"Going concern" v "insolvency": there is a difference

There are still too many among directors and senior management that believe an auditor's assessment of  a company as a going concern is the same as as a directors' assessment of its potential for insolvency. That is not a correct view, because the two concepts can diverge either way:

• an entity may still be capable of paying its debts as and when they fall due, but at the same time not be a going concern because the directors intend to liquidate or significantly curtail its operations within the relevant reporting period; and
• a company may still meet the criteria of being a going concern because of its intention and capacity to maintain the scale of its operations, while still facing significant uncertainty in being able to pay longer-term debts as and when they fall due.

An entity's status as a going concern arises from IAS 1, which is its current foundation  in Canadian GAAP. Securities laws require it to be addressed in an annual report's Management Discussion and Analysis, although the Ontario Securities Commission has noted major deficiencies in that regard.

The directors' assessment for the potential of insolvency is preemptive in nature, and arises from both statutory and contractual duties. CPA Canada has noted that there is a crucial need to ensure an early determination, in order to employ available  options and avert potential default on a timely basis.

Even if there are no immediate concerns, auditors must still address whether any material uncertainties may exist that need to be noted in a company's financial statements, and be prepared to issue an adverse opinion if such uncertainties are not addressed therein.

This is further evidence of the current requirement of directors and management to be proactive in addressing their duties, as being reactive will, in almost all cases, will be too late.

In performing their duties, directors must act reasonably.  It has been held that reasonable grounds do not include "unquenchable optimism," and the following list indicates factors that suggest where an unreasonable action has occurred in assessing insolvency:

1. Where, although the officer has never adverted to it, there is at the objective level no reasonable or probable ground of expectation  to the relevant effect;
2. Where the officer himself has a subjective expectation of the relevant kind, that there is no objective ground for the expectation;
3. Where, as a matter of subjective judgment, the officer lacks the expectation yet, unknown to him, there is, on an objective appraisal, a reasonable or probable ground of expectation; and
4. Where the officer does not care whether the postulated event of payment will occur, and it appears that objectively there was no ground of expectation.

On the other hand, directors cannot give a qualified opinion as to material uncertainties, either through an expression of hope or envisaging unlikely scenarios, and the use of boilerplate statements in either the MD&A or the notes to financial statements is viewed as being very unhelpful. For example, if a qualified opinion is being considered as to the availability of financing from a financial institution or shareholder to ensure continuing as a going concern, genuine negotiations with a reasonable likelihood of success should be shown to be underway at the date of the statement.

The future of HR for employers

Last month's ruling by the Supreme Court of Canada in Wilson v Atomic Energy of Canada Ltd—even though it is ostensibly restricted in scope to federally regulated employers—should give pause to all organizations in the management of their workforces. Taken together with other recent SCC judgments, we can see that the HR landscape is becoming quite different in many respects from what many of us have been used to over these past few decades.

This most recent decision has several notable aspects that have far-reaching consequences: Much comment has been made about the inability of federally regulated employers to terminate non-managerial employees without just cause (provided that they have worked for more than twelve months). It was noted that the federal scheme displaced the common law with a scheme requiring reasons to be given for dismissal, and that the payment of a generous package cannot avoid a determination under the Canada Labour Code on whether the dismissal is unjust. I can see this having an impact in dealing with complaints on human rights issues, such as under Ontario's Human Rights Code, where settlements can be reached only after a complaint has been filed. This scheme appears to qualify as another instance where the common law has been displaced in favour of a statutory right.

One commentator has suggested that perhaps, in the federal sphere, probation periods can be extended to twelve months in order to be able to quickly dismiss employees before the Code's protections kick in. I can see several practical reasons why this would not be so easy from the employer's point of view:

• such periods only exist when specified in an employment agreement, and its consequences must be explicitly laid out therein;
• they cannot be unreasonable in length (which will depend on the nature of the position and the qualifications of the incumbent), but can be extended when the agreement explicitly provides for such an option;
• there can be liability for negligent misrepresentation, where the parties are each under a duty to exercise reasonable care to ensure that any representations they make are correct, which can impact on the intent being expressed for the use of probation;
• if the specified period is greater than three months, the agreement must comply with the minimum notice provisions in the Employment Standards Act, 2000;
• liability for wrongful dismissal will still occur if termination occurs before a probation period even begins, as noted in a recent BC case;
• termination within the period does not mean that notice (or pay in lieu thereof) can be avoided, as the common law still requires adequate notice to be given even when statutory notice is not required; 
• keep in mind that employers in Québec are required to act in good faith during all stages of the employment relationship, while the common law provinces have such a duty only during the relationship and its termination.
• termination can only be done in good faith, and that concept should be reinforced by stating within the agreement the purpose for which the probation period is required, for which adequate documentation should be kept to support the employer's assessment of the employee's performance;
• however, there have been cases where a court has held that termination can occur without notice and without reasons when not done in bad faith.

