Update on Quebec: Legal Developments

Taxation

In 2003, significant changes to the business tax regime were announced by the then newly elected government of the province of Quebec. These measures suspended, reduced or eliminated a number of tax incentives that had been created to foster specific sectors of the Quebec economy. In the two successive provincial budgets delivered after the changes were announced in 2003, the government of Québec has tinkered with some of the announced changes.

The following summarizes some of the main aspects of recent provincial budgets, including the budget delivered on April 21, 2005, and provides a status report on some of the measures that were previously suspended, reduced or eliminated.

Return of the Flow-Through Share Regime

In March 2001, a new system was proposed to aid resource companies in their development and exploration activities. Rather than having recourse to flow-through shares that transfer certain deductions to investors in these companies, resource companies would instead be eligible to receive a refundable tax credit for exploration expenditures. Under the old system, an eligible corporation could issue flow-through shares, which provided the investor with deductions equal to the cost of acquiring the shares as well as an additional deduction for eligible expenses. Since March 2001, the flow-through share system had been continued on a temporary basis as a transitional measure. In the 2004-2005 budget, the government announced that the flow-through share system would be reinstated and made permanent.

Decrease in Capital Tax Rates

A corporation that has an establishment in Quebec in a taxation year is subject to a tax on capital, calculated on the basis of the paid-up capital shown in its financial statements for the year. Among the favourable measures that were introduced in the budget of April 21, 2005 is the reduction in the rate of the tax on capital applicable to corporations other than financial institutions, which will be gradually reduced from .6% to .29% by January 1, 2009. Furthermore, a corporation, other than a financial institution that makes an eligible investment during a taxation year may claim a non-refundable capital tax credit, for such taxation year, equal to 5% of the amount of such investment. Generally, investments in manufacturing and processing equipment are eligible for this credit. The assets must be acquired before January 1, 2008 to be used in the calculation of the capital tax credit.

Adjustments to Corporate Income Tax Rates

Currently, a corporation is subject to Québec income tax on its active income at a rate of 8.9%. Given the substantial reductions that were announced in the federal budget that was made public on February 23, 2005, the province of Québec will gradually raise its corporate tax rate applied on active income by 3 percentage points. A small-business deduction has been introduced that will reduce the tax rate for eligible corporations to 8.5%, as of January 1, 2006. This deduction will be available to the first $400,000 of annual income from an eligible business carried on by a Canadian controlled private corporation.

Elimination of the Five-Year Tax Holiday for New Corporations

Since 1986, the province of Quebec has provided new small or medium sized corporations with a five-year tax holiday where certain conditions were met. This tax holiday was eliminated as of March 30, 2004. Only corporations whose first taxation year began prior to March 30, 2004 may benefit from the tax holiday provided it meets the stipulated terms and conditions.

Adjustments to International Financial Centre Program

Special tax incentives encourage the establishment, development and maintenance in the city of Montreal, of businesses specializing in specified international financial transactions. A number of measures announced in the budget made public on March 30, 2004, were designed to focus the tax incentives on financial corporations and their subsidiaries. Notably, the changes allow a corporation that is the exclusive property of one or more financial corporations to qualify for these tax incentives.

Reduction in Deduction for Employee Stock Options

Where certain conditions are fulfilled, employees exercising stock options may be entitled to a deduction in the amount of the stock option benefit that must be included in the calculation of their taxable income. In 2003, the Quebec government reduced the tax deduction from 50% to 37.5%. In the government's budget for the 2004-2005 fiscal year, the deduction was further reduced from 37.5% to 25% as of April 1, 2004. As a result, employees subject to the highest marginal tax rate (48.22%) who can benefit from the deduction will effectively be taxed at a rate of 30.14% rather than 27.11% on the stock option benefit.

Limit on the Deductibility of Investment Expenses

In the 2004-2005 budget, the government announced substantial modifications to the rules concerning the deductibility of investment expenses incurred by individuals or trusts.  According to the budget text, the deduction for expenditures incurred to earn investment income will be limited to the income derived from those investments. These rules only apply to passive investing and are not applicable with regard to investments to earn active income, such as income from a business or rental income.

The following lists some of the types of investment income falling within the scope of these rules:

• Taxable dividends of taxable Canadian corporations;

• Interest from Canadian sources;

• The share of the income of a partnership of which the individual is a specified member;

• Gross foreign investment income;

• Taxable capital gains not eligible for the exemption on taxable capital gains;

• Benefits received as a shareholder of a corporation;

• Income from a trust;

• Income from property attributed to shareholders.

