Business and the Law
Business and the law go hand in hand. Neither develops in isolation. Rather, each shapes the other. Changes in accepted business practices are followed by changes in the law, and changes in the law are undertaken by legislators and the courts with a view to their effect on the business world.


As a small-business owner or as someone planning to start a small business, you should be aware of how the law affects your business and how your business practices can sometimes shape the law. What is the purpose of a shareholders’ agreement? How is a contract formed?
Why should you incorporate a company?
What happens when you sue?

These are just a few of the many legal questions you may encounter in the
day-to-day conduct of your affairs. Yet, as any businessperson knows, it is not always cost-effective or practical to seek a lawyer’s advice on matters as general, albeit important, as these.

Canadian Legal Guide for Small Business was written to answer the question,
What do I — as a small-business owner — need to know about the law in Canada”? 
The book opens with a discussion of the sources of law in Canada and how the law affects your small business.

The subsequent chapters consider specific issues of importance to anyone owning and operating a small business in Canada, including the following:

• The ways of carrying on a small business in Canada, and the advantages and disadvantages of each
• What every small-business owner should know about company law
• What every small-business owner should know about contract law
• What every small-business owner should know about consumer law
• What every small-business owner should know about resolving disputes
• The types of commercial and related legislation affecting your small business
• Frequently encountered business documents and their significance to you An understanding of the legal issues associated with owning and operating a small business can form an integral part of its success.

The goal of this book is to provide you with that understanding and with a solid grounding in how the law works, who it affects, and what it can do to help you achieve your business goals.

That requires an examination of the substantive law itself — that is, the legal rules and regulations that guide the business world — as well as what goes on “behind the scenes” of the law. In other words, we must look at why the substantive law is what it is and how it came to be that way.

This book can then serve as a valuable source of information regarding the law and as a guide to how those who shape the law think about and approach business issues. 

b. What Is a Small Business? 

To establish a context for discussion, let me define the term “small business” and examine what it means to own and operate one.
Who, in other words, is this book written for?

Defining a small business is no simple task.
Opinions vary as to what constitutes
a small business. Banks have their view. Governments have their view. Small-business owners have yet another view. Still, most agree that to be a Canadian small business, a business —
• must have fewer than 100 employees in the manufacturing sector and fewer than 50 employees in any other sector,
• must have annual revenues of less than $5 million in the manufacturing sector or less than $2 million in other types of business,
• will usually be owner operated, and
• must be located and operated primarily in Canada. In addition, a small business must, like any other type of business that is not run for a charitable or religious purpose, be run for profit. If you own a small business (or plan to) or if you operate one for someone else, this book is for you.

It is written with your concerns in mind, particularly as they relate to the law and the legal issues your business may face. Much of the information in this book is applicable to medium-size businesses as well.

c. The Law in Canada But what do I mean by the “law?
Simply this: those bodies of principles, standards, or rules that have been established and are enforced by the state in accordance with the will of its citizens.
At issue here are the laws of not just any state, but of Canada in particular, including the laws of various geographic areas, or jurisdictions, within Canada.

Moreover, the laws examined in this book are those that affect small businesses.
To understand how laws are made in Canada, it is important to know that the Canadian legal system is relatively unique in that it actually comprises two legal systems, both of which exist independently in other parts of the world.

1. Common Law versus Civil Law First there is the common law tradition, which Canada inherited from England and which is currently used in the United States, Australia, and, of course, England, among other places.

The common law tradition dates back to feudal times and is distinguished by the fact that its laws are developed through centuries of judgments and decrees of courts based on a body of previous judicial decisions.

Common law is, therefore, another way of saying judge-made law, provided one understands that in making laws, judges base their decisions on previous decisions. Each such decision is referred to as a case, and the common law is really a body of case law.

Canada’s other legal system was inherited from France, which in turn based its legal system on the Roman tradition. Known as the civil law tradition, it operates throughout most of the western world and, in Canada, in the province of Quebec.

Its distinguishing feature is that, unlike the common law tradition, the civil law tradition relies on codification of the law. In other words, judges do not determine legal disputes based on the decisions of previous judges
(that is, they don’t rely on precedent for their decisions); rather, they appeal to a codified set of laws that they are free to interpret and apply in any given set of circumstances.

