 Hello, it's Waylon Chow and this is Forms of Business Organization Module 5, Part E. In this part, we will look at the remaining key legal aspects of corporations. There are a number of legal rights that come along with being a shareholder. The first is a right to corporate assets that remain after all creditors are paid on the dissolution of the corporation. Another right is the right to vote to elect directors to appoint auditors and to approve on proposals. Now, one note to keep in mind is that this right to vote only applies to shares that have voting rights. There is no right to participate in managing the business of the corporation if you are a shareholder. The shareholder's right to vote is exercised at an annual meeting. A corporation is required to hold an annual meeting at least every 15 months. At this meeting, the directors are elected and also an auditor is appointed. The auditor is usually an accounting firm that is responsible for auditing the financial statements of the corporation. At this meeting, the financial statements are also presented and discussed. Now, for corporations with a small number of shareholders, we can dispense with the need to do an annual meeting by just assigning resolutions instead. For public corporations, shareholders can attend the annual meeting either in person or by appointing a proxy. A proxy is usually done by the shareholder filling out a proxy form and indicating how they want their shares voted in terms of who they want elected as director and who is going to be appointed as auditor or any other proposals that are on the table to be voted on at the annual meeting. Now, the way the proxy is given or sent out to the shareholders is by way of a document called a proxy management circular which is sent out a number of months in advance of the annual meeting. If you have shareholders who disagree with proposals made by management and these shareholders are typically called dissident shareholders, they have the ability to send out a dissident circular to all shareholders for them to consider their views. Shareholders also have a legal right to certain information. They can have access to the articles of incorporation, the corporate bylaws, the minutes of shareholders' meetings and shareholders' resolutions. They can also have access to the share register showing who are the owners of all the shares of the corporation. They also have access or have a legal right to see the audited financial statements of the corporation. Now, with private corporations, the shareholders can unanimously agree to dispense with the audit requirement. So the reason that they would do that is that an audit usually costs quite a bit of money. With a private corporation, it's not legally required to have audited financial statements while with a public corporation, audited financial statements are a must. Sometimes something happens with a corporation that a shareholder disagrees with or it has a negative impact on particular shareholders, especially minority shareholders. Now, what can that shareholder do? What remedies does it have? There are a number of different remedies that are available to a shareholder. The first is called a derivative action. So in a derivative action, the shareholder would sue on behalf of the corporation. So it would be suing in the name of the corporation, not the shareholder's name. And it would be suing to seek relief for a wrong that has been done to the corporation. The wrong usually could be either a breach of a duty of care or fiduciary duty by the officers or directors. So we'll talk in more detail about this duty of care and fiduciary duty a little later on. The second remedy that a shareholder may have is called the oppression remedy. Here, this also involves suing in court with an oppression remedy in contrast to the derivative action. The shareholder sues in their own name, not the corporation's name. So the oppression remedy applies when actions by directors or the corporation have oppressed or unfairly disregarded or prejudiced the shareholder's interest. So that phrase has been interpreted fairly broadly. Now, one way to look at that phrase is that we focus on the reasonable expectations of the shareholders. If the reasonable expectations of the shareholders about the way the company should be run by management have not been met, then the affected shareholder could use the oppression remedy to stop or get damages for that behavior. Some examples of oppressive actions. Now, I've mentioned before that what is considered to be oppressive is quite broad. So these are just merely examples of types of behavior that the courts in the past have found to be oppressive. So one example is the approval of a transaction that is lacking a valid corporate purpose that is prejudicial to a particular shareholder. Failure by the corporation and its controlling shareholder to ensure arms length terms for a transaction between them. So if this is referring to let's say the corporation enters into a deal to sell or buy a certain asset from a controlling shareholder and the price that's agreed to is not a price that normal arms length parties would agree to. In other words, it's not a market price then a minority shareholder could sue using the oppression remedy to stop that transaction. Another example is actions that benefit the majority shareholder but not minority shareholders and also a lack of adequate disclosure of information to minority shareholders or any kind of plan that would involve eliminating the minority shareholder. Another remedy available to a shareholder is liquidation or dissolution or another way of describing it is winding up the corporation. So what this involves is a court ordering the dissolution of the corporation. So because it involves basically eliminating the corporation this is only available in extreme situations such as where we have for example two shareholders who cannot in any way agree on how the corporation should carry on its business. The fourth available shareholder remedy is called dissent and appraisal. So this remedy is available to shareholders who disagree with a fundamental change to a corporation. So a fundamental change could be a major amendment to the articles in the corporation or a sale of most of the corporation's assets. So what this involves is the dissenting shareholder can ask to have their shares bought back by the corporation at their market value. So the drama now continues at Lucy's Lemonade Corp. So with the money and guidance of the dragons Lucy's Lemonade Corp expands with locations across Canada and is very profitable. The board of directors controlled by the dragons decide