The COVID-19 pandemic has left a lasting impact on the global economy, with small and medium enterprises (SMEs) in British Columbia feeling the brunt. As businesses continue to navigate the post-pandemic landscape, corporate insolvency rates have surged, posing significant challenges for business owners and directors. In this blog, we’ll explore the latest statistics on corporate insolvency rates in Canada and BC, the implications for SME owners and directors, and the personal obligations that arise from directors’ liabilities and the potential “piercing of the corporate veil.”
Rising Corporate Insolvency Rates
The latest data from the Office of the Superintendent of Bankruptcy Canada reveals a worrying trend. In 2023, corporate insolvency filings increased by 10% across Canada compared to the previous year. British Columbia has been particularly hard-hit, with a 15% rise in corporate insolvencies, marking the highest rate of increase in the country.
The trend is continuing in 2024. The OSB has reported that in Quarter 1 of 2024, corporate insolvencies surged 87% higher than the same quarter last year as reported by Better Dwelling.
This uptick in insolvency filings highlights the ongoing financial struggles faced by many businesses as they attempt to recover from the economic disruptions caused by the pandemic. The sectors most affected include retail, hospitality, and small manufacturing, which are crucial components of BC’s economy.
Implications for SME Owners and Directors
The rise in corporate insolvencies has significant repercussions for SME owners and directors. Understanding these implications is essential for navigating this challenging period.
1. Financial Losses
For shareholders, the primary concern is the potential loss of their own investment in the company. In insolvency proceedings, shareholders are often at the bottom of the repayment hierarchy, following secured and unsecured creditors. This means that the likelihood of recovering their initial investment is slim. One small positive thing about this type of investment, some personal investment in a Canadian controlled private company (CCPC) is that these losses act as a more powerful write off for tax purposes than other types of capital losses
2. Loss of Control
During insolvency proceedings, control of the company is transferred to the bankruptcy trustee. This shift can be particularly jarring for SME owners who are heavily involved in day-to-day operations, as they lose their influence over business decisions and management. SME owners are usually heavily involved in daily operation and shutting down a company can feel like the loss of a beloved friend.
Directors’ Personal Obligations
Directors of insolvent companies face additional challenges due to the potential personal obligations arising from their roles.
1. Legal Liabilities
Directors can be held personally liable for certain corporate debts under various statutes, including:
- Employee Wages: Directors may be responsible for up to six months of unpaid wages to employees.
- Source Deductions: Directors can be held accountable for unpaid employee deductions, such as income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums.
- GST/HST: Directors might also be liable for unremitted Goods and Services Tax (GST) or Harmonized Sales Tax (HST) collected by the company.
2. Common Obligations
Some of the most common obligations that can invoke director liability include ensuring accurate financial reporting, maintaining proper records, and complying with tax and employment laws. Directors must also act in good faith and in the best interest of the corporation, avoiding conflicts of interest and fraudulent activities.
3. Personal Guarantees
Certain types of debts do not automatically invoke director liabilities under legislation but arise due to personal guarantees signed by directors. These include:
- Bank Loans: Directors may have personally guaranteed loans taken out by the company, making them personally liable if the company defaults.
- Leases: Directors might be personally responsible for lease agreements on premises or equipment if they have provided personal guarantees.
- Supplier Credit: In some cases, directors may have guaranteed payment to suppliers, which can also lead to personal liability.
Piercing the Corporate Veil
“Piercing the corporate veil” is a legal concept where courts set aside the limited liability protection typically afforded by incorporation. This can occur when directors engage in wrongful or fraudulent activities, making them personally liable for the company’s obligations. Often for small business owners, they see themselves and their business as one entity. This is not the case legally and using corporate assets for personal gains comes with potential consequences. Often this means that SME owners have taken funds out of the corporation or used corporate assets that have not been properly taxed in their hands.
Given the rising insolvency rates and associated risks, SME owners and directors need to take proactive steps to mitigate their exposure.
Navigating the Challenges
1. Seek Professional Advice
Engaging with licensed insolvency trustees or corporate restructuring experts is crucial. These professionals can provide guidance on legal and financial implications and help navigate the insolvency process.
2. Review Personal Guarantees and Liabilities
Directors should assess any personal guarantees made for company debts and explore options for renegotiation or settlement to reduce personal financial risk. This may include limited personal expose for corporate bank loan by putting cap on the portion of debt guaranteed. This may help to ensure that any future corporate advances and not covered by personal obligations.
3. Consider Alternatives to Insolvency
Before resorting to insolvency, consider alternatives such as corporate restructuring, refinancing, or negotiating with creditors. Owner may want to consider selling of assets that are not used regularly in operations or reducing leased premises. These options might offer more favorable outcomes and help reduce potential personal exposure of SME owner.
4. Implement Strong Governance Practices
To avoid potential liabilities, directors should ensure compliance with statutory obligations and implement robust corporate governance practices. Directors should be aware of the potential of non-payment of legislative obligations (payroll, GST, PST etc.). To help protect themselves, they should set up polices and procedures to minimize potential personal obligations for these unpaid corporate debts (“due diligence defense”)
Recommended Resource: Limited Company – Insolvency or Bankruptcy, Director Personal Liability
Conclusion
The post-COVID rise in corporate insolvencies in BC presents significant challenges for SME owners and directors. Understanding the financial, legal, and personal implications of insolvency is crucial for navigating this difficult period. By seeking professional guidance, reviewing personal liabilities, and considering alternative solutions, SME owners and directors can better manage the risks and prepare for a more resilient future.
For personalized advice and support, visit our Licensed Insolvency Trustee offices in Victoria, Surrey, Langford, or Nanaimo. We’re here to help you navigate these challenging times with expertise and compassion.