Investment expenses that cannot be deducted in a given taxation year may be carried over against investment income earned in one of the three preceding taxation years or in any subsequent taxation year. These changes are in force as of March 30, 2004.

Moratorium on Tax Incentives to Raise Capital

Prior to changes announced in the budget for the 2003-2004 fiscal year, the Government of Quebec provided tax assistance to help Quebec businesses raise capital. There were two programs of note. First, companies having their head office or principal place of business in the province of Quebec could increase their capitalization using the Quebec stock savings plan to help them gain access to public capital markets. Under this initiative, individual investors could deduct up to 100% of the cost of their investment in shares of qualifying issuers from the calculation of their taxable income. The second program, the Quebec business investment companies program, enabled companies with assets of less than $50 million that operated in certain designated sectors to gain access to capital by providing investors with a tax deduction equal to up to 150% of the cost of making a qualified investment.

In the 2003-2004 budget, a moratorium was placed on these programs. In the 2005-2006 budget, the government announced that the Quebec stock savings plan would not be revived. In its place, the government announced the creation of the SME Growth Stock Plan. The new program is similar in structure to the previous program. However, the scope of the program has been restricted and some of the rules have been tightened. Notably, to be eligible for the SME Growth Stock Plan, a corporation must be a Canadian corporation whose assets are less than $100 million. Furthermore, the investor must hold eligible shares on December 31 of the year of acquisition and on December 31 of the three following years.

Refundable Tax Credit for Major Employment Generating Projects

A temporary refundable tax credit has been introduced regarding major employment generating projects in the information technology sector. An eligible corporation may claim a refundable tax credit equal to 25% of the eligible salaries it incurs as of January 1, 2005 until December 31, 2016. The minimum job creation threshold is 500 jobs.  In general, a corporation may claim the first half of its tax credits once it has created a minimum of 250 jobs and the other half once it has achieved the threshold of 500 jobs. The eligible salary with regard to a particular employee is limited to an amount of $60,000 per year. An eligibility certificate must first be obtained from Investissement Québec.

EMPLOYMENT LAW DEVELOPMENTS

Psychological harassment in the workplace

As of February 2005, eight months after the psychological harassment provisions of the Labour Standards Act (the "L.S.A.") came into force, 1580 psychological harassment complaints have been filed and are being processed by the Labour Standards Commission.

The new provisions that came into force June 1, 2004 grant all employees the right to a work environment free from psychological harassment. This right has become a minimum standard of employment. Employers in Quebec must take appropriate measures to ensure that this right is respected, otherwise they can be held liable.

The L.S.A. defines psychological harassment as follows: "any vexatious behaviour in the form of repeated and hostile or unwanted conduct, verbal comments, actions or gestures, that affects an employee's dignity or psychological or physical integrity and that results in a harmful work environment for the employee. A single serious incidence of such behaviour that has a lasting harmful effect on an employee may also constitute psychological harassment."

According to this definition, the key elements that must exist for there to be psychological harassment are the hostile or unwanted nature of conduct that, over time, becomes so humiliating or abusive for an employee that it affects his or her dignity or psychological integrity, or results in a harmful work environment. An isolated incident can also constitute psychological harassment if it is serious enough to produce lasting harmful effects.

As such, this definition of psychological harassment is sufficiently wide to encompass all types of conduct in the workplace, including abusive exercises of authority. It is also sufficiently broad to include other forms of prohibited harassment (sexual, racial, religious, political, etc.).

Under the new provisions of the L.S.A., the employer must take reasonable steps to prevent psychological harassment and, if such conduct is brought to its attention, put a stop to it. An employee who believes he has been the victim of psychological harassment can file a complaint with the Commission within 90 days of the last alleged incident of harassment. The Commission will then investigate the complaint and, if it concludes that the facts support a finding of harassment, the complaint will be referred to hearing before the Labour Relations Board. If, after a formal hearing, the Board finds that the employee has been the victim of psychological harassment and that the employer has failed to fulfill its obligations in that regard, the Board can then order a number of broad remedial measures including the reinstatement of the employee with lost wages, payment of punitive and moral damages and costs of psychological support.

The Commission receives approximately 10 new complaints each day. To respond to this high volume, the Commission has had to significantly increase its team of investigators. It now employs a team of 75 mediators and investigators trained to deal with the psychological harassment complaints.

