Chapter 2: Effects of Incorporation

Question 1

What is the memorandum system of incorporation?

Answer 1

Based on general contractual principles: people get together and decide to set up a corporation. They write a memorandum, which is an agreement between the people that sets out the rights and responsibilities of those involved. Incorporation occurs as of right, so anybody can do it.

Question 2

What is the letters patent system of incorporation?

Answer 2

Companies are given a grant from the Crown to operate a business. The Crown has discretion to refuse these grants for policy reasons.

Question 3

What happened in Bonanza Creek Gold mining v. The King? SCC, 1915

Answer 3

Provincially incorporated companies have the right to conduct business in other provinces, but without consent from that province they lack the capacity. Therefore, provinces determine what gives corporations the capacity to operate within them.

Question 4

Define “Articles of Incorporation”.

Answer 4

The fundamental constating document under the CBCA.

Question 5

Define “Memorandum of Association”.

Answer 5

The fundamental constating document under the NSCA.

Question 6

What is the difference between an Article of Incorporation and a Memorandum of Association?

Answer 6

The Articles of Incorporation are really just a government form, whereas the Memorandum is a contract between corporate members.

Question 7

What are “By-Laws”?

Answer 7

Under the CBCA model, By-Laws are the internal regulations of the corporation. These detail things like, who has signing authority and what bank to use.

Question 8

What are “Articles of Association”?

Answer 8

Articles of Association belong to the NSCA model and are the internal regulations of the company. The equivalent of a CBCA’s “By-Laws”.

Question 9

What is “due diligence”?

Answer 9

Looking at the corporation’s minute book.

Question 10

What is a “minute book”?

Answer 10

A minute book is used to store all important corporate documents such as the articles of incorporation, the minutes of shareholders and directors meetings, stock certificates, tax filings, by-laws and other legal documents.

Question 11

What are some special incorporation situations?

Answer 11

1) Banks are incorporated under the Banks Act
2) Insurance companies are incorporated under the Insurance Act.
3) Crown corporations are incorporated pursuant to their own act.

Question 12

What are the benefits of incorporating?

Answer 12

1) Limited liability
2) Perpetual existence
3) Ability to sell shares
4) Flexibility in corporate structure - the conditions on shares are almost entirely definable
5) Income tax– pro: taxed at a flat rate. con: double taxation: first in corporation’s hands, then the dividends are taxed in the individual’s hands.
6) Future Growth

Question 13

What happened in Salomon v Salomon?

Answer 13

A company is a separate legal entity and different from the directors/subscribers to the memorandum. This principle was used to indemnify Salomon’s personal assets from the creditors of his corporation.

Question 14

What is “thin capitalization”?

Answer 14

Companies with very thin capitalization can harm creditors. The harm comes are they are unable to go after the shareholders since shareholders are shielded by the corporate veil. Canada does not require minimum capitalization.

Question 15

What happened in Lee v Lee’s Air Farming Ltd. ?

Answer 15

Case showed that a person can be a controlling shareholder, a sole director, and an employee of a one person company. “There appears to be no greater difficulty in holding that a man acting in one capacity can contract with himself in another”.

Question 16

What happened in R. v. Marquardt?

Answer 16

Marquardt began fraudulently funneling money from his floundering corporation into his personal accounts. Even though Marquardt was the controlling shareholder of his one man company, the court found this action illegal. The assets belonged to the company, not to Marquardt.

Question 17

What happened in De Salaberry Realities v. MNR?

Answer 17

In De Salaberry Realties Ltd. the court was charged with properly interpreting the Canadian Tax Act to see if a sale of land should be deemed a ‘capital gain’ (with concomitant large tax savings) or as ‘income.’ In trying to reach a proper decision on the basis of the statute, the court examined the relationship of the groups of companies to interpret whether or not, on all the evidence, the business of the subsidiary was that of a trader in land. In the end, the court came to the conclusion that the subsidiary was trading in land and that because the property sold was ‘inventory,’ the proper characterization of the proceeds was as ‘income.’ Rather than just basing his decision on ‘the course of conduct’ of which he had ‘no doubt,’ the judge went on for pages justifying his piercing of the corporate veil on other tax and statutory cases which spoke of the lack of separate will or agency of the subsidiary. The subsequent debate then became if or when, as a general rule, the courts may pierce the corporate veil in parent-subsidiary relations.239 Yet, when properly characterized this case stands for little more than the proposition that the courts can look to all the facts when trying to characterize proceeds as ‘income’ or ‘capital gain’ under the Canadian Tax Act.

Ratio: For purposes of national revenue, the courts are willing to view a subsidiary as an instrument of the parent company, and tax it accordingly, when three factors are present:
+The subsidiary is thinly-capitalized
+The center of policy and decision-making is the parent
+The company is set up for the purpose of minimizing taxes.

Question 18

What happened in Walkovsky v. Carlton?

Answer 18

This is from New York. Carlton owned a fleet of taxicabs; however, the cabs were registered in grous of two as subsidiary corporations. This enabled Carlton to obtain the minimum level of liability insurance allowed by statute. When Walkovsky was injured he argued the subsidiaries were sham corporations. He noted they were undercapitalized and that their assets were intermingled. He claimed liability belonged with the owner, as holder of the cabs as a single entity, and that he should be personally liable for the amount of liability insurance afforded a cab company of this size.

The Salomon principle was extended to creditors in tort.

Ratio: To pierce the corporate veil, and attach liability to the owner, it must be argued that the owner was conducting business in his individual capacity, “shuttling his personal funds in and out of the corporations ‘without regard to formality and to suit their immediate convenience

Analysis: In this case, as opposed to De Salaberry, piercing the veil would be somebody personally liable. This may explain the court’s reluctance to find liability.

Dissent: “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.”
2 essential requirements for piercing the corp veil: 1) public interest vested in the corp, and 2) insufficient capital for liabilities certain to arise.