I recently got a phone call from a client after he had been served with a law suit. He had entered into an agreement of purchase and sale for a home, only to breach it by repudiating the contract before even providing the deposit. He was positive that he was “bullet proof” from such actions, because he had entered into the agreement under his corporate name. In a past article I espoused the prudence of incorporating a business in order to avoid personal liability. However, this particular case gave me an opportunity to qualify that notion, and explain when someone may be personally liable for the actions of their corporate entity.
Under the Ontario Business Corporations Act R.S.0 1990, shareholders, directors and officers are not personally liable for the actions of the corporation, subject, to some exceptions (such as directors being liable to employees for unpaid wages). However, under the common law doctrine of “Alter Ego” the courts can examine the conduct of the corporation and the individual(s), in order to determine whether or not attaching personal liability is appropriate and thereby “piercing the corporate veil”.
To pierce the corporate veil is to disregard the separate legal personality of a corporation. A corporation’s separate legal entity is a fundamental principle of corporate law, and cannot be easily disregarded. The courts have held that piercing is only justifiable when the company is incorporated for an illegal, fraudulent or improper purpose, or when those in control expressly direct a wrongful thing to be done. Further, the courts have held that piercing the corporate veil is justified where otherwise it would be flagrantly opposed to justice. Therefore, the courts take a thorough contextual approach based on the facts and evidence of every situation in order to determine whether or not to pierce (642947 Ontario Ltd. v. Fleischer, 2001 CanLII 8623 (ON C.A.)).
Some of the contextual factors a court will consider is the conduct of the individual(s) and the corporation to determine whether the corporation is an “Alter Ego” of the individual(s) who run the corporation. The courts will consider the organization and conduct of the corporation, including, but not limited to: whether the corporation keeps separate books; maintains corporate records; holds separate meetings with proper notice and procedure; makes regular tax and corporate filings; their ability to pay creditors and debtors; and whether the corporation owns assets. The courts are more readily inclined to pierce the corporate veil if they find conduct akin to fraud perpetrated by the corporation.
I asked the gentleman who the shareholders of his corporation were, and he answered that he was the only one. I also asked him whether his corporation conducted other business, and he stated that the only business conducted was the purchase of that particular home. I went on to ask him if he kept an organized minute book; he replied that he did not. I questioned him about whether the corporation had any assets, and again he responded in the negative. After a short examination of these factors, I advised him that the plaintiffs had a legitimate argument in asking the courts to pierce the corporate veil and to allow the action against him personally.
Individuals who fail to treat the corporation as a separate entity, and merely use the corporation as a shield for their misconduct may find themselves personally liable for the misconduct they have created under the guise of their corporate entity. It is important to treat your corporation seriously, and to consult a lawyer, in order to properly organize and structure your corporation.