I read an article that appeared in last week’s Your Business magazine in the Globe and Mail.  It is entitled “There Must be 50 Reasons to Leave Your Partner”.  Although the reference is to “partner”, it is not solely to a partnership in the purely legal sense, but, rather, a partnership in the generic sense – that is, whether the “partners” actually have a formal partnership, are in a joint venture or are shareholders in a corporation or some other arrangement.

The article talks about what happens when the two or more partners decide to go their separate ways and what to do about their business.

I have to admit, though, that there’s something about the lawyer they’ve quoted.  I agree with absolutely everything he said.  I hear he’s pretty good looking too … at least in his own mind

CALC

I was reading a promotional discussion that talked about the advantages for business owners to operate their businesses through “offshore companies”.  First and foremost a little clarification.  By “offshore”, we’re really talking about foreign companies or, more specifically, non-Canadian or American companies – hence, outside of Canada’s shores or “offshore”.  The particular discussion I was reading related to setting up companies in the United Arab Emirates but many of these companies relate to Caribbean or European companies – usually in small countries or principalities (for those who want to set up businesses in, say, Lichtenstein).

The thing I smiled the most about when it came to this particular discussion was the title that suggested that it was better to be safe than sorry and the connotation was that you were safer with an offshore company and sorry if you stayed with your plain-old Canadian company.  The discussion also touted the benefits that, in this example, the UAE companies didn’t have to pay Canadian taxes but only UAE taxes, you didn’t have to be a resident of the UAE, the company could have non-UAE bank accounts, etc.  These types of claims are made for the other offshore companies as well.

The first problem with offshore companies is that they involve a huge leap of faith.  Since you are not in the UAE (or Bermuda or Lichtenstein, etc.), there is always the possibility that someone unscrupulous could take over control of your company.  Will it happen every time?  No.  But then again, you have better control of the situation with a Canadian company than with an offshore company.

The second problem is that before you ever get involved in any of these companies you should get specialized taxation advice.  And, even then, you are probably best off to get two tax opinions.  Why is that?  Because it is not uncommon for the promoter to send you to a tax specialist who may not be completely independent.  Unfortunately, some of my clients have learned this the hard way.  This is not to say that the tax expert is somehow “in cahoots” with the promoter, but it is possible that the tax expert may not give enough emphasis to the downside risks that a truly independent expert may put on the situation.

A third problem, which is related to the second problem, is that these promoters may only be focusing on part of the issue.  For example, in this particular discussion, the person was promoting the fact that there was a tax treaty with the UAE that prevented double-taxation.  Fair enough, but this may not be the entire picture.  For example, if the UAE doesn’t tax on dividends at all, then it’s not an issue of double-taxation.  Rather, you still might have to pay Canadian tax with the result that you are still paying the same tax you would have had to pay if you had gone with a Canadian company.  Or, let’s suppose that the UAE tax rate is 30% while the Canadian rate is 35%.  You may not have to pay 65%, but you may still be required to pay 30% to UAE and 5% to Canada – again, no real net savings – and at the cost of the loss of some control over your company.

A fourth issue is to remind you that even if you have an “offshore company”, if you are intending to do business in Ontario, you will still have to register your company as an “extra-provincial corporation”.  The result is that you now have to not only submit whatever corporate forms or returns are required by the offshore country but also whatever Ontario requires.  Is this extra work offset by the potential savings of being offshore?  Maybe.  Maybe not.  But you should take this factor also into consideration.

Finally, a warning of how things could go very wrong.  One of my old clients invested in offshore corporations and sent money to what proved to be fraudsters.  They made off with $20 Million.  The problem was that my client’s money was tied up in U.S. stocks that had been earned through stock options.  The shares were in the client’s name and could not be moved to someone else without incurring huge tax consequences.  However, the client wanted to keep these shares for the benefit of the client’s heirs – which resulted in a further problem because the U.S. had huge estate taxes that would give money to the U.S. government which was unfair since the client and the client’s relatives all lived in Canada and had never worked in the U.S., all work done for the stock options was done in Canada and the only tie to the U.S. was the fact that the shares were traded on the NYSE.  So, the client implemented a tax structure that would minimize the impact through the use of offshore companies that was legitimate, but because control could be taken by the “foreigners”, that did occur and the client lost $20 Million.  After following the monies from the Caribbean to New York, to Europe and then back down through several Caribbean countries, we eventually found $12 Million and then had a huge fight over that money that cost the client tons of money in legal fees for lawyers in many countries.  In the process, the client’s house was sold, the client suffered financial and emotional strains and whatever benefits might have been gained were completely wiped away and then some.  Moreover, the client still had money to be able to fund the lawyers and the financial experts to follow the money and eventually get part of it back.  You may not be able to afford such a process.

