Chapter 11: Corporations Flashcards
Separate Legal Entity
LO 11.1 Analyze the separate legal entity principle
Separate Legal Entity
LO 11.1 Analyze the separate legal entity principle
An “owner” of an incorporated company
owns shares that can be bought and sold; thus, the shareholders can be
continually changing, while the company itself remains intact
Separate legal entity
the principle that a corporation exists separately from the people who created it
When the incorporation process is
completed, there are two legal persons:
1) the shareholder and
2) incorporated company, or corporation.
Who owns the assets?
Shareholders often have
difficulty understanding that they do not actually own the assets of the
business—the corporation they have incorporated does.
Corporate myth
a corporation is a legal fiction
Limited liability
liability is restricted to capital contributed; shareholders are shielded from
liability for the corporation’s debts
The Role of Agents
The Role of Agents
Since the corporate entity is a legal fiction, all of its activities must be
carried out through the services of real people acting as agents.
Pros and Cons of Incorporation
LO 11.2 Describe the advantages and disadvantages of incorporation
Describe the advantages and disadvantages of
incorporation
LO 11.2 Describe the advantages and disadvantages of incorporation
Advantages
1) Limited Liability
2) Taxes
3) Succession and Transferability
4) Obligations of the Participants
5) Management
Personal guarantee
a guarantee of payment for another’s obligation
Advantage 2: Taxes
At the very least, the shareholder can leave the funds in the corporation and use it as a vehicle of investment, thus deferring some taxes until a later date
Advantage 3: Succession and Transferability
Because a corporation is a separate legal entity and a mythical person, it does not die unless some specific steps are taken to end its existence
The death of even a 100 percent shareholder will not affect the existence of the corporation, although the loss may have practical implications, especially when the shareholder is involved in the ongoing operation of the business
Shares in a corporation, however, can usually be transferred at will, without reference either to
the other shareholders or to the corporate body
It is often said that a corporation cannot die, but actually there are several
things that can cause a corporation to be dissolved.
The ultimate end for a corporation going through the bankruptcy process is dissolution by operation of law
The shareholders themselves can vote to bring
the corporation to an end when they feel it is appropriate, filing articles of dissolution or a statement of intent to dissolve at the appropriate registry
office.
But the most common way is for the corporation to simply fail to file the required annual returns. After a year, the corporation will be considered inactive and removed from the registry
Advantage 5: Obligations of the Participants
Unlike partners, shareholders are generally free of any obligations or duties to the corporation or other shareholders
There is no fiduciary duty to act in the best interests of the corporation, or even to refrain from carrying on business in competition with the corporation.
Advantage 6: Management
In a corporation, however, it is common to
separate the managers from the owners
The shareholders elect a board of directors that controls the business. The directors, in turn, can hire professional managers who have the expertise to make sound business decisions on behalf of the corporation
Disadvantages
In the case of a corporation, however, the
incorporating documents themselves may have to be altered, which is an involved and expensive procedure
In closely held corporations, the free transferability of shares is restricted, either through shareholder agreements or by limitations placed in the
incorporating documents themselves
A corporation is the most expensive way to operate a business
Intellectual property
personal property in the form of ideas and creative work
such as patents or copyrighted materials.
Franchising
arrangements based on contracts of service and the supply of products between larger and smaller units of one organization
The Process of Incorporation
LO 11.3 Explain the process of incorporation
The Process of Incorporation
LO 11.3 Explain the process of incorporation
Deeds of settlement
contracts used historically for setting up a company
Registration
a legislated requirement for incorporating a company in some
jurisdictions in Canada
Letters patent
a method of incorporating used in some jurisdictions in Canada whereby the government grants recognition to the company as a separate legal entity
Articles of incorporation
a method of incorporating based on a US approach and used in some jurisdictions in Canada
In Canada, it is possible to incorporate a corporation at the
federal level or at the provincial level
Registration
Incorporation through registration recognizes the contractual relationship between its members and grants them corporate status
Nova Scotia is the only jurisdiction in Canada still using the registration system of incorporation
The process involves registering a “memorandum of
association” and “articles of association” with the appropriate government agency and paying the required fee
The British Columbia government introduced new corporate legislation moving away from the previous registration system, but retaining significant aspects of it and creating a process of incorporation unique to that province
Memorandum of assocaition
the constitution of a corporation in a registration jurisdiction
such as the name of the company, the authorized share capital (the total value of shares that can
be sold), and, when appropriate, the objects of the incorporation
Articles of association
internal regulations setting out the procedures for governing a corporation in a registration jurisdiction
These articles deal with such matters as how shares are to be issued and transferred, requirements for meetings of the board of directors and of shareholders, voting procedures at those meetings, regulations covering borrowing, powers of directors and other officers, requirements dealing with dividends, regulations concerning company records, and how notice will be given to shareholders
Letters Patent
The letters patent method of incorporation is based on the practice of the monarch granting a royal charter
The process involves an applicant petitioning the appropriate government body for the granting of the letters patent.
