Legal Myths Blog: Incorporation protects shareholders from personal liability

​Myth:  Incorporation protects shareholders from personal liability
Incorporating a business means that your sole proprietorship or partnership becomes its own legal entity. The corporation is separate from the individuals that own it, also known as shareholders.  An important characteristic of this separation is that if the corporation loses a lawsuit or incurs other debts, the shareholder cannot lose more than what he or she invested into the company.  This means that none of the other shareholders’ personal assets, such as real estate, bank accounts, cars, etc. are up for grabs.
So, because Canadian law gives shareholders immunity for corporate liabilities, it is not actually a myth to say that Incorporation protects shareholders from personal liability.  But of course, there is a catch.  A shareholder is guaranteed to enjoy this immunity only if he or she remains just a shareholder.  Once a shareholder becomes a directing mind of the corporation, that is when he or she may become personally liable.  Here are four ways it could happen:
 
Piercing the Corporate Veil
Some a corporation is set up as a sham, meaning that it is not really a separate entity.  An indication that a corporation might be sham is when a sole shareholder comingles corporate funds with his or her own personal funds or is otherwise operating the business as if the corporation didn’t exist.   When a sham corporation engages in fraudulent or improper conduct, a court may find personal liability on the part of a directing mind, usually an officer, director or shareholder (collectively, the “Principals”) of the corporation.  This situation is called piercing or lifting the corporate veil and typically affects closely held corporations owned by one or just a few individuals.  
 
Oppression
The Canada Business Corporations Act gives courts very broad range to make “any interim or final order it thinks fit” to remedy corporate behaviour that “unfairly disregards the interests” of a creditor.  Similar language is in the Ontario Business Corporations Act.  Know as the oppression remedy, it may also lead to personal liability against .  However, the oppression remedy does not actually require any fraudulent conduct, bad faith, or personal benefit to accrue.  In other words, the court can enforce, not just what is narrowly legal, but also what is fair given the particular business realities of the situation.
 
Canada Revenue Agency
One of the functions of the Canada revenue Agency (CRA) is to collect taxes from taxpayers and it has extensive powers to do so.   When the CRA cannot collect directly from the corporation, it may enforce against the assets or the corporation’s principals.  This is most common with unremitted GST/HST and payroll deductions.  If the principal still fails to pay the overdue amounts, the CRA can garnish the principal’s wages, place liens on his or her assets, and freeze bank accounts among other things.
 
Franchises
Sometimes, the corporate veil comes pre-pierced.  Ontario’s franchise laws provide a good example.  The Arthur Wishart Act addresses the Franchisor’s obligation to provide adequate disclosure about the franchise to properly inform the Franchisee.  If a franchisee incurs losses because of a franchisor’s failure to disclose, the franchisee has the right to sue not only the franchisor (which is often a corporation), but also the franchisor’s associate.  The Act defines “franchisor’s associate” as any person who controls the franchisor.  The franchisee automatically has this option and does not have to meet the requirements of the oppression remedy or piercing the corporate veil.
 
Conclusion
The short answer is yes, shareholders are protected from corporate liabilities.  However, as we know from the examples above, this protection has its limits.  If the shareholder actually controls the corporation, there are many different ways he or she may become liable for the debts and liabilities of the corporation.
 
The above information is for educational purposes only and is not to be construed as legal advice.  It may not be applicable in your particular circumstances.   Consult with a lawyer or contact our office by calling 905-605-5100 or emailing [email protected] to book an appointment.