Does this mean that all offshore companies are scams and should be avoided?  No.  But they can be fraught with danger and it’s something you should not go into lightly.

Something to think about.

CALC

The Supreme Court of Canada released reasons in three appeals dealing with the same issues yesterday.  The decision is found here.  In each of the cases there were businesses that were required to collect either or both provincial sales tax and the federal GST.  These businesses did collect the taxes but then went bankrupt.  Financial institutions that were owed loans and had registered security against the assets of the businesses claimed that they had priority over the assets.  The governments argued that the taxes required the businesses to collect the taxes as agents for the government and that, as a result, the money so collected was actually the government’s money and did not form a part of the businesses assets that were subject to the financial institutions’ security. 

If the governments were right, then they would get the money first and the financial institutions would fight over what was left.  However, the financial institutions argued that money was not specifically “earmarked” for the governments.  The money collected was mixed with other non-GST or PST monies and, ultimately, the businesses paid the governments money but not the actual monies received and, moreover, the businesses paid net amounts after taking various credits (such as input tax credits) into account so that if $100 in GST was collected it did not necessarily follow that the businesses had to pay $100 when the tax instalment was remitted.  As a result, the financial institutions argued that the governments could not say that it was “their money” and that, as a result, the governments were ordinary, unsecured creditors and that therefore the financial institutions, as secured creditors, had priority to the monies over the governments.  The Supreme Court of Canada has agreed with financial institutions with the result that the financial institutions won.

Now, at first blush you’re probably thinking “So what?”  If your busines goes bankrupt you won’t really be caring whether the bank or the government gets to pick at the bones first.  However, these cases do provide an opportunity to remind you that it may be worthwhile to grant security for any amounts you spend to start up your business.  For example, when I first started up my law practice, I had a loan given to me by a relative.  Even though I expected (and did) pay back the start up monies quite quickly, I ensured that my relative had a security agreement in place (and registered) to protect my relative’s interest.  If problems ever arose then I knew that my relative would have a chance of getting repaid before any other creditors. 

Let’s suppose that your business is operated by a corporation.  You may have personally advanced start up capital to your company which then usually takes the form of shareholder loans.  The rule that business gurus mention all the time is “pay yourself first”.  The reality, though, is that this is rarely followed with the result that the entrepreneur puts a lot of money into his/her business and is usually the last one to be paid.  If that’s the case, AND if you don’t have security, then the reality is that you will likely receive little to nothing from the business should it fail.  However, if your business grants to you a security interest in its assets, then you may have a chance of getting paid something if the business should ultimately fail.  And, based on these cases, you’ll have a better chance of getting paid than the government – at least until they change the bankruptcy or tax laws to change the result of these cases

Giving yourself security for monies you put into the business … something to think about.

CALC

It has been a long time since I studied law in Quebec and I make no efforts anymore to even try to keep up with the changes in Quebec law – nor do I advise on Quebec law anymore.  However, it is not uncommon for my clients to have Quebec subsidiary companies or affiliates or to otherwise be involved with Quebec companies from time to time (for example, being asked to be a director).  So, for the benefit of those persons, I am passing on a link to a web site for one of the larger firms in Quebec that highlights new changes that are being proposed for Quebec’s companies legislation that may be of interest.

You can find the summary here.

CALC

I was reading the latest issue of the Business Law Reports and it has a decision from late last year of the Ontario Divisional Court regarding shareholder agreements.  There is nothing particularly earth-shattering about the decision, but it does serve as a good reminder that if you wish to have a shareholder agreement upheld then you should have each party to the agreement obtain independent legal and financial advice.

In Masciathe parties had a shareholders agreement that dealt with the terms in which the parties could go their separate ways.  Dr. Mascia complained that the terms were an unfair penalty and the application judge agreed and relieved Dr. Mascia of the strictness of the terms.  The Divisional Court disagreed.  The burden of proof that the terms were an unfair penalty lay with Dr. Mascia and there was an initial presumption that shareholder agreements were fair.  As stated by the court:

        Generally, courts will not interfere with an agreement made by sophisticated parties acting at arms’ length and, in particular, will not set aside a shareholders agreement “that has been entered into in good faith by experienced persons who have had independent legal advice”: Kabutey v. New-Form Manufacturing Co., [1999] O.J. No. 3635, at para. 12 (S.C.J.). Where parties have agreed upon a formula for determining the price at which departing shareholders will be bought out of a company, the expectation is that they will live with that formula.