it is now a good time to take the corporation public by offering to sell 1 million shares for $10 each to the public and having Lucy's Lemonade Corp shares listed on the Toronto Stock Exchange. Lucy disagrees with this idea. She feels that going public would dilute her percentage ownership of the corporation and thus diminish her ability as CEO to run the business the way she wants. Lucy also feels that the price of $10 per share is too low. What are Lucy's legal options? Please pause the video at this point so that you can consider this question. What are Lucy's legal options? She can use one or more of the available shareholder remedies. The first remedy is the derivative action. Lucy can try to stop the corporation from going public by suing on behalf of the corporation using a derivative action. She would need to argue that number one, the directors did not exercise reasonable care in deciding to go public. In other words, they breached their duty of care and or number two, the directors are not acting in the best interest of the corporation by going public. In other words, the directors are breaching their fiduciary duty to the corporation. For example, Lucy can argue that the directors did not exercise reasonable care in pricing the shares at the low price of $10 and that selling the shares at that price is not in the best interest of the corporation. The second shareholder remedy that Lucy can consider is the oppression remedy. Lucy can sue in her own name using the oppression remedy in order to try to stop the corporation from going public. She would need to argue that as a minority shareholder, the plan to go public would unfairly prejudice her interests by diluting her shareholding and diminish her influence over the management of the business. The third remedy that Lucy can consider is dissent and appraisal. So instead of trying to stop the corporation from going public, Lucy can use dissent and appraisal to force the corporation to buy out her shares at marked value. Basically she would be asking to be cashed out and walking away from the corporation. Both the directors and officers owe fiduciary duty to the corporation. What that means is that they must act honestly and in good faith with a view to the best interest of the corporation. Now, what is considered to be the best interest of the corporation? The Supreme Court of Canada has said that the best interest of the corporation may be determined by considering the interests of not just the shareholders, but also the interests of employees, suppliers, creditors, consumers, governments and the environment. In other words, the Supreme Court is saying that a corporation has to be a good corporate citizen in order to determine what is in the best interest of the corporation. Now, what directors and officers are required to do with under their fiduciary duties is that they always have to put the corporation's best interests ahead of their own personal interests. Let's now look at various potential breaches of fiduciary duty. The first is transacting with the corporation. So when a director or officer enters into a transaction with the corporation that they work for, it creates what we call a conflict of interest. The conflict is between the director or officer's personal interests versus the interests of the corporation. So the director and officer's personal interests is to negotiate the best deal for himself. And that personal interest conflicts with the director's and officer's fiduciary duty to the corporation, which is to get the best deal for the corporation. Now, the way that a director and officer can avoid a conflict of interest in this type of situation where they are entering into a transaction with the corporation is to either just to avoid it altogether, do not enter into any kind of transaction with the corporation that you work for. Or the other way to deal with it is to give full notice or disclosure of the conflict of interest. So if you are a director, you're entering into a contract with the corporation, give full disclosure to the corporation and to the board of the conflict of interest and then excuse yourself from voting on the approval of that transaction or not be involved at all in reviewing or approving that transaction. So by doing that, you avoid that conflict of interest. Another potential breach of fiduciary duty is when a director or officer personally takes advantage of a business opportunity that properly belongs to the corporation. Now, when is an opportunity considered to belong to the corporation? A number of factors have been considered by courts as being relevant in determining that. One of those factors is the significance of the opportunity to the corporation. The more significant it is to the corporation's business, the more likely that it will be viewed as belonging to the corporation. Another factor is whether the opportunity was a private one. In other words, was the opportunity publicly advertised or otherwise widely known, or was it just known to a small number of people or small number of corporations. And a third factor that is considered is if the opportunity has not been rejected by the corporation, that's a fact that indicates that the opportunity still belongs to the corporation and the director or officer cannot take personal advantage of that opportunity. And a third potential breach of fiduciary duty is when the director or officer competes on a business level against the corporation that they work for. The rule is that a director or officer cannot compete against the corporation as long as that director or officer is still a director or officer of the corporation. So what that means is that if the director or officer quits or resigns from the corporation, then they're no longer subject to this fiduciary duty and they can compete against the director or officer subject to whatever non-competition agreements that they may have entered into when they originally were hired as a director or officer. Now, a related breach of fiduciary duty is when a director or officer, they may resign and then they go into competition with the corporation. But if in doing that, if they use confidential information that they obtained while they were with the corporation, that could be considered to be a breach of fiduciary duty. A common situation where directors and officers fiduciary duty comes into play is where one company has made a hostile takeover bid of another company. So this usually involves publicly traded companies where one company without the invitation of what we'll call the target company has started trying to buy up a controlling number of shares in order to take control