Latest Blog Posts
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Staffing – Employees vs. Independent Contractors
I’m often asked whether it’s better for the company to work with people as employees or as independent contractors (also called contractors or consultants – the differences are of style, not meaning). Consulting is common in the technology business in Canada, particularly during any recession, and as businesses staff up it’s an important question to ask.
Like most everything else, the answer is “it depends”. If you need occasional help, or a discrete task performed, using the services of an independent contractor can make a lot of sense – there’s no fussing with payroll, there are no employment benefits, existing teams are not disrupted, and there is often very little overhead involved. But the employment relationship is generally better suited for situations involving more permanence, and the law reflects this in a variety of ways. Here’s a summary, then, of legal considerations you should take into account when making this decision.
1. Employers are required to make certain source deductions – like income taxes, Canada pension plan contributions and employment insurance premiums – from salary and wage payments to employees, but not from payments to contractors, who are responsible for paying their own. Companies that in this regard treat personnel as independent contractors when they are in substance employees face the risk of being challenged on that determination, with a possible outcome being assessed for unpaid amounts, plus penalties and interest. Independent contractor agreements typically include indemnities under which the contractor agrees to make the client whole if this happens – but good luck collecting on the indemnity, which typically only becomes relevant because the contractor is having trouble paying its taxes and therefore is probably unable to satisfy a demand under an indemnity.
2. The employer’s obligation at common law to give reasonable notice on termination can be involved as well. This is because a staff member who was originally brought on as a contractor might in substance be an employee instead, or might over time in substance become an employee, in the eyes of the law.
An example of a scenario in which this could become an issue would be a staff member arguing after termination that on termination they were actually in substance an employee and not an independent contractor (even though they were described as an independent contractor in company records, in their agreement, and even though source deductions were not made) and therefore entitled to more notice of termination than agreed to in the independent contractor agreement. This claim is typically only worth making for longer-term staff members – people for whom the difference between termination notice for employees at common law and contractual termination notice under an independent contractor agreement can be significant.
How do you know who is an employee? The law generally looks at the person’s substantive relationship to the business (after all, if it were as easy as just picking the right job description, it would be easy for employers to avoid a whole host of legal obligations to employees.) The cases take a variety of approaches, but in substance if a person has only one client, works in the client’s office, works full-time, uses the client’s computers and other tools, works when and on projects directed by the client, and with the client’s employees, there is a pretty strong case to be made that the person is in substance an employee and not a contractor. And team members who start out as contractors can certainly see their relationship to the company evolve over time in this direction.
3. If a person who is in substance an employee is compensated as an independent contractor instead, certain amounts such as overtime, vacation pay, statutory notice and severance payments can be due to the person, and if not paid can result in substantial fines against the company and its directors.
4. The rules are somewhat complex but the result is that in Canada, employees receive preferential income tax treatment of the gains from a stock option grant. The differences between this treatment and the approach taken with contractors can be significant.
5. The default rules in Canada concerning who owns the intellectual property created for the company treat employees and contractors differently. Under the Copyright Act, for example, the employer generally owns copyrights created in the course of an employee’s employment. Under patent and other forms of intellectual property law the rules are somewhat different, but the essential point is that the result one gets can differ depending on the status of the team member.
For most companies, however, this is not an issue because they require each new team member to agree to a form of agreement that gives to the company ownership of intellectual property created in the course of employment.
6. Finally, the rules on SRED tax credits treat employees and consultants differently. Mark MacLeod has the details.
For a variety of reasons, the choice between treating team members as employees and independent contractors can mean very different results. And treating people who are in substance employees as independent contractors instead can have unexpected and adverse results. It’s a distinction you should take seriously, and consider early.
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Organization – The Basics
For many people, organizing the corporation is probably close to the most boring thing they can do without actually having to count all of the sand on a beach. Dull – perhaps, but in many cases quite necessary. It often comes as a surprise to people that when they incorporate a business in Ontario, there is more to do on initial setup than mere incorporation. But incorporation only provides you with the corporate entity – until it is ‘organized’, it has only (essentially) ‘acting’ director(s), and no shareholders, officers, by-laws, and so on. It’s governed by the applicable corporate law (in Ontario, the Business Corporations Act), but many specifics of how corporations work are left out of the applicable corporate statute, and are for the corporation to decide.
