Director Liability

Small Business Owner? – What Business Debts will you Owe Personally?

 

In Canada, a limited company in considered a separate “person” in terms of the law and taxes.  It can own it own assets, enter into its own business contracts and be obliged to pay its own debts. In most cases, a “Limited Company” limits the risk to the company’s owners and directors personally from a company’s financial debts and obligations under contracts or binding agreements.  This “limited liability” aspect of companies is what makes having your own business enticing – it limits your personal exposure as a business owner to the business debts

But the company’s creditors also know this fact and are interested in reducing their own risk of not getting paid back from the company by “piercing” this corporate veil.  They do this by making owners sign agreements to personally pay back the company debts and obligations.

On top of this pressure for owners to sign agreements that exposes themselves to the company’s debts, in some instances owners and directors of business are automatically made personally responsible for the business debts by laws that have been passed by provincial or federal governments.

So, personal liability of a director can result from multiple areas including:

  • fiduciary obligations
  • statutory obligations
  • contractual obligations: i.e., where directors have signed personal guarantees

Fiduciary

Under federal and provincial laws directors owe a fiduciary duty of care to all parties.  This duty required directors to act honestly, in good faith, and to always act in the best interest of the corporation.  In small businesses, there is often blurring of the lines between what is good for a director and what is best for a company.

The directors must approach their duties as a director with a reasonable degree of care, diligence, and skill.  If the company is in an insolvency situation, the directors are required to balance the interests of all stakeholders including creditors, shareholders, employees, government, and even the environment.  This varied group of stakeholders often have divergent interests, making the directors duties and obligations somewhat tricky and at times, at cross purposes.

For instance, if a director knows that the company may become insolvent and not able to pay back all of its debts, the director may want to protect the interests of some creditors over others.  A director who borrowed money from friends or family to start up a business, may want to be sure that they are paid in priority to other creditors, by granting them a secured charge or lien on some or all of the company’s assets.  But it would be inappropriate to give them special status for their loans, by granting them secured status, thus giving this special group of creditors a “leg up” over other unrelated creditors.

In general, a director’s fiduciary duty is to ensure that the corporation meets it statutory obligations.  Further, this duty requires directors to:

  • Act honestly and in good faith vis-à-vis the corporation.
  • Avoid conflicts of interest with the corporation.
  • Serve the corporation selflessly, honestly, and loyally.
  • Respect the trust and confidence that have been reposed in them to manage the assets of the corporation in pursuit of the realization of the objects of the corporation.
  • Not abuse their position for personal benefit; and
  • Maintain the confidentiality of information they acquire by virtue of their position.

Statutory

Beyond the efforts of some creditors to pierce the corporate veil by getting directors to sign personal guarantees, various federal and provincial statutes prescribe statutory duties that impose specific personal liabilities on directors.  So, even without directors signing any agreements or guarantees, they can be automatically held personally responsible for various company debts including:

  • liabilities relating to employees of the company, for unpaid wages and vacation pay
    (in British Columbia, Corporate directors and officers personally liable for up to 2 months’ wages per employee that were earned or should have been paid during their tenure. Limits: In BC Directors/officers are Not personally liable for:
    (i) Individual or group termination notice or money payable if corporation is in receivership or subject to certain bankruptcy actions;
    (ii) Vacation pay that becomes payable after they leave office; or
    (iii) Money left in an employee’s time bank after they leave office
    (
    Employment Standards Act, Sec. 96)
  • Liabilities for improper corporate actions:  This could include preferential payments or transfer under value in insolvent or near insolvent situations. (like the situation when a director pays back family members before CRA, or sells assets to a friend for less than what they are worth.  We see this from time to time, when a business owner has sold all of the assets of the company to another party (including another company owned by the director) in an attempts avoid creditors – a scheme sometime suggested by those less informed of the consequences
  • Tax Liabilities:  personal liability for the corporation’s failure to remit or make certain tax and other payments including:
    – GST
    – Payroll Source deductions, and
    – PST
  • Environmental Liability

In 1997 the British Columbia Government implemented the Waste Management Act which makes corporations liable for environmental breaches and clean-up costs. It is possible that a director or officer of a corporation will be considered to be in the class of “responsible persons” who are jointly and severally liable under the Waste Management Act.  This type of liability could potentially be quite large and possibly hard to quantify.

