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J. Anthony VanDuzer

The Law of Partnerships and Corporations

(1997)










ACKNOWLEDGMENTS




I would like to thank the following people for their assistance in reviewing earlier drafts of this book: Jeremy Farr, Marc LeBlanc, Jeffrey MacIntosh, Douglas Scott, Sean Wise, and Jacob Ziegel. Any errors, of course, remain my sole responsibility. I acknowledge the support of the Common Law Section at the University of Ottawa, the University of Toronto, Faculty of Law, where most of this book was written, the Law Foundation, and Macleod Dixon.

I also wish to thank my children, Taylor and Eli, for their patience, and my wife, Jodie Karpf, without whose constant indulgence and support this book would not have been possible.

J. Anthony VanDuzer





J. Anthony VanDuzer

The Law of Partnerships and Corporations

(1997)










FOREWORD




Canadian corporate law is messy. The federal government has its own corporate law statute, as does each of the ten provinces. Although there are similarities among these statutes, there are also substantial differences. Not only that, but provincial securities regulation also regulates corporate governance, and needs to be accounted for in any treatment of the Canadian corporate law regime. Further complicating matters are the many liabilities and duties, based on a range of statutes and common law doctrines, that regulate corporate behaviour.

Tony VanDuzer has written an indispensable book on the structure and operation of Canadian partnership and corporate law. Ever mindful of the complexities of the legal regime, he skilfully navigates his treatise through a number of doctrinal areas and gives the reader an appreciation of how the system works. He does so in a way that is sensitive to the distinct market and regulatory environment in which Canadian corporations operate.

All in all, this book is a distinguished piece of scholarship, and I commend it to both practitioners and students of corporate law.

Ronald J. Daniels




Dean, Faculty of Law




University of Toronto





J. Anthony VanDuzer

The Law of Partnerships and Corporations

(1997)










LIST OF STATUTES, REGULATIONS, AND ABBREVIATIONS




Statutes

ABCA Business Corporations Act, S.A. 1981, c. B-15

BCCA Company Act, R.S.B.C. 1979, c. 59

CBCA Canada Business Corporations Act, R.S.C. 1985, c. C-44

MBCA The Corporations Act, R.S.M. 1987, c. C-225

NBBCA Business Corporations Act, S.N.B. 1981, c. B-9.1 as amended by An Act to Amend the Business Corporations Act, S.N.B. 1984, c. 17

NCA Corporations Act, R.S.N. 1990, c. C-36

NSCA Companies Act, R.S.N.S. 1989, c. 81, as amended by Investors Protection Act, S.N.S. 1990, c. 15

NwtBCA Companies Act, R.S.N.W.T. 1988, c. C-12

OBCA Business Corporations Act, R.S.O. 1990, c. B.16

OBNA Business Names Act, R.S.O. 1990, c. B.17

OEPCA Extra-Provincial Corporations Act, R.S.O. 1990, c. E.27

OLPA Limited Partnerships Act, R.S.O. 1990, c. L.16

OPA Partnerships Act, R.S.O. 1990, c. P.5

OSA Securities Act, R.S.O. 1990, c. S.5

PEICA Companies Act, R.S.P.E.I. 1988, c. C-14

QCA Companies Act, R.S.Q. 1977, c. C-38

SBCA The Business Corporations Act, R.S.S. 1978, c. B-10

UKCA Companies Act (U.K.), 1985, c. 6

YBCA Business Corporations Act, R.S.Y. 1986, c. 15

Regulations

CBCA Regulations SOR/79-316

OBCA Regulation R.R.O. 1990, Reg. 62

OSA Regulation R.R.O. 1990, Reg. 1015
CHAPTER 1

INTRODUCTION










A. Introduction to This Book
















B.




What Is a Business and How Does Law Govern Business Organizations?













C.




