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BUSINESS LAW PUBLICATIONS

At Smutylo Sigler, we believe in educating our clients so that they know what to expect in their business transactions. Below are resources and information on various business law areas.

INCORPORATING YOUR BUSINESS

Why incorporate?

• split income with family members
• save and defer tax
• limit liability
• shelter capital gains on the sale of shares

Incorporation Considerations

• Where to incorporate? Federal or Provincial (Ontario or other province)
• Name of corporation
• Registered office
• Share structure
• Shareholders
• Directors
• Officers
• Choice of year-end

How to incorporate?

We would be pleased to assist you with your incorporation. To get started, contact us at info@smutylosigler.com or 613-869-5440. If you are not yet decided on whether to incorporate, give us a call and we will assist you understand the advantages and consequences of incorporating.

Alternatively, you may file the incorporation documents yourself directly with the registrar of your jurisdiction of choice or through various third party service providers. If you go this route, speaking with a lawyer or your accountant prior to incorporating may help you ensure that you achieve your objectives with the incorporation.

DIRECTOR DUTIES AND LIABILITIES (ONTARIO)

To assist you in make an informed decision regarding becoming or continuing as a director, we provide the following outline of the responsibilities and potential liabilities associated with being a director of an Ontario business corporation. In addition, we set out some of the strategies directors may limit their exposure.

Note that our focus in this Update is on private company directors. Additional responsibilities and potential liabilities apply to directors of public companies.

Typically in private, or closely-held companies, the three roles of shareholders, directors and day-to-day officers and managers are all filled by the same people. In our view, corporate governance for these companies refers to how such directors and officers satisfy their corporate responsibilities and limit their potential liabilities to three groups: creditors, investors and employees.

1. GENERAL RESPONSIBILITIES

(a) Duties

Subsection 115(1) of the Business Corporations Act (Ontario) (the “Act”) requires that, subject to any unanimous shareholder agreement, the directors of a corporation manage or supervise the management of the business and affairs of the corporation. The term “business” is self-explanatory; the term “affairs” is defined in the Act as meaning the relationships among a corporation, its affiliates (related corporations) and the shareholders, directors and officers of the corporation.

Directors may appoint a managing director or a committee of directors and delegate to that managing director or committee, as applicable, any of the powers of the directors. The managing director must be a resident Canadian or, if a committee of directors is appointed, a majority of the committee members must be resident Canadians. However, this right is constrained by subsection 127(3) of the Act and may be further constrained by the articles and/or by-laws of a corporation. In addition, unless the articles, the by-laws or any unanimous shareholder agreement provide otherwise, the directors may appoint officers and, subject to some exceptions which are set out in subsection 127(3) of the Act, delegate to them power to manage the business and affairs of the corporation.

The following matters, which are set out in subsection 127(3), may not be delegated to a managing director, committee of directors or the officers of the corporation:

(i) the submission to shareholders of any question or matter requiring the approval of the shareholders;

(ii) the filling of a vacancy among the directors or in the office of auditor or the appointment or removal of any chief executive officer, however designated, the chief financial officer, however designated, the chair or the president of the corporation;

(iii) subject to the exception set out in section 184, the issuance of securities except in the manner and on the terms authorized by the directors;

(iv) the declaration of dividends;

(v) the purchase, redemption or other acquisition of shares issued by the corporation;

(vi) the payment of a commission;

(vii) the approval of a management information circular;

(viii) the approval of a take-over bid, directors’ circular or issuer bid circular;

(ix) the approval of any financial statement;

(x) the approval of an amalgamation;

(xi) the adoption, amendment or repeal of by-laws.

Directors as Fiduciaries and Applicable Standard of Care

Subsection 134(1) of the Act requires every director and officer of a corporation in exercising his or her powers and discharging his or her duties to

(i) act honestly and in good faith with a view to the best interests of the corporation; and

(ii) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

The first requirement, to act honestly and in good faith with a view to the best interest of the corporation, represents the statutory recognition that directors and officers are fiduciaries of a corporation. As fiduciaries of the corporation, directors and officers may not permit their personal interests or interests of others to conflict with the responsibilities of their office. Under general legal principles, fiduciaries may not make unauthorized profits, may not delegate their responsibilities, must keep proper accounts and must act honestly, with due diligence and the utmost candour. Some of these principles have been codified and modified by specific sections of the Act.

Example 1: Disclosure of Conflicts. Subsection 132(1) of the Act restricts the right of a director or officer to be a party to a material contract or transaction with the corporation. An example of a situation that may trigger this provision would be a purchase of a service or property by the corporation from a director. If the contract or transaction is material to the corporation the director or officer must disclose the existence of his or her interest in writing to the corporation or request to have such interest entered in the minutes of the directors’ meeting, including the nature and extent of the conflict.

