 Hello, it's Waylon Chow and this is Basic Forms of Business Organization Module 4a Part D. In this part, we will begin our examination of the corporation. In particular, look at how a corporation is formed and start looking at some of the key legal aspects of a corporation. Let's now look at corporations. How is a corporation formed? If you are in Ontario and you want to form a business corporation, you need to decide whether you want to form your corporation as a provincial corporation under the Ontario Business Corporations Act or OBCA, or form a federal corporation under the CBCA or Canada Business Corporations Act. If you choose to form an OBCA corporation and if you are operating just in Ontario, then everything is fine. But if you do want to operate your OBCA corporation outside of Ontario in other provinces in Canada, you are able to do that, but you need to take an extra step of obtaining extra provincial licenses in each province that you will operate in that is outside of Ontario. If you choose to form a federal CBCA corporation, that allows you to operate anywhere in Canada without need for any additional licenses. So once you've decided to form an OBCA or CBCA corporation, the next step is to pay the appropriate fee and file various documents at the appropriate federal or provincial government office. What you need to file is a document called Articles of Incorporation, and you also need to file a name search report on the proposed name of your corporation. So that name search report will indicate whether or not that proposed name is already being used by someone else. So once you file those documents along with the fee, a certificate of incorporation is issued. So that marks the birth of the corporation. So this certificate is like the equivalent of a birth certificate, except it indicates the birth of this corporation. One of the documents that needs to be filed to form a corporation is the Articles of Incorporation. So the articles are usually prepared by a corporate lawyer and would contain the fundamental characteristics of the corporation, which would include the name of the corporation, the different classes and numbers of shares are authorized to be issued by the corporation, the number of directors that will be on the board of directors that manages the corporation, and any restrictions on the transfer of the ownership of the shares, and also any restrictions on the business that the corporation is allowed to carry on. There are generally two types of business corporations, public corporations and private corporations. Public corporations issues its shares to the general public, and those shares are listed on a public stock exchange, like the Toronto Stock Exchange. So that means that any member of the general public who has a brokerage account is able to buy and sell those shares on the stock exchange. Because the shares are available to the general public, public corporations are subject to an extra layer of government regulation under provincial securities law. Private corporations are essentially corporations whose shares are not listed on a public stock exchange. So the number of shareholders is usually much smaller than with a public corporation, and generally a private corporation because it does not meet the requirements of securities law, cannot issue shares to the general public. The key legal aspects of a corporation are, most significantly, it is a separate legal person, and there is limited liability for the shareholders of the corporation. Within the corporation, there is a separation of the ownership roles and the management roles. And like with a partnership agreement, for a corporation, it's highly advisable, highly recommended, that the shareholders have an agreement. We'll also look at shareholders' rights, shareholders' remedies. So these are the remedies available where a shareholder has to go to court to protect his or her interests. Another legal aspect is the directors and officers of fiduciary duty that they owe to the corporation, and also the directors' officers' duty of care. How well do they have to do their job? In contrast to a sole proprietorship or a partnership, a corporation is a separate legal person. It is separate from its owners, the shareholders. So a corporation, because it is a separate legal person, can do almost anything legally that a human person can do. It can carry on business, it can own property, it can possess rights, and it can incur liabilities. A shareholder can be an employee or creditor of a corporation, and that's because the corporation is a separate legal person. The corporation can hire a shareholder as an employee or the shareholder can lend money to the corporation because the corporation is a separate legal person. And because it is a separate legal person, a corporation can live on even if the original shareholder dies or withdraws from the business. The second key legal aspect is the limited liability of shareholders. Because a corporation is a separate legal person, any debts of a corporation is a debt of the corporation, and shareholders have no liability for the corporation's obligations or debts. So that would include obligations arising from contracts and also torts. However, it's quite common, especially with a private corporation, that a shareholder provide a personal guarantee for a corporation's debt. And because of that personal guarantee, the shareholder can be made personally liable for that debt. Quite often, a bank will ask for that personal guarantee, especially if the corporation, which is the borrower, does not have a sufficient credit rating or doesn't have sufficient assets or maybe revenue history for the bank to confidently lend to the corporation without that guarantee. The creditors of a corporation can only claim against the assets of the corporation because the corporation is the one that owes the money, not the shareholder. So that means the shareholder's personal assets are not at risk unless, of course, the shareholder has provided a personal guarantee of a corporation's debt. So a shareholder's liability, or in other words, the amount of money that it can potentially lose, is limited to the amount that the shareholder paid for his or her shares. There is an exception to this limited liability of shareholders. So this is where a court may, what we call, pierce the corporate veil to impose a corporation's liability on a shareholder. In other words, to make a shareholder personally liable for a debt of the corporation. So a court will only do this rarely, but where there is serious wrongdoing or unfairness, or in particular, if there's some kind of fraud where the corporation is used to perpetrate the fraud, then a court will ignore the fact that the corporation is a separate legal person and make the shareholder personally liable by piercing the corporate veil. With a corporation, we have at the very top of this diagram the shareholders who are the owners of the corporation, and if they are common shareholders, they have the ability to elect the directors of the corporation. So those directors form the board of directors, and the board of directors has the power to appoint