The above list is not exhaustive, but it applies to provincially regulated employers as well, and other concerns may easily arise. These are interesting times indeed!

Paid vs unpaid labour: key distinctions

There have been many assertions I have heard over the years in the private sector as to what rules apply where a worker is being hired, raising distinctions between permanent and casual labour, employment vs independent contractors, and when unpaid work is allowed. Many of those assertions - including ones made by fellow professional accountants - have turned out to be wrong. Here is an outline of what the true situation is for employers, at least as far as Ontario is concerned.

Where unpaid labour is allowed

I can only find the following circumstances where payment would not be allowed:

1. Where the work was undertaken as a volunteer, with no reasonable expectation of being paid (such circumstances would be rare in the private sector, but would more likely be able to occur in the public and non-profit sector);
2. For activity undertaken in the role of a director of a charity (but the Charities Accounting Act does allow for work by a director outside that role to be compensated upon the approval of a prescribed order); and
3. Training given by an employer, in restricted circumstances as specified in the Employment Standards Act, 2000.

There is no statutory definition of a volunteer under Ontario law,but a regulation under the Occupational Health and Safety Act does state that a "volunteer worker" is:

"a worker who performs work or supplies a service but who receives no monetary compensation for doing so other than an allowance for expenses or an honorarium." 

That is not a comprehensive definition in the matter, as it only aids in determining which workers are not counted for assessing whether a joint health and safety committee must be appointed for a workplace. There are few court cases that discuss the unique nature of a volunteer, but more recent ones stress that an organization's vicarious liability does extend to those persons' activities.

Training given by an employer can be unpaid only where it is:

• similar to that which is given in a vocational school,
• for the benefit of the individual, and
• the person providing the training derives little, if any, benefit from the activity of the individual while he or she is being trained,

 and the individual:

• does not displace employees of the person providing the training.
• is not accorded a right to become an employee of the person providing the training.
• is advised that he or she will receive no remuneration for the time that he or she spends in training.

All six of these criteria must be fulfilled, which effectively kills off most such schemes that had been in effect over the course of the last couple of decades. The Ministry of Labour is conducting blitzes of specific industries, such as with magazine publishing in 2014. As well, some managers have asserted that it was OK to give such participants an honorarium at the end of their work term, as the CRA only requires a T4 to be issued where a payment is greater than 500 dollars within a year, but the last criterion above effectively bars that from taking place.

Other statutes to watch out for include:

• the Workplace Safety and Insurance Act, 1997, which extends WSIB coverage to volunteer firefighters, ambulance workers and police auxiliary members;
• the Human Rights Code does apply to volunteer employment;
• OHSA's definition of "worker" includes those receiving no monetary compensation as a result of participating in a secondary school work experience, a program approved by a post-secondary institution, or in a training scheme as prescribed under the ESA, which effectively means that an employer has a statutory duty to provide them a safe workplace together with appropriate training.

"Casual labour" is still labour

Many managers have also asserted that "casual labour" does not have to be passed through payroll, but they conveniently forget the CRA notice outlined above. As long as it constitutes employment, a T4 must be issued. However, the University of Waterloo does have a nice little classification for the types of appointments that are available within its organization, which would be good for others to adopt as well (with necessary modifications). In it, they define "casual earnings staff" as those "employed for less than three months or on intermittent bases or who do not have regularly scheduled hours of work, or who are employed under an arrangement where they may elect to work or not when requested to do so." Note that a one-time engagement would qualify under this definition, and I doubt whether such work would be performed for 500 dollars or less. This definition is in contrast to those given for indefinite or definite-term appointments or for collective bargaining arrangements, but payments for all persons must be processed through payroll.

Employee or independent contractor?

Whether an engagement constitutes employment or a contract for services is highly fact-dependent, and has nothing to do with what an agreement might state. The relationship will depend upon certain factors as determined over the years through the courts, which include:

• control over how, what, where and when work will be done;
• who furnishes the tools and equipment required to perform the work;
• whether a person can subcontract the work or hire assistants to help out
• who bears the financial risk for performing the job;
• who is responsible for making the necessary capital investment and business decisions that can affect the profit or loss on the contract; and
• the opportunity to control proceeds and/or expenses in order to maximize profit.

