How Directors Can Be Liable For A Corporation’s Debt

Here are some of the liabilities we see directors forced to deal with personally when a business fails and can’t pay the debts, listed in order of how common they are in our experience:

• Liabilities for amounts owed by the corporation to Canada Revenue Agency (CRA)

Directors are legally liable to CRA for the following debts:

• Payroll remittances that were deducted from employees but not remitted to CRA; and
• Goods and Services Tax (GST) charged and received from customers (net of input tax credits paid) that were not paid to CRA.

• Personal guarantees

Creditors often require directors or others to guarantee loans made or credit extended to a corporation. Sometimes the guarantee is assigned a limit, but it’s more common that guarantors are jointly and severally liable for the entire debt. Many directors forget that they’ve signed personal guarantees until the creditor comes calling.

• Co-signed agreements

When a director signs an agreement on behalf of the corporation, it’s important they carefully review it to make sure they’re signing it only in their capacity as a signatory of the corporation, and not in their personal capacity as a co-signor. Individuals sometimes end up inadvertently liable due to lack of attention to agreements, particularly those involving leases, credit cards, and communications services.

• Unpaid wages

According to Alberta laws, directors of a corporation can be jointly and severally liable to employees for up to 6 months of unpaid wages.

• Transfers they received from the company while it was insolvent

If individuals who control a business transfer company assets to themselves (including payments of cash) while the business is insolvent, it is possible that those transfers will be overturned or result in a liability. There are a few of ways this could happen:

• CRA has the ability, under section 160 of the Income Tax Act, to assess certain related individuals who received any transfer of property (including cash) from that business if in their view that property should have been used to pay corporate taxes instead.
• There are laws that allow creditors or a bankruptcy trustee to look back at transactions and ask a court to overturn them if they are determined to be unfair, such as assets transferred without proper consideration being paid for them, or preferential payments to certain creditors. Those laws are particularly strict when people who controlled the corporation are involved as a party to the transactions.
• If the company ends up in bankruptcy, the bankruptcy Trustee can ask the court to require re-payment of dividends, share repurchases, severance pay, etc. that were paid to the directors (and other related parties) in the year prior to the bankruptcy.

• Debts arising from fraud, misrepresentation, gross negligence, etc.

Even if the individuals running the business conduct themselves ethically during normal times, there is a tendency to make bad decisions when the organization is under extreme financial stress. However, engaging in any type of misconduct is inadvisable for many reasons, not least that it increases the likelihood that a creditor’s attempts to “pierce the corporate veil” so they can pursue individuals will be successful. And if they are successful, those debts may not be able to be dealt with by a bankruptcy of the individual. This is because insolvency laws specifically exclude debts that arose as a result of fraud, criminal offences, false pretenses, etc. from being discharged at the conclusion of an individual’s bankruptcy.

• Other

There are many other ways a director (or others) can be liable for corporate obligations as a result of various laws that exist in the jurisdiction and industry where the corporation operates. These include liabilities enforced by regulators, such as fines assessed by the Alberta Securities Commission, environmental cleanup liabilities enforced by the Alberta Energy Regulator, or even liability for violations of anti-spam law. There can also be liability for trust funds that were meant to be held for sub-contractors related to construction projects. It’s important to seek legal advice from a lawyer familiar with your company’s industry so that you can understand all of the laws that might be applicable to your situation.

Directors have a lot to worry about when their corporation is struggling financially. In addition to guiding the corporation properly, they face potential personal liability. Seeking advice from qualified advisors as early as possible is important. You’ll need their support when making decisions for the corporation while also ensuring that you’re doing everything you can to protect yourself.

Here are some options for protecting yourself that you will want to discuss with a qualified advisor:

• Obtaining Directors and Officers insurance.
• Reviewing agreements carefully – preferably before signing them.
• Determining what debts you’ve personally guaranteed and, if things are going well right now, perhaps negotiating a reduction or elimination of the guarantees.
• Actively avoiding any type of conduct that could be viewed as fraud, misrepresentation, gross negligence, etc.
• Seeking legal advice regarding potential liability (and avenues of protection) related to specific laws that govern the corporation’s activities.
• If the corporation is working on a settlement or proposal to its creditors, ensuring whenever possible that the proposal terms deal also with any liability a director or officer may have for the debts.
• Discussing your options for getting relief from liabilities that you are personally responsible for but cannot pay.

Charla Smith & Company is a Calgary-based Licensed Insolvency Trustee, serving the southern Alberta region. We regularly help individuals who are dealing with personal liability stemming from corporate debt. If you would like advice on options for dealing with debts for which you're personally liable, or a referral to other professionals who can assist you with protecting yourself from ending up in this position, contact us for a free, no-commitment consultation.

Disclaimer: This publication provides general information and should be seen as broad guidance only. The information contained herein cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon this information without obtaining specific professional advice relating to your particular circumstances. Charla Smith & Company Ltd. does not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.