Craving A Little Company: Things to Consider When Deciding Whether to Incorporate (Part 1)
Other than popping ‘the question’ to that special man or woman in your life, deciding whether or not to incorporate your business may be one of the most important decisions you ever face. Although I suggest that you get professional advice based on your personal circumstances, here are some of the things to consider before taking the plunge. Rather than trying to ram this down your throat in a single article, I’ll nibble away on this topic a little at a time over the coming weeks. Today’s morsel shall be on companies and liability protection.
Incorporating and Limited Liability
A company is treated as a separate person for most legal purposes. As a result, if the company runs into legal problems and has been clearly representing itself as a company so that everyone is forewarned, the business owners may be able to protect their personal assets from being exposed to the company’s creditors. Accordingly, even though your business might become a thing of the past, you may still be able to hang on to your home and other personal assets.
Unfortunately, this protection is not universal. The rest of this article will discuss many of the gaps in coverage so you can see the true picture.
- Limited Protection for Professionals
Many professionals, such as lawyers and doctors, are allowed to incorporate in order to reap many of the other benefits of becoming a company. On the other hand, they are not allowed to use their corporate structure as a shield to protect themselves from professional negligence claims. In other words, although they can reap the tax benefits of incorporating and may still be able to avoid liability if they are being sued for something other than professional negligence, if a lawyer screws up your case, his house or many other personal assets are still up for grabs. Of course, most professional bodies require that their members carry large liability insurance policies to protect their members and the public from these sorts of slips anyway.
- Fraud and Criminal Acts – Piercing the Corporate Veil
Secondly, using typically dramatic legal language, the courts are reluctant to let evildoers “hide behind the corporate veil.” If someone can convince a judge that you were not just negligent but also a fraudster, then the judge will “piece the corporate veil” and make you personally responsible. This also applies to criminal acts the shareholders may have participated directly or indirectly.
- Director’s Liability
In addition, if you are a director of your company (which is usually the case), you might also be personally liable for some company debts if your business goes down the tubes. In particular, you will be on the hook for things like unpaid ‘source deductions’ (ie. CPP, EI, pension contributions and income tax the company was supposed to pay to the government on behalf of employees) and unpaid back wages for your employees for a set period such as 2 months. As well, directors might also be on the hook for dividends it pays out or company shares it buys back around the time the company goes under. To complete this cheery picture, directors can also be held personally liable for environmental infractions committed by their company, although usually only if they have been part of the problem or have shirked their duties as directors.
On a related note, directors may be liable to company for situations where they have personally profited from information they have received as a director, even if the company may not have actually lost money as a result. There are other situations where directors can be liable to “disgorge unjust gains” (to use more melodramatic legal languages) but that is really the subject for another article. Theoretically, these directors / shareholders might even be liable for these types of gains after selling out to new owners, although this is extremely rare.
- You Can’t Bank on the Banks
Another rather enormous roadblock in your desire to protect your personal assets from your business problems is dealing the banks. Unfortunately, if you need a loan in order to fund your company, your lender will probably want you to personally guarantee the loan. In other words, even though your corporate structure might otherwise safeguard your home and similar assets, your financial institution will still require you to pledge these assets in order to get their best rate or, in many cases, any loan at all. Want to solve the problem by transferring your home to your spouse? The bank will probably require your spouse to guarantee the loan as well.
Fortunately, as your business proves itself and acquires its own assets, you should eventually be able to get loans without personal guarantees and to get released from any old ones. In the meantime, however, despite taking the steps to incorporate, your personal assets may still be exposed to your biggest creditor, as well as any other creditors that require these sorts of guarantees.
Much to my surprise (but, perhaps, not to yours), it appears that we have barely scratched the surface of companies and creditor protection. My next article will try to undo some of that sense of pessimism I may have just generated. Despite the exceptions listed above, the creditor protections offered by incorporating can still a huge benefit. I will explain some of the things you can do to maximize this type of protection. If I have time, I’ll also talk about those personal assets that are actually safe from your creditor’s greedy claws and how you can use this to your advantage. Until then, I wish you a wonderful Canada Day, wherever it happens to find you.