could have been conducted at a meeting legally called “in any other manner.” In my view, the only phrase in the section lending any plausibility to a broader construction is the concluding phrase thereof “and any meeting called, held and conducted in accordance with such an order shall for all purposes be deemed to be a meeting of shareholders or members of the corporation duly called, held and conducted.” The wording in that phrase “for all purposes” when read in the context of the whole section clearly is limited in application to establishing the legality of the meeting so far as the calling, holding and conducting thereof as a meeting is concerned. This interpretation of the section would seem to bestow full effect on its complete wording. I hold that further specific provision, which is absent from the section, would be required to support a construction sanctioning the Court to “order,” as it were, shareholders to do in a meeting what they otherwise would have no power to do simply because it had been established that without the help of the Court it was “impracticable” to call, hold or conduct the meeting. As to the second issue raised in the appeal, the salient fact, of course, is the uncertainty as to the present composition of B.I.F.’s board of directors. If the contention of the plaintiffs in the action as to the purported election of directors in the July meeting be upheld, then the board of directors of the company as the same existed prior to that meeting is still B.I.F.’s board, s. 300(4); if the action, however, fails in this respect then the board elected in the July meeting is still in office and their term of office has not expired, s. 300(2). Respondents argue that B.I.F.’s By-law 1, cl. 5, provides for an “uncertain” term of office for directors and that another election of the board within one year is contemplated and sanctioned thereby. That clause provides: 5.  Term of Office.  The directors’ term of office (subject to the provisions, if any, of the letters patent and any supplementary letters patent of the Company) shall be from the date of the meeting at which they are elected or appointed until the annual meeting next following or until their successors are elected or appointed. As long as there is a quorum of directors in office, any vacancy occurring in the board of directors may be filled for the remainder of the term by the directors then in office.

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VI.  Shareholder Voice

I do not agree with the contention. I construe that clause to be in harmony with s. 300(4) of the Act: (4)  If an election of directors is not held at the proper time, the directors continue in office until their successors are elected.

Nor subject to the provisions of s. 66 of the Act do I think it competent for B.I.F. to hold what in effect amounts to a second election of an entire board of directors within one year. Section 300(2) provides: (2)  Unless the letters patent or supplementary letters patent otherwise provide, the election of directors shall take place yearly. •  •  •

I would allow the appeal with costs here and below, set aside the order in appeal and direct that an order go dismissing the application. Appeal allowed; application dismissed.

F.  Beneficial Owners With the increased volume of share trading and the use of electronic trading, many individual shareholders do not hold shares in their own name; rather, the shares are held by intermediaries who are the registered shareholders. The individuals purchasing the shares are called “beneficial” shareholders, as opposed to “registered” shareholders. Since corporate law and securities law grant voting rights to registered shareholders, changes in the market to the way that shares are held have disenfranchised individuals who believed that they were shareholders with full voting powers. The challenge for corporate governance is that the parties voting the shares, the intermediaries, are frequently no longer the parties with the direct economic interest in the corporation. Recall that shareholder voting rights are a mechanism to hold directors and officers accountable to act in the best interests of the corporation. Given that beneficial shareholders may wish to participate as shareholders at shareholders’ meetings, securities law provisions set out a basis on which they can be advised of developments and vote their interest in the shares. These shareholder rights are aimed at increasing the accountability of corporate directors and officers to investors.

Marshall v Marshall Boston Iron Mines Ltd (1981), 129 DLR (3d) 378 (Ont H Ct J) CALLAGHAN J (orally):

[1]  This is an application by William C. Marshall, a director and shareholder of Marshall Boston Iron Mines Limited (the Company) for an order under s. 252 of the Business Corporations Act, RSO 1980, c. 54 (the Act), directing the chairman of the adjourned annual and general meeting of the shareholders of the Company to tabulate the votes of 405,001 escrowed common shares of the Company in accordance with certain written directions of the beneficial owners thereof and not as voted by the registered owners of the said shares. The vote in issue relates to the election of the board of directors of the

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Company. If the vote is tabulated on the basis of the escrowed shares being counted as cast by the registered shareholders, the Company’s slate of directors continues in office. If the vote is tabulated in accordance with the written directions given by some of the acknowledged beneficial owners under the escrow agreement then there will be a switch of approximately 36,500 votes resulting in a slate of directors nominated by the applicant. •  •  •

[3]  The capital of the Company includes 405,001 common shares held in escrow by the Royal Trust Company pursuant to an agreement dated February 10, 1970. These shares are separately registered in the names of Raymond J. Marshall as to 202,501 and Charles Marshall Jr. as to 202,500. It is common ground that the beneficial ownership of the shares is divided amongst six directors of the Company and five other persons named in the material filed herein. [4]  The escrow agreement provides that the shares are not to be released without the consent of the Ontario or Québec Securities Commission. This agreement apparently follows upon an earlier agreement dated January 5, 1964, which was a vendor’s agreement attendant upon the incorporation of the Company. [5] In August, 1971, the registered owners of the escrowed shares executed an acknowledgment that these shares were held in trust in proportionate amounts for the named persons in the said acknowledgment. That agreement is set forth in the supplementary record at p. 89. [6]  The annual meeting was held on October 8, 1981. Prior thereto the applicant and two other beneficial owners of a number of these shares signed a written direction to Raymond J. Marshall, Charles Marshall Jr. and the Royal Trust Company to the effect that the escrowed shares beneficially owned by each were to be voted in favour of the slate of directors nominated by the applicant. At the meeting this direction was delivered to the chairman and the scrutineers of the voting. It should be noted that the chairman is the president of the Company and supports the management slate of candidates. On October 8th, a poll was taken at the meeting to determine the distribution of votes among the various candidates for election as directors. Charles Marshall Jr. voted all 202,500 escrowed shares, registered in his name, in favour of the applicant’s slate of candidates. Raymond J. Marshall voted 202,501 escrowed shares, registered in his name, in favour of the existing board of directors. Raymond J. Marshall did not execute a form of proxy in favour of the applicant’s slate for 36,750 escrowed shares representing the excess of the sum of the beneficial holdings pursuant to the above-mentioned written directions of those in favour of the applicant’s slate over the 202,500 escrowed shares registered in the name of Charles Marshall Jr. [7]  It is clear on the material before me that the chairman of the meeting, as well as the scrutineers, were aware of the written directions of the beneficial owners (see the affidavit of William Marshall, para.  9 and the affidavit of Rosemary Millan, paras. 18 and 19). It is the contention of the applicant on this proceeding that to ignore the written direction of the beneficial owners would violate and disenfranchise the vote of the beneficial owners of the escrowed shares relevant to that direction. The applicant relies on paras. 41 and 44 of the general by-laws of the Company which provide as follows:

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VI.  Shareholder Voice 41.  Votes to Govern.  At all meetings of shareholders every question shall, unless otherwise required by the letters patent or by-laws of the company or by law, be decided by the majority of the votes duly cast on the question. 44.  Votes on Polls.  Upon a poll, each shareholder who is present in person or represented by proxy shall be entitled to one vote for each share in respect of which he is entitled to vote at the meeting and the result of the poll shall be the decision of the company in annual or special meeting, as the case may be, upon that question. •  •  •

[11]  It would appear that Raymond J. Marshall was, at the time of the vote, the person entered in the books of the Company as the holder of these shares and, accordingly, he was entitled to vote for each share so held. The provisions of this by-law are consistent with s. 110, s-s. (2) of the Act which in turn is consistent with the general rule in company law that the persons entitled to vote as a shareholder are those shown on the company’s books to be shareholders. [12]  The narrow issue before me, as I see it, is whether or not the chairman of this annual meeting is required to go behind the share register, and, in case of dispute, accept written directions from beneficial owners as to the manner in which their vote shall be cast. In my view, I think he is not so required. The Company has no right whatsoever to enter into disputes between the beneficial owners as to the manner in which escrowed shares or shares held in trust should be voted. To do so would require the chairman to go behind the share register and to enter into legal questions of beneficial ownership, and in this case, the question of the propriety of a trustee of a private trust acting separately from his co-trustee. … •  •  •

[14]  … A chairman at an annual general meeting is not to be placed in the position of determining the legal rights of beneficial owners of shares registered in the name of others. He is entitled to rely on the votes as cast by the registered owner of those shares. In result, therefore, I am of the view that the chairman of the meeting herein should count the votes cast by the registered owners of the escrowed shares as voted and, accordingly, the application is dismissed with costs. Application dismissed. While the chair of the meeting need not become involved in questions between the registered owner and the beneficial owner of shares, the chair may be called on to decide who is in fact the registered owner and thus who is entitled to vote the shares. In litigation over control of United Canso in Re United Canso Oil & Gas Ltd (1980), 41 NSR (2d) 282, overreaching by a chair was successfully impeached. At the shareholders’ meeting at which the Buckley board was deposed in favour of the insurgents’ slate, the chair John Buckley had refused to accept (1) the proxies of corporate shareholders that had been executed with a facsimile signature; (2) the proxies of corporate shareholders without proof that their boards of directors had approved the proxies; (3)  proxies executed by stockbrokers holding securities on behalf of clients without clients’ authorizations; and (4) the tabulation of votes of the professional tabulators hired by management. The chair ruled that a quorum

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was not present, and adjourned the meeting for a judicial resolution of the dispute. Hallett J held that in all of these respects, the chair had acted in bad faith in an unlawful effort to retain control of the corporation. NOTES AND QUESTIONS

1.  When there is a battle for control, the chair of the meeting will be put in a position where his or her interests conflict with the interests of certain other shareholders. Should such a conflict of interest disqualify the chair from exercising the “quasi-judicial” functions of the chair of a shareholders’ meeting? 2.  Can the chair avoid being found to have breached the duty of good faith and impartiality if the chair relies on legal advice in making a ruling?

VII.  ACCESS TO RECORDS AND LIST OF SHAREHOLDERS Modern corporations statutes require corporations to keep extensive records and generally to make those records available for inspection by directors and shareholders and sometimes by creditors and, in the case of publicly held companies, by any other person.63 For example, the OBCA specifies: 145(1)  Registered holders of shares, beneficial owners of shares and creditors of a corporation, their agents and legal representatives may examine the records referred to in subsection 140 (1) during the usual business hours of the corporation, and may take extracts from those records, free of charge, and, if the corporation is an offering corporation, any other person may do so upon payment of a reasonable fee. (2)  A registered holder or beneficial owner of shares of a corporation is entitled upon request and without charge to one copy of the articles and by-laws and of any unanimous shareholder agreement.

Pursuant to CBCA s  21(3), a corporation must furnish a current list of shareholders, together with addresses and numbers of shares owned, to “shareholders and creditors … , their personal representatives, the Director and, if the corporation is a distributing corporation, any other person, upon payment of a reasonable fee.” The only limitation on this right is that the request must be accompanied by the requestor’s affidavit stating that the list will not be used “except in connection with … [a] matter relating to the affairs of the corporation.”64 It is an offence to use the list for other than authorized purposes.

A.  Access to Records Access to corporate records can provide information for the purpose of monitoring the performance of the corporation’s management. Thus, in addition to maintaining and providing access to shareholder lists, corporations are typically required to maintain and provide

63 CBCA ss 20 and 21, ABCA ss 21 and 23, BCBCA ss 42 and 46, and OBCA ss 140, 141, 144, and 145. 64 CBCA s 21(9); see also BCBCA s 49(3) and OBCA s 146(8).

VII.  Access to Records and List of Shareholders

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access to other corporate records. For instance, in addition to a shareholder list, a CBCA corporation must maintain adequate accounting records and records containing

1. 2. 3. 4. 5.

the articles and bylaws of the corporation and amendments thereto; any unanimous shareholder agreement; minutes of shareholders’ meetings and shareholder resolutions; minutes of meetings of the directors and resolutions of the directors; copies of notices of who the directors of the corporation are and of any changes in the members of the board of directors; and 6. a securities register.65

The accounting records are normally kept at the registered office of the corporation, but may be kept at another place as the directors think fit.66 Where accounting records are maintained outside Canada, the corporation must keep sufficient accounting records at a place in Canada that will allow directors to determine the financial position of the corporation with reasonable accuracy.67 Records other than accounting records must be kept either at the registered office of the corporation or at another place in Canada chosen by the directors.68 Access to the minutes of directors’ meetings, resolutions of directors, and accounting records must be open to inspection by directors at reasonable times.69 Minutes of directors’ meetings, directors’ resolutions, and accounting records are not available to shareholders, creditors, or the general public.70 Under BCBCA s 46, shareholders or any other person may be granted access to inspect the corporate records under the articles of the corporation.71 Shareholders and creditors, and their agents or representatives, have access to the articles, bylaws, any unanimous shareholder agreement, minutes of shareholders’ meetings, shareholder resolutions, notices of directors, and the securities register.72 Shareholders can examine and take extracts of the records free of charge during the usual business hours of the corporation.73 Where the corporation has made a distribution of shares to the public, the general public has access to the same records that shareholders and creditors do. Members of the general public can examine the records and may take extracts from the records for a reasonable fee.74 65 See CBCA ss 20(1) and 20(2); ABCA s 21(1), which also requires copies of financial statements and a register of disclosures by directors and officers in relation to contracts; BCBCA s 42(1), which has an extensive list; OBCA ss 140(1) and 140(2); NSCA ss 89(1), 90(1), 91, and 92; and QBCA s. 31. 66 CBCA s 20(4), ABCA s 21(7), OBCA s 140(1), and BCBCA ss 42, 43, and 196. 67 See e.g. CBCA ss 20(5) and 20(5.1) and ABCA ss 21(8) and 21(8.1). 68 See CBCA ss 20(1) and 20(5.1); see also ABCA ss 21(8) and 21(8.1); QBCA s 34; OBCA s 140(1); and BCBCA ss 42 and 43. 69 CBCA s 20(4); ABCA s 21(7); OBCA s 144(1); and BCBCA ss 46(8) and 196(3), and Regulation s 13. 70 See e.g. ABCA ss 21(1), 21(8.1), and 23; and OBCA ss 140(1) and 145(1). 71 BCBCA s 46 says that any person may inspect the records of the company without charge, to the extent permitted by the articles. 72 CBCA s 21(1), ABCA s 23, OBCA s 145(1). QBCA s 32 states that shareholders must have access to the records listed above, and that creditors may examine any unanimous shareholder agreement. 73 CBCA s 21(1), ABCA s 23, OBCA s 145, and QBCA s 32. 74 CBCA s 21(1); see also BCBCA ss 46(4) and 46(5); ABCA ss 23(4) and 23(5); and OBCA s 145(1).

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The courts have been clear that shareholders are entitled to access to documents and records pursuant to corporations statutes. In Leggat et al v Jennings et al, 2013 ONSC 903, the Ontario Superior Court of Justice held that both applicants were entitled to access as shareholders and one applicant, Leggat, was entitled both as a shareholder and as a director. The court held that shareholders are entitled to immediate, unfettered, and broad access to records under CBCA s 20(1), and the director through CBCA ss 20(10) and 155. In Li v Global Chinese Press Inc, 2014 BCCA 53, the BC Court of Appeal held that the CBCA sets out a comprehensive scheme to provide financial information to shareholders, and requires production of audited financial statements unless shareholders of a company unanimously decide otherwise. The appellate court held that if a company fails to comply with the statutory requirements, the court has the statutory authority to appoint an auditor and order production of the required documentation (at paras 8-14). An important part of access to these records is the list of shareholders, critically important for any shareholder who wishes to communicate with fellow shareholders concerning the management of the corporation or his or her desire to change management. For example, if a shareholder wants to rally others with voting shares to remove the directors, he or she might want access to the shareholder list to put together the owners of 5 percent of the voting shares to requisition a special meeting. Access to the list of shareholders is also of paramount importance in a takeover bid.75

B.  Mechanics of Access The CBCA provides two devices whereby a shareholder or other party might gain access to the list of shareholders. First, the shareholder might assert a right to examine the list and take extracts from it.76 Second, he or she might require the corporation, on ten days’ notice, to provide a copy of the list of shareholders, saving him or her from the trouble of making extracts. This latter device would seem more convenient, but it suffers from the drawback that the corporation is given ten days’ notice that something is up. On the other hand, where the corporation has thousands of shareholders, this option may be the only practicable method of obtaining the list. In addition, since a shareholder’s wish to communicate with other shareholders frequently indicates discontent with management, it is not surprising that corporate officials might seek to place a variety of obstacles in the way of a shareholder who wishes to inspect the list.77 NOTES AND QUESTIONS

1.  We have just spent more than 40 pages discussing shareholders’ rights, to the exclusion of discussion of rights of any other stakeholders. Why is it that shareholders receive so much attention when directors and officers are to act in the best interests of the corporation as a whole?

75 QBCA s 41 and NSCA ss 42 and 43 (register of members) 76 CBCA ss 21(1) and 138(4); see also ABCA ss 23 and 137(4); BCBCA s 49; and OBCA ss 100 and 146(1). 77 QBCA s 41 and NSCA s 43(2).

VIII.  Institutional Investor Monitoring and Activism

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2.  Why is it that Canadian corporate law does not grant voting rights to others with interests or investments in the corporation? 3.  In some jurisdictions, such as Germany, workers do have voting rights in respect of both election of directors and other fundamental corporate changes. Would such a model work in Canada? What would be the potential benefits of such a model?

VIII.  INSTITUTIONAL INVESTOR MONITORING AND ACTIVISM The issue of shareholder passivity is a challenge for the modern corporation. In Japan and Germany, quite a different pattern of investment developed in response to demand for large amounts of capital—large financial institutions developed large stakes in the corporations to which they provided financial assistance. These financial institutions play an important role in corporate governance in those countries.78 In recent years, changes in capital markets in North America have created the potential for shareholders to acquire large stakes in corporations. Institutional investors such as banks, trust companies, pension funds, insurance companies, mutual funds, and private equity funds have grown significantly in size and importance in both Canada and the United States. These institutional investors have had an increasing influence on corporate decision-making.79 However, such investors are subject to a variety of legal constraints that limit their ability to exert influence over corporate decision-making. The Canadian investment fund industry is a significant force in the marketplace with over $630 billion worth of assets under management, including mutual funds, commodity pools, labour-sponsored funds, venture capital funds, and closed-end funds.80 Most of these investment funds engage in some monitoring of corporations, depending on the nature of the investment and size of holdings. Currently, one-third of the shares of Canada’s major corporations are held by institutional investors, frequently managing the savings of Canadians.81 Many of these institutional shareholders represent “patient” capital, in that they are interested in advancing long-term investment returns through responsible corporate governance. Others are more interested in short-term return on their investment. Institutions are constrained in the acquisition of substantial stakes in corporations by laws that impose ownership limits on banks, trust companies, and insurance companies.82 Mutual funds are also subject to laws that limit the size of the stakes they can take in any individual corporation.83 Trust companies and loan companies are subject to a separate regulatory framework.84 Securities laws place significant constraints on the extent of share ownership an institution takes. A person is deemed to be an insider on the acquisition of 10 percent or more of

78 See e.g. MJ Roe, “Some Differences in Corporate Structure in Germany, Japan, and the United States” (1993) 102 Yale LJ 1927. 79 Bernard S Black, “Shareholder Passivity Reexamined” (1990) 89 Mich L Rev 520. 80 Ontario Securities Commission, Notice of National Instrument 81-107 Independent Review Committee for Investment Funds (2006) 29:30 OSCB (Supp 1) at 3. 81 Canadian Coalition for Good Governance, online: CCGG . 82 See e.g. the Bank Act, SC 1991, c 46, s 466(1) and the Insurance Companies Act, SC 1991, c 47, s 493(1). 83 NI 81-102 Mutual Funds; NI 81-101 Mutual Fund Prospectus Disclosure (2001) 24 OSCB 1071. 84 See e.g. Loan and Trust Corporations Act, RSO 1990, c L.25, as amended.

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the voting securities of a corporation, creating both new disclosure requirements and triggering insider reporting obligations and the restrictions on insider trading, as discussed at length in Chapter 7. The restrictions on insider trading put constraints on the institution’s ability to sell the shares of corporations of which it is an insider, because an insider cannot trade when the insider is in possession of undisclosed material information concerning the corporation. If the institution acquires 20 percent or more of a class of shares of a corporation, it is then subject to takeover bid requirements, as discussed in Chapter 15, which, subject to limited exceptions, require it to make an offer to buy the shares of all holders of shares of that class. If an institutional investor acquires 20 percent or more of the voting shares of a corporation, it is deemed to be a “control person,” as explored in Chapter 7 and will be subject to rules that constrain the sale of the shares. Although institutional investors with substantial stakes in the corporation have an incentive to exert influence over corporate governance, there are some constraints. Communications between shareholders are limited because of the risk that those communications will subject them to costly proxy solicitation requirements, although this ability to communicate has been opened up considerably. The CBCA allows shareholders to disclose publicly their plans to vote a particular way, and allows communications between up to 15 shareholders without triggering proxy solicitation requirements. The constraints on the sale of shares by a “control person” also raise concerns, because the person is subject to constraints if the person is “acting in concert” with other persons and together they hold a sufficient number of shares to affect materially the control of a corporation. An institutional investor may need to exercise caution in having one or more directors on the board of directors of a corporation, since it could result in a finding that the institutional investor is in a position to affect materially the control of the corporation. An institutional investor may also be reluctant to put an employee of the institution on the board of directors of a corporation since it can make the institution subject to insider trading restrictions, thereby constraining its ability to sell the shares. However, this concern can be controlled to some extent by restricting the flow of information between the institution’s appointed director and the trading department of the institution—a so-called “paper wall.” The Canadian Securities Administrators have issued NI 81-107 Independent Review Committee for Investment Funds (2006) 29 OSCB 8807, as amended 11 January 2015, which creates an independent oversight regime for all publicly offered investment funds, and NI 81-106 Investment Fund Continuous Disclosure (2006) 29 OSCB 8850, as amended 22 September 2014, which harmonized the continuous disclosure obligations of investment funds. Institutions such as securities firms, banks, trust companies, and insurance companies also often have contractual relationships with corporations in which they have made an investment. These relationships may give managers of the corporation some leverage over the institutional investor in that they can threaten to take their business elsewhere if the institutional investor does not vote in a particular way. Institutional investors can be subject to conflicts of interest, where the corporations in which they have a substantial stake are also their clients. They may side with management at the expense of minority shareholders.

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Institutional investors may take lesser stakes in corporations than they otherwise might legally take, suggesting that there are trade-offs between exerting control and maintaining liquidity—that is, the ability to sell shares quickly without significantly affecting the market price of the shares.85 Consequently, removing barriers to the taking of large shareholding stakes by institutional investors may not necessarily result in a substantial increase in the size of institutional investor stakes in corporations.86 In recent years, institutional investors have become active in corporate governance. The Canadian Coalition for Good Governance has 50 members, including pension funds, mutual funds, and third-party money with approximately $3 trillion in total assets under management. 87 The Coalition’s goals are to promote best corporate governance practice in Canada and to align the interests of corporate boards with investors. The Coalition’s objective is to promote high-performance boards and improved corporate governance practices through advocating both minimum standards and best practices. The Coalition has advocated for effective, committed, and independent directors who have a high degree of integrity and ethical standards, and board succession planning that ensures maintenance of the appropriate balance of skills and experience. These investors have also promoted mandatory share ownership for directors, to align director and investor interest. The Coalition advocates that corporate boards have a majority of independent directors. 88 These institutional investors have called also for a separation of CEO and board chair; independent board committees with clear mandates; independent and experienced audit committee members; ongoing performance evaluation of boards, committees, and individual directors; officer succession planning; management oversight and strategic planning; oversight of management evaluation and compensation; and transparency in reporting governance policies and practices to shareholders. Institutional investors with significant economic interests in a corporation may have access to information that would allow them to better assess the long-term benefits of investments in human capital, perhaps through training programs or other human capital development projects. It could reduce the short-term focus that capital markets with dispersed investors are said to have because of their inability to assess long-term investments. 89 The excerpt below suggests that institutional investors have an important role in effective governance in terms of the long-term sustainability of the corporations in which they invest.

85 Edward B Rock, “The Logic and (Uncertain) Significance of Institutional Shareholder Activism” (1991) 79 Geo LJ 445. 86 John C Coffee Jr, “Liquidity Versus Control: The Institutional Investor as Corporate Monitor” (1991) 91 Colum L Rev 1277 at 1318-29. 87 Canadian Coalition for Good Governance, online: CCGG . 88 Ibid, Corporate Governance Guidelines for Building High Performance Boards, at 11, online: 89 See Mark J Roe, Strong Managers, Weak Owners: The Political Roots of American Corporate Finance (Princeton, NJ: Princeton University Press, 1994) at 233-47.

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Janis Sarra, “Institutional Investors Must Take a Leadership Role in Financing Climate Mitigation and Adaptation” The Globe and Mail (2 April 2016), online: University of Toronto President Meric Gertler’s announcement yesterday that the University will direct its $6.5 billion assets under long-term management towards the fight against climate change is a welcome development. At the recent Conference of the Parties “COP21” in Paris, 195 countries adopted the first-ever “universal, legally binding global climate deal,” committing to limit global warming “to below 2°C above pre-industrial levels,” with a further goal of working towards a 1.5°C limit. The science is now clear: under our current approach to emissions, in 40 years we will face severe water and food scarcity and irreversible loss in biodiversity. The International Energy Agency estimates that the world must invest at least an additional 1 trillion US per year into clean energy by 2050 if there is any hope of limiting global warming. Carbon dioxide is the greenhouse gas to be most concerned about, as its life in the atmosphere is up to hundreds of millennia, far longer than other human-released greenhouse gas. There is need to drastically reduce the most serious generator of such emissions—fossil fuels. Yet in 2015, the top 200 fossil fuel companies allocated US$674 billion to develop more reserves, and governments continue fossil-fuel subsidies of US$548 billion annually, revealing a disconnection between global aspirational discussions and economic reality. Institutional investors have an important role to play in charting a new course in corporate approaches to climate change, aimed at long-term sustainability. Institutional investors such as pension funds are by their nature “patient capital” because of their size in the market and illiquidity of their shares; collectively they can have a significant influence on corporate decision makers in tackling climate change. Aside from our collective public interest in a sustainable world, there is a business case to be made. At risk is a significant portion of the value of diversified investment portfolios, Howard Covington and Raj Thamotheram suggest that value at risk due to climate change in just 15 years could result in a permanent reduction of up to 20% in portfolio value. Hence, there are compelling reasons for capital markets participants to aggressively press for immediate and comprehensive action. Indeed, arguably, institutional investors have a fiduciary duty to act to prevent risk to their portfolios from anthropogenic climate change. The strategies need to be multifold: decarbonization of electricity, a massive move to clean energy or lower carbon fuels, less waste in all sectors, and improvement of forests and other natural carbon sinks. There is a nascent but growing type of institutional shareholder activism, “forceful stewardship,” where investors are demanding a recasting of fiduciary obligation away from short-term shareholder returns towards ethical obligations and reduction of long-term environmental risks. Forceful stewardship involves helping directors and officers of all types of businesses understand that it is a breach of their fiduciary duties to ignore longterm environmental risks such as climate change. This activism by our most powerful advocates in the market is an important development in the potential to change the current course of climate change.

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•  •  •

Another recent example is the Swedish pension fund AP4, which is committed to decarbonizing its entire $20 billion listed equities portfolio in less than 5 years. It has a multifaceted strategy that includes opting out of companies with the greatest and most negative impact on the environment in terms of carbon dioxide emissions; providing funding for more green projects by being active in the primary market of the new issue of green bonds, as that is the only time actual funding of green projects takes place, in that capital is transferred directly to the issuer for green projects; and participating in the trading on the secondary market of green bonds to help the asset class become more liquid and more attractive. AP4 is a member of the Portfolio Decarbonization Coalition, a coalition of 25 investors committed to the decarbonization of $600 billion in assets under management. Forceful stewardship has potential impact across the financial system; for example, Lloyds announced last month that it will offer £1bn in cut-rate loans for green buildings, citing investor pressure to cut carbon emissions in buildings in which they invest. Preventable Surprises, a “think-do” tank that seeks to assist institutional investors align their activities with the long-term needs of their members, has suggested how investors might play a bigger role in the solution to climate risk. Investors can declare their intentions to vote in favour of shareholder resolutions that will help reduce systemic climate risk while growing shareholder value in the long-term; can vote in favour of resolutions that call for listed companies to publish robust analyses of their assessments of the physical and economic impacts to their businesses of carbon budgets; and they can press for a halt to the hundreds of millions of dollars spent on lobbying campaigns by the fossil-fuel industry to mislead the public regarding climate science and to delay adoption of costeffective policies. Institutional investors need to be innovative in how they encourage a shift away from short-termism. One approach is to seek amendment of corporate charters to specify that the company is to be managed in keeping with the objectives of the Paris Agreement, specifically, to hold the increase in the global average temperature to well below 1.5°C above pre-industrial levels. Enshrining such objectives in the constating documents would give directors and officers an express mandate to make business judgments with that corporate purpose in mind. The time for investor leadership is now.

IX.  PROXY SOLICITATION AND CORPORATE GOVERNANCE Both securities law and corporate law include requirements for corporate officers to solicit proxies from shareholders who may be unable to attend annual and special general meetings. Since many corporations have large numbers of shareholders, numbering often in the thousands or even the tens of thousands, it is not practicable for all or even a large number of shareholders to attend meetings in person. With quorum requirements typically running at levels of 50 percent or more of voting shares, meetings must be conducted by means of the appointment of proxies. The term proxy is commonly used to refer to a person appointed to represent a shareholder at a meeting. However, statutory provisions in Canada use the term “proxy” to refer

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to the form or instrument by which such person is appointed.90 The proxy process is the manner in which proxies for meetings are solicited from shareholders and information is provided to them in connection with the solicitation. Management solicitation must occur for every annual general meeting and special meeting that the issuer calls, and the proxy must be explicit with regard to the scope of authority sought. Mandatory disclosure in the form of an information circular must accompany this solicitation of proxies. The information circular provides the background information that allows investors to make informed decisions in respect of the control rights they possess: approval of directors, auditor approval, acceptance of financial statements, and special business to be considered at the meeting. With proxy solicitation, as with corporate governance, the focus is on the quality and timeliness of disclosure, as opposed to regulatory prescription of what must be contained in the proxy. The process by which proxies are solicited and exercised is important, because shareholders should be entitled to sufficient information to make informed choices in respect of proposed governance or capital structure changes. The proxy solicitation requirements discussed in this chapter become particularly significant in the takeover context, as discussed in Chapter 15.

Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed (Toronto: Emond, 2017) at 487 The information circular and proxy process allows securityholders to make informed decisions as to whether to purchase, sell, or continue to hold their securities. It can also allow investors to exercise their rights to participate through voting and shareholder proposal mechanisms, granted to them by both corporate and securities law statutes. The sale of shares by investors if they are dissatisfied with the overall governance and direction of the issuer is called “exit,” whereas the exercise of securityholder rights through the proxy process is often referred to as “voice.” Both have a governance role in that they may signal to directors and officers that there is a lack of confidence in the oversight or management of the issuer’s business or operations. However, exit as a governance tool is imprecise and can send mixed messages to managers regarding their governance activities. In contrast, the exercise of participation rights by securityholders can serve as a direct communication device to directors regarding investors’ confidence in the current management or strategic planning of the issuer. Where institutional investors are actively exercising their participation rights, it can also serve as a signaling device for retail investors who may not have the time or resources to fully review the activities of the issuer. In the mid-1990s, the Senate Standing Committee on Banking, Trade and Commerce commented on the importance of the governance aspects of the proxy solicitation process.

90 CBCA s 147, ABCA s 147, NSCA s 85A, BCBCA s 1(1), and OBCA s 109.

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Canada, Senate, Report of the Senate Standing Committee on Banking, Trade and Commerce on Corporate Governance (Ottawa: Public Works and Government Services, August 1996) at 145 and 159 Effective corporate governance is an ongoing process built on the foundation of continuing involvement by shareholders in the affairs of the corporation and with one another. Shareholders must be informed. They must conduct continual research on the company. They must review policies, prospects and decisions. When questionable decisions are made, they must indicate their concern. When good ideas surface that the company should review, shareholders must prod the company to consider them. The company, for its part, must assess the preference of shareholders and the views of the market, which is its best critic, on whether value is being realized. This process is founded on continual communication. Shareholders must speak with many people in the market. They must speak with each other to learn whether their views are widely shared or are a minority opinion. They must be able to speak with the company, as individuals or as a group. When a problem surfaces, they must be able to discuss their concerns; when a corporate proposal is made that demands opposition, they must be able to act. •  •  •

Information circulars and proxy solicitation requirements engage both securities law and corporate law. While corporate law is aimed at enabling the corporation to operate, setting out the respective rights and obligations of directors, officers and shareholders, securities law is implicated because of the need to protect the integrity of capital markets by ensuring that investors’ rights to information and exercise of voting are not compromised. Specifically, shareholders that are not able to attend general meetings are granted a voice in decisions at the meeting through the proxy process. Management’s obligation is to ensure that shareholders are notified of their proxy rights and given the opportunity to exercise them … . [T]he security holder, by signing a proxy, authorizes someone to vote on the shareholder’s behalf at the meeting, thus allowing the shareholder a “voice” at the meeting. The proxy solicitation provisions are also designed to provide an alternative to “exit,” that is, selling shares if security holders are dissatisfied with the governance of the company.

A.  Legal Developments in the Proxy Process It is only since the 1960s that the proxy process has been extensively regulated by statute. However, even before that time, the courts had held that where the information circular sent by management did not give shareholders sufficient relevant particulars to enable the shareholders to form a reasoned judgment on matters to be dealt with at the meeting, the results of the meeting would be set aside.91 Further, courts might not approve of management’s form of proxy if it did not enable the shareholder to exercise a real choice, even though it did not necessarily invalidate the meeting.92

91 Re Langley’s Ltd, [1938] OR 123, [1938] 3 DLR 230 (CA), and Re Dairy Corporation of Canada Limited, [1934] OR 436, [1934] 3 DLR 347. 92 Ibid; see also L Getz, “The Alberta Proxy Legislation: Borrowed Variations on an Eighteenth-Century Theme” (1970) 8 Alta L Rev 18.

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The impetus for modern Canadian proxy legislation was the 1965 Kimber Report. Under the Canadian legislation, a “proxy” is defined as a form signed by a shareholder that appoints a proxyholder.93 A “proxyholder” is defined as a person appointed to act on behalf of a shareholder. A proxyholder can be appointed by a shareholder entitled to vote at a meeting of shareholders.94 The proxyholder has the same rights as a shareholder. However, the shareholder can limit the rights of the proxyholder in the grant of authority given by the shareholder.95 At a meeting, the proxyholder cannot vote by a show of hands where the proxyholder holds proxies for more than one shareholder and has conflicting instructions from different shareholders. However, a proxyholder may register votes on conflicting instructions where a ballot is taken, which allows the proxyholder to record votes for the resolution on the basis of a proxy given by one shareholder while recording votes against the resolution on the basis of a proxy given by another shareholder.96 A ballot may be demanded by a shareholder in person or by a proxyholder. Otherwise, the vote can be conducted by a show of hands unless there are proxies representing more than 5 percent of all the voting rights of securities entitled to be represented and voted at the meeting that require that the securities represented by the proxies be voted against what would otherwise be the decision of the meeting.97

B.  Proxy Requirements Regulation 54 under the CBCA, in conjunction with CBCA s. 149(1) and NI 51-102 s. 9.4, requires that any form of proxy, whether used by management or by others, must state that the shareholder may appoint as proxy a person other than the one pre-designated on the form and must provide a space to do so. The form must either state clearly how the predesignated individual intends to vote on the business to be brought before the meeting or provide a means for the shareholder to specify how his or her shares shall be voted. With regard to the appointment of the auditor and the election of directors, for which the voting is not for or against but rather granted or withheld, the proxy form must provide a means for the shareholder to instruct whether or not his or her shares shall be voted for the nominees.98 In Re Goldhar et al and D’Aragon Mines Ltd (1977), 15 OR (2d) 80 at 81 (H Ct J), dissidents had requisitioned a meeting of shareholders for the purpose of removing the incumbent board and electing a new one. Management’s proxy form designated a named individual as proxy and provided a place for the shareholder to instruct the proxy to vote for or against the

93 CBCA s 147, ABCA s 147, BCBCA s 1(1), OBCA s 109, and NSCA s 85A. 94 CBCA s 148(1), ABCA s 148(1), OBCA s 110(1), BCBCA s 173(1), and NSCA s 85B. 95 CBCA ss 148(1) and 152(2); ABCA ss 152(2) and 148(1); OBCA ss 110(1) and 114(2); BCBCA s 173(1) and Table 1, s 9.7 of the Regulation; and NSCA ss 85B and 85F(2). 96 CBCA s 152(2), ABCA s 152(2), OBCA s 114(2), NSCA s 85F(2). QBCA s 173 specifies that a proxyholder who has conflicting instructions from multiple shareholders may not vote by hand. 97 CBCA s 152(3), ABCA s 152(3), OBCA s 114(3), and NSCA s 85F(3). 98 See also OBCA Regulation s 27(4).

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removal resolution. The form stated that if the removal resolution were passed, the person designated on the form would vote all shares for which he held proxies in favour of the reelection of the existing board. The court declared the proxy form to be “null and void” because it “is not only unfair but also … does not permit the shareholders to exercise their choice in connection with the transaction of the business stated in the requisition.” In Smoothwater Capital Partners LP I v Equity Financial Holdings Inc, 2014 ONSC 324, the applicants sought a restraining order under CBCA s  247, arguing that a press release by Equity, titled “Equity Financial Holdings Inc Sets the Record Straight” was a proxy solicitation within the meaning of the Act and was in violation of CBCA s 150 because it was released prior to the management proxy circular being sent. The court dismissed the application, finding that the press release did not constitute a proxy solicitation. The court held that the term “solicitation” is to be defined broadly and in an inclusive manner, and is a question of fact depending on the nature of the communication and the circumstances of the transmission. The court held that the circumstances in this case, the press release defending the company’s history, leadership, and decision to combine an AGM with a special meeting of shareholders, was a reasonable response to Smoothwaters’ press releases. It did not solicit proxies, but rather, advised that a management information circular would be available to shareholders in advance of the joint meeting. The fact that the release was issued during a proxy fight did not detract from the fact that the purpose of the press release was not to solicit proxies. The court did note that it was not to suggest that in other circumstances a press release could not constitute a solicitation.

C.  Who Must Solicit Proxies Management of a publicly held corporation must, concurrently with giving notice of a shareholders’ meeting, send a form of proxy to each shareholder entitled to receive notice of the meeting.99 Mandatory solicitation by management is the linchpin of the modern proxy rules because even the most complete disclosure regulations would not work if management were free to ignore them by not soliciting proxies or by soliciting them only from sufficient friendly shareholders to constitute a quorum. Dissenting shareholders that are seeking support for their position may also solicit proxies. Whether it is management or a dissident shareholder that solicits the proxies, an information circular must be sent. The information circular provides information such as the interest of persons making the solicitation in the matters to be voted on, which, in the case of a management solicitation, must note the interests of directors and senior officers, information concerning persons proposed as directors, information on executive compensation, the interest of insiders in material transactions, the indebtedness of directors and senior officers to the corporation or its subsidiaries, and details of management contracts under which a large share of management functions is performed by persons other than the directors and senior officers. Further, with respect to any special matters to be voted on, such as fundamental changes, the information circular must provide information in sufficient detail to permit security-holders to form a reasoned judgment concerning the matter. Where

99 CBCA s 149, ABCA s 149, and OBCA s 111.

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management fails to send a required information circular, a court will nullify the results of the shareholders’ meeting.100

D.  Sample Proxy Form Below is an example of a management proxy circular for an annual general meeting. The form is designed to give shareholders sufficient information to ensure that they can make an informed choice in assigning their voting rights to another individual. Also, note that proxy circulars now contain the corporate governance disclosure requirements discussed above. The next part of this chapter discusses beneficial shareholders, and refers to this proxy form to discuss these aspects of the form.

Notice of Annual and General Meeting of Shareholders and Management Information Circular [date, time, location] The purposes of the Meeting are: 1.  To receive and consider the financial statements of the Corporation for the fiscal year ended [date] and the auditors’ report thereon; 2.  to elect directors; 3.  to appoint auditors and authorize the directors to fix their remuneration; and 4.  to transact such other business as may properly be brought before the Meeting. If you are unable to attend the Meeting in person, please date, sign and return the enclosed form of proxy. Proxies to be used at the Meeting must be deposited with [name, address] prior to 5:00 p.m. on the last business day immediately preceding the Meeting or with the Corporation before the commencement of the Meeting or at any adjournment thereof. [dated, place, CEO signature] By Order of the Board of Directors These securityholder materials are being sent to both registered and non-registered owners of the securities. If you are a non-registered owner, and the issuer or its agent has sent these materials directly to you, your name and address and information about your holdings of securities have been obtained in accordance with applicable securities regulatory requirements from the intermediary holding on your behalf. By choosing to send these materials to you directly, the issuer (and not the intermediary holding on your behalf) has assumed responsibility for (i) delivering these materials to you, and (ii) executing your proper voting instructions. Please return your voting instructions as specified in the request for voting instructions.

100 Babic v Milinkovic (1971), 22 DLR (3d) 732 (BCSC), aff’d (1972), 25 DLR (3d) 752 (BCCA).

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Management Proxy Circular Solicitation of Proxies by Management This Management Proxy Circular is furnished in connection with the solicitation by the management of (the “Corporation”) of proxies to be used at the Annual and General Meeting of shareholders (the “Meeting”) of the Corporation to be held at the time and place and for the purposes set forth in the Notice of Meeting. It is expected that the solicitation will be made primarily by mail. However, officers of the Corporation may also solicit proxies by telephone, telecopier, e-mail or in person. The total cost of solicitation of proxies will be borne by the Corporation. Appointment and Revocation of Proxies The persons named in the enclosed form of proxy are directors and/or officers of the Corporation. A shareholder has the right to appoint as his or her proxy a person, who need not be a shareholder, other than those whose names are printed on the accompanying form of proxy. A shareholder who wishes to appoint some other person to represent him or her at the Meeting may do so either by inserting such other person’s name in the blank space provided in the form of proxy and signing the form of proxy or by completing and signing another proper form of proxy. A shareholder who has given a proxy may revoke it, as to any motion on which a vote has not already been cast pursuant to the authority conferred by it, by an instrument in writing executed by the shareholder or by the shareholder’s attorney authorized in writing or, if the shareholder is a corporation, under its corporate seal or by an officer or attorney thereof duly authorized. The revocation of a proxy, in order to be acted upon, must be deposited with [name, attention: Proxy Department, address] prior to 5:00 p.m. on the last business day immediately preceding the Meeting or with the CEO of the Corporation before the commencement of the Meeting or at any adjournment thereof. Exercise of Discretion by Proxies Shares represented by properly executed proxies in favour of the persons designated in the enclosed form of proxy, in the absence of any direction to the contrary, will be voted for: (i) the election of directors; and (ii) the appointment of auditors. Instructions with respect to voting will be respected by the persons designated in the enclosed form of proxy. With respect to amendments or variations to matters identified in the Notice of Meeting and with respect to other matters that may properly come before the Meeting, such shares will be voted by the persons so designated in their discretion. At the time of printing this Management Proxy Circular, management of the Corporation knows of no such amendments, variations or other matters.

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Voting Shares [list issued and outstanding common shares] Pursuant to the Business Corporations Act, the Corporation is required to prepare, no later than ten days after the Record Date, an alphabetical list of shareholders entitled to vote as of the Record Date that shows the number of shares held by each shareholder. A shareholder whose name appears on the list referred to above is entitled to vote the shares shown opposite his or her name at the Meeting unless that shareholder has transferred any shares after the Record Date, the transferee of those shares establishes that the transferee owns the shares and the transferee demands, not later than ten days before the Meeting, that the transferee’s name be included in the list before the Meeting. In such circumstances the transferee is entitled to vote those shares at the Meeting. Non-Registered Shareholders Only registered shareholders or the persons they appoint as their proxies are permitted to vote at the Meeting. However, in many cases, shares beneficially owned by a person (a “Non-Registered Holder”) are registered either: (i) in the name of an intermediary (an “Intermediary”) that the Non-Registered Holder deals with in respect of the common shares, such as securities dealers or brokers, banks, trust companies, and trustees or administrators of self-administered RRSPs, RRIFs, RESPs and similar plans; or (ii) in the name of a clearing agency of which the Intermediary is a participant. In accordance with National Instrument 54-101 of the Canadian Securities Administrators, entitled Communication with Beneficial Owners of Securities of a Reporting Issuer, the Corporation has distributed copies of the Notice of Meeting and this Management Proxy Circular (collectively, the “Meeting Materials”) to the clearing agencies and Intermediaries for distribution to Non-Registered Holders. Intermediaries are required to forward the Meeting Materials to Non-Registered Holders, and often use a service company for this purpose. Non-Registered Holders will either: (a) typically, be provided with a computerized form (often called a “voting instruction form”), which is not signed by the Intermediary, and that, when properly completed and signed by the Non-Registered Holder and returned to the Intermediary or its service company, will constitute voting instructions that the Intermediary must follow. … In certain cases, the Non-Registered Holder may provide such voting instructions to the Intermediary or its service company through the Internet or through a toll-free telephone number … . Should a Non-Registered Holder who receives a proxy form wish to vote at the Meeting in person (or have another person attend and vote on behalf of the NonRegistered Holder), the Non-Registered Holder should strike out the names of the persons set out in the proxy form and insert the name of the Non-Registered Holder or such other person in the blank space provided and submit it to [name] at the address set out above. •  •  •

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Principal Shareholders As at [date], to the best knowledge of the Corporation, no person beneficially owned, directly or indirectly, or exercised control or direction over, more than 10 percent of the common shares of the Corporation. Election of Directors The Board currently consists of [number] directors. The persons named in the enclosed form of proxy intend to vote for the election of the nominees whose names are set forth below. Each director will hold office until the next annual meeting of shareholders or until the election of his or her successor, unless he or she resigns or his or her office becomes vacant by removal, death, or other cause. [list of directors proposed, shareholders, information on their role] Remuneration of Directors and Officers Executive Compensation [particulars]; Option Exercises in Last Fiscal Year and Fiscal Year End Option Value [particulars]; Remuneration of Directors [particulars]. Indebtedness of Directors and Officers None of the officers or directors of the Corporation nor any of their associates is or has been indebted to the Corporation. Appointment of Auditors In accordance with Multilateral Instrument 52-110—Audit Committees, the audit committee of the board of directors of the Corporation has recommended to the board of directors that [name] be nominated as the auditor of the Corporation. Interest of Informed Persons in Material Transactions No “informed person” of the Corporation, that is: (a) the directors and executive officers of the Corporation; (b) any person who beneficially owns, directly or indirectly, or exercises control or direction over more than 10 percent of the Corporation’s outstanding voting shares; (c) any director or executive officer of a person referred to in (b) above; or (d) any associate or affiliate of any “informed person” of the Corporation, has any material interest, direct or indirect, in any transaction since [date the Corporation was incorporated] or in any proposed transaction that has materially affected or would materially affect the Corporation. Corporate Governance National Policy 58-201—Corporate Governance Guidelines and National Instrument 58-101—Disclosure of Corporate Governance Practices, which came into force on June 30, 2005, set out a series of guidelines for effective corporate governance. The guidelines address matters such as the composition and independence of corporate boards, the functions to be performed by boards and their committees, and the effectiveness and

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education of board members. Each reporting issuer, such as the Corporation, must disclose on an annual basis and in prescribed form, the corporate governance practices that it has adopted. The following is the Corporation’s required annual disclosure of its corporate governance practices: [listed here] Other Matters Management of the Corporation knows of no other matter to come before the Meeting other than those referred to in the Notice of Meeting. However, if any other matters that are not known to the management should properly come before the Meeting, the accompanying form of proxy confers discretionary authority on the persons named therein to vote on such matters in accordance with their best judgment. Shareholder Proposals The Business Corporations Act provides, in effect, that a registered holder or beneficial owner of shares who is entitled to vote at an annual meeting of the Corporation may submit to the Corporation notice of any matter that the person proposes to raise at the meeting (referred to as a “Proposal”) and discuss at the meeting any matter in respect of which the person would have been entitled to submit a Proposal. The Business Corporations Act further provides, in effect, that the Corporation must set out the Proposal in its management proxy circular along with, if so requested by the person who makes the Proposal, a statement in support of the Proposal by such person. However, the Corporation will not be required to set out the Proposal in its management proxy circular or include a supporting statement if, among other things, the Proposal is not submitted to the Corporation at least 60 days before the anniversary date of the last annual meeting of the Corporation or at least 60 days prior to the Meeting. As the Meeting is scheduled for [date], the deadline for submitting a proposal to the Corporation in connection with the Meeting was [date]. The foregoing is a summary only; shareholders should carefully review the provisions of the Business Corporations Act relating to Proposals and consult with a legal advisor. Additional Information Financial information about the Corporation is contained in its audited financial statements and Management’s Discussion and Analysis for the fiscal year ended [date] and in its unaudited interim financial statements dated [date]. Additional information about the Corporation is available on SEDAR at www.sedar.com. If you would like to obtain, at no cost to you, a copy of any of the following documents: (a) the audited financial statements of the Corporation for the fiscal year ended [date], together with the accompanying report of the auditors thereon and any interim financial statements of the Corporation and Management’s Discussion and Analysis with respect thereto; and (b) this Proxy Circular, please send your request to: [name, address]. Authorization The contents and the mailing of this Management Proxy Circular have been approved by the Board of Directors of the Corporation. [date, place, signed by CEO]

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The following excerpt illustrates the importance of disclosure when shareholders are seeking governance change through the proxy solicitation process.

Genesis Land Development Corp v Smoothwater Capital Corporation 2013 ABQB 509 ROMAINE J:

[1]  Genesis Land Development Corp. applied for an order disentitling the Respondents from voting their shares at the Genesis Annual General Meeting on the basis that they had failed to disclose to the market their common intentions to gain control of the Genesis board of directors. [2]  Following an oral hearing on August 15, 2013, I found that the Respondents were acting jointly and in concert with the objective of replacing the existing Board of Genesis with a slate of directors of their own choosing, and that they had failed to properly disclose that fact to the market, as they were required to do under securities law and regulation. I postponed Genesis’ Annual General Meeting for one month in order that proper disclosure could be made and proxy solicitation could take place in the context of full disclosure. [3]  I indicated to counsel that a written judgment would follow with reasons for my decision. These are my reasons. Issues [4]  In this judgment, I consider the following issues:

1. If the Respondents were acting “jointly or in concert” within the meaning of that phrase under securities law and regulation, did they have a duty to disclose that fact? 2. Were the Respondents, or any of them, acting jointly or in concert? 3. If so, have the Respondents adequately disclosed their status as joint actors? 4. If not, what is an appropriate remedy for this failure of disclosure? Analysis 1.  If the Respondents Were Acting “Jointly or in Concert” Within the Meaning of That Phrase Under Securities Law and Regulation, Did They Have a Duty to Disclose That Fact? [5]  The Respondents submitted that the term “jointly or in concert” is a term of art under securities law and regulation that is only relevant in the context of take-over bids. Since no one has made a take-over bid for Genesis, they argued, the question of whether any of the Respondents were acting jointly or in concert does not arise as a matter of fact or law. The Respondents submitted that Genesis, in its arguments, deliberately conflated the take-over bid and proxy solicitation regimes. They further argued that relief under section 180 of the Alberta Securities Act, RSA 2000, c S-4 is only available

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where the Court is satisfied that requirements relating to take-over bids have not been complied with. [6]  It is correct that the Multilateral Instrument, Take-Over Bids and Issuer Bids, ASC MI 62-104 (1 February 2008) (“MI 62-104”) largely deals with take-over and issuer bids. However, Part 5 of MI 62-104, entitled Reports and Announcements of Acquisitions, specifically applies to persons who acquire shares other than by way of a take-over bid or an issuer bid, and mandates early warning disclosure if an acquiror, as defined in section 5.1(a) of MI 62-104, acquires beneficial ownership of, or control or direction over, securities of a reporting issuer that would constitute 10% or more of the outstanding securities of a class. [7]  Pursuant to section 5.2(1) of MI 62-104, such an acquiror must issue and file a news release promptly and, within two business days, file a report containing the information required by section 3.1 of The Early Warning System and Related Take-Over Bid and Insider Reporting Issues, ASC NI 62-103 (30 April 2010) (“NI 62-103”). •  •  •

[19]  Thus, despite some ambiguity arising from the use of the term “offeror” in section 1.9, the early warning requirements under MI 62-104 must be interpreted to require disclosure of persons acting jointly or in concert with an acquiror if there is any “agreement, commitment or understanding” to exercise voting rights. [20]  It is next necessary to review the requirements of NI 62-103. It is noteworthy that the definition of “acting jointly or in concert” under this instrument refers to the meaning ascribed to that phrase “in securities legislation,” rather than specifically to section 1.9, implying a more general use of the term. The form for disclosure, Appendix E, makes a number of references to a “joint actor,” which is defined as “another entity acting jointly or in concert with the entity in connection with the ownership of, or control over, the security.” [21]  Appendix E sets out required disclosure, including “the general nature and material terms of any agreement … with respect to securities of the reporting issuer entered into by … any joint actor … or any other entity … including agreements with respect to … voting of any of the securities”: para 1(g). Also required are “the names of any joint actors in connection with the disclosure required by this Appendix”: para 1(h). •  •  •

[23]  In conclusion, I found that if the Respondents, or any of them, were acting jointly or in concert, they should have disclosed that fact in early warning press releases and reports. 2.  Were the Respondents, or Any of Them, Acting Jointly or in Concert? [24]  It is a question of fact as to whether the Respondents, or any of them, were acting jointly or in concert: Sterling Centrecorp Inc (Re) (2007), 30 OSCB 6683 (OSC) at para 97. The joint acting can be as a result of an agreement, a commitment or an understanding, and need not be by way of a formal or written agreement. The burden was on Genesis to establish that the Respondents were joint actors on the basis of “clear cogent evidence, not ambiguous or speculative evidence; however, reasonable inferences can always properly be drawn from evidence”: Sterling Centrecorp at para 116.

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[25]  Circumstantial evidence, such as family relationships, communication between the parties and attendance at meetings together, can be taken into account in determining whether the parties were making a concerted effort to bring about a specified objective: Re Kusumoto, 2007 ABASC 40 (ASC) at para 6. •  •  •

[52]  I found that the Respondents Liberty and Mr. Nordholm were acting jointly and in concert with Smoothwater and Garfield Mitchell to achieve the objective of replacing the existing board of directors with a slate of directors of their own choosing from July 8, 2013 forward. While there are indications that these parties may have been joint actors earlier than that, perhaps as early as February, 2013, the evidence falls short of establishing on a balance of probabilities that the Respondents were acting jointly or in concert prior to the July 8, 2013 date. As was the case in Drilcorp Energy Ltd v Knutson (March 24, 2005), Calgary 0501-02360 (ABQB) (unreported), communications during this period were susceptible of a number of interpretations and it is only speculative that an agreement or understanding to achieve a planned result had been reached during this earlier period. It is clear, however, that these Respondents were joint actors from July 8, 2013 forward from their participation in the conference call of that date and other calls, from Liberty providing a draft of the dissident proxy circular to Smoothwater, and, ultimately, from their participation in the formal voting support agreement of July 26, 2013. [53]  Mark Mitchell’s position is less clear. His conduct prior to July 8, 2013 is certainly susceptible to a number of interpretations, and he has given a plausible explanation for his share acquisitions in early 2013. However, despite his protestations, disclosing confidential committee proceedings to the other Respondents during the conference call of July 8, 2013 and participating in that conference call in the presence of proxy solicitation experts are not neutral acts. I must conclude that, even if he entered into no formal agreements with the other Respondents, there was an understanding from that point on that he would support their proposed new slate of directors by exercising his votes in their favour, and that he was a joint actor with the other Respondents in acting to achieve the objective of replacing the existing board. [54]  In summary, I found that Genesis had satisfied its burden of establishing that the Respondents were joint actors in a plan to replace the existing board of directors with a slate of their own nominees from July 8, 2013. While the individuals proposed in the slate may have varied from time to time, the common plan to replace the existing board did not. 3.  Have the Respondents Adequately Disclosed Their Status as Joint Actors? •  •  •

[62]  In the circumstances, the combination of disclosure in the July 26, 2013 Early Warning Reports filed by Garfield Mitchell and Smoothwater, and the Smoothwater Dissident Proxy Circular did not adequately disclose that the Respondents were acting jointly or in concert. Looking at the whole of what had been disclosed and alleged publicly, Genesis shareholders were left without a clear resolution of the issue. [63]  The Respondents submitted that better disclosure would make no difference to shareholders in deciding which slate of directors to accept. I could not decide that with

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any certainty. Shareholders may vote for directors on the basis of a number of factors, including credentials, experience and, I suggest, character. [64]  As the 2013 Notice suggests, market participants may be concerned about who has the ability to vote significant blocks of securities, as this can affect the outcome of control transactions, the constitution of the issuer’s board of directors and the approval of significant proposals or transactions. This Court cannot prejudge what difference proper disclosure would have made. 4.  What Is an Appropriate Remedy for This Failure of Disclosure? [65]  As a preliminary issue with respect to remedy, the Respondents submitted that an order under section 180 of the Alberta Securities Act is only available to restrain or remedy a breach of that Act and MI 62-104 relating to take-over bids. This submission followed from its submission that MI 62-104 only had relevance in the context of take-over bids. [66]  I found that MI 62-104 deals not only with take-over bids, but also early warning disclosure in the absence of a take-over bid. A breach or non-compliance with that instrument, falling as it does within the definition of “regulations” as referred to in section 180, can thus be the subject of a remedial order under this section. [67]  Genesis sought an order prohibiting the Respondents from exercising any or all of the voting rights attached to any Genesis securities at the upcoming Annual General Meeting, and a further order disqualifying any proxies that had been provided to Smoothwater pursuant to the Smoothwater Dissident Proxy Circular. [68]  Alternatively, Genesis proposed that: (a) the Respondents not be permitted to reduce the number of directors to be elected at the Annual General Meeting and not be permitted to nominate any directors for election at the upcoming Annual General Meeting, and that any directors proposed by the Respondents in the Smoothwater Dissident Proxy Circular not be available for nomination or election unless they have been also been nominated by management; (b) the Respondents be required to disclose to the market that they are, and have been, acting jointly or in concert by the filing of appropriate early earning reports, and (c) the Respondents not be permitted to requisition a shareholders’ meeting or file a further dissident proxy circular in respect of Genesis for a period of 120 days. [69]  As noted by Morawetz J. in Echo Energy Canada Inc v Challenge Gas Holding AB (2008), 94 OR (3d) 254 (SCJ) at para 88, “[a] shareholder’s right to vote is both a necessary and fundamental right in corporate democracy.” While section 180 affords this Court a wide discretion in fashioning an appropriate remedy where there has been non-compliance with securities regulation, “the surgery should be done with a scalpel, and not a battle axe”: 820099 Ontario Inc v Harold E Ballard Ltd (1992), 3 BLR (2d) 113 (Ont SCJ). [70]  In the circumstances of this case, even the alternate remedy suggested by Genesis would result in at least a temporary disenfranchisement of shareholders. The remedy should be less drastic. It should serve to ensure that shareholders would be in the same

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position with respect to information as they would have been had proper and full disclosure been made, and that they be allowed sufficient time to adjust their decisions on proxies if necessary. [71]  I directed that the Annual General Meeting should be postponed and the result of this hearing should be made public for the benefit of shareholders. While I agreed that the period of time that the meeting should be delayed should be roughly consistent with the period of time that would have been available to the market had proper disclosure been made, the timing issues relating to the early warning disclosure reports and the commencement of the Respondents acting jointly and in concert made that determination difficult. [72]  Ultimately, I directed that the meeting be postponed for one month. Details of how the disclosure record should be corrected and how the proxy solicitation rules should be amended were left to counsel, with leave to make further submissions if necessary. NOTES AND QUESTIONS

1.  The purpose of the management proxy circular is to give shareholders sufficient information to determine whether they wish the proxy service designated by the corporation to exercise their proxy, or whether they wish another individual to exercise it. In your view, does the proxy form accomplish this objective? 2.  The court in Genesis Land Development Corp v Smoothwater Capital Corporation makes clear that shareholders can attempt to control the board of a company through the exercise of their voting rights; why do you think disclosure is such an integral part of the process?

E.  Compliance with More Than One Set of Proxy Solicitation Rules Currently, all securities legislation includes mandatory proxy solicitation provisions.101 Canadian securities law requires that management must solicit proxies in order that investors are advised of their ability to participate and are given the opportunity to exercise their proxy rights. Previously there was overlap between requirements under securities law and corporations law, and there were provisions to address that overlap, but those provisions have now been repealed. Securities regulators have also promulgated a national instrument setting out the obligations of the corporation in terms of continuous disclosure obligations. NI 51-102 Continuous Disclosure Obligations is, in part, aimed at bringing transparency and continuity to the proxy provisions of securities laws.102 Many Canadian public corporations have a class of securities traded in US markets. Such corporations must comply with the proxy rules under the Securities Exchange Act of 1934, at least if they solicit US resident shareholders, already ordinarily required, since management of a CBCA corporation must solicit proxies from all holders of voting shares.103 Compliance with the US proxy rules is, if anything, more onerous than compliance with the CBCA.

01 See e.g. OSA s 85. 1 102 (2002) 25 OSCB 3718 (in force 30 March 2004), as amended 17 November 2015. 103 CBCA ss 135(1) and 149(1).

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Corporations may seek advance rulings from the US Securities and Exchange Commission (SEC) regarding compliance with US and Canadian rules where they appear to conflict. These rulings can be helpful, but in some cases the SEC is unwilling to give rulings where the Canadian regulatory requirements are principles-based only and the US requirements are highly specific.

F.  Restrictions on Soliciting Proxies and Exceptions to Allow for Shareholder Communication Proxy solicitation provisions in corporation statutes and securities legislation in Canada contain broad definitions of “solicitation,” which can have significant implications for the potential for the expression of dissident shareholder views. Solicitation can evoke extensive costs for shareholders;104 however, amendments to corporate law statutes in the late 1990s reduced constraints on shareholder communication and opened up the ability of shareholders to communicate without being in violation of solicitation rules: see CBCA s 147. In addition to management’s obligations under corporate and securities statutes to issue and disseminate proxy circulars, security-holders may wish to communicate with one another in order to influence the governance of the issuer or to influence the outcome of a particular issue or proposed vote. Hence, security-holders can also solicit proxies, and the rules governing their solicitation are highly codified. Unlike management, which issues the circular at the expense of the company, proxy solicitation undertaken by security-holders can be costly. The definition of what constitutes a proxy solicitation has been highly contested over the years, because some shareholder communication was found to be a proxy solicitation within the meaning of corporate or securities legislation, triggering costly dissident proxy solicitation requirements. Legislative amendments effective 2001, however, opened up the process by allowing increased communication among security-holders without activating the proxy solicitation requirements.105 The CBCA amendments were aimed at increasing the ability of shareholders to participate in shareholders’ meetings and exercise their voice through more active engagement in voting. The principal amendments were aimed at enhanced shareholder participation, including permitting corporations to have online electronic shareholders’ meetings and electronic voting through the use of new technologies, new provisions for shareholder proposals, and revised proxy rules meant to facilitate shareholder communication.106 While these amendments are important for shareholder democracy, the reality is that it is institutional investors, such as mutual funds and pension funds, that have the resources to monitor and actively challenge governance decisions. The following excerpt explains the significance of the amendments for proxy provision.

04 Brown v Duby (1980), 28 OR (2d) 745, 111 DLR (3d) 418, 11 BLR 129 (H Ct J). 1 105 Canada Business Corporations Regulations, 2001, SOR/2001-512, online: . 106 CBCA s 150.

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Janis Sarra, “The Corporation as Symphony: Are Shareholders First Violin or Second Fiddle?” (2003) 36 UBC L Rev 403 The most recent amendments to the CBCA were aimed at removing impediments to shareholder communication and thus promoting shareholder activism and accountability. Prior to 2001, most forms of communication to a shareholder could be deemed to be a solicitation (CBCA, s.  147(c), [RSC 1985, c.  C-44], prior to the 2001 amendments). Solicitation was defined to include: “the sending of a form of proxy or other communication to a shareholder under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy,” a provision now repealed. Any solicitation required a dissident proxy circular to be issued and circulated to all shareholders, an extremely expensive and time consuming process. Solicitation has now been redefined to allow broader communication without triggering dissident proxy requirements under the CBCA, including a public announcement by a shareholder of how the shareholder intends to vote and the reasons for that decision, or a communication for the purposes of obtaining the number of shares required for a shareholder proposal. CBCA, ibid., s. 147. The Regulations further codify solicitation, specifying that solicitation does not include a public announcement that is made by a speech in a public forum; or a press release, an opinion, a statement or an advertisement provided through a broadcast medium or by a telephonic, electronic or other communication facility, or appearing in a newspaper, a magazine or other publication generally available to the public (s. 67, Regulations). A person may now solicit proxies without sending a dissident’s proxy circular, if the total number of shareholders whose proxies are solicited is fifteen or fewer. There is a further exception for solicitation by “public broadcast,” where a person may solicit proxies without sending a dissident’s proxy circular if the solicitation is conveyed by public broadcast, speech or publication (s. 150(1.1), (1.2)). The new communication provisions will allow shareholders who were previously distanced by proxy solicitation prohibitions to communicate and build support for particular governance strategies. The proxy requirements of corporate and securities statutes frequently overlap, often with express statutory language specifying that compliance with the proxy requirements of one is deemed compliance with the other.

G.  Objecting Beneficial Owners and Non-Objecting Beneficial Owners As noted in the introduction to this chapter, most securities holders today are beneficial, as opposed to registered, security-holders. With the increase in volume of share trading and the use of electronic trading, the shares are held by intermediaries who are the registered shareholders, and the individuals purchasing the shares are called “beneficial” shareholders as opposed to registered shareholders. Only registered shareholders or the persons they appoint as their proxies are permitted to vote at a shareholders’ meeting. In many cases, shares beneficially owned by a person are registered in the name of an intermediary, such as a securities dealer or broker, or in the name of a clearing agency of which the intermediary is a participant. Under securities regulatory requirements, however, the notice of meeting and management proxy circulars must be sent by intermediaries for distribution to

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beneficial (non-registered) shareholders where those shareholders have indicated that they wish to receive such materials. Continuous disclosure obligations under NI 54-101 Communication with Beneficial Owners of Securities of a Reporting Issuer107 are aimed at enhancing access to information for beneficial security-holders by improving the procedures for delivery of proxy-related information to them. Regulators distinguish between those beneficial owners who wish to remain anonymous, called objecting beneficial owners (OBOs), and those who have no objection to having their names disclosed and are interested in receiving information and exercising some rights to participate, called non-objecting beneficial owners (NOBOs). OBOs and NOBOs are defined in Part 1.1 of NI 54-101 Communication with Beneficial Owners of Securities of a Reporting Issuer, as amended 8 February 2013, online: Ontario Securities Commission . NI 54-101 encourages participation of non-registered beneficial owners in the proxy process and is aimed at remedying previous problems associated with beneficial owners trying to use the proxy process. Look again at the management proxy circular discussed above. The beneficial holder who wishes to submit a proxy must properly complete the proxy form and submit it to the intermediary or specified proxy service. The purpose of these procedures is to permit beneficial shareholders to direct the voting of the common shares that they beneficially own. Should a beneficial shareholder who receives a proxy form wish to vote at a meeting in person, or have a designee vote on his or her behalf, he or she must strike out the names of the persons set out in the proxy form and insert his or her name or that of the designee and return it to the intermediary or its service company. A beneficial shareholder may revoke voting instructions that have been given to an intermediary at any time by written notice. The obligation of intermediaries under NI 54-101 to provide reporting issuers with NOBO lists upon request creates transparency in the beneficial ownership of the issuer, and also permits reporting issuers to communicate directly with their non-objecting beneficial shareholders. The direct communication afforded by the instrument is a fundamental change from National Policy 41 Shareholder Communication,108 now rescinded, and represents a marked improvement in the shareholder communication process. Stuart Morrow discusses the challenges for beneficial security-holders trying to exercise their rights to participate in governance of the corporation.

Stuart Morrow, “Proxy Contests and Shareholder Meetings” (2003) 36 UBC L Rev 483 at 484 Fundamental to the exercise of shareholder rights under both corporate and securities legislation is that those rights are only exercisable by or on behalf of registered shareholders. [An issuer is] only bound to recognize as its shareholders those persons recorded on its share register or who either derive their rights from the registered shareholder (i.e. 07 (2003) 26 OSCB 2641, as amended 8 February 2013. 1 108 (2002) 25 OSCB 3361, rescinded effective 30 June 2002.

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those who can establish the chain of title, or “connect the dots” so to speak, from the registered shareholder to the beneficial shareholder) or who can demonstrate an entitlement to have their names entered on the share register. NI 54-101 not only facilitates the delivery of proxy-related materials to beneficial shareholders, but it also allows for issuers to send materials directly to NOBOs, thereby according beneficial shareholders similar recognition as their registered counterparts. The distinction between registered and beneficial shareholders has subtle implications. The case of Fama Holdings Ltd. v. Powertech Industries Inc., [1997] BCJ no. 994 (CA) provides a good illustration of the confusion that can arise in the administration of proxies voted through the book-based system. A brokerage firm held about 2.2 million shares of the subject company’s stock, some 300,000 of which it held directly as a registered shareholder and the balance being held by it by two depository companies in which it participated. The brokerage purported to vote substantially all the shares held by it for client accounts on the basis of the two omnibus proxies provided by the depository corporations, having neglected that part of the shares to be voted were in registered form. The proxies submitted by it were held to be valid as it was able to establish that it had not voted more shares than it was entitled to vote directly (the registered shares) or by proxy at the meeting. A common misconception is that a beneficial shareholder who has himself [herself] appointed as his [her] own proxyholder, by filling in his [her] own name in lieu of management’s nominee on the form of proxy, will be put in the same position as a registered holder at the meeting. In most circumstances, that may work out to be the case, provided the form of proxy contains a grant of discretionary authority to deal with other business at the meeting (a right that is not statutorily required to be granted in a solicited proxy), and has not otherwise been completed such that the proxyholder will be bound on how to vote at the meeting. The proxyholder has no choice but to execute the instructions completed on the proxy and to be bound by any other restrictions contained in the form of proxy. A registered holder has discretion to decide how to vote right up to the time the question is put to the meeting—the beneficial shareholder, acting as his own proxyholder, may not have the same freedom if there are voting restrictions on his proxy. NI 54-101 also specifies limits to the use of the NOBO list.

National Instrument 54-101, Communication with Beneficial Owners of Securities of a Reporting Issuer (2003) 26 OSCB 2641, as amended 8 February 2013 PART 7  Use of NOBO List and Indirect Sending of Materials 7.1  Use of NOBO List (1)  A reporting issuer may use a NOBO list, or a report prepared under section 5.3 relating to the reporting issuer and obtained under this Instrument, in connection with any matter relating to the affairs of the reporting issuer.

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(2)  A person or company that is not the reporting issuer must not use a NOBO list, or a report prepared under section 5.3 relating to the reporting issuer and obtained under this Instrument, in any manner other than any of the following: (a)  for sending securityholder materials directly to NOBOs in accordance with this Instrument; (b)  in respect of an effort to influence the voting of securityholders of the reporting issuer; (c)  in respect of an offer to acquire securities of the reporting issuer. 7.2  Sending of Materials (1) A reporting issuer may send securityholder materials indirectly to beneficial owners of securities of the reporting issuer using the procedures in section 2.12, or directly to NOBOs of the reporting issuer using a NOBO list, in connection with any matter relating to the affairs of the reporting issuer. (2)  A person or company that is not the reporting issuer may send securityholder materials indirectly to beneficial owners of securities of the reporting issuer using the procedures in section 2.12, or directly to NOBOs of the reporting issuer using a NOBO list, only in connection with one or both of the following: (a)  an effort to influence the voting of securityholders of the reporting issuer; (b)  an offer to acquire securities of the reporting issuer. Canadian legislation specifically provides for the revocability of proxies through the deposit of the appropriate instrument in writing at the issuer’s offices or as otherwise permitted by law. For example, OBCA s 110(4) specifies that a shareholder may revoke a proxy by depositing an instrument in writing that is signed by the shareholder or by an attorney who is authorized by a document that is signed in writing or by electronic signature; by transmitting, by telephonic or electronic means, a revocation that is signed by electronic signature; or in any other manner permitted by law. The revocation must meet certain requirements in terms of form. The courts have the power to rectify errors in proxy-related decisions.

H.  The Adequacy of Disclosure and Materiality Standards When a corporation solicits proxies for a shareholders’ meeting, it must comply with statutory disclosure standards. First, it must give shareholders sufficient information of “special business” to permit a reasoned judgment to be formed.109 All business transacted at a special meeting of shareholders and all business transacted at an annual meeting, except consideration of the financial statements, auditor’s report, election of directors, and reappointment of the auditor, is deemed to be “special business.”110

09 CBCA s 135(6), ABCA s 134(7), and OBCA s 96(6). 1 110 CBCA ss 135(5) and (6); ABCA s 134(6); OBCA s 96(5); and BC Business Corporations Regulation, 211/2015, as amended 28 November 2016, s 7.4 and Part 8.

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Second, a similar materiality requirement is imposed on management when it solicits proxies, with the CBCA Regulations111 now referring to the requirements under Form 51-102F5 (Information Circular)112 Form 51-102F5 specifies: 14.1  If action is to be taken on any matter to be submitted to the meeting of securityholders other than the approval of annual financial statements, briefly describe the substance of the matter, or related groups of matters, except to the extent described under the foregoing items, in sufficient detail to enable reasonable securityholders to form a reasoned judgment concerning the matter. Without limiting the generality of the foregoing, such matters include alterations of share capital, charter amendments, property acquisitions or dispositions, reverse takeovers, amalgamations, mergers, arrangements or reorganizations and other similar transactions.

Form 51-102F2 Annual Information Report113 offers further guidance on materiality, specifying: “Would a reasonable investor’s decision whether or not to buy, sell or hold securities in your company likely be influenced or changed if the information in question was omitted or misstated? If so, the information is likely material.”114 Even prior to statutory disclosure requirements, courts sought to ensure that adequate disclosure was provided to shareholders by nullifying the effects of a shareholders’ meeting where inadequate disclosure had been made to them. The judicial principle of notice has now been codified, but the pre-statute decisions are still of interest with respect to the definition of materiality. In Pacific Coast Coal Mines Ltd v Arbuthnot, [1917] AC 607 (PC), there was a falling out between two groups of Pacific shareholders, each of whom held large blocks of shares. The group based in New York brought suit against the group based in British Columbia, which was in control of the corporation and against which allegations of serious breaches of fiduciary duty were made. In order to settle the litigation, the parties agreed that the BC group should retire from management and be given debentures in lieu of their shares. A shareholders’ meeting was called to approve the capital restructuring required to carry out the agreement, and approval by the requisite majority was secured. However, it was held that the shareholder approval was invalid, since the notice of the shareholders’ meeting failed to reveal that debentures were to be issued to the BC group, and that completion of the transaction would extinguish any claims of the corporation against the BC group for mismanagement. Viscount Haldane said at 618: Their Lordships are of opinion that to render the notice in compliance with the Act under which it was given, it ought to have told the shareholders, including those who gave proxies, more than it did. It ought to have put them in a position in which each of them could have judged for himself whether he would consent, not only to buying out the shares of directors, but to releasing possible claims against them. Now this is just what it did not do, and therefore, quite apart from the fact that the meeting was held in half an hour from the time the Act passed and before the shareholders could have had a proper opportunity of learning the particulars of what the

11 1 112 113 114

Canada Business Corporations Regulations, 2001 (SOR/2001-512), as amended 13 May 2016. As amended 30 June 2015. As amended 30 June 2015. Ibid, Part 1(e).

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legislature had authorized, their Lordships are of opinion that the notice was bad, and that what was done was consequently ultra vires.

A less rigorous standard of materiality was applied in Wotherspoon v Canadian Pacific Ltd (1982), 35 OR (2d) 449, 483-91 (CA), aff’d [1987] 1 SCR 952, 39 DLR (4th) 169. The plaintiff, a minority shareholder of the Ontario and Québec Railway Co (O  &  Q), sought to have the result of a shareholders’ meeting set aside on the ground of inadequacy of notice. Eighty percent of O & Q’s shares were owned by Canadian Pacific (CP), and the O & Q meeting had been called to secure shareholder approval of the sale of certain parcels of real estate by O & Q to a wholly owned subsidiary of CP (Marathon). The notice of meeting stated that the transaction price, $8.8  million, was “somewhat in excess” of the values of the properties according to appraisals done for O & Q. The gist of the complaint was that, while that was true, the lengthy appraisal reports were not provided to the O & Q shareholders. The O & Q shareholders were also not told that appraisals had been obtained for Marathon that were substantially higher than the O & Q appraisals. However, the Court of Appeal held that the disclosure was adequate on the basis that the price had been found to be fair by the trial court and that the appraisal reports were too voluminous to be sent to O & Q shareholders. This decision was affirmed by the Supreme Court. In Harris v Universal Explorations Ltd, immediately below, the Alberta Court of Appeal dealt with disclosure in the context of a meeting to vote on an amalgamation, finding that shareholders need to be given the controlling facts that enable them to come to a decision; and that an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. The Court held as follows:

Harris v Universal Explorations Ltd 1982 ABCA 87, 17 BLR 135 KERANS JA (for the court):

[7]  We now turn to the information circular before us. This circular proposes an amalgamation based on a share ratio of four shares in the new company for each share in Petrol, one of the amalgamated companies, and one share in the amalgamated company for each share in Universal, the other amalgamated company. The applicants (appellants here dissentient shareholders on the merger) are shareholders in Petrol. They rightly assert that they, and all shareholders in Petrol, have a right to be told all facts respecting which it might be said that there is a substantial likelihood that a reasonable Petrol shareholder would consider the fact important in deciding how to vote. Moreover, they had a right to be told accurately, or as this Court said in Norcan [Fogler v. Norcan Oils Ltd. (1964), 47 WWR 257, 43 DLR (2d) 508, reversed (sub nom. Norcan Oils Ltd. v. Fogler) [1965] SCR 36, 49 WWR 321, 46 DLR (2d) 630], “candidly.” •  •  •

[10]  The preliminary comment about the comparative analysis of the assets of the two companies begins with this statement: A comparative valuation of the net assets has been carried out using the following material:

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(i) an evaluation of Universal’s oil and gas reserves and undeveloped acreage prepared by D & S Petroleum Consultants (l974) Ltd. and dated July 1, 1981; (ii) an evaluation of Universal’s Jackson Lovett Hill Placer gold project prepared in February 1981 by Colt Engineering Corporation; (iii) an evaluation of Universal Gas (Montana) Inc.’s Monarch gold deposit prepared by Tetreau & Associates Ltd. and dated January 1, 1981; (iv) an evaluation of Petro[l]’s Canadian oil and gas reserves prepared by McDaniel & Associates Consultants Ltd. and dated December 31, 1980.

[11]  In our view, a fair reading of the information circular leads one inevitably to the conclusion that this statement was inserted to offer assurance to the shareholders that the values thereafter expressed had been fixed by independent experts. [12]  We are of the view that there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote whether the valuations had been fixed by independent experts in a case where, as here, a majority of the shares in Petrol were already owned by Universal and where the majority of the board of directors were common to both companies and where, therefore, it could be said that the transaction was not at arm’s length. [13]  Before the learned Chambers Judge, it became clear that the “evaluation” of Universal’s placer gold project prepared in February 1981 by Colt Engineering Corporation was in fact an analysis of the mining operation of Universal. Universal had started a project of placer mining of old gravel tailings in the Yukon. This project was analyzed by Colt. The general thrust of the report is an analysis from an operational point of view: it makes certain suggestions for improved operations and comments on the economic viability of the project. It in no way attempts to put a market value on the project, or settle or value the ore reserves. On the contrary, it recommends some effort be made to establish the reserves. In this context, there is appended a projection of future revenues based on an assumption as to future rises in the price of gold and other assumptions. The projected profit on these assumptions is then capitalized, that is, given a present value. This present value is inserted in the pro forma balance sheet of the amalgamated company as the value of the “project” for the purposes of the amalgamation. … [14]  In our view, the Colt report is not an independent and expert valuation of this asset. Indeed, when Colt discovered that its report had been used as a basis for an evaluation, they wrote a letter of protest. In our view, the fact that the Colt report was not an independent and expert attempt to value the property, and that any valuation contained therein was only incidental to its main purpose is a material fact having regard to the suggestion, implicit if not explicit in the information circular, that the report is something other than what it is. In our view, this information is the sort of information that a shareholder would consider important in deciding how to vote. In other words, we are not saying that it is necessary in an information circular to produce independent valuations. But, if it is sought to leave the impression with the shareholders that the figures used are based on valuations by independent experts, this must be true. •  •  •

[21]  … The correct test is not whether somebody in fact was misled but whether there is a substantial likelihood that someone was misled by the appellant.

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[22]  The misdescription of the support for the value might be excused as immaterial if the actual figures are demonstrably correct. But, here, the figures are open to serious attack. There are allegations of double counting which could result in errors of more than $5,000,000. There are other criticisms. We have not been satisfied that the figures supplied to the shareholders are necessarily correct, and we note that the learned Chambers Judge made no such finding. On the contrary, he sought to avoid the issue. [23]  He sought to avoid such a finding by going on to consider that, in any event, the proposal was a fair one and the Petrol shareholders would receive full value on an amalgamation because the 4:1 share ratio was generous and even if the property in question was treated as having no value at all the proposed share ratio would be fair. In our view, this is an error. The accuracy of the information circular is a threshold issue; one cannot validate an agreement in respect of which the voting shareholders might reasonably have been misled on a point where there was a substantial likelihood of their relying on the misinformation. Indeed, the very fact of some misdescription would be of significance to a shareholder as reflecting on the reliability of the whole proposal. [24]  Therefore, without passing on the question whether or not this was a fair offer, we are of the view that the information circular was in breach of the required duty and, therefore, the proposal cannot be approved. [25]  We accordingly set aside the decision of the learned Chambers Judge and make an order that the application is dismissed with costs here and in Chambers. … Appeal allowed. NOTES

After the Harris decision was rendered, a new meeting of Petrol shareholders was called. Again, the requisite majority approved the amalgamation, and again the court withheld approval. This time the notice of meeting was found to be inadequate because the balance sheets provided to the shareholders were out of date.115 The amalgamation was subsequently approved in November 1983.

I.  Express Statutory Remedy An express statutory remedy for non-disclosure in a proxy circular is provided by CBCA s 154(1), which permits an interested person to apply to court for a restraining order where a form of proxy or a management or dissident proxy circular “contains an untrue statement of a material fact or omits to state a material fact required therein or necessary to make a statement contained therein not misleading” in light of the circumstances in which it was made.116 On an application under s 154, “the court may make any order it thinks fit,” including an order restraining the solicitation, the holding of the meeting, or any person from implementing or acting on any resolution passed at the meeting to which the form of proxy,

15 Universal Explorations Ltd (Re) [1983] 1 WWR 542, 23 Alta LR (2d) 57 (CA). 1 116 See also ABCA s 154, BCBCA s 228, and OBCA s 253.

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X.  Proposals by Shareholders

management proxy circular, or dissident proxy circular relates; an order requiring correction of any form of proxy or proxy circular and a further solicitation; and an order adjourning the meeting. There are also requirements prohibiting material misstatements in securities legislation and instruments, with civil liability remedies, as discussed in Chapter 7. QUESTION

Do you think that the increased communication allowed between shareholders will enhance corporate accountability? Why or why not?

X.  PROPOSALS BY SHAREHOLDERS A. Eligibility Shareholders are entitled, in prescribed circumstances, to submit proposals for consideration at shareholders’ meetings.117 Management is obligated to give notice of such a proposal in its proxy soliciting materials and to include a brief statement in support of the proposal if a shareholder supplies such a statement. Management can include its views of the shareholder proposal in the document. The proposals, even if accepted by the majority of shareholders, are not binding on the directors. They may, however, be normatively persuasive, given that directors failing to act on a proposal that receives majority support of shareholders may leave themselves vulnerable to not being re-elected by shareholders. Access to management’s proxy circular can be very useful for shareholders with limited resources. If management refuses to include a shareholder proposal in its proxy soliciting materials, then the dispute will centre on the issue of whether the particular proposal is one that falls within the class of proposals that can be excluded.118 The main class of proposals that a corporation is not required to include under CBCA s 137(5) are those proposals that are primarily for the purpose of enforcing a personal claim or redressing a personal grievance against the corporation or its directors, officers, or security-holders. The corporation is also not required to include a proposal where it clearly appears that the proposal does not relate in a significant way to the business or affairs of the corporation, or where the proposal rights are being abused to secure publicity.119 Section 137 of the CBCA sets out who may make a proposal, what must be submitted, and the scope of proposal: Proposals 137(1)  Subject to subsections (1.1) and (1.2), a registered holder or beneficial owner of shares that are entitled to be voted at an annual meeting of shareholders may (a)  submit to the corporation notice of any matter that the person proposes to raise at the meeting (a “proposal”); and

117 CBCA s 137, ABCA s 136, BCBCA ss 187 and 188, OBCA s 99, and NSCA Regulation c 81, 3rd Schedule s 9(1)(a). 118 CBCA s 137(5), ABCA s 136(5), OBCA s 99(5), BCBCA s 189(5), and NSCA Regulation c 81, 3rd Schedule s 9(5). 119 CBCA ss 137(5), 137(5)(b.1), and 137(5)(e).

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(b)  discuss at the meeting any matter in respect of which the person would have been entitled to submit a proposal. Persons eligible to make proposals (1.1)  To be eligible to submit a proposal, a person (a)  must be, for at least the prescribed period, the registered holder or the beneficial owner of at least the prescribed number of outstanding shares of the corporation; or (b)  must have the support of persons who, in the aggregate, and including or not including the person that submits the proposal, have been, for at least the prescribed period, the registered holders, or the beneficial owners of, at least the prescribed number of outstanding shares of the corporation. Information to be provided (1.2)  A proposal submitted under paragraph (1)(a) must be accompanied by the following information: (a)  the name and address of the person and of the person’s supporters, if applicable; and (b)  the number of shares held or owned by the person and the person’s supporters, if applicable, and the date the shares were acquired. Information not part of proposal (1.3)  The information provided under subsection (1.2) does not form part of the proposal or of the supporting statement referred to in subsection (3) and is not included for the purposes of the prescribed maximum word limit set out in subsection (3). Proof may be required (1.4)  If requested by the corporation within the prescribed period, a person who submits a proposal must provide proof, within the prescribed period, that the person meets the requirements of subsection (1.1). Information circular (2)  A corporation that solicits proxies shall set out the proposal in the management proxy circular required by section 150 or attach the proposal thereto. Supporting statement (3)  If so requested by the person who submits a proposal, the corporation shall include in the management proxy circular or attach to it a statement in support of the proposal by the person and the name and address of the person. The statement and the proposal must together not exceed the prescribed maximum number of words. Nomination for director (4)  A proposal may include nominations for the election of directors if the proposal is signed by one or more holders of shares representing in the aggregate not less than five per cent of the shares or five per cent of the shares of a class of shares of the corporation entitled to vote at the meeting to which the proposal is to be presented, but this subsection does not preclude nominations made at a meeting of shareholders. Exemptions (5)  A corporation is not required to comply with subsections (2) and (3) if (a)  the proposal is not submitted to the corporation at least the prescribed number of days before the anniversary date of the notice of meeting that was sent to shareholders in connection with the previous annual meeting of shareholders; (b)  it clearly appears that the primary purpose of the proposal is to enforce a personal claim or redress a personal grievance against the corporation or its directors, officers or security holders; (b.1)  it clearly appears that the proposal does not relate in a significant way to the business or affairs of the corporation;

X.  Proposals by Shareholders

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(c)  not more than the prescribed period before the receipt of a proposal, a person failed to present, in person or by proxy, at a meeting of shareholders, a proposal that at the person’s request, had been included in a management proxy circular relating to the meeting; (d)  substantially the same proposal was submitted to shareholders in a management proxy circular or a dissident’s proxy circular relating to a meeting of shareholders held not more than the prescribed period before the receipt of the proposal and did not receive the prescribed minimum amount of support at the meeting; or (e)  the rights conferred by this section are being abused to secure publicity.

The persons eligible to make a proposal are prescribed in the CBCA Regulations, and require both a certain size of shareholding and that the shares have been held for a specific period. Part 6  Shareholder Proposals 46.  For the purpose of subsection 137(1.1) and paragraph 261(1)(c.1) of the Act, (a)  the prescribed number of shares is the number of voting shares (i)  that is equal to 1% of the total number of the outstanding voting shares of the corporation, as of the day on which the shareholder submits a proposal, or (ii)  whose fair market value, as determined at the close of business on the day before the shareholder submits the proposal to the corporation, is at least $2,000; and (b)  the prescribed period is the six-month period immediately before the day on which the shareholder submits the proposal. 47.  For the purpose of subsection 137(1.4) of the Act, (a)  a corporation may request that a shareholder provide the proof referred to in that subsection within 14 days after the corporation receives the shareholder’s proposal; and (b) the shareholder shall provide the proof within 21 days after the corporation’s request. 48.  For the purpose of subsection 137(3) of the Act, a proposal and a statement in support of it shall together consist of not more than 500 words. 49.  For the purpose of paragraph 137(5)(a) of the Act, the prescribed number of days for submitting a proposal to the corporation is at least 90 days before the anniversary date. 50.  For the purpose of paragraph 137(5)(c) of the Act, the prescribed period before the receipt of a proposal is two years. 51(1)  For the purpose of paragraph 137(5)(d) of the Act, the prescribed minimum amount of support for a shareholder’s proposal is (a)  3% of the total number of shares voted, if the proposal was introduced at an annual meeting of shareholders; (b)  6% of the total number of shares voted at its last submission to shareholders, if the proposal was introduced at two annual meetings of shareholders; and (c)  10% of the total number of shares voted at its last submission to shareholders, if the proposal was introduced at three or more annual meetings of shareholders. (2)  For the purpose of paragraph 137(5)(d) of the Act, the prescribed period is five years. 52.  For the purpose of subsection 137(5.1) of the Act, the prescribed period during which the corporation is not required to set out a proposal in a management proxy circular is two years. 53.  For the purpose of subsection 137(7) of the Act, the prescribed period for giving notice is 21 days after the receipt by the corporation of the proposal or of proof of ownership under subsection 137(1.4) of the Act, as the case may be.

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Chapter 12  Shareholder Participation in Corporate Governance QUESTIONS

1.  Why do you think there are restrictions on the size of shareholdings and the length of time that shares must be held before a shareholder can bring a proposal? 2.  Do these restrictions make sense or do they create an unnecessary barrier to shareholders’ participation?

B.  Scope of Proposals Has Been Broadened Under the previous language of corporations statutes, shareholders were prohibited from bringing proposals if they related to, or were primarily for the purpose of, promoting general economic, political, racial, religious, social, or similar causes. The courts frequently interpreted these provisions to exclude proposals, as illustrated in Varity Corp v Jesuit Fathers of Upper Canada, immediately below. During the apartheid years in South Africa, Varity Corporation in Canada applied to exclude a shareholder proposal that requested that the corporation take immediate steps to terminate Varity’s investments in South Africa and announce publicly to the South African government Varity’s plans to leave South Africa. The proposal noted support for disinvestment from South Africa by foreign enterprises in an effort to achieve a peaceful elimination of apartheid. The court rendered the following judgment.

Re Varity Corp and the Jesuit Fathers of Upper Canada (1987), 59 OR (2d) 459 (H Ct J), aff ’d (1987), 60 OR (2d) 640 (CA) AUSTIN J:  This is an application by Varity Corporation, formerly Massey-Ferguson, for an order permitting Varity not to include in its mailing to shareholders for the annual general meeting a proposal that the company end its investments in South Africa. The proposal is put forward by two shareholders, the Jesuit Fathers of Upper Canada and the Ursuline Religious of the Diocese of London in Ontario. Varity is a federal company. [Then] Section 131 of the Canada Business Corporations Act, 1974-75 (Can.), c. 33, applies and it provides that the shareholders may require the company to circulate proposals and supporting statements. There are exceptions based on shareholder status, timing and content. Varity admits that these shareholders have status, no issue was raised as to timing and the only objection raised involved the content of the proposal. The proposal reads as follows: WHEREAS the Commonwealth Eminent Persons Group concluded in June 1986 that the South African government was not prepared to negotiate the dismantling of apartheid, and that economic measures to compel change “may offer the last opportunity to avert what could be the worst bloodbath since the Second World War”; WHEREAS the South African Council of Churches, and the Confederation of South African Trade Unions (COSATU), as well as black leaders such as Bishop Desmond Tutu, now support the call for disinvestment by foreign enterprises from South Africa in an effort to achieve peaceful elimination of apartheid; WHEREAS many corporations have concluded that their social programs to improve the lives of blacks within and outside the workplace no longer justify the continued presence of

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X.  Proposals by Shareholders foreign investment within the persisting structure of apartheid; and the author of the US Sullivan Code of Conduct for companies in South Africa, the Rev. Leon Sullivan, has called for disinvestment if apartheid is not dismantled by May, 1987; •  •  •

THEREFORE BE IT RESOLVED that the shareholders ask the Board of Directors to: take

immediate steps to terminate Varity’s investments in South Africa; take immediate steps to terminate Varity’s license agreement with Atlantis Diesel Engines, and if there are legal obstacles, provide a report and a plan of action to the shareholders within ninety days; announce publicly to the South African government Varity’s plans to leave South Africa as soon as possible.

In support of that proposal is a “supporting statement” which reads as follows: Varity Corporation is among Canada’s largest transnational corporations. As a result of refinancing assistance to the company, the Government of Canada and the Government of Ontario are among its shareholders. Thus, the presence of Varity in South Africa is of particular significance, since it represents an investment by Canadian taxpayers in South Africa. We believe that a meaningful process of disinvestment involves the termination of all business which might provide support to the South African government, including sales and technology transfers. A meaningful process of disinvestment should also include the provision of full information to representatives of black workers, and consultation with them about the terms of withdrawal. In addition, in consultation with the workers and other anti-apartheid groups, the Company should establish, or continue, corporate financial contributions to projects for the enhancement of black welfare and in support of antiapartheid activities.

[Then] Section 131(5)(b) of the Act provides that a corporation is not required to comply with a shareholder’s request if (b)  it clearly appears that the proposal is submitted by the shareholder primarily for the purpose of enforcing a personal claim or redressing a personal grievance against the corporation or its directors, officers or security holders, or primarily for the purpose of promoting general economic, political, racial, religious, social or similar causes;

Varity applies for exemption from the mailing requirement upon the basis that the proposal has been submitted primarily for the purpose of promoting general economic, political, racial, religious, social or similar causes and in particular the abolition of apartheid in South Africa. The application was opposed by the Jesuit Fathers and the Ursuline Religious. … •  •  •

The language of the proposal and the supporting statement leave me in no doubt that the primary purpose of the proposal is the abolition of apartheid in South Africa. As I read the legislation, the fact that there may be a more specific purpose or target does not save the proposal. That more specific purpose here is the withdrawal of Varity. The legislation makes it clear that if the primary purpose is one of those listed, however commendable either the specific or the general purpose may be, the company cannot be compelled to pay for taking the first step towards achieving it. In other words, the company cannot be compelled to distribute the proposal.

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In my view, the applicant is entitled to the order asked for. It indicated at the outset that it would not ask for costs in any event so I make no order as to costs. Order accordingly. As noted above, the legislation was amended in 2001 to remove the restriction from the proposal provisions of the CBCA, as one of a number of measures aiming at increasing shareholder participation rights. The language “general economic, political, religious, social, or similar causes” was repealed, and the restrictions now focus on not allowing proposals where “it clearly appears that the primary purpose of the proposal is to enforce a personal claim or redress a personal grievance against the corporation or its directors, officers or security-holders” or where “it clearly appears that the proposal does not relate in a significant way to the business or affairs of the corporation.”120 The Shareholder Association for Research and Education (SHARE)121 documents increasing activism by shareholders in terms of both shareholder resolutions and opposition to management proposals. Although the level of success in Canada is limited, compared with the United States, it highlights a growing interest by shareholders. For example, at the 2015 annual meeting of Quebecor, 71.5 percent of Class B shareholders withheld their votes from a director nominated in election for the board, Mr Lavigne; in response, Mr Lavigne resigned, but the Quebecor board rejected the resignation and Mr Lavigne remains on Quebecor’s board. There were also shareholder proposals to conduct an independent human rights assessment of supply chain in the Western Sahara, at two Canadian fertilizer producers, Agrium Inc and Potash Corporation of Saskatchewan, which received 12 percent and 7 percent shareholder support respectively.122 Shareholders also filed resolutions at TransCanada Corporation and Enbridge Inc in 2015, which resulted in agreements by those companies to disclose political contributions, lobbying activity, memberships in trade associations that lobby, and corporate contributions to third-party organizations that conduct policy work. Both companies also agreed to adopt and disclose board-level oversight of political activity.123 As SHARE observes, these agreements help to set the bar for political activity disclosure in Canada. At Suncor’s 2016 annual general meeting, NEI Investments submitted for consideration the following shareholder proposal, which the Suncor board and management decided to support: Proposed Resolution Be it resolved that:

20 CBCA, ss 137(5)(b) and (b.1). 1 121 Shareholder Association for Research and Education [SHARE], Columbia Institute & Fonds de solidarité FTQ, “Voting for Value: Twenty Canadian Proxy votes that mattered in 2015” (Vancouver: 2016), online SHARE . 122 Ibid at 5. 123 SHARE, “Shareholder Proposal: Disclosure of Lobbying Expenditures,” online: SHARE .

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Suncor provide ongoing reporting on how it is assessing, and ensuring, long-term corporate resilience in a future low-carbon economy. Specifically, reporting could be stand-alone or integrated into current company reporting mechanisms and could address Suncor’s technology pipeline, emission reduction targets and performance, innovation and energy diversification strategies, provide a narrative on any stress-testing done against external low carbon scenarios (e.g. IEA’s 450 and 2ºC Scenarios), and other relevant strategies.124

Shareholders voted for this initiative by over 98 percent in favour.125 The success of this resolution may indicate that at least some corporations are becoming more open to the idea of investors suggesting how corporations can enhance their corporate governance practices. It is evident that when shareholders proposing resolutions can get management and the board of directors on side before the shareholder meeting, the likelihood of the resolution receiving strong support is greater. QUESTIONS

1.  Why do you think the board of Quebecor ignored the vote of the 71.5 percent of shareholders to not reappoint Lavigne to the board of directors? 2.  Should shareholder votes be binding on boards? Why or why not? 3.  Do you think shareholder resolutions are an effective means of shareholders influencing corporate governance? 4.  Consider the discussion of institutional investors above in Section VIII. Are issues such as climate change risk important for institutional investors to press for corporate boards to address, or is it better left to government policy? Should it be a combination of strategies?

XI.  THE ROLE OF REGULATORS IN CORPORATE GOVERNANCE Corporate law in Canada is viewed as largely enabling, with corporations statutes setting the framework for creation of corporations, director and officer oversight and control, shareholder rights, and winding-up and dissolution of corporations. Beyond setting the basic framework and rights and duties of various actors in the corporate structure, corporate governance has been left largely as an internal corporate matter. Increasingly, however, corporate governance is being regulated by securities regulators. Corporate law and securities law are no longer distinct areas of law, and there is an increasing amount of overlap. While much of the regulation is with respect to mandatory disclosure, the move by securities regulators into corporate governance as a means to advance investor protection goals raises important public policy questions regarding how this narrower conception of corporate governance fits into the broader policy discussion of the different theoretical conceptions of the corporation.

124 Suncor Energy Inc, “Management Proxy Circular: Notice of 2016 Annual General Meeting to be held on April 28 2016,” online: at A-1. 125 SHARE, “Sustainability Reporting,” online: SHARE .

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In recent years, particularly in the wake of US corporate failures such as Enron and WorldCom, and the failures of the global financial crisis in 2008 – 2010, US securities regulators have imposed a number of requirements aimed at enhancing governance practices. Many Canadian-based issuers are dependent on access to the larger US markets and thus they want to meet US requirements in order to provide investors with confidence in their governance and oversight activities. Given the move by US securities regulators to regulate corporate governance, Canadian regulators followed suit, although to a lesser extent. Regulatory and policy intervention in governance can be viewed as both investor-confidence and investor-participation measures, aimed at enhancing the efficiency and integrity of Canadian capital markets. Some of the regulatory intervention in Canada has provided greater certainty to shareholders with respect to their right to participate in voting. Given that there are often hundreds or thousands of shareholders of a corporation, most of whom cannot attend annual and special general meetings, corporate law and securities law provide a mechanism for them to exercise their voting power through signing a proxy that appoints another individual to vote on their behalf. The process by which these proxies are solicited and exercised is important, because shareholders require sufficient information to make informed choices with respect to proposed governance or capital structure changes. Consider whether the directives contained in various corporate law changes and securities regulatory requirements really empower shareholders and perform the accountability check that they are aimed at. There are disclosure requirements in respect of corporate governance, but not requirements for particular standards-of-governance best practice. With more direction may come greater certainty and predictability, but also increased cost, particularly with respect to meeting governance disclosure requirements. There is also the issue of whether greater direction facilitates or limits governance structures and activities. Consider whether regulators and legislators have struck the appropriate balance between mandatory and enabling governance provisions and the liability associated with failure to comply. The move by securities regulators into corporate governance is interesting, because there is no express statutory authority to do so. However, under the broad ambit of protection of investors, and as a result of regulatory changes in the United States and internationally, Canadian securities regulators have imposed numerous requirements. The objective of these requirements is to enhance the transparency of governance practices so that investors can make informed choices about their investments. There are remedies for failure to comply, particularly with the disclosure requirements, as discussed in Chapter 7. This change in external regulation of the corporation raises the question what are the appropriate roles of corporate law and securities law with respect to corporate governance.

Mary Condon, Anita Anand, Janis Sarra & Sarah Bradley, Securities Law in Canada, 3rd ed (Toronto: Emond, 2017) This move into the corporate governance market by Canadian securities regulators is somewhat contested. The issue of what appropriately belongs to corporate law and what is properly within the purview of securities regulation is not always clear. Although the relatively new governance requirements will likely ensure that there is greater transparency and protection for securityholders, it raises a fundamental question of whether

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regulators are improperly regulating what ought to be the domain of corporate law statutes and the courts that supervise their compliance. •  •  •

The CSA also published a national policy on corporate governance guidelines in 2005. The purpose of the policy is to provide guidance on corporate governance practices, taking account of the best practices at the time (National Policy 58-201NP, Corporate Governance Guidelines, effective 30 June 2005). Its express purpose was to provide guidance on corporate governance practices that had been formulated to achieve a balance between providing protection to investors and fostering fair and efficient capital markets and confidence in capital markets. It also sought to be sensitive to the realities of the greater numbers of small companies and controlled companies in the Canadian corporate landscape; and take account of the impact of corporate governance developments in the United States and globally, recognizing that corporate governance is evolving (58-201NP, s 1.1). One can contrast the situation in the United States and Canada with respect to corporate governance guidelines as one in which self-regulating organizations such as the NYSE and TSX are given the power to delist an issuer for failure to comply. However, noncompliance means something different in each jurisdiction. In the United States, it means failure to adhere to the guidelines. In Canada, it means the issuer’s failure to disclose its non-adherence to the guidelines. Thus, in Canada, the non-adhering issuer remains listed as long as it is disclosing, and the only sanction is the potential for shareholder exit. While the regime adopted in Canadian jurisdictions is consistent with the use of disclosure as a major regulatory tool, one may question whether securities regulation of corporate governance using this tool will result in any measurable change in an issuer’s governance. One can also question whether a major departure from the guidelines may form the basis of a legal action against directors under the applicable corporate law statutes, such as a claim that the departure constitutes a breach of the directors’ duties of loyalty and care, or oppressive conduct toward investors. •  •  •

Securities regulators have moved in recent years to require disclosure in respect of numerous aspects of corporate governance practice. Historically, corporate governance was considered primarily the domain of corporate law, and disclosures respecting corporate governance were chiefly dealt with by the listing requirements of the stock exchanges. Corporate governance had been thought of as an essential element of corporate law, not securities law. Securities law was traditionally aimed at protection of investors and the efficiency of, and confidence in, capital markets through regulation of the activities of issuers. There had been considerable debate as to whether corporate governance rules or guidelines properly fit under corporate law rather than securities regulation, and, until recently, corporate governance was not an area that securities regulators sought to regulate. That situation changed with the introduction of US corporate governance rules as a requirement for listing on the New York Stock Exchange (NYSE) and other exchanges. In an effort to harmonize regulatory approaches in Canada and the United States, the CSA proposed best corporate governance practices that were based on the NYSE corporate governance rules implemented after the US Sarbanes-Oxley Act came into force. Unlike the NYSE rules that are mandatory listing standards, however, Canadian regulators implemented voluntary compliance with a mandatory disclosure requirement in terms of requiring reporting issuers to describe how they meet the objectives of a guideline if

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they have not implemented the specific governance standards suggested by the guideline. This is known as a “comply or explain” system. Hence corporate governance standards are voluntary in Canada, but securities regulation requires disclosure of governance practices. In December 2008, the Canadian Securities Administrators (CSA) announced that it was considering revisions to corporate governance requirements and proposed the repeal and replacement of NI 58-101. The CSA proposed replacing the current governance policy with a more principles-based policy that would be broader in scope, with nine corporate governance principles and commentary explaining those principles, and replacing existing disclosure requirements with a new set of disclosure requirements that would be more general in nature, rather than based on a comply-or-explain model.126 However, in late 2009, the CSA announced that, after consulting with the issuer community, it had concluded that it was not the time to introduce significant changes because issuers were focused on business sustainability in the wake of the 2009 financial crisis: see CSA Staff Notice 58-305, Status Report on the Proposed Changes to the Corporate Governance Regime (3 November 2009).

XII. CONCLUSION This chapter has illustrated that many key aspects of corporate governance are now regulated by corporate law, securities law, or national instruments. Yet there continues to be considerable debate regarding the scope of regulation that is necessary to ensure that corporations are responsible to the stakeholders that have an investment in them. It is important to note that countries all over the world are trying to grapple with the extent to which corporate governance should be regulated. The United Kingdom consciously made the decision to move from a more rules-based approach to one that is principles-based. The United States, in contrast, has become even more codified in its governance requirements, although it has softened some of its governance requirements for smaller issuers, given the time and costs associated with compliance, and the results of the 2016 presidential election may alter this trend of highly codified governance requirements. Other countries are struggling with where they fit in the rules-based versus principles- or standards-based regulation of corporate governance. They are trying to determine the extent to which they must comply with US governance requirements if they are to be competitive in global capital markets. Japan, for example, which has had a regulatory structure that is highly dependent on internal and external audit functions and more of a stakeholder approach to corporate governance, is now trying to move, in some measure, toward the US model in an effort to access global capital markets, while at the same time trying to retain what it considers the best features of its stakeholder model. Hence the choices made by Canadian regulators need to be attuned to global developments in the quest to find the

126 CSA, Request for Comment, Proposed Repeal and Replacement of NP 58-201 Corporate Governance Guidelines (19 December 2008).

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appropriate balance between investor protection and being as fully competitive as possible in the market. Another issue that arises out of this chapter, but which is beyond the scope of its discussion, is that of retail investor involvement in the regulatory process. Julia Black observes that consumer awareness of the regulatory system is low in Canada, with only about a quarter of investors aware of the existence of the Ontario Securities Commission, let alone its regulatory role.127 She argues for a broadening of the range of participants and expertise in policymaking through increased opportunities for open and formal consultation so that regulators acquire a deeper understanding of the appropriate regulatory response. This chapter together with Chapters 10 and 11 offered a broad overview of the structure of corporate governance, and the scope and limits of private choices in governance structures and publicly regulated requirements. These choices become relevant in Chapters 13 and 14, which examine how directors and officers are held accountable to shareholders and other stakeholders for their decision-making and governance activities through particular statutory and common law liabilities.

127 Julia Black, Involving Consumers in Securities Regulation, Research Study for the National Task Force to Modernize Securities Legislation in Canada (Toronto: IDA, 2006) 545 at 583.

CHAPTER THIRTEEN

Fiduciary Duties in Corporate Governance





I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 839 II.  Theoretical Concepts for Analyzing Corporate Fiduciary Duties . . . . . . . . . . . . . . . . . . . . 840 A.  Agency Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 840 B.  Team Production Theory with the Board of Directors as a Mediating Hierarchy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 843 C.  Broader Stakeholder Interests and Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . 845 III.  Fiduciary Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 846 A.  The Basic Content of Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 847 B.  When Does a Fiduciary Relationship Arise? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 848 C.  The Default Nature of Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 849 IV.  Fiduciary Duties of Corporate Directors and Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 850 A.  The Duty of Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 851 1.  The Standard of Care Prior to Its Codification in Canadian Corporate Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 851 2.  Statutory Codification of the Duty of Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 853 3. Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 858 4.  Damages and Causation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 859 5.  Reasonable Reliance on Officials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 860 6.  Due Diligence in Complying with Certain Obligations Under the Statute . . 860 7. Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 861 8. Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 862 9.  Securities Regulators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 862 10.  Who Pays for Breaches of the Duty of Care? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 863 B.  The Duty of Loyalty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 864 1.  Conflicts of Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 864 2.  Corporate Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 871 3.  Proper Purpose and the Best Interests of the Corporation . . . . . . . . . . . . . . . . 883

I. INTRODUCTION The common law developed concepts of fiduciary duties that were applied to directors and officers of corporations. Statutes of incorporation in Canada now usually have a provision

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codifying the fiduciary duties of directors and officers of corporations.1 Two components of the codified fiduciary duties of directors and officers are the duty of loyalty and the duty of care. The corporate statutory duty of loyalty requires that the directors and officers of a corporation “act honestly and in good faith with a view to the best interests of the corporation.”2 The corporate statutory duty of care requires that the directors and officers “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.”3 This chapter provides a brief overview of fiduciary duties generally and then discusses fiduciary duties of directors and officers of corporations.4 Part II provides a way of thinking about fiduciary duties in terms of the concept of agency costs, team production theory, and broader stakeholder interests. Part III discusses fiduciary relationships generally before focusing on the fiduciary duties of the directors and officers of corporations in Part IV. The discussion of the fiduciary duties of directors and officers in Part IV includes an examination of the duty of care and the duty of loyalty, and in examining the duty of loyalty it looks at conflicts of interest, the taking of corporate opportunities, and the concept of acting for a proper purpose or, more generally, the best interests of the corporation.

II.  THEORETICAL CONCEPTS FOR ANALYZING CORPORATE FIDUCIARY DUTIES A.  Agency Costs Chapter 1 mentioned the economics concept of agency where a person performs an activity that is at least partly for the benefit of others. Chapter 9 also discussed the economics concept of agency. The economics concept of agency is a broader concept than the legal concept of agency because the economics concept of agency and agency costs can be applied to any situation in which the acts of one person affect the interests of one or more other 1 See the Canada Business Corporations Act, RSC 1985, c C-44 [CBCA], s 122(1). For corresponding provisions in general statutes of incorporation of the provinces and territories, see the Alberta Business Corporations Act, RSA 2000, c  B-9 [ABCA], s  122(1); the British Columbia Business Corporations Act, SBC 2002, c  57 [BCBCA], s 142(1); the Manitoba Corporations Act, CCSM c C225 [MCA], s 117(1); the New Brunswick Business Corporations Act, SNB 1981, c B-9.1 [NBBCA], s 79(1); the Newfoundland and Labrador Corporations Act, RSNL 1990, c C-36 [NLCA], s 203(1); the Northwest Territories Business Corporations Act, SNWT 1996, c 19 [NTBCA], s 123(1); the Nunavut Business Corporations Act, SNWT (Nu) 1996, c 19 (as duplicated for Nunavut by s 29 of the Nunavut Act, SC 1993, c 28) [NuBCA], s 123(1); the Ontario Business Corporations Act, RSO 1990, c B.16 [OBCA], s 134(1); the Québec Business Corporations Act, CQLR c S-31.1 [QBCA], s 119; the Saskatchewan Business Corporations Act, RSS 1978, c B-10 [SBCA], s 117(1); the Yukon Business Corporations Act, RSY 2002, c 20 [YBCA], s 124(1). The Nova Scotia Companies Act, RSNS 1989, c 81 and the Prince Edward Island Companies Act, RSPEI 1988, c C-14 do not have a corresponding provision. 2 See the Acts cited supra note 1. CBCA s 122(1)(a); ABCA s 122(1)(a); BCBCA s 142(1)(a); MCA s 117(1)(a); NBBCA s 79(1)(a); NLCA s 203(1)(a); NTBCA s 123(1)(a); NuBCA s 123(1)(a); OBCA s 134(1)(a); QBCA s 119; SBCA s 117(1)(a); YBCA s 124(1)(a). 3 See the Acts cited supra note 1. CBCA s 122(1)(b); ABCA s 122(1)(b); BCBCA s 142(1)(b); MCA s 117(1)(b); NBBCA s 79(1)(b); NLCA s 203(1)(b); NTBCA s 123(1)(b); NuBCA s 123(1)(b); OBCA s 134(1)(b); QBCA s 119; SBCA s 117(1)(b); YBCA s 124(1)(b). 4 The next chapter, Chapter 14, deals in part with how corporate stakeholders might go about suing directors and officers for breaches of fiduciary duties.