Contractual

Often, directors and officers of business are asked to sign personal guarantees for corporate debts.  Agreeing to pay back business debts personally, can expose owners to significant personal risk. These requests for personal guarantees are often required for business to secure financing or asset purchases. Banks and other lenders often require personal guarantees as additional security for lending to the business. This type of guarantee means that both the business and the director/office are on the hook to pay back the liability (joint and several liability).  As a director, you can ask to limit your personal exposure to a special dollar amount.

Personal guarantees may also arise under commercial leases to landlords and other creditors. This is particularly expensive when the lease lasts over many years as the guarantee may mean that a business owner must cover the rent until the lease is expired.

In insolvency situations where a business has closed, owner-managers may also be personally insolvent.  Informal negotiations with creditors is the first place to start in these types of situations as many creditors can be very flexible and are willing to accepted a negotiated reduced payment plan.  This is often not true with CRA.  If an informal negotiation is not possible, business owners personally have the option to enter into a more formal debt arrangement plan such as a personal proposal or personal bankruptcy.  A personal plan is called a consumer proposal where the business owner can offer to pay less than the full amount of the debt.

Instances where a director can be held personally liable

A breach of the duties or responsibilities, whether statutory or fiduciary, by a director can lead to the director being held personally liable, some of these instances are listed below:

  • declaring dividends where the corporation is insolvent or within 12 months of a formal bankruptcy
  • improper sale or use of company assets
  • breach of directors’ and officers’ duties and responsibilities under securities, employment, tax, and environmental law
  • fraud
  • failure to take reasonable steps to minimize losses to creditors
  • oppression remedies under corporate legislation (Generally speaking, the oppression remedy is a remedy available under corporate statutes to shareholders of a corporation in instances where the corporation or the board of directors of the corporation (owner/manager) have/had acted in a way which is oppressive, unfairly prejudicial to or which unfairly disregards the shareholder’s interests.

Implications 

Directors and officers need to understand their obligations and duties summarized above.  Often a breach of duties and responsibilities by a director can lead to civil liabilities. If a company ends up filing a formal bankruptcy, directors or officers can be convicted of a bankruptcy offence if the corporation committed an offence (breached their duties) at the directors’ instruction.   Bankruptcy offences can result in either imprisonment or fines, or both.

The court can also order a director or officer to make restitution (pay money). Directors or officers may also be civilly or criminally liable under tax, employment, environmental, and securities legislation. In the most extreme cases, directors may be fined or imprisoned for specific violations.

Statutory Due Diligence Defenses

Thankfully, most statutes that impose financial liability on a director or officer of a corporation also contain due diligence defense. Where a director has exercised the degree of care, diligence, and skill that a reasonably prudent person would have exercised in comparable circumstances, he/she will not be held personally responsible or the company debts. As a defense in court, if a director/officer can show that they did not participate in the offence, or did not willing ignore the actions of the corporation, then they will not be held liable for the failure to remit monies required under the statute (such as remitting GST or PST etc.)

With certain corporate transactions under the British Columbia Business Corporations Act, the ability to dissent from a resolution of the corporation creates an additional chance for the director or officer to eliminate potential liability.

Even if a director has not dissented to an improper resolution of the board regarding certain transactions, the defense extends to actions of the company the if the director/shareholder or could not have reasonably known actions were contrary to the British Columbia Business Corporations Act.  This is also true if director/officer relied and acted in good faith, and relied on verbal or written statements of others in a position of authority within the corporation (like reports of management or auditors).

While this due diligence defense may act to prevent liability in circumstances where the director relied on knowledge of other and acted in good faith, it does not remove director’s liability for actions that the director has been aware were taken by the board of directors but failed to dissent against.

In all situation, even if there is no due diligence defense under a specific statute, a wise director/shareholder should always be able to provide evidence of dissent to any contentious actions taken by board of directors.  Evidence of dissent may be something considered by a Court in assessing exposure to future monetary damages.