Again, the University of Waterloo has an excellent matrix covering the various possibilities. It is noteworthy that certain payments will require the issuing of a T4A at year-end, while others need only be accounted for in the contractor's Statement of Business/Professional Income required to be filed with their annual income tax return.

Some companies have attempted to do an end run around by this by claiming that an arrangement is with a separate corporation, as opposed to being with the individual concerned. This can work, but it also problematical, and it raises concerns of liability as well as whether the arrangement is legitimate and not a "sham" transaction. UW's policy is a good framework to help assess whether your arrangements in that regard might hold up.

What can be a "sham" transaction? I've heard of several instances where this was ostensibly in effect, but the principals never bothered to even set up a bank account in the corporation's name to receive the payments, preferring to deposit the cheques into their own personal account. One person even requested that the cheques be made out into his own name! Now that was obvious!

The Web is peering further into the past

It's interesting what you stumble across these days when you're searching on the Internet. I've known for years that the fact I lived in Acton means that all my family history as reported in The Acton Free Press in those years is now completely online. That is embarrassing enough, but I have discovered that another year in my life later on is available for viewing as well.


I've never hidden the fact that I attended Carleton University for a year after graduating from Acton High, but have never bothered to mention it on my résumé. After all, you only mention the places you graduate from! I have essentially treated it as my "gap year" before going to Sheridan and later heading into the business world.

However, I was a reporter with The Charlatan while I was living on campus, and all the work I did is available for the world to see. All you have to do is click on the link at the bottom left corner of the above image, type "Ellerby" in the search box, hit "Go" and see what pops up.

The first few issues see my name misspelt as "Ron Ellery" in the masthead, but then I started getting bylines and conducted some interesting interviews, including one with the eventual winning candidate for the presidency of the Carleton University Students' Association. Towards the end of that year, I was even editing the events section and working on layout at the printers. And now it can be verified by the entire world!

Since then, I have always had a great appreciation for the work of the media, especially for those in print. Perhaps that could have been a better calling? Who knows? I chose to pursue accounting as I thought it represented a similar quest for the truth, but, sadly, I have tended to be in the minority as far as that group has been concerned. Perhaps I was ahead of my time, as there appears to be greater emphasis these days on encouraging professional skepticism, as well as levying real penalties on those who cross the line. However, there has always been an undercurrent of power relationships and backroom politics in the profession that will still take a major effort to overcome. Those stories, however, are for another day.

For now, though, take a look back at what a bunch of intrepid reporters for a minor student newspaper were up to in 1972-1973.

NB: A version of this article appeared in my personal blog on Wordpress. However, the ability to embed the webpage above was lacking, so I have posted it here as well. Besides, Blogger is aimed at a somewhat different audience that might find it interesting.

How is your exposure with your bank?

We all know that the Canadian banks have always had a conservative approach towards minimizing their exposure when it comes to extending secured credit to businesses. The factors that such businesses must take into account have multiplied in recent years, but the banks have never been very explicit in their documentation as to why such factors are critical. Here is an attempt to classify them, based on past experience and current awareness.

For simplicity, we will assume only one line of credit secured by a charge against all company assets, with regular reporting of credit exposure to the bank in order to determine availability for drawing down upon the line. The basic formula for determining maximum availability of funds is:

$ (R*a + I) - (D+L) $

where R is eligible receivables (usually after deducting amounts over a certain age and amounts due from the Crown), a is the availability percentage specified in the credit agreement, I is eligible inventory (more often than not just a flat amount),  D is the sum of all statutory deemed trusts, and L is the sum of any liens against the business.

Each of these factors deserves separate discussion.

Receivables

How much you can get will depend on the creditworthiness of your customers, as well as the risk exposure of the sector you are in. These will influence the aging cutoff for determining the eligible amount, together with the overall percentage applied, against which the bank will extend funds.

Exclusion of debts due from the Crown is based on s. 67 of the Financial Administration Act, which states that, in general, "(a) a Crown debt is not assignable; and (b) no transaction purporting to be an assignment of a Crown debt is effective so as to confer on any person any rights or remedies in respect of that debt." Ontario does not have such a provision, but some other jurisdictions do. Further and more detailed discussion on this can be found here.

Inventory

Amounts allowed under this are quite variable, and it all has to do with the risk exposure involved. I was involved in an asset-based financing arrangement several years back, and the amount granted was quite minimal as the assumption was that, if the bank had to call their security, any goods would be disposed at a distressed value. In addition, suppliers have a super-priority right to claim back goods that had been shipped within thirty days prior to a bankruptcy, if a demand is filed with the bankruptcy trustee within the first ten days of such bankruptcy.