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persons even though the person carrying out the acts that affect one or more other persons might not be an “agent” in the legal sense of that word.5 Since the person engaging in the activity for the benefit of another is not receiving all of the benefit from the activity, that person may have an incentive to put in somewhat less effort or to be somewhat less careful than the person would be if he or she was receiving the whole benefit of the activity. In other words, the person performing the activity might say to himself or herself, “for every dollar that is earned through my efforts I only get 40 cents with the other 60 cents going to the benefit of others, so why should I work as hard as I would if I got all the benefit for myself.” This kind of behaviour in an economic agency relationship is referred to as “shirking.” If the person performing the activity is using assets provided by others, the person performing the activity may also have an incentive to try to take some of those assets for himself or herself. This kind of behaviour in an economic agency relationship is referred to as “looting” (or “self-dealing”). This shirking or looting behaviour imposes a cost on the person on whose behalf the activity is being performed, and this cost that arises in an economic agency relationship is known as an “agency cost.” The cost of an agency relationship may be considered acceptable where the benefit of the agency relationship outweighs its cost. There may also be net benefits from efforts to reduce this agency cost. Economic agency relationships are present in all kinds of situations, including various forms of organization for carrying business activities whether for profit or not for profit. A sole proprietorship, one might think, is a form of organization that would avoid agency costs, but agency costs in a sole proprietorship may arise in a number of situations and will certainly arise as soon as the sole proprietor engages an agent or employee or contracts to have some service provided by another person in the context of carrying on the sole proprietorship business. Even without engaging an employee, the way a sole proprietor manages the sole proprietorship business may have effects on a potentially wide range of other persons (who might broadly be described as “stakeholders”). A partner in a general partnership who engages in activities in the context of carrying on the business of the partnership will act, in part, for the benefit of himself or herself and, in part, for the benefit of the other partners who share in the profits of the partnership. Actions taken by the partner may also affect the interests of a potentially wide range of other persons. The directors and officers of a corporate general partner in a limited partnership will be carrying on the partnership business at least in part for the benefit of the limited partners, and their decisions may also affect the interests of a potentially wide range of other persons. Consider also a closely held corporation with more than one shareholder in which each of the shareholders takes part in the carrying on of the business as a director or officer. Each shareholder will be carrying on the business partly for his or her own benefit and partly for the benefit of the other shareholders. The management decisions of the shareholders may have effects on a potentially wide range of other persons. In a larger public corporation that has distributed shares to the

5 GHL Fridman, The Law of Agency, 7th ed (London: Butterworths, 1996) at 11 defines agency as “the relationship that exists between two persons when one, called the agent, is considered in law to represent the other, called the principal, in such a way as to be able to affect the principal’s legal position in respect of strangers to the relationship by the making of contracts or the disposition of property.” The economics concept of agency and the concept of agency costs can be applied in situations where one person’s acts affect the interests of one or more other persons even though the person engaging in the acts is not “considered in law to represent the other.”

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public, management decisions of directors and officers will affect the shareholders as well as a potentially wide range of other stakeholders. If any of these forms of business organization are at least partly debt-financed, obtaining revenues greater than expenses before interest expense from carrying on the business provides a benefit to the suppliers of the debt capital in the form of interest payments. The business is, therefore, carried on by the managers of the business partly for the benefit of these suppliers of debt capital. There may be many other stakeholders whose interests are affected by those making decisions concerning the management of the business. Agency costs of the sort briefly described above arise in all these relationships and in many other relationships in the context of business organizations. Agency costs have been said to have three components. The first component is called “monitoring costs.” The idea of this component is that it may be worthwhile for the person receiving the benefit of the economic agent’s activity to incur costs in monitoring the economic agent to see whether that economic agent is performing the activity well (that is, without shirking or looting). The second component of agency costs is called “bonding costs.” The idea of this component is that the economic agents, wanting to encourage persons to engage them or to increase their remuneration on being engaged, will have an incentive to find a way to signal or demonstrate that they will do a good job (that is, that they will not shirk or loot). Efforts by economic agents to signal that they will do a good job will involve costs. The third component of agency costs is referred to as “residual costs.” This component is the remaining cost due to shirking or looting that is not controlled by monitoring or bonding. At some point, the costs of further monitoring will outweigh the benefits of monitoring. At some point, the cost of bonding will outweigh the benefits of bonding. Since there will be limits on monitoring or bonding, there will be some residual agency costs that are not avoided through monitoring or bonding. Consider the corporate form of organization and the governance mechanisms discussed in Chapter 12. Access to records, financial disclosure, proxy circulars, shareholder voting, and voting by proxy, among other governance mechanisms, can be seen as means by which shareholders can monitor the behaviour of the persons managing the corporation and allow them to respond by removing persons who are not performing satisfactorily. These various mechanisms are not without costs. While disclosure and voting may facilitate monitoring, effort by shareholders is, nonetheless, still required. This effort by shareholders involves costs. Even where the monitoring by a shareholder involves just the time it takes to examine the disclosure and exercise a voting right, it is time the shareholder might have spent doing something else and is, therefore, a cost. Voting by proxy might be understood as a mechanism for reducing monitoring costs by making it easier (and therefore less costly) for shareholders to exercise their voting rights. The disclosure requirements might also be seen as a means of reducing monitoring costs in the sense that monitoring management behaviour without such disclosure, while not impossible, would be much more expensive without the required disclosure by management, who can, presumably, provide the information at lower cost than the shareholders would incur in gathering it themselves. The persons who sought capital by forming a corporation and issuing shares to investors had to first choose whether to carry on the business through a corporation. If they chose to carry on the business through a corporation, they would also then choose the statute under which the corporation would be formed. If the persons who sought the capital initially are persons who will be involved in carrying on the business, which they often would be, they

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have essentially chosen to commit themselves to the requirements of the particular corporate statute. If they wanted to avoid the requirements of the statute, they might have chosen to carry on the business through some other form of organization. Alternatively, they could have financed the business differently, perhaps through debt obligations or preferred shares that do not normally carry a voting right. If those persons chose to carry on the business through a corporation formed under a statute that provides various rights to shareholders and to raise capital by selling shares with voting rights, they might be said to have committed, or “bonded,” themselves to providing those rights. Those rights might include, for example, access to records, financial disclosure, proxy circulars, shareholder voting rights, and a right to vote by proxy. The topics covered in this chapter deal with rights of shareholders, and perhaps other stakeholders, to sue corporate directors and officers and impose liabilities on them for behaviour that might be characterized as shirking or looting. Many of these rights developed historically as fiduciary duties. These were, for the most part, default duties. They could be waived or at least modified. There was, therefore, some choice among promoters of a business in terms of the scope of these sorts of liabilities to which they committed themselves. Modern corporate statutes, such as the Canada Business Corporations Act and similar statutes in the provinces and territories, often put these fiduciary duties in statutory form, such as in CBCA s 122(1), and prevent the directors or officers from being relieved of these liabilities.6 The mandatory character of these now statutory obligations is, however, still discretionary in the sense that there is choice about the form of organization. If a corporate form is chosen, there is also a choice about the statute of incorporation. The promoters of a business may, therefore, be said to choose to expose themselves to liabilities that arise from breaching fiduciary duties. In this way, they may be seen as committing (or “bonding”) themselves to these liabilities and thereby signalling to investors that they will behave in the interests of the investors (that is, “if I don’t behave well, you can sue me”). Sometimes these commitments to liability by economic agents to signal investors that they will act in the interests of investors are referred to as “liability strategies.”

B.  Team Production Theory with the Board of Directors as a Mediating Hierarchy One may want to consider how the subject of this chapter fits with the notion of a corporate board of directors as part of “the corporation’s internal governing hierarchy” that mediates the share of corporate rents arising from a team production process that brings together contributions from “shareholders, managers, employees, and other groups that make firmspecific investments.”7 That notion suggested that “the public corporation can be viewed

6 CBCA s 122(3) provides that, “[s]ubject to subsection 146(5), no provision in a contract, the articles, the by-laws or a resolution relieves a director or officer from the duty to act in accordance with this Act or the regulations or relieves them from liability for a breach thereof.” For corresponding provisions in general statutes of incorporation of the provinces and territories, see the Acts cited supra note 1: ABCA s 122(3); BCBCA s 142(3)(a); MCA s 117(3); NBBCA s 79(3); NLCA s 203(3); NTBCA s 123(3); NuBCA s 123(3); OBCA s 134(3); QBCA s 120; SBCA s 117(3); YBCA s 124(3). 7 See Margaret M Blair & Lynn A Stout, “A Team Production Theory of Corporate Law” (1999) 85 Va L Rev 247 at 320. Chapter 9 has an excerpt of pages 319-28 of this article.

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most usefully not as a nexus of implicit and explicit contracts, but as a nexus of firm-specific investments made by many and varied individuals who give up control over those resources to a decision-making process in hopes of sharing in the benefits that can flow from team production.”8 It was also suggested that a notion of shareholder primacy in which shareholders are said to have unique rights to exercise control over the board of directors might be said to flow from shareholder voting rights and the right of shareholders to bring suits against the directors on behalf of the corporation (a “derivative action”).9 It was then said that “these rights are so limited as to be non-existent.”10 This chapter deals with the breach of fiduciary duty claim that shareholders could bring against directors or officers on behalf of the corporation. One may want to consider to what extent the assertion that derivative actions for breach of fiduciary duty are, in the Canadian corporate law context, “so limited as to be almost non-existent” and whether, perhaps, that leaves the directors “free to pursue whatever projects and directions they choose, subject only to the limitation that they not use their positions for their own personal enrichment.”11 One might also want to consider the mediating hierarchy notion in light of the answer, in Canadian corporate law, to the question, “To whom do the directors and officers owe their fiduciary duties?” One might then think of the answer to that question in terms of the agency cost concept discussed above in Section II.A. Are the “others” on whose behalf directors and officers are carrying out their tasks only the shareholders of the corporation, or do those “others” include various other stakeholders in the corporation? The “shirking” and “looting” (or “self-dealing”) that directors and officers might engage in would arguably impose agency costs on all stakeholders by reducing the gains (or corporate rents) that all stakeholders might share in. If so, that might suggest that the persons entitled to sue for breaches of fiduciary duties by directors and officers should not be limited to shareholders but should include other corporate stakeholders. However, how would one determine whether any given person is a “corporate stakeholder,” or, in legal terms, how would one determine who should be given standing to sue? If the agency costs imposed by director or officer shirking or looting are incurred not just by shareholders but by a much broader set of corporate stakeholders, and if the appropriate remedy is damages, to whom should the damages be paid? If the appropriate remedy is an accounting by directors or officers for profits made by their breach of a fiduciary duty (that is, requiring the directors or officers to return profits made), to whom should that accounting be made? Should the damages be paid, or the accounting be made, to the corporation to be shared among the various stakeholders, or should it be paid to, or made, only to the persons who commenced the suit? Could payment or an accounting to those suing serve as an inducement to them to better monitor management behaviour, perhaps by reducing the “small stake” problem that can make corporate stakeholders rationally apathetic? If one concludes that the directors and officers owe their fiduciary duties to corporate stakeholders generally, does that exacerbate the “free-rider” problem by expanding the range of stakeholders such that any given corporate stakeholder would be inclined to count on other corporate stakeholders to incur the costs of 8 Ibid at 285. 9 Ibid at 320. 10 Ibid. 11 Ibid.

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monitoring management behaviour and taking action while that given corporate stakeholder sits back and shares in the benefit without incurring the cost of monitoring and enforcement?

C.  Broader Stakeholder Interests and Fiduciary Duties Chapter 9 has an excerpt from “Corporate Law as Public Law” by Kent Greenfield. That excerpt describes the “contractarian,” “mainstream” view that sees corporations as private creations “insulated from politics and concerns about the public interest.” This is the approach to corporate law briefly noted in the introduction to Chapter 1 where the interests of most corporate stakeholders other than shareholders are addressed by laws such as employment law, tort law, environmental law, consumer protection law, competition law, and so on rather than by corporate law. Greenfield suggests that instead of taking the contractarian approach of insulating the corporation from politics or public policy, one should recognize that corporations have a public dimension and analyze corporate law with the same regulatory approach as for other areas of public law such as “environmental law, labour law, tax law and the like.” Corporate law, he suggests, “is predicated upon our collective political decisions about what we want our society to look like.” The project of constructing our corporate law, according to Greenfield, “ought to depend on a broader and ongoing project that sets social goals and analyzes the capacity of law, including corporate law, to get us closer to those ideals.”12 In other words, one should consider various regulatory alternatives for achieving those ideals, including alternative approaches to corporate law. One possibility to consider in this regard is whether the directors and officers should owe fiduciary duties not just to the shareholders of a corporation, but to a wider range of stakeholders. The analysis might suggest that the range of stakeholders to whom directors and officers of a corporation should owe their fiduciary duties should not be extended. Greenfield offers several possible arguments for such a conclusion, saying: Giving corporate managers more than one legal duty may increase the agency costs of their supervision; it is less costly to monitor the performance of an agent if the agent has one task than if the agent has two. Perhaps managers have no expertise with regard to social concerns, so giving them more power to address such concerns may be unlikely to have a significant positive effect and will provide a deadweight cost on the corporation, its shareholders, and society in general. Perhaps a loosening of management’s fiduciary duty to shareholders will make shareholders less likely to invest, because they will lose some of their legal power to monitor and constrain management. Perhaps these corporate reforms will be pointless, because shareholders will simply invest their capital in companies organized in states and countries that allow corporations to benefit shareholders at the expense of other stakeholders or the public interest.13

Greenfield says he is not convinced by such arguments. He says, “the success of such arguments turns on relative costs and benefits, effectiveness, and the relative strength of other

12 Kent Greenfield, “Corporate Law as Public Law” in The Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities (Chicago and London: University of Chicago Press, 2006) at 37. 13 Ibid at 38.

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options” and says that there are “reasons to believe that changes in corporate law should be part of the bundle of legal responses to correct market defects or to address other public policy objectives.”14 Statutes of incorporation in Canada have codified fiduciary duty provisions that indicate that the directors and officers of corporations incorporated under such statutes have a duty to act in the best interests of the corporation.15 Recent cases in Canada, discussed below, have made it clear that this duty of directors and officers to the corporation does not mean a duty limited to the interests of the shareholders but can include consideration of the interests of other stakeholders. Does this approach to the fiduciary duty of loyalty owed by directors and officers put a legal obligation on the directors and officers to act as a “mediating hierarchy” of the sort suggested by Blair and Stout? Does this approach raise “agency costs,” as Greenfield suggests the contractarians would likely argue? Do you agree with the other arguments Greenfield suggests the contractarians would likely make, or, like Greenfield, are you not convinced by such arguments? Are there ways of measuring the relative costs and strengths of having directors and officers owe a fiduciary duty of loyalty to stakeholders other than just the shareholders? Is it possible that an analysis of the relative costs and strengths would suggest different approaches in different situations—that is, directors and officers owing a fiduciary duty of loyalty only to shareholders in some situations but owing a fiduciary duty of loyalty to a broader range of stakeholders in other situations?

III.  FIDUCIARY RELATIONSHIPS As noted in the introduction, the main focus of this chapter is the fiduciary duties of directors and officers of corporations. In very general terms, a fiduciary relationship is said to be “a relationship in which one person is under a duty to act for the benefit of [another person] on matters within the scope of the relationship.”16 A trustee, for instance, is in a fiduciary relationship with the beneficiaries of the trust. The trustee is expected to be loyal to the beneficiaries in carrying out the trust obligations in the best interests of the beneficiaries. The trustee is also expected to exercise care in carrying out the trust obligations. Another long-accepted fiduciary relationship is that of an agent to the agent’s principal. An agent is expected to act with care and in the best interests of the principal. Officers of a corporation are agents for the corporation. Directors, while not normally acting in the capacity of agents for the corporation, were, nonetheless, held early on to be in a fiduciary relationship with the corporation and, therefore, to owe fiduciary duties to act in the best interests of the 14 Ibid at 39. 15 See the provisions cited supra note 2. 16 See the definition of “fiduciary relationship” in Black’s Law Dictionary, 10th ed (St Paul, Minn: Thomson Reuters, 2009). Similarly, The Dictionary of Canadian Law, 4th  ed (Toronto: Carswell, 2011) says that a “fiduciary duty” is “1. One that arises in the context of a trust. 2. Certain relationships give rise to this type of duty: trustee and beneficiary, guardian and ward, principal and agent. 3. A duty by which the law seeks to protect vulnerable persons in transactions with others.” The Dictionary of Canadian Law also says that a “fiduciary obligation” “[a]rises in a relationship in which the fiduciary has a discretion or power to exercise, the fiduciary can unilaterally exercise this discretion or power, and the beneficiary is vulnerable to or at the mercy of the fiduciary.”

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corporation and to exercise care in making management decisions with respect to the corporation. This section provides a general discussion of fiduciary relationships in the context of commercial relationships, since fiduciary duties are owed not just by directors and officers of a corporation but potentially by a wide range of other persons who may be acting on behalf of the corporation. In addition, there are, as noted in Chapter 1, many different forms of business organization and fiduciary relationships can arise in many contexts in the various forms of business organization. Fiduciary relationships can also arise between business organizations in the context of commercial relationships and between individuals in commercial relationships.

A.  The Basic Content of Fiduciary Duties Concepts of fiduciary duties developed over many years. Two of the many areas in which concepts of fiduciary duties developed were agency and trusts. An agent, as noted in Chapter 1, acts on behalf of another person, called the principal. An agent can, for instance, cause the principal to become a party to a contract with another person, thereby subjecting the principal to legally binding obligations. An agent can, therefore, significantly affect the legal relationships, or obligations, of the principal for whom the agent acts. Trustees act on behalf of other persons, referred to as beneficiaries. While trustees normally do not act as agents for beneficiaries and, therefore, cannot normally commit a beneficiary to a legal obligation, trustees are in a position to have a potentially significantly effect on the interests of a beneficiary by, for example, failing to make a required distribution of trust income to a particular beneficiary or failing to properly manage the trust property, thereby causing a loss to all the beneficiaries of the trust. An agent is legally obligated to carry out the terms of the agency, and a trustee is legally obligated to carry out the terms of the trust. In addition, agents and trustees may owe a range of other fiduciary duties. One of these is the duty of loyalty. The duty of loyalty requires that the fiduciary, such as an agent or trustee, act in the best interests of the person on whose behalf the fiduciary is acting. An important element of the duty of loyalty is that the fiduciary not put himself in a position where his personal interest conflicts with the interest of the person on whose behalf he is acting and, similarly, that he not put himself into a position where his duty to a person on whose behalf he acts conflicts with a duty he owes to another person on whose behalf he also acts. Another duty of a fiduciary is the duty of care under which the fiduciary is expected to exercise reasonable care in carrying out tasks on behalf of the person for whom the fiduciary acts. A fiduciary normally cannot delegate tasks the fiduciary has undertaken. The duty not to delegate is based on the notion that the person was chosen to act on behalf of another because that person was considered trustworthy and competent to so act. The principal in an agency relationship, for example, presumably chooses a particular person to act as agent because that person is capable of carrying out the agency task and can be trusted to do so with the best interests of the principal in mind. A trustee, to take another example, is likely chosen by the settlor of the trust because that person is capable of managing the trust property and can be trusted to carry out the trust obligation in the best interests of the beneficiaries. The fiduciary, therefore, should normally not delegate his or her fiduciary tasks to other persons.

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B.  When Does a Fiduciary Relationship Arise? Over the course of several centuries the concept of a fiduciary relationship was extended to a number of particular situations. In addition to the relationship of trustee – beneficiary and agent – principal, the fiduciary relationship concept was extended to the relationships of guardian – ward, solicitor – client, director – corporation, life tenant and remainder person, and partners in a partnership business.17 These were, by the 19th century, the accepted fiduciary relationship situations. Courts, however, noted on various occasions in the 20th century that fiduciary relationships were not limited to these established situations, saying that the categories of fiduciary relationships are never closed.18 The question then was how one might identify other situations in which a person could be said to operate in a fiduciary capacity. In 1987, in a dissenting opinion in the case of Frame v Smith,19 Wilson  J noted that “an extension of fiduciary obligations to new ‘categories’ of relationship presupposes the existence of an underlying principle which governs the imposition of the fiduciary obligation.”20 She then set out three general characteristics of a fiduciary relationship:

(1) The fiduciary has scope for the exercise of some discretion or power. (2) The fiduciary can unilaterally exercise that power or discretion so as to affect the beneficiary’s legal or practical interests. (3) The beneficiary is peculiarly vulnerable to or at the mercy of the fiduciary holding the discretion or power.21

Later in 1989, all five judges of the Supreme Court of Canada panel in Lac Minerals Ltd v International Corona Resources Ltd 22 agreed that the three characteristics of a fiduciary relationship set out by Wilson J in Frame v Smith were useful characteristics for assessing whether a fiduciary duty arises in a particular situation. Since then, fiduciary duties have been found to exist in situations other than the traditional situations identified above, with those traditional situations being referred to as “per se fiduciary relationships.” Some controversy about these three characteristics of a fiduciary relationship has arisen in subsequent Supreme Court of Canada decisions, particularly concerning the third characteristic of vulnerability. In the 1994 Supreme Court of Canada decision in Hodgkinson v Simms23 the majority opinion of La Forest J noted that “Wilson J.’s mode of analysis has been followed as a ‘rough and ready guide’ in identifying new categories of fiduciary relationships.”24 La  Forest  J added that the Frame v Smith guidelines “constitute indicia that help

17 See e.g. Wilson J in Frame v Smith, [1987] 2 SCR 99 at para 36. 18 See e.g. Frame v Smith, ibid at para 36 (per Wilson J); Guerin v The Queen, [1984] 2 SCR 335 at 384 (per Dickson J); Lac Minerals Ltd v International Corona Resources Ltd, [1989] 2 SCR 574 at 597; Goldex Mines Ltd v Revill (1974), 7 OR (2d) 216 at 224 (CA); and Laskin v Bache & Co Inc (1971), 23 DLR (3d) 385 at 392 (Ont CA). 19 Supra note 17. 20 Ibid at para 57. 21 Ibid at para 60. 22 Supra note 18. 23 Hodgkinson v Simms, [1994] 3 SCR 377. 24 Ibid at 408.

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recognize a fiduciary relationship rather than ingredients that define it,”25 and went on to say that outside the established categories of fiduciary relationship, “the question to ask is whether, given all the surrounding circumstances, one party could reasonably have expected that the other party would act in the former’s best interests with respect to the subject matter at issue.”26 La Forest J also indicated that “what is required is evidence of a mutual understanding that one party has relinquished its own self-interest and agreed to act solely on behalf of the other party.”27 More recently, Rowles JA, writing on behalf of the British Columbia Court of Appeal, said in Perez v Galambos, “I am of the opinion that where power-dependency relationships are at issue, fiduciary obligations may be imposed according to the objective standard [of] proof of a reasonable expectation that in all of the circumstances the defendant would act in the plaintiff’s best interests.”28 Where a fiduciary relationship is found, the content of the fiduciary duties of that relationship will depend on the particular circumstances of the fiduciary relationship. It may be that all the normal fiduciary duties of care, loyalty, and non-delegation briefly described above apply, or it may be that only some or part of the normal fiduciary duties apply.

C.  The Default Nature of Fiduciary Duties Even for the traditional fiduciary categories such as agent – principal, trustee – beneficiary, and director – corporation, fiduciary duties may be qualified by the express terms of the fiduciary relationship or by implication from the circumstances. An express provision (such as an “exculpation clause”) might, for instance, limit the scope of the duty of care.29 The duty not to delegate may be qualified by an express provision allowing the fiduciary to delegate certain tasks. The duty not to delegate may also be qualified by, for instance, circumstances that suggest that a person acting on the person’s own behalf would normally delegate in those circumstances.30 It might, for example, be reasonable for a trustee with a duty or power to sell real property held in trust to engage a real estate agent who knows the market and can assist the trustee in getting the best price for the property, thereby assisting the trustee in complying with her duty of loyalty to act in the best interests of the beneficiaries of the trust. There may even be an express provision allowing a person to have a conflict of interest. Such a provision may make sense in situations where conflicts of interest will almost inevitably arise. The question the provision might then address is how to provide a procedure for managing the conflict of interest in a way that reduces the risk that a decision will be made that is not in the best interests of the person on whose behalf the fiduciary is acting. Corporate charter documents in the past, for instance, often contained provisions that allowed a director to have a conflict of interest as long as the conflict was disclosed and the director

25 Ibid at 409. 26 Ibid. 27 Ibid at 409-10. 28 Perez v Galambos, 2008 BCCA 91 at para 43. 29 See e.g. Armitage v Nurse, [1997] 2 All ER 705 (CA); and in Canada see e.g. Poche v Pihera (1983), 50 AR 264, 6 DLR (4th) 40 (Alta QB); and Steven Thompson Family Trust v Thompson 2012 ONSC 7138. 30 Speight v Gaunt (1883), 9 AC 1.

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refrained from voting on the matter with respect to which the director had a conflict (allowing the other directors to make the decision with knowledge of the particular director’s conflict of interest). As discussed below, the Canada Business Corporations Act and similar corporate statutes in the provinces and territories contain a provision that allows for decisions to be made, or acts to be done, where directors or officers have a conflict of interest as long as certain requirements are met.31 Directors have, in the past, typically been permitted to decide on (that is, to vote on) their own remuneration as directors, something in which all the directors would have a personal interest that would conflict with the interests of the corporation. The CBCA and similar corporate statutes in the provinces and territories contain a provision that expressly allows directors to vote on a resolution concerning their own remuneration regardless of the conflict of interest involved in such a resolution.32

IV.  FIDUCIARY DUTIES OF CORPORATE DIRECTORS AND OFFICERS Early corporate statutes in England and Canada did not contain a statutory provision saying that directors and officers owed a fiduciary duty to the corporation. The director – corporation relationship was recognized early on as a fiduciary relationship. Officers appointed by the directors to manage the corporation can have authority to act as agents on behalf of the corporation. Their agency relationship was one of the traditionally accepted fiduciary relationships. Fiduciary duties, as noted above, can be qualified by an express provision or, in some situations, by implication from the circumstances. The drafters of the CBCA, following an approach taken earlier in several state corporate statutes in the United States, decided to codify the fiduciary duties of directors and officers. Section 122(1) of the CBCA provides: Every director and officer of a corporation in exercising their powers and discharging their duties shall (a)  act honestly and in good faith with a view to the best interests of the corporation; and (b)  exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. 33

Paragraph (a) is the duty of loyalty. Paragraph (b) is the duty of care. How much the wording of the statute may deviate from the corresponding common law fiduciary duties of directors and officers is discussed below. Section 122(3) does, however, set out a key distinction from the common law approach to fiduciary duties. It provides:

31 For the Canada Business Corporations Act, see s 120, discussed below in Section IV.B.1.c. For corresponding provisions in general statutes of incorporation of the provinces and territories, see the Acts cited supra note 1: ABCA s 120; BCBCA ss 147-153; MCA s 115; NBBCA s 77; NLCA s 198; NTBCA s 121; NuBCA s 121; OBCA s 132; QBCA ss 122-133; SBCA s 115; YBCA s 122. 32 CBCA s 120(5)(a). For corresponding provisions in general statutes of incorporation in the provinces and territories, see the Acts cited supra note 1: ABCA s 120(6)(b); BCBCA s 147(4)(c); MCA s 115(5)(b); NBBCA s 77(5)(b); NLCA s 198(5)(b); NTBCA s 121(6)(b); NuBCA s 121(6)(b); OBCA s 132(5)(a); QBCA s 127(1); SBCA s 115(5)(b); YBCA s 122(5)(b). 33 For corresponding provisions in general statutes of incorporation in the provinces and territories, see supra note 1.

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Subject to subsection 146(5), no provision in a contract, the articles, the by-laws or a resolution relieves a director or officer from the duty to act in accordance with this Act or the regulations or relieves them from liability for a breach thereof. 34

Directors and officers cannot, therefore, be relieved of their s 122(1) fiduciary duties by provisions in contracts, the articles or bylaws, or by a resolution of the directors or shareholders.

A.  The Duty of Care Corporate statutes in Canada and the United States now typically contain a statutory duty of care. The director – corporation relationship has, however, long been considered a fiduciary relationship that included a duty of care, even in the absence of such a duty being imposed pursuant to a provision in the statute under which the corporation was incorporated. The discussion below begins with a brief note on the law prior to its codification in Canadian corporate statutes and why it was considered necessary to codify it, followed by a discussion of the statutory codification of a duty of care for directors and officers in the CBCA.

1.  The Standard of Care Prior to Its Codification in Canadian Corporate Statutes The standard for the common law duty of care of directors and officers before its codification in CBCA s 122(1)(b) and other Canadian corporate statutes was arguably a very lenient standard. Consideration of a few of the oft-cited cases in this area gives a sense of this quite lenient standard. One aspect of the duty of care referred to in CBCA s 122(1)(b) is the “diligence” of directors and officers. The 1892 decision in Re Cardiff Savings Bank35 gives a sense of the pre-CBCA s 122(1)(b) common law diligence standard. The Marquis de Bute had become a director of the bank at the age of 6 but he did not attend a directors’ meeting until he was 27. When the Cardiff Savings Bank encountered financial difficulties resulting in the appointment of a liquidator, the liquidator sought compensation on behalf of the corporation from the Marquis de Bute for imprudent decisions that led to the bank’s financial difficulties. The court did not hold the Marquis de Bute liable for his failure to attend company meetings, saying that a director need only exercise reasonable care at the meetings he attends. Section 122(1)(b) of the CBCA refers to the exercise of care and skill.36 The common law duty of care for directors also had a care and skill requirement, but the care and skill expected of a director depended on the particular director’s circumstances. In 1911, in Re Brazilian Rubber Plantations and Estates Ltd,37 certain persons had acquired a Brazilian rubber plantation. Those persons then formed a company under the UK Company Act and appointed four persons as directors. One of the persons they appointed as director was

34 For corresponding provisions in general statutes of incorporation in the provinces and territories, see supra note 6. 35 Re Cardiff Savings Bank, [1892] 2 Ch 100. The case is also known as the Marquis of Bute’s Case. See also Re Denham & Co (1883), 25 Ch D 752, where the director had not attended any meetings of directors for a period of four years. 36 For corresponding provisions in general statutes of incorporation in the provinces and territories, see supra note 3. 37 Re Brazilian Rubber Plantations and Estates Ltd, [1911] 1 Ch 425.

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75 years old and deaf. Another person they appointed as a director said he was ignorant of business. The persons who had acquired the rubber plantation and formed the company did appoint as director a person who was knowledgeable about the rubber business since he was a “rubber broker,” but that person was, apparently, told that he was being appointed as a director simply to give a value to the rubber when it arrived in England. The fourth director was a business person, but he claimed to have been induced to become a director by seeing the name of the man who was 75 years old and deaf and the name of the person who was to give a value to the rubber when it arrived in England, both of whom he considered to be good men.38 Shares in the company were sold to various investors. The money obtained from those investors was used by the company to acquire the rubber plantation from the persons who had previously acquired the rubber plantation and who had set up the company and appointed the four directors described above.39 None of the directors were held liable for a breach of the duty of care. It was held that the degree of care to be expected of the 75-year-old deaf person was the degree of care one would expect of a deaf 75-year-old person. The degree of care to be expected of the person who was ignorant of business was the degree of care that should be expected of a person who is ignorant of business. It appears that the degree of care of the person supposedly appointed to price the rubber was the degree of care to be expected of a person with that particular role or knowledge. The common law position on the duty of care of directors and officers in the early part of the 20th century was summarized in 1925 in Re City Equitable Fire Insurance Co Ltd.40 Romer J set out the following propositions: (i) Reasonable Care: The degree of care to be taken is to be measured by the care an ordinary person might be expected to take in the circumstances on their own behalf. (ii) Degree of Skill: The degree of skill to be taken is that which can be expected of a person of his/her knowledge and experience. (iii) Degree of Attention: A director is not bound to give continuous attention to the affairs of the company. (iv) Trust of Officials: Directors can trust officers to perform duties honestly in the absence of grounds for suspicion.41 38 The four persons enticed to become directors are described in the report of the case, ibid at 427. 39 An option to buy the rubber plantation had been obtain by C Meiter, W Meiter, and K Meiter. The Meiters had sold the option to Mr Wood, who transferred the option to Mr Harbord. Harbord set up a syndicate to acquire the rubber plantation option from him. It was the syndicate, in which Harbord was the principle shareholder, that sold the rubber plantation to Brazilian Rubber Plantations and Estates Ltd. The directors of Brazilian Rubber Plantations and Estates Ltd caused that company to issue a prospectus that contained statements in a report that been prepared by the Meiters earlier on when they sold the option to buy. That report contained misrepresentations such as that the rubber plantation had 12,500 acres, when it likely had no more than 2,000 acres, and that it had 400,000 rubber trees, when it was found to have only 50,000 rubber trees. The directors had done nothing to investigate the claims in the report, believing it to be an honest report. 40 Re City Equitable Fire Insurance Co Ltd, [1925] Ch 407 (CA). 41 These propositions are discussed by Romer J, ibid at 428-29. For the fourth proposition, see also e.g. Re Denham & Co, supra note 35 at 766, where a director was said to be entitled, in the absence of grounds for suspicion, to trust that the books had been properly prepared. This principle was noted as well several years later in the House of Lords in Dovey v Corey, [1901] AC 477 (HL), per Earl of Halsbury LC at 485-86 and per Lord Davey at 492-93.

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2.  Statutory Codification of the Duty of Care In drafting the CBCA, the Dickerson committee expressed concern about the leniency of the standard for the duty of care of directors and officers under the common law.42 Presumably, the intention of the drafters in codifying the duty of care of directors and officers in the way they did in s 122(1)(b) of the CBCA was to make the standard of care stricter than it was under the common law. However, did the words “in comparable circumstances” in s 122(1)(b) allow for taking into account circumstances such as a particular person appointed as a director or officer being 75 years old and deaf or ignorant of business?

a.  Income Tax Act Cases Several cases addressing a statutory duty of care of directors have been cases based on an identically worded provision in the Income Tax Act dealing with the duty of directors to withhold and remit tax on wages or salaries paid to employees.43 An early example was Fraser v MNR,44 decided in 1987. Fraser was one of three directors of a corporation and was the vicepresident in charge of manufacturing. The two other directors held the offices of president and treasurer, respectively. One of the corporation’s major customers (Canada Post) was late in paying amounts due to the corporation. This was causing cash flow problems for the corporation that made it difficult for the corporation to pay amounts it owed, including its payroll expenses. Fraser had been informed that there were cash flow problems that were making it difficult to remit amounts withheld from employee paycheques to the receiver general of Canada, but he was assured by the treasurer of the corporation that this problem was being taken care of. The cash flow problems led to the winding up of the business about one year later. When the business was being wound up, Fraser once again inquired about the problem with remission of amounts withheld from employee paycheques to the receiver general. Amounts owing to the receiver general were ultimately left unpaid. The minister of national revenue sought payment by Fraser of the unremitted amounts pursuant to s 227.1 of the Income Tax Act, which imposes liability for such amounts on directors unless directors can show that they have met a duty of care in avoiding a failure to pay. The wording of the duty of care under ITA s 227.1(3) is that a director must show that he or she “exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.” That wording is

42 See Robert WV Dickerson, John L Howard, Leon Getz & Robert J Bertrand, Proposals for a New Business Corporations Law for Canada, vol I (Ottawa: Information Canada, 1971) at 83, para 224, where it was said that “[r]ecent experience has demonstrated how low the prevailing legal standard of care for directors is, and we have sought to raise it significantly.” 43 Section 153 of the Income Tax Act, RSC 1985, c 1 (5th Supp) [ITA] requires persons who pay salary, wages, or other remuneration to deduct and withhold from the payment an amount determined by prescribed rules that estimate the income tax that would be owed on that amount and to remit that amount to the receiver general. Section 227.1(1) of the Income Tax Act provides that where the employer is a corporation, the directors are jointly and severally liable together with the corporation to pay such amounts together with interest or penalties. Section 227.1(3) provides that “a director is not liable for a failure under subsection 227.1(1) where the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.” 44 Fraser v MNR, [1987] 1 CTC 2311, 87 DTC 250 (TCC).

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essentially identical to the wording in CBCA s  122(1)(b). Fraser’s inquiries were held to be insufficient to meet the degree of care, diligence, and skill required. The court did not accept as an excuse that the other two directors may have had a better opportunity to prevent the failure to remit the amounts. Would the interpretation of the duty of care provision in the Income Tax Act apply to the identically worded duty of care provision in CBCA s 122(1)(b)? In Soper v The Queen45 in 1997 the majority decision of the Federal Court of Appeal held that the standard of care to be exercised with respect to withholding tax remittances under the Income Tax Act is identical to that to be applied under CBCA s  122(1)(b).46 The majority in Soper said that s  122(1)(b) largely reflected the common law position set out in Re City Equitable Fire Insurance Co Ltd and that the competence expected of a director under s 122(1)(b), given the words “in comparable circumstances,” is that of a reasonably prudent person with the knowledge and experience of the particular director.47 It was not sufficient for a director to simply say that he or she had done his or her best.48 The majority also said the test of whether a director has met the standard of care contains both subjective and objective elements.49 The words “in comparable circumstances” provide the subjective element in which the particular director’s knowledge and experience is taken into account.50 The test of whether the director has met the standard of care is also objective, because the director must exercise the care that a reasonably prudent person of similar knowledge and experience would exercise.51 In the Soper case it was held that the appellant, as an experienced business person, knew, or ought to have known, from the exercise of reasonable prudence, that there might be a problem with the remittances.52 The majority contrasted Soper’s situation with that of Sanford, another director in the same corporation. Sanford had been held not liable in Sanford v The Queen53 on the basis that she had little involvement in the administrative or financial matters of the corporation and had no training or experience in these areas.54 Sanford had authority to co-sign cheques for the corporation. When she became aware of the failure to make remittances, she arranged for a cheque to be issued to pay the outstanding remittances, but she was not aware that the corporation’s bank account had insufficient funds to pay the amount. The majority in Soper also suggested that in withholding and remitting income taxes, there is a higher standard of care for inside directors (directors who are also officers of the corporation) than there is for outside directors (directors who are not also officers of the corporation).55

45 Soper v The Queen, [1997] 3 CTC 242, 97 DTC 5407 (FCA). 46 Ibid at paras 18, 19. 47 Ibid paras 21, 22. 48 Ibid at para 22. 49 Ibid at para 30. 50 Ibid. 51 Ibid. 52 Ibid at para 46. 53 Sanford v The Queen, [1996] 1 CTC 2016 (TCC). 54 Ibid, particularly at para 17. The decision in Sanford was, however, commented on critically in Soper, supra note 45 at para 37. 55 See supra note 45 at paras 33-35.

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While two identically worded statutory provisions would normally be interpreted in the same way, the context of duty of care in the governance of a corporation may be quite different from the context of the duty of care in withholding and remitting income taxes under the Income Tax Act. Shareholders in the corporate governance context have remedies other than causing the directors to pay damages. Shareholders concerned about a lack of care by directors can exercise their voting rights to replace the directors. If the corporation’s shares are publicly traded, the shareholders concerned about a lack of care by directors could sell their shares. A remedy of damages for a breach of the statutory duty of care of directors or officers under CBCA s 122(1)(b) may be of little benefit to complaining shareholders. The loss from a breach of the duty of care is likely to have been a loss to the corporation, and an award of damages is likely to be made to the corporation and not to shareholders directly. An award of damages to the corporation would allow the various corporate stakeholders to share in the award in accordance with their rights to share in corporate cash flows. The directors and officers against whom an award of damages is made would likely be able to obtain compensation under directors’ and officers’ insurance. That might lead to the corporation having to pay higher premiums for directors’ and officers’ insurance. The context of enforcement of the withholding and remittance of taxes under the Income Tax Act is quite different. The minister of national revenue does not have a voting right to remove directors who breach a duty of care in withholding and remitting taxes. Since the minister would not hold shares in the corporation that failed to withhold and remit taxes, he or she would not have the shareholder option of selling shares. The minister of national revenue, therefore, needs to impose responsibility on those who are in a position to ensure that the corporation complies with its withholding and remittance obligations under the Income Tax Act. The corporation’s shareholders may have little incentive to cause the corporation to meet its withholding and remittance obligations, especially when the corporation is on the brink of insolvency. When the corporation is on the brink of insolvency, fines on the corporation for non-compliance with its withholding and remittance obligations will be of little effect if the corporation becomes bankrupt and unable to pay the fines. In short, the context of the duty of care for the remittance of income tax withheld on wages or salary is different from that of the management of the corporation generally and arguably calls for a higher standard of care.56

b.  Interpretation of CBCA Section 122(1)(b) The duty of care of directors under s  122(1)(b) of the CBCA was discussed in the Ontario Superior Court of Justice decision in UPM-Kymmene Corp v UPM-Kymmene Miramichi Inc (also known as the Repap case).57 The case involved the approval of a compensation contract for

56 A statement noting the different context of CBCA s  122(1)(b) and ITA s  227.1 was made in Canada v Buckingham, 2011 FCA 142. Mainville JA said, at para 31,”[t]hough similar, the provisions of paragraph 122(1)(b) of the CBCA and of subsections 227.1(3) of the Income Tax Act and 323(3) of the Excise Tax Act have fundamentally different purposes. The different purposes to which these various provisions relate must inform the application of the standard of care, diligence and skill in each case.” 57 UPM-Kymmene Corp v UPM-Kymmene Miramichi Inc (2002), 214 DLR (4th) 496 (Ont Sup Ct J), aff’d (2004), 250 DLR (4th) 526 (Ont CA). The Ontario Court of Appeal held that the trial judge’s findings of fact supported her conclusions and that she properly considered the “business judgment rule” and did not substitute her view of the reasonableness of the compensation package for that of the board.

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a proposed chair of the board of directors of Repap Enterprises Inc that was alleged to be overly generous. Lax J noted that directors must make their decisions on an informed and reasoned basis.58 She said that “[a] Board is entitled, indeed encouraged, to retain advisors, but this does not relieve directors of the obligation to exercise reasonable diligence.”59 She went on to consider the “business judgment rule,” an expression that had been used in many earlier cases in the United States. She said: The business judgment rule protects Boards and directors from those that might second-guess their decisions. The court looks to see that the directors made a reasonable decision, not a perfect decision. This approach recognizes the autonomy and integrity of a corporation and the expertise of its directors. They are in the advantageous position of investigating and considering first-hand the circumstances that come before it and are in a far better position than a court to understand the affairs of the corporation and to guide its operation. However, directors are only protected to the extent that their actions actually evidence their business judgment. The principle of deference presupposes that directors are scrupulous in their deliberations and demonstrate diligence in arriving at decisions. Courts are entitled to consider the content of their decision and the extent of the information on which it was based and to measure this against the facts as they existed at the time the impugned decision was made. Although Board decisions are not subject to microscopic examination with the perfect vision of hindsight, they are subject to examination.60

Lax J held that the directors of the board did not meet their duty of care in approving the compensation contract. In reviewing the behaviour of the board, Lax J noted that “there was no urgency and yet the entire process was the subject of haste and a rush to approval.”61 The directors were mostly newly appointed directors and it was said that in the circumstances “the directors owed the shareholders a higher duty to go slowly and educate [themselves] thoroughly.”62 Section 122(1)(b) of the CBCA was also considered in the 2004 Supreme Court of Canada decision in Peoples Department Stores Inc (Trustee of) v Wise.63 Peoples Department Stores (“Peoples”) was a chain of department stores owned by Marks & Spencer Inc (“M&S”). Wise Stores Inc acquired Peoples from M&S, paying about a sixth of the purchase price with the remaining amount due later. M&S took a security interest in the assets of Peoples to protect against the risk of non-payment by Wise Stores Inc. M&S also set out a series of strict financial ratios that Wise Stores Inc was required to maintain with respect to Peoples, and M&S prohibited Peoples from giving any financial assistance to Wise Stores Inc. Sometime later, Lionel Wise, Ralph Wise, and Harold Wise resolved as directors of Wise Stores Inc to merge the warehouses of Wise Stores Inc and Peoples. After the Peoples – Wise Stores Inc 58 Ibid at para 128 (Ont Sup Ct J). Lax J referred to CW Shareholdings Inc v WIC Western International Communications Ltd (1998), 160 DLR (4th) 131 (Ont Gen Div [Com List]) in which Blair J, at para 43, said that directors “must make a decision and exercise their judgment in an informed and independent fashion, after a reasonable analysis of the situation and acting on a rational basis with reasonable grounds for believing that their actions will promote and maximize shareholder value.” 59 Supra note 57 at para 126 (Ont Sup Ct J). 60 Ibid at paras 152-53. 61 Ibid at para 146. 62 Ibid. 63 Peoples Department Stores Inc (Trustee of) v Wise, 2004 SCC 68, [2004] 3 SCR 461.

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warehouse merger, Peoples paid for merchandise ordered by Wise Stores Inc. This led to Wise Stores Inc owing Peoples $18 million. Subsequently, Wise Stores Inc and Peoples were declared bankrupt. The assets in which M&S had a security interest were sufficient to cover the full amount owed to M&S. That, however, did not leave enough to cover most of the amounts owed by Peoples to trade creditors. The trustee in bankruptcy for Peoples sued Lionel, Ralph, and Harold Wise. The basis of the claim by the trustee was that Lionel, Ralph, and Harold Wise “had favoured the interests of Wise [Stores Inc] over Peoples to the detriment of Peoples’ creditors, in breach of their duties as directors under s.  122(1) of the CBCA.”64 The unanimous judgment of the Supreme Court of Canada noted an important difference between the duty of care in paragraph (b) of s 122(1) of the CBCA and the duty of loyalty in paragraph  (a). Paragraph  (a) indicates that the duty of loyalty is owed to “the corporation.” Paragraph (b), however, does not indicate that the duty of care is owed specifically to “the corporation.”65 “Thus,” the court noted, “the identity of the beneficiary of the duty of care is much more open-ended, and it appears obvious that it must include creditors.”66 Creditors, therefore, can succeed in a claim under s 122(1)(b) of the CBCA if breach of the standard of care, causation, and damages are established.67 The court also said that the words “in comparable circumstances” “modif[y] the statutory standard by requiring the context in which a given decision was made to be taken into account.”68 The court rejected the Federal Court of Appeal’s “objective subjective” standard in Soper, preferring to describe the standard as an objective one. The court stated: To say that the standard is objective makes it clear that the factual aspects of the circumstances surrounding the actions of the director or officer are important in the case of the s. 122(1)(b) duty of care, as opposed to the subjective motivation of the director or officer, which is the central focus of the statutory fiduciary duty of s. 122(1)(a) of the CBCA.69

It also noted: Directors and officers will not be held in breach of the duty of care under s. 122(1)(b) of the CBCA if they act prudently and on a reasonably informed basis. The decisions they make must be reasonable business decisions in light of all the circumstances about which the directors or officers knew or ought to have known.70

The Supreme Court of Canada in Peoples Department Stores v Wise also addressed the causation requirement. It said that “[i]n order for a plaintiff to succeed in challenging a

64 Ibid at para 25. 65 Section s 79(1) of the NBBCA, supra note 1, is worded slightly differently so that both the duty of loyalty and the duty of care are owed to the corporation. Section 79(1) of the NBBCA provides: “Every director and officer of a corporation in exercising his powers and discharging his duties shall (a) act honestly and in good faith, and (b)  exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances in the best interests of the corporation.” 66 Supra note 63 at para 57. 67 Ibid. 68 Ibid at para 62. 69 Ibid at para 63. 70 Ibid at para 67.

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business decision he or she has to establish that the directors acted (i) in breach of the duty of care and (ii) in a way that caused injury to the plaintiff.”71 The court said: In determining whether directors have acted in a manner that breached the duty of care, it is worth repeating that perfection is not demanded. Courts are ill-suited and should be reluctant to second-guess the application of business expertise to the considerations that are involved in corporate decision making, but they are capable, on the facts of any case, of determining whether an appropriate degree of prudence and diligence was brought to bear in reaching what is claimed to be a reasonable business decision at the time it was made.72

While the court used the expression “business judgment rule” in noting the principle that a court will not second-guess management decisions, it did not import the US business judgment rule concept of a presumption that directors’ decisions have been made honestly and in good faith by a disinterested board of directors exercising due care.73 Instead, the court in Peoples Department Stores said, “[d]irectors and officers will not be held in breach of the duty of care under s. 122(1)(b) of the CBCA if they act prudently and on a reasonably informed basis.”74 A similar statement was subsequently made by the Supreme Court of Canada in its 2008 decision in BCE Inc v 1976 Debentureholders, noting that, “under the business judgment rule, deference should be accorded to business decisions taken in good faith and in the performance of the functions they were elected to perform.”75 Such deference arguably does not require a presumption that directors’ decisions have been made honestly and in good faith by a disinterested board of directors exercising due care.

3. Diligence In addition to the diligence aspect of the duty of care in s 122(1)(b) of the CBCA, the diligence of directors is also addressed in CBCA s 123. Non-attendance at directors’ meetings, like that of the Marquis de Bute in Re Cardiff Savings Bank,76 is dealt with in s 123(3) of the CBCA. Section 123(3) provides that a director who was not present at a meeting at which a resolution was passed, or at which action was taken, is deemed to have consented to the resolution or action unless within seven days after becoming aware of the resolution the director causes a dissent to be placed with the minutes of the meeting or delivers (or sends by registered mail) a dissent to the registered office of the corporation.77 Some attention to the task at hand is required where a director does attend a meeting. CBCA s  123(1) provides that a

71 Ibid at para 66 (emphasis added). 72 Ibid at para 67. 73 Ibid at para 64, discussing the business judgment rule and noting the adoption of the American name for the rule. 74 Ibid at para 67. 75 BCE Inc v 1976 Debentureholders, 2008 SCC 69 at para 99, [2008] 3 SCR 560. This case is discussed further in Section IV.B.3.b and in Chapter 14. 76 Supra note 35. 77 For roughly corresponding provisions in general statutes of incorporation in the provinces and territories, see the Acts cited supra note 1: BCBCA s 154(7), (8); MCA s 118(3); NLCA s 204(3); OBCA s 135(3); QBCA s 139; SBCA s 118(3); YBCA s 125(4).

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director who is present at a meeting of directors, or a committee of directors, is deemed to have consented to any resolution passed or action taken at the meeting unless the director’s dissent has been entered in the minutes of the meeting, the director requests that a dissent be entered in the minutes of the meeting, the director sends a written dissent to the secretary of the meeting before the meeting is adjourned, or the director sends a dissent by registered mail or delivers it to the registered office of the corporation immediately after the meeting is adjourned.78 CBCA s 123(2) provides that a director who votes for or consents to a resolution is not entitled to subsequently dissent from the resolution.79

4.  Damages and Causation While s 122(1)(b) of the CBCA and similar provisions in provincial and territorial general statutes of incorporation80 set out a statutory duty of care, they do not deal with other questions that normally arise in causes of action based on a duty of care, such as damages or causation. Damages and causation would, presumably, need to be established to succeed in a claim against a director or officer under CBCA s 122(1)(b). In Peoples Department Stores v Wise, once it was decided that creditors could bring a claim under CBCA s 122(1)(b), it was noted that they can succeed in a claim under CBCA s 122(1)(b) “if breach of the standard of care, causation and damages are established.”81 It may not be easy to establish that a breach of the duty of care by a director or officer caused a particular plaintiff’s loss. An oft-referred-to example is the American case of Barnes v Andrews,82 decided in 1924, in which Andrews was the largest shareholder in the corporation that produced starter parts for Ford motors and for airplanes. Andrews became a director of the corporation on October 9, 1919 at the urging of the president of the corporation, who was a friend of Andrews. Andrews resigned as director on June 21, 1920. During that time there had only been two meetings of the directors. Andrews attended one of them but missed the other one as a result of his mother’s death. Otherwise, he obtained occasional updates on the affairs of the corporation from talks with the president when they met from time to time. After Andrews resigned, Barnes, the plaintiff, was appointed receiver for the corporation. The receiver got only a small amount of funds from the sale of the corporation’s assets. Learned Hand J accepted that Andrews had failed to adequately perform his duty to keep informed of the corporation’s business, but said: The plaintiff must … go further than to show that he should have been more active in his duties. … The plaintiff must accept the burden of showing that the performance of the defendant’s duties would have avoided the loss, and what loss it would have avoided.83 78 For roughly corresponding provisions in general statutes of incorporation in the provinces and territories, see the Acts cited supra note 1: ABCA s 123(1); BCBCA s 154(5); MCA s 118(1); NBBCA s 80(1); NLCA s 204(1); NTBCA s 124(1); NuBCA s 124(1); OBCA s 135(1); QBCA s 139; SBCA s 118(1); YBCA s 125(1). 79 For roughly corresponding provisions in general statutes of incorporation in the provinces and territories, see the Acts cited supra note 1: ABCA s 123(2); BCBCA s 154(6); MCA s 118(2); NBBCA s 80(2); NLCA s 204(2); NTBCA s 124(2); NuBCA s 124(2); OBCA s 139(2); QBCA s 139; SBCA s 118(2); YBCA s 125(2). 80 See supra note 3. 81 Supra note 63 at para 57. 82 Barnes v Andrews, 298 F 614 (SDNY 1924). 83 Ibid at 616.

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Learned Hand J added: when a business fails from general mismanagement, business incapacity, or bad judgment, how is it possible to say that a single director could have made the company successful, or how much in dollars he could have saved? … [T]he plaintiff must show that, had Andrews done his full duty, he could have made the company prosper, or at least could have broken its fall. He must show what sum he could have saved the company.84

He concluded that there was no evidence that Andrew’s neglect caused any losses to the company.85

5.  Reasonable Reliance on Officials Section 123(5) of the CBCA provides that a director is entitled to rely in good faith on financial statements of the corporation represented to the director by an officer of the corporation, or in a written report of the auditor of the corporation, to fairly reflect the financial condition of the corporation.86 CBCA s 123(5) also allows a director to rely in good faith on a report of a person whose profession lends credibility to a statement made by the professional person. The Supreme Court of Canada in Peoples Department Stores v Wise suggested that the words “a person whose profession lends credibility to a statement made by the professional person” in CBCA s 123(5) refer to a person “subject to the regulatory overview of [a] professional organization and … [having] independent insurance coverage for professional negligence.”87 Officers or other employees (senior or not) of a CBCA corporation, or a corporation formed under a provincial or territorial statute with a provision similar to CBCA s  123(5), would therefore not normally be considered “professional” persons for the purposes of the provision.

6.  Due Diligence in Complying with Certain Obligations Under the Statute Section 118 of the CBCA imposes liability on directors for failure to comply with certain specific duties of directors in the Act.88 For example, directors can be liable under s 118 (in conjunction with s 25) where they issue shares, for consideration other than money, that have not been fully paid. They can also be liable under s 118 for declaring a dividend when the corporation does not have sufficient funds to do so according to solvency tests set out in s 42, or for repurchasing or redeeming shares or making a return of capital to shareholders when the corporation lacks sufficient funds to do so according to specified solvency tests in ss 34, 35, 36, and 38. CBCA s 119 also imposes liability on directors for up to six months of

84 Ibid at 616-17. 85 Ibid at 618. 86 For roughly corresponding provisions in general statutes of incorporation in the provinces and territories, see the Acts cited supra note 1: ABCA s  123(3); BCBCA s  157(1)(a); MCA s  118(5); NBBCA s  80(3); NTBCA s 124(3); NuBCA s 124(3); OBCA s 135(4); QBCA s 121; SBCA s 118(4); YBCA s 124(5). 87 Supra note 63 at para 78. 88 For roughly corresponding provisions in general statutes of incorporation in the provinces and territories, see the Acts cited supra note 1: ABCA s 118; BCBCA s 154; MCA s 113; NBBCA s 76; NTBCA s 119; NuBCA s 119; OBCA s 130; QBCA ss 155-158; SBCA s 113; YBCA s 119.

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unpaid wages owed to employees if the corporation becomes unable to pay the wages. CBCA s 123(4) provides a defence to these sorts of liabilities where the director has exercised the care, diligence, and skill that a reasonably prudent person would have exercised in comparable circumstances.89 The defence provided in CBCA s 123(4) includes good-faith reliance on financial statements of the corporation represented to the director by an officer of the corporation, or in a written report of the auditor of the corporation, to fairly reflect the financial condition of the corporation, or good-faith reliance on a report of a person whose profession lends credibility to a statement made by the professional person.

7. Indemnification Section 124(1) of the CBCA allows for indemnification of directors and officers.90 CBCA s 124(3) provides, however, that indemnification is not allowed if the director or officer did not act honestly and in good faith with a view to the best interests of the corporation, or, in the case of a criminal or administrative action or proceeding that is enforced by a monetary penalty, the director or officer did not have reasonable grounds for believing that his or her conduct was lawful. Section 124(1) of the CBCA allows the corporation to indemnify a director or officer “against all costs, charges and expenses, including an amount paid to settle an action or satisfy a judgment, reasonably incurred by the [director or officer] in respect of any civil, criminal, administrative, investigative or other proceeding in which the [director or officer] is involved because of [his or her] association with the corporation.” CBCA s 124(4) provides that where an action is taken by the corporation, or on behalf of the corporation,91 against a director or officer, the corporation may only indemnify the director or officer with the approval of a court, and the indemnification can only be for all costs, charges, and expenses reasonably incurred by the director or officer in connection with the action. Consequently, in an action by or on behalf of the corporation against a director or officer, the indemnification cannot include an amount paid to settle the action or satisfy a judgment.92 CBCA s 124(5) provides that a director or officer is entitled to indemnification for all costs, charges, and expenses reasonably incurred by the director or officer in connection with the defence of any civil, criminal, administrative, investigative, or other proceeding to which the director or officer is subject in his or her capacity as a director or officer of the corporation if the director or officer is found by a court or other competent authority not to have committed any fault or omitted to do anything that the director or officer ought to have done.

89 For roughly corresponding provisions in general statutes of incorporation in the provinces and territories, see the Acts cited supra note 1: ABCA s 123(3); MCA s 118(4); NBBCA s 80(3); NLCA ss 192, 193; NTBCA s 124(3); NuBCA s 124(3); OBCA s 135(4); QBCA s 121; SBCA s 118(4); YBCA s 124(5). 90 For roughly corresponding provisions in general statutes of incorporation in the provinces and territories, see the Acts cited supra note 1: ABCA s 124; BCBCA ss 159-164; MCA s 119; NBBCA s 81; NLCA ss 206, 207, 209; NTBCA s 125; NuBCA s 125; OBCA s 136; QBCA ss 159-161; SBCA s 119; YBCA s 126. 91 That is, a derivative action, which is discussed in Chapter 14. 92 In an action against a director or officer for a breach of the duty of care, therefore, indemnification could only cover costs incurred by the director or officer in connection with the action and not damages pursuant to a court order or an amount paid by the director or officer to settle the action.

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8. Insurance A right to, or potential for, indemnification of directors or officers will be of little assistance to directors or officers if the corporation is insolvent. Corporations typically acquire insurance to cover potential director or officer liability. CBCA s  124(6) specifically permits the corporation to acquire and maintain insurance for the benefit of directors and officers against any liability incurred by a person in the person’s capacity as a director or officer of the corporation.93 Insurance contracts often have exclusion clauses that leave certain kinds of liability uncovered. These gaps can expose directors and officers to potential liability that may well deter persons from becoming directors or officers. A response to this by some corporations has been to establish trust funds to compensate directors and officers for uninsured liabilities or for which indemnification and insurance are not available.

9.  Securities Regulators Canadian securities regulators can impose a broad range of administrative sanctions when it is “in the public interest to do so.” These administrative sanctions include ordering that trading in particular securities, including shares, cease; that particular persons, such as possibly directors or officers, cease trading in securities; that a director or officer be removed from his or her position as a director or officer of a corporation that has publicly traded securities in the jurisdiction; that a particular person be prohibited from being a director or officer of a corporation that has publicly traded securities in the jurisdiction;94 or that a particular person pay an “administrative penalty.”95 In assessing whether to impose such administrative sanctions, Canadian securities regulators have indicated that they may consider the degree of care that directors and officers have taken in exercising their duties. In 1990, in Re Standard Trustco Ltd,96 the Ontario Securities Commission indicated that it was willing to impose an administrative sanction in response to concerns about a lack of care exercised by directors and officers. In 2003, in Re YBM Magnex International Inc,97 the Ontario Securities Commission made the following observations about the duty of care of directors: Directors are not obliged to give continuous attention to the company’s affairs. … However, their duties are awakened when information and events that require further investigation become known to them. The standard of care encourages responsibility not passivity … . Directors act collectively as a board in the supervision of a company. Directors, however, are not a homogenous group. Their conduct is not to be governed by a single objective standard but rather one that embraces elements of personal knowledge and background, as well as board processes. More may be expected of persons with superior qualifications, such as experienced businesspersons. As such, not all directors stand in the same position. … 93 For roughly corresponding provisions in general statutes of incorporation in the provinces and territories, see the Acts cited supra note 1: ABCA s 124(4); BCBCA s 165; MCA s 119(4); NBBCA s 81(4); NLCA s 208; NTBCA s 125(4); NuBCA s 125(4); OBCA s 136(4.3); QBCA s 162; SBCA s 119(5); YBCA s 126(4). 94 See e.g. the Alberta Securities Act, RSA 2000, c S-4, s 198; the British Columbia Securities Act, RSBC 1996, c 418, s 161; the Ontario Securities Act, RSO 1990, c S.5, s 127(1). 95 See e.g. the Alberta Securities Act, RSA 2000, c S-4, s 199; the British Columbia Securities Act, RSBC 1996, c 418, s 162; the Ontario Securities Act, RSO 1990, c S.5, s 127(1). 96 Re Standard Trustco Ltd (1992), 15 OSCB 4322. 97 Re YBM Magnex International Inc (2003), 26 OSCB 5285.

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… [M]ore may be expected of inside directors than outside directors; … a CFO who is on the board may be held to a higher standard than one who is not … . When dealing with legal matters, more may be expected of a director who is a lawyer. Due to improved access to information, more may sometimes be expected of directors depending on the function they are performing, for example those who sit on board committees, such as a special committee or audit committee. An outside director who takes on committee duties may be treated like an inside director with respect to matters that are covered by the committee’s work … . In the absence of grounds for suspicion, it is not improper for a director to rely on management to honestly perform their duties … . Directors are entitled to rely on professional outside advisers, including legal counsel and underwriters … . Reliance would be unreasonable if the director was aware of facts or circumstances of such character that a prudent person would not rely on the professional advice.98

10.  Who Pays for Breaches of the Duty of Care? It was noted in Section IV.A.7 above that, in some circumstances, directors and officers can be indemnified for liabilities and expenses they have incurred in connection with carrying out their duties on behalf of the corporation. It was also noted in Section IV.A.8 above that corporations can also buy insurance to cover liabilities and expenses incurred by directors or officers of the corporation in connection with carrying out their duties on behalf of the corporation. Sometimes, as noted in Section IV.A.8, trust funds are set up to cover director or officer liabilities not covered by insurance. In the context of a breach of the duty of care, directors or officers may end up being compensated from one or more of these sources. Indemnification by the corporation will come out of corporate funds. The cost of the insurance will normally be paid by the corporation. Trust funds set up to compensate directors and officers will also normally come out of corporate funds. The source of funds to compensate a plaintiff in a successful breach of duty of care claim will, therefore, likely be the corporation itself. A study of directors’ liability in Australia, Canada, the United Kingdom, the United States, France, Germany, and Japan found significant differences in the willingness of courts to impose liability on directors. That same study, however, found that a common feature in all of the countries examined was that damages imposed on directors and legal fees incurred in their defence are either paid by the company or are covered by directors’ and officers’ liability insurance.99 A number of comments were made in Section IV.A.2.a above concerning the different context of the Income Tax Act provision regarding directors’ liability for failure to withhold and remit employee income taxes and the duty of care in the corporate governance context. For instance, shareholders in the corporate governance context have remedies other than causing the directors to pay damages. Shareholders concerned about a lack of care by directors can exercise their voting rights to replace the directors. If the corporation’s shares are publicly traded, the shareholders concerned about a lack of care by directors could sell their shares. A remedy of damages for a breach of the statutory duty of care of directors or officers 98 Ibid at paras 182-86. For other cases in which securities regulatory authorities have found directors or officers in breach of a duty of care, see e.g. Re Biovail Corporation (2010), 33 OSCB 8914; Re Banks (2003), 26 OSCB 3377; Re Specialized Surgical Services Inc, 2002 BCSECCOM 675; Re Slightham, [1996] 30 BCSC Weekly Summary 38 (BCSEC). 99 See Bernard Black, Brian Cheffins & Michael Klausner, “Liability Risk for Outside Directors: A Cross-Border Analysis” (2005) 11 Eur Fin Mgmt 153.

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under CBCA s 122(1)(b) may be of little benefit to complaining shareholders. The loss from a breach of the duty of care is likely to have been a loss to the corporation, and an award of damages is likely to be made to the corporation and not to shareholders directly. An award of damages to the corporation would allow the various corporate stakeholders to share in the award in accordance with the rights to share in corporate cash flows. The directors and officers against whom an award of damages was made would likely be able to obtain compensation under directors’ and officers’ insurance. That might lead to the corporation having to pay higher premiums for directors’ and officers’ insurance. Do these comments and the empirical evidence noted in the previous paragraph raise questions about the efficacy of imposing a duty of care on directors and officers and incurring costs of litigation claiming a breach of the duty of care of directors or officers? Who benefits and who loses from actions involving an alleged breach of the duty of care of directors or officers? To the extent that creditors might assert a breach of duty of care against the directors or officers of an insolvent corporation, is that an effective means of providing a measure of protection to creditors?

B.  The Duty of Loyalty The duty of loyalty of directors and officers, as noted above, is a duty of directors and officers to act in the best interests of the corporation. This includes a duty of directors and officers to avoid conflicts of interest and a duty of directors and officers not to take corporate opportunities for themselves. The discussion below addresses conflicts of interest and corporate opportunities and then returns to the more general duty to act in the best interests of the corporation.

1.  Conflicts of Interest a.  Strict Common Law Rule The early common law approach to fiduciaries engaging in transactions in which they had a conflict of interest was strict. The fiduciary could not benefit from any transaction in which he or she had a conflict of interest, even if the fiduciary appeared to have acted entirely in good faith.100 This strict approach was applied to directors of corporations as well. In Aberdeen Railway Co v Blaikie Brothers,101 a contract had been entered into in which Aberdeen Railway Co agreed to purchase 4,100 tons of railway chairs over the course of a couple of years from Blaikie Brothers. Aberdeen Railway Co took delivery of about 2,700 tons of railway chairs but then refused to take delivery of any more. Blaikie Brothers sought specific performance or damages in lieu of specific performance. Mr Blaikie was one of 16 directors of Aberdeen Railway Co. He was also a partner in the Blaikie Brothers partnership. One of the defences argued by Aberdeen Railway Co was that Blaikie had a conflict of interest that made the contract voidable. The court held that Aberdeen Railway Co could avoid the contract, noting that a corporation acts through its board of directors or agents and that directors and agents have a duty not to have

100 A strict approach was also taken in e.g. Keech v Sandford (1726), Sel Cas T King 61, 25 ER 223 (Ch D) and Ex Parte James (1803), 8 Ves Jun 337, 32 ER 385 (Ch D). Both of these cases are discussed in Section IV.B.2.a below in the context of discussing Regal (Hastings) Ltd v Gulliver, [1942] 1 All ER 378 concerning the taking of corporate opportunities. 101 Aberdeen Railway Co v Blaikie Brothers, [1843-60] All ER Rep 249 (HL).

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their interests conflict with the interests of their corporate principal. The court said this was a strict rule and there could be no question of how fair the transaction was in the circumstances. Aberdeen Railway Co could, therefore, avoid the contract even though Blaikie was just one of 16 directors on the Aberdeen Railway Co board of directors and all of the other directors had voted in favour of the contract.102

b.  Avoiding the Common Law Rule As noted in Section III.C above, fiduciary duties are default duties—they are presumed duties and the presumption can be rebutted either expressly or by implication from the circumstances. A person on whose behalf a fiduciary acts can, assuming that the person has the mental capacity to do so, allow the fiduciary to enter into a transaction in which the fiduciary has a conflict of interest. A trustee, for example, can commit a breach of trust, such as entering into a transaction in which the trustee has a conflict of interest, if the beneficiaries unanimously consent to, or ratify, the breach. Similarly, the principal in an agency relationship can grant an agent authority to enter into a transaction in which the agent has a conflict of interest or can ratify an act of an agent in which the agent had a conflict of interest. Similar possibilities were available for acts of directors of corporations. The articles or bylaws of the corporation could permit conflict of interest transactions under specified circumstances. Even where there was no such provision in the articles or bylaws of the corporation, or where such a provision did not apply, conflict of interest transactions could be ratified by the corporation.

i.  Conflict of Interest Provisions in Corporate Articles or Bylaws Provisions were put in corporate articles or bylaws (or in the articles of a memorandum of association company) that allowed for conflict of interest transactions as long as certain procedural safeguards were followed. A typical provision was one that required the interested director to disclose his or her conflicting interest and to refrain from voting on a resolution of the board of directors concerning the transaction. In Gray v New Augarita Porcupine Mines Ltd,103 for example, the company’s bylaws had a provision that permitted a director to enter into a contract with the company as long as he did not vote on the resolution of the board of directors dealing with such a contract. The provision also allowed a director to retain any profit he obtained from the contract if he had disclosed the nature of his interest in the contract before the board of directors voted on it.104

ii. Ratification A transaction entered into by the directors of the board of a corporation in which one or more directors had a conflict of interest, and either the corporation’s articles or bylaws did not have a provision allowing conflict of interest transactions or such a provision was not followed, could be ratified on behalf of the corporation by the corporation’s shareholders. In 102 In addition to the contract being void or voidable, the interested director or officer would have to return to the corporation any benefit the director or officer got from the transaction. 103 Gray v New Augarita Porcupine Mines Ltd, [1952] 3 DLR 1 (UK JCPC). 104 Ibid at 13.

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1887, in North-West Transportation Co Ltd v Beatty,105 the Privy Council allowed a vote by shareholders to ratify a transaction (namely, to buy the ship United Empire) in which a particular director, Mr Beatty, had a conflict of interest. The ratification was held to be valid even though Beatty voted, as a shareholder, in favour of the ratification and the shareholder resolution would not have passed if the votes on the shares held by Beatty were not counted.106

c.  The Statutory Conflict of Interest Provision While the strict common law rule could be avoided with provisions in the articles or bylaws (or articles of a memorandum of association company), it continued to apply if it was not so avoided. CBCA s  120 specifically addresses conflict of interest transactions.107 It does not follow the strict common law rule described above. Instead, it substitutes procedural and fairness safeguards. CBCA s 120 is not a default rule that corporations can adjust as they wish. One cannot, therefore, incorporate a CBCA corporation that allows conflict of interest transactions without the procedural and fairness safeguards provided for in CBCA s 120. The procedural safeguards in CBCA s 120 require (1) disclosure of the conflict of interest; and (2) approval by directors, with the interested director(s) not voting, or approval by the shareholders. The fairness safeguard is that the transaction must be reasonable and fair. CBCA s 120(7) provides that if these safeguards are met, the contract or transaction is not void or voidable and the director or officer is not accountable to the corporation or its shareholders for any profit made on the contract or transaction. CBCA s 120(8) says that if a director or officer of a corporation fails to comply with the requirements of s 120, the corporation or any of the shareholders of the corporation can apply to court and the court is empowered to set aside the contract or transaction on any terms it thinks fit, or require the director or officer to account to the corporation for any profit or gain made on the contract or transaction.

i. Disclosure Section 120(1) of the CBCA requires that a director or officer of a corporation disclose the nature and extent of any interest he or she has in a material contract or material transaction that has been made with the corporation or that is proposed. This disclosure is required where the director or officer is party to the contract or transaction, is a director or an officer of a party to the contract or transaction, or has a material interest in a party to the contract or transaction. The disclosure must be made in writing or by requesting that it be entered in the minutes of meetings of directors or of meetings of committees of directors. What makes a contract or transaction “material” is not defined. What counts as a “material interest” in a

105 North-West Transportation Co Ltd v Beatty (1887), 12 App Cas 589 (JCPC). 106 It was not clear, however, whether the ratification would relieve the interested director of the duty to account for any profits he received from the transaction. In Gray v New Augarita Porcupine Mines Ltd, supra note 103 at 13, it was held that, “Even if the contract is not avoided, whether because the company elects to affirm it or because circumstances have rendered it incapable of rescission, the director remains accountable to the company for any profit that he may have realized by the deal.” 107 For roughly corresponding provisions in general statutes of incorporation in the provinces and territories, see the Acts cited supra note 1: ABCA s 120; BCBCA ss 147-153; MCA s 115; NBBCA s 77; NLCA ss 198201; NTBCA s 121; NuBCA s 121; OBCA s 132; QBCA ss 122-133; SBCA s 115; YBCA s 122.

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party to the contract or transaction is also not defined. Whether a contract or transaction is “material” or whether a director or officer has a “material interest” in a party to the contract or transaction is a question that is left for a court to determine on a case-by-case basis.108 Section 120(2) of the CBCA deals with the timing of disclosure for directors and CBCA s 120(3) deals with the timing of disclosure for officers. The general principle in both of these subsections is that disclosure be made at the earliest opportunity. Disclosure by a director in CBCA s 120(2), for instance, must be made at the meeting at which a proposed contract or transaction is first considered. If, however, the director did not have an interest in the contract or transaction at the time it came before the meeting at which it was first considered, the director must disclose his or her interest at the first meeting after the director became so interested. If the contract has been made or the transaction entered into and the director was not interested in the contract or transaction at the time it was made or entered into, but subsequently becomes interested in the contract or transaction, the director must disclose his or her interest at the first meeting after the director becomes so interested. Also, if an individual who is interested in a contract or transaction later becomes a director, disclosure must be made at the first meeting after the individual becomes a director. CBCA s 120(3) sets out similar earliest opportunity disclosure requirements for officers. Section 120(4) of the CBCA deals with contracts or transactions that would not require approval by the directors or shareholders. It requires that a director or officer disclose the nature or extent of his or her interest immediately after the director or officer becomes aware of the contract or transaction, and it requires that disclosure be made in writing to the corporation or by requesting that it be entered in the minutes of meetings of directors or meetings of committees of directors. Section 120(6) of the CBCA allows a director or officer to provide disclosure by way of a general notice to the directors declaring that the director or officer is to be regarded as interested in a contract or transaction made with a particular party. The director or officer can provide this general notice where the director or officer is also a director or officer of a party to the contract or transaction or where the director or officer has a material interest in a party to the contract or transaction. General notice can also be provided where there has been a material change in the nature of the director’s or officer’s interest in a party to a contract or transaction. If, for example, a director or officer is also a director or officer of a major supplier or customer, or has a material interest in a major supplier or customer, the director or officer can make a general disclosure of this interest and does not have to repeat the disclosure each time the corporation enters into a contract or transaction with the same major supplier or customer. Section 120(6.1) of the CBCA says that the shareholders of the corporation may examine the portions of any minutes of meetings of directors or of committees of directors that

108 For a discussion of the meaning of materiality, see e.g. Zysko v Thorarinson, 2003 ABQB 911, where “material” in “material contract” is said to be a question of fact, that it extends beyond just a concept of financially material, and that includes the possibility that a director could benefit from the contract in more than a de minimis way. The court in Zysko v Thorarinson at para 63 cited D Peterson, Shareholder Remedies in Canada (Markham, Ont: LexisNexis, 1989) for the suggestion that a “material interest” exists where the director “has the ability to cause the person in question to enter into the contract with the corporation.” See also McAteer v Devoncroft Developments Ltd, 2001 ABQB 917; and Dimo Holdings Ltd v H Jager Developments Inc (1998), 43 BLR (2d) 123 (Alta QB).

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contain conflict of interest disclosures. The shareholders may also examine any other documents that contain conflict of interest disclosures. Gray v New Augarita Porcupine Mines Ltd, a case pre-dating the enactment of CBCA s 120, interpreted a provision in the articles of a company that allowed conflict of interest transactions as long as certain procedures, including procedures regarding disclosure, were followed. The court commented on the extent of disclosure required. It held that disclosure must disclose the “real state of things” and that “[i]f it is material to [the other directors’] judgment that they should know not merely that he has an interest, but what it is and how far it goes, then he must see to it that they are informed.”109

ii.  Abstention from Voting by Interested Directors Section 120(5) of the CBCA provides that a director who has a conflict of interest that must be disclosed cannot, subject to specified exceptions, vote on any resolution to approve the contract or transaction. The specified exceptions are contracts or transactions that (1) relate primarily to the director’s remuneration as a director, officer, employee, or agent of the corporation or an affiliate; (2) are for an indemnity or insurance permitted under CBCA s 124; or (3) are with an affiliate of the corporation.

iii.  Disinterested Director Approval and Reasonable and Fair to the Corporation Section 120(7) of the CBCA provides that a contract or transaction for which disclosure is required is not invalid, and the director or officer is not required to account to the corporation or its shareholders for any profit realized on the contract or transaction, if (1)  the required disclosure was made; (2) the directors approved the contract or transaction; and (3)  the contract or transaction was reasonable and fair to the corporation when it was approved. The director may be counted to determine whether a quorum existed at the meeting of directors as long as the three requirements of disclosure, disinterested director approval, and fairness are met. There has not been much judicial interpretation of the conflict of interest provision in CBCA s 120 or equivalent provisions in other Canadian corporate statutes. It was, however, suggested in Rooney v Cree Lake Resources Corp110 in 1998 that with regard to the fairness of the contract or transaction, the question is whether the contract or transaction bears the hallmarks of an arm’s-length bargain, or, in other words, whether the contract or transaction would have recommended itself to an independent board of directors that was acting in good faith and had the best interests of the corporation in mind.

iv.  Shareholder Approval Even Where Disclosure Was Not Made as and when Required Section 120(7.1) of the CBCA provides that even if the CBCA s 120 disclosure requirements are not met or the contract or transaction was not approved by a disinterested board of directors, a contract or transaction is not invalid and the director or officer is not accountable for any profits thereon if (1) the shareholders approve or confirm the contract or transaction by 109 Supra note 103 at 14. 110 Rooney v Cree Lake Resources Corp (1998), 40 CCEL (2d) 96 (Ont Ct Gen Div).

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special resolution (two-thirds of the votes cast)111 at a meeting of shareholders; (2) disclosure of the interest was made to the shareholders in a manner sufficient to indicate its nature before the contract or transaction was approved or confirmed; and (3) the contract or transaction was reasonable and fair to the corporation when it was approved or confirmed.

d.  Ontario and Québec Securities Regulation Requirements in the Context of Particular Conflict of Interest Transactions The Ontario Securities Commission and the Québec Autorité des marchés financiers have adopted Multilateral Instrument (MI) 61-101, Protection of Minority Shareholders in Special Transactions, which sets out steps to be taken in particular types of transactions in which conflicts of interest are likely to arise. MI 61-101 applies to issuers of securities, including corporations, that have publicly traded securities in Ontario or Québec. With the major stock exchange in the country, the Toronto Stock Exchange, located in Ontario, MI 61-101 is likely to apply to most corporations whose shares are publicly traded in Canada. MI 61-101 applies to “issuer bids,”112 “insider bids,”113 “related party transactions,” and certain types of “business combinations.” 11 See CBCA s 2(1), “special resolution.” 1 112 “Issuer bid” is defined in MI 61-101, para 1.1 by reference to the definition of “issuer bid” in National Instrument (NI) 62-104, Take-Over Bids and Issuer Bids, para 1.1. In general terms, an issuer bid is a bid (that is, an offer to buy) by an issuer of securities for its own securities. For instance, a corporation that has distributed its shares to the public might make an offer to buy its own shares. The directors and officers of the corporation, being directly involved in the management of the corporation, may have much better information about the value of the corporation’s shares than the shareholders to whom the offer is being made. MI 61-101 supplements disclosure requirements for issuer bids required under provincial securities acts (see MI 61-101, para 3.2). It also requires, subject to limited exceptions (see MI 6-101, para 3.4), that a “formal valuation” of the issuer be done by an independent valuator (see MI 61-101, para 6.1) and disclosed to offeree shareholders (see MI 61-101, para 3.3). The board of directors of the issuer or an independent committee must determine who the independent valuator will be and must also supervise the preparation of the formal valuation (see MI 61-101, para 3.3(2)). 113 “Insider bid” is defined in MI  61-101, para  1.1, together with the definitions of the expressions “offeree issuer” and “take-over bid” in NI 62-104, to mean a bid by an insider of an issuer that would lead to the insider owning 20 percent or more of the outstanding equity securities of a particular class of equity securities. “Insider” is defined in Ontario Securities Act, RSO 1990, c S.5, s 1(1) as including a person or company that controls more than 10 percent of the voting securities of the issuer, a director or officer of the issuer, or a director or officer of a subsidiary of the issuer or of a person or company that controls more than 10 percent of the voting securities of the issuer. See also the Québec Securities Act, CQLR c V-1.1, s 89. “Insider bid” is also defined, in MI 61-101, para 1.1, to mean a bid that would lead to the ownership of 20 percent or more of the outstanding equity securities of a particular class of equity securities by an associate or affiliate of the issuer or an associate or affiliate of a person or company that controls more than 10 percent of the voting securities of the issuer. An “affiliate” includes a subsidiary of the issuer, a parent company of the issuer, and another subsidiary of the parent company of the issuer (see MI  61-101, para  1.1, “affiliated entity”). An “associated entity” means an issuer of which a person beneficially owns or controls more than 10 percent of the voting rights attached to outstanding voting securities of that issuer, a partner of the person, a trust or estate in which the person has a substantial beneficial interest or in respect of which the person serves as trustee, a relative, including the spouse, of the person or a relative of the spouse if the spouse or relative has the same home (see MI 61-101, para 1.1, “associated entity”). MI 61-101 supplements the disclosure required in the securities acts for insider bids (see MI  61-101, para  2.2) and requires, subject to limited exceptions (see MI 61-101, para 2.4), that offeree shareholders be given a formal valuation prepared by a valuator chosen by an independent committee of the offeree issuer with the preparation of the formal valuation supervised by that independent committee (see MI 61-101, para 2.3).

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Related-party transactions and certain types of business combinations are subject to a “majority of the minority” shareholder voting requirement. This MI 61-101 requirement for relatedparty transactions and business combinations is briefly noted below. MI 61-101 sets out a list of “related party transactions” that include, for example, transactions in which a corporation with publicly traded shares purchases or acquires an asset from a related party for valuable consideration, sells or transfers an asset of the corporation to a related party, leases property to or from a related party, or assumes a liability of the related party.114 The term “related party” is broadly defined and includes, for example, a controlling shareholder, an affiliate of a controlling shareholder, the directors or senior officers of the corporation, or the directors or senior officers of a corporation that is a controlling shareholder.115 The definitions focus on transactions in which persons with direct or indirect control over a corporation may be in a position to cause the corporation to enter into transactions that are unfavourable to the corporation but are favourable to related parties. In addition to setting out disclosure and independent formal valuation requirements for related-party transactions,116 MI 61-101, subject to limited exceptions, requires that the transaction be approved by a majority of the minority shareholders.117 The majority of the minority approval of the transaction requires approval by shareholders in which the votes of shares controlled by the issuer, by related parties, or by parties interested in the transaction are not counted. In the context of a situation like the one that arose in North-West Transportation v Beatty,118 this would mean the resolution to buy the ship United Empire would have required that the resolution of the shareholders would only pass if there was a majority of votes of shareholders other than Mr Beatty. MI 61-101 defines a “business combination” to include, for example, an amalgamation of the issuer, an amendment to the terms of a class of equity securities of an issuer, or any other transaction of an issuer in which the interest of a holder of an equity security of the issuer may be terminated without the holder’s consent.119 If, for example, an amalgamation or an amendment to the articles of the corporation would result in certain shareholders being required to accept cash in exchange for their shares, certain requirements in MI 61-101 would apply. For such transactions, MI 61-101 sets out disclosure and formal valuation requirements.120 It also

14 See MI 61-101, para 1.1, “related party transaction.” 1 115 See MI 61-101, para 1.1, “related party.” 116 See MI 61-101, para 5.3, which sets out specific items of disclosure that must be provided in an information circular for the meeting of shareholders at which the related-party transaction will be subject to approval by a majority of the minority shareholders, and para  5.4, which requires, subject to limited exceptions (see MI 61-101, para 5.5), that the issuer obtain an independent formal valuation. 117 See MI 61-101, para 5.6, which requires “minority approval.” “Minority approval” is defined in MI 61-101, para 1.1 as “approval of the proposed transaction by a majority of the votes … cast by holders of each class of affected securities at a meeting of security holders of that class called to consider the transaction.” See also part 8 of MI 61-101, which sets out detailed requirements for minority approval. These requirements include (in para 8.1(2)) that the votes of the issuer, an interested party, or a related party of an interested party are excluded in determining whether the related-party transaction or business combination has been approved by a majority of the minority. The exceptions to the minority approval requirement for related-party transactions are set out in MI 61-101, para 5.7. 118 Supra note 105. 119 See MI 61-101, para 1.1, “business combination.”

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requires that such transactions, subject to limited exceptions, be approved by a majority of the minority.121 We will review MI 61-101 in further detail in Chapter 15.

2.  Corporate Opportunities While carrying out their duties on behalf of the corporation, directors or officers of a corporation may become aware of business opportunities that they would not have become aware of if they were not in their positions as directors and officers of the corporation. If such a business opportunity looks like it would be highly profitable, one or more of the directors or officers may be tempted to pursue that opportunity for themselves rather than on behalf of the corporation. They might ask themselves why they should share those likely high profits with the shareholders. Even if the directors or officers held some, or even a majority, of the shares in the corporation, they might ask why they should share those likely high profits with other shareholders. Why not take the opportunity for themselves? Why not bring the opportunity to a corporation of which they hold all the shares or at least a greater proportion of the shares? The directors and officers, however, owe a duty of loyalty that requires them to act in the best interests of the corporation. If the opportunity is one that the directors or officers became aware of only in their capacity as directors or officers of the corporation, and if it is a particularly promising opportunity, the best interests of the corporation would presumably dictate that the directors or officers bring the opportunity to the corporation and not take it for themselves. The implication of the duty of loyalty in the context of a business opportunity that the directors or officers became aware of only in their capacity as directors or officers of the corporation seems to be a straightforward one—they simply cannot take such an opportunity for themselves because doing so would seem to be a clear breach of their fiduciary duty of loyalty. Business opportunities may, however, arise in a wide range of situations that can be more complex than the simple situation presented above. What if the corporation cannot take the particular opportunity at the time it arises? Suppose, for instance, the corporation does not have funds available to take the opportunity, perhaps because it is a closely held corporation that has not made a public distribution of its shares so that selling new shares

120 See MI 61-101, para 4.2, which sets out specified items of disclosure that must be provided in an information circular for the meeting of shareholders at which the proposed business combination will be subject to majority of the minority approval, and para  4.3, which requires, subject to limited exceptions (see MI 61-101, para 4.4), that the issuer obtain an independent formal valuation. 121 See MI 61-101, para 4.6, and see the discussion of “minority approval,” supra note 117. For the exceptions to the minority approval requirement in the context of a proposed business combination, see MI 61-101, para 4.6. 122 Securities regulation requires that a receipt for a prospectus be obtained before selling securities, such as shares, unless there is an exemption from the prospectus requirement. A prospectus is expensive to produce and is usually beyond the means of most small issuers. Selling securities under a prospectus also leads to the issuer of the securities becoming subject to continuous disclosure requirements, which can be quite expensive on an annual basis. While there are exemptions available under which funds can be raised by small businesses, the exemptions are somewhat limited. Shares in small companies that have not gone public can be difficult to sell because they will not be regularly traded (that is, you probably can’t call your broker to sell them) and the selling shareholder will also need to rely on an exemption from the prospectus requirement. See generally Chapter 7.

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is difficult122 and it already has a high level of debt, making furthering debt financing difficult to obtain. Suppose the directors assess the potential for raising the funds through the corporation and conclude that it is not possible to do so. Can they then embark on the particular business venture on their own behalf and not on behalf of the corporation? Can the duty of loyalty extend to other persons working for the corporation who are not directors or officers of the corporation? If the opportunities that directors or officers are not allowed to take themselves are opportunities that they became aware of only in their capacity as directors or officers of the corporation, how does one decide whether an opportunity is one the directors or officers became aware of only in their capacity as directors or officers of the corporation? Even if an opportunity came to directors or officers in their capacity as directors or officers of the corporation, what if the opportunity is not in the same line of business that the corporation is in? Is it reasonable for the corporation’s shareholders or other stakeholders to expect that such an opportunity will be brought to the corporation? Suppose the opportunity is in the same line of business that the corporation is in. What if the directors or officers were, to the knowledge of the corporation’s shareholders or other stakeholders, involved in the same line of business on their own behalf before they became directors or officers of the corporation, and when they became directors or officers of the corporation it was explicitly or implicitly accepted that they would be allowed to continue to engage in similar lines of business on their own behalf? Should they be permitted to take some of the opportunities in that same line of business for themselves? Suppose a holding corporation has several subsidiaries, all or many of which are in the same or a similar line of business. Suppose an opportunity comes to the holding corporation and the directors of the holding corporation are deciding on how to pursue that opportunity. Can they choose to have that opportunity pursued through just one of the subsidiary corporations, or must they share that opportunity equally among the subsidiary corporations? A relatively strict approach to corporate opportunities was taken initially in England. If the directors or officers became aware of the opportunity only because they were directors or officers of the corporation and in the course of the execution of their tasks as directors or officers of the corporation, the directors or officers could not take the opportunity for themselves. Even if the directors or officers had decided in good faith that the corporation could not take the opportunity, they still could not take the opportunity for themselves. If they took such an opportunity for themselves, they would be in breach of their fiduciary duty of loyalty and would be required to account to the corporation for any gains they had made from the opportunity.123 In Canada, this strict approach has been relaxed in some respects. The discussion below begins by noting the strict approach in England and then discusses some Canadian cases that have taken a somewhat less strict approach.

123 The remedy of accounting compels a person to account for and pay over money owed. The accounting process is a factual inquiry into what has been done with property held by a fiduciary. The accounting process would allow for a determination of the amount of any gain received by the fiduciary in the fiduciary’s dealings with the property. See the discussion in e.g. Donovan WM Waters, Mark Gillen & Lionel Smith, Waters’ Law of Trusts in Canada, 4th ed (Toronto: Carswell, 2012) at 1273-75.

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a.  The Strict Approach The decision of the English House of Lords in the case of Regal (Hastings) Ltd v Gulliver124 provides a good example of a relatively strict approach to the taking of corporate opportunities. The company, Regal (Hastings) Ltd (“Regal”), owned a cinema in Hastings. Regal got an opportunity to acquire leases on two other cinemas. Regal formed a subsidiary corporation (“Amalgamated”) to acquire the leases. Amalgamated had the same five directors as Regal. The original idea, apparently, was that Regal would own all of the shares of Amalgamated. The landlord wanted the directors of Amalgamated to personally guarantee the payment of rent on the leases unless the paid-up capital of Amalgamated was £5,000. Regal’s directors did not want to give personal guarantees of rent payments. Regal’s board of directors met to discuss the matter. At the meeting it was concluded that Regal could only afford to invest, at most, £2,000 in the subsidiary. At a joint meeting of the boards of directors of Regal and Amalgamated, the chair of the meeting, Gulliver, said he would find persons to invest £500 in Amalgamated in return for shares of the subsidiary. He then asked whether the other four directors would do likewise. Each of the other four directors agreed to do the same. Garton, Regal’s solicitor, in response to a request from Gulliver and the other four directors, also agreed to invest £500 in exchange for shares of Amalgamated. Instead of paying for shares of Amalgamated on his own behalf, Gulliver arranged to have two other companies invest £200 each and one individual to invest £100 for a combined amount of £500 in exchange for shares in Regal’s subsidiary, Amalgamated. The four directors other than Gulliver and the solicitor Garton each made investments of £500 on their own behalf in exchange for shares of Amalgamated. The £5,000 minimum paid-up capital required by the landlord in order to avoid Regal’s directors from having to personally guarantee rent payments was, therefore, made up of a £2,000 investment by Regal and four £500 investments by the four directors other than Gulliver, a £500 investment by the solicitor Garton, and £500 invested by two companies and one individual through arrangements made by Gulliver. Later, Regal’s theatre and the leases held by the subsidiary were sold collectively for £92,000, with £15,000 of the £92,000 being allocated for the acquisition of the shares of Amalgamated owned by Regal. The four directors, the solicitor, Garton, and the two companies and the individual Gulliver had arranged to acquire shares of Amalgamated for £500 all got a gain on their shares. Subsequently, the shares of Regal were sold and the person who acquired the shares caused Regal to bring an action against its former directors and the solicitor Garton for breach of fiduciary duty. The House of Lords ruled in favour of Regal, and Regal’s former directors, other than Gulliver, were required to account to Regal for the profit they made from owning the shares of the Regal subsidiary. Lord Russell said that the opportunity to acquire the leases on the cinemas was a corporate opportunity that belonged to Regal because the directors became aware of that opportunity “by reason, and only by reason of the fact that they were directors of Regal and in the course of the execution of that office.”125 The question then was whether the directors could, nonetheless, take the lease acquisition opportunity on the basis that Regal was not itself able to take the opportunity. In

124 Supra note 100. 125 Ibid at 389.

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addressing this question, Lord Russell referred to the trust law case of Keech v Sandford,126 decided in 1726, and Ex Parte James,127 a case involving a solicitor, decided in 1803. These cases set out a strict rule for fiduciaries taking for themselves opportunities that arose in the context of carrying out their fiduciary obligations. In Keech v Sandford a trustee held a valuable lease on behalf of an infant beneficiary. The lease expired. The trustee attempted to renew the lease for the benefit of the infant beneficiary. The lessor, however, refused to renew the lease in favour of an infant beneficiary. The trustee then chose to enter into the lease on his own behalf. The Lord Chancellor ordered the trustee to assign the lease to the infant and ordered the trustee to account for the profits he had obtained from the lease. The Lord Chancellor gave the following reason for his order: if a trustee, on the refusal to renew, might have a lease to himself, few trust-estates would be renewed to cestui que use [that is, a beneficiary]; though I do not say there is a fraud in this case, yet he should rather have let it run out, than to have had the lease to himself. This may seem hard, that the trustee is the only person of all mankind who might not have the lease: but it is very proper that rule should be strictly pursued, and not in the least relaxed, for it is very obvious what would be the consequence of letting trustees have the lease, on refusal to renew to cestui que use.

The trustee could not benefit from the lease because of his conflict of interest. The trustee therefore held the lease on constructive trust. It was held that it did not matter whether the trustee had acted bona fide—he was the one person in the world who could not be permitted to benefit from acquiring the lease for himself. Keech v Sandford is a relatively early example of a general principle that the express trustee who made away with trust property was, in any event, liable as a trustee, in breach of his express trust obligations, but courts of Equity described him as a constructive trustee if he wrongfully transferred title in trust property to himself in his personal capacity.128

In Ex Parte James, a solicitor was acting on behalf of creditors of a bankrupt person. The bankrupt person owned land known as Southmead Estate. The creditors had, through the assignee in bankruptcy, obtained title to Southmead Estate. At a meeting of creditors it was agreed that Southmead Estate be sold at an auction with a minimum price of £10,000. The solicitor had recommended a minimum price of £10,500 but the creditors had overruled the solicitor’s recommendation. There were many bids for Southmead Estate at the auction and a bid of £12,030 was ultimately accepted. The accepted bid of £12,030 had been made by the solicitor, so Southmead Estate was sold to the solicitor. The case report indicated that the general opinion was, that the estate was purchased dear; and several of the creditors or their agents were present [at the auction]; and appeared highly pleased with the sale. Before the sale [the solicitor] asked the assignee, if he had or saw any objection to his being a bidder on his own account; who declared he had not; but should think the creditors benefited thereby; as the more bidders the better.

Lord Eldon set aside the sale to the solicitor, saying that

126 Supra note 100. 127 Supra note 100. 128 Waters, Gillen & Smith, supra note 123 at 484.

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the purchase is not permitted in any case, however honest the circumstances; the general interests of justice requiring it to be destroyed in every instance; as no court is equal to the examination and ascertainment of the truth in much the greater number of cases.

Lord Russell, in Regal (Hastings) Ltd v Gulliver, having considered Keech v Sandford and Ex Parte James, noted that the rule in these cases was that once one determined that the fiduciary had obtained a benefit that the fiduciary had become aware of only by reason of the execution of his duties as a fiduciary, it did not matter whether the fiduciary had acted in good faith. Similarly for directors, if they obtained an opportunity “by reason of and in the course of the execution of” their office, then it did not matter how fair the transaction was. Lord Sankey expressed a similar view, saying that “[a]t all material times they were directors and in a fiduciary position, and they used and acted upon their exclusive knowledge acquired as such directors.”129 Lord Macmillan said that the plaintiff must show: (i) that what the directors did was so related to the affairs of the company that it can properly be said to have been done in the course of their management and in utilisation of their opportunities and special knowledge as directors; and (ii) that what they did resulted in a profit to themselves.130

In a similar vein, Lord Wright said it was irrelevant that Regal suffered no loss or that the opportunity would be lost if not taken by the directors. The four directors were found liable to account for the gains they had made. Gulliver was not found liable since he did not invest himself and apparently received no benefit from the ownership of the shares by the two companies and one individual whom he arranged to have invest in Amalgamated. Garton, the solicitor, was not a director of Regal. It was held that he was not, in the circumstances, in a fiduciary relationship to Regal since he agreed to take the shares at the express request of the directors of Regal. He, therefore, was said by Lord Russell to have taken the shares not only with the consent of Regal but at the request of Regal (the directors of Regal were, according to Lord Russell, acting on behalf of Regal in requesting that Garton take the shares).131 He was, therefore, held not liable to account for the gain he made on the shares he held in the subsidiary. An interesting aspect of Regal that should be noted is that the ruling likely gave a windfall gain to the acquirer of Regal (Hastings) Ltd. In acquiring Regal (Hastings) Ltd, the acquirer had presumably paid a price that included only 2,000 shares in Amalgamated. The order that the directors account for the gain they had made on their shares in Amalgamated and pay it over to Regal (Hastings) Ltd meant that the acquirer, now owning the shares of Regal (Hastings) Ltd, got the gain on 2,000 other shares held by four of the former directors of Regal (Hastings) Ltd.

b.  Developments in Canada i.  Peso Silver Mines v Cropper (1965) Early signs of a step back from the relatively strict approach in Regal (Hastings) Ltd appeared in the 1965 decision of the British Columbia Court of Appeal in Peso Silver Mines Ltd v 129 Regal (Hastings) Ltd v Gulliver, supra note 100 at 382. 130 Ibid at 391-92. 131 Ibid at 391.

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Cropper.132 Peso Silver Mines Ltd (“Peso”) was in the mining business and had approximately 225 to 230 silver mining claims in the Yukon. Peso had publicly distributed its shares. Cropper, Verity, and Walker were promoters of Peso. Cropper, Verity, and Walker were also three of the six directors of Peso. Between December 1961 and April 1962, an offer for three groups of mining claims that were adjacent to Peso’s claims was brought to the attention of Peso’s board of directors by Dr Aho, a consulting geologist who had been retained by several mining companies including Peso. Peso’s board of directors concluded that it could not afford to make the investment given its financial condition at the time. The president of Peso said that Peso “didn’t have sufficient funds.” Peso, therefore, did not accept the offers. Six weeks later Dr  Aho approached Cropper, Verity, and Walker about the three groups of mining claims adjacent to Peso’s claims that had been the subject of the earlier offer to Peso. Dr Aho, Cropper, Verity, and Walker decided to incorporate a private company, Cross Bow Mines Ltd, to acquire the three mining claims adjacent to Peso’s claims. Sometime later Charter Oil Ltd (“Charter”) acquired sufficient shares of Peso to take over control of Peso. Charter demanded that Cropper, Verity, and Walker give their shares in Cross Bow Mines Ltd to Charter. Verity and Walker agreed to do so. Cropper refused. Cropper was fired from his position as executive vice-president of Peso and Peso brought an action against Cropper for an accounting for the benefit he had received from his interest in the private company, Cross Bow Mines Ltd, that had acquired the mining claims. At the trial Cropper testified that he had forgotten about the offer to Peso. The credibility of that forgetfulness was supported by Cropper’s claim that during the three-year period while he was a director of Peso he received two or three such offers per week. The majority decision in the British Columbia Court of Appeal was that Peso had made a bona fide decision not to take the claims. It would have been different if Cropper had taken the claims when Peso was considering them, but that was not the case. However, given Peso’s bona fide decision not to take the claims, it had no further interest in them. According to the majority, This is not a case like Keech v. Sandford … , where a trustee took unto himself property that had been trust property but which was impossible, although desired, to be continued as such. Nor is it the situation found in the Regal (Hastings), Ltd. case, where the full acquisition of the property was conceived and wanted by the company but other circumstances made it impossible to take that portion which the directors personally took.133

The majority also noted Lord Russell’s statement in Regal (Hastings) Ltd v Gulliver about getting the opportunity in the course of execution of the office of being a director and said that Cropper did not obtain the opportunity in the course of execution of his office but that it had come to him independently. According to the majority, undoubtedly the knowledge of the Cross Bow properties came to the respondent and others because they were directors of the appellant. Also it cannot be questioned that these directors were acting only as such and in execution of that office when they considered and rejected the offer to the company of the properties in question. But their later negotiation for and acquisition of the mineral claims, although based on such knowledge acquired as aforesaid, could not,

132 Peso Silver Mines Ltd v Cropper (1965), 56 DLR (2d) 117 (BCCA). 133 Ibid at 156.

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in my respectful opinion, be said to have been done “only” in their capacity as directors and “in the execution of that office.”134

The majority also took note of the following statement of Lord Russell in Regal (Hastings) Ltd v Gulliver: One final observation I desire to make. In his judgment Lord Greene, M.R., stated that a decision adverse to the directors in the present case involved the proposition that, if directors bona fide decide not to invest their company’s funds in some proposed investment, a director who thereafter embarks his own money therein is accountable for any profits which he may derive therefrom. As to this, I can only say that to my mind the facts of this hypothetical case bear but little resemblance to the story with which we have had to deal.135

With regard to this statement of Lord Russell, the court in Peso said: As Greene, M.R., was found to be in error in his decision, I would think that the above comment by Lord Russell on the hypothetical case would be superfluous unless it was intended to be a reservation that he had no quarrel with the proposition enunciated by the Master of the Rolls, but only that the facts of the case before him did not fall within it.136

The majority of the BC Court of Appeal in Peso appeared, therefore, to take the view, following the hypothetical of Greene MR in Regal (Hastings) Ltd v Gulliver, that if directors bona fide decide not to invest their company’s funds in some proposed investment, a director who thereafter embarks his own money therein is not accountable for any profits that he may derive therefrom. The decision in the BC Court of Appeal, therefore, appeared to take a somewhat more lenient approach than the approach taken in Regal (Hastings) Ltd v Gulliver because it suggested that a court could, in some circumstances, consider whether the company had made a prior bona fide decision not to take the opportunity. The BC Court of Appeal decision was appealed to the Supreme Court of Canada.137 In a unanimous judgment the Supreme Court also held in Cropper’s favour, but did so focusing on the test in Regal (Hastings) Ltd v Gulliver saying that Cropper did not obtain his interest in the mining claims as a result of execution of his office as a director of Peso.138 While that appears to have been the reason for deciding, the court made the apparently obiter dictum statement that the situation was one in which there had been a bona fide decision not to invest Peso’s funds in the adjacent mining claims and a director thereafter embarked his own money in the investment.139

ii.  Can Aero v O’Malley (1974) A more flexible approach to corporate opportunities was articulated by Supreme Court of Canada in its 1974 decision in Can Aero v O’Malley.140 O’Malley was the president and Zarzycki 134 135 136 137 138 139 140

Ibid at 157. Ibid at 157-58, quoting Regal (Hastings) Ltd v Gulliver, supra note 100 at 391. Ibid at 158. Peso Silver Mines Ltd v Cropper, [1966] SCR 673. Ibid at 682. Ibid at 682-83. Can Aero v O’Malley, [1974] SCR 592. For a recent application of Can Aero v O’Malley, see e.g. Matic v Waldner, 2016 MBCA 60.

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was the executive vice-president of Canadian Aero Service Ltd (“Canaero”). Canaero was seeking a topographical mapping contract in Guyana. O’Malley and Zarzycki had made trips to Guyana where they did preliminary aerial surveys and other work in preparing a bid for Canaero. O’Malley and Zarzycki were, however, concerned about limitations Canaero’s US parent company had imposed on the bid that could be submitted. They were also concerned that they would lose their jobs if Canaero did not obtain the topographical mapping contract in Guyana. They incorporated Terra Surveys Limited (“Terra”) and resigned from Canaero. Five days later Terra submitted a bid that won out over Canaero’s bid. Canaero sued O’Malley and Zarzycki seeking an accounting for profits they had made through Terra on the basis that they had taken advantage of a corporate opportunity that they should have brought to Canaero. Laskin J delivered the unanimous judgment of the Supreme Court of Canada. Laskin J held that a duty to account to the corporation can extend beyond the director’s or officer’s term of office or employment.141 The law in this area, Laskin J said, should not be constrained by a narrow reading of the principle of Regal (Hastings) Ltd v Gulliver, as adopted and applied in Peso Silver Mines Ltd v Cropper, that one determine whether the opportunity was a corporate opportunity by assessing whether the director or officer got the opportunity “by reason and only by reason of the fact that they were directors [or officers] … and in the course of the execution of that office.” Laskin J suggested instead an approach of assessing each case on its facts and applying a broad fairness standard rather than any strict rule to be applied in all cases. According to Laskin J: In holding that on the facts found by the trial judge, there was a breach of fiduciary duty by O’Malley and Zarzycki which survived their resignations I am not to be taken as laying down any rule of liability to be read as if it were a statute. The general standards of loyalty, good faith and avoidance of a conflict of duty and self-interest to which the conduct of a director or senior officer must conform, must be tested in each case by many factors which it would be reckless to attempt to enumerate exhaustively. Among them are the factors of position or office held, the nature of the corporate opportunity, its ripeness, its specificness and the director’s or managerial officer’s relation to it, the amount of knowledge pos-sessed, the circumstances in which it was obtained and whether it was special or, indeed, even private, the factor of time in the continuation of fiduciary duty where the alleged breach occurs after termination

141 Can Aero v O’Malley, supra note 140 at 607, where Laskin J said: “In my opinion, this ethic disqualifies a director or senior officer from usurping for himself or diverting to another person or company with whom or with which he is associated a maturing business opportunity which his company is actively pursuing; he is also precluded from so acting even after his resignation where the resignation may fairly be said to have been prompted or influenced by a wish to acquire for himself the opportunity sought by the company, or where it was his position with the company rather than a fresh initiative that led him to the opportunity which he later acquired.” Laskin J had also noted, at 606-7, that officers and not just directors acting as agents for the company owe fiduciary duties to the company. Canaero had been incorporated in 1948 under the Canada Companies Act, SC 1934, c 33. That Act did not have a provision regarding the duty of loyalty and care such as CBCA s 122 that specifically included officers. Liability for the taking of corporate opportunities has been extended to employees who are neither directors nor senior officers of a corporation. See MacMillan Bloedel Ltd v Binstead (1983), 22 BLR 255 (BCSC).

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of the relationship with the company, and the circumstances under which the relationship was terminated, that is whether by retirement or resignation or discharge.142

iii.  The Burg v Horn Situation Referred to in Can Aero v O’Malley Laskin J’s judgment in Can Aero v O’Malley noted in this context the American case of Burg v Horn.143 The Horns had encouraged Mrs  Burg to invest in a real estate company, Darand Realty Corp. The company was incorporated in September 1953 with shares subscribed for equally by three shareholders: Mrs Burg, George Horn, and Max Horn. Darand Realty Corp acquired a low-rent building in Brooklyn. When Mrs Burg invested in Darand Realty Corp she knew the Horns were carrying on real estate business through three other companies each of which also owned similar low-rent buildings in Brooklyn. At the time Mrs Burg invested in Darand Realty Corp there was no discussion of whether the Horns could continue carrying on real estate business through other companies they owned. Subsequently, the Horns became aware of other similar buildings. Two of them were purchased through Darand Realty Corp but nine others were purchased either by the Horns individually or through their other real estate companies. Mrs Burg later sued the Horns for having pursued some of the real estate investment opportunities they had become aware of through companies other than Darand Realty Corp. The trial judge dismissed the claim. Mrs Burg appealed and the Second Circuit Federal Court of Appeal held that the Horns were not, under the circumstances, liable to account to Mrs Burg. The appeal court discussed various approaches that had been taken in the United States to the usurping of corporate opportunities, including tests referred to as the “expectancy test” and the “line of business test.”144 The Second Circuit considered the line of business test to be too broad and adopted instead a test similar to the fairness test suggested in Can Aero v O’Malley. According to the appeal court: [its] holding that the scope of a director’s duty to offer opportunities he has found to his corporation must be measured by the facts of each case seems more consistent than any other with the holdings of New York courts applying the “interest or expectancy” test.145

The appeal court found the Horns not liable because, to the knowledge of Mrs Burg, they were involved in other real estate activities at the time Mrs Burg invested in Darand Realty 142 Can Aero v O’Malley, supra note 140 at 620. Can Aero v O’Malley has not always been read as advocating the broad approach suggested by Laskin J in the quoted paragraph. See e.g. Abbey Glen Property Corporation v Stumborg (1978), 85 DLR (3d) 35 (Alta SC (AD)). In that case, the Stumborg brothers were officers and directors of Abbey Glen’s predecessor corporation, Terra Developments (“Terra”). Terra was a land developer in the Edmonton area. Certain syndicates in which other Stumborg-controlled corporations were substantial participants owned two large parcels of land in Edmonton. On behalf of Terra, the Stumborgs approached Traders Finance Corporation Ltd (“Traders”) of Toronto to attempt to arrange a joint venture between Terra and Traders for the development of the two parcels. Traders refused to deal with Terra because Terra was publicly held and it was against Traders’ policy to enter into joint ventures with public corporations. Traders’ officials gave unequivocal and uncontradicted evidence at trial on this point. In the result, the Stumborgs and Traders formed a new corporation, Green Glenn, to develop the parcels, and the venture was a great success. The Stumborgs were held accountable to Abbey Glen for their profits from Green Glenn. 143 Burg v Horn, 380 F (2d) 897 (2d Cir 1967). 144 Ibid at 900. 145 Ibid.

