Most jurisdictions in Canada require the unanimous consent of all shareholders (including non-voting shareholders) in order for a non-distributing corporation to dispense with an audit. The requirement is absolute and mandatory with very limited exceptions (namely, non-reporting issuer status and unanimous consent). While the public policy rationale behind the rule may be laudable, its implementation in practice can be austere. As previously written in Auditing the Audit, it is time to revisit the universal audit requirement as it applies to non-distributing corporations.
The Canada Business Corporations Act (and most of its provincial counterparts) generally provides that shareholders of non-distributing corporations may resolve not to appoint an auditor provided that such resolution is consented to by all shareholders, including shareholders not otherwise entitled to vote. Although the Companies Act of Prince Edward Island is silent on point, case law there suggests that audited financial statements are required (see MacLeod v Murray). In striking contrast to every other jurisdiction in Canada, New Brunswick permits, but does not mandate, the appointment of an auditor. Moreover, if an auditor is appointed in any given year, such appointment may be dispensed with in the ensuing year by ordinary resolution (thus not requiring unanimity). Similarly, the Yukon recently amended its corporate legislation to exempt certain private companies from the audit requirement, unless: (i) a company’s articles or unanimous shareholder agreement requires an audit, or (ii) holders of not less than five percent of the issued shares of a company (including non-voting shares) requisition the appointment of an auditor.
Universal application of the audit requirement can have unintended and severe consequences, particularly on small, privately-held corporations. In many instances, an audit is unnecessary or the cost is prohibitively expensive and disproportionate to the financial resources of the company and the value of a shareholder’s investment. Audits can cost tens of thousands of dollars and paying the cost of an audit can leave a company with reduced or no profits to distribute to shareholders, or worse yet, further indebted. Ironically, the very application of the rule that is intended to protect shareholders’ investments could in many cases jeopardize them.
Since dispensing with an audit requires unanimous consent, the fate of a company, and every other shareholder’s investment in that company, could rest in the hands of a single shareholder, regardless of such shareholder’s status as a voting or non-voting shareholder and regardless of the size of such shareholder’s investment. As much as it may be unfair to a minority shareholder to deny an independent assessment of a company’s financial statement, it is equally, perhaps more, unfair to the remaining majority shareholders to endure the consequences of such an assessment if otherwise unnecessary or uneconomical.
The case law has held that a shareholder’s motive in, and the financial consequences of, requiring an audit is irrelevant. Struck with the unwavering harshness of this rule, some justices have (rightly) tried to alleviate its ramifications. In Barbour v Jamestown Lumber Co, Justice Handrigan wrote:
“I took this limitation into account by restricting the audit to Jamestown Lumber’s most recent fiscal period. It would, in the circumstances here, be an unfair and unnecessary expense to the corporation and ultimately for its other shareholders to bear to require an audit for any longer period.”
More recently, in Packall Packaging Inc v Ciszewski, Justice Laurence A. Pattillo of the Ontario Superior Court of Justice dismissed the application of a minority shareholder seeking to require all of the companies (including non-operating companies) in a related group of companies to deliver audited financial statements on an ongoing basis. Justice Pattillo found that such audited statements would not provide any additional useful information and would cost more money to prepare (and thus was nothing more than a nuisance request). The Ontario Court of Appeal ultimately overturned the lower judgement but limited its order to only one of the holding companies in which the applicant was a direct shareholder. In obiter dictum, the Court of Appeal suggested that relief from the audit requirement could have been sought by pleading oppression (which regrettably had not been plead in the application at hand).
When compared with other leading corporate law jurisdictions, Canada’s model of universality is draconian. Some American states (including New York and Delaware) do not require audited financial statements for private companies. In both the United Kingdom and Australia, statutory exemptions from audit requirements (based on revenues, assets and number of employees) are provided to small private companies. The flexibility offered in the Business Corporations Act of New Brunswick and the recent changes to the Yukon Business Corporations Act are welcome and overdue in the Canadian landscape. Canada’s ironclad audit requirement is ill-suited, imbalanced and disproportionate for countless small, private companies. A better balance between the rights of minority and majority shareholders is necessary.