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By David Feindel, Barry Horne & Deborah Patterson
Last year Alberta joined nova scotia in allowing unlimited liability corporations. How do their rules compare?
In May 2005, amendments to the Alberta Business Corporations Act (ABCA) came into force permitting the formation of unlimited liability corporations (ULC). Until then, the Nova Scotia Companies Act (NSCA) was the only legislation in Canada that permitted formation of ULCs. A ULC is a corporation for Canadian income tax purposes and is used by many US taxpayers for investments in Canada, as well as by Canadian taxpayers for dealings in the US (e.g., Tower and income depository securities structures). However, the default classification of a ULC for US income tax purposes is a disregarded entity if it has a single member (i.e., shareholder) or a partnership if it has more than one member. A ULC can also elect to be treated, for US tax purposes, as a corporation.
There are, however, significant differences in the corporate legislation that governs the Nova Scotia unlimited liability company (NSULC) and the Alberta unlimited liability corporation (AULC). A client who is considering the use of a ULC should be aware of these differences and give them careful consideration when deciding which jurisdiction better suits the client’s risk tolerance and other business requirements.
The NSCA has no Canadian residency requirement for directors. This is particularly attractive to US parent corporations given that NSULCs are used primarily in crossborder corporate structures in which both the NSULC and the US corporate entities are managed from the US. Under the ABCA, one-quarter of the directors of an AULC must be residents of Canada. Thus, if an NSULC is used, directors can be chosen based solely upon their ability. In addition, US parent corporations do not need to be concerned about finding Canadian directors, or the ongoing administrative inconvenience of having directors who reside in a different location from the managers of the business and who have no involvement in the business.
The ABCA provides for an objective test with respect to the duty of care required of directors and imposes liability for directors in respect of a broad range of corporate acts, including the payment of dividends or the purchase or redemption of shares contrary to the financial tests set out in the ABCA, or the issuance of shares for inadequate noncash consideration. The NSCA does not deal extensively with directors’ liability. Although there are some provisions in the NSCA that impose relatively minor statutory liability on directors, it is the common law test for directors’ liability that generally applies.
Under the ABCA and Alberta employment standards legislation, directors have a statutory liability for up to six months’ unpaid wages owed to employees. Under Nova Scotia law, directors have no such liability. Instead, unpaid wages owed to employees can be protected by a lien on the employer’s assets.
Further, the NSCA does not impose any limitation on the scope of indemnification that an NSULC can provide to its directors. On the other hand, the ABCA limits the scope of the indemnity to specifically enumerated matters.
A client concerned about the scope of the personal liability imposed upon directors and the extent to which they can be indemnified for such liability may prefer to use an NSULC rather than an AULC.
Nature of unlimited liability of NSULC vs. AULC
Under the NSCA, the liability of a shareholder of an NSULC arises only in the event that the company is woundup and its assets are insufficient to pay its debts and liabilities and the expenses of the winding-up. In that situation, shareholders are liable for the shortfall. In other words, the shareholders are not codebtors or guarantors of the obligations of the NSULC and only become liable for any deficiency upon the winding-up of the NSULC. Thus, the shareholders have the protection that the assets of the NSULC afford as a cushion against claims by creditors.
The liability imposed by the ABCA on shareholders of AULCs is considerably broader and more onerous. In order to qualify as an AULC, the articles of the corporation must include an express statement that the liability of each of its shareholders "for any liability, act or default of the unlimited liability corporation is unlimited in extent and joint and several in nature." Accordingly, a creditor of an AULC will have a direct claim against all shareholders of the corporation for all liabilities owed to the creditor without having to first seek recourse against the AULC or have it woundup.
Further, the unlimited liability of shareholders of an AULC extends to all present and past shareholders of the corporation. On the other hand, under the NSCA, a past shareholder of an NSULC is not liable to contribute to a deficiency upon liquidation if it ceased to be a shareholder one year or more before the wind-up. Further, a past shareholder is not liable for any debt or liability of the NSULC contracted after it ceased to be a shareholder. In addition, former shareholders of an NSULC are not liable to contribute unless the court determines that the current shareholders cannot satisfy the deficiency.
The unlimited liability of shareholders of an AULC extends to actions and proceedings commenced by or against the AULC before its dissolution or within two years after dissolution. However, upon dissolution of an NSULC, only shareholders among whom its assets have been distributed remain liable to creditors following dissolution, and legal proceedings to enforce such liability must commence within one year from the date of dissolution.