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Corp and a duty to bring all other business to Darand could not be implied in the circumstances.146

iv.  Director of Many Corporations The US case of Johnston v Greene147 provides an example of a situation in which a person is a director of many corporations. The plaintiff was a shareholder of Airfleets Inc (“Airfleets”). He sued Floyd Odlum, the president and “dominating director” of Airfleets, alleging Odlum had diverted to his personal benefit a corporate opportunity belonging to Airfleets. Odlum was a director of Airfleets. He was also a director of Atlas Corporation, which was Airfleets’ largest single shareholder, and of numerous other business corporations. Lester Hutson owned a patent for the manufacture of self-locking nuts, used in the manufacture of airplanes, as well as all the outstanding shares of Nutt-Shel Company, the exclusive licensee of the patent. Hutson wished to sell both these assets, and to that end he approached Odlum, whom he knew by reputation to be a prominent financier. Odlum thought favourably of the purchases. He was advised by counsel that for tax reasons it would be undesirable for the shares in the patent licensee and the patents themselves to be under common ownership. Odlum caused the shares of Nutt-Shel Company to be offered to Airfleets. Airfleets had been formed to finance aircraft sales but it never, in fact, engaged in that business. When Odlum offered Airfleets the patents and shares of Nutt-Shel Company, Airfleets was cash-rich and looking for profitable investments of any type. Airfleets’ board decided to buy the shares of Nutt-Shel but not the patents. Although Odlum refrained from voting, it was found that he dominated the other directors and that the board’s decision not to buy the patents was in fact his. Subsequently, Odlum bought the patents for a syndicate of 35 individual investors including himself. The chancellor found the purchase of the patents to be an opportunity belonging to Airfleets that had been diverted by Odlum. The Delaware Supreme Court reversed the chancellor’s decision. The following is excerpted from the Supreme Court’s opinion. The first important fact that appears is that Hutson’s offer, which was to sell the patents and at least part of the stock, came to Odlum, not as a director of Airfleets, but in his individual capacity. The Chancellor so found. The second important fact is that the business of Nutt-Shel—the manufacture of self-locking nuts—had no direct or close relation to any business that Airfleets was engaged in or ever had been engaged in, and hence its acquisition was not essential to the conduct of Airfleets’ business. Again, the Chancellor so found. The third fact is that Airfleets had no interest or expectancy in the Nutt-Shel business, in the sense that those words are used in the decisions dealing with the law of corporate opportunity. It is one thing to say that a corporation with funds to invest has a general interest in investing those funds; it is quite another to say that such a corporation has a specific interest attaching in equity to any and every business opportunity that may come to any of its directors in his individual capacity. This is what the Chancellor appears to have held. Such a sweeping extension of the rule of corporate opportunity finds no support in the decisions and is, we think, unsound. It is, of course, entirely possible that a corporate opportunity might in some cases arise out of a corporate need to invest funds and the duty of the president or any other director to seek such an opportunity. But, whether it does arise, in any particular case, depends on the

146 Ibid. 147 Johnston v Greene, 121 A (2d) 919 (Del SC 1956).

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facts—upon the existence of special circumstances that would make it unfair for him to take the opportunity for himself. We cannot find any such circumstances in this case. At the time when the Nutt-Shel business was offered to Odlum, his position was this: He was the part-time president of Airfleets. He was also president of Atlas—an investment company. He was a director of other corporations and a trustee of foundations interested in making investments. If it was his fiduciary duty, upon being offered any investment opportunity, to submit it to a corporation of which he was a director, the question arises, Which corporation? Why Airfleets instead of Atlas? Why Airfleets instead of one of the foundations? So far as appears, there was no specific tie between the Nutt-Shel business and any of these corporations or foundations. Odlum testified that many of his companies had money to invest, and this appears entirely reasonable. How, then, can it be said that Odlum was under any obligation to offer the opportunity to one particular corporation? And if he was not under such an obligation, why could he not keep it for himself? Plaintiff suggests that if Odlum elects to assume fiduciary relationships to competing corporations he must assume the obligations that are entailed by such relationships. So he must, but what are the obligations? The mere fact of having funds to invest does not ordinarily put the corporations “in competition” with each other, as that phrase is used in the law of corporate opportunity. There is nothing inherently wrong in a man of large business and financial interests serving as a director of two or more investment companies, and both Airfleets and Atlas (to mention only two companies) must reasonably have expected that Odlum would be free either to offer to any of his companies any business opportunity that came to him personally, or to retain it for himself—provided always that there was no tie between any of such companies and the new venture or any specific duty resting upon him with respect to it. … It is clear to us that the reason why the Nutt-Shel business was offered to Airfleets was because Odlum, having determined that he did not want it for himself, chose to place the investment in that one of his companies whose tax situation was best adapted to receive it. He chose to do so, although he could probably have sold the stock to an outside company at a profit to himself. If he had done so, who could have complained? If a stockholder of Airfleets could have done so, why not a stockholder of Atlas as well? It is unnecessary to labor the point further. We are of opinion that the opportunity to purchase the Nutt-Shel business belonged to Odlum and not to any of his companies.

v.  Corporation with Many Subsidiaries Another difficulty that can arise in determining whether directors or officers have taken a corporate opportunity occurs when directors or officers of a parent corporation make a decision as to how to allocate a corporate opportunity among numerous subsidiary corporations one or more of which have minority shareholders. In the US case of Sinclair Oil Corporation v Levien,148 Sinclair Oil Corporation (“Sinclair”) held 97 percent of the shares of Sinclair Venezuelan Oil Company (“Sinven”). A minority shareholder of Sinven brought an action against the parent corporation, Sinclair, for an accounting for damage due to the denial of business opportunities to Sinven. The court said that the plaintiff had not proved that there were business opportunities that had come to Sinven independently. From 1960 to 1966, however, Sinclair had purchased or developed oil fields in Alaska, Canada, Paraguay, and other places around the world. The plaintiff claimed that these were all opportunities that

148 Sinclair Oil Corporation v Levien, 280 A (2d) 717 (Del SC 1971).

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could have been brought to Sinven. Sinclair had apparently had a company-wide policy of developing new sources of revenue through its subsidiaries, but Sinven was not permitted participate and was confined to its activities in Venezuela. On appeal the Supreme Court of Delaware held: the plaintiff could point to no opportunities which came to Sinven. Therefore, Sinclair usurped no business opportunity belonging to Sinven. Since Sinclair received nothing from Sinven to the exclusion of and detriment to Sinven’s minority stockholders, there was no self-dealing. … Even if Sinclair was wrong in developing these opportunities as it did, the question arises, with which subsidiaries should these opportunities have been shared? No evidence indicates a unique need or ability of Sinven to develop these opportunities. The decision of which subsidiaries would be used to implement Sinclair’s expansion policy was one of business judgment with which a court will not interfere absent a showing of gross and palpable overreaching. … No such showing has been made here.149

vi.  Yukon Business Corporations Act Safe Harbour for Taking of Business Opportunity The Yukon Business Corporations Act150 specifically allows for a resolution of directors permitting one or more of the directors to take a corporate opportunity. Section 122.1 of the YBCA, added in 2010,151 provides: 122.1(1)  In this section “interested director” means a director whose objectivity or judgment when voting on a resolution under subsection (3) would reasonably be expected to be impaired as a result of (a)  a family, professional, employment or financial relationship with the director seeking authorization; or (b)  an actual or potential benefit or detriment that would devolve on the director (other than one that would devolve on the corporation or its shareholders generally) depending on the outcome of the vote. (2)  Subject to the articles, the bylaws and any unanimous shareholder agreement, a director may take advantage, directly or indirectly, of a business opportunity if, before becoming legally obligated respecting the business opportunity, the director obtains authorization from the corporation in accordance with subsection (3) or (4). (3)  Authorization may be given by resolution of the directors only if (a)  before the resolution is passed the director seeking authorization discloses in writing to every other director all material facts relating to the business opportunity that are then known to the director; (b)  the director seeking authorization and any other interested director abstain from voting on the resolution; and (c)  in the case of a resolution passed at a meeting of directors (i)  a quorum of directors is present at the meeting without counting the director seeking authorization or any other interested director, and (ii)  the resolution is approved by a majority of the directors who cast votes.

149 Ibid at paras 10-11. 150 Supra note 1. 151 Act to Amend the Business Corporations Act, SY 2010, c 8, s 64.

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(4)  Authorization may be given by special resolution of the shareholders only if (a)  before the special resolution is passed the director seeking authorization discloses in writing to each shareholder entitled to vote all material facts relating to the business opportunity that are then known to the director seeking authorization; (b)  in the case of a resolution passed at a meeting of shareholders, shares registered in the name of or beneficially owned or controlled by the director seeking authorization or any other interested director are not voted on the special resolution; and (c)  in the case of a written resolution passed in accordance with section 143, the resolution is approved by all the shareholders under paragraph 143(1)(a) and paragraph 143(1)(b) shall not apply. (5)  A copy of the portion of any minutes of meetings or resolutions of directors that record authorizations made under this section together with the written disclosure shall be kept at the corporation’s records office in the register of disclosures. (6)  If a director takes advantage, directly or indirectly, of a business opportunity after having received authorization to do so under this section, such activity shall not be subject to equitable relief nor give rise to an award of damages or other remedies against the director in a proceeding by or on behalf of the corporation on the ground that such activity constitutes a breach of the director’s duties under this Act or the common law. (7)  If a director takes advantage, directly or indirectly, of a business opportunity without having sought authorization to do so under this section, that fact shall not create an inference that the opportunity should have been presented by the director to the corporation nor alter the burden of proof otherwise applicable to establish that the director breached a duty to the corporation in the circumstances.

Section 143(1)(a) of the YBCA allows for a resolution in writing by shareholders in lieu of a resolution at a meeting as long as the resolution is approved by all the shareholders entitled to vote on the resolution. To what extent is this provision different from the conflict of interest provisions discussed in Section IV.B.1 above? One difference is that there is no express power for a court to consider, as in CBCA s 120(7), whether the taking of the business opportunity is “reasonable and fair to the corporation,” and YBCA s 122.1(6) seems to preclude a court from granting a remedy based on such a consideration.

3.  Proper Purpose and the Best Interests of the Corporation Persons such as trustees, agents, and directors of corporations are given powers, or authority, to act on behalf of others. A power gives the person with the power the authority, or permission, to do something. That person must act within the scope of the power given to him or her. The person has no permission to act beyond the scope of the power. In the context of decisions of directors or officers it is, therefore, important to ask whether the directors have, or the particular officer has, the power, or authority, to do a particular thing. This question was largely addressed in Chapter 11, which discussed the various powers of directors and officers. The powers of the directors include the power to manage or supervise the management of the corporation (CBCA s 102), the power to issue shares (CBCA s 25), and the power to appoint officers and delegate tasks to them (CBCA s 121). In assessing whether directors or a particular officer had acted within the scope of a power given to them, courts looked to see whether the directors or officer had exercised the power in a way that was consistent with the purpose for which the power was given. If the power was exercised for a purpose consistent with the purpose for which it was given, then

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the power was said to have been exercised for a proper purpose and the directors or officer had, therefore, acted within the scope of the power. If the power was exercised for a primary purpose that was not consistent with the purpose for which it was given, then the exercise of the power was said to have been beyond the scope of the power. If the directors or an officer had the power to act and had exercised the power for a proper purpose, the next question was whether the power had been exercised in a way that was consistent with the fiduciary duty of loyalty to act in the best interests of the corporation.152 The discussion below, therefore, first considers the “proper purpose test” and then the “best interests of the corporation.” Many of the cases that have considered the proper purpose test and the best interests of the corporation have done so in the context of takeover bids. A takeover bid is a bid, or offer, for the shares of a corporation with a view to obtaining sufficient voting rights to determine who the directors of the corporation will be and, therefore, control the management of the corporation. The validity of acts of directors in response to a takeover bid is discussed in more detail in Chapter 15.

a.  The Proper Purpose Test The difficulty with the proper purpose test described above is that the purpose of a corporate power is rarely, if ever, set out. A court would, therefore, have to infer the purpose for which the power was given. There may, however, be more than one purpose for a particular power. The Privy Council noted the possibility that there might be more than one purpose for a power in its 1974 decision in Howard Smith Ltd v Ampol Petroleum Ltd.153 Rather than 152 The proper purpose rule has been said to have been present for many years with cases applying it in the trust context as early as Lane v Page (1754), Amb 233 and Aleyn v Belchier (1758), 1 Eden 132 at 138, where Lord Northington claimed that “no point was better established.” Lord Westbury LC expressed the rule in the following way in Duke of Portland v Topham (1864), 11 HLC 32 at 54, 11 ER 1242 at 1251, “that the donee, the appointor under the power, shall, at the time of the exercise of that power, and for any purpose for which it is used, act with good faith and sincerity, and with an entire and single view to the real purpose and object of the power, and not for the purpose of accomplishing or carrying into effect any bye or sinister object (I mean sinister in the sense of its being beyond the purpose and intent of the power) which he may desire to effect in the exercise of the power.” See also Balls v Strutt (1841), 1 Hare 146, 66 ER 984. 153 Howard Smith Ltd v Ampol Petroleum Ltd, [1974] 1 AII ER 1126, [1974] AC 821 (PC). Ampol Petroleum Ltd (“Ampol”) owned 29.8  percent of the shares of RW Miller (Holdings) Ltd (“Millers”) and Bulkships Ltd (“Bulkships”) owned 25.1 percent of the shares of the shares of Millers. Together, Ampol and Bulkships owned 54.9 percent of the shares of Millers. Ampol had made a bid for all the remaining issued shares of Millers. Discussions were held with Howard Smith Ltd concerning the making of a competing offer for the shares of Millers. The directors of Millers met to consider an offer from Howard Smith Ltd to acquire newly issued shares of Millers that would have the effect of reducing the Ampol and Bulkships combined percentage share ownership to 36.6 percent of the outstanding shares of Millers. Millers needed capital, and the number of shares to be issued to Howard Smith Ltd was determined according to Millers’ need for capital on the basis of legal advice that the raising of capital was the only bona fide basis for the exercise by the directors of the power to cause Millers to issue shares. Previous cases had inferred that the purpose of the power to issue shares was to raise capital. Two competing arguments were made. One was that where the purpose of the power is not identified, the only duty of the directors is to exercise the power in the best interests of the corporation. The other was that if the purpose of the share issuance was found to be other than the raising of capital, the share issuance was invalid. The Privy Council held that neither of these extreme positions was correct, and their Lordships went on to set out the approach described in the text above.

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attempting to infer a single specific purpose, or set of purposes, the Privy Council’s approach was to determine the “substantial or primary purpose” for which the power was exercised and then ask whether that purpose fit within any of the possible purposes for which the power was likely to have been given. Their Lordships set out that test in the following words: In their Lordships’ opinion it is necessary to start with a consideration of the power whose exercise is in question, in this case a power to issue shares. Having ascertained, on a fair view, the nature of this power, and having defined as can best be done in the light of modern conditions the, or some, limits within which it may be exercised, it is then necessary for the court, if a particular exercise of it is challenged, to examine the substantial purpose for which it was exercised, and to reach a conclusion whether that purpose was proper or not.154

The proper purpose rule has been codified in the UK Companies Act, 2006, s  171(b) of which says that a director of a company must “only exercise powers for the purposes for which they are conferred.” The provision was considered and the proper person doctrine was discussed in the 2015 UK Supreme Court decision in Eclairs Group Ltd and Glengary Overseas Ltd v JKX Oil & Gas plc.155 Eclairs Group Ltd (“Eclairs”) owned 27.55 percent of the issued shares of JKX Oil & Gas plc (“JKX”). In 2013, Eclairs wrote to JKX calling on JKX to convene an extraordinary general meeting to consider resolutions for the removal of the JKX’s chief executive and its commercial director from the board of directors and for the appointment of three new directors. JKX responded by calling an annual general meeting with various resolutions and demanding disclosure notices, pursuant to s 793 of the Companies Act, 2006, requesting information from Eclairs about any interest it had in the shares of JKX and any agreement or arrangements it had with persons interested in the JKX shares. Article 42 of the articles of JKX permitted the directors to restrict the voting of shares by a person where the board knew or had reasonable cause to believe that the information provided in the disclosure was false or materially incorrect. The board of directors, with the chief executive and commercial director recusing, exercised the power given to the directors of the board in article 42 of the JKX’s articles to restrict the voting of shares held by Eclairs. Lord Sumption, in the part of his judgment concurred in by the four other judges who heard the case, said the following about the application of the proper purpose rule: The submission of Mr Swainston QC, who appeared for the company [JKX], was that where the purpose of power was not expressed by the instrument creating it, there was no limitation on its exercise save such as could be implied on the principles which would justify the implication of a term. In particular, the implication would have to be necessary to its efficacy. In my view, this submission misunderstands the way in which purpose comes into questions of this kind. It is true that a company’s articles are part of the contract of association, to which successive shareholders accede on becoming members of the company. I do not doubt that a term limiting the exercise of powers conferred on the directors to their proper purpose may sometimes be implied on the ordinary principles of the law of contract governing the implication of terms. But that is not the basis of the proper purpose rule. The rule is not a term of the contract and does not necessarily depend on any limitation on the scope of the power as a matter of construction. The proper purpose rule is a principle by which equity controls the exercise of a fiduciary’s powers in respects which are not, or not necessarily, determined by the instrument. Ascertaining the

154 Howard Smith Ltd v Ampol Petroleum Ltd, supra note 153 at 835. 155 Eclairs Group Ltd and Glengary Overseas Ltd v JKX Oil & Gas plc, [2015] UKSC 71.

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purpose of a power where the instrument is silent depends on an inference from the mischief of the provision conferring it, which is itself deduced from its express terms, from an analysis of their effect, and from the court’s understanding of the business context. The purpose of a power conferred by a company’s articles is rarely expressed in the instrument itself. It was not expressed in the instrument in any of the leading cases about the application of the proper purpose rule to the powers of directors which I have summarised. But it is usually obvious from its context and effect why a power has been conferred, and so it is with article 42. Article 42(2) authorises the issue of a restriction notice only in the event that a disclosure notice has been issued under section 793 of the 2006 Act and the company has received either no response or a response which it knows or has reasonable cause to believe is false or materially incorrect. … As Millett J observed in In re Ricardo Group Plc [1989] BCLC 566, 572 about the corresponding power of the court to impose restrictions under what was then section 216 and Part XV of the Companies Act 1985, these restrictions “are granted as a sanction to compel the provision of information to which the company is entitled. It follows, in my judgment, that once the information is supplied, any further justification for the continuance of the sanction disappears.” The inescapable inference is that the power to restrict the rights attaching to shares is wholly ancillary to the statutory power to call for information under section 793. It follows that I accept the view of Mann J [the trial judge] that the purpose of article 42 is to provide a “sanction or incentive” to remedy a failure to comply with the disclosure notice. But I would not limit it to inducing the defaulter to comply … . Otherwise the board would be disabled from imposing restrictions in a case where the defiant obduracy of the defaulter made it obvious that the restrictions would not produce compliance. I would therefore identify the purpose in slightly different terms. In my view article 42 has three closely related purposes. The first is to induce the shareholder to comply with a disclosure notice. … Secondly, the article is intended to protect the company and its shareholders against having to make decisions about their respective interests in ignorance of relevant information. … Thirdly, the restrictions have a punitive purpose. They are imposed as sanctions on account of the failure or refusal of the addressee of a disclosure notice to provide the information for as long as it persists, on the footing that a person interested in shares who has not complied with obligations attaching to that status should not be entitled to the benefits attaching to the shares. That is the natural inference from the range and character of restrictions envisaged in article 42(3), which affect not only the right to participate in the company’s affairs by voting at general meetings, but the right to receive dividends. These three purposes are all directly related to the non-provision of information requisitioned by a disclosure notice. None of them extends to influencing the outcome of resolutions at a general meeting. That may well be a consequence of a restriction notice. But it is no part of its proper purpose. It is not itself a legitimate weapon of defence against a corporate raider, which the board is at liberty to take up independently of its interest in getting the information.156

Lord Sumption applied the proper purpose principle to the facts of the case, saying: What the judge’s findings amount to is that although at the critical board meeting the majority genuinely wanted to receive the information which they had requisitioned, once they were satisfied that it had not been provided and turned to consider the issue of restriction notices, they were interested only in the effect that this would have on the outcome of the forthcoming general meeting. They “did not have in mind the protection of the company pending the provision of the information; they had in mind protecting the company full stop” (para 200(d)). In any case where concurrent purposes are being considered, they must have been actual purposes in

156 Ibid at paras 30-32.

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the minds of the directors, not merely possible or hypothetical ones. If the only consideration which actually influenced the decision was an improper one, it is difficult to envisage any basis on which their decision could have been sustained.157

In 1973, one year before the UK decision in Howard Smith Ltd v Ampol Petroleum Ltd, a different approach to the problem of attempting to infer the purpose, or purposes, for a power was taken in Canada in Teck Corporation Limited v Millar.158 In Teck Corporation Limited v Millar, the directors of Afton Mines Ltd (“Afton”), including Millar, sought to prevent Teck Corporation Limited (“Teck”) from using its ownership of the majority of the shares of Afton it had acquired to exercise control of Afton. The directors of Afton caused Afton to issue enough shares of Afton to Canadian Exploration Ltd to reduce the proportion of shares held by Teck so that it could no longer exercise control of Afton. There was previous authority saying that the purpose of a power to issue shares is to raise capital for the company.159 The argument on behalf of Teck was, therefore, that the directors of Afton had acted for an improper purpose. It was alleged that the purpose for which the directors of Afton had exercised the power to issue shares was to block Teck from exercising control of Afton. This, it was said, was inconsistent with the purpose of the power to issue shares, since the purpose of the power to issue shares was to raise capital. Noting the difficulty of attempting to infer a purpose, Berger J said that the test should, instead, be simply a test of whether the directors or officers acted in good faith in the best interests of the corporation. Berger J said: My own view is that the directors ought to be allowed to consider who is seeking control and why. If they believe that there will be substantial damage to the company’s interests if the company is taken over, then the exercise of their powers to defeat those seeking a majority will not necessarily be categorized as improper. I do not think that it is sound to limit the directors’ exercise of their powers to the extent required by Hogg v. Cramphorn … . But the limits of their authority must be clearly defined. It would be altogether a mistake if the law, in seeking to adapt itself to the reality of corporate struggles, were to allow the directors any opportunity of achieving an advantage for themselves at the expense of the shareholders. … If the directors have the right to consider the consequences of a take-over, and to exercise their powers to meet it, if they do so bona fide in the interests of the company, how is the Court to determine their purpose? In every case the directors will insist their whole purpose was to serve the company’s interest. And no doubt in most cases it will not be difficult for the directors to persuade themselves that it is in the company’s best interests that they should remain in office. Something more than a mere assertion of good faith is required. How can the Court go about determining whether the directors have abused their powers in a given case? How are the Courts to know, in an appropriate case, that the directors were genuinely concerned about the company and not merely pursuing their own selfish interests? … I think the Courts should apply the general rule in this way: The directors must act in good faith. Then there must be reasonable grounds for their belief. If they say that they believe there

157 Ibid at para 41. 158 Teck Corporation Limited v Millar (1972), 33 DLR (3d) 288, [1973] 2 WWR 385 (BCSC) [Teck cited to DLR]. 159 See e.g. Hogg v Cramphorn, [1967] Ch 254, [1966] 3 All ER 420; and, in Canada, see e.g. Bonisteel v Collis Leather Co Ltd (1919), 45 OLR 195.

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will be substantial damage to the company’s interests, then there must be reasonable grounds for that belief. If there are not, that will justify a finding that the directors were actuated by an improper purpose.160

This approach was followed in a number of subsequent decisions in Canada.161

b.  The Best Interests of the Corporation The duty to act in good faith in best interests of the corporation (that is, the duty of loyalty) can arise in various ways, some of which have been discussed above. These include conflict of interest transactions and the taking of corporate opportunities. The duty of loyalty of directors and officers has long been expressed as a duty to act in the best interests of the corporation,162 but this has sometimes been interpreted as the best interests of shareholders.163 This interpretation of the duty to act in the best interests of the shareholders has been referred to as the “shareholder primacy model.” However, in Teck Corporation Limited v Millar, Berger J said: A classical theory that once was unchallengeable must yield to the facts of modern life. In fact, of course, it has. If today the directors of a company were to consider the interests of its employees no one would argue that in doing so they were not acting bona fide in the interests of the company itself. Similarly, if the directors were to consider the consequences to the community of any policy that the company intended to pursue, and were deflected in their commitment to that policy as a result, it could not be said that they had not considered bona fide the interests of the shareholders.164

In 2004 the Supreme Court of Canada, in Peoples Department Stores v Wise,165 quoted this statement of Berger J in Teck with approval. The Supreme Court of Canada said: We accept as an accurate statement of law that in determining whether they are acting with a view to the best interests of the corporation it may be legitimate, given all the circumstances of a given case, for the board of directors to consider, inter alia, the interests of shareholders, employees, suppliers, creditors, consumers, governments and the environment.166

In 2008 in BCE Inc v 1976 Debentureholders,167 the Supreme Court of Canada quoted this statement from Peoples Department Stores with approval and said:

160 Teck, supra note 158 at 315-16. 161 See e.g. Icahn Partners LP v Lions Gate Entertainment Corp, 2011 BCCA 228; Maple Leaf Foods Inc v Schneider Corp (1998), 42 OR (3d) 177, 44 BLR (2d) 115 (CA); 347883 Alberta Ltd v Producers Pipelines Inc (1991), 80 DLR (4th) 359 at para 38, [1991] 4 WWR 577 (Sask CA); and Re Olympia & York Enterprises Ltd and Hiram Walker Resources Ltd (1986), 59 OR (2d) 254, 37 DLR (4th) 193 (Div Ct). 162 Re Smith & Fawcett Ltd, [1942] Ch 304 at 306 (the directors “must exercise their discretion bona fide in what they consider … is in the interests of the company”). 163 See e.g. Martin v Gibson, [1907] 15 OLR 623 (H Ct J). 164 Teck, supra note 158 at 314. 165 Supra note 63. 166 Ibid at para 42. 167 Supra note 75.

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In considering what is in the best interests of the corporation, directors may look to the interests of, inter alia, shareholders, employees, creditors, consumers, governments and the environment to inform their decisions.168

In BCE Inc the court also said that [t]he fiduciary duty of the directors to the corporation is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is an ongoing concern, it looks to the long-term interests of the corporation. The content of this duty varies with the situation at hand. At a minimum, it requires the directors to ensure that the corporation meets its statutory obligations. But, depending on the context, there may also be other requirements. In any event, the fiduciary duty owed by directors is mandatory; directors must look to what is in the best interests of the corporation.169

In Canada, therefore, the Supreme Court of Canada has confirmed, in accordance with the wording of CBCA s 122(1)(a), that directors owe their duty of loyalty to the corporation. The Supreme Court has also confirmed that in considering what is in the best interests of the corporation, directors can consider not just shareholder interests but the interests of other stakeholders such as employees, creditors, and consumers. In 2006 the UK Companies Act was amended to provide in s 172(1) as follows: A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to— (a)  the likely consequences of any decision in the long term, (b)  the interests of the company’s employees, (c)  the need to foster the company’s business relationships with suppliers, customers and others, (d)  the impact of the company’s operations on the community and the environment, (e)  the desirability of the company maintaining a reputation for high standards of business conduct, and (f)  the need to act fairly as between members of the company.170

To what extent is this similar to what was said in the Supreme Court of Canada decisions in Peoples Department Stores v Wise or BCE Inc? Do the opening words of s  172(1) of the UK Companies Act, 2006—“benefit of its members [that is, shareholders] as a whole”—effectively prescribe a shareholder primacy test with the interests of employees, suppliers, and customers, and the impact of the company’s operations on the community and the environment only taken into account to the extent that it is “for the benefit of its members as a whole”? Should a similar statutory provision be adopted in Canada?

168 Ibid at para 40. In Psychological Association (Ontario) v Mardonet, 2016 ONSC 4528, it was argued that directors and officers owed a fiduciary duty specifically to an employee. The court said, at paras 23 and 24, that this statement in BCE Inc confirms that the loyalty of directors and officers is owed to the corporation and added, “It does not suggest that there is a duty of loyalty to employees independent of that directed to the corporation.” 169 BCE Inc, supra note 75 at para 38. 170 See the Companies Act, 2006, c 46, s 172(1).

CHAPTER FOURTEEN

Stakeholder Remedies







I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 891 II.  The Derivative Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 892 A.  At Common Law: The Rule in Foss v Harbottle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 892 B.  Statutory Derivative Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 894 III.  The Oppression Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 914 A.  UK Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 914 B.  Canadian Oppression Remedy Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 915 C.  Who May Bring an Application for an Oppression Remedy? . . . . . . . . . . . . . . . . . . 916 D.  Closely Held Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 924 E.  Widely Held Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 940 F.  Relationship Between the Derivative Action and the Oppression Remedy . . . . 970 IV.  Appraisal Remedy (Right to Dissent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 975 V.  Other Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 990 A.  Compliance Orders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 990 B.  Winding Up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 991 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 991

I. INTRODUCTION A corporation is a separate legal person, managed by an autonomous board of directors and senior officers. Those directors and managers make the business decisions for the corporation, and in doing so owe duties of care and skill and fiduciary obligations to that constructed entity. But without other stakeholders who finance the corporation, contractually engage, or otherwise interact with it, those directors and managers would not have much to do. Although these various stakeholders are vital to the growth and prosperity of the corporation, corporate management has no direct duty to them; traditional corporate theory and judicial authority dictate that management serves only the interests of the corporate entity itself. Of course sound management of the corporation will also likely serve the interests of these various stakeholders. However, should management breach its obligations to the corporation, with the downstream result that other corporate stakeholders are also negatively affected, those stakeholders may be barred from seeking justice or compensation. Only the directors and managers, who caused the harm, have the ability to cause the corporation to take any legal action. In such circumstances, they are unlikely to cause the corporation to take action against themselves. The common law was of little help to most corporate stakeholders, denying them standing to sue, unless the impugned act gave rise to a personal right of action. Today, the Canada 891

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Business Corporations Act, RSC 1985, c C-44 (CBCA) and similar provincial and territorial corporate statutes have established a code that allows certain stakeholders to file suit on behalf of the corporation when the management refuses to do so. Apart from corporate rights, the stakeholders of a corporation also have long-recognized personal rights. Shareholders, in particular, have the right to receive notice of meetings, the right to vote, and the right to accurate corporate information, as discussed in Chapters 10 and 12. However, English and Canadian courts demonstrated a strong disinclination to interfere in “internal corporate affairs,” often ignoring situations where minority shareholders were disregarded by the majority and corporate management. Modern corporation statutes in Canada now provide several procedural vehicles to bring issues involving stakeholder personal rights before the courts. By far the most expansive remedy is an application for relief from oppression. The oppression remedy not only protects strict personal legal rights, but also considers the reasonable expectations of certain parties. The remedy is available if an act or omission of the corporation is oppressive, unfairly prejudicial, or unfairly disregards the interests of a listed stakeholder. Such equitable considerations significantly expand the protection of stakeholders from certain decisions of corporate management. The remedies discussed in this chapter are often referred to as “shareholder remedies.” Although shareholders are likely the stakeholders who most often benefit from these remedies, and in the case of the appraisal remedy are the only ones to whom the remedy applies, it is clear from the legislation and the case law that various parties are entitled to seek many of these remedies to counter management conduct that negatively affects either the corporation in which they have an interest or their personal rights and expectations.

II.  THE DERIVATIVE ACTION A.  At Common Law: The Rule in Foss v Harbottle

MA Maloney, “Whither the Statutory Derivative Action?” (1986) 64 Can Bar Rev 309 at 310-14 (footnotes incorporated into text) The modern corporation, and consequently modern corporation statutes, is premised on two complementary principles: the concepts of separate legal personality and internal autonomy. These principles are particularly important from the perspective of shareholder remedies. The separate legal entity of the corporation ensures that when a wrong is done to the company then it is a wrong for which only the corporation can sue and not individual shareholders. Accordingly, the corporation is the only proper plaintiff. Complementing this, the internal autonomy rule requires that the corporate decision to sue must be taken by the board of directors, or in certain circumstances by the majority of shareholders in general meeting. A “catch-22” situation arises from the overlap of these two tenets when the wrongs that are done to the company are done by the very people who control the company, the board of directors or, as the case may be, the majority shareholders. It is highly unlikely that wrongdoers will propose bringing an action on behalf of the company against themselves. Consequently, from the minority shareholders’ perspective,

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the combination of these factors has often been disastrous. It has been extremely difficult, if not impossible, to bring an action against a miscreant director if the wrong complained of can be classified as a wrong to the corporation instead of, or in addition to, a personal wrong to a shareholder. … The common law position was clearly pronounced in the seminal case of Foss v. Harbottle, [(1843), 2 Hare 460, 67 ER 189 (HL)] in which the Vice-Chancellor held that a shareholder had no locus standi to sue on the company’s behalf where the breach complained of was a wrong done to the company by the directors. Any decision to sue must be taken by the board of directors or the shareholders in general meeting, failing which no action could be brought. Four exceptions to the rule in Foss v. Harbottle were developed, enunciated by Jenkins L.J. in Edwards v. Halliwell [[1950] 2 All ER 1064 (CA)]. These consisted of conduct which could be classified as: ultra vires acts; fraud on the minority; requiring special majorities which had not been obtained; or giving rise to a personal cause of action. The first, third and fourth of the exclusions are self-evident, and strictly speaking, do not fall within the ambit of the Foss v. Harbottle rule. The former two merely allow a shareholder to bring an action where some illegality has taken place, and the latter is simply a reaffirmation that a shareholder has in some circumstances (for example, for voting rights) a personal right of action. All are independent actions regardless of the Foss v. Harbottle rule. The only true exception to the rule is the second category: that of fraud on the minority. Not surprisingly then, this is the category most invoked and the one that has raised the most problems. Fraud on the minority, defined loosely, concerns an abuse of power usually by the directors. The applicant must show evidence of abuse and furthermore that the conduct was not in the best interests of the company. This is no easy task. Although the courts have proclaimed a willingness to intervene in any case where injustice is being worked, and to prevent the management of companies being so conducted as to produce injustice or injury to any of the members, the practical results have been slight. The courts’ concept of injustice has a high threshold. The inequities that may arise because of the courts’ refusal to widen the concept of “fraud on the minority” is illustrated well by the case of Pavlides v. Jenson [[1956] Ch 565, [1956] 2 All ER 518 (Ch D)]. In this case the directors sold assets worth over a million pounds for only one hundred and eighty-two thousand pounds. Not surprisingly, the minority shareholders complained. There were allegations of fraud and gross mismanagement. The court held that the action was not maintainable, negligence only having been shown; no fraud on the minority could be proved. This meant that as the shareholders could ratify the negligent acts in general meeting the applicant shareholder had no right to bring the action. … [T]he prohibitive general rule in Foss v. Harbottle has been extended to cover most cases where the wrongs complained of are in fact carried out by the directors. … There are advantages to such a strict rule. Certainly when Foss v. Harbottle is placed in its historical context, in the midst of the industrial revolution and at the height of the railway boom, it is understandable. Freely available registration of companies was still unavailable and automatic limited liability another decade away. The courts may have been insulating entrepreneurs from actions by individual shareholders to encourage risk-taking and bold management.

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… There are other reasons still applicable today for the courts’ refusal to enter the corporate fray in this area. The courts are reluctant to intervene in the business affairs of corporations which are private entities. All internal disputes should be resolved by members themselves. This ensures that the shareholders in general meeting do have the last say in the company’s affairs. If the irregularity is one which can be ratified, Foss v. Harbottle prevents an action being brought until a general meeting has been held to decide the issue. … One danger of allowing such an action would be the prospect of unlimited litigation, with disgruntled shareholders running to the courts every time a corporate resolution is passed or action taken which is not entirely to their liking or in their interests.

B.  Statutory Derivative Actions One of the major reforms of modern Canadian corporation statutes establishes a procedure which overcomes some of the hurdles of the rule in Foss v Harbottle. These statutes contain sections authorizing various applicants to bring representative actions on behalf of corporations and, in some jurisdictions, their subsidiaries, as of right, subject only to the judicial discretion involved in interpreting legislative conditions. However, the remedy is not meant to address indirect harm to the stakeholders. In 2016, the Québec Court of Appeal indicated that a shareholder has no direct cause of action against a director for indirect loss of share value due to harm done to the company.1 Although the decision was based on the Civil Code of Québec, the court indicated that the relevant provision of the Code replicated the long established common law rule of Foss v Harbottle. CBCA ss 238-240 and 242 set out the rules governing shareholder derivative actions. A “complainant” under s  238 may commence a derivative action with leave of court under s 239. “Complainant” is defined as: (a)  a registered holder or beneficial owner, and a former registered holder or beneficial owner, of a security of a corporation or any of its affiliates, (b)  a director or an officer or a former director or officer of a corporation or any of its affiliates, (c)  the Director, or (d)  any other person who, in the discretion of a court, is a proper person to make an application.

Most provincial counterparts to the CBCA adhere to this definition (although Alberta,2 New Brunswick,3 and Nova Scotia4 also specifically mention “creditor” in the definition of “complainant”). The court will only permit the action to be brought under s 239(2) if: (a)  the complainant has given reasonable notice to the directors … of the complainant’s intention to apply to the court … [for leave] if the directors … do not bring [or] diligently prosecute … the action;



1 2 3 4

Groupe d’action d’investisseurs dans Biosyntech c Tsang, 2016 QCCA 1923. Business Corporations Act, RSA 2000, c B-9 [ABCA], s 239 (iii). Business Corporations Act, SNB 1981, c B-9.1 [NBCA], s 163(c). Companies Act, RSNS 1989, c 81 [NSCA], Third Schedule, s 7(5).

895

II.  The Derivative Action (b)  the complainant is acting in good faith; and (c)  [the action] appears to be in the best interests of the corporation.

It is not clear what condition (b) adds to (c). While an honest but misguided complainant might wish to bring an action that would not be in the best interests of the corporation, it is hard to imagine the reverse. Consider the following application of these preconditions for leave to the facts of this case.

Primex Investments Ltd v Northwest Sports Enterprises Ltd 1995 CanLII 717, [1995] BCJ No 2262 (SC) [Northwest owned the Vancouver Canucks National Hockey League franchise. Northwest was building a new arena for the Canucks and had begun to pursue a National Basketball Association (NBA) franchise, which would also use the new arena after it was built. The new arena was being built by the Arena Corporation, a wholly owned subsidiary of Northwest. This dispute concerned an allegation that Griffiths, the majority shareholder in Northwest, had obtained permission from the Northwest board to pursue a NBA franchise for Vancouver on behalf of a partnership he had created by misleading the directors about a crucial fact. He let them believe that the NBA franchise would be renting space in the new arena that Northwest was building when he and his partners had agreed that they would take over the arena for their partnership. Griffiths and his partners then obtained control of the arena from Northwest by making a takeover bid for Northwest that some minority shareholders alleged undervalued the assets. They brought an application to commence a derivative action against Griffiths and other directors.] Criteria for Leave [28]  Subsection 225(1) of the Act [British Columbia Company Act] provides that a member of a company may, with leave of the court, bring an action on behalf of the company. Subsection 225(3) sets out the criteria for the granting of leave: A member or director may, on notice to the company, apply to the court for the leave referred to in subsection (1) or (2) and, if (a) he has made reasonable efforts to cause the directors of the company to commence or diligently prosecute or defend the action; (b) he is acting in good faith; (c) it is prima facie in the interests of the company that the action be brought or defended; and (d) in the case of an application by a member, he was a member of the company at the time of the transaction or other event giving rise to the cause of action, the court may require that notice of the application be served on those persons, and may grant the leave on terms it considers appropriate.

[29]  There is no issue over whether the Petitioner has satisfied clauses (a) and (d) of s. 225(3). The contest has been over the criteria contained in clauses (b) and (c).

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Good Faith [30]  The principal of the Petitioner has deposed that it is acting in good faith in wanting Northwest to bring a lawsuit in connection with the NBA franchise and the disposition of the Arena Shares. The Respondents submit that the Petitioner has not satisfied the onus on it to demonstrate good faith. Relying on the following passages from Tremblett v. S.C.B. Fisheries Ltd. (1993), 116 Nfld. & PEIR 139 (Nfld. SC)., they say that the onus is a substantial one: … it is necessary that an applicant bring cogent evidence establishing clearly on a preponderance of evidence that the application is in fact brought in good faith. (p. 151) •  •  •

… in an application such as this there is a substantial onus on an applicant-complainant himself to positively establish “good faith”  … [I]t seems to me that this is a logical and appropriate requirement where the remedy sought is to place in the control of an applicant who is potentially, and indeed perhaps usually, a minority shareholder or single director, the authority to cause the resources of the corporation to be directed towards pursuing a court proceeding which is not willingly pursued by the majority of shareholders of the board. Even though this matter is assessed on an application, as opposed to a trial, in my view there is a substantial onus to be met by any applicant, including the applicant here, with respect to the establishment of good faith. (pp. 157-8)

[31]  The Respondents point to many manifestations of the alleged bad faith (counsel for the Petitioner counted a total of 17) but they are all illustrations of the following two bad faith motives asserted by the Respondents: (a) the Petitioner is pursuing a personal vendetta against Mr. Griffiths; (b) the Petitioner is not concerned about the best interests of Northwest but, rather, it is attempting to maximize its profits.

Although the Respondents did not expressly make the allegation in their written submissions, I infer from comments made during their counsel’s oral submissions that they view the Petitioner’s activity as a form of extortion to force 453333 to buy the Petitioner’s shares in Northwest at a price higher than the $75 amount of the takeover bid. [32]  It is my view that the Petitioner has satisfied the onus of showing that it is acting in good faith. The principal of the Petitioner, Mr. Rennison, may not like Mr. Griffiths but I do not believe that he is being motivated by spite. The Respondents point to the several facts, particularly Mr. Rennison writing “Arthur’s Evil Plan” on a piece of paper on which he analyzed 453333’s takeover bid and Mr. Rennison’s potential offence resulting from Mr. Griffiths’ comment that his group would not “touch him with a ten foot pole” but might be prepared to include other Northwest minority shareholders as investors in 453333. Neither of these facts establish bad faith. Mr. Rennison believes that Mr. Griffiths has acted improperly and, if there were no substance behind the belief, one could conclude that he is pursuing a vendetta. However, as I conclude when dealing with the criteria under s. 225(3)(c), there is an arguable case that Northwest has a claim against Mr. Griffiths. Mr. Rennison cannot be said to be acting in bad faith because he wants Northwest to pursue what he genuinely considers to be a valid claim against Mr. Griffiths.

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II.  The Derivative Action

[33]  The Respondents point to the fact Mr. Rennison did not make an objection to the transfer of the Arena Shares in the spring of 1994 and they say he was only interested in maximizing the price for the Petitioner’s shares in Northwest. The Respondents also say that a $10 million offer for the Arena Shares made by another company owned by Mr. Rennison in April 1994 was no more than a free option and that the offer was made in bad faith. I fail to see how these demonstrate bad faith on the part of the Petitioner in bringing this application. The $10 million offer for the Arena Shares shows that Mr. Rennison was of the view that the $100 transfer price offered by 453333 was too low. It is not surprising that Mr. Rennison devoted his efforts in the spring of 1994 to maximizing the price for its Northwest shares because that was the Petitioner’s primary interest. [34]  I have no doubt that the Petitioner is acting out of self-interest in wanting to prosecute the derivative action. The self-interest is to maximize the value of its shares in Northwest by pursuing causes of action which it may have against Mr. Griffiths and the other directors. The Petitioner’s self-interest coincides with the interests of Northwest. This does not mean the Petitioner is acting in bad faith: see Richardson Greenshields v. Kalmacoff (1995), 22 OR (3d) 577 (Ont.  CA). Anything that benefits a company will indirectly benefit its shareholders by increasing the share value and it is hard to imagine a situation where a shareholder will not have a self-interest in wanting the company to prosecute an action which is in its interests to prosecute. [35]  There is no evidence that the Petitioner is using the threat of a derivative action as a means to force 453333 to buy its shares. The Petitioner has not offered to drop the lawsuit if its shares are bought. When the Petitioner was attempting to negotiate a higher takeover bid from 453333, it was not looking for special treatment. It wanted the bid to be improved for the benefit of all of the minority shareholders. There was nothing wrong with the Petitioner attempting to maximize the amount of the takeover bid. It was not satisfied with the amount of the final takeover bid and it ultimately chose not to tender its shares. It has assessed the situation following the completion of the transactions and it bona fide wishes Northwest to pursue causes of action in relation to the transactions which left Northwest without the arena and any interest in the NBA franchise. Interests of the Company (a)  General Principles [36]  Counsel disagree with respect to the test to be applied in determining whether it is prima facie in the interests of the company that the action be brought. Counsel for the Petitioner submits that the test is set out in Bellman v. Western Approaches Ltd. (1981), 33 BCLR 45, 17 BLR 117, 130 DLR (3d) 193 (BCCA). Counsel for the Respondents urge me to utilize the test as I articulated it in Intercontinental Precious Metals Inc. v. Cooke (1993), 10 BLR (2d) 203 (BCSC). Both of these decisions involved the Canada Business Corporations Act where the corresponding section has wording slightly different from s. 253(2)(c). [Clause 239(2)(c) of the Canada Business Corporations Act requires the court to be satisfied that “it appears to be in the interests of the corporation or its subsidiary that the action be brought.”] [37]  In Bellman Nemetz CJBC said the following about the corresponding clause in the federal legislation:

898

Chapter 14  Stakeholder Remedies The section does not say that the court must be satisfied that it is in the interests of the corporation. It says that no action may be brought unless the court is satisfied that it appears to be in the interests of the corporation to bring the suit. I take that to mean that what is sufficient at this stage is that an arguable case be shown to subsist. (pp. 54-5 of 33 BCLR) …

Nemetz CJBC went on to conclude that although the section changed the common law in relation to derivative actions, it did not affect the logic of the common law in looking at the decision of the directors not to sue when considering whether the bringing of the suit appears to be in the interests of the corporation. [38]  In the Intercontinental decision I made the following statement after reviewing the Bellman case and the decision in First Edmonton Place Ltd. v. 315888 Alberta Ltd. (1988), 60 Alta. LR (2d) 122, 40 BLR 28 (Alta. QB). (The leave to commence a derivative action was stayed by the Alberta Court of Appeal ((1989), 45 BLR 110) on the basis that it was premature until another action had been completed.): I take from these two decisions that in dealing with the third condition, the Court should, after considering the views of independent directors of the corporation and without endeavouring to try the case, decide whether the proposed action has a reasonable prospect of success. (p. 221)

[39]  The Respondents asked me to apply this “reasonable prospect” test rather than the “arguable” test from the Bellman case. In my view, there is no difference between these two tests. Any position can be argued by competent counsel but, in using the word “arguable,” I believe Nemetz CJBC was referring to a reasonable argument which would not be dismissed out of hand. An argument which is not dismissed out of hand is one which has a reasonable prospect of succeeding. In Re Marc-Jay Investments Inc. and Levy (1974), 50 DLR (3d) 45 (Ont. HC), O’Leary J said this: It is obvious that a Judge hearing an application for leave to commence an action, cannot try the action. I believe it is my function to deny the application if it appears that the intended action is frivolous or vexatious or is bound to be unsuccessful. Where the applicant is acting in good faith and otherwise has the status to commence the action, and where the intended action does not appear frivolous or vexatious and could reasonably succeed; and where such action is in the interest of the shareholders, then leave to bring the action should be given. (p. 47) …

This passage was quoted in the First Edmonton Place decision to which I referred. [40] The Canada Business Corporations Act emulated from the Dickerson Report [RWV Dickerson et al, “Proposals for a New Business Corporations Law for Canada” (Ottawa: Information Canada, 1971)]. Although that Act uses different language from the BC Act, the Dickerson Report had recommended the language which is in the BC Act (i.e., “prima facie in the interests of the company”). The Dickerson Report said the following about the requirement: And by requiring the complainant to establish that the action is “prima facie in the interests of the corporation” it blocks actions to recover small amounts, particularly actions really instituted to harass or to embarrass directors or officers who have committed an act which, although unwise, is not material. (p. 161, vol. 1)

II.  The Derivative Action

899

[41]  The authorities are clear that the Court should not attempt to try the case when deciding whether the requirement in s. 225(3)(c) has been satisfied. The Court should determine whether the proposed action has a reasonable prospect of success or is bound to fail. If it is asserted that the proposed defendants in the derivative action have a defence to the claim, the Court must decide whether such a defence is bound to be accepted by a trial judge following the completion of the trial of the derivative action. It is not necessary for the applicant to show that the action will be more likely to succeed than not. As noted in the Dickerson Report, the Court should also be satisfied that the potential relief in the proposed action is sufficient to justify the inconvenience to the company of being involved in the action. [42]  When a person who feels aggrieved is deciding whether to sue over the grievance, one of the important factors normally taken into account by them is the amount of legal costs required to prosecute the action. The person will assess whether the incurring of the estimated legal costs is justified in light of the prospects of success of the liability aspect of the action and the value of the relief likely to be granted. If the aggrieved party is a corporation, the amount of the legal costs will be an important consideration of the directors when deciding whether it is in the interests of the corporation to pursue the legal action. [43]  However, the amount of the legal costs is not as important a consideration when the Court is considering whether it is prima facie in the interests of the corporation to allow a member to pursue a derivative action under s. 225. The reason is that the Court has flexibility with respect to costs. Subsection (5) of s. 225 provides as follows: On the final disposition of the action the court may order that the costs taxed as between a solicitor and his own client incurred by the (a) member or director bringing or defending the action or other person controlling the conduct of the action be paid to him by the company or other parties to the action; or (b) company and any director or officer of the company be paid to them by the member or director bringing the action or other person controlling the conduct of the action.

In general terms, one would think that the decision of the Court to have the legal costs of the derivative action paid by the company or the person with conduct of the action will largely depend on whether the action was a success or a failure. [44]  I made the following comment about legal costs of the derivation action in the Intercontinental case: Many decisions in the course of litigation are influenced by the attendant legal costs and it is appropriate in my view that the person having conduct of a derivative action should make the decisions bearing in mind that they will not necessarily be reimbursed for the legal costs. I believe that the decisions regarding the legal costs incurred in connection with the derivative action and the costs of this proceeding should await the outcome of the derivative action. (p. 225)

[45]  Subsection 225(4) provides that a person having conduct of a derivative action may apply to court for an order that the company pay him interim legal costs. The provision expressly acknowledges that the person may be accountable to the company for such costs on the final disposition of the derivative action. In addition, there is authority for

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the proposition the Court should make an order for the payment of interim legal costs only if the person with conduct of the derivative action can demonstrate financial need: see Johnson v. Meyer (1987), 62 Sask. R 34 (Sask. QB). [46]  In the application at bar, the Petitioner is not requesting at the present time that Northwest pay the legal costs of the proposed action. If leave to commence the derivative action is granted, the Petitioner will be at risk for the legal costs related to the action pending the final disposition of the action. [47]  The Petitioner wants to pursue the derivative action in respect of the NBA franchise and the transfer of the Arena Shares. I will deal separately with the issue of whether it is prima facie in the interests of Northwest to have an action brought in respect of these two matters. (b)  The NBA Franchise [48]  The Petitioner wants Northwest to sue Mr. Griffiths and Ms. Griffiths-Hamilton for the taking of Northwest’s opportunity to have an interest in the NBA’s Vancouver franchise. It also wants to sue 453333, S.A.G. Holdings Ltd. and Vancouver Basketball Management Ltd. for an accounting of profits made by them in connection with the NBA franchise. Ms. Griffiths-Hamilton was a director of Northwest in early 1994 and she is a principal of S.A.G. Holdings Ltd., one of the shareholders in 453333. The Petitioner is not proposing that Northwest sue the McCaws or their company, Sportco. [49]  A cause of action based on the taking of a corporate opportunity is founded on the fiduciary relationship between the corporation and its directors and officers. The leading statement in Canadian jurisprudence with respect to the consequences of the fiduciary relationship is found in Canadian Aero Service Ltd. v. O’Malley [citation and quotation omitted]. [50]  The main defence of Mr. Griffiths and Ms. Griffiths-Hamilton would presumably be that Northwest approved the Griffiths group pursuing the NBA franchise when its directors passed the resolution of February 2, 1994. That defence would bring into issue whether Mr. Griffiths made full disclosure to Northwest prior to the approval being given. [51]  It is my view the proposed claim against Mr. Griffiths and Ms. Hamilton-Griffiths has a reasonable prospect of success. Their defence is not bound to succeed. The trial judge may reasonably find that Mr. Griffiths did not make full disclosure to the other directors of Northwest. In approving the Griffiths group pursuing the NBA franchise on its own, the directors considered it to be of importance that the franchise would become a tenant in the arena. It is open to a trial judge to conclude that Mr. Griffiths failed to make full disclosure because he did not tell the directors about the McCaws’ condition of involvement in the arena and the intention of 453333 to acquire the Arena Shares. [52]  The Respondents assert that the claim in relation to the NBA franchise will fail for three other reasons. The first two reasons are that there was no corporate opportunity for Mr. Griffiths to misappropriate because (i) Northwest did not have the capability on its own to acquire an NBA franchise and (ii) Northwest was no longer pursuing an NBA franchise. The third reason is that, after the directors were aware of all the facts, they ratified Northwest’s approval of the Griffiths group pursuing the franchise. They rely on the decisions in Peso Silver Mines Ltd. (NPL) v. Cropper (1966), 58 DLR (2d) 1 (SCC) and Queensland Mines Ltd. v. Hudson, [1978] 52 ALJR 399 (PC).

II.  The Derivative Action

901

[53]  The fact that Northwest did not have the capability to acquire the NBA franchise is not necessarily a defence to a claim against a director for taking a corporate opportunity: see Abbey Glen Property Corp. v. Stumborg (1976), 65 DLR (3d) 235 (Alta. SC), affirmed (1978), 4 BLR 113 (Alta. CA) and Weber Feeds Ltd. v. Weber (1979), 24 OR (2d) 754 (Ont. CA). [54]  The minutes of meetings of Northwest’s directors disclose that in the fall of 1993 Northwest was not pursuing an NBA all on its own. It was pursuing the franchise for itself and other investors with the view that it would be the managing partner and would have a small equity interest of up to 15%. That is the corporate opportunity which the Petitioner says was taken by Mr. Griffiths and Ms. Hamilton-Griffiths. The evidence is not unequivocal that Northwest had stopped pursuing that opportunity prior to February 2, 1994. In addition, there is evidence to suggest that Mr. Griffiths was pursuing an NBA franchise for his own accord prior to any decision by Northwest to cease pursuing the opportunity. In the Peso Silver case, it was clear that the company had decided to refrain from further pursuing an opportunity prior to the individual directors deciding to pursue the opportunity on their own. [55]  Two extracts from minutes of meetings of Northwest’s directors were relied upon as ratification of the February 2, 1994 resolution after all of the relevant information was known. The first extract was from the next meeting of Northwest’s directors held on February 18, 1994: Minutes February 2, 1994 meeting, which had previously been distributed to the directors, were taken as read and approved.

The second extract was from the Board’s meeting of April 29, 1994: There was also discussion about the claim by a minority group that a corporate opportunity with respect to the NBA was being diverted improperly. The directors present confirmed their discussions at earlier meetings that the Company never contemplated retaining a meaningful interest in the NBA Franchise but instead looked upon the franchise bid as a means of securing a tenant for the new Arena. The directors present confirmed their understanding that the company released Arthur Griffiths to pursue an NBA franchise and that the company had no interest in same.

[56]  In my view, it is open to the trial judge to conclude that these two extracts merely confirm that the resolution of February 2, 1994 was passed and that they did not ratify the decision of the directors approving the pursuit of the NBA franchise by the Griffiths group. In addition, it may be that a breach of fiduciary duty of the nature alleged by the Petitioner is not capable of being ratified by the directors or the shareholders of the company. See “The Saga of Peso Silver Mines: Corporate Opportunity Reconsidered,” Stanley M. Beck, (1971) 59 Can. Bar Rev. 80 at p. 114. [57]  In the Queensland case the board of directors, knowing all of the facts, renounced the company’s interests in the opportunity and assented to a director pursuing the opportunity on his own. In this case, it is open to the trial judge to conclude that the directors did not have all of the relevant information when they passed the resolution of February 2, 1994 and that the directors have not ratified the resolution with full knowledge of the relevant information or were not capable of ratifying the resolution even if they had full knowledge of all the relevant information.

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[58]  In concluding that it is prima facie in the interests of Northwest to pursue a cause of action in relation to the NBA franchise, I have taken into account the refusal of Northwest’s directors to pursue the action proposed by the Petitioner. No reasons for their refusal were provided to me but I infer their reasons have been converted into instructions to Northwest’s counsel in resisting the Petitioner’s application for leave to commence the derivative action. I have not found to be persuasive the arguments of Northwest’s counsel to the effect that the claim does not have a reasonable prospect of success. (c)  The Takeover Bid [59]  The Petitioner asserts that the directors are liable to Northwest in connection with the takeover bid in three respects:

(a) the issuance of the debentures as part of the consideration for the purchase of the shares contravened s. 127 of the Act, and the directors are liable for any consequential loss pursuant to s. 151 of the Act; (b) the sale of the Arena Shares as a condition for the making of the takeover bid contravened s. 127 of the Act, and the directors are liable for any consequential loss pursuant to s. 151 of the Act; (c) the directors contravened s. 142 of the Act when they approved the transfer of the Arena Shares to 453333. [Discussion of whether debentures contravened s 127 of the Act omitted.] [65]  It is the position of the Petitioner that the directors are liable for approving the transfer of the Arena Shares to 453333 because it constituted financial assistance under s. 127 or they were not acting in the best interests of Northwest, as required by s. 142, when they approved the transfer. In my view, there is a reasonable argument to be made that the directors were not acting in the best interests of Northwest when they approved the transfer of the Arena Shares as a condition of 453333 making the takeover bid. [66]  The Respondents say that the directors considered the offer for the Arena Shares on a stand-alone basis and the Court should not review commercial decisions made by directors in good faith. They point to the facts that the transaction complied with Policy Statement 9.1 [now OSC Rule MI 61-101]. issued by the Ontario Securities Commission and that the transfer of the Arena Shares was approved by a majority of Northwest’s minority shareholders. In the alternative, the Respondents say that the directors were entitled to consider the takeover bid when approving the transfer of the Arena Shares. [67]  In my view, it is open for a trial judge to conclude that the directors did not consider the offer for the Arena Shares on a stand-alone basis. In its March 28, 1994 report Goepel Shields clearly took the takeover bid into account in concluding that it was appropriate to transfer the Arena Shares for nominal consideration. In its March 28, 1994 report the Independent Committee referred to the transfer of the Arena Shares as a component of the takeover bid. In the Directors’ Circular dated March 28, 1994 the directors stated that they relied on and considered, among other things, the reports of Goepel Shields and the Independent Committee. Later, following the negotiations to increase the amount of the takeover bid if changes were made to the agreement for the transfer of the Arena

II.  The Derivative Action

903

Shares, the Independent Committee and the Board of Directors weighed the benefits to the shareholders of an increased takeover bid against the disadvantages of these changes. This evidence may lead a trial judge to conclude that the directors did not consider the transfer of the Arena Shares on a stand-alone basis. [68]  The fact that the transaction complied with Policy Statement 9.1 of the Ontario Securities Commission is of little moment. The Policy Statement is directed at matters of securities law, not transfers of assets by a company. Compliance by the directors with securities law does not necessarily mean that they have complied with all of their duties. [69]  Approval of the transfer of the Arena Shares by Northwest’s shareholders may be something to be taken into account but it is not a complete answer to the claim that the directors were not acting in the best interests of Northwest. The shareholders were advised that they should vote in favour of the transfer of the Arena Shares if they wanted the revised takeover bid to be made. A trial judge may conclude that the shareholders were only considering their own interests and that their interests did not coincide with the interests of Northwest. [70]  Counsel for the Respondents cited several authorities to the effect that the directors are entitled to take the interests of the shareholders into account when there is a takeover bid: see, for example, Teck Corporation v. Millar (1972), 33 DLR (3d) 288 (BCSC), Re Olympia & York Enterprises Ltd. and Hiram Walker Resources Ltd. (1986), 37 DLR (4th) 193 (Ont. Div. Ct.), Re 347883 Alberta Ltd. and Producers Pipeline Inc. (1991), 80 DLR (4th) 359 (Sask. CA) and Dawson International plc. v. Coats Paton plc, [1989] BCLC 233 (Ct. Sess.). However, counsel did not cite any authorities which state that the directors are entitled to consider the interests of the shareholders when those interests are in conflict with the interests of the company. Counsel for the Petitioner pointed to the following passage in the Dawson International decision to the opposite effect: I think it is important to emphasise that what I am being asked to consider is the alleged fiduciary duty of directors to current shareholders as sellers of their shares. This must not be confused with their duty to consider the interests of shareholders in the discharge of their duty to the company. What is in the interests of current shareholders who are sellers of their shares may not necessarily coincide with what is the interests of the company. The creation of parallel duties could lead to conflict. Directors have but one master, the company. (p. 243)

[71]  In my view, it is open to a trial judge to conclude that a company should not sell an asset for less than its fair market value in exchange for its shareholders receiving a more attractive takeover bid. The shareholders who do not accept the takeover bid are left with shares in a company which no longer owns the asset. [72]  The Respondents also argued that the derivative action in relation to the transfer of the Arena Shares would not be in the interests of Northwest because the Wood Gundy and Goepel Shields reports show that the Arena Shares had no value and, hence, no damages can be recovered. Based on the following passage from the Bellman decision, the obligation on an applicant to prove damages does not appear to be an onerous one: While it is true that a quantifiable loss was not proven, nevertheless it was sufficient to have adumbrated a potential loss resulting from the covenant in the guarantor’s agreement requiring the borrowers to pay a fee to the guarantor in the event that they were not able to cause the company to go public. (pp. 56-7 of 33 BCLR)

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The Concise Oxford English Dictionary defines “adumbrate” as “indicate faintly; represent in outline; foreshadow.” In addition, the Petitioner was not able to have its expert comment on the valuations by Wood Gundy and Goepel Shields because the Respondents successfully resisted the Petitioner’s interlocutory application to be provided with the data supplied to Wood Gundy and Goepel Shields. In any event, on the basis of all of the evidence before me, it is my view that the Petitioner has a reasonable prospect of establishing damages at the conclusion of the trial process. •  •  •

[75]  Accordingly, I am satisfied that it is prima facie in the interests of Northwest for an action to be brought against its directors in connection with the issuance of the debentures and the transfer of the Arena Shares. In reaching my conclusion, I have taken into account the refusal of Northwest’s directors to cause Northwest to pursue such an action. Their refusal cannot be said to be given impartially because most, if not all, of the directors who refused to pursue the action would be defendants in the action. NOTES AND QUESTIONS

1.  Do the “good faith” and “best interests of the corporation” requirements for leave perform separate functions in this case? 2.  If the court is not supposed to try the case during the leave application, but is supposed to assess both the plaintiff’s legal claims for a reasonable prospect of success and whether the defendant’s defences are bound to be accepted by the trial judge at the conclusion of the trial, do you think the threshold for obtaining leave is high?

A derivative action may not be settled except upon approval of the court (CBCA s 242(2)). This provision is of American origin. It is designed to obviate the possibility of collusive settlements between a derivative plaintiff and the corporation whereby the corporation might buy off the plaintiff to settle a nuisance suit or even a meritorious suit for less than the total damages by offering the plaintiff more than the loss to his particular investment, but less than the total loss for all shareholders. Suits brought by plaintiffs precisely for the purpose of settlement (often by the corporation buying the plaintiff’s shares at an exorbitant price) came to be known as “strike suits.” One American device specifically not permitted under the CBCA is the requirement that the plaintiff give security for the corporation’s costs. It can be appreciated that these costs, and hence the cost of a bond to cover them, can be substantial owing to the number of parties who may require separate representation in the litigation and the corporation’s obligation to indemnify such of them as are its officers or directors in the event that claims against them prove not well-founded. The need to require derivative plaintiffs to post security for costs is more pressing in the United States than in Canada because in that country there is not the inherent discipline against litigiousness that exists in our loser-pay-all-costs rules. Generally, in the United States, subject to a number of statutory exceptions, each party bears his or her own costs, including legal fees, irrespective of the outcome of the litigation. Where provision is made for a statutory derivative action, it is the exclusive method by which a shareholder can vindicate corporate rights: Churchill Pulpmill Ltd v Manitoba, [1977]

905

II.  The Derivative Action

6 WWR 109 at 115-20 (CA) (Manitoba Corporations Act); Farnham et al v Fingold et al, [1973] 2 OR 132 at 135 (CA) (Ontario Business Corporations Act). That is, a shareholder cannot avoid the requirement that leave of court be obtained before an action may be commenced on behalf of a corporation by attempting to bring the action under one of the so-called exceptions to the rule in Foss v Harbottle. However, as will be seen later in this chapter, actions brought to vindicate personal claims through the statutory oppression remedy do not require leave of the court under CBCA s 239. The rule in Foss v Harbottle is changed by CBCA s 242(1), which provides that derivative litigation shall not be dismissed by reason only that the conduct complained of has been or may be ratified by the shareholders. Ratification may, however, be taken into account by the court as a factor in determining whether the proposed litigation would be in the best interests of the corporation. Shareholder ratification may also be taken into account by the court in proceedings under CBCA ss 214 (just and equitable winding up) and 241 (oppression).

Re Northwest Forest Products Ltd [1975] 4 WWR 724 (BC SC) CASHMAN LJSC:  This is an application under s. 222 of The Companies Act, 1973 (BC), c. 18, that leave be given to the applicants to commence an action in the name of and on behalf of Northwest Forest Products Ltd. against five directors of that company for an accounting of what but for their wilful default or negligence the company’s shareholdings in the Fraser Valley Pulp and Timber Ltd. ought to be worth and payment of the amount found due, or alternatively for damages for misfeasance. •  •  •

The requirements of subs. (3) [of s. 222 of the British Columbia Companies Act, 1973] are:

1. That the applicant had made reasonable efforts to cause the directors of the company to commence the action; 2. That the applicant is acting in good faith; 3. That it is shown that it is prima facie in the interests of the company that the action be brought; and 4. That the applicant was a member of the company at the time of the transaction giving rise to the cause of action. [The applicants are shareholders who wish to bring an action against the five directors of Northwest. Northwest, which was incorporated in 1950, owned 51 percent of the shares of Fraser Valley Pulp and Timber Ltd, which was incorporated in 1965. The basis for the action is the sale of Fraser Valley in 1972 to Green River Log Sales Ltd. Fraser Valley was sold for $199,813.99 and, on the date of the sale, Green River pledged the Fraser Valley assets to the Royal Bank for $290,500. The trial judge noted that the assets appeared to have increased in value by $91,700 on the day of sale and that no reasonable explanation for this appeared on the record. The only explanation offered is that Fraser Valley was an insolvent company.]

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By letter dated 3rd April 1974 Mr. Ross [one of the applicants] wrote to the president and directors of the company requesting the company take the action sought in this application and the last paragraph on page one of the letter, continuing on the top of page two, says this: I further request and require you as directors of Northwest Forest Products Ltd. to cause the shares of Fraser Valley Pulp and Timber Ltd. held by the company to be voted at a meeting of Fraser Valley Pulp and Timber Ltd. to bring action to set aside the sale by Fraser Valley to Green River on the ground that the assets of Fraser Valley in such sale were so grossly undervalued to the knowledge of the directors of both Fraser Valley and Green River as to amount to a fraud on the shareholders of Fraser Valley.

No response to that letter appears to have been forthcoming. On 6th May 1974 Mr. Ross requisitioned a meeting to pass a resolution to commence an action. At the meeting held pursuant to that requisition that motion was defeated. Counsel for the company submits that in this case I must be governed by the fact that what was done by the directors in selling Fraser Valley’s assets was done with the approval of the majority of the shareholders and indeed the various minutes filed would tend to show that that is correct. Section 222(7) says that this is a factor that “may” be taken into account by the Court. However here it should be noted that the company had issued 4,125 shares. J.A. Wood and Norman Wood between them owned 1,570 shares which were less than 50 per cent of the issued shares. The other three directors owned no shares in the company. On the other hand no minutes have been produced to indicate how many shareholders or how many shares were represented at that meeting. In this connection it should be borne in mind that Vancouver Island Utilities Ltd. owns 1,090 shares. There is no evidence as to who voted those shares or indeed whether any shares were voted by proxy. For these reasons I do not take into account the apparent approval of the members of the company. Mr. McConnell submits that when viewed as a whole the affidavit and material in support of the motion does not disclose a prima facie case and furthermore that the directors were never informed of the specification they were requested to take prior to this motion and indeed he questions whether the motion itself discloses an action. As I understand his submission it appears that while he does not necessarily agree that the applicants are acting in good faith as required by subs. (3)(b) or that both were members of the company within the meaning of subs. (3)(d) he does not seriously contend that these things are not so. Accordingly I find that the applicants have satisfied the requirements of s. 222(3)(b) and (d). He does however submit that while the applicants did make a reasonable effort to cause the directors to commence an action the applicants failed to specify the precise nature of the action. In making this submission he relies upon the United States case of Halprin v. Babbit (1962), 303 F. 2nd 138 at 141. He submits that there is no evidence that the directors had full knowledge of the basis of the claim. It is in my view that that is the correct interpretation of the requirement of s. 222(3)(a). The directors could hardly bring any action whether by their own initiative or on the requisition of a minority shareholder without knowing the specific cause of action.

II.  The Derivative Action

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However I would think that no more would be required than that sufficient to found an endorsement on a generally endorsed writ of summons. Mr. McConnell submits that there is a difference between the relief sought in the motion and that set out in the requisition, the two paragraphs of which read as follows: 1.  To pass a resolution that the Company take action against the persons who were directors of the Company during the time when certain shares of Fraser Valley Pulp & Timber Ltd. owned by the Company were voted for a special resolution to sell the assets of Fraser Valley Pulp & Timber Ltd. to Green River Log Sales Ltd., and against the person who held the proxy for the said shares and cast them for such special resolution. 2.  To pass a resolution that the directors of the Company cause the shares of Fraser Valley Pulp & Timber Ltd., held by the Company be voted at a meeting of Fraser Valley Pulp & Timber Ltd. to bring action to set aside the sale by Fraser Valley Pulp & Timber Ltd., to Green River Log Sales Ltd., on the ground that the assets of Fraser Valley Pulp & Timber Ltd., in such sale were so grossly undervalued to the knowledge of the directors of both Fraser Valley Pulp & Timber Ltd. and Green River Log Sales Ltd., as to amount to a fraud on the shareholders of Fraser Valley Pulp & Timber Ltd.

In my view that notice sufficiently specifies the cause of action and contains sufficient information to found an endorsement on a writ. While there are some differences between the wording of the requisition and that relief sought in the motion, which is conceded by Miss Southin, I do note that Mr. Ross’s letter of 3rd April 1974 sets out the relief sought in substantially the same words as contained in the motion. Those words I have set out heretofore in this judgment. Furthermore the relief sought is in the nature of equitable relief and there is in my view no substantial difference between the requisition and the motion as both refer to fraud. Furthermore there is no evidence that the directors refused to commence the action in the terms specifically set out in either the letter or the requisition. All the directors did was defeat the motion. Accordingly I find that the applicants have satisfied the requirements of s. 222(3)(a). [A discussion of best interests of the corporation is omitted. The court granted leave.] A minority shareholder at common law may face substantial financial hurdles when contemplating litigation on behalf of the corporation. Under CBCA s  240, the court may make a variety of orders to govern the conduct of the action, including that the corporation pay the complainant’s reasonable legal fees and that the amount of any recovery be paid, not to the corporation, but to its present or former security-holders. The effect of the latter type of order is not to convert a derivative into a personal action but rather to avoid what would otherwise be an incongruous result where either the defendants are major shareholders in the corporation or the shareholders at the time of the injury are not the shareholders at the time of the action. Under s 242 of the statute, the court may order the corporation to pay the complainant’s interim costs, including legal fees and disbursements, but such interim award would be without prejudice to an allocation of costs as between the corporation and the complainant upon final disposition of the action.

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Turner v Mailhot (1985), 50 OR (2d) 561 (H Ct J) REID J:  Plaintiff, having earlier obtained leave from this court to commence these proceedings as a derivative action pursuant to the Business Corporations Act, now applies for an order requiring defendant Superior Grain By-Products Storage Limited (the company) to underwrite his incurred and future fees and costs of the litigation. The application rests on s. 246 of the Business Corporations Act, 1982 (Ont.), c. 4, which reads: 246.  In connection with an action brought or intervened in under section 245, the court may at any time make any order it thinks fit including, without limiting the generality of the foregoing, (a)  an order authorizing the complainant or any other person to control the conduct of the action; (b)  an order giving directions for the conduct of the action; (c)  an order directing that any amount adjudged payable by a defendant in the action shall be paid, in whole or in part, directly to former and present security holders or the corporation or its subsidiary instead of to the corporation or its subsidiary; and (d)  an order requiring the corporation or it subsidiary to pay reasonable legal fees and any other costs reasonably incurred by the complainant in connection with the action.

The application rests particularly on cl. (d). Other relief is claimed but it depends upon the grant of an order pursuant to cl. (d). The threshold question is therefore whether such an order should be made. Counsel inform me that notwithstanding an assiduous search of the law, which includes the Search/Law data base through the computer, they have been able to find no decision on cl. (d) or on any equivalent statutory provision in any other jurisdiction. The only decision that touches the issue is that of the Court of Appeal of England which is based on common law and found in Wallersteiner v. Moir (No. 2), [1975] 1 All E.R. 849. One matter of significance must be stated immediately. It was part of applicant’s case that he does not have the means to finance the litigation. That ground was, however, abandoned by Mr. Bode in reply. The application must be decided in the absence of any such contention. The company was incorporated in 1977. Plaintiff and his wife between them have from the beginning been owners of 30% of the common shares. The balance are owned or controlled by Mailhot and his wife Anne Gordij. Plaintiff and Mailhot were the only directors from incorporation to the time when these proceedings were commenced. During the same period the officers of the company were Mailhot, president, plaintiff vice-president and Anne Gordij, secretary. Plaintiff ’s wife acted as the company’s bookkeeper. Plaintiff Turner and defendant Mailhot are the real protagonists in this litigation and for convenience I may at times refer to the opposing factions simply by referring to them individually. The company prospered from its inception. Most of its profits were paid out to the shareholders in the form of salaries or bonuses. Very large amounts were distributed in this way.

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I must be careful not to say anything that might suggest a predetermination of the merits of the lawsuit but I may safely observe that one of its causes appears to have been a difference of view between the two progenitors of the company, Turner and Mailhot, about the company’s intended life span. Mailhot appears to have viewed it from the start as having a life of only some six years. Turner appears to have disagreed with that view but suggests that he was forced to accept it. In any event, a disagreement arose which led to plaintiff and his wife being locked out of the company’s premises, the termination of their employment and of Turner’s positions as a director and officer of the company. The object of the lawsuit is principally to force the return to the company of income, assets, profits and benefits allegedly wrongfully paid out or diverted to the advantage of Mailhot, through the alleged machinations of Mailhot. I make no comment on the merits of these claims save to observe that, if successful, they would be to the benefit of no party except the company, in the sense that substantial funds would be returned to its treasury, and to plaintiff and his wife as the minority shareholders in the sense that there would be an ostensible increase in the value of their shares. There could be no benefit to Mailhot and his family for he and they would be forced to return to the company funds they are said to have wrongfully diverted or removed for their own use or benefit. The situation here may be compared with that before the English Court of Appeal in Wallersteiner v. Moir (No. 2). That was a carefully considered decision which justifies close scrutiny and extensive reference. Each of the judges, Lord Denning M.R. and Buckley and Scarman L.JJ., wrote separate reasons which although not entirely in agreement with each other produced a commonly agreed result. In that case Moir was acting as the representative of the minority shareholders in litigation equivalent to a derivative action under the Business Corporations Act. An order was made indemnifying him against his fees and costs. The gist of the court’s decision was that the order rested upon equity and the court’s discretion, the court having concluded that the action was reasonable and prudent in the company’s interest, was brought in good faith and, as well, in Lord Denning M.R.’s view was also in the public interest. It was observed that Moir had exhausted his own funds in fighting the litigation for over ten years and contributions from other minority shareholders had as well been exhausted. As Lord Denning M.R. said, Moir had “come to the end of his tether” (p. 856) yet the litigation was not finished. Moir had “not any money left with which to pay the costs in further matters” and was fearful of the prospect of having to pay personally costs if he should lose (ibid., pp. 856-7). On that basis there is a clear distinction between that case and this for I have already observed that Turner makes no such claim. Another distinction exists. The company on whose behalf Moir was suing was “a substantial public company of long standing” (ibid., p. 853a-b) (sometimes referred to in the judgments as “the companies.”) Moir was a minority shareholder holding only a few shares. We are not told how many, or what relation their number bore to the number of issued shares of the company but comments made in the judgments are revealing. Lord Denning M.R. referred at p. 857a-b to Moir’s “few shares which might appreciate a little in value” if he were successful in the litigation. At p. 860a he observed further: “It would appear that any advantage to Mr. Moir himself would be trivial, seeing that he holds so few shares.” In contrast, Turner and his wife are the only minority shareholders in the defendant company. It is not realistic here to say, as was said in Wallersteiner, that if Turner

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“wins all the way through no part will redound to his own benefit” (loc. cit.) If Turner is successful in this litigation the monetary benefit to the company could be in the millions. That, in turn, would greatly increase the book value of Turner’s shares. Whether he would be capable of forcing the reluctant majority to turn that into a realizable benefit for him and his wife is certainly open to question at this point. Yet, that aside, this action more closely resembles a struggle between Turner and Mailhot over their own advantage with the company used as a vehicle than an attack by an almost lone altruist (Moir) upon an entrenched and devious miscreant (Wallersteiner) for the advantage of the company involved. The judges in Wallersteiner appear to have thought that Moir, or anyone else in his situation, was prima facie entitled to indemnification if the action was “a reasonable and prudent course to take in the interests of the company” (report p. 859b-c). Lacking a statute like the Business Corporations Act they proposed a course of action for anyone who wished to secure entitlement to the indemnity. They described it in somewhat different terms, but the preliminary step they proposed involved an application to the court for leave to commence the action. On the subject of indemnity for costs Buckley L.J. said (at pp. 869-70): On the effective hearing of the summons the court would determine whether the plaintiff should be authorised to proceed with the action and, if so, to what stage he should be authorised to do so without further directions from the court. The plaintiff, acting under the authority of such a direction, would be secure in the knowledge that, when the costs of the action should come to be dealt with, this would be on the basis, as between himself and the company, that he has acted reasonably and ought prima facie to be treated by the trial judge as entitled to an order that the company should pay his costs, which should, I think, normally be taxed on a basis not less favourable than the common fund basis, and should indemnify him against any costs he may be ordered to pay to the defendants. Should the court not think fit to authorise the plaintiff to proceed, he would do so at his own risk as to the costs.

Scarman L.J. said, at p. 871: I agree that it is open to the court in a stockholder’s derivative action to order that the company indemnify the plaintiff against the costs incurred in the action. I think that the principle is the same as that which the court applied in Re Beddoe, [1893] 1 Ch 547, which concerned the costs incurred by a trustee in an action respecting the trust estate. The indemnity is a right distinct from the right of a successful litigant to his costs at the discretion of the trial judge; it is a right which springs from a combination of factors: the interest of the company and its shareholders, the relationship between the shareholder and the company, and the court’s sanction (a better word would be “permission”) of the action to be brought at the company’s expense. It is a full indemnity such as an agent has who incurs expense in the authorised business of his principal. As a general rule, I would expect an application for leave to bring proceedings at the expense of the company to be made at the commencement of the action: but, as Lindley LJ in Beddoe’s case, [1893] 1 Ch at 557, recognised in relation to a trustee’s action on behalf of the trust estate, if at the end of the case the judge should come to the conclusion that he would have authorised the action had he been applied to, he can even then allow the plaintiff his costs on a full indemnity basis against the company. In my opinion, Mr. Moir should have his indemnity not only against costs already incurred by

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him on behalf of the two companies but also against costs to be incurred up to and including discovery, after which he should obtain the further directions of the court. I agree that the procedure proposed by Buckley LJ would be suitable and should be adopted until such time as a rule of court is made which covers the situation.

The result was an order reflecting Lord Denning M.R.’s words, at p. 862h-i: Mr. Moir himself should be indemnified by the companies for all the costs he has incurred in the past and will reasonably incur in the future (over and above those which he recovers from Dr. Wallersteiner). I trust that with this assurance he and his solicitors will be prepared to continue with the case. It is in the public interest that they should do so.

If that reasoning were applied here it would suggest strongly that Turner, having obtained leave of this court to bring the action, had established a prima facie claim to indemnity. There is nothing in the Business Corporations Act, which would indicate to me that the views expressed in Wallersteiner would not form a reasonable basis for the interpretation of the sections of the Act governing the application before me. The section of our Act that governs applications for leave to bring a derivative action simply states in statutory language the gist of what the judges of the Court of Appeal said in Wallersteiner. Thus, it must be established that directors of the relevant company refused to bring the action, that the complainant is acting in good faith, and that the action appears to be in the interests of the company. Section 245 is the relevant provision. It states: … Since an applicant, in order to obtain leave under s. 245 must, in effect, fulfil the conditions laid down in Wallersteiner, he or she could reasonably be taken to have established a prima facie right to indemnity. It is true that the section of the Business Corporations Act which provides for an application for indemnity, s. 246, is separate from s. 245, which provides for leave. That was the basis for a submission by counsel that no inference of prima facie entitlement to indemnity should be drawn from the grant of leave under s. 245. Yet s. 246 provides that in connection with an action brought or intervened in under s. 245 the court may at any time make an order for indemnity under cl. (d). It would seem therefore that an application for leave and an application for indemnity could be brought at the same time. That being so there is no significance in the separation of the governing provisions. I see no reason therefore why the reasoning in Wallersteiner should not be applied here, at least to that extent. I am satisfied that Turner, having obtained leave of this court, has established a prima facie right to indemnity. Yet the right is merely prima facie. There may, in my opinion, be considerations arising out of the circumstances of particular cases that might affect the question whether that prima facie right should be turned into a proven right. I would think, for instance, that financial inability to carry on an action would weigh heavily in favour of a grant of indemnity and may well overbear any considerations raised by a respondent. In the absence of such an element, however, other factors might predominate. I have already said that Turner makes no claim of financial inability and the beneficiaries of a successful outcome would not so much be the company as the two minority shareholders. I do not think that the financial ability to carry on an action should necessarily deprive a plaintiff in a derivative action of indemnification: that would be contrary to the principle that the plaintiff is the agent of the company for the purposes of the action. Yet the fact

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that the benefit sought is more for plaintiff than the company is a consideration that weighs with me. In the result I do not think that, at this stage anyway, an order for complete indemnity should be made. I therefore direct that Turner is entitled to indemnity to the extent of one-half of his incurred and reasonable future fees and costs. That direction is made without prejudice to any future application that Turner might be advised to make for more complete indemnification as would be the case, for instance, if the day arrived when he was financially incapable of sustaining the litigation. The disposition of the threshold question in this fashion makes it necessary to consider the other claims for relief. At the hearing of the motion those claims, as set out in the notice of motion, were modified by the abandonment of a claim (set out in cl. (c)(ii) of the notice of motion) calling for the return to the company’s treasury by a solicitor retained by the company of the $40,000 I shall deal with shortly. Of the remaining claims those for the return of $350,000 allegedly paid to Mailhot and for $150,000 allegedly paid to Anne Gordij as improper bonuses after the exclusion of plaintiff from the company’s boardroom are, in my opinion, too close to the heart of the litigation to be dealt with at this time. I accept that there is a substantial issue to be tried. That is clearly implied by the grant of leave by this court to commence the action. Yet these claims for the return of the bonuses are part and parcel of the litigation itself. The proper disposition of these claims will necessarily involve questions of credibility and other issues that, in my opinion, require nothing short of a trial. The remaining claim is for the return to the company of the sum of $40,000 paid out to solicitors for the defence of Mailhot. It cannot be said that these funds were paid out for the defence of the company. Mailhot’s answers and those of his counsel, made on his behalf on a cross-examination filed, are consistent with this view. I would be surprised if they were not for I cannot see any justification for funds being paid out by the company for its own defence. The company did not appear on the application for leave nor was it represented by counsel. Its position in the litigation is merely formal. It is made a party to facilitate the litigation in several different ways including discovery, and for the enforcement of any order or judgment made by the court. But it cannot oppose the claim when through its own inaction it lost the right to pursue it. The claim is opposed essentially now, as it was on the application for leave, by Mailhot. In a real sense, Mailhot opposes the company. There can be no basis for viewing them as co-defendants with common interests. The company’s interests are represented by the plaintiff. In my opinion it was inappropriate to pay out company funds for the defence of Mailhot. Similarly it would be inappropriate to pay out further funds for that purpose. Since the funds were paid out essentially for Mailhot’s benefit and at his direction an order shall go directing Mailhot to pay into court the sum of $40,000 for the purpose of furnishing indemnification for Turner in accordance with the order that I have made or with any future order of this court. In view of the company’s financial situation it would be ineffective to order that the funds be returned to the company’s treasury for they might thereby be made available to creditors and the object of this order frustrated. Furthermore, it is highly unlikely that the company would make payment of any indemnity to plaintiff or on his behalf for that would depend upon corporate action directed by Mailhot and that clearly cannot be

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counted on. I think a series of trips back to court would be almost inevitable. Finally, I derive some comfort from s. 246(c). If my order is not within its letter I believe it to be within its spirit. I therefore direct that Mailhot pay into court the sum of $40,000 forthwith. Turner is at liberty to tax his incurred fees and costs and to apply to court for reimbursement of one-half of the amount taxed forthwith. I will remain seized of the matter. The motion may be made to me and I will set a time for a hearing unless the matter can be settled on consent. In that case an application may be made in writing. So far as future costs are concerned, I am doubtful of the master’s jurisdiction to award them and therefore grant leave to Turner to apply to me for the purpose of establishing a figure for a reasonable estimate of future fees and costs and for payment thereof out of court. That motion may be made on the same basis as the foregoing. I have endorsed the record as follows: “For written reasons plaintiff shall have one-half of his reasonably incurred and future costs of this action and defendant Mailhot is ordered to pay into court the amount of $40,000. Costs of the motion to plaintiff to be paid by Mailhot.” Order accordingly. What is the role of the board of directors when it is given notice of the complainant’s intention to apply for leave to commence a derivative suit? If the directors proceed to commence the action in the name of the corporation then, presumably, the complainant will not seek leave. However, what is the position where the directors refuse to proceed? If the directors argue that as a matter of their considered business judgment the corporation ought not to become embroiled in litigation, should this be accepted uncritically by the court when asked to grant leave? In the United States it has become common for the board of directors to appoint a litigation committee to investigate the merits of the proposed litigation. Is it really possible for a corporation to create a truly independent litigation committee? If not, what weight ought to be given to the opinion of a litigation committee? These issues have been canvassed in a number of US cases, with varying results. Two of the most frequently cited US cases on this issue are Auerbach v Bennett (1979), 393 NE (2d) 994 (NYCA) and Zapata Corporation v Maldonado (1981), 430 A  (2d) 779 (Del  SC). In Auerbach, the court held that the decision of the committee was protected by the business judgment rule, and so could not be substantively challenged. In Zapata, the court argued for a “middle course between those cases which yield to the independent business judgment of a board committee and [cases] which would yield to unbridled plaintiff stockholder control.” This middle course would require a court before whom a motion to dismiss a derivative action has been made to apply a two-step test. Step one would involve a determination as to “independence and good faith of the [corporation’s independent committee] and the bases supporting its conclusions.” Step two would require the court to “determine, applying its own independent business judgment, whether the motion should be granted.” In Jay v North, 692 F (2d) 880 (2d Cir 1982) the Court of Appeals adopted the approach taken by the Delaware Supreme Court in Zapata and rejected the decision in Auerbach.

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III.  THE OPPRESSION REMEDY This section examines a statutory remedy that protects the interests of security-holders, directors, officers, and creditors from conduct by the corporation or its directors that is oppressive or unfairly prejudicial to those interests or that unfairly disregards them. If a court finds that oppressive or unfair conduct has occurred, it can make any order it thinks fit, including replacing a board of directors, amending the corporation’s articles, or requiring it to issue securities to certain individuals. This wide-ranging power stands in stark contrast to the courts’ deferential attitude toward the decision-making of managers and directors, evidenced in the cases concerning the business judgment rule. The oppression remedy can be distinguished from the other legal proceedings imposing liability on directors because it protects the interests of certain stakeholders, rather than rights arising out of contracts, the corporation’s articles or bylaws, or the general duties of the directors to the corporation and its stakeholders. By protecting interests, the oppression remedy is protecting the reasonable expectations of members of the protected class about how the corporation and its managers will conduct themselves with respect to those interests, even where those expectations do not arise from an express agreement, but rather from implicit understandings that form the basis of the relationship with the corporation. The oppression remedy in Canada is a unique creation of Canadian legislatures and courts that provides “the broadest, most comprehensive and most open-ended shareholder remedy in the common law world.”5 Canadian courts recognize its unique character and their responsibility for its development.6

A.  UK Legislation A statutory oppression remedy was first introduced in s 210 of the UK Companies Act, 1948, the purpose of which was to provide a more flexible remedy than that available through a winding-up action. A winding-up remedy caused the corporation to cease its activities, pay all liabilities, and distribute any surplus after these payments to those entitled pursuant to the priority rights attached to their securities. Section 210 provided that “any member of a company” might apply to a court to show that “the affairs of the company are being conducted in a manner oppressive to some part of the members.” If the court was satisfied that such was the case and that a “just and equitable” winding up could be ordered, but that such an order would unfairly prejudice the oppressed members, then the court might make an order “regulating the conduct of the company’s affairs in the future, or for the purchase of the shares of any members … by other members … or by the company.” An identical provision was adopted as s 185 of the BC Companies Act. This original version of the oppression remedy came to be seen as having three major shortcomings. Because the conduct had to be oppressive against a person in his or her 5 Stanley M Beck, “Minority Shareholders’ Rights in the 1980s” in Corporate Law in the 80s: Special Lectures of the Law Society of Upper Canada (Don Mills, Ont: Richard De Boo, 1982) 311 at 312. 6 The Supreme Court of Canada, in Peoples Department Stores Inc (Trustee of ) v Wise, 2004 SCC 68, [2004] 3 SCR 461 at para 48, adopted Beck’s, ibid, description of the oppression remedy, while pointing out that it also protects the interests of creditors.

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capacity as member (shareholder), the remedy did not reach one of the prototypical fact situations—exclusion of of a director or manager. Section 210 was also read as requiring a continuous course of oppressive conduct rather than a single oppressive transaction: see Re HR Harmer Ltd, [1958] 3 All ER 689 (CA). Finally, the conduct had to be serious enough to warrant a winding-up before the courts could exercise remedial powers under the oppression remedy. The latter two conditions were amended in s 75 of the UK Companies Act, 1980.

B.  Canadian Oppression Remedy Legislation The oppression remedy was introduced into Canadian statutes in 1975 by the CBCA. This remedy is much broader than that of the old English s 210. CBCA s 241 provides an oppression remedy provision: 241(1)  A complainant may apply to a court for an order under this section. (2)  If, on an application under subsection (1), the court is satisfied that in respect of a corporation or any of its affiliates (a)  any act or omission of the corporation or any of its affiliates effects a result, (b)  the business or affairs of the corporation or any of its affiliates are or have been carried on or conducted in a manner, or (c)  the powers of the directors of the corporation or any of its affiliates are or have been exercised in a manner that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer, the court may make an order to rectify the matters complained of. (3)  In connection with an application under this section, the court may make any interim or final order it thinks fit including, without limiting the generality of the foregoing, (a)  an order restraining the conduct complained of; (b)  an order appointing a receiver or receiver-manager; (c)  an order to regulate a corporation’s affairs by amending the articles or by-laws or creating or amending a unanimous shareholder agreement; (d)  an order directing an issue or exchange of securities; (e)  an order appointing directors in place of or in addition to all or any of the directors then in office; (f)  an order directing a corporation, subject to subsection (6), or any other person, to purchase securities of a security holder; (g)  an order directing a corporation, subject to subsection (6), or any other person, to pay a security holder any part of the monies that the security holder paid for securities; (h)  an order varying or setting aside a transaction or contract to which a corporation is a party and compensating the corporation or any other party to the transaction or contract; (i)  an order requiring a corporation, within a time specified by the court, to produce to the court or an interested person financial statements in the form required by section 155 or an accounting in such other form as the court may determine; (j)  an order compensating an aggrieved person; (k)  an order directing rectification of the registers or other records of a corporation under section 243; (l)  an order liquidating and dissolving the corporation; (m)  an order directing an investigation under Part XIX to be made; and (n)  an order requiring the trial of any issue.

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(4)  If an order made under this section directs amendment of the articles or by-laws of a corporation, (a)  the directors shall forthwith comply with subsection 191(4); and (b)  no other amendment to the articles or by-laws shall be made without the consent of the court, until a court otherwise orders. (5)  A shareholder is not entitled to dissent under section 190 if an amendment to the articles is effected under this section. (6)  A corporation shall not make a payment to a shareholder under paragraph (3)(f) or (g) if there are reasonable grounds for believing that (a)  the corporation is or would after that payment be unable to pay its liabilities as they become due; or (b)  the realizable value of the corporation’s assets would thereby be less than the aggregate of its liabilities. (7)  An applicant under this section may apply in the alternative for an order under section 214.

The CBCA oppression remedy departs from the legislative scheme in the United Kingdom in several important aspects. It broadens the class of potential applicants for the remedy, expands the range of conduct that may be the foundation of a successful application, and expands the types of interests protected beyond the scope of the UK legislation. Under CBCA s 241, any “complainant” may make an application for the remedy—the term “complainant” is defined in CBCA s  238 as a present or former security-holder (not just shareholder), an officer or director (including former officers and directors) of the corporation or of any of its affiliates, plus any person who, in the discretion of the court, is a proper person to be a complainant. The conduct complained of may be “oppressive” or “unfairly prejudicial” to, or may simply “unfairly disregard” the interests of, any security-holder, creditor, director, or officer. Moreover, the act or omission about which one is complaining may be that of the corporation, any of its affiliates, or that of the corporation’s directors. The statute provides a long list of possible remedial orders, and the list is without prejudice to the ability of a court to make such further orders as it thinks fit. The introduction of the oppression remedy in the CBCA led to all provinces and territories adopting a similar provision.

C.  Who May Bring an Application for an Oppression Remedy? Section 241(1) of the CBCA states that a “complainant,” as defined in s 238, may apply for an order under that subsection. The various provincial/territorial definitions of “complainant” applicable to the derivative action, above, will generally also apply to the oppression remedy. If a relevant stakeholder is not explicitly captured by the relevant statute, the court is given general discretion by the legislation—for example, CBCA s 238(d)—to allow a party to seek an oppression remedy. Despite the fact that “creditor” is not explicitly included in the definition of “complainant” under the CBCA, the Supreme Court of Canada has suggested that CBCA s 241 is a possible mechanism for creditors to protect their interests.7

7 Peoples Department Stores v Wise, ibid at para 41.

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First Edmonton Place Ltd v 315888 Alberta Ltd (1988), 40 BLR 28 (Alta QB) [A landlord provided a package of inducements to get a numbered company controlled by three lawyers to sign a 10-year lease. The package of inducements included an 18-month rent-free period, a leasehold improvement allowance of $115,900, and a cash payment of $140,126. The lawyers promptly had the cash distributed to themselves. They made use of the premises during the rent-free period and for a further three months without the numbered company having entered into a formal lease. They then vacated the premises and no further rent was paid. The landlord sought leave to bring an oppression action under s 234 of the Business Corporations Act (Alberta) or, in the alternative, a derivative action under s  232 and alleged that the actions of the three lawyers as directors of the numbered company were unfairly prejudicial to or unfairly disregarded the landlord’s interests.] McDONALD J: … In Brant Investments v. KeepRite [(1987), 60 OR (2d) 737, 37 BLR 65 at 108, 42 DLR (4th) 15 (HC)], Anderson J expressed the following concern (at 99 [BLR]): The jurisdiction is one which must be exercised with care. On the one hand the minority shareholder must be protected from unfair treatment; that is the clearly expressed intent of the section. On the other hand the Court ought not to usurp the function of the board of directors in managing the company, nor should it eliminate or supplant the legitimate exercise of control by the majority.

He went on to state (at 100 [BLR]): Business decisions, honestly made, should not be subjected to microscopic examination. There should be no interference simply because a decision is unpopular with the minority.

There are almost no decisions on the availability of s. 234 to creditors. Most applications under s. 234 are made by minority shareholders. With respect to the applicability of decisions involving minority shareholders to cases involving creditors, in Bank of Montreal v. Dome Petroleum Ltd. (1987), 54 Alta. LR (2d) 289 (QB), Forsyth J quoted the above statements of Anderson J in Brant Investments. He then commented (at 298): While Mr. Justice Anderson in that decision was dealing with the rights of minority shareholders, I fully subscribe to those views and would adopt the same approach in dealing with the rights of creditors when it is alleged same are being unfairly dealt with in some fashion and relief is sought under s. 234.

In the Dome Petroleum case, supra, the Bank of Montreal claimed that an arrangement agreement entered into by Dome and Amoco, coupled with certain confidentiality agreements, which effectively restricted any sale of Dome shares or assets for an indeterminate amount of time, unfairly prejudiced or unfairly disregarded the Bank of Montreal’s position as a creditor. As the arrangement agreement could not go forward in the absence of the Bank of Montreal’s consent, Forsyth J could not find any oppression, unfair prejudice, or unfair disregard on the evidence before him. As such, he granted Dome Petroleum’s application for summary dismissal of the application under s. 234. •  •  •

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Where, as in s. 234 of the ABCA, it [the oppression remedy] may be used as an instrument for the protection of the interests of a creditor, the basic formula for establishing unfair prejudice or unfair disregard of the interests of the creditor should reflect as a goal the desire to seek to balance protection of the creditor’s interest against the policy of preserving freedom of action for management and the right of the corporation to deal with a creditor in a way that may be to the prejudice of the interests of the creditor or that may disregard those interests so long as the prejudice or disregard is not unfair. The s. 234 remedy would be available if the act or conduct of the directors or management of the corporation which is complained of amounted to using the corporation as a vehicle for committing fraud upon a creditor. An example might be the directors of a corporation using it to obtain credit for the purchase of goods by means which, if the credit were obtained by an individual, would be fraudulent on the part of the individual. Assuming the absence of fraud, in what other circumstances would a remedy under s. 234 be available? In deciding what is unfair, the history and nature of the corporation, the essential nature of the relationship between the corporation and the creditor, the type of rights affected, and general commercial practice should all be material. More concretely, the test of unfair prejudice or unfair disregard should encompass the following considerations: the protection of the underlying expectation of a creditor in its arrangement with the corporation, the extent to which the acts complained of were unforeseeable or the creditor could reasonably have protected itself from such acts, and the detriment to the interests of the creditor. The elements of the formula and the list of considerations as I have stated them should not be regarded as exhaustive. Other elements and considerations may be relevant, based upon the facts of a particular case. •  •  •

Is the applicant a “Complainant” under Section 231(b)(iii)? Under s. 231(b)(iii), a person may be a “complainant” if he is a person “who, in the discretion of the Court, is a proper person to make an application under this Part.” This is not so much a definition as a grant to the Court of a broad power to do justice and equity in the circumstances of a particular case where a person who otherwise would not be a “complainant” ought to be permitted to bring an action under either s. 232 or s. 234 to right a wrong done to the corporation which would not otherwise be righted, or to obtain compensation himself or itself where his or its interests have suffered from oppression by the majority controlling the corporation or have been unfairly prejudiced or unfairly disregarded, and the applicant is a “security holder, creditor, director or officer.” The report of the Institute of Law Research and Reform of Alberta had some reservations about the inclusion of such a broad power to permit a person to complain. It is stated, at p. 150: We have some reservations about legislation which confers broad statutory discretions without guidelines. Here, however, we think such discretion appropriate. The specific listed classes appear to us to cover all cases in which the derivative and personal remedies should be available, but foresight is necessarily imperfect, and the general discretion would allow the courts to make up for the imperfections of foresight. We think also that the courts can

919

III.  The Oppression Remedy be relied upon to allow only proper applications. S. 231(b)(iv) of the draft Act therefore follows CBCA s. 231(d).

(It should be noted that what was s. 231(b)(iv) in the draft Act became s. 231(b)(iii) in the ABCA.) The Institute’s report thus recommended that the question of who is a “proper person” be left to the discretion of the Court. Even accepting that the s. 232 and s. 234 remedies should be given a liberal interpretation, the circumstances in which a person who is not a security holder (as I have interpreted that phrase) or a director or officer should be recognized as “a proper person to make an application” must show that justice and equity clearly dictate such a result. •  •  •

I turn now to an application by a person who claims to be a “proper person” to make an application under s. 234. As in the case of an application made under s. 232, an applicant for leave to bring an action under s. 234 does not have to be a security holder, director, or officer. The applicant could be a creditor, or even a person toward whom the corporation had only a contingent liability at the time of the act or conduct complained of. However, it is important to note that he would not be held to be a “proper person” to make the application under s. 234 unless he satisfied the Court that there was some evidence of oppression or unfair prejudice or unfair disregard for the interests of a security holder, creditor, director, or officer. Having said that, assuming that the applicant was a creditor of the corporation at the time of the act or conduct complained of, what criterion should be applied in determining whether the applicant is “a proper person” to make the application? Once again, in my view, the applicant must show that in the circumstances of the case, justice and equity require him or it to be given an opportunity to have the claim tried. There are two circumstances in which justice and equity would entitle a creditor to be regarded as “a proper person.” (There may be other circumstances; these two are not intended to exhaust the possibilities.) The first is if the act or conduct of the directors or management of the corporation which is complained of constituted using the corporation as a vehicle for committing a fraud upon the applicant. In the present case there is no evidence suggesting such fraud, although there is some evidence of the directors having used the money paid as a cash inducement for their own personal investment purposes, and that, as I shall later explain, may constitute fraud against the corporation: see … R v. Olan [[1978] 2 SCR 1175, 5 CR (3d) 1, 41 CCC (2d) 145, 86 DLR (3d) 212, 21 NR 504]. Second, the Court might hold that the applicant is a “proper person to make an application” for an order under s. 234 if the act or conduct of the directors or management of the corporation which is complained of constituted a breach of the underlying expectation of the applicant arising from the circumstances in which the applicant’s relationship with the corporation arose. For example, where the applicant is a creditor of the corporation, did the circumstances which gave rise to the granting of credit include some element which prevented the creditor from taking adequate steps when he or it entered into the agreement to protect his or its interests against the occurrence of which he or it now complains? Did the creditor entertain an expectation that, assuming fair dealing, its chances of repayment would not be frustrated by the kind of conduct which subsequently was engaged in by the management of the corporation? Assuming that the evidence

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established the existence of such an expectation, the next question would be whether that expectation was, objectively, a reasonable one. Thus, in the present case, an inquiry would properly be directed at trial toward whether the lessor, First Edmonton Place, at the time of entering into the lease, consciously and intentionally decided to contract only with the numbered company and not to obtain person guarantees from the three lawyers. A further proper inquiry would be into whether the lessor entered into the lease fully aware that it was not protecting itself against the possibility that the corporation might pay out the cash advance to the lawyers, leaving no other assets in the corporation, and that the corporation might permit the lawyers to occupy the space without entering into a sublease either for ten years or for any lesser period. In the absence of evidence establishing at least a prima facie case that an injustice would be done to the lessor or that there would be inequity if the lessor were not allowed to bring its action and go to trial, leave to bring the action ought not to be granted. There is, in the present case, no evidence showing that there was an expectation on the part of the lessor that the lessee corporation would retain the funds in its hands for any set period of time or any time at all. Nor is there any evidence that there was an expectation that the lessee corporation would grant a lease for a term of 10 years or any other set term beyond the rent-free period, to the law firm or any other person or persons. It is true that the lease contemplated the possibility that the corporation would enter into a lease with the lawyers, for it specified that the lessee could do so. That falls far short of evidencing the existence of an expectation that there would be a lease for the entire 10-year period or for any set term longer than the rent-free period and less than 10 years. Nor does the evidence establish any inequality of bargaining power between First Edmonton Place on the one hand and the three lawyers and their corporation on the other, at the time the lease was being negotiated. If there were some circumstances evidencing such inequality of bargaining power, the result might be different. It is not without significance that the ABCA does provide specific remedies to creditors where, for example, money is paid out of the corporation and the solvency test has not been passed, or where a director contravenes other parts of the Act (such as ss. 113(5), (6) and 240) [s. 113 is now s. 118; s. 240 is now s. 248]. The relevant provisions are as follows: 113(5)  If money or property of a corporation was paid or distributed to a shareholder or other recipient contrary to section 32, 33, 34, 39, 40, 42, 119, 184 or 234, the corporation, any director or shareholder of the corporation, or any person who was a creditor of the corporation at the time of payment or distribution, is entitled to apply to the Court for an order under subsection (6). (6)  On an application under subsection (5), the Court may, if it is satisfied that it is equitable to do so, do any or all of the following: (a)  order a shareholder or other recipient to restore the corporation any money or property that was paid or distributed to him contrary to section 32, 33, 34, 39, 40, 42, 119, 184 or 234; (b)  order the corporation to return or issue shares to a person from whom the corporation has purchased, redeemed or otherwise acquired shares; (c)  make any further order it thinks fit. •  •  •

921

III.  The Oppression Remedy 240  If a corporation or any shareholder, director, officer, employee, agent, auditor, trustee, receiver, receiver-manager or liquidator of a corporation contravenes this Act, the regulations, the articles or bylaws or a unanimous shareholder agreement, a complainant or a creditor of the corporation may, in addition to any other right he has, apply to the Court for an order directing that person to comply with, or restraining that person from contravening any of those things, and on the application the Court may so order and make any further order it thinks fit. [emphasis added]

In these provisions, creditors are specifically mentioned as persons entitled to apply to the Court for remedies. While these sections do not preclude creditors from applying for other remedies (such as those provided for by ss. 232 and 234), the Legislature has singled out cases in which creditors generally are specifically entitled to protection. •  •  •

In deciding who is a “proper person,” and whether justice and equity require a particular applicant to be recognized as a “proper person,” it is appropriate to bear in mind the purposes of the statutory actions provided for in ss. 232 and 234. To the extent that these actions were intended to protect minority shareholders, Professor Bruce Welling, in Corporate Law in Canada (Toronto: Butterworths, 1984), stated at p. 504: “A statutory representative action is the minority shareholder’s sword to the majority’s twin shields of corporate personality and majority rule.” In addition to protecting minority shareholders, the actions provided for by ss. 232 and 234 serve the more general purpose of ensuring managerial accountability. That purpose encompasses protection of the rights of not only minority shareholders but also creditors and even the public in general. It is obvious that by permitting s. 232 and s. 234 actions to be brought by persons other than shareholders, the Legislature intended that the abuse of majority corporate power be capable of remedial action at the invocation of persons other than shareholders. The derivative action has been characterized as “the most important procedure the law has yet developed to police the internal affairs of corporations” (Rostow, “To Whom and for What Ends is Corporate Management Responsible?” in E.S. Mason, ed., The Corporation in Modern Society (1959) at 48). In support of the view that the derivative action should be available to a broad base of applicants is the dominant role which corporations presently play in our society. As stated by Professor Stanley M. Beck in “The Shareholders’ Derivative Action” (1974) 52 Can. Bar Rev. 159 at 159-160: The large corporation, as the dominant economic institution of our time, is particularly being redefined. No longer is it seen as a private institution operating solely for profit or on behalf of and answerable only to its one true constituency, its shareholders. It is realized that it is a public institution in the sense that its major decisions have as significant an impact on the economy as do those of government and that its constituency, like government’s, is the entire citizenry whether in the guise of shareholder, worker, consumer, supplier, or simply user and enjoyer of clean air and water.

It is arguable that the modern-day corporation, affecting as it does such a wide variety of persons and interests, must be policed in a manner to protect these other interests. By allowing a derivative action to be brought by a wider group of interested persons, the Legislature has decided that such a procedure is an effective manner in which to enhance managerial accountability by ensuring that a wrong done to a corporation is remedied.

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While much of the impetus for such a reform may have originated with concern for the social impact of large corporations, no attempt has been made to limit the applicability of the reform to such corporations. In her article [M.A. Maloney, “Whither the Statutory Derivative Action?” (1986) 64 Can. Bar Rev. 309], Professor Maloney supported the availability of the derivative action on a wider basis (at 315): Derivative actions are in effect liability rules designed to act as a deterrent and, as a necessary corollary, create incentives to engage in socially desirable conduct, in this case honest and skilful management. Facilitating such conduct must of course be done in such a manner as to avoid undue interference with managerial decision-making and risk-taking. The desire to maintain an appropriate balance between corporate self-determination and the desire to ensure, from a shareholder (and the public’s) perspective, that the directors or majority shareholders do not run roughshod over minority shareholders’ rights or abuse the corporate form has produced much of the tension that exists in present day statutory shareholder remedies and in the judicial decisions in this area.

And further at p. 319, she said: Finally and importantly, the category of applicants should not remain or become static. The changing face of capitalism and the role which corporations play in furthering its aims dictate the necessity of flexibility. As the notion of which interests the corporation is working towards changes, and becomes increasingly sophisticated, so must the pool of applicants change. Any fears regarding floodgate possibilities or limitless applications can be dealt with by the other procedural or substantive requirements.

Powerful as these arguments are, the Legislature has not gone so far as expressly to permit any interested person to be a “complainant.” However broad the discretion provided for in s. 231(b)(iii) may be, it nevertheless contemplates that a limiting line will be drawn. That line should, in my view, be drawn by application of the criteria which I have enunciated. •  •  •

If an Action Were Brought under Section 234 on the Ground that the Conduct of the directors was “Oppressive or Unfairly Prejudicial to” or Unfairly Disregarded “the Interests of Any … Creditor,” Was the Lessor a “Creditor” at the Time of the Conduct Complained of? •  •  •

I turn to the requirement of s. 234(2) that, if leave to commence the action is to be granted, it must be shown that the conduct of the directors was oppressive or unfairly prejudicial to or unfairly disregarded the interests of, inter alia, a “creditor.” The applicant must have had an interest as creditor at the time the acts complained of occurred: R v. Sands Motor Hotel Ltd., 28 BLR 122, [1985] 1 WWR 59, [1984] CTC 612, 84 DTC 6464, 36 Sask. R 45 (QB). The wording of s. 113(5) supports this view, at least with respect to creditors. Section 113(5) gives creditors “at the time of the payment or distribution” relief for payments or distributions contrary to certain provisions of the Act, including s. 234. At the time of the acts complained of, there was not any rent yet due under the lease. The applicant contends that the lease obligations of the corporation were a present debt

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III.  The Oppression Remedy

at the time of the acts complained of, citing Re Hulbert & Mayer (1916), 11 Alta. LR 239, [1917] 1 WWR 380, 31 DLR 330 (SC (Chambers)). According to Re Hulbert & Mayer, the legal liability to pay rent is incurred at time the lease is created. Thus, at the time of the acts complained of, although the corporation did not owe any rent to the applicant, it did have an obligation to the applicant in respect of future rent. Notwithstanding this obligation, it may be that the applicant was not a creditor at the relevant time as its claim was for unliquidated damages. In Re Porcupine Gold Reef Mining Co., [1946] OR 145, 27 CBR 216, [1946] 2 DLR 618 at 622 (HC), aff ’d. 28 CBR 105, [1947] OWN 185, [1947] 1 DLR 918 (CA), Urquhart J defined “creditor” as “one to whom a debt is owing—correlative to debtor.” In attempting to arrive at a definition for debt,” Professor C.R.C. Dunlop, in his work, Creditor-Debtor Law in Canada (Toronto: Carswell, 1981), stated, at pp. 19-20: The above discussion indicates that the word “debt” is not today a term of art with a clear, never-changing denotation. Instead of trying to define a core meaning, it would seem better to agree with the editors of the Corpus Juris Secundum that “[the word] takes shades of meaning from the occasion of its use, and colour from accompanying use, and it is used in different statutes and constitutions in senses varying from a very restricted to a very general one.” One can say that the most common use of the word “debt” is to describe an obligation to pay a sum certain or a sum readily reducible to a certainty. The obligation may or may not depend on an express or implied contract, depending on the context in which the word is used, but to this writer the essence of the term is that, if there is an obligation to pay a certain or ascertainable sum, the courts should tend not to concern themselves with the precise nature of the cause of action. Claims for unliquidated damages will generally not be describable as debts unless the context suggests otherwise. •  •  •

My conclusion is that the word “creditor” as it is used in s. 234 does not include a lessor in respect of rent which is not owing at the time of the acts complained of, and that therefore the applicant could not succeed in its claim insofar as it is based upon the lease. •  •  •

In the case of the application under s. 232, the applicant was not a holder of a security or a “creditor” at the time of use of the cash inducement money by the three directors. However, there is some evidence that the cash inducement money was not used for purposes of the corporation and that its use might have been a fraud upon the corporation. If it was a fraud upon the corporation, and if the corporation were entitled to recover the money from the three directors, the applicant may have a genuine interest in advancing the claim to such recovery because the corporation might be liable in damages to the applicant. Therefore, the applicant is in my opinion a proper person to make an application under s. 232 and should be granted leave to bring an action in the name and on behalf of the corporation in respect of the payment of the cash inducement money to or for the benefit of the three lawyers. Moreover, as for the three lawyers, as directors of the corporation, permitting themselves as lawyers to occupy the leased premises without paying rent or entering into a lease, whether that conduct constituted a wrong to the corporation is a matter that should be tried. Once against, if there was a wrong, the applicant might ultimately stand to benefit from any recovery by the corporation. Therefore, the applicant is in my opinion a proper person to make an application under s. 232 in regard to this head of claim and should be

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granted leave in the same action to advance a claim in the name and on behalf of the corporation in respect of the occupation of the premises by the directors for their own personal purposes and in respect of the failure of the directors to obtain from themselves personally (or their law firm) a sublease for the term of the lease. Granting leave to bring the statutory derivative action under s. 232 does not in any way imply that on the basis of the evidence placed before me I am of the view that the action is likely to succeed. As to that, of course, I offer no opinion. During the course of argument, there was no suggestion that if leave were granted any condition or conditions would be appropriate. If counsel for the respondents wishes to make any submission in that regard now that leave has been granted, he should make this known to me without delay. In the case of the application under s. 234, leave to bring an action in regard to either claim is denied because the applicant was not a creditor at the time of the act or conduct complained of. Costs may be spoken to. Application allowed in part. QUESTIONS

1.  Do you think ordinary creditors should generally be permitted to seek an oppression remedy, even though the legislation may not explicitly mention creditors? 2.  Does the oppression remedy allow creditors an alternative to seeking to lift the corporate veil?