The Act sets out detailed rules specifying when and how such disclosure is to be made and prohibits a conflicted director or officer from voting on any resolution to approve the contract or transaction unless it is an arrangement by way of security for money lent to or obligations undertaken by the director for the benefit of the corporation or an affiliate, relates primarily to his or her remuneration as a director, officer, or employee or agent of the corporation or an affiliate, involves the indemnification of a purchase of insurance for directors or officers by the corporation or is a contract or transaction with an affiliate of the corporation.

The Act also requires that the contract or transaction must also be “reasonable and fair to the corporation at the time it is approved”.

Failure to comply with the disclosure provisions in the Act could render such director or officer accountable to the corporation or its shareholders for any profit or gain realized from the contract or transaction and the contract or transaction void or voidable.

Example 2: Avoid Taking Direction. As fiduciaries of the corporation, directors and officers need not follow the day-to-day advice or wishes of the shareholders or directors, in case of officers, that elected or appointed them. In fact, it is their duty to run the business as they see fit, not as dictated by someone else.

The latter statutory obligation set out in clause 134 (1) (ii), to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances, is typically referred to using the tort law concept of “standard of care”. It includes three elements: skill, care and diligence. The subjective component of this test means that the behaviour that is required of a director or officer will differ as between two persons. Generally, a director or officer need only exhibit such skill as may reasonably be expected from a person of his or her knowledge and expertise. Similarly, a director or officer must exercise care by applying what skills he or she has in activities undertaken by the director or officer. Directors and officers must exercise the diligence of a person who is reasonably prudent. This latter element means that ignorance is generally not a viable defense.

2. SPECIFIC RESPONSIBILITIES

In addition to their general responsibilities, the Act imposes other specific obligations applicable to directors and officers.

(a) Compliance with the Rules and Organizational Documents

Every director and officer is required under subsection 134(2) of the Act to comply with the Act, the regulations, the corporation’s articles and by-laws and any unanimous shareholder agreement in effect.

(b) Safeguarding the Financial Position of the Corporation

The Act requires that directors and officers refrain from taking certain actions which could have an adverse effect on the financial position of the corporation. For example, subsection 38(3) of the Act stipulates that directors may not declare a dividend if there are reasonable grounds for believing that after the payment of the dividend,

(i) the corporation would be unable to pay its liabilities as they become due; or

(ii) the realizable value of the corporation’s assets would be less than the total of its liabilities and its stated capital (money or other consideration paid to the corporation for shares) of all classes.

Under subsection 130(2) of the Act directors who vote for and consent to a resolution authorizing certain corporate actions having an adverse effect on the financial position of the corporation contrary to the Act are jointly and severally liable to restore to the corporation any amounts distributed or paid and not otherwise recovered by the corporation. This means that each consenting director is potentially liable for the full amount. Liability under section 130 is limited to the 2 year period from the date of the resolution authorizing the action complained of.

(c) Insider Liability

Directors and officers must also be aware that they are “insiders” of the corporation and as such are exposed to additional restrictions and potential liability. Under the Act an insider who, in connection with a transaction in a security of the corporation or any of its affiliates, makes use of any specific confidential information for the insider’s own benefit or advantage that, if generally known, might reasonably be expected to affect materially the value of the security,

(a) is liable to compensate any person for direct loss suffered by that person as a result of the transaction, unless the information was known or in the exercise of reasonable diligence should have been known to that person; and

(b) is accountable to the corporation for any direct benefit or advantage received or receivable by the insider as a result of the transaction.

Although the potential for liability under the provision is great, the ambiguity of the various elements required to be proven to establish liability makes it difficult to prove insider trading under the Act. Note that securities laws impose additional constraints on insiders of public companies.

(d) Liability to Employees for Wages

Directors are personally liable to employees in certain circumstances. Under subsection 131 of the Act the directors of a corporation are jointly and severally liable to the employees of the corporation for all debts not exceeding six months’ wages that become payable while they are directors for services performed for the corporation and for the vacation pay accrued while they are directors. However, subsection 131(2) of the Act limits the exposure; a director is only liable if (a) the director is sued while he or she is a director or within 6 months after ceasing to be a director and (b) the action is commenced within 6 months after the debts became payable, and (i) the corporation is also sued but is unable to pay in whole or in part, or (ii) the corporation is bankrupt.

Liability for up to six months unpaid wages is also imposed under the Employment Standards Act, 2000 (Ontario), which has a two year limitation period.

(e) Tax Liability and Other Liabilities

Directors should also be aware that the Income Tax Act (Canada) imposes criminal liability on directors in certain circumstances relating to unpaid taxes. Corporations are required by the Income Tax Act (Canada) to remit source deductions from employees to the Canada Customs and Revenue Agency. Directors may be personally liable for unremitted funds. In addition, directors may be liable for unpaid provincial sales taxes, unpaid Goods and Services Tax and any unpaid Employer Health Tax.

