The Risks of Incorporating Online

With increasing frequency, I meet individuals that have incorporated their companies online. Typically, people decide to incorporate online due to convenience, some urgent business need or to save a little bit of money.  All of the above reasons are understandable.  But, what people do not know is that they may be missing important elements of the incorporation, or post-incorporation, process which can place them and their companies offside with provincial legislation or the Canada Revenue Agency (“CRA”).  Such deficiencies can result in significant negative consequences down the road.

Here are a few of the things that I have seen go wrong with incorporating online:

Lack of an Incorporation Agreement

Pursuant to Section 15(1)(a) of the Business Corporations Act (British Columbia) (the “Act”), a “completing party” (i.e. the individual(s) that is/are filing to incorporate the company), prior to filing (online or otherwise) an incorporation application with the Registrar of Companies, is required to:

• examine the articles and incorporation agreement to ensure that both are properly signed;

• designate as incorporators in the incorporation application all those persons who have signed the articles and the incorporation agreement; and

• complete the “completing party statement” in the incorporation application.

In general, the incorporation agreement sets out the agreement on the part of the incorporator to form the company, take shares in its capital and the form of articles that will be used (in the absence of a form of articles, the statutory Form 1 articles of incorporation will apply).

In most of the cases that I have encountered, where an individual has incorporated online, no incorporation agreement has been signed.  If the completing party statement is false or misleading in a material respect, the completing party has committed an offence and is liable to a fine not to exceed $10,000.

No Shareholder or Director Meetings

Once a company has been incorporated, it must hold initial shareholder and director meetings to organize its affairs.  Typically, the first meetings are done by way of consent resolutions in writing signed by the incorporator.  For example, issuance of shares, fixing of the financial year end, appointment of officers, waiver of an auditor and adoption of any pre-incorporation contracts.  The Act provides that a company must hold its first annual general meeting not more than 18 months after the date on which it was incorporated.

Often in the case of online incorporations, such meetings or consent resolutions have not been held, which can create compliance issues and, in fact, legal issues.  A lack of organizational formalities can have a serious impact on parties in the event of a later dispute, e.g. if a party is under the belief that they have shareholder rights and, in fact, may not even be a shareholder.

No Evidence of Paid-Up Capital in Shares

Related to the lack of organizational meetings that I have noted above, are also deficiencies that can arise when shares are not properly evidenced or paid for (not to mention whether such shares have been properly issued).  For example, even if the directors of the company have held a meeting, or signed a unanimous resolution to issue shares, has the appropriate amount of consideration passed between the shareholder and the company?  Section 64(2) of the Act states that a share must not be issued until it is fully paid for by the subscriber.  In fact, directors may be held personally liable in the event that shares are issued in contravention of s. 64.

One of the things that CRA may examine in a company audit is whether the shares were fully paid-up at the time of issuance (e.g. by way of a cheque from the subscriber to the company).  If shares have not been fully paid-up, then any dividends issued in connection with such shares may be re-characterized by CRA as loans or some other form of individual benefit.  Such re-characterization can have significant tax consequences for the company and the individual(s) in question.

Lack of a Central Securities Register

Another problem that I have noticed in connection with online incorporations is the absence of a central securities register for the company.  Pursuant to Section 111 of the Act, companies must maintain a central securities register and include in it all shares of the company which are issued or transferred, together with the following information:

• the name and last known address of each person to whom the shares have been issued or transferred;

• the class, and any series, of the shares;

• the number of shares held by each person to whom the shares have been issued or transferred; and

• the date and particulars of each issue or transfer.

Conclusion

Although online incorporation is convenient, there are risks involved which incorporators should be aware of.  The foregoing list represents only a few of the risks that I have noticed with incorporating online.   There are many more, especially in situations where a company requires any sort of customized legal or tax structure.

The costs associated with reorganizing a company, which was poorly organized online, can far exceed the costs associated with receiving timely legal and financial advice at the outset of the company’s formation.

For more information on corporate matters, do not hesitate to contact Murphy & Company at (604) 360-7014 or by email at: tmurphy@murphyandcompany.ca

This article is not legal advice and is not intended as legal advice.  This article is intended to provide only general, non-specific legal information.  This article is not intended to cover all the issues related to the topic discussed.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  This article is based on British Columbia law.  You should consult with an attorney familiar with the issues and the laws of your country.  This article does not create any attorney client relationship and is not a solicitation.