D.  Closely Held Corporations The oppression remedy has evolved from being a legal mechanism for minority shareholder protection to one that examines the equitable circumstances of shareholders, directors, and others. In the context of a closely held corporation, in particular, “reasonable expectations” may depend on factual circumstances and considerations other than strict legal rights. The following is the first Canadian case to consider the meaning of “reasonable expectations” of stakeholders in a closely held corporation, and illustrates the expansion of the remedy to address actions that may be “unfairly prejudicial” or that “unfairly disregard interests.”

Diligenti v RWMD Operations Kelowna Ltd (1976) 1 BCLR 36 (SC) [The applicant and the three individual respondents had incorporated two companies (the corporate respondents) to operate restaurants in Kelowna and Prince George. The applicant and the three individual respondents each held one-quarter of the issued shares of each company. Each of these four individuals held a one-quarter interest in the lands on which the restaurants were situate (and which were leased to each of the companies). Each of the four individuals were directors of both companies The applicant had spent a good deal of time setting up the two restaurants and supervising their operation.

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925

Differences arose between him and the three individual respondents resulting in, inter alia, his being removed as a director of both companies and being relieved of all day to day managerial functions in both companies, and the payment of management fees by the two restaurant companies to a separate management company owned by the three individual respondents (but not the applicant). The preliminary motion for dismissal of the application for relief under s 221 of the Companies Act was dismissed. The court dealt first with the removal of the applicant as a director of both companies. Dealing with the removal of the applicant as a director of the companies, the court found that on the authorities this did not constitute oppression of the applicant as a shareholder under s 221(1)(a). However, s 221(1)(b), which was new in the 1973 Companies Act, provided relief where an act was “unfairly prejudicial” to a member, and this was a widening of the scope of the “oppression” remedy in s 221(1)(a). Relying heavily on Ebrahimi v Westbourne Galleries Ltd, (1972) 2 All ER492, the court found that certain equitable rights of the applicant as a shareholder had been breached by his removal as a director and hence from participation in the direction of the companies’ affairs, and that although such removal might have been done in strict compliance with the Act and the articles, it was prima facie unjust and inequitable and unfairly prejudicial to his status as a member. In addition, the court found that the combined action of removing the applicant from participation in management affairs and the payment of a management fee to a company owned by the three individual respondents was prima facie at least unfairly prejudicial to the applicant, if not oppressive to him.] [6]  At this point it is appropriate to summarize briefly the background of the relations between the parties and the developments out of which the conduct and acts complained of arose. In late 1972 and early 1973 the applicant and the individual Respondents discussed and finally agreed to the setting up, on a joint venture basis—which, according to the material before me, I find to have been to all intents and purposes a partnership basis—of a restaurant business in Kelowna. A franchise was obtained from Keg Restaurants Ltd. (“the Keg”) to operate a Keg’n Cleaver Restaurant in Kelowna, and a site was purchased in that city in the names of the four partners. RWMD Kelowna was incorporated to carry on the business, and the site was leased to that company. All four partners were directors of the company, and each held 225 shares therein. As matters developed the applicant, who had previous experience in setting up restaurant businesses, and is a management consultant, devoted a good deal of his time to establishing the operation on a profitable basis. A similar undertaking was decided on in Prince George and a similar pattern was followed—negotiation of a Keg franchise, purchase of a site in the names of the four individuals, the incorporation of a company—RWMD Prince George—to lease the premises and carry on the business, with each partner holding 225 shares and each being a director. Mr. Diligenti says that he did the leg work in connection with getting this enterprise organized, and supervised the operation continuously from its outset. [7]  His position was, and is, that it was agreed that he was to be entitled to receive recompense by way of management fees for his work in both companies on a continuing basis. Discussions between the individuals as to the specific basis of this arrangement led to sharp differences of opinion, towards the end of 1975 and into 1976, between Mr. Diligenti on the one side and his three partners—and co-directors—on the other. The outcome was that the three individual Respondents took steps, and caused the companies to take

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steps, which are more particularly set out hereafter. In the result Mr. Diligenti was ousted from all day-to-day managerial responsibilities and functions with respect to both the joint venture—the partnership—and the companies. I find specifically, and as a matter of significance, that the underlying and continuing partnership concept was recognized in that one of the things done was to require Mr. Diligenti to turn over to the others not only the books and records of the corporate Defendants, but also—and specifically—those of the “Joint Venture involved in the subject matters” (Ex. 21 to the affidavit of Diligenti). [8]  Returning to the history of the steps taken by the companies and the directors thereof which are the subject of these proceedings, the material shows that the matters complained of as grounds for the order sought by the applicant are the following:





(a) The decisions of the directors of both companies on 25th February 1976 by which Mr. Diligenti was removed from any authority relating to the operations of those companies—Exs. 22 and 23. (b) The special resolutions adopted at extraordinary general meetings of both companies on 3rd May 1976—Mr. Diligenti dissenting—which removed him as a director of those companies. (c) The resolutions of the directors of RWMD Prince George adopted at a meeting of 21st April 1976 having the following effects: (i) Increasing the rent payable in respect of the Prince George Restaurant premises to the equivalent of 2 per cent of gross sales, payable monthly— the respondents having in the meantime purchased the applicant’s interest in those premises; (ii) Providing for payment of director’s fees in future at $1,000 per month; (iii) Providing that a fee equal to 1⁄ 2 per cent per month of the amount guaranteed be paid to each shareholder who had guaranteed the company’s borrowing from Norco—the applicant being the only shareholder of the four who was not a guarantor; and (iv) Providing that the first annual general meeting of the shareholders be held outside British Columbia. (d) The proposals, approved by the directors of both companies on 22nd June 1976 (the applicant no longer being a director), that at the respective annual general meetings of each company to be held on 14th July 1976, a special resolution be adopted authorizing the leasing of the undertakings of those companies to RWM Management Ltd., a company of which the three individual respondents only are the shareholders. (e) The payment to RWM Management Ltd. since 9th April 1976 of fees for management services at the rate of 21⁄ 2 per cent of gross sales, for which payment there is no specific authorization by way of directors’ or other resolution.

[9]  These proceedings were commenced by originating notice of motion filed and served on 2nd July 1976, at which time all the actions taken and proposals made as enumerated above stood unaltered. Since that time the four resolutions in question of the directors of the Prince George company of 21st April have all been rescinded, and rent which had been pre-paid to the respondents at the rate provided under the first of those

III.  The Oppression Remedy

927

resolutions has been refunded to the company. The annual general meetings of the two companies proposed for 4th July 1976 did not in fact take place, and by resolution of the directors of both companies adopted at meetings on 1st September 1976 the notices of the proposed special resolution for consideration at the forthcoming annual general meetings were rescinded. I am advised that in fact the annual general meetings of both companies have been postponed pending the outcome of these proceedings and for seven days thereafter. It appears therefore that all the matters referred to under headings (c) and (d) above have been effectively brought to an end or remedied as matters of complaint, and they do not per se afford grounds for specific relief. This finding does not, however, prejudge or dispose of the question of whether they may be considered at a later stage, along with such other matters as may in fact be found to afford continuing ground for complaint, to determine whether or not a pattern of conduct of the affairs of the companies or of the exercise of the powers of the directors has been established, and is continuing, which is oppressive. [10]  It follows that the matters enumerated which have not been brought to an end or remedied are:

(a) The actions of a majority of the directors in relieving the applicant of all dayto-day managerial functions. (b) The actions of the other three shareholders in removing the applicant as a director leaving only themselves as directors. (c) The decision to pay, and the payment of, management fees to RWM Management Ltd., the company of the individual Respondents, of 21⁄ 2 per cent of gross sales.

[11]  At this point I should refer to the specific provisions under which this application is brought, and in respect of which the objection is taken that the relief sought does not lie. The relevant portions of s. 221 of the 1973 Act read as follows: 221(1)  A member of a company or an inspector under section 230 may apply to the court for an order on the ground (a)  that the affairs of the company are being conducted, or the powers of the directors are being exercised, in a manner oppressive to one or more of the members, including himself; or (b)  that some act of the company has been done, or is threatened, or that some resolution of the members or any class of members has been passed or is proposed, that is unfairly prejudicial to one or more of the members, including himself.

[12]  Then follows subs. (2) to which I have already referred. [13]  In respect of both paras. (a) and (b), I agree with the submission of counsel for the respondents, on the basis of the authorities cited, that the oppression and the unfair prejudice must be with respect to the rights, position or interests of the applicant as member, that is, as shareholder, of the companies and not with respect to his rights, interests or position as director, officer, or employee. Looking then at the matters which form the continuing grounds of complaint, the question is: Do these on the face of them affect the rights and interests of the applicant as shareholder, or affect him in his rights and interests in some other capacity? Bearing in mind that this is a preliminary motion only, it is my view that I should at this stage deal with the question on a prima facie basis

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only: Does the conduct or do the acts complained of on the face of them oppress the applicant, or unfairly prejudice him, in his status as a member? If that be decided in the negative, that is an end of the matter; but if it be decided otherwise, then the question of whether the extent of the oppression or of the prejudice in fact warrants the granting of the relief sought is, as I view it, a matter to be decided on the basis of the evidence to be presented and submissions to be made on the merits. [14]  Before dealing with the arguments for and against the preliminary motion and the authorities cited, it is necessary to consider briefly the changes in the legislative scheme brought about by the 1973 Act, and compare its provision with the earlier provisions under which the cases referred to both here and in the United Kingdom were decided. So far as I am aware this is the first occasion on which the points at issue here have come forward for decision under the 1973 Act. [15]  Previously the specific relief for minority shareholders who considered themselves aggrieved by the actions of the majority were contained in s. 185 of the former Companies Act, R.S.B.C. 1960, c.  67. The relevant portions of that section read as follows: 185(1)  Any member of a company who complains that the affairs of the company are being conducted in a manner oppressive to some part of the members (including himself) … may make an application to the Court by petition for an order under this section. (2)  If on any such petition the Court is of opinion (a)  that the company’s affairs are being conducted as aforesaid; and (b)  that to wind up the company would unfairly prejudice that part of the members, but otherwise the facts would justify the making of a winding-up order on the ground that it was just and equitable that the company should be wound up, the Court may, with a view to bringing to an end the matters complained of, make such order as it thinks fit.

[16]  It is common ground that that provision was on all fours with s. 210 of the Companies Act, 1948 (Eng.), c. 38, under which a number of the cases cited to me were decided. [17]  The former Companies Act of this province also contained a section, s. 219, providing generally that a member might apply for an order that the company be wound up, and that the court might so order in any case where the court thinks it “just and equitable” that this be done. This provision corresponded to s. 222 of the English Act. The provision of s. 219 empowering the court to order winding-up on application of a member if it deems it just and equitable to do so is continued in s. 292 of the 1973 Act; s. 293 of the 1973 Act now provides, however, that where a member applies for a winding-up order the court may, if it is of opinion that the applicant is entitled to relief either by winding-up or under s. 221 which we are presently considering, either make an order for winding-up or make such order under this section as it considers appropriate. [18]  It will be seen, then, that the scheme is to provide, under s. 221, the sort of relief formerly provided for under s. 185 without the necessity of proving that the circumstances are such that it would be just and equitable to order a winding-up, but with power to the court, if it thinks it appropriate, to include within the relief that can then be ordered, an order for winding- up. It is also apparent that, as compared to s. 185, whereas formerly the only ground for relief (apart from winding-up) available to a member was that the

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affairs of the company were being conducted in a manner oppressive to himself as a shareholder, two new grounds are included: the first, in subs. (1)(a), that the powers of the directors are being exercised in a manner oppressive to him as a shareholder, and the second, in subs. (1)(b), that some act of the company or resolution of the members has been done or proposed that “is unfairly prejudicial” to a member or members including himself. This latter ground is not included in the English Act. [19]  I have therefore to consider whether the inclusion of the two new grounds, and particularly the ground in s. 221(1)(b) that what has been done is “unfairly prejudicial” to the member, has enlarged or changed the application of the rules laid down in the cases as to the basis upon which the relief sought may be given. I will deal with the three continuing grounds separately, and will defer consideration of the first ground—that the applicant has been deprived of all authority in connection with the day-to-day administration of the affairs of the companies—until after I have dealt with the second ground. [20]  As to this ground—the removal of the applicant from his position as director of both companies, there is an impressive line of authorities which have held that where a shareholder has been removed as a director, in some cases holding an equal number of shares with each of those whose combined votes have brought about his removal, an application for relief under the English Companies Act provision and the former British Columbia Companies Act provision could not succeed because such conduct did not oppress the individual concerned in his status as member but affected his status as director only. Amongst the cases referred to me which I have considered are Elder v. Elder and Watson (1952) S.C. 49; In Re Lundie Bros. Ltd. (1965) W.L.R. 1051; and, in British Columbia, Re B.C. Aircraft Propeller & Engine Co. Ltd. (1968) 66 D.L.R. (2d) 628. In a recent case under the English provision, Ebrahimi v. Westbourne Galleries Ltd. (1972) 2 All E.R. 492, the decision was the same; but in that case the House of Lords held that the conduct of the other shareholders in removing the petitioning shareholder from his position as director was, in the circumstances there prevailing, unjust and inequitable, and confirmed the order for a winding-up under the “just and equitable” provision. The judgment of Lord Wilberforce has great significance for the case before me in the light of the present “unfairly prejudicial” provision of the 1973 Act in this province, and I will be reviewing that judgment in more detail shortly. [21]  On the face of it it would appear to me that, particularly in a company of the nature of those involved here—private companies, closely held, formed to take over the operations of four individuals who have been equal founders and proprietors of a venture and in which companies each of the four holds the same number of shares—each of its members has a very real interest and concern in the management of the affairs of the company. I am referring here to management generally in the sense that management of the affairs of the company is in the hands of the directors and policy decisions and general business decisions affecting the future of the companies are made by them, as distinct from a particular managerial position to which a director—or a member—may be appointed. In my view, as such shareholder he would have a very real interest in being and remaining a director so as to have a voice and a vote in the shaping of the policies and the general business decisions which the board, in its overall responsibilities, will make on behalf of the company. This is not solely a matter of protection of his interests in the narrow sense—for being one of four he can always be out-voted: it is a matter of whether or not he has a right, in the circumstances, to the opportunity for a continued

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voice and vote in shaping policies. Nevertheless I recognize that the applicant can derive no assistance from subs. (1)(a) because the authorities have held that his removal from his directorship does not oppress him in his status as member. [22]  The question, then, is: Does the addition of the provision regarding the doing of an act that is “unfairly prejudicial” assist the applicant in the circumstances here? In my view, it does. In reaching this conclusion I have been assisted in part by a consideration of the rules of statutory interpretation generally, as well as of interpretations that have been given to the expression “conducted in a manner oppressive” which is continued in the 1973 Act, and the interpretation that may, or ought to, be given to the new expression therein, “is unfairly prejudicial.” [23]  It is a principle of statutory interpretation, as I appreciate it, that where the legislature has amended an enactment by adding a new provision, the intent was to remedy some deficiency in, or to extend the scope of, the previous enactment. Subsection (1)(a) of s. 221 retained substantially the same terms and is to the same effect as the former s. 185(1). It is subs. (1)(b) that is new in its terms. It is fair to ask then, what was the intent of the legislature in importing the new provision with its new terms? One answer is that it was to remedy the situation which had arisen by reason of the fact that the words in former s. 185(1), repeated in new subs. 221(1)(a), “the affairs … are being conducted,” had been interpreted as requiring a continuing course of conduct in order to give rise to the remedy (see Gower, Modern Company Law, 3rd ed., p. 602), although a single act could in fact be very damaging. This remedy is provided by the use of the singular throughout subs. 221(1)(b)—”that some act … has been done,” etc. However, it is surely not without significance that in defining the nature or effect of the act referred to in subs. (1) (b) which makes it a ground for relief, the legislature has been careful to use words different from those defining the nature or effect of the conduct referred to in subs. (1)(a) which makes that a ground of relief: in the former words it is conduct “oppressive to” the member, in the new provision it is an act, etc., that is “unfairly prejudicial” to him. I am satisfied that this deliberate use of that new expression in this context denotes an intent that in applying that new provision the court should give those qualifying or defining words an effect different from and going beyond that given to the word “oppressive”: if not, the expression used would have been the same. [24]  Turning than to the meaning and effect which have been given to the words which are retained and that which should be given to the new expression, I note that in Scottish Co-operative Wholesale Society Ltd. v. Meyer (1959) A.C. 324, [1958] 3 All E.R. 66, which was followed in the cases cited above and others to which I was referred, Viscount Simonds said, at p. 342, that he adopted the “dictionary meaning of the word” (oppressive) as “burdensome, harsh and wrongful.” In Elder v. Elder and Watson, supra, Lord Keith said at p. 60 that “oppression involves, I think, at least an element of lack of probity or fair dealing to a member in the matter of his proprietary right as a shareholder.” In both these cases, which were followed in our court in the B.C. Aircraft case, supra, it is clear that the courts approached the matter on the basis that since no legal right of the member in respect of his position or proprietary interests as a shareholder had been infringed, there had been no oppression of him as a shareholder—there had been no wrong-doing. [25]  There has been no interpretation, in this context, of the words “unfairly prejudicial.” Turning to the dictionaries for assistance, I find the following definitions in the Shorter Oxford English Dictionary, 3rd ed.:

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Prejudice … I. Injury, detriment, or damage, caused to a person by judgment or action in which his rights are disregarded; hence, injury to a person or thing likely to be the consequence of some action … Prejudicial … I. Causing prejudice; detrimental, damaging (to rights, interests, etc.) … Unfair … Not fair or equitable; unjust. … Hence, unfairly.

[26]  It is significant that the dictionary definitions support the instinctive reactions that what is unjust and inequitable is obviously also unfairly prejudicial. [27]  In considering the whole effect which should be given to the expression “unfairly prejudicial” in the light of these definitions, and of the rule summarized above, I agree that it must be borne in mind that the consequences in question must flow to, the applicant as a member, and not as a director or employee. Prejudicial, according to the dictionary, means detrimental or damaging to his rights, interests, etc. The question then is: Does the applicant have some rights or interests as a shareholder in respect of which he has been unfairly prejudiced? [28]  It is forcefully contended by Mr. Cumming that he does not. His rights as shareholder, according to this argument, are determined by the articles of association of the companies, which provide that the shareholders shall elect the directors. In this context, he is not a partner in a partnership, he has no legal right to participate in the management of the affairs of the company—he has no legal right to be a director and—so the argument runs, it would be wrong to import into the process of decision here principles or rights based upon partnership law, for to do so would in effect be to alter the effect of the articles of the companies by which he is bound, and to give him a legal right which he does not have—that is, to be a director of the companies. Reliance is placed upon one passage in the judgment of Lord Wilberforce in Ebrahimi v. Westbourne Galleries, supra, at p. 500. The other shareholders, it is contended, have done him no wrong: they have done nothing other than that which, by the articles, all shareholders have the right to do, that is to determine who shall be directors, and therefore he cannot have been unfairly prejudiced in his status as member. [29]  I consider, however, that the new provision is not to be so narrowly interpreted or its effect so narrowly confined, for to do so would be to deal with it as though the word was still “oppressive.” I consider that there are rights—equitable rights—attaching to the position of the applicant as shareholder in the circumstances present here, in respect of which he has been unfairly prejudiced, and in reaching this conclusion I rely upon and respectfully adopt the reasoning of Lord Wilberforce as distilled from a perusal of the whole of his judgment in the Ebrahimi case. [30]  In that judgment, concurred in either specifically or in the result by the other four law Lords, Lord Wilberforce found as a fact that equitable rights arise with respect to the shares and the position of a shareholder in circumstances remarkably similar to those existing here, and that an act such as complained of here—removing him as a director—amounts to a breach of those rights and is unjust and inequitable treatment. [31]  In that case the facts are summarized in the headnote at p. 492, as follows: Since about 1945 the appellant and N had carried on in partnership a business as carpet dealers. As partners they had an equal share in the management and profits. In 1958 they formed a company to take over the business. The appellant and N were the signatories to the company’s memorandum and were appointed its first directors. Of the issued share capital

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Chapter 14  Stakeholder Remedies of 1,000 shares, 500 were issued to each of the subscribers. … Soon after the company’s formation N’s son G, was appointed a director and each of the two original shareholders transferred to him 100 shares. The company made good profits, all of which were distributed by way of directors’ remuneration. No dividends were ever paid. Differences arose between the appellant and N, with whom G sided, about the running of the business. In August 1969, at a general meeting, N and G, by means of an ordinary resolution which was legally effective under s  184 of the Companies Act 1948 [c.  38] and the company’s articles, removed the appellant from the office of director and thereafter excluded him from any share in the conduct of the company’s business. The appellant petitioned for an Order under s 210 of the 1948 Act that N and G purchase his shares in the company and, in the alternative, for an Order under s 222 of the 1948 Act that the company be wound up on the ground that it was just and equitable to do so.

[32]  The trial judge rejected the application under s. 210, holding in accordance with the authorities referred to that the conduct in question was not oppressive of the applicant in respect of his rights as member, but granted an order for winding-up under the provisions of s. 222 of the English Act. It was with respect to this order that the appeal was taken to the House of Lords. Lord Wilberforce dealt extensively with the question of what rights, if any, attach to the holding of shares in these circumstances, so as to make the conduct, although strictly legal, nevertheless wrongful so as to give rise to a right of action under the “just and equitable” provision. Since the judgment is, in my view, of direct application here, I quote from it at some length. [33]  Lord Wilberforce started with a consideration of the meaning of the words “just and equitable” in the provision of the Act allowing for a winding-up on the application of a member if in the opinion of the court it is just and equitable to do so. Recognizing that they had their origin and first application in a partnership context, he reviewed the authorities where they have been applied in company cases. He said, at p. 500: The words are a recognition of the fact that a limited company is more than a mere judicial entity, with a personality in law of its own: that there is room in company law for recognition of the fact that behind it, or amongst it, there are individuals, with rights, expectations and obligations inter se which are not necessarily submerged in the company structure. That structure is defined by the Companies Act 1948 [c. 38] and by the articles of association by which shareholders agree to be bound. In most companies and in most contexts, this definition is sufficient and exhaustive, equally so whether the company is large or small. The “just and equitable” provision does not, as the respondents suggest, entitle one party to disregard the obligation he assumes by entering a company, nor the court to dispense him from it. It does, as equity always does, enable the court to subject the exercise of legal rights to equitable considerations; considerations, that is, of a personal character arising between one individual and another, which may make it unjust, or inequitable, to insist on legal rights, or to exercise them in a particular way. (The italics are mine.)

[34]  Lord Wilberforce continued (p. 500): It would be impossible, and wholly undesirable, to define the circumstances in which these considerations may arise. Certainly the fact that a company is a small one, or a private company, is not enough. There are very many of these where the association is a purely commercial one, of which it can safely be said that the basis of association is adequately and

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exhaustively laid down in the articles. The super-imposition of equitable considerations requires something more, which typically may include one, or probably more, of the following elements: (i) An association formed or continued on the basis of a personal relationship, involving mutual confidence—this element will often be found where a pre- existing partnership has been converted into a limited company; (ii) An agreement, or understanding, that all, or some (for there may be “sleeping” members), of the shareholders shall participate in the conduct of the business; (iii)  Restriction on the transfer of the members’ interest in the company—so that if confidence is lost, or one member is removed from management, he cannot take out his stake and go elsewhere.”

[35]  In my view these conditions exist in the case before me. It is true that the partnership had not been of as long standing as in the Ebrahimi case, but it is clear from the material which I have reviewed that the whole concept commenced on a joint venturepartnership basis, with each of the four partners sharing equally in the responsibility and expecting to share equally in the continuing management and direction of affairs. This is borne out by the fact that the properties in question where the operations were to be carried on were acquired in the names of the four partners jointly, and that the shares in the companies formed to take over the operations were held in equal proportions, and that each of the partners became a director of those companies. [36]  Lord Wilberforce continues, at p. 500: It is these, and analogous, factors which may bring into play the just and equitable clause, and they do so directly, through the force of the words themselves. To refer, as so many of the cases do, to “quasi-partnerships” or “in substance partnerships” may be convenient but may also be confusing. It may be convenient because it is the law of partnership which has developed the conceptions of probity, good faith and mutual confidence, and the remedies where these are absent, which become relevant once such factors as I have mentioned are found to exist: the words “just and equitable” sum these up in the law of partnership itself. And in many, but not necessarily all, cases there has been a pre-existing partnership the obligations of which it is reasonable to suppose continue to underlie the new company structure. But the expressions may be confusing if they obscure, or deny, the fact that the parties (possibly former partners) are now co-members in a company, who have accepted, in law, new obligations. A company, however small, however domestic, is a company not a partnership or even a quasi-partnership and it is through the just and equitable clause that obligations, common to partnership relations, may come in. My Lords, this is an expulsion case, and I must briefly justify the application in such cases of the just and equitable clause. The question is, as always, whether it is equitable to allow one (or two) to make use of his legal rights to the prejudice of his associate(s). The law of companies recognises the right, in many ways, to remove a director from the board. Section 184 of the Companies Act 1948 confers this right on the company in general meeting whatever the articles may say.

[37]  Lord Wilberforce then summarizes the various methods by which a director may be “lawfully” removed, and continues [at p. 501]: In all these ways a particular director-member may find himself no longer a director, through removal, or non-reelection: this situation he must normally accept, unless he undertakes the burden of proving fraud or mala fides. The just and equitable provision nevertheless comes to

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Chapter 14  Stakeholder Remedies his assistance if he can point to, and prove, some special underlying obligation of his fellow member(s) in good faith, or confidence, that so long as the business continues he shall be entitled to management participation, an obligation so basic that if broken, the conclusion must be that the association must be dissolved. And the principles on which he may do so are those worked out by the courts in partnership cases where there has been exclusion from management … even where under the partnership agreement there is a power of expulsion.

[38]  Lord Wilberforce then (p. 501) adopted a portion of the judgment of the trial judge, which reads: [W]hile no doubt the petitioner was lawfully removed, in the sense that he ceased in law to be a director, it does not follow that in removing him the respondents did not do him a wrong. In my judgment, they did do him a wrong, in the sense that it was an abuse of power and a breach of good faith which partners owe to each other to exclude one of them from all participation in the business on which they have embarked on the basis that all should participate in its management. The main justification put forward for removing him was that he was perpetually complaining, but the faults were not all on one side and, in my judgment, this is not sufficient justification. For these reasons, in my judgment, the petitioner therefore has made out a case for a winding-up order.

[39]  And he concluded: Reading this in the context of the judgment as a whole, which had dealt with the specific complaints of one side against the other, I take it as a finding that the respondents were not entitled, in justice and equity, to make use of their legal powers of expulsion and that, in accordance with the principles of the cases  … the only just and equitable course was to dissolve the association. (The italics are mine.)

[40]  Adopting, as I respectfully do, this reasoning in its entirety, three things appear to me to emerge quite clearly. First, in circumstances such as exist here there are “rights, expectations and obligations inter se” which are not submerged in the company structure, and these rights are enjoyed by a member as part of his status as a shareholder in the company which has been formed to carry on the enterprise: amongst these rights are the rights to continue to participate in the direction of that company’s affairs. Second, although his fellow members may be entitled as a matter of strict law to remove him as a director, for them to do so in fact is unjust and inequitable, and is a breach of equitable rights which he in fact possesses as a member. And third, although such breach may not “oppress” him in respect of his proprietary rights as a shareholder, such unjust and inequitable denial of his rights and expectations is undoubtedly “unfairly prejudicial” to him in his status as member. And from these three findings it follows that, although in England the only remedy to which the member was entitled was an order for winding-up, in this province by virtue of the choice of remedies under the scheme of the 1973 Act, and the inclusion of the “unfairly prejudicial” provision in s. 221, the applicant is prima facie entitled to one or more of the remedies—including winding-up—which that section makes available to a shareholder who has thus been unfairly prejudiced. •  •  •

[44]  I am not suggesting for a moment that the applicant had any inherent right to management fees, or to continue in the position as manager and be paid therefor: subject

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to any contractual obligations in that regard directors, as I have said, have the right to terminate or vary the terms of such appointment in their discretion. It would have been perfectly equitable, and not oppressive, for instance, for the directors to decide that if they or their company were to take an active role in management along with the applicant, the remuneration therefor should be shared. But can it be equitable for three shareholders to say to the fourth: “You shall not take any further part in management, so you shall not benefit directly in that way,” and then appoint their own creature to manage so that they benefit directly and exclusively? In my opinion the answer must be “No”—that such an act is unfairly prejudicial to, if not indeed oppressive of, that fourth shareholder. I do not consider that the respondents can gain any assistance from the provision in the letter agreement between the four partners and the Keg, that management fees at 21⁄ 2 per cent of gross sales will be paid to the Keg and that if the Keg does not in fact provide those services then “the Partners will provide such management services, in which case, in consideration of such services, the partners will receive 21⁄ 2% of such gross sales.” (para. 10(d), p. 6 of Ex. 1 to the affidavit of Diligenti). Here there is clear indication of the intent that “the partners” would collectively provide and collectively share, whereas what has happened is that Diligenti has been effectively excluded. Nor can they derive assistance from the fact that Mr. Diligenti was paid, and is still claiming further payment, for his services when he was actively engaged in the management of the company: for Mr. Diligenti’s claim there is that it was agreed between all four partners that he would provide those services, over and above his normal participation as partner and later as director; here there is no suggestion of agreement between all four. [45]  I am of the view that the same sort of rights and obligations inter se attach to the position of the partners—now the shareholders—in respect of arrangements of this kind as were found by Lord Wilberforce in connection with their rights to be directors. Certainly the judgment of McFarlane  J.A., for the Court of Appeal in National Building Maintenance Ltd. v. Dove, [1972] 5 W.W.R. 410 at 412 (B.C.), is authority for the proposition that the taking of management fees as a device to divert the profits of the company to a majority is conduct oppressive to a minority. It is not necessary for me to make a substantive finding at this stage on the point whether the device was deliberately adopted for this purpose, or had this effect—that would be for the court to determine at a later stage: but there is evidence that substantial sums were and are still being so diverted to a company owned by the three majority shareholders, and in my view in the circumstances here—the exclusion of the applicant from all enjoyment of such moneys and the diversion of them to those three shareholders—there is thus prima facie evidence of an act at least unfairly prejudicial to the applicant, if not indeed of conduct oppressive to him. One such act or piece of conduct might not have been so regarded, but the one step having been taken, then the taking of the other step invests each, or both, with the aura of prejudice or oppression. A second stage of proceedings in the Diligenti case was heard by Fulton J of the BC Supreme Court in Chambers on 22 September 1977. That decision is reported in (1977) 4 BCLR 134 (SC). The dispute in the second stage of the proceedings was confined to the price to be paid for Diligenti’s shares and whether they should be purchased by the individual respondents or by the corporate respondents. Fulton  J determined that Diligenti’s shares should be

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purchased by the companies and that the worth of the shares was to be the fair value, not the market value, and was to be determined by reference to the value of the business as a going concern. The price paid to Diligenti was to be his proportionate interest in each company as a going concern. The following case demonstrates that although the oppression remedy provides for a wide array of possible remedies, the courts are generally careful to ensure that any relief granted does not overreach the complainant’s reasonable expectations.

Naneff v Con-Crete Holdings Ltd (1995), 23 OR (3d) 481 (CA) [A father made his two sons equal owners of his business, but retained voting control of the company. A family dispute erupted. One son was pushed out of the business and applied for an oppression remedy. The trial judge found that the conduct was indeed oppressive and ordered a public sale of the business as a going concern. On appeal, the Court of Appeal found that the remedy of public sale was inappropriate and ordered instead that the son’s shares be purchased by the father and brother at fair market value.] GALLIGAN JA: I agree with and adopt Landry J.’s analysis as a correct statement of the law. Persons who are shareholders, officers and directors of companies may have other personal interests which are intimately connected to a transaction. However, it is only their interests as shareholder, officer or director as such which are protected by s. 248 of the O.B.C.A. The provisions of that section cannot be used to protect or to advance directly or indirectly their other personal interests. I conclude, therefore, that the discretionary powers in s. 248(3) O.B.C.A. must be exercised within two important limitations:

(i) they must only rectify oppressive conduct (ii) they may protect only the person’s interest as a shareholder, director or officer as such. The law is clear that when determining whether there has been oppression of a minority shareholder, the court must determine what the reasonable expectations of that person were according to the arrangements which existed between the principals. The cases on this issue are collected and analyzed by Farley J. in 820099 Ontario Inc. v. Harold E. Ballard Ltd. (1991), 3 B.L.R. (2d) 113 at p. 123 (Ont. Gen. Div.), affirmed (1991), 3 B.L.R. (2d) 113 (Ont. Div. Ct.). I agree with his comment at pp. 185-86: Shareholder interests would appear to be intertwined with shareholder expectations. It does not appear to me that the shareholder expectations which are to be considered are those that a shareholder has as his own individual “wish list.” They must be expectations which could be said to have been (or ought to have been considered as) part of the compact of the shareholders.

The determination of reasonable expectations will also, in my view, have an important bearing upon the decision as to what is a just remedy in a particular case.

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The finding made by Blair J. that Alex expected ultimately to be an equal co-owner of the business with his brother cannot be challenged. However, it must be interpreted in the light of two other important and intertwined considerations. The first consideration is that Alex fully understood that until death or voluntary retirement his father retained ultimate control over the business even to the extent of deciding what dividends would be paid and what would be done with any of those dividends. The second consideration is that this was a family business which had been built by his father. The importance of the first of those considerations is that Alex knew that until his father died or retired he could under no circumstances have any right to have or even to share absolute control of the business. Therefore, under no circumstances could Alex’s reasonable expectations include the right to control the family business while his father was alive and active. The second consideration is important because, while Alex expected that his father would give him an equal share in the control of the business upon his death or retirement, that expectation was based upon his belief that his father would continue to be bountiful to him in the future. It should have been apparent to Alex that he could not expect that paternal bounty to continue if his father for good reason or bad no longer considered him to be a dutiful son. It would have been quite unrealistic of Alex to expect that his father would continue to be bountiful to him if his family ties were severed. Alex knew that the reason for his father giving him one-half of the equity in the family business was his father’s desire for his sons to work with him in his business. He must also have known that it would be impossible for him, Mr. Naneff and Boris to work together in the business as a family if the family bonds ceased to exist. It is for those reasons that Alex’s reasonable expectation must be looked at in the light of the family relationship. It is my view that the first error in principle in this remedy is that it did more than simply rectify oppression. As I noted above, the O.B.C.A. authorizes a court to rectify oppressive conduct. I think the words of Farley J. in Ballard, supra, at p. 197 are very appropriate in this respect: The court should not interfere with the affairs of a corporation lightly. I think that where relief is justified to correct an oppressive type of situation, the surgery should be done with a scalpel, and not a battle axe. I would think that this principle would hold true even if the past conduct of the oppressor were found to be scandalous. The job for the court is to even up the balance, not tip it in favour of the hurt party. I note that in Explo [Explo Syndicate v. Explo Inc., a decision of the Ontario High Court, released June 29, 1989], Gravely L.J.S.C. stated at p. 20: In approaching a remedy the court, in my view, should interfere as little as possible and only to the extent necessary to redress the unfairness.

The order of Blair J. gave Alex something which he knew he could never have while his father was alive and active—the opportunity to obtain full control of the family business. A remedy that rectifies cannot be a remedy which gives a shareholder something that even he never could have reasonably expected. Moreover, I am unable to view the remedy as anything other than a punitive one towards Mr. Naneff. There was never any doubt among the three men that Mr. Naneff would exercise ultimate control of the family business until he died or retired. Mr. Naneff solidified his right of complete control by the corporate arrangements he put in place at

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the time of the estate freeze and which he kept in place to the knowledge of his sons throughout the time that the three of them worked together. It is not the task of any court of law to judge the family dispute or to rule upon the justice of the expulsion of Alex from the family. However, I am unable to accept as anything other than punitive, a remedy which puts at risk the very condition upon which Mr. Naneff exercised his bounty in favour of his sons—his total control of the business during his active life. The O.B.C.A. authorizes a court to rectify oppression; it does not authorize the court to punish for it. The second error in this remedy is that it attempts to protect Alex’s interest in the family business as a son and family member, in addition to protecting his interest as a shareholder as such. As I mentioned above, it is my view that Alex’s expectation of ultimately obtaining an equal share of the control of the business with Boris was based upon his expectation of being the continuing object of his father’s bounty. That in turn depended upon him remaining in his father’s favour and remaining in his father’s eyes a member of the family. The remedy of public sale, which gives Alex the opportunity to buy the company, enables him to obtain that control while out of his father’s favour. This appears to protect much more than his interest as a shareholder as such; it protects, indeed it advances, his interest as a son. It is my view, therefore, that the remedy imposed in this case constituted an error in principle in that it did more than rectify oppression, and it did more than protect Alex’s interest as a shareholder as such in the companies. As well as concluding that the remedy granted to Alex was wrong in principle, it is my view that the remedy was unjust to Mr. Naneff. By the time of Alex’s ouster from the business, Mr. Naneff had devoted almost 40 years of his life to creating, nurturing and building the business into a very significant enterprise. Instead of using profits from the business to acquire other personal assets, he used them to finance the growth and expansion of the business. There was never any doubt in the minds of his sons that their father gave them their equity positions upon the understanding that he would retain ultimate control as long as he wanted to exercise it. No one can disparage the productive and devoted work which Alex put into the business. But his nine years of contribution pales to almost insignificance when compared with that of his father’s contribution. The effect of the relief granted to Alex is to put Mr. Naneff in the position where he is just another person, equal to Alex, who is entitled to buy the business which he had himself founded and built from nothing. The remedy jeopardizes something which Alex knew was always to be his father’s, the right to ultimate control of the business. The remedy gives to Alex the possibility of taking control of the business, something he knew he could never have during his father’s lifetime. Having regard to the circumstances of this case this remedy, which jeopardizes the right which everyone knew belonged to Mr. Naneff and which gives Alex the opportunity to take away that right, strikes me as unjust. At trial there were three possible fundamental remedies suggested to the trial judge. One of them was properly rejected out of hand. No more need be said about it. The alternative remedy to public sale of the business as a going concern was that Mr. Naneff and Boris acquire Alex’s shares of the companies at fair market value, without minority discount. In my view that was the just remedy in this case. While I find that Mr. Naneff ’s oppressive conduct should not endanger his right to control the business, neither should he be able to take away what he had given to Alex, or to take away what Alex had contributed to the business. This remedy, together with certain of the other remedies ordered

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by Blair J., would have had the effect of fully compensating Alex for the value of the equity given to him by his father and for his own contributions to the business. The value of his shares would reflect the success of the business and Alex’s contribution toward that success, as well as the value of the gift of equity which he had received from his father. When I discuss the remedy respecting the shareholders’ loans, it will be seen that when the business was ordered to repay Alex the amounts of his loans, in fact he was receiving his share of the operating profits of the business over previous years. This remedy would be just because it will put Alex, in so far as money can, in the position which he would have been in had he not been ejected. It would not give him an opportunity to which he had no reasonable expectation. It would not put at risk Mr. Naneff ’s right to ultimate control which Alex knew was a condition of his father’s gift of equity. The remedy would protect Alex’s interest as a shareholder as such. It is my opinion that para. 9 of the trial judgment, which provides for the sale of the appellant companies on the open market as a going concern, cannot be sustained. In its place, I would order that the appellants acquire Alex’s shares of the companies at fair market value fixed as of the date of his ouster, December 25, 1990. It is conceded on behalf of the appellants that it would not be fair to apply a minority discount to the market value of Alex’s shares. I agree and would order that there be no minority discount when fixing the fair market value of his shares. Alex is also entitled to prejudgment interest on the value of his shares as provided in the Courts of Justice Act, R.S.O. 1990, c. C.43, from December 25, 1990. In the event that the parties cannot agree upon the value of the shares or to having the value of them fixed in some other way, I would direct a new trial restricted to fixing the value of Alex’s shares in the appellant companies as of December 25, 1990. In my view the costs of such a new trial ought to be in the discretion of the judge presiding at it. The issue of whether liability should be imposed personally on corporate directors was addressed in the leading case Budd v Gentra Inc (1998), 43 BLR (2d) 27 (Ont CA). Doherty JA confirmed that the court has broad discretion to fashion a remedy under the oppression remedy section, including a monetary judgment against a director of the corporation. He described, generally, the circumstances in which a remedy may lie against a corporate director personally: [52]  … To maintain an action for a monetary order against a director or officer personally, a plaintiff must plead facts which would justify that kind of order. The plaintiff must allege a basis upon which it would be “fit” to order rectification of the oppression by requiring the directors or officers to reach into their own pockets to compensate aggrieved persons. The case law provides examples of various situations in which personal orders are appropriate. These include cases in which it is alleged that the directors or officers personally benefitted from the oppressive conduct, or furthered their control over the company through the oppressive conduct. Oppression applications involving closely held corporations where a director or officer has virtually total control over the corporation provide another example of a situation in which a director or officer may be held personally liable to rectify corporate oppression.

Parties to a unanimous shareholders’ agreement (USA) or other contract can expect a court to determine their reasonable expectations in light of the written agreement. Courts

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are generally reluctant to interfere with a USA or award an oppression remedy in circumstances where a contractual remedy is available. In Taylor v London Guarantee Insurance Co (2000), 11 BLR (3d) 295, [2000] OJ No 1430 (SC), the court found that heavy-handed behaviour is only relevant as it relates to the reasonable expectations of the parties. Where expectations are reasonable on their face and where there is a contract specifically dealing with those expectations, in this case a shareholders’ agreement with an “entire agreement clause,” the reasonableness of those expectations cannot prevail against a contract that specifically lays out these expectations. In Armstrong v Northern Eyes Inc (2000), 48 OR (3d) 442 (Sup Ct J), aff’d [2001] OJ No 1085 (CA), the court addressed the relationship between a dispute resolution mechanism previously agreed on between the parties and the oppression remedy. The court concluded that there was nothing unfair about holding the parties to the arbitration clause they had drafted, particularly since it dealt with the kind of dispute in question. The application of the oppression remedy to employees who are also shareholders has been considered by the courts. In Flatley v Algy Corp (2000), 9 BLR (3d) 255 (Ont SC) a minority shareholder invested in a new bar and claimed that she and the majority shareholder had an agreement with respect to the distribution of profits. She also worked at the bar as a bartender and was terminated from her employment there by the majority shareholder. The court found that the complainant’s claim for unjust termination was a matter for a wrongful dismissal action, but also found unfair prejudice and unfair disregard of her rights as a shareholder and ordered the return of her investment as a remedy for oppression. Does a former shareholder have any entitlement under the oppression remedy? A 2016 majority decision of the Supreme Court of Canada held that a shareholder in a closely held corporation could not successfully claim oppression in circumstances where the shareholder had three years earlier resigned as an officer and director of the company, and on a finding of fact by the trial judge, also ceased to be a shareholder upon his resignation. The court held that in these circumstances the complainant had no reasonable expectation as a shareholder, because he had expressly removed himself from that status. Although the subsequent transfer of the complainant’s shares did not meet the statutory requirements of the CBCA, the majority of the court found that because the complainant knew of this deficiency there could be no reasonable expectation on his part: see Mennillo v Intramodal Inc, 2016 SCC 51, [2016] 2 SCR 438.

E.  Widely Held Corporations The reasonable expectations test has emerged as a fundamental consideration in the assessment of conduct that is “unfairly prejudicial to” or “unfairly disregards the interests of” a party seeking the oppression remedy. In the context of a small, closely held corporation, such conduct is often ascertainable from the facts, including the history of the corporation. Parties involved in closely held companies may expect fair treatment from the corporation, its directors, and majority shareholders, such that even absent a violation of strict legal rights equitable circumstances can be considered. But what can a shareholder or creditor expect from a large, widely held corporation (except adherence to legal rights outlined in the governing statute or at common law)? The directors and officers of corporations owe a fiduciary duty to the corporation, not to the individual constituents or stakeholders of the corporation. There may be times when

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corporate management, acting in the overall best interests of the corporation, makes decisions that will make some stakeholders unhappy. To second-guess the directors’ decisions in these circumstances may also run afoul of the business judgment rule. Courts have generally been cautious not to substitute their own business judgment for that of a corporation’s management.

Themadel Foundation v Third Canadian General Investment Trust Ltd (1998) 38 OR (3d) 749 (CA) [This case involved an appeal from oppression remedies granted to minority shareholders of two public companies. A third party made unsolicited bids to acquire the shares of the two companies. The controlling shareholder opposed the bids, but entered into negotiations with the independent directors of the companies to enhance shareholder value. Each company took steps to qualify as investment corporations under the Income Tax Act. The two companies made offers to their shareholders regarding purchase of their shares. For the first company the price of the shares was set at $42.50, which ignored the capital gains tax refund that would have flowed from the status of an investment corporation. The trial judge found that the omission resulted in unfairly prejudicial treatment of the minority shareholders, and topped up the payment per share to $44.90. For the second company the price of the shares was fixed at $81.75, in which no deduction was made for deferred income taxes. The trial judge held that reasonable expectations were not met in that the calculation did not follow the formula set out in an information circular. Therefore, based on an independent audit and by adjusting the valuation period, the price was topped up by $8.64 per share. The Ontario Court of Appeal found that the unfairness to the shareholders of the first company had been clearly identified and the relief granted to remedy the prejudice flowed directly from the finding of unfairness as a mathematical calculation. For the second company, the Court of Appeal found that granting of an oppression remedy was appropriate in the circumstances, but the trial judge went beyond the reasonable expectations of the shareholders by adjusting the valuation period.] [13]  The real issue in the present case is the identification of oppression or unfairness and the remedy which should follow if such is found. The provisions of the Canada Business Corporations Act, R.S.C. 1985, c. C-44, s. 241 … and those of the Ontario Business Corporations Act, R.S.O. 1990, c. B.16, s. 248 … have been acknowledged in all of the authorities to be extremely broad sources of power for the court to protect the rights of minority shareholders. That said, courts must avoid using such power to look over the shoulder of business as a counsel of perfection. Nor, when interference is justified, should the court go beyond the range of objectively established expectations in providing relief. The point at which relief is justified and the extent of relief are both so dependent upon the facts of the particular case that little guidance can be obtained from comparing one case to another and I would be hesitant to enunciate any more specific principles of approach than have been set out above.

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The following excerpt offers further reasoning with respect to two issues in a large, publicly traded corporation: (1) the source of reasonable expectations in a corporation where shareholders are dealing with each other and the corporation in a purely commercial manner; and (2)  the relationship between the oppression remedy (in a case where bad faith is not an issue) and the business judgment rule.

Ford Motor Co of Canada v Ontario Municipal Employees Retirement Board (2006) 263 DLR (4th) 450, 79 OR (3d) 81 (CA) [Ford Motor Company (“Ford US”) took its subsidiary Ford Motor Company of Canada, Limited (“Ford Canada”) private. Ford US owned approximately 94 percent of the shares of Ford Canada. The remaining approximately 6 percent common shares were widely held by various persons other than Ford US, including the Ontario Municipal Employees Retirement Board (OMERS). A special shareholders meeting on 12 September 1995 approved the various resolutions to take Ford Canada private and make it a wholly owned subsidiary of Ford  US. A majority of the minority shareholders dissented. However, because Ford US held over 90 percent of the common shares of Ford Canada, minority shareholder approval was not required. In July 1995, a special committee of Ford Canada recommended that the minority shareholders accept the offer by Ford US of $185 per share. The special committee relied on a report from CIBC Wood Gundy that concluded that the fair value of the shares was in the range of $170 to $200 per share. Minority shareholders had the right under the CBCA and OBCA to have their shares purchased at fair value and, in October 1995, Ford Canada commenced an action for a declaration to fix the fair value of the common shares of OMERS and the other dissenting shareholders. OMERS and some other dissenting shareholders asserted a counterclaim against Ford Canada and Ford  US on grounds of oppression because the transfer-pricing system between Ford US and Ford Canada caused Ford Canada to record losses that a fair pricing system would not have generated. The transfer-pricing system determined the prices that the two entities paid each other for the purchase of parts and vehicles. Throughout the period from 1985 to 1995 (and even earlier), Ford Canada consistently recorded losses. At trial, Ford Canada attributed these losses to events over which the company had little control—most important, the decline in the value of the Canadian dollar and the prolonged recession in Canada for much of this period. The OMERS shareholders attributed the continuing losses to the transfer-pricing system. The trial judge found that the system was unfair and oppressive to the minority shareholders. For that reason, the OMERS shareholders were entitled to an award for historical oppression for the period from 11 January 1994 to 11 September 1995.] II.  The Facts (1)  Introduction: The Transfer Pricing System and Related Elements •  •  •

[14]  … The system is a product of the Canada-United States Auto Pact and, more recently, the free trade agreements that created a single, integrated market for vehicles made and sold in Canada and the United States. To a large extent, the structure of the

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system is tax driven. Canadian and US tax regimes require entities that do not deal with each other at arm’s length to attribute arm’s-length transfer prices to their goods and services to prevent entities from artificially allocating losses in the high-tax regime and profits in the low-cost regime. For Ford US and Ford Canada, the transfer pricing system is the mechanism utilized to comply with the tax laws in the two countries. [15]  However, the transfer pricing system can impact on shareholders, such as the minority shareholders of Ford Canada. If the system is unfairly skewed to assign losses to the Canadian subsidiary, the subsidiary’s minority shareholders will be deprived of their fair share of Ford Canada’s profits. The parent, Ford US, will not be injured since it will offset the loss from its Canadian holdings through increased profits in its US operations. •  •  •

[19]  The other important aspect of this case concerns the allocation of profits and losses between the divisions of Ford US and Ford Canada. The companies each have three functional divisions: the manufacturing, assembly and vehicle divisions. The manufacturing divisions sell component parts to the assembly divisions. The assembly divisions sell the completed cars to the vehicle divisions. The design and engineering development function is carried out by the vehicle divisions, the Canadian Vehicle Division (“CVD”) and the United States Vehicle Division (“USVD”). The CVD and the USVD are the “residual risk takers” in that the profits and losses are credited to the vehicle divisions. [20]  Most of the design and engineering development is actually done in the United States. Under intercorporate agreements, the CVD is required to pay a proportionate share of the design and development expenses. These expenses, referred to in the evidence as TELO (for tooling, engineering, launch and obsolescence), became an important focus of the trial. •  •  •

[22]  While the transfer pricing system and the other intercorporate arrangements are intricate, they have the following elements that are important to this case. The first element is price parity: the Canadian and US vehicle divisions pay the same price for a vehicle whether it is manufactured in Canada or the United States. Second, the price is denominated in US dollars. Thus, if the Canadian dollar declines, the cost to Ford Canada of importing vehicles and parts from Ford US becomes increasingly more expensive. Third, the manufacturing and assembly divisions each take a mark-up as the vehicles pass through their operations. In other words, prices are based on fully allocated costs. Fourth, Ford Canada is a price-taker. The CVD is bound to accept the same prices set by Ford US for the USVD. Fifth, the price allocated to a part is calculated, where possible, by reference to prices of outside suppliers for identical products. Where that is not possible, Ford US uses a formula to calculate the appropriate price. Sixth, Ford Canada, in particular the CVD, assumes the standard warranty obligations on vehicles sold in Canada. (2)  The Decline in Ford Canada’s Profitability •  •  •

[25] In the result, Ford Canada had a loss from North American operations of $709  million for the period 1985 to 1995. While Ford Canada assembly and

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manufacturing divisions made profits of $5.245 billion, the CVD lost $5.954 billion. The CVD had been recording losses since 1977. •  •  •

III. Analysis •  •  •

(2) Oppression •  •  •

(d)  The Fairness of the Transfer Pricing System [The reasons for rejecting the grounds of appeal based on alleged errors in assessing the impact of the transfer-pricing system on a division-by-division basis and allegations that the trial judge used hindsight bias have been omitted.] [41]  The trial judge reviewed the expert evidence given by both parties at great length and concluded that the transfer pricing system was unfair to minority shareholders to the point of oppression. An undercurrent to Ford Canada’s argument that the trial judge erred in concluding that the system was unfair is that there was little that Ford Canada’s board or management could have done to enhance the company’s profitability. In addressing this argument, I note that the trial judge’s findings of fact and the inferences drawn from the facts are reviewable on the standard of palpable and overriding error: Waxman, paras. 300-5. [42]  The trial judge reviewed the evidence given by Ford Canada’s experts in detail. He did not find any of these witnesses incredible but he found that he could not rely upon their opinions as to the fairness of the transfer pricing system because, for cogent reasons, he rejected some of their critical underlying assumptions. For example, although Dr. Wright had conducted an extensive review of the transfer pricing system for purposes of United States taxation regulation, she did not review the pricing of vehicles into the Canadian market. Further, she accepted the legitimacy of the price parity principle even though it meant that the CVD was paying more for vehicles than it could recover in selling the vehicles to independent dealers. [43]  The trial judge also dealt at length with the evidence of Dr. John P. Brown, a retired principal in the Economic Consulting Services Group of KPMG LLP and one of Ford Canada’s experts who responded to the OMERS shareholders’ experts. The trial judge concluded that Dr. Brown’s assumptions were “too simplistic” and resulted in a system that would have a manufacturer “irrationally buy and re-sell goods at an inevitable loss” (para. 423). He found a key component of Dr. Brown’s opinion illogical as it suggested that “it would be a normal arm’s-length business relationship for Ford Canada as an entrepreneur to continue to buy vehicles from a supplier, Ford US, and always sell those vehicles to its independent dealers at a market loss, simply because of the ownership of intangibles for the Canadian market being with Ford Canada” (para. 434). [44]  On the other hand, the trial judge accepted the opinions of the OMERS shareholders’ experts that the profit-split approach is required in the circumstances. The trial judge noted at para. 150 that the profit-split approach is more appropriate where it [is]

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less likely to leave either party (here, Ford Canada and Ford US) with an “improbable profit result.” At para. 192, the trial judge accepted the critique by Dr. Gregory Ballentine of Dr. Wright’s evidence. According to Dr. Ballentine, “on Dr. Wright’s analysis the average rate of return on investment for CVD would be negative 23.5% over 1985 to 1995, while the average rate of return for USVD would be a 26.8% return on investment.” The trial judge held that, “Neither rate of return on investment over 11 straight years is reasonable by objective standards of the marketplace. Dr. Ballentine concluded as well, correctly in my view, that such a disparity cannot be justified by the statistics concerning the circumstances in the US and Canadian markets.” [45]  The trial judge explained why he accepted the opinions of the OMERS shareholders’ experts and why he drew the inference that the transfer pricing system was unfair to the minority shareholders to the point of oppression. I need not set out in detail his reasons, a few examples will suffice. • According to Dr. Horst, “the operating margins and the rates of returns on net fixed assets of the total Ford manufacturing and assembly divisions exceeded the highest comparable profit rate of any of the 13 core business comparables used by [Dr. Wright]” (para. 394). • CVD’s substantial operating losses in every year were “indicative of a skewed transfer pricing system that did not achieve an arm’s-length result” (para. 394). • The “profit split method is appropriate not only from the standpoint of better achieving arm’s-length results but also accords with the substantive reality of the Ford enterprise” (para. 402). • The transfer pricing system was not realistic and “would not be seen with two parties who are truly at arm’s length” (para. 406). [46]  As noted above, an important theme of Ford Canada’s arguments is that in reality there was little that the board or management could have done to enhance Ford Canada’s profitability. As I understand it, this is not just an argument based on the impact of unalterable economic forces but rather on the assertion that the suggestions from the OMERS shareholders’ experts of how to cure the problem were unrealistic. I do not accept this submission. [47]  The trial judge was alive to the issue of Ford Canada’s ability to negotiate a fairer arrangement. As he said at para. 164, fairness is determined “by considering what structural changes a truly independent entity in the position of Ford Canada would insist upon before carrying on business, and be able to negotiate in an arm’s-length relationship with Ford US [emphasis added].” [48]  The OMERS shareholders’ experts proffered different theories as to what a fair relationship would look like. While Ford Canada criticizes these approaches as unrealistic, there were two real-life models on which the experts could rely and which the trial judge could base his findings, namely, the agreements that Ford US made with unrelated third parties (Mazda and KIA) selling vehicles into the North American market under the Ford name and the treatment by the other two large North American automakers, General Motors and Chrysler, of their Canadian subsidiaries. [49]  Under the agreements that Ford US made with Mazda and KIA, the manufacturer (Mazda or KIA as the case may be) and distributor (Ford dealers) each received a reasonable margin and profit and prices would be competitive in each market. Thus, vehicles

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sold in Canada were priced differently than in the United States. The agreements could also be renegotiated if the guiding principles could not be adhered to (para. 195). It was open to the trial judge to ask why such an agreement could not have been negotiated between Ford US and Ford Canada. [50]  The trial judge also relied upon the operations of General Motors and Chrysler, which treat Canada as a profitable incremental market where vehicles are sold at less than fully allocated costs. Conducting business on this basis recognizes that the costs of developing vehicles for the large United States market are essentially fixed costs to the United States parent company, with little or no incremental costs by selling into Canada. In other words, if this approach is applied in the case of Ford, most of the TELO costs would have had to have been incurred by Ford US whether or not there were any sales in Canada. It was not inevitable that Ford Canada had to consistently sell vehicles to the independent dealers at a loss, and thus incur decades of losses from those sales. [51]  In a slight variation of these arguments, Ford Canada also argues that it was unrealistic to expect it to make changes to the transfer pricing agreement because reasonable forecasts indicated that Ford Canada would be profitable in the 1985-1995 period. Ford Canada points out that it had some of its best years immediately before 1985. [52]  The trial judge dealt with Ford Canada’s argument regarding its profitability. He did not look only at the 1985-1995 period. To the contrary, he considered Ford Canada operations from the mid-1970’s. For example, he described the OMERS shareholders’ claim in these terms at para. 212: [The OMERS shareholders] do not claim that the system was changed at any point in time to their detriment. They claim it was to their detriment from the mid-1970’s when the exchange rate went against the Canadian dollar and, in particular, was to their detriment for the eleven-year period from 1985 to 1995. They claim oppression because the system was unchanged and appropriate adjustments were not made to the transfer price system and inter-corporate arrangements. Consequently OMERS is seeking to invoke the oppression remedy.

[53]  He then concluded as follows at para. 430: Ford attempts to rationalize its position by pointing out that Ford Canada was profitable under the transfer pricing system as an entity in every year other than the years of economic recession, being 1979 to 1982 inclusive, and 1990 to 1995. This simplistic approach overlooks the fact that CVD had significant losses in every single year since 1977 which increased the overall losses of Ford Canada as an entity or significantly reduced the profit that it otherwise would have earned. The issues in this case are not answered by observing that Ford Canada sometimes earns an overall profit. Rather, the issue is whether there is oppression and unfairness in the transfer pricing system which results in an understatement of the profits (or conversely an overstatement of the losses) that Ford Canada would earn if it were truly acting at arm’s length from Ford US in respect of transfer pricing.

Therefore, the trial judge quite correctly observed that just because Ford Canada was profitable overall does not mean that the transfer system was fair. [54]  In conclusion, I do not accept Ford Canada’s argument that the trial judge erred in concluding that the transfer system was unfair and that Ford Canada, as an independent entity, would have been able to negotiate changes to the system.

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(e)  The business judgment rule [55]  Ford Canada anchors its criticisms of the trial judge’s approach to the oppression issue in the business judgment rule. The trial judge summarized the rule at paras. 223-24. As he said, “Absent bad faith, or some other improper motive, business judgment that, in hindsight, has proven to be mistaken, misguided or imperfect, will not give rise to liability through the oppression remedy.” The significant impediment to Ford Canada’s reliance on the business judgment rule lies in the evidence accepted by the trial judge that the Ford Canada board brought little judgment to bear on the transfer pricing system. [56]  The evidence shows that Ford Canada’s board had little understanding of the transfer pricing system and its impact on the profitability of Ford Canada’s operations. There was little discussion of the system at the board level and Ford Canada did not conduct any independent review of the system. The evidence suggests that Ford Canada simply accepted the system that was put in place by Ford US, the majority shareholder. There was no evidence that Ford Canada tried to negotiate an agreement that was more consistent with arm’s-length principles and failed; the attempt was never made. In fact, when Dr. Wright concluded her study shortly before the 1995 transactions and suggested a slight change to the TELO allocation that favoured Ford Canada, the change was made. [57]  Following are some of the trial judge’s findings: [307]  The problems inherent to the transfer pricing system would have been recognized by the senior management of both Ford Canada and Ford US by 1984. From 1977 onwards, Ford Canada generally budgeted losses for CVD. There was no apparent sentiment on the part of management to change the regime, at least until Mr. Bennett voiced his concerns in 1995. Even then there was no detailed analysis made by the board of directors to explain and understand clearly the problem from the standpoint of determining fair value for the minority shares. The existing regime was satisfactory to Ford US. •  •  •

[319]  The transfer pricing agreements could be terminated on 30 days’ notice. However, there was no new transfer pricing agreement after 1979. The mark-ups to manufacturing and assembly were negotiated within Ford US’s divisions without input from Ford Canada. •  •  •

[352]  The chairperson of the Special Committee acknowledged that there was little analysis of transfer pricing principles or how TELO costs are calculated. The evidence indicates that the board of directors had a limited knowledge of the inter-company pricing arrangements. There is nothing in the record to suggest that either the board of directors or the Audit Committee ever addressed the fundamental question of fairness to the minority shareholders because of the complex inter-company pricing arrangements. The record suggests the contrary, that is, that the reality was that the inter-corporate pricing system was determined solely by Ford US and accepted uncritically through the years by Ford Canada’s management. Mr. Bennett’s letter of February, 1995 is the first and only critical comment in the evidentiary record. It was followed by the decision of Ford  US within two months to buy out the minority shareholders. •  •  •

[357]  In fact, Mr. Bennett acknowledged that there were no negotiations between Ford Canada and Ford US with respect to prices paid by Ford Canada. Rather, all such prices and

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[432]  The record indicates that the Ford Canada management and Board of directors did not give any consideration at any time to the reasonableness of the TELO paid, nor did the management and Board of directors conduct any studies or give any consideration to the fairness to Ford Canada and in particular, to its minority shareholders, of the transfer pricing system in place.

(Emphasis added) These and other findings of fact are supported by the record. They strongly tell against any argument in favour of business judgment. [58]  Justice Blair summarized the business judgment rule in these terms in CW Shareholdings Inc. v. WIC Western International Communications Ltd. (1998), 39 O.R. (3d) 755, [1988] O.J. No. 1886, 160 D.L.R. (4th) 131 (Gen. Div.) at p. 774 O.R., p. 150 D.L.R.: It operates to shield from court intervention business decisions which have been made honestly, prudently, in good faith and on reasonable grounds. In such cases, the board’s decisions will not be subject to microscopic examination and the Court will be reluctant to interfere and to usurp the board of directors’ function in managing the corporation.

(Emphasis added) [59]  On this record, it was open to the trial judge to find that the board did not act on reasonable grounds and therefore was disentitled to the deference ordinarily accorded by the operation of the business judgment rule. As Lax  J said in UPMKymmene Corp. v. UPM-Kymmene Miramichi Inc., [2002] O.J. No.  2412, 214 D.L.R. (4th) 496 (S.C.)J., affd [2004] O.J. No. 636, 42 B.L.R. (3d) 34 (C.A.), at para. 153, “directors are only protected to the extent that their actions actually evidence their business judgment.” (f)  Oppression and Shareholders’ Reasonable Expectations [60]  Having found that the trial judge did not err in his application of the business judgment rule, to overturn the trial judge’s decision it would be necessary to find a palpable and overriding error in the facts found by the trial judge or the inferences drawn from those facts, that the transfer pricing system and related intercorporate arrangements had the effect of oppressing the minority shareholders. … [61]  I would not give effect to Ford Canada’s submission concerning the trial judge’s finding of oppression. The trial judge made two findings of fact to support the finding of oppression by Ford Canada. One finding concerned the reasonable expectations of the shareholders. The other concerned what was reasonably foreseeable to the board. The findings of the trial judge, who agreed with the OMERS shareholders’ argument that Ford Canada held out to its shareholders that transactions with Ford US were calculated on an arm’s-length basis, are found in various parts of his reasons. Below are some expressions of the findings:

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[249]  OMERS submits that a new shareholder would purchase his or her shares under the implicit representation that Ford Canada’s transfer pricing system was not oppressing the minority shareholders. I agree. •  •  •

[276]  The financial reports told Ford Canada shareholders that prices for products would be negotiated between Ford Canada and Ford US when apparently there was no such negotiation. The public documents about the transfer pricing system suggested that prices were determined at arm’s length. Shareholders have the right to rely upon the public pronouncements of public corporations as promises, with resulting reasonable expectations. •  •  •

[298]  Ford Canada submits that, to succeed in the case at hand, the dissenting shareholders must establish on a balance of probabilities that they had reasonable expectations that the historical structural transfer pricing arrangements between Ford Canada and Ford US would be changed to a profit-sharing arrangement. I disagree. •  •  •

[356]  Ford Canada’s minority shareholders had the reasonable expectation that management would act in the best interests of the corporation (meaning all of the shareholders) and take all reasonable steps to enhance profitability by changes to the inter-corporate pricing system. •  •  •

[431]  Ford Canada seeks refuge in the disclosure to shareholders in its annual reports that the overall impact of a drop in the Canadian dollar was negative upon the profits of Ford Canada and that the ability of Ford Canada to be profitable in the Canadian market was largely dependent upon the performance of the Canadian dollar. Reasonable foreseeability

[300]  The impact of the transfer pricing system is to understate profits or overstate losses earned from the Canadian market for Ford Canada. This realization does not arise from the benefit of hindsight. The results would be reasonably foreseeable to the management of Ford Canada from, at least, 1984 onwards. •  •  •

[303]  Hindsight is easier than foresight. However, it should have been clear by 1984 that there was a serious problem in the transfer pricing system in terms of fairness to Ford Canada and, in particular, to its minority shareholders. •  •  •

[307]  The problems inherent to the transfer pricing system would have been recognized by the senior management of both Ford Canada and Ford US by 1984. •  •  •

[323]  OMERS submits that at arm’s length, CVD would not have agreed to purchase a product at a price whereby it would reasonably foresee the probability, indeed, the near certainty, of a loss. OMERS also submits that a reasonable person manufacturer in the position of Ford US, acting in its self-interest, would have agreed to sell its vehicles to CVD at less than fully-allocated costs if it recovered its incremental costs and some contribution toward its fixed costs. I agree. •  •  •

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Chapter 14  Stakeholder Remedies [326]  By 1984 the management and directing minds of both entities would have realized two realities: first, that for the foreseeable, indefinite future CVD would have significant losses. (This realization is evidenced by the annual budgets of Ford Canada in 1984-1995, each of which forecasts a loss to CVD for the next fiscal year.) The risk of loss for the next year from the Canadian market as foreseen in each budget was a reasonable certainty and hence, was forecasted. Such a risk cannot properly be described as an entrepreneurial risk. A self-interested, independent entrepreneur, acting reasonably, would not accept the certainty of endless losses. [327]  Second, the directing minds would realize that the TELO allocation could not be rationally supported upon an entrepreneurial risk-taking premise. A rational entrepreneur would not agree to pay significant money for intangibles that would very probably result in continuing, sizeable losses.

[62]  Then in his conclusion on the finding of oppression, the trial judge combined the two concepts of reasonable expectations and reasonable foreseeability: The reasonable expectations of the minority shareholders were that the management of Ford Canada would at all times act in the best interests of all the shareholders to make best efforts to earn a reasonable profit from Ford Canada’s business operations. This was not possible over 1985-1995 given the structure of the transfer pricing system and its impact upon Ford Canada. A truly independent entity in the position of Ford Canada would have renegotiated and, moreover, would have been successful in doing so because it would be in Ford US’s self-interest to accede to a changed arrangement. It is not necessary for OMERS to establish bad faith on the part of Ford Canada’s directors or management. It is enough to establish, as has been done, that the foreseeable results of the omission of Ford Canada’s directors and management to renegotiate the structure of the transfer pricing system would be oppressive and unfairly prejudicial to, and unfairly disregard the interests of, the minority shareholders (para. 448).

[63]  Ford Canada attacks these findings on two bases. First, it submits that the trial judge in fact replaced hindsight for foresight. I have already discussed this above. It is not a tenable argument. In any event, it is not at all clear that it was necessary for the trial judge to find that the effects of the transfer pricing policy on the minority shareholders were reasonably foreseeable by the Ford Canada board in order to find oppression. Section 241(2)(a) of the CBCA focuses on the effects of the corporation’s acts or omissions. If the act or omission effects a result that is “oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder,” in this case the minority shareholders, the shareholders will be entitled to a remedy. [64]  Second, Ford Canada submits that there was no evidence of reasonable expectations on the part of the minority shareholders. This submission consists of two related concepts. Ford Canada submits that there should have been evidence from the minority shareholders about their reasonable expectations. In addition, it submits that the record simply does not support the trial judge’s findings of reasonable expectations as it may be based on the public record. [65]  I can find no support for the proposition that there must be evidence, in the form of testimony, from the shareholders as to their expectations. The existence of reasonable expectations is a question of fact and like any question of fact can be proved by direct

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evidence or by drawing reasonable inferences from circumstantial evidence. This point is made by the Divisional Court in Arthur v. Signum Communications Ltd., [1993] OJ no. 1928 at para. 7: The state of a man’s mind as to the future—intentions and expectations—is a question of fact. In determining that fact, there is no error in looking at prior statements and drawing an inference based on the respective weight of all the individual pieces of evidence. It is a pure question of fact what Arthur’s intentions and expectations were at the material time and a pure question of fact whether they were reasonable.

[66]  Where the minority shares in a public company are widely held it may be difficult to adduce cogent direct evidence of the reasonable expectations of the shareholders. In such cases, it is open to the trial judge to infer reasonable expectations from the company’s public statements and the shared expectations about the way in which a public company should be run. As Farley J said in 820099 Ontario Inc. v. Harold E. Ballard Ltd., [1991] OJ no. 266, 3 BLR (2d) 113 at 123 (Ont. Ct. (Gen. Div.)) at para. 129, aff ’d. [1991] OJ no. 1082, 3 BLR (2d) 113 at 122 (Ont. Div. Ct.), “It does not appear to me that the shareholder expectations which are to be considered are those that a shareholder has as his own individual ‘wish list.’ They must be expectations which could be said to have been (or ought to have been considered as) part of the compact of the shareholders.” [67]  This court has held as much in Themadel Foundation v. Third Canadian General Investment Trust Ltd. (1998), 38 OR (3d) 749 at 753-54: The public pronouncements of corporations, particularly those that are publicly traded, become its commitments to shareholders within the range of reasonable expectations that are objectively aroused. In Naneff v. Con-Crete Holdings Ltd. (1995), 23 OR (3d) 481 at p. 490, 23 BLR (2d) 286 (CA), Galligan JA put it as follows: The law is clear when determining whether there has been oppression of a minority shareholder, the court must determine what the reasonable expectations of that person were according to the arrangements which existed between principals. The cases on this issue are collected and analyzed by Farley J in 820099 Ontario Inc. v. Harold E. Ballard Ltd. (1991), 3 BLR (2d) 113 at pg. 123 (Ont. Gen. Div.), aff ’d. (1991), 3 BLR (2d) 113 (Ont. Div. Ct.). I agree with his comment at pp. 185-86: Shareholder interests would appear to be intertwined with shareholder expectations. It does not appear to me that the shareholder expectations which are to be considered are those that a shareholder has as his own individual “wish list.” They must be expectations which could be said to have been (or ought to have been considered as) part of the compact of the shareholders.

[68]  In the same case at the trial level, Farley J said the following at (1995), 23 OR (3d) 7 (Gen. Div.) at 14-5: I think it reasonable that shareholders be entitled to rely on written and public pronouncements of what corporations in which they hold shares will do. This is especially so in the case of corporations which offer their shares to the public as it is an offence for such corporations to be other than truthful in public pronouncements. …

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[69]  As indicated, Ford Canada submits that there was no evidence to support the trial judge’s findings about shareholders’ reasonable expectations. The trial judge made three critical factual findings about reasonable expectations based on Ford Canada’s public statements: (1) Prices for products would be negotiated between Ford Canada and Ford US. (2) Intercorporate prices were determined at arm’s length. (3) Management would act in the best interests of the corporation and take all reasonable steps to enhance profitability by changes to the intercorporate pricing system. [70]  Since a finding concerning reasonable expectations is a question of fact, to succeed on this ground Ford Canada must show a palpable and overriding error in the sense discussed earlier in these reasons. Ford Canada puts its case on two bases. First, that there was a complete absence of evidence to support the finding and, second, that the trial judge misapprehended the evidence, especially the evidence of the public disclosure that was made about currency fluctuations. In my view, the trial judge did not make a palpable and overriding error. [71]  The clearest public statements concerning the use of arm’s-length pricing are found in the financial statements that precede the period in question (1985-1995). For example, the Notes to Ford Canada’s 1978 financial statements state: Under long standing arrangements, the Company and its subsidiaries obtain at cost many types of advice and services from Ford Motor Company [Ford US]. In a large number of transactions with Ford Motor Company and its affiliates, the Company and its subsidiaries in the ordinary course of business buy and sell vehicles and components, and buy tractors and components. The Ford policy is that prices for products be negotiated on an arm’s-length basis by the affected organizations.

(Emphasis added) [72]  By 1985, the wording of the Notes had changed: The Company is a subsidiary of Ford Motor Company which owns approximately 92% of Ford of Canada’s issued shares. In a large number of transactions with Ford Motor Company and its affiliates, the Company and its affiliates in the ordinary course of business buy and sell vehicles and components, and buy tractors and components. The prices for items purchased or sold are calculated to approximate levels charged by competitive sources for similar goods. In addition, under long standing arrangements, the Company and its affiliates obtain services at cost from Ford Motor Company.

(Emphasis added) [73]  This formula was repeated in virtually identical terms in all the succeeding financial statements. The 1985 financial statements and those that followed also made significant reference to the impact of the declining Canadian dollar on Ford Canada’s profitability. [74]  In my view, despite the change in wording, it was open to the trial judge to draw the inferences he did about reasonable expectations. The principle that “in the ordinary course of business” prices were “calculated to approximate levels charged by competitive sources” could be understood by a reasonable reader as using an arm’s-length standard

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that implied negotiation. Moreover, the evidence of Ford’s own witness supports this interpretation. Mr. Bennett, who was a director of Ford Canada from 1965 to 1995 and President and Chief Executive Officer of Ford Canada from 1970 to 1981, testified for Ford. In cross-examination, counsel pointed out the change in wording of the Notes. Mr. Bennett testified as follows: Q.  And that language is saying [in] different words, the same thing essentially that we looked at in the prior notes? A.  I would think that’s the intent. Q.  Right. It is an arm’s-length concept, right? A.  Yes, um-hmm.

[75]  In my view, it cannot be said that the trial judge made a palpable and overriding error in his findings concerning reasonable expectations. Further, it was open to the trial judge to find that public disclosure to shareholders concerning the impact of currency fluctuations did not alter those expectations. The trial judge reasoned as follows at para. 431: Ford Canada seeks refuge in the disclosure to shareholders in its annual reports that the overall impact of a drop in the Canadian dollar was negative upon the profits of Ford Canada and that the ability of Ford Canada to be profitable in the Canadian market was largely dependent upon the performance of the Canadian dollar. This ignores the fact that Ford US was gaining profits (through component manufacturing, US assembly sales to CVD and TELO payments by CVD) at the expense of Ford Canada by the decline in the Canadian dollar and that a truly independent entity acting rationally in its self-interest at arm’s length to Ford US would have renegotiated the pricing of vehicles into the Canadian market (and/or TELO) to capture some of these foregone profits.

(Emphasis added) [76]  This inference is entitled to the same deference as the trial judge’s findings of primary facts. I see no palpable overriding error. [77]  In conclusion, then, I find that the trial judge did not err in allowing the OMERS shareholders’ claim of oppression against Ford Canada. NOTES AND QUESTIONS

The trial judge characterized the operation of the business judgment rule in oppression remedy cases as follows: “Absent bad faith, or some other improper motive, business judgment that, in hindsight, has proven to be mistaken, misguided or imperfect, will not give rise to liability through the oppression remedy.” Is there any finding of bad faith or improper motive in this case? What element or elements led to the refusal to use the business judgment rule to excuse the action or inaction of Ford Canada’s board?

The Supreme Court of Canada has addressed the issue of the application of the oppression remedy to secured creditors of large public corporations and more generally examined the reasonable expectations that stakeholders may have when directors must consider the interests of multiple stakeholders in the context of the best interests of the corporation.

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BCE Inc v 1976 Debentureholders 2008 SCC 69, [2008] 3 SCR 560 [30]  The issues, briefly stated, are whether the Court of Appeal erred in dismissing the debentureholders’ s. 241 oppression claim and in overturning the Superior Court’s s. 192 approval of the plan of arrangement. These questions raise the issue of what is required to establish oppression of debentureholders in a situation where a corporation is facing a change of control, and how a judge on an application for approval of an arrangement under s. 192 of the CBCA should treat claims such as those of the debentureholders in these actions. These reasons will consider both issues. [31]  In order to situate these issues in the context of Canadian corporate law, it may be useful to offer a preliminary description of the remedies provided by the CBCA to shareholders and stakeholders in a corporation facing a change of control. [32]  Accordingly, these reasons will consider:

(1) the rights, obligations and remedies under the CBCA in overview; (2) the debentureholders’ entitlement to relief under the s. 241 oppression remedy; (3) the debentureholders’ entitlement to relief under the requirement for court approval of an arrangement under s. 192. [33]  We note that it is unnecessary for the purposes of these appeals to distinguish between the conduct of the directors of BCE, the holding company, and the conduct of the directors of Bell Canada. The same directors served on the boards of both corporations. While the oppression remedy was directed at both BCE and Bell Canada, the courts below considered the entire context in which the directors of BCE made their decisions, which included the obligations of Bell Canada in relation to its debentureholders. It was not found by the lower courts that the directors of BCE and Bell Canada should have made different decisions with respect to the two corporations. Accordingly, the distinct corporate character of the two entities does not figure in our analysis. V. Analysis A.  Overview of Rights, Obligations and Remedies Under the CBCA [The court provided a basic overview of fiduciary duties.] [41]  Normally only the beneficiary of a fiduciary duty can enforce the duty. In the corporate context, however, this may offer little comfort. The directors who control the corporation are unlikely to bring an action against themselves for breach of their own fiduciary duty. The shareholders cannot act in the stead of the corporation; their only power is the right to oversee the conduct of the directors by way of votes at shareholder assemblies. Other stakeholders may not even have that. [42]  To meet these difficulties, the common law developed a number of special remedies to protect the interests of shareholders and stakeholders of the corporation. These remedies have been affirmed, modified and supplemented by the CBCA. [43]  The first remedy provided by the CBCA is the s. 239 derivative action, which allows stakeholders to enforce the directors’ duty to the corporation when the directors

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are themselves unwilling to do so. With leave of the court, a complainant may bring (or intervene in) a derivative action in the name and on behalf of the corporation or one of its subsidiaries to enforce a right of the corporation, including the rights correlative with the directors’ duties to the corporation. (The requirement of leave serves to prevent frivolous and vexatious actions, and other actions which, while possibly brought in good faith, are not in the interest of the corporation to litigate.) [44]  A second remedy lies against the directors in a civil action for breach of duty of care. As noted, s. 122(1)(b) of the CBCA requires directors and officers of a corporation to “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.” This duty, unlike the s. 122(1)(a) fiduciary duty, is not owed solely to the corporation, and thus may be the basis for liability to other stakeholders in accordance with principles governing the law of tort and extracontractual liability: Peoples Department Stores. Section 122(1)(b) does not provide an independent foundation for claims. However, applying the principles of The Queen in Right of Canada v. Saskatchewan Wheat Pool, [1983] 1 S.C.R. 205, courts may take this statutory provision into account as to the standard of behaviour that should reasonably be expected. [45]  A third remedy, grounded in the common law and endorsed by the CBCA, is a s. 241 action for oppression. Unlike the derivative action, which is aimed at enforcing a right of the corporation itself, the oppression remedy focuses on harm to the legal and equitable interests of stakeholders affected by oppressive acts of a corporation or its directors. This remedy is available to a wide range of stakeholders—security holders, creditors, directors and officers. [46]  Additional “remedial” provisions are found in provisions of the CBCA providing for court approval in certain cases. An arrangement under s. 192 of the CBCA is one of these. While s. 192 cannot be described as a remedy per se, it has remedial-like aspects. It is directed at the situation of corporations seeking to effect fundamental changes to the corporation that affects stakeholder rights. The Act provides that such arrangements require the approval of the court. Unlike the civil action and oppression, which focus on the conduct of the directors, a s. 192 review requires a court approving a plan of arrangement to be satisfied that: (i) the statutory procedures have been met; (ii) the application has been put forth in good faith; and (iii) the arrangement is fair and reasonable. If the corporation fails to discharge its burden of establishing these elements, approval will be withheld and the proposed change will not take place. In assessing whether the arrangement should be approved, the court will hear arguments from opposing security holders whose rights are being arranged. This provides an opportunity for security holders to argue against the proposed change. [47]  Two of these remedies are in issue in these actions: the action for oppression and approval of an arrangement under s. 192. The trial judge treated these remedies as involving distinct considerations and concluded that the debentureholders had failed to establish entitlement to either remedy. The Court of Appeal, by contrast, viewed the two remedies as substantially overlapping, holding that both turned on whether the directors had properly considered the debentureholders’ expectations. Having found on this basis that the requirements of s. 192 were not met, the Court of Appeal concluded that the action for oppression was moot. As will become apparent, we do not endorse this approach. In our view, the s. 241 oppression action and the s. 192 requirement for court approval of a change to the corporate structure are different types of proceedings, engaging different

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inquiries. Accordingly, we find it necessary to consider both the claims for oppression and the s. 192 application for approval. [48]  The debentureholders have formally cross-appealed on the oppression remedy. However, due to the Court of Appeal’s failure to consider this issue, the debentureholders did not advance separate arguments before this Court. As certain aspects of their position are properly addressed within the context of an analysis of oppression under s. 241, we have considered them here. [49]  Against this background, we turn to a more detailed consideration of the claims. B.  The Section 241 Oppression Remedy [50]  The debentureholders in these appeals claim that the directors acted in an oppressive manner in approving the sale of BCE, contrary to s. 241 of the CBCA. [51]  Security holders of a corporation or its affiliates fall within the class of persons who may be permitted to bring a claim for oppression under s. 241 of the CBCA. The trial judge permitted the debentureholders to do so, although in the end he found the claim had not been established. The question is whether the trial judge erred in dismissing the claim. [52]  We will first set out what must be shown to establish the right to a remedy under s. 241, and then review the conduct complained of in the light of those requirements. (1)  The Law [53]  Section 241(2) provides that a court may make an order to rectify the matters complained of where (a)  any act or omission of the corporation or any of its affiliates effects a result, (b)  the business or affairs of the corporation or any of its affiliates are or have been carried on or conducted in a manner, or (c)  the powers of the directors of the corporation or any of its affiliates are or have been exercised in a manner that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor, director or officer. …

[54]  Section 241 jurisprudence reveals two possible approaches to the interpretation of the oppression provisions of the CBCA: M. Koehnen, Oppression and Related Remedies (2004), at pp. 79-80 and 84. One approach emphasizes a strict reading of the three types of conduct enumerated in s. 241 (oppression, unfair prejudice and unfair disregard): see Scottish Co-operative Wholesale Society Ltd. v. Meyer, [1959] A.C. 324 (H.L.); Diligenti v. RWMD Operations Kelowna Ltd. (1976), 1 B.C.L.R. 36 (S.C.); Stech v. Davies, [1987] 5 W.W.R. 563 (Alta. Q.B.). Cases following this approach focus on the precise content of the categories “oppression,” “unfair prejudice” and “unfair disregard.” While these cases may provide valuable insight into what constitutes oppression in particular circumstances, a categorical approach to oppression is problematic because the terms used cannot be put into watertight compartments or conclusively defined. As Koehnen puts it (at p. 84), “[t] he three statutory components of oppression are really adjectives that try to describe inappropriate conduct … . The difficulty with adjectives is they provide no assistance in formulating principles that should underline court intervention.”

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[55]  Other cases have focused on the broader principles underlying and uniting the various aspects of oppression: see First Edmonton Place Ltd. v. 315888 Alberta Ltd. (1988), 40 B.L.R. 28 (Alta. Q.B.), var’d (1989), 45 B.L.R. 110 (Alta. C.A.); 820099 Ontario Inc. v. Harold E. Ballard Ltd. (1991), 3 B.L.R. (2d) 113 (Ont. Div. Ct.); Westfair Foods Ltd. v. Watt (1991), 79 D.L.R. (4th) 48 (Alta. C.A.). [56]  In our view, the best approach to the interpretation of s. 241(2) is one that combines the two approaches developed in the cases. One should look first to the principles underlying the oppression remedy, and in particular the concept of reasonable expectations. If a breach of a reasonable expectation is established, one must go on to consider whether the conduct complained of amounts to “oppression,” “unfair prejudice” or “unfair disregard” as set out in s. 241(2) of the CBCA. [57]  We preface our discussion of the twin prongs of the oppression inquiry by two preliminary observations that run throughout all the jurisprudence. [58]  First, oppression is an equitable remedy. It seeks to ensure fairness—what is “just and equitable.” It gives a court broad, equitable jurisdiction to enforce not just what is legal but what is fair: Wright v. Donald S. Montgomery Holdings Ltd. (1998), 39 B.L.R. (2d) 266 (Ont. Ct. (Gen. Div.)), at p. 273; Re Keho Holdings Ltd. and Noble (1987), 38 D.L.R. (4th) 368 (Alta. C.A.), at p. 374; see, more generally, Koehnen, at pp. 78-79. It follows that courts considering claims for oppression should look at business realities, not merely narrow legalities: Scottish Co-operative Wholesale Society, at p. 343. [59]  Second, like many equitable remedies, oppression is fact-specific. What is just and equitable is judged by the reasonable expectations of the stakeholders in the context and in regard to the relationships at play. Conduct that may be oppressive in one situation may not be in another. [60]  Against this background, we turn to the first prong of the inquiry, the principles underlying the remedy of oppression. In Ebrahimi v. Westbourne Galleries Ltd., [1973] A.C. 360 (H.L.), at p. 379, Lord Wilberforce, interpreting s. 222 of the U.K. Companies Act, 1948, described the remedy of oppression in the following seminal terms: The words [“just and equitable”] are a recognition of the fact that a limited company is more than a mere legal entity, with a personality in law of its own: that there is room in company law for recognition of the fact that behind it, or amongst it, there are individuals, with rights, expectations and obligations inter se which are not necessarily submerged in the company structure.

[61]  Lord Wilberforce spoke of the equitable remedy in terms of the “rights, expectations and obligations” of individuals. “Rights” and “obligations” connote interests enforceable at law without recourse to special remedies, for example, through a contractual suit or a derivative action under s. 239 of the CBCA. It is left for the oppression remedy to deal with the “expectations” of affected stakeholders. The reasonable expectations of these stakeholders is the cornerstone of the oppression remedy. [62]  As denoted by “reasonable,” the concept of reasonable expectations is objective and contextual. The actual expectation of a particular stakeholder is not conclusive. In the context of whether it would be “just and equitable” to grant a remedy, the question is whether the expectation is reasonable having regard to the facts of the specific case, the relationships at issue, and the entire context, including the fact that there may be conflicting claims and expectations.

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[63]  Particular circumstances give rise to particular expectations. Stakeholders enter into relationships, with and within corporations, on the basis of understandings and expectations, upon which they are entitled to rely, provided they are reasonable in the context: see 820099 Ontario; Main v. Delcan Group Inc. (1999), 47 B.L.R. (2d) 200 (Ont.  S.C.J.). These expectations are what the remedy of oppression seeks to uphold. [64]  Determining whether a particular expectation is reasonable is complicated by the fact that the interests and expectations of different stakeholders may conflict. The oppression remedy recognizes that a corporation is an entity that encompasses and affects various individuals and groups, some of whose interests may conflict with others. Directors or other corporate actors may make corporate decisions or seek to resolve conflicts in a way that abusively or unfairly maximizes a particular group’s interest at the expense of other stakeholders. The corporation and shareholders are entitled to maximize profit and share value, to be sure, but not by treating individual stakeholders unfairly. Fair treatment—the central theme running through the oppression jurisprudence—is most fundamentally what stakeholders are entitled to “reasonably expect.” [65]  Section 241(2) speaks of the “act or omission” of the corporation or any of its affiliates, the conduct of “business or affairs” of the corporation and the “powers of the directors of the corporation or any of its affiliates.” Often, the conduct complained of is the conduct of the corporation or of its directors, who are responsible for the governance of the corporation. However, the conduct of other actors, such as shareholders, may also support a claim for oppression: see Koehnen, at pp. 109-10; GATX Corp. v. Hawker Siddeley Canada Inc. (1996), 27 B.L.R. (2d) 251 (Ont. Ct. (Gen. Div.)). In the appeals before us, the claims for oppression are based on allegations that the directors of BCE and Bell Canada failed to comply with the reasonable expectations of the debentureholders, and it is unnecessary to go beyond this. [66]  The fact that the conduct of the directors is often at the centre of oppression actions might seem to suggest that directors are under a direct duty to individual stakeholders who may be affected by a corporate decision. Directors, acting in the best interests of the corporation, may be obliged to consider the impact of their decisions on corporate stakeholders, such as the debentureholders in these appeals. This is what we mean when we speak of a director being required to act in the best interests of the corporation viewed as a good corporate citizen. However, the directors owe a fiduciary duty to the corporation, and only to the corporation. People sometimes speak in terms of directors owing a duty to both the corporation and to stakeholders. Usually this is harmless, since the reasonable expectations of the stakeholder in a particular outcome often coincides with what is in the best interests of the corporation. However, cases (such as these appeals) may arise where these interests do not coincide. In such cases, it is important to be clear that the directors owe their duty to the corporation, not to stakeholders, and that the reasonable expectation of stakeholders is simply that the directors act in the best interests of the corporation. [67] Having discussed the concept of reasonable expectations that underlies the oppression remedy, we arrive at the second prong of the s. 241 oppression remedy. Even if reasonable, not every unmet expectation gives rise to claim under s. 241. The section requires that the conduct complained of amount to “oppression,” “unfair prejudice” or “unfair disregard” of relevant interests. “Oppression” carries the sense of conduct that is

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coercive and abusive, and suggests bad faith. “Unfair prejudice” may admit of a less culpable state of mind, that nevertheless has unfair consequences. Finally, “unfair disregard” of interests extends the remedy to ignoring an interest as being of no importance, contrary to the stakeholders’ reasonable expectations: see Koehnen, at pp.  81-88. The phrases describe, in adjectival terms, ways in which corporate actors may fail to meet the reasonable expectations of stakeholders. [68]  In summary, the foregoing discussion suggests conducting two related inquiries in a claim for oppression: (1)  Does the evidence support the reasonable expectation asserted by the claimant? and (2) Does the evidence establish that the reasonable expectation was violated by conduct falling within the terms “oppression,” “unfair prejudice” or “unfair disregard” of a relevant interest? [69]  Against the background of this overview, we turn to a more detailed discussion of these inquiries. (a)  Proof of a Claimant’s Reasonable Expectations [70]  At the outset, the claimant must identify the expectations that he or she claims have been violated by the conduct at issue and establish that the expectations were reasonably held. As stated above, it may be readily inferred that a stakeholder has a reasonable expectation of fair treatment. However, oppression, as discussed, generally turns on particular expectations arising in particular situations. The question becomes whether the claimant stakeholder reasonably held the particular expectation. Evidence of an expectation may take many forms depending on the facts of the case. [71]  It is impossible to catalogue exhaustively situations where a reasonable expectation may arise due to their fact-specific nature. A few generalizations, however, may be ventured. Actual unlawfulness is not required to invoke s.  241; the provision applies “where the impugned conduct is wrongful, even if it is not actually unlawful”: Dickerson Committee (R.W.V. Dickerson, J.L. Howard and L. Getz), Proposals for a New Business Corporations Law for Canada (1971), vol. 1, at p. 163. The remedy is focused on concepts of fairness and equity rather than on legal rights. In determining whether there is a reasonable expectation or interest to be considered, the court looks beyond legality to what is fair, given all of the interests at play: Re Keho Holdings Ltd. and Noble. It follows that not all conduct that is harmful to a stakeholder will give rise to a remedy for oppression as against the corporation. [72]  Factors that emerge from the case law that are useful in determining whether a reasonable expectation exists include: general commercial practice; the nature of the corporation; the relationship between the parties; past practice; steps the claimant could have taken to protect itself; representations and agreements; and the fair resolution of conflicting interests between corporate stakeholders. (i)  Commercial Practice [73]  Commercial practice plays a significant role in forming the reasonable expectations of the parties. A departure from normal business practices that has the effect of undermining or frustrating the complainant’s exercise of his or her legal rights will generally (although not inevitably) give rise to a remedy: Adecco Canada Inc. v. J. Ward Broome Ltd. (2001), 12 B.L.R. (3d) 275 (Ont. S.C.J.); SCI Systems Inc. v. Gornitzki Thompson &

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Little Co., (1997), 147 D.L.R. (4th) 300 (Ont. Ct. (Gen. Div.)), var’d (1998), 110 O.A.C. 160 (Div. Ct.); Downtown Eatery (1993) Ltd. v. Ontario (2001), 200 D.L.R. (4th) 289, leave to appeal refused, [2002] 2 S.C.R. vi. (ii)  The Nature of the Corporation [74]  The size, nature and structure of the corporation are relevant factors in assessing reasonable expectations: First Edmonton Place; G. Shapira, “Minority Shareholders’ Protection—Recent Developments” (1982), 10 N.Z. Univ. L. Rev. 134, at pp. 138 and 145-46. Courts may accord more latitude to the directors of a small, closely held corporation to deviate from strict formalities than to the directors of a larger public company. (iii) Relationships [75]  Reasonable expectations may emerge from the personal relationships between the claimant and other corporate actors. Relationships between shareholders based on ties of family or friendship may be governed by different standards than relationships between arm’s length shareholders in a widely held corporation. As noted in Re Ferguson and Imax Systems Corp., (1983), 150 D.L.R. (3d) 718 (Ont. C.A.), “when dealing with a close corporation, the court may consider the relationship between the shareholders and not simply legal rights as such” (p. 727). (iv)  Past Practice [76]  Past practice may create reasonable expectations, especially among shareholders of a closely held corporation on matters relating to participation of shareholders in the corporation’s profits and governance: Gibbons v. Medical Carriers Ltd. (2001), 17 B.L.R. (3d) 280, 2001 MBQB 229; 820099 Ontario. For instance, in Gibbons, the court found that the shareholders had a legitimate expectation that all monies paid out of the corporation would be paid to shareholders in proportion to the percentage of shares they held. The authorization by the new directors to pay fees to themselves, for which the shareholders would not receive any comparable payments, was in breach of those expectations. [77]  It is important to note that practices and expectations can change over time. Where valid commercial reasons exist for the change and the change does not undermine the complainant’s rights, there can be no reasonable expectation that directors will resist a departure from past practice: Alberta Treasury Branches v. SevenWay Capital Corp. (1999), 50 B.L.R. (2d) 294 (Alta. Q.B.), aff ’d (2000), 8 B.L.R. (3d) 1, 2000 ABCA 194. (v)  Preventive Steps [78]  In determining whether a stakeholder expectation is reasonable, the court may consider whether the claimant could have taken steps to protect itself against the prejudice it claims to have suffered. Thus it may be relevant to inquire whether a secured creditor claiming oppressive conduct could have negotiated protections against the prejudice suffered: First Edmonton Place; SCI Systems.

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(vi) Representations and Agreements [79]  Shareholder agreements may be viewed as reflecting the reasonable expectations of the parties: Main; Lyall v. 147250 Canada Ltd. (1993), 106 D.L.R. (4th) 304 (B.C.C.A.). [80]  Reasonable expectations may also be affected by representations made to stakeholders or to the public in promotional material, prospectuses, offering circulars and other communications: Tsui v. International Capital Corp., [1993] 4 W.W.R. 613 (Sask. Q.B.), aff ’d (1993), 113 Sask. R. 3 (C.A.); Deutsche Bank Canada v. Oxford Properties Group Inc. (1998), 40 B.L.R. (2d) 302 (Ont. Ct. (Gen. Div.)); Themadel Foundation v. Third Canadian Investment Trust Ltd. (1995), 23 O.R. (3d) 7 (Gen. Div.), var’d (1998), 38 O.R. (3d) 749 (C.A.). (vii) Fair Resolution of Conflicting Interests [81]  As discussed, conflicts may arise between the interests of corporate stakeholders inter se and between stakeholders and the corporation. Where the conflict involves the interests of the corporation, it falls to the directors of the corporation to resolve them in accordance with their fiduciary duty to act in the best interests of the corporation, viewed as a good corporate citizen. [82]  The cases on oppression, taken as a whole, confirm that the duty of the directors to act in the best interests of the corporation comprehends a duty to treat individual stakeholders affected by corporate actions equitably and fairly. There are no absolute rules. In each case, the question is whether, in all the circumstances, the directors acted in the best interests of the corporation, having regard to all relevant considerations, including, but not confined to, the need to treat affected stakeholders in a fair manner, commensurate with the corporation’s duties as a responsible corporate citizen. [83]  Directors may find themselves in a situation where it is impossible to please all stakeholders. The “fact that alternative transactions were rejected by the directors is irrelevant unless it can be shown that a particular alternative was definitely available and clearly more beneficial to the company than the chosen transaction”: Maple Leaf Foods, per Weiler J.A., at p. 192. [84]  There is no principle that one set of interests—for example the interests of shareholders—should prevail over another set of interests. Everything depends on the particular situation faced by the directors and whether, having regard to that situation, they exercised business judgment in a responsible way. [85]  On these appeals, it was suggested on behalf of the corporations that the “Revlon line” of cases from Delaware support the principle that where the interests of shareholders conflict with the interests of creditors, the interests of shareholders should prevail. [86]  The “Revlon line” refers to a series of Delaware corporate takeover cases, the two most important of which are Revlon Inc. v. MacAndrews & Forbes Holdings Inc., 506 A (2d) 173 (Del. 1985), and Unocal Corp. v. Mesa Petroleum Co., 493 A (2d) 946 (Del. 1985). In both cases, the issue was how directors should react to a hostile takeover bid. Revlon suggests that in such circumstances, shareholder interests should prevail over those of other stakeholders, such as creditors. Unocal tied this approach to situations where the corporation will not continue as a going concern, holding that although a board facing a hostile takeover “may have regard for various constituencies in discharging its responsibilities, … such concern for non-stockholder interests is inappropriate when … the object

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no longer is to protect or maintain the corporate enterprise but to sell it to the highest bidder” (p. 182). [87]  What is clear is that the Revlon line of cases has not displaced the fundamental rule that the duty of the directors cannot be confined to particular priority rules, but is rather a function of business judgment of what is in the best interests of the corporation, in the particular situation it faces. In a review of trends in Delaware corporate jurisprudence, former Delaware Supreme Court Chief Justice E. Norman Veasey put it this way: [It] is important to keep in mind the precise content of this “best interests” concept—that is, to whom this duty is owed and when. Naturally, one often thinks that directors owe this duty to both the corporation and the stockholders. That formulation is harmless in most instances because of the confluence of interests, in that what is good for the corporate entity is usually derivatively good for the stockholders. There are times, of course, when the focus is directly on the interests of the stockholders [i.e., as in Revlon]. But, in general, the directors owe fiduciary duties to the corporation, not to the stockholders. [Emphasis in original.]

(E. Norman Veasey with Christine T. Di Guglielmo, “What Happened in Delaware Corporate Law and Governance from 1992-2004? A Retrospective on Some Key Developments” (2005), 153 U. Pa. L. Rev. 1399, at p. 1431) [88]  Nor does this Court’s decision in Peoples Department Stores suggest a fixed rule that the interests of creditors must prevail. In Peoples Department Stores, the Court had to consider whether, in the case of a corporation under threat of bankruptcy, creditors deserved special consideration (para. 46). The Court held that the fiduciary duty to the corporation did not change in the period preceding the bankruptcy, but that if the directors breach their duty of care to a stakeholder under s. 122(1)(b) of the CBCA, such a stakeholder may act upon it (para. 66). (b)  Conduct Which Is Oppressive, Is Unfairly Prejudicial or Unfairly Disregards the Claimant’s Relevant Interests [89]  Thus far we have discussed how a claimant establishes the first element of an action for oppression—a reasonable expectation that he or she would be treated in a certain way. However, to complete a claim for oppression, the claimant must show that the failure to meet this expectation involved unfair conduct and prejudicial consequences within s. 241 of the CBCA. Not every failure to meet a reasonable expectation will give rise to the equitable considerations that ground actions for oppression. The court must be satisfied that the conduct falls within the concepts of “oppression,” “unfair prejudice” or “unfair disregard” of the claimant’s interest, within the meaning of s. 241 of the CBCA. Viewed in this way, the reasonable expectations analysis that is the theoretical foundation of the oppression remedy, and the particular types of conduct described in s. 241, may be seen as complementary, rather than representing alternative approaches to the oppression remedy, as has sometimes been supposed. Together, they offer a complete picture of conduct that is unjust and inequitable, to return to the language of Ebrahimi. [90]  In most cases, proof of a reasonable expectation will be tied up with one or more of the concepts of oppression, unfair prejudice, or unfair disregard of interests set out in s. 241, and the two prongs will in fact merge. Nevertheless, it is worth stating that as in

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any action in equity, wrongful conduct, causation and compensable injury must be established in a claim for oppression. [91]  The concepts of oppression, unfair prejudice and unfairly disregarding relevant interests are adjectival. They indicate the type of wrong or conduct that the oppression remedy of s. 241 of the CBCA is aimed at. However, they do not represent watertight compartments, and often overlap and intermingle. [92]  The original wrong recognized in the cases was described simply as oppression, and was generally associated with conduct that has variously been described as “burdensome, harsh and wrongful,” “a visible departure from standards of fair dealing,” and an “abuse of power” going to the probity of how the corporation’s affairs are being conducted: see Koehnen, at p. 81. It is this wrong that gave the remedy its name, which now is generally used to cover all s. 241 claims. However, the term also operates to connote a particular type of injury within the modern rubric of oppression generally—a wrong of the most serious sort. [93] The CBCA has added “unfair prejudice” and “unfair disregard” of interests to the original common law concept, making it clear that wrongs falling short of the harsh and abusive conduct connoted by “oppression” may fall within s. 241. “[U]nfair prejudice” is generally seen as involving conduct less offensive than “oppression.” Examples include squeezing out a minority shareholder, failing to disclose related party transactions, changing corporate structure to drastically alter debt ratios, adopting a “poison pill” to prevent a takeover bid, paying dividends without a formal declaration, preferring some shareholders with management fees and paying directors’ fees higher than the industry norm: see Koehnen, at pp. 82-83. [94]  “[U]nfair disregard” is viewed as the least serious of the three injuries, or wrongs, mentioned in s. 241. Examples include favouring a director by failing to properly prosecute claims, improperly reducing a shareholder’s dividend, or failing to deliver property belonging to the claimant: see Koehnen, at pp. 83-84. (2)  Application to these Appeals [95]  As discussed above (at para. 68), in assessing a claim for oppression a court must answer two questions: (1)  Does the evidence support the reasonable expectation the claimant asserts? and (2) Does the evidence establish that the reasonable expectation was violated by conduct falling within the terms “oppression,” “unfair prejudice” or “unfair disregard” of a relevant interest? [96] The debentureholders in this case assert two alternative expectations. Their highest position is that they had a reasonable expectation that the directors of BCE would protect their economic interests as debentureholders in Bell Canada by putting forward a plan of arrangement that would maintain the investment grade trading value of their debentures. Before this Court, however, they argued a softer alternative—a reasonable expectation that the directors would consider their economic interests in maintaining the trading value of the debentures. [97]  As summarized above (at para. 25), the trial judge proceeded on the debentureholders’ alleged expectation that the directors would act in a way that would preserve the investment grade status of their debentures. He concluded that this expectation was not made out on the evidence, since the statements by Bell Canada suggesting a commitment

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to retaining investment grade ratings were accompanied by warnings that explicitly precluded investors from reasonably forming such expectations, and the warnings were included in the prospectuses pursuant to which the debentures were issued. [98]  The absence of a reasonable expectation that the investment grade of the debentures would be maintained was confirmed, in the trial judge’s view, by the overall context of the relationship, the nature of the corporation, its situation as the target of a bidding war, as well as by the fact that the claimants could have protected themselves against reduction in market value by negotiating appropriate contractual terms. [99]  The trial judge situated his consideration of the relevant factors in the appropriate legal context. He recognized that the directors had a fiduciary duty to act in the best interests of the corporation and that the content of this duty was affected by the various interests at stake in the context of the auction process that BCE was undergoing. He emphasized that the directors, faced with conflicting interests, might have no choice but to approve transactions that, while in the best interests of the corporation, would benefit some groups at the expense of others. He held that the fact that the shareholders stood to benefit from the transaction and that the debentureholders were prejudiced did not in itself give rise to a conclusion that the directors had breached their fiduciary duty to the corporation. All three competing bids required Bell Canada to assume additional debt, and there was no evidence that bidders were prepared to accept less leveraged debt. Under the business judgment rule, deference should be accorded to business decisions of directors taken in good faith and in the performance of the functions they were elected to perform by the shareholders. [100]  We see no error in the principles applied by the trial judge nor in his findings of fact, which were amply supported by the evidence. We accordingly agree that the first expectation advanced in this case—that the investment grade status of the debentures would be maintained—was not established. [101]  The alternative, softer, expectation advanced is that the directors would consider the interests of the bondholders in maintaining the trading value of the debentures. The Court of Appeal, albeit in the context of its reasons on the s. 192 application, accepted this as a reasonable expectation. It held that the representations made over the years, while not legally binding, created expectations beyond contractual rights. It went on to state that in these circumstances, the directors were under a duty, not simply to accept the best offer, but to consider whether the arrangement could be restructured in a way that provided a satisfactory price to the shareholders while avoiding an adverse effect on debentureholders. [102]  The evidence, objectively viewed, supports a reasonable expectation that the directors would consider the position of the debentureholders in making their decisions on the various offers under consideration. As discussed above, reasonable expectations for the purpose of a claim of oppression are not confined to legal interests. Given the potential impact on the debentureholders of the transactions under consideration, one would expect the directors, acting in the best interests of the corporation, to consider their short and long-term interests in the course of making their ultimate decision. [103]  Indeed, the evidence shows that the directors did consider the interests of the debentureholders. A number of debentureholders sent letters to the Board, expressing concern about the proposed leveraged buyout and seeking assurances that their interests would be considered. One of the directors, Mr. Pattison, met with Phillips, Hager & North,

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representatives of the debentureholders. The directors’ response to these overtures was that the contractual terms of the debentures would be met, but no additional assurances were given. [104]  It is apparent that the directors considered the interests of the debentureholders and, having done so, concluded that while the contractual terms of the debentures would be honoured, no further commitments could be made. This fulfilled the duty of the directors to consider the debentureholders’ interests. It did not amount to “unfair disregard” of the interests of the debentureholders. As discussed above, it may be impossible to satisfy all stakeholders in a given situation. In this case, the Board considered the interests of the claimant stakeholders. Having done so, and having considered its options in the difficult circumstances it faced, it made its decision, acting in what it perceived to be the best interests of the corporation. [105]  What the claimants contend for on this appeal, in reality, is not merely an expectation that their interests be considered, but an expectation that the Board would take further positive steps to restructure the purchase in a way that would provide a satisfactory purchase price to the shareholders and preserve the high market value of the debentures. At this point, the second, softer expectation asserted approaches the first alleged expectation of maintaining the investment grade rating of the debentures. [106]  The difficulty with this proposition is that there is no evidence that it was reasonable to suppose it could have been achieved. BCE, facing certain takeover, acted reasonably to create a competitive bidding process. The process attracted three bids. All of the bids were leveraged, involving a substantial increase in Bell Canada’s debt. It was this factor that posed the risk to the trading value of the debentures. There is no evidence that BCE could have done anything to avoid that risk. Indeed, the evidence is to the contrary. [107]  We earlier discussed the factors to consider in determining whether an expectation is reasonable on a s. 241 oppression claim. These include commercial practice; the size, nature and structure of the corporation; the relationship between the parties; past practice; the failure to negotiate protections; agreements and representations; and the fair resolution of conflicting interests. In our view, all these factors weigh against finding an expectation beyond honouring the contractual obligations of the debentures in this particular case. [108]  Commercial practice—indeed commercial reality—undermines the claim that a way could have been found to preserve the trading position of the debentures in the context of the leveraged buyout. This reality must have been appreciated by reasonable debentureholders. More broadly, two considerations are germane to the influence of general commercial practice on the reasonableness of the debentureholders’ expectations. First, leveraged buyouts of this kind are not unusual or unforeseeable, although the transaction at issue in this case is noteworthy for its magnitude. Second, trust indentures can include change of control and credit rating covenants where those protections have been negotiated. Protections of that type would have assured debentureholders a right to vote, potentially through their trustee, on the leveraged buyout, as the trial judge pointed out. This failure to negotiate protections was significant where the debentureholders, it may be noted, generally represent some of Canada’s largest and most reputable financial institutions, pension funds and insurance companies. [109]  The nature and size of the corporation also undermine the reasonableness of any expectation that the directors would reject the offers that had been presented and

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seek an arrangement that preserved the investment grade rating of the debentures. As discussed above (at para. 74), courts may accord greater latitude to the reasonableness of expectations formed in the context of a small, closely held corporation, rather than those relating to interests in a large, public corporation. Bell Canada had become a wholly owned subsidiary of BCE in 1983, pursuant to a plan of arrangement which saw the shareholders of Bell Canada surrender their shares in exchange for shares of BCE. Based upon the history of the relationship, it should not have been outside the contemplation of debentureholders acquiring debentures of Bell Canada under the 1996 and 1997 trust indentures, that arrangements of this type had occurred and could occur in the future. [110]  The debentureholders rely on past practice, suggesting that investment grade ratings had always been maintained. However, as noted, reasonable practices may reflect changing economic and market realities. The events that precipitated the leveraged buyout transaction were such realities. Nor did the trial judge find in this case that representations had been made to debentureholders upon which they could have reasonably relied. [111]  Finally, the claim must be considered from the perspective of the duty on the directors to resolve conflicts between the interests of corporate stakeholders in a fair manner that reflected the best interests of the corporation. [112]  The best interests of the corporation arguably favoured acceptance of the offer at the time. BCE had been put in play, and the momentum of the market made a buyout inevitable. The evidence, accepted by the trial judge, was that Bell Canada needed to undertake significant changes to continue to be successful, and that privatization would provide greater freedom to achieve its long-term goals by removing the pressure on short-term public financial reporting, and bringing in equity from sophisticated investors motivated to improve the corporation’s performance. Provided that, as here, the directors’ decision is found to have been within the range of reasonable choices that they could have made in weighing conflicting interests, the court will not go on to determine whether their decision was the perfect one. [113]  Considering all the relevant factors, we conclude that the debentureholders have failed to establish a reasonable expectation that could give rise to a claim for oppression. As found by the trial judge, the alleged expectation that the investment grade of the debentures would be maintained is not supported by the evidence. A reasonable expectation that the debentureholders’ interests would be considered is established, but was fulfilled. The evidence does not support a further expectation that a better arrangement could be negotiated that would meet the exigencies that the corporation was facing, while better preserving the trading value of the debentures. [114]  Given that the debentureholders have failed to establish that the expectations they assert were reasonable, or that they were not fulfilled, it is unnecessary to consider in detail whether conduct complained of was oppressive, unfairly prejudicial, or unfairly disregarded the debentureholders’ interests within the terms of s. 241 of the CBCA. Suffice it to say that “oppression” in the sense of bad faith and abuse was not alleged, much less proved. At best, the claim was for “unfair disregard” of the interests of the debentureholders. As discussed, the evidence does not support this claim. Although the oppression remedy is available to several types of stakeholders, and has been applied in the context of both large and closely held corporations, the efficiency of its

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application to all corporate stakeholders has been criticized for unduly increasing both transaction-planning and litigation costs by allowing judges to define terms of corporate relationships after the fact. Applying nexus of contracts theory, the authors of the following paper conclude that a general fair treatment standard is appropriate only in the case of minority shareholders in closely held corporations. In all other situations, the authors conclude that stakeholders can either bargain for a “fair treatment” clause at reasonable cost or would prefer more defined protection through legal rules before the fact.