Directors may also be liable for corporate actions under environmental protection and other legislation.

3. REMEDIES

As already mentioned, employees may look to the directors for unpaid wages. In addition, under the Act a “complainant” is able to take certain actions if he or she is of the view that the directors or officers are not discharging their duties.

A “complainant” is defined in section 245 as

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,

a director or an officer or a former director or officer of a corporation or any of its affiliates, and

any other person who, in the discretion of the court, is a proper person to make an application.

It is worth noting that bond holders likely have standing under clause 245(a) of this provision, but ordinary trade creditors holding unsecured debt obligations generally do not. However, trade creditors may qualify under clause (c) of the section 245 definition.

Derivative Action. Section 246 enables a complainant to commence an action on behalf of the corporation, subject to certain conditions which are set out in subsections 246(1) and (2).

Oppression Remedy. Subsection 248(1) of the Act authorizes a complainant to apply to the court if the interest of any security holder, creditor, director or officer of the corporation is being subjected to oppressive or unfairly prejudicial activity or activity that unfairly disregard the interests of any security holder, creditor or officer of the corporation.

4. SUMMARY – SOME PRACTICAL ADVICE

(a) Know and Comply with the Rules and the Corporation’s Organizational Document

Directors and officers should familiarize themselves with the Act, the regulations and, particularly, the articles, by-laws and any unanimous shareholders agreement in effect. Failure to do so could result in liability under subsection 134(2) and other provisions of the Act.

(b) Appoint Effective Committees and Officers

Subject to some exceptions, the Act authorizes directors to appoint committees and officers and delegate to them certain powers. Ensure that any such appointments are made with a view to the best interests of the corporation.

(c) Use Experts

The Act provides a defense to sections 130 (financial responsibilities) and 134 (fiduciary duties) for directors who rely in good faith upon financial statements prepared by an officer or auditor of the corporation or, generally, upon a report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to a statement made by any such person.

Select knowledgeable, competent officers and consultants you trust and document their advice and your reliance upon same.

(d) Get Indemnified and Insured

Indemnification.Subsection 136 (1) of the Act authorizes a corporation to indemnify a director or officer, a former director or officer of the corporation or a person who acts or acted at the corporation’s request as a director or officer of a subsidiary, and his or her heirs and legal representatives. Such an indemnity may relate to all costs, charges and expenses, including an amount paid to settle an action or satisfy a judgment, reasonable incurred by such indemnified person in respect of any civil, criminal or administrative action or proceeding to which he or she is made a party by reason of being or having been a director or officer. However, the indemnification must be conditional upon:

(a) the person having acted honestly and in good faith with a view to the best interests of the corporation; and

(b) in the case of criminal or administrative action or proceeding that is enforced by a monetary penalty, the person must have had reasonable grounds for believing that their conduct was lawful.

Insurance.Subsection 136(4) of the Act also authorizes a corporation to purchase and maintain insurance for the benefit of any director or officer, former director or officer of the corporation or a director or officer of a subsidiary of the corporation who acted as such at the request of the corporation, and such person’s heirs and legal representative. The person may be insured against any liability incurred by the person in his official capacity and provided such person has acted honestly and in good faith with a view to the best interests of the corporation.

(e) Install a Unanimous Shareholder Agreement

The Act empowers shareholders to usurp the directors’ powers in any situation through the use of a unanimous shareholder agreement. Such an agreement can limit the directors’ right to manage, to the extent stipulated in the agreement. However, a unanimous shareholder agreement not only transfers power to the shareholders but also the legal and equitable obligations to the corporation as were formerly owed, collectively and individually, by the board of directors. Such is the effect of subsection 108(5) of the Act. Shareholders thereby acquire, and the directors are relieved of, all the rights, powers, duties and liabilities (including liabilities for unpaid employee wages) of a director, to the extent such agreement restricts the discretion or powers of the directors.

Obviously the installation of a unanimous shareholder’s agreement would only protect non-shareholder directors and only to the extent of the agreement.

(f) Resign

Resigning as a director of the corporation is an effective means of limiting liability. However, resigning will generally not protect a director from liabilities incurred while he or she was a director. In addition, note that subsection 115(4) of the Act provides that, subject to a few limited exceptions which are set out in subsection 115(5), where all of the directors have resigned or have been removed by the shareholders without replacement, any person who manages or supervises the management of the business and affairs of the corporation is deemed to be a director for the purposes of the Act.

DIRECTOR’S DUTIES AND LIABILITIES IN THE FACE OF CORPORATION’S INSOLVENCY

Insolvency occurs when a corporation is unable to pay its liabilities as they become due. In Canada, it may be possible for a corporation to continue its operation with the indulgence of its creditors for a period of time. Alternatively, the creditors may require the company to restructure under a private agreement or under the BIA or CCAA. Secured creditors may take steps to have a receiver appointed, to realize and liquidate the assets of the company.