Basic Forms of Business Organizations










1) Sole Proprietorships
2) Partnerships
a) Introduction
b) Characteristics
c) Limited Partnerships
3) Corporation
a) Formation
b) Characteristics i) Separate Legal Existence ii) Separation of Ownership and Management
4) Other Methods of Carrying on Business
a) Joint Venture
b) Co-ownership
c) Licence
d) Franchise
e) StrategicAlliance
















D. Chapter Summary













Further Readings





J. Anthony VanDuzer

The Law of Partnerships and Corporations

(1997)




CHAPTER 1, INTRODUCTION




A. INTRODUCTION TO THIS BOOK




This book provides an overview of the essential features of the law governing business organizations in Canada. It is intended to be an accessible and practical reference for law and business students, lawyers, accountants, and others concerned with business organizations.

The three legal arrangements most commonly used for carrying on business in Canada are the sole proprietorship, the partnership, and the corporation. The law governing these forms of business organization touches all of us, in a variety of diverse and overlapping ways, as employees, managers, customers, creditors, and, most significantly, investors. Although only some of us may invest our money directly in businesses, almost all of us have some stake as investors, since our deposits in our bank account, the premiums we pay to our insurance company, and our contributions to our pension fund are all reinvested by these financial intermediaries in businesses. [Note 1: Some money deposited in bank accounts, of course, is not invested in business, but loaned to consumers.]

Every business carries on some commercial activity that involves certain risks. Although the specific sources of risk will vary from one business to the next, in every business the fundamental nature of the risk is the same: there will be those who benefit if the business prospers and those who lose if it does not. As investors and in our other relationships with business enterprises, the main way business organizations law affects us is by allocating the risks associated with carrying on the business. In general, business organizations law strikes a balance between the interests of investors and the other stakeholders, including employees, managers, customers, creditors, and the public, by establishing rules that assign liability in connection with business activities. For example, business organizations law determines when individual investors are personally liable for the debts and other obligations of the business. By affecting the allocation of the risks of doing business in this way, business organizations law influences the incentives for entrepreneurs to engage in business. Business organizations law is concerned also with providing an organizational structure for the operation of businesses. [Note 2: Business organizations in Canada, as elsewhere, were developed and are peculiarly adapted to facilitate the operation of a market-based capitalist economy. This book does not address the relative merits of such an economy, but accepts it as a given.]

This book examines the balance struck between the interests of investors and other stakeholders in the sole proprietorship, the partnership, and the corporation and the particular kind of organizational structure provided by each. Throughout the book, emphasis is placed on the practical application of legal rules in an everyday context, including, in particular, in a lawyer's practice.

This chapter continues with an examination of the nature of a business and the interests of its stakeholders, and then takes a first look at how the law governing business organizations mediates among these interests. Next, the basic characteristics of the sole proprietorship, the partnership, and the corporation, as well as some other forms and methods of carrying on business, such as joint ventures, franchises, and co-ownership arrangements, are described. Both legal and practical considerations are discussed, and some of the advantages and disadvantages of each are identified.

In the remainder of the book, partnerships and corporations, respectively, are addressed in detail. In relation to each, the following areas are covered:

* How is the business organization formed?

* What are the relationships among the people who own and manage the business and how are they governed?

* What are the relationships between the business organization and those it deals with, such as creditors, customers, and tort [Note 3: A tort is an act or omission giving rise to civil liability. The most important tort is negligence. If a person can prove that the act or omission of another meets the legal standard for negligence, that person will be entitled to compensation from such other person for any loss suffered as a result. ] victims, and how are they governed?

The discussion of partnerships in chapter 2 also covers two special kinds of relationships: limited partnerships and joint ventures.

Chapters 3 through 12 on corporations make up the largest section of the book, reflecting the pervasive use of the corporate form to carry on business. Although the content of these chapters follows the model outlined above, the discussion is much more detailed. Most of the discussion focuses on smaller private corporations, the most common type of corporation in the marketplace. Nevertheless, some of the distinctive issues relevant to large public corporations, such as corporate governance, insider trading, and takeover bids, will be addressed in passing throughout the book and are the focus of chapter 11.