Mohamed F Khimji & Jon Viner, “Oppression: Reducing Canadian Corporate Law to a Muddy Default” (2015) 47 Ottawa L Rev 123 (footnotes omitted) We observe that the judicial understanding of the oppression action has resulted in the action effectively becoming a muddy default term in all corporate law relationships. The content of this default term is that the corporation has imposed upon it a very general obligation of reasonableness and fairness in its dealings with all stakeholders. In effect, the oppression action is a universal default rule that leaves unclear the rights and obligations of contracting corporate stakeholders until an ex post and potentially lengthy judicial analysis of the oppression action particular to the parties is undertaken. While commonly lauded as the most comprehensive and most open-ended shareholder remedy in the common law world, it is argued that a muddy default in the form of the oppression action is in fact inefficient in most corporate law relationships. The key issue we consider is whether, assuming transactions costs were zero, all stakeholders would hypothetically bargain for such a clause when dealing with a corporation. Aside from the particular context of minority shareholders in close corporations, we argue that they would not and, therefore, such an overarching default rule in corporate law is inefficient. Such a muddy default term unduly raises both ex ante business and contracting costs and ex post expenses of litigation and judicial inquiry. Costs are raised both with respect to transaction planning before the fact when uncertainty exists regarding the content of the rule, and litigation costs after the fact when unpredictability exists regarding how the rule will be applied. We conclude that such costs are outweighed by the benefits only in the context of minority shareholders of private corporations. Of course, if parties other than minority shareholders in private corporations wished to contract expressly for such an “oppression” clause, they would be able to do so reasonably cheaply, as transaction costs would not be prohibitively high. More importantly, such parties would be able to contract for an oppression clause at a lesser cost than forcing parties to contract out of oppression because it is a default term in all corporate relationships. … Before illustrating how the Canadian oppression action has effectively become an overarching muddy default, it is important to first set out the broader analytical lens through which the action is being assessed. Law and economics scholars have long theorized the corporation to be a nexus of contracts. That is, the corporation is analyzed not as an entity itself but as a series of explicit and implicit contracts between corporate constituents. These corporate constituents, such as employees, managers, investors, and creditors, voluntarily enter into complex contractual arrangements rationally and for their own self-interest. Each corporate actor may choose to accept the terms of a contract,

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negotiate for more advantageous terms, or reject the terms offered and search for a participant who is offering more desirable terms. Note that a contract in this sense is not limited to strictly legal contracts but also long-term relational contracts. This contractarian approach to the corporation influences how corporate law is evaluated. Corporate law codes are said to be “enabling” in nature. In other words, these codes form the backdrop against which corporate participants bargain and contract for their own self-interest. Under this framework, corporate law exists as a set of standard default contractual terms which corporate parties are free to contract around. These default terms serve an important gap-filling function that reduces transaction costs and facilitates private contracting. Transaction costs are reduced as parties may choose to contract only on matters that are of specific importance to their particular circumstances. As well, should an unexpected contingency arise that was not addressed in the contract, the default terms provided will fill this contractual gap. From the contractarian mode of analysis flows the conclusion that, generally, the courts should enforce voluntary agreements between rational self-interested corporate actors. However, it must be acknowledged that, in a world of transaction costs, no contract is entirely complete. That is, no contract will define each party’s rights and obligations in every possible state of the world. Therefore, a contract between corporate actors will consist not only of the terms that the parties specifically contracted for but also the default terms provided by corporate statutes and interpreted by the courts. While the explicit contractual terms are understood to be a mutually beneficial and efficient agreement between self-interested actors, the question arises as to how default terms should be structured to facilitate efficient private ordering. … Under a contractarian framework, the oppression action is a default contractual term embedded in any contract between a corporate stakeholder and the corporation. Parties contract understanding that they may bring an oppression action where particular “oppressive” or “unfairly prejudicial” corporate behaviour is not governed by explicit contractual provisions. When an oppression action is brought, the idea is that a latent contractual gap has become apparent. The parties had not contracted explicitly on a particular contingency that in fact materialized and there is a contractual gap as to the rights and obligations of the parties in such a situation. The broad language of section 241 of the CBCA leaves it to the courts to determine what approach to contractual gapfilling should be undertaken when interpreting the oppression provisions. Tracing the historical judicial application of the oppression action to the decision in BCE can be understood as an examination of how courts have chosen to fill contractual gaps between corporate stakeholders. A survey of this history, outlined above, reveals three universal features when it comes to the judicial treatment of the oppression action. Firstly, protection of reasonable expectations is the foundation of the Canadian oppression action. Secondly, all corporate stakeholders are entitled to reasonably expect “fair treatment.” Thirdly, what constitutes reasonable expectations is contextual and highly fact-specific. Courts have noted on multiple occasions that precedents are only of limited value. These three universal features, understood in the context of contractual gap filling, effectively amount to a muddy default being placed in every corporate contract involving every corporate stakeholder in the form of a general “fairness” or “reasonableness” obligation imposed upon the corporation. Recall that a muddy default term requires courts to

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determine the rights and obligations of the particular parties in light of the particular circumstances that have occurred. Under such a muddy default term, the obligations of the parties are deemed to be unclear ex ante and extensive judicial examination is required ex post to determine what was “fair” or “reasonable.” In applying the oppression provisions with a new fact-specific inquiry in each case involving every type of stakeholder, the judiciary incorrectly assumes that it is always more costly for parties to identify contingencies ex ante than it is for courts to verify contingencies ex post. Such a muddy default term, when applied in a context not involving a minority shareholder of a private corporation, is inefficient as it unjustifiably raises contracting costs, litigation expenses, and the public cost of judicial adjudication. Business and contracting costs are raised since directors, even while acting in the best interests of the corporation, must take efforts to ensure that they consider the impact of corporate actions on all stakeholders so as to avoid an accusation of unfair treatment. Litigation costs are higher because of the unpredictable nature of the judicial application of the oppression action. Adverse parties will have a more difficult time reaching a settlement not knowing how the court may apply the oppression provisions. The malleable concept of reasonably expected fair treatment might encourage more corporate actors to proceed with an oppression claim, even when such actors could have explicitly contracted for protection from the corporate behaviour complained of reasonably cheaply ex ante. Corporate participants may even use the oppression action for nefarious purposes to extract a settlement from a corporation. Furthermore, the courts’ judicial treatment of the oppression provisions through fact-specific investigation has a high public cost and potential for judicial error that is not justified in most corporate situations. … In all situations, aside from the minority shareholders in the close corporations context, the oppression action as a muddy default term is inefficient. The lack of certainty and predictability as to rights and obligations raises unduly ex ante contracting and business costs and ex post litigation and judicial expenses. These unnecessary costs would be reduced with a default term that limits the availability of the oppression action to minority shareholders in private corporations, in whatever capacity. Minority shareholders in public corporations are passive investors who may easily sell their shares on the market when they disapprove of particular corporate conduct. They invest with an eye towards investment returns and therefore, the fiduciary duties owed to the corporation by managers and the ability to enforce these duties through a derivative action are more appropriate legal mechanisms for any harm they wish to redress. Debtholders, lenders, trade creditors, and contract counterparties enter into discrete contractual relationships with the corporation. Their disputes may be resolved entirely through contract law and any other more specific default rules that the law provides. Of course, if these contract creditors decide to insert a muddy “oppression” or “unfair treatment” clause into their agreements, they would be able to do so at reasonable cost before the fact. … The oppression action as a default term is efficient only in the context of minority shareholders of close corporations whose idiosyncratic bargains are relational in quality and dynamic in nature. In most other contexts, it is more efficient to force parties to bargain for a “fair treatment” clause, should they wish to. Under the current regime, opportunistic behaviour after the fact is encouraged as parties have an incentive to litigate in order to have their rights defined. Even where the transaction costs are high

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before the fact, such as with tort creditors, a default term in the form of the oppression action is inefficient as the parties would prefer to have their rights defined more clearly before the fact.

F.  Relationship Between the Derivative Action and the Oppression Remedy

Christopher Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) at 434 and 435 The derivative action and the oppression remedy are two of the most important Canadian corporate statutory remedies. The oppression remedy, in particular, has become an especially flexible tool in the hands of creative lawyers representing the interests of aggrieved corporate stakeholders. The interplay of the derivative action and the oppression remedy helps to illustrate the essential tension in corporate law between respect for the notion of the corporation as a separate legal entity (seen, for example, in the formal justification for the derivative action procedures) and the recognition of the economic realities of the corporation, especially private corporations of the “incorporated partnership” variety. … Derivative and oppression applications—although often overlapping in real life, especially in the case of small, privately held corporations—are, in principle, quite distinct. The derivative action is available only in the case of harms alleged to have been committed against the corporation itself. Accordingly, a plaintiff not otherwise included in the specifically enumerated categories of the “complainant” definition ought only to be permitted to launch such an action if there is a good reason to believe that the plaintiff is well positioned (and, one might add, well motivated) to champion the interests of the corporation and not merely the plaintiff ’s own interests. No such consideration applies in the case of the oppression action, which was intended, after all, to protect the interests of the disenfranchised security holders and perhaps other corporate stakeholders. Despite the legal distinction between a derivative action and the oppression remedy, complainants have frequently relied on the oppression remedy rather than the derivative action.8 A complainant must meet a number of statutory prerequisites and obtain the leave of the court before being permitted to launch a derivative action. In situations where wrongs done to the corporation include oppressive conduct to individual stakeholders, it is easy to understand why a complainant would choose to bring an application for the oppression remedy. Over the years, the line between the two remedies has become increasingly blurred. In 2015, the Ontario Court of Appeal recognized that the two remedies are not mutually exclusive. However, the court also confirmed that the remedies are for distinctly different 8 Brian Cheffins, “The Oppression Remedy in Corporate Law: The Canadian Experience” (1988) 10 U Pa J Intl L 305 at 334.

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purposes, and that the oppression remedy should not generally be available to complainants unless their personal interests have been uniquely affected.

Rea v Wildeboer 2015 ONCA 373 (footnotes omitted) BLAIR JA:

[12]  The general issue raised on this appeal is whether a complainant may assert, by way of an oppression remedy proceeding, a claim that is by nature a derivative action for a wrong done solely to the corporation, thereby circumventing the requirement to obtain leave to commence a derivative action. •  •  •

[18]  The derivative action was designed to counteract the impact of Foss v. Harbottle by providing a “complainant”—broadly defined to include more than minority shareholders—with the right to apply to the court for leave to bring an action “in the name of or on behalf of a corporation … for the purpose of prosecuting, defending or discontinuing the action on behalf of the body corporate”: Business Corporations Act, R.S.O. 1990, c. B.16, s. 246 (“OBCA”). It is an action for “corporate” relief, in the sense that the goal is to recover for wrongs done to the company itself. As Professor Welling has colourfully put it in his text, Corporate Law in Canada: The Governing Principles, 3rd ed. (Mudgeeraba: Scribblers Publishing, 2006), at p. 509, “[a] statutory representative action is the minority shareholder’s sword to the majority’s twin shields of corporate personality and majority rule.” [19]  The oppression remedy, on the other hand, is designed to counteract the impact of Foss v. Harbottle by providing a “complainant”—the same definition—with the right to apply to the court, without obtaining leave, in order to recover for wrongs done to the individual complainant by the company or as a result of the affairs of the company being conducted in a manner that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of the complainant. The oppression remedy is a personal claim: Ford Motor Co. of Canada v. Ontario (Municipal Employees Retirement Board) (2006), 79 O.R. (3d) 81 (C.A.), at para. 112, leave to appeal refused, [2006] S.C.C.A. No. 77; Hoet v. Vogel, [1995] B.C.J. No. 621 (S.C.), at paras. 18-19. [20]  These two forms of redress frequently intersect, as might be expected. A wrongful act may be harmful to both the corporation and the personal interests of a complainant and, as a result, there has been considerable debate in the authorities and amongst legal commentators about the nature and utility of the distinction between the two. In the words of one commentator, “the distinction between derivative actions and oppression remedy claims remains murky”: Markus Koehnen, Oppression and Related Remedies (Toronto: Thomson Canada Limited, 2004), at p. 443. [21]  Yet the statutory distinctions remain in effect. The Parties’ Positions [22]  The appellants submit that the distinction between the remedies has been significantly moderated and that a complainant is entitled to pursue an oppression remedy

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even where the wrong in question is a wrong in respect of the corporation, provided that the shareholder’s reasonable expectations have been violated by means of conduct caught by the terms “oppression,” “unfair prejudice” or “unfair disregard.” They rely on the decision of the Supreme Court of Canada in Re BCE Inc., 2008 SCC 69, [2008] 3 S.C.R. 560, at para. 68, for this proposition. The rationale, they say, is that the oppression remedy provisions provide stakeholders with “a personal, statutory right” not to have their reasonable expectations violated in this manner. [23]  The appellants stress that in Malata Group (HK) Ltd. v. Jung, 2008 ONCA 111, 89 O.R. (3d) 36, and Jabalee v. Abalmark Inc., [1996] O.J. No. 2609 (C.A.), this Court acknowledged that there could be a degree of overlap between claims that could be made out as a derivative action and those that could fall under the oppression remedy, and that “the two are not mutually exclusive”: Malata, at para 30; Jabalee, at para. 5. [24]  The respondents submit, on the other hand, that the distinction between the two remedies remains, and for good reason. They accept—as did the motion judge—that there has been some relaxation in the approach to the commencement of oppression remedy actions in cases where the factual circumstances create an overlap between the two remedies, particularly in the case of small closely held corporations. But they contend that the distinction remains important—because of the leave requirement for derivative actions—in the case of publicly held corporations such as Martinrea. [25]  In such cases, they argue, the leave requirement fulfills its important threefold purpose of (i) preventing strike suits, (ii) preventing meritless suits, and (iii) avoiding a multiplicity of proceedings—all of which may lead to the corporation incurring significant and unwarranted costs, concerns that are less acute for closely held corporations. Relying on Malata themselves, the respondents point to the importance Armstrong J.A. placed in that case on the fact that Malata was a closely held corporation (para. 38) and to his observation, at para. 39, that: [i]n disputes involving closely held corporations with relatively few shareholders … there is less reason to require the plaintiff to seek leave of the court. The small number of shareholders minimizes the risk of frivolous lawsuits against the corporation, thus weakening the main rationale for requiring a claim to proceed as a derivative action.

Discussion [26]  I accept that the derivative action and the oppression remedy are not mutually exclusive. Cases like Malata and Jabalee make it clear that there are circumstances where the factual underpinning will give rise to both types of redress and in which a complainant will nonetheless be entitled to proceed by way of oppression remedy. Other examples include: Ontario (Securities Commission) v. McLaughlin, [1987] O.J. No 1247 (H.C.J.); Deluce Holdings Inc. v. Air Canada (1992), 12 O.R. (3d) 131 (Gen. Div.); C.I. Covington Fund Inc. v. White, [2000] O.J. No. 4589 (S.C.), aff ’d [2001] O.J. No. 3918 (Div. Ct.); Waxman v. Waxman, [2004] O.J. No. 1765 (C.A.), at para. 526, leave to appeal refused, [2004] S.C.C.A. No. 291. [27]  However, I agree with the respondents that claims must be pursued by way of a derivative action after obtaining leave of the court where, as here, the claim asserted seeks to recover solely for wrongs done to a public corporation, the thrust of the relief sought

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is solely for the benefit of that corporation, and there is no allegation that the complainant’s individualized personal interests have been affected by the wrongful conduct. [28]  It is true that the jurisprudence is inconsistent about how to treat cases where there is an overlap and that there has been considerable discussion amongst legal commentators about this and whether the distinction should be maintained. See, for example, the following texts and articles and the jurisprudence referred to therein: Koehnen, at pp. 440-448; Jeffrey G. MacIntosh, “The Oppression Remedy: Personal or Derivative?” (1991) 70 Can. Bar. Rev. 29; Edward M. Iacobucci and Kevin E. Davis, “Reconciling Derivative Claims and the Oppression Remedy” (2000) 12 S.C.L.R. 87. [29]  While this debate is interesting, it is not necessary to resolve it here. On my reading of the authorities, in the cases where an oppression claim has been permitted to proceed even though the wrongs asserted were wrongs to the corporation, those same wrongful acts have, for the most part, also directly affected the complainant in a manner that was different from the indirect effect of the conduct on similarly placed complainants. And most, if not all, involve small closely held corporations not public companies. •  •  •

[32]  Here, however, on the facts pleaded, there is no overlap between the derivative action and the oppression remedy (once one goes beyond the boiler plate repetition of the statutory language from the OBCA describing the oppression remedy). The appellants are not asserting that their personal interests as shareholders have been adversely affected in any way other than the type of harm that has been suffered by all shareholders as a collectivity. Mr. Rea—the only director plaintiff—does not plead that the Improper Transactions have impacted his interest qua director. [33]  Since the creation of the oppression remedy, courts have taken a broad and flexible approach to its application, in keeping with the broad and flexible form of relief it is intended to provide. However, the appellants’ open-ended approach to the oppression remedy in circumstances where the facts support a derivative action on behalf of the corporation misses a significant point: the impugned conduct must harm the complainant personally, not just the body corporate, i.e., the collectivity of shareholders as a whole. [34] The oppression remedy is not available—as the appellants contend—simply because a complainant asserts a “reasonable expectation” (for example, that directors will conduct themselves with honesty and probity and in the best interests of the corporation) and the evidence supports that the reasonable expectation has been violated by conduct falling within the terms “oppression,” “unfair prejudice” or “unfair disregard.” The impugned conduct must be “oppressive” of or “unfairly prejudicial” to, or “unfairly disregard” the interests of the complainant: OBCA, s. 248(2). No such conduct is pled here. [35]  That the harm must impact the interests of the complainant personally—giving rise to a personal action—and not simply the complainant’s interests as a part of the collectivity of stakeholders as a whole—is consistent with the reforms put in place to attenuate the rigours of the rule in Foss v. Harbottle. The legislative response was to create two remedies, with two different rationales and two separate statutory foundations, not just one: a corporate remedy, and a personal or individual remedy. [36]  The derivative action provides aggrieved minority stakeholders with the ability to pursue a cause of action on behalf of the corporation to redress wrongs done in respect of the corporation, provided leave is obtained from the court to do so. As Professor MacIntosh has observed:

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Chapter 14  Stakeholder Remedies The corporation will be injured when all shareholders are affected equally, with none experiencing any special harm. By contrast, in a personal (or “direct”) action, the harm has a differential impact on shareholders, whether the difference arises amongst members of different classes of shareholders or as between members of a single class. It has also been said that in a derivative action, the injury to shareholders is only indirect, that is, it arises only because the corporation is injured, and not otherwise. [See, for example, Farnham v. Fingold, [1973] 2 O.R. 132 (C.A.); Goldex Mines Ltd. v. Revill (1974), 7 O.R. (2d) 216 (C.A.)]. •  •  •

[44]  It may be that, in some circumstances, the failure to provide proper disclosure of material information to shareholders can constitute oppressive conduct and, similarly, that in some circumstances wrongfully withholding information from a director may be “oppressive” to the director’s ability to carry out his or her role in that capacity. However, no such pleading is asserted here. To the extent that the preparation of inaccurate financial statements and the lack of candour vis-à-vis fellow directors are asserted as facts in the statement of claim, they are pleaded as examples of the Insider Defendants’ breach of fiduciary duty to the corporation, not as something that impacts the interests of the appellants in any individual manner other than what might affect the collectivity of the shareholders. Mr. Rea is the only plaintiff who was a director and he asserts no claim that his interests have been affected in that capacity. As pleaded, these wrongs are relevant as tools used to perpetrate the fraud against Martinrea, not as acts that have any particularized impact on any of the plaintiffs individually. [45]  At its heart, the appellants’ allegation involves the misappropriation of corporate property by the Insider Defendants, assisted in some cases by the respondents here (IM and Pashak) and others. The substantive remedy claimed is the disgorgement of the illgotten gains back to Martinrea. [46]  The misappropriation of corporate property was effected through the alleged Improper Transactions which in essence consisted of: (i) payment to the Insider Defendants of secret kickbacks and improper commissions in relation to services provided and equipment sold to Martinrea, as a result, at inflated prices; (ii) payments by Martinrea to third parties for construction, renovation and other services (including in one case the settlement of potential legal exposure) for the personal benefit of the Insider Defendants; and (iii) in the case of the respondents IM and Pashak, the purchase of used equipment by Martinrea at inflated prices (feeding kickbacks to the Insider Defendants) and the purchase of real estate in Kitchener by Martinrea from a related Pashak company, on terms unfavourable to Martinrea. All of these allegations, if proved, will establish losses sustained by the corporation to its financial bottom line—i.e., to the collectivity of shareholders as a whole—and not to any particular shareholder, including the appellants, individually. [47]  For these reasons, I do not accept that the wrongs as pleaded in the statement of claim are wrongs other than wrongs done to the corporation that form the basis of a derivative action. As noted earlier, I do not see this as a case involving overlap between the oppression remedy and the derivative action. •  •  •

[49]  For the reasons outlined above, I am satisfied that the appellants’ statement of claim does not disclose a reasonable cause of action based upon the oppression remedy. Nor do I think it is a novel or unsettled principle of law that wrongs done solely to a

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corporation, for which remedies are sought on behalf of the corporation, give rise to a derivative action and require leave of the court before an action can be commenced to assert those claims. Where the facts may give rise to both a “corporate claim” and a “personal” oppression remedy claim—as Malata and the other cases referred to above illustrate—the question of whether an oppression remedy proceeding is available will have to be sorted out on a case by case basis. This task does not arise on the facts as pleaded here, however. [50]  Accordingly, I would dismiss the appeal. NOTES AND QUESTIONS

1.  The Ontario Court of Appeal in Rea v Wildeboer concludes that a case-by-case analysis is required to determine if a wrong to the corporation may be pursued via the oppression remedy. Does the court provide any specific guidance for future litigants? 2.  The court indicates that any harm in this case would affect the collective shareholders as a whole. Should it matter if individual shareholders, even in these circumstances, wish to seek an oppression remedy for the harm that is done specifically to them?

IV.  APPRAISAL REMEDY (RIGHT TO DISSENT)

Christopher Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) at 438-58. The shareholder dissent right and appraisal remedy is the means by which the CBCA attempts to reconcile the competing values of majority rule and fair recognition of the legitimate concerns of minority investors when the fundamental nature of their investment is to be changed. The dissent and appraisal remedy, accordingly, permits the majority to make whatever fundamental changes to the business they deem appropriate, but accords to the minority in the case of certain fundamental changes a right that ordinary equity holders normally do not enjoy—namely, the right to demand that their shares be repurchased by the company and their capital returned to them. … To take advantage of the appraisal remedy, shareholders need to be made aware of it. The CBCA therefore requires that when a shareholder’s meeting is called to consider a transaction that may trigger appraisal rights, the material sent to shareholders concerning such a meeting must disclose the fact that the proposed transaction may trigger these rights. It is sometimes said that the existence of appraisal rights may well constrain business decision making. That is, an otherwise beneficial major transaction might become impossible if a significant number of dissenting shareholders threaten to exercise their appraisal rights. The corporation would thus be compelled to repurchase the dissidents’ shares, resulting in an inordinate drain on the corporation’s cash resources. This risk is well understood. It was specifically referred to by the Dickerson committee in their report, and is frequently mentioned by practitioners. However, it is not clear how significant an impediment to beneficial transactions the possibility of multiple dissenters

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actually poses. Robert Clark, for example, notes that, if a proposed transaction has genuine economic benefit for a corporation and these benefits are properly explained by a corporation’s management, it seems difficult to understand why a significant number of shareholders would dissent. But, in any event, he reasons, even if large numbers of shareholders did dissent (perhaps on non-economic grounds), it is unclear why the shareholders would not be able to raise sufficient financial resources to purchase the shares of the minority. Perhaps, however, professor Clark underestimates the occasional difficulty that firms of a certain size have in obtaining debt finance—especially when, by definition, the purpose of that financing would be to reduce the equity cushion that lenders would otherwise enjoy. Moreover, a corporation may be very reluctant to take on additional debt if, for example, market interest rates are particularly high. … Not every corporate change triggers the right of dissenting shareholders under the CBCA to demand that their shares be repurchased. Those corporate actions that do trigger these rights are often commonly referred to as “fundamental changes.” However, although this phrase does appear as the title of part XV of the CBCA, it is neither a defined term under the CBCA nor otherwise a legal term of art. The proposed changes that will trigger appraisal rights under the CBCA are specifically itemised in s. 190. The list includes: • amendments to provisions of the corporation’s articles relating to: (1) restrictions or constraints on the issue, transfer, or ownership of shares of the class owned by the dissenting shareholder, (2) restrictions on the business(es) that the corporation may carry on, and (3) the rights of holders of a class of shares, as described in s. 176; • amalgamations (other than so-called short-form amalgamations under s. 184 between a corporation and its wholly owned subsidiary); • continuance of the corporation into another jurisdiction; • a sale, lease, or exchange of all or substantially all of the corporation’s property other than in the ordinary course of the corporation’s business; • “going-private transactions” and “squeeze-out transactions” (as expressly defined in the CBCA); and • an arrangement under s. 192, if the court orders that shareholders are permitted to dissent in connection with the arrangement. … There are two other features of these CBCA appraisal-triggering events that deserve mention. First, s. 190(2) provides that holders of any class or series of shares entitled to vote under s. 176 will also have dissent rights if the articles are amended in any of the ways described in s. 176. Section 176 permits even those shareholders whose shares do not normally enjoy voting rights to vote in respect of certain proposed changes affecting their shares. There is something especially noteworthy about the list of changes set out in s. 176. It includes not only amendments to the articles that would directly affect the class of shares entitled to vote, but also certain amendments made to the share conditions of other classes or series of shares, having an indirect effect on the holders of the class entitled to vote. … The detailed appraisal remedy procedures in the CBCA were evidently modelled on comparable provisions in New York’s corporate statute. There is no question that the rules are complex. The Dickerson committee, although acknowledging the unwieldy

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length of these provisions, nonetheless viewed them “necessary to render the substantive right to dissent meaningful.” Some amount of procedural complexity is surely unavoidable. Shareholders must be told—specifically—how and when they are required to register their dissent. Corporations, similarly, must be given specific guidance as to how and when they are obliged to purchase shares from dissenters. If the Act did not specify dates by which certain events must take place, it would obviously be difficult for anyone to complain that actions had not been taken in time. Furthermore, the matter of establishing the “fair value” at which dissenters’ shares are to be purchased by the corporation is especially problematic. The appraisal procedures require the corporation to offer dissenting shareholders a price for their shares. If that price is accepted, the sale may be easily and swiftly concluded. But, if the dissenters are not satisfied with the corporation’s offer, matters become much more complicated. The appraisal section must set out the procedures that will govern the ensuing process. … Valuation of any asset is difficult. Valuation of intangible assets, like shares, is especially challenging. The court will not necessarily be required to determine the fair value of dissenting shareholders’ shares. In the first instance, it is the obligation of the corporation to calculate the fair value of the shares to be purchased, and to make an offer to purchase the dissenting shareholders’ shares at that amount, including with the offer an explanation of how that value was determined. If the dissenting shareholders accept the price offered by the corporation for their shares, that is the end of the matter. However, things may not run quite so smoothly. The CBCA specifically permits either the corporation or the dissenting shareholders to apply to the court to have the court fix fair value … . Accordingly, appraisal cases frequently include judicial discussion about the proper valuation of corporate shares, and the various methods that have been adopted by valuers and the court to this end. An important decision of the Alberta Court of Queen’s Bench found that the market value approach was appropriate to determine the fair value of the shares of dissenting shareholders of an early stage oil sands company that was subject to a second-stage amalgamation after a takeover bid. Note the court’s assessment of the business judgment of the directors in their appraisal determinations.

Deer Creek Energy Limited v Paulson & Co Inc 2008 ABQB 326, aff ’d 2009 ABCA 280 A.  Statutory Basis for Determination of Fair Value [480]  Under section 191(3) of the ABCA, the dissenting shareholders are entitled to be paid “fair value” for their shares, determined as of the last business day before the day on which the resolution from which the shareholder dissents was adopted, the “Valuation Date” being December 9, 2005 in this case.

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[481]  The ABCA does not define fair value but it provides that it may be fixed by the court. [482]  In a leading case that combined an oppression action with the determination of fair value, Brant Investments Ltd. v. KeepRite Inc. (1987), 60 O.R. (2d) 737 (H.C.), aff ’d. (1991), 3 O.R. (3d) 289 (C.A.), the trial court reflected on the meaning of fair value as follows at 774-5: … The right as I view it is to recover the value of the investment so that the proceeds may be utilized elsewhere. In such circumstances I see no reason why market value is not “fair value.” Market value (in some comment called “fair value,” in some “intrinsic value”) is defined as the highest price available in an open and unrestricted market between informed, prudent parties acting at arm’s length and under no compulsion to act, expressed in terms of money or money’s-worth. In my view, on the facts of this case, “market value” will constitute “fair value” within the meaning of that term as used in s. 184(3) [of the CBCA]. It is on that basis that I propose to determine the award to the dissenting shareholders. In this context it is necessary to keep in mind the distinction between “market value” as thus defined and the “market value approach” to valuation referred to in the judgment of Greenberg J. in Domglas … . The latter has reference to use of the quoted price or prices on the stock market. Such prices reflect actual transactions of purchase and sale. “Market value” as defined above is a notional or hypothetical concept; an opinion arrived at by evidence, assumptions, calculations and judgment, in the absence of an actual transaction. The distinction is important for the disposition of this case.

[483]  On appeal, the Court agreed that, on the facts of that case, “fair value” and “market value” could be equated, but such is not necessarily always the case. What is clear is that fair value is a value that is “just and equitable,” one that provides adequate compensation or indemnity, consistent with the requirements of justice and equity: Manning v. Harris Steel Group Inc. (1986), 7 B.C.L.R. (2d) 69 at 75 (B.C.S.C.), citing Domglas Inc. v. Jarislowsky et al. (1980), 13 B.L.R. 135 at 164 (Que. S.C.). [484]  The dissenting shareholders appear to rely on a definition of fair value taken from the American case of Roessler v. Security Savings & Loan Co., 72 N.E.2d 259 (Ohio 1974), which refers to fair value as the “intrinsic value” of shares. As noted in Morrison v. United Westburne Industries Ltd., [1988] O.J. No. 378 (H.C.J.) at p. 11, “intrinsic value” has a particular meaning that may not make it synonymous with fair value and I prefer not to use that term. [485]  The determination of fair value pursuant to the statutory right set out in the ABCA and similar legislation is highly fact specific. In making its determination, a court is advised to be prudent—to proceed not on the basis of the most optimistic approach, but to recognize that a prudent purchaser will have certain fall-back positions in mind: New Quebec Raglan Mines Ltd. v. Blok-Andersen (1993), 9 B.L.R. (2d) 93 at 132 (Ont. Gen. Div.). While each party who asserts a proposition must prove it by a preponderance of evidence on the balance of probabilities, there is no burden on either side to establish value, as this is a judgment for the court to make: Silber v. BGR Precious Metals Inc. (1998), 41 O.R. (3d) 147 (Gen. Div.). [486]  Generally, neither the parties nor the court may rely on hindsight evidence. Events that were not known as of the valuation date or that occurred afterwards are not relevant to determination of fair value on the valuation date. At trial in Smeenk v. Dexleigh

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Corp. (1990), 74 O.R. (2d) 385 (H.C.J.), affirmed on this point by the Court of Appeal at (1993), 15 O.R. (3d) 608 at 614 (C.A.), Henry J. stated at p. 404: The advantages of hindsight are not available either to the applicant or to the court. It is the policy of the Act to divorce the value of the shares on the valuation date from the effects of the amalgamation whether anticipated or ex post facto. Events that were not known on the valuation date or which occurred thereafter are therefore, in ordinary circumstances, not relevant to the issue which is to determine fair value on the valuation date; where they may nevertheless have some relevance or probative value they should on the basis of the same principle be given little weight.

[487]  The general rule on hindsight was clarified in Ford Motor Co. of Canada v. Ontario Municipal Employees Retirement Board (2000), 48 C.P.C. (4th) 272 (Ont. Sup. Ct.  J.) at para.  5, where Ground  J. comments that factual hindsight information (not opinions) may be used to compare actual results achieved after the valuation date to projected corporate results said to be reasonably foreseeable or to challenge the reasonableness of assumptions made by the valuators. [488]  As the valuation experts point out, there are at least four accepted methods of valuing shares:

(a) market valuation, which is sometimes restricted to the use of quoted prices on a stock exchange; (b) net asset valuation; (c) investment valuation; and (d) a combination approach. As noted in Grandison v. NovaGold Resources Inc., 2007 BCSC 1780 at para. 154, these options are not exhaustive and “[e]verything that has a bearing on the question of value must be considered.” [489]  The approaches that may be appropriate to this valuation are the market-based approach, the net asset valuation approach, or a combination of the two. As noted in Cyprus Anvil Mining Corp. v. Dickson (1986), 33 D.L.R. (4th) 641 at 652 (B.C.C.A.): The one true rule is to consider all the evidence that might be helpful, and to consider the particular factors in the particular case, and to exercise the best judgment that can be brought to bear on all the evidence and all the factors.

The Court in Cyprus Anvil also noted at pp. 652-3 that no method of determining value that might provide guidance should be rejected, but that in the end it is up to the court to exercise judgment to determine fair value. The determination of “fair value” is not a process characterized by mathematical certainty and exact calculation. B.  Adequacy of Marketing and Market Testing and the Role of Business Judgment [490]  The dissenting shareholders are critical of the process undertaken and decisions made by the Deer Creek board and management, suggesting that it was inadequate, that the board was outmaneuvered, that the process was ill thought-out or perhaps that there was no process at all but merely an insufficiently rigorous reaction to events as they occurred. They dismiss the $31 price offered by Total as evidence of fair value in part

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because of what they allege are insufficiencies of process and diligence and in part because of what they allege are imperfections in the market-based valuation approach generally. [491]  If it was true that the process was flawed or nonexistent, that would weaken the case for a market-based approach to the valuation of the Deer Creek shares, since bad management and poor strategy may tend to invalidate the trading prices of Deer Creek at the time of the Total offer and the final offered bid of $31 per share as indications of “fair market value,” the highest price available in an open and unrestricted market between informed, prudent parties acting at arm’s-length and under no compulsion to act, expressed in terms of money or money’s worth. Deer Creek submits through its expert Mr. Clark that the market-based approach is the most appropriate valuation approach in this case, backed up by a discounted cash flow approach. [492]  The dissenting shareholders submit through their primary valuation witness Mr. Dovey and through Professor Hayes that the discounted cash flow approach is best, arguing that a market-based approach that focusses on stock-trading prices is unreliable in this case because the market did not appropriately value this kind of company and because the process was flawed. [493]  In responding to these submissions, Deer Creek called a great deal of evidence about the process followed by the board and submits that the role of business judgment is of fundamental importance in the case, both on the issue of the adequacy of the process followed by the board and management of Deer Creek and on the issue of whether there were powerful indicators of market value. Deer Creek submits that business judgment was exercised at many different levels and that it all supports the conclusion that Deer Creek’s fair value as at December 9, 2005 was, at best, the $31 offered by Total in the takeover bid. [494]  The dissenting shareholders respond that the business judgment rule is a “red herring,” that it has no place in a fair value case and that deference to business judgment amounts to placing an improper onus on the dissenting shareholders. [495]  The business judgment rule is not a substantive rule of law, but a presumption applied by the court that, in the classic statement as expressed under Delaware law, provides that in making business decisions, the directors acted on an informed basis in the honest belief that an action taken was in the best interests of the company; see In re Walt Disney Co. Derivative Litigation, 907 A.2d 693 at 750. The Court in that case explained that the business judgment rule exists because courts are ill-equipped to engage in an after-the-fact substantive review of business decisions and the rule precludes a court from imposing itself unreasonably on the business and affairs of the corporation. The Supreme Court of Canada recognized these policy considerations in quite similar language in Peoples Department Stores Inc. (Trustee of) v. Wise, [2004] 3 S.C.R. 461, 2004 SCC 68. The Court in Walt Disney noted at pp. 747-8 that the business judgment presumption applies when there is no evidence of fraud, bad faith or self-dealing and does not apply if a decision “cannot be attributed to any rational business purpose” or if the directors “have made an unintelligent or unadvised judgment” or have been unduly passive. In the United States, a variation on the presumption has developed in the context of takeover battles and change of control situations, namely the Revlon enhanced scrutiny variant: Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 at 179 (Del. 1986). While the rule under Delaware law is quite specific and well-developed, when it has been used in Canada, it has sometimes been less than fully nuanced. It often arises

IV.  Appraisal Remedy (Right to Dissent)

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when a decision of a board of directors is assailed in hindsight. The issue arises in this case, not because of allegations of breach of fiduciary duty or duty of care per se, but to allege that implied breaches of this kind make the market price of the Deer Creek shares of little or no utility in the determination of fair value. [496]  It has been suggested that where, as here, a personal remedy is sought, a court should hesitate before rejecting recourse to it by invoking the business judgment rule as, in such a case, the issue is not the protection of a business decision or the directors that made it, but instead the protection of a complainant’s interests against abuse or injustice: Paul Martel, “The Oppression Remedy and the Business Judgment Rule—Some Reflections” (Paper presented to the National Judicial Institute Civil Law Seminar: Emerging Issues in Corporate, Commercial and Insolvency Law, May 9, 2007) at 7. This may be so if an attempt was made to justify a value for shares held by dissenting shareholders by asking the court simply to defer to the judgment of directors as to value, rather than to engage in its own duty of valuation, but it is not a “red herring” to consider the events that led to the Total acquisition in September 2005 or to the second stage transaction that gave rise to dissent rights and established the Valuation Date in order to consider the submissions of the dissenting shareholders about process and market flaws and to consider the submissions of Deer Creek on the propriety of a market value approach to fair value. [497]  In doing so, I am required to review the actions, reactions and decisions of the Deer Creek board and management. In this case, even if I apply hindsight to the reactions and decisions of the board in this case, they withstand that rigorous test and I am not tempted to substitute a different opinion on what was done or should have been done by the board in the years and months prior to the Valuation Date. This is not a case where deference to the opinions of the directors may have produced a different result. I do not impose an onus on the dissenting shareholders to do other than what they are required to do in this kind of proceeding: to establish on the balance of probabilities their allegation that the process was flawed and the market imperfect by evidence. [498]  I accept that Deer Creek had a strong board of directors with extensive industry knowledge and experience and a deep background with the company and its project. They were aided in their deliberations by a strong management team and two teams of highly regarded investment bankers with considerable transactional and industry-specific experience. [499]  I find the directors, managers and professional advisors who testified for Deer Creek to be credible and knowledgeable witnesses who provided the history of a process undertaken by the company to consider alternatives for the future development of the Joslyn Project during the period of time most relevant to this case, commencing in the fall of 2004 and extending to the Valuation Date. The board of Deer Creek, its management and its financial and legal advisors were faced with the considerable challenge of responding to Total’s bids to acquire Deer Creek and determining a course of action that would maximize value for Deer Creek’s shareholders. The directors were required to exercise their business judgment in a compressed time frame, in the context of tough negotiations with a sophisticated bidder and in the context of an offer that compelled them to engage in the process of negotiations with the bidder so that Deer Creek’s shareholders could decide for themselves whether or not to tend to the bid. [500]  Deer Creek engaged in a deliberate and organized process of considering alternatives for the future development of the Joslyn Project, particularly dating from the

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board’s strategy session in the fall of 2004 when it formally recognized the difficulty the company would have in continuing its development of the Joslyn Project and the need to involve a party with far greater financial and technical expertise. [501]  The dissenting shareholders submit that Deer Creek was doing just fine with its one-step-at-a-time strategy and that it could have continued along those lines without either great dilution or requiring a strategic partner. This is unrealistic and contrary to the evidence, given the huge capital outlays required for Deer Creek’s next steps in development and the board’s recognition of that issue in late 2004, if not earlier. [502]  I am satisfied that Deer Creek had adopted and was following a strategy of ensuring that the market was better aware of the long-term potential of the Joslyn Project, which does not mean that it expected its share price to reach the values suggested by the dissenting shareholders, but that the goal of the board and management was to better align share price with value and appropriate appreciation of risk. It was making progress in that goal, as can be seen by the movement of its share price over the spring and summer of 2005. [503]  Deer Creek also undertook the first steps of a process to identify and engage in discussions relating to a joint venture with a strategically-chosen partner. I am satisfied that the Deer Creek board and management recognized that the risks of undertaking such a process included the risk of attracting a bid for the entire company and that they attempted to manage that risk in an appropriate manner by encouraging and requiring confidentiality agreements that included standstill provisions from prospective joint venture partners. What they discovered was that many prospective partners were not interested in tying their hands by entering into such agreements and that there was sufficient public data available on Deer Creek that a strings-attached opportunity to review the most-recent drilling core results or to double-check high level public disclosure against underlying reserve reports was not attractive, at least at the early stages, to potential partners considering their position. As indicated by Mr. Jackson, the potential joint venture partners approached by Deer Creek and who approached the company had their own views of the value of the Joslyn Project from publicly disclosed data, indeed had the company already “scrubbed-down.” The submission that the process did not allow potential purchasers sufficient time to enter into confidentiality agreements and review confidential data is not reasonable or persuasive, given the reality of the extent of Deer Creek’s public disclosure and the relative sophistication of companies that might have the financial and operational capacities to take on the project. [504]  I find that the Deer Creek board acted appropriately and responsibly in its negotiations with Total, that the board, management and advisors were alive to the issues identified in this proceeding by the dissenting shareholders about the long-term potential of the Joslyn Project and used those positive aspects appropriately in negotiations both in their search for joint venture partners and in their reaction to the Total bids for a corporate transaction. The Deer Creek board considered all of the available options, including a public auction, and the risks inherent in each option and settled on a controlled pre-market check of potential other parties. The members of the Deer Creek team were tough negotiators and elicited a process that allowed the Total bid to be put before Deer Creek shareholders for their consideration, while leaving the door open through their insistence on a “fiduciary out” for a post-announcement market check. That strategy resulted in a higher bid and a large premium to the then-existing

IV.  Appraisal Remedy (Right to Dissent)

983

market price to a level that, in the view of the Deer Creek board and management, better reflected value. [505]  I agree that the process was a competitive process among potential purchasers best suited to acquire and develop the Joslyn Project and allowed those companies best able to pay for and develop the project the option to bid for the resource at a price that reflected the high end of valuation at the time. It is noteworthy, while not conclusive of value, that the $31 price represented a premium of 72% over Deer Creek’s prior trading price and a 128% premium to its last financing share price. It is also noteworthy that virtually all of Deer Creek’s shareholders, heavily weighted toward sophisticated institutional shareholders, endorsed the bid price by either tendering their shares or selling at the newly-set market price. Clearly not all of the shareholders did so and I will comment on this issue more extensively later in this decision. [506]  I find, therefore, that the board followed a more than adequate process to market the company and to test the market and that it was not outmaneuvered or out-negotiated. The issue of whether there were powerful and valid indicators of market value in this case will be reviewed later in this analysis. [507]  The dissenting shareholders attack the independence of the Deer Creek witnesses. While GLJ may have performed prior evaluations for Deer Creek, they are a firm of independent appraisers whose credibility in the market depends on the professional impartiality they are required to exercise in evaluations. Mr. Bruce had a role in the process leading to the Total bid, and I have taken his role as advisor during the transaction into consideration in evaluating his opinion. Mr. Sembo was only peripherally involved in the transaction and his role did not affect his independence as an expert witness in my view. Mr. Clark, whose opinion on value is the most important to my decision, is fully independent and was not connected to the acquisition in any way. C.  The Market Value Approach [508]  In considering whether to apply the market approach to valuation, courts have considered, among other factors, the trading volume of the company, the ease of asset valuation, and possible market imperfections: Silber at p. 152. [509] In Canadian Gas & Energy Fund Ltd. v. Sceptre Resources Ltd. (1985), 61 A.R. 67(Q.B.), Forsyth J. noted at para. 29 that the shares in question were widely held and actively traded, that there was no control by a single shareholder or a significant block of shares that could effect trading patterns, and that: … [c]ertainly, the extensive evidence heard during this trial from both sides indicated numerous and variable assumptions as to values of oil and gas assets in various parts of the world which had a considerable impact and effect on any ultimate determination of value. The evidence would certainly confirm the fact that during this period of time the impact of the National Energy Program as well as the volatility of the energy situation throughout the world created a situation where it was most difficult to estimate realistic values. These reasons assisted me in reaching the conclusion that market value most realistically reflected fair value.

[510]  While currently there is no National Energy Program, Forsyth J.’s comments about the volatility of the energy situation certainly apply to the period of time prior to

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the Valuation Date and there was a wide range of views expressed about the future price and value of oil in this hearing. [511]  While in Montgomery v. Shell Canada Ltd. (1980), 3 Sask. R. 19 (Q.B.), twothirds of the shares had been held by a holding company, the court found that such a control block did not depress the market as the remaining shares were widely and actively traded, and took the market value approach. [512] In New Quebec Raglan Mines Ltd., the court considered fair market value, particularly stock market price, to be “a good starting place” for assessing the fair value of the company’s shares, even where there was a trading control block. Farley J. described at para. 10 the “imperfections” of the stock market on a general basis, as well as “greater degrees of imperfections” that may be a factor in cases where, for instance, stocks are thinly traded or subject to rumours in the market place and he commented that there may need to be adjustments to the stock price to take into account special or unusual circumstances. At para. 14, however, he noted that in his view: … the preferred approach to the quest for fair value of the shares would have been first to analyze the stock exchange prices with suitable adjustments … then to check and confirm this valuation process with valuation concepts applied to the underlying asset of the potential mine.

He proceeded to do just that, despite the fact that the expert opinions he had heard did otherwise. Farley  J. used the undisturbed market price of shares just prior to the announcement of the transaction in question as compellable evidence of market value, even though the valuation date was nearly two months later. [513]  In this case, the issues relating to whether the market valuation approach is an appropriate valuation tool are as follows:

a) Was there an open and unrestricted market for the Deer Creek shares? b) Did the Deer Creek board and management act prudently and in an informed and thorough manner? c) Does the intervening period of time between September 2005 and the Valuation Date affect the validity of the market valuation approach? [514]  I accept the opinions of Mr. Bruce and Mr. Sembo that there was a valid and liquid market for the Deer Creek shares and, in fact, there was no persuasive evidence or opinion to the contrary. I accept that Deer Creek was well-covered by financial analysts and that Lime Rock’s significant shareholding, given Lime Rock’s nature as an investor, did not skew their value. [515]  It is true that the Deer Creek board and management were concerned that the market did not value Deer Creek the way that it should and was disproportionately discounting the company for risk, but that was in the context of share prices much lower than the $18 a share that had been achieved prior to the announcement of the first Total bid. The company was taking active and effective steps to remedy the situation. [516]  On the next issue, the Deer Creek directors were thoroughly briefed on their legal and fiduciary responsibilities. The board and management were fully alive to the potential of the company’s sole asset and fully involved in an evaluation of its value and a consideration of the risks of development, from at least the fall of 2004 if not earlier.

IV.  Appraisal Remedy (Right to Dissent)

985

[517]  The directors formed their own evaluations of value with advice from independent advisors which had full access to the company’s data and valuation modelling and had conducted their own thorough reviews of value. There were 10 formal board meetings in the time between Total’s initial offer on July 15, 2005 and August 12, 2005, each lasting several hours, and extensive informal meetings and discussion amongst board members, management and the financial advisors. Scripts were developed for key negotiating steps and every step of the process was analysed carefully by the entire negotiating team. [518]  It is patently wrong to suggest, as the dissenting shareholders do, that this was a passive board and negotiating team or that the directors, management and financial advisors were manipulated by Total or lacked market savvy. [519]  I am also satisfied from the evidence that there was an adequate pre-deal canvass of the most likely and capable parties for a joint venture, and that this process aided both Deer Creek and potential third parties in evaluating the company and establishing value. There was no clear division between the search for a joint venture partner and the canvass of potential parties for an en bloc offer, nor did there need to be for there to be an effective pre-deal market check. Whether or not the market has been sufficiently canvassed is a question of fact in the circumstances of a particular case. I am satisfied that in this case the list of likely purchasers was canvassed, the step from joint venture to en bloc offer in terms of necessary due diligence was not a major factor and Deer Creek’s publiclyavailable information was sufficiently extensive to allow prospective purchasers to evaluate an offer without access to confidential information, which could be accessed relatively briefly after the fact. I am satisfied that the Deer Creek board and management recognized in the fall of 2004 that it could not continue to develop the project on its own and that the directors and officers recognized that the process they had begun to undertake might lead to a takeover offer. I am satisfied that Goldman Sachs and Peters & Co. were retained to advise on both the joint venture and the possibility of a takeover bid and the fact that the financial advisors continued drafting a confidential offering memorandum despite the Total offer was just prudence while the alternate option of an en bloc offer was being explored. I am satisfied that the decision not to conduct a public auction was prudent and reasonable in the circumstances, given the risks of a failed auction and that the deal protection terms reached with Total were not anticompetitive and allowed other parties to bid in competition in the intervening 40-day period, as Shell in fact did. [520]  In this case, the marketing efforts by the Deer Creek board, management and advisors were extensive and focussed on achieving value for shareholders. There was no bad faith or lack of competence by the directors, management or the financial advisors. The Total offer was supported by carefully-considered fairness opinions and accepted by a vast majority of existing shareholders. The results of the marketing efforts are relevant and persuasive evidence of fair value. One of the circumstances in CBCA s 190 that triggers the right to dissent involves a corporation resolving to sell, lease or exchange all or substantially all of its property other than in the ordinary course of business of the corporation. Canadian courts have indicated that the determination of “substantially all” requires both a quantitative and a qualitative assessment. In addition to the case below, we review some of the relevant jurisprudence in further detail in Chapter 15, Section II.B.

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85956 Holdings Ltd v Fayerman Brothers Ltd (1986), 46 Sask R 75 (CA) VANCISE JA:

The appellant appeals a fiat of Geatros J., wherein he found the respondent was a dissenting shareholder as contemplated by s. 184 of the Business Corporations Act, R.S.S. 1978, c. B-10, and that it was entitled to be paid the face value of the shares it owned in the appellant company. The facts are straightforward and not in dispute. The appellant is a wholesale-retail merchant carrying on business in the City of Prince Albert. The business was operated for many years by Sidney and Joseph Fayerman. Their health was failing and they were finding it increasingly difficult to compete with the chain stores and lumberyards which had entered the marketplace in direct competition with Fayerman Brothers Limited. A notice of the annual meeting of the appellant company was sent to all shareholders. That notice contained a notification that the directors would be invited to consider the recommendation of the directors of the company to discontinue its business operations and effect a liquidation of its inventory and to adopt said recommendations. A management position outline accompanied the notice of the meeting. At the annual meeting of the shareholders held on June 24, 1984, management recommended that the business continue to operate but that no further inventory be purchased. That item was discussed and the following resolution adopted by a majority of shareholders: Item 3 of the notice of meeting was discussed and it was decided to continue to operate the business as to sales in the normal manner, but no further inventory to be purchased unless for a special order. If the business is unable to eventually dispose of all of the inventory (such inventory shall) be disposed of by the managers in whatever way will generate the best return. The real estate of the Company should be retained at least until the real estate market recovers, and then the shareholders to decide what to do with the real estate.

The respondent opposed the motion to discontinue buying inventory. When the motion passed, the respondent through its authorized representative requested that the appellant consider buying its shares. After discussion by the other shareholders during which time the respondent’s representative was not present, the respondent was informed that the appellant was not prepared to buy its shares. The respondent instructed its solicitors to file the notice contemplated by s. 184(7) demanding payment of the fair value of its shares. It is admitted by the appellant that all notices required to be served by the respondent pursuant to s. 184, were served within the time frames required. Issue The sole issue on this appeal is whether the respondent is a dissenting shareholder. If the appellant has resolved to sell all or substantially all of its business other than in the ordinary course of business, such a sale requires approval of the shareholders pursuant to s. 183(2) of the Act. If the course of action contemplated by the appellant corporation is a sale in the ordinary course of business, the respondent is not a dissenting shareholder and not entitled to be bought out at fair value. …

987

IV.  Appraisal Remedy (Right to Dissent) •  •  •

In order to determine whether the respondent is a dissenting shareholder, one must answer a number of questions:

1. Is this a sale of all or substantially all of the appellant’s property? 2. Is this a sale in the ordinary course of business? I will consider those matters in reverse order. 1.  Sale in the ordinary course of business Before a shareholder has a right to dissent as contemplated by s. 184 of the Act, the corporation must resolve, inter alia, to do one of the things enumerated in ss. 1(a) to (e) inclusive. For our purposes there must be a resolution to sell all or substantially all of the corporation’s property. Historically, the sale of all of the assets of an ongoing business required the consent of all the shareholders. That was based on the theory of implied contract between the shareholders to pursue the business for which the corporation was formed. A sale of the assets would destroy that corporate purpose and therefore could not be consummated without mutual agreement to cancel the contract. (See Cotton v. Imperial and Foreign Agency and Investment Corporation, [1892] 3 Ch. 454). A dissenting shareholder could demand an exorbitant price for his concurring vote and exercise influence on the company beyond the extent of his interest. The common law rule was altered to allow disposition in certain circumstances, and a sale of all or substantially all of the property of the corporation made in the ordinary course of business did not require shareholder approval. Before determining whether this transaction is a sale of substantially all of the property of the corporation, it is necessary to determine whether the sale is outside the regular course of business. In order to answer this question, which is a question of fact, one must determine what the corporation’s regular business is. The evidence does not contain a certificate of incorporation or a certificate of continuance which describes the kind and type of business the corporation was engaged in. In order to determine what business the corporation was engaged in, one must examine the actual operation of the corporation as opposed to relying on how the corporation styled itself. Here the company was engaged in the business of a wholesale distributor of hardware, plumbing, and electrical supplies. It operated a contract division which supplied finishing and architectural hardware. Normally, the corporation would purchase inventory and stock and resell it to its customers. The business was an ongoing operation selling merchandise of a particular kind at both wholesale and retail. The sale contemplated here was not a sale in the regular course of business. It was a sale in the normal way, that is, a sale by the corporation to its customers of merchandise it regularly stocked but with the difference that the merchandise was not to be replaced. It was not a sale in the regular course of its business but a liquidation sale—a sale of all the inventory. It matters not, in my opinion, that the sale took place over time and involved a large number of sales as opposed to one massive sale of inventory. What is important is that the sale was not an ordinary sale; it was a sale with unusual features, i.e., the liquidation of the inventory which would result in the liquidation of the operating arm of the company.

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A similar question was considered in Re Bradford Roofing Industries Property Ltd., [1966] 1 N.S.W.R. 674; 84 W.N. (N.S.W.) 276 (S.C.). There the court had to consider a section of the New South Wales Companies Act, 1961, which prohibited managers from disposing of any of a company’s assets without leave of a court, “save in the ordinary course of the company’s business.” The court defined that phrase as follows: Perhaps a satisfactory working phrase to describe the particular concept enacted in s. 207(1) is that the transaction must be one of the ordinary day-to-day business activities, having no unusual or special features, and being such as a manager of a business might reasonably be expected to be permitted to carry out on his own initiative without making prior reference back or subsequent report to his superior authorities such as, for example, to his board of directors.

That definition appeals to me and I adopt it as embracing the fundamental concept contained in the phrase. A transaction in the ordinary course of business that has no unusual features because it is part of the undistinguished common flow of the company’s business does not require shareholder consent. Here the sale was not part of the common flow, not part of the ordinary day-to-day business activities of the company. There was an added feature, the purpose of the sale was to liquidate the operating part of the business, leaving the company with no sales component but cash and real estate. The sale had unusual features and is one which would require approval before a manager would embark on such a course of conduct. In fact the managers sought approval of the board prior to embarking on such course. I therefore conclude that the subject sale was not one in the ordinary course of business of the company. 2.  Sale of all or substantially all of the corporate assets Having concluded that the sale is not one in the ordinary course of business, it is necessary to determine whether the sale is one of substantially all of the assets of the company. The resolution authorized a sale of all of the inventory and a retention of the company’s real estate pending an improvement in the market. According to the company’s financial statement as at December 31, 1983, the company had four classes of assets:

1. Cash and term deposits $226,900.00 2. Receivables 221,400.00 3. Inventory 238,700.00 4. Real estate and equipment (book value) 33,000.00 After the liquidation of the inventory and the collection of the receivables, the company will have cash and real estate. It will not possess an operating component. The nature of the business will have been fundamentally altered and changed. If one examines the sale from a purely quantitative perspective, that is, a percentage of the total assets of the company which have been sold, it is obvious that “substantially all of the assets” have not been sold. In my opinion, the issue cannot be determined on a quantitative basis. The purpose of statutes like the one under consideration was to protect the shareholders from a fundamental change in the corporation and to ensure that the means to accomplish the object of the corporation were not impaired. A sale of all of the

IV.  Appraisal Remedy (Right to Dissent)

989

assets of the company would destroy the corporate business. The phrase “substantially all” is, in my opinion, intended to mean a sale which would effectively destroy the corporate business. There is no Canadian jurisprudence on the interpretation of the meaning of a sale of substantially all the assets of a corporation. There is, however, a reasonably large body of case law which has been developed in the United States. There the phrase has been interpreted on a qualitative basis. In Stiles et al. v. Aluminum Product Co., 338 Ill. App. 48, a manufacturer of aluminum products and stainless steel cooking utensils sold off its plant, machinery, and goodwill for $1,406,570.00. It retained a realty company, accounts receivable, and cash valued at $760,622.00. The court held that although the sale amounted to only 64 percent of the assets, it did destroy the company’s business and the sale and had the effect of a sale of substantially all the assets of the corporation. In Good et al. v. Lackawanna Leather Co., et al., 233 A. 2d 201, the New Jersey Superior Court had to consider the same question. Good Brothers sold its operating assets piecemeal over a long period of time, and retained substantial liquid investments. In 1966 it disposed of the remaining tanning equipment necessary for it to be able to continue in that business. After that sale, the company held land, buildings, cash, notes receivable, and investments. The test to determine whether there had been a sale of substantially all of the assets was described by the court in these terms at p. 210: The remaining issue is whether Good Bros. sold substantially all of its assets and good will to bring it within the purview of N.J.S.A. 14:35. I find that it did not. In order to qualify as a sale of substantially all of the property and assets within the contemplation of the statute, the sale must be one out of the ordinary course of business and tantamount to the winding up of a going business operation. This conclusion is evidenced by the language in the statute which allows appraisal rights when there is a sale of assets, including good will. By making the disposal of good will a prerequisite to appraisal rights, the Legislature apparently contemplated a situation whereby the selling corporation completely winds up its business affairs since a disposal of good will would, in effect, destroy the corporation. Thus, the test to be applied is not the amount or value of the assets disposed of, but rather the nature of the transaction, i.e., is the sale in furtherance of the express objects of the corporation’s existence (emphasis added).

A similar result was obtained in Campbell v. Vose et al., 515 F. 2d 256 (1975), (Oklahoma, C.A.). There, one-third of the corporate assets were transferred to a subsidiary corporation in return for stock and debentures. All land, buildings, machinery, inventory and all other tangibles of the company were transferred to the subsidiary. The assets retained were bank balances, promissory notes, and the investment portfolio. The court, in determining whether there was a sale of substantially all of the assets, noted that the statutes spoke in purely quantitative terms, but not withstanding that it held: The consequences of the creation of the subsidiary discussed above with the fact all operating assets were transferred to it, together with the debt back makes the transaction a sale and results in a situation where for all practical purposes, “substantially” all of the assets were sold. All the effective operating assets were sold. The investment segment remaining was large in dollars but was the last and a large step in the change in the nature of corporate activity. In these circumstances, more than dollar values must be considered. It was another

990

Chapter 14  Stakeholder Remedies significant step also in the prevention of current income which was another aspect of the change in corporate purpose. The transaction was thus one which required consideration by the stockholders, and gives rise to the rights of dissenting shareholders under the Oklahoma statutes.

It will be seen that the qualitative test, which I referred to earlier, has been adopted by the U.S. courts to determine whether there has been a sale of substantially all of the assets. When one reviews the sale here on a qualitative basis, it is evident that it has the effect of fundamentally changing the nature of the business formerly carried on by Fayerman Brothers Limited. The business was a merchandising operation both at the wholesale and retail level. After the sale of its inventory which represents approximately 33 percent, and the merchandising operation, it will be a holding company with no ability to accomplish the purposes or objects for which it was incorporated. The sale will have the effect of destroying the corporation’s business because it is a sale of a part of the business so integral as to be essential for the transaction of its ordinary day-to-day business. It follows that the sale is a sale of substantially all the assets and that the respondent is a dissenting shareholder within the meaning of s. 184 of the Act. The appeal is dismissed with costs. Appeal dismissed.

V.  OTHER REMEDIES A.  Compliance Orders Historically, it was not clear whether a shareholder could sue to enforce compliance with a corporation’s letters patent or bylaws. The situation for memorandum jurisdictions appeared to allow such enforcement, because the corporation was contractually bound with its members. When Ontario and other letters patent jurisdictions came to reform their corporation statutes they rejected the “contractual theory” in favour of a compliance order remedy. The following section of the Ontario Business Corporations Act was enacted to ensure that a shareholder could enforce any provision of a bylaw or the articles of incorporation in addition to any provision in the Act itself. 253(1)  Where a corporation or any shareholder, director, officer, employee, agent, auditor, trustee, receiver and manager, receiver, or liquidator of a corporation does not comply with this Act, the regulations, articles, by-laws, or a unanimous shareholder agreement, a complainant or a creditor of the corporation may, notwithstanding the imposition of any penalty in respect of such noncompliance and in addition to any other right he has, apply to the court for an order directing the corporation or any person to comply with, or restraining the corporation or any person from acting in breach of, any provisions thereof, and upon such application the court may so order and make any further order it thinks fit.

A similar provision was subsequently adopted by the CBCA (s 247). Some early judicial decisions indicted that the remedy was limited to the rectification of simple mechanical omissions: Re Goldhar and Quebec Manitou Mines Ltd et al (1975), 61 DLR

991

VI. Conclusion

(3d) 612, 9 OR (2d) 740 (H Ct J (Div Ct). More recent decisions have indicated that the remedy allows for a broader judicial discretion: see e.g. Caleron Properties Ltd v 510207 Alberta Ltd, 2000 ABQB 720.

B.  Winding Up Although the remedy of winding up a corporation may be sought under the oppression remedy: see e.g. CBCA s  214(1)(a), the broad range of remedies available to the court for oppression suggests that the terminal remedy of winding up will be a rare occurrence. Other bases for winding up a corporation under the CBCA include a triggering event set out in any unanimous shareholders’ agreement (s 214 (1)(b)(i)), and where the court is satisfied that it would be “just and equitable” that the corporation be liquidated and dissolved”: s 214(1)(b)(ii). Historically, dissolution pursuant to the “just and equitable rule” occurred in very limited circumstances, including when there was a shareholder deadlock (for example, in two-shareholder companies), where the corporation became hopelessly unprofitable (for example, the loss of a vital asset such as a licence), or when the actions of a controlling director or shareholder resulted in a total loss in confidence.

VI. CONCLUSION As we have seen from earlier chapters, liability of officers and directors is grounded in duties owed to the corporation. However, when corporate decision-makers breach those duties, it is unlikely they will seek to remedy harm done to the corporation. Modern corporate legislation enables corporate stakeholders outside of management to pursue the corporation’s claims through the derivative action. The legislative scheme requires such stakeholders to demonstrate that they are acting in good faith and with the best interests of the corporation in mind. Issues of obtaining leave of the court and the problem of litigation costs are crucial to the effectiveness of the remedy. Other remedies are designed to address personal wrongs and expectations of corporate stakeholders. For example, in limited circumstances, corporate legislation allows shareholders to dissent from decisions made by corporate managers and requires that the corporation buy back their shares at an appraised price; stakeholders may also request that the court require management to comply with corporate legislation, bylaws, and agreements. The oppression remedy provides a broad and powerful remedy for corporate securityholders, officers, and directors, and sometimes creditors, when their interests have been oppressed, unfairly prejudiced, or disregarded. Because the remedy is aimed at the effects on protected interests, the availability of the remedy will depend on the relationships among the stakeholders in each corporation. The outcome of each case will depend on the particular facts, and the reasonable expectations of the stakeholders will differ depending on the kind of corporation involved—for example, a closely held private corporation versus a widely held public one. The duty of officers and directors to the corporation may mean that the business judgment of management will affect what personal expectations a stakeholder can reasonably hold. Nevertheless, the oppression remedy’s clear procedural advantages, its broad remedial scope, and the availability of derivative remedies without having

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Chapter 14  Stakeholder Remedies

to obtain leave of the court make it an attractive form of litigation for stakeholders protected by it. Recent case law has made it clear, however, that although the two remedies may sometimes overlap, they are, in principle, distinct remedies designed to address harm to different persons.

CHAPTER FIFTEEN

Mergers and Acquisitions I.  Introduction and Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 994 A.  Fact Pattern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 994 B.  Social and Economic Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 995 1.  Value Creation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 997 2.  Consequences of Mergers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 998 3. Stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1000 II.  Formal Aspects of Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1002 A.  Sale of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1004 B.  Sale of Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1004 1.  The Quantitative Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1019 2.  The Qualitative Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1019 C. Amalgamation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1021 D.  Other Merger Techniques . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1024 1.  Plan of Arrangement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1024 2.  Reverse Acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1025 3.  Triangular Merger . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1025 III.  Appraisal Remedy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1026 A.  The Market Exception . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1028 B.  Valuation of Dissenters’ Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1029 IV.  Buyouts and Going-Private Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1032 A.  Class Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1042 B.  Buyout Requirements in Ontario and Québec: MI 61-101 . . . . . . . . . . . . . . . . . . . . 1043 C.  Benefits and Costs of Buyouts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1045 V.  Takeover Bids . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1046 A.  Control Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1046 1.  Selecting the Target Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1046 2.  Techniques for Acquiring Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1047 B.  Takeover Bid Regulation and Auction Theories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1049 1.  Takeover Bid Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1049 2.  Auction Theories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1051 C.  Defensive Tactics: An Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1052 1.  Making the Target Seem Attractive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1053 2.  Making the Target Seem Unattractive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1053 3.  Offensive Tactics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1053 4.  Share Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1054

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5.  Takeovers and Stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1054 6.  Managerial Passivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1063 D.  Defensive Tactics: The US Landscape . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1066 E.  Defensive Tactics: The Canadian Landscape . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1082 1.  Poison Pills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1082 2.  Staggered Boards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1084 3.  Shark Repellents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1084 F.  Which Institutions Should Supervise Defensive Tactics in Canada? . . . . . . . . . . . 1103 VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1133

I.  INTRODUCTION AND OVERVIEW This chapter examines the law governing mergers and acquisitions (M&A). There are a number of different ways in which corporations can effect M&A transactions, and the impact of these transactions can be significant. Many of the issues seen in previous chapters become deeply intertwined in this area of business law. As a result, the law governing M&A is fertile ground for debate. Section I of this chapter begins with a review of social and economic considerations relevant to thinking about how best to regulate M&A transactions. Section II then reviews different ways in which M&A transactions can be effected, including through the sale of shares, the sale of assets, amalgamations, and other merger techniques. Section III considers the appraisal remedy, an avenue that is open to shareholders who would rather see their shares repurchased than participate in an M&A transaction. Section IV examines buyouts and going-private transactions, which include transactions that are often designed with an eye to having minority shareholders sell their entire position in a company. Section V then turns to takeover bids, one of the more controversial and intriguing aspects of the law governing M&A.

A.  Fact Pattern You will recall from the fact pattern in Chapter 1, Section II.A that Quick Buys Ltd built a reputation for reliable delivery and excellent customer service because of employees’ willingness to make on-time and accurate deliveries. This willingness was attributed to a comprehensive employee training program, a strategy of providing employees with cutting edge communication technology, and the implementation of an employee profit-sharing plan. Corner Store Inc, however, uses a different business model. It is run as a franchise. Because of tight profit margins, employees are typically paid minimum wages and their suggestions for improving service and efficiency are not solicited. Corner Store Inc provides no delivery service to its customers. Corner Store Inc decided that it would make an offer to buy Quick Buys Ltd. Its intention was to put Corner Store franchisees in former Quick Buys’ stores located in malls where there are no Corner Store franchises and to close the rest of the Quick Buys stores. It also planned to close down the delivery business because it does not fit comfortably with its franchise business model. Quick Buys’ employees would therefore lose their jobs, except for a few hired by the new franchisees at minimum wages. Quick Buys Ltd’s suppliers would suffer a

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loss of business because Corner Store Inc purchases its inventory nationally, not locally. Some of the suppliers would have to close down because they have no other customers, and others would have to cut staff as a result of the slowdown in business. Time has passed since the facts as set out in Chapter 1, Section II.A first came to light. Corner Store is under increased pressure to acquire Quick Buys. Aya is unsure what to do— should she sell, or should she preserve her business? Anjala Marshall, Ken Biway, Maria Toscana, and Enrico Slate—original investors and close associates of Aya’s—own shares that together represent more than 50 percent of the common shares that are outstanding. They have made it clear that they would like to sell “if the price is right.” But several of Aya’s employees have expressed great concern about the impact of the transaction on their jobs. Government officials have also been made aware of Corner Store’s interest and have told Aya that they are concerned about the impact of a deal on employees and local suppliers. Aya receives a call from Corner Store’s CEO. He tells her that he intends to make an offer that Quick Buys’ shareholders will find very attractive. He tells her he knows this because Ken Biway and Maria Toscana have agreed to support his offer. He concludes by asking her to agree to support his offer and to recommend to Quick Buys’ board of directors that it support the offer. He explains that he would far prefer to do a deal that is friendly, but is prepared to make a hostile offer if that is what it takes. Aya does not provide Corner Store’s CEO with any reaction, saying she will get back to him with a response in 48 hours, after she has consulted her board of directors. Aya immediately summons a meeting of Quick Buys’ board of directors. QUESTIONS

1.  Whose interests should Quick Buys’ board of directors be thinking about as it considers what to do? 2.  Is it relevant that some of Quick Buys’ shareholders have made it clear that they want to sell? If so, does this mean that Quick Buys should sell to Corner Store? What if there are other companies that might be interested in purchasing Quick Buys? 3.  Is it open to the board of directors to conclude that the best interests of the corporation require it to resist Corner Store’s overtures? How far should the board be able to go in resisting these overtures? 4.  What role, if any, should the government play in this matter? What if the government learns that Best Practices Inc—another company with the financial heft to make a competitive offer and with a much better employee-relations track record than Corner Store—is open to making an offer?

B.  Social and Economic Considerations Corporate combinations or mergers have had an enormous impact over the years, both globally and within Canada. In some cases, such as a parent company’s decision to merge two wholly owned subsidiaries, a merger might not have immediate or significant economic effects. But when the combination represents the union of two distinct businesses, it may be possible to create new value. As a result, companies will often consider growing or modifying their business through mergers rather than relying solely on the longer term process of investing in organic growth. In a highly competitive industry sector, a company may not

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have the time or resources to develop a new line of business that it feels is important to its success. It may therefore conclude that the best course of action is to acquire, or even merge with, a business that has the desirable characteristics that it is after. Unfortunately, misconceived or poorly executed mergers or acquisitions may also serve to destroy value. Indeed, it is frequently difficult to stitch together two different businesses. This process requires integrating infrastructures that may not fit together as neatly in practice as was initially anticipated, not to mention getting people to work together who were previously functioning in different organizations that may have had different values and different ways of running their affairs. Many a merger that seemed brilliant in theory has foundered in practice because there are many practical challenges associated with weaving organizations into a new whole. Mergers also hold the potential for substantial disruption. For example, employee layoffs may result from efforts to integrate or rationalize the businesses in question. This may give rise to any number of negative consequences for the communities in which the employees live. Some might argue that this kind of disruption may on occasion be necessary in order for a company to adapt to changes in the market for its products or services. Businesses that do not evolve rapidly to meet changing competitive forces risk becoming stagnant; they may die a slow death that can have just as serious a social impact as a merger (if not an even more profound one) on their employees and communities. A fundamental policy issue for any country’s business law framework is therefore (1) whether it should encourage M&A to take place with few, if any, legal impediments so that businesses can rapidly restructure; or (2) whether M&A should instead be regulated in order to ensure that the interests of those most directly affected are protected from the potentially disruptive impact of M&A transactions. Different countries balance these competing perspectives in different ways. Canadian corporate law, through statutes like the Canada Business Corporations Act, RSC 1985, c C-44 (CBCA), and provincial securities law, through statutes like the Ontario Securities Act, RSO 1990, c S.5 (OSA), and through the rules and policy statements that securities commissions promulgate, set out the framework that governs M&A in Canada. Some of the rules are facilitative—that is, they are designed to give companies the tools they need to merge with, or acquire, another business. Other provisions are directive—essentially telling boards of directors and management which interests they must take into account when planning and executing transactions of this kind. Developing a coherent framework rooted in a clear set of public policy choices would be challenging enough if one were dealing with just one legislature that was mapping out the rules of the road in this area, but it is even more demanding when one is dealing with countries such as Canada or the United States, where there are several legislatures that must work together, as well as with one or more securities regulators, to put in place clear and consistent policies and principles. As you work through the material in this chapter, ask yourself whether you think Canada has a coherent framework that regulates mergers and acquisitions—one based on a clear set of public policy choices. Are there moments when there appear to be competing policy objectives at play? If so, what are those objectives and are there ways in which they could be better harmonized? In considering these questions, bear in mind that securities law is typically focused on protecting the interests of security-holders—most notably, shareholders. Corporate law is typically focused on the best interests of the corporation, something which you may think— depending on your understanding of the nature of the corporation—requires boards of directors to consider factors in addition to security-holder interests. The interplay between

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securities law and corporate law in connection with M&A transactions has, as a result, occasionally given rise to tension between different visions of the firm.1 In reviewing the material in this chapter, it is therefore important to keep in mind the question how best to harmonize the objectives that corporate and securities laws seek to achieve when regulating M&A transactions.

1.  Value Creation Certain propositions relevant to the policy choices that must be made might be thought to be relatively self-evident. For example, assets may be purchased because they are worth more to their purchaser than to their seller—that is, the purchaser believes that it can generate more wealth from those assets than the seller believes that it can. We might therefore conclude that assets acquired in a merger will be worth more when held together with those of the acquiror than when held apart. The combination should—at least in theory—result in synergistic gains. In principle, facilitating an environment in which parties can transfer assets to those who can make the best use of them would seem to be a desirable objective that policy-makers should encourage as part of any effort to make an economy competitive. A vibrant M&A market might therefore be thought to be something worth promoting. Corporate combinations do not, however, always create value. Indeed, it is sometimes argued that an economy that is too M&A friendly can lead companies to rush into transactions that are value-destroying. Some acquisitions may well result in the creation of a valuedecreasing conglomerate, as with the purchase of an unrelated business that when put together with the acquiring business simply generates inefficiencies because it is not possible for management to focus effectively on several fundamentally different businesses at the same time. In some cases, firm value may then only be capable of being increased through deconglomerization, or the disposition by conglomerates of unprofitable divisions. One way in which this may be accomplished is through the sale of a division. The proceeds of that sale may then be reinvested in a more profitable line of business, or may be distributed to shareholders as a cash dividend. Furthermore, if the firm does not reduce its size voluntarily, and asset value exceeds market value, it may well become a candidate for a breakup or bust-up merger, in which insurgents seek to gain control of a firm and reimburse their acquisition financing through the sale of one or more divisions of the firm. All of these transactions assume that the firm has grown too large, and that divesting itself of a division would represent a bargain opportunity. Policy makers anxious to ensure that an economy is competitive will also wish to ensure that businesses have the tools with which to implement divestitures of this kind. A challenge for any country concerned with ensuring that M&A activity does in fact create value is to decide whether to let its business community make unfettered decisions

1 See Robert Yalden, “Competing Theories of the Corporation and Their Role in Canadian Business Law” in Anita I Anand & William F Flanagan, eds, The Corporation in the 21st Century (Kingston: Queen’s Annual Business Law Symposium, 2003); and “Canadian M&A at the Crossroads: The Regulation of Defence Strategies after BCE” (2014) 55 Can Bus LJ 389; see also Sean Vanderpol & Ed Waitzer, “Mediating Rights and Responsibilities in Control Transactions” (2010) 48 Osgoode Hall LJ 639.

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about whether a transaction—be it an acquisition or a disposition—will generate value. In some countries, the state will play a more active role in encouraging or discouraging certain kinds of M&A activity than in other countries. Countries with capitalist economies or economies transitioning to capitalism all wrestle with the question whether, and to what degree, it is desirable to have the state influencing the outcome of M&A transactions. It is worth noting that in recent years Canadian regulators have, by and large, been inclined to let M&A transactions proceed, and that Canada is generally seen as a country where acquisitions can be effected with relatively limited state involvement. This might be contrasted with France, where government has been more inclined to try to create domestic “global champions” and to frustrate foreign acquisitions of companies in sectors seen to be of strategic importance to France’s economy.

2.  Consequences of Mergers A lively debate has grown in North America around the question whether M&A does in fact serve to create value. Some studies suggest that takeover bids are associated with significant gains for offeree shareholders and that the defeat of a takeover bid results in offeree shareholder losses. These studies suggest that the gains are permanent when the bid is successful, but are reversed when the bid is defeated by the defensive manoeuvres of offeree firm management.2 There are also some studies that suggest that acquiring firms share in the merger gains, although not as much as target shareholders. Bradley found that offeree shareholders received an average 49 percent premium for their shares, while offerors saw their own shares appreciate by 9 percent as a result of the offer, likely as a consequence of anticipated merger gains.3 In his study of 1,500 Canadian offerors over a period of 20 years, Eckbo reported positive abnormal returns of 4.3 percent for the 12-month period preceding a successful bid.4 However, other studies have found that shareholders of acquiring firms are unaffected or negatively affected by mergers.5 Moreover, you might ask yourself whether studies that focus solely on what a merger does to a company’s share price are working with a

2 See Michael Bradley, Anand Desai & E Han Kim, “The Rationale Behind Interfirm Tender Offers: Information or Synergy?” (1983) 11 J Fin Econ 183; Bradley, Desai, and Kim, “Synergistic Gains from Corporate Acquisitions and Their Division between the Stockholders of Targets and Acquiring Firms” (1988) 21 J Fin Econ 3; Gregg A Jarrell, James A Brickley & Jeffry M Netter, “The Market for Corporate Control: The Empirical Evidence since 1980” (1988) 2 J Econ Persp 49; and B Espen Eckbo, “Mergers and the Market for Corporate Control: The Canadian Evidence” (1986) 19 Can J Econ 236; Gregor Andrade, Mark Mitchell & Erik Stafford, “New Evidence and Perspectives on Mergers” (2001) 15:2 J Econ Persp 103-20; Robert F Bruner, “Does M&A Pay? A Survey of Evidence for the Decision-Maker” (2002) 12:1 J Applied Finance 48-68. 3 See Michael Bradley, “Interfirm Tender Offers and the Market for Corporate Control” (1980) 53 J Bus 345; and Robert F Bruner, “Where M&A Strays and Where it Pays” in Deals from Hell, 1st ed (New York: John Wiley & Sons, 2005) ch 2. 4 B Espen Eckbo, supra note 2 at 251. 5 Paul Asquith, “Merger Bids, Uncertainty, and Stockholder Returns” (1983) 11 J Fin Econ 51 (statistically insignificant loss of 0.46 percent); Paul Asquith & E Han Kim, “The Impact of Merger Bids on the Participating Firms’ Securityholders” (1982) 37 J Fin 1209; Abraham Tarasofsky & Ronald Corvari, Corporate Mergers and Acquisitions: Evidence on Profitability (Ottawa: Economic Council of Canada, 1991); Paul André, Maher Kooli & Jean-François L’Her, “The Long-Run Performance of Mergers and Acquisitions: Evidence from the Canadian Stock Market” (2004) 33 Fin Man 27.

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sufficiently expansive understanding of the kind of value that it is desirable to enhance through M&A activity. There are several reasons why two firms may potentially be worth more in combination than when held apart. The acquired corporation may be managed inefficiently, such that new management could operate it more profitably. Mergers may also result in efficiency gains through synergistic benefits that arise when two firms are combined. One source of this synergy may be economies of scale, where larger firms achieve efficiencies in production and marketing that are unavailable to smaller firms. For example, economies of scale are available when $1,000,000 spent on research and development by a major firm will likely produce more results than $100,000 spent separately by each of 10 smaller firms.6 Another example of synergy arises through vertical integration, where a firm merges with a supplier of inputs or purchaser of outputs. Thus, a distributor might merge with its manufacturer, or a mining company with a steel manufacturer. Vertical integration will then reduce the transaction costs of bargaining between separate firms.7 In practice, the likelihood of success will depend not only on whether there is the potential for synergy through a business combination but also on whether the managers effecting the merger are able to successfully integrate the newly acquired business with the acquiring business. This is often more difficult than it may seem. Success often depends on whether the lines of business involved are in fact compatible (something that is all too often clearer after the fact than before), the skills that the managers bring to bear as they work to combine the businesses in question (not to mention the degree of preparation that has gone into planning the way in which the businesses will be combined), and the overall economic climate in which the merger takes place. Suffice it to say that many mergers that seemed to make sense in principle prior to an acquisition have gone off the rails after the “deal is done.” Combining two organizations with different sets of employees, different cultures and values, different infrastructures, and different ways of doing business has got the better of more than one CEO and his or her management team. Ascertaining whether mergers and acquisitions are a positive phenomenon or a negative phenomenon is therefore no easy task. In practice, much may depend on the characteristics of the transaction in question and the competence of those responsible for making the merger work. Different countries have different views on the extent to which the state should either second-guess senior managers with respect to the wisdom of a proposed merger or acquisition or, at a minimum, insist that particular considerations and interests be taken into account in assessing the advisability of proceeding with a transaction. The policy choices that a country makes in this regard will therefore have an important impact on the chances that any given deal has of being a success. In turn, this might be of direct relevance to a country’s overall economic performance: countries that do a good job of ensuring that mergers succeed might

6 See F Scherer, Industrial Market Strategy and Economic Performance, 2nd ed (Chicago: Rand McNally, 1980) at 81-104. 7 See O Williamson, Markets and Hierarchies: Analysis and Antitrust Implications (New York: Free Press, 1975) at 20-40; R Romano, “A Guide to Takeovers: Theory, Evidence, and Regulation” (1992) 9 Yale J Reg 119; SM Bainbridge, Mergers and Acquisitions (New York: Foundation Press, 2003) at 49; and David M Schweiger & Robert L Lippert, Integration: The Critical Link in M&A Value Creation in Mergers and Acquisitions: Managing Cultural and Human Resources (Stanford, Cal: Stanford University Press, 2005) ch 2.

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be thought to have an advantage over countries that deliberately or even inadvertently end up frustrating mergers that are capable of generating economic efficiencies.

3. Stakeholders Another issue that weighs heavily in debates about mergers and acquisitions is the question what consideration should be given to interests other than those of shareholders. The answer chosen will affect views about what rights shareholders, creditors, employees, or any other affected constituency should be given with respect to the decision whether to proceed with an M&A transaction. Not surprisingly, competing theories of the firm seen in Chapters 9 and 10 are therefore often very much concerned with the question whose interests a board of directors should take into account when evaluating an M&A transaction, as well as with the question what impact an M&A transaction may have on shareholders and on constituencies other than shareholders. Shareholder wealth gains on a takeover would be of great concern if they resulted simply from a redistribution of wealth rather than from enhanced efficiency. In other words, takeovers might be viewed as troubling if shareholder gains were attributable solely or even largely to a wealth transfer to shareholders from any one or more of the following kinds of stakeholders: the state, consumers, creditors, or employees. Objections to business law frameworks that allow takeovers to occur with few if any impediments put in the path of an acquiror are often rooted in concerns that takeovers generate wealth transfers of this kind rather than enhancing corporate efficiency. The question, then, is whether these concerns have merit, such that greater restrictions should be placed on takeovers.

a.  The State US and Canadian tax laws might be thought to subsidize debt financing because they permit firms to deduct interest but not dividend payments. A portion of the gains behind mergers financed by high interest rate paying or “junk” bonds might thus reflect the benefits of a tax regime that is prepared to forego revenue on certain kinds of financing. On the other hand, firms may increase their debt levels without a merger, and this account of merger gains requires an explanation of why managers had foregone such benefits before the merger.8 It is therefore not clear that M&A activity is simply transferring wealth from the state to firms that use debt financing to acquire businesses.

b. Consumers In theory, merger gains might be attributed to increased market concentration and the prospect of monopolistic profits. However, there is little evidence that corporate

8 See Ronald Gilson, Myron Scholes & Mark A Wolfson, “Taxation and the Dynamics of Corporate Control: The Uncertain Case for Tax Motivated Acquisitions” in John C Coffee, Louis Lowenstein & Susan RoseAckerman, eds, Knights, Raiders and Targets: The Impact of Hostile Takeovers (New York: Oxford University Press, 1988) at 271; see also Steven Kaplan, “Management Buyouts: Evidence on Taxes as a Source of Value” (1989) 44 J Fin 611.

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acquisitions result in greater levels of industry concentration (and, of course, many countries have elaborate competition or anti-trust laws designed to ensure that this is not the outcome of any given merger).9

c. Creditors Mergers that result in increased debt levels increase the likelihood of default, and might effect a wealth transfer from existing creditors. Before the advent of junk bond financing, mergers did not appear to affect creditor wealth.10 However, in the leveraged buyouts (LBOs) of the 1980s, where a firm repurchased public stock interests and financed that acquisition with an issue of high-yield debt, debt levels increased dramatically and creditor losses were reported as new lenders entered the picture. For example, in one study of 15 LBOs, the outstanding debt of eight firms was downgraded while the debt of the remaining firms was put on a credit watch.11 But even then, certain studies suggest that shareholder gains greatly exceed creditor losses—suggesting that these gains are not just a function of creditor losses.12 As a result, some have argued that problems of creditor expropriation should be left to the creditors themselves to cure, through veto or conversion rights on a takeover or LBO. For example, after the highly publicized RJR Nabisco LBO of 1988, where bond values declined by $1 billion, lenders insisted on stronger protective devices.13

d. Employees Finally, breakup mergers might effect a wealth transfer from employees. Employees might not merely lose their jobs when firms downsize, but the job loss might constitute an expropriation of firm-specific skills. Where the firm has implicitly promised its employees tenure to promote investment in such skills, employee terminations will constitute a form of shareholder opportunism. Given the threat of job loss, employees will inefficiently underinvest in these skills. On such arguments, therefore, all parties may be made better off through the concession of job tenure to employees.14 Responding to this, some economists have 9 See B Espen Eckbo, “Mergers and the Market Concentration Doctrine: Evidence from the Capital Market” (1985) 58 J Bus 325. 10 See E Han Kim & John J McConnell, “Corporate Mergers and the Co-Insurance of Corporate Debt” (1977) 32 J Fin 349. 11 Yakov Amihud, “Leverage Management Buyouts and Shareholders’ Wealth” in Yakov Amihud, Leveraged Management Buyouts: Causes and Consequences (Homewood, Ill: Dow Jones Irwin, 1989) at 11. 12 See K Lehn & A Poulsen, “The Economics of Event Risk: The Case of Bondholders in Leveraged Buyouts” (1990) 15 J Corp L 199 at 209-10 (reviewing findings that bondholder losses account for less than 4 percent of shareholder gains). 13 See Marcel Kahan & Michael Klausner, “Antitakeover Provisions in Bonds: Bondholder Protection or Management Entrenchment?” (1993) 40 UCLA L Rev 931. 14 See Andrei Shleifer & Lawrence H Summers, “Breach of Trust in Hostile Takeovers” in Alan J Auerbach, ed, Corporate Takeovers: Causes and Consequences (Chicago: University of Chicago Press, 1988) at 33; Jack Lam, Kimberly E Fox, Wen Fan, Phyllis Moen, Erin LK Kelly, Leslie B Hammer & Ellen Kossek, “Manager Characteristics and Employee Job Insecurity Around a Merger Announcement: The Role of Status and Crossover” (2015) 56 Soc Q 558; and Eero Lehto & Petri Bockerman, “Analysing the Employment Effects of Mergers and Acquisitions” (2008) 68 J Econ Behav & Org 112.

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suggested that in order for this perspective to hold true, certain assumptions must be made. First, it must be assumed that the employees were under a bargaining handicap that prevented them from negotiating for tenure. Otherwise, employees could protect themselves as easily as lenders did after encountering the first LBOs. Thus, the argument for paternalistic rules might be thought weakest for unionized employees who delegate bargaining duties to skilled negotiators. Second, the skills must indeed be job-specific—that is, the argument for mandatory tenure is weakest for low-skill jobs or for skills that are fungible. Third, even if job tenure is efficient for some employees who cannot bargain for themselves, this is not an argument for takeover bid barriers, but only for restrictions on termination rights under labour contracts. Finally, theorists concerned to protect jobs should be able to show that takeovers result in job losses. Some economists suggest that the evidence points in the other direction.15

Notwithstanding arguments of the kind just seen to the effect that takeovers do not create shareholder wealth through distributional effects (as opposed to efficiency effects), takeovers remain controversial, and in many jurisdictions—notably several US states—measures have been put in place over the years (through so-called stakeholder statutes) that give the boards of target companies greater power to take into account a range of interests in deciding whether or not to facilitate a takeover: see Section V of this chapter). Moreover, many countries have business law frameworks that do not reflect a desire to facilitate takeovers. The fundamental question for those concerned with whether business law frameworks are achieving the right balance between promoting economic efficiency and minimizing social disruption is therefore how much merit there is to economic arguments in favour of allowing as liberal a takeover bid market as possible.

II.  FORMAL ASPECTS OF MERGERS AND ACQUISITIONS “Merger” and “acquisition” are not terms of art in Canada. Indeed, the terms are often used indiscriminately to describe virtually any form of business combination, whether achieved through (1) a purchase or sale of shares, (2) a purchase or sale of assets, (3) an amalgamation, (4) an acquisition effected by way of a court-approved plan of arrangement, or (5) a takeover bid. The terms may even on occasion be extended to other kinds of combinations, such as where one corporation transfers its business to another under a long-term lease. From a financial point of view, there may be little difference between these kinds of combinations. However, different legal problems arise depending on which technique is selected. This is

15 See Charles Brown & James L Medoff, “The Impact of Firm Acquisitions on Labor” in Alan J Auerbach, supra note 14 at 9; David. W Blackwell, M Wayne Marr & Michael F Spivey, “Plant-Closing Decisions and the Market Value of the Firm” (1990) 26 J Fin Econ 277 (finding little evidence of a relationship between plant closings and takeover attempts); but see Sanjai Bhagat, Andrei Shleifer & Robert Vishny, “Hostile Takeovers in the 1980s: The Return to Corporate Specialization” in M Bailey & C Winston, eds, Brookings Papers on Economic Activity: Micro-economics Vol 1, 2nd ed (Washington, DC: Brookings Institution, 1990) at 55 (finding that layoffs are an important but not dominant source of tender offer gains). See further R Romano, “A Guide to Takeovers: Theory, Evidence, and Regulation” (1992) 9 Yale J Reg 119; Ronald J Daniels, “Stakeholders and Takeovers: Can Contractarianism Be Compassionate?” (1993) 43 UTLJ 315.

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why it is important for any country’s business law framework to be re-examined regularly to assess how best to address these legal problems and discover whether new M&A techniques should be developed. One problem that arises concerns the procedural requirements necessary to accomplish the transaction. For example, some, but not all, transactions involving a merger or sale require shareholder approval. This may prove to be a substantial impediment to getting a deal done. In addition, appraisal rights, under which shareholders who do not support the merger may require the corporation to purchase their shares at fair value, are triggered in some, but not all, cases, and careful thought needs to be given to whether and when to give shareholders such rights. Further issues arise when shareholders receive disparate treatment on a merger. One example of this is “squeeze-out” transactions, described further in Section  IV, in which minority shareholders are forced out of the amalgamated corporation, receiving cash for their shares, while majority shareholders are permitted to participate in the combined enterprise. Countries concerned with ensuring that their business law is seen to be respectful of investors’ interests will be especially concerned about how minority investors are treated in situations in which they are being forced out of their investment. The process leading up to completion of an M&A transaction can at times be quite complex, and experienced M&A lawyers are frequently needed to assist companies as they navigate their way through this complicated terrain. Experienced M&A lawyers are able to assess which of the various possible acquisition techniques is most appropriate in a given context, given the advantages and disadvantages associated with each technique. A wide range of factors, including considerations relating to how best to complete an acquisition on a tax-efficient basis, may be relevant to decisions about the best approach to take. Parties to a potential transaction may initially agree to a non-binding letter of intent setting out the principal terms they propose to govern the transaction. They may contemporaneously sign a confidentiality or non-disclosure agreement that enables the buyer to begin due diligence on the target in order to ensure that the buyer is satisfied with what it is proposing to buy and that the proposed price is appropriate. The negotiation of a definitive purchase agreement will then ensue, with the results of due diligence also being relevant to the terms of the agreement. As part of this process, decisions will have to be made about which of the different available acquisition techniques is the best one to use given the parties’ objectives. A buyer unable to convince a widely held company that it should agree to be bought may instead resort to a hostile takeover bid—effectively going-over the heads of the target company’s directors and making its case directly to the target’s shareholders. In these circumstances, a bidder will not typically have signed a confidentiality agreement and will have to rely on the company’s disclosure record—if it is a public company subject to ongoing disclosure obligations—rather than on due diligence. Contested takeover bids are considered in Section V of this chapter; this area has given rise to extensive debates about whether the decision to sell the company should rest with the target’s board of directors or its shareholders. The questions that arise include how much deference should be shown to a board of directors exercising its business judgment about what is best for the company, as well as whether shareholder interests should have primacy in the course of these deliberations or whether the focus should instead be on what is best for the corporation or for its various stakeholders.

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We now turn to an examination of some of the options that may be used in Canada to implement an M&A transaction.

A.  Sale of Shares A sale of a controlling block of shares in one corporation to another corporation or to the latter’s shareholders will vest control of the two enterprises in common hands. Selling shareholders may receive purely monetary consideration for their shares, in which case they will have no interest in the merged corporation. However, they will continue to participate in the combined corporation if the consideration for their shares consists of shares of the purchaser. The kinds of consideration received may give rise to different tax consequences, because capital gains tax liability might be triggered on a merger where selling shareholders receive cash only, while tax liability can instead be deferred through a share-for-share exchange until one disposes of the new shares received. As a result, shareholders may in some instances be prepared to accept a lower price on a share exchange than a sale for cash. Because shares are personal property, a transaction pursuant to which shareholders propose to sell their shares to a purchaser does not require shareholder approval by all shareholders by way of special resolution. The sale may, however, trigger duties of compliance with legislative provisions governing takeover bids. An offer to purchase shares that, when aggregated with the offeror’s existing shares in the target corporation, exceed 20 percent of the target’s outstanding voting securities is a takeover bid under provincial securities legislation: see National Instrument (NI) 62-104, Take-Over Bids and Issuer Bids. The offeror is then required to make the same offer to all shareholders of the class of securities sought, with special duties of disclosure governing a takeover bid circular that must be sent to all shareholders. Takeover bid legislation is discussed further in Section V. A further concern arises when a controlling block of shares is sold at a premium above market price. Because the premium paid for the control block is not offered to non-controlling shareholders, the two classes of shareholders are not accorded equal treatment. Some have therefore complained about legal regimes that permit these transactions to take place, and this debate is discussed further in Section V. Mergers accomplished through a sale of shares do not normally have a direct effect on the value of debt claims. For example, if all of the shareholders of Quick Buys sell their shares to Bestbuy Corp, Quick Buys’ creditors may continue to assert rights against Quick Buys, whose value is unchanged. Quick Buys will have outside debt claims but no outside equity claims, and will become a wholly owned subsidiary of Bestbuy Corp. That said, some debt instruments will nonetheless provide that, upon a change of control of Quick Buys, the debtholders are entitled to have their debt claims repurchased. Whether a debt instrument will contain such a provision will be a matter for negotiation when the debt is initially incurred, and a company will wish to consider carefully the potential impact on efforts to effect a future change of control transaction.

B.  Sale of Assets Two corporations may combine if one sells to the other all or substantially all of its assets. The same transaction might also be structured as a lease of assets if the term of the lease

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is so long that the lessor obtains substantially all of the economic value of the leased business. As in a sale of shares, the selling or leasing corporation may receive either shares of the purchasing corporation or cash. If the sale is paid for with a share consideration and the selling corporation distributes all of the shares it receives to its shareholders, the transaction is in many ways equivalent to proceeding by way of amalgamation. Even if no distribution of shares is made by the selling corporation, a sale of assets for shares is financially identical to an amalgamation, for the selling firm will become a holding corporation whose only asset is shares in the purchasing corporation. A sale or lease of all or substantially all of the corporation’s assets requires approval by two-thirds of the votes cast by shareholders under CBCA s 189(3), with even non-voting shares endowed with voting rights in certain circumstances under s 189(6). This is because the corporation is disposing of the very business the shareholders invested in. Many corporate statutes therefore provide shareholders with a say in this decision. In a widely held corporation, this will require compliance with proxy regulation requirements, including the mailing of an information circular to all shareholders. If a shareholder dissents from the special resolution, he or she may subsequently require the corporation to repurchase his or her shares by asserting appraisal rights under CBCA s 190(1)(e), as discussed in Section III. A corporation will therefore care a great deal about whether a proposed sale—for example, of one of its more significant divisions—amounts to a sale of substantially all of its assets.16 However, whether a sale is of substantially all of a firm’s assets may not always be clear. Yet a vendor and a potential purchaser will obviously want to understand whether a proposed transaction is subject to the risk that, notwithstanding that the vendor’s board of directors has approved the transaction and believes it to be in the corporation’s best interests, the vendor’s shareholders may take issue with the basis on which the proposed transaction might proceed. A party to a proposed transaction might simply be unwilling to proceed with a transaction if there is a meaningful possibility that shareholders will get an opportunity to vote on the transaction. This may amount to risk that a vendor or purchaser is unwilling to tolerate. As the decision of the Saskatchewan Court of Appeal in 85956 Holdings Ltd v Fayerman Brothers Ltd (1986), 46 Sask R 75 (CA) (see Chapter 14, Section IV) and the following case illustrate, a growing body of Canadian law seeks to provide parties to a potential transaction with tests designed to enable them to determine whether shareholder approval is required. As you review the following case, ask yourself whether you feel that the approach the court develops provides a useful framework for parties that need to assess whether a transaction involves the sale of all or substantially all of a business. Are the tests that are set out ones that can easily be applied in practice?

16 See M Gannage, “Sale of Substantially All the Assets of a Corporation” (2000) 33 Can Bus LJ 264. For provisions that are analogous to the CBCA, see the Ontario Business Corporations Act, RSO 1990, c B.16 [OBCA], s 185(1)(e); British Columbia Business Corporations Act, SBC 2002, c 57 [BCBCA], s 238(1)(e); and Alberta Business Corporations Act, RSA 2000, c B-9 [ABCA], s 191(1)(e).

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Cogeco Cable Inc v CFCF Inc (1996), 136 DLR (4th) 243 (Que CA) BIRON JA [TRANSLATION]:  The Board of Directors of CFCF Inc. agreed to sell to Le Groupe Videotron Ltee (Videotron) all the shares of CF Cable TV Inc. (CF Cable). The appellant is appealing against the decision of the Superior Court which rejected its application brought under s. 247 of the Canada Business Corporations Act, RSC 1985, c. C-44 (the Act), for the issuance of an order requiring that the transaction be submitted for shareholders’ approval as required by s. 189(3) of the Act and s. 3.3.6 of the respondent company’s articles of incorporation. The intervenant agrees with the result sought by the appellant. The appeal raises two issues:



(1) Does the transaction constitute the sale of substantially all of the company’s property? (2) If a vote is ordered, is the adoption of the resolution subject to approval by special resolution of the shareholders of each class of shares? I.  The Parties The appellant CFCF is a corporation constituted in accordance with the Canada Business Corporations Act. The only shares of CFCF, issued and in circulation, are shares in the class known as “multiple voting shares” which give the right to 10 votes each, and shares in the class known as “subordinate voting shares” which give the right to only one vote each. One hundred per cent of the multiple shares, numbering 1,497,440, are held by Jean A. Pouliot, Chairman of the Board of CFCF, or by companies which he controls. The subordinate shares, numbering 12,516,020, are registered and traded on the Montreal and Toronto stock exchanges. They are held by various investors. CFCF operates in the communications industry, primarily in cable distribution and television broadcasting. It operates the cable distribution activities through CF Cable, a wholly owned subsidiary of 299 9943 Canada Inc., which is itself a wholly owned subsidiary of CFCF. Cogeco Cable Inc. is a cable distribution company in competition with CFCF. It holds 1,184,900 of the subordinate shares purchased during the 1995 fiscal period. Serge Leclerc et Associes Inc. (Leclerc) is an investment advisor and institutional equity manager. Leclerc owns 100 subordinate shares in CFCF and holds and manages an additional 170,000 for its clients. These shares were purchased over the course of the last two years. Videotron is a communications company which operates its activities in the areas of cable distribution and television broadcasting. It operates, among others, the television station, Tele-Metropole. II.  Relevant Legal and Regulatory Provisions The relevant sections of the Act are as follows: 189(3)  A sale, lease or exchange of all or substantially all the property of a corporation other than in the ordinary course of business of the corporation requires the approval of the shareholders in accordance with subsections (4) to (8).

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(4)  A notice of a meeting of shareholders complying with section 135 shall be sent in accordance with that section to each shareholder and shall (a)  include or be accompanied by a copy or summary of the agreement of sale, lease or exchange; and (b)  state that a dissenting shareholder is entitled to be paid the fair value of his shares in accordance with section 190, but failure to make that statement does not invalidate a sale, lease or exchange referred to in subsection (3). (5)  At the meeting referred to in subsection (4), the shareholders may authorize the sale, lease or exchange and may fix or authorize the directors to fix any of the terms and conditions thereof. (6)  Each share of the corporation carries the right to vote in respect of a sale, lease or exchange referred to in subsection (3) whether or not it otherwise carries the right to vote. (7)  The holders of shares of a class or series of shares of the corporation are entitled to vote separately as a class or series in respect of a sale, lease or exchange referred to in subsection (3) only if such class or series is affected by the sale, lease or exchange in a manner different from the shares of another class or series. (8)  A sale, lease or exchange referred to in subsection (3) is adopted when the holders of each class or series entitled to vote thereon have approved of the sale, lease or exchange by a special resolution. 2(1) …

•  •  •

“ordinary resolution” means a resolution passed by a majority of the votes cast by the shareholders who voted in respect of that resolution; •  •  •

“special resolution” means a resolution passed by a majority of not less than two-thirds of the votes cast by the shareholders who voted in respect of that resolution or signed by all the shareholders entitled to vote on that resolution;

The relevant part of s. 3.3.6 of CFCF’s articles of incorporation reads as follows: The holders of the Multiple Voting Shares and the holders of the Subordinate Voting Shares shall be entitled to vote separately as a class upon a proposal; … (ii) to sell, lease or exchange all or substantially all the property of the Corporation other than in the ordinary course of business of the Corporation or other than to one or more wholly-owned subsidiaries of the Corporation. •  •  •

IV.  Legal Remedy Cogeco claims, with the support of Serge Leclerc, that CFCF’s refusal to submit the Transaction for shareholders’ approval is a violation of s. 189(3) of the Act and of s. 3.3.6 of its articles of incorporation. It therefore asks the court to order it to submit the Transaction for the approval of shareholders as provided for in s. 189(3) of the Act. CFCF disputes the application and also requests that the court decide what percentage of votes is required under s. 3.3.6 of its articles of incorporation.

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V.  The Judgment at First Instance The principal findings of fact of Halperin J would appear to be as follows:







1. The cumulative results of the TQS operations have been the source of considerable losses to the Company. 2. On the cable distribution side, a series of no fewer than six major acquisitions have been consummated since 1993. 3. These acquisitions were financed by very substantial borrowings. This policy decision was announced publicly in the company’s annual report and elsewhere. 4. There is no doubt that this extended penetration into cable distribution contributed significantly to the survival of the company in the six-year period 1990-95. The net operating profits derived from this sector amounted to some $48 million while the broadcasting sector suffered a loss of $66 million for a net loss for the period of approximately $18 million. 5. Its publicly announced commitment to long-term involvement in those operations notwithstanding, management decided to redefine its mission(s) by disposing of its major interests in the cable distribution sector and concentrating on the broadcast sphere. 6. On a number of important issues arising from the various analyses presented the experts were not able to agree on the accounting standards or terms of reference to be applied. 7. Respondent has regarded itself for more than 10 years as being a diversified Canadian communications company which operates primarily in the business of television broadcasting and cable television. Its history on the broadcast side is long. As regards cable distribution, it engaged rather modestly in that endeavour as early as 1982; in 1993, its involvement in that field expanded considerably, but not at the expense of the broadcast sector. 8. The cable expansion was largely funded by the creation of debt. 9. Its expansion while considerable was not deep-rooted. 10. The decision to concentrate on one to the exclusion of the other does not remove the company from its involvement in the communications industry. 11. The implementation of the Transaction Agreement will see the acquisition by the company of Tele-Metropole including the TVA Network, which, without expressing an opinion as to its efficacy, will significantly enhance the company’s presence in the domaine. The trial judge correctly identified the problem by saying that it was a matter of deciding whether CFCF proposed selling substantially all of its property within the meaning of s. 189(3) of the Act. CFCF does not, in fact, claim that the sale was part of the ordinary course of its business. After noting that Canadian case law in this area is limited and that it borrows and applies principles developed in American jurisprudence, he analyzes the major decisions.

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With respect to the concept of “substantially all of the property,” he sets forth the following principles at pp. 17-18 of his decision: 1.  Statutory language notwithstanding, the literal interpretation of the expression yields if not entirely, at least to a very considerable degree to the qualitative test. This approach derives from the generally understood legislative intention underlying this provision. 2.  The “substantially all” test is met when the assets which remain are essentially trivial in importance and value, most especially when operating assets have been disposed of. 3.  Whatever the test, the issue is whether the proposed sale strikes at the heart of the corporate existence and purpose of the company, whether it effectively destroys the corporate business or whether it produces a fundamental change in the corporation. Incidental to the foregoing principles are the following additional guidelines which are relevant for our purposes: 1.  Even the sale of an independent important division of a corporate business does not necessarily require shareholders’ approval. 2.  Generally speaking there is to be excluded from consideration the business efficacy of the intended sale.

The judge cites the three following passages from Fraser and Stewart, Company Law of Canada, 6th ed. (Toronto: Carswell, 1973): Fraser and Stewart, Company Law of Canada, 6th ed. (Toronto: Carswell, 1973), at p. 574 describe the purpose of s. 189(3) thus: Since the purpose of the provision is to protect the shareholders from a destruction of the corporation’s business, the transaction must be tantamount to the winding-up of the corporation’s business in order to require a special resolution: Good v. Lackawanna Leather Co. (1967), 233 AS. (2d) 201, quoted with approval in 85956 Holdings Ltd. v. Fayerman Brothers Ltd., [1986] 2 WWR 754 (Sask. CA).

At pp. 20-21: The difficulty inherent in the mathematical approach in determining whether the “substantially all” test has been met, prompted Fraser and Stewart to observe at p. 573: The important question is, of course, what constitutes ‘all or substantially all’ and there is some jurisprudence on the issue. The Canadian tax authorities apparently take the position that ‘all or substantially all’ in the federal Income Tax Act means at least 90 per cent. The issue does not, however, appear susceptible to such precise mathematical calculation: Wood v. MNR (1987), 87 DTC 312 (TCC). A better view would appear to be that both the quality as well as the quantity of the property in question must be examined: Wardean Drilling Co. v. MNR (1974), 74 DTC 6164 (FCTD); aff ’d. 78 DTC 6202 (FCA). (Emphasis added.)

At pp. 28-9: Even if the two were entirely separate businesses, the sale of one would not, according to Fraser and Stewart, require shareholder approval:

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Chapter 15  Mergers and Acquisitions It seems that the sale of as little as one third of the company’s assets might trigger the operation of s. 189(3): 85956 Holdings, supra; Campbell v. Vose (1975), 515 F 2nd 256. Such extreme cases occur when the balance of the assets are monetary including cash, promissory notes or an investment portfolio. On the other hand, where a corporation carries on one or more businesses, the sale of one such business would not cause the provision to become operative, provided the corporation retains business assets: Olympia and York Enterprises Ltd. v. Hiram Walker Resources Ltd. (1986), 59 OR (2d) 254; Martin v. F.B. Bourgault Industries Air Seeder Division Ltd. (1987), 45 DLR (4th) 296 (Sask.); Re Vanalta Resources Limited (unreported) (1976), (BCSC). (Emphasis added.)

After pointing out that the applicant had the burden of proof, he proceeded to apply the law to the facts. The appellant quite rightly points out that of all the expert evidence submitted before him, the judge based his decision solely on the analysis by Michel Perreault, one of the experts for Cogeco, an analysis entitled “Repartition en fonction des actifs consolidés de CFCF” (ex. I-18). The judge did not comment on the respective competence of the experts and did not make findings of credibility. He did, however, find the criterion of “market value” of the assets sold to be inappropriate because, he said, it would amount to speculation. He added, at p. 37, speaking of the market value approach: “This approach is also flawed because it is based upon the presumed existence of an open and unrestricted market. This is a highly questionable proposition … .” The judge then concluded that Cogeco had not discharged its burden of proof with respect to quantitative criteria. The judge then posed the following question: How will the company be affected by the implementation of the transaction agreement? Clearly, it cannot be said that the company will have disposed of its operating assets. While the transaction agreement will bring about a change in the nature of the company, even an important change, the quality of that change will not be “fundamental” in the sense that the case law instructs.

As for the shareholders’ state of uncertainty in light of CFCF’s statements regarding its plans for cable distribution, the judge held that he did not have to take that into account because he was not dealing with a remedy under s. 241 of the Act and because it is not alleged that the company was acting in bad faith. In his opinion: “The options available to a disappointed shareholder in a company whose shares are publicly traded are clear.” Thus he rejected the application and the intervention. VI.  The Appeal The appellant, with the support of the intervenant, presents four main arguments, namely:

(1) that the trial judge’s application of the case law was erroneous, reductive and incomplete; (2) that the trial judge clearly erred in fact and in law by refusing to consider all of the financial data submitted to him in evidence by the expert witnesses;

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(3) that the trial judge erred in his qualitative analysis of the Transaction by accepting only incomplete or erroneous financial data; and (4) that the trial judge should have paid particular attention to the articles of incorporation and, inter alia, that he should have analyzed the evidence submitted not only in light of s. 189(3), but also in light of the articles and the particular circumstances surrounding investment decisions by CFCF’s subordinate shareholders and representations made to the latter by CFCF. I will now examine the arguments which I group under the following headings:



A.  The state of the law B.  The evidence and conclusions to be drawn from it A.  The State of the Law with Respect to the Interpretation of Section 189(3) of the Canada Business Corporations Act As the trial judge pointed out, our case law is based on principles developed by the American courts which have had occasion to analyze provisions identical to ours. However, I will simply make some brief comments on two of those decisions, only one of which I accept as applicable to this case. (1)  The American Case Law The trial judge quoted a passage from the frequently cited decision in Gimbel v. Signal Companies, Inc., 316 A2d 599 (Del. Ch., 1974) at p. 605. I would like to quote the following passage from that case: “it is not our law that shareholders’ approval is required upon every ‘major’ restructuring of the corporation.” I feel that the following comment, found at p. 606 of the case, should be added: If the sale is of assets quantitatively vital to the operation of the corporation and is out of the ordinary and substantially affects the existence and purpose of the corporation, then it is beyond the power of the Board of Directors.

