Legal Business Advice 101
Tips, Traps, and Legal Basics for Small Business
1. Incorporations, Partnerships, & Sole Proprietorships
Business starts when you start making money doing something, not when you hire a lawyer, or an accountant, or incorporate. However, meeting with a lawyer first can save you time and money, and avoid costly mistakes.
There are three basic kinds of legal organization: Sole Proprietorships, Partnerships, and Corporations. Each has benefits, and each has weaknesses. It is best to choose the one that is right for you, rather than finding out later what kind of business you have … especially after something has gone wrong.
If you are a sole business operator and have not legally organized, you are probably a sole proprietor. Some advantages of being a sole proprietor are:
- It’s easy; there is nothing to do.
- It doesn’t cost anything to become a sole proprietor
- You have direct control over your decision making
- There are certain tax advantages if your business is not doing well, such as deducting losses from your personal income
- All profits will go to you directly
There are, however, some significant disadvantages to being a sole proprietorship. These include:
- Unlimited personal liability. That is all of your personal wealth and assets are exposed to pay any debt you acquire, including lawsuits and judgments against your business
- As your business income forms part of your personal income, there can be negative tax consequences when your business is profitable, as your business income may put you in a higher tax bracket
- You can’t take on investing shareholders
If you have a business partner and haven’t incorporated a company, you are likely a partnership. With a partnership, financial resources are combined and put into the business. In the event of a lawsuit, or other liability, the default is that all partners are jointly and severally liable (that is, each partner is responsible for the entire debt until the creditor is paid).
If you are engaged in a business partnership, you should have a partnership agreement. A partnership agreement lets you set the terms of your business with your partner and protect yourself in case of a disagreement or dissolution of the business. A partnership agreement should set out each partner’s contribution, the sharing of profits, the management of the partnership, and an exit strategy when it’s time to sell or move on. It is also possible to limit your liability by agreement. Please note, however, that there are legal requirements for establishing and operating a limited liability partnership – consult a lawyer!
Some advantages of being a partnership are:
- Can be easy to fall into – can become a partnership without hiring a lawyer
- Costs are shared with your partner
- Management, profits, and assets are shared
- Like a sole proprietorship, there are certain tax advantages if your business is not doing well, such as deducting losses from your personal income
Some disadvantages of being a partnership are:
- Can be easy to fall into – can become a partnership without hiring a lawyer
- Unlimited personal liability – Similar to sole proprietorship, as there is no legal difference between you and your business
- Hard to find a suitable partner & inevitable conflict
- You are financially responsible for decisions made by your partner
- If you don’t have a proper partnership agreement, may be difficult to exit
A corporation is a separate legal entity created by filing articles of incorporation with a federal or provincial company’s office. A corporation is a separate legal person from its shareholders. As a shareholder of a corporation, you are not personally liable for the debts, obligations or acts of the corporation (with limited exceptions).
As with a partnership, if you and a partner will be shareholders in a corporation, you can (and should!) establish the terms of your business and protect yourself in case of a disagreement or dissolution by drawing up an agreement (a shareholder’s agreement). A shareholder’s agreement should govern issues like each partner’s contribution, the sharing of profits, the management of the company, and an exit strategy when it’s time to sell or move on.
Some advantages of incorporating are:
- “Limited” liability – you are not personally liable for the debts, obligations or acts of the corporation
- Ownership is transferable
- Continuous existence
- Separate legal entity
- Easier to raise capital
- Possible tax advantage – taxes may be lower for an incorporated business
Some disadvantages of incorporating are:
- Cost (legal, accounting)
- Records maintenance
- Lack of flexibility
- If you don’t have a good shareholder’s agreement, may be difficult to exit
2. Choosing a Business Name
The Business Names Registration Act (Manitoba)requires that every person who is carrying on, or intending to carry on, business, in Manitoba,
- in the case of an individual, under a name or style other than his family name or surname;
- in the case of a corporation, under a name or style other than its corporate name; and
- every person associated in partnership and carrying on or intending to carry on, business
cause to be registered a registered business name.
Anyone can have a registered business name by registration with a provincial Company’s Office. Registration lasts 3 years and must be renewed.
There is a difference between a “business name” and “corporate name.” A business name cannot have a legal element (e.g. “Inc.” or “Ltd.”), and a corporate name must have a legal element. This is because the legal element is notice to the world of corporate identity and limited liability.
In addition to it being required by law, there is a significant benefit to registering a business name. While the act does not expressly grant you an exclusive right to the name, a new registration cannot be identical or confusingly similar to an existing trademark, business, association or corporation. This means that the Company’s Office will not register a confusingly similar name to the one you have registered, and thereby grants you a degree of protection in Manitoba over your chosen business name.
3. A Few Comments about Corporations
What’s an Annual Return?
One of the most common confusions I encounter is the difference between a corporate annual return and a corporate tax return. These are two different things, and you need both.
