This article addresses questions as to whether a director of a corporation in Alberta could be held personally liable for some debts of the corporation if the corporation is declared insolvent. In other words, under what circumstances would a director be held personally liable for the debts of a corporation when a corporation undergoes fails to pay its debts in Alberta? A related question is: what consequences flow from insolvency of a corporation on the director’s personal credit score and his/her ability to serve as a director of another corporation in Alberta?
Introduction
If a corporation is unable to pay its debts and its assets cannot cover all its outstanding obligations, the corporation meets the threshold requirement for bankruptcy. A shareholder or a director of the corporation is protected by the doctrine of corporate personality and cannot be held personally liable for corporate debts. However, where a shareholder or director of the corporation has issued personal guarantees for the debts of the corporation, the shareholder or director would be held liable to the full extent of his/her personal guarantees. Where he/she cannot satisfy those personal guarantees and judgment is obtained against him, enforcement action may affect his personal property. Finally, except in very exceptional circumstances, the director’s personal credit rating and his ability to serve as a director of another Alberta corporation would not be impacted negatively where the corporation becomes insolvent. However, where the director is unable to meet his/her personal guarantee obligations, his/her credit score will be negatively impacted.
What happens if the assets of the corporation are not sufficient to pay off the debts of the corporation
When a business faces financial difficulties and has debts with no money to pay or to continue its business operations, bankruptcy may be one of the options to consider. In Canada, business bankruptcy is governed by the Bankruptcy and Insolvency Act (BIA). The BIA provides that when a company can’t meet its financial obligations, and when the option of selling off all its assets would not generate enough money to cover its debts, then the company is bankrupt.
Under the BIA, to be considered bankrupt, certain basic conditions must be met, namely, your business is owing at least $1,000.00 or the business has debts greater than the sale value of its assets and the business is unable to pay its debts when they become due. In practice, when a business faces financial struggles and is unable to pay its debts, the creditor would call in the assets of the corporation used as collateral for the debts. Collateral would also include any personal guarantee obtained to secure the debts. If after disposing of the assets of the corporation and collecting on the personal guarantee, the money realized is insufficient to repay the debts, the creditor may also seek to know if there are other assets that may be sold. It is in this context that bankruptcy which will reveal the true financial position of the corporation may be considered. The fact that corporate assets have been sold and personal guarantees collected, does not mean that the corporation is free from its debts if payment collected is insufficient to meet its debt obligations. Any remaining unpaid balance, after realization of the secured assets and enforcement of the Personal Guarantee, constitutes an unsecured debt.
From the foregoing, if the corporation is unable to pay its debts, and the outstanding obligation is above the statutory threshold, it satisfies the statutory requirements for insolvency.
Can a director of a corporation be held personally liable for the debts of the corporation if the corporation is declared insolvent?
One of the reasons for incorporating a limited liability company ( a “corporation”) is to limit the personal liability of the shareholders, directors and other officers of the corporation. While incorporation provides some measure of protection, it is not a complete shield against the liability of directors and other interest holders in a corporation. There are several ways a director (or in many cases, even an officer of the corporation) can be held personally liable for the debts and other obligations of the corporation. Below are some circumstances where directors and others may be held personally liable for corporate debts.
(1) 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;
Goods and Services Tax (GST) charged and received from customers (net of input tax credits paid) that were not paid to CRA.
EI/CPP withholdings/contributions/remittances.
(2) Personal guarantees
Banks and other Creditors, as a matter of practice, do require directors or others to provide personal guarantees for loans made or credit extended to corporations. Frequently, such guarantees are provided up to a certian portion of the debts, but more often, guarantors are jointly and severally liable for the entire debts of the corporation. In such instances, where the corporation runs into financial turbulence and is unable to pay its debts, such guarantors would be held liable to the full extent of the debts of the corporation they guaranteed. Where part of the asset of corporation is sold, the proceeds would be used to pay the debts and the guarantor’s laibility would be net of the amount outstanding after applying the amount realized from the sale of corporate assets.
(3) Co-signed Agreements
Sometimes, directors sign agreements on behalf of a corporation. When called upon to do so, directors must carefully review it to ensure that they are signing it only in their capacity as a signatory of the corporation, and not in their personal capacity as a co-signor. Signing an agreement as a co-signor and not on behalf of the corporation renders the director personally liable for corporate debts. Examples of such agreements include leases, credit cards, and communications services.
