Legal Blog

Personal Liability

Business people use corporations for many reasons, the most important of which relate to tax (paying as little of it as possible) and liability (having as little of it as possible). Because tax is not our area of expertise, we will only discuss liability.

A corporation has a separate existence quite apart from the people who own or control it (i.e. shareholders, officers, and directors). A corporation that enters into a contract may be liable if it breaches that contract, but, unless the other contracting party can demonstrate unusual circumstances, the corporation’s shareholders, officers, and directors are not personally liable for the breach. Of course, there are exceptions to the rule and, consequently, the other contracting party often joins the principal(s), who run and own a corporation, as defendants in an action against the corporation. In many cases, it is not necessary to do this because the corporation is viable and will have sufficient assets to pay a judgment; in other cases, when it is apparent that the corporation either does not, or is unlikely to, have sufficient assets to pay a damages award, it is crucial to join its principals if there is any evidence to support personal liability.

Examples

We will discuss two 2024 Ontario Superior Court of Justice cases in which one contracting party joined, in its action against the other corporate contracting party, that party’s sole shareholder, officer, and director: To v. Psonic Inc. and Forefront Electric v. Dutchies.

In one of these cases, a homeowner was suing his contractor for damages because the contractor abandoned the project after the homeowner had already overpaid the contractor. In the other case, a contractor was suing an owner for payment of the contractor’s time and material invoices. In each case, the plaintiff joined the principal as an additional defendant in the action.

Bad Contractor

Residential projects, as compared to commercial projects, seem to engender a greater possibility that the corporate contractor is either incompetent, financially fragile, or downright fraudulent.

In Psonic, the owner made a series of payments to the contractor but 15 months later, aside from some drawings, the contractor had done nothing to advance the project. Instead of pulling the plug, the owner forwarded even more funds to the contractor. Three more months had passed when the owner learned from the municipality that the contractor had made no permit application regarding the project. At that point, the corporate contractor’s principal admitted to the owner that (i) the corporation was having financial difficulties stemming from a CRA audit and, worse yet, (ii) CRA’s audit stemmed from CRA’s suspicion that the corporation was receiving payments in cash and not declaring them. The principal also said that, if he dissolved the corporation, the CRA problem would go away. Wrong! The problem would most certainly not go away. By this time, the owner had paid the contractor $143,000.

The owner sued the contractor and its principal for the return of his money. The owner alleged that the principal had guaranteed that he would be responsible ‘for taking care of this matter.’ The owner also requested that the court (i) pierce the corporate veil that would normally shield the principal from the corporate contractor’s responsibilities and, additionally, (ii) hold the principal liable because the principal made misrepresentations to the owner to obtain money to perform specific work that the corporation never carried out.

Corporate Veil

A court will not pierce the corporate veil to hold a principal liable for a corporation’s debts and other obligations unless the court makes a finding that the corporation is a mere façade concealing the true facts or was incorporated by the principal for a fraudulent or improper purpose. It may well be that this was the case in Psonic, but the judge found that he could not determine, on a summary judgment motion from the written evidence before him. that the principal used the corporation for these purposes. Accordingly, the judge dismissed that part of the summary judgment motion and held that that issue had to be decided at a full trial.

Guarantee

Before a guarantee can be effective, the beneficiary of that guarantee must show that:

• it was made,
• the guarantor received some consideration for the guarantee, and
• the guarantee was in writing.

The judge accepted that the principal gave some sort of guarantee, but did not accept that the owner had provided any consideration to get the guarantee and noted that the guarantee was not in writing. Accordingly, the judge dismissed the owner’s claim based on the alleged oral guarantee.

Misrepresentations

The principal had not merely said that the contractor needed money for construction. The principal had actually represented that the corporation required $x to pay a municipal development charge, $y to pay for grading, and $z to pay for insurance; $61,000 in aggregate. The judge found that these representations were untrue and that the corporation and the principal merely pocketed the funds; they did not use them for the uses to which they were to be put. Worse yet, at the principal’s request, the homeowner had paid some of this money directly into the principal’s bank account. Accordingly, the judge held that, based on the principal’s misrepresentations, the principal was personally liable to the owner for the $61,000 paid.

Bad Owner

In Forefront Electric, an owner hired an electrical contractor to perform electrical work on its grocery store. The contractor provided $210,000 of services on a time and material basis, but the owner paid nothing. The owner made spurious claims in its defence, asserting that it should not have to pay for employee breaks and overtime, even if the overtime was warranted. The owner provided no evidence at trial that the amounts being claimed were improper and, accordingly, the judge fixed the damages at the amount claimed without deduction.

The real question was with whom had the electrical contractor contracted. The principal signed the contract as the president of ‘Duchies Fresh Food Market.’ However, there was no such entity as Duchies Fresh Food Market. No corporation or individual had registered a name and style like that. There was a numbered company that operated as ‘Duchies Fresh Food Market Limited.’ However, this name made no sense. The “Limited” in the name and style would indicate that the name and style entity was a corporation – except it was not.

The trial judge noted that the owner and its principal did not identify, as a party to the contract, a corporation that existed at law. The judge held “the Court will not indulge a shell game intended to distort or cloud findings in this regard.”

The judge found that the principal who actually signed the contract was a sophisticated business person and knew or ought to have known that the name under which he signed did not exist. Yet, he still inserted that name into the contract and signed the contract its non-existent president.

The judge relied on section 21(1) of Ontario Business Corporations Act. It states: “Except as provided in this section, a person who enters into an oral or written contract in the name of or on behalf of a corporation before it comes into existence is personally bound by the contract and is entitled to the benefits thereof.” That was enough for the judge to order that the principal be personally liable to the contractor.

Results

In each of these cases, had counsel for the plaintiff not sought to obtain a judgment against the principal of the corporation, the plaintiff would have collected nothing from the corporation. At times, it pays to be aggressive. The key is for counsel to understand what cases warrant an attack against the principals of a corporation and in what cases this type of attack would be futile.

 

Image courtesy of Tumisu.

Written by Jonathan Speigel, the founding partner of Speigel Nichols Fox LLP, leads the litigation and construction practices.