The government representative, acting by statute, grants a charter of incorporation to applicants who meet certain qualifications.
Today, only Prince Edward Island uses this method of incorporation
Articles of Incorporation
The articles-of-incorporation method has features of both the letters patent and the registration methods
As with letters patent companies, corporations under this system are primarily the creations of government
rather than being based on contract
The articles of incorporation serve the same function and contain the same types of information as the memorandum of association and the letters patent in the other systems.
The “articles” in an articles-of-incorporation jurisdiction is
the main incorporating document and so corresponds most closely to the
letters patent in that system or the memorandum of association in a
registration jurisdiction.
Other Incorporated Bodies
Cities, universities, and other public institutions are incorporated legal entities that can sue or be sued in their own right
Under both federal and provincial legislation, it is also possible to establish (incorporate) nonprofit bodies, sometimes called “societies” or non-share capital
corporations
These bodies are primarily cultural, social, charitable, and religious organizations, such as the BC Society for the Prevention of Cruelty to Animals
Capacity
In provinces using the registration system of incorporation, the capacity
of the company to enter contracts was limited
Funding
LO 11.4 Discuss the funding of a corporation
LO 11.4 Discuss the funding of a corporation
Share
the means of acquiring funds from a large number of sources to run a corporation; an interest in a corporation held by an investor
Point of owning shares
Owning shares gives the shareholder control of the corporation and, under certain circumstances, a right to the assets of the corporation upon dissolution.
Par-Value versus No-Par-Value Shares
Par-Value versus No-Par-Value Shares
Par-value shares
a share with a stated value at issuance (most shares are now no par value)
Such practice involves each share being given a specific value, such as $1, at the time of issuance
This method is declining
No-par-value share
allowing the marketplace to determine the value.
The articles of incorporation jurisdictions (except
British Columbia) have abolished par-value shares.
Common shares
shares to which no preferential rights or privileges are attached
If there are no preferred shares
the common shares must include the rights to
vote at shareholders’ meetings, to receive dividends declared by the corporation, and to receive the property of the corporation on its dissolution
Preferred shares
shares giving the shareholder preference over other classes of shares; that preference often pertains to the payment of dividends
Preferred shareholders
holders of preferred shares who may have a right to vote arising if dividends are not paid
Common shareholders
holders of common shares who do not have any preferential rights or privileges
Special shares are used for other purposes, such as estate planning, when
two classes of shares can be created:
1) one with a right to vote and with
some control in the affairs of the corporation but no right to dividends or to receive money upon dissolution,
2) and the other with a right to
dividends but no right to vote
Borrowing
The corporation can also borrow funds, thus accumulating debt. This can be done by borrowing large sums from a single creditor, such as a bank,
which usually requires a mortgage on the property of the corporation
It can also be accomplished through the issuing of bonds or debentures, either secured or unsecured, to many different creditors
Bond
a share interest in the indebtedness of a corporation; often used synonymously with “debenture,” though a bond is normally secured against specific assets, while a debenture is likely not
Debenture
an acknowledgment of debts by a corporation normally involving more than one creditor; often used interchangeably with “bond,” but whereas a
bond is typically secured against a specific asset, a debenture may be unsecured or secured by a floating charge against inventory
Restrictions to bond holders
a bondholder
has no right to vote and cannot affect management decisions
Closely Held and Broadly Held
Corporations
Closely Held and Broadly Held
Corporations
Closely held corporation
corporations in which there are relatively few shareholders; referred to as
non-distributing corporations in some jurisdictions
There are restrictions on the sale of shares, which
cannot be sold to the general public openly or on the stock market.
