Property, intellectual property, credit and insolvency, and capstone: a legal risk audit

Businesses own, rent and borrow against property of many kinds: land and buildings, equipment and inventory, accounts receivable and, increasingly, intangible assets such as brands, software and data. This final lesson surveys the law of real and personal property, introduces the main forms of intellectual property, explains how lenders take security and what happens when a business cannot pay its debts, and then brings the whole course together in a capstone: a legal risk audit of an invented business. Copyright, licensing and creative business structures are covered in more depth in PHOT-410 and CRE-330.

Real property and leases

Real property is land and everything permanently attached to it, such as buildings and fixtures. The most complete form of ownership is the fee simple, which can be sold, leased, mortgaged and inherited. Other interests include leases, easements (such as a right of way across a neighbour's land) and mortgages, which give a lender security over land. Ownership and interests in land are recorded in provincial land registries. Ontario, British Columbia, Alberta and other western provinces use land titles (Torrens) systems, in which the government guarantees the title shown on the register, and Ontario's registry is now almost entirely electronic. Buyers search the register, obtain title insurance or a lawyer's opinion and register their interest promptly, because unregistered interests can lose priority.

Most businesses lease rather than own their premises, so the commercial lease is often one of their largest contracts. Unlike residential tenancies, commercial leases are governed mainly by the lease itself and the common law, with few statutory protections. Key terms include the rent and how it escalates; whether the lease is gross (the landlord pays operating costs) or net (the tenant pays its share of taxes, insurance and maintenance, often called additional rent or common area maintenance); the permitted use and any exclusivity; responsibility for repairs and capital replacements (lesson 4's roof example); assignment and subletting rights; renewal options; personal guarantees; and what happens on default. A tenant should model the total occupancy cost over the term and negotiate before signing, because the lease will usually be enforced as written.

Personal property is everything else that can be owned: tangible goods, such as equipment, vehicles and inventory, and intangibles, such as accounts receivable, shares and intellectual property. When one person holds another's goods with permission, such as a repair shop holding a customer's car or a warehouse storing inventory, the relationship is a bailment, and the bailee must take reasonable care of the goods, with the standard depending on who benefits from the arrangement. Warehouses and carriers typically limit their liability by contract, as in London Drugs (lesson 4).

Intellectual property

Intellectual property (IP) law gives creators and businesses exclusive rights over certain intangible creations. The main categories are copyright, which protects original works of authorship; patents, which protect new, useful and non-obvious inventions; trademarks, which protect signs that distinguish one business's goods or services from another's; industrial designs or design patents, which protect the visual appearance of products; and trade secrets (lesson 7). IP rights are territorial, so protection must generally be obtained in each country where it is needed, although treaties simplify filing.

Ownership of IP is a frequent source of disputes. Under the Copyright Act, the author is the first owner of copyright, except that works made by an employee in the course of employment belong to the employer unless agreed otherwise. Works created by independent contractors, such as a freelance designer's logo or a developer's code, belong to the contractor unless the contract assigns them in writing. Authors also have moral rights, to the integrity of the work and to be associated with it, which cannot be assigned but can be waived. Patents belong to the inventor unless an employment contract or assignment says otherwise, so businesses use invention assignment clauses. Since 2019, the Trademarks Act allows registration without proof of use, which has led to trademark squatting; businesses should file early in the classes that matter to them.

Secured transactions

When a business borrows, lenders usually take security over its assets, so they can seize and sell them if the business defaults. In the common law provinces, security over personal property is governed by personal property security acts (PPSAs), and in Quebec by the hypothec provisions of the Civil Code. A security interest attaches when value is given, the debtor has rights in the collateral and the debtor signs a security agreement describing it. To protect its priority against other creditors and a trustee in bankruptcy, the secured party must perfect its interest, usually by registering a financing statement in the provincial registry. Priority between competing perfected security interests generally goes to the first to register, even if the security agreement was signed later. A purchase-money security interest (PMSI), taken by a seller or lender who finances the purchase of specific collateral, gets super-priority over an earlier general security interest in the same collateral if it is perfected within a short period and, for inventory, after notice to the earlier secured party. Banks can also take special security under section 427 of the Bank Act. Security over land is taken by registered mortgage or charge.