      When he entered into the shareholders agreement, Dr. Mascia had the benefit of both independent legal advice as well as independent financial advice. He negotiated the terms on which he was prepared to invest in Dixie. …

In these circumstances, then, the court upheld the terms of the agreement.  The upshot is that if you wish to enforce the terms of a shareholders agreement and to defend against any attack that claims that the agreement is unfair, one of the easiest ways to do so is to ensure that the other parties get independent legal and financial advice.  This is a prudent way to proceed in any event, but Mascia shows how important this prudent approach can be when a fight later occurs among the parties.

CALC

An interesting occurrence has been happening lately.  I have received at least one phone call or e-mail per day for the last few weeks for people seeking to incorporate new companies.  Given the current economic climate, this would appear to be counter-intuitive – when times are bad, people want to keep their jobs, not go out and start new businesses.  The answer to this apparent quandary is if we suppose that a person was “downsized”, “rightsized”, “capsized”, whatever, and is given a severance package of, say, six months.  After three or four months of searching for a new job, the person discovers that there aren’t any other jobs out there and if he/she wants to make money to keep going in a few months, they’d better create their own job.  Hence all the calls and e-mails now.

The primary question I am being asked lately is: how much is this going to cost me? The answer is that the general cost is: (a) legal fees of $900; plus (b) GST of $45; plus (c) filing fee for articles of incorporation – between $300 and $360 – depending on whether you do an Ontario or a federal incorporation; plus (d) approximate cost for a minute book of $200 (including one set of share certificates); plus (e) the cost of obtaining a NUANS search of $30 – which is not required if you go with a numbered name (for example, 1234567 Canada Inc.).  Total cost: $1,545 including all taxes (assuming the highest incorporation fee and a NUANS search).  Also, this assumes a relatively straightforward incorporation.  If you start getting into multiple classes of shares with different share attributes, etc., etc., the cost for the legal fees goes up – the more complicated, the more expensive.  Now, the first thing you’re going to do is to have your jaw drop and think “Holy Smokes! (or something like that) I can go down to the paralegal who is advertising incorporation for only $400.”  Let’s make sure, though, that you are comparing apples to apples and not apples to oranges. 

The first thing that you see is that the advertisement says “$400 for incorporation” and usually has an asterisk that if you look down at the bottom of the add will then say “plus applicable filing fees and taxes”.  So, you’re looking at $400, plus the $300 to $360 for the filing fee, plus the GST.  This means that, right away, $400 is really $400 plus $20 for GST plus $360 (again, assuming the highest cost for the filing fee), or $780. 

The second thing is to realize that you are paying for an incorporation – nothing more, nothing less.  The end result is that you will get a copy of the Articles of Incorporation and that’s it.  There will be no by-laws, no resolutions to create shares and issue them to shareholders, no election of directors, no appointment of officers, no appointment of accountants or auditors, no setting up bank accounts – all of which is known as “organizing” the company.  If the company is not organized, this can have huge impacts (and huge costs) down the road if the company ever gets audited by the tax man, or you wish to sell the company or do estate planning, etc.  Ultimately, the $1,545 you pay today is less than the amount you’ll have to pay later to fix things up retroactively – assuming that this can even be done in the circumstances.

CALC

The Supreme Court of Canada dismissed an application for leave to appeal last week in the case of Frye v. Sylvestre.  This upholds, then, a decision this past September of the Ontario Court of Appeal.

In this case, the father built up his business and decided to leave the shares of the company equally to his five children.  One of the children later decided to sell his shares back to the company with the result that the remaining four children held 25% of the shares each.  Another child subsequently died and left his shares to his sister.  This would result in the sister holding 50% of the shares and the other two brothers holding 25% each.  The wrinkle, however, came from the fact that the articles of incorporation (known in those days as “letters patent”) and a shareholders agreement that had been signed by the deceased brother both restricted the right to transfer shares in the corporation and required the approval of the Board of Directors and a majority of the other shareholders before the transfer was valid.  The brother argued that the proposed disposition of the shares in the will from the deceased brother to the sister was null and void.

