Business Owner? – What Business debts will you Owe Personally in a Corporate Insolvency?

December 16, 2022 1:25 am Published by Leave your thoughts

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. But owners and directors of business can be held responsible for some corporate debts. What specific debts transfer to personal debts, will depend on individual circumstances and director liability defence especially in a insolvency situation.

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.  To maximize the director liability defense options is also a consideration for all new directors.

The company’s creditors also know that directors are protected behind the “corporate veil” .  They 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

Each area has its own obligations and directors can director liability defence response has to be specific to each area.

Fiduciary

Directors liability defence stems first from the directors overall fiduciary duty.  Directors owe a duty of care to all parties under federal and provincial laws.  In small businesses, there is often blurring of the lines between what is good for a director and what is best for a company.

All Directors of a Corporation have a general duty to

  • Act honestly,
  • Act in good faith, and to
  • Always act in the best interest of the corporation.  This particularly tricky when the interests of the company do not align with the interests of the owners personally.

Overall, the directors must approach their duties as a director with a reasonable degree of care, diligence, and skill.  All of these factor into the strength of the directors liability defence.  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.  Director liability defence looks to the directors obligation 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

Often creditors attempt to pierce the corporate veil by getting directors to sign personal guarantees. Additionally, various federal and provincial statutes impose statutory duties that results in directors incurring automatic obligation for some corporate debts.  Unknowingly directors and officers can be held personally responsible for the following corporate debts: In these cases, director liability defence is harder to negotiate out of.

  • Employees:
    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 holiday or overtime bank after they leave place of employment
    (
    Employment Standards Act, Sec. 96)
  • Corporate “Bad Behaviour”
    Liabilities for improper corporate actions:  Consider 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 an owner is attempting to sell off the business assets to try to safeguard them from creditors.  Often business owners will try to set up new companies they control that are fee of debt.  For example. – If a company has sold its assets to another party (including another company owned by the director) and leaves the “Old Company” with no assets but just the debt.  This can be an ill-advised scheme as there is legislation to “catch” these types of actions which can have some very negative 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 BC the Waste Management Act makes corporations liable for environmental breaches and clean-up costs.  Depending on actions taken by directors to avoid such issues, directors and officers will be held as “responsible persons”.  A “responsible person” under the Act are jointly and severally liable for any clean up coasts.  This type of liability can be costly and take years to resolve.

Contractual

Often, directors and officers of business are asked to sign personal guarantees for corporate debts.  These types of guarantees are the “cost of doing business” but expose owners to significant personal risk. These requests for personal guarantees are generally used by banks when business small business owners are seeking financing or asset purchases. Lenders use personal guarantees as additional in case the company were to default on payments.

Personal guarantees come into play when the company cannot pay all of its debts on its own.  Lender’s can look to both the company and the directors guarantees to settle the debt (joint and several liability).  Initially a directors should try limit the guarantee to a special dollar amount.  But this is not always an option for small businesses.

Commercial landlords are another potential area when personal guarantees are often required. This can be costly if the lease is over a long term.   Cancelling the lease early may mean that a business owner must cover the full rent (and common area costs) until the lease is expired.

If a business is insolvent or close, often owner-managers may also be personally insolvent.  In these types of situations we always recommend personal discussions with landlords and other parties holding personal guarantee.  Commercial landlords especially are often quite flexible and are willing to accepted a negotiated settlement plan.

However, this is not true with the Canada Revenue Agency CRA.  CRA will not accept any “partial payment” plan.  (think if everyone decide to only pay a “portion” of their taxes back by simply negotiating with CRA, there would be tax pandemonium

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 

The duties summarized above need to be clearly understood by directors/officers.  Often a breach of duties and responsibilities by a director can lead to civil liabilities. If a company files a formal bankruptcy, directors/officers can be charged with bankruptcy offence.  This depends on the conducted of the directors.   if the corporation committed an offence (breached their duties) at the directors’ instruction.   Some bankruptcy offences can result in 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: Director Liability Defence

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, the defense extends to actions of the company the if the director/shareholder or could not have reasonably known actions were contrary to the BC 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.

Contact Us for Free Consultation

Finally, each situation is unique. If you are committed to working towards the viability of your company, we are here to assist you.
Colleen Craig and her staff have lived and worked in the Victoria area for over 16 years and are committed to providing accurate and personal service.
We offer a Free Consultation where we sit down with business owners experiencing financial difficulties to outline their options.

Please call C.E. Craig & Associates today for your Free Consultation at 250-386-8778

C.E. Craig & Associates Inc is a federally Licensed Insolvency Trustee.

The Federal Government under the Office of the Superintendent of Bankruptcy oversees the Canadian Insolvency Process and has advice for corporate debtors at https://www.canada.ca/en/services/business/bankruptcy.html

Other Corporate Insolvency Topics

Director Liability

Corporate Bankruptcy

Insolvent Business Options

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