(a) Directors’ Duties

In Canada, it appears that directors have a duty to consider and act in the best interest of creditors when the corporation becomes insolvent or nears insolvency. If a receiver-manager is appointed by the creditors, the powers of the directors are suspended until the receiver is discharged. The receiver has the power to carry on the business in order to protect the security interest of those creditors who appointed them

Any action of the directors to move assets out of the corporation will be scrutinized by the receiver-manager to ensure that it did not precipitate the insolvency. Such actions include paying dividends and/or redeeming shareholder’s shares. If the receiver-manager can prove that the action precipitated insolvency, they have the authority to start an action holding the directors personally liable to return the funds to the corporation. Similarly, any payment to creditors will be reviewed to see if it constituted a fraudulent preference. A trustee in bankruptcy may also review certain non-arm’s length transactions in which the corporation was involved.

(b) Personal Liability

Wages, Vacation Pay and Termination Pay

Both the Ontario and federal corporate statutes impose personal liability on directors for the payment of wages not exceeding 6 months, for services performed while the directors held office and up to 12 months of vacation pay under the Employment Standards Act. The Supreme Court of Canada ruled in Crabtree Estate that directors are not liable for termination pay in lieu of notice under the CBCA. Directors are not held liable for amounts owing to employees unless they are sued while a director or within 2 years after ceasing to be a director. Under the OBCA, the director must be sued while he or she is a director or within 6 months after ceasing to hold that position.

Directors are only liable for the amounts that accrued while the directors held office. Therefore, some directors have chosen to resign when it becomes obvious that the corporation will not be able to satisfy its obligations in the future.

It must be noted that directors are jointly and severally liable with all of the other directors for wages, however any director who has paid a claim is entitled to contribution from the other directors who were liable for the claim.

Source deductions

Various amounts are required to be deducted from employees’ wages and remitted to the government. Examples include income taxes and employees’ premiums for employment insurance and contributions to the Canada Pension Plan. If a corporation fails to deduct and remit these amounts, the directors at the time may be held jointly and severally liable for the amounts, including interest and penalties.

A possible defence for directors is that of due diligence. Directors must be able to show that they exercised the degree of care, diligence and skill and took positive steps to ensure that source deductions are being made and remitted that reasonably prudent persons would have exercised in comparable circumstances. One way is to implement a procedure requiring senior management to certify to the board on a regular basis that the source deductions have been paid to the government. This confirmation should be given more frequently when there are signs of financial instability.

Dividends/Redemption of Shares

A director may be personally liable for dividends paid, redemption or purchase of shares if these purchases were made while the corporation was insolvent during the 12 months preceding its bankruptcy under s. 101 of BIA. If the event occurred more than 12 months prior to the bankruptcy, the trustee or creditor would have to look to the relevant corporate statute instead. There is a due diligence defence available if the directors can show they had reasonable grounds to believe the company was solvent, or would not become insolvent as a result of the payment. The court will look to see if the directors acted as prudent, diligent persons would have acted in similar circumstances and whether they relied in good faith on financial statements or professional reports.

Directors should be aware that there are different solvency tests that must be satisfied if a corporation is paying a dividend, purchasing shares or redeeming shares. Under the Ontario and federal corporate statutes, the corporation cannot purchase shares or pay a dividend if there are reasonable grounds for believing that:

(i) the corporation is, or after the payment would be, unable to pay its liabilities as they become due, or

(ii) after the payment, the realizable value of the corporation’s assets would be less than the aggregate of its liabilities and its stated capital of all classes. (OBCA 30(1), CBCA 34(1)).

Directors who consent to a resolution authorizing payment in contravention of the section are jointly and severally liable to restore to the corporation any amounts paid out.

There are 5 exceptions that permit the purchase of shares after meeting a more lenient solvency test (OBCA 31(1), (2) & (3), CBCA 35(1), (2) & (3)):

I. Settle or compromise a debt
II. Eliminate fractional shares, and
III. Fulfill the terms of an agreement with a current or former director, officer or shareholder
IV. Satisfy the claim of a shareholder who dissents under s. 185 OBCA
V. Complying with an order under s. 248 OBCA (oppression remedy)

Similarly, with the redemption of shares, under s. 32(2), there is a solvency test that must be met that is much like the test under OBCA s. 31(3).

We recommend that prior to becoming a corporate director you fully understand your duties and liabilities, including those arising in an insolvency situation. Similarly, if you are the director of a corporation that is facing insolvency you should review your duties and liabilities with a lawyer to ensure you continue to comply with your duties and you limit your personal liability to the extent possible.

DIRECTOR’S RISK MANAGEMENT STRATEGIES

How to protect yourself

Directors run the risk of being exposed to significant personal liability for their actions. A risk-management strategy should be developed with 2 broad objectives in mind: it should limit the potential liability of directors and try to shift the remaining risk away from the directors.