the officers of the corporation, and the board has the responsibility of high-level supervision and management of the corporation. So the officers that are appointed by the board of directors are typically called the executives. So these would include the CEO, CFOs, and various VPs, vice presidents. So these officers are the ones that are responsible for the day-to-day management of the business of the corporation. Now, there is a separation of ownership and management with a corporate structure. The ownership is represented by the shareholders, and the management is done by the board of directors and the officers. So the board of directors takes care of the high-level stuff and the officers take care of the day-to-day management. Now, one thing to keep in mind is that even though these are three different roles, being the shareholders, directors, and officers, it is entirely possible for one person to have more than one role. One person could conceivably be a shareholder, a director, and an officer or any combination of those three. A shareholder's agreement is typically used with private corporations. The issue that the shareholder's agreement is meant to address is the general rule, being that majority rules. So what that specifically means is that the shareholder with more than 50% of the voting shares can impose their will and have full control over a corporation without any say from the minority shareholders. So basically, the majority can do whatever they want. So with the shareholder's agreement, it allows the minority shareholders to have some role or influence as agreed to within the shareholder's agreement. So specifically, a shareholder's agreement may deal with a number of different things, including the voting rights of the shareholders, how the directors are selected. Let's say, for example, if we have a 60% shareholder and a 40% shareholder, without a shareholder's agreement dealing with a selection of directors, the 60% shareholder would have, because of the majority rules rule, the 60% shareholder would have the right to select all of the directors on the board or directors. But with the shareholder's agreement, we can have a more fair allocation of the selection of the directors between the majority shareholder and the minority shareholder. The shareholder's agreement could also deal with the selection of officers. So if with a private corporation, we might want one of the shareholders to be the CEO. So if we want to put that in writing, then we would put that into the shareholder's agreement. We would also put into the agreement various requirements for shareholder approval, like what different types of decisions or subjects that need to be approved by the shareholder and by how many or what percentage of shareholders. We would also, or we could also put in the shareholder's agreement any restrictions on the transfer of ownership of shares of the corporation. With a unanimous shareholders agreement, all of the shareholders could agree to transfer some or all of the directors' powers over to the shareholders. So those powers have to do with the high level of supervision and management of the corporation. In terms of share transfer restrictions, in a private corporation, shareholders usually do not want other shareholders to sell their shares to just anyone. The typical restrictions that we could see in a shareholders' agreement are, for example, a right or first refusal. So if we have one shareholder who wants to sell their shares, and they get an offer from someone else to buy their shares, they have to first offer those shares for sale to the other shareholders of the corporation at the same price that the outside person is willing to pay. Another type of restriction in terms of selling off shares is called a shotgun buy-sell provision. So this is a very interesting kind of provision. So the best way to explain it is with an example. So if we have shareholder A, so we have a corporation with two shareholders, shareholder A and shareholder B, shareholder A offers to sell his or her shares to shareholder B for $100 per share. So on receiving that offer, shareholder B now has a choice to make. Shareholder B can choose to either buy shareholder A shares for $100 per share or, more interestingly, the other choice is for shareholder B to sell all of his or her shares to shareholder A at the same price that shareholder A offered. So for the $100 price. So what this type of provision forces someone like shareholder A to do when offering to sell shares at a particular price, it requires shareholder A to think much, much harder about what is a fair price for the sale of the shares because shareholder A will know that shareholder B, if the price is low, will turn around and buy, buy out shareholder A. Let's now get back to Lucy's lemonade. The limited partnership with Lucy, Marcy and Mom has been very successful. They now operate from three profitable locations. Lucy and Marcy want to raise even more capital so they can open storefront locations and sell franchises across Canada. So they go on the show, Dragon's Den and are able to convince two dragons to invest $100,000 into the business. In exchange, the dragons want control over the high level management of the business. But Lucy and Marcy want to maintain control over the day-to-day management. How should the business be reorganized? Please pause the video at this point so you can consider that question. How should the business be reorganized? The first step is to convert the limited partnership into a corporation named Lucy's Lemonade Corp. Now, given that part of the plan is to expand across Canada, it would make better sense to incorporate under the CBCA instead of OBCA. If it was done under the OBCA, we would need to take the extra step of obtaining extra provincial licenses in each province outside of Canada. So we've decided to incorporate a CBCA corporation. Now we need to decide on what is the appropriate share structure of this corporation. So the share structure can be set up in any number of different ways, but the simplest structure would be to have one class of common shares. More than 50% of those shares would be issued to the Dragons, and the remaining shares would be split between Lucy, Marcy, and Mom. Now we would also need, after we set up the corporation and the share structure, we would need a shareholder's agreement. So that would be negotiated between Lucy, Marcy, Mom, and the Dragons. The Dragons would want to select at least a majority of the Board of Directors and they would want control over the high-level management of the corporation, so that requires having control over at least a majority of the Board of Directors. And Lucy and Marcy would probably want to be directors in order to have some high-level influence over the management of the corporation. Now to give Lucy and Marcy control over day-to-day management, because remember that's one thing the shareholder's agreement could specify that Lucy and Marcy be appointed by the Board of Directors to be the officers of the corporation. So let's say we could make Lucy the CEO and Marcy the vice president or chief operating officer, let's say.