Managing Environmental Liability: Considerations for Structuring Your Business

There are several options for how to structure your business, for example, operating as a sole proprietorship, corporation, partnership, or joint venture. Factors such as tax implications and contract risk are often considered when choosing which structure to use. Liability for environmental offences is rarely top of mind, however, in some cases this can have severe and unforeseen consequences. There continues to be increased scrutiny on environmental performance by regulators, project owners and investors, and penalties can climb into the millions. This article discuses different forms a business could take, and how each can affect environmental liability of the parties involved.

Overview of Environmental Offences in Canada

Environmental offences in Canada are generally regulatory or “quasi-criminal” in nature. Environmental legislation is often considered to be a matter of public welfare and can be enacted by various levels of government – federal, provincial, and municipal. Offences under environmental legislation are generally “strictly liability”– a species of offence where the prosecution bears the onus to prove only the prohibited act or “actus reus”. The prosecution must prove the actus reus beyond a reasonable doubt, a standard of proof generally applicable to criminal offences. If the actus reus is made out, the onus shifts to the defendant to prove a due diligence defence on the lesser standard of a balance of probabilities, sometimes expressed as “more probable than not”[1]; a standard of proof typically applied in civil proceedings. Regulatory offences are generally distinguishable from true criminal offences where the prosecution must prove both the prohibited act (actus reus) and a mental component (mens rea), both beyond a reasonable doubt. Further, a due diligence defence is often not available for criminal offences. The seminal case establishing the framework for strict liability offences in Canada is the Supreme Court decision in R v Sault Ste. Marie (City)[2].

Liability of Individuals, Corporations, and Partnerships

In the environmental context, individuals, corporations, partnerships as well as partners to a partnership can be held liable for strict liability regulatory offences. Individuals may be convicted even where the activity is conducted through a corporation, if the individual is found to be a controlling mind of the corporation and participated or acquiesced to the offence.[3] In R v Eldin[4], an Edmonton-based owner of a dry cleaning operation pled guilty to 5 offences under the Canadian Environmental Protection Act[5] in relation to the use of a regulated substance, tetrachloroethylene. Mr. Eldin was sentenced to 4 months in jail, to be served in the community under a conditional sentence order. This was the first time in Canada that we are aware of where an individual had their liberty restricted for an environmental offence.

In R v Bata Industries Ltd.[6], the corporate defendant was convicted for causing a discharge of a toxic substance contrary to the Ontario Environmental Protection Act[7]. A director and a general manager of the corporate defendant were charged with, and ultimately convicted of, failing to take all reasonable care to prevent the discharge. Reviewing relevant articles, texts and case precedents, the court developed a “minimum profile” against which directors’ liability should be measured.[8] Specifically, the court asked the following questions in assessing whether sufficient defence of due diligence was established to absolve the directors from liability:

1. Whether the board of directors established a pollution prevention “system” as indicated in Sault Ste Marie; [9] and
2. Whether each director ensured that the corporate officers have been instructed to set up such a system, to report to the board on the operation of the system as well as any substantial non-compliance with environmental laws.[10]

The court went on and listed the directors’ responsibility with respect to the corporation’s environmental practices, which includes reviewing environmental compliance reports provided by the officers of the corporation and immediately and personally reacting to system failures.[11] Ultimately, the Court held that the defendant director failed to ensure his instructions were carried out to minimize the damage as required by “due diligence”.[12] Accordingly, the director was found guilty. As such, Bata stands for the position that corporate directors ought to take active steps to ensure the implementation of their instructions and compliance with environmental laws to avoid personal liability.

With respect to corporate defendants, according to Sault Ste. Marie and Ontario (Ministry of the Environment) v Stelco Inc.[13], the key factors for determining liable parties in relation to strict liability offences are management and control of the undertaking or conduct that led to the offence. Specifically, in Sault St. Marie, Dickson J. found that “[t]he element of control, particularly by those in charge of business activities which may endanger the public, is vital to promote the observance of regulations designed to avoid that danger”.[14]

In Stelco, the Ontario Court of Appeal held that “primary liability flows from the ownership and control over the enterprise that has caused the regulatory violation.”[15] Unlike vicarious liability – where a corporation can be liable for the acts of its employees, it is unnecessary that an employee of a corporate defendant be found liable.[16] Rather, the assumption of management and control is sufficient for the onus to shift onto the corporate defendant to prove due diligence.[17]

Pursuant to Stelco, a parent corporation can be liable for environmental offences committed by its subsidiary corporation, although in principle, those two entities have separate legal identities.[18] Citing “Environmental Law, Third Edition” (Toronto, Canada: Irwin Law Inc, 2009) by Jamie Benidickson, Quon J.P. found that expansive approaches to interpreting “management and control” might potentially “extend environmental liability to institutions and individuals whose original connection with contaminated properties was financial in nature rather than operational”.[19]

In Alberta, similar to the Ontario legislation, the Environmental Protection and Enhancement Act defines a “person responsible” for things such as taking remedial steps and imposing reporting obligations, as a party that had “charge, management or control” over a substance.[20] Therefore, the reasoning in Stelco may apply under Alberta legislation and parties beyond those who directly caused the environmental harm may be found liable.

Significantly, it is often not recognized by organizations that each partner entity of a partnership can be held liable for strict liability regulatory offences, even if practically the partnership functions as an autonomous organization. In Ontario (Ministry of Labour) v NMC Canada Inc.[21], the Ontario Court of Appeal found that at common law, a partnership is not recognized as a legal person separate from the partners who compose it, and therefore, proceedings by or against partnerships have to be brought by or against the partners.[22] Based on that reasoning, the court allowed the Crown to amend the charging document (Information) to pursue charges against the two partner corporations, instead of the partnership that was involved in the offence.