Statutory deemed trusts

Federal and provincial statutes have been providing an expanding list of what amounts can fall within this category, but they fall within one of two categories: those which can survive bankruptcy, and those might not.

In the first group (more fully discussed here):

• Payroll source deductions for tax/CPP/EI
• Municipal taxes
• Requirements to Pay issued under the Income Tax Act or the Excise Tax Act
• Remediation orders issued by the Crown to recover environmental remediation claims
• Current employer and employee contributions to pension plans

In the second group:

• GST/HST and other sales taxes due
• other payroll taxes accrued
• other pension plan liabilities
• liability for vacation pay
• liability to carriers for freight charges incurred shipping to consignees

 

Considerations

It is prudent to have your payroll service provider charge and remit your payroll source deductions every pay period, in order to minimize your ongoing exposure to this critical item.

Accounting systems allow for grouping of vendors, which will help to identify vendors that would be identified within any of the above items.

Vacation pay liability is a sleeper issue that deserves more attention than it gets. Most payroll systems track the accrual for hourly employees, but the liability with respect to salaried employees has historically been treated as a "pay as you go" arrangement. This is not quite right these days, as IAS 19 requires accrual for any liability. That could cause problems if many salaried employees have been discouraged from taking their vacation time, as has occurred too frequently in recent years. While ASPE does not explicitly call for such comprehensive treatment, it may only be a matter of time before materiality considerations call for similar treatment.

Liens

The bank will need to know about all that exist, but you will need to know what their nature is:

• Possessory liens will trump a secured creditor's right in the same item, up to the amount required to satisfy the lien in full.
• A non-possessory lien right also trumps a secured creditor's interest but only if the non-possessory lien is registered prior to the secured creditor's interest.

They can be in the form of:

• tax liens
• construction liens (including any holdbacks)
• repair and storage liens
• maritime liens
• equitable liens

Needless to say, you should work to ensure that such amounts, in general, never arise to begin with. That is more a question of financial management as opposed to accounting, but holdbacks can be separately identified in most accounting systems.

Honesty with your lender

I have heard of other companies where the exposure reporting has been somewhat less than truthful, in order to squeeze out as much funding as possible. This is never ethical, and can attract significant liability when things go wrong. Several years ago, the Ontario Court of Appeal held that a CFO was personally liable to a lender for misrepresentations he had made about the financial viability of a subsidiary that was subsequently sent into CCAA proceedings. In its ruling, the Court quoted from prior jurisprudence:

"The consistent line of authority in Canada holds simply that, in all events, officers, directors and employees of corporations are responsible for their tortious conduct even though that conduct was directed in a bona fide manner to the best interests of the company, always subject to the Said v. Butt exception."

The exception mentioned concerned inducing a breach of contract. In any case, this emphasizes the duty that we have to ensure that we are dealing with lenders in good faith.

How effective are your agreements?

In all of the management positions I have held, there was responsibility for examining and reviewing a fair bit of corporate documentation either for research or for assessment as to how it would impact decisions to be taken. In addition to documents prepared in Ontario and notarial acts « en minute » from Quebec!, there have been many documents prepared in the USA, the UK France and Belgium! That's given me an interest in keeping up to date with what's going on in the area of commercial law.

I've been gathering a bit of a "cheat sheet" as to what to keep in mind for B2B (business to business) contracts. First of all, we need to remind ourselves as to what a contract is, and Halsbury's Laws of England gives a basic definition, much of which is still applicable in Ontario. Here's the 1909 edition, at paragraph 740:




In brief:

• a contract may be made either verbally or in writing;
• if it is in writing, either under hand only or under seal; but
• certain contracts must be in writing, and of these some must be in the form of a deed (ie, under seal).

The area is horrendously complex, so let's focus on those that need to be in writing between corporations. However, there are certain other statutes that will come up.

The contract is formed when:

• an offer is made by one person to another, and it is accepted by the person to whom it is made;
• there has been valid consent by both parties, without duress, undue influence or fraud; 
• both parties have the capacity to enter into the contract;
• it is either sealed, or valuable consideration is given by the promisee to the promiser.

The rules governing the use of seals are fairly rigid. The one that can really trip up users is the "sealed contract rule", which states that when it is executed under seal, an undisclosed principal can neither sue nor be sued upon the contract. That's because only the named parties acquire rights and obligations under it. In a simple contract (ie, one with valuable consideration) an undisclosed principal is able to sue and be sued under contracts entered into by his agent. The Supreme Court of Canada confirmed this in Friedmann Equity Developments Inc v Final Note Ltd in 2000.