These new provisions must be taken seriously by all employers, who would be best served by immediately putting into place reasonable preventive measures to ensure that their work environment is free of harassment, thereby limiting potential litigation.

SINGLE REGULATORY STRUCTURE FOR FINANCIAL SECTOR

On February 1, 2004, a new single "super regulator" for the Quebec financial sector was established. The Agence Nationale d'encadrement du secteur financier (also known as the Autorité des marchés financiers) (the "Autorité")  replaced the four most important financial industry regulators in Quebec, namely the Commission des valeurs mobilières du Québec, which had authority over public companies, securities offerings, investment dealers and advisors; the Bureau des services financiers, which had jurisdiction over market intermediaries such as insurance agents, brokers and mutual fund dealers; the Inspector General of Financial Institutions, which had jurisdiction over Quebec insurance, trust and savings companies; and the Régie de l'assurance-dépôt, which had jurisdiction over Quebec deposit-taking institutions. The Autorité's affairs are administered by its chief executive officer, Mr. Jean Saint-Gelais, who was appointed by the Quebec government. Mr. Saint-Gelais is assisted by four superintendents who manage the activities and operations of the Autorité's seven branches and directorates.

With this new regulatory structure and chief executive officer comes a new approach on enforcing the law. Mr. Jean Saint-Gelais has publicly declared that, as part of its get-tough enforcement policy, the Autorité will now investigate and prosecute rather than negotiate settlements. The Autorité has decided to stress enforcement and prosecution in order to make good on its commitment to crack down on financial wrongdoing. The chief executive officer of the Autorité believes that negotiated settlements – which often involve fines without admission of guilt – are not the best way to build confidence in today's market.

On October 5, 2004, the Ministers of Quebec and all provinces and territories responsible for securities regulation (except Ontario) signed, agreed to sign or agreed to present to their Cabinet for a decision in the 2004 fall session, the "Provincial Territorial Memorandum of Understanding Regarding Securities Regulation" (the "MOU"). This MOU is an important step towards harmonizing the provincial system of securities regulation. The MOU provides for the implementation of a "passport system" for securities regulation that will result in a single window of access to capital markets in participating provinces and territories by August 2005. It will also further harmonize, streamline and simplify securities laws scheduled to be implemented in late 2006 and make other improvements to the current system. The Ontario minister abstained because the Ontario government believes that one national securities commission is the best option for the future of Canada 's financial industry.

CORPORATE LAW DEVELOPMENTS

In its Camirand v. Rossi and Acier Leroux Inc. v. Tremblay decisions dated April 2003 and March 2004, respectively, the Court of Appeal of Québec ruled that an arbitration clause in a shareholders' agreement may enable an arbitrator to adjudicate an "oppression remedy" to the exclusion of the courts, provided it is drafted properly. An oppression remedy is an open-ended equitable remedy provided for in most corporate statutes in favour of "complainants" such as security holders, directors, officers and, in many cases, creditors. Arbitration clauses should be broad enough to cover oppressive acts committed by the corporation or its directors and should not only apply, in the usual boilerplate fashion, to the interpretation and application of the agreement. An obiter in Camirand suggests that the arbitrator should expressly be given the same powers a judge would have under the statutory oppression remedy.

The Court of Appeal of Québec also clarified an important aspect of the personal liability of directors with respect to debts of the corporation for services performed by its employees. In the December 2003 case Wright v. Syndicat des techniciennes et techniciens du cinéma et de la video du Québec, it was ruled that while directors were not statutorily liable for the debt the corporation incurred when it failed to give reasonable notice, such debt having arisen from contractual damages rather than from services performed (as was established by the Supreme Court of Canada in the 1993 decision Barrette v. Crabtree), they could be held liable for the pay in lieu of notice provided for in a collective agreement. This latter amount can be regarded as "debts for services performed by the corporation," as the employees are entitled to such amounts simply because they have worked for a certain time. This reasoning, specified the Court, applies to the statutory liability under both Quebec and federal corporate statutes.