(4) 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.
(5) Transfers received from the company while it was insolvent
Where a person who controls a business transfers corporate assets to himself/herself whether cash or any other asset when the business is insolvent, those transfers may not be recognised and may result in personal liability. There are a few 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 a 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.(Non-arm’s length transactions) Those laws are particularly strict when people who control 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.
(6) Debts arising from fraud, misrepresentation or gross negligence
If individuals running a business engage themselves in any type of misconduct, this increases the likelihood that a creditor will attempt to “pierce the corporate veil” so they can pursue individuals who engage in such misconduct. If successful, insolvency laws specifically exclude debts that arose as a result of fraud, criminal offences, false pretenses, etc. from being protected.
Is it possible to become a director of another company?
According to the Canada Business Corporations Act (CBCA), an undischarged bankrupt is disqualified from acting as a director. The Alberta Business Corporations Act (ABCA) mirrors the CBCA on undischarged bankrupts. While the law disqualifies an undischarged bankrupt from becoming a director of a corporation, there is nothing that stops a director of an insolvent company from becoming a director of another company as long as they haven’t been disqualified.
The circumstances where a director of an insolvent company may be disqualified from serving as a director of another company include:
(a) Misconduct or Unfit Conduct: If a director engages in reckless behavior, fraud, or breaches fiduciary duties during insolvency, they may face legal consequences, including disqualification.
(b) Court Orders: Courts can issue orders to remove or disqualify directors based on evidence of misconduct or unfit behavior.
(c) Personal Liability: Directors may be held personally liable for wrongful trading or actions that prioritize personal interests over creditors.
(d) Reporting by Insolvency Practitioners: Insolvency practitioners are required to report any unfit conduct to regulatory authorities, which may initiate proceeding resulting in a disqualification
Therefore, if the director’s conduct in the management of the corporation was above board and no malfeasance could be found against him, it is possible that he can still serve as a director in Alberta.
What is the implication of the corporation being declared insolvent on the credit score of the director?
A company’s liquidation does not automatically affect a director’s personal credit score because a company is a separate legal entity benefiting from limited liability protection. Credit bureaus’ practice is to maintain personal credit files separately from corporate credit files. Where a corporation is declared insolvent, the director’s personal credit score will be unaffected except in the following situations:
(1) Personal Guarantee of Corporate Debt
Where a director signed a personal guarantee (which is common in small businesses, leases, loans, or credit lines), and the corporation defaults, the creditor may pursue the director personally. Judgments, collections, or defaults related to the guarantee will appear on the director’s personal credit report.
(2) Personal Bankruptcy or Consumer Proposal
Where a director files for bankruptcy or a consumer proposal (even in response to corporate insolvency-related liability), the filing will directly affect the credit score of the director.
(3) Court Judgment for Director’s Liability
If the director is found personally liable for unremitted taxes (e.g., payroll, GST/HST), unpaid employee wages, fraud, or breach of fiduciary duty, any civil judgment entered against the director could appear on the director’s credit file and negatively affect his score.
In the vast majority of cases, where directors have acted in good faith and fulfilled their legal duties, insolvency will not impact their personal credit rating. The legal separation between a company and its directors protects directors from the company’s financial liabilities in most circumstances.
What options are open to the director to manage their exposure?
Directors of companies struggling financially have a lot to worry about. In addition to guiding the corporation properly, they face potential personal liability in some situations. The need to seek advice from qualified advisors as early as possible cannot be obver-emphasized.
Here are some options for protecting yourself, as they useful to keep in mind for the future:
- Obtain Directors and Officers insurance, early.
- Review agreements carefully before signing them.
- Determine what debts you’ve personally guaranteed and consider whether you want to negotiate a payment plan if immediate payment is not available.
- Avoid any type of conduct towards the corporation that could be viewed as fraud, misrepresentation, or gross negligence.
- Seek legal advice regarding potential liability and avenues for protection related to specific laws that govern the corporation’s activities, some of which have been provided in this blog.
- Discuss your options for getting relief from liabilities that you are personally responsible for but cannot pay.
If your business is facing financial challenges or you’re worried about what insolvency might mean for you personally, it’s important to get clear, practical advice early. We can help you understand your responsibilities, reduce your risks, and protect your personal finances. Reach out to our team today to discuss your situation and explore your options with confidence.