What, then, constitutes a deed? It is a written instrument that must be sealed and delivered. Signing and witnessing are not strictly required, but are encouraged for purposes of proof.




At common law it is necessary for:

• the conveyance between living persons of incorporeal hereditaments (eg, rents or rights of way);
• any power of attorney which authorizes the attorney to execute a deed;
• gifts or gratuitous assignments of tangible goods (where not accompanied by delivery of possession); and
• rendering enforceable any gratuitous promise.

In equity, a deed must be employed "whenever any claim is made in a court of equitable jurisdiction of any assurance or alleged assurance made gratuitously of any legal estate, interest or right." This applies with respect to any real or personal property, or any other right.




There are three statutes in Ontario that have modified the application of deeds. The first is the Conveyancing and Law of Property Act, which provided for the following:

• effectively requiring a deed to be used for any transfer of rights in land; and
• an execution of a power of appointment by deed must be witnessed by two or more witnesses.

In addition, there is the Statute of Frauds, which reinforces the CLPA's deed requirements, as well as stating that most leases must be under deed as well.




Finally, we have the Land Registration Reform Act, which notably provides that "a transfer or other document transferring an interest in land, a charge or discharge need not be executed under seal by any person, and such a document that is not executed under seal has the same effect for all purposes as if executed under seal."




Now that is quite a broad change, but it does not completely displace the requirements for deeds.They are still useful where it is necessary to declare that the parties are conclusively bound by its terms (subject to the discussion in Friedmann above), or where there are questions of the adequacy of any consideration. Guarantees and indemnities come to mind, as well as conferring rights upon third parties, and deeds conferring a power of appointment by a corporation for executing a deed has certainly not disappeared. Seals may still be necessary on occasion, unless Ontario finally decides to follow the UK's Law of Property (Miscellaneous Provisions) Act 1989. I'm not holding my breath.

Quebec is quite different. Their Civil Code only recognizes contracts, and consideration is not a requirement for validity. Instead, their definition is quite succinct:

1385. A contract is formed by the sole exchange of consents between persons having capacity to contract, unless, in addition, the law requires a particular form to be respected as a necessary condition of its formation, or unless the parties subject the formation of the contract to a solemn form.

It is also of the essence of a contract that it have a cause and an object. 

They can be expressed as authentic acts (the solemn form, in article 2813 et seq.) or private writings (most contracts, in article 2826 et seq.), for purposes of proof. The rules are quite straightforward, and we can learn a lot from their approach. That's a discussion for another day, though.

How does all of this impact the internal administration of a corporation? I haven't even discussed tax consequences, and they do exist in multiple circumstances. The question of intercompany agreements for the handling of goods, services and cost-sharing is another sprawling area as well. However, it is necessary to understand how agreements are formed and become valid, before we can worry about the other myriad details that arise!

The distinction between innovation and growth

I've been on this topic before, but an op-ed piece in The Globe and Mail today makes the case quite clearly:

"In the 21st century, prosperity comes from ideas commercialization throughout the private sector – high tech to low tech, agriculture to services. Countries that innovate prosper; countries that do not decline. We know that without public intervention to create an ecosystem enabling our innovators to make money here, we will have less innovation than we need for prosperity. By confusing general growth policies with strategic innovation policy, Canada risks falling further behind globally.

"The aim of growth policies is to entice people or companies pursuing specific, well-developed activities to move or create businesses in your jurisdiction. By handing out public money, a government can entice foreign companies to open new campuses and create jobs in "innovation industries." Singapore and Ireland achieved rapid economic development this way, and Canadian governments have tried to. Yet this approach does not help foster domestic innovation.

"The aim of innovation policy is to foster the development of industries, products and services that do not yet exist and whose business models and markets have yet to be created. Organizations and individuals capable of inventing these technologies must be attracted or developed, and the results of their labours must be channelled into economic growth.

"That means we cannot use a process of long-term planning. Instead, we need continuous experimentation. Policy makers must rapidly come up with new initiatives, kill those that don’t work, scale up those that do and then keep changing incentives to keep pace with growing, dynamic industries."

There's nothing here that states anything more than plain common sense. However, too many policy makers tend to conflate these two aims into something that is less than clear, and too many Canadian enterprises confuse innovation and growth with surfing on the next wave that is coming through, as opposed to really determining what will beneficially work for them. That probably also explains why our rate of capital investment is so laughably low.

Let's see if this never-ending debate will finally come to a real conclusion...