The Ontario Court of Appeal held that the disposition of the shares was not null and void.  Rather, there was a two-step process to be completed.  Section 67 of the Business Corporations Act (Ontario) provides that where a shareholder dies, his/her executor takes over holding the shares.  The result in this case was that the deceased brother’s shares were held by his executors.  However, since the will had indicated that the shares were to go to the sister, the executors were required to either transfer the shares to the sister – if this could be done in accordance with the requirements of the articles and the shareholders’ agreement – OR the executors were to hold the shares until such time as they could be properly transferred to the sister and in the meantime to act as directed by the sister (who was the beneficiary of the shares).  The result was that either the sister would get outright 50% control over the company if the transfer could be effected in accordance with the articles and the shareholders agreement, or she would remain with direct 25% control from her personal shareholding and indirect 25% control from her ability to direct that the executors do as she wished.

By dismissing the application for leave to appeal, the Supreme Court has upheld the Court of Appeal’s decision.  The result is that where there are restrictions on share transfers, one way around this may be to give the shares to the transferee through a bequest in your will.  As our population ages, this may become a more interesting option.  However, it should be remembered, though, that in doing this you need to ensure that whomever is your executor is capable of handling such shareholding duties (for example, what if you want to leave the shares to a child who is incapable of deciding how to vote his/her shares) or to ensure that the will provides sufficient instructions to the executor so that there is less of a chance of a dispute between the executor and the beneficiary as to how the shares are to be voted.  As well, the fact that the shares form a part of the estate through this option could also lead to estate taxes or probate fees for the value of the shares – which might not be optimal.  That said, it does provide for an interesting option to avoid restrictions on share transfers.

CALC

An old saying is “He Who Waits is Lost” – in other words, if you don’t act quickly, it might be too late.  That principle was applied last week in a decision by the Superior Court on an arbitration matter.

In Bouchan, two dentists formed a professional corporation and one of the dentists then became disabled and had to stop practising.  A dispute arose between the dentists as to certain amounts to be paid (a fight over money, whoda thunk it?!).  In any event, the shareholders agreement provided for arbitration and when the one dentist sought to have a lawsuit stopped and have the parties only go forward with arbitration the Court denied the request.

Mr. Justice O’Marra gave two reasons for the denial.  The first was that an arbitration will only be mandatory under the Ontario Arbitration Act where the subject-matter of the dispute is one which is covered by the arbitration provision.  So, in this instance several claims were advanced by the plaintiff.  Many dealt with whether certain payments should be made by the defendant dentist to the plaintiff dentist.  Justice O’Marra held that these disputes were ones which fell within the arbitration provision that required arbitration for any dispute that arose over “the interpretation” of the agreement.  However, the plaintiff also alleged that the defendant had acted in an oppressive manner and that the plaintiff was therefore entitled to relief from that oppression pursuant to the “oppression remedy” found in Section 248 of the Business Corporations Act.  That issue did not deal with interpretation of the agreement and therefore fell outside of the arbitration provision and thus was not required to go to arbitration.  Since part of the claim did not require arbitration, it made sense to have everything dealt with at the same time, so the request for arbitration was denied.

Justice O’Marra went further, though, and held that even if all of the issues were covered, the defendant dentist was too late in requesting that the lawsuit be stopped and sent to arbitration instead.  In this case, the parties had exchanged pleadings and several other procedural steps before the defendant said that they should go to arbitration.  This was too late for Justice O’Marra who accepted that the rule should be that if you want an arbitration, you should ask for it right away and if you take any steps in the lawsuit, such as even serving a Statement of Defence, then you’re in the lawsuit and it’s too late to force the matter to arbitration.

Arbitrations are generally faster and less costly than full-blown trials.  It is now quite common to find many agreements that contain arbitration clauses.  However, the Bouchan decision helps to show that such clauses and the rights provided under them are fragile and can be easily lost.  As times get tougher and businesses start to fight over failed commercial relationships, a first question you should ask yourself (and tell your lawyer) is whether there is an arbitration agreement.  If you do not, you could be stuck with a more costly lawsuit.

CALC

Today’s Globe and Mail reports online a comment from the leader of the Ontario New Democratic Party, Howard Hampton, regarding the bailout of the three North American automobile manufacturers.  It says:

“Ontario NDP Leader Howard Hampton said he would like to see the government take some shares in the companies in return for the loans.

“If, worst case scenario happens and one of these companies goes under, you’ll want some assets.”

A clearer example of someone NOT understanding how the system works couldn’t be found.  As a shareholder, the shareholders are entitled, upon a dissolution or a bankruptcy, to a division of the equity of a company.  However, while the equity comes from “some assets”, it is only those assets which are left over after all of the creditors have been paid.

