The Default StructuresSo, you want to start a business and can’t wait to build that new prototype of your ground-breaking, market-disrupting product. Maybe this is a joint effort, and you get together with some tech savvy friends, and borrow some seed money from yet more friends to get started. So, what’s the problem here?
When you start a business by yourself (a Sole Proprietorship), there is no distinction in the eyes of the law between yourself and the business. Taxes are filed together, money earned is considered personal income, and most importantly, obligations of the business are your personal obligations. You are personally on the hook for everything the business does or does not do. This is the first default way of doing business.
When you get together with others to “carry on a business in common with a view to profit” you’ve triggered the second default way of doing business, by entering into a Partnership. Like the previous default structure, there is no distinction made between the business and the partners. Partnership income is the same as the partner’s income, but with the added catch that if no agreement is made between the partners, that income (or loss) is to be divided equally among the partners. The Partnership Act governs some of the key elements, but the interpretation of the above underlined terms is found in the case law.
In addition, partners owe to each other stringent fiduciary duties that compels them to act in the best interests of the partnership. In practice this includes: not competing with the partnership, the sharing of any benefits accrued from the partnership, full disclosure of information pertaining to the partnership, and confidentiality, among others. Liability incurred by the partnership for wrongs committed against a third party is also joint and severable between the partners. This means that an injured third party may claim against any partner for the full quantum of damages.
There surely are some benefits for using these default structures but that is a topic for another time. However, one of the biggest risks is the personal exposure to liability.
The Corporate Form
A popular alternative to the above default structures is the corporate form. This is not a default way of doing business because it requires positive procedural steps to trigger its formation. A corporation does not arise automatically from indirect actions of the involved parties. To start a corporation, you must follow procedures in a Business Corporations Act. There is both a federal and provincial version of this act with a large degree of similarly (albeit there are some differences too). Incorporation can be done under either of them, but not both simultaneously.
The main benefit of the corporate form is that it effectively splits ownership from management in the eyes of the law. This gives the corporation “legal personhood”, sometimes also called a “juridical person”. A corporation therefore is considered a separate entity that files taxes, declares income, borrows money, and incurs liability on its own, separate from the true owners. The owners in this case are the “shareholders”, and the management of the corporation is led by the “board of directors”. The trick here is that the owners are protected from liability above the amount they have invested in the corporation. This protection is known as the “corporate veil”. Only on very limited and extreme occasions is the corporate veil breached by a Court to hold the owners personally liable for an action of the corporation.
Ownership of a corporation is therefore comparatively less risky, which facilitates activities such as obtaining new investment from people looking to buy shares or from institutions looking to lend capital. Another benefit is that ownership does not preclude the individual from also being a manager or employee. However, unlike the owners, individuals acting as managers do have to contend with other legal duties and potential liability.
The shareholders maintain control over the board of directors by using statutory mechanisms in the Business Corporations Act and also through provisions in the “articles of incorporation”. The articles are akin to a corporate constitution, and it will govern the relationship between the owners and managers. It does this through restrictions on what the company can and cannot do, and through the rights associated with the shares that a company can issue.
The distribution of liability between the managers depend on the scope of their relationship to the company. The board of directors will carry the largest burden because they are ultimately responsible and in charge of making strategic decisions for the corporation. In addition, they owe a fiduciary duty of loyalty and care to the corporation itself. In practice, this often means that they attempt to maximize benefits for the shareholders. To attract and retain competent directors, a corporation will typically indemnify directors for liability that they could personally incur so long as they were acting in good faith and did not breach their fiduciary duties.
Senior officers include managers that are hired and appointed directly by the board of directors. Officers owe a fiduciary duty to the corporation because their influence over the affairs of the company are analogous to that of the directors, and because they are included alongside directors under the fiduciary provision in the Business Corporations Act. Other managers of a corporation may also owe a fiduciary duty to the company, but the scope of the duty will be circumscribed by: 1) the degree of influence they exert over the daily operations, and 2) the terms in their employment contract. As a general rule, the more senior and influential a manager is, the more likely they will owe a fiduciary duty and the greater the scope of that duty.
Finally, the employees of a corporation generally do not owe any additional duties to the corporation beyond those that arise from general principles under the common law, and through their employment contract. This often means that any non-competition, non-solicitation, and confidentiality restrictions on an employee are spelled out in a contract.
 Partnership Act s.15
 Alberta Business Corporations Act [“ABCA”] and Canada Business Corporations Act [“CBCA”]
 Salomon v Salomon & Co.
 Lee v Lee’s Air Farming Ltd.
 ABCA s.122
 International Corona Resources v Lac Minerals
 ABCA s.122
Blog posts are by students at the Business Venture Clinic. Student bios appear under each post.