Incorporating a business is a relatively easy, quick and inexpensive thing to do. In fact, many people follow books, software or internet advice and incorporate themselves in order to save money. But the structure you pick can carry financial risks and consequences. I’ll help you choose wisely.
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Decisions regarding the share structure of the corporation and the naming of directors and officers are often made without much thought. They are often made with little or no consideration of future consequences for the business and its shareholders (owners), the duties and liabilities of officers and directors, creditor proofing, estate planning and other issues.
We have seen clients with various companies: some operating, some dormant, some as a single company and some with multiple holding companies. In essence, a holding company generally carries on no business other than owning the shares of other companies. Sometimes these extensive groups of companies make sense but all too often they don’t.
On the flip side we also see clients with a variety of businesses and multiple assets (for example, land and buildings) in a single corporation when, for a variety of reasons, there should be separate companies for some of these businesses and assets.
Companies are almost as quick and easy to create as babies some might say! However, we all know that babies require a lot of work, can’t fend for themselves, are costly and require the constant foresight of their parents to keep them healthy and progressing well.
A company is no different except that babies grow up and hopefully one day stand on their own. Companies never grow up. They always need their directors and officers to act on their behalf.
Even if the company has no operations and is dormant, it requires the cost and attention of maintaining a corporate records office, filing annual legal reports, preparing and filing financial statements and corporate income tax returns, and compliance with any additional laws and regulations affecting the specific corporation.
I cannot emphasize enough how important it is to seek appropriate specialist advice before deciding to create a new company or companies (including holding companies), and deciding who the shareholders, directors and officers will be.
Many people believe that all of their business ventures must be immediately incorporated because, in this manner, they will enjoy limited liability from creditors and those who could sue for some alleged wrongdoing.
In fact, some are naïve enough to believe that they can act with virtual impunity. As discussed earlier, it is clear that directors and officers face various responsibilities and liabilities because of various statutes and regulations. Let’s look at the practical side of business life.
Most businesses of any size eventually have bank or other borrowings in order to finance the working capital requirements of the business.
In addition to specific charges on certain fixed assets and a General Security Agreement (GSA) on all assets of the business, banks and other lenders will almost 100% of the time require personal guarantees from the shareholder or shareholders of the borrowing company and often they will want to place a charge on the home(s) of the shareholders.
Before lending to the business, banks and other lenders want to see that the shareholders have put their cash into the business in the form of share capital or shareholder loans. Banks will often require the shareholders to subordinate their loans to the priority of the bank so that the bank is not funding the repayment of the loans and increasing its exposure and risk while the shareholders lower their exposure and risk.
Even suppliers and other parties extending any significant amounts of credit may require the shareholders to sign personal guarantees. All of these situations strip away the perceived protection of having a corporation and the shareholders’ liabilities being limited to the amount they invested as share capital.
A corporation does not prevent the directors, officers and corporate employees from being sued for damages resulting from a wide variety of acts of commission or omission, including negligence, fraud, human rights violations, etc.
The advice is to not be too worried about immediately incorporating every venture. Given that the legal protection is of limited value, other considerations should affect the decision as to when or if to incorporate.
One of the most important considerations is that of taxation. There are often situations where it makes sense to allow the business to start as a proprietorship or partnership so that the losses usually incurred in the start-up phase can be applied against any and all other forms of personal income.
In general, certain types of assets should be held in corporations separate from other assets or business ventures. As an example, in a situation where there is an active business and the land and buildings from which it conducts its activities are owned (i.e. not leased), these may be financed. It is usually a good practice to have the active business in one corporation and the land and buildings in the other. The business then leases those assets from the other company. If the operating business becomes insolvent for any reason, the land and buildings will generally be safe.
Some couples set up their corporations and automatically agree to have the shareholdings be 50/50, have both as directors, and both as named officers. This is true even when one of the spouses is not active in the business in any real sense. Sometimes children are included in this. Often the reason cited for doing this comes down to the notion of income splitting. The fact is that this approach is a simplistic one that is fraught with potential danger for the entire family.
Income splitting can be achieved by having a spouse, and in some cases children, hired as employees and being paid wages, salary, bonus or some other method of compensation. If the spouse and/or children are shareholders, they can participate in dividends. You do NOT want to have your spouse or your children be directors or officers unless necessary. This is due to the issues of liabilities (such as CRA debts) that attach to directors and officers as we mentioned earlier, and because of the laws that govern insolvency and bankruptcy of corporations and liabilities that survive and attach to the directors and officers.
When possible seek to have one spouse facing all the potential director, officer and business-related debt and liabilities and have the other spouse own all the personal assets such as the house and all other significant assets. It is important to retain proper professional advice with competence in this specific area.
To deal with some issues it takes a team who coordinate their work and let the client know of all possible ways of dealing with their affairs along with the pros and cons of each approach. Then it becomes the client’s responsibility to choose their priorities and the best way to proceed. The more you plan these things out the better and more certain the future outcomes are likely to be.
A corporation also requires directors and officers. Here is the difference between directors and officers.
Directors are elected by the shareholders to represent their interests in overseeing and governing the activities of the corporation. The total number of elected and appointed directors at any time constitutes the Board of Directors.