If the auto makers need bailouts – and that is the case for Daimler-Chrysler and G.M. (but in Canada, for the moment, not for Ford) – then that means that they are insolvent.  Insolvency, as defined in the Bankruptcy & Insolvency Act, is the inability to meet your financial obligations as they come due.  In other words, you can’t pay your bills.  So, if their liabilities exceed their assets, then there are no assets left to pay the shareholders.  It’s therefore all well and good for Mr. Hampton to say that the federal and provincial governments should take shares, but if the shareholders are the last ones to ever get paid (and likely wouldn’t ever get paid if the “worst case scenario” happens) then the shares are worthless pieces of paper.  Instead, the governments should have the opportunity of converting their loans (ie. debt) into shares (ie. equity) if and when the auto manufacturers turn the financial corner.

So, what does this mean for your business?  Well, again, it is great for you to have all sorts of shares in the company or other forms of equity.  But, if things start to go downhill, then your shares mean that you have a one-way ticket to the back of the line behind the other creditors.  Instead, you should think about making loans to the company rather than taking an increased equity position in the business.  To make things even better, have the company grant security for the loans and have that security registered with the personal property security registry.  That way, if things do go badly, you may not have a position at the front of the line, but you will not be guaranteed to be at the back of the line.  Similarly, the loan agreements can give you the right to convert your loans into equity later on if the business does well.  That way you can cover the good and the bad times.

CALC

I happened to be browsing a newspaper today in Toronto that is very well known for its sports section and if you are right-wing type of person who likes pictures of women in bikinis then this is your newspaper.  Honest, I picked it up for the sports section.

In any event, I happened to be flipping through its classified section and an ad caught my eye that said something to the effect of “Incorporations – Same Day – $200″.  This is truly “buyer beware”.  Why?  Because if all I had to do was pay $200, that wouldn’t cover the filing fee for articles of incorporation (which in Ontario the last time I checked were $300 if you filed electronically and $360 if you filed over the counter).

Oh, so what it really means, then, is $200 fee PLUS the out-of-pocket expenses like the filing fee.  OK, just a little miscommunication there, I get it now and all is right with the world.  Um … er … well, nope.  “Same day”.  Yes, most likely, but that is if you want a numbered company – for example, 1234567 Ontario Inc.  If you want a named company – for example “Caruana Corporation” – then you need to obtain a NUANS search AND there cannot be any sufficiently similarly named companies.  Using my example, let’s say someone else had “Caruana Incorporated”, then I would have to pick another name.  That is likely to take more than 1 day and even this also assumes that the NUANS search report can be obtained right away.  The end result is that it is only guaranteed “same day” if you have a numbered company, and if you want a named company then there cannot be such a guarantee.  Oh, another little miscommunication.

Then we have the biggest miscommunication of them all.  I have had several clients come in over the years who incorporated with an operation like this and, yes, that is exactly all that they got – an incorporated company and the original copy of the articles of incorporation.  As I have previously explained to my clients, think of it like this:

- the incorporation is like giving birth to a person who has a skeleton, skin, hair and internal organs – but nothing else.  The company is “alive”, but it cannot do anything.

- ORGANIZATION of the company (through the allocating of shares to shareholders, the passing of by-laws, the holding of the first directors’ and shareholders’ meetings at which resolutions are passed, applying for a business number with Revenue Canada, etc.) is the equivalent of giving this new person muscles, a brain and a nervous system that now allows the person to actually DO something (and, in this case, gives the actors – directors, officers, shareholders – by which those things can be done).

In the case of the ad I saw, $200 will get you the incorporation (ie. creation of the company) – that is after you pay the other expenses.  But most people when they think of incorporation, they actually think of both incorporation and organization.  They expect that when they walk out of the office they have a corporation that exists and is authorized to do things like open bank accounts and sell goods and pay taxes, etc.  However, in this case, the offer is $200 solely to do the incorporation – the organization of the company is not included.  Again, another little miscommunication.

Why does this matter?  As an example, I recently had a client come to me.  The client is a very good client who has run a reputable business for well over a decade.  I looked at the client’s corporate records and realized that not only had the client not been properly organized, but the client also had not passed any annual resolutions since the corporation was first incorporated – being almost 15 years ago.  The end result was a quite hefty legal bill while I figured out what had happened and cleaned everything up.  Far more than the client initially saved of approximately $600 by going with a “$200 to incorporate” operation.

This is not to say, however, that such places are a scam.  BUT, before you decide to go with such an operation, you should definitely ask what all the costs are and determine if the service being offered is both incorporation and organization or only the incorporation.

CALC