Perhaps the best way to illustrate the distinction between common law and civil
law is with an example.
Suppose two farmers are arguing over which of them owns a particular sheep. In a common law jurisdiction, the court deciding the issue would look to similar disputes that in the past had been brought to court and, by comparing them to and distinguishing them from the dispute in question, would base its decision on the tradition established thus far. If a similar case had been decided in favour of the person on whose land the sheep did most of its grazing, the issue of ownership in the present case would be decided on the same basis.

As you can imagine, the ability to compare and distinguish cases in your favour before a court could be of great benefit to anyone involved in a dispute. Thus, persons skilled in those arts — lawyers — came to acquire a certain importance in the common law tradition, one that survives today.
This is not to say that lawyers aren’t important in the civil law tradition. Under that system, ownership of the sheep would be decided based on a codified set of rules or principles that a judge would refer to in coming to a decision.

That code might have said (as the common law did) that the issue of ownership must be decided on a basis of where the sheep did most of its grazing. In these circumstances, one of the people involved in the dispute might have sought the assistance of a lawyer to try to persuade the court as to how the phrase “most of its grazing” should be interpreted. Should it be interpreted to mean “where the sheep ate most of its food” or to mean “where the sheep most often ate”?
As anyone with even a passing interest in the law knows, such distinctions can determine a dispute.

As you can see, both systems of law can result in a similar outcome when presented with a similar set of facts. Neither has a monopoly on justice. The split between the civil law tradition operating in Quebec and the common law tradition operating in the rest of the provinces, federally, and in the territories may not always be as significant as might first appear. That said, this book focuses exclusively on the law of the common law jurisdictions in Canada; that is, everywhere in Canada, except Quebec. Though some (or even much) of what is said here may apply to the laws of Quebec, this book does recognize that Quebec operates under a legal system distinctly its own and should for that reason receive independent consideration elsewhere.

2. Sources of Law in Canada There are two sources of law in Canada: case law and legislation.
(a) Case Law Case law, as already noted, refers to a body of decisions of courts. Each case itself comprises a specific set of facts relating to a dispute brought before a court.

By applying the law to those facts, a decision in the case is rendered and the dispute resolved. But cases aren’t significant in themselves. What makes a case important is the reasons for the judge’s decision, the ratio decedendi, as it is referred to in legal circles. Those reasons are the basis for any precedent the case might set.


(A precedent is a standard or authority that can be used by any future court in deciding identical or similar cases.) Must a court use a past case as a precedent?
In short: yes, according to the Latin principle of stare decisis et non quieta movere, or “To adhere to precedents and not to unsettle things which are settled.” In practice, this principle operates to make the decision of a higher court in a particular jurisdiction binding on a lower court within the same jurisdiction
(see chapter 13, Resolving Disputes, for a discussion of the hierarchy of courts in Canada).

Thus, the ratio decedendi of a decision of the Supreme Court of Canada, as the highest court in the land, is binding on every court in Canada from the date that decision is made. It is through this interplay of ratio decedendi and stare decisis that Canada has built a body of case law as a source of law.

(b) Legislation The other source of law in Canada is legislation, the body of laws enacted by the state through its legislatures. Most legislation, when enacted, takes the form of a statute: a declaration of a legislature codifying, commanding, or prohibiting something as law.
There are literally tens of thousands of items of legislation currently in effect in Canada. Many of those cover business issues ranging from the sale of goods to the collection of interest. In applying statutes to the cases brought before them, judges interpret the provisions of those statutes in much the same way one might do under a civil law system.

There is, however, an important distinction in that the common law often develops around legislative provisions and must (where applicable) be used in interpreting statutory provisions. That said, legislation is often enacted with the specific purpose of changing the common law. When judges resist that kind of change, an interesting tension often arises between the forces of justice, as embodied by the judicial system, on the one hand, and the will of the people, as embodied in the actions of its freely elected legislators, on the other. When all is said and done, it is those (sometimes competing) interests that are the ultimate source of the law.

d. The Small-Business Owner and the Law Which brings us back to the case of Mr. Salomon. Why is it significant to you, as a small-business owner? To answer that question, you have to consider what Mr. Salomon did. Mr. Salomon incorporated a company, to which he then sold his small business. In exchange, Mr. Salomon received a large block of shares and £10,000 worth of debentures.
A debenture is simply a written promise to pay back a debt
(see Chapter 6, Financing Your Small Business, for a further explanation).