The maximum and minimum number of directors is usually set in the Articles or By-laws of the Corporation as amended by the shareholders from time to time. Their specific duties and responsibilities are also detailed in the articles and by-laws.
Directors are responsible for governing the organization by establishing broad policies and objectives; appointing the CEO; reviewing the performance of the CEO and his executive team; setting compensation policies covering the CEO and senior executives; approving annual budgets; approving the business plan and annual budgets; reporting to the shareholders on the corporation’s performance; approving extraordinary transactions such as acquisitions and divestitures; governing management’s behaviour to ensure adherence to all applicable laws, regulations and corporate governance standards.
Directors carry responsibility and liability for certain corporate actions and liabilities. Some of the most common liabilities attaching to directors are salaries and wages, vacation pay, unremitted GST/HST collected by the corporation, and, unremitted payroll withholdings owing to CRA.
These often crystallize in the event of insolvency and bankruptcy. These liabilities are joint and several.
This means that each director is responsible for the full amount of all such liabilities and the affected creditor(s) are able to seek collection of the debt from any and all of the directors in full or partial amounts and leave it to the directors to sort out amongst themselves thereafter as to what director owes what amount to a fellow director or fellow directors.
In BC, each private corporation must have at least one director and each public corporation a minimum of three directors. There is no maximum limit. A director must be a living person and in BC must be at least 19 years of age. Another corporation or other legal entity that is not a living person cannot be a director.
A director may be but does not need to be a shareholder of the corporation. The various provincial and federal Business Corporations Acts have different requirements regarding the minimum percentage of directors that must be residents of Canada. BC does not require that any of the directors be residents of Canada.
Officers are appointed by a resolution of the Board of Directors. There are slight variations amongst the various provincial and the federal Business Corporations Acts as to what titles are automatically considered as officers.
Generally, all of the following titles are presumed to be officers of a corporation: Corporate Secretary, Treasurer, Chief Executive Officer (CEO), Chief Financial Officer (CFO), Chief Operating Officer (COO), any other Chief XXXX Officer, Vice-President, General Manager, Controller, Business Director (not a Board Director). Any qualifying individual may carry one or more officer titles and directors may be officers.
The importance of being designated as an officer is that many aspects of the law applying to the Board of Directors applies similarly to officers. They are held by the courts to a higher standard often called “duty of care.”
As stated in a memorandum “Directors’ and Officers’ Duties and Liabilities” by a large legal firm, Gowling Lafleur Henderson, in August 2010, “in addition to the statutory duties of the directors, at common law, officers and directors owe a fiduciary duty to the corporation, which can be described as a duty of loyalty and good faith. As such, officers and directors are obliged not to put themselves in positions of conflict with their duty to the corporation. The courts have rigidly applied this concept by insisting that directors and officers avoid not only actual conflict but also the potential for conflict.”
The memorandum further states: Liability for Wages and Other Employee Related Payments. One of the more frequent areas of exposure for directors is in respect of amounts owing to employees and for source deductions owing to government authorities in respect of employees.
Under the Acts, directors are generally jointly and severally, or solidarily in the case of the CBCA, liable to employees of the corporation for all debts not exceeding six months wages payable to each such employee for services performed for the corporation while they are directors respectively.
Under the OBCA, directors are also liable for vacation pay accrued while they are directors, for not more than twelve months under the provincial Employment Standards Act and the regulations thereunder, or under any collective agreement made by the corporation.
There are certain conditions precedent to a director being held liable under these provisions as well as certain limitations on directors’ liability for amounts owed by the corporation to employees.
In addition, provincial employment standards legislation and other federal legislation in Canada impose liability on directors for employee wages and for employee source deductions for income tax, employment insurance premiums and Canada Pension Plan contributions.
Employees have the option of pursuing directors under either the applicable business corporations statute or such other legislation.
Another Important Item: Liability under Environmental Legislation. An area which can give rise to significant liability for directors and officers is under environmental legislation.
Under applicable environmental legislation, officials can issue remediation orders directly against directors or officers of a corporation to rectify environmental contamination. Such orders can be issued against a corporation and its directors and officer even without “fault” and without proof of causation, on the basis of a corporation’s ownership, management or control of a property.
Defenses to such orders by directors and officers have included a demonstration of having acted with due diligence and prudence and without having created or aggravated the contamination problem.
Also, in the same memorandum: Liability under Other Statutes. In addition to liability under the Acts, employment-related legislation, environmental legislation and securities legislation (in the case of a public corporation), it should be noted that other federal and provincial legislation can impose liability on directors in a variety of areas (for example, consumer legislation).
The conclusion to be drawn is that being a director or officer of a corporation is not a duty to be accepted and consented to lightly. The duties and liabilities may be very onerous.
As Gowling stated it in their memorandum, “Directors and officers of corporations should be aware of common law and statutory duties applicable to them and understand how to comply with such duties. Directors and officers of corporations should also be aware of the liabilities which they may face and understand how to mitigate those liabilities.”
Always seek good legal counsel. The money you pay may save you from liabilities that hugely outweigh the cost of the advice!
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