The Corporate Paradox

Tom Locke - Insolvency Trustee in London, Ontario
November 11, 2021

To incorporate or not to incorporate, that is the corporate paradox.   In some industries licensing is contingent on incorporation, so incorporation cannot be avoided.  In some cases, incorporation provides a measure of protection from lawsuits, and in others an incorporated entity can provide a measure of tax relief.

Small closely held corporations tend to confer less of the benefits of incorporation than might apply to larger enterprises.  For example, “limited liability” or limited the exposure of directors in the case of a lawsuit.  In a large corporation the directors may have little or nothing to do with the day-to-day operations a lawsuit for a slip and fall in a Walmart would be less likely to name directors than a lawsuit for a slip and fall at a local variety store.

Similarly, liability for corporate debts is usually restricted to the company itself when the company is a large enterprise.  By contrast, a small closely held business will be more likely to attract a personal guarantee from one or more of the directors.  This also applies to some tax debt the directors of a small company may be pursued for what is known as a “director’s liability” for unpaid GST/HST or source deductions.

Sole proprietorships may, at times, confer more benefits in terms of tax relief, for the business owner who is able to write off a different variety of business expenses.  Sole proprietorships also tend to lower accounting fees.  You should talk with both your lawyer and your accountant to determine whether incorporation is the right solutions for you.

When a company is insolvent should it file for bankruptcy or make a proposal?  The purpose of this blog is not to explore the relative advantages and disadvantages of either of those options but to discuss some of the practicalities of insolvency proceedings for small corporate entities. 

A corporation can be assigned into bankruptcy by its director(s) once assigned the directors may become liable for debts that are guaranteed or co-signed, or for which there is a deemed liability.  Those personal liabilities could trigger the director to file for bankruptcy.  Once a director has filed a bankruptcy, he is no longer able to be a director:

“(5) No undischarged bankrupt shall be a director, and, if a director becomes a bankrupt, he or she thereupon ceases to be a director.  R.S.O. 1990, c. C.38, s. 286 (5).”

Ironically the trustee (LIT) may have required a guarantee of the director its fees under the corporate bankruptcy, any such agreement would be nullified by the director’s own bankruptcy filing.  The LIT must, therefore, ensure either that the corporation has sufficient liquifiable assets available to cover its costs or obtain a substantial retainer from the director.

Because a corporation must have a director in order to function there is no other means, that we are aware of, by which a bankrupt may “resign” as a director as required under the Corporations Act.  However, after a protracted period of abeyance the corporation’s charter may be revoked by the Ministry of Finance. 

In the case of a small closely held corporation that is insolvent and cannot afford to pay the fees for winding up – leaving it in abeyance may be an affordable solution for a shareholder/director who is contemplating filing a personal assignment into bankruptcy.

If you have a small business that has become insolvent, and you need to review your options call our offices for a free consultation:  519-646-2222