If the corporation is to have only one shareholder, the person who incorporates it – the incorporator – sometimes skips organization – the incorporator generally controls the corporation anyway (because they typically establish themselves as the first director, and that person has the power to issue shares, which in general grounds the power to do everything else). Some people defer organization because they see it as something they can do later, when they need it done for some specific purpose. This delay is often of little or no significance for many – in the short term, whether or not a corporation is organized will generally be of no importance to customers, many suppliers and other third parties, so it is sometimes ignored, at least at the outset.
But certainly for the corporation that has more than one shareholder, organization can be critical – it establishes important details of key legal relationships between the shareholders, basics without which the potential for costly misunderstandings can increase. And banks will generally require some organizational steps be taken when you open an account. As a result, in many cases it makes sense to get it done when you create the corporation.
Organization is generally very easy – in simple cases there are a few corporate resolutions to prepare, shares to be issued, a by-law or two to adopt, and director(s) and officer(s) to elect and appoint. There are common forms for much of this, and most lawyers have clerical staff handle it, at a small cost to the client.
The most complex aspect of organization arises when the corporation needs a shareholders agreement – the form of agreement used when the shareholders want to go beyond the basics of the applicable corporate law and the by-laws in their establishment of the rules that are to govern how the corporation manages its affairs, and how its shareholders are to relate to each other and the corporation. In the near future, I’ll post on shareholders agreements in Ontario, and what purposes they serve.
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Employment – Making the Offer and Varying the Contract
From time to time, I’ll be posting information of interest provided by other lawyers and professionals with whom I sometimes work. Today, I’m posting an article by Daniel Lublin of Whitten & Lublin LLP. Dan recently wrote a piece on a case that illustrates the dangers when employees and employers do not share a common understanding of the terms of employment. For employers, one of the lessons of this piece is to ensure that when the offer is made to the employee, the terms of the offer are clear. If there is an employment agreement to be signed, it should be given to the prospective employee before the job is accepted, and the employee should be given time to reflect and seek advice. And of course, if the terms of employment are varied later on, the variation must be done properly.
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Fresh “consideration” required to support variation of contract
On Krzysztof Rejdak’s first day of work, he found himself in a pickle. He was given an employment contract with a three-month probationary term and asked to sign his name. For Rejdak, who had already resigned from his previous long-term job, his options were grim: he could either sign his name and agree to be a probationary employee or he could refuse and potentially be unemployed. Fortunately for Rejdak, he later learned in court that not all signed agreements will ultimately be enforced.
For seven years, Rejdak honed his skills as a sports editor at the Ontario-based sports television network, The Score. When an opportunity came about at The Fight Network Inc., a start-up digital television channel focusing on fighting, Rejdak’s response was swift. He interviewed for an editor’s position.
Impressed with his skills, The Fight Network then telephoned Rejdak and offered him the job. After they had discussed his title, salary and start date, Rejdak was satisfied with the offer and the next morning he resigned from The Score.
Later in the day, Rejdak showed up at The Fight Network set to work. But his bosses were surprised to see him there so quickly, since he hadn’t yet signed the standard employment contract given to all new employees. Rejdak was then given a contract containing a three-month probationary period.
(read the rest here)
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Before you start your startup
I see a lot of people who are at the very early stages of planning a new business. As a result, I’ve developed an informal standard ‘laundry list’ of cautions to pass along to these clients in the first call I have with them.
Many people are surprised to learn that there are legal steps they should be taking toward their new business before they start building it. But there are, and they’re important, and dealing with these issues can be difficult and expensive if they’re left until some later time. (In a recent example, problems in this area cost a new client months of time in the market and a lot of money in legal fees for a litigator).
Summary
In brief, before you start you need to ensure that (i) any intellectual property and confidential information you create for your new business will be your own; (ii) you comply with any obligations you have in agreements with your current employer or with clients.
Background
Here’s the background on why these issues come up:
(1) The default rule in Ontario, absent a written agreement, is that if you’re an employee, the copyright to any work you create in the course of your employment belongs to your employer – but this is subject to any specific agreement with the employer. If you’re not an employee (we generally call these people “independent contractors”) the copyright belongs to you unless there’s a written agreement that says it belongs to your client. (Patent ownership rules are different, and unfortunately, somewhat murky. Heenan Blaikie’s site has a good short summary. I covered these issues in a post a while ago.
(2) In addition, whether or not there is a written agreement, employees and contractors can have confidentiality obligations (and in some cases, other obligations as well) to their employers / clients.