As outlined above, the potential liability of the shareholders of an AULC is considerably broader and more direct than the potential liability of the shareholders of an NSULC in regard to quantum, past shareholders and the limitation period within which claims are permitted. A client who wants the tax advantages of a ULC under US laws while minimizing the risk of liability for current and former shareholders of the ULC may therefore prefer to use an NSULC rather than an AULC.
Lenders that provide financing to corporate groups that include an NSULC frequently take a pledge of the shares of the NSULC as collateral security. Enforcement of such security could result in lender liability if the lender inadvertently becomes, or is legally deemed to have become, a shareholder of the NSULC. Enforcement of a pledge of the shares of an AULC raises the same concern. However, given the significantly broader scope of shareholder liability for an AULC compared with an NSULC, lenders who take such pledges as collateral security may prefer that transactions be structured using an NSULC rather than an AULC.
Unlike the ABCA, the NSCA has no statutory restrictions related to the declaration of dividends. Instead, the common-law rules on dividend payments apply in Nova Scotia. These rules can provide greater flexibility for dividend payments than the statutory restrictions on dividends under the ABCA. Further, the NSCA provides for the right of a Nova Scotia company, including an NSULC, to issue par-value shares in addition to shares without nominal or par value. Under the ABCA, a corporation can only issue shares without nominal or par value.
The NSCA also permits shares to be issued without being fully paid or in consideration for a debt instrument. The ABCA only allows the issuance of fully paid shares and doesn’t permit the issuance of shares in consideration for a debt instrument.
The ABCA does not permit subsidiaries to hold shares in its parent company except in very limited circumstances. Under the NSCA there is no such restriction.
Return of paid-up capital
The ABCA provides that a corporation may reduce its stated capital with the approval of a special resolution if the applicable financial tests are met. Under the NSCA, while a company limited by shares is required to make a court application for authorization to return capital, an NSULC can return paid-up capital to its shareholders in the manner provided for in its articles of association (often by a shareholders’ resolution), and such a return is not subject to any statutory financial test.
The NSCA currently requires a court application for approval of an amalgamation whereas, under the ABCA, an amalgamation can be authorized by special resolution (or in some circumstances, a directors’ resolution) if financial tests are met. Although more time consuming, the NSCA amalgamation process may be advantageous in certain circumstances, as there are no statutory financial tests to be met.
Under the ABCA, a company can be continued into Alberta as an AULC, and an existing Alberta corporation can convert to an AULC by a special resolution of shareholders. Under the NSCA, an extra-provincial corporation can be wound-up into an NSULC to convert it to an NSULC. Alternatively, an extra-provincial corporation can be continued into Nova Scotia as a company limited by shares and then either amalgamated with a Nova Scotia company or converted under a plan of arrangement in order to become an NSULC.
The ABCA expressly permits the giving of financial assistance by a corporation to any person for any reason (subject to a requirement of disclosure in certain circumstances). The NSCA, on the other hand, contains a prohibition on financial assistance given by a company for the purpose of or in connection with the purchase of such company’s shares unless the company meets financial tests. This restriction does not apply to an issuance of new shares by a Nova Scotia company.
Under the ABCA, a corporation may capitalize contributed surplus by special resolution. The NSCA does not have a similar mechanism, although it may be possible, in some circumstances, for an NSULC to undergo a reorganization of capital that will accomplish the same result.
Government fees and taxes associated with the incorporation or amalgamation and annual renewal of an NSULC are significantly higher than the government fees associated with the incorporation or amalgamation and annual renewal of an AULC.
The government of Nova Scotia recently indicated it is considering amendments to the NSCA. To this end, it has commissioned a discussion paper on the modernization of the NSCA. The discussion paper, released September 23, 2005, sets out detailed proposals to address some of the concerns noted above while maintaining the unique advantages described herein.
The discussion paper proposes the addition of an alternative amalgamation procedure that would be similar to the amalgamation procedures under the ABCA (the court application route would be maintained for situations where the solvency test could not be met). The discussion paper also proposes that a company be permitted to continue into Nova Scotia as an NSULC, and that an existing Nova Scotia company limited by shares be entitled to convert to an unlimited company by a unanimous shareholders’ resolution.
Also proposed is that the financial assistance provisions of the NSCA be replaced with an express statement indicating that financial assistance may be given to any person for any reason.
If these proposals result in amendments to the NSCA, the NSCA will maintain its unique benefits and advantages while eliminating many of its potential drawbacks.
David Feindel, Joseph Macdonald, Barry Horne, Deborah Patterson, Hayley Clarke, Michael Simms. The coauthors are members of the law firm of McInnes Cooper in Halifax
Technical editor: Trent Henry, partner, Ernst & Young LLP