AKA a private company
Broadly held corporations
corporations that are publicly traded on the stock market; referred to as
distributing corporations in some jurisdictions
AKA a public company
Corporate Directors, Officers, and Shareholders
LO 11.5 Examine the roles of corporate directors, officers, and shareholders
Corporate Directors, Officers, and Shareholders
LO 11.5 Examine the roles of corporate directors, officers, and shareholders
Directors (Managers)
Within the Corporation
The shareholders normally exercise control over a corporation through the election of directors at the annual meeting.
Once the directors are elected, the shareholders have little real say in the operation of the corporation until the next election, but the expectation is that if they want to be re-elected, the directors will follow the wishes of the shareholders.
The federal legislation,
for example, now requires directors to exercise
the care, diligence, and
skill of a “reasonably prudent person” when exercising their powers and
discharging their duties
Directors info
Directors also owe a fiduciary duty to the corporation
Directors are not permitted to take personal advantage of opportunities that arise because of their positions
as directors, nor can they start a business in competition with the corporation
When a director is personally involved in some transaction that the corporation may become involved in, the director must disclose that interest by making a declaration to the board of directors, avoid any
involvement in the discussion of the matter, and abstain from voting on it
Derivative action
a lawsuit in which certain shareholders are given the right to launch a civil action against the directors on behalf of an injured corporation ; also called a representative action
Representative action
a lawsuit where certain shareholders are given the right to launch a civil action against the directors on behalf of an injured corporation; also called a derivative action
Insider knowledge
information that affects share pricing that is not publicly known; directors, officers, and large shareholders, among others, cannot profit by improperly using confidential knowledge about the corporation
External Obligations
External Obligations
Various federal and provincial statutes impose personal liability on the
director primarily in three areas.
1) Directors can be held personally liable when a corporation fails while owing workers unpaid wages
2) A second area of personal liability for directors involves unpaid taxes.
3) The third area involves environmental regulation
Due diligence
doing everything reasonable to avoid a problem leading to legal liability
senior officer definition
includes a director, the chief
executive officer, and the chief financial officer
Promoter
a person who participates in the initial setting up of a corporation or who assists the corporation in making a public share offering
Securities commission
a provincial agency that serves as a watchdog for the stock market
Prospectus
a public document disclosing relevant information about a corporation
to disclose all pertinent information of interest to investors about the corporation and its business
operations
Shareholders
One of the main attractions of incorporation is that shareholders have few obligations to the corporation, or to other shareholders, other than to not
use insider knowledge for their own purposes
Rights
Shareholders do have significant rights and remedies. Certain records must be kept at a designated corporate office and made available to the shareholders
These records include the following:
-the documents of incorporation
-lists of all the shareholders
-lists of transactions or changes in relationship to the shares
-lists of officers, directors, and debenture holders
minutes of shareholders’ meetings.
Auditor
a party responsible for ensuring that an organization’s financial statements have been properly prepared
The auditor’s duty is to the shareholders, not to the
directors, and the auditors have access to the corporation’s books to ensure the accuracy of their conclusions
Annual general meeting
a meeting where shareholders elect directors and vote on other important resolutions
Advance notice of this meeting, including the appropriate financial statements, must be given to
the shareholders
Proxy
when shareholders designate another person to vote on their behalf at an annual general meeting
The bylaws or articles set out how many votes each shareholder is entitled to, but this may vary with the type of shares held
Holders of common shares are usually entitled to one vote per share.
Preferred shareholders usually cannot vote unless a promised dividend has not been paid
Pre-emptive rights
the right of a shareholder to buy new shares in the same proportion as her current ownership of shares
Shareholder Protections
To protect minority shareholders from abuse, the statutes have provided several safeguards
Oppression action
an action against the directors who have allegedly offended the rights of creditors or minority shareholders
Dissent and appraisal
the right of minority shareholders who are adversely affected by major changes to indicate their opposition and force the corporation to buy back their shares at a fair price
Dividend
a payment to shareholders out of corporate profits
Shareholder Agreement
an agreement among the shareholders of a corporation that sets out the
terms of their relationship
Most shareholder agreements ensure that each of the shareholders will be elected to the board of directors every year.