In doing this, Mr. Salomon became both the owner and a creditor of his company. Now it happened that the company, through no fault of Mr. Salomon, could not meet its debts. Having fallen on hard times himself, it occurred to Mr. Salomon that as a creditor, he could sue his company for what it still owed him under the debentures. Naturally, this did not please the other creditors of the company. They thought they should be the first to be paid what was due them.

They argued that because the company both belonged to and was run by
Mr. Salomon, it was only fair that he should bear the brunt of any losses. Indeed, the company’s creditors went so far as to call Mr. Salomon’s company a sham, created simply for the purpose of avoiding his business debts, and reasoned that he was, therefore, personally indebted to them out of his own pocket.
The English Court of Appeal agreed with the creditors.
But Mr. Salomon did not give up, and he took his case to the House of Lords, the highest court in Britain. After a long and bitter battle between Mr. Salomon and his company’s creditors, Mr. Salo-mon prevailed.

The court reasoned that Mr. Salomon and his company were not — despite outward appearances — the same thing. Legally, they were as different as if they were two separate persons, and as such, they could sue each other and be sued by each other. Moreover, as a separate entity from his company, Mr. Salomon was not any more responsible for its debts than he would have been for the debts of anyone else.
In short, as a shareholder of an incorporated company, Mr. Salomon had the benefit under the law of limited liability
(see Part I, Ways of Carrying On a Small Business, for a further discussion of limited liability). What, then, can you — a small-business owner — learn from Mr. Salomon? First, Mr. Salomon’s case shows how business shapes the law.

Imagine what might have happened to Mr. Salomon had his creditors prevailed.
What effect might that have had on others in business?
A chilling effect, to be sure.
Many people would have been reluctant to invest in business ventures for fear of risking (and possibly losing) their personal property to their business creditors.
The economy might then have stagnated for lack of investment capital.

Ultimately, this was what was in the judges’ minds when they came to their decision. The court concluded that a legal distinction between Mr. Salomon and his company was needed to ensure that he — and millions of others like him — could risk money in a business venture without at the same time risking everything he owned personally if the venture went bad. In short, the court reasoned that the economic needs of society outweighed the debts owed to Mr. Salomon’s company’s creditors, and it shaped the law accordingly.


Second, Mr. Salomon’s case shows how the law shapes business.
By incorporating a company, Mr. Salomon sought to take advantage of the limited liability this step could afford him personally.
Both Mr. Salomon and the creditors of his company wished to test the strength of the law granting him that limited liability by fighting the matter in court.
The court ultimately decided in favour of Mr. Salomon and thereby set a precedent that has been accepted in Canada as good law
(both in legislation and at common law).

As a result, people such as you and I may, in pursuing our business ventures, rely on this precedent, confident of the risks we are assuming.

Finally, Mr. Salomon’s case illustrates that business law is about real people and real businesses in real situations. Today, much of what businesspeople are forced to undergo at the hands of lawmakers seems, at first glance, arbitrary or irrelevant. What you will discover as you read this book, however, is that everything that happens in the law happens for a reason.

Every law affecting your business serves a purpose, sometimes social, sometimes purely commercial. As a small-business owner, it is incumbent on you to know and understand these laws and the purposes behind them. That alone can help you conduct your business affairs, confident that the law is on your side. * * * This book addresses both start-up issues and ongoing concerns in the life of your business.

The focus throughout will be practical in nature, with the goal of providing you with useful information you can use on a day-to-day basis in your small business.

Part I (Chapters 1 to 3) explores the different ways in which you can carry on a small business: as a sole proprietorship, partnership, or corporation.
Part II covers start-up issues.
Chapters 4 and 5 deal with the legal issues of naming your business and obtaining licenses and permits.
Chapter 6 considers what financing you might need and the legal issues associated with obtaining it. The final start-up related issue — your insurance needs as a small-business owner — is contained in
Chapter 7. Part III looks at the various legal issues associated with operating a small business successfully.
Chapter 8 examines how to protect your copyrighted works, trademarks, patents, and other intellectual property.
Chapter 9 covers privacy issues.
Chapter 10 focuses on writing and interpreting business contracts.
Chapter 11 suggests guidelines for ensuring good consumer relations.
And Chapter 12 helps you to ensure that you get paid for what you do by exploring the legal aspects of billing and collecting your accounts.
Chapter 13 takes up the legal issues involved in finding, hiring, and firing employees. In Chapter 14, we consider the resolution of legal disputes.