Unlike the other forms of business organization, the corporation is an entity separate in law from the people who own it, the shareholders, and those who manage it, the directors and officers. Chapter 3 introduces the corporation by tracing the historical development of corporate law in Canada and examining the constitutional competence of the federal and provincial governments to incorporate and regulate corporations. This chapter also looks at the nature of the corporation's separate personality. Chapter 4 outlines the process of and considerations relating to incorporation. Chapter 5 discusses some of the operational issues arising in the context of the corporation's external relationships which are created by the corporation's separate legal existence, such as how the corporation becomes liable in contract and for torts and crimes.

The rest of the book is devoted largely to the internal relationships in the corporation. The legal scheme set out in Canadian corporate statutes is explained and some of the current issues of corporate governance in practice are discussed. Chapter 6 deals with the nature of shares, the ownership interests in the corporation. Chapter 7 deals with the division of powers to manage and control the corporation among the shareholders, who are the owners of the corporations; the directors, who are elected by the shareholders to manage the corporation; and the officers who are appointed by the directors and to whom the directors delegate management authority. Chapter 8 deals with the duties of directors and officers. The focus is on corporate law duties designed to ensure that directors and officers manage competently in the corporation's best interests, though the burgeoning statutory duties of directors and officers imposed to ensure the attainment of other public policy objectives, such as compliance with environmental legislation, are also considered. Chapter 9 looks at the remedies available to shareholders when directors and officers fail to meet their legal obligations. In Chapter 10 the technical and practical aspects of fundamental corporate changes, such as the amalgamation of two corporations and the dissolution of the corporation, are considered. Chapter 11 addresses some of the technical and practical issues of specific relevance to larger public corporations, such as takeover bids and insider trading. A brief introduction to securities law is included as well.

The final chapter of the book, chapter 12, introduces some of the current issues in business organizations law. It looks at possible future developments in areas such as corporate governance and the responsibilities of corporations to be accountable to non-shareholder stakeholders, including employees and the public.

In putting the book together, several features have been added to facilitate its use. Each chapter contains a chapter summary and a list of further readings, as well as a number of examples. At the end, a glossary of important terms has been provided, along with a comprehensive index.

J. Anthony VanDuzer

The Law of Partnerships and Corporations

(1997)




CHAPTER 1, INTRODUCTION




B. WHAT IS A BUSINESS AND HOW DOES LAW GOVERN BUSINESS ORGANIZATIONS?




All businesses carry on some commercial activity and, in doing so, become the focus of a variety of relationships (see figure 1.1). [Note 4: The idea for presenting stakeholder interests in this way came from E.E. Palmer & B. L. Welling, Canadian Company Law: Cases, Notes and Materials, 3d ed. (Toronto: Butterworths, 1986) at 2-5.] One of the major concerns of business organizations law is the relationship of owners and managers to the business and to each other. For this reason, in this book we look at what rights and obligations the sole proprietor, the partner, and the shareholder have to manage the business themselves and to monitor and control others who manage. We also look at what remedies are available to owners where management is acting in a manner inconsistent with the best interests of the business. We will stray into securities law, to the extent that it addresses some of these same concerns.

Figure 1.1Stakeholders in Business Organizations




Government

Financial Creditors

Trade Creditors













?










Managers

Business

Owners










Organization













Customers

Employees

Public










Commercial Activity




The second major concern of business organizations law is the responsibility of the business, the owners, and the managers to other stakeholder groups. The focus of business organizations law in this regard, however, is narrow. For the most part, relations between non- shareholder stakeholders and business organizations, their owners, and their managers is governed by other types of laws.