(3) In any event, in the technology world, written employment and independent contractor agreements are the norm. As a practical matter, these always say that the employer, and almost always say that the client, owns the creative output of the relationship (all kinds – not just copyright), and these agreements typically also contain an array of other protections for the employer / client that are, at least in the employment context, almost always biased strongly in the employer’s favour. (And, frankly, these agreements often contain drafting mistakes that can make it very difficult to know just what they mean.)
As a result, if you have a job or are an independent contractor when you start your startup, there are a variety of potential pitfalls. Be aware of them, and plan for them.
Avoiding Problems
What should you do you do to avoid these situations? First, when you join a new employer or take on clients, you should read the fine print in the agreements, and make sure you understand it. Try to resolve uncertainties before you’re stuck with them.
Next, when you’re starting to gear up for your new startup, keep in mind the checklist that U.S. lawyer Yokum Tatu has on his blog. It’s a really great post written by a lawyer who genuinely knows what he’s talking about, and it’s a generally fair statement of the situation here in Ontario (there are differences between the law in California and in Ontario, but at a high level the approach is similar).
Last, as you start up, make sure you have good documentation in place between co-founders and with any contractors and employees you have working with you. For the most part, these documents are simple, and any lawyer familiar with startups should have them for your free or very inexpensive use. I’ll be posting on these in the not-too-distant future. (Note: there are various forms on this site – you can see them all here).
These are probably the single best things you can do to help launch your new project; a little attention when you join your new employer or take on clients and also when you first get the itch to start something on your own could save you a lot of aggravation down the road.
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Incorporation – What, Why, Where and How
Over the next while I’ll be posting on some of the more common questions I get from clients. Please feel free to leave a comment if you have something to add. Today, it’s the basics of incorporation.
What is incorporation and why do I need to incorporate my business?
Incorporation is the process that legally creates a corporation – a form of organization that is probably the most common form for technology businesses. There are many reasons for this, but the three most important are probably the tax advantages one gets from incorporation; the corporation’s independent, perpetual existence; and the corporation’s limited liability. The latter two mean that a corporation is a separate legal person, distinct from its owners, and that in general the owners do not have anything at risk other than their investment in the corporation. For obvious reasons, these characteristics facilitate operating, financing and selling businesses.
Not every business needs to incorporate – sole proprietorship and partnership, for example, are popular vehicles in many contexts. But the typical life-cycle of a technology business involves activities and relationships with third parties that make incorporation the best choice in most cases.
Where do I incorporate?
Incorporation is done in Canada under one of our many provincial and federal incorporation statutes. These statutes used to be quite different in important respects, but in recent years they’ve mostly been conformed and they’re now very similar (though there are still some differences that can matter for specific needs). In Ontario, the Business Corporations Act is probably the most common statute used, but many businesses based in Ontario are incorporated under the federal Act, called the Canada Business Corporations Act (“CBCA”). Generally, because of cost and duplication of effort considerations, most businesses in Canada incorporate under their home province’s statute or under the CBCA. Here is a recent paper from Wilson Vukelich, co-authored by my friend Jordan Dolgin, explaining some of these considerations.
How do I incorporate?
Incorporation is a pretty simple process. There is a government fee to pay and forms to complete, but that’s about it. Here’s a slightly dated but still useful outline. And here’s Industry Canada’s guide to incorporating under the CBCA, and a couple of guides for Ontario. There are a few services now that will do your incorporation online. Or you can consult a lawyer, who can do it for you.
What about the company’s name?
I usually advise clients to defer picking a name until the dust has settled on choosing the brand. Most of the clients I work with will change their vision of the brand several times before they settle on their final choice. As a result, I usually suggest quickly locking down relevant domains on any possible choice, but staying with the default numbered name (eg., 1234567 Ontario Inc.) until the choice is settled and the brand is ready to be used in public. Once you’re ready to pick a name there is a search process that must be undertaken to ensure that the name can be used as the corporate name.
Picking the name is obviously a longer discussion, but before it’s settled it’s a good idea to do an exhaustive search, including in trade-mark registries, for similar names. And if the business is carrying on business or identifying itself to the public under a name other than its corporate name (eg. a brand name different than the corporate name), that name should be registered under the Business Names Act. Finally, trade-mark registration, while costly to the typical startup, offers some advantages, and should be considered at some point.
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Notes
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It seems like there’s a failure-to-redact case about every week these days. I’m mystified by why it causes so much trouble.
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A very powerful piece on EBC, NRC-IRAP, and SR&ED.
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This is mind-boggling.
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