Going to court is only one — and not necessarily always the best — option.
Chapter 15 looks at the taxes relevant to small businesses, while
Chapter 16 offers insight into the professional services of accountants, bankers, and lawyers, and considers what you can and should expect from them as a small-business owner. This book closes with a few concluding remarks.

By this point, you will have come to better understand the legal issues affecting your small business. As Mr. Salomon has shown, your success as a small-business owner depends on it. A final word about this book.

The breadth and scope of the law in Canada make it impossible to account for every development or contingency that may affect the law in your area. As such, the contents of this book are provided to you for general information purposes only and should not be taken to be a complete statement of the law or any aspect of it.

Views expressed in this book are for assistance only and should not be considered
as binding on any court, government agency, or organization.
A qualified lawyer should be consulted in connection with any action you take in relation to a legal issue facing you or your small business.

Ways of Carrying On a Small Business
There are three ways for you to carry on a small business in Canada. You can operate as a sole proprietor. You can carry on business in partnership with another person (or persons). Or you can incorporate a company.
Each of these ways of doing business has advantages and disadvantages.

The purpose of Part I is to help you determine which business form is best suited to meet your particular needs and expectations.

The simplest and least expensive way to carry on a small business in Canada is the sole proprietorship.
As its name implies, a sole proprietorship means one person in business for himself or herself.
As a way of carrying on a small business, sole proprietorship has proven especially popular with students, homemakers, and people who are just starting up a business or are already employed full time in some other enterprise.
Typical examples of businesses that are sometimes conducted as sole proprietorships are —
• a student mowing lawns in his or her neighbourhood;
• an employed person who supplements his or her income by spending weekends making pizzas at home, freezing them, and then selling them to neighbourhood restaurants; and
• a house painter who does not necessarily require much equipment or overhead and, for the most part, can do the job alone or with minimal help from others.


These examples share an important similarity, one that defines the very essence of a sole proprietorship; namely, as a sole proprietor, you are the business.

a. Setting Up a Sole Proprietorship Because, as a sole proprietor, you are the business, no special legal steps are needed to set up a sole proprietorship.

As soon as you do business for yourself — that is to say, as soon as you engage in some sort of commercial activity — you are doing business as a sole proprietor.
Thus, the term “sole proprietorship” does not refer to any formal legal structure; it merely designates that you are involved in a commercial activity.

It is worth noting that you are nonetheless required to obtain licenses or permits to engage in certain types of commercial activity. For example, you may operate a plumbing business as a sole proprietor; however, to do so legally, you must be licensed by the municipality in which you plan to carry on that business.

(See Chapter 5, Licenses and Permits, for a further discussion of license and permit requirements relevant to your small business.)

As a sole proprietor, you may carry on business under a name other than your own. For example, a house painter by the name of Fred Green can, if he wishes, carry on business under the name.

The Happy House Painter.
That means he can advertise to the public under that name, list his business in the telephone book under that name, enter into contracts as

“The Happy House Painter,”
and do anything else in connection with his business under that name that he can legally do under the name Fred Green. Note, however, that anyone who carries on business under a name other than his or her own name is required to register that name with the relevant government authority.

This is necessary to ensure that both the government and the public can determine who, in a given instance, is carrying on business under a particular business name. (See Chapter 4, Choosing a Business Name, for a further discussion of business name registration requirements.) b. Advantages and Disadvantages To determine whether you should operate your small business as a sole proprietorship, consider some of this structure’s advantages and disadvantages.

1. Advantages There are several advantages to operating your small business as a sole proprietorship: (a) You can start doing business right away. You don’t need to do anything to set up a sole proprietorship. Your sole proprietorship is established when you begin whatever business activity you plan to carry on.

(b) It is inexpensive compared to other ways of carrying on a small business.
This is because no special legal steps need to be taken to conduct business as a
sole proprietorship.
(c) Though most sole proprietors carry on business alone, a sole proprietorship can have employees. Being able to hire employees means you can spread the workload among several people.
This is useful if the job you do requires you to be in several places at once or for work that can’t be done by one person alone, such as moving furniture. An employee is also capable of filling in for you when you are sick or otherwise unable to work.
(See Chapter 13, Employees, for a further discussion of employment matters.)