of the target company. Now, when that type of situation happens, there is a potential conflict of interest for the directors and officers of the target company. Because in terms of their personal interests, they usually don't want the other company to take over the target company because they'll likely lose their jobs once the company is taken over. But their fiduciary duty to act in the best interest of the corporation, the target corporation could be to support the bid if it's in the corporation's best interest, especially the shareholders' best interest in terms of getting a high price to sell their shares to the acquiring corporation. Now, the way hostile takeover bids are dealt with to avoid this conflict of interest, what could be done is to have a committee of independent directors consider the takeover bid. So independent directors are those who have no other connection to the corporation. They are not officers of the corporation, so they are considered to be purely independent. So that committee of independent directors would consider whether the takeover bid is a good one or a bad one. Let's go back now to Lucy's Lemonade Corp, which is now a publicly traded company on the TSX. So Lucy was unable to stop the corporation from going public. She is still the CEO of what is now a public corporation. There is a new board of directors elected by the new shareholders. Lucy is no longer a director. As CEO, Lucy puts forward a business proposal to the board to enter the market to sell packaged lemonade in grocery stores. That market is currently dominated by companies like MinuteMade and Tropicana. The board rejects the proposal. While still working as the CEO of Lucy's Lemonade Corp, Lucy decides to start her own new company to pursue this business idea. The question is, is Lucy in breach of her fiduciary duty to Lucy's Lemonade Corp? Please pause the video to take a moment to consider this question. So Lucy, as an officer of Lucy's Lemonade Corp, owes a fiduciary duty to act in the best interest of that corporation ahead of her own personal interest. So generally, personally pursuing a business opportunity that came first to the corporation would be a breach of fiduciary duty. However, since this business opportunity to sell packaged lemonade was rejected by the board of Lucy's Lemonade Corp, Lucy should be now free to personally pursue this opportunity. In addition, as a matter of caution, just to avoid any kind of accusation of breach of fiduciary duty, Lucy should openly disclose the fact that she is pursuing this opportunity outside of the corporation to the board of directors of Lucy's Lemonade Corp. In addition to a fiduciary duty, the directors and officers also owe a duty of care to the corporation that they work for. Now this duty of care is very similar to the one that we looked at in relation to negligence towards in module 3.2. This duty of care requires that every director or officer must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. Now more specifically, let's say for a director, this duty of care would include the director having a basic understanding of the business or to acquire that understanding. If you are hired as a director or appointed as a director for a corporation, you have an obligation to get to know that business in order to be able to properly make decisions regarding that corporation. Another aspect of duty of care is that the director should keep informed about the corporation's policies and its business. The director should regularly attend board meetings. And a director with a higher level of knowledge or experience, let's say if you are a director for a mining company and you happen to be a geologist, you are held to the higher standard of knowledge and experience that you have as a geologist and therefore you have to meet a higher standard of care because of that. In applying this duty of care to directors and officers, the courts have clearly said that it will not second guess the business decisions of directors and officers where they have acted reasonably and the decision was within the range of reasonably available alternatives. So this is called the business judgment rule. So in effect it's saying that we don't expect directors and officers to have a crystal ball and to absolutely be perfect in making their decisions, but we only expect them to act reasonably and make a decision within the range of reasonably available alternatives. So one thing I'd like you to think about is if the company called or used to be called Research in Motion, which is now called Blackberry a couple of years ago, they decided to come out with their own tablet called the Blackberry Playbook to compete against the Apple iPad. So the Blackberry Playbook failed miserably. So a query did the directors and officers of Research in Motion exercise their duty of care in deciding to compete against Apple by producing the Blackberry Playbook tablet. So give that some thought on your own. So back at Lucy's Lemonade Corp. So let's say instead of rejecting that proposal to sell packaged lemonade through grocery stores, the board of Lucy's Lemonade Corp actually did approve that proposal. However, this business venture turns out to be a resounding failure due to the dominant companies in this market. It was very difficult for Lucy's Lemonade Corp to get shelf space in grocery stores as well. Manufacturing the packaged lemonade with the same taste as the lemonade sold in the stores proved to be much more difficult than anticipated. The packaged lemonade tasted sour and had a bad aftertaste. Question is, did the officers and directors fulfill their duty of care to Lucy's Lemonade Corp in approving this proposal to market the packaged lemonade? Please pause this video so you can consider this question. So did the officers and directors fulfill their duty of care to Lucy's Lemonade Corp? We would need to find out whether or not the directors and officers exercise their due diligence in investigating and planning this business venture to market packaged lemonade. So we need to ask, did they investigate how to get shelf space in grocery stores? Did they conduct taste testing of the packaged lemonade? Did they investigate various packaging and manufacturing processes? Those are only a few examples of the types of questions that we would need to look into to determine whether or not the directors and officers exercise due diligence. Although a court will be reluctant to second guess the business judgment of the directors and officers under the business judgment rule, it will still assess whether they acted reasonably and within the range of reasonably available alternatives.