The most significant development in corporate law, however, came from the Peoples Department Stores Inc. (Trustee) of v. Wise case. In February 2003, the Court of Appeal of Québec unanimously overturned a Superior Court ruling in which the directors of a bankrupt, wholly-owned subsidiary were held personally liable for $4.4 million in inter-corporate debt. According to the Superior Court, the directors had allowed the holding corporation to incur this debt through a common purchase program it ruled ill advised and in violation of their duties of care and loyalty. The Superior Court provoked an uproar in Canadian business and legal circles when it stated that Canadian corporate law should evolve in the same direction as legislation in the U.K, Australia and New Zealand, all countries that impose on directors of insolvent corporations a duty to consider the interests of their creditors. This was the first time a Canadian court had taken such a stance. The Court of Appeal of Québec categorically rejected this "creditors as stakeholders" doctrine and ruled that, in this instance, the bad faith of the directors had not been demonstrated and they were therefore not liable for an "honest error of business judgment." The Supreme Court of Canada heard the appeal of the Peoples case in May 2004, and its anxiously awaited decision was released in October 2004. In it, the Court confirmed the exoneration of People's directors, and shed new light on the duties and liabilities of corporate directors, establishing that: 1) in determining the best interests of the corporation, directors may (but are not obliged to) take into account the interests of stakeholders such as shareholders, employees, suppliers, creditors, consumers, governments and environment; 2) directors do not owe a duty of loyalty to the corporation's creditors by virtue of the fact that the corporation enters the "vicinity of insolvency"; 3) the "business judgment rule", as it exists in the U.S.A., applies in Canadian law, protecting "reasonably informed" decisions of directors from a posteriori judicial scrutiny; 4) directors may incur direct extracontractual liability towards the corporation's creditors in breaching their duty of diligence and prudence. This last and somewhat worrisome principle is not readily reconcilable with basic principles of company law, in Quebec or in Canada; it remains to be seen how Canadian and Quebec courts will interpret and apply it.

LITIGATION DEVELOPMENTS

Quebec is the sole Canadian province to be governed by a civil law system. Because of its civil law tradition, Quebec jurisprudence often interprets and applies legal principles that are not found elsewhere in Canada. This is a review of some important cases decided in 2004.

Contract Resiliation

The rules applicable to contracts in Quebec are found in the Civil Code of Quebec ("C.C.Q.").

The C.C.Q. includes some specific rules for contracts of enterprise or for services, which are defined as a contract by which a person undertakes to carry out physical or intellectual work for another person, the client or to provide a service, for a price which the client binds himself to pay.

One of these rules is article 2125 C.C.Q., which states that the client party to a contract of enterprise or for services may unilaterally terminate the contract even though the work or provision of service is already in progress, and this without cause. Pursuant to 2129 C.C.Q., upon termination of a contract, the client is bound to pay to the contractor or the provider of services, in proportion to the agreed price, the actual costs and expenses, the value of the work performed before the end of the contract or before the notice of termination and, as the case may be, the value of the property furnished, where it can be returned to him and used by him. The client is also liable for any other injury that the other party may have suffered.

Until a recent trilogy of Court of Appeal cases, there was significant debate regarding what the contractor or provider of services could recover as "any other injury."  Some argued that this type of injury could include the loss of future profit on the contract. The Court of Appeal first addressed this issue in Pelouse Agrostis Turf Inc. v. Club de golf Balmoral. Justice Baudouin maintained that to permit the contractor or provider of services to obtain compensation from the client for loss of future profit on the contract would be contrary to the very purpose of article 2125 C.C.Q. which is to give a client the right to unilaterally put an end to the contract. As such, the Court concluded that the appellant contractor was not entitled to claim damages equalling the loss of future profits. The Court of Appeal reiterated this in Société de transport de Longueuil v. Marcel Lussier Ltée and Société canadienne des postes v. Michel Morel, both of which deal with the same issue.

Class action

On January 1, 2003 a number of modifications were made to the Code of Civil Procedure ("CCP"). In Québec like in many other jurisdictions, a person wishing to institute a class action must first obtain the prior authorization of the Court. Both prior to and after the amendments of 2003, a person wishing to institute a class action (the "Member") must file a motion seeking authorization to institute a class action (the "Motion") in which the Member states the facts giving rise thereto, indicates the nature of the recourses for which authorization is applied for and describes the group on behalf of which the Member intends to act.

Prior to 2003, this Motion had to be supported by an affidavit signed by the member. The filing of the affidavit permitted the person against whom the applicant intended to exercise the class action to examine the Member and subsequently produce and file a written contestation to the Motion. Since the 2003 amendments to section 1002 CCP, the Member is no longer required to support the Motion by an affidavit and as such is no longer subject to an examination. Furthermore, it is now provided that the Motion can only be contested orally but that a judge may allow relevant evidence to be submitted.

