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Incorporation

Posted on August 1, 2009 | Posted in Collections

One of the main reasons for a person to incorporate is to obtain the benefit of limited liability (i.e. the corporation, as a separate legal entity, is liable for its debts; its shareholders are not). However, regardless of incorporation, directors can be held liable for a corporation’s obligations in a number of ways. Some liability is created through statute (e.g. tax withholdings at source, Construction Lien Act obligations, etc.) and some through contract (e.g. a guarantee by which an individual guarantees the debts of a corporation to a creditor).

When all else fails, and the facts fit the law, a creditor can rely on section 248, the oppression section, of the Business Corporations Act to claim personal liability. This is what occurred in Far East Food Products Limited v. 110472 Ontario Ltd., a 2009 Superior Court of Justice decision.

Midnight Move 

The plaintiff supplied baking ingredients to corporation #1, a bakery. On April 28, corporation #1 owed $22,000 to the plaintiff. Between April 28 and May 1, corporation #1 seemingly moved its place of business to a new address.

The plaintiff’s representative discovered the new address of corporation #1 and attended at it to investigate. He found that a new bakery, under a different name, was being set up; many of the employees at the site were the same as at the old site; and much of the equipment was the same.

Ian Latimer of our firm acted for the plaintiff. He determined that corporation #2 operated the new business and that one principal person was the officer and director of both corporation #1 and corporation #2. The plaintiff alleged that the principal took most of the hard assets of corporation #1, its accounts receivable, and its goodwill and transferred them to corporation #2, attempting to ensure that corporation #1 could avoid paying its debts.

The principal did not deny these allegations outright, but testified that corporation #1 was in major financial difficulties and that, since the principal had also put his own money in corporation #1, its equipment was really his and everything was therefore proper. The judge disagreed.

Oppression 

Section 248 of the Act allows a security holder, creditor, director, or shareholder to apply to the court for relief if the business affairs of a corporation are run, or the powers of the directors are exercised, in a manner that is oppressive to the complainant.

The principal argued that he did not run corporation #1 in a manner that was oppressive to the plaintiff; rather, he did what he had to do because corporation #1 was sinking into financial oblivion and because he had to protect the means of his livelihood. The judge understood the explanation, but did not consider it a valid excuse.

The judge relied on a prior case in which a corporation transferred assets to the shareholders, repaid shareholder loans, and paid dividends to shareholders to render the corporation insolvent. The court in that case allowed a creditor under a promissory note to obtain judgment against the directors of the corporation who had allowed this to occur.

The judge in the Far East case found that the principal did not manage corporation #1 in accordance with his and the corporation’s legal obligations and, therefore, breached the reasonable expectations of the plaintiff that the principal would do so.

Result 

The judge gave judgment against corporation #1 and the principal personally for the monies due. 

The key to this favourable decision was demonstrating that the principal was instrumental in stripping the corporation of its assets. Had the principal transferred the assets of corporation #1 to corporation #2 with adequate consideration, the plaintiff could have done little about it. However, when a principal strips the assets of a corporation for his own benefit, then that principal is fair game.

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