Incorporated companies must file a corporate annual return every year. Failure to do so, and to pay the fee, will cause the company to be struck from the record and cease to exist after 2 years. While you can do this yourself, many companies hire a law firm to simply maintain the necessary filings and ensure that the company does not get dissolved and struck from the record. The cost is nominal and the value for peace of mind is significant. In addition, the cost of reviving a defunct corporation is fairly costly.
Note also that “dead” (defunct) corporations can still be liable for their debts.
As noted previously, a company’s shareholder is not personally liable for the debts, obligations, or acts of the corporation. There are exceptions. If you do not properly document your actions, you can undermine your corporate personality and limited liability.
While a company is a legal person, it does not have a human body. It must act through its officers, directors, or shareholders. Generally, Shareholders elect directors, who elect officers (such as the President), who sign documents or cause the company to act. Even in the case of a single shareholder, single officer company, the company still must act (and can only act) in this way.
Documents must be signed in a certain way to avoid confusion. The company signs, “per” the authorized individual. Don’t just sign in your own name, or it might be found to be outside of company authorization and a personal action (potentially attracting personal liability).
Directors are not usually personally responsible for contracts that they sign on behalf of the corporation, provided that they have proper legal authority to sign, and so long as they are acting within the scope of their authority and in the best interests of the corporation.
Directors acting outside the scope of their authority are personally responsible for any decisions or actions they take. Directors who breach any of their duties to the corporation may be liable if the corporation suffers a loss that can be directly attributed to their actions or omission. Also note that directors of charitable corporations have potentially higher exposure to personal liability than do directors of other not-for-profit corporations
If you are concerned about your personal liability, director’s liability insurance can be purchased to provide protection.
Note that, even if you “dot all your I’s and cross all your T’s,” you could still be personally liable in certain extreme situations, such as fraud.
4. Employee Issues
Usually my clients come ask about their employee obligations after the bad situation has already developed. By then it may be too late – or expensive – or both, to do something about it.
Always have your employees sign a contract. This can be as simple as a signed letter of engagement.
A good contract is clear and easy to understand. It sets out the rights and obligations of both parties during the relationship, and deals with end of relationship issues such as severance, notice, confidentiality, non-competition, and ownership of company property.
In addition to getting a contract signed, talk to your employee! Invite discussion. Make your expectations clear and agreed.
5. Twenty First Century Business
The Internet Changes Everything
Success in the business world depends largely on the message you convey and the image you project. If people cannot pick you out easily from the crowd, you are likely to be overlooked in favour of an individual or firm with a stronger presence.
Businesses succeed where there is traffic. Today, customers “travel” online, and increasingly, on their “smart” phones and other devices. For many new modern businesses, street location is less and less important. Online presence is increasingly vital.
All kinds of new business dangers have emerged online:
- Where previously businesses competed with other local businesses for attention and position, now you can be competing with companies across the globe. Word of mouth referrals – both bad and good – have also morphed. News can and does go “viral.”
- Online, anonymity is commonplace. Defamation is easy to get away with. In fact, there are websites devoted to it.
- Theft of IP is common. Businesses have always imitated and copied each other’s best ideas. However there is a hard line between imitation and theft. Unfortunately, the internet makes theft easy. Sometimes it’s as simple as “cut and paste.” Also, as visitors to your website may be anonymous, and the theft “invisible,” traditional safeguards and deterrents are no longer present.
- Cybersquatting is common. In fact, if your company is successful enough online, you may find that aggressive competitors buy up names associated with your business to steal your business away or extort you.
What can you do about it?
Chose a business name carefully. While generic names are valuable for easy search results, a successful unique name has greater long-term benefits. If you are going to chose something generic, do so with your eyes wide open and fully informed as to your competitive environment.
Register a trade-mark to strengthen your legal position. You can have an unregistered TM through use, but that must be proven. Get a registered trademark. Mark your property with “TM.” Trademark registration is stronger than registration of a business name. A registered trademark gives you the exclusive right to use the mark across Canada for 15 years (registration is renewable every 15 years after that). Registration in Canada can also give you an advantage when registering in the USA.
There are anti-cybersquatting laws that can allow you to “turn the tables” on an unscrupulous competitor and compel the Registrar of the website to deliver a cybersquatting website to you.
Although the law may not provide a guarantee to having defamatory content taken down, many online businesses, recognizing the potential harm to their brands, will voluntarily review offensive content and take down materials if you (or your well-informed lawyer) are sufficiently persuasive.
Troy Harwood-Jones is a commercial lawyer and corporate litigator at PKF Lawyers, in Winnipeg, Manitoba. Troy’s primary areas of practice are in the arenas of Civil Litigation, Corporate and Commercial Law, and Wills, Estates, and Elder Law. Troy has unique expertise in the practice areas relating to e-commerce businesses as well as Trademarks and Intellectual Property Law.