The rights and obligations of employees in relation to the business are governed by their contracts of employment, subject to a range of regulatory laws including employment standards and occupational health and safety legislation. There are a small number of discrete kinds of protection for employees in business organizations law, but its main impact on employees is to determine who bears responsibility for obligations to employees: Is it the owners, the managers, or the organization itself that is responsible? In chapter 12 we discuss briefly the extent to which business organizations law permits or requires managers to take employees' interests into account in making business decisions.

The particular relationships between a business and its trade creditors (e.g., suppliers of goods and services to the business), financial creditors (e.g., banks), and customers are not the subject of business organizations law but are dealt with under various other categories of law, such as contract, tort, property, commercial, and criminal law. Business organizations law is concerned with the narrower issue of when the business organization is liable for the obligations created under these other categories of law. In other words, we will not look at the substantive basis of a claim that a crime or a tort, for example, has been committed, but rather at the circumstances in which a business organization can be said to have committed the crime or the tort. As with employees, business organizations law does provide certain limited protection for creditors and customers, and addresses the extent to which management is permitted or required to take their interests into account.

Business organizations have a complex and multifaceted relationship with the public. Decision making by business organizations has an enormous impact on the public interest in relation to such areas as employment, the environment, and tax revenues. The consequence, of course, is that businesses are subject to a variety of forms of direct regulation in these areas. Such regulation is not the subject of business organizations law. We are concerned in this book only to address the limited ways in which business organizations law permits or requires management to take public interests into account.

Businesses operate, then, within a web of relationships involving a number of stakeholders which are regulated by a wide variety of laws designed to achieve a range of public policy objectives. Business organizations law focuses primarily on a subset of these relationships - those between owners, managers, and the business. It is important to remember, however, that the other relationships and the rules which govern them not only constitute the context in which business organizations law operates but have a significant impact on the behaviour of management and owners.

J. Anthony VanDuzer

The Law of Partnerships and Corporations

(1997)




CHAPTER 1, INTRODUCTION




C. BASIC FORMS OF BUSINESS ORGANIZATIONS




1) Sole Proprietorships

The sole proprietorship is the simplest form of business organization. A sole proprietorship comes into existence whenever an individual starts to carry on business for her own account without taking the steps necessary to adopt some other form of organization, such as a corporation. Although the sole proprietor may enter into contracts of employment with others and, in this way, allocate certain functions in the business to them, the sole proprietor is the sole owner of the business and the only person entitled to manage it. Indeed, both legally and practically, there is no separation between the sole proprietorship business organization and the person who is the sole proprietor. One consequence is that the sole proprietor may not be an employee of the business. There is no one with whom she can contract.

All benefits from the business accrue to the sole proprietor, and all obligations of the business are his responsibility. In terms of the relationships between the business and the other stakeholders in the business, the sole proprietor's complete responsibility has several important implications.

* The sole proprietor is exclusively responsible for performing all contracts entered into in the course of the business, including, for example, sales contracts with customers, financial commitments, contracts with suppliers, and employment contracts.

* The sole proprietor is exclusively responsible for all torts committed by her personally in connection with the business, and she is vicariously liable for all torts committed by employees in the course of their employment.

* All the sole proprietor's personal assets, as well as those contributed to the business, may be seized in fulfilment of the obligations of the sole proprietor's business.

* For income tax purposes, the income or loss from the business is included with the income or loss from other sources in calculating the sole proprietor's personal tax liability.

The chief attraction of the sole proprietorship is its simplicity and ease of creation. It is equally easy to dissolve; the sole proprietor simply ceases to carry on business. Ceasing to carry on business, however, has no effect on liabilities incurred in connection with the business while it was being carried on. The chief disadvantage of the sole proprietorship is unlimited personal liability. All the sole proprietor's personal assets, not just those of the business, may be taken by third parties in satisfaction of obligations of the business. As the scale of the business and the concomitant liabilities increase, this exposure to personal liability becomes an increasingly important disincentive to using this form of business organization. By comparison, the corporation, but not the partnership, provides protection against personal liability. Another problem with sole proprietorships is raising money. Every business needs additional investment to grow. It is not possible to divide up ownership of the sole proprietorship, so the only method of financing is for the sole proprietor to borrow money directly. As will be discussed below, an advantage of both the partnership and especially the corporation is that they permit a wider range of investment possibilities. For both these reasons, sole proprietorships are used only for relatively small businesses.