Insolvency and bankruptcy

A business is insolvent when it cannot pay its debts as they come due or its liabilities exceed its assets. Federal law governs insolvency. Under the Bankruptcy and Insolvency Act (BIA), a debtor can make an assignment in bankruptcy, or creditors can apply for a bankruptcy order; a licensed insolvency trustee then takes control of the debtor's property, sells it and distributes the proceeds. Alternatively, a debtor can file a proposal to its creditors to restructure its debts; if creditors holding the required majorities approve and the court approves, the proposal binds them. Larger companies, with debts over $5 million, can restructure under the Companies' Creditors Arrangement Act (CCAA), which gives a flexible, court-supervised process with a stay of proceedings while a plan is negotiated. Secured creditors can also appoint or apply for a receiver to take control of assets and sell them. Transactions before bankruptcy can be challenged: preferences to arm's-length creditors in the three months before bankruptcy, made with a view to preferring them, and transfers at undervalue, with longer look-back periods for related parties.

Distributions follow a strict order of priority. Secured creditors are paid first from their collateral, up to its value. Certain claims have statutory priority. Unsecured creditors share pro rata in what is left, and shareholders receive anything only after all creditors are paid in full, which rarely happens. Because unsecured trade creditors often recover only a small fraction of their claims, suppliers manage credit risk through credit checks, deposits, credit insurance, retention of title clauses and purchase-money security.

Important priorities under the BIA include deemed trusts for unremitted source deductions (income tax, CPP and EI withheld from employees), which rank ahead of secured creditors; a super-priority charge for unpaid employee wages and vacation pay earned in the six months before bankruptcy, up to $2,000 per employee (plus up to $1,000 of expenses for travelling salespeople), and for certain unpaid pension contributions; the right of unpaid suppliers to recover goods delivered in the 30 days before bankruptcy if they remain identifiable and unchanged and a demand is made within 15 days after the bankruptcy; and a list of preferred claims, such as limited landlord claims, which rank ahead of ordinary unsecured creditors.

Insurance as a risk management tool

Insurance transfers financial risk to an insurer in exchange for a premium. Common business coverages include commercial general liability (bodily injury and property damage to third parties, including premises and product liability), property insurance, business interruption insurance, automobile insurance, professional liability or errors and omissions, directors' and officers' liability, cyber insurance, employment practices liability and, where required, workers' compensation. Insurance contracts are interpreted against the insurer where ambiguous, and insurers owe a duty of good faith in handling claims, but policyholders must disclose material facts when applying, comply with notice requirements and read exclusions carefully. Insurance does not cover everything: fines, deliberate wrongdoing, contractual liabilities assumed beyond the law and unremitted taxes are commonly excluded or uninsurable.

Capstone: a legal risk audit

A legal risk audit is a structured review of where a business is exposed to legal liability and what it is doing about it. It draws on every lesson in this course. The process has five steps: understand the business (its activities, people, contracts, assets, customers and locations); identify legal risks in each area; assess each risk by likelihood and impact; decide on a response (avoid, reduce, transfer through contracts or insurance, or accept); and assign owners and deadlines for the actions, with periodic review. The output is a risk register that management and the board can use.

The capstone business is invented. Harbourline Coffee Roasters Ltd. is an Ontario corporation owned by two founders, each holding 50 % of the shares with no shareholder agreement. It has 45 employees, including six delivery drivers and two "freelance" baristas who work regular shifts. It roasts coffee in a leased warehouse, sells wholesale to 120 cafés under its own standard terms and conditions, runs an online store with customer accounts and an email newsletter of 18,000 subscribers collected over five years, and has just signed a five-year lease for a second café, personally guaranteed by both founders. Its logo was designed by a freelancer. It is negotiating a large supply contract with a grocery chain that requires a cap on Harbourline's liability of no more than the contract value and a strict product recall indemnity.

The audit is not a one-time exercise. Laws change, as many examples in this course show, and the business itself changes as it grows, enters new markets and launches new products. A short annual review, plus a review before any major decision such as a new location, product launch, financing or acquisition, keeps the register current. The audit also improves relationships with professional advisers: a lawyer given a clear risk register can focus advice where it matters most, and an insurance broker can match coverage to actual exposures.