They also ensure that major changes will not take
place without the unanimous agreement of the shareholders
A unanimous shareholder agreement (USA)
is usually given special status
under legislation governing corporations.
The Canada Business Corporations Act, for example, allows the powers of the directors to
manage the business and affairs of the corporation to be restricted by a unanimous shareholder agreement
Termination of the Corporation
LO 11.6 Distinguish the ways that a corporation can be
terminated
Termination of the Corporation
LO 11.6 Distinguish the ways that a corporation can be
terminated
Corporations can be dissolved in several ways
-Dissolution can take place either voluntarily or involuntarily, and the procedure can be induced
internally, by the directors or shareholders, or externally, by the courts or creditors
-The process can be voluntary, by following the winding-up procedure found in the corporate law statutes or, in some jurisdictions, in a separate winding-up act
- If the corporation owns sufficient assets, it
may be worthwhile to follow this process, but often it is not worth the expense.
Occasionally, a court will order a corporation to be dissolved when
a minority shareholder has been unfairly treated.
If there are more debts owing to the creditors than the corporation has assets to cover, the common procedure is bankruptcy, and the end result is usually the dissolution of the corporation.
One of the most common ways for corporations, especially small, closely
held corporations, to come to an end is for
the principals simply to
neglect to file the annual return.
Characteristics of incorporation
- Separate legal entity
- Owners hold shares, which may be bought or sold, so he owner can change
- In Canada, you can incorporate provincially or federally
- If you carry on business in another province, you can register in just that province
Separate legal entity
-Legal fiction / corporate myth
-‘lifting the corporate veil’ where they go after the directors and officers
-Allows for the acquisition of capital without involving shareholders
-Shareholder have limited liability
-
Pros of incorporation
- limited liability
- tax benefits
- succession and transferability
- Shareholders are free from obligations and duties
Cons of incorporation
- Limited liability can be weakened by personal guarantees
- Statutory and other restrictions
- Expensive
Three methods of incorporation
1) Registration
2) Letters patent
3) Articles of incorporation
- Only focus on this one as it is in BC
- Based on filing of articles of incorporation and the granting of certificate of incorporation
Ways to fund a corporation
Debt or Equity
Difference between a corporation and a company (exam question)
There is no difference, they are synonyms
Equity
Ability of the corporation to acquire capital
Three different clases of shares
Common - gives rights to vote
Special: may have special rights and restrictions
Preferred: usually give shareholders dividends
Debt
Bonds : not participants in corporation
Debentures: likely to be unsecured
Loans
Advantage of debt, no control over management
Public compnay
Broadly held
Restrictions on sales, securities legislation applies
Public company
Closely held
Directors
- Shareholders exercise control of the corporation by electing directors at an annual meeting
- Fiduciary duty to corporation and not shareholders
- Directors can face personal liability in some cases (ie., unpaid wages, unpaid taxes)
- Can escape liability if they show they acted in due diligence
- Indemnities and insurance can mitigate some of the risk
Officers and Senior Executives
- Directors usually appoint a president or CEO who is given responsibility for managing the company.
- Owes the same types of duties and care but may be held to higher standards
Promoters and Securities Law
“promotor” is someone who participates in the initial setting up of the corporation or who assist the corporation in making a public share offering
Shareholders
- Few obligations
- No duty to act in the best interests of the corporation
- Cannot use insider information for own benefit
Shareholder rights
- Inspect records
- Receive copies of annual financial statements and auditors report
- May attend annual general meeting and use proxy
- Have no right to force a dividend payment but can vote out directors
Termination of corporation
- Voluntarily
- Involuntarily
- Initiated internally by directors of shareholder or externally by courts or creditors
- Not file annual returns
Sales of a corporation
Share sale
Asset sale
Share sales
Preferred by sellers to keep the corporation intact
The right to a derivative or representative
action exists in British Columbia, Nova Scotia, and those jurisdictions that
use the
articles-of-incorporation method of incorporation