In the Gimbel case, after noting at p. 608 that the sale and purchase of companies was part of Signal’s normal business, the court concluded that the sale of Signal Oil which represented 41% of Signal’s net value and 15% of its profits did not amount to the sale of substantially all of Signal’s property. I would agree with that assessment but I would point out that the facts are quite different from those in the case at bar. The decision in Katz v. Bregman, 431 A2d 1274 (1981), also handed down by the Chancery Court of Delaware, was not cited by the trial judge but the parties did submit it as an authority to this court. It deserves some attention. In Katz, the court held that Plant Industries’ proposed sale of all of its Canadian assets representing 52.4% of its before-tax profits, 51% of its total assets and 45% of its net sales, constituted “a sale of substantially all of the assets of Plant Industries.” In support of this proposition, Chancellor Marvel made two observations:

(1) the acquisition and sale of industries was not one of Plant’s usual activities which distinguished the Katz case from the facts in the Gimbel case; and (2) in fact, its activity involved the manufacture of steel drums.

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He concluded that: … the proposal, after the sale of National, to embark on the manufacture of plastic drums represents a radical departure from Plant’s historically successful line of business, namely steel drums.

I would point out that that decision seems to me to be quite a departure from the opinion of Fraser and Stewart quoted by the trial judge. (2)  The Canadian Case Law Halperin J cites the decision in Vanalta Resources Ltd., an unreported decision of Legg J rendered on January 27, 1977 (Court File No. A760559/76 (BCSC)). Legg J had to interpret s. 149 of the British Columbia Companies Act which provided for a vote in the case of the sale “of the whole or substantially the whole of the undertaking of the company.” Halperin J points out that Legg J relied on Gimbel and applied the two criteria, qualitative and quantitative, before concluding that “the sale of the property in question was not one ‘which struck at the heart of the corporate existence and purpose of Vanalta’ because the ‘sale was not a sale of the whole or substantially the whole of the undertaking of Vanalta.’” The evidence indicates that Vanalta proposed to sell its interests in an oilfield for $655,000. Legg  J estimated that Vanalta still had oilfields valued at more than $4 million. In addition, after referring to the testimony of a Mr. Budrug “that a company of Vanalta’s nature generally raised required funds for property development, administration costs, acquisition of new properties, by selling its developed property,” which made the Vanalta case similar to the Gimbel case, he said that the proposed transaction was not “such an unusual transaction that it could be said to have struck at the heart of the corporate existence of Vanalta.” The decision in 85956 Holdings Ltd. v. Fayerman Brothers Ltd. (1986), 25 DLR (4th) 119, 32 BLR 204, [1986] 2 WWR 754 (Sask. CA), deals with the interpretation of a provision of the Saskatchewan Business Corporations Act similar to s. 189(3) of the Act. Halperin J concludes from this decision that the issue in dispute cannot be resolved on the basis of quantitative criteria and that we should focus on qualitative criteria. In my view, however, it should be pointed out that in the decision in Fayerman, the shareholders had decided, at a meeting called for that purpose, to liquidate the inventory and not to renew it. The court only had to decide whether the opponent could be considered a dissenting shareholder and whether, as such, it had the right to demand that the company purchase its shares. Vancise JA pointed out that if the inventory were liquidated and the accounts receivable collected, all that would remain of the company would be its cash and immovables evaluated at $33,000 or less than 5% of the total assets. In light of these facts, I conclude that the trial judge’s findings with respect to the decision in Fayerman are too general and that the focus should be on qualitative criteria rather than quantitative criteria.

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Halperin J agrees with the decision in Martin v. F.P. Bourgault Industries Air Seeder Division Ltd. (1987), 45 DLR (4th) 296, 38 BLR 90, 62 Sask. R 297 (CA), that the sale of one division of a company to another company newly formed for that purpose “did not result in a fundamental alteration in the nature of the company.” The following passage, which is found at p. 299 of that decision, is, I believe, relevant: On a qualitative basis, the company continued to manufacture agricultural products as it had always done. It continued to carry on essentially the same business for which it had been incorporated. Its ability to carry on that business was not destroyed. Both on a qualitative and quantitative basis, it is not possible to say that the company sold all or substantially all its property within the meaning of s. 184.

I find that in the Martin case, the Saskatchewan Court of Appeal did not dissociate qualitative criteria from quantitative criteria as the trial judge seems to want to do. The case of Benson v. Third Canadian General Investment Trust Ltd. (1993), 14 OR (3d) 493, 13 BLR (2d) 265, 41 ACWS (3d) 298 (Gen. Div.), was considered by the trial judge. He expresses the opinion that Farley J shared the views expressed in the decisions in Fayerman and Martin mentioned above and adds that Farley J “went a small step further in asserting ‘that the qualitative test is to be preferred as the acid test.’ In concluding that the creation of open-end mutual fund companies from closed-end companies constituted ‘a fundamental change,’ he went so far as to question whether the quantitative approach even comes into play.” I recognize that Farley J favours the qualitative approach but in my view, he does not reject the quantitative approach. Halperin J also cites the case of Lindzon v. International Sterling Holdings Inc. (1989), 45 BLR 57, 17 ACWS (3d) 759 (SC), and points out, correctly in my opinion, that the quantitative approach was rejected in favour of the qualitative approach. The Lindzon case concerns the sale of an office building. The judge noted that the building had never been the object of the company’s business. Applying the qualitative approach and adopting the formulation used by Legg  J in the decision in Vanalta Resources cited above, he held that the sale of the building “was not such an unusual transaction that it could be said to have struck at the heart of the corporate existence and purpose.” The decision in Re Olympia & York Enterprises Ltd. and Hiram Walker Resources Ltd. (1986), 37 DLR (4th) 193 at p. 194, 59 OR (2d) 254 at p. 255 (HCJ), was not cited in the case before us but it is not without interest. That case deals with an application for an injunction to prevent a hostile take-over bid and it involves the application of a provision of the Ontario Business Corporations Act similar to that in the case before us. Hiram Walker had three divisions: a company which produced alcohol, another which distributed gas and a third company referred to as a natural resource business. The company proposed selling the alcohol division which represented 43% of the market value of all Hiram Walker’s assets, 29% of its assets according to their value in pounds, 40% of its profits and 30% of its annual sales. In my view, Montgomery J considered only quantitative criteria. He said as follows [at 216]:

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Chapter 15  Mergers and Acquisitions It is fallacious to suggest that when a holding company that has three distinct divisions and sells one of three divisions for 2.6 billion dollars out of a total worth of six billion dollars, it could possibly fall within s. 183(3).

(3) Doctrine Little has been written on this subject. I will simply cite the following passage from Droit Corporatif Québecois, Les ed. FM, at no. [30-315] [TRANSLATION]: Notion of all or substantially all of the assets There is little difficulty when it is a question of deciding whether the company is or is not disposing of all of its assets. The same cannot be said when it is a matter of determining what constitutes the transfer of substantially all of the assets. One can take a quantitative or a qualitative approach in order to determine whether or not the provisions of section 189(3) of the Canada Business Corporations Act apply. The quantitative approach is the simplest and is based on mathematical calculations. Evaluation is based on the percentage of the assets sold. It is then a matter of determining at what point substantially all of the assets were sold. It is clear that a proportion of 30% is not enough but if that proportion were as high as 75% or more, it could be said that a substantial portion of the company’s assets had been sold. The qualitative approach is more complex and is actually based on the assets on which the company’s basic activities depend. Thus, a sale of one third of the total assets of the company can become a sale of substantially all of the assets of the company if those assets are the assets used by the company to exercise its basic or principal activities. The quantitative approach does not pose a problem and is applicable in the context of section  189(3) of the Canada Business Corporations Act. The qualitative approach also applies in particular when the assets sold are not a substantial proportion of all of the company’s assets.

Before formulating the principles which I consider applicable to the case before us, I would like to express my disagreement with two of the trial judge’s findings. With respect, I do not agree with Halperin J when he says that: “the literal interpretation yields if not entirely, at least to a very considerable degree to the qualitative test” and that “the ‘substantially all’ test is met when the assets which remain are essentially trivial in importance and value,” if it is a condition sine qua non. I am also of the view that it is wrong to conclude that a vote is not required unless the company would be destroyed. To apply such a test would be to make s.  189(3) meaningless. I will now describe, in light of the case law and the doctrine, the principles which we should follow in interpreting s. 189(3) of the Act when, as in the case at bar, there is no dispute about the fact that the proposed sale does not come within the framework of the normal course of a company’s activities:

(1) in the interpretation of s. 189(3) of the Act, it is appropriate to take into account both quantitative and qualitative criteria; (2) the concept of “substantially all of the property” has acquired a special meaning in this particular area of the law;

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(3) it is difficult to fix a percentage, but in my view, when the sale involves 75% of the value of the property, it ought to be submitted for shareholders’ approval; (4) if the case cannot be decided by using the quantitative test, then we must proceed with a qualitative analysis of the transaction; (5) in such a case, it must be determined whether the proposed transaction constitutes a fundamental reorientation which strikes at the heart of the company’s activities, in other words, whether this is a transaction which is out of the ordinary and which substantially affects the company’s purpose and existence; and (6) application of the qualitative test must take quantitative criteria into account; the greater the proportion of property sold in relation to all of the company’s property, the more likely we would be to conclude that the transaction strikes at the heart of the company and necessitates the shareholders’ approval. The moment has come to apply these principles to the facts of the case. B.  The Evidence The appellant criticizes the trial judge for refusing to consider all the financial data which allegedly lead to an erroneous qualitative analysis. It is a fact that of all the evidence submitted to him with respect to the value of the property sold, the trial judge accepted only the “Repartition en fonction des actifs consolidés de CFCF” contained in the report by Michel Perreault, the expert for Cogeco. In the absence of evidence to the contrary, it does not seem to me that Mr. Perreault’s credibility is in the least bit tarnished. I intend to examine the evidence in light of the decision of this court in the case of Cie de Volailles Maxi Ltee v. Empire Cold Storage Co. (CAM, 500-09-001340-876, October 16, 1995) [summarized 58 ACWS (3d) 1181] which reads as follows at pp.  14-15 [TRANSLATION]: Even if a finding of fact does not depend on credibility, an appeal court has neither the duty nor the right to evaluate, a second time, evidence submitted at trial. However, the appeal court may examine the trial record to determine whether the court took proper account of all of the evidence relating to litigious issues. If it appears from the record and from the reasons for judgment that there was a failure to appreciate pertinent elements of the evidence or, more particularly, that they were completely disregarded, the reviewing court must then intervene: see Geffen v. Goodman Estate (1991), 81 DLR (4th) 211 at pp. 235-6, [1991] 2 SCR 353, 42 ETR 97; Harper v. The Queen (1982), 133 DLR (3d) 546 at p. 563, 65 CCC (2d) 193, [1982] 1 SCR 2; Schreiber Brothers Ltd. v. Currie Products Ltd. (1980), 108 DLR (3d) 1, [1980] 2 SCR 78, 31 NR 335.

With respect, I am of the opinion that the trial judge was wrong not to consider the evidence submitted to him with regard to the market value of the property sold and he was especially wrong to prefer the evidence offered by Claude Michaud, CFCF’s expert, to that submitted by Mr. Perreault. Mr. Perreault is a chartered accountant, MBA and financial analyst who, for 25 years, has studied the communications sector in order to advise investors. He has no interest in

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the case other than that of an individual who was paid to produce a report and to testify. It is clear from his report and his testimony that he is very competent. CFCF’s expert, Claude Michaud, an engineer with an MBA, is employed by ScotiaMcLeod Inc. as vice-president and manager. He has a vested interest in the result of the deal since in addition to being paid for his expert’s report, the company which employs him will be paid a fee if the transaction is completed. In addition, Mr. Michaud only dealt with that part of Mr. Perrault’s report which deals with quantitative criteria. He admitted in his testimony that he did not consider qualitative criteria (vol. 10, p. 1826). In my view, Mr. Perreault’s findings as reported below are convincing and the trial judge was wrong to ignore much of his testimony. With respect, the trial judge should have taken the market value of CF Cable into account in deciding the issue in dispute. Perreault stated that a company’s “Ebitda” enables us to calculate its market value. Ebitda takes into account “earnings before interest, tax, depreciation and amortization.” The French equivalent of the acronym “Ebitda” is “Profits d’exploitation” and is commonly used in this field. It is surprising that the judge did not take market value into account as Perreault invited him to do since Michaud, CFCF’s own expert, said at pp.  1832-3 of his examination [TRANSLATION]: A:  Because there is the notion of market value which plays a role. Q:  Which should be taken into account and which is very important, right? A:  Which is very important. Q:  Now, the Ebitda, as such, isn’t it an extremely important test in the industry? A:  It is very important in determining total value.

And, at p. 1877: “the only thing that is important is the market value of CF Cable TV, what we sell today.” Therefore, in my opinion, the findings of Perreault’s report and his testimony should not only be taken into account, they should be accepted. Perreault’s report is found at pp. 70 et seq. of vol. 1 of the appellant’s factum. Table 3, at p. 73, indicates that during 1995, cable distribution represented 78.9% of CFCF’s operating profits. That percentage had been 72.9% in 1994, 62.9% in 1993, 65.1% in 1992 and 100% in 1991. As for the value of the various assets accepted by the trial judge, Table 4, p. 75, indicates that on August 31, 1995, CF Cable’s assets were $375.2 million whereas those of the television broadcast division were $189.3 million or 66.5% for cable distribution against 33.5% for television broadcasting. According to the trial judge, at p. 24 of his judgment, the respondent concluded that these assets represent 61% of the total. In Table 5 of his report, p. 77, Perreault makes an evaluation as a function of multiples without considering indebtedness. Thus he arrives at a comparative value of 83.7% for CF Cable and 16.9% for television broadcasting. By considering indebtedness as Michaud suggests and by taking into account multiples recognized in the cable distribution sector, in other words $1,200, for each CF Cable subscriber and 7.45% of the Ebitda of the television broadcasting sector, he arrives

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at a comparative value of 80% for cable distribution and 20% for television broadcasting. As for the qualitative test, Perreault said as follows in his report at p.  87 [TRANSLATION]: Without the cable distribution sector and its generous and continuous monetary contributions, the company could not have tolerated or perhaps even survived the serious damage suffered since the year 1987 following deficits at the Television Quatre-Saisons network, which, according to our estimates, exceeded $100  million for the six years from 1987 to 1992.

The judge agreed with Perreault since he said at p. 8 of his decision, as I have already pointed out, that: “there is no doubt that this extended penetration into cable distribution contributed significantly to the survival of the company in the six-year period 1990-95.” The trial judge said as follows in his qualitative analysis at p. 27 of the decision, namely that the acquisition of Tele-Metropole “will significantly enhance the company’s presence in the broadcast domain.” But it would seem to me that such a statement is premature since Tele-Metropole has not yet been purchased. This is clear from the minutes of a meeting of CFCF managers held on November 14, 1995 (ex. R-37, vol. 9, p. 1124), which contain the following passage: Major risks for CFCF in the proposed transaction were also outlined: •  CRTC: saying no to joint ownership TM-TQS; •  Negative tax decision: $72 M to be paid; •  Possibility of increasing TM bid price.

To these considerations, I add that in his qualitative analysis of the transaction, the trial judge seems to have attached little importance to the very clear messages sent by management about the importance of cable distribution to the company, as is revealed by the review which I have provided above. Therefore, after considering the applicable quantitative and qualitative criteria, I find that the proposed Transaction constitutes a fundamental change which strikes at the very heart of the company and that it would substantially affect the corporate existence and purpose. This conclusion does not contradict the view of Jean Pouliot as reported by his son, Adrien, in press release R-18 dated December 11, 1988, quoted above, where he described the company’s “core business” as being “television and cable broadcasting.” With respect for the contrary opinion, to conclude otherwise would render s. 189(3) of the Act devoid of meaning and deprive the shareholders of a very important right, that of expressing their view of this major and extraordinary transaction which affects substantially all of the company, despite representations made to investors and to the public for years. This would defeat the object of the legislation which was to make corporate democracy more transparent. I would therefore allow the appeal and submit the transaction for shareholders’ approval in accordance with s-ss. (4) to (8) of s. 189 of the Act.

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Consequently, it is necessary to deal with the respondent’s subsidiary argument. C.  What Majority Is Required? Section 189 of the Act and s. 3.3.6 of CFCF’s articles of incorporation must be considered. It is clear that a company’s articles of incorporation cannot diminish the powers which the Act confers on shareholders but they can increase those powers. It is my view, therefore, that unless there is incompatibility, both the Act and the company’s articles of incorporation must be given effect. Under s. 189(7) holders of a particular class of shares are entitled to vote separately on the advisability of a sale proposed under s-s. (3) only if such class is particularly affected by the sale, which is not the case here. Therefore, I find by virtue of s. 189(8), that the adoption of the Transaction is subject to approval by special resolution of the shareholders of the two classes of shares together. For the Transaction to be approved, the resolution must therefore be adopted by twothirds of the votes cast by shareholders in the two classes. At the time of the vote, shareholders with multiple voting shares will have a right to 10 votes per share, in accordance with the articles of incorporation, whereas holders of subordinate shares have a right to only one vote per share. We shall now consider how s. 3.3.6 of the articles of incorporation should be applied. The appellant and the intervenant argue that shareholders in each class of shares must be allowed to vote separately and that the Transaction will only be approved if the resolution is adopted by two-thirds of the votes cast by the shareholders in each class in separate votes. CFCF does not dispute that there must be a vote by class of share in application of s.  3.3.6 of the articles but argues that the resolution can be adopted by a simple majority. In my view, CFCF is right. In fact, as Paul and Maurice Martel have written at p. 734 of their book, La compagnie au Québec—Les aspects juridiques (Montreal: Wilson & Lafleur, 1994): “At a shareholders’ meeting, questions are generally decided by a simple majority (50% + 1) of the votes cast.” If a higher majority is to be required, it must be so provided by statute or in the articles of incorporation. In the case before us, a vote must be held by class only if required by the articles of incorporation. The articles could have imposed the adoption of a special resolution by shareholders in each class, but that is not the case. The vote will therefore be decided by a simple majority. To sum up, there will therefore be three votes: • a vote by shareholders in the two classes; for the Transaction to be approved, it must be passed by two-thirds of the votes cast by the shareholders who voted; • a vote by shareholders in the class “Multiple Voting Shares”; such a resolution must be passed by a simple majority; • a vote by shareholders in the class “Subordinate Voting Shares”; such a resolution must be passed by a simple majority.

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Therefore, I would allow the appeal with costs, both in favour of the appellant and the intervenant and order that the respondent, CFCF Inc., send to its shareholders, within 21 days, a notice of meeting as provided for in ss. 135 and 189(4) of the Canada Business Corporations Act and in s. 3.3.6 of CFCF’s articles of incorporation, so that votes provided for in s. 189(3) of the Canada Business Corporations Act and in s. 3.3.6 of the respondent’s articles of incorporation may be held. Appeal allowed. As Cogeco makes clear, determining whether a sale of assets constitutes a sale of all or substantially all of the assets may not be a simple exercise and may require the application of several tests.

1.  The Quantitative Test The quantitative test involves a comparison of the value of the property sold, leased, or exchanged with the value of the overall property of the corporation: [39]  … [T]hree different measures [have been] applied by courts in this regard: a comparison of the book value of the assets sold and the book value of the total assets of the corporation, a comparison between the contribution to the gross revenue by the assets sold and the total gross revenues of the corporation, and the impact upon profitability or net income as a result of the sale of the assets.17

As we have just seen, in Cogeco, Biron JA stated that the quantitative criteria had to be studied first and then, if necessary, a qualitative analysis had to follow.

2.  The Qualitative Test When should managers be required to submit a transaction to shareholders for their approval? Where a class of transactions is invariably value-increasing, shareholder consent might be thought a wheel that turns nothing. Is there any reason for shareholder ratification for transactions that appear wholly benign, such as the sell-off of unrelated firm assets? Such divestitures reverse inefficient acquisitions and are associated with significant positive shareholder returns. Should the qualitative test be applied to exempt such sales, even if they amount to a quantitatively large portion of the firm’s assets? What about a situation where the firm proposes to sell its historical core assets for the purpose of thwarting a takeover bid? Sell-offs of core assets made to resist takeover bids are associated with significant declines in the price of offeree stock.18 17 Hovsepian v Westfair Foods Ltd, 2003 ABQB 641, [2004] 5 WWR 519. 18 See Larry Y Dann & Harry DeAngelo, “Corporate Financial Policy and Corporate Control: A Study of Defensive Adjustments in Asset and Ownership Structure” (1988) 20 J  Fin Econ 87 (reporting a decline of 2.33 percent).

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A sell-off is more likely to require shareholder consent where the division represents core assets. In Katz v Bregman, 431 A (2d) 1274 (Del Ch 1981), for example, a plan to sell 51 percent of Plant Industries’ assets generating 45 percent of its net sales had to be put to the shareholders for approval. The assets in question had been the only ones to produce income in the previous four years, and their sale “represented a radical departure from [the seller’s] historically successful line of business.” Shareholder ratification was waived on a defensive sell-off of core assets, however, in Re Olympia & York Enterprises Ltd and Hiram Walker Resources Ltd et al; Re Interprovincial Pipe Line Ltd and Hiram Walker Resources Ltd et al (1986), 37 DLR (4th) 193, 59 OR (2d) 254 (H  Ct  J (Div Ct)). The sell-off was one of the devices used by Hiram Walker to resist an Olympia & York (O & Y) takeover. Hiram Walker sold its liquor division to Allied-Lyons, a British food and drink manufacturer, that with Hiram Walker funded a third corporation, which made a rival bid for the Hiram Walker stock at a higher offer price than the O & Y bid. The liquor interest represented 43 percent of Hiram Walker’s total assets at market value and 29 percent of its total assets at book value, and accounted for 40  percent of earnings and 30  percent of annual sales. The court held that this was “not even close to all the assets. … It is fallacious to suggest that when a holding company that has three distinct divisions and sells one of three divisions for 2.6 billion dollars out of a total worth of six billion dollars, it could possibly fall within [s 189(3)].” Can this result be defended on the basis that the sell-off usefully brought a second bidder into an auction contest for Hiram Walker? The decision that the sell-off did not require ratification might have benefited Hiram Walker shareholders. Through its existing stock interest in the target and its superior knowledge of Canadian business conditions, O & Y had important first mover advantages over the British bidder, and Allied-Lyons might have refused to take the risk that the O & Y offer would fail had the asset sale required ratification. Hiram Walker shareholders might then have accepted the low premium offer from O & Y.19 When considering the qualitative test, courts have used a number of different formulations to get at the heart of the problem before them. The following extract provides a useful summary of the different ways in which courts have sought to define the problem.

Mark Gannage, “Sale of Substantially All the Assets of a Corporation” (2000) 33:2 Can Bus LJ 264 at 278 • Does it strike “at the heart of the corporate existence and purpose of ” the Company (Vanalta Resources Ltd. (Re), Unreported, December 17, 1976, BCSC, Vancouver File No. A760559)? • Would it remove the Company’s “ability to accomplish the purposes or objects for which it was incorporated” and “have the effect of destroying the corporation’s business” (85956 Holdings Ltd. v. Fayerman Brothers Ltd., (1986), 32 BLR 204, 25 DLR (4th) 119 (Sask. CA)? • Would its effect “fundamentally alter the nature of the company from an operating company to a holding company” and destroy “the company’s main business” 19 See further FH Buckley, “The Divestiture Decision” (1991) 16 J Corp L 805.

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• • •

•

•

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(Martin v. F.P. Bourgault Industries Air Seeder Division Ltd., (1987), 38 BLR 90, 45 DLR (4th) 296 (Sask. CA)? Would its consequence “be the effective destruction of the company’s business” (Lindzon v. International Sterling Holdings Inc., (1989), 45 BLR 57 (BCSC)? Would it “radically and fundamentally alter” the Company (Benson v. Third Canadian General Investment Trust Ltd., (1993), 14 OR (3d) 493, 13 BLR (2d) 265 (Gen. Div.))? Does it constitute “a fundamental change which strikes at the very heart of the company and … would substantially affect the corporate existence and purpose” (Cogeco Cable Inc. v. CFCF Inc., (1996), 136 DLR (4th) 243, [1996] RJQ 278 (Que. CA))? Will it “have the effect of fundamentally changing or destroying the nature of the corporation’s business,” and is it “tantamount to the winding-up of the corporation’s business” (GATX Corp. v. Hawker Siddeley Canada Inc., (1996), 27 BLR (2d) 251 (Ont. Ct. (Gen. Div.))? Will it destroy or alter the company so that it no longer does “what it was originally created for” (Colwill v. 601999 Saskatchewan Ltd., (1999), 92 ACWS (3d) 442 (QB))?

C. Amalgamation A third way in which one business may be combined with another is by filing articles of amalgamation under CBCA s 181 et seq. If one corporation is wholly owned by another, or if both are wholly owned by the same person, they may be amalgamated without formal shareholder consent under s 184 as a “short-form” amalgamation. In other cases, the amalgamation agreement under s 182 must be approved by special resolutions of the shareholders of both corporations. In widely held corporations, this will require full disclosure of the details of the amalgamation and prospectus-level financial disclosure in the information circular that must be sent to shareholders being asked to vote on the matter.20 Amalgamations also give rise to appraisal rights under s 190(1)(c) (discussed below in Section III). As of the date set out in the certificate of amalgamation, the two corporations continue as one corporation that possesses all the rights and property and is subject to all the liabilities of each of the two amalgamating corporations: CBCA s 186. 21 Questions have nevertheless arisen about whether an amalgamation continues or extinguishes the predecessor corporations. In R v Black and Decker Manufacturing Co, immediately below, the accused corporation was charged with offences under the Combines Investigation Act, alleged to have occurred between 1966 and 1970. Black and Decker Manufacturing Co was incorporated in 1922 under the federal Companies Act and in 1971 amalgamated with two other corporations under the Canada Corporations Act. The charges in question were laid

20 National Instrument [NI] 51-102, Continuous Disclosure Obligations (2004) 27 OSCB 3439 and (2005) 28 OSCB 4975. 21 See also the decision of the Ontario Superior Court of Justice in 1184760 Alberta Ltd v Falconbridge Ltd (2006), 20 BLR (4th) 6 (Ont Sup Ct J).

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in 1972 and the question arose whether the amalgamated corporation was liable for them. Then section 137(13)(b) of the Canada Corporations Act, RSC 1970, c C-32, repealed 2009, c 23, s 313, provided that “the amalgamated company possesses all the property, rights, assets, privileges and franchises, and is subject to all the contracts, liabilities, debts and obligations of each of the amalgamated companies,” while then s 137(14) stated that “all debts, contracts, liabilities and duties of [a predecessor] company … attach to the amalgamated company and may be enforced against it.” While these provisions seemed to have provided an answer to the question, the Ontario Court of Appeal held that they did not extend to criminal liability under the Combines Investigation Act. The Supreme Court nevertheless held that criminal liability for offences committed prior to 1971 survived the amalgamation. Justice Dickson, who delivered the judgment of the court, found the successor corporation guilty of the offence. He provided the following description of the nature of an amalgamation under Canadian law, a description that remains a definitive explanation of its distinctive consequences.

R v Black and Decker Manufacturing Co [1975] 1 SCR 411 at 420-22 DICKSON J (for the court):

The word “amalgamation” is not a legal term and is not susceptible of exact definition: In re South African Supply and Cold Storage Company [[1904] 2 Ch 268]. The word is derived from mercantile usage and denotes, one might say, a legal means of achieving an economic end. The juridical nature of an amalgamation need not be determined by juridical criteria alone, to the exclusion of consideration or the purposes of amalgamation. Provision is made under the Canada Corporations Act and under the Acts of various provinces whereby two or more companies incorporated under the governing Act may amalgamate and form one corporation. The purpose is economic: to build, to consolidate, perhaps to diversify, existing businesses; so that through union there will be enhanced strength. It is a joining of forces and resources in order to perform better in the economic field. If that be so, it would surely be paradoxical if that process were to involve death by suicide or the mysterious disappearance of those who sought security, strength and, above all, survival in that union. Also, one must recall that the amalgamating companies physically continue to exist in the sense that offices, warehouses, factories, corporate records and correspondence and documents are still there, and business goes on. In a physical sense an amalgamating business or company does not disappear although it may become part of a greater enterprise. There are various ways in which companies can be put together. The assets of one or more existing companies may be sold to another existing company or to a company newly-incorporated, in exchange for cash or shares or other consideration. The consideration received may then be distributed to the shareholders of the companies whose assets have been sold, and these companies wound up and their charters surrendered. In this type of transaction a new company may be incorporated or an old company may be wound up but the legal position is clear. There is no fusion of corporate entities. Another form of merger occurs when an existing company or a newly-incorporated company acquires the shares of one or more existing companies which latter companies may then

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be retained as subsidiaries or wound up after their assets have been passed up to the parent company. Again there is no fusion. But in an amalgamation a different result is sought and different legal mechanics are adopted, usually for the express purpose of ensuring the continued existence of the constituent companies. The motivating factor may be the Income Tax Act or difficulties likely to arise in conveying assets if the merger were by asset or share purchase. But whatever the motive, the end result is to coalesce to create a homogeneous whole. The analogies of a river formed by the confluence of two streams, or the creation of a single rope through the intertwining of strands have been suggested by others. Counsel for the accused argued that an amalgamation agreement provides for so many changes (s. 137(3)) and the transformation of the amalgamating companies is so complete as to amount to extinction of life. I do not agree. A company can, by supplementary Letters Patent, make equally drastic changes without affecting, in the slightest, corporate longevity. It was also submitted that if the amalgamating companies continue in amalgamation, in all their plenitude, then ss.  137(13)(b) and 137(14) are mere surplusage. I would not so regard them. These sections spell out in broad language amplification of a general principle, a not uncommon practice of legislative draftsmen. If ss. 137(3)(b) and 137(14) are to be read, however, as other than merely supportive of a general principle and other than all-embracing, then some corporate incidents, such as criminal responsibility, must be regarded as severed from the amalgamating companies and outside the amalgamated company. What happens to these vestigial remnants? Are they extinguished and if so, by what authority? Do they continue in a state of ethereal suspension? Such metaphysical abstractions are not, in my view, a necessary concomitant of the legislation. The effect of the statute, on a proper construction, is to have the amalgamating companies continue without subtraction in the amalgamated company, with all their strengths and their weaknesses, their perfections and imperfections, and their sins, if sinners they be. Letters patent of amalgamation do not give absolution. Justice Dickson’s reference to two streams coming together to form a river is an analogy that is often used to describe the consequences of an amalgamation. The metaphor and its consequences are significant because some countries’ business laws do not provide for this kind of fusion of corporate existence, requiring instead that one company’s existence come to an end. The need to terminate a company’s existence may have unintended or undesirable consequences: for example, it may mean that contracts with third parties come to an end and need to be revisited with an eye to determining whether the surviving entity will be able to assume their benefit. This result may prove a cumbersome process at best, and at worst may lead parties to conclude that a merger is not possible because it may mean the loss of a valuable contract. The development of the law on amalgamations in Canada is therefore a very good example of the reasons why a country must show ingenuity and creativity when crafting provisions in a business law statute designed to facilitate mergers and acquisitions. As in a share or asset transaction, the CBCA contemplates that the acquisition may be paid for through either a share or a cash consideration. Thus, CBCA s 182(1)(d) states that the

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amalgamation agreement must set out whether shareholders of an amalgamating corporation are to receive shares in the amalgamated firm or cash. This appears to permit amalgamations to be structured as cash-out mergers, with shareholders of one predecessor firm receiving shares in the successor firm and shareholders in the other predecessor firm paid off in cash. Buyouts are discussed in Section IV.

D.  Other Merger Techniques There are a variety of other methods that may be used to effect a corporate combination.

1.  Plan of Arrangement The CBCA provides for a court-approved plan of arrangement (s 192) that can be used to implement an M&A transaction: see also Ontario Business Corporations Act, RSO 1990, c B.16 (OBCA), s 182, British Columbia Business Corporations Act, SBC 2002, c 57 (BCBCA), s 288, and Alberta Business Corporations Act, RSA 2000, c B-9 (ABCA), s 193. This provision allows parties to have courts approve M&A transactions that cannot readily be effected using standard techniques because it would be impracticable to attempt the transaction without being able to deviate from the procedures that must normally be followed. Frequently, transactions that involve complex structuring designed to achieve a desirable tax outcome will be implemented by way of a plan of arrangement. Plans of arrangements have become an increasingly common way to implement a friendly acquisition of a public company. Indeed, takeover bids (discussed below in Section V) have become less common as a technique for implementing friendly public company acquisitions than they once were, though they remain the tactic most often used to initiate a hostile bid for a public company. Courts typically require shareholder approval of transactions effected by way of plan of arrangement. If a transaction involves a company with multiple classes of securityholders, it may well be desirable to have these classes vote together as a single group— something that it is open to a court to sanction—rather than separately as the CBCA might otherwise require. The procedures that govern plans of arrangement therefore allow a petitioning company a great deal of flexibility with respect to the grouping of votes that it may ask a court to approve, and this is an attractive feature of the provisions. At all times, the court is entrusted with the responsibility of ensuring that the transaction is effected in a fair manner. The onus is therefore on the petitioning party to make the case that its proposed approach is indeed fair. Parties completing an M&A transaction by way of plan of arrangement will typically enter into an arrangement agreement. This will provide for the proposed approvals that need to be obtained. A court will then hold an initial hearing and will issue an interim order setting out the procedures that must be followed. After the security-holders’ meeting is held, the court will then hold a final hearing during which it will assess the fairness of the proposed transaction. An example of a significant transaction that was to be completed by way of plan of arrangement was the leveraged buyout that the Supreme Court of Canada considered in BCE Inc v 1976 Debentureholders, 2008 SCC 69, [2008] 3 SCR 560. Christopher Nicholls makes the following observation about plans of arrangement.

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Christopher Nicholls, Corporate Law (Toronto: Emond Montgomery, 2005) at 455-56 Statutory Arrangements The statutory arrangement procedure in s. 192 of the CBCA has become a very important part of Canadian corporate law practice; but its significance will not become immediately apparent from a simple reading of the statutory language. The word “arrangement” itself may lead some to confuse this procedure (which is regularly used by healthy corporations to effect sophisticated transactions) with statutory measures to which only distressed corporations typically have recourse. Statutory arrangements can be used as a means of structuring business acquisitions and complex reorganizations such as spin offs. A detailed discussion of the specific reasons for pursuing arrangements and the advantages for doing so are well beyond the scope of this book. The only point to be made here is that arrangements may involve the same sort of fundamental change to a business or to a shareholders’ interest as an amalgamation or amendment to the corporation’s articles. However, the CBCA does not automatically accord dissent rights to a shareholder in the case of changes effected by arrangement. The court has discretion under s. 192(4)(d) to grant (or indeed not to grant) such rights to dissenting shareholders. In Re Electrohome Ltd. [(1998), 40 BLR (2d) 210 (Ont. Ct. Gen. Div.)], Spence J, interpreting similar provisions of the Ontario Business Corporations Act, held that dissent rights would not be appropriate in the context of a particular transaction, and included with his reasons a memorandum, which provides useful insight into the sort of considerations that are relevant in such a case. 2.  Reverse Acquisition On a purchase of assets, a large corporation (Bigco) normally purchases a business operated by a smaller company (Littleco). Littleco shareholders must then approve the transaction under CBCA s 189(3) and may, if they choose, dissent under s 190, requiring the corporation to purchase their shares. If this presents a problem, it may perhaps be avoided by reversing the roles and selling Bigco’s business to Littleco. So long as the consideration is Littleco shares and the entire Bigco business and assets are acquired, it makes relatively little difference who purchases whom. The requirement of shareholder ratification and the appraisal remedy will then arise in the case of Bigco, but possibly not Littleco. If Bigco shares are not widely held or if Bigco is incorporated in a jurisdiction that lacks an appraisal remedy, this may be a very real advantage.

3.  Triangular Merger A triangular merger is one that involves a subsidiary of one of the merging corporations. For example, Bigco might prefer to amalgamate Littleco with one of Bigco’s subsidiaries. This would offer several advantages. Bigco would be insulated from Littleco’s liabilities, which would be assumed by the amalgamated corporation. The transaction would not have to be approved by a shareholder meeting of Bigco, and Bigco’s shareholders could not assert the appraisal remedy. Thus Bigco could form a subsidiary and issue the subsidiary’s shares to

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Littleco shareholders in the amalgamation. Alternatively, in order to make the amalgamation more palatable to them, Littleco shareholders might be issued shares of Bigco itself and not of the new subsidiary. This is sometimes done in the United States by having Bigco create a subsidiary and then transferring Bigco’s stock to the subsidiary. However, this device is complicated in Canada by the presence of provisions like CBCA s 30(1), which prohibits a subsidiary from holding a parent’s shares (a provision found in some but not all Canadian corporate statutes).22 A triangular merger may perhaps be accomplished under CBCA s 182(1)(d), which expressly contemplates that shareholders of an amalgamating corporation may receive securities of a corporation other than the amalgamated corporation. This might then permit Littleco shareholders to receive Bigco shares on the amalgamation, without a prohibited issue of the parent’s shares to the subsidiary. Because the Bigco shares are not held by its subsidiary prior to the amalgamation, they must be issued by Bigco in return for further Littleco shares.

III.  APPRAISAL REMEDY Under CBCA s 190, shareholders who wish to dissent in respect of certain kinds of transactions have the right to require the corporation to repurchase their shares rather than having to hold shares in a new entity in which they do not wish to hold an interest: see also OBCA s 185, BCBCA s 244, and ABCA s 191. These appraisal rights are triggered by “fundamental” corporate transactions, such as amalgamations and sales of substantially all of the firm’s assets. Appraisal rights may therefore be seen as a trade-off for the loss of individual veto rights, which shareholders had when corporate laws required that these transactions receive unanimous approval. Thus, a firm may now amalgamate over the wishes of dissenting shareholders, but the amalgamation is only effective if approved by special resolution, with appraisal rights for dissenters. The introduction of liability consequences as a result of the appraisal remedy replacing veto rights mitigates the problem of a transaction being blocked by a rump group of shareholders who refuse to approve the deal. But the appraisal remedy creates its own costs. The principal cost is the corporation’s need to stay liquid to meet appraisal claims. In some cases, the firm may be quite prepared to buy back shares, even if valuation uncertainties in what is likely already an exceedingly complicated transaction will impose their own costs. But in some instances the possibility of large appraisal claims may deter a firm from embarking on a transaction. Evidence of this is provided by conditions frequently found in amalgamation agreements that the transaction may be abandoned if a specified number of shareholders (often 5 percent) decide to appraise out. The remedy is also in many ways of limited benefit to a shareholder. If he or she does not appraise out on a share-for-share amalgamation, the issue of shares by the amalgamated corporation will not be taxable. But moneys paid on an exercise of the appraisal remedy may give rise to taxable dividend or taxable capital gains treatment. Furthermore, without a lawyer, a shareholder will find it difficult to understand how to assert appraisal rights. The

22 The BCBCA is an example of a statute that provides for more flexibility in this regard: see specifically s 85, which permits a subsidiary to purchase or acquire shares of its parent.

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procedure is highly technical, with several distinct steps to be completed in limited time periods. One can be forgiven for thinking that the appraisal remedy was designed to ensure that it would be infrequently invoked. If this is so, then the objective was largely successful since the remedy is in fact rarely invoked in Canada. Appraisal rights do not arise unless the shareholder dissents or abstains at the meeting and sends a written objection under CBCA s 190(5) to the corporation at or before the shareholders’ meeting. The appraisal remedy is not triggered by this written objection and the shareholder must still send a demand for payment to the corporation within the 20-day period of s  190(7) before it has a duty to repurchase the shares. Dissenting shareholders must also return the share certificates under s 190(8) within 30 days thereafter. If an offer is made by the corporation, the shareholder has 30 days to accept it under s 190(14). If no offer is made, or if the offer is rejected, the corporation can bring the matter to court, failing which the shareholder has a 20-day period to do so under s 190(16). Failure to perform any step within the allotted time may result in the loss of appraisal rights, although courts sometimes do not interpret these requirements strictly.23 A further cost arises due to the time all this will take, during which the investment is frozen. After the demand for payment is sent in, the dissenting shareholder loses any rights to participate in the corporation under s 190(11). A shareholder may also be called on to pay expert witness fees in any dispute as to the true value of the shares. Given these costs, a shareholder may simply prefer to sell his or her shares on the market, rather than assert appraisal rights. Even with these costs, however, the appraisal remedy still finds its defenders. The following extract from Melvin A Eisenberg, “The Legal Roles of Shareholders and Management in Modern Corporate Decision Making” (1969) 57 Calif L Rev 1 at 85-86, summarizes the conclusions of one of the leading advocates of appraisal rights: It has already been seen that the appraisal right presents many difficulties from the shareholder’s perspective: It is always technical; it may be expensive; it is uncertain in result, and, in the case of a publicly held corporation, is unlikely to produce a better result than could have been obtained on the market; and the ultimate award is taxable. It is, in short, a remedy of desperation—generally speaking, no shareholder in a publicly held corporation who is in his right mind will invoke the appraisal right unless he feels that the change from which he dissents is shockingly improvident and that the fair value of his shares before the change will far exceed the value of his shares after the change. But may not the existence of just such a right—a switch which will be pulled only in case of emergency—be desirable in connection with transactions of the utmost gravity, in which self-interest and lack of investment skills may seriously obscure management’s vision?

Eisenberg regards the appraisal remedy as a no-fault buyout right, where a shareholder who suspects oppression may exercise a “put” option—that is, may put his or her shares to the company—by requiring the corporation to repurchase his or her shares without demonstrating unfairness. On this analysis, the appraisal remedy can be justified only if the list of triggering transactions corresponds to those circumstances where oppression is most to be feared, and a prophylactic remedy is preferred to one that requires proof of oppression.

23 See Re Domglas Inc (1980), 13 BLR 135 at 157-58 (Que SC).

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However, the list of triggering transactions in s 190 seems imperfectly correlated with real shareholder concerns. For example, is an amendment to the firm’s objects clause really of such fundamental importance that shareholders should be permitted to assert appraisal rights? If the true fear is of self-dealing, should appraisal rights instead be offered whenever the firm enters into an interested director’s contract?

A.  The Market Exception Appraisal rights may be most useful to shareholders in close corporations, where no market exists for the shares. In a widely held firm, shareholders may prefer to sell their shares on the market rather than absorb the costs associated with appraising out. The OBCA formerly restricted the appraisal remedy to non-public offering corporations, and in the last 30 years approximately 20 states, including Delaware, have abolished appraisal rights for firms whose shares are listed on a stock exchange or are widely traded. The market exception was, however, deleted in the OBCA and never appeared in the CBCA. QUESTIONS

1.  It is often said that companies in Canada have more controlling shareholders than those in the United States. Is this a reason to retain the appraisal remedy? 2.  Is the case for retaining an appraisal remedy stronger or weaker under the mediating hierarchy theory of the corporation seen in Chapter 9? Under the theory of the corporation as publicly accountable wealth creator seen in Chapter 9?

Report on Mergers, Amalgamations and Certain Related Matters (Toronto: Ontario Select Committee on Company Law, 1973) at 52 Most of the corporation statutes in the United States provide that the dissenting shareholder is entitled to receive the “value” or the “fair value” of his shares. In the case of the shares of corporations listed on a stock exchange or actively traded in the over the counter market, what is such value? The experience in the United States would seem to indicate that the courts, in most instances, have refused to go beyond an enquiry as to the market price of the stock on the date determined to be relevant. Where the shares of a corporation are not actively traded, or there is no market at all, the determination of value or fair value is more difficult and a court must then come up with its own estimate of value using whatever techniques for value it deems appropriate. If, in the case of a corporation whose shares are actively traded, the criterion of value or fair value is the price put on the shares by the market, one may question the value of an appraisal remedy except perhaps in the situation where the market has taken a sudden drop in reaction to the proposed transaction. While in theory the appraisal remedy may, in the case of shares which are actively traded, seem to give dissenting shareholders the benefit of an independent valuation, it is extremely doubtful that courts in Canada would do more than seems to have been the case in the United States, i.e., accept the value placed on the stock by the investing public.

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B.  Valuation of Dissenters’ Shares One of the greatest difficulties surrounding the appraisal remedy involves determining the value of dissenters’ shares. This is particularly challenging if the shares are not traded widely or actively. Until recently, courts in Delaware applied a weighted average method of valuation, under which various elements of value—for example, dividends, market and asset values, and earnings—were each assigned a particular weight. There was often little satisfactory explanation of how a figure was chosen for any one component of value, although a consistently high weight was placed on asset or book value, which ordinarily was higher than market or earnings values.24 As a result, the Delaware “block,” as the weighted average test came to be called, gave dissenting shareholders a greater return than they would have received had they sold their shares on the market. Canadian courts also place a heavy emphasis on asset and earnings value, in effect awarding the dissenter a premium over market value. There are exceptions to this. Where there were no allegations of unfairness and the shares were widely traded, a market value of $16.50 for Shell Canada Ltd was accepted in place of an alleged asset value of $28.50 in Montgomery and Montgomery v Shell Canada Ltd (1980), 111 DLR (3d) 116 (Sask QB). The plaintiff held 550 of the 63,840,000 Class A common shares of the corporation and dissented from an innocuous resolution authorizing the creation of a new class of preferred shares. Estey J stated that asset value should be discounted when a corporation is a going concern and its shares are actively traded. The identification in Montgomery of fair value with market value has much to commend it. If an appraisal premium was systematically offered to dissenting shareholders, they would be given an incentive to appraise out in triggering transactions, which might then be abandoned by the firm, even if wealth-maximizing. In Silber v BGR Precious Metals Inc (1998), 41 OR (3d) 147 (Gen Div), Ferrier J stated that “the dissent remedy is present as a safeguard, not a bonus.” This suggests that strategic assertions of the appraisal remedy may be feared unless market price is taken to reflect the value of widely held shares. In addition, the market price of widely traded shares may ordinarily be presumed better informed than the mythic “intrinsic” value discovered by a court. Several arguments have, however, been made for second-guessing market value, and these must now be considered. First, market value may be discounted as a measure of firm worth if the shares are thinly traded. A stock market listing does not always entail a broad market for the shares, with investment intermediaries absorbing substantial screening costs to determine firm value. The judgment of insiders concerning firm value is then more likely to diverge from the market’s judgment than in the case of a widely traded firm. In addition, the information presented to a court about firm value in such cases is largely in management’s hands, so that assigning a relatively high weight to asset value (where it exceeds market value) may be thought to be a reasonable response to business realities. After all, management is unlikely to argue that the firm is undervalued on the market when the appraisal remedy is asserted.

24 See Note, “Valuation of Dissenters’ Stock under Appraisal Statutes” (1966) 79 Harv L Rev 1453 at 1468-71.

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The second argument for second-guessing market value is that it may be depressed simply because the dissenters wish to sell their shares. For this to happen, the block of shares would have to be considerable, since the demand for widely traded shares is generally elastic. In other words, a change in the number of demanders will ordinarily not significantly affect market value. Even if sales by some large shareholders (usually institutional investors) might in fact alter the market price, the dissenters will no doubt have taken this into account when first purchasing the securities. The empirical evidence indicates that the magnitude of the price depression on a sale of a large block of securities is typically no more than a few percentage points of stock price, and on average is less than 1 percent.25 Block trades made at prices lower than those that prevailed prior to the trade may be attributed to the signalling effect of the trade. The fact that a major investor wants out may reveal information about the firm’s declining prospects.26 It may also be argued that market value should be discounted because the market will already have reacted to the transactions that triggered the appraisal rights. Prior to 1979, shareholders were entitled to sell out at pre-adjustment prices, since the CBCA specifically excluded “any change in value reasonably attributable to the anticipated adoption of the resolution” from the court’s determination of value.27 Since the dissenting shareholder has objected to the particular transaction, this may at first glance seem reasonable. However, disagreements about corporate policy are unlikely in the case of widely held firms whose shareholders are passive investors. Even if policy differences are observed, moreover, this may not justify granting appraisal rights unless management’s investment policies are so improvident as to diminish market price. In the absence of management misbehaviour, then, an investor who disagrees with management might be left to his exit option of selling out on the market. On the other hand, where the triggering transaction might appear to give rise to fairness concerns, there may be a stronger reason to discount market value as at the date of the resolution. Under Canadian statutes, the valuation of dissenters’ stock is generally made as of the date of the resolution, and not as of a time prior to the announcement of the transaction. BCBCA s 237(1) provides that the value to be paid is to exclude “any appreciation or depreciation in anticipation of the corporate action approved or authorized by the resolution.” As presently worded, CBCA s 190(3) appears to echo the BC provision, since fair value is to be determined “as of the close of business on the day before the resolution was adopted or the order was made.” By that time, market price would have reacted to news of the change. 28 In Silber v BGR Precious Metals, above, the dissenting shareholders acquired their shares after the company’s announcement of the proposed fundamental change. The court stated that “[a]ll shareholders in a situation like this have a right of dissent, regardless of the time of purchase.”

25 See Jeffrey MacIntosh, “The Shareholders’ Appraisal Right in Canada: A Critical Reappraisal” (1987) 24 Osgoode Hall LJ 201 at 218-19. 26 See e.g. Myron S Scholes, “The Market for Securities: Substitution Versus Price Pressure and the Effects of Information on Share Prices” (1972) 45:2 J Bus 179. 27 See Neonex International Ltd v Kolasa (1978), 84 DLR (3d) 446 at 452, [1978] 2 WWR 593, 3 BLR 1 (BCSC). 28 But see Canadian Gas & Energy Fund Ltd v Sceptre Resources Ltd, [1985] 5 WWR 43 at 57 (Alta QB) (market value not adopted on a CBCA appraisal because the market had reacted to the triggering transaction).

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Courts have, however, circumvented these provisions in buyout transactions. In fact, a large number of appraisal cases arise in cash-out mergers, where all that is at issue is the adequacy of the payout. If one motive for the buyout is an insider’s desire to acquire shares on the cheap in what amounts to insider trading, this might be thought to justify secondguessing market price. In such cases, management also has an incentive to depress market price—for example, through non-disclosure of good news concerning the firm, since this will decrease the purchase price of the shares to be acquired. These considerations suggest an explanation of why Canadian and American courts have in recent years granted dissenting shareholders a special premium in cash-out mergers. The first such case was Re Domglas Inc (1980), 13 BLR 135 at 228-29 (Que SC), aff’d (1982) 138 DLR (3d) 521 (Que CA), where Greenberg J awarded dissenting shareholders a 20 percent premium. He stated at pp. 222-23: In legislating the term “a fair value,” Parliament conveyed upon the Court the equitable jurisdiction and the obligation to fix a value which is fair, just and equitable, having regard to all of the circumstances; including, in particular, a situation which is tantamount to an expropriation of the shares held by the minority shareholders. •  •  •

In cases of the “squeeze-out” of the dissenting shareholders, which is equivalent to an expropriation, “fair value” goes beyond the concept of “intrinsic value,” in that the former must include a premium for forcible taking, and is not subject to a minority discount. In this Court’s opinion, in a “squeeze-out” situation, as exists in the case at Bar, the absence of a discount in valuing a minority holding and the increment or premium for forcible taking are the essence of the distinction between “fair market value” and “fair value.” The Court will, therefore, first calculate and establish the “fair market value” of the dissenting shareholders’ shares; and from there go on to fix “a fair value” for those shares. •  •  •

The payment by the petitioner of “a fair value,” even if more than the “intrinsic value” of the shares, is the price that must be paid by it for the privilege of effecting the amalgamation over the protest of the dissenting shareholders, who in effect are being ousted from the corporation.29

In Ford Motor Co of Canada v Ontario Municipal Employees Retirement Board (1998), 36 OR (3d) 384 (CA), the Ontario Court of Appeal stated that “[t]he rules [under the appraisal remedy] should be interpreted so that corporations are encouraged to make a true fair value offer, not an offer premised on the corporation’s view as to the minimum value that might be set after the prolonged and complex litigation that s 185 [OBCA] applications appear to engender.” A buyout premium would also have been awarded in Weinberger v UOP, Inc, 457 A (2d) 701 (Del 1983), where the defendant’s majority shareholder sought to eliminate minority shareholders in a cash-out merger. Although the plaintiff had not sought an appraisal, but rather rescissionary damages, the chancellor held that the weighted average method of valuation should be employed. On appeal, the Delaware Supreme Court, at 713, rejected the “mechanistic procedure” of the Delaware block, preferring instead “a more liberal approach [that] must include proof of value by any techniques or methods which are generally considered

29 See also Les Investissements Mont-Soleil Inc v National Drug Ltd, [1982] CS 716 (Que Sup Ct).

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acceptable in the financial community and otherwise admissible in court.” One of the factors that a court might then take into account is the nature of the triggering transaction, because when a dissenter objects to a cash-out merger he or she may be entitled to a premium for his or her shares. Whether this means that shareholders in Delaware firms will obtain more when they appraise out on a cash-out merger is by no means clear. The Delaware block already gives shareholders a premium through heavy weighting of asset value. If asset value is discounted and a premium granted, the end result may be that shareholders are left no better off. The same may not be true in Canada, however, if a premium over an already inflated asset price is granted. If the Delaware block was prompted by a fear of cash-out mergers, a further Domglas premium might chill efficient buyouts of minority shareholders. Moreover, the premium would be reflected in a higher issue price of shares, so that shareholders would pay for the premium on purchase of their shares.

IV.  BUYOUTS AND GOING-PRIVATE TRANSACTIONS The techniques by which a firm acquires all or substantially all of its outside shareholder interests—and thereby ceases to be widely held—are described as “buyouts.” Buyout techniques are also described by a variety of other terms—for example, “freezeouts,” which are transactions where insiders require outside shareholders to sell their shares to the corporation. The net result of the freezeout is that inside shareholders are left in control of the firm. While “buyout” refers generally to all transactions in which outside shareholders are eliminated, “freezeout” is the more specific term, describing compulsory acquisition techniques. Buyouts are also frequently referred to as “going-private transactions,” although that term more narrowly describes the transformation of the corporation from a widely held firm to a closely held firm. When this happens, the corporation will delist from stock exchanges on which its securities are traded, and seek exemptions from disclosure requirements under securities and corporations statutes. Freezeouts are, therefore, going-private transactions, although not all going-private transactions are freezeouts. For example, a firm may delist after shares are repurchased on an issuer bid, with all but a few shareholders tendering their shares. However, if the shares of the remaining outside shareholders are not compulsorily reacquired, they will not have been frozen out. When shares are acquired in a “management buyout,” residual value is transferred from outsiders to an insider team of managers. This kind of transaction is therefore to be distinguished from one in which the shares come to rest in the hands of a major shareholder. The shareholders whose shares are so acquired may be either widely dispersed or else concentrated in a major shareholder. In the latter case, the management buyout sometimes occurs when a parent shareholder seeks to dispose of one of its divisions.30

30 See Jody S Langhan, “Wealth Effects and Agency Conflict in Division Management Buyouts” (1996) 54 UT Fac L Rev 193.

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If, as is usually the case, the transaction is financed by large loans or other forms of debt, it is also called a “leveraged buyout.” This refers to a buyout that leaves the firm with a high ratio of debt to equity, frequently after the issue of junk bonds—that is, bonds with a high interest rate that are issued to pay back banks that initially lend the funds used to effect the acquisition. Management buyouts are sometimes followed a few years later by a public issue of shares at a price that represented a substantial profit for management. Management may seek to freeze out minority shareholders through a variety of methods, some of which have been seen already. The following is a non-exclusive list of such methods: • Pursuant to a statutory power of expropriation.  See CBCA s 206, discussed below in Neonex International Ltd v Kolasa (note that at the time that Neonex was decided, the relevant provision was numbered CBCA s 199). As a matter of procedure, this is the most difficult method of going private, since it requires the concurrence of minority shareholders holding 90  percent of the shares held by the minority shareholders. • Amalgamation.  This involves a statutory amalgamation of the corporation with a shell corporation that is wholly owned by the principal shareholder. In the amalgamation, the minority shareholders are given redeemable preference shares and the majority shareholders are given common shares. The preference shares are redeemed for cash immediately thereafter by the amalgamated entity and the minority shareholders are thereby eliminated. This is a strategy that is commonly used after a takeover bid in which the acquiror has secured slightly less than the 90 percent that would otherwise entitle it to use the statutory power of expropriation: see e.g. the strategy used in Neonex International Ltd v Kolasa, reproduced below. • Arrangement.  A cash-out amalgamation may also be effected pursuant to CBCA s 192 or similar arrangement provisions in other statutes. Instead of an amalgamation, the arrangement may involve a stock split under which a certain number of existing shares—for example, 1,000 or 10,000—are reclassified as 1 new share, with fractional shares then being eliminated. The objective in setting the reclassification ratio is to choose one that will eliminate most or all smaller shareholders who hold less than the relevant number of shares needed to end up with at least 1 whole share. This is referred to as a reverse stock split. Arrangements under CBCA s 192 differ from s 181 amalgamations in that, in the former case, judicial approval is expressly required. • Amendment to the articles.  CBCA s 173(1)(g) specifically provides for reclassification of shares. The shares may then be changed into redeemable shares, which are convertible into a new class of shares. The principal shareholder (and some minority shareholders) will convert its shares, while the other shareholders will be redeemed out at an attractive redemption price. • Sale of assets.  A corporation may sell its assets to an affiliate for cash or redeemable preference shares. The vendor corporation would then go into dissolution and distribute the consideration to its shareholders. A sale of substantially all of the assets triggers the appraisal remedy, but a dissolution does not. For a further discussion of buyout techniques, see George C Glover Jr & Alan M Schwartz, “Going Private in Canada” (1978) 3 Can Bus LJ 3.

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Neonex International Ltd v Kolasa (1978), 84 DLR (3d) 446, [1978] 2 WWR 593, 3 BLR 1 (BCSC) BOUCK J:  Neonex International Ltd. is applying by way of petition pursuant to s. 184(15) of the Canada Business Corporations Act, 1974-75-76 (Can.), c. 33 (the “CBCA”), for an order:



1. Fixing the fair value of certain shares for those respondents who dissented to a scheme of amalgamation, and 2. For directions regarding entitlement if any of the remaining respondents to be paid for the value of the shares formerly held by them. The respondents McCartney and Sladden are two of the dissenting shareholders. They ask for an adjournment of the petition for the purpose of obtaining further information from the petitioner as to the fair value of the shares. Because it was impossible to know whether the respondents were entitled to an adjournment without knowing the nature of the claim, the whole of the facts and the law giving the rights of the petitioner to apply and the rights of the respondents were fully argued before me by counsel. I am grateful to them for their thorough and thoughtful presentations. Facts There are or have been two separate corporations called Neonex International Ltd. Prior to November 1, 1977, it carried on a variety of enterprises across Canada. On that latter date it amalgamated with Jim Pattison (British Columbia) Ltd. (“J.P.L.”) and out of this merger arose a new company bearing the identical name—Neonex International Ltd. For convenience it will be appropriate to refer to them as “Old Neonex” and “New Neonex.” Old Neonex existed prior to November 1, 1977, and New Neonex came into existence after that date. On September 8, 1977, Old Neonex sent a 67-page management proxy circular to its members. Its purpose was to inform the shareholders of the reason for a special meeting set for September 30, 1977, in Winnipeg. In this circular was a copy of an unsigned amalgamation agreement made as of October 3, 1977. The parties to the contract were J.P.L. and Old Neonex. By its terms the two companies agreed to amalgamate upon the approval of their respective shareholders. J.P.L. was wholly owned by a Mr. James A. Pattison through a company called Jim Pattison Holdings Ltd. (“Holdings”). At the time of the proposed amalgamation Pattison alone, or through associated companies which he controlled, also held 46.5% of the shares of Old Neonex. Each shareholder of Old Neonex other than Pattison could elect to receive either $3 in cash for one share or a non-voting preference share in New Neonex with a stated capital of $3. Pattison agreed to exchange the 46.5% interest he held in Old Neonex for preference shares in New Neonex. The two companies who were parties to the amalgamation agreement also contracted to exchange the 3,866,667 common shares of J.P.L. held by Holdings for 3,866,667 common shares of New Neonex. Through these manoeuvres Pattison then became the direct owner of 100% of the equity capital of New Neonex.

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The meeting of the shareholders of Old Neonex took place in Winnipeg on September 30, 1977. At that time the company had an authorized capital of 14,000,000 common shares. Of these 7,214,748 were issued. Only 5,381,660 votes were cast; 302,588 (5.6%) voted or were deemed to have been voted against the special resolution. Pattison’s 46.5% controlling interest represented approximately 3,354,857 shares or 62.3% of the votes cast in favour of amalgamation. All that was required to complete the transaction was a special resolution of the shareholders of Old Neonex and J.P.L. Section 2 of the CBCA defines a special resolution as a resolution passed by a majority of not less than two-thirds of the votes cast by the shareholders. Since Pattison held 62.3% of the shares present at the meeting and since all that was required was a vote by 662⁄ 3%, it was not difficult to achieve this percentage. And so on November 1, 1977, a certificate of amalgamation was issued. Old Neonex had retained earnings of $23,649,000. After amalgamation the retained earnings of New Neonex were stated to be $7,943,000. A number of unexplained accounting entries in the pro forma balance sheet of the consolidated companies left me with the impression that these retained earnings were used by Pattison to purchase the other 53.5% of the shares of Old Neonex. In other words the shareholders’ own money in the form of retained earnings was spent to buy their shares. It looks as if it cost Pattison nothing. The respondents objected to the resolution of amalgamation and this triggered the dissent provisions of the CBCA. Prior to amalgamation and after, Old Neonex and New Neonex carried on many kinds of enterprises either directly or through associated or affiliated companies. In the jargon of the trade it could be called a conglomerate. One segment referred to as the Consumer Products Division operated 42 self-serve supermarkets and five discount food markets in British Columbia. Another division manufactured and distributed mobile homes, travel trailers and the like in Western Canada and New Brunswick. The Service Industry Division manufactured, sold and leased electric signs throughout Canada and outdoor advertising displays in British Columbia. In 1976 and 1977 Old Neonex acquired a total of 41% of the common shares of Crush International Ltd. of Toronto for about $22,000,000. Crush produces and distributes soft drink concentrates to over 60 countries around the world. As well, Old Neonex owned real estate in Canada and the United States of America. The book value of Old Neonex as at December 31, 1976, was $4.21 and as at June 30, 1977, $4.10. The common shares of the company were traded on the Toronto and Vancouver stock exchanges. From the first quarter of 1975 until the end of the second quarter in 1977 they had a high of $2.40 per share and a low of $1.04 per share. There was conflicting affidavit evidence filed by both parties as to whether or not the market was controlled by the insiders during 1977. The inference I was asked to draw was that the market price was therefore artificial. Since it is impossible to decide this issue on conflicting affidavits I cannot reach such a conclusion. However, on the petitioner’s own material for the period January, 1975 to July, 1977, 2,155,373 shares were traded on the Toronto Stock Exchange and of these 494,223 were sales or purchases by insiders. Following the issuance of the certificate of amalgamation on November 1, 1977, the board of directors of New Neonex decided the fair value of the common shares to be purchased from the dissenting shareholders was not $3 per share but only $2.50. Accordingly, on November 8, 1977, New Neonex caused to be sent to the shareholders who had

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not accepted the offer of $3 and who had dissented in accordance with the provisions of the CBCA another offer, of $2.50 per share. This was not acted upon. At the hearing before me counsel for the petitioner stated the offer had now been amended and the original one of $3 per share restored. The respondents McCartney and Sladden oppose the petition. They ask for further information so they might decide whether $3 does in fact represent the fair value of their shares. They also move for the appointment of an appraiser pursuant to s. 184(21) of the CBCA. Law The CBCA is a relatively new statute which was enacted in 1975. It replaced the Canada Corporations Act, RSC 1970, c. C-32. A comparison between the previous legislation and the new Act in relation to the so-called forcing-out provisions and amalgamation may be helpful. … First of all, the forcing-out sections: By s.  136 of the 1970 legislation, 90% of the shareholders could approve a contract to transfer their shares to a purchasing corporation. Should any of the shareholders representing not more than 10% of the issued shares dissent to the proposal, they could then apply to the Court to stop the sale. It is important to remember the 90% majority meant just that and not 90% of the votes counted at a meeting of the shareholders. In the latter instance only a minority of shareholders might attend the meeting and so Parliament decided, meeting or no meeting, the approval must be based on 90% of the issued shares. When a minority applied to the Court to stop the sale the ground rule was to place the onus of proof on them to establish the terms of the sale were unfair. Discovery was not allowed. The theory was that since 90% had accepted the offer this gave considerable weight to its fairness. Furthermore, the takeover could not be completed until the dissenters either settled or were ordered to transfer their shares by the direction of the Court. The Supreme Court of Canada in Esso Standard (Inter-America) Inc. v. J.W. Enterprises Inc. et al. (1963), 37 DLR (2d) 598, [1963] SCR 144, commented upon these provisions. They held the 90% required must be made up of shares independently held. It could not include shares held by the offering company. The same idea has been carried forward into the CBCA, Part 16, s. 199. Parliament also adopted the common law interpretation set out in the Esso Standard case. When proceedings are taken under Part 16 to fix the fair value of a dissenting shareholder a Court is given very wide powers. In fact it may “make any order it thinks fit” during the course of the litigation. Now to amalgamation: Section 137 of the Canada Corporations Act also had a code of procedure which two companies were required to follow if they proposed to amalgamate. Generally speaking, the arrangement required the approval of 75% of the votes cast at a meeting called for the purpose of approving an amalgamation agreement. A dissenter holding at least 10% of the shares could apply to a Court to set aside the agreement of amalgamation which had been approved by the majority. If no such action were taken the two companies could then ask the Minister to issue new letters patent in the name of the amalgamated company.

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If a dissenter succeeded in his opposition to the amalgamation it was annulled. If he failed he had no right to anything more than what the amalgamation agreement provided. The 1970 Act did not allow a company to purchase its own shares. An amalgamation such as this one could not have taken place because the statute would have prevented Neonex from buying out its own shareholders. Besides these changes, significant alterations have been made to the law on amalgamation by other sections of the CBCA. First of all, a shareholder may now dissent to an amalgamation and be paid the fair value of his shares (s. 184). Before, a successful action by a dissenting shareholder resulted in the annulment of the amalgamation agreement but he was not entitled to be bought out. Secondly, an amalgamation agreement may now be approved by 662⁄ 3% of the shareholders and not 75% as was the previous requirement (s. 176(5)). Thirdly, once the amalgamation agreement is approved by the shareholders and new articles of association filed with the Director of the Act, the amalgamation is achieved upon his issuance of a certificate (ss. 179, 180). Before, a certificate of amalgamation might be held up when there were proceedings before the Court. Now, the fact that some of the shareholders have dissented and applied to the Court for relief does not by itself prevent the amalgamation from going ahead. Since the Director has issued his certificate of amalgamation no complaints can now be raised so as to prevent the amalgamation from proceeding. The matter is closed. There is no way it can be undone. Parliament decided to grant a controlling shareholder an easier way to force out the minority than was previously the case. Pattison accepted the offer. The legality of the amalgamation is not in question. Its morality is for others to assess. William Kolasa appeared in person. He had no law books nor any particular legal point to make but what he had to say goes to the heart of the matter. I can only paraphrase his comments since no court reporter was present. Nor can I reproduce on paper the deep sense of hurt which was evident in his remarks. He said: The leaders of this country have asked us all to invest in Canada as good citizens. My wife and I took our savings and bought shares in Neonex for over $5.00 each. Now we are told we must sell them for $3.00. We seem to have little choice. Why is this so?

Why indeed. The reason for these new provisions is not clear because it would seem the 90% forcingout method (s. 199) is redundant. A majority shareholder need not bother using that process when the same result can be achieved with only a vote of 662⁄ 3% of those present at a meeting. What is more the instigator of the takeover can even count his own shares in arriving at the 662⁄ 3%. If Pattison had been compelled to follow the normal forcing-out provisions enunciated in s. 199, a variety of protective mechanisms would have been available to the minority which are not available on amalgamation. In particular there is no definition of fair value in the s. 199 procedure. It is at least arguable that the fair value should reflect any benefit the majority might receive by reason of the takeover. However, where a Court is called upon to assess the fair value of a dissenter’s shares on an amalgamation such as this, the calculation must be determined at the close of business on the day before the

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amalgamation resolution was adopted (s. 184(3)). Any change in value reasonably attributable to the anticipated adoption of the resolution must be excluded. This seems to mean that any benefits Pattison gained by the amalgamation cannot be taken into consideration when valuing the dissenter’s shares. Such a result is in direct contradiction to the earlier legislation because where two companies amalgamated under that statute the minority shared any benefits given the majority in the amalgamated company. It was a pro rata distribution of shares amongst all the shareholders and not a confiscation of their shares at a fixed price. I have outlined the facts in the very barest of detail. Eventually witnesses will be called and all of the evidence presented for analysis. There are several reasons for pursuing such a course. They are not necessarily based on previous case law because this is an entirely new statute which requires a somewhat different approach. Counsel for the petitioner submitted the material was adequate enough to determine summarily the fair value of the shares without further evidence or argument. In support of his position a number of cases were cited to me which were decided under the earlier 90% forcing-out sections. They included such authorities as Esso Standard (Inter-America) Inc. v. J.W. Enterprises Inc., supra; Re Hoare & Co., Ltd., [1933] All ER Rep. 105; Re Press Caps Ltd., [1949] Ch. 434. Because of the unique and different nature of the new legislation it is my respectful opinion these decisions do not apply. New ground must be plowed and new principles enunciated. If a shareholder wants to acquire all the other shares in the company by using the amalgamation sections rather than the forcing-out provisions then the law will be particularly concerned over the rights of the dissenters. Their property is being expropriated. It has always been the policy of the common law to protect the rights of the minority as against the abuse of an unreasonable majority. This is more so where an individual’s property is being taken by the majority and it is claimed there has not been adequate compensation. If Parliament intended to deprive the minority of these common law rights then the law demands the statute say so in the most clear and unequivocal language. Otherwise, the common law will blossom through the cracks and crevices of the legislation and try to ensure that justice is done. Because of these principles and because of the facts which I have enunciated, a heavy burden rests upon Neonex to show that it has offered the dissenters a fair value for their shares. Any reasonable argument the dissenters may present calls for an inquiry. Unlike the earlier forcing-out legislation it should not be assumed the majority is entitled to its way simply because of a 662⁄ 3% approval. The respondents’ submissions which have persuaded me they must be given a hearing are as follows:

1. At the time of the meeting the book value of Neonex shares was $4.10. No convincing explanation was set out in the information circular as to why the fair value should be $1.10 less than the book value. 2. There are at least four ways of valuing shares in a company: (a) Market Value: this method uses quotes from the stock exchange. (b) Net Asset Value: this takes into account the current value of the company’s assets and not just the book value.

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(c) Investment Value: this method relates to the earning capacity of the company. (d) A combination of the preceding three. The information circular did not specify in any detail under these separate headings an assessment of the fair value using each method. The material attempted to support the offer of $3 mainly on a comparison with the market price, which was something less. That is insufficient, particularly where a large block of controlling shares amounting to 46.5% is lurking in the background. Such a block must have had some depressing effect upon the true or fair value of the stock. 3.  Pattison controlled Neonex. He derived substantial benefits because of the amalgamation. It would be naive to think that he detailed all the facts in the information circular which illustrated the highest fair value for the shares. His interests were to offer as little as was reasonably possible. $3.00 may represent the fair value of the shares, but the dissenters should not be compelled to accept Pattison’s assurances on blind faith and untested evidence. What is the next step? The petitioner has asked the court to fix a fair value. The respondents want an adjournment so they can get further information. They also ask for the appointment of an appraiser. Where an amalgamated company has only one easily appraised piece of property, the appointment of an independent appraiser might be appropriate. It is not suitable for this kind of a complaint due to the complex nature of the operations of New Neonex. Many practical problems come to mind if the respondents’ suggestion is followed. For example, who would pay the cost of the appraiser during the course of such an inquiry? Costs are a creature of statute and not the common law. An appraiser could take months or years conducting an investigation. Generally speaking, the rules and procedure of this Court only allow an award of costs at the conclusion of a proceeding. They cannot be advanced part way through to help finance the other side’s claim or defence. From whom would the appraiser take his instructions? Not from the Court, because it must remain impartial if it is to perform its proper function. If the Court did appoint an appraiser where does the onus of proof lie? Whose witness is the appraiser? What happens if his evidence is shown to be erroneous? What other evidence would the Court then have to reach a decision? Our procedure, our rules of evidence and our adversary system cannot adjust to the kind of inquiry as recommended by the respondents. Although it may be tempting to embark upon a hearing of this nature and see if it can be done, I believe the wisest course is to stick to what has been tried and tested in the past. In the long run it will be less expensive. There are seriously contested issues of fact to be resolved. A petition is not an appropriate vehicle to handle this kind of a dispute. Issues are not crystallized as in an action because pleadings are not exchanged. Consequently discovery, if allowed, is unwieldy and the advantages of testing the admissibility of evidence on the basis of the issues as raised in the pleadings is lost. Trials drag on. More time is spent in argument than in resolution.

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Therefore I intend to order the petition be converted into an action. One side will be the plaintiff and the other the defendant. At first I was inclined to think the respondents should be the plaintiffs because it was in their interest to move the matter along. But on reflection it seems this would place the burden of proof upon them. They would have to show the fair value was not $3 but something more. All the petitioner would have to do is to defend the allegation. That would be unfair. The better, but not the perfect answer is to put the petitioner in the position of the plaintiff and require that it proves the fair value of each share is in fact $3. Through discovery of documents and examination for discovery the respondents will be able to inquire into the basis of the petitioner’s evaluation. I quite appreciate the financial burden this may place upon the respondents. Also, I am not overlooking the obvious. It will be in the petitioner’s interest to try and prove the fair value was something less than $3. There is no particular answer to this dilemma which has been created by the legislation. Since the Act does not shut out the dissenters’ right to a trial it seems to be the only common law remedy left available to them. NOTES AND QUESTIONS

1.  Ignoring votes cast by Pattison or corporations controlled by him, what percentage of minority shareholders of Old Neonex voted in favour of the special resolution? To what extent does this provide evidence of the fairness of the amalgamation? The question is important because it is often said that if a majority of shareholders other than the one who will end up controlling the company vote in favour of the transaction, this is evidence that the consideration offered in order to buy them out was fair. 2.  If 90 percent approval by minority shareholders is required under CBCA s 206 (s 199 at the time Neonex was decided), does this suggest that courts should be less ready to question the fairness of the transaction and impeach the takeover bid price? It has been said that the offering price should be presumed to establish the fair value of the remaining shares under s 206(3)(c)(ii).31 However, dissenting shareholders were said not to have the onus of proving the offering price to be unfair in Cyprus Anvil Mining Corp v Dickson.32 In determining whether an onus of proof arises, should a court consider other factors, such as whether the transaction was an arm’s-length one, or whether adequate disclosure was made in the information circular? 3.  Was it in fact the case that the transaction “cost Pattison nothing”? 4.  The theme that a certificate of incorporation from the relevant government department, however procured, will not be impeached occurs frequently in Canadian cases. Thus the legality, if not the morality, of the amalgamation in Neonex was not open to question. This is often desirable, since a contrary result may introduce an intolerable uncertainty in

31 Esso Standard (Inter-America) v JW Enterprises et al and MA Morrisroe, [1963] SCR 144 at 149; Re Shoppers City Ltd and M Loeb, Ltd, [1969] 1 OR 449, 3 DLR (3d) 35 (H Ct J); and Re Whitehorse Copper Mines Ltd (1980), 10 BLR 113 (BCSC). 32 Cyprus Anvil Mining Corporation v Dickson (1982), 40 BCLR 180 at 196-97, 20 BLR 21 at 42-43 (BSC).

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business affairs. In an amalgamation of two operating corporations, it might indeed be extremely difficult thereafter to redivide the combined enterprise. 5.  If Kolasa had such a deep sense of hurt about being frozen out, why did he assert dissenting shareholders’ rights under s 190 (s 184 at the time Neonex was decided) instead of petitioning under s 241 (the statutory oppression remedy)? Do you think that the statutory oppression remedy (discussed in Chapter 14) ought to enable a minority shareholder to obtain an order blocking or unwinding the kind of transaction seen in Neonex? Presumably Old Neonex’s board of directors, which was subject to its fiduciary duty to act in the best interests of Old Neonex, thought that the amalgamation was in the best interests of Old Neonex. In your view, what consideration should have the upper hand—the need for a company to have the flexibility to rearrange its capital structure to suit its objectives, or a shareholder’s desire to remain as a shareholder of that company? In light of the material on the nature of the share seen in Chapter 6, do you agree with Bouck J’s view that Neonex involves a situation in which the dissenters’ “property is being expropriated”? What basis is there for suggesting that a shareholder has a right to remain a shareholder of a corporation until such time as he or she decides to stop being a shareholder? Questions concerning majority – minority shareholder relations in a corporation have been addressed under several different branches of Canadian corporate and securities law, but it is not always clear that these different branches reflect a common understanding of the best way to balance a company’s need for flexibility with respect to its capital structure and the interests of shareholders. While revisions to the CBCA introduced in the 1970s were designed to ensure that corporations had some room to manoeuvre when seeking to alter their capital structure (with shareholders typically being given the option to seek fair value for their shares), since that time securities regulators have imposed fairness standards on transactions that are designed to squeeze out shareholders. For example, Multilateral Instrument (MI) 61-101 (discussed below in Section IV.B) imposes a requirement that a majority of shareholders other than those seeking to effect the squeeze-out approve a transaction that would eliminate the minority shareholders’ interest. MI 61-101 does not, however, require minority approval with respect to transactions in which the holder of 90  percent or more of a class of participating securities seeks to buy out the remaining shareholders—for example, where a party that has acquired 90 percent of a target’s common shares pursuant to a takeover bid seeks to squeeze out the remaining shareholders pursuant to CBCA s 206. MI 61-101’s injection of distinctive fairness principles into the picture obviously limits a company’s ability to effect the kind of transaction seen in Neonex. Is the introduction of this kind of veto power for minority shareholders a step forward or a step backward in the development of Canadian corporate law? Are the fairness principles that underlie MI 61-101’s call for majority of the minority approval consistent with the fairness or equality principles found in the corporate law on the nature of the share: see Chapter 6? Are they consistent with the corporate law’s treatment of the oppression remedy: see Chapter 14? Following on the heels of the securities regulators, the director appointed under the CBCA struggled with questions concerning the fairness principles that should govern goingprivate transactions and how best to balance the corporation’s need for flexibility with shareholder interests. In particular, the director had to consider whether compulsory acquisitions could only be accomplished under the CBCA by way of s 206 or whether tactics of the

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kind seen in Neonex were permissible.33 Initially, the director took the position that the elimination of shareholders could only be effected pursuant to s 206.34 The case law, however, was less than consistent on this point and the advent of earlier incarnations of MI 61-101 led the director to consider whether going-private transactions could be accomplished using techniques other than the one provided for in s 206 (relying on MI 61-101 and the oppression remedy as tools to protect the interests of minority shareholders).35 The matter was clarified and amendments to the CBCA added going-private transactions and squeeze-out transactions to the list of transactions in s 192 that can be subject to an “arrangement” and therefore brought before a court for approval as being not otherwise practicable to effect.36 Are you sympathetic with the argument, still accepted in some American courts, that the appraisal remedy is a dissenting shareholder’s exclusive remedy on a going-private amalgamation?37 Or do you favour instead the Ontario Securities Commission’s view as expressed in MI 61-101 that minority shareholders should be able to veto a going-private transaction?

A.  Class Voting Rights Holders of a separate class of shares, such as preferred shareholders, have the right to vote separately as a class in the circumstances listed in s 176(1). In this way, a proposal that unduly favours one class at the expense of a less numerous one is unlikely to secure approval. Class voting rights may also arise on a long-form amalgamation: s 183(4), a sale of assets: s 189(7), or a dissolution: s 211(3). Voting separately as a class will protect public preferred shareholders from elimination by a majority common shareholder. But what of minority common shareholders? The primary meaning of a “class” of shares is a group of shares with special rights, privileges, or restrictions listed in the articles under s 6(1)(c). However, in Re Hellenic & General Trust Ltd, [1976] 1 WLR 123 (Ch), the minority shareholders of the Hellenic company who faced elimination under a going-private arrangement were held to constitute a separate class. A company referred to as MIT held 53 percent of Hellenic’s common shares, while the objector, National Bank of Greece SA, held 14 percent. MIT’s shares were all held by Hambros Ltd. Under the arrangement, all common shares would be cancelled for cash, and new common shares would be issued to Hambros, which would become Hellenic’s sole shareholder. The arrangement required three-quarters class approval and would have failed had MIT not voted in favour of it. On these facts, Templeman J held at 126 that the minority common shareholders constituted a separate class:

Ibid. See “Policy Statement” (1994) 17 OSCB 1749. See Discussion Paper, “Going Private Transactions Under the CBCA” (1994) 17 OSCB 1745. See John Kazanjian & Firoz Ahmed, “Reform of the Canada Business Corporations Act” (2001) 12 Can Curr Tax 1 at 9; and Robert E Milnes, “Acting in the Best Interests of the Corporation: To Whom Is This Duty Owed by Canadian Directors? The Supreme Court of Canada in the BCE Case Clarifies the Duty” (2009) 24 BFLR 601. 37 See Ferguson v Imax Systems Corp (1980), 12 BLR 209 (Ont H Ct J) at 220-22, rev’d (1983), 43 OR (2d) 128 (CA). 33 34 35 36

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Hambros are purchasers making an offer. When the vendors meet to discuss and vote whether or not to accept the offer, it is incongruous that the loudest voice in theory and the most significant vote in practice should come from the wholly owned subsidiary of the purchaser. No one can be both a vendor and a purchaser and in my judgment, for purpose of the class meetings in the present case, M.I.T. were in the camp of the purchaser.

Re Hellenic is not law in Canada and class voting rights for minority shareholders in a buyout were specifically rejected in Stevens v Home Oil Co (1980), 123 DLR (3d) 297 (Alta QB). In that case, however, management had voluntarily undertaken to secure approval by a majority of minority shareholders.

B.  Buyout Requirements in Ontario and Québec: MI 61-101 As noted above, special procedural duties are imposed on a going-private transaction under MI 61-101, Protection of Minority Shareholders in Special Transactions. MI 61-101 is the successor to separate policies that the Ontario Securities Commission (OSC) and the Autorité des marchés financiers (Québec) (AMF) had previously adopted. No other Canadian securities commission has adopted a similar approach. But since most Canadian public companies have shareholders in Ontario and Québec, in practice all Canadian public companies must be sensitive to MI  61-101. The AMF and the OSC sought comments in 2006 on proposed MI 61-101, which sought to introduce harmonized requirements in Québec and Ontario for enhanced disclosure, independent valuations, and a majority of minority security-holder approval for specified types of transactions. In Ontario, MI 61-101 replaced Rule 61-501, which had itself replaced OSC Policy 9.1. Rule 61-501 and OSC Policy 9.1 regulated insider bids, issuer bids, going-private transactions, and related-party transactions. Policy 9.1 was first adopted in 1977, but was subsequently revised and expanded in 1991. The adoption of the revised Policy 9.1 was a source of considerable controversy because many observers felt there had been inadequate public consultation. In essence, the OSC was accused by some of having unilaterally imposed a detailed, complex, and expensive panoply of requirements on a wide range of transactions without having adequately considered either how the policy statement was to interact with business corporations acts or the views of those who would have to operate under the regime. The policy was amended and expanded in 1991 in order to deal with problems that the OSC felt were particular to the Canadian business community—notably, the fact that (unlike the United States) Canada had (and still has) a significant number of companies with a controlling or majority shareholder. The OSC was therefore concerned that considerable potential exists in Canada for the unfair treatment of minority shareholders. Accordingly, the OSC decided that certain kinds of transactions should comply with procedural requirements designed to protect the interests of minority shareholders. The OSC did not, however, explain why it felt that the oppression remedy was not up to the job. In view of the decisions on the oppression remedy, seen in Chapter 14, do you think there was a need for a detailed code of conduct to protect minority shareholders, or was the common law up to the task?38

38 See Anita I Anand, “Fairness at What Price? An Analysis of the Regulation of Going-Private Transactions in OSC Policy 9.1” (1998) 43 McGill LJ 115.

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For “going-private transactions” (which are now captured in the definition of the term “business combination” in MI 61-101), the rule extends to any transaction in which a securityholder’s interest in an equity security is terminated without that person’s consent. In connection with a business combination transaction, a corporation must first prepare a formal valuation in accordance with detailed rules set out in MI 61-101. The formal valuation must be prepared by a qualified and independent valuator. The valuation must value the affected securities. A formal valuation report must be prepared in accordance with guidelines set out in the instrument. A summary of the formal valuation must then be included in the information circular that is sent to shareholders in conjunction with the shareholders’ meeting called to approve the transaction. The summary of the valuation must provide “sufficient detail to allow the readers to understand the principal judgments and principal underlying reasoning of the valuator so as to form a reasoned judgment of the valuation opinion or conclusion” and must disclose “the effective date of the valuation” and “any distinctive material benefit that might accrue to an interested party as a consequence of the transaction, including the earlier use of available tax losses, lower income taxes, reduced costs or increased revenues.” The firm is exempt from valuation requirements if the price was arrived at within the 12 months immediately preceding the date of the announcement of the transaction through an arm’s-length transaction or negotiation with a selling security-holder of a control block of securities. The corporation must also comply with a majority of the minority test, securing the approval of a majority of outside shareholders. This requirement is waived if the controllers hold 90 percent of the shares and statutory appraisal rights are available. In addition, on a two-step acquisition, those shares tendered to the corporation in the first-step takeover bid may be included for the purpose of computing the majority of the minority in the secondstep freezeout transaction if the intent to eliminate minority shareholders was disclosed when the offer was made. It is clear that if a firm cannot bring itself within an exemption from the requirements of MI 61-101, it will have to comply with a time-consuming and expensive set of requirements. In your view, is the cost associated with complying with MI 61-101 warranted? Would it have been enough simply to rely on the corporate law’s oppression remedy and to allow a board of directors to decide for itself what procedures should be followed? The oppression remedy leaves companies greater flexibility than MI 61-101 with respect to the measures to be taken to ensure that the interests of minority shareholders were not unfairly disregarded. But it would not necessarily have provided the degree of protection offered in MI  61-101. 39 Whether or not one is an advocate of measures like MI 61-101 will in part depend on just where one stands on the debate about the importance of providing a corporation with flexibility with respect to its affairs versus the protection of shareholder interests, an issue that surfaces again and again in Canadian business law.

39 For cases of relevance where the oppression remedy was involved, see Casurina Limited Partnership v Rio Algom Ltd (2002), 28 BLR (3d) 44 (Ont Sup Ct J); and Highfields Capital I LP v Telesystem International Wireless Inc (2002), 29 BLR (3d) 249 (Ont Sup Ct J); see also Stephanie Ben-Ishai & Poonam Puri, “The Canadian Oppression Remedy Judicially Considered: 1995-2001” (2004-2005) 30 Queen’s LJ 79.

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C.  Benefits and Costs of Buyouts Although buyouts are regarded with suspicion by courts, it is important to recognize that, even though they differ from M&A transactions that seek to create value through synergistic gains, they may nonetheless offer potential gains. One such benefit is the cost savings associated with the favourable tax treatment under the Canadian Income Tax Act that is granted to Canadian-controlled private corporations. In addition, public corporations must make costly disclosure under corporations and securities statutes. If the firm is willing to absorb these costs when it requires an injection of capital, it may find them entirely wasteful when it has sufficient surplus cash to contemplate a buyout. Retention of “free cash flow”—that is, cash flow exceeding the firm’s investment needs—in these circumstances rather than using that cash to effect a buyout would in fact give rise to costs and would prove an inefficient way to maximize the value of the firm. In addition, costs are eliminated when outside shareholders are bought out. For example, the firm would not have to concern itself with the costs of requisitions, proposals, shareholders’ meetings, auditors, and internal monitoring devices, as well as the cost of annoying shareholder litigation. The impact of the myriad securities laws, regulations, and policies that apply to public companies (and that are both time-consuming and expensive to comply with) would be significantly reduced. Beyond this, the firm will not bear the residual costs of outside equity that resist governance and liability strategies. Because of all of these costs, a close corporation may decide not to go public, and, once public, may wish to go private. In some cases, however, shareholders have argued that they have a special interest in owning shares in a particular firm, so that buyouts should be impeached. This raises the question seen in Chapter 6 regarding whether shareholders are, properly speaking, “owners” who are entitled to veto a decision to “expropriate” their interest in the corporation. The OSC, with its shareholder-oriented mandate, has on more than one occasion suggested that shareholders should be able to resist attempts to squeeze them out. For example, in In the Matter of Loeb, Ltd, [1978] OSCB 333, Provigo Inc sought to eliminate minority Loeb shareholders through an amalgamation between it and a wholly owned Provigo subsidiary. Provigo had acquired 80 percent of Loeb’s common shares in 1977, and both firms carried on business in central Canada as food wholesalers. One of the minority Loeb shareholders, Empire Co, also carried on business as a food retailer in the Maritimes. Empire’s argument that the buyout would contravene OSC Policy 3-37 was accepted by the Commission, which refused to grant an exemption from the policy.40 The OSC listed several reasons why Empire had a special interest in owning Loeb shares: • Empire wished to participate in the food business on a nationwide basis and the investment in Loeb and Provigo was its only opportunity to do so. Empire would therefore have been willing to take Provigo shares in exchange for Loeb shares. It was not, however, willing to take cash for the Loeb shares, since there was not an equivalent type of investment in the food business available in Canada.

40 Former OSC Policy 3-37 forms the basis of what is now OSC Policy 48-501, OSC Policy 62-602, MI 61-101, and Companion Policy 61-101.

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• Other minority shareholders, apart from Empire, had purchased their shares for longterm investment purposes, and did not wish to be deprived of them for cash compensation. • Some of these latter shareholders were members of the Loeb family who attached a sentimental and historic value to their shares. The last argument against buyouts is that market price may discount true firm value. This may happen through the market’s mistaken perception of firm worth because insiders choose not to disclose good news about the firm in order to minimize the cost of the buyout. On the other hand, the market may recognize firm value all too clearly, discounting it as a consequence of perceived managerial inefficiency. It may then be thought that, in fairness, market price should be second-guessed, particularly if what is proposed is a management buyout.41

V.  TAKEOVER BIDS A.  Control Transactions 1.  Selecting the Target Corporation An acquisition-minded corporation will typically look for reasonably successful, relatively debt-free target corporations. It helps if management does not hold much stock of the target, and if shareholders have no great attachment to management. When institutional investors own large blocks of shares, the offeror should have some idea of how closely allied they are to management. Although it may be difficult to gauge how management of the target will react to a control transaction, the offeror will wish to know how likely it is that the offer will be rejected or countered with defensive manoeuvres. In some cases, the acquisition of a target may prove difficult because of regulatory statutes in, for example, the broadcasting, telecommunications, natural resource, and transportation industries. These statutes may place limits on the percentage of a company that may be owned by non-Canadians. In sensitive industries, the target may seek political support through the review techniques provided for in these statutes—for example, early in 1995, a bid launched by Canfor Corporation (“Canfor”) for Slocan Forest Products Ltd (“Slocan”) came to a grinding halt when it became clear that the minister responsible for the administration of the Forest Act in British Columbia was not comfortable with allowing Canfor to seize control of Slocan. The Investment Canada Act, RSC 1985, c 28 (1st Supp), which replaced the more burdensome Foreign Investment Review Act, will also be relevant in cases where the bidder is a non-Canadian (although since early 1995, Investment Canada has allowed private sector members of World Trade Organization (WTO) nations to invest up to certain amounts ($800 million in enterprise value, as of 2017) and state-owned enterprise WTO investments up to certain amounts ($379 million, as of 2017) without review, subject to certain limited and industry-specific exceptions). The Competition Act, SC 1986, c  26 may pose less of a

41 For a discussion of some of the reasons why companies effect going-private transactions, see Joshua Koenig, “A Brief Roadmap to Going Private” (2004) Colum Bus L Rev 505; and M Todd Henderson & Richard A Epstein, “The Going-Private Phenomenon: Causes and Implications” (2009) 76 U Chicago L Rev 1.

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barrier than American anti-trust statutes, although mandatory prenotification requirements, inspired by the US Hart-Scott-Rodino Premerger Notification Act, require parties to a merger to notify the competition bureau in advance of completing a merger if (1) the combined Canadian revenues and/or assets of the parties and their affiliates exceed $400 million, and (2) the firm being acquired has assets or sales of $88 million (these being the relevant dollar thresholds in 2017). The competition bureau will then have a limited period to decide whether it will challenge the merger. Information about the target corporation may be gleaned from business publications. The target’s articles of incorporation, proxy circulars, quarterly and annual filings with securities regulators, and prospectuses are publicly filed and readily available. The articles will in particular be examined for provisions designed to make it difficult for the insurgent to acquire control of the target. Consideration will be given to whether the target has adopted a shareholder rights plan (also known as a “poison pill” and discussed below in sections V.D, E, and F) and, if so, how to deal with that rights plan. In addition, insider trading reports will reveal the target’s major shareholders. Although the extent of the search activities by insurgents is not undisputed, it seems reasonably clear that some costs arise in identifying potential targets. If they could be spotted without cost, their price would rise well in advance of the control transaction to reflect the probability of merger gains. However, all of the available evidence suggests that the price of the target’s shares is constant or declining until shortly before the control transaction is announced.42 This implies that even sophisticated investors cannot easily identify potential targets, because if they could the bargain opportunity would have been eliminated well in advance of the takeover bid. In your view, does the fact that bidders clearly believe that bargain opportunities exist with respect to publicly traded companies suggest that the capital markets are less than completely efficient at incorporating all available information about a target’s value into its share price? What are the implications for arguments that suggest that the price for the minority’s shares on a buyout should be the market price?

2.  Techniques for Acquiring Control Control transactions may take the form of either a proxy battle or a takeover bid. Proxy battles have historically been less popular than takeover bids as a technique for displacing management, although in recent years proxy battles have become more common in Canada. One reason for the less frequent use of proxy battles may be shareholder apathy, since it may not be worth investors’ taking the time to determine which side is best able to manage the firm. In addition, if the control transaction is motivated by anticipated merger gains, insurgents will not share in them directly unless they acquire an equity interest in the firm. However, some offerors have used proxy battles to supplement a takeover bid. For example, where target directors have responded to the threat of a takeover bid with strong defensive tactics, offerors have sought to impeach these tactics by placing their own slate

42 See e.g. Michael Bradley, “Interfirm Tender Offers and the Market for Corporate Control” (1980) 53 J Bus 345 at 370-71.

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of directors on the board. This is especially true in the United States where it has typically been harder than in Canada to get courts or securities commissions to strike down defensive tactics. Takeover bids (or “tender offers” as they are known in the United States) are launched through a public offer for the shares of all of the shareholders and are discussed further below, in Section V.B.1. Even before this, however, the offeror may buy up to 20 percent of the target’s voting stock without triggering securities law takeover bid requirements. (Note that the recent amendments to the CBCA removed takeover bid provisions from the Act and now defer to the regulation provided for in provincial securities laws.) However, the offeror must disclose when he or she has acquired 10 percent of the target’s voting stock under s 5.2 of NI 62-104. Pre-bid purchases are frequently made at a lower price than the offering price, and therefore economize on the cost of acquiring control. They also make it more likely that the offeror will acquire voting control in the bid (in part because other bidders may be deterred by the prospect of having to live with a shareholder who already holds a significant stake in the company). Pre-bid notification under NI 62-104 therefore increases the cost of the bid for the offeror because it alerts other shareholders to the potential for a takeover bid and may lead to an increase in the market price of the target company’s shares. Takeover bids may be classified as “friendly” or “unfriendly,” depending on the reaction of the target’s management. A friendly takeover bid is uncontested by the target, which will issue a directors’ circular indicating its support for the offer. The offeror will then be far more likely to succeed than under a contested bid, where the target’s management attempts to defeat the takeover bid through defensive manoeuvres. A further advantage of an uncontested offer is that the offeror will have a far better idea of firm value than in a contested offer. During the course of the negotiations, the offeror will typically be provided with a substantial amount of confidential information about the target, and with this may more accurately determine the offering price. The disclosure of information will also give the offeror a considerable advantage over rival offerors who may make an offer for the target’s shares in competition with the first offeror. From the perspective of target management, a cooperative attitude in the negotiations may make the offeror better disposed to incumbent management, but at the same time this will increase the likelihood of the bid’s success. Once confidential information is disclosed, it becomes difficult for target management to break off negotiations, since the offeror may then follow up with a contested offer, with a substantial informational advantage over rival bidders. For this reason, the target will seldom open up all of its books to the offeror prior to the offer. The offeror may commence preliminary negotiations with a “casual pass.” This involves a vague indication that a tender offer is contemplated or some other form of business union is desired. Price is not specified, and if the target does not wish to pursue the matter further, no public disclosure is necessary. On a casual pass, there may be no pressure on the target corporation to react immediately. As an alternative to protracted negotiations with a target, the offeror may adopt a “bear hug” approach. Here, target management is notified of a proposed takeover bid at a stated price, but without an immediate public announcement by the purchaser. For example, the target may have the weekend to consider the bid if initial contact is made on a Friday, after trading of its shares on the stock exchange has ceased. Negotiations during such a period have occasionally resulted in an uncontested offer.

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An unfriendly offer (also known as an “unsolicited” or “hostile” offer) is typically commenced without any communication to target management apart from a courtesy call. Such bids might formerly have been open for acceptance for a few days, although longer periods are now prescribed by takeover bid legislation—for example, 105 days under NI  62-104, discussed further below. A decision will also have to be made about the price to be offered to the target company’s shareholders. This will involve some very careful strategic thinking when making an unfriendly bid. A bidder might wish to make a “blowout bid,” in which case it will seek to offer a sizeable premium over the current trading price of the target company’s shares. The bidder will thereby seek both to make clear to third parties that if they enter the fray they will likely overpay for the company and to put pressure on the target’s board of directors to acknowledge that the bid will provide shareholders with fair value for their shares. Alternatively, the bidder may wish to see whether any other bidders are likely to come out of the woodwork. The bid may then be designed with the knowledge that the offer price will likely have to be increased if another bidder enters the picture. Takeover bids are usually made for all outstanding shares that the offeror does not already own. But bids may also classified as “partial” or “any-and-all.” A “partial offer” is made subject to the condition that a specified number of shares (say 50 percent) are tendered to the bid. If the condition is not met, the offeror is not obligated to take up the shares. If more than that number are tendered, the offeror must take them up on a pro rata basis under NI 62-104. Sometimes a partial offer also gives the offeror the option of taking up all shares tendered at the offer price if more than the stipulated amount is tendered. An “any-and-all offer” is made for all of the shares that are tendered, so that the offeror must purchase all such shares even if they are not sufficient to amount to a control block. Changes to minimum tender conditions under Canadian takeover bid regulations enacted in 2016 mean that anyand-all offers are no longer permitted in Canada.

B.  Takeover Bid Regulation and Auction Theories 1.  Takeover Bid Regulation The 1966 Ontario Securities Act pioneered comprehensive takeover bid requirements extending to both cash offers (shares for cash) as well as exchange offers (shares for shares). Today NI 62-104 Take-Over Bids and Issuer Bids and its corresponding National Policy (NP)  62-203 govern takeover bids in a harmonized way for all Canadian jurisdictions. NI 62-104, like its 1966 ancestor, regulates the techniques of acquisition with the goals of equality of treatment of offerees and an open environment for competing offers. Pursuant to NI 62-104 s 2.9(1), the offer may be commenced either by publishing an advertisement announcing the bid or by mailing the offer to shareholders. This will start the clock on the minimum period under NI 62-104, during which the offer must remain open. Regardless of how that clock is started, the offer must be delivered to all shareholders of the same class along with a takeover bid circular. This must contain prescribed disclosure, but need not be pre-cleared with securities administrators. Under NI  62-104, takeover bids (including partial bids) are subject to the following requirements:

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1. 50 percent minimum tender requirement.  Bids are subject to a mandatory minimum tender requirement of more than 50 percent of the outstanding securities of the class that are subject to the bid, excluding those beneficially owned, or over which control or direction is exercised, by the bidder and its joint actors. In other words, at least 50 percent of the securities subject to the bid must accept the offer. 2. 10-day extension requirement.  Following the satisfaction of the mandatory minimum tender requirement and the satisfaction or waiver of all other terms and conditions, bids are required to be extended for at least an additional 10-day period. 3. 105-day bid period.  Bids are required to remain open for a minimum of 105 days, subject to two exceptions. First, the target issuer’s board of directors may issue a “deposit period news release” in respect of a proposed or commenced takeover bid providing for an initial bid period that is shorter than 105 days but not less than 35 days. If so, any other outstanding or subsequent bids will also be entitled to the shorter minimum deposit period counted from the date that other bid is made. Second, if an issuer issues a news release that it has entered into an “alternative transaction”—effectively a friendly change of control transaction that is not a bid, such as an arrangement—then any other outstanding or subsequent bids will be entitled to a minimum 35-day deposit period counted from the date that other bid was or is made. Where a bid is made for less than all of a class of shares, NI  62-104 s  2.26(1) requires the offeror to take up the shares on a pro rata basis. Before these provisions are triggered, the offer must come within the definition of a takeover bid under NI 62-104 s 1.1. First, an offer to purchase shares that, when aggregated with the offeror’s existing shares of the same class in the target corporation, do not exceed 20 percent of the target’s outstanding voting securities of that class is not a takeover bid. The 20 percent figure is an absolute criterion of a NI 62-104 takeover bid, and an accumulation of shares in a target corporation up to that threshold will not trigger the other takeover bid requirements. At 20 percent, an offer to purchase one more share is a takeover bid, subject to the exemptions provided by NI  62-104 part  4. Even before the 20  percent figure is reached, however, the offeror may find that the target’s stock price has increased as a response to the anticipated takeover bid. One way this might happen is through a slippage of inside information. In addition, NI 62-104 s 5.2 requires offerors to disclose publicly forthwith upon acquiring 10 percent of the target’s voting shares, and thereafter each time an additional 2 percent of the voting shares are purchased, up to a total of 20 percent of the stock. This means that an offeror cannot expect that bargain prices for the target’s stock will persist after the first disclosure reveals that the target is “in play,” which will significantly reduce the profits available to an offeror, since the merger gains on a public tender offer appear to accrue largely to target shareholders.43 Pre-bid purchasers, then, represent an important source of profit to offerors, and s 5.2 of NI 62-104 can be expected to increase the cost of acquiring corporations. Prior to 1979, the exemption for private agreements under OSA s 93(1)(c) was relied on when the offeror sought to purchase a controlling block of shares at a premium. Pursuant to NI 62-104 s 4.2.(1)(c), however, the availability of the exemption is conditioned on a premium

43 See Michael Bradley, ibid.

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that does not exceed the market price for the relevant securities by more than 15 percent. A de minimis exemption is available under s 4.5 on the acquisition of less than 2 percent of the outstanding securities held by beneficial owners of the securities of the class, subject to the bid, provided that (1)  there are fewer than 50 beneficial owners in the local jurisdiction, (2) such beneficial owners are entitled to participate in the bid on terms at least equal to those that apply to the general body of that class of security-holders, and (3) materials are also sent to security-holders whose last address is in the local jurisdiction. Takeover bids must be made to shareholders of the same class and kept open for a minimum period of 105 days under NI 62-104 s 2.29.1 (subject to the exceptions noted above). Shareholders who tender their shares on a takeover bid assume the risk that the bid will fail through the offeror’s reliance on one of the terms or conditions of the offer. Shares tendered by an offeree shareholder may be withdrawn at any time before the securities have been taken up by the offeror under s 2.30(1)(6).

2.  Auction Theories The desirability of takeover bid legislation has been the subject of a lively debate. Frank Easterbrook and Daniel Fischel have argued that the best takeover bid regulation is no regulation at all, since requiring takeover bids to be open for a given waiting period makes tender offers less likely to be successful. The target is given more time to react with defensive manoeuvres, and competing offerors may also free ride on the first offeror’s identification of a suitable target. With less chance of ultimate success, the offeror will be less ready to absorb these search costs.44 Takeover bid regulation has, however, been defended in a series of articles by both Lucian Bebchuk and Ronald Gilson.45 First, Bebchuk argues that the abolition of takeover bid regulation would give rise to fairness concerns, because an offeror might otherwise keep the offer open for only a day or two in a “Saturday night special.” This will violate egalitarian norms, since geographically remote shareholders will have a lessened ability to participate in the offer. These concerns are mitigated (although not eliminated), however, by an offeree’s ability to diversify his or her investments, purchasing shares of possible offerors as well as those of possible targets. The argument may also overestimate the effect of the relative remoteness of Moose Jaw as compared with Mississauga. In addition, even if there is an observable difference (left uncompensated by government transfer payments), the argument assumes

44 Frank H Easterbrook & Daniel Fischel, “Auctions and Sunk Costs in Tender Offers” (1982) 35 Stan L Rev 1 at 4; see also Easterbrook & Fischel, “The Proper Role of a Target’s Management in Responding to a Tender Offer” (1981) 94 Harv L Rev 1161; Alan Schwartz, “Search Theory and the Tender Offer Auction” (1986) 2 JL Econ & Org 229; and Schwartz, “Bebchuk on Minimum Offer Periods” (1986) 2 JL Econ & Org 271. 45 See Lucian Bebchuk, “The Case for Facilitating Competing Tender Offers” (1982) 95 Harv L Rev 1028; Bebchuk, “The Case for Facilitating Competing Tender Offers: A Reply and Extension” (1982) 35 Stan L Rev 23; Bebchuk, “The Case for Facilitating Competing Tender Offers: A Last (?) Reply” (1986) 2 JL Econ & Org 253; Ronald Gilson, “A Structural Approach to Corporations: The Case Against Defensive Tactics and Tender Offers” (1981) 33 Stan L Rev 819; and Gilson, “Seeking Competitive Bids Versus Pure Passivity in Tender Offer Defense” (1982) 35 Stan L Rev 51; see also Louis Lowenstein, “Pruning Deadwood in Hostile Takeovers: A Proposal for Legislation” (1983) 83 Colum L Rev 249 (proposing that bids remain open for acceptance for six months to facilitate an auction).

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that the offeror should not be permitted to direct the offer to one group of shareholders— for example, those with easy access to their brokers. The strongest arguments by both Bebchuk and Gilson for takeover bid regulation may therefore seem to be those based on efficiency concerns. By requiring the offeror to keep the takeover bid open for at least 105 days, NI 62-104 permits competing bids to come forward from other offerors. In the auction between rival bidders, the winner will be the firm that values the target most, with the auction moving assets to their highest-valued user. As against this, Easterbrook & Fischel argue that the first offeror could still resell the target to a higher-valued user in a second transaction, and that the costs of a drawn-out auction might exceed the transactions costs of a subsequent sale of the target. Because the likelihood of the offeror’s success is reduced when auctions are permitted, offerors will also be less ready to incur search costs in identifying potential targets, and the number of takeover bids will decline. On the other hand, auction theorists argue that Easterbrook & Fischel overemphasize the costs of identifying potential targets, and that they may be sufficiently compensated for such costs by pre-bid purchases of stock up to the disclosure threshold (5 percent in the United States and 10  percent under NI  62-104), even if the major portion of takeover bid gains still accrues to offeree shareholders. Moreover, fears that the 105-day period will permit the target to defeat the first takeover bid would be somewhat dissipated if, as most auction theorists propose, defensive manoeuvres were restricted. As such, they argue, auctioneering will permit the bidder who values the target most to acquire the target. Do auction theories justify an issue of shares by a target to a white knight, in addition to a solicitation of rival bids? The difference between the two strategies is that (1) the share issuance may lock up control in the white knight, rather than opening up the possibility of a bidding war; (2) offeree shareholders will not be able to sell out at a premium price; and (3) the issue price may not be higher than the offer price. On auction theories, assistance from white knights should therefore be restricted to competing offers to offeree shareholders. Similarly, “lock-up” options, which assure the white knight of control, may be viewed more unfavourably than other defensive manoeuvres whose effects are less dramatic. Lockups are reviewed below.46

C.  Defensive Tactics: An Introduction In order to defeat a takeover bid, management of a target corporation may adopt a variety of strategies to make an offeror’s efforts to acquire control more difficult. These may be either pre-offer tactics adopted prior to a takeover bid or post-offer measures made in response to a bid.47 Pre-offer tactics include “shark repellent” provisions in the corporate charter, whose purpose is to deflect hostile bids: see below, Section V.E.3. Post-offer strategies also require

46 For recent discussions of these and other issues relating to takeover bids, see Lucian Bebchuk & Oliver Hart, Takeover Bids Versus Proxy Fights in Contests for Corporate Control (October 2001) Harvard Law and Economics Discussion Paper No 336; Lucian Bebchuk, “The Case Against Board Veto in Corporate Takeovers” (2002) 69 U Chicago L Rev 973; and Marcel Kahan & Edward B Rock, “How I Learned to Stop Worrying and Love the Pill: Adaptive Responses to Takeover Law” (2002) 69 U Chicago L Rev 871. 47 See Richard A Shaw, “Hostile Takeover Bids: Defensive Strategies” (1999) 38 Alta L Rev 111.

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advance planning of some kind. Although NI 62-104 takeover bids are kept open for acceptance for at least 105 days, target management must still be in a position to react quickly and coherently to the offer. This generally entails the assembly of a takeover team to take charge of formulating and executing a response. Usually, a senior officer is designated to head the team, which is also composed of in-house and outside lawyers, bankers, and investment counsel. The transfer agent will be instructed to report immediately to the corporation when a request is made for the shareholders’ list. In some cases, a “defence manual” containing drafts of shareholder letters, newspaper ads denouncing a bid, and board resolutions is prepared. It may also include competition law analyses and a draft of a “poison pill” in the event that the company has not already adopted one.

1.  Making the Target Seem Attractive The first tactic that the target might adopt is one aimed at making it look more attractive to its shareholders. If this strategy is successful, the firm will not appear to be a suitable candidate for a takeover bid motivated by an offeror’s belief that he or she can manage the firm more efficiently. These strategies can include, for example, a dividend payout or share repurchase that eliminates free cash flow. The target can also seek to defeat a takeover bid by appealing to the loyalty of existing shareholders through newspaper ads or letters to the effect that the shares are worth more than the offer price. Propaganda campaigns are likely to be of limited utility, however, since the target’s claims will not seem entirely credible when control is on the line. More tangibly, after a bid is made, target management may declare a dividend or effect a buyback in the expectation that this will be taken as a signal that the firm’s market price is undervalued.

2.  Making the Target Seem Unattractive The target may also seek to repel offerors by making itself unattractive to them. If the offeror seeks to acquire control of a particularly attractive division (called a “crown jewel”), the target may agree to sell it off to a third firm. Another method is a shareholder rights plan (also known as a “poison pill”), which might be adopted either before or after a takeover bid is commenced. This is a device (discussed in greater detail below) in which the acquisition of control in a takeover triggers contractual rights that may decrease firm value. For example, the target might issue new kinds of securities that are convertible into voting shares on a change of control by all holders other than the bidder, and that would then dilute the voting power of the bidder should it proceed with its bid. The target might also arrange for provisions in its relational contracts, such as bank loan agreements, pursuant to which those contracts would terminate on a change of control. It has also been suggested that golden parachutes amount to a form of poison pill. These are contractual arrangements in which management may treat a change of control as constructive dismissal, with relatively large amounts of money to be paid by the target as compensation to managers who leave the firm.

3.  Offensive Tactics Another strategy might be to take the fight to the offeror. Sometimes this is the point of a propaganda campaign, which attacks the capacity of the offeror to increase firm value. The

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target may bring defensive lawsuits. If a misrepresentation is apparent in the takeover bid circular (and even if one is not), the target corporation might seek an injunction to prevent the bid from continuing. The target might also request securities commissions across Canada to issue cease-trading orders on the basis of alleged misrepresentations in the circular.