One of the legal requirements in connection with the use of a sole proprietorship is that the name of the sole proprietorship must be registered under the business name legislation in each province in which the proprietorship is carrying on business if it is using a name other than simply the name of the proprietor. In Ontario, registration is governed by section 2(2) of the Business Names Act (OBNA). So, for example, Janet Smith would not have to register if she were carrying on a convenience store business under the name Janet Smith Milk and Nuts, but would if she chose instead to use the name World's Best Milk and Nuts. A sole proprietor may also register voluntarily (OBNA, s. 4).

The OBNA and other provincial names legislation contain certain inducements to register. In Ontario, if you do not register when required to, without reasonable cause, you are committing an offence and are liable for a fine of up to $2000 (OBNA, s. 10(2)). Also, you may not sue in Ontario for an obligation incurred in connection with the business except with leave of the court (OBNA, s. 7). The court must grant leave if the failure to register was inadvertent, there is no evidence that the public has been deceived or misled, and, at the time of application to the court, you have filed a registration (OBNA, s. 7(2)). The main reason for these incentives is to ensure that there is a public record for creditors and others to search to find out the identity of the person behind the business name who will bear responsibility for any obligation of the business. The registration of the name of a sole proprietorship also has the effect of discouraging others from using the name and so reducing the likelihood of confusion in the marketplace. This is one reason to register even if you are not obliged to.

Another sort of advantage to registration is the right to statutory damages up to $500 against any person who registers a name that is deceptively similar to another registered name and that causes injury (OBNA, s. 6). It is important to note that this right is in addition to any other legal right an aggrieved person may have in connection with someone using a confusingly similar name. For example, you may have a claim against such a person under the common law tort of passing-off.

Where a plaintiff in an action brought under OBNA, section 6, is successful, the court must also order the cancellation of the offending registration. The availability of statutory damages and cancellation encourages sole proprietors to police the names register themselves and so protects the integrity of the public record. Registration does not, however, create any proprietary interest in a name. Such interests are protected only under provincial passing-off laws and federal trade-marks law. These laws are discussed in relation to corporate names in chapter 4.

The only other category of requirement for sole proprietorships, one that applies equally to all forms of business organization as well, is business licences. In order to commence certain types of businesses, a sole proprietor must obtain a licence from one of the levels of government. For example, most municipalities in Ontario require the proprietors of taxi-driving businesses and restaurants to obtain a licence. Provincial governments have enacted licensing requirements for many types of businesses, such as real estate agents, car dealers, and securities dealers. In areas of federal legislative competence, licensing requirements may also be imposed. Anyone starting up a business should check the relevant licensing requirements.

2) Partnerships

a) Introduction

The law of partnerships was developed by the courts in England and was codified in the English Partnership Act of 1890. [Note 5: See chapter 2.] All provinces, other than Quebec, have legal systems based on the English common law approach, [Note 6: The English common law system is discussed in chapter 2.] and all have partnership legislation based on this English statute. The Ontario Partnerships Act (OPA) is typical. Quebec also has partnership legislation that has many similarities to the legislation in the common law provinces. Because the Acts are quite short and have never been revised substantially, they often do not provide a satisfactory scheme for organizing a partnership. For this reason, partners will frequently supplement or modify the rules governing their relationship in a contract commonly referred to as a partnership agreement. Some of the ways in which this is done are described below and in chapter 2. In order to deal with any issue involving a partnership, one must have regard both to the relevant partnership statute and to any partnership agreement.
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