(i) Indemnities

Canadian corporate statutes allow a corporation to indemnify its directors, both past and present, where the directors have acted in good faith and in the best interests of the corporation.

However, there are certain limitations. Indemnities will only protect in the case of negligence, and will not cover a breach of a director’s fiduciary duty. In cases where a corporation is suing a director, the corporation may not indemnify the director for costs without the approval of the court. This situation arises in a derivative action where a shareholder or creditor has sued the director on behalf of the corporation. Allowing for an indemnity would mean that the corporation would be reimbursing directors for amounts which directors were required to pay to the corporation.

A corporation is allowed to indemnify a director for fines in criminal or administrative proceedings only if the director had reasonable grounds for believing that the conduct was lawful.

There is mandatory indemnity as prescribed by statute where a director acts honestly, in good faith and in the best interests of the corporation, and is substantially successful on the merits in defending the action. This indemnity applies to past and present directors of the corporation and at the corporation’s request, any person who acts as a director of another entity of which the corporation is a shareholder or creditor.

The corporation shall reimburse all costs relating to litigation in which the director was involved as a result of having been a director. There is no statutory requirement for a corporation to indemnify for any amounts paid to settle an action or satisfy a judgment.

(ii) Insurance

Insurance may provide coverage in situations where an indemnity may not be available, either because indemnification is prohibited by a statute or because the corporation has become insolvent and the directors become liable for amounts such as wages and vacation pay of employees.

A corporation may purchase insurance to protect against any liability incurred by past and present directors and any person who, at the corporation’s request, acts as a director of another entity of which the corporation is a shareholder or a creditor. A corporation may not however, purchase insurance to cover a director’s failure to act honestly and in good faith and in the best interests of the corporation.

(iii) Ratification

Where the director is concerned that the decision was a breach of duty, the board may be able to ratify the decision. It is difficult to apply general rules in these situations. Ratification is not always available and is subject to limitations.

(iv) Resignation

There may be situations when the only way of avoiding liability is to resign from the board. In cases where the corporation is insolvent and cannot meet its obligations to its employees, entire boards have resigned.

Directors should be aware that this only protects them against events after they resign, but does not absolve them of responsibility for any actions taken before their resignations.

We recommend that prior to becoming a corporate director you fully understand your duties and liabilities, including those arising in an insolvency situation. We also recommend you seek independent legal advice as necessary to comply with your duties and you limit your personal liability to the extent possible.

AN INTRODUCTION TO PARTNERSHIPS

What is a “partnership”?

A partnership is relationship created by a contract entered into between or among two or more individuals, partnerships or corporations that carry on business together with a view to profit. The partnership agreement can be very detailed or very short, depending upon the purpose of the partnership. In the agreement, the rights and obligations of the partnership, the payment details, the auditing frequency and process, the dissolution rights of the partners and the disposition of assets on dissolution may be set out.

What are the various types of partnerships?

A partnership may be either a general partnership, a limited partnership or, in some Canadian jurisdictions, a limited liability partnership. In addition, some Canadian jurisdictions, such as Ontario, have special rules for extra-provincial partnerships.

  1. General Partnership. In a general partnership, all partners are entitled to participate in ownership and management of the partnership and have implied authority to bind the partnership within the ostensible scope of the partnership’s business.  Each partner is jointly and severally personally liable for the debts and liabilities of the partnership.
  2. Limited Partnership. In a limited partnership, there must be at least one general partner who manages the business and is subject to unlimited personal liability for the debts and liabilities of the partnership and there may be other limited partners who contribute capital (which is at risk) but who have no personal liability, unless they participate in the management of the business, in which case they also become personally liable for the debts of the partnership.  Accordingly, participation by a limited partner in the management of the business may strip the partner of his or her limited liability. Also, remember: when drafting the limited partnership agreement, the limited partners should not reserve to themselves too much responsibility or they will lose their limited liability status.  For this reason, a limited partnership is generally more suitable for passive investors.
  3. Limited Liability Partnership. In a limited liability partnership, the partners are not personally liable for the negligent acts of another partner or an employee who is directly supervised by another partner.  Partners are liable for their own negligence and for the negligence of someone under their direct supervision or control and are jointly and severally responsible for the general obligations of the partnership.  Generally, limited liability partnerships are only permitted for the purpose of practicing a profession recognized by legislation in a province where the governing body of the profession requires the partnership to maintain not less than a minimum amount of liability insurance and the partnership registers its firm name with the appropriate provincial registrar.

Is a partnership structure appropriate for your business?

Using a partnership, particularly a limited partnership, as a business vehicle is desirable whenever you want a flow-through of tax treatment to the investors, particularly where the primary investment incentive is the utilization of tax losses and deductions generated by the partnership to offset income from other sources. Generally, income generated from the partnership is income of the partners and is taxed accordingly. For example, limited partnerships are often used in the resource development and real estate industries.