4.  Share Transactions Finally, the target could embark on a series of share transactions designed to make acquisition of control more difficult for the offeror. One device might be a new issue of securities to an inside group or to one of its allies (called a “white knight”) better disposed to incumbent management. Unless impeached, such tactics might easily defeat the bid, preventing offeree shareholders from participating in the premium. The least troubling defensive manoeuvre is the solicitation of a rival takeover bid, since the auction of the firm as between the initial offeror and the rival bidder will typically serve to generate an attractive premium for shareholders who tender to the winning bid. Evidence of the value of an auction to offeree shareholders is provided by a study that found (1) target firms that vigorously resisted an offer by bringing defensive lawsuits earned higher returns than passive targets, but that (2) when these same firms actually defeated the initial bidder, they did significantly worse than passive targets.48 Apparently, the key to the puzzle is that litigious targets are much more likely to be the subject of an auction among competing bidders. If an auction develops, and a competing bidder succeeds, that bidder will do so only at a higher price than that offered by the initial bidder. But if the target defeats all bids, its shares will be worth less than the initial offer price.

5.  Takeovers and Stakeholders As discussed in Section I of this chapter, much of the literature in North America concerning takeovers has focused on the impact of takeovers on the share price of the target company and, to a lesser extent, on the share price of the company making the bid. Much of this literature suggests that takeovers are good for share price and profitability. But other studies are a good deal more ambivalent: see e.g. Abraham Tarasofsky & Ronald Corvari, Corporate Mergers and Acquisitions: Evidence on Profitability (Ottawa: Economic Council of Canada, 1991), which looked at the performance of more than 100 Canadian companies acquired from 1963 to 1983 and concluded that although some 42 percent became more profitable after they were acquired, 43 percent showed a decrease in profit (with the balance [15 percent] remaining essentially unchanged). In your view, are share price and profitability all that are at stake in a takeover? You might here review the discussion of different theories of the firm in Chapter 9. If a bidder has concluded that the target would be more efficient if it got out of certain businesses, then the bidder may intend to “bust up” the target company by selling off particular units, which may lead to significant dislocation for employees of the target

48 Gregg A Jarrell, “The Wealth Effects of Litigation by Targets: Do Interests Diverge in a Merger?” (1985) 28 JL & Econ 151.

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corporation. The question therefore arises whether directors should take into account the interests of constituencies other than shareholders when evaluating one or more bids for the company and, if so, what weight should be given to those interests relative to those of shareholders. The answer to this question will turn in part on the vision of the firm that one favours. If, for example, one thinks that shareholders are “owners” of the corporation, then one may well favour the argument that directors should concentrate on how best to “maximize shareholder value.” If instead one is an advocate of the mediating hierarchy or team production theory of the firm, then one may feel that it is appropriate for the board of directors to consider the impact of a bid on constituencies such as creditors and employees. The question would then be what weight should be given to the interests of those constituencies relative to the weight given to the interests of shareholders. Similarly, thought would have to be given to the extent to which promoting the interests of target company shareholders (who may well be bought out as part of, or subsequent to, the takeover bid) in this equation will result in a more efficient, productive, and successful company. Where you land in this debate will have a considerable influence on how you think that strategies concerned with directors’ duties and the oppression remedy should be structured. Moreover, your conclusion may well affect your view of the role that securities regulators and courts should play with respect to takeover bids. For example, because securities regulators are concerned first and foremost with shareholder interests, you might conclude that securities commissions provide a less than ideal setting in which to assess the merits of a board of directors’ response to a takeover bid. Depending on the view you take with respect to the constituencies that the liability strategies explored in Chapters 13 and 14 should be sensitive to, you might feel that courts are better placed to weigh the competing factors that directors must consider than are securities commissions, and that the law on directors’ duties and the oppression remedy provides a better avenue for regulating takeover bids than securities law. These issues are particularly germane in Canada because in recent years securities regulators have assumed an increasingly prominent role with respect to the regulation of takeover bids. For example, tactics seen in some US bids have simply been outlawed in Canada. Companies seeking to challenge defensive tactics adopted by Canadian companies have also shown an inclination to bring challenges to those defensive tactics before securities commissions. The heightened presence of securities commissions in the takeover bid process has not, however, been accompanied by much in the way of public debate about the proper balance between shareholder interests and the interests of creditors or employees and other groups with an interest in the takeover bid process.49 As you review the decision in Teck, immediately below, and subsequent takeover cases, ask yourself what vision of the firm underlies the analysis set out in the case and whether you share that vision of the firm. After reading Teck, you may also wish to review the Supreme Court of Canada’s 2004 decision in Peoples Department Stores Inc v Wise (extracted in Chapter 11, Sections I and VII) and its 2008 decision in BCE Inc v 1976 Debentureholders (extracted in Chapter 11, Section I; Chapter 14, Section III.E; and also below).

49 See Yalden, supra note 1.

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Teck Corporation Ltd v Millar (1972), 33 DLR (3d) 288, [1973] 2 WWR 385 (BCSC) [At issue in this case was an attempt by the plaintiff, Teck Corporation, to take over Afton Mines Ltd, and the alleged manoeuvres of Afton’s directors to prevent such a takeover. From its inception in 1965, Afton had lacked sufficient capital to carry out its plans. Because several past financings had yielded unsatisfactory returns, its directors (Millar, Price, and Haramboure) sought to interest wealthier companies to participate in developing its mines. In the normal course of events, such companies (called majors) would provide capital for exploration and development, personnel, technical assistance, and managerial and marketing experience in return for an equity interest in the mining company. This arrangement is known in mining circles as an “ultimate deal.” Teck was anxious to obtain an ultimate deal with Afton, but Afton preferred to deal with Placer Development Ltd, which, although it had made a less generous offer than Teck, nevertheless had a much better reputation. On March 22, 1972, Afton reached a preliminary agreement with Canadian Exploration Ltd (Canex), a Placer subsidiary. The contract provided for the sale of 100,000 Afton shares to Canex and gave it a right of first refusal on any future ultimate deals submitted to Afton. The final details of the contract were left open. When it learned of this, Teck indicated that it would offer terms twice as advantageous as any made by Canex. After being rebuffed by Afton, Teck began purchasing Afton shares on the open market on May 8. By May 31, it owned 1,312,011 of Afton’s 2,600,000 outstanding shares. The defendant Afton directors reached an oral agreement with Canex officers on May 30. While Canex initially wanted 60 percent of Afton’s equity, it finally agreed to take only 30 percent. However, the agreement was conditional upon a favourable feasibility study, to be carried out by Canex. If Canex determined that the Afton property should not be put into production, then no shares would be issued to Canex. If Canex decided to place the property into production, it would receive sufficient shares to equal 30 percent of the issued shares. Teck would then no longer be Afton’s majority shareholder. On May 30, Teck directors requisitioned a shareholders’ meeting. Afton’s agreement with Canex was made public on June 2. On that date, Teck launched the present action.] BERGER J: … The claim for declaratory relief is based on the allegations that the directors were actuated by an improper purpose. It is said that their purpose in signing the contract was to defeat Teck’s majority share position, and that Canex knew it. If that allegation is made out then the means adopted to effectuate that purpose cannot be allowed to stand. The contract of May 30th would have to be declared null and void. That is the whole basis of Teck’s action. So if the plaintiff establishes that the contract was simply a colourable device to further the directors’ improper purpose, the plaintiff ought to have its declaration. •  •  •

Teck had the right, however, like any other shareholder, to challenge the exercise of any power by the directors on the ground that such power was being exercised for an improper purpose. This is not an allegation that the directors acted ultra vires, it is rather

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an allegation of abuse of power: Gower, Principles of Modern Company Law, 3rd ed. (1969), at p. 524. The cases decided in the United Kingdom make it plain that directors, in the exercise of their powers, must act in what they bona fide consider to be the best interests of the company. If they issue shares to retain control for themselves, that is an improper purpose: Fraser v. Whalley (1864), 2 H & M 10, 71 ER 361; Punt v. Symons & Co., Ltd., [1903] 2 Ch. 506; Piercy v. S. Mills & Co. Ltd., [1920] 1 Ch. 77. The cases decided in Canada proceed on the same footing: Madden et al. v. Dimond (1905), 12 BCR 80 (Full Court); Bonisteel v. Collis Leather Co. Ltd. (1919), 45 OLR 195 (Ont. High Court); Smith et al. v. Hanson Tire & Supply Co., Ltd., [1927] 3 DLR 786, 21 SLR 621, [1927] 2 WWR 529 (Sask. CA). Now counsel for Teck does not accuse the defendant directors of a crass desire merely to retain their directorships and their control of the company. Teck acknowledges that the directors may well have considered it to be in the best interests of the company that Teck’s majority should be defeated. Even so, Teck says, the purpose was not one countenanced by the law. Teck relies upon Hogg v. Cramphorn Ltd., [1967] Ch. 254, [1966] 3 WLR 995, [1966] 3 All ER 420. In that case the directors of Cramphorn Ltd. established a trust for the benefit of the company’s employees and allotted shares to the trust, nominating themselves as trustees to enable them to purchase the shares. Buckley J (as he then was) found that the directors had done so to ensure that a Mr. Baxter, who was seeking to acquire control of the company, could not achieve a majority. Buckley J was persuaded that the directors had acted in good faith, believing they were serving the best interests of the company. •  •  •

Buckley J found the primary purpose was to retain control. He said at p. 266: Accepting as I do that the board acted in good faith and that they believed that the establishment of a trust would benefit the company, and that avoidance of the acquisition of control by Mr. Baxter would also benefit the company, I must still remember that an essential element of the scheme, and indeed its primary purpose, was to ensure control of the company by the directors and those whom they could confidently regard as their supporters. Was such a manipulation of the voting position a legitimate act on the part of the directors?

Buckley J then said at pp. 268-9: It is not, in my judgment, open to the directors in such a case to say, “We genuinely believe that what we seek to prevent the majority from doing will harm the company and therefore our act in arming ourselves or our party with sufficient shares to outvote the majority is a conscientious exercise of our powers under the articles, which should not be interfered with.” Such a belief, even if well founded, would be irrelevant. A majority of shareholders in general meeting is entitled to pursue what course it chooses within the company’s powers, however wrongheaded it may appear to others, provided the majority do not unfairly oppress other members of the company. These considerations lead me to the conclusion that the issue of the 5,707 shares, with the special voting rights which the directors purported to attach to them could not be justified by the view that the directors genuinely believed that it would benefit the company if they could command a majority of the votes in general meetings. … The power to issue shares was a fiduciary power and if, as I think, it was exercised for an improper motive, the issue of these shares is liable to be set aside.

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Thus Buckley J takes the view that the directors have no right to exercise their power to issue shares, in order to defeat an attempt to secure control of the company, even if they consider that in doing so they are acting in the company’s best interests. Counsel for Teck says the reasoning in Hogg v. Cramphorn Ltd., supra, is applicable in the case at bar. He says the defendant directors believed Teck would use its dominant position to compel Afton to give Teck the ultimate deal. They believed that under Teck’s management the property would not be developed as profitably as it would under Placer’s management. They also believed that the value of Afton’s shares, including their own, would decline, under Teck’s management. Therefore, the argument goes, the defendant directors entered into the contract with Canex so that shares would be allotted under the contract to defeat Teck’s majority. The case then is on all fours with Hogg v. Cramphorn Ltd. Counsel for Teck says that Hogg v. Cramphorn Ltd. offers an elaboration of the rule that directors may not issue shares for an improper purpose. If their purpose is merely to retain control, that is improper. So much may be taken for granted. Counsel then goes on to say that Hogg v. Cramphorn Ltd. lays down that an allotment of shares, and any transaction connected with it, made for the purpose of defeating an attempt to secure a majority is improper, even if the directors genuinely consider that it would be deleterious to the company if those seeking a majority were to obtain control. This, it seems to me, raises an issue of profound importance in company law. Lord Greene MR expressed the general rule in this way in Re Smith & Fawcett Ltd., [1942] Ch. 304 at p. 306, [1942] 1 All ER 542: “They [the directors] must exercise their decision bona fide in what they consider—not what a court may consider—is in the interests of the company, and not for any collateral purpose.” Yet, if Hogg v. Cramphorn Ltd., supra, is right, directors may not allot shares to frustrate an attempt to obtain control of the company, even if they believe that it is in the best interests of the company to do so. This is inconsistent with the law as laid down in Re Smith & Fawcett Ltd. How can it be said that directors have the right to consider the interests of the company, and to exercise their powers accordingly, but that there is an exception when it comes to the power to issue shares, and that in the exercise of such power the directors cannot in any circumstances issue shares to defeat an attempt to gain control of the company? It seems to me this is what Hogg v. Cramphorn Ltd. says. If the general rule is to be infringed here, will it not be infringed elsewhere? If the directors, even when they believe they are serving the best interests of the company, cannot issue shares to defeat an attempt to obtain control, then presumably they cannot exercise any other of their powers to defeat the claims of the majority or, for that matter, to deprive the majority of the advantages of control. I do not think the power to issue shares can be segregated, on the basis that the rule in Hogg v. Cramphorn Ltd. applies only in a case of an allotment of shares. Neither can it be distinguished on the footing that the power to issue shares affects the rights of the shareholders in some way that the exercise of other powers does not. The Court’s jurisdiction to intervene is founded on the theory that if the directors’ purpose is not to serve the interest of the company, but to serve their own interest or that of their friends or of a particular group of shareholders, they can be said to have abused their power. The impropriety lies in the directors’ purpose. If their purpose is not to serve the company’s interest, then it is an improper purpose. Impropriety depends upon proof that

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the directors were actuated by a collateral purpose, it does not depend upon the nature of any shareholders’ rights that may be affected by the exercise of the directors’ powers. Should Hogg v. Cramphorn Ltd. be followed? … In Canada there is authority on both sides of the question: in Bonisteel v. Collis Leather Co. Ltd. (1919), 45 OLR 195, Rose J anticipated Hogg v. Cramphorn Ltd. He said at p. 199: Upon the evidence there is no doubt at all that the purpose of the defendant directors in all that they did was to deprive the plaintiff of the controlling position which he had acquired. No doubt they thought it was not in the best interest of the company that he should control its affairs, and, in that sense, they acted in good faith and in what they believed to be the best interest of the company; but, nevertheless, I think that what they attempted to do was exactly what Martin v. Gibson (1907), 15 OLR 623, shows that directors have no right to do: they were making a one-sided allotment of stock with a view to the control of the voting power …

On the other hand, Harvey CJA, in Spooner v. Spooner Oils Ltd., [1936] 2 DLR 634 at pp. 635-6, [1936] 1 WWR 561, said quite the opposite: The cases cited and relied on by the plaintiff on this branch of the case merely establish that when an issue of shares by the directors for the purpose of giving control cannot be deemed to be intended to be in the interest of the shareholders generally but on the contrary appears to be intended to accomplish some other purpose, then it constitutes a breach of trust on the part of the directors who occupy a fiduciary position in which they must act bona fide for the interests of the general body of shareholders. It is simply an instance of the acts of the directors being at variance with this duty. There is nothing in the authorities cited that would stand in the way of … giving someone control of the company if the directors honestly believed on reasonable grounds that it was for the interest of the company that that should be done.

The classical theory is that the directors’ duty is to the company. The company’s shareholders are the company: Boyd C, in Martin v. Bigson (1907), 15 OLR 623, and therefore no interests outside those of the shareholders can legitimately be considered by the directors. But even accepting that, what comes within the definition of the interests of the shareholders? By what standards are the shareholders’ interests to be measured? In defining the fiduciary duties of directors, the law ought to take into account the fact that the corporation provides the legal framework for the development of resources and the generation of wealth in the private sector of the Canadian economy: Bull JA, in Peso Silver Mines Ltd. (N.P.L.) v. Cropper (1966), 56 DLR (2d) 177 at pp. 154-5, 54 WWR 329 (BCCA); affirmed 58 DLR (2d) 1, [1966] SCR 673, 56 WWR 641. … [T]he corporation has become almost the unit of organization of our economic life. Whether for good or ill, the stubborn fact is that in our present system the corporation carries on the bulk of production and transportation, is the chief employer of both labor and capital, pays a large part of our taxes, and is an economic institution of such magnitude and importance that there is no present substitute for it except the State itself.

Jackson J, in State Tax Commission v. Aldrich et al. (1942), 316 US 174 at p. 192. A classical theory that once was unchallengeable must yield to the facts of modern life. In fact, of course, it has. If today the directors of a company were to consider the interests of its employees no one would argue that in doing so they were not acting bona fide in

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the interests of the company itself. Similarly, if the directors were to consider the consequences to the community of any policy that the company intended to pursue, and were deflected in their commitment to that policy as a result, it could not be said that they had not considered bona fide the interests of the shareholders. I appreciate that it would be a breach of their duty for directors to disregard entirely the interests of a company’s shareholders in order to confer a benefit on its employees: Parke v. Daily News, [1962] Ch. 927. But if they observe a decent respect for other interests lying beyond those of the company’s shareholders in the strict sense, that will not, in my view, leave directors open to the charge that they have failed in their fiduciary duty to the company. In this regard, I cannot accept the view expressed by Professor E.E. Palmer in Studies in Canadian Company Law, c. 12, “Directors Power and Duties,” pp. 371-2. So how wide a latitude ought the directors to have? If a group is seeking to obtain control, must the directors ignore them? Or are they entitled to consider the consequences of such a group taking over? In Savoy Corp. Ltd. v. Development Underwriting Ltd. (1963), NSWR 138 at p. 147, Jacobs J said: It would seem to me to be unreal in the light of the structure of modern companies and of modern business life to take the view that directors should in no way concern themselves with the infiltration of the company by persons or groups which they bona fide consider not to be seeking the best interests of the company.

My own view is that the directors ought to be allowed to consider who is seeking control and why. If they believe that there will be substantial damage to the company’s interest if the company is taken over, then the exercise of their powers to defeat those seeking a majority will not necessarily be categorized as improper. I do not think it is sound to limit the directors’ exercise of their powers to the extent required by Hogg v. Cramphorn Ltd., [1967] Ch. 254, [1966] 3 WLR 995, [1966] 3 All ER 420. But the limits of their authority must be clearly defined. It would be altogether a mistake if the law, in seeking to adapt itself to the reality of corporate struggles, were to allow the directors any opportunity of achieving an advantage for themselves at the expense of the shareholders. The thrust of companies legislation has brought us a long way since Percival v. Wright, [1902] 2 Ch. 421. If the directors have the right to consider the consequences of a take-over, and to exercise their powers to meet it, if they do so bona fide in the interests of the company, how is the Court to determine their purpose? In every case the directors will insist their whole purpose was to serve the company’s interest. And no doubt in most cases it will not be difficult for the directors to persuade themselves that it is in the company’s best interests that they should remain in office. Something more than a mere assertion of good faith is required. How can the Court go about determining whether the directors have abused their powers in a given case? How are the Courts to know, in an appropriate case, that the directors were genuinely concerned about the company and not merely pursuing their own selfish interests? Well, a similar task has been admitted in cases of conspiracy to injure. There the question is whether the primary object of those alleged to have acted in combination is to promote their own interests or to damage the interests of others: Crofter Hand Woven Harris Tweed Co. v. Veitch, [1942] AC 435.

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I think the Courts should apply the general rule in this way: The directors must act in good faith. Then there must be reasonable grounds for their belief. If they say that they believe there will be substantial damage to the company’s interest, then there must be reasonable grounds for that belief. If there are not, that will justify a finding that the directors were actuated by an improper purpose. •  •  •

In the United States the whole question of directors’ exercise of their powers to defeat an attempt to take over a company has been considered in the State of Delaware. In the United States the law allows a company to purchase its own shares, and the cases have usually arisen where directors have sought to deal in the company’s shares. Of course, directors in the exercise of such a power must bona fide consider the best interests of the company. The Delaware Courts have held that they cannot exercise their power merely for the purpose of retaining control: Bennett v. Propp (1962), 187 A2d 405 (Supreme Court of Delaware). But in Kors v. Carey (1960), 39 Del. Ch. 47, 158 A2d 136 (Court of Chancery of Delaware), it was held that directors were entitled to exercise their power to deal in the company’s shares for the purpose of defeating an attempt to take over the company that they believed would not be in the best interests of the company. The Delaware Courts regard the presence of reasonable grounds for the directors’ exercise of their powers as the test of good faith. The directors must have considered the consequences of a transfer of control, and must have acted upon reasonable grounds: Cheff v. Mathes (1964), [199] A2d 548 (Supreme Court of Delaware). If there are no reasonable grounds for the directors’ alleged belief, but their purpose is merely to freeze out a group of shareholders, the transaction will be set aside: Condec Corp. v. Lukenheimer Co. (1967), 230 A2d 769 (Court of Chancery of Delaware). What extent of damage must the directors anticipate to justify the exercise of powers to defeat those seeking a majority? In both Kors v. Carey and Cheff v. Mathes the directors anticipated a change in policy, though in each case a fundamental change. That change was in each case one that would have had profound consequences to the company’s whole way of doing business, and one that the directors believed would damage the company’s interests. It was held that constituted reasonable grounds for the exercise of the directors’ powers. I am not prepared therefore to follow Hogg v. Cramphorn Ltd., supra. I think that directors are entitled to consider the reputation, experience and policies of anyone seeking to take over the company. If they decide, on reasonable grounds, a take-over will cause substantial damage to the company’s interests, they are entitled to use their powers to protect the company. That is the test that ought to be applied in this case. 8.  The directors’ purpose in the case at bar •  •  •

So it is necessary, then, to disentangle the directors’ primary motive or purpose from subsidiary ones. I do not think it is necessary to distinguish motive, purpose or object. The question is, what was it the directors had uppermost in their minds? •  •  •

I find their object was to obtain the best agreement they could while they were still in control. Their purpose in that sense was to defeat Teck. But, not to defeat Teck’s attempt

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to obtain control, rather it was to foreclose Teck’s opportunity of obtaining for itself the ultimate deal. That was, as I view the law, no improper purpose. In seeking to prevent Teck obtaining the contract, the defendant directors were honestly pursuing what they thought was the best policy for the company. •  •  •

I have put the defendants’ purpose in a negative way, that is, I have said they wanted to foreclose to Teck’s opportunity of obtaining the development contract. But in a larger sense their purpose was a positive one. They wanted to make a contract with Placer while they still had the power to do so. But not at any price. Millar stood firm in his rejection of Placer’s 60-40 offer of May 19th, even when he knew that Teck’s share position was eroding his control of the company. He was not prepared to concede 40% equity simply in order to sign a contract providing for the issuance of shares to Placer. He held out for a better contract, and he got it. Now I suppose it is possible that if Millar had held out even longer, if he had carried on with his drilling program he would have been able to negotiate a contract even more favourable to Afton than the contract of June 1st, but I do not think there was any reasonable basis for him to think he could have. The odds were against it. Teck would soon be in a position to compel Afton to sign a contract with them, and Millar did not believe that Canex’s first right of refusal offered Afton any real protection against such an eventuality. He knew that time was short. At the same time, Placer knew that if it was going to obtain the contract, it would have to reach agreement with Millar before Teck had an opportunity of replacing the directors. So all things conspired to bring about the signing of the contract. Teck was the catalyst. Millar, Price and Haramboure were, in my view, acting in the best interests of the company. And the evidence shows that they had reasonable grounds for that belief. Now Teck, of course, was a shareholder. And it is said that it was no part of Millar’s purpose to protect Teck’s interests. I think it is fair to say that Millar’s primary purpose was to make the most advantageous deal he could for Afton. That is as far as the Court ought to go in seeking to analyze his motivation. And, in my view, in trying to make the best deal he could for Afton, Millar was acting in the best interests of the general body of shareholders, including Teck, because Teck’s interest in acquiring control is put to one side, its interest, like that of the other shareholders, was in seeing Afton make the best deal available. I find Millar’s purpose was to serve that interest. The defendant directors were elected to exercise their best judgment. They were not agents bound to accede to the directions of the majority of the shareholders. Their mandate continued so long as they remained in office. They were in no sense a lame duck board. So they acted in what they conceived to be the best interests of the shareholders, and signed a contract which they knew the largest shareholder, holding a majority of the shares, did not want them to sign. They had the right in law to do that. When a company elects its board of directors and entrusts them with the power to manage the company, the directors are entitled to manage it. But they must not exercise their powers for an extraneous purpose. That is a breach of their duty. At the same time, the shareholders have no right to alter the terms of the directors’ mandate except by amendment of the articles or by replacing the directors themselves. •  •  •

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If I am wrong in rejecting Hogg v. Cramphorn Ltd., [1967] Ch. 254, [1966] 3 WLR 955, [1966] 3 All ER 420, it is not applicable here in any event. In Hogg v. Cramphorn Ltd. the primary purpose of the directors was to frustrate an attempt to obtain control of the company. In the case at bar the primary purpose of the directors was to make the best contract that they could for Afton. I find that the primary purpose of the directors was to serve the best interests of the company. Their primary purpose was to see that the ultimate deal the company made was a deal with Placer, not Teck. They were not motivated by a desire to retain control of the company. They may have thought the issuance of shares under the contract with Canex would enable them, if they had Canex’ support, to regain control from Teck. If they did, that was a subsidiary purpose. On any view of the law, therefore, no allegation of improper purpose can be sustained against the defendant directors. •  •  •

The plaintiff ’s action is dismissed with costs. Action dismissed. QUESTIONS

Do you agree with Berger J that the classical theory of the firm must “yield to the facts of modern life”? Securities regulators in Canada have suggested, in NP 62-202, Take-Over Bids— Defensive Tactics, that the “primary objective of the takeover bid provisions of Canadian securities legislation is the protection of the bona fide interests of the shareholders of the target company” (see below). In your view, does this statement reflect what Berger J calls a classical theory of the firm? Is it compatible with Berger J’s view that it should be open to a board of directors to “observe a decent respect for other interests lying beyond those of the company’s shareholders in the strict sense”?

6.  Managerial Passivity Berger J’s proper purposes test closely resembles Delaware decisions that apply a business judgment standard to control transactions. One of the leading cases, approved by Berger J in Teck, is Cheff v Mathes, 199 A (2d) 548 (Del 1964). In that case, the paramount question was said to be the motives of the target directors in making a “greenmail” payment—that is, the purchase of shares from a party that threatens that it will seek to acquire the company if these shares are not bought back by the company (at 554): [T]he allegation is that the true motives behind such purchases were improperly centered upon perpetuation of control … . [I]f the actions of the board were motivated by a sincere belief that the buying out of the dissident stockholder was necessary to maintain what the board believed to be proper business practices, the board will not be held liable for such decision. … On the other hand, if the board has acted solely or primarily because of the desire to perpetuate themselves in office, the use of corporate funds for such purposes is improper.

On this standard, where management demonstrates that its motives were based on a difference of policy between it and the offeror, then the conflict of interest is treated as

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resolved and a business judgment rule is applied. Since management can ordinarily find a policy difference between itself and the offeror without too much difficulty, the test may then be thought to collapse into the business judgment standard.50 Although Hogg v Cramphorn, [1967] Ch 254, [1966] 3 All ER 420 and Teck represent variants of the proper purposes doctrine, the two tests are strikingly different. The proper purposes doctrine in Hogg is an objective one: any issue of shares to retain control is improper, even if management is actuated by an honest belief that firm value is maximized if it remains in control. Justice Berger’s test in Teck is more subjective—shares may be issued to defeat a takeover bid if the board, on reasonable grounds, in good faith believes it to be in the best interests of the corporation that the bid not succeed. But although the board’s belief must be reasonable, there might be doubt about whether this amounts to a substantial qualification of the test. It would likely not, for example, require a court to investigate the rival merits of both parties to manage the target corporation, since that clearly is beyond judicial competence. Thus the difference between the Teck and Hogg tests does not appear to go to a review of managerial motives. Under Teck, the target has a considerable discretion to adopt defensive manoeuvres, while in Hogg the rule collapses into a flat prohibition of certain defensive tactics. The issue, then, is not what management feels, but what it does. Which test one prefers will depend on one’s attitude to takeover bids. A target’s resistance to a takeover bid increases the probability that the bid will fail, and thus increases its cost. Passivity duties, such as those of Hogg, therefore encourage takeover bids, which are made more costly under Teck standards. Since takeover bids are broadly viewed as serving efficiency goals, writers who are of the view that efficiency should be promoted have preferred strong barriers to defensive manoeuvres, like those of Hogg.51 Other writers adopt a more benign view of defensive manoeuvres. Even if merger gains result from a successful takeover bid, a target’s resistance may increase the price the offeror will pay to acquire control. The first way this may happen is by shifting a greater portion of the merger gains to target shareholders. With a stronger bargaining position, target shareholders can anticipate a larger share of the bargaining surplus. In addition, defensive tactics may draw out a rival bidder to participate in an auction for control of the target. This will result in a further increase in the offer price if the rival is prepared to pay more than the first bidder was. These distributional concerns do not, however, provide an allocational justification of auctions. In addition, the probability of a higher offer price must be balanced against the reduced probability that a bid will be made in the first instance, since the first bidder’s incentives to make the offer will have been reduced. Auction theorists have therefore argued that this incentive cost is not great, and that an auction will move a target to its most highly valued user. These arguments are considered below.

50 See Ronald Gilson, “A Structural Approach to Corporations: The Case against Defensive Tactics and Tender Offers,” supra note 45 at 821-31. For recent discussions of these and other issues relating to takeover bids, see Edward M Iacobucci, “Why Does Ontario Require Equal Treatment in Sales of Corporate Control?” (2008) 58 UTLJ 123. 51 See e.g. Frank H Easterbrook & Daniel Fischel, “The Proper Role of a Target’s Management in Responding to a Tender Offer” (1981) 94 Harv L Rev 1161; Frank H Easterbrook & Gregg A Jarrell, “Do Targets Gain from Defeating Tender Offers?” (1984) 59 NYUL Rev 277; Office of the Chief Economist, Securities & Exchange Commission, “A Study on the Economics of Poison Pills” (5 March 1986) Fed Sec L Rep (CCH) at § 83,971 [1985-86 Transfer Binder].

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A second argument for defensive manoeuvres focuses on target management’s personal investment in the firm. Management may be led to make an inefficient investment in its services to the firm if its anticipated returns through long-term compensation may be cut off in a takeover bid. A successful takeover bid can then be seen as shareholder opportunism, and reducing its likelihood through defensive tactics may encourage managers to make a more efficient investment in firm-specific personal services.52 Although Teck is one of the best known Canadian decisions on the proper purposes doctrine, other courts have taken a different approach to defensive tactics. The objective English test was adopted in Bonisteel v Collis Leather Co (1919), 45 OLR 195 (H Ct J) and Bernard et al v Valentini et al (1978), 18 OR (2d) 656 (H Ct J). Teck was, however, adopted by the Manitoba Court of Appeal in Olson v Phoenix Industrial Supply Ltd (1984), 9 DLR (4th) 451 (Man CA), and in Olympia & York Enterprises Ltd v Hiram Walker Resources Ltd.53 Teck was also approved in First City Financial Corp v Genstar Corp (1981), 33 OR (2d) 631 at 646 (H Ct J); Northern & Central Gas Corporation Limited v Hillcrest Colliers Limited (1976), 59 DLR (3d) 533 (Alta SC); and Shield Development Co v Snider, [1976] 3 WWR 44 (BCSC). The Privy Council reaffirmed the objective English test in Howard Smith Ltd v Ampol Petroleum Ltd, [1974] 1 All ER 1126, [1974] AC 821 (PC), an appeal from New South Wales. Howard Smith and Ampol both sought to acquire control of a third corporation, which issued a large block of shares to Ampol to defeat Howard Smith’s tender offer. In finding that the issue was improper, the court (at 1135) noted that “an issue of shares purely for the purpose of creating voting power has repeatedly been condemned.” Teck was distinguished on the basis that the issue of shares in Afton was made to give Canex the “ultimate deal,” and not simply to defeat a control transaction. The English test is, however, considerably eroded by the relative ease with which breaches of the proper purposes doctrine may be ratified. In Hogg v Cramphorn itself, Buckley J obligingly stood the action over to permit shareholders to approve the allotment of shares. In that case, Cramphorn Ltd was a corn and seed distributor, with 60 retail branches. Earnings were not high, and there was some suggestion that the corporation would be worth more were it to sell off its retail outlets. The shares were relatively widely held, but were not listed on a stock exchange. Of the 126,000 issued shares, management controlled 37,000. When approached with an offer to buy all of Cramphorn’s issued shares, its directors issued further shares to its employees’ pension fund, of which they were trustees, loaning the fund the money to purchase shares on interest-free terms. It was conceded that the purpose of the issue of shares was to prevent the takeover bid from succeeding, although management’s bona fide belief that the issue was in the best interests of the corporation and its shareholders was not contested. The takeover bid had, not unexpectedly, an “unsettling” effect on the employees in the 60 retail outlets. While the issue of shares was found to be improper, the breach was held ratifiable and the directors permitted “to convene a

52 See John C Coffee, “Shareholders Versus Managers: The Strain in the Corporate Web” (1986) 85 Mich L Rev  1; and David D Haddock, Jonathan R Macey & Fred S McChesney, “Property Rights in Assets and Resistance to Tender Offers” (1987) 73 Va L Rev 701 at 712-17. 53 [1986] OJ 679, aff’d on other grounds, (1986), 37 DLR (4th) 193, 59 OR (2d) 254 (H Ct J (Div Ct)) (competing bid by subsidiary of target).

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general meeting to consider such resolutions as may be submitted to it.”54 The editor of the Chancery Reports noted in a footnote that the shareholders “ratified and adopted every act and deed done by the directors of the company … in connection with these matters.”55 Canadian securities commissions indicated in NP 62-202 that they may impeach defensive manoeuvres that would likely result in offerees being deprived of the ability to respond to a takeover or competing bid. The policy, however, distinguishes defensive tactics aimed at entrenching an incumbent board in power from those adopted as part of a genuine search by the target for a competing offer at a better price from a third party. The securities administrators stated that they did not seek to favour either party in a contested bid, and that unrestricted auctions produce the most desirable results in a tender offer.

D.  Defensive Tactics: The US Landscape Jurisprudential tests used in Delaware to assess defensive tactics have evolved considerably since the proper purpose doctrine was set out in Cheff v Mathes in 1964, a decision that, as we have seen, greatly influenced Berger J’s reasoning in Teck. This section reviews developments in Delaware since Cheff v Mathes, developments that have frequently served as important points of reference for discussions about the tests that should govern the use of defensive tactics in Canada.

Peter Dey & Robert Yalden, “Keeping the Playing Field Level: Poison Pills and Directors’ Fiduciary Duties in Canadian Take-Over Law” (1990) 17 Can Bus LJ at 254-261 (footnotes omitted) The Origins of Poison Pills: The American Experience (1)  The U.S. Business Environment While mergers and acquisitions have a long and venerable history, the advent of the hostile take-over is relatively new. Viewed in the beginning as somewhat uncouth corporate behaviour, worthy only of a handful of troublesome raiders, the hostile take-over has become a permanent fixture in American business, with major companies attempting increasingly ambitious acquisitions. In part, the rather special structure of the American shareholder profile accounts for a climate in which it has been possible to launch hostile bids for a wide range of major corporations. For example, in 1983 only 1% to 2% of the companies listed on the Standard and Poor’s Index had a shareholder with legal control (50% or more of voting shares) and only 13% to 14% had a shareholder with effective control (20% to 49.9% of voting shares), whereas some 84% to 86% were widely held. Because most major American companies continue to be widely held, attempts by a bidder to convince these companies’ shareholders to tender their shares to a bid, despite management’s

54 Hogg v Cramphorn Ltd, [1967] Ch 254 at 272. 55 Ibid; see also Bamford v Bamford, [1970] 1 Ch 212 (CA).

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objections, are on average far more likely to succeed than in jurisdictions where few companies are widely held. But the rise of hostile take-over bids is also integrally related to, and in part the inspiration for, a wide range of innovative financing techniques. The classic example of the kind of financial instrument that has facilitated the corporate raid is of course the “junk bond”: a form of high-yield, below investment-grade bond. In recent years, particularly adept investment banks regularly used junk bonds as the financial instrument of choice to assist companies in obtaining the large-scale financing needed in order to launch a hostile take-over. In a world where the speed with which one can launch a raid is often a critical factor in ensuring that a hostile acquisition is successful, investment banks have come to pride themselves on the rapidity with which they can offer financing to a raider—typically refinancing the loan at a later date through the junk bond market. The speed with which financing of staggering proportions can be raised, combined with the “hands-off ” attitude that Congress and the Securities and Exchange Commission (the “SEC”) have adopted with respect to hostile take-overs, has led American raiders to develop a wide range of take-over tactics. Particularly effective has been the “street-sweep,” a practice whereby arbitrageurs who have accumulated shares in a corporation known to be in play sell their holdings to a raider before the end of the 10-day period in which that raider, once it has acquired 5% of a class of equity securities of a publicly traded company, must file a Schedule 13D disclosure statement with the SEC. The arbitrageur’s business has blossomed in part because American courts have decided not to treat the type of accumulation process that they engage in as a tender offer that falls within the ambit of the Williams Act and that is therefore subject to its disclosure requirements. The legal status of arbitrage has not only greatly facilitated the speed with which take-overs can take place, but it has also increased raiders’ ability to use the element of surprise when launching take-over bids. At the same time, the United States has witnessed the use of coercive strategies that deliberately discriminate among shareholders of a target company: for example, the twotier, front-end loaded bid that Robert Campeau used in the course of his 1988 bid for Federated Department Stores. This kind of bid typically involves a cash offer for a controlling block of the target’s securities at a relatively high price (the “front-end”) with a promise to complete the acquisition in a second step merger at a lower price (the “backend”), often payable in securities of the highly leveraged surviving company. The structure of the bid is not only coercive, in that it tries to force stockholders to sell into the “frontend” (where they capture part of the control premium that is offered to those who tender early) lest they get stuck in the low “back-end” (which offers no control premium), but it is discriminatory because it offers different consideration to different shareholders. In short, tactics that exploit advantages gained by moving quickly, that are coercive and that discriminate among shareholders are by now quite familiar to those who have followed the twists and turns in the evolution of the American take-over environment. Describing this environment, one commentator has observed: A complex take-over culture has developed in the United States … . This development has only been possible because take-overs in the United States are subject to only modest government regulation. The rules governing the behaviour of both raiders and defenders largely

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(2)  The Shareholders’ Rights Plan The shareholders’ rights plan is but one device in a defensive armoury filled with tactics designed to deal with the hostile take-over. But it has become a weapon of choice because it has proven particularly effective in providing the board of directors of a target company with the bargaining power to deal with a fast-moving discriminatory take-over bid. At the end of the day, shareholders’ rights plans may not stop, and on most occasions have not stopped, the determined raider. But they have bought valuable time for target companies concerned to ensure that shareholders are treated fairly and obtain full and fair value for their shares. The shape of a poison pill often varies from company to company. But while there are different capsules and coatings, the essential ingredients remain much the same. Indeed, as with many defensive tactics developed in recent years, the mechanics of shareholders’ rights plans are quite straightforward. By virtue of their power under the relevant corporations Act, a company’s board of directors will issue rights (“Rights”). Typically, one Right will be distributed for each common share and can only be transferred with that common share until the occurrence of a “triggering event.” The Rights are priced “out of the money”: that is, at a prohibitively expensive price (the “exercise price”) that is considerably in excess of the price at which that company’s securities trade in the market. The Rights do not detach from the shares and cannot be exercised until a triggering event has taken place. The triggering event is usually defined to include either one of two possible scenarios: an “acquiring person” must acquire a designated percentage of common shares, or a set number of days must elapse after “an acquiring person” has launched a take-over bid that is designed to give that person beneficial ownership of a designated percentage of common shares. The critical feature of most shareholders’ rights plans is a provision (the “flip-in” provision) that stipulates that once an acquiring person has crossed the designated threshold of beneficial ownership, each Right entitles all holders except the acquiring person to purchase that number of common shares having an aggregate market price equal to twice the exercise price for the exercise price (i.e., at half their normal price). As for the acquiring person, his or her Rights become null and void upon crossing the designated threshold of share ownership. It is the “flip-in” provision that has proven particularly effective in ensuring that raiders are forced to negotiate with a target company’s board of directors. Because shareholders’ rights plans provide that the target company’s board of directors may redeem the Rights at a minimal price up until the relevant triggering event has taken place, raiders are in effect forced to go to the board with their offer in order to convince the board to redeem the Rights. Failing that, raiders may choose to condition their bid on a court finding that the board’s use of the shareholders’ rights plan is illegal. But regardless of the way in which the raider chooses to address the rights plan, it serves to slow down the speed with which the raid can take place.

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The structure of poison pills has evolved considerably in recent years. The flip-in provision is itself a relatively new feature, as shareholders’ rights plans first involved little more than “flip-over” provisions that were designed to produce substantial dilution in those instances where a raider, having crossed a given share ownership threshold, sought to acquire the remaining target common stock in a business combination transaction or sought to acquire a significant portion of the target’s assets. Under a flip-over provision (which is still a common feature in most shareholders’ rights plans), the Rights entitle shareholders to purchase stock in the acquiring person’s company at what amounts to half their market price. A more recent development that is now a common feature of many Canadian rights plans is a clause known as a “permitted bid” provision. Permitted bid provisions enable an acquiror, having satisfied certain conditions, to by-pass the target board and to deal directly with the target shareholders without creating a “flip-in event.” For example, a permitted bid provision might enable shareholders to vote on whether they wish to accept a bid and to have the Rights redeemed. The bid will, however, normally have to satisfy certain conditions (which vary from one permitted bid provision to another) before it may be put to a special shareholder vote: for example, the bid must be made in compliance with the provisions of the relevant take-over bid code and it must be made to all shareholders. Some permitted bid provisions also require that the take-over bid be accompanied by a fairness opinion concerning the terms of the bid. The provision requires that the bid then be accepted by a majority of the shares not owned by the bidder to avoid triggering a “flip-in.” In the end, though, it is the presence of the flip-in provision that has proven a particularly potent antidote to attempts to launch unfair and discriminatory take-overs and it is this aspect of the shareholders’ rights plan that has attracted the most criticism. By threatening substantial dilution of the acquiror’s position the shareholders’ rights plan has been used in the United States to redress an imbalance in power that has often arisen where a raider uses acquisition tactics that take advantage of the wide distribution of a company’s shares and that exploit the time limits on the bidding process set out in the Securities and Exchange Act 1934. The plan provides a target company’s board of directors with the time to evaluate a raider’s bid, to ascertain whether there may be other bidders that are prepared to offer more to the company’s shareholders, and if necessary to run an auction in an attempt to ensure that the company’s shareholders are paid an amount that reflects the company’s underlying value. Of course, any raider can, and most do, seek to enjoin the shareholders’ rights plan once a bid is made, usually on the ground that it is being used in a way that violates the target company’s directors’ fiduciary duties. As a result, target companies’ directors are regularly subject to close judicial scrutiny that places pressure on them to make sure that the rights plan is not used to deny their company’s shareholders the opportunity to accept an offer of full and fair value. Poison pills in the United States and Canada have evolved since Dey and Yalden wrote their article. Moreover, while Canadian poison pills first looked very much like US poison pills, the Canadian regulatory landscape has led to changes that mean that the poison pills that most Canadian companies have adopted are structured somewhat differently than US-style poison pills—for example, in Canadian pills the flip-over provision is no longer seen and

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permitted bid provisions are now typically quite standardized. Canadian rights plans are discussed in further detail in the next section of this chapter. The following extract reviews a number of important decisions that the Delaware courts handed down in the 1980s in the face of the wave of hostile M&A that unfolded in that decade. These landmark decisions—notably, Unocal Corp v Mesa Petroleum Co, 493 A (2d) 946 (Del 1985); Moran v Household International Inc, 500 A (2d) 1346 (Del 1985); and Revlon, Inc v MacAndrews & Forbes Holding, Inc, 506 A (2d) 173 (Del SC 1986)—dealt with a range of defensive tactics (including poison pills) and remain important points of reference for discussions in Delaware about the appropriate use of defensive tactics. They have also frequently been cited in Canadian case law addressing defensive tactics. Indeed, one of the challenges that Canadian courts have had to wrestle with is whether to follow the approach adopted in Delaware.

Jody W Forsyth, “Poison Pills: Developing a Canadian Regulatory and Judicial Response” (1992) 14 Dal LJ 158 at 168-70, 173-75, and 176 (footnotes omitted) An investigation into the standard of conduct required of a director in order to meet his/ her fiduciary duty of loyalty to his/her company in the context of a hostile take-over must begin with the decision of the Supreme Court of Delaware in Unocal Corp. v. Mesa Petroleum Co. In that case, Mesa Petroleum Co. (“Mesa”) initiated a two-tier, front-end loaded cash take-over bid for sixty-four million shares of Unocal Corp.’s (“Unocal”) outstanding stock at a price of U.S. $54 per share. This number, together with the number of shares already held by Mesa, would have been sufficient to give it control of Unocal. The back-end of the transaction would have resulted in the exchange of the remaining publicly held shares of Unocal for subordinated securities worth U.S. $54 per share. After meeting with both its financial and legal advisors, Unocal’s board of directors adopted a unanimous resolution rejecting Mesa’s tender offer as inadequate. At a subsequent meeting, after once again receiving advice from its advisors, Unocal’s board of directors unanimously resolved to exchange forty-nine percent of its outstanding shares for debt obligations worth U.S. $72 per share. The Unocal offer excluded Mesa. Mesa promptly challenged the propriety of this discriminatory defensive self-tender. The Court first stated that a Delaware corporation may deal selectively with its shareholders, provided that in so doing its directors do not breach their fiduciary duties. While it then went on to hold that the business judgement rule applies in the context of a takeover, the Court also stated that: Because of the omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders, there is an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred. In the face of this inherent conflict directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another person’s stock ownership. However, they satisfy that burden “by showing good faith and reasonable investigation … .”

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A further aspect is the element of balance. If a defensive measure is to come within the ambit of the business judgement rule, it must be reasonable in relation to the threat posed. [Footnotes omitted.]

The Court then concluded that the actions of Unocal’s directors, confronted with a coercive take-over bid from a “corporate raider with a national reputation as a ‘greenmailer,’ “ satisfied the above tests and that they were therefore protected by the business judgement rule. As a result, a preliminary injunction that was granted against Unocal was vacated. That the principles enunciated in Unocal are also applicable to evaluate the standard of directoral conduct in relation to both the adoption and maintenance of shareholder rights plans was confirmed by the Delaware Supreme Court in Moran v. Household International Inc. In that case, the board of directors of Household International, Inc. (“Household”) adopted a flip-over rights plan prior to any announcement of a take-over bid for the company’s shares. Moran was both a director of Household and chairman of Dyson-Kissner-Moran Corporation (“DKM”), Household’s largest shareholder. DKM was interested in conducting a leveraged buyout of Household and therefore challenged the propriety of that company’s poison pill. The Court first noted that, unlike previous cases, the defensive measures employed by Household’s directors were not adopted in response to any specific threat. However, it concluded that: This distinguishing factor does not result in the Directors losing the protection of the business judgment rule. To the contrary, pre-planning for the contingency of a hostile takeover might reduce the risk that, under the pressure of a takeover bid, management will fail to exercise reasonable judgment. Therefore, in reviewing a pre-planned defensive mechanism it seems even more appropriate to apply the business judgment rule.

After finding that the directors were authorized to adopt the shareholder rights plan, the Court then applied the three-prong test outlined in Unocal to determine whether or not the directors would be afforded the protection of the business judgment rule. First, the Court found that the directors had acted in good faith in reacting to what they “perceived to be the threat in the market place of coercive two-tier tender offers.” Next, the Court held that the directors were reasonably informed of the effects of the poison pill given that they received advice from both their legal and financial advisors and that the plan was critiqued before the board by Moran himself. Finally, the Court concluded that the rights plan was reasonable in relation to the threat posed from the ever increasing frequency of coercive take-overs in the financial services industry. It is important to note that while the Court upheld the adoption of the flip-over plan in Moran it also cautioned that that does not end the matter. The ultimate response to an actual takeover bid must be judged by the Directors’ actions at that time, and nothing we say here relieves them of their basic fundamental duties to the corporation and its stockholders … Their use of the Plan will be evaluated when and if the issue arises.

A liberal reading of Moran would suggest that so long as coercive take-over tactics continue to be employed, and so long as directors properly “paper” their transactions, the adoption of a shareholder rights plan will not be invalidated as a breach of the directors’

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fiduciary duties. This theory is supported by a long line of cases in which the adoption of flip-over, flip-in and back-end rights plans have all been upheld. … Assuming that, in general, directors act upon reasonable grounds in adopting shareholder rights plans, it is important to remember that their actions in relation to the maintenance of those plans must also meet the three-prong test enunciated in Unocal. This principle comes into play where the directors refuse to redeem poison pill rights in the face of a take-over bid. This was exactly the situation before the court in Grand Metropolitan Public Ltd v. Pillsbury Co. In that case, Grand Metropolitan Public Ltd. (“Grand Met”) sought an order directing Pillsbury Co. (“Pillsbury”) to redeem rights associated with its flip-in poison pill so that Grand Met could proceed with a fully financed take-over bid for all common shares of Pillsbury at a cash price of U.S. $63 per share. The sole basis on which the directors refused to redeem the rights was the alleged inadequacy of the offered price. After stating that the case was governed by the principles enunciated in Unocal; the Court concluded that Surely, Board action which bars Pillsbury shareholders from electing to sell their stock … when, (a) only shareholder interest is at stake … is harsh treatment of shareholders to whom fiduciary duties are owed. And the means to accomplish that treatment, considered in context and result, are Draconian. In the principal, if not in all, Delaware cases validating use of the Pill, it is apparent that the purpose thereof was to create a “defense” against hostile, coercive acquisition techniques.

Given that the take-over bid was a cash offer for all of the common shares of Pillsbury, there was no coercion involved and the directors were therefore ordered to redeem the poison pill rights so that the take-over bid might proceed. It was noted in Pillsbury that the only interests at stake were those of the shareholders. However, that may not always be the case, and where other interests are affected by a take-over bid, it appears that such interests may be taken into account by the directors. As stated by the Delaware Supreme Court in Unocal: If a defensive measure is to come within the ambit of the business judgment rule, it must be reasonable in relation to the threat posed. This entails an analysis by the directors of the nature of the takeover bid and its effect on the corporate enterprise. Examples of such concerns may include: inadequacy of the price offered, nature and timing of the offer, questions of illegality, the impact on “constituencies” other than shareholders (i.e., creditors, customers, employees, and perhaps even the community generally), the risk of nonconsummation, and the quality of the securities being offered in the exchange. (Emphasis added)

It is important to note that the above principle was modified by the Delaware Supreme Court in Revlon, Inc. v. MacAndrews & Forbes Holding, Inc. In that case, Pantry Pride, Inc. (“Pantry Pride”) had made a conditional take-over bid for Revlon, Inc.’s (“Revlon’s”) common shares at a cash price of U.S. $56.25 per share. Revlon’s directors instead agreed to a leveraged buyout by Forstmann Little & Co. (“Forstmann”) because the latter was willing to support the face value of recently issued Revlon notes. As part of that agreement,

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Revlon agreed to both a “lock-up” option on two of its divisions and a “no-shop” provision. Pantry Pride then challenged the Revlon-Forstmann agreement. On appeal, the Court first found that the directors’ decisions to both adopt the backend rights plan and issue certain note obligations were protected by the business judgement rule pursuant to the principles enunciated in Unocal. It then went on to state that when it became apparent that the company was to be sold [t]he directors’ role changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company

The Court concluded that the directors had put the interests of the noteholders before the interests of the shareholders and that, on the facts of the case, this constituted a breach of their duty of loyalty. The directors had argued that, under the Unocal principles, they were permitted to consider the effect of a take-over on constituencies other than the shareholders. The Court rejected this argument, holding that: A board may have regard for various constituencies in discharging its responsibilities, provided there are rationally related benefits accruing to the stockholders: Unocal, 493 A.2d at 955. However, such concern for non-stockholder interests is inappropriate when an auction among active bidders is in progress, and the object no longer is to protect or maintain the corporate enterprise but to sell it to the highest bidder.

The reasoning of the Court in Revlon has been applied in several subsequent cases … . To summarize, the American position appears to be that, in most instances, the directors’ decision to adopt a poison pill will not be questioned, so long as the transaction is properly “papered.” However, the directors’ decision to not redeem rights issued pursuant to the adoption of a poison pill in the face of a non-coercive take-over bid will come under closer scrutiny. Where the directors have made a decision to sell the corporation, they appear to be permitted to consider only the interests of the shareholders. Furthermore, where such an “auction” has come to an end, the directors must permit the shareholders to decide which of two or more non-coercive alternatives is in their best interests.

Jack B Jacobs, “Fifty Years of Corporate Law Evolution: A Delaware Judge’s Retrospective” (2015) 5 Harv Bus L Rev 141 at 154-55, 160-64, and 168-72 (footnotes omitted) For the evolution of corporation law to make sense, the story of how the standards of review evolved needs to be told. To summarize that story in a paragraph: in the beginning, there were only two standards. Then, two major developments occurred. First, the Delaware courts added clarity and content to those two pre-existing standards, to afford guidance for their proper application. Second, those courts created an entirely new, “intermediate” set of standards in the landmark cases of Unocal, Revlon and Blasius. These new intermediate standards were needed to address new realities and issues arising out of novel legal and financial technologies, in order to solve the problem of whether and

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how boards should respond to hostile corporate takeovers. That evolution was gamechanging. It reshaped the governance of boards and the conduct of all players, including legal and financial advisors, in the area of mergers and acquisitions. The two bedrock standards of review in corporation law have always been—and still are—business judgment and entire fairness. The business judgment rule or standard (BJR) is a rebuttable presumption that “in making a business decision the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company.” Where that standard applies, the directors’ decision will be upheld, meaning that if the case falls into “business judgment land,” the board always wins. The only exception arises if and where the same business decision that receives business judgment review is found to be “irrational” (because, for example, it constitutes corporate waste)—an event never proved in any case that I am aware of. The BJR presumption is rebuttable if the plaintiff can show that the directors breached either their fiduciary duty of care or of loyalty (including acting in bad faith). If the BJR presumption is rebutted, then “the burden shifts to the director defendants to demonstrate that the challenged act or transaction was entirely fair to the corporation and its shareholders.” The second bedrock standard is entire fairness—the most onerous standard our law imposes on corporate fiduciaries. The entire fairness standard applies whenever the fiduciaries propose or effect a transaction where the fiduciaries have a self-interest which conflicts with that of the shareholders. The paradigmatic case is an “interested” cash-out merger between a parent corporation and its subsidiary. Under this standard, the majority stockholder and the interested board members have the burden of proving that their actions and approvals were entirely fair to the corporation and its shareholders, both in terms of process and price. Although the entire fairness standard has been with us since the beginning of corporate law time, it was amorphous and open-ended—that is, it lacked specific content that facilitated predicting the outcome of litigation—until 1983. Not until Weinberger v. UOP, Inc. did the Delaware Supreme Court gave the practicing bar and the courts more detailed procedural guidance and a clearer analytical framework for determining whether a conflicted transaction is entirely fair. Because the outcome of a transactional case most often will depend on what review standard is applied, it is not surprising that, over the last five decades, the issues of what standard applies and the nuances of its application have been heavily litigated. These issues are in both the business judgment and the entire fairness spaces. … •  •  •

The intermediate standards, as we know, were announced in the 1985 Unocal and Revlon cases and also in Blasius which was decided in 1988. The intermediate standards were developed because the two pre-existing standards—business judgment and entire fairness—were neither well suited nor responsive to the concern presented by hostile takeovers. The concern was that even independent target company directors not financially threatened by a hostile takeover might have a genuine but hard-to-prove aversion to being forcibly ousted from their board positions. That bias, in turn, could render the independent directors unable to evaluate, objectively and dispassionately, whether the hostile bid is in the best interest of the shareholders. That elusive potential bias was not only impossible to prove, but also did not fit either the entire fairness or the business judgment review analytic paradigm. The entire fairness standard governs transactions

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that either involve self-dealing by a majority stockholder or that were approved by a board having a financial conflict of interest. Yet, most corporate boards that adopted defenses against hostile tender offers had a majority of independent directors whose livelihoods would not be threatened by the outcome of the contest for control. In those cases, no concrete, identifiable self-dealing of the kind that triggers classic entire fairness review was presented. Nor did board-adopted defenses against hostile tender offers comfortably fit the business judgment paradigm either. That standard presupposes a board decision that involves the business or assets of the company. A hostile tender offer, in form at least, is a transaction that involves only the shares owned by the shareholders, not the assets or business of the company. And, as a formal matter, a tender offer involves only the offeror and the stockholders—but not the board, which had no statutory authority to approve or disapprove a tender offer by a third party. Equally important, applying the traditional review standards to hostile tender offer defenses created the risk of an either over- or under-inclusive regulation. Reviewing a takeover defense under the entire fairness standard created a significant risk of overinclusion, that is, that the board-adopted defense would be found unfair merely because the defense would deprive the shareholders of an opportunity to receive a premium over the pre-tender market price of their shares. If employed, that approach would leave wellintended target boards unable to protect their shareholders against coercive and underpriced takeover bids of the kind struck down in Unocal. Conversely, applying business judgment review would virtually guarantee that every defensive measure would be upheld. Review under that standard created the risk that courts would unduly defer to defensive actions by compliant boards that had no conflicting financial interest and even acted in subjective good faith, yet were servile to the views of senior managers with a concrete, career-based self-interest in opposing a bid that, viewed objectively, would best serve shareholder interests. 2.  The Quest for an Intermediate Standard This Catch-22 prompted the Delaware courts to embark on a quest to develop a review standard that would better address the complexities of hostile takeovers and the subtle motives that drove target board defensive responses. That twenty-five-year quest (19601985) involved experimenting with two alternative standards and ultimately jettisoning both in favor of the “reasonableness” standard articulated in Unocal and Revlon. The first experimental effort, reflected in cases such as Bennett v. Propp and Schnell v. Chris Craft Industries, Inc. employed the “sole or primary purpose” test—whether the board was using the corporate machinery for the “sole or primary purpose” of maintaining itself in control. This test had the virtue of squarely addressing the concern that a nonfinancial conflicting interest may be driving the target board’s defensive response to a hostile bid. To that extent, the “sole or primary purpose” test avoided the almost reflexive deference afforded by business judgment review. The drawback of that test was that to apply it—to prove that a board acted for the sole or primary purpose of entrenchment— required divining the directors’ subjective motives, an inquiry laden with difficult problems of proof. The second experimental approach—more objective yet still unsatisfactory—was exemplified by cases such as Kars v. Carey and Cheff v. Mathes. Under the doctrine

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endorsed in those cases, a board would be entitled to defend against a dissident’s threat to capture control if the board shows it had “reasonable grounds to believe a danger to corporate policy and effectiveness existed.” This test—clearly a forerunner of Unocal—had the virtue of being easier to prove and more objective for courts to apply than the “sole or primary purpose” standard. Its drawback, however, was that all contested takeovers could plausibly be argued to involve a “policy dispute” over how the target company should be managed in the future. In the real world, every hostile acquirer will necessarily have a business strategy that differs from the one being pursued by incumbent management. Therefore, under this approach almost every takeover defense would be upheld. These two experimental standards were ultimately jettisoned because they did not accomplish three objectives required of an effective review standard: (1) thwart defensive tactics motivated by management self-interest, (2)  protect defensive tactics genuinely motivated to secure the best value for the shareholders, and (3) uncover defensive tactics being justified, pretextually, as in the shareholders’ best interests, but in fact cloaking self-interested behavior.” An important reason why it was so difficult to locate a review standard that would accomplish all these objectives was that two underlying predicate issues also had to be resolved. The first issue was who should have the power to decide whether or not to accept an unsolicited takeover bid—the stockholders or the board? The second issue was which branch and institution of government—the executive, legislative, or judicial—should decide the first question. The second issue was ultimately resolved, largely by default, by the state courts—and predominately those of Delaware—because no federal or other governmental institution was asserting an interest in regulating this field. The first question was ultimately answered by the Delaware Supreme Court in Unocal and Revlon. 3.  The New Intermediate Standards: Their Virtues and Drawbacks Adopting a completely new analytical framework tailored specifically to contests for control, Unocal and Revlon established that the target company board, constrained by principles of fiduciary duty and policed by the courts, should decide whether a hostile bid would be permitted to go forward. To get there analytically, the Supreme Court was required to surmount the nettlesome problem that, as a state law statutory matter, the board has no power to approve, disapprove, or otherwise intervene in tender offers that, in form, do not implicate the corporation’s assets or business. The court did that by innovating, as a matter of principle, the proposition that certain hostile bids may adversely affect the corporation’s business and policy. In such cases, the board, under its general statutory power to manage the corporation’s business and affairs, may lawfully intervene between the hostile bidder and the shareholders. Unocal accomplished two other conceptual breakthroughs. First, it addressed the unique concern posed by board defensive conduct that neither the business judgment nor the entire fairness standards could do successfully. Second, Unocal created a new analytical framework that objectified the inquiry for determining the validity of boardadopted defensive measures. Under that framework, a board-adopted defense could become entitled to business judgment review, but the target board must first earn the right to that deferential review by carrying its burden to show that the board reasonably perceived that the hostile offer constituted a threat to corporate business or policy, and

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next, that the defense the board adopted was a reasonable, and not disproportionate, response. Only if the board satisfied both of these criteria would its defensive action receive business judgment review. Similarly, Revlon, which applies in the distinct setting where the target board’s defensive response is to sell the company, also imposed on target boards the burden of showing that the process they used to sell the company was reasonable and resulted in the shareholders receiving the best value reasonably available. Although these new standards represented a conceptual breakthrough, they were hardly trouble-free. As we now know, it took ten years for the courts to work out fundamental problems of application. Unocal generated questions such as: what kinds of threat will trigger the board’s right to defend; what analysis should the courts employ in determining whether the board-adopted defense is disproportionate; and how should this standard be applied to strike the proper balance between respecting the target board’s judgment and upholding the court’s determination that, on occasion, will require overturning that board decision? Many, though not all, of those doctrinal issues were resolved in the 1995 Unitrin case, where the Supreme Court reframed and refined the proportionality prong of Unocal to tilt the balance in favor of respecting the judgment of the target board. Revlon, for its part, also generated fundamental questions, such as what precisely should trigger Revlon review, and how should the courts determine whether the target board’s decision making process was reasonable and whether the transaction price constituted the best value reasonably available? … •  •  •

IV.  Potential Future Directions of Corporate Law I conclude by sharing briefly some thoughts about the directions in which corporation law may evolve in the future. As Yogi Berra said, predictions are difficult, particularly about the future. Even so, there is one indisputable reality—the radical alteration of the shareholder profile of U.S. public companies (incorporated disproportionately in Delaware)—from which some modest predictions may plausibly be extrapolated. As mentioned earlier, our American capital markets are now “deretailized.” That is, unlike in the 1950s, when individual retail investors owned over 75% of all outstanding U.S. corporate equities, today institutional investors—including public and private pension and retirement funds, mutual funds, and hedge funds—comprise nearly 70% of that shareholder base. Today’s retail investors—people like us—are only indirect investors in those public companies, our direct investment being in the institutional funds and retirement plans that own directly the shares of those portfolio companies. This transformation of the shareholder profile of U.S. public corporations has profound implications for the evolution of corporate law because the institutional shareholder base adds to the calculus two new and important elements. First, unlike the retail shareholder paradigm, the institutional shareholder base is economically and legally empowered. It is economically empowered because the institutions have substantial financial resources, and because voting control of the shares they own is concentrated in a relatively small group. And, it is legally empowered because of structural changes in the legal environment that have taken place during the past fifteen years. Second, those institutional shareholders have a short-term investment horizon and perspective. They are managed by persons or firms whose compensation depends on

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generating short-term returns from the portfolio company stocks under institutional management. Because of this combination of elements, institutional investors have both the wherewithal and the incentive to exert pressure on portfolio company managements and boards to deploy corporate assets and develop business strategies designed to yield short-term profits—in many cases, at the expense of alternative strategies that would yield higher profits over the longer term. Converging with this combination of institutional investor wealth and short-term outlook have been changes in the legal environment, that have given this new shareholder base the tools to lawfully influence corporate boards and managements to be more responsive to their economic agendas. In this regard, two developments are especially relevant: (1) the increased resort to the shareholder bylaw adoption process to limit the power of boards to adopt governance rules, including takeover defenses; and (2)  the enactment of new rules providing for shareholder proxy access and proxy expense reimbursement. For over a decade, institutional shareholders have invoked the shareholders’ statutory authority to adopt and amend bylaws in order to restrict or eliminate the board’s power to adopt poison pills. As a result, a significant percentage of public companies have dismantled their pills. Institutional shareholders have also invoked the bylaw amendment process to reform the proxy election system in a manner favorable to their interests. These bylaws typically require the corporation to reimburse the expenses of any dissident shareholder group that nominates a “short slate” of board candidates that is successfully elected. That development was validated initially by a 2008 Delaware Supreme Court decision holding that proxy reimbursement was a proper subject for shareholder action and would not infringe the board’s statutory power to manage the corporation. It later was reinforced legislatively by the adoption of §§ 112 and 113 of the DGCL [Delaware General Corporation Law]. Those provisions authorize the adoption of bylaws that allow a dissident shareholder group’s proxy materials to be included in the board’s proxy materials at company expense. Alternatively, should the dissident group choose to conduct its proxy contest independently, those statutes provide for the reimbursement of the dissident group’s proxy solicitation expenses in specified circumstances. The result has been to reduce the cost to dissident shareholders (including activist investors) of conducting a proxy contest for board representation or control. Not only have these developments empowered activist shareholders to alter the composition of the board, but they have also made even their threat to do so more credible, thereby increasing activists’ leverage to influence board decision-making. In this vein, activist institutional shareholders have used their enhanced power to influence the approval of charter amendments dismantling staggered or classified boards, thereby making directors more vulnerable to removal and more motivated to respond to activist investor agendas. Just how far-reaching the consequences of these developments have been can be grasped by contrasting the diminished power of corporate boards in relation to shareholders today, with the relative power boards possessed only fifteen years ago. In order to achieve higher returns, traditional institutional investors, including some university endowment funds, have increasingly invested significant resources with activist investors, thereby creating and making a new “asset class,” now exceeding $200 billion, available to activist investors to finance their short-term agendas. Accordingly, over the past two years, the number and the success of activist investor initiatives have increased, such that today

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no corporation is too large to escape being an activist target. Two recent examples are Trian’s campaign to change DuPont’s business model, and Third Point’s attempt to add to Dow Chemical’s board two nominees who would be compensated separately by Third Point based on Dow Chemical’s stock market performance. One consequence of the altered character of the public company shareholder profile is that public company boards now operate under the shadow (that is, the implied threat) of a proxy contest to oust them at the next annual meeting should they resist or deviate from the agendas of their large institutional stockholders. Even without any threatened proxy contest, companies that have a majority vote requirement remain subject to the threat of a campaign to deny board incumbents the majority vote needed for their reelection. Those threats become accentuated if the activist investor initiative focused on a specific corporation is endorsed by proxy advisors such as ISS and Glass Lewis. This change in the identity and the nature of the public company shareholder base poses, I suggest, a challenge to the ongoing vitality of the board-centered model of corporation law. Personally, I believe that is not a good development, because it diminishes one of the few significant advantages the United States has in an increasingly competitive global economy—the ability to innovate new products. As I have argued elsewhere, the ability to innovate new products that the world will demand and be willing to pay for requires the U.S. corporate community to nurture what has been described as “patient capital.” To do that requires a legal and economic environment that permits boards to govern for the longer term, free from capital market-created pressures to generate quarterly returns or to liquidate assets for distribution to shareholders. But, whether or not a more shareholder-centric world is thought to be good or bad, one can plausibly make some modest predictions. First, it is predictable that many boards will resist activist investor interventions, which in turn will generate litigation over whether, and on what doctrinal basis, the courts will uphold board anti-activist defenses. In developing the law, I believe that Delaware courts will play a significant role by default, since no other governmental agency is likely to step up to the plate. In this highly politicized environment, Congress is unlikely to act, and any effort by the SEC [Securities and Exchange Commission] to regulate this area will also likely meet with paralyzing political opposition. So, what we may witness is a replay of the 1980s, where the courts were forced to fashion new principles to redefine the power of the board to oppose hostile takeover bids by third-party bidders. This time, however, the “outsiders” will literally be “insiders”—the corporation’s own institutional stockholders. We have glimpsed an inkling of that future in the recent Sotheby’s case’’—the effort by Third Point to force a change in the business model and management of Sotheby’s. In Sotheby’s, the legal analysis was conventional because the case involved only a new variation of a now traditional poison pill defense. In future cases, however, boards may be forced to innovate entirely new defense strategies that may require courts to fashion new doctrine to demarcate more precisely the limits of a board’s power to protect the corporation against its own shareholders. To express it a different way, this litigation may force the Delaware courts to reconsider to what extent the board-centric model can be preserved. Second, the new institutional shareholder base may itself be good cause for the courts to reassess the need for judicial protection of shareholders in factual patterns of the kind

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involved in cases such as Unocal, Revlon, and Blasius. As I have suggested elsewhere, those cases rest on a premise that is now outdated—namely, a shareholder base consisting of unsophisticated, powerless retail shareholders that need the courts to protect them from overreaching boards, majority shareholders, or hostile bidders. In today’s world, the new shareholder base consists of wealthy, powerful, and highly motivated institutional investors fully capable, in many cases, of protecting themselves. It is, therefore, predictable that in future cases, the courts may be called upon to recalibrate, and perhaps in certain respects dial back, their perceived role as guardians of minority shareholder interests. But, whether and how these developments will occur is not for me to say. My privilege has been to witness, and play a small role in, the evolution of American corporate law over the past fifty years. It will now be the privilege of your generation to shape and witness how that law develops during the next half-century. NOTES AND QUESTIONS

1.  The decision in Unocal accepts that provided a board of directors lives up to its fiduciary duties, it may deal selectively with its shareholders. Thus, it was open to Unocal’s board to exclude Mesa from Unocal’s exchange offer. This clearly involves treating shareholders of the same class differently. In view of the analysis of the nature of a share set out in Chapter 6, would such discriminatory tactics be allowed in Canada? Did Berger J effectively allow the use of similar discriminatory tactics in Teck? What are the implications of these decisions for the debate seen in Chapter 6 concerning the concept of equality that should govern the treatment of shareholders? 2.  Securities and Exchange Commission (SEC) rules now negate the Unocal decision with respect to discriminatory tender offers. Rules 13e-4(f)(8)(i) and 14d-10(a)(i), adopted in 1986, require bidders to extend the offer to all securities holders of the class of securities subject to the offer. A similar “all-holder” requirement is featured in NI 62-104. The Unocal decision is, however, still of considerable interest as to the validity of poison pills in general. 3.  Mesa’s two-tier bid for Unocal was designed to place pressure on shareholders to tender to the bid. Moreover, if successful, it would have resulted in Unocal having to carry a more substantial debt load than it had prior to the bid. In assessing the “threat posed” by Mesa’s bid, the court stated that a board of directors in the exercise of its fiduciary duties was entitled to consider the impact of the bid on constituencies other than shareholders. Is this a matter that directors should bear in mind? Is Unocal’s approach to this issue consistent with the approach Berger J favoured in Teck? Do Teck and Unocal share a common vision of the firm? 4.  It is worth noting that in Unocal, the court relied extensively on the 1964 decision of the Delaware Chancery Court in Cheff v Mathes, a decision that Berger J also looked to for inspiration in Teck. In view of the shared reliance on Cheff v Mathes, do you think that Canadian courts looking to build on the decision in Teck should be willing to look for guidance to Unocal and some of the other Delaware decisions that build on Cheff v Mathes? If so, should Revlon be one of those cases? In considering how best to answer this question, you will want to reflect on the implications of the Supreme Court of Canada’s decision in BCE Inc v 1976 Debentureholders. 5.  One of the reasons that Unocal’s self-tender was upheld was because the Mesa bid was two-tiered. However, a self-tender was itself impeached as two-tiered in AC Acquisitions

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Corp v Anderson, Clayton & Co, 519 A (2d) 103 (Del Ch 1986), a decision that allayed fears that defensive self-tenders would uniformly be upheld after Unocal. The target corporation had sought to resist a tender offer at $56 per share through a buyback offer to acquire 65 percent of its outstanding stock at $60 per share. But while the tender offeror proposed a cashout merger at $56 per share, the target did not seek to acquire more than 60 percent of its stock and the court accepted evidence that shareholders who failed to tender in the share repurchase were likely on its success to experience a substantial loss in the market value of their shares. In these circumstances, the court held that the self-tender could not be characterized as opening up an auction for the stock. A rational shareholder would have no effective choice as between the two offers, but would have to accept the self-tender. In the result, although target management had demonstrated a “reasonable ground for believing that [the tender offer constituted] a danger to corporate policy,” it failed to satisfy the second leg of the Unocal test, that the defensive measure was “reasonable in relation to the threat posed” (at 112 and 113). A share repurchase effected through the target’s subsidiary was upheld in Re Olympia & York Enterprises Ltd and Hiram Walker Resources Ltd et al, (1986), 37 DLR (4th) 193, 59 OR (2d) 254 (H Ct J (Div Ct)). An Olympia & York affiliate made a takeover bid for 39 percent of Hiram Walker’s 103,000,000 shares at $32 a share, which apparently represented a premium of only 11.3  percent over immediately preceding trading highs for the shares.56 Hiram Walker responded with (1) a sale of a liquor division to Allied-Lyons PLC for $2.6 billion, and (2) a competing offer for 48 percent of Hiram Walker shares at $40 a share by a Hiram Walker subsidiary. The sale of the liquor division would then finance Hiram Walker’s competing offer. These transactions were approved by the Hiram Walker board, two-thirds of whose members were independent directors (with the offer made by the subsidiary rather than by Hiram Walker itself for tax reasons). Olympia & York raised its bid to $35, and succeeded in acquiring control of Hiram Walker. Olympia & York then sought to reacquire the liquor division, which had been sold to Allied-Lyons, arguing that the sale and the self-tender offer breached the proper purposes doctrine. Montgomery J rejected this argument. Adopting the Teck decision, he stated: I am satisfied on the basis of the affidavits that the sole purpose of the conduct of the directors of Hiram Walker was to maximize the position of all their shareholders after Gulf’s take-over bid. It is idle speculation and complete hearsay … to attempt to attribute motives to the directors of Hiram Walker. As a question of fact I am satisfied that the directors acted prudently, properly, reasonably and fairly upon the advice of their legal and financial advisers and resorting to the opinions of management and their collective store of business acumen. [Counsel for Olympia & York] argued that while the board of Hiram Walker has a discretion to carry on a certain type of conduct, there is a line beyond which it may not go. He contended that the board had gone too far. I am satisfied that the board did not cross that line. It was a legitimate objective for the directors to insure that as much as possible of all economic value go to all shareholders and not just to these shareholders. I also find as a fact that that was the sole and primary objective of the directors.

On appeal, the Divisional Court affirmed the decision of Montgomery J in rejecting the application for interlocutory relief. Some doubt was expressed about the use by Hiram

56 See WH McConnell, RL Simmonds & Margaret A Shone, Note (1987) 66 Can Bar Rev 626 at 627.

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Walker of a subsidiary to make the offer in view of OBCA s 28(1)(b), under which a subsidiary may not hold shares of its parent: see CBCA s 30(1)(b). However, the court declined to hold that the offer was illegal, leaving open the possibility that the transaction might have been upheld as an indirect repurchase by Hiram Walker of its own shares under OBCA s  30(1) (CBCA s 34). 6.  For further discussions of the proper application of Unocal, see Unitrin, Inc v Am Gen Corp, 651 A (2d) 1361 (Del S Ct 1995); and Omnicare, Inc v NCS Healthcare Inc, 818 A (2d) 914 (Del 2003).

E.  Defensive Tactics: The Canadian Landscape 1.  Poison Pills As the extract from Dey & Yalden, above, points out, one of the most popular defensive tactics seen in Canada and the United States is the so-called poison pill or shareholder rights plan. Poison pills threaten a bidder who has not convinced the target company’s board of directors to terminate the pill with the prospect of a massive dilution of the bidder’s stake in the company. The purpose of a shareholder rights plan is to make it extremely unattractive for a bidder to proceed with a bid without having convinced the target company’s board of directors to do away with the rights plan. Poison pills have been adopted by thousands of companies in the United States and by several hundred Canadian companies. In the United States, poison pills come in many different forms. Originally, they involved a so-called flip-over provision, which entitled the rightsholder (other than the bidder) to acquire securities in the successor corporation on a merger. While flip-over provisions are still found in US pills, they are no longer common in Canadian pills. Instead, Canadian pills rely almost exclusively on the so-called flip-in provision, one that is also common in US pills. The adoption of a poison pill in the United States is accomplished through board action, without the need for shareholder approval. In Canada, however, in response to the presence of NP 62-202 and the rules of stock exchanges governing the issuance and listing of new securities, companies frequently sought to have their shareholders ratify the adoption of a shareholder rights plan. The Toronto Stock Exchange (TSX) eventually adopted a policy governing the circumstances in which it expects to see shareholder rights plans put to a vote. Typically this must be done within six months of adoption of the rights plan.57 Boards have nonetheless been known to put a pill in place quickly without shareholder approval, something that may be very useful where management seeks to respond to a hostile takeover bid. Boards that put in place pills in these circumstances do so knowing that the bidding process will likely be over before they have to hold a shareholder vote on the pill. In Canada, poison pills have evolved rather differently than in the United States. The first Canadian company to adopt a poison pill (Inco Limited, in 1988) embraced a US-style pill. Since then, Canadian companies have adopted rights plans that contain a permitted bid provision. These provisions state that a bidder may acquire more than the percentage of 57 See Toronto Stock Exchange, TSX Company Manual, Part VI: Changes in Capital Structure of Listed Issuers, N: Security Holder Rights Plans (4 February 2011), s 636: TSX Approach, s 636(a), online: TSX .

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shares that would otherwise trigger the shareholder rights plan in the event that the bid satisfies a number of conditions. Initially, Canadian permitted bid provisions contained a detailed list of conditions. However, institutional investors in Canada have placed considerable pressure on companies to shorten the list of conditions. Because Canadian companies (responding to the concerns of securities regulators and stock exchanges) have typically sought shareholder ratification of rights plans, institutional investors have come to have a good deal more influence on the structure of rights plans in Canada than in the United States. As a result, rights plans adopted in more recent years in Canada contained permitted bid provisions that required little more than that the bid be kept open for a fixed period— for example, 60 days—and that, in the event that more than 50 percent of the shares of the class subject to the bid were tendered to that bid, the bid be extended for a further 10 days—to allow remaining shareholders to participate in the bid, thereby eliminating the possibility that shareholders might feel obliged to tender to an inadequate bid, but ensuring that they may tender if it becomes clear that others have accepted the bid. Rights plans in Canada also included terms exempting a variety of institutional investors from the operation of the rights plan, provided that they were purchasing in a purely passive capacity—that is, were not launching, or cooperating with, a bid. Canadian companies adopting rights plans insisted that the 35-day period the Canadian securities legislation required that a bid be kept open did not provide sufficient time for a board to prepare an effective response, one designed to get maximum value for target company shareholders. Critics of Canadian rights plans have not necessarily disagreed with this point, but argued that 60 days was too much time and that rights plans gave management too much of a say in the takeover bid process. Obviously, one’s views about the usefulness of rights plans will be intimately linked to one’s views about the nature of a shareholder’s interests in a corporation and the appropriate balance of power between a board of directors and shareholders. Very few bids for a Canadian target with a shareholder rights plan in place have been made by way of a permitted bid. Most continue to be conditioned on the target company’s rights plan being found invalid or being otherwise terminated. Nonetheless, in those instances where the target’s board has refused to terminate the shareholder rights plan, the process of challenging the plan before the courts or securities commissions has taken time and has given the target company more than the statutory 35 days it used to have to respond to an unsolicited bid.58

58 See e.g. 347883 Alberta Ltd v Producers Pipelines Inc, (1991) 80 DLR (4th) 359, [1991] 4 WWR 577 (Sask CA), reproduced below, as well as Lac Minerals Ltd, (1994), 17 OSCB 4963 and MDC Corporation and Royal Greetings & Gifts (1994), 17 OSCB 4971 (both of which are discussed in the Questions following Producers Pipelines). For a lively exchange concerning the value of shareholder rights plans in Canada, see Jeffrey MacIntosh, “The Poison Pill: A Noxious Nostrum for Canadian Shareholders” (1989) 15 Can Bus LJ 276; Peter Dey & Robert Yalden, “Keeping the Playing Field Level: Poison Pills and Directors’ Fiduciary Duties in Canadian Take-Over Law” (1990) 16 Can Bus LJ 252; Jeffrey MacIntosh, “Poison Pills in Canada: A Reply to Dey and Yalden” (1991) 17 Can Bus LJ 323; and Robert Yalden, “Controlling the Use and Abuse of Poison Pills in Canada: 347883 Alberta Ltd v Producers Pipelines Inc” (1992) 37 McGill LJ 887. For recent discussions of these and other issues relating to poison pills and director duties, see Ronald Podolny, “Fixing What Ain’t Broke: In Defence of Canadian Poison Pill Regulation” (2009) 67 UTLJ 47; and Hunter Parsons, “Jagged Little Pill: The New Frontier for Shareholder Rights Plans and the Fiduciary Duty of Target Boards” (2013) 22 Dalhousie J Leg Stud 125.

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Given that the new takeover-bid regime in Canada now requires a hostile bid to be open for 105 days (unless and until the target board waives down the 105-day period), it remains to be seen what role poison pills will continue to play in Canada. Some think that they will have a limited role to play in future and that it may even no longer be necessary for Canadian companies to adopt rights plans. Others think that rights plans are still a useful device because they prevent a hostile bidder from acquiring more than 20  percent of a target’s shares without the target board’s consent. Time will tell what role poison pills will continue to play in Canada and to what extent their importance will diminish relative to other defensive strategies.

2.  Staggered Boards A staggered board (or classified board) is one in which the directors are placed into different classes and serve overlapping terms. Because only part of the board can be replaced each year, an outsider who gains control of a corporation may have to wait a few years before being able to gain control of the board.59 The use of staggered boards as a defensive strategy is much more common in the United States than in Canada. This is because it is much harder for a bidder to have a rights plan set aside in the United States than in Canada. As a result, bidders in the United States frequently marry a bid with a proxy contest designed to replace a target’s board of directors with individuals sympathetic to the bidder’s cause who will take steps to terminate the rights plan. A potential target in the United States will therefore often ensure that it has a staggered board so that it is that much harder to replace the board and terminate the rights plan. In Canada, however, given that it is easier to gain control of a company and in turn replace its board, there is less of an incentive to put a staggered board in place.60

3.  Shark Repellents Charter provisions that place obstacles in the path of potential acquirors are called shark repellents. The variety of shark repellents is far greater in the United States than in Canada, since it is easier in Canada to acquire control of a company and then amend these provisions to do away with them. For example, the charter might provide for supermajoritarian voting

59 See MM Companies v Liquid Audio, Inc, 813 A (2d) 1118 (Del 2003). 60 For a US perspective of staggered boards, see Marcel Kahan & Edward B Rock, “How I Learned to Stop Worrying and Love the Pill: Adaptive Responses to Takeover Law” (2002) 69(4) U Chicago L Rev 871 at 911 (“Corporate governance theorists and empiricists regard a staggered board combined with a pill to be a much more potent takeover defense than a pill by itself and have adduced empirical evidence that staggered board provisions reduce shareholder wealth”). For a critical analysis of the consequences of staggered boards, see also Lucian Arye Bebchuk, John C Coates  IV & Guhan Subramanian, “The Powerful Antitakeover Force of Staggered Boards: Further Findings and a Reply to Symposium Participants” (2002) 55 Stan L Rev 885. For a different perspective, see Mark Gordon, “Takeover Defenses Work: Is That Such a Bad Thing?” (2002) 55 Stan L Rev 819; Lynn A Stout, “Do Antitakeover Defenses Decrease Shareholder Wealth? The Ex Post/Ex Ante Valuation Problem” (2002) 55 Stan L Rev 845; and Stephen M Bainbridge, “Director Primacy in Corporate Takeovers: Preliminary Reflections” (2002) 55 Stan L Rev 791.

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barriers to second-step transactions, such as freezeouts. A merger or sale of substantially all the assets might require as much as 95 percent shareholder approval, instead of the typical two-thirds approval for a special resolution. Another voting restriction prevents shareholders who have acquired stock in the firm after a certain date from voting the shares until three years after their purchase. An acquiring firm might then have to wait years to assume control. These voting provisions are, of course, ineffective unless their amendment requires supermajoritarian ratification as well. Otherwise, the new owners of the firm could simply remove a 95 percent ratification requirement through a two-thirds vote of shareholders in a special resolution. QUESTIONS

1. In Unocal (discussed above in Section V.D), the court suggested that it was open to a board of directors seeking to abide by the proportionality test to consider the interests of constituencies other than shareholders. However, in Revlon, the court suggested that such consideration must end once it becomes clear that the breakup of the company is inevitable. Do you think that this is a necessary conclusion? Why should a board not be entitled to consider which among several offers for a company will most likely ensure that the company is able to look after the interests of creditors and employees in addition to those of shareholders? While target company shareholders will naturally wish to accept whatever bid offers them the most money for their shares, once in the Revlon auction mode should a target’s board be entitled to consider whether that bid may lead to the demise of the corporation? 2.  In your view, do the Unocal and Revlon decisions rely on the same vision of the firm? Is the decision in Revlon internally consistent in its vision of the corporation? 3.  How would you advise a Canadian board of directors faced with the issues seen in Revlon? What impact would the presence of the oppression remedy, with its explicit reference to the interests of creditors, have on your advice? Equally relevant is the Supreme Court of Canada’s decision in BCE Inc v 1976 Debentureholders (discussed below)—what impact would that decision have on your advice? As it turns out, Canada’s approach to a board’s duties in circumstances such as those seen in Revlon is not identical to the approach seen in the United States. As you consider the following decision, ask yourself in what respect the approach adopted in Canada differs from the one seen in Revlon. You may then wish to revisit questions 1 through 3 above.

Maple Leaf Foods Inc v Schneider Corp (1998), 42 OR (3d) 177, 44 BLR (2d) 115 (CA) WEILER JA:

Overview

The appellants are Maple Leaf Foods Inc. (“Maple Leaf ”), a bidder for the shares of Schneider Corporation (“Schneider”), and two small shareholders of Schneider who are supporting Maple Leaf. They raise two principal issues. The first concerns the duties of a Special Committee of the Board of Directors of Schneider Corporation and of the Board

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itself when dealing with a bid for change of control of the company. The second involves the interpretation of a provision in the articles of a company commonly known as the “coattail provision.” Schneider Corporation is an 108 year old Ontario corporation that is controlled by members of the Schneider Family (“the Family”) through a holding company. The issued share capital of Schneider consists of common voting shares and Class  A non-voting shares. Both classes of shares trade on the TSX, with the Class A shares representing most of the equity in the company. Although the Family only owns 17% of the non-voting shares, the Family controls the company because it owns approximately 75% of the common voting shares. On November 5, 1997, Maple Leaf, a competitor of Schneider, announced its intention to make an unsolicited take-over bid for Schneider at $19 a share, through its holding company SCH. In response, the Board established a Special Committee consisting of the independent non-family directors to review the Maple Leaf offer and to consider other alternatives. Subsequently Maple Leaf itself made an offer of $22 a share, but this offer was rejected by the Family. Ultimately, the Family told the Special Committee that the only offer it would accept was an offer made by Smithfield Foods, an American company that, at the time, was equal to $25 a share. In order for the Family to accept the Smithfield offer, which would have had the effect of enabling Smithfield to “lock-up” control of Schneider, the Board had to take certain steps which, on the advice of the Special Committee, it took. Despite this, and after the Family had agreed to the Smithfield offer, on December 22, 1997, Maple Leaf made a further offer of $29 a share to Schneider’s common and Class A shareholders. The law as it relates to the general duties of the directors of a company is well known. The directors of a company have an obligation to act honestly and in good faith in the best interests of the corporation: s. 134(1)(a) Business Corporations Act, RSO 1990, c. B.16 (the “OBCA”). Further, in discharging their obligations, the directors must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances: s. 134(1)(b). If the actions of the directors unfairly disregard the interests of a shareholder, unfairly prejudiced those interests, or are oppressive to them, s. 248 of the OBCA comes into play and allows the court to grant any remedy it thinks fit. The appellants attack the actions of the Special Committee on the basis, first, that it was not in fact independent, and second, that the advice given by the Special Committee to the Board was not in the best interests of Schneider and its shareholders. The appellants allege that the Special Committee did not act independently because it allowed Dodds, the Chief Executive Officer of Schneider, to negotiate on the Committee’s behalf with potential bidders. Furthermore, the appellants submit that Dodds and the members of the Special Committee were unduly deferential to the wishes of the Family. The appellants’ position is that public statements made by the Family created an expectation that an auction for the controlling block of shares of Schneider (the Family Shares) would be held and that those shares would be sold to the highest bidder. The appellants say that, because Maple Leaf was not given a chance to bid after the Smithfield offer of $25 a share was received, the Special Committee, in acceding to the Family’s request to accept the Smithfield offer, truncated the auction process. Maple Leaf and the other appellants seek to have this court invalidate the agreement between the Family and Smithfield on the basis that the process undertaken by the Special Committee and the Board, which led to the Family’s

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agreement with Smithfield, unfairly disregarded the interests of the non-Family shareholders and unfairly prejudiced them. The second issue involves the coattail provision in Schneider’s articles. A typical coattail provision provides that if an offer is made for the voting shares of a corporation and the non-voting shareholders are excluded from that offer because an identical bid is not made for their shares, the non-voting shareholders have the right to convert their non-voting shares to common voting shares. They can then tender to the offer for the common shares. Maple Leaf offered the same premium to the Class A non-voting shareholders as it did to the holders of common voting shares. But Maple Leaf claims that its bid nonetheless triggered the coattail provision in Schneider’s articles because the condition attached to its bid for the non-voting shares was not identical to the condition attached to its bid for the common shares. As a result, Maple Leaf says that the effect of its bid was to convert the non-voting Class A shares into common voting shares. If all Class A non-voting shares were converted into common voting shares the Family’s percentage of common voting shares would be diluted to a level where the Family’s support might not be necessary for Maple Leaf ’s bid to be successful. Maple Leaf might then be able to gain control of Schneider despite the Family’s lock-up agreement with Smithfield. Farley J dismissed the appellants’ actions. In relation to the first issue, he concluded that the Special Committee and the directors “exercised their powers and discharged their duties honestly, and in good faith, with a view to the best interests of Schneider and that they exercised the care, diligence and skill that a reasonable and prudent person would exercise in comparable circumstances in relation to dealing with the take-over bid situation.” He also found that because Schneider was known to be controlled by the Family which could decide whether or not to sell its shares, the company was never truly in play and no public expectation was created that an auction would be held. In relation to the second issue, Farley J found that to the extent that Maple Leaf ’s bid did not exclude the Class A shareholders from the premium being offered for the Family’s shares, the coattail provisions were not triggered. Even if Maple Leaf ’s offers were exclusionary, he held that the conversion rights did not arise because, pursuant to Schneider’s articles, the Family had filed certificates undertaking not to accept an exclusionary offer without giving written notice to its transfer agent. For the reasons which follow, I am of the opinion that Farley J was correct. The Oppressions Claims, Reasonable Expectations, and the Duties of Officers and Directors Facts I do not propose to repeat all of the facts outlined in the reasons of Farley J and the facta of the parties, but some further information is essential to understand the issues which must be determined on this appeal. The Board of Schneider consists of nine persons: two members of the Schneider Family (Eric Schneider and Anne Fontana), two members of the senior management (Douglas Dodds, the Chairman of the Board and Chief Executive Officer, and Gerald Hooper, the Chief Financial Officer), and five outside directors who are all successful business persons with no connection to the Schneider Family. The Board established a Special Committee

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consisting of the five independent non-Family directors to review and consider the Maple Leaf offers and to make appropriate recommendations to the Board. The Special Committee retained Nesbitt Burns Inc. as its financial advisor and Goodman, Phillips & Vineberg as its legal advisor. The first SCH/Maple Leaf offers for Schneider were formally made on November 14, 1997 to both the common voting and Class A non-voting shareholders. After the first SCH/Maple Leaf offers, the Special Committee through its financial and legal advisors, and the senior management of Schneider, commenced a process of contacting other parties that might be interested in acquiring Schneider. Schneider also established a data room containing confidential information to be provided to potential bidders. As a condition to being provided with access to the data room, potential bidders were required to sign a confidentiality agreement which contained a standstill provision that prevented them from acquiring or making any proposal to acquire shares of Schneider for two years without the written consent of the board of directors of Schneider. The form of confidentiality agreement used by Schneider provided that the only representatives of Schneider that potential bidders could contact were Dodds, the Chairman and Chief Executive Officer, Hooper, the Chief Financial Officer and Eric Schneider, the General Counsel, Secretary and a Vice-President. On November 23, 1997, the Board issued its directors’ circular responding to the Maple Leaf offer and recommended that Schneider shareholders not tender to the Maple Leaf offer on the basis that, among other things, the Maple Leaf offer was not reflective of the fair value of the shares of Schneider and that the Family had no intention of accepting the Maple Leaf Offer. Under the heading “Alternatives to the Offers” the directors’ circular stated: The Board of Directors is committed to maximizing Shareholder value. In this connection, the Corporation and Nesbitt Burns have held discussions with several interested parties concerning possible transactions which would result in Shareholders receiving greater value for their Shares than under the Maple Leaf Offers. The Board of Directors and Nesbitt Burns are actively exploring alternatives to maximize Shareholder value. The Schneider family, which collectively beneficially owns or controls approximately 75% of the Common Shares and approximately 17% of the Class A shares on a fully-diluted basis, has advised the Board of Directors that it might consider accepting a financially more attractive offer for its Shares.

Also on November 23, 1997, the Family confirmed in writing to the Board that: The undersigned also confirm that they might consider alternative control transactions involving the Corporation and acknowledge that, on the basis of such confirmation, Nesbitt Burns Inc., financial advisor to the special committee of the Board of Directors constituted to consider the Offers, is pursuing alternatives to the Offers.

On December 2, 1997, Schneider adopted a temporary shareholder rights plan. A rights plan is a common interim measure intended to give a Board time to see if there are other bids for a company and to stall an unsolicited or hostile take-over bid. Here, the rights plan provided that if a purchaser acquired 10% or more of the shares of Schneider, both classes of shareholders had the right to purchase Class A shares at 50% of the market price as at November 4, 1997 ($13.25) following a special meeting of shareholders. The press release announcing the Rights Plan stated:

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In the midst of ongoing discussions with several parties who have expressed interest in the company, the Board of Directors of Schneider Corporation today announced that, on the recommendation of its Special Committee, the Corporation has adopted a temporary Shareholder Rights Plan. This measure has been enacted to ensure that the Board and its advisers have the opportunity to fully explore all options for maximizing shareholder value … “The Board adopted the Rights Plan to create a stable environment in which it will have the time and flexibility it needs to explore and evaluate the options for maximizing value for all Schneider’s shareholders” said Douglas W. Dodds, Chairman and CEO…

On December 11, 1997, Dodds wrote to Maple Leaf and requested that it deliver enhanced offers by December 12, 1997, stating that: The process of shareholder value maximization in which our Board of Directors has been engaged since receipt of your offers is fast approaching its climax. Schneider Corporation will be receiving alternative offers to the Maple Leaf Foods offers from interested parties by this Friday December 12, 1997 … Accordingly, we invite you to deliver to us your enhanced offers by this Friday. We encourage you to put forward your enhanced offers on a basis that most appropriately and fairly reflects the inherent and strategic values to Maple Leaf Foods of Schneider Corporation. Please also advise how we may be in contact with you and your advisers over this weekend.

On December 12, 1997, Maple Leaf increased its offer for Schneider shares to $22 per share and allowed Schneider’s shareholders to elect to receive part of this consideration in the form of shares of Maple Leaf Foods Inc. On the same day, Schneider received written proposals from each of Booth Creek Inc. and Smithfield to acquire all of the shares of Schneider. The proposal from Booth Creek contemplated a take-over bid for all of the outstanding shares of Schneider at a price per share of $24.50 cash, conditional upon 662⁄ 3% of the common voting shares and non-voting shares being deposited under the offer. The proposal from Smithfield contemplated a take-over bid for all of the outstanding shares of Schneider, with Schneider shareholders receiving shares exchangeable into shares of Smithfield. Based on the closing price of Smithfield shares on December 12, 1997, and the relevant exchange rate on that date, the Smithfield proposal was worth approximately $23 per share. Prior to the announcement of the unsolicited bid by Maple Leaf ’s subsidiary on November 5, 1997, the Family had no intention of selling its shares. By December 13, 1997, the Family had indicated a tentative preference to sell its shares to Smithfield and doubted that either Booth Creek or Maple Leaf would enhance their offers sufficiently that the Family would tender to them. However, the Family had made no decision to sell, and if they were to sell, to whom, or at what price. The criteria used by the Family to evaluate offers were first arrived at on December 13. On December 14, 1997, at a meeting of the Board of Directors, management advised that it believed that Schneider was “too big to be small and too small to be big,” and that a strategic merger was in the best long-term interests of Schneider. The Family stated that it shared this belief. The Family also advised the board of directors that it had reviewed the amended Maple Leaf offer as well as the proposals from Booth Creek and Smithfield in terms of three factors: financial value, continuity of Schneider in a manner consistent with the Family’s desires, and the effect of any transaction on customers and suppliers. The Family told the Board that, while the Smithfield proposal did not meet its financial

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adequacy criteria, it did meet the Family’s other two criteria and that, assuming [that] Smithfield could satisfy the Family’s financial adequacy criteria, a strategic merger would be in the best interests of Schneider. Following this, a meeting was held by a working group that included Dodds and advisers from Nesbitt Burns and Goodman’s. This group made the decision that Dodds should go to see Luter, the Chairman of the Board and Chief Executive Officer of Smithfield, and enter into negotiations with Booth Creek. On December 15, Dodds conducted further negotiations with Booth Creek and on the morning of December 16, he met with representatives of Smithfield, including Luter. Dodds explained why Schneider was historically undervalued. Around lunchtime, Smithfield increased the value of its offer to $25 per share on the basis of the price of Smithfield’s shares and the relevant exchange rate on that date. In addition, Dodds obtained Smithfield’s agreement that it would not sell Schneider for at least two years, and would allow the Schneider family to appoint a representative to Smithfield’s board of directors. Luter told Dodds that this was his best, last offer and that if he had any suspicion Schneider was using Smithfield’s offer to try to obtain higher offers from others, he would withdraw his offer and make a public announcement disclaiming any interest in the company. The Smithfield offer was open until 8 a.m. on December 18. That same day, Dodds reported this offer to the Family and Mida, the director of mergers and acquisitions at Nesbitt Burns and an adviser to the Special Committee. After Dodd’s meeting with Luter, the Board issued an amended directors’ circular recommending that Schneider shareholders not tender to the revised Maple Leaf offers. The Board of Directors did not disclose that the Family would evaluate the offers using criteria additional to financial considerations. Under the heading “Alternative Transactions” the circular stated: The Board of Directors has been actively engaged in a process of identifying other transactions that might result in greater value to Shareholders than was offered under the Original Offers. On December 12, 1997, the Board of Directors received proposals for, and is in the process of negotiating, alternative transactions which might result in greater value to Shareholders than is being offered under the Amended Maple Leaf Offers.

At 5 p.m. on December 17, 1997, Booth Creek made a revised written proposal to Schneider increasing the value of its offer to $25.50 cash and stated that its offer was open until 8 p.m. that same evening. At $25.50 the Booth Creek proposal was less attractive financially to the Family than the Smithfield share exchange proposal, which would yield them a tax saving of $4 per share. Non-family shareholders, depending on their individual tax position, might or might not be in the same position. Booth Creek, a private company, could not offer a share exchange transaction. At the meeting of the Board on December 17, 1997, the Family announced that it wanted to accept the revised offer from Smithfield. Among other things, the Family stated to the Board that: We also think that it is important to reiterate that we as a family did not seek to sell this company but that through the process of the last 6 weeks we have come to the conclusion that now is the time to sell the control of the company.

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At a subsequent meeting of the Special Committee that night, Nesbitt Burns advised that while the Smithfield proposal was within the $25-29 fair price range, the risk associated with adverse share price movement and exchange rate movement during the short period until the offer could be formally accepted should be reflected by applying a 6% discount to the offer so that its present value was $23.50. Nesbitt Burns also told the Special Committee that, in its view, if the Smithfield offer were permitted to expire and no other change of control transaction involving Schneider were consummated, the shares of Schneider would settle in a trading range between $18 and $20 a share. The Special Committee then recessed and Dodds made enquiries of Smithfield as to whether it would raise its offer. Smithfield refused to pay more but Dodds was successful in negotiating a slight improvement in the exchange rate aspect of the offer. The original proposal, as submitted by Smithfield, contemplated that the transaction would proceed by way of a plan of arrangement or merger. That is the Board would approve of the Family entering into a lock-up agreement for its shares with Smithfield, then the merger proposal would be voted upon by all shareholders and approved by the court. Before asking the shareholders and the court to approve the merger the Board would have had to provide an opinion that the transaction was fair. In light of Nesbitt Burns’ discounted valuation of the Smithfield proposal, the Board was unwilling to do so. To avoid the Board having to issue an opinion that the proposed transaction was fair, Smithfield made offers by way of take-over bids to acquire any and all common voting shares and all Class A shares of Schneider on the condition that the Family agree to tender its shares. The shares of Schneider were to be exchanged for 0.5415 of a share in a newly incorporated, wholly-owned Canadian subsidiary of Smithfield. Each whole exchangeable share would then be exchangeable for one common share in Smithfield. The structure of this second transaction meant that Smithfield might not be able to acquire two-thirds of the Class  A shares and, therefore, might not be able to take Schneider private. In order for the Family to accept the offer from Smithfield, it was still necessary for the Board to waive the standstill provision in the confidentiality agreement Smithfield signed and to remove the rights plan. The Family asked the board to do this. Upon the recommendation of the Special Committee, the Board did so. On December 18, 1997, the Family entered into the lock-up agreement. On December 22, 1997, Maple Leaf announced that, despite the Family’s lock-up agreement with Smithfield, it was increasing its offer to $29 per share, cash, conditional on obtaining two-thirds of each class of share. Prior to this, Maple Leaf entered into deposit agreements with two funds to buy Maple Leaf ’s shares at $29, no matter what the outcome of its latest bid was. On December 30, 1997, five Class A shareholders, holding in aggregate 675,000 shares, representing more than 10% of the total Class  A shares outstanding, wrote a letter to Schneider’s Board of Directors complaining that “the actions or inaction of the Special Committee, together with those of the Schneider family have in effect contaminated the value maximization process outlined by the board in its directors’ circular and in its public statements.”

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Determining Whether the Directors Have Acted in the Best Interests of the Corporation The mandate of the directors is to manage the company according to their best judgment: that judgment must be an informed judgment; it must have a reasonable basis. If there are no reasonable grounds to support an assertion by the directors that they have acted in the best interests of the company, a court will be justified in finding that the directors acted for an improper purpose: Teck Corp. v. Millar (1972), 33 DLR (3d) 288 (BCSC) at 315-316, adopted as the law in Ontario by Montgomery J in Olympia & York Enterprises Ltd. v. Hiram Walker Resources Ltd. (1986), 59 OR (2d) 254 at 255 (Ont. HC), affirmed (1986), 59 OR (2d) 254 (Ont. Div. Ct.). One way of determining whether the directors acted in the best interests of the company, according to Farley J, is to ask what was uppermost in the directors’ minds after “a reasonable analysis of the situation”: 820099 Ontario Inc. v. Harold E. Ballard Ltd. (1991), 3 BLR (2d) 113 at 123 (Ont. Gen. Div.), affirmed (1991), 3 BLR (2d) 113 (Ont. Div. Ct.); CW Shareholdings Inc. v. WIC Western International Communications (May 17, 1998), Doc. Toronto 98-CL-2821 (Ont. Gen. Div.). It must be recognized that the directors are not the agents of the shareholders. The directors have absolute power to manage the affairs of the company even if their decisions contravene the express wishes of the majority shareholder: Teck Corp. v. Millar (1972), 33 DLR (3d) 288 (BCSC) at 307. However, acting in the best interests of the company does not necessarily mean that the directors must act in the best interests of one of the groups protected under s. 234. There may be a conflict between the interests of individual groups of shareholders and the best interests of the company: Brant Investments Ltd. v. KeepRite Inc. (1987), 60 OR (2d) 737 (Ont. HC), aff ’d. (1991), 3 OR (3d) 289 (Ont. CA) at 301. Provided that the directors have acted honestly and reasonably, the court ought not to substitute its own business judgment for that of the Board of Directors: Brant Investments v. KeepRite Inc., supra, which deals with the analogous section of the Canadian Business Corporations Act, RSC 1985, c. C-44. If the directors have unfairly disregarded the rights of a group of shareholders, the directors will not have acted reasonably in the best interests of the corporation and the court will intervene: 820099 Ontario Inc. v. Harold E. Ballard Ltd., supra. The appellants have urged this court to consider the actions of the directors pursuant to a standard which is derived from statute law in the State of Delaware known as “enhanced scrutiny.” The key features of the enhanced scrutiny test are a judicial determination of the adequacy of the decision-making process employed by the directors, and a judicial examination of the reasonableness of the directors’ actions in light of the circumstances then existing: Paramount Communications Inc. v. QVC Network Inc., 637 A2d 34 (US Del. Super. 1994) at 45. The directors have the onus of satisfying the court that they were adequately informed and acted reasonably. Some Canadian authorities such as Exco Corp. v. N.S. Savings & Loan Co. (1987), 35 BLR 149 (NSTD) and 347883 Alberta Ltd. v. Producers Pipelines Inc. (1991), 80 DLR (4th) 359 (Sask. CA) have adopted a proper purpose test, which is similar to enhanced scrutiny in that it shifts the burden of proof to the directors to show that their acts are consistent only with the best interests of the company and inconsistent with any other interests. These cases recognize that there may be a conflict between the directors who manage the company and the interests of certain groups of shareholders, particularly those s. 248

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is designed to protect, and have espoused shifting the burden of proof as a method of overcoming the potential conflict. The law as it has evolved in Ontario and Delaware has the common requirements that the court must be satisfied that the directors have acted reasonably and fairly. The court looks to see that the directors made a reasonable decision not a perfect decision. Provided the decision taken is within a range of reasonableness, the court ought not to substitute its opinion for that of the board even though subsequent events may have cast doubt on the board’s determination. As long as the directors have selected one of several reasonable alternatives, deference is accorded to the board’s decision: Paramount, supra, at 45: Brant Investments, supra, at 320. Themadel Foundation v. Third Canadian Investment Trust Ltd. (1998), 38 OR (3d) 749 (Ont. CA) at 754. This formulation of deference to the decision of the Board is known as the “business judgment rule.” The fact that alternative transactions were rejected by the directors is irrelevant unless it can be shown that a particular alternative was definitely available and clearly more beneficial to the company than the chosen transaction: Brant Investments, supra, at 314-315. A common method used to alleviate concerns that a conflict of interest exists between directors, who may be major shareholders, and the interests of a minority or non-voting group of shareholders, is the creation of a special committee from among the independent members of a board who do not have a conflict. The purpose of a special committee is to advise the Directors and to make a recommendation as to what the Board should do. It appears that under the law of Delaware, where a Board acts on the recommendation of a special committee, the decision will be accorded respect under the business judgment rule, provided that the special committee has discharged its role independently, in good faith, and with the understanding that in a situation where a change of control transaction is contemplated, the special committee can only agree to a transaction that is fair in the sense of being the best available in the circumstances: First Boston, Inc. Shareholders Litigation, Re, Fed. Sec. L Rep. P 95,322 (US Del. Ch. 1990). The duty of directors when dealing with a bid that will change control of a company is a rapidly developing area of law and as I have indicated, Canadian authorities dealing with the question of the onus, or burden of proof, have not been uniform. In Brant Investments, supra, the issue whether the burden of proof is on the directors to justify their actions as being in the best interests of the company or on the shareholders challenging the actions of the company was also raised. McKinlay JA, at 311-312, found it unnecessary to decide the question because the trial judge had dealt with the issues on a substantive basis, and his decision did not turn on which party had the onus or burden of proof. The same is true in the present case. I would add, however, that it may be that the burden of proof may not always rest on the same party when a change of control transaction is challenged. The real question is whether the directors of the target company successfully took steps to avoid a conflict of interest. If so, the rationale for shifting the burden of proof to the directors may not exist. If a board of directors has acted on the advice of a committee composed of persons having no conflict of interest, and that committee has acted independently, in good faith, and made an informed recommendation as to the best available transaction for the shareholders in the circumstances, the business judgment rule applies. The burden of proof is not an issue in such circumstances. The members of the committee acted in good faith in the sense that they acted honestly. The Committee’s decision was also informed, in the sense that the Committee was aware

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that any offer for Schneider’s shares might be bettered by Maple Leaf, and that the Family would not sell to Maple Leaf. While the appellants have challenged Farley J’s finding that the Family would not sell to Maple Leaf, there is ample evidence to support this finding. Even at $29 a share, when tax considerations were factored in, the Maple Leaf offer was only as advantageous as the Smithfield offer to the Family, not more advantageous. Apart from financial criteria, Maple Leaf did not meet the Family’s expressed concern about the effect of a change of control on the continuity of employment for Schneider’s employees, the welfare of suppliers, and the relationship with its customers, whereas Smithfield did. Once again, the real questions are whether the Committee was independent and whether the process undertaken by the Special Committee was in the best interests of Schneider and its shareholders in the circumstances. While Paramount, supra, indicates that nonfinancial considerations have a role to play in determining the best transaction available in the circumstances, here it was conceded that the court should only have regard to financial considerations. The Special Committee •  •  •

(ii)  Should Members of Schneider’s Senior Management, Particularly Dodds, Have Been Permitted to Have a Significant Role in the Sale Negotiations with Potential Bidders? The appellants submit that Dodds had a conflict of interest because he had an interest in continued employment with Schneider and a further conflict arising out of his loyalty to the Family. A potential conflict of interest arises because as a director of a target company, the senior executive has a duty to act in the best interests of the shareholders, but as a member of senior management the executive retains an interest in continued employment. In actively negotiating with a potential bidder the executive is negotiating with his potential boss or executioner. The appellants rely on the decision of Blair J in CW Shareholdings Inc. [supra] for the proposition that no senior executive of a company being sold should be permitted to have a significant role in the sale process. The raison d’etre of a Special Committee independent of management and the controlling shareholder is to protect the interests of minority shareholders and to bring a measure of objectivity to the assessment of bids. If, as was the case in CW Shareholdings, senior management in the target company is a member of the Special Committee, the purpose in setting up the Special Committee might be compromised and less reliance placed on its assessment of a particular bid than if the committee were truly independent. Blair J recognized this and he was critical of the role played by senior management in CW Shareholdings. In the end, however, he concluded that the involvement of management in the Special Committee did not so taint its approval of the Shaw Communications bid as to undermine the transaction. He also found that the committee had conducted itself in a fashion that enabled the directors to carry out their objective of maximizing shareholder value. In that case, Blair J upheld the Board’s decision, based upon the Special Committee’s recommendation to enter into an agreement with Shaw that provided for a break fee and asset agreement in the event that its bid was not accepted.

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A major distinction between the CW Shareholdings decision and this case is that senior management, including Dodds, was not part of the Special Committee that was set up and consequently had no vote as to whether to recommend a bid. A potential conflict of interest still existed, however, because of the active role Dodds played in negotiating with the bidders. Farley J recognized that in allowing Dodds and, to a lesser extent, Hooper, the Chief Financial Officer of Schneider, to deal with bidders directly, a potential conflict of interest existed but that this had to be balanced against the benefits to be obtained. He stated: It would be appropriate, however, to comment as well [th]at the use of the two management directors, Dodds and Hooper, in dealing with the bidders and advisors directly, would not seem inappropriate. Potentially there could be conflict, but that must be balanced against the reasonable benefits to be obtained. They knew the operations of the business—what the bidders would be interested in and they were guided by the advisors. They reported to the Special Committee which could make the “final” decisions and give directions. Potential conflict was minimized by the bail-out packages granted them. From the material before me it would not appear that these management persons acted or behaved inappropriately overall. It would be undesirable to subject each step they took to isolated microscopic inspection. I note in passing that Dodds would have received approximately $1,000,000 in stock and options value extra if the Maple Leaf $29 offer had been accepted as opposed to the Smithfield one; of course no one but Maple Leaf knew how much it would have offered if it had been solicited on December 17th.