(d) All the benefits of the business belong to you personally.
That means the assets and income of the business are yours to do with as you please. For example, if you carry on business fixing small appliances in your basement on weekends, the tools you buy all belong to you personally.

If you decide to stop doing business, the tools remain yours. As you will see, this is not necessarily the case with other business forms. In addition, any money you earn in your business becomes part of your personal income: your business profits are your profits.

(e) Business losses may reduce your personal income tax. Because any income your business earns becomes part of your personal income, it is added to any other income you earn (for example, as an employee of another business) and taxed at the individual rate set under the federal Income Tax Act.

Depending on your financial circumstances, this may not be an advantage.
However, if your business creates losses — that is, if the costs you incur in your business exceed its revenue — those losses may be used to reduce your personal income tax and possibly place you in a lower tax bracket.
(See Chapter 15, Taxes, for a further discussion of tax matters.)

(f) Because there is nothing involved in setting up a sole proprietorship, there is nothing involved in winding one down. Your sole proprietorship ends when you stop doing whatever work you were performing as a sole proprietor.

As you might expect, there are disadvantages to sole proprietorships:
(a) Just as the benefits of the business belong to you personally, so too do the obligations.
If, as “The Happy House Painter,” you have a telephone line installed in your basement, the cost of installation and any telephone bills become your personal obligations.
That is because you are the business. Any debts or liabilities you incur in conducting your business are your debts and liabilities. As you can see, the knife cuts both ways.

(b) Your liability for things you do in the course of operating your business is unlimited. In other words, not only are the obligations of the business your obligations, but there is also no limit on the amount for which you may be obligated. Moreover, your business obligations can be satisfied by recourse to your personal assets.
If you agree to paint someone’s living room and, while doing so, accidentally splash paint on their Renoir painting, not only are you obligated to repair or replace that Renoir but you may also be required to use your personal assets

(e.g., dip into your savings account) to satisfy that obligation.

The risk associated with unlimited liability is the single biggest deterrent to carrying on business in the form of a sole proprietorship.

To avoid that risk, you must either incorporate a company and do business that way (see Chapter 3, Corporation) or procure adequate insurance against any possible mishaps. In some cases, your insurance coverage may be all that stands between you and personal bankruptcy
(See Chapter 7, Insurance, for a further discussion of insurance matters affecting your small business.)

(c) Though you can employ others, you cannot employ yourself. While employing oneself might seem a little strange, being able to employ oneself — as is possible when you carry on business in the form of a corporation — may result in tax savings.

(d) In Canada (to the chagrin of many), individuals are taxed at progressively higher rates than corporations. A sole proprietor cannot take advantage of the more favourable tax treatment afforded incorporated businesses.

(e) The federal government and certain provincial governments have established grant and loan programs as well as other small-business assistance measures that often apply only to incorporated businesses. Therefore, these programs are not available to sole proprietorships.

(f) Certain types of business arrangements will not allow you to carry on your small business as a sole proprietorship.
For example, if you want to carry on business as a franchisee of a pizza chain, it is likely that the franchisor will require you to incorporate a company in order to operate that franchise.

(g) There is a (misguided) perception that a sole proprietor may not be as serious about his or her business as is someone who does business in the form of a corporation. This can raise problems where you require a loan from a bank or credit from a supplier.
(h) When you stop doing business, the sole proprietorship ceases. It does not continue without you.
The business cannot be passed on after you die, if that is your intention.

That is not to say you cannot pass on the assets that make up the business, but it means that the person to whom the business is passed will have to start his or her own business with those assets or make them part of a business that he or she already operates.

c. Is a Sole Proprietorship Right for You?
The ideal candidates for carrying on a small business in the form of a sole proprietorship will have a special skill or talent that they wish to use in earning income. They will also be capable of running the business substantially on their own.

C h e c k l i s t If sole proprietorship seems right for you, before starting business, remember to do the following:

• Register any names under which you plan to carry on business.
• Obtain the necessary licenses and permits to legally allow you to do what you do.
• Obtain appropriate insurance coverage.

d. Summary Many successful small businesses are run as sole proprietorships.

In addition, many large businesses started out as sole proprietorships and were incorporated only after the business itself became too much for one person to handle. In short, sole proprietorship remains the basis of many a great entrepreneurial begin

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