In addition, partnerships are useful in connection with businesses which do not need to retain large operating profits in the business for future expansion or for businesses in the formative stages before they become very profitable and produce large amounts of unsheltered income.

Limited liability partnerships are only available in certain provinces and then only for the purpose of practicing a recognized profession.

We recommend that prior to entering into any partnership agreement you obtain advice from a lawyer and an accountant qualified to provide you with good advice so that the structure accomplishes your business objectives, protects your investment and limits your liability to the extent possible and minimizes, and where possible defers, the amount of taxes you pay upon funds distributed from the partnership.

ORGANIZING A TSX VENTURE EXCHANGE CAPITAL POOL COMPANY

When the markets are hot, CPCs are all the rage. What is a CPC? What is so great about a CPC? How do you organize a CPC?

A “CPC”, or Capital Pool Company, is a shell public company organized in accordance with the rules of the TSX Venture Exchange for the purpose of finding and acquiring an active business. CPCs are a common vehicle sophisticated investors use to take successful or promising active businesses public. In effect, the investors create an asset, being the clean public company, which they then offer to another company for its going public vehicle. In theory, the investors increase the value of their shares by rolling the active business into their shell and the active business benefits from all the advantages of being a public company i.e. access to capital and liquidity.

Creating a CPC is a three step process.

Step 1 – Creating The Shell Company

•   A corporation is incorporated, under the Canada Business Corporations Act or one of the provincial corporate statutes.

•   Three to six individuals with an appropriate combination of business and public company experience put up a minimum of the greater of $100,000 and 5% of total funds raised.

•   Each founder subscribes for shares at a minimum price per share between the greater of $0.05 and 50% of the price at which subsequent shares are to be sold via prospectus (See Step 2).

Step 2 – Taking the Shell Public

•   A prospectus is prepared and filed with the appropriate securities commission(s). The prospectus sets out management’s intention to raise between $200,000 and $4,750,000 by selling CPC shares at typically twice the issuance price of the seed shares, and to use the proceeds to identify and evaluate potential acquisitions. At the same time, the CPC applies for listing on TSX Venture Exchange.

•   The CPC hires a broker/sponsor to sell the CPC shares to at least 200 arm’s length shareholders, each of whom buys at least 1,000 shares. No one purchaser can purchase more than 2% of the offering, and no one purchaser together with his, her, or its associates or affiliates can purchase more than 4% of the offering.
Once the offering is completed and closed, the CPC is listed and commences trading on the TSX Venture Exchange.

Step 3 – Identifying The Qualifying Transaction

•   Within 24 months, the CPC must identify an appropriate business to acquire. This acquisition is the CPC’s “qualifying transaction”.

•   The CPC prepares a draft filing statement or information circular providing prospectus-level disclosure on the business that is to be acquired.

•   TSX Venture Exchange reviews the disclosure document and evaluates the business to ensure it meets minimum listing requirements.

Step 4 – Completing A Financing And The Qualifying Transaction

•   Typically, a private placement financing is completed contemporaneously with the closing of the qualifying transaction. The reason being that often funds are needed as consideration for the sale of the business to the CPC.

•   The qualifying transaction (that is, the business purchase) may not be closed until a minimum of 7 business days have past since the posting of the filing statement on SEDAR.

•   Upon completion of the qualifying transaction, the company ceases to be a CPC and trades as a regular TSX Venture Exchange listed company.

For more information on CPCs:

•   TSX Venture Policy 2.4 – Capital Pool Companies

•   Guide to the Capital Pool Company Program

•   Currently Available Capital Pool Companies

If you have an active business and are considering a reverse take-over by a public shell company, have a look at the list of available CPCs. As these companies get closer to the 2 year deadline for completing a qualifying transaction, their organizers will likely be anxious to find an active business. As a result, your leverage increases as the deadline looms.

ORGANIZING A NOT-FOR-PROFIT CORPORATION – CORPORATIONS ACT (ONTARIO)

CHECKLIST

The incorporation of a not-for profit corporation involves a 4-step process:

Step 1: Corporate Name

•   Select the proposed corporate name. The proposed corporate name should contain a distinctive and descriptive element. That is, the corporate name should not be deceptively similar to an existing name and should describe the nature of the corporate undertaking. The use of a legal element, such as “Corporation”, “Corp.”, “Incorporation” or “Inc.”, is optional.

•   Select alternate corporate names in case the proposed corporate name is too similar to an existing name.

Step 2: Application for Incorporation for Issuance of Letters Patent

•   Designate a head office in Ontario where corporate records are to be kept. It is not necessary for the corporation to own or lease property in its own name for this purpose.

•   Identify at least three (3) first directors and provide residential addresses of each. The first directors act as the directors of the corporation until replaced by other individuals duly elected in their stead. A director should be prepared to assume the legal responsibilities and potential liabilities involved with the office of director.