However, in some cases the prosecution could also be advanced in the name of the partnership. This may occur where the relevant statute provides that a legal person includes a partnership.[23] In those circumstances, the prosecution retains the discretion of whether to lay charges against the partnership, its partners, or both, based on their involvement in the regulatory violation.

Interestingly, there is precedent in Alberta for a partnership being the entity convicted under the Environmental Protection and Enhancement Act even though that statute does not expressly state that a partnership is a “person” that may be convicted of an offence.[24] Nor is a partnership included in the definition of “person” under Alberta’s Interpretation Act[25] or the Provincial Offences Procedure Act.[26] It is unclear if this is an outlier situation or if the law in Alberta is distinguishable from the Ontario case law. Either way, it may be relevant to consider which entities may bear liability for environmental offences when deciding how to structure one’s organization and operations.

Proprietorships, Corporations, Partnerships, and Joint Ventures

Parties have several options when choosing the type of company model to use, including sole proprietorships, corporations, partnerships, and joint ventures. Each have different complexities, tax treatments, and liability protection.

Sole proprietorships are the simplest form of company for individuals but offer no liability protection or tax deferrals since there is no separation between the individual and the business. Many businesses start as sole proprietorships before converting to another structure as it grows. From an environmental liability perspective, a sole proprietorship would offer essentially no protection as the principal individual, or “proprietor”, is viewed as one and the same as the company.

Corporations are considered separate legal entities. As a separate legal entity, the corporation can own assets, incur debts, and conduct business as if it were a separate person. It is also taxed as a separate entity – often at reduced rates. The shareholders (owners) are not taxed on the income unless and until the corporation distributes the funds to the shareholder, thereby allowing for the deferral of personal taxes. Shareholders also enjoy limited liability against the liabilities of the corporation since the corporation is considered a separate person with its own assets, debts, and obligations. [27] However, the liability protection has its limitations. Shareholders can be held liable if a court determines there is sufficient misconduct to justify “piercing the corporate veil” – often the misconduct must be akin to fraud or if the corporation is a mere façade. Directors can also be held liable for certain obligations, such as those set out above in the environmental context, as well as others discussed further in the recent article by Claudia Sanchez, Duties, Responsibilities, and Liabilities of Corporate Directors.

Partnerships are another structure that offers varying levels of liability protection and can be used when the business has more than one party. These are often governed by a partnership agreement.[28] They enjoy a quasi-legal entity status where they commit to contracts, open bank accounts and conduct business but are taxed as flow-through entities. Partnerships come in a variety of forms: general partnerships, limited partnerships, or limited liability partnerships.

General partnerships do not offer much liability protection for the partner organizations or individuals, as each partner is jointly and severally liable for the conduct of the partnership.[29] The partners, however, can include terms in their agreement to seek indemnity against the partner whose conduct created the liability. Also, subject to an agreement stating otherwise, all partners will receive an equal share of the profits. If a partnership is not registered as a limited partnership or a limited liability partnership, it will, by default, be considered a general partnership.

A limited partnership must be registered with corporate registry to be considered valid. These offer protection for the “limited partners” but there must always be at least one “general partner” that has unlimited liability for business of the partnership.[30] The general partner accepts this unlimited liability because it oversees the operations and management of the partnership while the limited partners take a passive role in the business. To compensate for bearing the responsibilities of the business and the risks associated with same, the general partner is often paid a fee or a larger share of the profits. Limited partnerships may have a corporation act as its general partner, to add a further layer of liability protection.

Limited liability partnerships are only permitted for certain professions, such as lawyers and accountants.[31] They must also be registered with the corporate registry and their regulatory professional body should be valid. Limited liability partnerships offer liability protection for the partners against the business of the partnership and against the negligence, fraud, or willful misconduct of another partner.[32]

Partnerships are desirable due to their flexibility – almost any terms can be negotiated and included in a partnership agreement. However, there are also drawbacks to this flexibility, as the more complex the agreement, the more complex the structure. Also, partnerships are taxed as flow-through entities meaning all income of the partnership is taxed in the hands of the partners. There is no deferral of personal tax, and this is true regardless of the type of partnership. Another reason against using partnerships is the tax rule that deems any partnership with a non-resident partner to be a non-resident partnership. Therefore, any non-resident partner will convert the entire partnership to a non-resident.

A joint venture is purely based on contract. The parties, which can be individuals, corporations, or partnerships (general, limited, or limited liability), enter into a contract that sets out the responsibilities, obligations, and contributions of each party. It will often also set out the purpose of the venture and entitlements to the profits. Joint ventures are often done for specific projects, not for ongoing businesses. Joint venturers sometimes create a corporation to complete the joint venture, which adds a layer of liability protection for the parties involved. For example, a corporation may be created to purchase land for development. The joint venturers would each be a shareholder of that corporation. The parties involved in a joint venture are taxed on the income distributed or allocated to them. With respect to environmental considerations, each party to the joint venture would continue to have liability. As the joint venture is not a legal entity, it does not provide any additional liability protection to the member organizations.

Take Away

In general, environmental legislation has a board scope of which parties could be liable for regulatory offences. The regulator’s reach can extend to individuals, corporations, subsidiaries, partnerships, and partners to a partnership based on whether they have “management and control” of the business or property involved in the offence. Further, the prosecution has discretion over which entities to pursue charges against. These factors may be relevant in deciding how to structure one’s organization and operations. Structuring a business for a particular endeavor, including corporations and partnerships, may provide some liability protection, however, there may other implications and complexities that result.

If you would like to discuss this article in greater detail and how it may affect your business, please contact one of the authors or any member of our Environmental & Energy Practice Group.