When a company faces insolvency or bankruptcy, the directors (and sometimes officers) of the company can face personal liability for the company’s debts. Although a properly incorporated company is a separate legal person and as a general rule its creditors have no personal claim against the company’s directors, there are many exceptions to this rule.
Areas of potential exposure
Examples of potential exposure include:
1. Liability under statute. Various federal and provincial laws deem directors to be liable for their company’s debts. The most common are:
- Payroll deductions under the federal Income Tax Act
- Net GST under the federal Excise Tax Act
- Wages under the Provincial Employment Standards Act
2. Breach of corporate duties. A director’s duties are to the company, but these duties can extend to the company’s creditors in certain circumstances. Directors can be liable for breaching these duties.
3. Guarantees and indemnities. Directors voluntarily assume responsibility for the company’s debts when they give guarantees or indemnities to lenders, suppliers, landlords, and other creditors of the company. Sometimes these guarantees are “hidden” in the fine print in credit applications or similar documents.
Possible avenues for recourse
Taking action to reduce or avoid director liability can involve a number of considerations. For example, placing a company into bankruptcy, receivership or some other insolvency process extinguishes director liability for wages, but creates liability for PST under the Provincial Sales Tax Act. So, assessing the exposure a director is facing is important before taking any action.
Companies routinely provide directors with indemnification for liabilities incurred in the performance of their duties, often backed up with Directors & Officers Insurance in the event that corporate resources are insufficient to cover exposures – a scenario that is highly likely in insolvency situations.
Before accepting a directorship or when director insurance is renewed each year, the terms, exclusions and limits of coverage should be carefully assessed, preferably with the help of independent counsel. If directors and the company are covered by the same insurance policy, directors’ coverage should take priority or have separate limits that are unaffected by claims against the corporation.
Directors and officers are wise to consult with a lawyer experienced in navigating bankruptcy and insolvency to plot the best course before, during, and after a company’s insolvency.