•   Define the objects of the corporation. The objects should be a broad (but not vague) statement of the purpose of the corporation and its primary undertakings.

•   Define special provisions. Special provisions pertain to the governance of the corporation and the ancillary powers of the corporation. For example, distribution of assets, directors’ terms in office and directors’ remuneration may be specified in the special provisions.

•   Please note that special provisions contained in the Letters Patent cannot be changed unless Supplementary Letters Patent are filed. Thus the incorporators should be relatively certain of the scope and content of special provisions to be included in the Letters Patent. Alternatively, corporate governance may be addressed in the by-laws, which are more easily amended.

•   Define the terms of membership qualification. Membership qualification may be addressed in the Letters Patent or the by-laws, depending on the degree of flexibility required.

•   Obtain consent if applicable. Government consent may be required where the organization uses a name that suggests a connection with the government, the corporation is subject to supervision by the government, Ministry or Agency or the corporation, or if financial assistance is sought from the government. If the organization already exists as an unincorporated association, a consent and undertaking may be required from the unincorporated association.

Step 3: Corporate Organization

•   Adopt by-laws. After a director’s quorum has been established, by-laws pertaining to the general rules for operating the business and affairs of the corporation must be adopted.

•   Establish banking arrangements.

•   Adopt a corporate seal.

•   Appoint auditors.

•   File required statutory notices.

Step 4: Ongoing Corporate Records and Filings

•   Hold an annual meeting of members to elect directors and appoint auditors on an ongoing basis.

•   Maintain proper records, including accounting records and a minute book containing the Letters Patent, by-laws, minutes of meetings, registers of directors and officers and other corporate documents.

•   Submit statutory filings to the Ministry of Consumer and Commercial Relations on an ongoing basis.

How can you find out more information?

If you have questions or would like help organizing a not-for-profit company, or applying for charitable status for your not-for-profit corporation, we would be pleased to answer your questions and help you move forward.

STRATEGIES FOR CREDITOR PROOFING YOUR BUSINESS

Effective creditor proofing isolates the business and its assets from future claims of future creditors. Any asset transfer made to a related corporation with the intent to hinder or defeat creditors, may be overturned.

Generally, the best time to implement a creditor proofing strategy is when the business is either starting-up or is healthy and not facing creditor claims. The following are a few creditor proofing strategies we recommend to our clients.

Before implementing a creditor proofing plan, be sure to consult your tax advisers to avoid undesirable tax consequences.

Use of multiple corporations

Don’t put all your “eggs in one basket”. If you have multiple businesses, use multiple corporations.

Hold real estate, equipment, vehicles, fixtures and intellectual property (trade-marks, copyrights, patents, etc…) and other material assets in separate corporations, thereby isolating valuable assets from creditors. The asset holding company can license or lease the assets to the operating company and, if the operating company run into trouble, the licenses and leases terminate and the assets are preserved. The operating company’s assets should usually be restricted to its contracts, accounts receivable and inventory.

Fund the Business by Secured Loan

Rather than making equity or unsecured investments in your business, use a secured loan to give you priority over the assets of the business. If you obtain bank financing, likely you will be asked to postpone or subordinate your security interest to give the bank priority of the assets of the business. However, you will continue to be next in line should the business fail.

A secured loan is a loan (i.e. use a loan agreement or promissory note) secured against the assets of the corporation by way of a general security agreement registered under the Personal Property Security Act (Ontario).

Providing Services to the Operating Business through Another Company

An affiliated company may provide consulting, information processing, administrative or other services to the company operating the business, and the amounts which the affiliated company is owed for such services can be secured by the assets of the operating company.

Hold a Valuable Lease Separate from the Operating Business

This is a strategy sometimes used by restaurants, retail businesses and other businesses where the business location is valuable. The lease is held by one corporation and that corporation enters into a sub-lease with the operating corporation. This way, if the operating corporation fails, the sub-lease is terminated, as long as the head-lease is kept in good standing, the leased premises are preserved.

Another strategy is to use a separate or “shell” company with few assets other than the lease to execute the lease on behalf of the operating company. If the business fails, the landlord has recourse only to the “shell” company and not against the operating company.

If the lease is held by the operating corporation, a related corporation may enter into an option with the landlord to lease the premises should the operating business fail. In this way, the valuable asset – the location – is preserved.

Keep Deposits and Loans at Different Banks

If the business borrows from a bank and also keeps its operating deposit accounts at the same bank, if the business defaults on its loan the bank will set off the debt against deposits. Keeping deposits and loans at separate banking institutions prevents this risk of set off.

Stripping Equity

This strategy involves continually reducing the amount of assets vulnerable to potential creditor claims by converting such assets to cash and distributing the cash to shareholders i.e. a related corporation.