Dodds’ employment agreement entitled him to resign within two years following a change of control transaction with 30 months’ severance. In CW Shareholdings, Blair J commented that a golden parachute did not eliminate the potential for conflict of interest that exists when a member of senior management negotiates directly with bidders. Here, however, Dodds was not given any assurances by Smithfield of continued employment although he knew that Smithfield intended to leave Schneider’s management in place and allow it to operate as an autonomous unit. On the other hand, Dodds was given some assurance of continued employment by Maple Leaf if Schneider was taken over by it. He was told that he would manage the integration of Schneider for two years, and be a candidate to head the meat operations of the two companies. He was also told that he would retain his salary and be issued additional options in Maple Leaf. In addition, at the time, Dodds held 250,000 options in Schneider with a strike price of $13 and it was believed that Maple Leaf would top any bid that was openly made for Schneider. It seems that if there was any financial bias arising out of Dodds’ self interest in continued employment it would have been a bias in favour of Maple Leaf. The appellants also submit that Dodds had a conflict of interest in conducting the negotiations because his loyalties were to the Schneider Family. But the Family did not ask Dodds to negotiate with potential bidders. After Nesbitt Burns suggested that Smithfield might be a potential bidder, Dodds’ meetings with Smithfield were at the behest of the Special Committee, or its advisers, Nesbitt Burns and Goodman, Phillips & Vineberg. Farley J found that the deadline for considering bids had been set by Mida, the VicePresident of Nesbitt Burns and its director of mergers and acquisitions, as an appropriate deadline in order to prevent the process from stalling. He also found that it was appropriate for Dodds to keep the Family informed of the progress of the negotiations since they

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could veto any sale. Counsel for the appellants strenuously submitted that inasmuch as Dodds advised the Family of the result of his negotiations with Smithfield on December 16th, and did not advise any member of the Special Committee of the negotiations, an inference should be drawn that Dodds’ loyalties were to the Family and that this was illustrative of yet another conflict that Dodds had. The evidence indicates that although Dodds did not advise any members of the Special Committee directly on the 16th, he called Mida of Nesbitt Burns, the adviser to the Special Committee. It does not appear that Mida told anyone on the Special Committee of the Smithfield proposal, as the evidence indicates that the Committee was unaware of it until it met on the evening of the 17th. In the circumstances there would appear to be no reason to impute bias to Dodds because of this omission. The appellants also allege that it was Dodds’ suggestion to Luter that Smithfield proceed by way of a takeover for any and all shares of Schneider—as opposed to a plan of arrangement—and that this suggestion also indicates Dodds’ bias against Maple Leaf. The proposal to proceed by way of takeover as opposed to merger was not a suggestion that came from Dodds, but one that had been identified previously as the alternative Luter was prepared to pursue if the Board could not recommend the Smithfield proposal. Farley J found that Dodds pressed the negotiations with the bidders diligently and did nothing inappropriate. His conclusions are supported by the evidence. There is no merit in this ground of appeal. Process Arguments (i)  Should the Special Committee Have Been Created? The appellants submit that by creating a special committee, hiring advisers, and setting up a data room, the Family used Schneider’s money to better the offer from Maple Leaf, which it was not entitled to do. In addition to being rejected by Farley J, a similar argument was rejected by Montgomery J in Olympia & York, supra, at p. 272. The reason is obvious; the appointment of a special committee is intended to ensure that the interests of those the oppression remedy is intended to protect are not unfairly disregarded or prejudiced. It is clearly in the interests of a company, and of all shareholders, for alternatives to an unsolicited takeover offer to be explored. It might give the shareholders a higher price for their shares. The creation of a Special Committee was part of the process undertaken by the Board to obtain the best transaction available in the circumstances. (ii)  Should the Special Committee Have Created a Data Room? The appellants’ submission that proprietary confidential information obtained from the data room was a valuable corporate asset that was either given away to the acquiring company or dissipated must also fail. As Farley J pointed out, access to the data room was essential in order to conduct a market canvass for alternative offers. Other bidders, particularly those who had not operated in the Canadian market, needed to gain an appreciation of market conditions, and of Schneider’s business. That could only be obtained with access to Schneider’s confidential information. No alternative

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bid would have been elicited without access to Schneider’s confidential information. Maple Leaf, as a competitor of Schneider for many years, had an appreciation of market conditions and of Schneider’s business and did not require further information in order to make its bid. The decision to establish a data room at the company’s expense was that of the Special Committee, made with full knowledge of the Family’s position that it was not committed to selling. The Board did not seek the approval or the consent of the Family to establish the data room, for the use of information, or for the nature of the confidentiality agreements that were signed with prospective bidders. In creating a data room the Special Committee acted independently and reasonably. The creation of a data room made confidential information available to all bidders as part of a process to get the best transaction available to the shareholders in the circumstances. I see no merit in this ground of appeal. (iii)  Flawed Committee Process The appellants submit that the trial judge ignored or failed to appreciate the evidence given by Ruby, the Chairman of the Special Committee, to the effect that the Special Committee had no involvement in any negotiations with prospective bidders, that Dodds conducted the negotiations, and that the Special Committee did not consider whether Dodds had any conflict of interest. After considering the circumstances under which Dodds acted, I have already concluded that Dodds did not have a conflict of interest. The Special Committee had no prior experience in dealing with a take-over bid and did not have the in-depth knowledge of Schneider that Dodds did. It was therefore appropriate for the Special Committee not to conduct the negotiations with potential bidders directly. Farley J found that although the Special Committee did try to determine the views of the Family “recognizing its gatekeeper and veto role,” there was no evidence that the approval of the Family was sought with respect to any decision taken by the Special Committee. The evidence supports the conclusion that the members of the Special Committee acted independently in the sense that they were free to deal with the impugned transaction on its merits. This ground of appeal also fails. (iv)  Should the Special Committee Have Insisted that Maple Leaf and Any Other Interested Party be Given an Opportunity to Make Their Best and Final Offer Prior to the Board of Directors of Schneider Taking the Steps that It Did on December 17, 1997 to Commit Its Shares to Smithfield? The appellants submit that the Board was obliged to keep the bidding process alive by going back to Maple Leaf after it received the Smithfield bid on December 17th. This submission has two alternative premises: 1) the Directors could only discharge their duty to act in the best interests of the corporation by conducting an auction of the shares of Schneider; 2)  a public expectation had been created by the comments made by the Schneider family that an auction would be held and therefore both the Family and the Board were under a duty to ensure that an auction was conducted. The appellant’s first premise is wrong in law. The second is contrary to Farley J’s findings of fact and those findings are supported by the evidence.

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Was There a Duty to Conduct an Auction of the Shares of Schneider? The decision in Revlon Inc. v. MacAndrews & Forbes Holdings Inc., 506 A2d 173 (US Del. Super. 1985), stands for the proposition that if a company is up for sale, the directors have an obligation to conduct an auction of the company’s shares. Revlon Inc. is not the law in Ontario. In Ontario, an auction need not be held every time there is a change in control of a company. An auction is merely one way to prevent the conflicts of interest that may arise when there is a change of control by requiring that directors act in a neutral manner toward a number of bidders: Barkan v. Amsted Industries Inc., 567 A2d 1279 (US Del. Super. 1989) at 1286. The more recent Paramount decision in the United States, supra, at 43-45 has recast the obligation of directors when there is a bid for change of control as an obligation to seek the best value reasonably available to shareholders in the circumstances. This is a more flexible standard, which recognizes that the particular circumstances are important in determining the best transaction available, and that a board is not limited to considering only the amount of cash or consideration involved as would be the case with an auction: Paramount, supra at 44. There is no single blueprint that directors must follow. Although the decision in Paramount and the other decisions of the courts in Delaware to which I have referred are not the law of Ontario, they can, however, offer some guidance. When it becomes clear that a company is for sale and there are several bidders, an auction is an appropriate mechanism to ensure that the board of a target company acts in a neutral manner to achieve the best value reasonably available to shareholders in the circumstances. When the board has received a single offer and has no reliable grounds upon which to judge its adequacy, a canvass of the market to determine if higher bids may be elicited is appropriate, and may be necessary: Barkan, supra, at 1287, citing Fort Howard Corp. Shareholders Litigation, Re, Doc. Civ. A 9991 (US Del. Ch. August 8, 1998). The Family did not seek to sell its controlling interest in Schneider. The Board received an offer from Maple Leaf that it felt was inadequate, but, in the final analysis, the best way to judge its adequacy was to determine if higher bids could be elicited through a market canvass. The fact that a market canvass was conducted did not mean that the Family would agree to sell its stake. Indeed, Farley J found as a fact that the Family’s decision to sell was highly conditional on a satisfactory offer being received. The appellant submits that there was considerable evidence indicating that the Schneider Family had by December 17th, if not before, concluded that a sale of its shares was inevitable. Having undertaken a market canvass, however, there was no obligation on the Special Committee to turn this canvass into an auction, particularly because to do so was to assume the risk that the competing offers that the market canvass had generated might be withdrawn. There was no obligation on the Special Committee or the Board to go back to Maple Leaf on December 17th and ask it to make another offer. A market canvass and not an auction was being conducted; the Special Committee and the Board only had a short time within which to consider Maple Leaf ’s offer; Maple Leaf had already been asked to make an appropriate offer and there was no certainty it would make a higher bid. There was an obligation on the Special Committee and the directors to consider the bids which their market canvass had realized in addition to Maple Leaf ’s bid. Farley J found Maple Leaf knew, or should have known, that the bidding process was almost over when it made

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its $22 per share bid. Maple Leaf ’s board had authorized the issuance of enough Maple Leaf shares to finance a $29 a share bid for Schneider before the bidding process entered its final stage. Maple Leaf was nonetheless content to let its $22 bid stand despite knowing that there were competing bids that might be accepted in preference to its own, and despite the fact that Maple Leaf ’s board had authorized a higher $29 bid. This was a risk Maple Leaf chose to assume. Was There a Public Expectation Created by the Family that an Auction Would Be Held? Conduct which disregards the interests of any shareholder and not simply a shareholder’s legal rights will infringe s. 248 of the OBCA. This is because the oppression remedy is basically an equitable remedy and the court has jurisdiction to find an action is oppressive, unfairly prejudicial, or unfairly taken in disregard of the interests of a security holder if it is wrongful, even if it is not actually unlawful: Westfair Foods Ltd. v. Watt, [1990] 4 WWR 685 (Alta. QB), aff ’d. [1991] 4 WWR 695 (Alta. CA), leave to appeal refused [1992] 1 WWR lxv (SCC). A statement made to shareholders in a press release can create a public expectation that is deserving of protection through the oppression provisions of the OBCA. As Carthy JA stated in Themadel Foundation, supra, at 753: The public pronouncements of corporations, particularly those that are publicly traded, become its commitments to shareholders within the range of reasonable expectations that are objectively aroused.

While s. 248 protects the legitimate expectations of shareholders, those expectations must be reasonable in the circumstances and reasonableness is to be ascertained on an objective basis. The interests of the shareholders of a company are intertwined with the expectations that have been created by the company’s principals: Naneff v. Con-Crete Holdings Ltd. (1995), 23 OR (3d) 481 (Ont. CA). Therefore, the question is whether the statements made by the Family, and widely reported in press releases issued in response to Maple Leaf ’s bids, created a reasonable expectation that an auction would be held. Whether or not a reasonable expectation has been created is a question of fact: Arthur v. Signum Communications Ltd. (July 29, 1993), Doc. 123/91 (Ont. Div. Ct.). Campbell J, for the court, at paras. 6-7. After examining the press releases and the evidence, Farley J found that any expectations of the claimants, who were non-Family shareholders, were not reasonable or founded in fact. A summary of his findings on this point is as follows: • [T]he Family’s position on selling its controlling shareholding in Schneider was always conditional to a high degree. The Family only said that they “might consider” selling. The conditional nature of the Family’s position was always clearly expressed by the Board in its public statements. • [I]t was inappropriate for Maple Leaf to ignore the plain meaning of the public statements made by the Family and the Board. Maple Leaf “wished” that there was an unrestricted auction for Schneider but in fact there never was. • [T]he claimants had not proved that their reasonable expectations were thwarted. “When the gatekeeper shareholder merely indicates that it ‘might consider’

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accepting a more financially attractive offer, then the shareholders are speculating that a deal on that basis may come to pass in which they could participate.” There was more than adequate evidence to support these findings and they cannot be disturbed. Inasmuch as there was no reasonable expectation on the part of the non-Family shareholders that an auction would be held after receiving the last Smithfield bid, the Special Committee was not obliged to give Maple Leaf an opportunity to make a third bid for Schneider’s shares. Was the Course of Action and the Advice Given by the Special Committee in the Best Interests of Schneider and Its Shareholders? Should the Special Committee and the Board of Directors Have Refused to Waive the Standstill Provisions in the Confidentiality Agreement with Smithfield? The appellants allege that the advice given by the Special Committee to the Board of Schneider was not in Schneider’s best interests or those of its shareholders. They submit that the Special Committee should have refused to waive the standstill provisions in the confidentiality agreement with Schneider, thereby preventing the agreement between the Family and Smithfield. The appellants also submit that if the Board of Schneider could not enter into a share exchange with Smithfield because of fairness concerns it could not agree to a takeover bid. These submissions are really alternative ways of saying that the transaction with Smithfield was unfair to the non-Family shareholders, that it was not in the best interests of the company. If the Smithfield offer can reasonably be considered to be the best available offer in the circumstances, then the Smithfield offer was not unfair or contrary to the best interests of the company. This is also essentially a fact driven question on which Farley J made the following findings: • [T]he Smithfield offer was solicited by Schneider. Smithfield, a reluctant suitor, had to be “coaxed” to make a bid. Smithfield imposed a “no-shop” condition on its offer to the Schneider Family and did not want to haggle. • [T]here was no breach of confidence in the communications between Smithfield, and the Schneider Board and the Family. The spirit of the standstill provision between Smithfield and Schneider was honoured. Confidential information was used appropriately in the best interests of the shareholders. At all times the Schneider Board remained in control of the process dealing with the Smithfield offer. • [I]t was reasonable for the Board to accommodate a transaction between Smithfield and the Family by waiving the standstill provision contained in the Smithfield confidentiality agreement in view of advice received that the share price of Schneider would fall back to a range of $18 to $20 per share in the absence of a change of control transaction. • Maple Leaf could not have made an offer that would have been satisfactory to the Schneider Family at that time. • [T]he Board exercised their powers and discharged their duties honestly and in good faith.

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• [T]he Board pursued all available opportunities to maximize shareholder value and achieved reasonable results for all of the shareholders of Schneider. • [I]t was unfair to say that the Special Committee had the Family’s interests uppermost in its mind not those of the shareholders generally, or the non-Family shareholders specifically. It was beyond the power of the Special Committee to insist that the Family give up its veto power and the Special Committee realized this. As Farley J emphasized, one of the particular circumstances having a bearing on a board of directors’ attempts to obtain the best deal available in the circumstances was whether the company has a controlling shareholder. For example, in Paramount, supra, control of the corporation was not vested in a single person, entity, or group, but was widely held by a number of unaffiliated shareholders. In that case, the proposed sale of shares represented a premium for the change and consolidation of control of the company in a group that would have the power to materially alter the interests of the widely dispersed shareholders. Here, the control premium for the shares of Schneider belongs to the Family. The unaffiliated shareholders do not own, and are not giving up, the power to control the company’s future. Another distinction between this case and Paramount is that the offer from Maple Leaf, which was before the Special Committee at the time it was asked to make its decision, was considerably less than the Smithfield offer. In coming to its conclusion that it was not in the interests of the non-Family shareholders to prevent the Family from entering into a lockup agreement with Smithfield the Special Committee considered, among other things:

a) that the shares would likely trade in the $18 to $20 range if no sale was effected; b) the position of the Family that it would not accept the Maple Leaf offer at $22 or the Booth Creek offer—or indeed any other offers from them; [and] c) that Smithfield would publicly withdraw its offer if the offer was shopped and, if this happened, the amount that Maple Leaf would be prepared to offer was problematic. While Smithfield’s offer was not within the range that Nesbitt Burns had placed on the shares as fair value, “a decent respect for reality forces one to admit that … advice [of an investment banker] is frequently a pale substitute for the dependable information that a canvass of the relevant market can provide”: Barkan, supra, at 1287. It was widely known that a change of control was being considered, and few rival bids were forthcoming over an extended period of time: these facts support the decision to proceed with the impugned transaction. The Board acted on the advice of the Special Committee in agreeing to facilitate the Smithfield bid by passing a resolution waiving the standstill provision, thereby allowing Smithfield to bid and to enter into the lock-up agreement with the Schneider Family. Unless another bid was received that was not conditional on the tender of any of the Schneider Family shares, which was highly unlikely, this decision by the Board had the effect of making the Smithfield bid the only one which would effectively be available to the shareholders. Implicit in the steps taken by the Board was a decision by the Board that the Smithfield bid was in the best interests of all the shareholders and therefore a bid which the Board could recommend to the shareholders.

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The Special Committee was entitled to make, and did make, business and negotiating judgment calls which, having regard to the interests of the non-Family shareholders, were reasonable in the intense and time-limit-driven context. The deal with Smithfield was the only deal that the controlling shareholder was willing to consider. With respect to the alleged pre-empting of the process by not going back to Maple Leaf, Farley J stated: … [I]t appears that this merely prevented a further round of enquiry of Booth [Creek] and Maple Leaf which may or may not have elicited a higher bid than Smithfield whose last bid was tested.

If Maple Leaf was given an opportunity to top the Smithfield bid and that bid was then publicly withdrawn, then there was no guarantee that Maple Leaf would make a higher offer. There was no alternative bid which was definitely available and clearly more beneficial to Schneider and all its shareholders than the Smithfield bid. The Board acted on the advice of the Special Committee. The advice given and accepted was reasonable at the time and fair to the non-Family shareholders. I would dismiss the first main ground of appeal. •  •  •

Disposition For the reasons given, the appeals from the judgment of Farley J are dismissed. Because I have held that Farley J did not err in holding that the offer to purchase common shares made by Maple Leaf to shareholders of Schneider was not an exclusionary offer within the meaning of the articles of Schneider, it was not necessary to deal with the cross-appeals by the Family. •  •  •

Appeal dismissed. QUESTIONS

1.  Are there factors at play in takeover bids that warrant applying a stricter standard when evaluating whether directors are discharging their fiduciary duties than might be applied to their decisions with respect to other corporate acts? Should stricter standards apply when a board takes the decision that it is in fact desirable to sell the company? 2.  Which approach to a board’s duties in circumstances such as those seen in Schneider is the more compelling: the approach seen in Revlon (which might be thought to impose a duty to sell to the highest bidder), or the approach seen in Schneider (which accords considerably more deference to a board’s decision regarding whom the company should be sold to)? If the Schneider decision had gone up on appeal to the Supreme Court of Canada, how would that appeal have been decided? 3.  Note the court’s observations about the importance of process and the role of the special committee. Do you agree that provided such a process is followed, courts should typically defer to the outcome? In what circumstances do you think a Canadian court should be prepared to review the decision of a special committee on its merits? Is there reason to

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be concerned that a highly process-oriented approach means that boards will rarely, if ever, find their decisions impeached? If so, is this a good outcome or a bad outcome? 4.  When assessing the appropriate standard of review to apply to a board of directors’ decisions, should courts have regard to principles that govern judicial review of administrative tribunals? Is the basis for deference in that context rooted in different theoretical foundations? 5.  To what extent should the fact that securities commissions in Canada have made clear that they view shareholder interests as paramount in M&A transactions influence the courts’ understanding of a board of directors’ duties in this context and the appropriate standard of review? 6.  For another Canadian case of consequence that considers the role of special committees, and that deals with breakup fees and asset options, see CW Shareholding Inc v WIC Western International Communications Ltd (1998), 39 OR (3d) 755, 160 DLR (4th) 131 (Gen Div).

F.  Which Institutions Should Supervise Defensive Tactics in Canada? Robert Yalden, “Canadian Mergers and Acquisitions at the Crossroads: The Regulation of Defence Strategies after BCE” (2014) 55 Can Bus LJ 389 at 404 The Supreme Court of Canada’s Decision in BCE (i)  The Facts and the Decision In retrospect, the facts at the heart of the BCE Inc. case were relatively straightforward. After conducting a highly publicized and extensive process that saw multiple bidding groups put forward proposals to acquire the company, the board of directors at BCE Inc. (BCE) decided to enter into an agreement to be purchased by a group including the Ontario Teachers’ Pension Plan Board, Providence Equity Partners Inc., Madison Dearborn Partners LLC and Merrill Lynch Global Private Equity. The proposed transaction was to be structured as a leveraged buy-out that would have seen shareholders receive an important premium for their shares, BCE taken private and a very significant increase in BCE’s debt load. In connection with a proposed arrangement under section 192 of the Canada Business Corporations Act (CBCA) (“the Plan”) that was designed to implement the transaction, holders of Bell Canada debentures (Debentureholders) challenged the Plan on a number of grounds, including that the Plan, by failing to consider the interests of these Debentureholders (including their reasonable expectations), was not fair and reasonable in the circumstances. BCE’s increased debt load would have resulted in the relevant debentures losing their investment grade status and would therefore have caused their value to diminish. This was because the arrangement was to be financed in part through BCE’s assumption of an additional $38.5 billion in debt, of which $30 billion was to have been guaranteed by its subsidiary Bell Canada. The Debentureholders objected that the transaction would diminish the trading value of their debentures by an average of 20%, while conferring a premium of approximately 40% of the market price to holders of BCE

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common shares. In effect, the Debentureholders argued that the board had acted inappropriately by favouring the interests of shareholders over those of the Debentureholders. The Supreme Court of Canada concluded that the Debentureholders did not have a reasonable expectation that their debentures’ investment grade rating would be maintained. Statements that Bell Canada had made suggesting a commitment to retain investment grade ratings had been accompanied by warnings such that investors could not reasonably form such an expectation. Moreover, the Debentureholders had not negotiated contractual protections such as change of control and credit rating covenants. Ultimately, the transaction never closed. The legal battle had taken place against a backdrop of deteriorating economic conditions. By September 2008, it was clear that the world’s financial markets were headed into a major crisis. A condition to closing the transaction, the tabling of a solvency opinion, could no longer be met. (ii)  Ramifications of the BCE Decision I have suggested elsewhere, and again in my observations above, that Canadian business law has long suffered from a marked tension between the vision of the corporation shaping our securities law and the approach at play in our corporate law’s vision of the corporation. Securities law, with its focus on protecting security holder interests, is strongly drawn to a shareholder centric model and has frequently adopted the language of the law and economics movement to justify its perspective. Canadian corporate law, on the other hand, has been less inclined to accept that there is a pre-ordained hierarchy of interests when embarking on an analysis of the CBCA and its implications for change of control transactions. Nor has it, generally speaking, chosen to rely on concepts and ways of reasoning drawn from the law and economics movement. This is in part because the CBCA simply does not include statements regarding the priority that a board of directors should assign to competing interests, preferring instead to instruct a board to act in the best interests of the corporation—and leaving it to the board to unpack what that may entail in any given context. Notwithstanding that the CBCA does not reflect the same vision of the corporation as the one that has driven securities law in Canada over the last 30 years, prior to the BCE decision M&A practitioners worked hard to find a way to reconcile the two perspectives. Indeed, it was quite common for M&A practitioners in Canada to advise boards that the best interests of the corporation could be understood to mean the best interests of the shareholders as a whole. Certainly that is what I was taught as a young corporate lawyer by those who had been advising boards of directors for many years. However much I may have thought that this did or did not make sense as an interpretation of the CBCA’s fiduciary duty provisions, it nevertheless reflected what boards of directors in Canada were in practice very often being told. While the Supreme Court of Canada’s 2004 decision in the Peoples case (which focused on a board’s duties on the eve of insolvency and which affirmed that the board’s duty was to the corporation, not any one stakeholder) should have alerted practitioners to the fact that this line of reasoning needed to be refined, for my part I saw little change in the advice that M&A lawyers were giving boards after the Peoples decision was rendered. It was not until the BCE decision that M&A practitioners accepted that the logic of Peoples was

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unavoidable and that they would have to re-examine the way that they were framing their advice to boards of directors. The Supreme Court took full advantage of the BCE case to make clear that it had meant what it had said in Peoples both when it asserted that there are diverse “stakeholders” whose interests a corporation’s actions can affect and when it went on to stress that there is no pre-ordained hierarchy of interests: rather, there is a need to take into account those stakeholder interests that are affected by a board’s actions when assessing what is in the corporation’s best interests. Peoples had been largely focused on issues having to do with the relative importance of creditor interests as a corporation approaches insolvency. The Supreme Court of Canada extended that line of reasoning into the realm of M&A and concluded that in the same way that creditor interests do not necessarily rise to the top of the heap in an eve of insolvency scenario, neither do shareholder interests necessarily rise to the top of the heap in a change of control scenario. Particularly powerful are four sets of observations that underscore the Court’s rejection of a shareholder-centric vision of the corporation and that point to quite a different way of understanding directors’ duties: (i) “People sometimes speak in terms of directors owing a duty to both the corporation and to stakeholders. Usually this is harmless, since the reasonable expectations of the stakeholder in a particular outcome often coincide with the best interests of the corporation. However, cases (such as these appeals) may arise where these interests do not coincide. In such cases, it is important to be clear that the directors owe their duty to the corporation, not to stakeholders, and that the reasonable expectation of stakeholders is simply that the directors act in the best interests of the corporation.” [at para 66] (ii) “In considering what is in the best interests of the corporation, directors may look to the interests of, inter alia, shareholders, employees, creditors, consumers, governments and the environment to inform their decisions. Courts should give appropriate deference to the business judgment of directors who take into account these ancillary interests, as reflected in the business judgment rule.” [at para 40] (iii) “Directors, acting in the best interests of the corporation, may be obliged to consider the impact of their decisions on corporate stakeholders, such as the debentureholders in these appeals. This is what we mean when we speak of a director being required to act in the best interests of the corporation viewed as a good corporate citizen.” [at para 66] (iv) The cases on oppression taken as a whole, confirm that the duty of the directors to act in the best interests of the corporation comprehends a duty to treat individual stakeholders affected by corporate actions equitably and fairly. There are no absolute rules. In each case, the question is whether, in all the circumstances, the directors acted in the best interests of the corporation, having regard to all relevant considerations, including, but not limited to, the need to treat affected stakeholders in a fair manner, commensurate with the corporation’s duties as a responsible corporate citizen.” [at para 82]

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While the Supreme Court of Canada’s decision builds on the groundwork set out in its earlier decision in Peoples, one cannot read these passages without being struck by the way in which ideas found in Peoples get fleshed out using terms that were not previously part of the way in which most Canadian M&A advisors spoke of a board’s duties. Although it was clear after Peoples that the Supreme Court was open to having the term “stakeholder” form part of Canadian corporate law’s lexicon, it is fair to say that most Canadian M&A advisors had not fully digested the relevance of Peoples for their advice with respect to a board’s duties when confronted with an M&A transaction. But the Supreme Court in BCE not only made repeated use of the term “stakeholder” in its discussion of one of the quintessential forms of M&A transaction—the leveraged buy-out—it also made clear that its vision of the corporation was one that sees a corporation engaged in an M&A transaction as being caught up in a process that has the potential to affect the interests of a range of stakeholders and that will therefore frequently give rise to a need to consider these interests carefully. Not only did many an M&A practitioner find the repeated reference in this context to the need to consider the relevance of these stakeholder interests a marked (and for some alarming) deviation from past practice, but the references to a corporation’s duties as a “good” or a “responsible” “corporate citizen” left even more wondering what the implications of the decision were for the way in which they should advise boards studying M&A transactions. Here is where we come to what is, in my view, one of the most important aspects of the decision. If it is true, as I have suggested above, that the CBCA does not endorse a shareholder centric model of the corporation and certainly does not contain provisions stating that a board has a duty to maximize value for shareholders or to put their interests before those of other stakeholders, it must also be acknowledged that the CBCA does not use the term “stakeholder” and does not speak of the corporation as a “corporate citizen.” So in the same way that one cannot say that the CBCA’s fiduciary duty provisions are shareholder centric, it is equally difficult to suggest that the CBCA embraces an alternate vision of the firm rooted in a particular stakeholder theory. The legislator has instead designed a statute that avoids advancing one theory over another, leaving it to a board of directors to assess in practice how best to understand the corporation’s interests and to courts entrusted with the interpretation of these provisions to ensure that a board does not lose sight of this responsibility. That said, it is important to reiterate that even while remaining faithful to the legislator’s directive concerning the entity whose interests a board is ultimately responsible for, the Supreme Court weaves in concepts and terminology into its judgment that have not historically formed part of the language that was used to interpret the CBCA’s fiduciary duty provisions. It is, in turn, difficult to escape the conclusion that more recent currents in the debate over the nature of the corporation and a board’s duties had some bearing on the Court’s decision to fold these newer concepts into its reasoning. At the same time, it seems to me that the Court was careful not to suggest that it was up to something much more radical than refining and expanding concepts used to discuss the choices that boards are confronted with. The Court cannot in my view be said to have gone so far as to have embraced a developed “stakeholder” based theory of the firm. The court simply does not suggest that a board of directors has fiduciary duties to particular stakeholders, reiterating instead that its duty is to the corporation.

V.  Takeover Bids

1107

Not surprisingly, in the years since the Court rendered its decision a considerable amount has been written on what the Court was up to and whether it was seeking to advance a particular theory of the firm; analyses that have proven all the more intriguing given that the Court avoided making reference to any of the various theories of the firm that have formed the subject of academic discourse for the last thirty years. Many have criticized the Court for its perceived failure to delve into this debate and for refusing to embrace either a shareholder-centric vision of the corporation or, on the other hand, for failing to be more explicit about the nature of the “stakeholder” theory of the firm that some perceive it as having advanced. But it seems to me that both sets of criticisms are wide of the mark. The court understood full well that its role is not to get ahead of the legislature and that the CBCA can no more be said to embrace a law and economics perspective on what a board should focus on than more recent stakeholder oriented theories concerning the interests that a board should put in the balance. However frustrating commentators may find it, the reality is that legislators across Canada have not chosen to amend statutory provisions that stipulate that a board must act in the best interests of the corporation. They have instead chosen to keep in place a deliberately open ended concept that leaves it to a board to decide what interests it should consider as it assesses what is the best course of action for the corporation in any number of difficult and challenging situations. At one important level, then, the Supreme Court of Canada was reminding us that that is in fact the public policy choice that our legislatures have made. And unless and until a legislature chooses to codify an obligation on the part of the board to prioritize the interests of one or more stakeholders, it is not for the courts to take it upon themselves to implement such a fundamental shift in public policy. If there is one lesson that one can take away from recent literature concerning the factors that have influenced different countries as they have developed and refined their business law frameworks over many decades, it is that there are important public policy issues at stake in the design of business law frameworks and that our legislators are the ones that need to deal with these issues head on. Expecting or demanding of our courts that they inject expansive theories into our corporate law statutes, theories that would take them in directions that there is no evidence the legislature wished to see them go in, is asking our courts to play a role that goes well beyond what the institution can or should be expected to take on. These are profound public policy decisions that ultimately shape the fabric of the form of capitalism that a society embraces and it is important that institutions that are designed to allow for a full airing of these social and political currents, such as our legislatures, be the ones that make those decisions. It is therefore critical that those concerned with increasingly pressing issues confronting the M&A landscape in Canada carefully consider the implications of the BCE decision. In rejecting a shareholder-centric approach to the interpretation of a board’s duties, the decision puts significant pressure on the model that our securities regulators have long worked with. At the same time, we need to recognize the limits of what we can expect our courts to do in resolving the debate about whose interests a board should take into account. Simply leaving this to some sort of ongoing dialectic between securities commissions and the courts is no way to let matters unfold. What is needed are governments and legislatures that are prepared to look at corporate and securities law as an integrated

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whole and that seek to have this whole rooted in a single and unified vision of the nature of the corporation and the role of a board of directors. As you review the next case, which is one of the few instances in which a Canadian court (as opposed to a securities commission) has considered the use of a poison pill, ask yourself whether, given the decision in Teck (which, you will recall, looked to the decision of the Delaware courts in Cheff v Mathes for inspiration) and the more recent decision in BCE Inc (discussed in Yalden’s extract, immediately above), a body of case law could be developed in Canada that would govern defensive tactics, or whether it is necessary to look to the views of Canadian securities regulators to provide the appropriate framework. Note that the reference below to NP 38 is to the same policy statement that is now NP 62-202.

347883 Alberta Ltd v Producers Pipelines Inc (1991) 80 DLR (4th) 359, [1991] 4 WWR 577 (Sask CA) SHERSTOBITOFF JA (Tallis JA concurring):

[1]  The issue in this appeal [from [1991] 4 WWR 151] is the validity of a poison pill defence strategy undertaken by the directors of the respondent public corporation, Producers Pipelines Inc. (“PPI”), to stave off an apprehended take-over bid by Saskatchewan Oil & Gas Corporation, (“Saskoil”) through its wholly owned subsidiary, 347883 Alberta Ltd., the appellant. [2]  The appellant, as a shareholder in PPI, applied for an order under s. 234 of the Business Corporations Act, RSS 1978, c. B-10, setting aside a shareholder rights agreement (“SRA”) and an issuer bid, the mechanisms used to implement the defence strategy, as being oppressive, or unfairly prejudicial to, or as unfairly disregarding the interests of the appellant and other shareholders in PPI The application was dismissed and this appeal is against that dismissal. The Facts [3]  The judge below outlined the facts as follows: Background Producers is a Saskatchewan incorporated public corporation with approximately 170 shareholders. The shares are not listed on any stock exchange, but are traded in the over-thecounter market. Because of the limited number of shareholders, it appears that there has never been any significant trading in the shares. In August 1990 there were 1,433,945 common shares of Producers outstanding and 230,000 preferred shares. Penfund Capital (No. 1) Limited (“Penfund”) owned all of the preferred shares and 280,000 common shares. It also controls an additional 170,800 common shares. It, therefore, owned or controlled approximately 31.4 per cent of the common shares. On February 15, 1991 Penfund converted all of its preferred shares into common shares. Consequently, there are now 1,663,945 common shares outstanding. The percentage of voting shares owned or controlled by Penfund is now 40.9 per cent.

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V.  Takeover Bids

A nominee of Penfund is a director of Producers. Penfund, together with the other directors of Producers and their associates, controlled more than 50 per cent of the voting shares prior to December 1990. On December 3, 1990 Saskatchewan Oil and Gas Corporation (“Saskoil”) purchased, through a wholly owned subsidiary—the applicant—all of the shares of one of the directors. The applicant now owns 143,200 shares, acquired at a price of $18.25 per share. Saskoil had written to the president of Producers on August 27, 1990, stating that it was “able, willing and wishes to make an offer for all of the shares of Producers.” It was further stated that “On the basis of the somewhat limited information received to date an offer would likely be in the range of $16.00 – 18.00 per share.” The letter prompted the implementation of the “poison pill”—the shareholder rights agreement.

Poison Pill The shareholder rights agreement, dated as of August 27, 1990, is between Producers and the Royal Trust Company, as rights agent. It is a lengthy and detailed agreement. The initial article in the agreement, entitled “Certain Definitions,” comprises, in itself, over 12 pages. The principal purpose of the agreement was to grant rights to each shareholder as of August 27, 1990 to purchase 10 additional common shares of Producers for a price equivalent to $7.50 per share upon the occurrence of certain events. If no “triggering” event occurred, the agreement, and the rights granted, would expire on December 27, 1990. The agreement was unquestionably designed as a defensive tactic to a hostile take-over bid. Although there is a lengthy definition in the agreement of a “permitted bid,” which specifies the types of take-over bids which are permissible, the definition excludes a take-over bid by a person, not “grandfathered” by the agreement, beneficially owning more than 5 per cent, and not more than 10 per cent, of the outstanding common shares of the Producers. The acquisition by the applicant on December 3, 1990 of 143,200 common shares made Saskoil the beneficial owner of approximately 9.9 per cent of the outstanding common shares of Producers. A “triggering” event, permitting exercise of the rights to purchase additional common shares, includes, of course, a non-permitted take-over bid. If the bid should emanate from a person who beneficially owned more than 5 per cent of the common shares of Producers, such as Saskoil, that person would not be entitled to exercise any rights which might be annexed to his or its common shares. The principal complaints of the applicant, however, involve two other aspects of the shareholder rights agreement. The first is an amendment to the agreement, by resolution of the directors of Producers on December 15, 1990, that even before a “permitted” take-over bid, as defined in the agreement, can be so categorized, it must receive the unanimous approval of the board of directors of Producers. The second complaint is that the agreement, although expressed to be valid only until December 27, 1990, was extended, by resolution of the board of directors of Producers, to February 26, 1991 and further extended to April 15, 1991, without shareholder approval. Although the annual meeting of shareholders was held on October 26, 1990, and a special meeting was held on February 25, 1991, the agreement was not presented to the shareholders for their approval at either meeting. Saskoil was fully aware of the existence of the agreement when it acquired its shares on December 3, 1990, but it had anticipated that the agreement would expire, by its own terms, when it was not presented to the shareholders at the annual meeting for their approval.

1110

Chapter 15  Mergers and Acquisitions A special general meeting of the shareholders on February 25, 1991 was convened for the purpose of passing a resolution authorizing Producers to make the issuer bid to purchase a maximum of 560,000 of its shares at a price of $21.50. 88 per cent of the outstanding shares were represented in person or by proxy at the meeting. 88.2 per cent of the shares represented at the meeting voted in favour of the resolution. 11.8 per cent voted against the resolution, including Saskoil. The last date upon which shareholders may tender their shares, pursuant to the issuer bid, is March 28, 1991. Producers may take up and pay for any tendered shares immediately after March 28, but must do so, in any event, within ten days thereafter. The circular annexed to the issuer bid includes a rather lengthy summary of the evaluation report of Meyer Corporate Valuations Ltd., requisitioned by the directors, wherein it expressed the opinion that, as of October 31, 1990, the fair market value of the shares of Producers was in the range of $19 to $21.50 per share. The circular also stated that the “board group members,” comprising the directors of Producers and their affiliates and associates, but not including the nominee of Penfund, would not be tendering their shares, comprising 314,435 shares. It was also stated that Penfund, owning or controlling 680,800 shares, would tender some but not all of its shares. The shareholders were informed at the special general meeting that Penfund would tender 196,000 shares. If all of Penfund’s tendered shares are taken up by Producers, the number of shares which it will then own and control would be reduced to 484,800. That number of shares, when added to the shares owned or controlled by the “board group members,” total 799,235. If 560,000 shares should be tendered and taken up by Producers, the number of outstanding shares will then be reduced to 1,103,945. The applicant does not object to the issuer bid per se, but complains that the existence of the issuer bid, while the shareholder rights agreement remains in force, has the practical effect of precluding a take-over bid by Saskoil. The only complaint expressed with respect to the issuer bid itself is that if 560,000 shares, or even a significant portion of that number, are acquired by Producers, the board of directors will be “entrenched.”

Producers Since 1985 In 1985 Producers became a public company. Its principal business at that time consisted of a crude oil gathering system in southern Saskatchewan. However, in 1988-89, it acquired a significant interest in a gas field, and a 100 per cent interest in a gas gathering network and processing plant in western Saskatchewan. An asphalt plant in Moose Jaw was purchased in 1989 … The initial issue price of the shares of Producers has not been revealed in the material filed. However, share options and warrants were exercised from 1987 to 1990, in one instance at $5.50, and in all other cases at $7 per share. The over-the-counter price of the shares apparently was approximately $5.25 until at least the spring of 1990. But in a letter dated August 23, 1990, ScotiaMcLeod Inc. informed an officer of Producers that the market price in the last trade of Producers shares was at $10 per share. On August 31, 1990 Producers informed R.B. Richards, the President and Chief Executive Officer of Producers, and a director, that his employment was terminated as of that date for

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V.  Takeover Bids

cause. Mr. Richards was not re-elected as a director of Producers at the annual meeting on October 26, 1990, and he sold the 143,200 common shares owned or controlled by him to Saskoil on December 3, 1990.

[4]  There are some other pertinent facts not mentioned by the chambers judge in his summary of the facts. The management information circular, which accompanied the notice of special meeting of shareholders to be held on February 25, 1991, indicated that a shareholders agreement was in the process of being concluded between board group members and the Penfund group members whereby they agreed not to tender their shares into a take-over bid unless the bid satisfied a number of conditions. One of the conditions was that the take-over bid be an all cash bid for all the shares of the corporation at some minimum price per share. In the circular accompanying the issuer bid it is indicated that on February 20, 1991, the minimum price per share was established at $25. [5]  One other pertinent fact not mentioned by the chambers judge is that the shareholders were not advised that the SRA would be extended from February 28, 1991, to April 15, 1991, until a news release dated February 25, 1991. This information was not conveyed to shareholders in the material which accompanied the notice of meeting. The Issues [6]  The appellant’s grounds of appeal are that the directors of PPI acted unlawfully (1)  in failing to obtain shareholder approval of the SRA, although two shareholders’ meetings were held after its implementation, (2) in amending the SRA to provide that the directors must unanimously approve any take-over bid before it could be put to the shareholders as a permitted bid under the amended SRA, (3) in entering into the SRA when it discriminated against the appellant shareholder, and (4) in failing to act in the best interests of the corporation because it could not be demonstrated that there was any valid business purpose for the issuer bid and that the effect of it would be to entrench the board of directors and give them control of a majority of the shares in the corporation. [7]  For its part, aside from the above issues, the respondent questioned the right of this appellant to relief under s. 234 for two reasons: (1) it purchased its shares in PPI after SRA was in place and thus voluntarily “bought in to any oppression” that might exist, and (2)  its purpose in bringing the application was to permit it to make a take-over bid, something unrelated to the rights conferred by ownership of the shares. Poison Pills in Canada [8]  The poison pill was developed in the United States as a defence to coercive takeover bids. It has begun to appear more frequently in Canada and has been subjected to critical analysis in Coleman, “Poison Pills in Canada” (1988), 15 Can. Bus. LJ 1, and Jeffrey G. MacIntosh, “The Poison Pill: A Noxious Nostrum for Canadian Shareholders” (198889), 15 Can. Bus. LJ 276. The poison pill in this case conforms with the typical poison pill described by Mr. Coleman … . •  •  •

[10]  The coercive tactics which the poison pill was intended to counteract are two tier bids, street sweeps and greenmail. They are described by Mr. Coleman at p. 3 and Mr. MacIntosh at pp. 279-80. However, in Canada, these tactics are limited by securities laws

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designed to protect shareholders in cases of take-over bids. Such legislation was first enacted in Ontario and in Saskatchewan is Part XVI of the Securities Act, 1988, SS 198889, c. S-42.2. This Part includes Rules: (i) requiring that identical consideration be paid to all shareholders in connection with the bid (s. 106); (ii) integrating prebid purchases made within 90 days prior to a formal offer by requiring that the subsequent offer be made at a consideration at least equal to the consideration paid in connection with the prebid purchases (s. 103(6)); (iii) restricting market acquisitions during the course of a bid (s. 103(2)); (iv) prohibiting postbid acquisitions for a period of 20 days following the expiration of a bid (s. 103(7)); (v) restricting private agreement acquisitions at a premium to the market price (ss. 103(2), (6), (7), 104 and 106); (vi) regulating certain private transactions (ss. 110, 111). [11]  The effect of these provisions is to prohibit, or at least render less effective, coercive tactics available to corporate raiders in the United States. As a result, Canadian securities regulators have generally taken the position that poison pills are unnecessary in Canada. [12]  This is reflected in National Policy No. 38, published by the Canadian Securities Administrators, which says, in part, as follows: 2.  The primary objective of take-over bid legislation is the protection of the bona fide interests of the shareholders of the target company. A secondary objective is to provide a regulatory framework within which take-over bids may proceed in an open and even-handed environment. The rules should favour neither the offeror nor the management of the target company, but should leave the shareholders of the offeree company free to make a fully informed decision. The administrators are concerned that certain defensive measures taken by management may have the effect of denying to shareholders the ability to make such a decision and of frustrating an open take-over bid process. •  •  •

5.  The administrators consider that unrestricted auctions produce the most desirable results in take-over bids and is reluctant to intervene in contested bids. However, the administrators will take appropriate action where they become aware of defensive tactics that will likely result in shareholders being deprived of the ability to respond to a take-over bid or to a competing bid. 6.  The administrators appreciate that defensive tactics, including those that may consist of some of the actions listed in paragraph 4, may be taken by a board of directors in genuine search of a better offer. It is only those tactics that are likely to deny or severely limit the ability of the shareholders to respond to a take-over bid or a competing bid, that may result in action by the administrators.

[13]  The National Policy also makes the point that prior shareholder approval of corporate action against apprehended or actual take-over bids would, in appropriate cases, allay concerns over shareholders’ rights.

1113

V.  Takeover Bids •  •  •

[17]  … One of the fundamental issues in this case is the extent to which the policy considerations behind the securities legislation should influence the court’s interpretation of (a) the powers of directors to act, in respect of actual or apprehended takeover bids, with or without the approval of shareholders, (b) the duties of the directors to act in the best interests of the corporation, including the shareholders, and (c) the right of shareholders to decide the disposition of their shares and the terms of disposition. Powers and Duties of Directors in Respect of Issue of Shares: The Proper Purpose Test [18]  The effectiveness of the poison pill generally, and the SRA in this case, is based on the power of the directors to issue new shares and rights to purchase new shares at a discount to real value (ss.  25 and 29, the Business Corporations Act). The appellant’s argument is that this power was used for an improper purpose. [19]  The powers and duties of the directors are set out in ss. 97(1) and 117(1) of the Business Corporations Act: 97(1)  Subject to any unanimous shareholder agreement, the directors of a corporation shall: (a)  exercise the powers of the corporation directly or indirectly through the employees and agents of the corporation; and (b)  direct the management of the business and affairs of the corporation. •  •  •

117(1)  Every director and officer of a corporation in exercising his powers and discharging his duties shall: (a)  act honestly and in good faith with a view to the best interests of the corporation; and (b)  exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

[20]  Although the duties of the directors are stated to be to the corporation, the authorities say that the corporation cannot be considered as an entity separate from its shareholders. The directors must act in the best interests of the corporation and all of its shareholders. In Martin v. Gibson (1907), 15 OLR 623, Boyd C said [p. 632]: Now, the persons to be considered and to be benefited are the whole body of shareholders—not the majority, who may for ordinary purposes control affairs—but the majority plus the minority—all in fact who, being shareholders, constitute the very substance (so to speak) of the incorporated body.

Evershed MR said in Greenhalgh v. Arderne Cinemas, [1951] Ch. 286 at 291, [1950] 2 All ER 1120 (CA): … The phrase, “the company as a whole” does not (at any rate in such a case as the present) mean the company as a commercial entity, distinct from the corporators: it means the corporators as a general body.

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[21]  There are limits to the powers of directors to issue shares to defeat a take-over bid. Howard Smith Ltd. v. Ampol Petroleum Ltd., [1974] AC 821, [1974] 2 WLR 689, [1974] 1 All ER 1126 (PC), is the leading case cited by those who attack the validity of the poison pill. Lord Wilberforce said at pp. 1135-36: Just as it is established that directors, within their management powers, may take decisions against the wishes of the majority of shareholders, and indeed that the majority of shareholders cannot control them in the exercise of these powers while they remain in office … so it must be unconstitutional for directors to use their fiduciary powers over the shares in the company purely for the purpose of destroying an existing majority, or creating a new majority which did not previously exist. To do so is to interfere with that element of the company’s constitution which is separate from and set against their power … The right to dispose of shares at a given price is essentially an individual right to be exercised on individual decision and on which a majority, in the absence of oppression or similar impropriety, is entitled to prevail. Directors are of course entitled to offer advice, and bound to supply information, relevant to the making of such a decision, but to use their fiduciary power solely for the purpose of shifting the power to decide to whom and at what price shares are to be sold cannot be related to any purpose for which the power over the share capital was conferred on them.

See also Hogg v. Cramphorn Ltd., [1967] Ch. 254, [1966] 3 WLR 995, [1966] 3 All ER 420. [22]  On the surface, Teck Corp. Ltd. v. Millar (1972), [1973] 2 WWR 385, 33 DLR (3d) 288 (BCSC), presents a different point of view on this issue. Berger J held that it was within the proper purposes of the directors to consider who is attempting to take over the company, and whether this would be in the interest of the company as a whole. If it was not, then it would be appropriate for the directors to take action with the purpose of defeating such a take-over notwithstanding that they acted contrary to the wishes of the majority shareholders. He said at p. 315: My own view is that the directors ought to be allowed to consider who is seeking control and why. If they believe that there will be substantial damage to the company’s interests if the company is taken over, then the exercise of their powers to defeat those seeking a majority will not necessarily be categorized as improper.

[23]  However, as Richard J points out in Exco Corp. v. Nova Scotia Savings & Loan Co. (1987), 35 BLR 149 at 259, 78 NSR (2d) 91, 193 APR 91 (TD), Teck could have been decided on a much narrower footing. In Teck, the company over which control was sought was a small company with a mining interest it wished to develop. The normal practice in the industry was for such a small company to find a major mining company to participate in the development. It was customary in such a venture for the major mining partner to acquire a significant shareholding in the minor company. Thus, the question of the allotment of shares in Teck was inextricably bound up in a question of business judgment concerning the ordinary course of the affairs of the business. This factor placed the decision properly within the purview of the directors. Indeed, Lord Wilberforce spoke of Teck with approval in Howard Smith (at p. 1135) on this basis. [24] In Teck, the following test was formulated for determining whether or not the directors acted with a proper purpose at pp. 315-16:

1115

V.  Takeover Bids

I think the Courts should apply the general rule in this way: The directors must act in good faith. Then there must be reasonable grounds for their belief. If they say that they believe there will be substantial damage to the company’s interests, then there must be reasonable grounds for that belief. If there are not, that will justify a finding that the directors were actuated by an improper purpose.

[25] In Exco, Richard J said this at p. 261: Even the test laid out by Berger J, in the Teck case requires further refinement if it is to be applied generally. When exercising their power to issue shares from treasury the directors must be able to show that the considerations upon which the decision to issue was based are consistent only with the best interests of the company and inconsistent with any other interests. This burden ought to be on the directors once a treasury share issue has been challenged. I am of the view that such a test is consistent with the fiduciary nature of the director’s duty, in fact, it may be just another way of stating that duty.

[26]  At p. 262 he stated: In relating the facts of this case to the law respecting the duty of directors in issuing treasury shares I find that NSS&L directors made a one-sided allotment of shares for the purpose of “watering down” the commanding share equity position of the so-called EXCO group. The NSS&L directors used their rather substantial power for a wrong purpose, i.e., a purpose which was not demonstrably in the best interests of the company. They used their power to support one group in a take-over, a group which the directors had sought out and which was “not unfriendly” to those directors. What the directors did in this case is more consistent with a finding of self-interest than with bona fide company interest. Or, to put it more in the context of the test which I previously set out, what the directors did was not inconsistent with self-interest. In so doing they breached their fiduciary duty to the general body of the shareholders. •  •  •

[29]  The tests adopted by Berger J in Teck and by Richard J in Exco, while stated in a different way, do not conflict with the business judgment rule developed in the United States. Although different states have developed different rules, some of the more notable jurisdictions in corporate law have developed a business judgment rule. It recognizes that, in a take-over situation, the directors will often be in a conflict of interest situation, and, in implementing a poison pill defence strategy, the directors must be able to establish that (a) in good faith they perceived a threat to the corporation, (b) they acted after proper investigation, and (c)  the means adopted to oppose the take-over were reasonable in relationship to the threat posed: Unocal Corp. v. Mesa Petroleum Co., 493 A2d 946 (Del. SC, 1985) and Desert Partners Ltd. Partnership v. USG Corp., 686 F. Supp. 1289 (ND Ill., 1988). [30]  The tests developed in Teck and Exco, and in the American authorities above referred to, contain relevant considerations. They also extend considerable deference to bona fide business judgments of the directors. However, they do not go far enough to determine this case. They give no principles for determining whether or not the defensive strategy was reasonable in relationship to the threat posed. They do not deal with the principle that shareholders have the right to determine to whom and at what price they

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will sell their shares as stated in Howard Smith Ltd. They fail to consider the effect of the take-over provisions in the provincial securities legislation. [31]  In respect of the latter, National Policy No. 38 of the Canadian Securities Administrators referred to earlier in this judgment accurately reflects the policy considerations behind that legislation and must have a substantial impact in any review of defensive tactics against take-overs. Just as the provisions were intended to prevent abusive, coercive or unfair tactics by persons making take-over bids, they were equally intended to limit the powers of directors to use defensive tactics which might also be abusive, coercive or unfair to shareholders, or tactics which unnecessarily deprive the shareholders of the right to decide to whom and at what price they will sell their shares. Section 108 of the Securities Act, 1988, indicates that the primary role of the directors in respect of a take-over bid is to advise the shareholders, rather than to decide the issue for them. As noted in the policy statement, the primary objective of the legislation is to protect the bona fide interests of the shareholders of the target company and to permit take-over bids to proceed in an open and even-handed environment. Unrestricted auctions produce the most desirable results in take-over bids. Accordingly defensive measures should not deny to the shareholders the ability to make a decision, and it follows that, whenever possible, prior shareholder approval of defensive tactics should be obtained. There may be circumstances where it is impractical or impossible to obtain prior shareholder approval, such as lack of time, but in such instances, delaying measures will usually suffice to give the directors time to find alternatives. The ultimate decision must be left with the shareholders, whether by subsequent ratification of the poison pill, or by presentation to them of the competing offers or other alternatives to the take-over bid, together with the take-over bid itself. [32]  In summary, when a corporation is faced with susceptibility to a take-over bid or an actual take-over bid, the directors must exercise their powers in accordance with their overriding duty to act bona fide and in the best interests of the corporation even though they may find themselves, through no fault of their own, in a conflict of interest situation. If, after investigation, they determine that action is necessary to advance the best interests of the company, they may act, but the onus will be on them to show that their acts were reasonable in relation to the threat posed and were directed to the benefit of the corporation and its shareholders as a whole, and not for an improper purpose such as entrenchment of the directors. [33]  Since the shareholders have the right to decide to whom and at what price they will sell their shares, defensive action must interfere as little as possible with that right. Accordingly, any defensive action should be put to the shareholders for prior approval where possible, or for subsequent ratification if not possible. There may be circumstances where neither is possible, but that was not so in this case. Defensive tactics that result in shareholders being deprived of the ability to respond to a take-over bid or to a competing bid are unacceptable. Conclusion as to Proper Purpose [34]  In applying the above criteria to the facts of this case, the most important issue is whether the directors, in adopting the defensive tactics culminating in the issuer bid, met the onus upon them to show that they acted in the best interests of the corporation as a whole, and whether their actions were reasonable in relation to the threat posed.

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There was no direct evidence from the directors as to their purpose in implementing their defensive strategy. The evidence from which the court must draw its inferences may be summarized as follows. [35]  From the point of view of the directors, the stated purpose of the SRA in documents circulated to the shareholders was to give the directors time to assess any take-over offer and to consider alternatives. Later, after amendment of the SRA, the purpose was stated to be “to protect shareholders from an unfair, abusive, or coercive take-over bid.” The circular accompanying the issuer bid to shareholders stated as follows: 2.  Purpose of the Offer

The directors believe that the Corporation’s prospects in the medium to long term are excellent. The Corporation is not, however, widely known in the capital markets nor are its Shares listed for trading on any stock exchange. Although the Shares trade in the over-the-counter market, because of the small number of shareholders and the nature of the shareholdings, trading in the Shares is extremely limited and the trading value of the Shares is not reasonably ascertainable. Accordingly, the opportunity for shareholders to realize on their investment is limited and the directors believe that the price available to shareholders for their Shares does not adequately reflect their value. The directors believe that the purchase by the Corporation of up to 560,000 Shares at a price of $21.50 a Share represents a worthwhile investment and is an appropriate use of the Corporation’s funds while providing the Corporation’s shareholders with an opportunity to sell a portion of their Shares at a favourable price. •  •  •

[37]  It is fair to infer that the board of directors saw the proposed bid of Saskoil in August to be too low and that, in response, it implemented the SRA to give it until December 27, 1990, when the agreement would expire, to consider alternatives. In view of the subsequent valuation of the shares at $19 to $21.50 per share, the concern of the directors was clearly justified and their actions to this point were reasonable, except in one respect. They did not put the SRA to the shareholders for ratification at the meeting in October 1990. It was said that this was done because the SRA would lapse, by its own terms, on December 27. However, that proved not to be the case. [38]  It was the extension and amendment of the SRA, which was outlined in a management information circular accompanying the notice of special general meeting of the shareholders scheduled for February 25, 1991, which was the real cause for complaint. The circular stated as follows: … In order to protect shareholders from an unfair, abusive or coercive takeover bid, on December 15, 1990, the Board of Directors amended the Rights plan to extend its operation until February 28, 1991. The Rights plan was also amended to provide that a permitted bid can now only be made with the prior approval with the Board of Directors even if it is an all cash bid for all the common shares of the Corporation. The Rights plan will terminate on February 28, 1991.

[39]  Later, the SRA was again extended to April 15, 1991, a date after which the issuer bid would be completed. [40]  The purpose of the extended and amended SRA, in conjunction with the issuer bid, was, at this point, unequivocal. The terms of a permitted take-over bid were, all cash, for all shares, and only with the unanimous approval of the board of directors. There was

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agreement among the directors that approval would not be given at a price less than $25 a share, a price 25 per cent above the appraised value. These terms were so onerous that any take-over bid was effectively prohibited. [41]  At the same time as the shareholders were deprived of the right to consider any take-over bid, they were forced to consider authorization of the issuer bid. The effect of these tactics was coercion of the shareholders for the reasons stated in Mr. Ludke’s affidavit. In view of the lack of liquidity, due to lack of market for the shares, those shareholders who wanted to realize anything approaching the appraised value of a portion of their shares had no choice but to tender to the issuer bid. While the result would be liquidation of an uncertain number of their shares at appraised value, they would be left with a substantial number of the shares which, if saleable at all, would be saleable at a substantially less value. A shareholder seeking some liquidity, with the knowledge that take-over bids were effectively prohibited, would have no choice but to authorize the issuer bid and to tender to it. For these reasons, no weight can be given to the shareholder vote authorizing the issuer bid. [42]  The purpose of the defensive action is apparent: effective prohibition of the appellant’s proposed take-over bid or any other take-over bid, until after the shareholders were forced to consider authorization of and tender to the issuer bid. The result was to deprive the shareholders of any alternative to the issuer bid except to hold their shares which, if marketable, would no doubt continue to trade at a value substantially less than appraised value. The fact that the SRA was not put to the shareholders for ratification either prior to, or simultaneous with, the issuer bid confirms the view that the purpose of the directors was to force the issuer bid on the shareholders without the choice of any possible alternative such as the appellant’s proposed take-over bid or any other take-over bid. [43]  These actions were in interference with the shareholders’ rights to determine the disposition of their shares. That raises the question of whether acting without shareholder approval of the SRA was necessary in the circumstances. No reason was advanced by the directors for failure to put the matter to the shareholders. The only inference which can be drawn from that is that the directors wished to make the decision themselves in order to ensure their continued control of the company. They thus acted for an improper purpose. [44]  There are a number of other reasons which support a conclusion that the defensive action was neither reasonable in proportion to the threat posed, nor taken in the best interests of the company, but was taken with a view to further entrenching the directors group: (a) the board of directors made no effort to show that a take-over by Saskoil would be harmful to the corporation except that the proposed offer at $16 to $18 per share was below the appraised value of the shares; (b) they made no effort to negotiate with Saskoil to increase the amount offered per share; (c)  they did not seek any competitive bids (except their own issuer bid) although the material indicated that a couple of other parties had indicated an interest in making a take-over offer; (d) they made no effort to establish, through evidence, that tender of shares to the issuer bid would ultimately result in a better value to the shareholders for all of their shares than a take-over bid, even at a price of $16 to $18 per share; (e) they agreed among themselves that they would not permit a bid under the SRA at less than $25 per share, some 25 per cent above appraised value; (f) they offered no valid business reason, from the point of view of the company, for the issuer

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bid, the completion of which would further entrench the directors at the expense of a substantial increase in the indebtedness of the company. [45]  None of these things point to any effort to increase or maximize the value of the shares, or to obtain the best possible offer for them. They point to one objective, and one objective only: the prohibition of any take-over bid until after completion of the issuer bid, the result of which would be that the directors group would control a majority of the shares, thus making the company impregnable to any take-over bid unacceptable to the board. [46]  In fairness to the directors, it was assumed by all parties, and accepted by the court, that the board of directors acted bona fide and in the belief that the future of the company was such that the shareholders would be better off maintaining the corporation as it was, rather than letting it be taken over by Saskoil. [47]  However, as noted above, the directors did not meet the onus upon them to show that their actions were necessarily in the best interests of the company. Furthermore, a decision of that nature was one to be taken by the shareholders, and the directors were not, in the circumstances, entitled to deprive them of the right to make that decision. [48]  The chambers judge found that the purpose of the SRA could not be to entrench the directors because they were already entrenched. The evidence is unclear as to the exact percentage of the shares that the directors group controlled at the time Saskoil purchased its shares. It was certainly over 40 per cent. Whatever percentage was controlled by the directors at all relevant times, the effect of the SRA and completed issuer bid would be to increase it and thus increase the control of the directors. If that was to be the effect, the inference must be that that was the purpose. And that was an improper purpose unless the board could show that it was for the benefit of the corporation as a whole, including the shareholders. It did not do so. [49]  The actions taken by the directors in this case amounted to telling Saskoil that it would not, under any circumstances, permit itself to be taken over. We agree with the following comment by Mr. Coleman in his article at p. 6: Some US securities lawyers have suggested that so long as they act in good faith and on reasonable grounds, boards of directors can just say no to a potential acquirer whose price the board believes to be inadequate. In such a case, it is argued, directors should be able to resist pressure to withdraw poison pill defences and they do not have to seek higher bidders or recapitalize to boost short term value. Because it is reminiscent of the “just say no” antidrug campaign, this approach has been termed the “Nancy Reagan defence.” Does a Board breach its fiduciary duty by refusing to negotiate with a potential acquirer to remove the coercive and inadequate aspects of an offer? A Board may decide not to bargain over the terms of an offer because doing so conveys a message to the market that (a) the company is for sale when, in fact, it is not; and (b) the initial offer by the bidder is “in the ballpark” when, again, it is not. However, it can be expected that the courts will conclude that a “just say no” response to a cash take-over bid for all shares does not justify keeping a Pill in place indefinitely if shareholders are prevented from responding to the bid.

[50]  The SRA is objectionable in three other respects. First, as found by the trial judge, it may, in certain circumstances, require the directors to act contrary to the rule that the directors cannot, without the consent of the shareholders, fetter their future discretion: Gower, Principles of Modern Company Law (4th Ed.), p. 582, Ringuet et al. v. Bergeron,

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[1960] S.C.R. 672. Second, it may, in certain circumstances, require the directors to act contrary to s. 108 of the Securities Act, 1988, quoted above, which imposes certain duties upon the directors when a take-over bid is made, including the duty to send a directors’ circular to every person affected within ten days of a take-over bid. Third, its extension beyond December 27, 1990, violated the terms of the SRA itself, which provided that it would expire on December 27, 1990, if not previously ratified by the shareholders of the corporation. [51]  The appellant made an argument that the SRA was illegal to the extent that it discriminated against the appellant, as a shareholder, by making it ineligible, in the event of a take-over bid by it, to exercise the rights granted by the SRA to other shareholders. The appellant would thus suffer punitive dilution. The substance of this argument is summarized by Mr. Coleman in his article at p. 9. In view of our conclusions above, we need not consider this aspect of the matter. Section 234, Business Corporations Act [52]  This application is brought under s. 234 of the Business Corporations Act, which provides as follows: 234(1)  A complainant may apply to a court for an order under this section. (2)  If, upon an application under subsection (1), the court is satisfied that in respect of a corporation or any of its affiliates: (a)  any act or omission of the corporation or any of its affiliates effects a result; (b)  the business or affairs of the corporation or any of its affiliates are or have been carried on or conducted in a manner; or (c)  the powers of the directors of the corporation or any of its affiliates are or have been exercised in a manner; that is oppressive or unfairly prejudicial to or that unfairly disregards the interests of any security holders, creditor, director or officer, the court may make an order to rectify the matters complained of.

[53]  For convenience, the remedy under s. 234 will be referred to in this judgment as the oppression remedy whether based on a finding that the actions were “oppressive,” “unfairly prejudicial” or that “unfairly disregard.” The meaning of these terms was considered by this court in Eiserman v. Ara Farms and Eiserman (1988), 67 Sask. R 1. The legislation is remedial and is to be given a broad interpretation. Each case turns on its own facts: what may be oppressive or unfairly prejudicial in one case may not necessarily be so in a different setting: Eiserman, and Re Ferguson and Imax Systems Corp. (1983), 43 O.R. (2d) 128 (Ont. C.A.). [54]  The respondent argued that since the appellant acquired its shares in the respondent for the purpose of a take-over bid, and that its purpose in making this application was to permit it to proceed with a take-over bid, a remedy under s. 234 was inappropriate since the right to make a take-over bid had nothing to do with rights accruing from ownership of shares. That overlooks the fact that when the appellant acquired its shares, for whatever purpose, it acquired the same rights as any other shareholder. And those included the right to determine to whom and at what price to sell its shares in the event of a take-over bid. While its own proposed offer was the only one in evidence, and it could

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not sell to itself, the poison pill was effective against any possible take-over bid. There was some evidence that others were interested in a take-over. Thus, the appellant, as a shareholder, was deprived of the right to consider possible take-over bids and thus had status to claim relief under s. 234. In any event, any shareholder has status to object to an illegal poison pill whether any offer is in prospect or not. This judgment has determined that the appellant’s right to determine disposition of its shares was violated by the directors acting beyond their powers. Such action was unfairly prejudicial to the appellant and entitles the court to grant relief under s. 234. [55]  The respondent argued that, since the appellant purchased its shares when it knew the SRA was in place, it knowingly bought into any oppression and should be denied relief. However, the actions found to be beyond the powers of the directors occurred later. In any event, we agree with the reasoning of Southey J in Palmer v. Carling O’Keefe Breweries of Canada Ltd. (1989), 41 BLR 128, 56 DLR (4th) 128 at 136-37, 67 OR (2d) 161, 32 OAC 113 (Div. Ct.): I am unimpressed with the argument that no relief should be given in respect of shares purchased after the intention to amalgamate became known. The submission was that, in respect of those shares, the purchasers “bought into the oppression.” If relief is given to anyone in these proceedings, it will mean that the applicant correctly appreciated the legal rights of the preference shareholders. If the applicant and others could not take advantage of those rights with respect to the shares they were bold enough to purchase while those rights were still in dispute, it would mean that less sanguine owners would be deprived of the advantage of selling their shares during the pending litigation at prices reflecting the purchasers’ estimate of the chances of success. Any such rule would place a new and, in my view, unwarranted restriction on the price of shares that are traded on a stock exchange. The conduct of the applicant and those associated in the same interest will either turn out to have provided an effective check on unlawful acts by the directors, or it will prove to have been a very expensive exercise in tilting at windmills. The owners of small numbers of shares probably could not afford to run the risks involved in providing such check.

Remedy [56]  PPI suggested that an appropriate remedy, if oppression were found, would be to require the respondent to buy the appellant’s shares. It further argued that any order setting aside the issuer bid might be unfairly prejudicial to those shareholders who had tendered to it and had expected to receive the proceeds of the sale. [57]  We are fully aware of the breadth of s. 234 and the problem of balancing the rights of an individual shareholder in conflict with the rights of the company as a whole, or with the rights of all of the other shareholders. [58]  This case poses no such problem in that a remedy is available which will give the shareholders, as a whole, the right to determine the issue themselves. The remedy is to set aside the SRA and to extend the closing date of the issuer bid from March 28, 1991, to 45 days after the date of this judgment. All other dates under the issuer bid are extended accordingly. Otherwise, all terms remain the same. This will permit the appellant, or any other person interested, to make a take-over bid and will give all shareholders a choice between the issuer bid (if the respondent chooses not to withdraw it) and any take-over

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bid. The parties are to agree on the form of the formal judgment before it is issued and, failing agreement, application may be made to the court for further directions. [59]  The appellant will have its costs of this application under double Column V. QUESTIONS

1.  Early on in its analysis of the Saskatchewan Business Corporations Act, RSS 1978, c B-10 (SBCA), s 117, the Court of Appeal points to older case law that suggests that the corporation and its shareholders are one and the same. Is this vision of the corporation consistent with the vision that the Supreme Court of Canada set out in BCE Inc v 1976 Debentureholders? 2.  The Court of Appeal makes reference to the decision in Unocal in passing, only to conclude that the US case law does not provide enough guidance with respect to the standards that should govern the use of defensive tactics. In light of the Delaware jurisprudence reviewed earlier in this chapter, do you think that this was a valid observation? Was it necessary to turn to NP 38 (now known as NP 62-202) for guidance? Is it appropriate for a court to rely on the pronouncements of securities regulators regarding their approach to takeover regulations when interpreting sections of a business corporations act? 61 In commenting on the decision in Producers Pipelines, Robert Yalden offers the following observation:62 The end result in Producers is that in the course of interpreting provisions having to do with fiduciary duties, the Court of Appeal has reached out to a policy statement that was issued in order to set out standards that securities commissions felt were not captured by directors’ fiduciary duties. Thus the Court of Appeal ends up adopting a role similar to the one that securities regulators have carved out for themselves: that is, it has embraced fairness claims developed independently of any analysis of the SBCA. While one can understand the position taken by securities regulators, it is not easy to formulate a rationale for courts taking it upon themselves to enforce National Policy 38. It would have been considerably easier to justify an approach to this case that focused squarely on section 117 of the SBCA in light of the division of power between shareholders and management that the Act put in place and that then went on to provide an account of the reasons why, given that framework, shareholders should not be prevented from having the final say with respect to the adoption of a poison pill and the acceptability of a given take-over bid. While Sherstobitoff JA quite rightly notes that Canadian law with respect to directors’ fiduciary duties in the course of a take-over bid does not speak to the use of poison pills, there is American case law that tackles this question and that can quite readily be looked to for inspiration.

3.  In the same way that Canadian securities regulators have imposed their own vision of fairness in the context of buyout transactions through MI 61-101, so too they have introduced distinctive standards in the takeover context through the adoption of NP 62-202. Once again, one needs to consider whether this is in fact necessary and whether the desire to impose a particular vision of fairness on the takeover process comes at the cost of restricting a target company’s flexibility in pursuing corporate objectives. We have already seen that the decision

61 For one perspective on these questions, see Robert Yalden, “Controlling the Use and Abuse of Poison Pills in Canada: 347883 Alberta Ltd v Producers Pipelines Inc” (1992) 37 McGill LJ 887. 62 Ibid at 911.

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in Teck relied on Cheff v Mathes for guidance, the same decision of the Delaware courts that underlies cases stretching from Unocal through Revlon and subsequent cases. Could takeovers in Canada not be regulated through a body of law that builds on the decision in Teck? Or do securities regulators bring a perspective that would otherwise be missing? If you think there is a role for securities regulators, to what extent should they give consideration to the Supreme Court of Canada’s decision in BCE Inc v 1976 Debentureholders? In relying on NP 38, the Court of Appeal relied on a policy statement that is influenced by a particular vision of the corporation. For example, Stanley Beck, the chairman of the Ontario Securities Commission at the time that the statement was adopted, has written that “National Policy 38 reflects an attempt to ensure that the owners of the company have the ability to sell their ownership rights; hence a restriction on target management intervention.”63 Do you share this vision of the shareholder’s relation to the corporation? Is it consistent with the vision of the firm set out in Teck or in the more recent decision of the Supreme Court of Canada in BCE Inc v 1976 Debentureholders? In view of the material seen in Chapter 6, Section II.E, is it accurate to refer to shareholders as the owners of the corporation? 4. While Producers Pipelines was brought by way of a claim under the oppression remedy, in fact little time is spent analyzing that remedy. Do you think that the court should have spent more time looking at the role of the oppression remedy in connection with takeovers instead of focusing on NP 38? What conclusions might it have reached? Does the oppression remedy offer a framework for considering the impact of takeovers on the interests of constituencies other than shareholders? 5.  In the first case to come before the OSC in which a rights plan was challenged (In the Matter of Canadian Jorex Limited and Mannville Oil & Gas Ltd (1992), 15 OSCB 257), the OSC found that the time had come for a rights plan that had not been ratified by shareholders “to go.” In its decision, the OSC stated: Underlying our conclusion was our view of the public interest in matters such as this. As is amply reflected in National Policy 38, the primary concern of the Commission in contested take-over bids is not whether it is appropriate for a target board to adopt defensive tactics, but whether those tactics “are likely to deny or severely limit the ability of the shareholders to respond to a take-over bid or a competing bid” (paragraph 6) or “may have the effect of denying to shareholders the ability to make a [fully informed] decision and of frustrating an open take-over bid process” (paragraph 2). If so, then as National Policy 38 clearly indicates, the Commission will be quite prepared to intervene to protect the public interest as we see it. For us, the public interest lies in allowing shareholders of a target company to exercise one of the fundamental rights of share ownership—the ability to dispose of shares as one wishes—without undue influence from, among other things, defensive tactics that may have been adopted by the target board with the best of intentions, but that are either misguided from the outset or, as here, have outlived their usefulness.

6.  In late 1994, the Ontario Securities Commission was twice called on to consider poison pills that had been ratified by shareholders: Lac Minerals Ltd and Royal Oak Mines Inc (1994),

63 Stanley Beck & Robert Wildeboer, “National Policy 38 as a Regulator of Defensive Tactics,” McGill University, Faculty of Law, Meredith Memorial Lectures: Acquisitions and Take-Overs—Acquisitions et offres publique d’achat (Montréal: Yvon Blais, 1987) at 119-39.

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17 OSCB 4963 and MDC Corporation and Royal Greetings & Gifts (1994), 17 OSCB 4971. In both cases the OSC acknowledged that boards of directors must abide by their fiduciary duties when assessing the merits of an unsolicited takeover bid and that this process involves decisions about whether it is appropriate to terminate a rights plan. But the OSC went on to state that its responsibility was not to assess whether directors were acting reasonably and for a proper purpose in using the rights plan. Rather, its job was “to focus on whether it is in the public interest, more particularly the interest of target company shareholders, that the shareholder rights plan be allowed to continue to operate” (Lac at 4968). In both cases, the OSC allowed a shareholder rights plan to stay in place for a limited period, but made clear that after that period it would issue a cease-trade order in respect of the rights issued under the shareholder rights plan in order to allow the target company’s shareholders to decide on the merits of the bid. The OSC referred to NP 38 as a touchstone for its analysis. It also placed considerable weight on the views of shareholders regarding the merits of keeping the shareholder rights plan in place. Further discussions of importance concerning rights plans include the joint decisions of the BC, Alberta, and Ontario securities commissions in Royal Host Real Estate Investment Trust and Canadian Income Properties Real Estate Investment Trust (1999), 22 OSCB 7819 (see below) and the OSC’s decisions in Re Chapters Inc (2001), 24 OSCB 1657 and Falconbridge (2006), 29 OSCB 6783. The following observations in Royal Host are particularly important, both because Canadian securities commissions (rather than the courts) became the principal forum in which poison pills were challenged and because these observations have since been regularly referred to in subsequent securities commission decisions concerning rights plans: In applying these principles to the determination of the public interest in a particular case, the challenge we face is finding the appropriate balance between permitting the directors to fulfill their duty to maximize shareholder value in the manner they see fit and protecting the right of the shareholders to decide whether to tender their shares to the bid. We can make this determination only after considering all of the relevant factors in that particular case. While it would be impossible to set out a list of all of the factors that might be relevant in cases of this kind, they frequently include: • • • • • • • • • • •

whether shareholder approval of the rights plan was obtained; when the plan was adopted; whether there is broad shareholder support for the continued operation of the plan; the size and complexity of the target company; the other defensive tactics, if any, implemented by the target company; the number of potential, viable offerors; the steps taken by the target company to find an alternative bid or transaction that would be better for the shareholders; the likelihood that, if given further time, the target company will be able to find a better bid or transaction; the nature of the bid, including whether it is coercive or unfair to the shareholders of the target company; the length of time since the bid was announced and made; the likelihood that the bid will not be extended if the rights plan is not terminated.

The OSC therefore set about assessing the merits of rights plans on a basis that does not treat questions concerning a board’s fiduciary duties as the focal point for analysis. At the same time, Producers Pipelines suggests that courts that focus on fiduciary duties are

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prepared to look to NP 62-202 to provide content to an analysis of those duties (even though that policy statement is not an expression of the will of the legislature). As for the oppression remedy, it has received little attention. Does the way in which this picture has unfolded trouble you? Does it leave any room for a consideration of the interests of constituencies other than shareholders? What is the relevance of the decision in BCE Inc v 1976 Debentureholders to an analysis of rights plans? 7.  In its decision in Re Neo Material Technologies Inc (2009) 32 OSCB 6941, the OSC initially appeared open to considering the implications of the BCE Inc decision for an analysis of rights plans: [107]  We acknowledge that in many instances a primary purpose for adopting a shareholder rights plan is to allow the board to pursue alternative value-enhancing transactions, which includes seeking an alternate bid. In fact, we recognize that in the circumstances of many of the cases referred to, and considered by us, that obligation may have crystallized. However, we do not see this as the only legitimate purpose for a shareholder rights plan. As stated above, Canadian law imposes and recognizes a fiduciary duty owed by a board to the corporation as a whole. The so-called “business judgment” rule properly permits directors to make appropriate decisions sufficient to fulfill their fiduciary obligations. To the extent that the scope and content of these duties were not clear in the context of a hostile take-over bid, they have been better amplified by the recent statements of the Supreme Court of Canada in BCE Inc., Re, [2008] 3 S.C.R. 560 (“BCE”). … [108]  The Court went on to state: … Directors, acting in the best interests of the corporation, may be obliged to consider the impact of their decisions on corporate stakeholders, such as the debentureholders in these appeals … . However, the directors owe a fiduciary duty to the corporation, and only to the corporation. People sometimes speak in terms of directors owing a duty to both the corporation and to stakeholders. Usually this is harmless, since the reasonable expectations of the stakeholder in a particular outcome often coincides with what is in the best interests of the corporation. However, cases (such as these appeals) may arise where these interests do not coincide. In such cases, it is important to be clear that the directors owe their duty to the corporation, not to stakeholders, and that the reasonable expectation of stakeholders is simply that the directors act in the best interests of the corporation. (BCE at para. 66) [109]  In our view, these statements make it clear that there is no specific formula to apply on directors in every case, including an obligation to permit and facilitate an auction of company shares each and every time an offeror makes a bid. In fact, Canadian courts have historically not imposed such duty on directors to the corporation. As the Ontario Court of Appeal stated in Schneider: The decision in Revlon v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), stands for the proposition that if a company is up for sale, the directors have an obligation to conduct an auction of the company’s shares. Revlon is not the law in Ontario. In Ontario, an auction need not be held every time there is a change of control of a company. (Schneider at para. 61) [110]  We also defer to the comments of the Supreme Court of Canada in BCE where the Court noted: What is clear is that the Revlon line of cases has not displaced the fundamental rule that the duty of directors cannot be confined to particular priority rules, but is rather a function of

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Chapter 15  Mergers and Acquisitions business judgment of what is in the best interest of the corporation, in the particular situation it faces … .

(BCE at para. 87) [111]  We are bound by this principle as a matter of law, and have a duty to apply it in cases such as these. However, we add that in our view this articulation is not a deviation from past Commission determinations but is consistent with them. [112]  As discussed above, in this case, Pala submits that the only proper use of a shareholder rights plan in the face of a take-over bid is to allow a board of directors sufficient time to seek out alternative bidders. Consistent with the Supreme Court’s statements in BCE and the established body of corporate case law it is our view that shareholder rights plans may be adopted for the broader purpose of protecting the long-term interests of the shareholders, where, in the directors’ reasonable business judgment, the implementation of a rights plan would be in the best interests of the corporation.

In a decision issued in 2010, however, and in decisions since then, the OSC has on several occasions reverted back to its traditional framework for the analysis of poison pills. In Re Baffinland Iron Mines Corp. (2010) 33 OSCB 11385, the OSC stated: [48] In Neo, the Commission concluded that it would defer to the wishes of shareholders who had overwhelmingly voted to keep the relevant rights plan in place in the face of the specific bid that was before shareholders at the time of the vote. The vote was held only two weeks before the hearing. NP 62-202 states that “prior shareholder approval of corporate action would, in appropriate cases, allay” concerns with respect to a defensive tactic. In Neo, the Commission concluded that it should defer to the wishes of shareholders as expressed by the recent shareholder vote. •  •  •

[51]  Accordingly, in our view, Neo does not stand for the proposition that the Commission will defer to the business judgment of a board of directors in considering whether to cease trade a rights plan, or that a board of directors in the exercise of its fiduciary duties may “just say no” to a take-over bid. Such a conclusion would have been inconsistent with the provisions of NP 62-202 and the relatively long line of regulatory decisions that began with Canadian Jorex. To the contrary, the Commission in Neo deferred to the wishes of shareholders as contemplated by NP 62-202. Neo suggests only that whether or not the board of directors of a target issuer is acting in the best interests of that issuer and its shareholders, and is complying with its fiduciary duties, is a relevant, although secondary, consideration for the Commission in deciding whether to cease trade a rights plan. Whether a board of directors is complying with its fiduciary duties does not determine the outcome of a poison pill hearing.

8.  The question of the relevant roles that courts and securities commissions should play is not one that is limited to rights plans. Other tactics that are frequently challenged in contested takeover bids raise similar questions. For example, consider the issues raised above in reviewing the following extract from Blair J’s decision in CW Shareholdings Inc v WIC Western International Communications Ltd (1998), 39 OR (3d) 755 (Gen Div), which deal with break fees. Should courts or, instead, securities commissions regulate their use? Or do both have a role to play? A break fee—or “bust-up fee,” as it is sometimes called—is a payment employed by the target corporation for the purpose of enticing another competitive bidder to enter the fray. It is paid to the competitive bidder when its bid fails or is superseded by a better offer. Partly, the inducement is paid to compensate the bidder being wooed for its time, effort, costs and lost

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V.  Takeover Bids

opportunity in putting forward the opposing bid; partly the break fee is purely and simply bait to lure another party into the arena in order to generate a free for all for the prize. Such fees are effective inducements, and they are common in take-over bid situations and accepted as proper techniques in appropriate circumstances. The Ontario, Alberta and British Columbia Securities Commissions have acknowledged this concept only a few days ago, in this particular takeover battle—on an application by CanWest to cease trade the Shaw bid as being contrary to the public interest. On May 5, 1998, the Commission stated: Although break-up fees have become a more or less usual feature of the take-over bid landscape, the quantum of a specific fee could, in our view, result in the agreement to pay such a fee being an improper defensive tactic. However, a break-up fee in an appropriate amount could, in our view, be properly agreed to by a target company if it were necessary to agree to it in order to induce a competing bid to come forward. In both Corona Minerals Corp. v. GSA Management Ltd. … , and in Re Everfresh Beverages Inc. [1996] OJ no. 105 this Court has accepted as valid transactions which involved break fees and which resulted in “excess value realized.” I accept that break fees are appropriate in such circumstances where, (a)  as the Commissions have noted, they are “necessary … in order to induce a competing bid coming forward”; (b)  that bid represents a better value for the shareholders, and where (c)  the break fee represents a reasonable commercial balance between its potential negative effect as an auction inhibitor and its potential positive effect as an auction stimulator.

9.  Private placements are another example of a defensive tactic that raises the question what role should courts and securities commissions play. The issuance of shares as a defensive tactic was of course the subject of Berger J’s landmark 1972 decision in Teck (reproduced above in Section V.C.5). The appropriate approach to the regulation of private placements conducted in the course of a contested M&A transaction was more recently considered in 2016 in joint reasons of the OSC and the BC Securities Commission (BCSC) delivered in connection with a hostile bid made for Dolly Varden Silver Corporation. As you review the extract below, ask yourself once again whether you think that courts or securities commissions are better placed to resolve the issues in question and to what extent Canadian securities regulators should take into account the principles set out in BCE Inc.

Hecla Mining Company (Re) 2016 BCSECCOM 250, 39 OSCB 8927 [In the first contested transaction under the newest iteration of the takeover bid regime, Hecla Mining Company launched a formal takeover bid on 8 July 2016 to acquire all the shares of Dolly Varden Silver Corporation that it did not already own. The bid was for Cdn $0.69 per share, representing a 55 percent premium on the closing price of the Dolly Varden common shares immediately prior to the initial announcement on 27 June 2016 of the intention to make the offer. Hecla at that time held about 15.7 percent of the Dolly Varden common shares on a fully diluted basis. On July 5, 2016, Dolly Varden announced its intention to undertake a private placement financing to raise up to Cdn $6 million through a sale of common shares at a price

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Chapter 15  Mergers and Acquisitions

of Cdn  $0.62 per common share and “flow-through” common shares at a price of Cdn $0.70 per share, with an anticipated closing date of 15 July 2016, representing potential dilution of up to 43 percent of the existing fully diluted share capital of Dolly Varden. The proposed private placement did not require shareholder approval under the applicable rules of the TSX’s Venture Exchange (TSX-V). Hecla subsequently filed applications with the BCSC and the OSC seeking an order to cease trading the securities to be issued in connection with the proposed private placement transactions or, in the alternative, an order to cease trading the private placement unless and until Dolly Varden obtained shareholder approval for the private placement at a duly convened meeting of shareholders.] [74]  This was the first instance in which the Commissions have had to consider whether a contemplated private placement is an inappropriate defensive tactic after the adoption of the changes to the Canadian take-over bid regime that became effective in May 2016. These changes require that all take-over bids:

a. remain open for a minimum period of 105 days unless the target board reduces the bid period (to a minimum of 35 days) or agrees to certain competing transactions (in which case the minimum bid period will automatically be 35 days); b. be subject to the Required Minimum Condition; and c. be extended for at least 10 days after the Required Minimum Condition is satisfied. [75]  These changes did not modify NP 62-202 regarding defensive take-over bid tactics, which must now be interpreted in light of these changes to the basic requirements for all bids. [76]  Subsection 1.1(2) of NP 62-202 provides that the primary objective of the takeover bid provisions “is the protection of the bona fide interests of the shareholders of the target company” and that “[a] secondary objective is to provide a regulatory framework within which take-over bids may proceed in an open and even-handed environment.” The Policy expresses concern that certain defensive measures taken by a target’s management may have the effect of denying shareholders the ability to make a decision whether to tender or not and “frustrating an open take-over bid process.” In subsection 1.1(3) of the Policy, the Commissions state that they are “prepared to examine target company tactics in specific cases to determine whether they are abusive of shareholder rights.” [77]  The Policy goes on to state, in part, at subsection 1.1(4): Without limiting the foregoing, defensive tactics that may come under scrutiny if undertaken during the course of a bid, or immediately before a bid, if the board of directors believe that a bid might be imminent, include (a) the issuance … of … securities, … (b) entering into a contract other than in the normal course of business or taking corporate action other than in the normal course of business …

[78]  The Policy states, at subsection 1.1(5), that we will: [t]ake appropriate action if [we] become aware of defensive tactics that will likely result in shareholders being deprived of the ability to respond to a take-over bid or a competing bid.

1129

V.  Takeover Bids

[79]  The Policy states expressly that a securities issuance, could, in certain circumstances, constitute a defensive tactic attracting regulatory scrutiny on the basis that it may frustrate the ability of shareholders to respond to a bid or a competing bid. [80]  Much of the activity by Commissions involving defensive tactics has involved shareholder rights plans and the focus has been upon when the plans no longer serve the purpose of maximizing shareholder value and choice and should be cease traded. [81]  Private placement transactions, in contrast, may serve multiple corporate objectives. They are therefore more challenging for securities regulators to review than cases involving shareholder rights plans, where the corporate objective is only to alter the dynamics of a bid environment. [82]  When reviewing a private placement in accordance with NP 62-202, the Commissions need to balance: 1) the extent to which the private placement serves bona fide corporate objectives, for which corporate law gives significant deference to a board of directors in exercising its business judgment, with 2)  the securities law principles of facilitating shareholder choice with regard to corporate control transactions and promoting open and even-handed bid environments. [83]  The appropriate balancing of these considerations promotes certainty in corporate decision-making, while deterring a target’s board of directors and management from entering into abusive transactions that deny shareholders the ability to participate in an offer or that improperly alter bid dynamics. [84]  Securities regulatory review of private placements is further complicated by the varied circumstances and options available for presenting and addressing the issue. Outside of securities commissions, a private placement may be: 1) the subject of a court proceeding, and 2) subject to stock exchange review and approval. Varying remedies are available in each of these forums. [85] Once completed, unwinding a completed financing transaction will involve potentially difficult issues denying the target and its shareholders and the investors in the private placement of the benefits of the contractual commitments that have been made. [86]  In this case, the TSX-V had not approved the Private Placement at the time of our hearings, so the issue of forum did not arise. As a result of the undertaking by Dolly Varden not to close the Private Placement prior to the issuance of a decision in this matter, we were afforded the opportunity to consider these issues without concern about what remedy could be afforded after a transaction has closed. Those issues can be reserved for other cases. •  •  •

[88]  Public confidence in the capital markets requires us to consider the responsibilities of boards of directors in implementing corporate actions, including the duties owed by directors to the corporation, the standard of care imposed on directors, and the deference afforded to the business judgment of properly informed directors following appropriate governance processes. We must consider these corporate law principles when our discretion is sought to be invoked to prevent shareholder abuse of the kind that NP 62¬ 202 is intended to address. We must also take into account that corporate law has its own remedies, available through the courts, for actions that fall short of corporate law standards, including, in appropriate cases, the oppression remedy found in many Canadian corporate law statutes. Contract law may also afford remedies in particular cases as between corporations and their

1130

Chapter 15  Mergers and Acquisitions

shareholders. It is not the role of securities regulators to offer redress on these grounds or duplicate these remedies. [89]  We agree with the BCSC’s decision Re Red Eagle, 2015 BCSECCOM 401 (Red Eagle) at paragraph 89, which cited with approval the approach stated by the Alberta Securities Commission in Re ARC Equity Management (Fund 4) Ltd., 2009 ABACC 390 (ARC), as follows: We agree with the policy perspective in ARC, that securities regulators should tread warily in this area and that a private placement should only be blocked by securities regulators where there is a clear abuse of the target shareholders and/or the capital markets. •  •  •

[91]  In addressing the effect of the waiver of the 50% minimum condition, the BCSC stated in Red Eagle, at paragraph 95: Without the waiver of the 50% minimum tender condition by Red Eagle, it was likely that this application would have become considerably more difficult to decide. If the shares issued under the Private Placement were acting as a bar to Red Eagle meeting a mandatory 50% minimum tender condition, then the objectives in the Policy of ensuring target shareholders have an opportunity to tender to bids would have become more directly engaged.

[92]  Now that the Required Minimum Condition is in effect, it is not open to a party to voluntarily waive this condition, as in Red Eagle. However, in considering remedies to be granted in respect of particular applications, a party could potentially seek alternative relief from the Commissions, such as not including the shares issued in a private placement with a tactical motivation in the number of outstanding shares (i.e., the denominator in the calculation), for the purpose of the satisfaction of the Required Minimum Condition. This is a less drastic remedy, but also one that may be unsatisfactory to a bidder seeking a defined percentage of legal or de facto control of the target. In these proceedings, Hecla affirmatively declined to request such relief, and we did not consider the availability of this relief in this case. We were therefore presented with a binary decision to cease trade the Private Placement or allow it to proceed. If the request for alternate relief had been made, there may have been different considerations that would apply; however, we did not have to consider that issue in this case. 2.  The Applicable Test: Is the Private Placement a Defensive Tactic? (a)  If the Private Placement is clearly not a defensive tactic •  •  •

[94]  The starting point for the analysis of a private placement in the bid context is first whether the principles set out in NP 62-202 are engaged at all. The first question is: does the evidence clearly establish that the private placement is not, in fact, a defensive tactic designed, in whole or in part, to alter the dynamics of the bid process? [95]  If the private placement is not such a defensive tactic, then the principles in NP 62-202 are inapplicable and it would only be left to consider whether there was some other reason, under the Commissions’ broader public interest mandate to interfere with the private placement.

V.  Takeover Bids

1131

[96]  In considering whether the private placement is a defensive tactic, there is the question of evidentiary onus. Where the applicant is able to establish that the impact of a private placement on an existing bid environment is material, as was the case with a potential 43% dilution in this instance, then it would seem appropriate for the target board to have the onus of establishing that the private placement was not used as a defensive tactic. [97]  A non-exhaustive list of considerations that would be relevant to answering this first question would include:

a. whether the target has a serious and immediate need for the financing; b. whether there is evidence of a bona fide, non-defensive, business strategy adopted by the target; and c. whether the private placement has been planned or modified in response to, or in anticipation of, a bid. (b)  If the Private Placement Is or May Be a Defensive Tactic [98]  Where a panel is unable to clearly find that the private placement was not used as a defensive tactic, either because there appear to be multiple purposes or there is insufficient evidence as to purpose, then the principles set out in NP 62-202 are engaged. In this circumstance, it will be necessary to find the appropriate balance between those principles and respecting a board’s business judgment. [99]  As the recent amendments to the take-over bid rules represent a material readjustment of the bid dynamics in favour of allowing target boards more time to respond to hostile bids and allowing for majority shareholder approval of bids, we think, generally, that defensive tactics other than shareholder rights plans will become more common and will attract a high level of regulatory scrutiny. [100]  If a transaction is or may be a defensive tactic, in addition to the considerations listed in paragraph [97] above, the following is a non-exhaustive list of considerations that are relevant to whether a private placement should be interfered with:





a. would the private placement otherwise be to the benefit of shareholders by, for example, allowing the target to continue its operations through the term of the bid or in allowing the board to engage in an auction process without unduly impairing the bid? b. to what extent does the private placement alter the pre-existing bid dynamics, for example by depriving shareholders of the ability to tender to the bid? c. are the investors in the private placement related parties to the target or is there other evidence that some or all of them will act in such a way as to enable the target’s board to “just say no” to the bid or a competing bid? d. is there any information available that indicates the views of the target shareholders with respect to the take-over bid and/or the private placement? e. where a bid is underway as the private placement is being implemented, did the target’s board appropriately consider the interplay between the private placement and the bid, including the effect of the resulting dilution on the bid and the need for financing? [101]  As noted above, separate and apart from any evaluation of a private placement under the Policy, a panel must also consider whether there are any other capital markets

1132

Chapter 15  Mergers and Acquisitions

policy considerations or other public interest considerations that are relevant under the circumstances. [102]  As market participants implement transactions under the modified take-over bid regime, the considerations we apply, and how they are applied, will necessarily evolve based on the facts presented. 3.  Application of the Law [103] In this case, we found that the Private Placement was instituted for nondefensive business purposes. The evidence established that Dolly Varden was contemplating an equity financing considerably in advance of Hecla’s announcement of the Offer. Further, the size of the Private Placement was not inappropriate given Dolly Varden’s current liabilities (including the obligation to repay the New Loan) and what would be required (as acknowledged by Hecla itself) to carry out the next phase of the exploration work on the Dolly Varden silver property. Finally, there was evidence that Dolly Varden considered a larger financing and decided not to pursue that opportunity. •  •  •

[113]  The development of Dolly Varden’s strategy recounted above took place well before Hecla even announced its intention to proceed with its bid, let alone its actual commencement of the bid. Our point in recounting these events from earlier in the year is not to analyze whether Dolly Varden’s strategy and plans were reasonable in the exercise of business judgment or not, but to demonstrate that Dolly Varden was implementing a bona fide strategy that its Board developed in the exercise of its business judgment. The Private Placement was not implemented for the purpose of circumventing any bid, since none had yet been advanced when the strategy had crystallized. There was no evidence presented to us that the Private Placement was modified in response to the bid so as to become defensive in character. The financing was not planned (nor modified) in response to, or in anticipation of, a bid and was therefore not pursued as a defensive tactic. [114]  Dolly Varden’s Board made the judgment that it did not want to extend the Senior Loan, even on more attractive financial terms, and that it preferred equity financing without the restrictive covenants, and the resulting control that the debt financing had conferred on Hecla. In the circumstances, it is not appropriate for us to second guess the Dolly Varden Board’s decision to implement an equity financing versus an extended loan from Hecla that included restrictive covenants. [115]  As discussed above, Hecla knew or would reasonably have known that Dolly Varden was planning to raise equity capital once the New Loan was announced. Once the offer of an extended loan was rejected and the repayment of the Senior Loan was imminent, Hecla announced and then later implemented its bid. The bid materialized after Dolly Varden’s Private Placement plans had been put in motion. We accept that the bid was announced in response to the planned repayment of the Senior Loan and the Private Placement and not vice versa. [116]  In addition, there was no evidence presented that the Private Placement was modified in response to the bid so as to become defensive in character. [117]  Based on the foregoing evidence, Dolly Varden was pursuing a bona fide corporate objective of increasing its flexibility by seeking to terminate the restrictive covenants in the Senior Loan and to seek equity capital in order to repay indebtedness and

1133

VI. Conclusion

implement a considered exploration program. In doing so, it was adjusting its strategy based on changes in commodity prices and market conditions and was seeking to develop shareholder value as an independent company. [118]  Having reached this finding, we did not need to pursue the balancing of factors set out in paragraph [100]. [119]  In this case, we found the application of NP 62-202 to be relatively straight forward given the extensive evidence supporting a non-defensive purpose for the Private Placement. We recognize that other cases may involve a record where there is evidence of mixed motivations that will require the balancing of the other factors we have identified, and other factors applicable in new circumstances.

VI. CONCLUSION As noted at the beginning of this chapter, mergers and acquisitions give rise to intriguing debates that force one to deal with a wide range of issues that cut across different areas of our business law and that we have seen throughout this book. This chapter was designed to provide you with an introduction to an area that is itself frequently the subject of an entire course. In addition to raising the issues covered in each section of this chapter that M&A advisers must regularly deal with, M&A transactions frequently force one to grapple with issues that are fundamental to the law governing business corporations—how best to understand the nature and purpose of a corporation, as well as which interests boards of directors should focus on when making decisions about what is best for the corporation.

Index Aboriginal Peoples, see First Nations business structures accounting standards for private entities, 33 acquisitions, see mergers and acquisitions agency authority, corporate contracts, 382-89 economic concept of, 9 fiduciary duties in governance, and, 840-43 legal concept of, 8 amalgamations, see mergers and acquisitions appraisal remedy, 975-90, 1026-32 audit committee role exemptions, 747 financial literacy, 745-46 independence, 477-45 non-audit services to be approved, 746 overview, 742-44 business judgment rule, 709-11 business organizations agency, 8-9 combined for-profit/not-for-profit forms, 27-30 First Nations, 240-342 for-profit forms, 9-25 franchises, 31 joint ventures, 30-31 multiple contracts, 31-32 not-for-profits forms, 25-26 business organizations law, 4 business trusts 21-year deemed disposition rule, 23-24 current uses, 23-24 defined, 21-22 example, 23

First Nations, 311-12 forms of association corporate equivalents, 22 investors as settlors and beneficiaries, 22 limited liability, 22-23 mutual fund trusts, 24 real estate investment trusts, 25 capital structure, see corporations, capitalization closely held corporations choice of, 723-24 defined, 711-15 different statutory treatment, 715-16 oppression remedy, and, 924-40 shareholder agreements, 716-18 collateral, 7 community contribution companies British Columbia, 574-76 Nova Scotia, 576-78 overview, 573 compliance orders, 990-91 convertible securities anti-dilution provisions, 457-59 rights and warrants, 456 valuation, 456-57 co-operative associations community service co-operatives, 573 new generation co-operatives, 572-73 overview, 27-28, 527-33, 571 renewable energy co-operatives, 572 solidarity co-operatives, 571-72 corporate governance audit committee role exemptions, 747 financial literacy, 745-46

1135

1136 Index corporate governance cont’d independence, 477-45 non-audit services to be approved, 746 overview, 742-44 board independence board committees, 695-96 need for board diversity, 691-95 outside directors, 687-91 charitable activities, 747-49 closely held corporations defined, 711-15 different statutory treatment, 715-16 shareholder agreements, 716-18 director appointments election of, 699-700 few minimum requirements, 696-98 filling vacancies, 701 increasing board size, 701 residency requirements, 698-99 term of office, 700 director authority borrowing powers, 707 bylaw adoption, amendment, or repeal, 707 dividend declarations, 708 director removal, 701-6 director replacement, 701 directors’ discretion, 718-20 directors’ meetings, 709 duties of directors and officers, 647-87 national corporate governance guidelines, 724-30 officer appointment and compensation, 708 overview, 18-19 role of directors and shareholders, 2 role of regulators, 833-36 securities regulation, and, 2, 730-42 share transfer restrictions, 720-22 shareholder agreements, 716-18 shareholder participation access to records and list of shareholders, 796-99 distribution of voting rights, 760-77 institutional investors, 799-803 overview, 752-53 proxy solicitation, 803-27

shareholder meetings, 779-85 shareholder proposals, 827-33 shareholder voice, 785-96 shareholder voting rights, 753-60 significance of voting rights, 777-79 corporate social responsibility, 640-46 see also social enterprises corporations as a legal person/limited liability doctrinal implications, 161-76 economic justification, 149-61 capitalization convertible securities, 455-59 debt securities, 434-39 overview, 391-95 preferred shareholders, 439-55 shares, 395-433 contractual liability agent authority, 382-89 compliance with internal procedures, 381-82 corporate capacity, 377-81 pre-incorporation contracts, 344-77 corporate legislation history and development, 129-32 mandatory versus enabling corporate law, 135-37 models for incorporation, 132-35 relationship between federal and provincial, 137-44 corporate veil, piercing of, 176-237 governance, see corporate governance incorporation articles of incorporation, filing, 144-49 models of, 132-35 liquidation, rights on, 449-55 overview limited liability, 16-17 management structure, 18-19 perpetual existence, 17-18 policy choices, 19-20 separate existence, 15-16 shareholders, 16 debt, 8 debt finance, see debt securities

1137

Index debt securities overview, 8, 434-37 priority rights, 437 varieties of, 437-39 derivative action, 892-914 dividends defined, 441-42 legal aspects of directors not obligated to declare, 445-46 legally permitted types, 444 power of directors to declare, 445 protection of creditors, 446-49 types of cash dividends, 442-43 dividends in specie, 443 stock dividends, 443-44 duty of care breaches, costs of, 863-64 compliance with statutory obligations, 860-61 damages and causation, 859-60 diligence aspect, 858-59 indemnification, 861 insurance, 862 prior to Canadian codification, 851-52 reasonable reliance of officials, 860 securities regulators, 862-63 statutory codification, 853-58 duty of loyalty best interest of the corporation, 888-89 conflicts of interest, 864-71 corporate opportunities, 871-83 proper purpose test, 883-88 equity, 7 fiduciary duties in corporate governance directors and officers duty of care, 851-64 duty of loyalty, 864-89 fiduciary relationships basic content of duties, 847 characteristics, 848-49 default nature of, 849-50 theoretical concepts agency costs, 840-43

broader stakeholder interests, 845-46 team production theory, 843-45 financial disclosure requirements audit committee role, 742-47 auditing of financial statements, 735-39 certification of disclosure, 739-41 fair presentation, 740-41 financial reports, 734-35 reporting on internal controls, 741-42 voluntary guidelines, 730-34 First Nations business structures corporate form fiduciary duties of directors, 282-92 future economic development, 251-57 legal personality, 244, 257-74 restrictions on ownership, 245 separation of ownership and management, 274-82 tax exemptions, 245-51 economic development, and co-operatives/non-profits societies, 312-18 corporations, 311 economic and policy challenges, 297-309 joint ventures, 310 legal ethics, 292-96 partnerships, 311 trusts, 311-12 limited partnership structural issues, 318-41 overview, 240-43 rise of business organization issues, 2 for-profit business associations business trusts, 21-25, 311-12 corporations, 15-20, 311 limited liability companies, 20 limited liability partnership, 14 limited partnership, 13-14, 318-41 partnership, 11-13, 45-125, 311 sole proprietorship, 9-11 unlimited liability companies, 20-21 US “C corporations” and “S corporations,” 21 for-profit social enterprises, 542-49 franchises, 31 impact investing, 585-87 see also corporate social responsibility

1138 Index incorporation articles of incorporation, filing business of the company restrictions, 149 classes and maximum number of shares, 147-48 name of corporation, 145-46 number of directors, 148-49 registered office, 147 transfer of shares restrictions, 148 models of letters patent, 134 memorandum and articles of association, 133-34 statutory division of powers, 13-35 Indigenous peoples, see First Nations business structures international financial reporting standards, 33 joint ventures, 30-31, 117-24, 310 limited liability doctrinal implications, 161-76 economic justifications, 149-61 First Nations, see First Nations business structures overview, 16-17 piercing the corporate veil, 176-237 limited liability companies, 20 limited liability partnerships overview, 14, 112-16 structure and statutory provisions business name registration requirements, 117 full-shield liability, 117 limited partnerships business management, 103-9 First Nations, 318-41 overview, 13-14, 101 relations among partners, 110-12 statutory provisions, 102-3 tax considerations, 102 mergers and acquisitions appraisal remedy, and market exception, 1028 overview, 1026-28

valuation of dissenters’ shares, 1029-32 buyouts/going-private transactions benefits and costs, 1045-46 class voting rights, 1042-43 Ontario and Québec requirements, 1043-45 overview, 1032-42 formal aspects to implementation amalgamation, 1021-24 plan of arrangement, 1024-25 reverse acquisition, 1025 sale of assets, 1004-21 sale of shares, 1004 triangular merger, 1025-26 overview, 994-1002 takeover bids auction theories, 1051-52 control transactions, 1046-49 defensive tactics, 1052-1133 regulation, 1049-51 multiple contracts businesses, 31-32 mutual organization, 28 not-for-profit business associations, see also social enterprises First Nations, 312-18 non-profit corporations, 25-26, 533-42 unincorporated associations, 27 oppression remedy Canadian legislation, 915-16 closely held corporations, 924-40 eligible applicants, 916-24 relationship with derivative action, 970-75 UK legislation, 914-15 widely held corporations, 940-70 partnerships definition and existence common law, 49-59, 62-88 importance, 48 statute, 59-62 First Nations, 311 legal status as a firm, 92-93 common law, 89-92

Index limited, see limited partnerships limited liability, see limited liability partnerships nature of, 46-47 origins, 47-48 overview, 12-13 relations between partners and third parties liability in contract, 97-98 liability in tort, 99 other matters, 99-100 retirement of partners, 100 relationship between partners default provisions, 94-97 formation and governance, 93 perpetual existence corporations, 17-18 sole proprietorship, and, 11 policy choices, 19-20 pre-emptive rights, 416-22 preferred shareholders dividends, 441-44 legal aspects of dividends, 444-49 overview, 439-41 rights on liquidation, 449-55 pre-incorporation contractual liability common law, and, 344-55 statute law, 355-77 private corporations, see closely held corporations prospectus disclosure continuous disclosure academic debate on need for, 508-9 annual information forms, 503 financial statements, 501-2 liability for misrepresentation, 505-8 management discussion and analysis, 502-3 material changes, 503-5 “reporting issuers,” 500-501 disclosure materiality and content, 485-86 prospectus form, contemporary developments, 482-84 prospectus review, 484-85 sanctions for non-compliance, 486-87

1139 exemptions “accredited investor” exemption, 496-98 crowdfunding exemption, 496 family, friends, and business associates exemption, 496 minimum amount investment exemption, 498 offering memorandum exemption, 4 98-99 policy objectives, 490-93 private issuer exemption, 493-95 resale rules, 499 sources of law, 493 misrepresentation available defences, 488-89 continuous disclosure, and, 505-8 defined, 488 limitation, 489-90 potential defendants, 488 statutory civil remedy, 487-88 public corporations, see widely held corporations securities, see also shares convertible securities, 455-59 debt securities, 434-39 defined, 473-78 distribution of, 478-82 prospectus disclosure, see prospectus disclosure regulation enforcement, 509-14 overview, 466-72 securities law corporate governance disclosure requirements auditing of financial statements, 735-39 certification of disclosure, 739-41 fair presentation, 740-41 financial reports, 734-35 reporting on internal controls, 741-42 voluntary guidelines, 730-34 enforcement administrative orders, 512-14 Criminal Code provisions, 509-10 quasi-criminal provisions, 510-12

1140 Index securities law cont’d overview, 466-72 regulators’ role in corporate governance, 833-36 security interest, 7 separate existence, 15-16, 245 shareholders access to records of, 796-99 closely held corporations, and, 716-18 institutional investors as, 799-803 meetings annual meetings, 779 beneficial owners, 793-96 conduct of, 782-85 constitutional requirements, 791-93 court-ordered, 786-87 ordinary and special resolutions, 780 place of, 780-81 principle of notice, 781-82 quorum, 781 requisitioned by shareholders, 785-86 special meetings, 779-80 widely held corporations, 787-91 overview, 16 preferred, see preferred shareholders proposals by broadening of scope, 830-33 eligibility, 827-30 proxy solicitation legal developments in process, 805-6 mandated solicitors, 807-8 objecting/non-objecting beneficial owners, 819-22 overlapping solicitation rules, 817-18 overview, 803-5 requirements, 806-7 restrictions on, 818-19 sample proxy form, 808-17 statutory disclosure standards, and, 822-27 remedies, 415, 826-27 see also stakeholder remedies voting rights amendment of bylaws, 755-56 class voting rights, 758-60 distribution, 760-77

election of directors, 755 fundamental changes, 757-58 significance of, 777-79 unanimous shareholder agreements, 756-57 shares authorized and issued capital 402-3 common and preferred, 403-4 consideration on issuance discount stock, 405-9 need for consideration, 405 shareholder remedies, 415 unacceptable consideration, 411-15 watered stock, 409-11 defined, 396-402 nature of, 422-33 pre-emptive rights, 416-22 share transfer restrictions types, 720-22 validity, 722 subscriptions, 404 social enterprises, see also not-for-profit business associations Canada, and community contribution companies, 573-78 co-operative developments, 571-73 financing impact investing, 585-87 responsible investment, 579-85, 646-49 international developments Belgium, Greece, and the Netherlands, 562-69 overview, 549 United Kingdom, 550-52 United States, 552-62 law of, origins co-operative associations, 527-33 for-profit social enterprises, 542-49 not-for-profit corporations, 533-42 overview, 28-30, 515-23 popularity, 2 sole proprietorships balance sheet, 35-36, 37-39 management/governance, 11 perpetual existence, and, 11

1141

Index single equity investor, 9 statement of cash flows, 39-42 statement of changes in equity, 39 statement of earnings, 37 unlimited liability, 10-11 stakeholder debate consideration of broader stakeholder interests, 629-34 international human rights obligations, 650-72 mediating hierarchy notion, 636-37 overview, 621-22 shareholder primacy, and, 622-29, 634-636 advantages, 723-24 stakeholder remedies appraisal remedy, 975-90 compliance orders, 990-91 derivative action common law, 892-94 statutory, 894-913 oppression remedy Canadian legislation, 915-16 closely held corporations, 924-40 eligible applicants, 916-24 relationship with derivative action, 970-75 UK legislation, 914-15 widely held corporations, 940-70 overview, 891-92 winding up, 991 takeover bids auction theories, 1051-52 control transactions target corporation, selection, 1046-47 techniques, 1047-49

defensive tactics introduction, 1052-53 making the target seem attractive, 1053 making the target seem unattractive, 1053 managerial passivity, 1063-66 offensive tactics, and, 1053-54 poison pills, 1082-84 shark repellents, 1084-1103 staggered boards, 1084 shared transactions, 1054 stakeholders, and, 1054-63 supervisory institutions, 1103-33 US tactics, 1066-82 regulation, 1049-51 theories of the firm economic theories agency cost theory, 602-5 nexus of contracts theory, 594-600 transaction cost theory, 600-602 overview, 590 wealth maximization and rational choice, 591-94 socio-economic theories, 606-18 trade creditors, 7 trusts, see business trusts unlimited liability companies, 20-21 US “C corporations” and “S corporations,” 21 widely held corporations advantages, 723-24 national corporate governance guidelines, 724-30 oppression remedy, and, 940-70 shareholder meetings, 787-91 winding up, 991