Personal Liability of Directors and Executives for Wrongs Committed through a Corporation
By Peter S. Spiro
The corporation is the dominant form of business organization in the modern economy. It is a flexible structure that accommodates both one-person businesses and mega-organizations with billions of dollars of revenue.
One of the key legal features of the corporation that makes it attractive is limited liability. It makes it possible for people to invest in a corporation, and not have to worry about being personally sued for the debts or obligations of the corporation. That is pretty foolproof for the small shareholders of a large corporation. For anybody else associated with a corporation, whether directors, controlling shareholders, or executives, the protection offered by the corporate form is distinctly weaker.
These concerns rise to the forefront when the corporation is in financial difficulty. That is when creditors and others with a claim against the corporation start looking around for somebody else to blame.
That was observed in the widely publicized case of Sears Canada, which is under CCAA protection (unable to pay its debts, but not yet bankrupt). A group of creditors, unable to recover from Sears itself, has attempted to sue executives of Sears. The creditors allege negligent misrepresentation, arguing that the executives are personally responsible.
An executive is an employee of the corporation, just like a sales clerk. The difference is that an executive typically had a large salary and has likely accumulated significant personal wealth — enough to make it worth suing that person.
No employee of a corporation is responsible for the debts of a corporation if they are merely debts. However, suppose that it can be proven that an executive misled a supplier, by telling it that the corporation was solvent and would pay for the supplies, when he knew or ought to have known that was false. The executive may be financially responsible for the loss to the supplier.
Corporate limited liability means that you cannot be sued for the debts of a corporation just because you are its share owner. However, if you are a corporate owner, director or executive who personally causes the corporation to do something negligent, there may be no protection. If the corporation is insolvent, and the people behind it committed legal wrongs such as misrepresentation, it is fair game to go after them for it.
This is sometimes referred to as lifting “the corporate veil.” Legal theorists and jurists still debate exactly what is meant by this. Certainly, corporate statutes such as the Business Corporations Act state clearly that shareholders are not liable for the debts of the corporation. Courts of equity can get around this restriction, not by violating the black letter of the corporate statute, but by finding an alternative remedy. If somebody associated with a corporation personally committed a legal wrong (a “tortious act”) that person becomes personally liable, not for all the debts of the corporation, but for whatever damage can fairly be attributed to his own decisions.
Merely going into debt, with the honest intention of repaying it but finding yourself unable to do so, is not a legal wrong. Something beyond this must be proven to create personal liability.
Corporations are legal fictions, without hearts or minds. Everything that a corporation does is by the act of a real human being who made a decision. If it was a malicious or negligent decision that caused harm to somebody else, that person is liable for the damage caused. There is individual responsibility where evidence can be found that a particular individual was responsible for the fateful decision.
It is important to stress that the responsibility of corporate executives and directors is based on individual acts that can be attributed to a specific person. There is no group responsibility. The jurisprudence on this was reviewed a few years ago by the British Columbia Court of Appeal in Merit Consultants International Ltd. v. Chandler, 2014 BCCA 121. That was a case where the Board of Directors had published a statement that the plaintiff alleged was defamatory. As the company was now insolvent, the plaintiff sought to recover from the directors. The court, quite properly, rejected this, as the statement was a corporate consensus view that could not be attributed to the directors as individuals:
… it appears to be the law in Canada that as long as tortious conduct on the part of an employee or agent of a corporation (or any other employer) is properly pleaded and proven as an “independent” tort by the employee or agent, the wrongdoer can be held personally liable notwithstanding that he or she may have been acting in the best interests of (and at the behest of) the employer or principal.
Given the murky internal workings of a large corporation, it is often difficult to identify who was actually responsible. That makes it challenging to get the evidence to assign blame. Sometimes large corporations will deliberately settle and give in to doubtful claims, in order to avoid investigations that might identify individual executives who could be blamed.
It is riskier to be the executive of a small business corporation, where there are fewer players and it is easier for plaintiffs to prove who was at fault. To take an example, if you incorporate your small restaurant, and somebody falls down the stairs going to the washroom — you are personally liable for the injury if you designed those stairs in a negligent manner. If the corporation has no insurance or assets, or not enough to cover the damages, the injured person may seize your personal property, such as your car, personal bank account or house. Incorporation provides you with no protection against this type of liability if it can be shown that your personal mistake caused the injury. In the case of the restaurant, a damage award of more than $2 million was made against the proprietor and his corporation, jointly and severally. As a result of the suit, he became personally bankrupt.
Even in the case of a small corporation, the outcome is not a foregone conclusion. The judge will interpret the specific facts to determine if the actions of the director or officer are sufficiently outside the scope of their proper duties so as to become an “independent tort.” In Marydel Homes (West) Inc. v Cachet Estate Homes (Castlemore) Inc., 2015 ONSC 4333, a dispute alleging improper use of letters of credit, Friedmans Law associate Judy Hamilton successfully defended the director of a corporation. The judge found that the facts could not establish that the director had committed an “independently actionable wrong.”
The risk is particularly significant when it comes to taxes such as HST and CPP that companies collect on behalf of the government. The tax statutes have been written so that the burden of proof is reversed. Unlike the situation of private plaintiffs, the government does not have to prove that the director was negligent. Unfortunately, the federal Tax Court (unlike the Superior Court) is a statutory court that is not descended from the historic Court of Chancery. Therefore, it is not a court of equity where judges have equitable discretion, and it is not constrained by considerations of fairness. Merely being a director makes you personally liable unless you can prove that you met the statutory standard of being actively diligent in ensuring the company was remitting taxes.
It often happens in small business corporations that friends or non-participating family members are signed on as directors, sometimes even without their knowledge. If you are a director, you are legally responsible to the government under the Excise Tax Act, even if you had no clue about what the corporation was doing. The CRA can be relentless in going after people who owe taxes, and does not accept ignorance as an excuse. People often argue that they had a passive role or did not even know they were directors. In one recent case, the judge accepted that a woman had no active role in her common-law spouse’s company, of which she was a director, and that he had misled her about its business. She was nevertheless found liable for more than $130,000 of GST that the company had failed to remit.
If you are the director of a corporation, merely walking away and having nothing further to do with it is not enough. You should take formal steps to legally resign as a director in order to get free of responsibility. On the other hand, even formally resigning may not be enough if you continue to run the business and behave as if you were a director. Courts have sometimes found that somebody is a de facto director, and liable for these debts, even though he was never formally appointed as a director. As too often happens, it is small business people that get caught in these traps for the unwary.
The legal information in this article is of a general nature, and should not be considered legal advice to the reader.