Selling or factoring accounts receivable, keeping inventory at lowest levels possible, selling and then leasing back equipment or selling intellectual property and licensing it back, are all strategies to generate cash to be dividended out and to thereby reduce the assets vulnerable to future creditor attack.

Dividing Ownership amongst Family Members

Creditors may be deterred from attempting to go after shares in any of the related companies if such shares don’t represent a controlling interest. By selling additional shares to other family members, or other family controlled corporations, or family trusts or limited partnerships, ownership may become diluted enough to avoid creditor efforts to seize the shares. Spreading ownership of a corporation amongst family members so that no one family member owns more than 49 percent may achieve the desired result.

However, just as with any transfers of personal assets by a business owner to members of his immediate family, transferring shares to family members still requires an owner to consider the stability of his marriage and his relationship with his children prior to the transfer. While transferring assets to family members may provide creditor protection, the owner may lose control of the assets as a result. Use of a family trust to hold the assets may be a preferred alternative.

Furthermore, bankruptcy and insolvency, fraudulent conveyance, and assignment and preference legislation makes transfers to family members particularly suspect. While putting assets in a spouse’s or adult child’s name may be a popular form of creditor proofing, such transfers may be void if the transferor becomes insolvent within one year of the transfer, and creditors may be able to reach back five years after the transfer and have it unwound with proper grounds. Also, transfers to children may have adverse tax consequences for the owner, given the capital gains and income attribution rules which may apply.

ACCREDITED INVESTOR VERIFICATION

The accredited investor exemption is a way companies and investment funds raise money without being required by securities laws to file a prospectus (Canada) or registration statement (U.S.). To be an accredited investor, an investor must satisfy certain income or net worth criteria.

Securities regulators in both Canada and the United States have stated that it is not sufficient for issuers/dealers to simply rely on an investor initialing or checking a box in an Accredited Investor Certificate (or a schedule to a subscription agreement) indicating that the investor is an accredited investor. In Ontario, the Ontario Securities Commission Staff Notice 33-735 states the issuer/dealer selling the security is responsible for determining whether an investor meets the definition of accredited investor and is therefore eligible to participate in the private placement. According to the OSC, the issuer/dealer must have “sufficient information to determine whether the [purchaser] qualifies as an Accredited Investor”.

Similarly, in the United States, the SEC recently stated that the issuer/dealer must take “reasonable steps to verify” the income and/or net worth of the investor. According to the SEC, whether the steps taken to verify accredited investor status are reasonable will be an objective determination by the issuer/dealer, in the context of the particular facts and circumstances of each purchaser and transaction. The SEC also stated that third party confirmation is an acceptable way to verify the investor’s status as an accredited investor.

To assist issuers and dealers comply with the private placement exemptions when selling to Canadian investors, we’re pleased to offer an Accredited Investor Verification Service.

As part of our Accredited Investor Verification Service we:

•   Collect current bank, brokerage and other statements of securities holdings, certificates of deposit, tax assessments, appraisal reports, credit agency reports.

•   Review the collected financial data to confirm the investor satisfies the applicable accredited investor criteria.

•   Obtain a declaration from the investor confirming that all assets and liabilities necessary to determine the investor’s net worth have been fully and accurately disclosed.

•   Issue a written confirmation verifying whether the investor is an accredited investor based on either their income or net worth.

Find out how our Accredited Investor Verification Service is a better way for issuers/dealers to verify income and net worth of investors!

ACCREDITED INVESTOR QUALIFICATIONS FOR INDIVIDUALS

There are three ways an individual may qualify under the accredited investor exemption based on financial thresholds. These financial thresholds must be satisfied at the time of the distribution of, or trade in, the exempt security.

$1M Financial Asset

• An individual, alone or with a spouse, must beneficially owns “financial assets” with an aggregate realizable value, before taxes but net of any related liabilities, of $1 million.

• Financial assets means (a) cash, (b) securities or (c) a contract of insurance, a deposit or an evidence of a deposit that is not a security for the purposes of securities legislation, but does not include real property such as a personal residence. The test permits individuals to include the value of any financial assets they “beneficially” own.

$5M Next Asset Test

• An individual, either alone or with a spouse, has net assets of at least $5 million. Net assets are determined by subtracting the total amount of the individual’s liabilities from the total value of the individual’s assets. The dollar amounts assigned to assets and liabilities must be fair estimates of value.

• An individual can include the value of their primary residence in their net asset test but must deduct the amount of any mortgage on the property. The calculation does not require a deduction for any future income taxes, but any taxes that are outstanding and payable at the time of the trade must be deducted.

Income Text

• An individual with net income before taxes exceeds $200,000 in each of the two most recent calendar years; or net income before taxes combined with that of a spouse exceeds $300,000, in each of the two most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year.


The content on this website is provided for informational purposes only and does not constitute legal advice or opinion of any kind. Should you require legal advice or have any questions regarding the content, please call 613-744-8025 or send us an email at info@smutylosigler.com.