It is possible that in the process of restructuring your small business, you – the owner/operator – may become personally liable for directors liabilities and/or personal guarantees. Depending on your financial situation, it may be necessary to consider restructuring alternatives for your personal financial situation concurrent with your small business restructuring.
Directors Liabilities
Director Liabilities arise in incorporated businesses and include the following:
- Deductions withheld at source from employee payroll – Income tax, CPP and EI
- GST
- PST
- Wages and Vacation Pay (within last 6 months)
- Environmental liabilities
When all efforts to collect any of the above debts from the corporation have failed, the creditors may pursue collection activities against the directors personally. It is therefore important when considering assigning a small business into bankruptcy to understand the potential risk to you the owner for any of these debts.
Commencement of collection actions for Director Liabilities by Canada Revenue Agency must occur within 2 years of resignation.
It may be possible to have director liabilities discharged or reduced as a term of a Division 1 Proposal. For the Proposal to be approved by the Court, it must be fair to all parties involved.
If a Director exercised the degree of care, diligence and skill of a reasonably prudent person with respect to the compliance and payment of the above noted financial obligations, (s)he may not be found personally liable for these debts as a result of what is termed the due diligence defense?.
It is therefore, very important that all directors:
- Familiarize themselves with the withholding and remittance requirements of the various taxing authorities
- Ensure that the corporation has systems in place to ensure compliance with these requirements, and
- Receive regular written reports on the status and effectiveness of these policies.
Purchasing director liability insurance will provide protection to directors from these potential personal liabilities.
Personal Guarantees
Another area personal risk to the Owner/Operator of a small business is personal guarantees. Personal Guarantees are sometimes required for small businesses, especially when they are starting up. Personal guarantees are commonly required for bank loans, lease agreements with landlords and to obtain credit terms from key suppliers.
These personal guarantees can not be eliminated through any of the above techniques. It is therefore important when setting up or growing a business to try to avoid personal guarantees where possible.