In Pharmascience Inc. v. Option Consommateur, the constitutionality of s. 1002 CCP provision was challenged on the basis that it was contrary to article 23 of the Charter of Human Rights and Freedoms of Quebec (the "Charter") which provides that "every person has a right to a full and equal, public and fair hearing by an independent and impartial tribunal, for the determination of his rights and obligations or of the merits of any charge brought against him". It was argued that article 23 of the Charter required that a formal hearing be held where a judge would determine whether the conditions for the bringing of a class action were met and that such a hearing necessitated that the Member prove the facts alleged in the Motion. The Court of Appeal in a unanimous decision disagreed with this proposition and found that the s. 1002 CCP as amended was not contrary to article 23 of the Charter.

The Court insisted that the hearing on the Motion regarding the authorization of the class action not be confused with the hearing on the class action itself. The purpose of the Motion and the hearing thereon is to filter and verify whether the facts alleged seem to justify the conclusions sought. By removing the obligation to produce an affidavit and limiting examinations to those permitted by the Court, the authorization process is greatly accelerated, the whole without fundamentally modifying the class action regime or sterilizing the role of the judge. Furthermore, the Court found that article 23 of the Charter was not violated considering that a public hearing to consider the Motion is held and that the person against whom the Member intends to exercise the class action is allowed to present a contestation thereto even is such contestation is only verbal. Finally, considering that once the class action is authorized the person against whom it is exercised will have all of the rights to present a full defence, the Court concluded that article 23 of the Charter was not violated and confirmed the constitutionality of article 1002 of the CCP.

Solicitor-Client Privilege

The Supreme Court of Canada recently rendered a decision on the issue of professional secrecy in Quebec in Foster Wheeler Power Co. v. Société intermunicipale de gestion et d'élimination des déchêts (Siged)Inc.. This judgement is key in the determination of the burden of proof concerning the privileged nature of the information shared in cases where there is a prolonged relationship between the client and his attorneys.

Professional secrecy in Quebec civil law has two components: first, an obligation of confidentiality, which imposes a duty of discretion in all lawyers and creates a correlative right to their silence on the part of their clients. Second, in relation to third parties, an immunity from disclosure that protects the content of information against compelled disclosure, even in judicial proceedings, subject to any other applicable legal rules or principles. The Supreme Court of Canada recognized that although professional secrecy is essential to the maintenance of a properly functioning justice system, not every aspect of the relation between a lawyer and a client, especially in a complex and prolonged mandate, is confidential.

The Court held that in the case of a complicated and prolonged mandate, all communications between client and lawyer and the information they shared could be considered prima facie privileged. The opposing party who wishes to obtain specific information has the burden of showing that the information is subject neither to the obligation of confidentiality nor to the immunity from disclosure, or that this is a case where the law authorizes disclosure notwithstanding professional secrecy.

Such a presumption does not exist in the case of an individual professional act where the burden of proving the confidential nature of the information is on the person claiming professional secrecy.

Non-Compete Covenants

It is common in Quebec, as in other jurisdictions, to include non-compete covenants in employment contracts. The C.C.Q. expressly permits the inclusion of such covenants if they are given in writing, in express terms, and are limited as to time, place and type of employment to whatever is necessary to protect the legitimate interests of the employer. There are thousands of cases in which the courts have reviewed non-compete covenants and declared them invalid on the basis that the length, breadth or scope of the covenant was wider than that considered necessary to protect the legitimate interests of the employer. Faced with such a body of case law, employers in Quebec, as in other common law jurisdictions, began including multi-level, non-compete covenants in which, upon the striking down of the most onerous non-compete covenants, a second less onerous covenant would come into force. Should the second level of non-compete covenant be judged invalid, a third even less restrictive covenant would them come into force and so on. Such multi-level, non-compete covenants have generally been judged valid in American and Canadian common law jurisdictions.

In Drouin v. Surplec Inc., the Court of Appeal of Quebec considered the validity of such clauses in light of Quebec civil law for the first time. In a majority ruling, it held that such clauses were invalid under civil law. First, the Court considered that the presence of a multi-levelled obligation ran contrary to the civil law requirement that the performance required of a debtor of an obligation be determined or determinable.  Second, it considered that such a covenant did not meet the C.C.Q. requirement that non-compete covenants in a contract of employment be stipulated in express terms. Since the employee cannot determine prior to the intervention of the Court which level of the non-compete covenant will be judged valid and enforceable, it is impossible for the employee to determine the scope of his or her obligation and, as such, the Court found that it was contrary to the principles of civil law.